The Hindu Business Line : Balrampur Chini Mills: Hold

CONTINUED buoyancy in sugar prices, an increase in cane crushing volumes and new revenue streams from by-products have helped Balrampur Chini Mills report a 53 per cent jump in operating profits on a 40 per cent rise in net sales, for the half-year ended September 2005. Since crushing operations are concentrated in the November-May period, a higher proportion of the company's profits usually accrue in the second half of the financial year.

The company's trailing 12-month earnings now stand at about Rs 8, valuing the stock at about 10 times its per share earnings at the current market price of Rs 84. The valuation levels are high, considering that they capture earnings at a high point in the sugar cycle. Further equity dilution also cannot be ruled out given the ambitious expansion plans. However, with new capacities set to contribute to revenues and sugar prices expected to hold firm at current levels, there is a high degree of visibility to earnings over the next one-two years. The stock may not deliver returns of the magnitude seen over the past couple of years, but could manage 10-15 per cent per annum. Investors with moderate return expectations can buy the stock; it remains the preferred long-term exposure to the sugar sector.

Sugar outlook

The domestic sugar market looks set to remain tightly placed in 2005-06. The season is set to open with stocks of about 35 lakh tonnes. With cane acreage at about 41 lakh hectares by mid-October, assuming a normal yield and recovery factor, a sugar output target of 180 lakh tonnes appears achievable for the season. With mills carrying a re-export obligation for about 24 lakh tonnes, the total sugar availability for the season is likely to be at about 191 lakh tonnes, after netting out exports. Sugar consumption for the year is forecast at about 190 lakh tonnes; pointing to minuscule closing stocks. Demand is known to be income-elastic and the consumption figure could be higher than expected. All this suggests a robust outlook for sugar prices, which could remain locked in the Rs 17-18 per kg range, despite the recovery in output. This would translate into a 6-7 per cent increase in realisations over the previous year.

Capacity boost

For companies such as Balrampur Chini, there could also be an additional boost to earnings from a scaling up of capacities and a longer crushing season in 2006 as cane availability improves substantially from the previous year.

The company now controls crushing capacities of 29,000 tcd at its units at Balrampur and Babhnan in East Uttar Pradesh. There are plans for scaling up capacities to 47,000 tcd by the 2006-07 crushing season. One phase of this expansion, a new 7,000 tcd unit at Akbarpur, is expected to be commissioned by this November and will contribute to 2005-06 revenues.

Another 4000 tcd is in the process of being added through de-bottlenecking of existing operations. Fresh capacities of 7,000 tcd are also proposed to be added at Mankapur by November 2006.

More resilient earnings

Trends in sugar prices would play a key role in determining earnings growth beyond a one-year time frame.

Though Balrampur Chini has displayed lower sensitivity to sugar price fluctuations than many of its peers, its earnings have witnessed a significant decline in 2002-03 — a surplus year in the sugar cycle. But earnings are unlikely to witness a downtrend of the magnitude seen earlier. The substantial scale-up in capacities could provide considerable cushion to the company's earnings, even if the sugar cycle enters a downturn earlier than expected.

Over the past couple of years, Balrampur Chini has built up power cogeneration capacities of about 40 MW and has begun selling surplus power to the State grid. With the pricing environment for co-generated power improving, this has emerged a steady source of earnings.

Plans are afoot to scale up power cogeneration capacities to about 75 MW, once the new crushing capacities are commissioned. The company has also rolled back its earlier foray into the liquor business and now plans to focus on ethanol for fuel blending. Additions are expected to take distillery capacities to 220 kilolitres by 2006-07.

The expansion projects are together expected to absorb in excess of Rs 500 crore. Of this, Rs 113 crore has been tied up through a private placement and is reflected in the equity base now. There is also a proposal to raise Rs 200 crore through GDR/FCCBs. These could result in significant equity dilution over the next one year. But if the expansion is timed to a robust phase in the sugar cycle, it will not impede double-digit earnings growth at the per share level.

Risks

The key risk to the company's earnings outlook would come from an earlier-than-expected reversal in sugar prices. Domestic sugar supplies could turn comfortable if imports are larger than expected or if cane output exceeds current expectations; this could result in a meltdown in sugar prices. Given the equity dilution that is likely from the ambitious capacity expansion plans, an earlier-than-expected reversal in sugar prices could dent earnings growth. This could rapidly unravel stock valuations.

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