The Hindu Business Line : Uttam Sugar Mills: Avoid

The offer seems ambitiously priced even after factoring in benefits from the expansion. There are other listed candidates in the sector with more attractive valuations.

Adding scale through expansion
Offer ambitiously priced
Location-related risks
More attractive listed sugar plays

Investors can avoid subscribing to the initial public offer from Uttam Sugar Mills. The company's expansion plans, when complete, could substantially ramp up earnings from current levels and position the company among the frontline sugar producers. But the offer seems ambitiously priced even after factoring in the benefits from the expansion. There are other listed investment candidates in the sugar sector, with similar potential, available at more attractive valuations.

With intense competition for cane in the areas where the company's units are located, the payoffs from the project carry some uncertainty.

Capacity expansion

Uttam Sugar Mills operates cane crushing capacities of about 9,750 tcd and cogeneration capacities of 26 MW spread over two locations in Uttaranchal.

An expansion project for another 3,500 tcd is underway. This initial public offer will fund two new greenfield units with a total capacity of 9,500 tcd and power cogeneration facilities of 45 MW in Western Uttar Pradesh.

By October, the scheduled completion date for these projects, Uttam Sugar will control cane crushing capacities of 22,750 tcd and power cogeneration capacities of 81 MW. Though the company has diversified into cogeneration of power from bagasse, it does not plan to completely integrate its operations by processing molasses into ethanol.

After reporting small profits in the preceding years, Uttam Sugar reported earnings of Rs 27 crore on revenues of Rs 187 crore in the year ended September 2005. This captures the results for crushing capacities of just 6,250 tcd with 16 MW of power.

Uttam Sugar's financials for the preceding years are not really representative of its earnings potential after the expansion projects go onstream.

With the benefits from the expansion projects set to kick in, the company's capacities for 2005-06 will be at twice this level and that for 2006-07 will represent a more than threefold increase.

With crushing capacities of 22,750 tcd, the company will be among the top ten domestic sugar producers.

The expansion, if commissioned on time, will contribute to earnings from the financial year 2006-07 and may be well-timed to take advantage of the favourable phase in the sugar cycle.

Potential risks

However, there are quite a few risks associated with the offer. For one, the company's capacities are concentrated in Uttaranchal and West Uttar Pradesh, where substantial new capacities are set to come up over the next couple of years, aided by the UP Government's capital subsidy programme. This region is already characterised by severe competition for cane and the concentration of capacities may acerbate the problem.

This could push up procurement costs and create problems of cane availability, either of which can delay contribution from the expanded capacities.

Second, though the company has diversified into power and has refining capacity to handle raw sugar, it does not have the capacity to process sugar into ethanol.

This could reduce the valuation that this stock would enjoy post-listing, in relation to fully integrated sugar producers with similar capacities. The economics appears to be in favour of producers who have fully integrated facilities with a three-way linkage between sugar, ethanol and co-generated power.

Integration into ethanol appears particularly attractive now, with the market for bio-fuels expanding in a big way.

Finally, the pricing of the offer is ambitious, resulting in a substantial downside risk for investors if the earnings from expanded capacities do not flow in to the extent expected.

Given the substantial scaling up of capacities, the offer price is at a steep multiple of about 25 times the trailing earnings.

At the higher end of the price band, the offer price of Rs 340 discounts the company's estimated FY-06 earnings by 16-18 times and estimated FY-07 earnings by 12-13 times, if one factors in fully expanded capacities. This pricing leaves a very small margin of comfort for investors, to take care of execution risks.

For those looking to ride out the uptrend in the sugar cycle, there are listed companies in the sugar sector with similar growth prospects available at more attractive multiples. Therefore, there appears to be no compelling reason to subscribe to this offer.

Offer details

Uttam Sugar Mills is making an offer of 40 lakh equity shares with a face value of Rs 10 per share.

The price band for the book built offer is Rs 290-340. Bulk of the offer proceeds of Rs 116-120 crore will go towards funding two greenfield cane crushing units totaling to 9,500 tcd. The equity base post-offer will be Rs 25.7 crore.

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