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Saturday, 29 September 2007
The bitter truth about Sugar
The new sugar season begins on Monday. From all evidence, one can only approach it with trepidation. However, sugar shares got a sudden adrenaline when food minister Sharad Pawar said mills would be allowed to make ethanol directly from cane. I have only one question to put before that enthusiastic crowd: Have you done the maths?
Back-of-the-envelope calculations show that with cane in Uttar Pradesh priced at Rs 13, if a mill only makes ethanol, it would cost about Rs 26/l. Without any sugar or other by-products to share the cost of manufacture, the same ethanol becomes more expensive. But the most that oil marketing companies are willing to pay for it is just Rs 21.50/l.
So any local mill which decides to only make ethanol from cane is obviously headed for further financial disaster. Brazil, on the other hand, can do it is because with cheaper cane, the cost of its ethanol is only around Rs 16/l.
Now it's not the minister's job to do these calculations while making politically correct announcements. Neither is he investing his own cash. But surely investors need to delve a bit deeper.
Ethanol is important because it can help offset losses from sugar on a company's balance sheet. But not every company has large ethanol capacity. In fact, the share of ethanol in the total revenue stream of even the largest companies is not sufficient to make a significant dent.
In Bajaj Hindusthan, India's largest sugar company, for instance, the share of ethanol, co-gen and other by-products together is unlikely to exceed 15% of total revenue in fiscal 2008.
This means more than 80 paise out of every rupee earned by the company would still come from sugar. In Balrampur Chini, ethanol and the rest add up to 25% of total revenue. That may be better but with 75 paisa of every rupee depending on sugar, it is kind of tough to get overjoyed over ethanol. Ethanol has its uses. But in a market with limited demand, monopolistic buyers and government-negotiated prices, the upside is severely limited, at least for the foreseeable future.
Industry watchers also went dizzy with delight at news of interest-free loans to sugar mills. While that sounds good, I'm not sure people are yet aware of the enormity of the problem. The numbers are crazy. At the end of this sugar year, the total debt of the industry may touch Rs 230-250 billion. By next year it would need to borrow about Rs 350-400 billion.
This debt includes money mills need to carry unsold sugar, pay for cane, and expand capacity. Just paying the interest on these loans may well be enough to bring the average factory down to its knees. But it is still too early to tell how far the government will go to provide succour.
To an industry with a net worth of about Rs 100 billion, banks have already lent Rs 230-250 billion, which is enough to give any CFO sleepless nights. So lenders may become extremely reluctant to double that figure in the new season. In such a scenario, mills would have only one option. Cut down on their single biggest cost, namely purchasing cane.
In all likelihood, 10% of the new season's cane could be left standing forlornly in the fields with no takers. That means 30 million tonnes of cane, worth Rs 27 billion, may be burnt in the fields. That is a genuinely scary number because it hides within it the enormity of the humanitarian crisis that could swathe cane fields across the country. Can you imagine the repercussions if polls are announced as well?
Meanwhile, the government's desperate attempt to keep the industry afloat may well fan the fire. Cane arrears are estimated to touch around Rs 150 bn by the end of the 2008 season. If the government provides support, it will be stepping into a bigger financial trap than it can handle.
Of course, the fate of individual companies would wary considerably depending on the health and life-sustaining capability of their balance sheets. But that is even more reason to be cautious of the sector as a whole. You need to carefully pick out the cherries from the lemons in the basket.
India is poised to become the largest sugar producer in the world. The International Sugar Organisation has now pegged India's output in the new season at 33.2 mn tonnes. That should be enough to make us pause. Those pinning their hopes on crude oil prices going on overdrive and Brazil pumping more ethanol to end sugar's troubles forget one important fact.
Between 1999 and 2006, Brazil's cane acreage has increased by 16%, cane output by 31%, ethanol output by 31% and mark this one, sugar output by 47%. With cane acreage of around 6 mn hectares, Brazil will start producing sugar the minute prices become attractive. That means India has no option but to remain a price taker for a long while to come.
The corporate suffering is pretty much global. Shares in Tate & Lyle slumped to a three-year low on Friday as the sugar and sweetener multinational forecast among other things, a half-year loss for its sugar trading business after a previous profit of 15 million pounds.
Truth is that the sugar sector's agony is unlikely to abate before 2009, when lower cane output, lower sugar production and lower inventories may provide a modicum of relief. Any celebration before that is certain to be short-lived. Irving Berlin in his song Let's Face the Music and Dance says:
"There may be trouble ahead... Soon/ we'll be without the moon/ humming a diff'rent tune/ and then There may be teardrops to shed". It may well be the theme song of India's new sugar season. Learn the basics: http://knowmarket.blogspot.com/
Its time to develop a new risk paradigm
It's time developing countries stopped seeing themselves through the eyes of the developed ones. The gathering subprime storm over the US is enough of a trigger for the major emerging economies to stop being passive victims of somebody else's folly.
The subprime crisis started with lenders in the US pushing home loans to people who just didn't have the capacity to service them.
These unviable loans do not stay on the books of the lenders for long. They are securitised and sold off to other investors in various esoteric combinations. How risky these instruments were, the investors didn't have a clue — they chose to swallow the triple A rating the credit rating agencies gave them and bought them up by the tonne anyway.
When interest rates went up, as the Fed raised rates to combat inflation, default on these loans began. Worse, fears of large-scale default began to mount. And defaults on loans lead to mortgage foreclosures, bringing houses on to the market.
House prices have not just stopped soaring in the US, but also started declining, as more and more houses come up for sale. The drop in house prices makes the outstanding loans riskier still — the loan-to-house-value ratio goes up. If the loan against a house is larger than the market price of the house, even foreclosure will not prevent loss. So, the closer the value of the loan approaches the value of the house, the riskier the loan.
When this perception of risk goes up, lending freezes up, throwing sand into the economy's machinery. Further, funds undertake a manoeuvre called flight to safety. This is where developing economies like India get hurt. India, and such economies classified as emerging markets, are still seen by developed country fund managers as risky propositions. So the flight to safety will see some funds pull out of countries like India. This could lead to a stock markets slide in these economies, loss of confidence and slowdown of the real economy. This is one source of disruption.
The other source of disruption is construction-led slowdown in the US. This could hit developing economies that export a lot to the US. Around 40% of Chinese exports, for example, go to the US. About 22%of Indian goods exports go to the US and a significantly larger share of India's service exports.
Why should we crib about such disruptions? If the Indian economy is growing at 9% plus rates thanks to globalisation, and we celebrate that, we should also be able to absorb some shocks arising from the same globalisation process; shouldn't we? Wouldn't it make more sense to be a little philosophical about it? Even if the Indian economy is fundamentally strong, and even if the domestic stock market is well governed, Tsunamis from the global economy could still batter us.
Fatalism would be completely the wrong response to the present sort of crisis. It is important to see that developing countries are part of the problem and that they can do something constructive as well.
The original sin in the subprime crisis, apart from the greed of the American loan-pushers, is the surplus liquidity sloshing around in the US. A large contributor to this surplus liquidity is the group of developing economies with trillions of dollars in combined forex reserves. Instead of investing the bulk of their reserves in US treasuries, these economies should invest them in other economies, including themselves. This calls for breaking the paradigm of risk set up by the developed economies and blindly followed by India and the rest.
The crux of the new perspective would be faith in the growth potential of the developing countries. A flight to safety for developing economies should mean investing in themselves, rather than investing in the developed economies.
If Mexican telecom can make Carlos Slim the richest man in the world, isn't Mexican telecom a safe bet for India, China, Brazil and South Africa? Why can't Indian Information Technology, in which firms have routinely been growing at 30% and more a year, be seen as an oasis of safety for the deployment of Russian and Middle Eastern oil surpluses? Why can't South African coal-to-gas-to-liquid technologies and Brazilian aircraft manufacture be seen as feeding and feeding off the robust growth of the developing economies and thus fairly well insulated from risk?
All this, of course, is complete heresy from a traditional standpoint of risk assessment. How can foreign exchange reserves, worth cumulative trillions in the hands of the developing economies, be deployed in anything but the most gilt-edged of developed country debt? But let us appreciate that the government of Singapore has been investing, and investing very profitably, in emerging market companies for quite some time. And even India has turned its back on traditional assessment of political risk while buying into oil blocks in Africa.
Time was when 'developing' was a euphemism for basket cases. The times, they're a-changing — except in official policy Courtesy : Economic times Learn the basics: http://knowmarket.blogspot.com/
Monthly Call
The company was originally set up as Omaxe Builders Private limited in 1989, promoted by Shri. Rohtas Goel , the founder, to undertake construction & contracting business. The company further changed its constitution to a limited company known as Omaxe Construction Ltd., in 1999. The name of the company has now changed to OMAXE LTD from 2006. The company began life as a civil construction and contracting company, has Successfully executed more than 120 prestigious Industrial, Institutional, Commercial, Residential and Hospital construction projects.
The company entered the Real Estate Development business in 2001 and in now amongst the large Real Estate Development companies in India
The company has executed construction contracts for a number of prestigious Indian private, public sector and Multinational's clients.
Omaxe was founded by Shri. Rohtas Goel , a first generation entrepreneur, a civil engineer by qualification and a visionary having more than two decades of experience in Construction and Real Estate Development. Mr. Goel, as the Chairman & Managing Director of Omaxe has been at the forefront, a man with a mission of building globally comparable quality Residential & Commercial projects, his moto "Turning Dreams Into Realty "
Omaxe has received a number of awards from the industry, recognition of its continued efforts towards achieving excellence and quality. The company became the first Construction Company of northern India to receive an ISO 9001:2000 Certification.
The company which was founded as a civil construction and contracting organization in1989 and subsequently diversified its business to focus on Real Estate Development from the year 2001, to capture the opportunity offered by the growing Real Estate markets in India , is today among the large Real Estate Development companies in India.
The company in a short span of 5 years has completed and delivered 10 projects consisting of 8 residential and 2 commercial covering approx 5.13 million sq. ft of area, with all "on time deliveries". The company currently has 52 projects under development. These include 21 group housing projects,16 integrated townships,14 shopping malls and commercial complexes and 1 hotel. The company is at present developing over 140 million sq ft of saleable area across 30 towns in 9 states in Northern and Central India..
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Six Month Call
UTV Software
Strong movie production, co-production and distribution pipeline for the next three years with more than 122 films slated for release in 2007-08 (Apr-Mar), 15 films in 2008-09 and 18 in 2009-10 make UTV an attractive stock.
The company recently re-engineered its business model into three verticals: content (movies and television), interactive (animation and gaming), and broadcasting. This augurs well for the company as the Rs 43,700-crore entertainment and media industry is seen growing at an compounded annual rate of 18 per cent over the next five years.
UTV's $11-million animation projects are to be delivered over the next 24 months. The company plans to produce four animation films including one in collaboration with Will Smith's Overbrook Entertainment.
It recently entered the high-growth gaming segment by acquiring 70 per cent in Ignition Entertainment of UK and 59 per cent in India Games.
The company's broadcasting business is expected to deliver long-term growth with nine television channels planned by June 2008.
Concerns
Movie production and distribution is exposed to fair amount of financial risk, arising from uncertainty regarding the success of films.
Broadcasting is a risky venture with a long gestation period, although the returns can be significant in the long run.
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Target-A-Year
Tanla Solutions
CMP: 601
Target 1: 940
Target 2: 1030
Current Quote of Tanla Solutions
Tanla Solutions is an outperformer with a price target of Rs 940.
Tanlan is expected to clock revenues of Rs 410 crore in 2007-08 (Apr-Mar) and Rs 620 crore in 2008-09. At the current market price of Rs 601, the stock trades at 19.7 times the 2007-08 estimate earnings per share of Rs 31.1 and at 13 times 2008-09 estimate earnings per share of Rs 47.2. The target price is quite achievable if we factor in the contribution from Ireland and its been believed that this stock is on a path of re-rating.
The company has forayed into Ireland. "Tanla has tied up with all the Irish operators which include 3, O2, Vodafone and Meteor. The total addressable market for Tanla is around Rs 1,000 crore. Revenues would start flowing in from second quarter of 2007-08. The margins in Ireland will be at par with the company level as there is no major capex involved here.
Tanla's US subsidiary has begun operations and revenues are likely to flow in three months. It is also looking for acquisitions there.
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Grey Market Premium
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Recent Happenings
Sensex up nearly 1400 points after Fed cuts rates, crosses b-d line of RT. FIIs pump in $1.2 billion in 3 days after Fed rate cut. BSE's listed market Cap pierces through Rs. 5000000 cr. mark. US Fed cuts key interest rates by 0.5% for the first time in four years. Inflation drops to 5-year low of 3.32%. Gold price surges to 28-year high. Crude oil leaps to all-time high levels above $82 mark. India's mobile users hit 200 million mark, 4 months ahead of schedule. Direct Tax collections up 41%, cross Rs.100000 cr. mark by Sep'15. Share of TDS in direct tax collection up to 50%, from 28% last year. RBI to examine extent of bad loans in real estate sector. HSBC Holding to close US sub-prime mortgage unit, takes $945 m. hit.
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