The world sugar price has recently risen close to last year's highs. Shares of the two large listed sugar producers, Illovo Sugar and Tongaat Hulett, have strongly outperformed the JSE's resources and industrial sectors over more than a year.
Illovo, which derives all its revenue and profits from sugar and associated activities, is the only pure sugar play on the local market, as it makes all its profits from cane growing, sugar and related products. Tongaat Hulett made just over half of its operating profit from sugar in the year to December, with the rest coming from starches (21%) and property development (23%).
Sugar prices on the world market have remained firm partly because supply from India, the second-biggest producer, has fallen. Exports from Brazil, the leading producer, have also slipped as more of its sugar cane crop has been used to generate energy.
Illovo CE Don MacLeod says world sugar consumption has grown at an annual rate of 2% for the past 50 years and at 2.5% in the past couple of years. With the global downturn, it is forecast to decline this year to about 1.5%, still considerably stronger growth than is likely for many industrial commodities.
“We are seeing a deficit of sugar in the world,” says MacLeod.
The two big SA producers have also gained from increased access to markets in Europe, which moved from being a net exporter of sugar to a net importer. The European Union reduced protection for local producers and provided for preferential imports from producers in “least developed” countries.
These producers have secured supply agreements to markets in Europe and are assured of prices at significant premiums to world prices. This has encouraged Illovo and, to a lesser extent, Tongaat Hulett, to invest in large expansions in low-cost regions in Africa.
“I expect we will supply more into Europe, which is our best market after the regional markets where we produce,” says MacLeod. “But the best thing about it is that we could do all our expansions with the price underpinned for six years.”
MacLeod, who retires this week (and becomes deputy chairman) after 17 years as CE, has overseen Illovo's expansion into Africa since the mid-1990s.
The group remains the largest local sugar producer, but in the half-year to September it made only 16% of its operating profit in SA. Its other operations are in Malawi (45% of profit), Zambia (16%), Swaziland (8%) Tanzania (10%) and Mozambique (5%).
Production costs in countries such as Malawi and Zambia are among the lowest in the world and growing yields are high. This leads to much better profit margins than could be attained in many other countries, including SA. Sugar cane is supplied from irrigated land, which reduces risk.
Illovo has expansion projects in all the countries in which it operates. One of its largest expansions reaches completion this week in Zambia, where the company's sugar production rises from 245t in 2007 to 450t.
Together, these expansions — with a new operation in Mali which starts production in 2011 — will increase Illovo's 2007 sugar output by almost 880000t, or 51%. MacLeod says he expects continuing growth for the company.
Tongaat Hulett is also expanding its sugar capacity, mainly in Mozambique, but has slowed its property development plans because of market conditions.
Based on p:e ratings, both shares are trading at significant premiums to the market but both are rated as buys on the I-Net Bridge consensus forecast.
Source: Financial Mail
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