Not just sugar

POUND WISE

The country's largest sugar producer Bajaj Hindusthan is diversifying into particle boards. Well, for a good reason.

When the largest sugar player in the country says that it is foraying into particle boards, the temptation is to dismiss it as one of those diversification moves that is sure to destroy shareholder value.

But Bajaj Hindusthan's decision to produce Medium Density Fibre Board (MDF) and Particle Board (PB), which are substitutes for plywood, seems well thought out.

A captive raw material base and the absence of any significant domestic player in a product segment that is growing at a scorching pace make a perfect recipe for business success.

From bagasse to board

Bajaj Hindusthan plans to set up a 100 per cent subsidiary - Bajaj Ecotec Products for the purpose. What pulled the company into this is the largely unmet demand.

The company plans to set up three plants "� two for MDF in eastern and central Uttar Pradesh and one for PB in western UP. This will result in a total production capacity of 2.10 lakh cubic metre per annum.

The plants to be set up at a cost of Rs 240 crore are expected to commence commercial production from November 2007.

"85 per cent of the domestic demand for MDF and 50 per cent for PB are met by imports," says Himanshu Shah, chief executive officer, Bajaj Ecotec. He says, "We are expecting revenues to the tune of Rs 350 crore and profit before tax of Rs 150 crore from this venture in the first year of operations."

MDF and PB will be produced from excess bagasse generated from its sugar mills. 10 lakh tonne of excess bagasse will come from the company's 14 sugar mills that will be operational from next year. 60 per cent of this will be used for production of MDF and PB.

The excess bagasse generated by sugar companies is currently either sold to paper mills or used for power co-generation. This forward integration portends well for the company, say analysts, given the growing demand for furniture.

"The exponential growth in demand for housing is boosting the demand for engineered wood. Moreover, with legislative changes forcing the closure of existing saw mills and plywood factories, the demand for MDF/PB in manufacturing wooden panels and furniture is spiralling. Other fast-growing sectors of the economy, like IT, ITES and organised retail are projected to create a demand for around 25 lakh cubic metres of panels alone," says Shah.

The MDF industry is pegged at Rs 1,500 crore or 6.7 lakh cubic meters. The PB industry is estimated at Rs. 1,000 crore (around 4.9 lakh cubic metres) and is growing at 20 per cent.

The value of MDF imports into India has more than doubled from $5 million in 2003 to $13 million in 2005. The value of MDF imports into the country is estimated to rise to $300 million by 2010. India's demand for MDF is of the order of 0.67 million cubic metres.

All season plan

What Bajaj Hindusthan intends to do is a unique move not tried by any sugar company before. By foraying into particle boards, the company will essentially remove the seasonal nature in its business to a large extent.

When the sugar production is good, which means more crushing and hence more supply of bagasse, prices of bagasse tend to slip dragging down overall realisations.

This is where forward integration helps. Apart from a diversification of revenue streams, this move will cushion the company against fluctuations in sugar prices.

"Going forward, margins in the sugar business are going to be under pressure as the cost of cane is rising but sugar prices are coming down. Thus, this is a good move by the company to add to its non-cyclical revenues," says an analyst from a leading broking firm.

The management feels that this project will ensure a dominant position for Bajaj Hindusthan in MDF from day one as there are very few players. There are just eight manufacturers of PB and two manufacturers of MDF currently.

Even later, Shah does not see much competition coming in. He says, "An average sugar mill generates about 20,000-30,000 tonne of bagasse which is not enough to achieve economies of scale. Availability of bagasse close to a manufacturing centre is very important. Also, the big sugar companies have increased their co-generation capacities to improve realisations. It will be difficult for these companies to meet their raw material requirements if they enter this sector. As far as other entrants (non-sugar players) are concerned, they will have to depend largely on the sugar mills for baggase. This may not be cost efficient in the long term," feels Shah.

"We have all that is required - bagasse, power and steam to produce MDF and PB in-house," says Shah. This will lower the manufacturing costs for the company.

Being the largest sugar producer will definitely come to Bajaj Hindusthan's aid. It has a crushing capacity of 56,200 tonnes crushed per day (TCD) and plans to increase this to 1,36,000 TCD by FY07.

This kind of capacity not only means benefits of scale for the company, but also enough and more bagasse. Unlike other sugar companies, Bajaj Hindusthan does not generate power in a big way currently. But the company does plan to set up a power co-generation plant, which would enable it to export 90 MW during the sugar season.

Besides, the company is on course to increase its distillery capacity, which will increase its ethanol production. Three of its green field projects - at Saharanpur, Pilibhit and Lakhimpur -- will start operations from October.

This will double Bajaj Hindusthan's distillery capacity to 640 kilo litre per day (KLPD) in FY06 (September year-end). By FY07, the distillery capacity will go up to 800 KLPD. Analysts see a big opportunity in the ethanol business once the government makes it mandatory to blend ethanol in fuel and there is some clarity on ethanol prices.

Bajaj Hindusthan had recently announced that it had exported ethanol at around Rs 23-25. The realisation of ethanol in the domestic market is only Rs 21 (Rs 18.75 plus a MODVAT credit of 16 per cent), which means realisations could improve going forward.

Still sweet

While trying to maximise yields from its by-products, the company continues to take major strides in the sugar business. Recently, it acquired a 60 per cent stake in Pratappur Sugar and Industries for Rs 40 crore.

Pratappur has a capacity of 3,200 TCD which will be increased to 6,000 TCD by October. The company is strategically located in eastern UP and is near the sugar markets of West Bengal.

"The acquisition is a strategic decision to leverage managerial capabilities in sugar business without taking risk on Bajaj Hindusthan's balance sheet," says Vikram Suryavanshi, an analyst at Karvy Stock Broking.

The company has also set up a subsidiary in Brazil and is looking for potential acquisitions of sugar and ethanol companies there.

Bajaj Hindusthan's revenue for the June quarter was up 24 per cent y-o-y to Rs 444.63 crore while net profit increased 21 per cent to Rs 63.88 crore. The EBIDTA (earnings before interest, depreciation, tax and amortisation) margins improved by 240 bps at 24.6 per cent.

At the current market price of Rs 299.65, the stock is trading at a P/E of 17.08 times its trailing twelve months earnings. Even though the stock commands a higher valuation as compared to its peers, analysts are bullish about its future prospects. As per Karvy estimates, the stock trades at 21 times and 10 times its FY06 and FY07 earnings.