Tongaat TON SJ
May 25, 2016 - 3:23pm EST by
bafana901
2016 2017
Price: 107.00 EPS 6.78 8
Shares Out. (in M): 135 P/E 15.7 13
Market Cap (in $M): 922 P/FCF 0 0
Net Debt (in $M): 338 EBIT 115 134
TEV ($): 1,259 TEV/EBIT 10.9 9

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  • Commodity exposure
  • South Africa
  • Africa
 

Description

I am recommending Tongaat (TGH JSE) as a buy. It is a simple reversion to the mean trade. The worst drought in 100 years has cut Tongaat’s sugar production to 1mil tons and profits from the sugar are down 80%.

 

The sugar business generated an operating profit of R1 400mil in 2013. In 2016, the profit was only R124mil. This is a bet that the rains will return and that sugar production will recover to 1.6mil tons per annum. There are signs that El Nino is lifting and hopefully the next set of results will begin to reflect a recovery.

 

Tongaat is currently trading at R107. My target price is R151. The high before the drought hit was R180.

 

 

 

DESCRIPTION

 

Tongaat consists of 3 operations

  • Sugar production (growing + milling) in South Africa, Zimbabwe, Mozambique and Swaziland.
  • Starch operation, operates the only wet mill in Africa
  • Land development, Tongaat have a land bank of 8 026 hectares earmarked for development. They plan to sell from 3 736 hectares over the next 5 years, 683hecates are currently under negotiation.

 

 

In the remainder of the report I describe and value these operations and derive the following SOTP value.

 

 

Land

12,000

Starch

6,580

Sugar

10,000

Minorities

(2,000)

Head Office

(850)

EV

25,730

Debt

(5,274)

Mcap

20,456

#shares

135

Target Price

151

 

 

The SOTP price is R151 representing a 41% upside on the current share price.

 

 

Price

107

#shares

135

Mcap

                           14,457

Net Debt

                            5,274

EV

                   19,731

 

 

 

 

 

 

 

SOTP VALUATION

 

 

 

The operating profits generated by the three operations are shown below.

 

 

 

   

 

Mar-16

Mar-15

Mar-14

Mar-13

Mar-12

Mar-11

Mar-10

Sugar operations – total

                                      124

                              806

                   908

               1,430

               1,428

                   840

               1,046

Starch operations

                                      658

                               561

                   482

                   388

                   363

                   303

                   251

Land Conversion and Developments

                                   1,115

                               829

               1,080

                   366

                   218

                   189

                   239

Central+Other Costs

-                     -89

-                  -107

-                  -96  

-                     -53

-                     88

                         6

-                     36

Consolidated total

                               1,808

               2,089

               2,374

               2,131

               1,921

               1,338

               1,500

 

 

 

 

Land Development

 

(Note: 1hectare=10 000m2=107 600ft2)

Tongaat’s land streches to the north and west of Durban, South Africa's busiest port. As Durban expands, agricultural land needs to be converted for urban use. Tongaat has earmarked 8 026 developable hectares for sale. The initial plan is to have 3 736 hectares ready for sale over the next 5 years.

 

 

 

The profit form land sold since 2007 is shown in the following table.

 

 

Average

 

Mar-16

Mar-15

Mar-14

Mar-13

Mar-12

Mar-11

Mar-10

Dec-08

Dec-07

Hectares Sold

                      130

 

121

108

259

65

42

144

169

181

83

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

                      671

 

awaiting

1087

1471

658

366

207

274

412

892

EBIT

533

 

1115

829

1080

366

218

189

239

285

476

margin

79%

 

 

76%

73%

56%

60%

91%

87%

69%

53%

 

 

 

 

 

 

 

 

 

 

 

 

Revenue/Hect

                        6.3

 

 

        10.1

           5.7

        10.1

           8.7

           1.4

           1.6

           2.3

        10.7

EBIT/HECT

                        4.7

 

           9.2

           7.7

           4.2

           5.6

           5.2

           1.3

           1.4

           1.6

           5.7

 

 

 

 

 

Valuation

 

·         The average profit/ha from sales is R4.7mil. This implies a total profit of R37bil for the 8 026 developable hectares compared to the R19bil EV. Even with severe haircuts it is not difficult to understand why many analysts conclude that investors get the sugar and starch operations for free.

 

·         Tongaat provide regular reports on their land bank. [http://www.tongaat.co.za/downloads/Land_Portfolio_Nov_2015.pdf] I have spent hours on these reports and feel comfortable that R5mil/ha profit is a fairly safe bet.  Assuming the historic margin of 79% holds, this implies a selling price of R6.3mil for a hectare of land.

 

·         How much is R6.3mil ($400k) per hectare? This is what a developer of a mall is prepared to pay for land to ensure the economic viability of the mall. Residential land goes for a lot more. In fact, over 35% of Tongaat’s land by value is located in the wealthiest part of Durban (Umhlanga) were land is sold for R30mil per hectare. (See appendix for a current list of land for sale in the Umhlanga area.)

 

·         Management are currently in negotiations to sell 658ha over the next two years. The estimated profit on these deals is R3.35bil, or just over R5mil per hectare.

 

·         For my SOTP valuation I value the land at R12 000mil using the following assumptions: sell 200ha per annum, selling price = R6.3mil/ha and a discount rate of 10%.

 

 

 

 

Starch

 

Tongaat operates the only maize wet mill operation in sub-Saharan Africa. The four wet-mills use 630 000 tons of maize per annum producing a wide range of products for the food and beverage industry as well as some industrial users (eg paper).

 

 

 

segment

Mar-16

Mar-15

Mar-14

Mar-13

Mar-12

Mar-11

Mar-10

Revenue

waiting

         3,447

         3,210

         2,859

         2,580

         2,357

         2,243

EBIT

658

            561

            482

            388

            363

            303

            251

Margin

 

16%

15%

14%

14%

13%

11%

 

 

 

 

 

 

 

 

g-Revenue

 

7%

12%

11%

9%

5%

 

g-EBIT

17%

16%

24%

7%

20%

21%

 

 

 

 

The starch business locks in long term cost-plus supply agreements with their clients. Profits have grown steadily as the operation benefitted from

 

  • Focus on higher margin products
  • Increasing utilization
  • Volume growth which has exceeding GDP growth.

 

 

I think the starch business deserves a premium ratings as

  • the operation has long term cost plus contracts
  • with defensive food and beverage customers
  • limited competition (only from imports if SA maize prices exceed world prices by a significant margin.)
  • Benefiting from economies of scale as utilization increases

 

 

 

Given the above,  I think an EV/EBIT multiple of 10 (equivalent to PE=14) is fair. This implies a value of R6 580mil for the starch operation.

 

 

 

 

Sugar Operations

 

Tongaat operate sugar operations in South Africa, Zimbabwe, Mozambique and Swaziland. The cane for the mills comes from a mix of their own farms and from external growers. Tongaat’s mill capacity is 2.1mil tons. (South Africa 1.2mil, Zimbbwe 0.6mil, Mozambique 0.3mil)

 

The sugar is typically sold in the local market and the balance is exported. The local market is protected by tariffs so the local prices are normally more attractive compared to the world price. The world price is regarded as a dumping price.

 

Until recently the EU paid a premium to the world price for sugar from Least Developed Countries (LDC’s) which included Mozambique, Zimbabwe and Swaziland. This premium has been falling putting pressure on export realisations for these countries.

The results of from the sugar operations are shown below.

 

 

 

Mar-16

Mar-15

Mar-14

Mar-13

Mar-12

Mar-11

Mar-10

Revenue

 

 

 

 

 

 

 

 Zimbabwe

 waiting

           3,471

           2,896

           3,222

           2,266

        1,646

           1,325

 South Africa

 waiting

           6,143

           6,224

                  5,739

                  5,269

        4,630

           4,381

 Mozambique

 waiting

           1,804

           1,704

           1,688

           1,437

           715

              447

 Swaziland

 waiting

              203

              211

              207

              163

           126

              133

 Sugar operations

 waiting

         11,621

         11,035

         10,856

                  9,135

        7,117

           6,286

               

EBIT

             

Zimbabwe

waiting

              386

              330

              625

              621

           454

              518

South Africa

waiting

              261

              340

              308

354

234

              336

Mozambique

waiting

              130

              168

              421

              402

           135

              141

Swaziland

waiting

                29

                70

                76

                51

             17

                51

Sugar operations

124

              806

              908

           1,430

                  1,428

                 840

                  1,046

               
               

Tons Produced

Mar-16

Mar-15

Mar-14

Mar-13

Mar-12

Mar-11

Mar-10

Zimbabwe

            412,000

            445,000

            488,000

            475,000

            372,000

       333,000

            259,000

South Africa

            323,000

            541,000

            634,000

            486,000

            486,000

       445,000

            564,000

Mozambique

            232,000

            271,000

            249,000

            235,000

            233,000

       166,000

            134,000

Swaziland

               56,000

               57,000

               53,000

               58,000

               59,000

          54,000

               54,000

 total

       1,023,000

       1,314,000

       1,424,000

       1,254,000

       1,150,000

       998,000

       1,011,000

 

 

 

 

 

Observations

 

·         El Nino has hurt the last two South African crops and production has fallen from 634 000 tons to 323 000 tons. This has depressed profits as very little sugar is left for exports after supplying the local market.

 

·         Mozambique and Zimbabwe sugar is irrigated and are only vulnerable to a drought if dam levels fall to dangerous levels.

 

·         Zimbabwe production is recovering from a drought and low dam levels in 2013. The operations are also adapting to the loss of the EU premium. Zimbabwean import tariffs are high and the operations benefited from a high local prices and limits on imports.

 

·         Mozambique operations have been hurt by the loss of the EU premium. In addition, import tariffs were not high enough to protect the local market from imports and Tongaat was forced to sell sugar at the low world price. Import tariffs have been raised to protect the local market which should benefit future profitability.

 

·         It is worth noting that Tongaat is the largest private company employer in Mozambique and Zimbabwe. Tariffs are important and are needed to protect these jobs.

 

 

Sugar Price

The sugar price reached a low of 10c/lb in Aug2015 and has recovered to a current 15c/lb. This should benefit both local and export prices of sugar in the various operations mitigating some of the losses from the drought.

 

 

Valuation

 

Illovo Sugar (ILV SJ), Tongaat’s main competitor, recently agreed to a take-over offer from British Foods. The offer valued ILV at 9 times it’s average 2015 to 2012 EBIT.

 

Using the same metric Tongaat’s sugar operations are valued at R10 000mil. (9*R 1 143mil). The minorities own 20% of the production and I estimate a R2 000mil value for the minorities.

 

The book value of the sugar assets is R20 000mil. The book value of the sugar crop alone is worth R5bil, so, the R10bil value is very conservative and is probably a fraction of the replacement cost of the mills.

 

 

Central Costs

 

I estimate central costs of R85mil per annum and knock R850mil off the valuation for head office costs.

 

 

 

CONCLUSION

 

 This a reversion to the mean trade and as experienced investors know timing is everything when making these bets. While it does appear that El Nino is lifting I do not recommend a full position until adequate rains have fallen as I believe there is lots of time to play the normalization of the weather. Tongaat report results on May30,2016. The news will not be good. I hope to build an initial position on weakness.

 

 

 

 

 

APPENDIX: LAND FOR SALE IN UMHLANGA

 

Below is a list of land currently for sale in Umhlanga. The list is drawn from the main on-line realtor site in South Africa.

 

http://www.property24.com/?gclid=Cj0KEQjwmpW6BRCf5sXp59_U_ssBEiQAGCV9GiIkDmi3F7LTUJ_dgcBljPPLHRiqG3uV44RJuKqkg_4aAvlf8P8HAQ

 

 

 Price(mil)

 m2

 Price/Ha(mil)

Umhlanga

                             7.50

               2,300

                                   33

Umhlanga

                          11.00

               1,155

                                   95

Umhlanga

                             4.00

               1,277

                                   31

Umhlanga

                             4.25

               1,500

                                   28

Umhlanga

                             6.95

               1,501

                                   46

Umhlanga

                             5.50

               1,433

                                   38

Umhlanga

                             4.50

               1,227

                                   37

Umhlanga

                             6.25

               1,181

                                   53

Izinga Ridge

                             2.00

                   800

                                   25

Izinga Ridge

                             3.90

               1,067

                                   37

Cornubia

                          16.00

            10,000

                                   16

Cornubia

                          14.70

               8,724

                                   17

Cornubia

                          13.40

               7,958

                                   17

Cornubia

                          12.60

               6,949

                                   18

 

 

 

 

 

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

Catalyst

Drought ends and rain returns

Continued recovery in the world sugar price

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