Financial Mail - Investors Monthly - - Opening Bell - Stafford Thomas

Ef­fi­cient mar­ket hy­poth­e­sists ar­gue that the mar­ket is al­ways right when it comes to the pric­ing of a com­pany’s shares. But is that al­ways the case? Not when it comes to SA’s largest listed sugar pro­ducer, Ton­gaat Hulett, be­lieves War­ren Jervis of Old Mutual In­vest­ment Group. “Ton­gaat Hulett should be trad­ing at about R150/share, yet it is only at R121,” says Jervis. “I am sur­prised that the mar­ket is not get­ting it.”

What the mar­ket ap­pears not to be get­ting is that the worst drought to hit South­ern Africa in more than three decades has been bro­ken in Ton­gaat Hulett’s three key grow­ing re­gions: KwaZulu Na­tal (KZN), Mozam­bique and Zim­babwe. It sets the scene for the sugar group to en­joy at least two years of vig­or­ous pro­duc­tion in­creases and surg­ing prof­itabil­ity.

“The dom­i­nant theme in the next two years will be fall­ing unit costs of pro­duc­tion,” says Ton­gaat Hulett CEO Peter Staude. “Our mar­ginal cost of ad­di­tional pro­duc­tion is ex­tremely low.”

Of the group’s sugar milling costs, 85% are fixed and 15% vari­able.

The first signs of a ma­jor im­prove­ment in the for­tunes of the sugar op­er­a­tions were seen in the com­pany’s year to March. Strong per­for­mances in the three key grow­ing ar­eas made sugar oper­at­ing profit roar in at R1.271bn, up from a mere R15m the pre­vi­ous year.

Sugar pro­duc­tion it­self was not up sig­nif­i­cantly.

Still ex­pe­ri­enc­ing the last ef­fects of the drought, it rose by a mar­ginal 33,000 t to 1.056Mt, around half of the group’s milling ca­pac­ity. About 20% of pro­duc­tion was ex­ported, pri­mar­ily to the EU.

Some other pos­i­tive fac­tors were at work, not least a 29% rise in the SA sugar ref­er­ence price dur­ing 2016. The first hike of 12.5% was in Fe­bru­ary and the sec­ond, of 15%, in July. The ref­er­ence price was upped by an­other 7.75% in Fe­bru­ary 2017. “There is a good chance the price will be in­creased again this year,” says Staude.

Higher ex­port prices also pro­vided a profit kicker but from now on ris­ing sugar pro­duc­tion will be the main growth en­gine.

In its fore­casts, Ton­gaat Hulett is look­ing to pro­duce 1.2 Mt-1.3 Mt in its year to March 2018, and 1.48Mt1.59 Mt the fol­low­ing year. At the high end of the 2019 fi­nan­cial year fore­cast pro­duc­tion would have risen by 534,000 t (51%) in the two years.

Sus­tain­abil­ity of pro­duc­tion has also im­proved markedly in Zim­babwe and Mozam­bique. Un­like pro­duc­tion in SA, which is to­tally re­liant on rain, ir­ri­ga­tion plays a big role in those two coun­tries. Pro­duc­tion there ac­counted for 62% of Ton­gaat Hulett’s sugar out­put in its past year. Yields were hard hit by low dam lev­els dur­ing the drought, says Staude. But the prob­lem is well and truly over.

A risk of an­other sort faces Ton­gaat Hulett from a pro­posed tax on sugar-sweet­ened bev­er­ages, which could dam­age de­mand — but the risk ap­pears lim­ited. At the level of tax pro­posed now the group es­ti­mates that sugar con­sump­tion in SA will fall by less than 5%.

Sugar is not Ton­gaat Hulett’s only big profit gen­er­a­tor. Its line-up in­cludes its maize­based starch and glu­cose busi­ness, Ton­gaat Hulett Starch (THS), which pro­duces an­nual rev­enue of R4.2bn.

The ma­jor mar­kets of this busi­ness are al­co­holic bev­er­ages, cof­fee cream­ers, con­fec­tionery and pa­per.

THS faced the head­wind of a drought-re­lated maize price rise dur­ing the past fi­nan­cial year. “Maize prices moved to im­port par­ity, where our mar­gins get squeezed,” says Staude.

Maize prices have since moved back to THS’s pre­ferred ex­port par­ity but it will still take time to work through or­ders placed at the time of par­ity pric­ing. “I ex­pect [THS] to have a great sec­ond half this year,” says Staude.

An­other of Ton­gaat Hulett’s big in­vest­ment at­trac­tions is 7,709 ha of sugar cane fields in the Dur­ban area ear­marked for ur­ban de­vel­op­ment.

There is no short­age of po­ten­tial de­mand. Dur­ban’s pop­u­la­tion is pro­jected to rise by 500,000 to 4.1m by 2021.

Land sales by Ton­gaat Hulett in the past fi­nan­cial year came in at 75 ha, down from 121 ha the pre­vi­ous year, while oper­at­ing profit fell from R1.115bn to R641m. “Ac­tive nega­tions are un­der way on 233 ha. The profit po­ten­tial is about R1,58bn.”

Look­ing fur­ther ahead, Ton­gaat Hulett’s ob­jec­tive is to sell 607 ha-1,211 ha of de­vel­opable land over the next five years. It rep­re­sents an an­nual av­er­age of 121 ha-242 ha.

The group grew its head­line EPS by 45%, a level it is ca­pa­ble of re­peat­ing in the cur­rent year.

On a for­ward p:e of around 10 the share looks like a sit­ter.

An­other in­vest­ment at­trac­tion is 7,709 ha of sugar cane fields in the Dur­ban area ear­marked for ur­ban de­vel­op­ment

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