Download - Cavalry - CFA Institute · 2015-07-17 · a stake in Hippo Valley Estates. These operations are able to achieve sugar milling capacities of 600 000 tons. Zimbabwe’s geographical

Cavalry holdings This report is published for educational purposes only by students competing in the CFA South Africa Investment Research Challenge.

Important disclosures appear at the back of this report 1

Highlights over the past six months

Significant expected expansion in sugar production: Management intends to increase sugar production by 77.22% by the end of the 2009/2010 season.

Consolidation of Zimbabwean operations:

Following a shift to a Dollar and Rand based economy, Zimbabwean operations have been reinstated in the interim results through a large take-on gain.

World sugar price at an all-time high: Supply

shocks and increased demand have pushed sugar prices to unsustainable levels.

Biofuel production offers the potential

opportunity to move into energy industry: Ethanol production from sugar is a growing industry, yet true profitability lies beyond the analysts’ investment horizon.

Anglo American Ltd offloads their 49.5%

holding in Tongaat Hulett Ltd: Shock caused an instantaneous drop of 15% in market price, yet the entire bookbuild was quickly sold out.

Tongaat Hulett Ltd

25 September 2009

Ticker: TON Recommendation: BUY Target Share Price: R113.26 Current Share Price: R91.00 Upside Potential: 24.46%

Company Data Price R 91.00 Date of Price 25-Sep-09 Price Target R 113.26 Price Target End Date 25-Sep-10 52-week range R 102.55 - R 55.00 Market Cap R 9.56bn # Shares in issue 103,247,000 Beta 0.63

Shareholding

Top 5 Holdings 10.87%

Metlife 3.19%

Liberty Life 2.38%

PIC 1.85%

GEPF Equity 1.77%

Old Mutual Life 1.68%

Director Holdings 0.31%

EPS P/E P/BV ROA ROE Div Yield 2006A R 6.66 16.38 2.08 11.34% 15.92% 5.03% 2007A R 0.58 157.23 2.95 8.88% 9.19% 3.40% 2008A R 5.66 9.07 1.57 7.91% 9.72% 6.04% 2009E R 8.52 10.81 1.74 7.32% 17.91% 2.71%

Food Processing Sector

Source: McGregor BFA

Source: Cavalry Holdings research, company data



CFA South Africa Investment Research 9/25/2009 Challenge Student Research

2

Source: McGregor BFA with additions by Cavalry Holdings

Investment Summary The 2009 year has been very eventful for Tongaat Hulett Ltd. Tongaat has begun to reap the rewards of long-term investments in SADC countries. Furthermore, shifts in economic policy in Zimbabwe have resulted in the consolidation of Zimbabwean operations, which were previously excluded from the balance sheet. Zimbabwean consolidation In recent months, certain economic reforms were instituted in the Zimbabwean economy, which included a shift to a Rand and U.S. Dollar based monetary system. This has resulted in Tongaat being able to consolidate significant Zimbabwean assets in its financial statements. Anglo American Ltd offload On 12 August 2009, Anglo American Ltd announced the sale of its entire 49.5% stake in Tongaat Hulett Ltd. This immediately caused the market price of the Tongaat Hulett’s shares to drop by 15%. The analysts however conclude that the sale is related to Anglo American’s own liquidity and debt situation, and is not due to perceived overvaluation by Anglo American. The bookbuild was completed on 13 August 2009. Industry Analysis The global sugar industry is rife with distortion caused by protectionist measures, which can make global trade fairly challenging. In South Africa, the industry is dominated by a few large firms and will remain so due to insuperable barriers to entry. Global demand appears to be exhibiting an upwards trend, whilst global supply is being stunted by numerous external factors, such as weather. Another salient feature of the South African sugar industry is its low production costs, which bolster global competitiveness. Financial Analysis Analysis of the Tongaat’s financial statements indicates growing revenues, operating margins and cash flows, associated with expanded production. Leverage is being utilised in line with decreased costs of debt and the capital structure is well-managed. The company’s financial positioning appears fundamentally sound and conducive to growth. Investment Risks Political risk within Zimbabwe which could affect Tongaat Hulett’s Triangle Sugar subsidiary is considered a major concern associated with the company. The relevant risks associated with this operation include: exchange rate fluctuations, abnormal weather conditions, the volatile world sugar price and protectionism both within and beyond the South African context. Further causes for concern include property value, hedging risk and restructuring of the company Valuation A free cash flow to the firm model was utilised to calculate an intrinsic value of R 113.26. This was based on the planned 77.22% expansion in sugar production over the next two years, whilst accounting for the additional political risk associated with the Zimbabwean operations. Compared with the current market value of R 91.00, the derived intrinsic value indicates that the company is exceptionally undervalued. Conclusion Based on a complete fundamental value analysis, the analysts post a BUY recommendation with a 12-month target price of R 113.26.


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Valuation For the purposes of determining fair value, it was decided that a Free Cash Flow model would be most appropriate. The deciding factors included positive projected cash flows over the coming years, together with the expectation of revenue growth, due to the use of previously unutilised capacity. These factors could both be sufficiently incorporated into the FCF model. The reason for selecting Free Cash Flow to the Firm (FCFF) over Free Cash Flow to Equity (FCFE) was due to recent fluctuations in total leverage. Revenue Growth Over recent years the company has made significant investments in sugar cane and sugar production facilities in Southern Africa, primarily in its Zimbabwean and Mozambiquean operations. Management has repeatedly stated that it intends to increase production from 1,106,000 tons in 2008 to in excess of 1,960,000 tons by then end of the 2009/2010 season. This represents an increase in sugar production of 77.22%. However, the company has sufficient capacity to generate production in excess of these targets. The analysts prudently assumed that this capacity would only be achieved by the end of the 2010/2011 season – one year later than management’s expectations. Historically, 63% of Tongaat Hulett’s revenue stream is generated from sugar production. It was therefore decided to extrapolate a 77.22% increase in the 63% portion of revenue generated by sugar production over 3 years. As it was estimated that approximately 17.63% of the 77.22% excess will be utilized by the end of 2009, the remaining portion of 50.97% of growth was allocated as 22.87% to 2010 and 2011 respectively. It is assumed that after this period of above average growth, the growth rate of revenue will revert to the long term sustainable growth rate of 7.53%. EBIT Margin The EBIT margin for 2009, from the period of January until June, amounts to 22.06%, up from 17.15% in 2008. Both these margins are significantly above the historical average. This can be attributed to the relatively cheap sugar production within Zimbabwe and Mozambique. With the capacity expansion within both these markets, the analysts believe this trend is expected to continue. However, it is prudently assumed that this trend is ultimately unsustainable, and for the purposes of the model a constant average margin of 19% is used. Net Investment in Fixed Assets Following a period of large capital investment in Mozambique and Zimbabwe, net investment in fixed assets is expected to decline in the next three to five years.

Recommendation: BUY

Target Share Price: R113.26

Free cash flow to the Firm Model Estimate Estimate Estimate Estimate 2008 2009 2010 2011 2012 Revenue 7106000 8358840 9573855 10965482 11791183

Revenue growth% 11.12% 17.63% 14.54% 14.54% 7.53%

EBIT Margin 17.15% 22.00% 21.00% 21.00% 21.00%

EBIT 1,219,000 1,838,945 2,010,510 2,302,751 2,476,148

EBIT growth% N/A 50.86% 9.33% 14.54% 7.53%

Tax Rate 28% 28% 28% 28% 28%

Tax Expenditure -341,320 -514,905 -562,943 -644,770 -693,322

Depreciation 262,000 470,000 343,000 355,914 368,828

Net Investment in Fixed Assets 1,704,000 1,380,000 1,214,400 1,260,122 1,305,844

Change in Working Capital -83,000 167,000 115,615 119,974 124,332

Free Cash Flow to the Firm (FCFF) -481,320 247,040 460,552 633,799 721,478

FCFF/share -4.6618 2.3927 4.4607 6.1387 6.9879

#shares 103,247

Weighted Average Cost of Capital (WACC) 12.74%

Terminal Growth Rate (g) 7.53%

Intrinsic Value R 113.26

WACC 12.74% Cost Of Debt (after tax) 9.70% Cost Of Equity 14.99% Beta 0.63 Market Risk Premium 12% Risk Free Rate(R153) 7.43% Interest Bearing Debt to Equity ratio 0.74 Long Term Sustainable Growth Rate 7.53%





4


Weighted Average Cost of Capital (WACC) CAPM was used to derive a cost of equity of 14.99%, with a share premium above market consensus added to account for the additional political risk in the Zimbabwean operation. Cost of debt was calculated as 9.7%. The WACC amounts to 12.74%. Intrinsic Value Based on the FCFF model, which indicates that the share is highly undervalued, a BUY recommendation is issued with a twelve month exit price of R 113.26. Sensitivity Analysis of Intrinsic Value Included below is a sensitivity analysis, demonstrating the different intrinsic values calculated by the FCFF model, given changes in the assumed values of WACC and Long Term Sustainable Growth. Sensitivity Analysis of Intrinsic Value

Business Description The Tongaat Hulett Group was formed in 1982 when Tongaat Group Limited merged with Huletts Corporation Limited. The company was well diversified and operations were wide-ranging, and included the production of cotton, building materials, aluminium, sugar and numerous other operations. In 2007, The Tongaat Hulett Group subsequently divided into two separately listed companies; namely Tongaat Hulett and Hulamin. Tongaat Hulett is a leading large-scale agri-processing company involved primarily in the agricultural activities of sugar and starch production. The company is however well diversified and its business operations include land management and property development, electricity cogeneration and the production of bio-ethanol. Tongaat Hulett is the second largest sugar producer in South Africa and is also a major producer of starch and glucose on the African continent, converting more than 600 000 tons of maize into starch and starch-based products per annum. Tongaat has sugar operations in South Africa, Zimbabwe, Mozambique and Swaziland. Tongaat Hulett’s South African sugar operations are situated on the North Coast of KwaZulu-Natal and in the Zululand area. These operations comprise four sugar mills with the capacity to produce 1 million tons of sugar per annum. The Mozambiquean operation consists of fully irrigated sugar mills which are located in areas with optimal growing conditions and in proximity to ports. It is expected that sugar production in Mozambique will be more than 300 000 tons by 2010. Zimbabwean sugar operations are composed of Triangle and a stake in Hippo Valley Estates. These operations are able to achieve sugar milling capacities of 600 000 tons. Zimbabwe’s geographical endowments, irrigation systems and suitable climate lends itself to the low cost production of sugar, allowing Zimbabwe to be the cheapest producer of sugar in Africa. Tongaat owns the Huletts® and Voermol® brands. Tongaat Hulett has a primary listing on the JSE, and a secondary listing on the LSE.

Sustainable

Growth

6.5000% 6.7500% 7.0000% 7.2500% 7.53% 7.7500% 7.7500% 7.7500% 7.7500% 11.750% R 122.05 R 127.85 R 134.25 R 141.36 R 150.33 R 158.26 R 158.26 R 158.26 R 158.26

12.000% R 116.47 R 121.72 R 127.50 R 133.88 R 141.88 R 148.90 R 148.90 R 148.90 R 148.90

12.250% R 111.37 R 116.15 R 121.39 R 127.15 R 134.32 R 140.59 R 140.59 R 140.59 R 140.59

12.500% R 106.69 R 111.06 R 115.83 R 121.05 R 127.53 R 133.15 R 133.15 R 133.15 R 133.15

WACC 12.74% R 102.56 R 106.58 R 110.96 R 115.73 R 113.26 R 126.71 R 126.71 R 126.71 R 126.71

13.000% R 98.42 R 102.12 R 106.11 R 110.46 R 115.80 R 120.39 R 120.39 R 120.39 R 120.39

13.250% R 94.75 R 98.16 R 101.84 R 105.83 R 110.71 R 114.89 R 114.89 R 114.89 R 114.89

13.500% R 91.34 R 94.49 R 97.89 R 101.56 R 106.04 R 109.86 R 109.86 R 109.86 R 109.86

13.750% R 88.16 R 91.09 R 94.24 R 97.63 R 101.75 R 105.26 R 105.26 R 105.26 R 105.26


Tongaat Hulett

Sugar (70%)

Zimbabwe - R305m

South Africa - R171m

Swaziland - R34m

Mozambique - R134

Starch (27.8%)

Land Management and Property

Development (2.2.%)


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Other Headings Corporate Governance Composition and Independence of the board of directors 10 out of 13 (77%) directors are independent, in line with the global best practice recommendation of at least 75%. Independence of chairman The chairman of the board and the chief executive officer occupy two distinct portfolios. Having two different individuals in these positions (JB Magwaza and PH Staude) is considered strong corporate governance practice. Qualifications of directors All directors are highly qualified in their respective fields and most offer experience relevant to the industry Tongaat Hulett operates in. How the board is elected Staggered elections in conjunction with three year election periods are utilised to ensure board continuity. Annual elections would be preferable to avoid entrenchment and ensure that board members’ agendas are aligned with those of the shareholders. However, shareholders do have the power to discharge and replace board members at the annual general meeting; this is seen as a strong corporate governance policy. Board self-assessment practices Board effectiveness seems to be well assessed at annual intervals and attendance of board meetings is excellent. Frequency of separate sessions for independent directors No general meetings for independent board members without management attendance take place. It should be noted, however, that the Audit committee meets quarterly without the attendance of management, a strong corporate governance practice. The independence of other committees and the independent board members in general are however a point of concern, as global best practice recommends that independent board members meet, in the absence of management, at least annually. Audit committee The audit committee is comprised entirely of independent board members that meet at regular intervals, without the attendance of management. External and internal auditors report directly to the committee. Nominating committee The nominating committee consists primarily of independent board members, but the attendance of management by invitation creates a possible conflict of interest. Although one could argue that management’s input would be valuable in nominating possible directors, this practice is discouraged by the CFA Institute corporate governance manual. Compensation committee The compensation committee comprises only independent board members and meets at least 3 times a year; this is in line with global best practice. However, the attendance of the CEO by invitation creates a serious conflict of interest that should be addressed. Statement of governance policies The company exhibits a commitment to effective corporate governance by supplying a statement of corporate governance policies to the public. A code of ethics, director’s oversight, management responsibility, board self-assessment and management performance assessment is well defined within this material Disclosure and transparency The board seems to make a deliberate effort towards achieving the perception of transparency and audited financial results are of a high quality.

Source: WorldofStock.com


6

Conclusion The only real criticism of the company’s corporate governance policy is the attendance of certain committee meetings by the CEO. If it is common practice to excuse him when decisions need to be made, this is acceptable. In general the corporate governance policies and practices are excellent and comply with global best practice.

Biofuel Sustainability Biofuel is considered by many to be the solution to the worlds’ dependence on non-renewable fossil fuels, as well as a step towards decreasing carbon emissions. It is however possible that biofuel might not be as advantageous as expected and that continued production in biofuel might be globally pernicious. First generation biofuels constitute fuel made from food products, sugar cane, vegetable oil, animal fats and so forth. This is the type of fuel that Tongaat Hulett stands to benefit from due to the company’s sugar cane production. However, the production of this biofuel is contentious due to the fact that food which could otherwise be used to feed the world’s expanding population is instead being utilised within the more profitable arena of fuel production. Biofuel was one of the major contributors to the recent 75% increase in food prices. World hunger has escalated to encompass one sixth (approximately one billion people) of the world’s population and it is therefore apparent that biofuel production is a pertinent concern. Needless to say, for many under-utilised countries which are richly endowed with agricultural resources, the economic growth as well as job creation potential which could ensue from biofuel production could help to mitigate poverty. It is true that biofuels create fewer carbon emissions and that the plant materials used to create biofuels are renewable, but this does not mean that they are infinite. Furthermore, the use of biofuels to alleviate climate change and environmental concerns might be somewhat contradictory due to the deforestation and erosion which will ensue from crop expansion, and the fact that the agricultural industry is the largest consumer of water. Biofuel is however a young technology which requires further exploration. In the South African context, where fuel refining capacity is diminishing, the construction of biofuel refineries would be far less costly than building additional coal refineries. There would also be the added social and economic benefits of fuel security. Furthermore, Southern Africa is endowed with the climate and resources to develop the industry and was recently identified as an area with extensive biofuel potential (Smeets et al., 2007 in Von Maltitz & Brent, 2008:2). Mozambique was identified as the most promising country in tropical Africa for biomass production (Batidzirai et al., 2006 in Von Maltitz & Brent, 2008:3) which bodes well for Tongaat because the company already has production in these areas and plans for further expansion. Furthermore Mozambique, Zambia and Angola have the potential to meet all of the local liquid fuel needs as well as to maintain an export market in fuels and food produce. The salient question is whether there are sufficient financial incentives to warrant investment in the industry. Brazil, the major success story when it comes to biofuel, has shown that it is possible to create ethanol from sugar which is able to compete with crude oil and results in between 70 and 90 percent less CO2 emissions. Government intervention in the form of subsidies and incentives was however necessary to ensure the development of the biofuel industry. Further measures included compelling car manufactures to produce ethanol compliant cars (Grad, 2006 in Von Maltitz & Brent, 2008:2).

Source: EducatingAfrica.com


7

It is therefore the analysts’ opinion that the biofuel industry is in the developing stages within Southern Africa and is heavily reliant upon government intervention to gain a foothold and allow companies like Tongaat to take advantage of the new developing industry. Measures to expand the biofuel industry include the creation of local demand by forcing car manufactures to produce ethanol compliant cars. The following are reasons as to why the government might want to expand this industry: job creation, fuel security, reduction of foreign exchange expenditure and the development of rural farming economies. Possible hindrances include a short-term reduction in tax collected from imported fuels. In short it will require many years for the industry to take the necessary steps to derive great profits from biofuel. Although these gains are very tempting and promising they are beyond our investment horizon. It is for this reason that we have not accounted for their impact in our valuation model at this point in time. Industry Overview and Competitive Positioning Tongaat Hulett is listed on the JSE under the food-processing sector and the company’s core business undertakings entail sugar and starch production, as well as agricultural land conversion and development. Domestic and Global Overview Sugar South Africa The South African sugar industry currently generates an average of 2.3 million tons of sugar per season which engenders an estimated direct income of R7 billion annually.1 Surveys indicate that South Africa ranks fifteenth out of 100 global industries, in terms of cost competitiveness.2 The structure of the local sugar industry allows for an auspicious competitive advantage due to advanced agricultural practices, intensive research in the field, sound infrastructure and effective production strategies. These advantages are however hindered by subsidised production in foreign countries, high tariffs and tariff agreements between foreign countries, which make market penetration challenging. The major constituents of the South African sugar industry are Illovo, Tongaat Hulett, Crookes Brothers, TSB and a number of smaller producers. The Global Industry An investigation into the global sugar market is imperative due to the fact that South Africa is a major exporter. A report published by the Levin Institute in 2008 listed the following key global sugar producers: Brazil (18.6 percent), the EU (13.7 percent), India (13.3 percent), and China (7.2 percent).3 Brazil - Being the world’s largest sugar producer, Brazil has considerable impact on global prices. It is salient to note that approximately 55% of Brazil’s sugar cane crops are used for ethanol production.4 Brazil exhibits avidity with regards to ethanol production, and future increases in the amount of sugarcane utilised for ethanol could depress global sugar supply and cause price hikes. Brazil’s sugar industry was adversely affected by weather conditions this year, which have depressed supply. However, a larger portion of sugarcane has been allocated towards sugar production, as apposed to ethanol production this year, i.e. 43.33% in comparison with 40.07% last year. To reap the benefits of rising sugar prices, Brazil has invested in 23 new mills which should be operational by 2009/2010 and which will raise sugar production by 0.1 million to 38 million tons.5 This increase in global supply could reduce sugar prices in subsequent periods. India - India is usually an exporter of sugar, but due to an unfavourable monsoon season, production has diminished which has necessitated the import of sugar by India. The monsoon resulted in an 8 million ton decline in production, to 15 million tons. Furthermore, India has experienced a shift from sugar production to the cultivation of other crops due to volatile sugar prices and low prices paid to farmers for their sugar.6

Source: HealthLine


8

Starch South Africa In terms of the starch industry, the focus is directed towards maize, due to the fact that Tongaat only utilizes maize in its starch production. Maize is the most important grain crop in South Africa and had a Gross Value exceeding R11.5billion in 2006/2007.7 South Africa is self-sufficient in maize production and is usually a net exporter to neighbouring countries, but in 2006/07 and 2007/08 imports exceeded exports. Tongaat Hulett is one of the major producers of starch and starch based products in the country and the only wet miller. 73% of the maize market is composed of the following for dry millers: Premier Foods, Tiger Milling, Pioneer Food and Afgri.8 The Global Industry: Argentina, USA, China and Brazil are amongst the largest maize producing countries globally. An in-depth industry analysis will now be performed on Tongaat Hulett. Due to the company’s extensive sugar production, which accounts for approximately 70% of its operating profits, the focus will be directed towards sugar and the sugar industry in particular.

Industry Classification Industry life cycle position South Africa’s sugar output has remained constant at about 2.3 million tons per season.9 This is indicative of a mature industry with a few participants competing for market share. There however appears to be the possibility of a relapse into a growth phase due to increased global sugar demand and increased prices which could serve as incentive for Tongaat to expand production by making use of its unutilised capacity. The increasing interest in biofuel technology has also opened up opportunities to enter a growth industry. Globally, Brazil is set to expand production in 2009/2010 by investing in an additional 23 mills in order to meet increasing global demand. This indicates potential for an additional growth phase within the sugar industry. External factors Technology Global research is being conducted on biotechnologically enhanced sugar. Genetically modified sugar beet has already been documented to provide increased crop yields and improved production. These genetically modified crops are produced in 23 countries worldwide. Further research is being conducted on the genetic modification of sugar cane, which will include properties such as pest, herbicide and drought resistance as well as increased sugar content.10 Government Protectionism within the sugar industry has been prevalent since the 1800s. This is particularly true for the northern hemisphere where sugar is derived from sugar beet, instead of sugar cane, which is nearly twice as expensive.11 Protectionist measures include the subsidisation of production and the use of tariffs. In the EU, U.S. and Japan, and other foreign countries, sugar production is heavily subsidised. The EU allows duty-free sugar trade with 6 SADC countries, namely, Malawi, Mauritius, Swaziland, Tanzania, Zambia and Zimbabwe.12 Government intervention in South Africa within the sugar industry takes place through the following channels: Tariffs Protection is only applicable when the global sugar price drops below the long-term average. This protection system is dollar-based.

Source: Uwe Hermann


9

The (SADC) Sugar Co-operation Agreement: This agreement aims to promote the production and consumption of sugar in accordance with fair trade and to create a stable investment environment which is conducive to growth. It also seeks to engender production efficiency through education and training and to espouse global competitiveness of member-states. Lastly it aims to support small and medium firms and promote stable markets in order to attract FDI and create employment.13

Foreign The global supply of sugar is dominated by Brazil, the EU and India. These countries are able to exert significant influence on global prices due to their extensive sugar supplies and exports. The sugar industries within these countries have already been discussed extensively above. In short, the foreign industry has been experiencing a recent shortage in sugar supply, due to adverse weather conditions in Brazil and India. There also appears to be a shift from sugar cane crops towards more lucrative crops within India. In the U.S., the Agriculture Department expects a 43% drop in sugar supplies by 2010.14 As mentioned, the implementation of 23 mills which will take place in Brazil in 2009/2010 will increase global supply. Demand analysis End users Sugar is used as a production input in factories specialising in bread, confectionery, carbonated drinks and a myriad of other products. Furthermore, it is consumed globally by households. Increase in Demand In 2008/2009, global consumption of sugar exceeded global production, due to a combination of decreased supply as well as increased demand. It looks as though this trend in rising consumption is set to continue. According to the International Sugar Association, world demand is likely to exceed production by 5 million tons in the next season.15 Supply Analysis Degree of concentration The South African sugar industry has a Herfindahl-Hirschman Index of 0.288, indicating extreme concentration i.e. low levels of competition. The industry comprises 6 sugar producers with three of them, namely, Illovo, Tongaat-Hulett and TSB dominating the industry. A further look at the food industry in general, provides us with a Herfindahl-Hirschman Index of 0.271. Yet again, this indicates low levels of competition within the food industry, and the domination of a few large firms. The food producers with the highest market share include Tiger Brands, Illovo and Tongaat Hulett.

Ease of entry Gaining entry into the sugar industry is highly challenging. This is due to the extensive capital requirements which are imperative to the production of sugar. Secondly, the industry experiences supply-side economies of scale, which makes competition by newly established and smaller firms difficult. Lastly, participation within the industry requires specialised knowledge of planting, harvesting and production procedures. Industry capacity The sugar industry exhibits room for increased domestic supply due to unutilised capacity in South Africa and neighbouring countries. Illovo is involved in an expansion project in Swaziland which will see the establishment of 12 000 hectares of irrigated agricultural land over six to seven years. This project is expected to see an increase of 500 hectares of sugar cane by 2009/2010.16 Tongaat Hulett is also in the process of utilising existing milling capacity and expects sugar output to increase by 854 000 tons by 2009/2010.17 Furthermore, the plans to increase production in Brazil also indicate excess capacity.

Herfindahl-Hirschman Index

Sugar Producers %of industry

Illovo 904000 39.30% 0.154483

Tongaat 664000 28.87% 0.083345

TSB 500000 21.74% 0.047259

UCL 77333.33 3.36% 0.001131

Umfo 77333.33 3.36% 0.001131

Ushuke 77333.33 3.36% 0.001131 HHI

2300000 0.288479

Herfindahl-Hirschman Index

Food producers %of industry

Tongaat 14.60% 0.021316

Illovo 23.68% 0.056074

Tigar Brands 41.60% 0.173056

AVI 10.19% 0.010384

PNR Foods 9.90% 0.009801 HHI

0.270631




10

Profitability Supply and demand analysis

An examination of the world sugar balance highlights an increase in global sugar consumption from 2007/2008 to 2008/2009. Similarly, production has decreased by more than the increase in consumption. Cost factors South Africa utilises sugar cane in its production of sugar, which happens to be more cost effective than the sugar beet utilized by some foreign countries. This is due to the fact that sugar beet is a rotational crop, requiring approximately four times as much land in order to produce sugar quantities equatable with that of cane fields. Furthermore, sugar cane produces by-products which are used to fuel boilers, whereas by-products from sugar beet are unsuitable for this purpose.18 During 2008/2009, the effect of increases in input costs resulted in a 400 000 ton decline in sugar cane production in South Africa.19 Furthermore, it is reported that approximately 100 000 small-scale sugar cane producers had to shut down operations due to increasing input costs.20 In the 2008 period, the depreciation of the rand led to an increase in fertilizer costs of about 200%.21 Regardless of increasing input costs, the South African sugar industry has operations in Malawi, Zimbabwe, Swaziland, Zambia, South Africa, Mozambique and Tanzania. These are amongst the lowest cost producers in the world, which gives the South African sugar industry a considerable competitive advantage.

Pricing Due to relatively low production costs, the South African sugar industry is able to sell its sugar to the global market at competitive prices. This competitive advantage is however hindered by protectionism. To overcome this obstacle, South African firms channel their global exports through less developed countries, which are usually granted duty-free trading rights. The sugar price has reached a 28 year high, and if it remains that way due to increased global demand and reduced global supply, then the South African sugar industry stands to be very profitable owing to its low cost structure. Furthermore, due to low competition within the South African sugar industry, firms are able to set price levels, whilst consumers have only marginal power in this regard and are forced into a price taking position. Conclusion The global sugar industry is heavily distorted by trade subsidisation and tariffs. In the South African context, the sugar industry is highly concentrated and exhibits a paucity of competition. South African sugar firms exhibit a low cost structure due to production being outsourced to less developed countries. The global sugar industry has experienced a depression in supply, whilst demand seems to be on an upward trend. Demand is expected to increase in coming years, whilst countries such as Brazil and South Africa are already making efforts to expand production.

World Sugar Balance 2008/09 2007/08 Change Change m tonne, raw value m tonne % Production 161.527 168.611 -7.084 -4.20 Consumption 165.801 162.241 3.560 2.19

Surplus/Deficit -4.274 6.370 Import demand 49.621 45.948 3.673 7.99 Export availability 49.608 46.245 3.363 7.27 End Stocks 66.272 70.533 -4.261 -6.04 Stocks/Consumption ratio in%

39.97 43.47

Source: ISO quarterly market outlook, February 2009

Source: Illovo Sugar Limited




11

Financial Analysis For the purpose of financial statement analysis, reported results were adjusted to present what the analysts believe to be a more accurate representation of the firm’s financial position. Earnings, cash flow and balance sheet, and financing analysis follow. Earnings Earnings Quality The prevalence of irregular items in the company’s financial statements is the primary concern as to the quality of reported earnings. Adjustments made directly to equity, especially non-cash adjustments, needed to be considered unsustainable and removed for the purposes of earnings analysis. The take-on gain associated with the consolidation of Zimbabwean operations was included as an operating income in the June 2009 interim results. This once-off, non-cash result has been temporarily disregarded, as its inclusion would distort earnings analysis. Similarly, the capital gains profit on an insurance claim was removed from operating income. Though it is a cash income, it could never be considered a part of sustainable operations. Earnings Analysis Return on Equity ROE has increased despite the increases in equity from the consolidation of the Zimbabwean operations. This seems to reiterate statements by management that expanded sugar production in Zimbabwe and Mozambique is relatively cheap. Operating Margin The operating profit margin has substantially increased from the previous year, attributable to increases in sugar production in the relatively low-cost areas of Mozambique and Zimbabwe. This trend is expected to continue as the company plans to further increase production in these areas. Net Profit Margin Improved operating margins have trickled down into an improved net margin, though not to the same degree. This could be due to increased finance costs, as debt has substantially increased during the last financial year. Growing operating margins due to lower production costs are expected to continue having positive effects on net profit. Conclusion Even after the relevant adjustments, earnings appear to be of a high, measurable quality. Margins are improving and are expected to continue doing so in the next 3 to 5 years. Cash Flow Cash flow reporting quality The company’s cash flow reporting seems to be very prudent and adjustments were deemed unnecessary, with the exception of removing irregular cash items mentioned above. The seasonal nature of the company’s business sees the majority of positive cash flows occurring during the second have of the year. Cash Flow Analysis Debt to Cash flow The interest bearing debt to cash flow ratio has weakened from previous periods, attributable to increased leveraging. However, this situation is considered a temporary occurrence as significant cash flows from the Mozambique operations are expected to improve this ratio in the next financial reporting period.

Industry 09 Tongaat 2008 Tongaat 2009E

17.4314.47

17.91

ROE


20.76

14

22

Operating Profit Margin %


17.1

9.1612.77

Net Profit Margin %


12

Operating Cash Flow Ratio The operating cash flow ratio also weakened, indicating lower cash flow relative to current liabilities. As with the above ratio, this situation is expected to reverse and the trend is not considered a cause for concern. Conclusion Operating cash flows are growing and expected to continue doing so with the expansion of operations in the cheaper production areas of Zimbabwe and Mozambique. However, increased leveraging and associated finance costs are exerting pressure on cash flows and this situation will have to be carefully managed. Balance Sheet and Financing Balance sheet and financing reporting quality Balance sheet items that pose potential issues with misrepresentation, such as goodwill, pension benefit obligations, intangible assets and provisions, are disclosed transparently and conservatively. True economic expenses are simple to calculate from figures provided in the notes to the audited, full-year financial statements. Interim results were adjusted to remove intangible assets and goodwill. For the purposes of time series comparisons and making certain calculations, the consolidation of Zimbabwean operations was also removed. Where appropriate, such as the calculation of ROE or ROA, the Zimbabwean assets were included in the denominator, but the take-on gain was excluded from the numerator. The reporting of finance cost is generally transparent, with issues such as the nature of operating and finance leases disclosed in the notes to the financial statements. The interims however do not include these disclosures. It will be imperative to analyse the nature of large increases in short-term borrowings through 2009 once audited results are available. Balance Sheet and Financing Analysis Total Asset Turnover Total asset turnover has diminished since 2008, primarily due to Tongaat’s higher asset values, rather than lower revenues. Revenues have increased but not to the same order as asset values. This shift was primarily due to the consolidation and recognition of Zimbabwean assets. Gearing ratio (Debt/Equity) The company has been utilising increased leverage over recent years. The increased use of debt is the consequence of intense capital investment, but is expected to decline in coming years as capital expenditure requirements diminish. Current Ratio The current ratio has remained relatively stable, with assets nearly covering liabilities. The ratio remains more prudent than the industry average. Interest Coverage The increased operating (EBIT) margin has lead to an improved interest cover, despite significant increases in leverage. This can be attributed to the lower cost of debt associated with current interest rates. Conclusion Balance sheet and financing transparency is excellent and – after making the necessary adjustments – indicate that the company’s capital structure is stable and well-managed. Increased use of debt coincides with decreases in the cost of debt and is therefore considered to be the utilisation of an opportunity rather than a cause for concern.


0.640.75

0.62

Total Asset Turnover


0.99 1.111.44

Debt/ Equity


0.87

0.98

0.92

Current Ratio


4.794.19

5.63

Interest coverage


13

Conclusion The most noticeable shifts from previous reporting periods include increasing operating margins and leverage. Earnings and cash flows are increasing at a favourable rate. The company’s financial positioning appears fundamentally sound and conducive to the period of earnings growth that is expected over the next 3 to 5 years. Investment Risks Zimbabwean Operations Tongaat Hulett’s operations in Zimbabwe, which are vested in their subsidiary Triangle Sugar, and their sub-subsidiary Hippo Valley Estates, have come under much scrutiny in recent years due to the political unrest in Zimbabwe. The political upheaval has essentially caused the effective failure of the majority of agricultural and mining sectors within Zimbabwe. The collapse of the Zimbabwean financial system, as well as subsequent hyperinflation and exchange controls, resulted in the company having to write down much of its interests in Triangle Sugar. Income from the operation was accounted for on a dividend basis, whereby only currency received was recognised. However, during the first half of 2009, the formation of a national unity government, the switch to a ZAR Rand and U.S. Dollar economy and subsequent positive developments in currency control have prompted the company to consolidate their Zimbabwean operations back into the financial statements. This included a R1.969 billion take-on gain in the income statement. Zimbabwe is considered the African country that produces sugar at the cheapest rates, an immense opportunity in itself, and one understands why the company continues to pursue expansive operations in the country. Assuming that the current government continues to respect the property rights of sugar producers, the company’s expansion of production will continue. Political risk remains a concern in Zimbabwe. Recent discussions within government indicate the intention to nationalise mining operations. The situation will need to be monitored and the risk managed appropriately. To incorporate additional political risk of investment in Zimbabwe into the model, the equity risk premium was increased. Exchange rates Tongaat Hulett is exposed to considerable exchange rate risk, as a significant portion of both their sugar and maize produce is exported overseas. They benefit from a weaker Rand and are disadvantaged by a stronger Rand. The exchange rate movements could therefore have a huge effect on the companies’ future profits in either direction. Climate Unusual or extreme weather conditions, such as droughts or unexpected floods, have a significant effect on agriculture and the quality of the crop harvest in a given season. This could negatively affect future earnings. Given that the company’s sugar operations are situated in three distinct geographical areas, Tongaat Hulett is relatively diversified against the effects of adverse weather conditions. Restructuring Tongaat Hulett has a history of investing in operations other than its core agricultural base. Examples include operations in aluminium refinement (now unbundled) and more recently, property development. If the company were to continue this trend it could lead to a situation of excessive risk exposure. The argument for diversification benefits is invalid, as the investor chooses his/her own diversification and risk exposure, and usually does not expect the company to move beyond its core business.


14

Sugar Price The world sugar price affects the value of Tongaat Hulett’s exports and therefore its earnings. Recently, unfavourable weather conditions in Brazil have led to diminished global supply. Furthermore, adverse weather conditions in India have lead to poor harvests. These supply side shocks have contributed to the all time high in current world sugar prices. Although this situation will not reverse immediately, the advent of the 2010/2011 season should see prices normalise, especially with the expectation of expanded production in Brazil, as discussed above. The development and adaptation of biofuel, and the associated use of sugar in ethanol production, could however continue to put upward pressure on the world sugar price. Property Value A significant portion of Tongaat’s past revenue has come from Agricultural land development, averaging approximately 8% of profits from operations. This stream of revenue is subjugated to prevailing property market prices. The company does however follow a strategy when managing fluctuations in property values; they buy and develop during bearish market conditions and sell when property prices are higher. It is the analyst’s opinion that in the short term property prices will remain depressed, thereby limiting revenue from this area of operations within the 12-month investment horizon. Therefore, future income from property development has been kept constant within our model with no expectations of excessive gains in the near term. Protectionism The South African sugar industry is the only agricultural sector that has not been deregulated and still receives tariff protection. With a world sugar price that can be severely eroded by subsidy induced over production from some of the major sugar producing countries, losing this protection could be a major potential risk. The EU has tariffs on sugar imports to protect their own producers. Imports from LDC-status (Least Developed Countries) states are however exempt from these tariffs. Tongaat-Hulett exploits this situation by producing and exporting sugar from Mozambique and Zimbabwe, both LDC-status countries. Hedging Risk The company follows certain hedging strategies, which carry some risk. In 2003 poor decision-making caused hedging strategies to result in significant losses. More recently results have been generally positive, indicating that this strategy has been well managed. Model Risk The chosen model encompasses certain assumptions that, if violated, could compromise the accuracy of the calculated intrinsic value. A relatively high cost of equity is utilised in order to compensate for the relatively higher risk of investing in Zimbabwean operations. It is possible that the Zimbabwean operation might develop into a considerable success, as planned. In this case the conservative cost of equity would be inaccurate and the intrinsic value higher than calculated. Similarly, should biofuel development become a lucrative venture in the near future because of an as yet unknown supply shock or property values rise unexpectedly within the report’s time horizon, intrinsic value will be higher than the model currently indicates. Most of the revenue growth within the time horizon is expected to originate from sugar production, so any such restructuring would cause the model to be misspecified. The included sensitivity analysis can be used as a guide to gauge the possible effect of misspecification.

Source: London International Financial Futures and Options Exchange


15

Figure 1: Adjusted Interim Income Statement in millions

Tongaat Hulett Ltd Adjusted Adjusted

Unaudited Unaudited Unaudited Unaudited Half-year Half-year Half-year Half-year 30 June 30 June 30 June 30 June 2009 2008 2009 2008 Revenue 3852 3109 3852 3109 Profit from operations 864 443 864 443 Capital profit on land 2 15 2 15 Capital profit on insurance claim 12 0 BEE IFRS 2 charge and transaction costs -15 -17 -15 -17 Zimbabwe consolidation take-on gain 1969 0 Valuation adjustments -1 6 -1 6

Operating profit 2831 447 850 447 Share of associate company's profit 1 1 Net financing costs -151 -85 -151 -85

Profit Before tax 2681 362 700 362 Tax -208 -84 -208 -84

Net Profit for the period 2473 278 492 278

Profit Attributable to: Shareholders of Tongaat Hulett 2419 266 481.2567732 266 Minority (non-controlling) interest 54 12 10.74322685 12

2473 278 492 278

Headline earnings attributable to

Tongaat Hulett shareholders 440 252 440 252

Source: Company Documents, Student Estimates


16

Figure 2: Adjusted Interim Balance Sheet in millions

Tongaat Hulett Ltd Adjusted Adjusted Unaudited Unaudited Unaudited Unaudited Half-year Half-year Half-year Half-year 30 June 30 June 30 June 30 June 2009 2008 2009 2008 ASSETS Non-Current Assets Property, plant and equipment 7696 3855 5288 3870 Growing crops 1517 575 1030 575 Long-term receivable 196 196 196 196 Goodwill 255 86 0 0 Intangible assets 5 5 0 0 Investments 7 267 7 267

9676 4984 6521 4908 Current Assets 3767 3920 3536 3920

Inventories 1605 1207 1605 1207 Trade and other receivables 1922 2310 1922 2310 Derivative instruments 22 21 22 21 Tax 65 65 Cash and cash equivalents 218 317 121 317 Working capital adjustment -134

TOTAL ASSETS 13443 8904 10057 8828

EQUITY AND LIABILITY Capital and reserves Share capital 138 138 138 138 share premium 1512 1503 1512 1503 BEE held consolidation shares -1009 -1038 -1009 -1038 Retained income 4335 1884 2366 1884 Other reserves -370 384 29 384 Equity adjustment -96 -91

Shareholders' interest 4606 2871 2940 2780 Minority interest in subsidiaries 889 247 247 247

Equity 5495 3118 3187 3027 Non-current liabilities 4089 2564 3011 2579

Deferred tax 1562 688 666 688 Long-term borrowing 1263 806 1263 806 Non-recourse equity-settled BEE borrowings 780 803 780 803 Provisions 484 267 286 267 Capitalised operating leases 16 15


17


Current liabilities 3859 3222 3859 3222

Trade and other payables 1781 1862 1781 1862 Short-term borrowings 2019 1350 2019 1350 Derivative instruments 2 2 Tax 57 10 57 10

TOTAL EQUITY AND LIABILITIES 13443 8904 10057 8828


18

Figure 3: Adjusted Interim Statement of Cash Flows in millions

Tongaat Hulett Ltd Unaudited Unaudited Half-year Half-year 30 June 30 June 2009 2008 Operating profit 2831 447 Profit on disposal of property -14 -15 Non-cash items: Depreciation 235 120 Other non-cash items -2509 -200 Tax payments -123 -99 Change in working capital -167 -73

Cash flow from operations 253 180 Net Financing costs -151 -84

Cash flow from operations 102 96 Expenditure on property, plant and equipment: New -559 -437 Replacement -98 -163 Major plant overhaul costs capitalised -31 -38 Expenditure on intangible assets Expenditure on growing crops -23 -26 Proceeds on disposal of p, p and e 17 16 Investments 4 -54 Long-term receivable 7

Net cash flow before dividends and financing activities -588 -599 Dividends paid -166 -175

Net cash flow before financing activities -754 -774 Borrowings raised 727 668 Non-recourse equity-settled BEE borrowings -12 -9 Shares issued 6 5 Settlement of share-based payment awards -8 -9

Net decrease in cash and cash equivalents -41 -119 Balance at beginning of period 229 396 Foreign exchange adjustment -38 27 Exchange rate translation (loss)/gain -1 13 Subsidiaries consolidated 69

Cash and cash equivalents at the end of period 218 317



19

Figure 4: Income Statement in millions Year 2008 2007 2006 2005 2004

Months Covered 12 12 12 12 12

Year End Month Dec Dec Dec Dec Dec

Income Statement (000) ZAR ZAR ZAR ZAR ZAR

051 Turnover 7,106,000 8,043,000 7,848,000 6,926,000 6,298,000

052 Change In Turnover % 11 2 13 10 -4

053 Cost Of Sales 5,578,000 5,072,000 6,168,000 5,218,000 4,972,000

054 Trading Profit 1,219,000 1,144,000 1,349,000 1,062,000 667,596

055 Interest Received 45,000 74,000 126,000 71,000 182,000

056 Income Unlisted Investment 0 0 3,000 0 6,000

057 Income Listed Investment 0 0 0 0 0

058 Income Unconsolidated Subsidiaries

35,000 53,000 61,000 19,000 51,000

059 Total Income Investment 80,000 127,000 190,000 90,000 239,000

060 Surplus Sale Investment 2,000 -4,000 -1,000 6,000 51,000

061 Surplus Sale Non Trading Assets 19,000 48,000 28,000 12,000 22,000

062 Extraordinary Profits 203,000 3,046,000 -54,000 -74,000 -97,000

063 Total Profits Extraordinary Nature 224,000 3,090,000 -27,000 -56,000 -24,000

064 Auditors Remuneration And Costs 8,000 6,000 6,000 7,000 6,000

065 Depreciation Other Fixed Assets 233,000 213,000 260,000 254,000 220,000

066 Depreciation Land And Buildings 11,000 9,000 12,000 11,000 11,000

067 Rental Fixed Assets 16,000 11,000 13,000 16,000 14,000

068 Directors Remuneration: Direct 3,000 2,000 2,000 2,000 773

069 Directors Remuneration: Other 18,000 93,000 55,000 29,000 23,823

070 Management And Other Services 15,000 20,000 17,000 13,000 15,000

071 Total Cost Shown 304,000 354,000 365,000 332,000 290,596

054 Trading Profit 1,219,000 1,144,000 1,349,000 1,062,000 667,596

059 Total Income Investment 80,000 127,000 190,000 90,000 239,000

063 Total Profits Extraordinary Nature 224,000 3,090,000 -27,000 -56,000 -24,000

072 Total Income 1,523,000 4,361,000 1,512,000 1,096,000 882,596

071 Total Cost Shown 304,000 354,000 365,000 332,000 290,596

073 Profit Before Interest And Tax (EBIT)

1,219,000 4,007,000 1,147,000 764,000 592,000

074 Total Interest Paid 325,000 216,000 149,000 131,000 275,000

075 Profit Before Taxation 894,000 3,791,000 998,000 633,000 317,000

076 Taxation 243,000 243,000 151,000 62,000 53,000

077 Profit After Taxation 651,000 3,548,000 847,000 571,000 264,000

078 Minority Interest In Profit 31,000 28,000 1,000 0 10,000


20

079 Profit to Ordinary And Preference Shareholders

620,000 3,520,000 846,000 571,000 254,000

080 Ordinary Dividend 320,000 320,000 585,000 415,000 174,000

081 Preference Dividend 0 0 0 0 0

082 Retained Profits 300,000 3,200,000 261,000 156,000 80,000

083 Earnings Before Interest, Tax, Depreciation And Amortisation (EBITDA)

1,465,000 4,229,000 1,420,000 1,030,000 825,000



21

Figure 5: Balance Sheet in millions Year 2008 2007 2006 2005 2004



Balance Sheet (000) ZAR ZAR ZAR ZAR ZAR

001 Ordinary Share Capital 103,000 138,000 107,000 104,000 102,000

002 Non Distributable Reserves 869,000 801,000 982,000 882,000 828,000

003 Distributable Reserves 2,514,000 2,304,000 4,550,000 4,272,000 4,158,000

004 Cost Of Control 99,000 42,000 21,000 21,000 35,000

005 Intangible Assets 6,000 6,000 14,000 12,000 0

006 Ordinary Shareholders Interest 3,381,000 3,195,000 5,604,000 5,225,000 5,053,000

007 Minority Interest 276,000 223,000 76,000 75,000 71,000

008 Preference Share Capital 843,000 865,000 0 0 0

009 Total Owners Interest 4,500,000 4,283,000 5,680,000 5,300,000 5,124,000

010 Land And Buildings 1,888,000 1,258,000 1,146,000 1,120,000 1,156,000

011 Total Depreciation: Land and Buildings

209,000 176,000 141,000 129,000 127,000

012 Cost Other Fixed Assets 5,721,000 4,302,000 5,361,000 5,045,000 4,840,000

013 Total Depreciation: Other Fixed Assets

1,802,000 1,590,000 1,723,000 1,559,000 1,347,000

014 Total Fixed Assets 5,598,000 3,794,000 4,643,000 4,477,000 4,522,000

015 Long Term Loans Advanced 199,000 206,000 260,000 236,000 406,000

016 Unlisted Investments 265,000 264,000 263,000 24,000 15,000

017 Shares In Unconsolidated Subsidiaries

0 0 0 0 0

018 Listed Investments 0 0 0 0 0

019 Total Long Term Investments 464,000 470,000 523,000 260,000 421,000

020 Total Long Term Assets 6,062,000 4,264,000 5,166,000 4,737,000 4,943,000

021 Secured Long Term Borrowings 71,000 60,000 3,000 3,000 3,000

022 Debentures 0 0 0 0 0

023 Other Long Term Borrowings 1,420,000 611,000 343,000 418,000 727,000

024 Total Long Term Loan Capital 1,491,000 671,000 346,000 421,000 730,000

025 Net Investment in Long Term Assets

4,571,000 3,593,000 4,820,000 4,316,000 4,213,000

026 Total Inventory 1,512,000 1,100,000 1,434,000 1,254,000 1,427,000

027 Debtors 1,647,000 1,742,000 1,879,000 1,337,000 1,106,000

028 Short Term Loans Advances 53,000 65,000 33,000 41,000 0

029 Cash And Bank 229,000 396,000 509,000 526,000 803,000

030 Other Current Assets 0 25,000 0 0 0

031 Total Current Assets 3,441,000 3,328,000 3,855,000 3,158,000 3,336,000


22

032 Short Term Borrowings 464,000 165,000 1,258,000 796,000 1,314,000

033 Creditors 1,476,000 1,331,000 1,258,000 1,009,000 953,000

034 Bank Overdraft 1,305,000 977,000 62,000 34,000 29,000

035 Provision For Taxation 112,000 0 44,000 44,000 6,000

036 Provision For Distribution 155,000 165,000 373,000 291,000 123,000

037 Total Current Liabilities 3,512,000 2,638,000 2,995,000 2,174,000 2,425,000

038 Net Current Assets -71,000 690,000 860,000 984,000 911,000

039 Net Assets 4,500,000 4,283,000 5,680,000 5,300,000 5,124,000

042 Surplus Value Over Bookvalue of Investment

0 0 0 0 0

040 Total Assets 9,503,000 7,592,000 9,021,000 7,895,000 8,279,000

041 Operating Assets 8,986,000 7,057,000 8,465,000 7,594,000 7,858,000



23

Figure 6: Statement of Cash Flows in millions Year 2008 2007 2006 2005 2004



Cash Flow Statement (000) ZAR ZAR ZAR ZAR ZAR

701 Operating Profit/loss 748,000 330,000 841,000 618,000 317,000

702 Depreciation & Non Cash-items 262,000 587,000 286,000 279,000 289,000

703 Cash Ex Operations 1,010,000 917,000 1,127,000 897,000 606,000

704 Investment Income 35,000 53,000 61,000 0 0

705 Other Income 0 0 0 0 0

706 Decrease/increase Working Capital 83,000 -175,000 -407,000 -109,000 -203,000

707 Decrease/increase Inventory -366,000 -216,000 -115,000 169,000 123,000

708 Decrease/increase Accounts Receivable

96,000 -276,000 -558,000 -231,000 63,000

709 Increase/decrease Accounts Payable

353,000 317,000 266,000 -47,000 -389,000

710 Increase/decrease Interest-free Loans

0 0 0 0 0

711 Cash Ex Operating Activity 1,128,000 795,000 781,000 788,000 403,000

712 Net Interest Paid/received 280,000 119,000 23,000 0 93,000

713 Taxation Paid 163,000 293,000 152,000 0 71,000

714 Cash Available 685,000 383,000 606,000 788,000 239,000

715 Ordinary Dividend 355,000 551,000 506,000 247,000 132,000

716 Preference Dividend 0 0 0 0 0

717 Net Retained Cash 330,000 -168,000 100,000 541,000 107,000

718 Cash Invested 1,800,000 857,000 742,000 381,000 210,000

719 Fixed Assets Acquired 1,578,000 759,000 485,000 309,000 191,000

720 Increase In Investments 0 2,000 257,000 72,000 19,000

721 Net Investment In Subsidiaries/ Businesses

55,000 0 0 0 0

722 Other Expenses/losses 167,000 96,000 0 0 0

723 Cash Ex Investment Activities 96,000 58,000 85,000 47,000 64,000

724 Proceeds Disposal Fixed Assets 96,000 58,000 85,000 42,000 64,000

725 Proceeds Disposal Investment 0 0 0 0 0

726 Other Proceeds 0 0 0 5,000 0

727 Cash Generated -1,374,000 -967,000 -557,000 207,000 -39,000

728 Increase/decrease Long-Term Liabilities

1,167,000 1,542,000 377,000 -560,000 51,000

729 Increase/decrease Short-Term Liabilities

231,000 -174,000 74,000 291,000 -42,000

730 Change In Share Capital -24,000 -401,000 106,000 62,000 30,000

731 Other (Cash Generated) 0 0 0 0 0

732 Cash Utilised 1,374,000 967,000 557,000 -207,000 39,000



24

Endnotes 1 South African Sugar Association. Industry Overview. [Online] Available from: http://www.sasa.org.za/IndustryOverview43.aspx [Accessed: 2009-09-25]. 2 South African Sugar Association. Market Competitiveness. [Online] Available from: http://www.sasa.org.za/MarketCompetitiveness44.aspx [Accessed: 2009-09-25]. 3 The Levin Institute. 2008. Globalization01.org. Global Sugar Trade. [Online] Available from: http://www.globalization101.org/index.php?file=news1&id=105 [Accessed: 2009-09-25]. 4 Renewable Energy World. 2009. Brazil's 2009 Ethanol Production Volume Set to Break Records. [Online] Available from: http://www.renewableenergyworld.com/rea/news/article/2009/09/brazils-2009-ethanol-production-set-to-break-records [Accessed: 2009-09-25]. 5 Indian Sugar Mills Association. 2009. World Sugar Market Review. [Online] Available from: http://www.indiansugar.com/briefings/wsm.htm [Accessed: 2009-09-25]. 6 Russia Today. 2009. Indian Sugar Industry in Difficult Times. [Online] Available from: http://www.russiatoday.com/Top_News/2009-09-21/indian-sugar-industry-bitter.html [Accessed: 2009-09-25]. 7Department of Agriculture and Land Reform. 2007. Maize Industry. Situational Analyses, Market Indicators and Outlook for 2008 Season. [Online] Available from: http://www.agrinc.gov.za/docs/Maize%20Outlook%202008.pdf [Accessed: 2009-09-25]. 8 Barnett, J.L. 2004. Growth Strategies for the South African Maize Industry, CSIR, 4:23-24. 9 Indian Sugar Mills Association. 2009. World Sugar Market Review. [Online] Available from: http://www.indiansugar.com/briefings/wsm.htm [Accessed: 2009-09-25]. 10 AgriFood Awareness Australia Limited. 2008. Biotechnology and Sugar Research. [Online] Available from: www.afaa.com.au/resource_guides/Biotech_Sugar_Research [Accessed: 2009-09-25] 11 Mitchell, D.O. 2005. Sugar Policies: An Opportunity for Change. In: Aksoy, M.A. & Beghin, J.C. (eds.) Agricultural Trade and Developing Countries. Washington DC, The World Bank. [Online] Available from: http://books.google.com/books?hl=en&lr=&id=Fm3bqFbXIEIC&oi=fnd&pg=PA141&dq=sugar+cane+vs+sugar+beet&ots=b1c2Cl-yja&sig=FQRe5rN6Pn6kujgJLv9ZvyfQQg0#v=onepage&q=&f=false [Accessed: 2009-09-25]. 12 Sandrey, R. and Vink, N. 2007. Future prospects for African sugar: sweet or sour? tralac Working Paper No 11. [Online] Available: www.tralac.co.za. [Accessed: 2009-09-25]. 13 South African Sugar Association. Market Competitiveness. [Online] Available from: http://www.sasa.org.za/MarketCompetitiveness44.aspx [Accessed: 2009-09-25]. 14 Kilman, S., Cui, C. & Brat, I. 2009. The Wall Street Journal. Food Firms Warn of Sugar Shortage. [Online] Available from: http://online.wsj.com/article/SB125011957488227095.html [Accessed: 2009-09-25]. 15 Singh, S.D., Carpenter, C. & Parija, P. 2009. Business Day: World Heading for Sugar Shortage. [Online] Available from: http://www.businessday.co.za/articles/Content.aspx?id=78136 [Accessed: 2009-09-25]. 16 Illovo Sugar Limited. 2009. News. On the Future Expansion Front. [Online] Available from: http://www.illovosugar.com/News/Archived_News.aspx [Accessed: 2009-09-25]. 17 Tongaat Hulett. 2009. Introduction. [Online] Available from: http://www.tongaat.co.za/au/introduction.asp [Accessed: 2009-09-25]. 18 Sugar Knowledge International. 2009. How Beet Sugar is Made. [Online] Available from: http://www.sucrose.com/lbeet.html [Accessed: 2009-09-25]. 19 Indian Sugar Mills Association. 2009. World Sugar Market Review. [Online] Available from: http://www.indiansugar.com/briefings/wsm.htm [Accessed: 2009-09-25]. 20 Food and Beverage Reporter. 2009. Sugar production and small-scale growers under stress. [Online] Available from: http://www.developtechnology.co.za/index.php?option=com_content&task=view&id=22648&Itemid=63 [Accessed: 2009-09-25].


25

21 Jackson, A. 2008. Media Group. International Prices Lead to Pressure on Sugar industry. [Online] Available from: http://www.mediagroup.co.za/archive/stories/sugar.htm [Accessed: 2009-09-25].

Further References Amigun, B., Sigamoney, R. & Von Blottnitz, H. 2006. Commercialisation of biofuel industry in Africa: A review. Renewable and Sustainable Energy Reviews,12 (2008) 690–711. [Online] Available from: Science Direct: www.sciencedirect.com [Accessed: 2009-09-25]. Hermann, U. Sugar Cube Image. [Online] Available from: http://www.flickr.com/photos/uwehermann/132244825/ [Accessed: 2009-09-25]. Illovo Sugar Limited [Online] Available from: http://www.illovosugar.com/Home.aspx [Accessed: 2009-09-25]. McGregor BFA. [Online] Available from: http://www.mcgregorbfa.com/ [Accessed: 2009-09-25]. Southern African Biofuels Association. 2007. Comments on the Draft National Biofuels Strategy. [Online] Available from: http://www.saba.za.org/site/ [Accessed: 2009-09-25]. Tongaat Hulett. [Online] Available from: http://www.tongaat.co.za/ [Accessed: 2009-09-25]. Von Maltitz, G.P. & Brent, A. 2008. Assessing the Biofuel Options for Southern Africa. [Online] Available from: http://www.ceepa.co.za/docs/Biofuel%20Potential%20in%20Southern%20Africa%20Von%20Maltitz%20Brent.pdf [Accessed: 2009-09-25].


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Disclosures: Ownership and material conflicts of interest: The author(s), or a member of their household, of this report [holds/does not hold] a financial interest in the securities of this company. The author(s), or a member of their household, of this report [knows/does not know] of the existence of any conflicts of interest that might bias the content or publication of this report. [The conflict of interest is…] Receipt of compensation: Compensation of the author(s) of this report is not based on investment banking revenue. Position as a officer or director: The author(s), or a member of their household, does [not] serves as an officer, director or advisory board member of the subject company. Market making: The author(s) does [not] act as a market maker in the subject company’s securities. Ratings guide: Banks rate companies as either a BUY, HOLD or SELL. A BUY rating is given when the security is expected to deliver absolute returns of 15% or greater over the next twelve month period, and recommends that investors take a position above the security’s weight in the S&P 500, or any other relevant index. A SELL rating is given when the security is expected to deliver negative returns over the next twelve months, while a HOLD rating implies flat returns over the next twelve months. Investment Research Challenge and Global Investment Research Challenge Acknowledgement: CFA South Africa Investment Research Challenge as part of the CFA Institute Global Investment Research Challenge is based on the Investment Research Challenge originally developed by the New York Society of Security Analysts. Disclaimer: The information set forth herein has been obtained or derived from sources generally available to the public and believed by the author(s) to be reliable, but the author(s) does not make any representation or warranty, express or implied, as to its accuracy or completeness. The information is not intended to be used as the basis of any investment decisions by any person or entity. This information does not constitute investment advice, nor is it an offer or a solicitation of an offer to buy or sell any security. This report should not be considered to be a recommendation by any individual affiliated with CFA South Africa, CFA Institute or the Global Investment Research Challenge with regard to this company’s stock.