Khon Kaen Sugar Industries (KSL Group) is a well-established sugar manufacturer in Thailand. It is the fourth largest domestic producer and its market share of the industry stands at 7%. The company exports two-thirds of its sugar output to traders such as Cargill, Kerry, Tate & Lyle and Louis Dreyfus. It also sells sugar directly to food manufactures and counts Unilever, Dutch Mill and Kraft Foods among its customers. Other than sugar manufacturing, KSL Group is also involved in ethanol production, organic fertiliser and biomass electricity production. It operates a total of four sugar factories in three provinces: Khon Kaen, Kanchanaburi and Chonburi.
• KSL Group has a well-established presence in the private Thai sugar industry, being the fourth
largest sugar manufacturer in the country.
• It has diversified its businesses into ethanol production and electricity, so as to leverage off the Thai government's drive for alternative fuel sources, especially for vehicles.
• Relatively low product diversification despite efforts to expand downstream sugar activities.
• The company has a relatively high debt that could prevent it from embarking on further expansion activities, especially after its recent foray into Indochinese markets.
• Short-term weaknesses include Khon Kaen Sugar's poor hedging strategies, as seen in FY10, when unfavourable hedging positions mainly caused the 80% year-on-year fall in a net income despite a 3.4% rise in revenue.
• The company could further leverage off its strong expertise in the sugar industry to expand into overseas markets and further diversify earnings. Indeed, KSL Group has already established a presence in Laos and Cambodia and has made use of its wide trading network to start exporting from there.
• The company is well placed to tap Asia's booming sugar consumption and widening deficit, as Thailand is the only country in the region with Australia to produce consistent sugar surpluses.
• Khon Kaen is investing in downstream sugar activities such as ethanol and electricity generation, which can help it cushion the impact from volatile sugar business.
• Exposed to regulatory and operational risks of its sugar operations in Laos and Cambodia.
• KSL is vulnerable to Thailand's government control on prices, where food prices are a sensitive policy issue. A strong anti-inflationary macro policy could lead to capped sugar prices.
• Being a large exporter, the company is heavily exposed to international sugar price and foreign exchange fluctuations. Indeed, a strong Thai baht could hurt export earnings. We expect the Thai baht to depreciate towards the THB33.00/US$ mark by end-2012 and see the baht average THB32.50/US$ in 2013, compared to THB32.60/US$ in 2012.
| Limited Diversification |
|Khon Kaen - Revenues By Product (LHS) & By Region In FY11 (As % of total)|
Due to higher sugarcane crushing volumes and revenues from exporting operations out of Laos and Cambodia, KSL reported revenue of THB7.20bn in Q312 (May-July), up 15% quarter-on-quarter (q-o-q) and 24% year-on-year (y-o-y). Net profits came in at THB840mn, up 26% q-o-q and 6% y-o-y. Although gross margins stood at 25.8% and profit margins at 11.7% in Q312, down 11.7% and 32.0% y-o-y respectively, KSL's margins are still close to its peers' average.
| Average Margins |
|Select Companies - Operating (LHS) & Profit Margins (%)|
The results were driven by crushing capacity expansion, due to the commencing of the Bo Ploy project and by better profitability from the ethanol and power plant businesses. Total sugar production rose 16.1% y-o-y to 281,170 tonnes. Ethanol production soared by 152.4% y-o-y to 23.7mn litres, compensating lower average prices. Meanwhile, electricity production rose 39.0% y-o-y to 62,060 Megawatt/hour (MW/hr) and Thai electricity prices climbed by 18.5% y-o-y in Q312 to THB3,340/MW.
While there are many potential areas of growth for KSL in the medium term, coming from the expansion towards the downstream sector and the boom of sugar consumption in Asia, we believe that the company faces significant challenges to overcome in order to fully leverage on these opportunities. Thus, we hold a cautious outlook towards the company over the medium term.
| Surpluses Weighting On Prices |
|Sugar - Global Production Balance, Mn Tonnes (LHS) & Front-Month Sugar, USc/lb|
In the coming years, high crushing capacity due to the new sugar plants should partially offset lower sugar prices (we forecast ICE sugar prices to average USc21.50/lb in 2013 and USc20.00/lb in 2014, compared to USc22.00/lb in 2012) and support KSL's revenues. Given the new sugarcane production capacity from Bo Ploy of 4,000tonnes/day and Loei project of 16,000 tonnes/day, KSL's total production capacity in FY2013 would be 100,000 tonnes/day, up 25% from the current capacity. According to company guidance, KSL's sugar output is projected to increase by 9.5% y-o-y to 800,000 tonnes. This represents 7.3% of our forecast for Thailand's total production for 2012/13 of 11.0mn tonnes.
KSL's supply of sugarcane and production of sugar is likely to keep on increasing. In fact, we hold a positive view on Thailand's sugar sector, and see production rise by 31.8% to 13.4mn tonnes between 2011/12 and 2016/17. The Thai sugar industry's growth will endure in the coming years, as farmers increase acreage pushed by higher profitability, strong government support to the sector and good market prices. The sector will also benefit from Asia's ballooning sugar deficit. Various Asian countries, such as China, Indonesia, Bangladesh and Malaysia, have the potential to become major importers of sugar in the coming years, as production cannot keep up with soaring demand.
KSL's diversification towards the downstream industry should also help the company compensate for the volatility on its sugar business and increase its earnings in the coming years. The company announced in September 2012 plans to buy a beverage producer to expand its business line. Moreover, KSL will invest in order to expand its power plant's production capacity from 30 to 65MW capacity.
| Improving But Still Relatively High |
|Select Companies - Total Debt/EBITDA Ratio (LHS) & Interest Coverage Ratio|
However, we also note that unstable operating income growth and poor hedging strategies add to the risks to KSL's medium-term earnings potential. Fluctuating operating income growth suggests that the company's core sugar business is volatile. Indeed, between FY2007 and FY2011, operating income growth oscillated between -10.6% to 168.3% y-o-y despite continuously increases revenues. Although KSL reported losses from derivatives at THB17.8mn in FY2011, recovering from the abysmal losses of THB993.9mn from derivatives in FY2010, we continue to remain cautious on the company's hedging strategies.
KSL is comparatively less liquid, as both its current and cash ratios are significantly below its peers'. Lastly, KSL's increasing debt burden due to the company's expansionary activities gives us reason for caution. Although the total debt/EBITDA ratio has been decreasing since FY10, it remains high compared to KSL's peers, standing at 3.5 in Q312. However, we are not that concerned about this level of debt as the interest coverage ratio is comparatively high and stable.
KSL enjoys rather high efficiency, given its relatively high and increasing inventory turnover, and profitability, as both its operating and profits margins are high relative to its peers'. Moreover, the company has had positive and steadily growing cash flows from operations in the past six years as well as higher free cash flow/revenue ratios than its peers.
| Underperforming |
|Khon Kaen Sugar & SET Index, Rebased|
KSL's price to EBITDA (P/EBITDA) is relatively cheap, currently standing at 4.8x, and on a downtrend, as it was at 6.3x as of the beginning of January. São Martinho, Cosan and Shree Renuka's average is currently coming in at 3.8x, while the Bloomberg World Food Index's P/EBITDA is at 8.1x.
Khon Kaen share price is likely to continue trading in its wedge pattern. We expect the share price to bounce back in the coming weeks as we see strong support around the THB12.5 level. However, should it break through this multi-year support, the company's share price is likely to come to next support coming in at THB11.3.
| Testing Support |
|Khon Kaen Sugar Share Price (THB) & RSI (Below)|
Risks To Outlook
The risks to our outlook are weighted to the downside. Khon Kaen is highly exposed to Asian markets, where demand for sugar is more elastic than in developed countries. Further macroeconomic headwinds, as seen for example in China in 2012, could keep a lid on the company's performance and share price.
Moreover, CPF's share price could be dragged down by broader weakness on the Stock Exchange of Thailand Index (SETI) in the coming months. In fact, we see major downside potential for the SETI in the short term ( see 'SETI: The Hallmarks Of A Top', October 25, 2012, BMO Online).
Khon Kaen Sugar Industry PCL's Financial Highlights, 2007-2011
| || 2007 || 2008 || 2009 || 2010 || 2011 |
|*In THBmn. Source: BMI, Bloomberg |
| Revenues* ||8,916.9 ||11,056.0 ||11,671.0 ||12,071.3 ||16,459.8 |
| Revenues Growth ||42.4 ||24.0 ||5.6 ||3.4 ||36.4 |
| Operating Income* ||1,221.6 ||1,209.2 ||1,233.7 ||1,103.5 ||2,961.4 |
| Operating Margin ||13.7 ||10.9 ||10.6 ||9.1 ||18.0 |
| Net Income* ||835.9 ||859.5 ||919.6 ||158.7 ||1,889.9 |
| Profit Margin ||9.4 ||7.8 ||7.9 ||1.3 ||11.5 |
| Net Debt/EBITDA ||2.1 ||3.0 ||4.4 ||7.6 ||3.3 |
| Earnings Per Share (THB) ||0.5 ||0.6 ||0.6 ||0.1 ||1.2 |
| PE Ratio ||23.9 ||10.7 ||25.5 ||122.6 ||10.9 |