IC Market Espresso 21 Jan 2019

Let Them Eat Cake, While It’s Still Cheap

Europe’s sugar industry is at a turning point as many companies are facing a severe drop in sales and profitability after the sugar price plummeted as a result of production quotas being removed by the European Union.

How it all started

Production quotas in Europe were introduced back in 1968, along with a support price for producers at a level significantly above the world market price. At the time, the recently introduced Common Agricultural Policy (CAP) had as one of its main objective the self-sufficiency of the continent for its food production by encouraging agricultural production with remunerative and stable prices for farmers. Quotas, together with a support price, gave a welcome incentive to achieve these goals in the sugar sector.

The first signs of cavity 

Over time things began to change and so in 1992 a shift from product support (through prices) to producer support (through income support via direct payments) occurred, before an additional reform in 2003 consolidated this transition by decoupling the direct payments from the production of any particular product. Following this important decisions, Member States agreed upon ending the quota system in 2015, which was latter rescheduled to 2017.

Following the abolishment of sugar beet production limits, which occurred at the end of September 2017, Europe’s sugar production surged as companies were looking to reduce production costs through economy of scale by processing more beet and producing more sugar. However, the production boost came at a time when an increasingly health-conscious consumer is wary towards sugar consumption. As a result, supply exceeded demand and the global inventories were stacking up, eventually causing the price of sugar to plummet. The price fell so low that in August of 2018 it reached its 9 year low of USD 303.7 per ton.

Source: Bloomberg, InterCapital Research

Low prices are expected to discourage some companies from producing the same amount of sugar as they did in previous years which could lead to a shortfall in 2019 and help to somewhat decrease the high global stockpile.

In a conference call held recently, during which they discussed their Q3 2018 results (this is the end-Dec period), Agrana’s Management stated that the production expectations of the European market for this year were lower than in the year before due to drought and poorer yields in the large European beet-growing regions, mainly in Northern Europe and also in Western Europe. The production is now expected to go from 22m down to 19m tonnes of sugar within the European Union. As a result, one might expect that the price development should be favourable for the manufacturers. However, price increases will be modest as supplies are expected to remain abundant following high prices in recent years.

Source: F.O. Licht (20 December 2018), InterCapital Research

Finally, the companies…

European sugar manufacturers have been hit hard by the plummeting sugar price with many of them posting a double digit decrease in sales and profitability.

Croatia’s only listed sugar manufacturer, Viro, posted a 33% YoY decrease in sales in Q3 2018 (end-Sep period) while loss went up 46% YoY. Other European manufacturers were hurt as well, albeit now as much. For example, Agrana’s sales in the first three quarters of 2018 were down 7% to EUR 1.9bn while net profit was slashed to EUR 37m (just one quarter of 128m recorded in the previous year). Meanwhile Sudzucker, one of Europe’s largest sugar manufacturers also recorded a slight decrease in sales (-2.1% YoY), while their net profit plummeted 86% YoY to EUR 36m. Finally, Associated British Foods recorded a 15% YoY decrease in sales from their sugar segment, while the segment’s net profit fell -51% YoY. Meanwhile, overall results on the Group have actually slightly improved (note that ABF already posted their FY 2018 report due to a different calendar year).

The reason why Viro’s top line decrease at such a higher amount than other manufacturers lies in the fact that other producers have a diversified portfolio of products ranging from fruit to beverages which served them as a safety net.

On the chart below, we present you with the key multiples of some European sugar manufacturers. Note that Viro was excluded, as they have recorded both a negative EBITDA and net income.

Source: Bloomberg, InterCapital Research

In an attempt to cope with the situation on the market Viro recently announced a joint venture with another Croatian sugar manufacturer. This serves as a perfect example of just how important the economy of scale has become in the sugar industry. Furthermore, the industry is currently in danger of losing many of its current members who don’t have a strong enough balance sheet which would enable them to wait for the sugar price to recover, to invest into diversification or to acquire other competitors.

However, there is a silver lining here and that is the positive effect which lower sugar prices have on the production costs of companies who use sugar as an input. Many companies in the food industry have seen improved margins as a result of decreasing sugar prices (e.g. Altantic Grupa, Podravka), once again proving the old proverbial saying that one man’s loss is another man’s profit.

Adris Files for Squeeze-Out of HUP-Zagreb Minority Shareholders
As it was expected and earlier announced on the shareholders’ assemblies, Adris has filed for a squeeze-out of minority shareholders of HUP-Zagreb. The price is HRK 3,446 per share.

To recap, Adris acquired a 59% stake in HUP-Zagreb through the acquisition of Expertus early in 2018. A mandatory bid followed in which Adris offered HRK 3,969.16 per share and ended owning 94% shares of HUP-Zagreb (slightly above 95% if we take into account the treasury shares). On 10 December 2018 HUP-Zagreb held a shareholders’ assembly where they approved the squeeze-out at HRK 3,446 per share and a dividend of HRK 515 per each HUP-Zagreb share (ex-date was 13 Dec 2018).

On 18 January 2019 Adris filed a squeeze-out request with the Court Registry. The transaction will be finalized once the Court approves the request.

Energia Naturalis Has to Make Takeover Offer for Luka Ploce
According to a statement made by Luka Ploce on the Zagreb Stock Exchange, their largest shareholder (Energia Naturalis) has to make a takeover bid after passing the 25% threshold.

Originally, PPD bought 15% of Luka Ploce from the State in October 2014. By 2016, this was increased to 24.9%. In May 2018 PPD’s stake was transferred to Energia Naturalis (PPD’s mother company). On 16 January 2019, Energia Naturalis acquired another 2,848 shares of Luka Ploce, increasing the total stake to 25.62% and passing the 25% mandatory bid threshold.

The bid price is not yet known and subject to regulatory approval. According to Croatian legislation, the bid price needs to be the higher of:
a) the 3-month price average on ZSE and
b) the highest price at which the buyer acquired stakes within the last year.

According to our own calculation based on ZSE trading data, Energia Naturalis’ share acquisition on 16 January 2019 was done at HRK 368 per share. The 3-month average price stands at HRK 343 per share.

Calculating with HRK 368 per share, we get P/E of 75x and EV/EBITDA of 8.3x. As a comparison, Luka Koper is now traded at 8.5x P/E and 5.0x EV/EBITDA.

A quick look at Luka Ploce’s financials shows that they still need to put a lot of effort into hiking returns. In 2011 the company did a HRK 168m capital increase for investment needs. A slow use of the proceeds resulted in a very low ROE (average below 1%). The port lacks scale and is further pressured by low economic activity in its surroundings. However, a major project is underway – the construction of the petroleum products terminal which might make the port an important regional hub and hopefully help overcome the profitability issues.

Romanian Banks to Cut Costs as a Result of the New Asset Tax
 The CEO of Banca Transilvania, Omer Tetik, stated that they have already stopped the renovation of more than 200 branches, reduced training programs and postponed the second phase of the digitalization program.

According to the media, Romanian banks are preparing to cut spending as a result of the new asset tax. Because of that, the CEO of Banca Transilvania, Omer Tetik, stated that they have already stopped the renovation of more than 200 branches, reduced training programs and postponed the second phase of the digitalization program.

 At the moment, Banca Transilvania does not see raising interest rates as an option, as SMEs would not be able to absorb an aggressive rise in interest rates.

The CEO further states that it is not the customers fault that the tax has been introduced, but as a result of if, fewer SMEs might receive funds from Banca Transilvania.

Will the spending cuts be enough to absorb the impact of the new tax alone is yet to be seen.

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