The Hindu Business Line : Bajaj Hindusthan: Hold

AMBITIOUS capacity expansion has made Bajaj Hindusthan the leading Indian sugar producer within a short time span of two years. The company's business is focussed on sugar and ethanol, setting it apart from other frontline players which diversify their revenue streams by co-generating power. For those who would like to capitalise on the upswing in the domestic sugar cycle and the opportunities opening up in global ethanol trade, the stock is a good investment option.

Investments in the stock can, however, be timed to declines as the valuation appears stretched after its recent spurt. At Rs 292, the Bajaj Hindusthan stock trades at about 13 times expected earnings for 2005-06, after factoring in the contribution from new capacities. The stock now trades at a premium to other frontline sugar stocks.

Timing helps

Bajaj Hindusthan's operations over the last couple of years have been characterised by a relentless expansion drive. The company has added capacities at greenfield locations in Western UP, to take its crushing capacities from about 31,000 tcd (tonnes crushed per day) in 2004-05 to about 56,000 tcd this season (starting October 2005).

The company commissioned three new 7,000 tcd units this November, which have begun contributing to revenues.

This, combined with the recent acquisition of Pratappur Sugars (3200 tcd), will lead to a doubling of sugar production volumes in the financial year 2005-06. The company expects a turnover of Rs 1,725 crore for 2005-06 (financial year October-September) against Rs 900 crore the previous year.

This appears feasible as these projects have gone on stream during a favourable phase in the sugar cycle. A 10-12 per cent rise in domestic sugar prices this year can magnify the impact of higher volume sales on the company's bottomline. With the country's sugar output for 2005-06 forecast at about 175 lakh tonnes, consumption at about 195 lakh tonnes and low carry-in stocks, the domestic sugar market is likely to remain tight this year. This can provide a firm underpinning to domestic sugar prices. Sugar prices have ruled at Rs 20-21 per kg at the retail level over the past two quarters, about 12 cent higher than last year.

No stress from funding

Healthy operating cash flows, coupled with timely execution, have helped the company handle its capex programme so far with little stress on the balance-sheet. However, the sharp rise in sales and profitability this year has helped the company take the equity expansion due to conversion of bonds issued in the overseas market in its stride. The earnings per share have grown from Rs 6.99 in 2003-04 to Rs 11.8 in 2004-05 after factoring in the expanded equity.

Close watch on execution

The company is still far from completing its expansion drive. Plans are afoot to further expand sugar capacities to 1 lakh tcd (from the present 56,000 tcd) in time for the 2006-07 crushing season. Expansion of ethanol processing capacities from the present 160 klpd (kilolitres per day) to 800 klpd is also on the anvil. These projects are expected to absorb Rs 630 crore over the next two years.

This is equivalent to about four years' operating cash flows. These projects carry execution risks. But if they do contribute to revenue streams in the 2006-07 crushing season, there could be substantial upside to the revenues and earnings from current levels. Global raw sugar prices have climbed sharply in recent months on expectations of a tighter market. The cessation of subsidised sugar exports from Europe and the increasing diversion of Brazilian sugar to ethanol are expected to change the dynamics of the global sugar trade, creating more opportunities for Indian exporters.

Rising prices of crude oil and increasing acceptance of ethanol to dope petrol are also expected to open up large opportunities for ethanol trade. After the ambitious scaling up of its capacities in both sugar and ethanol, Bajaj Hindusthan will, no doubt, be well-placed to capitalise on such opportunities.

Hurdles to overcome

There are other risks associated with the stock as well:

Bajaj Hindusthan's ambitious capex programmes have attracted the ire of mills located close to the company's cane area with a few of them even seeking legal intervention. This can curtail the company's business plans.

With several competitors putting up new capacities to protect their catchment area, enhanced competition for procurement may raise cane prices in the company's command areas, lowering the profitability of the sugar operations.

For now, it is the domestic market that is the key profit driver for Indian sugar companies. A rapid expansion in domestic capacities or greater freedom to import sugar could lead to an earlier-than-expected downturn in the domestic sugar cycle.

This can affect Bajaj Hindusthan, if its expansion projects coincide with a downturn in sugar prices. While other sugar companies have diversified their revenues through power cogeneration, this company's fortunes rely heavily on the sugar and ethanol cycle.

The success of the ethanol expansion programme depends on players negotiating better prices for supply of ethanol with the oil companies. A favourable policy regime for domestic sugar companies to trade freely in sugar and ethanol would also be a must.

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