The Hindu Business Line : Shree Renuka Sugars: Book profits

Good management and a sound business model make this a superior play in the sugar space. But valuations capture much of the likely growth potential.

Handsome returns from the IPO: Mr Narendra Mukumbi, Managing Director - Paul Noronha

The Shree Renuka Sugars stock, which has appreciated more than three-fold from the offer price of Rs 285, has delivered handsome returns to investors who participated in its initial public offer.

Investors can now book profits on at least a part of their holdings in the stock, as its current valuation seems to capture a sizeable proportion of the gains likely from the growth in the company's earnings over the next two years.

The stock has outperformed frontline sugar stocks such as Balrampur Chini Mills since listing and now trades at a valuation premium. It may now be in for a sluggish spell. Investors wishing to take advantage of the upturn in the sugar cycle can deploy part of the proceeds in frontline sugar stocks such as Balrampur Chini Mills.

Changes, post-IPO

The company's plans have undergone significant change since itsIPO in October 2005. At the time of its IPO, Shree Renuka Sugars was a relatively small player in the sector, with cane crushing capacities of about 5,000 tcd and sugar refining capacities of 1,000 tpd. The IPO was to fund an aggressive scaling up of capacities in each of these segments — cane crushing to 12,500 tcd, cogeneration capacity to 35.5 MW and ethanol facilities to 240 kilolitres per day. The expansion projects were expected to go on-stream in the financial year 2006-07.

These capex plans have been scaled up further since the stock's listing. Through a combination of leased and owned facilities, the company now plans to ramp up cane crushing capacities to 20,000 tcd and cogeneration capacities to 50 MW by 2006-07. The facilities will be spread over seven locations situated in Karnataka and Maharashtra.

Shree Renuka has also flagged off a new 2000 tonne-a-day port-based sugar refinery at Haldia in West Bengal. This facility will process raw sugar from the company's crushing facilities and serve as a hub for the company's export and trading operations. These capex plans are expected to absorb Rs 539 crore, of which Rs 108 crore has been raised through the IPO.

Shree Renuka plans to fund the rest of the project cost through debt and internal accruals. This will significantly raise the debt burden. But the leverage will remain at manageable levels as the company has room for debt in its balance-sheet, after its recent IPO.

The company's capex plans, if they go onstream within the expected timeline, would be well timed to take advantage of the favourable phase in the sugar cycle. The outlook for the sugar sector appears more favourable now, than it did at the time of the IPO.

In the domestic market, sugar supply promises to be tight, with both sugarcane acreage and yields on crushing likely to be lower than was originally expected. This lends a firm underpinning to domestic sugar prices. Export prospects for sugar also appear quite promising, with Brazil diverting a larger portion of its cane output to ethanol and the European Union set to move out of the white sugar market.

Right strategic moves

On its part, Shree Renuka appears to be making the strategic moves to capitalise on these opportunities. For one, it enjoys relatively free access to cane, with its mills located far away from the competitive cane-growing areas of Uttar Pradesh. Proximity to the ports ensures easy access to overseas markets, for trading.

Second, the company's integrated facilities, with the flexibility to produce power and use raw sugar in lean months, provide stability to the earnings from the seasonal and cyclical swings inherent to the sugar sector.

Third, the combination of owned and leased facilities for ramping up capacities may help the company use its capital efficiently. Once the capex plans are in place, the company would be among the top five sugar producers in terms of size and scale.

The flip side

There are a few risks associated with the company's operations.

The substantial trading component in the company's revenues exposes it, to a higher degree to swings in global sugar prices.

The policy environment for sugar would also play a bigger role in the company's finances than is the case for its peers. The company is creating substantial refining capacities for sugar to tap into export opportunities in sugar. However, sugar trade into and from India, is now restricted to the advance licensing route.

If the government decides to impose restrictions on sugar exports to alleviate the domestic shortage, it may prevent the company from capitalising fully on export opportunities. With the domestic market heading towards a tight supply situation, such restrictions cannot be completely ruled out. Given the manifold expansion in capacities planned over the next year, the earnings outlook is also subject to execution risks.

Overall, a sound business model and good management make this a good stock to own, for those keen on riding the favourable phase in the sugar cycle. But with the valuations already factoring in a substantial ramp-up in earnings, the near-term outlook for the stock is muted.

At the current market price, the stock trades at a price-earnings multiple of about 26 times its estimated earnings for FY-06 and 15 times the estimated earnings for 2006-07.

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