Hear the profound sayings of the father/son duo of the promoter group, Shishir and Kushagra Bajaj, in their pontification to the shareholders in the annual report for the 12 months period ended September 30, 2010. 'The amalgamation of our subsidiary Bajaj Hindustan Sugar and Bajaj Hindustan Limited (BHL) has reinforced BHL's position as the largest sugar producer in Asia with a cane crushing capacity of 136,000 tonnes per day, across 14 locations in the northern state of Uttar Pradesh' says Kushagra the son. 'The window of opportunity for India to emerge as a formidable global player in sugar is shrinking with the domestic industry caught in the volatile cycles in addition to other policy constraints imposed. India is only second to Brazil in terms of sugar production. Yet nations like Brazil, Thailand and Australia reap commandeering positions in the global sugar market as a result of the benefits enjoyed due to a complete decontrol and operational freedom these nations offer to their sugar producers' is the take of the father Shishir Bajaj. With the coming of age of Bajaj Hindustan, the promoters have decided to straddle the high horse on behalf of the sugar producers.
The sugar cane cycle
The company continues to implement the September year ending for accounting purposes due to the seasonality of the agri product and its only raw material - sugar cane. The sugar cane cultivation/crushing season in India follows the October/September cycle, barring a few states like Tamil Nadu which are bigger beneficiaries of the North East monsoon than the South West monsoon. The management's decision to have all its factories in UP also appears to be rooted in overwhelming ground realities. More than 47% (2 m hectares) of the total area of 4.2 m hectares under sugar cane cultivation in India is in Uttar Pradesh. Sugar cane is cultivated in more than 20 states. The other very interesting disclosure, in the variety of statistics that the company has provided, is that the average yield per hectare of sugarcane has been stagnant at around 65 tonnes since the year 1989-90. That implies a status quo in production yields in the last 20 years or so!
Why has there been no effort to introduce higher yielding varieties of sugar cane in the interim? What is the precise game here? There are very definite clues on why it did not happen. Bajaj Hindustan for example does not spend a dime (that's right not a penny's worth) on Research and Development - either on capital account or on revenue account! Considering that the industry lodestar sees such spending to be a waste of precious resources, one can well imagine what the thought processes of the less exalted industry mortals in this trifling matter are.
Another perplexing act during the year was the decision of the promoter group to consolidate their hold over the voting stock of the company by exercising their option on warrants allotted on a preferential basis - the payment for which was spread over two years. What consolidation they had in mind is not clear, as the present holding after exercising their right is 37%. The exercise led to the issue of 14.5 m shares at Rs 52 per share for an aggregate amount of Rs 756 m. In any event, what may be the extra mileage that the management has obtained from this piecemeal exercise? There is also a severe mismatch, if one can call it so, between the paid up equity of Rs 191 m, the reserves and surplus of Rs 31 bn, gross sales of Rs 29.7 bn, and a gross block of Rs 65 bn in 2009-10. The equity capital is being wantonly kept suppressed for a very deliberate reason. By keeping the floating stock low in the bargain, it leads to less investor/predator interest for one.
The company's operating results for the latest year and its balance sheet figures are not strictly comparable with that of the preceding year. The operative results include the working results of the amalgamated subsidiary, Bajaj Hindustan Sugars, for 6 months, and the balance sheet figures incorporate the figures of the subsidiary.
Results not a pretty picture
The results do not a pretty picture make - though the operations have become more humungous. This inspite of the company having extracted more bang for the buck from its principal product line - sugar. Sugar sales accounted for 92% of gross revenues for either year. The company squeezed out revenues of Rs 29,472 per metric tonne of sugar, against Rs 22,492 per metric tonne in the preceding year. In line with higher realisations, sugar volume sales rose to 930,000 tonnes from 670,000 tonnes previously. Other titbits which add to the turnover - methanol, industrial alcohol, molasses, and power are mere 'extras' in the overall scheme of things. From the manner in which matters are panning out however, the ground realities may get a trifle more difficult - but more on this later.
It was a trying year all right for the company. It registered a negative cash flow from operations of all things. That was primarily because of a sharp spurt in inventory holdings of finished stock as it was not able to download all that it produced in the marketplace. Production rose to over 1 m tonnes in 2009-10 from 490,000 tonnes previously. Whether the mismatch between what it produced and what it could sell was deliberate or not is not known - but the net effect is that stock valuations have rocketed. With the company also recording a negative cash flow from investing activities too, the company was forced to borrow large sums of money (Rs 16.7 bn) just to stay afloat. Consequently borrowings at year end ballooned to Rs 55.4 bn from Rs 30.7 bn previously. The flummoxing aspect here is how the company managed to peg the increase in interest outflow on debt to a mere Rs 355 m from Rs 283 m previously (excluding finance charges), in the context of the sharp increase in interest bearing borrowings. The point is also that the interest costs debited to the P&L account are already eating into earnings. In 2009-10 the interest paid out accounted for more than half the pre- interest profits.
The odd standouts
The other very odd standout aspect of the company's working is the fact that it boasted a gross block of Rs 65 bn at year end (excluding capital work in progress of Rs 930 m). Against this gross block value it could only log a gross turnover of Rs 30 bn in 2009-10. (Based on replacement cost, the gross block will be substantially higher.) The plant and machinery accounts for 73% of the gross block, while buildings take away another 17%. Okay, some of this gross block also goes to generate electricity and such like, but the mismatch is still very glaring. Is the sugar industry so acutely capital intensive? On top of this the management insists that sugar industry economics is purely the end product play of both the state advised price (SAP), and the free and remunerative price (FRP) fixed respectively by the state and central governments. But sugar producers have perforce to follow the dictates of the SAP. The price paid for sugarcane is also based on a sugar cane juice yield. Further; the open market price of sugar is largely determined by the sugar crop in Brazil. By all yardsticks this is one of the diciest organised sector businesses to get into.
Diversification into thermal power
As a way of insulating the company against the vagaries of the sugar industry cycle, the management has now come to the remarkable conclusion that the way forward is to go full tilt into power generation - and how! Currently it generates through co-generation facilities, 428 MW of power (with bagasse as raw material), the bulk of which is used for captive consumption. The new independent units will be coal fired power plants. In the first phase it will set up thermal units of 80 MW capacity each, at five of its plants and they will have an aggregate capacity of 400 MW. It will be subsequently raised to 90 MW each. The project cost of Rs 23 bn will be funded through a debt equity mix of 3:1. This capex will not feature as a division of the company. The assets so created will be spun off into an independent entity -Bajaj Energy Pvt. Ltd. The company will be a shareholder of this venture along with another undertaking of the group. No direct benefits will thus accrue to the company - barring any dividends if and when it is declared.
It gets even scarier as we go along. In what the company refers to as Phase 11, it will set up another power unit of 1,980 MW capacity and costing all of Rs 120 bn as of now. This venture will be kicked off through another subsidiary called Lalitpur Power Generation Company. The story gets even more intricate as the management gives full flight to its stated intentions. Phase 111 involves yet another power unit of 1,980 MW costing another Rs 120 bn through yet another legal entity. Here Bajaj Hindustan will hold a 26% stake in the venture. (As per the agreement with the UP state government the holding of Bajaj Hindustan in each of these three ventures will be at least 26% of the total capital base and they will also implement the three projects.)
Some thought on the diversification
That the company is thinking big in the power sector in the same manner as it thought when it was a pure play sugar manufacturer is one thing. (The merger of the subsidiary with the parent to project a more solid base was the first step in its diversification plans). Putting it all together is something else. Bajaj Hindustan will get no direct accounting or tax benefit from these proposed moves. And, at the same time, it will have to dish out large sums as its share of the capital base (one of the proposed ventures is a subsidiary of all things for the present). It will also have to stand guarantees for the humungous loans that the associate ventures will be contracting. On the other hand it will merely be the recipient of dividends if and when the newly floated ventures are in a position to declare them. In the meantime it will have to find the resources to keep the sugar division going at a hot pace. Then there is its move to acquire dedicated coal companies to supply feedstock to the thermal power units. That will involve another bundle of dosh and also includes incorporating companies outside the shores of Bharat.
It will be interesting to see how the company will put it all together. For, it will tax their mindsets to the very extreme. The company will be forced to issue additional permanent capital to finance the future cash flows, which infers that the management will have to rustle up their share of the additional capital. This may not be all that easy. It will have to flog the sugar plants to the hilt to get the maximum bang for the buck and hope to hell that sugar price realisations hold - but the latter is merely a game of chance. For the promoters it is nevertheless a big leg up regardless, as it increases the asset size of their group many folds. For the non management shareholders it may well be a very different tale in the making.
Disclosure: Please note that I hold 171 shares in this company
This column Cool Hand Luke is written by Luke Verghese. Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.
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