Indian sugar mills association

Blame it on Rio

Date:	23 Feb 2012

Source:	The Economic Times

Reporter:	Kaushik Datta

News ID:	934

Pdf:	blameitonrio.pdf
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Two Brazilian acquisitions have backfired for Shree Renuka,but Narendra Murkumbi is confident of a comeback at the company he built by buying sick mills and turning them around.Kausik Datta examines a strategy in ferment

little over two-and-a-half years ago,Shree Renuka Sugars (SRS) decided it was time to venture where no Indian sugar maker had gone before beyond domestic shores.Between November 2009 and July 2010,the Belgaum,Karnataka-based sugar producer bought two sugar companies in Brazil for $332 million.The plan to get a foothold in the worlds largest sugar-producing market was an audacious one.But the Murkumbi family,promoters of SRS,had a sound rationale for buying Brazilian producers.A presence in Brazil,coupled with a strong foundation in India,which is the worlds biggest sugar consumer,would make a formidable combination,reasoned the Murkumbis.Whats more,the SRS management is a past master at acquiring sick companies and turning them around.The Brazilian assets were expected to follow that pattern.Two years later,the move appears to have backfired.After crashing into the red with a net loss of 616 crore in the quarter ended September 2011,as against a net profit of 128 crore in the previous years corresponding period,SRS did manage to return to the black in the October-December quarter.But sales have been stagnant,and in the quarter ended December 2011,they shrunk by 9% to 2,247 crore over a year ago.The drag is clearly the two Brazilian acquisitions.Renuka do Brasil (RdB),the bigger of the two,is still running at 60% capacity and wont be able to break even by March 2012,as was promised at the time of the purchase.For SRS,which has been an ET Award winner twice (once as Entrepreneur of the Year,and once as Company of the Year),the sudden change in prospects in Brazil was clearly unanticipated.A prolonged drought last year unprecedented in the past decade impacted cane production.The softening of both the Indian and Brazilian currencies against the dollar aggravated the situation,forcing SRS to incur mark-to-market losses in the September quarter.The main concern for SRS is that it is sitting on a pile of debt as high as 9,100 crore at last count,which is four times its equity.SRS inherited a little over half of that debt from the Brazilian buyouts.The company also exhausted its war chest of cash to finance the acquisitions.And fundraising in tight markets to retire debt is proving a difficult proposition in markets plagued with poor investment appetite.The stock,naturally,reflects the gloomy mood.It has fallen 50% over the past one year;the benchmark BSE Sensex,in contrast,was down 1% in that period.The falling stock forced the promoters to pledge more shares only a third of the promoters 38% is free from any encumbrance."Shree Renuka is another example of an aggressive,first-generation entrepreneur biting off more than he can chew,"says SP Tulsian,a Mumbai-based independent analyst.Immediate reduction in debt,which can only come through the sale of assets,can ease its problems,he adds. LN MITTAL OF INDIAN SUGAR

Not all is lost.SRS has put in place a robust sugarcane procurement programme to minimise the curse of the rain gods in Brazil."We should have managed cane production better in Brazil,"admits Narendra Murkumbi,the 41-year old vice chairman & managing director of SRS from his corporate headquarters overlooking the Nehru Centre in downtown Worli in Mumbai.Murkumbi knows that the key to getting back on track is a turnaround at RdB.And hes confident of pulling that off."RdBs turnaround is delayed,but its not derailed, says the SRS chief.It will turn around in 2012-13,"adds the man who has built a sugar empire by acquiring mostly sick entities and nurturing them into shape.Its that magic touch that earned him the sobriquet LN Mittal of the Indian sugar industry.Eleven of SRS 12 manufacturing units seven in India and four in Brazil were bought when they were ailing.This penchant for inorganic growth catapulted SRS into a 1,105 crore operation by 2006,just eight years after it forayed into sugar making by taking over a shut unit in Karnataka.It was around that time that the Murkumbis began plotting an entry into Brazil.But the two acquisitions took four years to materialise.For two reasons: sellers were demanding a high price and SRS financial muscle was limited.The situation changed dramatically after the 2008 global financial crisis;as sugar producers battled tough conditions,their asking prices came down.With the buyouts in the bag,between fiscal 2006 and fiscal 2010,SRS was able to show a compounded average growth of 62% in its top line and 56% in profits.

THE BRAZILIAN BUYOUTS

The first buyout,in March 2009,was of Vale Do Ivai SA Acucar e Alcool for $82 million.With Vale,SRS got a total sugar and ethanol crushing capacity of 3.1 million tonnes a year,along with a strategic stake in godowns and loading facilities at Paranagua port in Brazil.The distressed sugar companys location in the export-oriented Parana state,which offers the best infrastructure after capital Sao Paulo,was the icing on the cake.Gautam Watve,head of strategy & planning at SRS,says Vale has turned around.In the December-ended quarter,it recorded a profit before tax of 40 crore on net sales of 270 crore.In July 2010,SRS bought Equipav (which was rechristened RdB),Brazils seventh largest company with a capacity to make 10.5 million tonnes of sugar and ethanol,and produce 203 mega watt of power.SRS paid $250 million,in the process outbidding big names like Bunge and Noble.SRS funded the buyout with $105 million it had raised a year ago through the sale of shares to qualified institutional investors;the balance came from internal accruals.SRS immediate challenge was to grapple with the $970 million debt that came bundled with these two acquisitions.That was going to be no walk in the park as four mills two of each company were running much below their installed capacities and were making operating losses.RdBs problems were more acute as its net worth had been eroded.Immediate repayment of loans was impossible.Thats where Murkumbis negotiation skills came handy.The talks were protracted,with the underlying message: the companies would repay once they began running at full capacity.Lenders obliged.RdB and Vale were allowed to pay only interest on their borrowings for the first three years.On the principal repayment,Vale will have to pay up the principal in five years after the three-year moratorium;RdB has seven years to pay the principal.

DROUGHT DAMAGE

One of the biggest draws of Brazil for SRS was the focus on corporate agriculture.Mills produce cane on land they own as opposed to India,where they buy it from farmers.SRS buys cane from 65,000 farmers to produce 7 million tonnes of sugar a year in India.It needs to buy from only 700 farmers to produce an equivalent capacity in Brazil.A sugar maker in Indian states like Maharashtra and Karnataka (where SRS has its mills) can typically produce around 111.5 kg of sugar from a tonne of cane that costs Rs 2,500.In Brazil,one can make 135 kg of sugar from a tonne of cane that costs 1,600.In other words,for every rupee spent,SRS can make 90% extra sugar in Brazil than its mills in India.Another characteristic of sugar irrigation in Brazil is that its completely rain-fed.Thats what boomeranged badly on SRS as Brazil witnessed in 2010 its worst drought in a decade;2011 was also bad.The drought was followed by dense fog.The double whammy hit production of primary agriproducts like sugar,coffee and oranges;it also took the Amazon river to its lowest level in five decades.Drying up too were SRS cash flows,as production and recovery (of sugar from cane) in Brazil dipped.Production fell by around 30% in Parana and Sao Paulo,where SRS has its mills,says Sanjay Manyal,research analyst at brokerage ICICI Direct.But SRS cant just attribute its misery to external factors beyond its control.If inadequate rain in Brazil reduced sugar production,it also means that prices would have shot up as Brazil accounts for two-thirds of the world market.But SRS had limited success in cashing in on the price spurt.Vale managed to restrict its loss but RdB,the larger one,suffered losses disproportionate to the price hikes.This raised doubts about its operational efficiency,and consequently SRS cane management skills.Says AK Prabhakar,senior vice president (equity research) at Anand Rathi Securities: SRS has failed to read the Brazilian market.

DAMAGE CONTROL

The company has reacted quickly to control the damage.It has entrusted the CEO of Vale with the task of managing sugarcane procurement in Brazil;and replaced the agri-director of RdB who failed to react to the drought.Measures such as collective buying of sugarcane and fertiliser,outsourcing of harvesters and transportation of cane,and reduction in maintenance charges will have a combined 8% saving on cost in Brazil,says Murkumbi.Meantime,Vales production capacity has been augmented from 1.5 million tonnes (mt) a year when SRS bought it to 2.3 mt.In a year it hopes to reach full capacity of 3.1 mt.For RdB,the capacity utilisation is now 60% of 10.5 mt.Also,SRS has changed the product mix so that it can reap the benefit of price movements in sugar and ethanol.Typically,sugar is traded at a premium to ethanol.But there are exceptions when the reverse takes place.A flexible product mix helps sugar mills jack up production of either of the two commodities,depending on price trends.Simply put,a mill can make more sugar if sugar prices are high and vice-versa.Both SRSs subsidiaries can produce 70% of either sugar or ethanol.Results for the October-December quarter indicate that SRS may well be on the mend.Operating profit at RdB and Vale stood at 147 crore and 86 crore,respectively.The good news is that the two producers are able to take care of their interest payments RdB had an outgo of 89 crore and Vale 11 crore in the December quarter.Overall,operating profits of SRS were up,although lower than analysts predictions."Still concerns remain about the huge debt,"says ICICI Directs Manyal.Consolidated debt (Brazilian plus Indian operations) spiked from 8,600 crore in September to 9,100 crore in December because working capital requirements soared on the back of a peak crushing season in India.RdB has $820 million ( 4,045 crore) of debt,while Vale has $150 million ( 740 crore).The rest is on the Indian balance sheet.SRS has been trying to sell 138 MW co-generation power capacity of RdB since October.A potential buyer was identified in December,but it subsequently sought an extension till February 10 and the deal is yet to be signed.SRS hopes to generate a maximum of 1,000 crore from the sale.Analysts feel that SRS will be on a better wicket if it can retire at least 2,000 crore in debt.Selling assets is the only option for now.But even that respite will be temporary.By June 2013,RdB will have to begin repayments $100 million in principal and $60 million of interest.To be able to do that,RdB needs to run at full capacity and bolster the bottom line.Murkumbis target is to make that happen in 2013-14.His time starts now.

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