Renuka-Wilmar deal disappoints Street

Low valuation, high equity dilution weigh

The acquisition of 27.5 per cent stake in Shree Renuka Sugars (SRS) by Wilmar Sugar Holdings, the wholly-owned subsidiary of Wilmar International, hasn’t been viewed favourably by the Street.

While the deal will provide respite to SRS in terms of helping it reduce debt in Indian operations from the current Rs 3,700 crore to Rs 2,500 crore, analysts such as Rohit Agarwal of SPA Securities are disappointed. Agarwal says the deal valuation of 0.9 times the price-to-book value (P/BV) has been disappointing, considering in good times, sugar companies fetch valuations of 1.8-two times the P/BV and during a slowdown, at least be 1.2 times the P/BV. Thus, while the market expected the open offer to be Rs 27-30 a share, the offer price of Rs 21.89 has disappointed.

Amid this backdrop, the SRS stock (which gained 22 per cent in last one week) fell 10 per cent intra-day, before closing 6.22 per cent lower at Rs 21.1 on Friday. The deal was announced on Thursday evening.

The issuing of preferential shares to Wilmar in the first step; the share buyback will be followed by a rights offer. This will lead to substantial equity dilution. Though the price of the rights offer is yet to be decided, assuming the current share price as the offer price, the equity dilution could be high — 92-100 per cent —, analysts estimate.

While the deal with Wilmar will bring synergistic benefits to Renuka, it could be expected to draw benefits in a longer duration (three-five years). Some analysts, however, don't expect significant benefits to accrue to SRS, as Wilmar is a palm oil major and sugar only contributes in a small way (about seven per cent) to the latter’s revenues. Therefore, the deal brings more benefits to Wilmar, which will get a technologically strong company with healthy prospects, at cheap valuations.

  In the current environment, the prospects of domestic sugar producers aren’t very encouraging. For millers in Maharashtra, the effective cost of sugarcane is Rs 27-28 a kg, almost at a par with its selling price. SRS’s performance in the December quarter was hit by high sugarcane prices. Analysts at ICICI Securities said lower sugarcane availability in Maharashtra this season (October 2013-September 2014) had led to an increase in sugarcane prices, with sugar production likely to fall about 20 per cent year-on-year. The company's raw material cost for the December 2013 quarter accounted for 82 per cent of sales, compared with 73 per cent in the year-ago period, impacting gross margins. Though the company has processed 400,000 tonnes of raw sugar in the December quarter, analysts believe trading margins will remain low.

Looking at the weakness in the domestic market, the company might not be able to report strong revenue growth and earnings in the near term. During this period, the stock, however, is likely to hover at current levels, supported by the open offer price, analysts say.

Even from a financial point of view, the inflow of about Rs 1,250 crore will not provide significant relief. Though it will help cut domestic debt by about a third from Rs 3,700 crore (and interest costs proportionately), given SRS reported earnings before interest, tax, depreciation and amortisation of about Rs 85 crore and interest cost stood at Rs 212 crore in the first nine months of FY14, the company will still record a loss at the net level on a standalone basis. After the deal, the consolidated debt will still be about Rs 8,000 crore.