The move to acquire Equipav will benefit Shree Renuka Sugars in the long run through backward integration and economies of scale.
In a bid to tackle the cyclicality of the sugar industry and integrate its operations, Shree Renuka Sugars (SRS) is acquiring another company in Brazil. After the acquisition of VDI in November 2009, the company has now entered into an agreement to buy a majority stake in Equipav S.A. Considering that the deal will provide SRS certain operational synergies as well as scale in the years to come, analysts seem more confident about the company’s prospects and have raised their price targets for SRS’ stock. Additionally, the deal is being done at reasonable valuations as compared to some of the listed companies in Brazil as well as few recent deals.
The deal
For acquiring a 50.79 per cent stake in Equipav, SRS will be paying $329 million, of which, the existing promoters of Equipav will get $50 million. The remaining $279 will be infused in Equipav for the purpose of investing in new capacities, working capital and prepayment of debt.
Considering all the adjustments, the enterprise value (EV) of Equipav works out around $1.2 billion. Considering this, the EV for every tonne of existing capacity (10.5 million tonnes) works out to $113, which seems to be marginally higher compared to some of the recent deals, which were done at about an EV of about $80-100 per tonne.
However, if the acquisition price is adjusted for Equipav's power capacity of 203 MW, including 100 MW exportable power, the valuations look fair. Equipav will further increase its power capacity by about 77 MW, part of which will be used for the captive consumption and remaining will be sold in the market. Even otherwise, the replacement value of the existing power capacity is in the range of about $200-220 million or $21 per tonne (included in EV of $113 per tonne), which in turn means that the EV for the sugar capacity is reasonable at about $90 per tonne.
The good thing about this deal is that it will be primarily funded through SRS’ internal accruals. For instance, on the back of the increase in sugar realisation this year, analysts estimate SRS to earn cash profit of about Rs 1,200 crore in 2009-10 (September year ending), which is good enough to fund this Rs 1,530 crore deal.
| BRAZILAN PEERS TRADING AT $115/TONNE | ||||
| Market Cap (USD mn) | Enterprise Value (USD mn) | Cane crushing capacity (mnt) | EV/t | |
| Cosan | 5,508.30 | 8,250.00 | 80.0 | 103.1 |
| Sao Martino | 1,123.30 | 1,652.80 | 12.0 | 137.7 |
| Acucar Guarani | 861.70 | 1,260.40 | 12.0 | 105.0 |
| VDI | unlisted | 242.00 | 3.1 | 78.1 |
| Equipav* | unlisted | 1230.00 | 10.5 | 117.1 |
| Source: JM Financial, Bloomberg, *assuming upfront payment of $209 mn, debt of $822 million and current capacity | ||||
Combined synergies
More than valuations, the acquisition would provide a lot of synergies and scale for SRS in the long run, in terms of enabling it become a global player, de-risk its business from the cyclical nature of the industry and take advantage of limited supply of sugar in the domestic market. With the acquisition of VDI earlier and Equipav now, SRS will have an established presence in the world’s largest sugar exporting country, Brazil. Since both these companies have their manufacturing facilities near the ports, it aides exports.
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In India, the volatile cane production has always been a worry for companies; the non availability of the sugarcane during an upturn in the sugar cycle has been a big issue. In a way, this move should help SRS have sufficient access to sugarcane supplies to make sugar and enable it to capitalise on the sugar prices in the domestic and international markets.
Consider this. Equipav has sugarcane crushing capacity of 10.5 million tonnes, which it is expanding to 12 million tonnes. More importantly, about 66 per cent of the company's sugarcane requirements are met from its own cultivation on 115,000 hectare of land. Same is the case with VDI, which cultivates almost 72 per cent of its cane requirements at its farms. This indicates that SRS is now to a great extent a backward integrated company namely, from cultivation of sugarcane to production of finished sugar. The benefits of backward integration will accrue in the form of protection of operating margins through better revenue mix such as flexibility to produce ethanol when sugar prices are low. Effectively, since the combined crushing capacity of both the companies (Equipav and VDI) would be 13.6 million tonnes, SRS can now take care of more than 50 per cent of its requirements for raw sugar.
Conclusion
Overall, the synergies include operational benefits as well as increased scale of its consolidated business. However, since SRS is yet to disclose the financial details of these two companies, analysts believe that VDI and Equipav are making losses at the net level due to the high debts on their books. In this light, how fast SRS is able to turnaround the two entities will be among crucial things to watch. Notably, these companies are profitable at the operating level; restructuring of these companies could be a rewarding strategy. If that happens, it will boost profits.
| DEAL VALUATIONS | |
| in $ milion | |
| Deal amount for 50.79% | 329 |
| Total Equity value | 648 |
| Debt | 822 |
| Equity value + Debt | 1,470 |
| Payment to Equipav promoters | 50 |
| Value excl. payment | 1,420 |
| Less surplus* | 279 |
| EV | 1,191 |
| EV / Tonne ($) | 113 |
| Note: *surplus amount is after deducting the promotors payment from the total deal amount , Formula for EV is Market cap+debt-cash | |
Typically, a Brazilian sugar company makes an EBIDTA of about $10-13 per tonne of sugar. This means on the combined capacity (Equipav and VDI) of 13.6 million tonnes, their combined operating profit should be in the range of about Rs 600-800 crore or 27-35 per cent of the estimated standalone operating profit of SRS for the year ending September 2010. However, given that the combined debt of Equipav and VDI is estimated at $1 billion, a large chunk of their profits is being used to service the debt. How fast and efficiently SRS is able to restructure this debt and lower interest outgo will decide their contribution to SRS’ consolidated earnings.
For now, while financials of the two Brazilian companies is awaited, SRS is expected to report significant improvement in its standalone earnings led by higher margins and volumes. The company is expected to report an EPS of about Rs 46 in 2009-10 and about Rs 30 in 2010-11. At Rs 166.65, the stock is trading at about 6 times its 2010-11 estimated earnings as compared to the price target of Rs 320-340 pegged by analysts.