Over 80 percent of Zimbabwe’s sugar cane crop is produced by two large Tongaat Hulett owned estates, the Triangle Sugar Estate and Hippo Valley Estate, with the remaining 20 percent coming from private producers.
These two estates have a sugar production capacity of about 640 000 tonnes and installed milling capacity of 4 million tonnes of sugar cane per annum. Our focus is on Hippo Valley Estates Ltd which only produces raw sugar and controls 53 percent of the market.
The company’s inflation adjusted revenue marginally went up by 4 percent to $30 billion for the period ended March 2022. This was as a result of low cane deliveries due to low yields during the period. Total industry sugar production fell by 4 percent to 390 415 tonnes from 408 260 produced in 2021. Current sugar production levels are way below the industry average and has not returned to the peak production of 578 000 tonnes achieved in the 2002/03 marketing year. The decrease in sugar production was mainly due to the rapid decline in the economic performance which limited production over the years.
Hippo is forecasted to marginally increase production to 1,7 million tonnes of sugarcane in 2023/2024 marketing season from 1,69 million tonnes produced in the previous season. This is supported by the availability of irrigation water and an increase in area planted. However, sugar cane yield is expected to remain subdued as a result of local farmer’s inability to apply optimal amounts of fertiliser and chemicals due to increasing input costs in Zimbabwe.
Hippo Valley is a good example to demonstrate why looking at free cash flows is essential when making investment decisions. The company is currently spending millions of dollars on expanding its farming areas to increase production. If you look at its income statement, then it seems like they have impressive profits. 2022 had $4 billion profit after tax.
However, these earnings include various non-cash items like depreciation, monetary losses and positive adjustments in biological assets. These are expenses that do not lead to reduced cash, but they affected the company’s earnings. As a result, earnings are smoothed out. But looking at the cash flow statement, Hippo had $328 million negative free cash flow. Accounting earnings of $4 billion, but they are spending $328 million more in cash than they make in a year.
In this case, accounting earnings are highly misleading. They are not even close to profitability according to the cash flow statement. Hippo Valley is actually taking a large amount of debt to fund its ongoing projects. In the previous trading period they acquired a total debt of over $1 billion.
But you won’t see this by just looking at earnings. Free cash flows tell the real story and this is typical for a company that is undertaking massive capital intensive projects.
Operating margins jumped to 21 percent from 17 percent in the previous period. I expect them to stabilise at 20 percent beyond FY2023 as the currently ongoing project Kilimanjaro starts to pay off. At a share price of $210, the stock was trading at a PE ratio of 10x and a Price to NAV of 2x on the writing date. My estimated intrinsic value (DCF) is just above $370 making it fairly valued and a potential 2 bagger. However, caution is advised in applying these valuations. Our macro-economic environment is too volatile and so is my attitude in tweaking assumptions overtime.
Disclaimer: Business Weekly has taken all reasonable steps to ensure that the information within this article is correct and no liability is accepted for any loss arising from reliance on it. All opinions and estimates expressed in this report are (unless otherwise indicated) entirely those of the writer. Readers of this article shall be solely responsible for making their own independent investigation of the business, financial condition and prospects of companies referred to in this report.
Sylvester Mupanduki/Phone: 0771 623 648/Twitter: @Real_UncleSly/Email: [email protected]