EXPERT SPEAK: Sugar pricing outlook positive; Brazilian acquisition a game changer for SRS

Motilal Oswal hosted an exclusive session with Mr Jonathan Kingsman (Independent Analyst and Global Expert on Sugar), Mr Fabiano Costa (GM, Corporate Affairs, Shree Renuka do Brasil) and Mr Narendra Murkumbi (Co-founder & MD, Shree Renuka Sugars) for their valuable insights on the global sugar industry and to understand Shree Renuka's Brazilian operations. We present our key takeaways.

Highlights of Mr Kingsman's presentation

In September 2010, Kingsman had lowered its global sugar surplus estimate for SY11 from ~5.2mt to ~3.5mt, a downward revision of 32% v/s its second estimate. It expects a further downgrade in December 2010 to ~1.5mt, a downward revision of ~57% v/s its third estimate. This downgrade would primarily be on the back of weather-related issues across key sugar producing countries, resulting in lower sugar production.

It has been observed that the world deficit/surplus has high correlation with the Indian (largest sugar consumer and second largest sugar producer) production cycle. Since global sugar prices are largely governed by the marginal change in demand-supply outlook, any change in Indian crop estimate results in high volatility in global sugar prices. In case of Indian sugar industry, there has historically been high variance between the initial and final crop estimates. While a couple of months back, there was a view that the Indian sugar crop could be >26mt, such a possibility now seems remote due to delayed crushing and weather-related crop losses in the key sugar producing state of Uttar Pradesh.

Overview of Shree Renuka's Brazil business

Shree Renuka Sugars has acquired 100% stake in Vale do Ivai and majority stake of 50.34% in Equipav (renamed as Renuka do Brasil). These Brazilian acquisitions have propelled it from a leading domestic sugar company to one of the largest integrated sugar players globally. Its Brazilian acquisitions are characterized by (i) assured low cost cane availability for 6-12 years, and (ii) a settled balance sheet, with debt at very moderate (below market) costs and repayment staggered over 10 years. The cash flows from the Brazilian operations would not only be sufficient to meet their obligations but also yield surplus to enable consolidation in the next few years.

Shree Renuka is the only sugar/ethanol producer in the world, with almost a year-long cane crushing activity, as it has operations in Brazil and India, which have complementary cane crushing seasons. This allows it to maximize/plan inventory, benefit from price arbitrage between sugar/ethanol, raw/white sugar and play price arbitrage between India's regulated sugar industry and liquid global markets. It also allows the company to leverage on synergies, minimize risks and offer steady returns despite the cyclical nature of the industry.

Valuation and view

We believe Shree Renuka Sugars is the best proxy to play the global sugar industry recovery and is a direct play on rising sugar/ethanol prices. Strong cash flow visibility would allow it to deleverage itself and address concerns regarding its high leverage. We expect the company to post revenue and net profit CAGR of 19% and 20%, respectively, over SY10-12. The stock trades at 7.1x SY11E EPS of Rs12.3, 1.6x SY11E BV of Rs55.7, and an EV of 4.8x SY11E EBITDA. We value the stock at Rs119 (EV of 6x SY12E EBITDA), an upside of 43%. Buy.

Source : Equity Bulls

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