The Hindu Business Line : Sree Renuka Sugars: Invest at cut off

The offer is stiffly priced, and demands a premium valuation on the company's current earnings. The offer price, at Rs 300 (the higher end of the band), discounts the likely earnings for 2005-06 by about 10 times. This is in line with the price-earnings multiples commanded by frontline sugar companies. However, the IPO proceeds are to be deployed in a substantial scaling up of operations, which will significantly alter the earnings picture by FY 07.

The outlook for the domestic sugar sector is positive for the next couple of years, given the tight demand-supply balance. The company's capability to produce high-grade sugar from its refining facilities is also a plus at a time when new export markets for sugar are opening up and the outlook for global prices is optimistic. The company's strategy of adding capacities through the lease of co-operative sugar mills and its focus on the institutional market may lend stability to the earnings during a downturn in the sugar cycle. This suggests that the company may be in a position to deliver growth rates that are superior to that of the sector over the next three-four years.

Starting with a 1,250-tcd (tonnes crushed per day) sugar unit in 1998, Sree Renuka Sugars has steadily scaled up its operations to 5,000 tcd now, by investing internal accruals and leasing ailing co-operative mills. It has also integrated forward into ethanol and power cogeneration and set up sugar refining capacities for 1,000 tpd so that its facilities are fully integrated and can produce sugar from imported raw sugar as well as cane. The refinery gives the company the capability to produce high-grade sugar, suitable for institutional buyers and exports. About two-thirds of the company's sales go to institutional buyers.

Revenues and earnings have grown at a healthy pace, out-stripping the industry average over the past three years. In the nine months ended June 2005, with a 5,000 tcd crushing capacity, the company registered earnings of Rs 32 crore on revenues of Rs 420 crore. On an annualised basis, this would translate into per share earnings of about Rs 18 on the equity base expanded by the offer to Rs 24.4 crore.

With the proceeds from this IPO, the company proposes to expand its capacities at Munoli in Karnataka threefold to 7500 tcd, and add ethanol and power cogeneration capacities as well. The full contribution from the expansion projects will flow from FY 07. Given the company's integrated operations, proximity to ports and its large refining capacities, it could be well placed to tap into the export market for sugar.

Export prospects for sugar appear bright at this juncture, on account of the imminent restructuring of EU subsidies on exports, the diversion of Brazilian production to ethanol and the growing deficits in the neighbouring Asian countries.

On the domestic front, a tightening demand-supply balance should lend support to sugar prices. The company is focused on marketing sugar to corporate buyers through long-term supply contracts. This could mean that the company may not reap benefits from temporary or seasonal spikes in sugar prices in the wholesale market. However, as offtake is assured, it lends stability and predictability to the earnings stream. The strategy of augmenting capacities through the lease route and integrated facilities could lead to better use of assets and a lower fixed cost component. This, coupled with the export presence and contracted offtake, could make the company more resilient to a downturn in the sugar cycle.

But only investors with a three-year horizon should subscribe to the offer. A substantial scale-up in the crushing operations, which is factored into the offer price, is likely to materialise only in FY 07. In 2005-06, earnings growth will be generated mainly from crushing additional volumes of cane on the existing facilities.

The key risks to the company's business plans would arise from any policy measures that restrict sugar exports from India, a dramatic change in the global sugar supply scenario arising from Brazil's re-entry and a sooner-than-expected unravelling of the sugar cycle on account of a rapid capacity build-up in the domestic market.

Background: Sree Renuka Sugars operates two sugar units, one for 2,500 tcd at Munoli and a second leased mill at Ajara in Maharashtra for 2,500 tcd. A third unit with a 2,500 tcd capacity was recently leased at Mohannanagar in Maharashtra for a six-year period. The last is proposed to be expanded to 4,000 tcd, through de-bottlenecking. In addition to this, the company owns sugar-refining capacities for 1,000 tcd, capacities to process 60 kilolitre per day of ethanol and power cogeneration capacities of 20 MW. Proceeds from this offer will be used to expand the crushing capacities at the Munoli unit to 7,500 tcd and augment the ethanol and power cogeneration facilities as well. The company may control crushing capacities of about 12,500 tcd, once its expansion projects are commissioned, in 2006-07. The price band for the offer is Rs 250-300, and it proposes to raise Rs 100 crore, with a greenshoe option for Rs 10 crore.

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