Upper Ganges Limited – at a sweet spot in an even sweeter sector

Disclaimer

This article is only for information purpose and not be understood as any recommendation. We are not encouraging any reader to take any investing decision purely based on this article. This is only our best attempt to appraise the readers with the current situation in Sugar sector and the potential investment opportunities in our view.

We are holding the shares of Upper Ganges and other sugar companies along with many other stocks in our portfolio, before writing this article. We may buy more, hold or sell in the market based on what we think is good for our portfolio at any point of time in future.

Registration status with SEBI: We are not registered with SEBI under the (Research Analyst) regulations 2014 and as per clarifications provided by SEBI: "Any person who makes recommendations or offers an opinion concerning securities or public offers ony through public media is not required to obtain registration as research analyst under RA Reguations"

The facts, numbers and statements presented here are from the collection of various readings, news articles, information available on the internet, Company’s Annual reports and other filings etc. which we believe are to be true. We couldn’t verify these sources nor could we keep a track of the exact sources of these information. Readers are advised to do their own due diligence. 

Upper Ganges Limited – at a sweet spot in an even sweeter sector (CMP Rs. 262 )

This one is going to be a bit longer – so have patience, enrich you with knowledge instead of jumping on to execute any market order.

In our previous article we had mentioned that, we were bullish about the near term prospects of the sugar sector but the picture wasn’t very certain till then, so we opted to play safe on sugar sector and found Kakatiya Cement which offered the good mix of exposure to booming sugar and cement sectors together and available at a very reasonable price.

And it paid off - much earlier than we expected!!!! – A more than 100% appreciation within 2 months. 

(The caution - we re-iterate that we do not write this blog as a recommendation and the stocks discussed are only for the benefit of a common investor to understand a company/sector much better.  -Read disclosure again at the top if you have ignored it in the first place)

Now, as evident – with some more recent and visible developments in the sugar sector at global level, we are more confident about performance of this sector now. We strongly believe that its just the start of an inflection point for a huge J curve type returns in coming months. 

Most of the sugar stocks have already given returns of more than 400-500% in last less than 12 months and still this sector remains a highly neglected and under owned sector. Despite of round the clock 24 hours cacophony of 10s of business news channels and 100s of brokerage houses publishing their colorful research reports every day, the sector has been heartlessly rejected by the so called big and famous investors. The reasons for this apathy generally quoted  – Government intervention in the sector, Cyclical nature of the business, the rise in sugar prices is temporary, Govt. will not let the prices increase due to elections, all the companies are loss making & heavily debt ridden etc. etc. Well we do not deny any of these, but at the same time we also acknowledge that there will be significant deficit in world sugar production vs. demand in the coming year(s) and the sector is in for a good ride even from these levels. Just to highlight how under owned this sector is - still after so much of run-up, of all the 32 odd listed sugar companies market cap put together is close to 20,000 crore- this is when most of the companies are already up by 4 to 5 times in last 8-10 months.  

And on an average – even if we take out roughly 50% of promoter’s stake, just 10000 crore worth of public + HNI+ Institutional (FII, DII, Mutual Funds.) holding remains. Imagine the whole of India’s listed sugar sector (floating stock) is available for 10000 crore, this is not even 4% of Infosys’s market cap. Another interesting observation is, if we exclude the top 6 large sugar companies, the market cap of remaining 25-26 sugar companies are hardly 5000 crore put together and  less than  2500 crore of floating stock on an average.

What is happening to Sugar (Globally as well as locally)

Some basics first - . Total Sugar production as well as consumption in the world is largely in the range of 174 to 180 million tons. Brazil is the largest producer of Sugar with an annual production of 38 million tones out of which it can export 24-26 million tons which depends of many factors like world sugar prices, price of ethanol, currency value etc. India is the  second largest producer with production in the range of 28M tons however India is also a big consumer and therefore not  a large exporter. Thailand is a large producer with annual production of 9 to 10 million tons but more importantly the second biggest exporter after Brazil. Despite of good production numbers Europe US and China remain a large importer of Sugar. So the basic stats are that the total Sugar demand of the world stands  in the range of 174-175 million tons and production stands at almost similar levels 175 million tons in a normal year.  And opening/closing stock keeps on changing based on fluctuations in demand & production.  Another important point is world demand for sugar is increasing steadily for past many years with increasing income levels of emerging markets consumers and changing lifestyles.

What has happened over the years is that due to Surplus production from last 5 years in India, Thailand and Brazil ,better yield in Sugar, favourable Brazilian Real-Dollar-Ethanol equation, the world supply of sugar has been constantly going up resulting in huge inventories and subsequently fall in the global sugar prices.

However, due to severe climatic conditions in last 2 years (Drought, El Nino etc.) resulting in widespread sugarcane crop failure , all major South Asian producers including India has suffered significant decline in production. As a result, there will be a sugar Deficit ( demand more than production) in the world first time after 2011 and likely to continue next year.. Almost every major international commodity firms have predicted a  deficit between  3  to 11 million tons this year at Global level. (The US Department of Agriculture also forecast global sugar consumption would again outpace production in 2016/2017 and would draw stocks to the lowest level since 2010/2011. The last time world production was less than consumption was in 2011 and since then sugar has always been into surplus leaving a huge supply glut build over last 5 years.)

Another point is, theoretically, the opening stock of sugar this year was supposedly sufficient to meet any shortfall in sugar production, but little is known that this stock is not distributed evenly. Countries like India & China were holding large opening stocks at the start of the year and because of the drought situation are not keen for exports as the domestic price is more favourable. This has created an imbalance in Global sugar availability and Globally Raw sugar prices have already gone up more than 60% from their lows of 11 Cents per Pound last year  to more than 19 Cents per Pound now. Due to adverse weather condition, there will be a dip in production in all South Asian countries India, China and in Thailand in current and next year and the only major force is Brazil which is going to see record production & export to feed the sugar hungry world.But there is a catch in Brazil as well. Brazil is the second largest producer of ethanol worldwide and the single largest producer of sugar cane based ethanol around 28 billion Liter. In Brazil, Ethanol is produced directly with Sugarcane (and not from Molasses after crushing sugarcane like India) and a lot of factors decide whether mills in Brazil will use the sugarcane to divert to ethanol production or to sugar production. Currently between  55%-58%  of sugar cane in Brazil goes into ethanol and this nos. keep on fluctuating depending on these three factor. - Price of Ethanol (which in turn is affected by price of Oil) , the price of Sugar in international markets and value of Brazilian currency.

For how long this sugar under-production will last – With receding El Nino weather conditions and normal climatic conditions in south and south east Asian countries, rainfall is going to be normal in sugar producing areas, but most of the crop for next year production is already destroyed due to drought and new sowing also couldn’t be done due to lack of rainfall. This makes it obvious that next year sugar production in India will be lower as well (Close to 21-22 million tons as against consumption of 26-27 million tonners). At the same time, this year Brazil has suffered some heavy rainfall just before the crushing – this has slightly delayed the crushing and slightly negatively affected the production.

Another important factor is –La Nina ( the sister climatic condition of El Nino) mostly follows in 80% of the cases after El Nino diminishes . This climatic condition is set to bring heavy rains in Indian subcontinent and south Asia but will result into dry parts of South and North America including South Brazil after next year . There is no clarity on its impact on Sugar crop of Central-South Brazil (the part which produces 90% of sugar of Brazil) though, but most likely after next year , the production in Asian countries will return to normalcy but Brazil might suffer sugarcane production . Also, if Oil sustains recovery or Brazilian currency continues to appreciate, the current international price will not remain attractive for Brazil to export sugar and the price will have to go up. Thus since for current & next year South Asian countries’ production is affected and after that possibly Brazil’s production will  be less , we expect this sugar prices to remain firm for sometime.

The price in international markets has already close to its 3 year high , and the net Long position in sugar contracts in international market is at its all-time high suggesting further bullish trend and the contracts’ Relative Strength Index is not yet in the territory to suggest that its overbought or headed for a fall.

Now lets talk about the  Indian Scenario –

Without going much in detail, sugar remains a highly regulated and most intervened commodity by Central as well as state Govts. The central govt. declares FRP (Fair remunerative price for sugarcane ) and on top of it, states add their own SAP ( state administered prices ) which varies from state to state. There are talks that to converge this mechanism and follow only one FRP , but all states are not yet willing to follow that mechanism. Apart from this, most of the sugar companies are involved in distillery and power business over which also states policy have high influence.

Indian sugar stock- at a glance  -.

Current year Indian opening stock 9.5m

+Production 25m

-Consumption 27m

-export 2m

=Stock at the end of this year=5.5m

+Production next year 22m (could be even less)

-consumption next year 27m (without assuming any growth)

-export 0 m

=closing stock next year =0.5m

India may be having a deficit of sugar by  next year crushing season.

When it comes to Sugar sector in India – the biggest risk is govt itself. Sugar has been a politically sensitive commodity and for some reason always heavily controlled by Govt. historically. (Till few years back, Govt. even used to  fixed the sale quota per month for the mills). To make sure that the prices do not go out of sync due to traders & hoarders activities, Govt. has already taken many steps which may have impact on the sector, even ignoring the facts that the Mills were suffering for last 6 years and almost reached to the stage of bankruptcy and before their Balance Sheet could be repaired with the sector turnaround, the Govt. started its curbing measures.

Lets see what are the measures that are already applied and what more Govt. can do. 

1.     Stock limits (applied already and seems ineffective)

2.     Reducing import duty (Govt. already mulling over it, but high chances are that this also will be ineffective given the high global prices)

3.     States increasing their SAP over the Central Govt. fixed minimum price- this indeed is a real risk. However we think that with global momentum, the price in domestic commodity market will be able to pass on some of this hike. But as mentioned, this remains the biggest risk to profitability.

4.     Removing production subsidy – govt. did already remove the 45 rs. Per ton subsidy, but the this subsidy itself was so meagre that removal didn’t impact the financials much.

5.     Making export costly or Banning Export – Govt. already thinking about putting export duty on sugar. Though this will have only psychological impact on NCDEX prices to some extent , as companies are not interested in exporting since the domestic prices are higher than export prices currently. However, with exports banned, the domestic prices will be practically de -linked to global prices and any major spike in international prices will have a limited impact on domestic     prices.

6.     Putting excise on ethanol.- currently ethanol is given the preferred treatment , however this is not going to impact sugar prices , and Govt. has to increase the uses of ethanol, so this incentive should continue.

7.     Putting some arbitrary taxes, VAT, entry taxes, Octroi and so on – there are smaller tools, and state govt. will continue playing with these. This shouldn’t affect the sugar market demand and supply situation in a big way.

8.     Putting direct limit on sugar prices or directly controlling the sugar distribution quantity – after the decontrol of sugar, such steps are out of question. Especially the current Govt. at the center is known for being friendly with the industries, step of this kind will not be expected.

What is ironical is that Government fails to recognize that most of sugar consumption is by industrial buyers and household direct sugar consumption   is less than 10% of the total sugar consumption. Sugar is largely used in Industries such as Confectionary, Soft Drinks, Syrups etc. etc. But yes, eventually the increase in price of these items is also passed on the retail customer.

If the sector looks convincing, which company to pick out of 35 odd big small listed companies available.

After studying many factors – fundamental, technical , political, management quality, current valuation and other company specific factors – we have zeroed down to Upper Ganges.  Read on to know why !!

Upper Ganges limited

Imagine a company of an excellent pedigree, available at Forward PE of 2 (may be less than 2), in a turnaround sector  – with a reasonably comfortable Balance sheet and an improving leverage situation.

Upper Ganges is a KK Birla Group company existing for many decades and, KK Birla Group is a major player in key industries like fertilizers, chemicals, textiles, shipping, etc. apart from sugar. From a modest beginning in 1932, UGSIL has grown to become the pioneer in the Sugar Industry. UGSIL has three sugar manufacturing units situated in the cane rich region one - as an integrated sugar unit in the Bijnor district of U.P. - and the other two in Gopalganj and Samastipur districts of Bihar. In last few years, like any other companies Upper Ganges also had suffered from depressed situation of this sector  in India and globally. Till last year, the sugarcane FRP price was 2300 Rs and SAP price in UP was another 500 Rs which means , the company had to buy sugarcane at 2800 and then after processing into sugar had to sell at ruling price of less than 2500. But with the increase in price of sugar to 3500 now, an exponential jump in the profits of the company is expected and this is going to continue as sugar prices are going to remain firm for many quarters from now.

Now, the valid question: When everyone is making the same product - why Upper Ganges and not any other sugar company or for that matter why not Oudh sugars, its bigger sister from the same group.

Here are our rationales on why Upper Ganges have some distinct advantages:

Financials.

Lets have a look at the most important aspect of any balance sheet, that’s the Debt figures. As per the recent numbers declared by the company, the total debt on the book stands at 562 odd Cr which comprises of Long term debt of 186  and short term debt of 376 Cr. The company’s current  inventory of 529 Cr ( recorded at cost and market value of almost 750 crores) is sufficient to take care of its short term debt and its payables. The long term debt of 186 crore, which was taken for the capex, is at a comfortable level compared to annual cash generation as we expect a PAT of close to 150 Cr (conservatively) for the next fiscal year (PAT for the last quarter was 57 odd cr.). The best part of this industry is that there are practically no receivables, the entire stock is sold either on cash basis or on Sales+30 days basis. Apart from this, they have investments in their Balance sheet worth 250 crore market value.

The company made a profit of 57crore last quarter including Cogen & Distillery business. In UP based sugar mills, since crushing season ends by march, the Q1 doesn’t have any Cogen business & Distillery also has only marginal volume. So Q1 and Q2 will see only sales of the inventory of sugar which is crushed in last 2 quarters. Now the case on the point is – The Q4’16 average sugar price was in the range of 3150-3200.  But this quarter the sugar ex-mill prices has been in the range of 3400-3500 and this will reflect in the sugar segment profits of all the company in Q1'17 results.

Demerger: The Company's Board has recently approved a complex scheme of demerger of entangled holdings of KK Birla’s group’s sugar mills in UP and Bihar owned by Upper Ganges and Oudh sugars –  and their investments in group companies and other businesses of food processing and tea etc.

In principle- what will result into is ;

·         The Bihar based mills of Upper Ganges and Oudh will be transferred to a different company Magadh Sugars.

·         UP Based mills of Upper Ganges and Oudh will be transferred/merged to a separate company Avadh Sugars.

·         The investment & Tea business of Upper Ganges will be transferred to a separate company Ganges securities [ which will further be separated into separate investment company & Tea company ].

·         The investment & food processing business of Oudh sugars will be transferred to a separate company Palash investments [ which will further be separated into separate investment company & food processing company ].

Company has made it clear that upon demerger , all the resulting companies – Avadh Sugars, Magadh Sugars, Palash , Ganges will be listed.

The details of demerger can be found on the Company’s website and also on the BSE notifications.

In summary, a shareholder in Upper Ganges will get some shares in Magadh Sugars, Avadh Sugars, Ganges securities and also the demerged Tea Company of Upper Ganges.

We believe that this demerger will unlock huge wealth tapped into these investments and other sundry businesses of Upper Ganges and Oudh Sugars. Also, from what appears that Upper Ganges will benefit slightly over Oudh looking at swap ratios of resulting companies. This is however, only an assumption as a lot of details is not clear relating to what profitability & debt is attributable to Bihar based mills and UP based mills. And we are sure that market will value these demerged companies accordingly so that the Upper Ganges & Oudh Shareholders get an equal deal and none is favoured over the other.

Our belief is: this is a special situation opportunity which is not available with other sugar companies. The sum of parts will always be more that the whole – at least in theory and empirical evidences suggests (reliance demerger is a case in the point)

Huge Non-Current Investments – Biggest Margin of safety

Very few people know that Upper Ganges is one of the holding companies of the KK Birla Group. i.e. the company holds large number of equity shares of the group entities, which are tabulated below

Script Name	Numbers	Price	Total market Price
New India Retailing and Investments	285,573.0	-	-
Chambal Fertilizers	1,966,795.0	65.0	127,841,675.0
Oudh Sugar Mills	3,326,901.0	97.0	322,709,397.0
Haryana oxygen Limited	5,000.0	-	-
SIL Investments Limited	2,019,339.0	84.0	169,624,476.0
Sutlej Textiles and Industries	3,041,697.0	583.7	1,775,286,454.1
Manbhawani Investments	73,500.0	-	-
Manavta Holdings Limited	73,500.0	-	-
Total in Rs million			2,395.5

As per the above table, the company with a market cap of 250 odd crores already holds equity shares of group companies valued at over 240 odd crores. So practically you are getting the entire sugar business for free. No other company in this sector has this kind of valuation comfort.

Just as a comparison – other comparable companies like Ugar sugar is currently at more than 3 times of Price to book Value ( book value 11 rs. Vs. price of 36 rs.) while Upper Ganges is practically available at less than its book value.  

Book Value = Fixed Assets : 331 crore + Quoted Investments 240 crores  less long term borrowings of 186 crore = 500 crore vs. market cap of 290 crore.  =  A price to Book value of close of 0.5 times. Vs. 3 more than times of Ugar sugar.

3. Huge Inventory – Upper Ganges is holding close to 21 lakh bags of Sugar inventory from the current crushing season , and valued them at around rs.2700 per quintal in books. The current quarter ex-mill prices have been in the range of 3400-3500 per quintal. You can calculate the gains on inventory that will be realized in the following quarters when this inventory is sold. Its safe to assume that sugar segment profits for current quarter will be even better than previous quarters. And mind it, this inventory gain  is a certain gain sitting in the books if the price of sugar doesn’t go down in next 2 quarters. If the price of sugar goes further up from here, the gain on this inventory is going to be even higher which will reflect in the results of Q1 & Q2. In our personal opinion, the ex mill prices are going to be up to anywhere close to 3800-4000 levels. This inventory advantage is generally not available to south based mills because their crushing season goes on for 180-220 days in a year and they do not hold large inventories. ( Which means they didn’t get the advantage of increase in sugar price by 50% since last year on their sugar inventory?)

4. Limited Liquidity and Floating stock (shares)  

The actual floating shares of the company in market in actually much lesser that what is visible in the shareholding structure. After including the (most likely) promoter pseudo entities shareholding, there is practically only 22%-25% of the holding is floating in the market, including HNIs. If we take out the physical shares, HNIs & non promoter members of Birla families etc. practically 20-25 lac shares (Roughly 20% available in the market). This gives a good insight of the liquidity situation. We have been closely observing the delivery stats for the company for the last 3 months, it is easy to see that more than 70% of the above mentioned stock has been churned and people have entered and bought the stock at much higher levels.

2015 March 31st list of large shareholders is as below. If our assumption is right, some of these are pseudo promoter entities which might not be part of float. The below top shareholders already constitute 75% of the equity leaving practically much lower quantity of floating shares:

Entity	Number of Shares	%ge of total shares	Our assumptions
Promoter	6514304	56.37%
LIC	397210	3.44%
Manu Chabaria	142020	1.23%
Earthstone	141561	1.22%	Pseudo entity-our guess
Navjeevan	718317	6.22%	Pseudo entity –our guess
Parasram	115625	1.00%	Pseudo entity – our guess
Akhtar Banu	70000	0.61%
Jyotsana Poddar	59243	0.51%	Promoter family
Shobhana Bhartia	59243	0.51%	Promoter family
Globe Capital	58364	0.50%	New entered in 2015
Kunar rakesh	53380	0.46%
Tejinder kaur	50225	0.43%
Physical shares	200000	1.73%

5. Birla Pedigree – Though not the best wealth creators, at least people trust Birla’s that there companies are clean and will not be involved in any misdeed. The name of Birla’s still carries trust, among investors, bankers and people in general. And these companies are existing since before independence and have survived many ups and downs. Especially when the sector now is booming (and other companies of this group – Chambal Fertilizers, Sutlez Industries etc. are doing good) there is no reason to believe of any wrongdoing from the management’s side.

6. Much efficient Co-generation (power) business with among Industry high margins – Upper Ganges has a much better profitability in co-generation business. The reason for this could be either 1) probably better tariffs rates signed with state govt. (UG has 2 mills in Bihar compared to other companies who are all in UP . This is not verified yet – just an assumption ) or 2) a more efficient co-generation power plant as suggested below - a quote from their Balancesheet.

“Efficient conventional electricity generation using a large scale centralised power plant is assumed to be at 35%. A typical medium pressure boiler operates at an efficiency of about 85%. Assuming that an industrial process needs both heat and power in a ratio 1.5:1, the overall energy generation efficiency will thus be about 54%. In case, similar thermal and electrical energy is supplied using a suitable co- generation system, the overall efficiency could range from 65 to 95%. If the efficiency is assumed to be 75%, the total primary fuel savings would be about 28%.” – source - Annual Report 2014-15

7. Credit Rating of Investment grade (BBB -) Upper Ganges has the credit rating of BBB- for its Bank Facilities -fund based long term. This is better than most of the other comparable sugar companies of same size (who are mostly either Speculative Grade or Default Grade).

To conclude, Govt. is trying everything possible to curb the price of sugar but is unable to do it because of the global shortage and reduced production at India. The price of sugar is only going to go up in next 3-4 quarter at least. Next year production in India will also be affected because of the drought conditions this year. And following the next year - there are strong chances of La Nina hitting Brazil - which might affect the production there. Overall the sugar sector is set for giving much sweeter returns from current levels and Upper Ganges will be front runner.