Khairpur Sugar Mills Limited

Khairpur Sugar Mills Limited (PSX: KPUS) has been in operation since 1973, as an unregistered proprietorship/partnership unit. It was incorporated on August 23, 1989 as a public limited company followed by an IPO on Pakistan Stock Exchange (then Karachi Stock Exchange) in 1992.
The company commenced its commercial operations as a PLC three years later with production (crushing) capacity of 4,000 tons of canes per day (TCD). Principal activity of the company is manufacturing and selling of sugar and its by-products such as molasses and bagasse. Registered office of the company is situated in DHA area of Karachi, whereas mills are located in Kot Diji tehsil of Khairpur district in Sindh province.
Khairpur Sugar Mills began operations under plant and machinery licensed by Fives Call Babcock (FCB), one of the most noted industrial groups in France. Fifteen years into operation, the company decided to expand its capacity by undertaking BMR activities that led to increase in production capacity to up to 7,000TCD; this up gradation was completed in 2011. Today, it is one of the largest sugar crushing units in the province of Sindh and the largest amongst listed firms in the sector.
Biogas project of the company recently commenced operations. Biogas consists of waste produced during crushing of sugarcane, which is then used to produce ethanol. This is a grid-connected development which is powered by biogas engines obtained from General Electric, USA.
The sugarcane biogas plant provides onsite source of power to help mill's industrial operations to meet production requirements. The biogas used to fuel the plant is extracted from spent wash, a by-product of the ethanol production operation that uses sugarcane molasses as raw material. The plant is expected to achieve about 20,000 tons in emission reductions, annually certified under Kyoto Protocol.
Sponsor group and pattern of shareholding
Khairpur Sugar Mills is owned by Jumani group of companies, which is a reputable name in the real estate and construction business in Karachi. Its flagship entity, Arisha Enterprises (Pvt.) Limited is considered a construction magnate. During the last decade, the group has also entered the hospitality business, managing hotels in state of Florida, USA.
Khairpur Sugar Mills has a very tightly held structure, with close to 80 percent disclosed shareholding resting with sponsor family. Out of this, 69 percent is held with sponsor directors belonging to the Jumani family, whereas 4 percent is held with a director's dependent. An additional 6 percent is held with Allah Warayo Jumani, member of sponsor family not present on the BoD.
Other significant shareholding is held by Bankers Equity Limited, an investment bank with long term shareholding across several manufacturing sectors. BEL was established in 1979 with shareholding of SBP and five major nationalised banks to accelerate the pace of industrial development and expansion of local capital markets in the country.
No other institutional shareholders had any significant holding in the company as at balance sheet date. It is not disclosed whether the remainder six percent shareholding is held with general public or other members of sponsor family in smaller blocks. Due to the limited free float, there has been no trading in the stock since January 2018.
Sector analysis
During the year, price of sugarcane as set by provinces recorded no change over the previous year. The harvest season began (October 2017) with an opening stock of close to 2.5 million tons, highest ever in country history, and close to 46 percent of total domestic demand. Due to the high opening stock, Sindh government notified commencement of crushing season with a delay, beginning November 30th, 2018.
It should be recalled that while wholesale and retail prices of white sugar is not regulated, raw material prices are carefully controlled by the government through support price mechanism, which is notified by the provinces to support farming community.
At a time when price of white sugar has touched historic bottom (in real terms) in international market, indicative price of sugarcane is held high artificially that creates distortion in the market place. High support price encourages growers to increase sugarcane cultivation, which creates a supply glut in the market, even as demand for final product has been inching forward at snail's pace.
As a result, sugar mills have to rely on support from the government for dumping of excess supply in global commodity market. During MY18 alone, the subsidy cost the federal and provincial exchequers close to Rs24 billion in total.
As the country has recorded domestic production of sugar in excess of local demand for at least past seven years, seasonal increases in minimum support prices of sugarcane seem to have plateaued for at least past three crushing periods at Rs180 per maund (average for 3 crushing provinces).
Sugar mills from the province have eagerly contested the minimum price set by provincial departments in courts, petitioning that the price be lowered given the supply-demand dynamics of the crop. Upon court's intervention, millers made payment at Rs160 per maund to growers during MY17 season. As of March 2019, high court has asked the provincial government to review the price; however, for all intents and purposes, the crushing season has almost drawn to a close.
Due to the uncertainty on the support price for the past two seasons, sowing of sugarcane crop for the MY19 has finally lost the overdrive seen during past five years. With no further increase in sugarcane rate on the horizon for upcoming periods, it is expected that the crop is losing its momentum, with growers switching to alternate crops such as cotton.
Thus, white sugar rates are expected to stabilize in coming months, at least so far as the domestic market is concerned, as sugar production is expected to decline from historic level recorded in MY18.
Business analysis MY18
Based on disclosures in Director's report, back of the envelope calculations suggest that the company began its marketing year with close to 30,000 tons of white sugar in inventory. However, anticipating substantive subsidy on export from the government to offload sugar surplus in the domestic market and support farmers; the company ramped up production which reached highest ever, closing at 85,625 tons.
While the ECC announced export quota for export of up to 2 million tons for the sector, the company was not able to fully take advantage of the same as competing mills were able to secure orders more quickly. Out of total sale of close to 90,000 tons of sugar during the year, only 30 percent or 25,948 tons was to export market. Remaining stock sold was absorbed by customers in the domestic market, at an estimated selling price of Rs50-52 per kilo.
The company received government support on volume exported of Rs10.7 per kg by the federal government, which was on first come first avail basis on total allowable quota. In addition, additional freight support was announced by Sindh government only for mills located in the province of up to Rs9.3 per kilo for up to 20,000 tons only per milling unit.
Thus, one reason for below industry average share of exports in total sales could be that once the Rs20 per kg freight support was exhausted, export was not viable any longer. Note that selling price of sugar exported during the year by the company is estimated at Rs37.5 per kg.
During the period under review, Khairpur Sugar Mills operated for a total of 148 days, up from 140 days of sugarcane crushing during last year's operation. While the company reached record levels of production, crushing volume declined by a nominal three percent over last year due to improved sucrose recovery, which increased by 53bps from last year and was 32basis points higher than national average.
Based on industry standard operating cycle of 150 days, crushing capacity stood at 1.05 million metric tons; however, capacity utilisation only stands at 79 percent, down from 81 percent last year due to lower crushing.
Financial analysis
Ex-subsidy on exports, contribution margin remained very thin due to high cost of raw material consumed. On average, sugarcane constitutes 80 - 90 percent of production cost of final product. Thus, the company's gross profitability is adversely affected by high support price, especially since its top line is not adequately diversified in allied products.
At average sucrose recovery rate of 10 percent and minimum support price of Rs180 per 40 kg of sugarcane, raw material cost alone comes out at Rs45 per kg of sugar produced. Inclusive of manufacturing overheads ancillary to production process, average production cost hovers in the range of Rs50-55 per kg.
In contrast, average selling price in both domestic and exported market remain depressed, resulting in a barely positive gross margin of 1 percent.
However, top line grew significantly on the back of anticipation of government support on external front, which came in the form of Rs464 million in freight support. This is reflected in other income for the year, which takes EBIT margin to 6.4 percent, despite substantial year on year growth in distribution costs due to marketing for export orders.
However, cash flow position continues to be challenged as the government has released only 20 percent or Rs92 million out of total Rs464 million owed to the company in the form of subsidy.
Outlook
The crushing season has begun with a delay of two months, in first week of December 2018. As notified support price in Sindh and Punjab have remained unchanged at Rs182 and Rs180 per 40 kg respectively, crop size is expected to be 25 percent lower than last year.
So far, the federal government has not announced any subsidy on export quota of 1.1 million tons, due to which export during 1QMY19 remained very low at just 70,614 tons. While, industry expects respite in export following announcement of subsidy by government of Punjab for Rs5 per kg of export. However, it remains to be seen whether Sindh government will follow suit and announce subsidy for mills located in the province, as the political party in power is beleaguered by allegations of unfairly supporting sugar mills.

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Khairpur Sugar Mills Limited

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Rs (mn)                              MY18      MY17        YoY

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Sales                               4,237     2,933        44%

Cost of Sales                     (4,195)   (2,739)        53%

Gross Profit                           42       194       -78%

Administrative expenses             (185)     (130)        42%

Distribution Costs                   (78)      (17)       358%

Profit from operations              (221)        47      -572%

Other income                          503        12      4112%

Other expenses                       (10)       (0)

Earnings before interest & taxes      271        58       364%

Finance cost                        (179)     (169)         6%

Profit before tax                      92     (111)

Taxation                             (70)        17

Net profit for the period              22      (93)

EPS (Rs)                             1.39    (5.84)

GP margin                           0.99%     6.61%   -5.62 pp

Operating margin                   -5.22%     1.60%   -6.81 pp

EBIT margin                         6.40%     1.99%   +4.41 pp

PBT margin                          2.17%    -3.78%   +5.95 pp

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Source: Company accounts

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Pattern of Shareholding (as at September 30, 2018)

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Categories of Shareholders                                   %

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Directors & their dependants                             73.3%

Sponsor Family other than directors & dependants          6.0%

Significant Minority Shareholder: Banker's Equit         16.7%

Others including General Public                           4.0%

Total                                                   100.0%

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