Balrampur Chini not simply another commodity play

Announcement of a share buyback by Balrampur Chini Mills went unnoticed during the past fortnight. The buyback was announced at a 55 per cent premium to the market price (when was the last time any company offered such a premium for its own stock?). The premium, coupled with an interim dividend of Rs 3.5 per share, translates to a nine per cent yield for the small investor in 2016-17.

Why would a company in a cash-hungry sector announce a buy-back? 

Some probable reasons:

One, the company has probably graduated into a sweet spot: What it could require by way of investment in capacity creation and debottlenecking is likely to be provided adequately by sizable accrual.

Two, it possesses a capacity-equity ratio that will respond sensitively to any prospective increase in sugar realisations: A rupee’s increase in free-sale prices can add Rs 75 crore to pre-tax profit.

Three, the company has cut the long-term costs of staying in business: Repayment of Rs 450 crore long-term debt this financial year makes it debt-free for the first time in living memory. The company has also widened the coverage of superior cane varieties, translating into enhanced recovery. 

Four, the company in my estimate would have Rs 225 crore of debt on its books (two-thirds at zero per cent interest) and Rs 300 crore of cash after its term loan repayment and liquidation of all working capital debt by the start of the current sugar season. Remarkable for a company that even as recently as two years ago was batting on a turning wicket.

The company is clearly return on capital employed (ROCE)-focused. Any retention of profit would have increased the reserves and consequently depressed the return ratios. The company probably felt it would serve shareholder interests better by buying equity, repaying debt and reporting a higher ROCE, leading to an enhanced price-earnings ratio (the market rewards zero-debt and high ROCE companies handsomely).

The Uttar Pradesh government, for the current season, announced a cane price of Rs 305 a quintal. This is Rs 15 a quintal lower than market expectation, creating the ground for medium-term sectoral stability (most industry cycles were the creation of sharp populist increases in cane prices).

The company could have elected to pay out all Rs 175 crore as dividend but this would have included a large dividend tax payout as well. So, the buy-back represents a direct transmission of corporate wealth into shareholder value.

Overview

The number one play on the country’s sugar sector is priced less than Rs 3,000 crore, the current year’s profits are likely to be the highest in the history, the company is likely to generate net cash from this point onwards, the cost of sugar production has moderated to a point where the company is likely to break-even in the worst of markets, will use accruals to drive all its growth (I think) and report an ROCE that compares with your fast-moving consumer goods majors. Just shows what a commodity company can achieve when managed with focus, passion and integrity. 

The author is a stock market writer, tracking corporate earnings and investor psychology to gauge where markets are not headed