JDW Sugar Mills Limited

Founded in 1990 as a private limited company in Rahim Yar Khan, Jehangir Tareen’s JDW Sugar Mills Limited (PSX: JDWS) is by far the largest white sugar producer in the country, 2.3 times larger than the second largest mill by output (Hamza Sugar, 2018).

As of MY18, combined output of company’s three units accounts for close to 13.4 percent of Pakistan’s total sugar production. However, the group owns three additional units (detail below), whose combined output takes group’s share in domestic production to 1.26 million tons or 19 percent of national sugar output. With a market capitalization north of Rs16 billion, JDW is the only sugar mill that consistently qualifies for the KSE100 index composition.

From the original Rahim Yar Khan unit, the company expanded and went on to acquire two more units; JDW Unit 2 (formerly United Sugar Mills) in 2005, while JDW Unit 3 (formerly Ghotki Sugar Mills) was put up in 2006. The three units put JDW’s combined crushing capacity at 44,000 TCD (tons of cane per day).

The company has several subsidiaries, including Deharki Sugar Mills (Pvt.) Limited, Faruki Pulp Mills Limited, Sadiqabad Power (Private) Limited, and Ghotki Power (Private) Limited. AKT Sugar (formerly: Gulf Sugar (Pvt.) Limited) is a private-limited concern that was acquired in 2018 by group sponsor Ali Tareen, and is located in Ghotki. The group is also claimed to have acquired Imperial Sugar Mills’ Khanewal unit recently; however, independent confirmation of the same could not be made.

The holding company, JDW Group, claims annual revenue of almost Rs50 billion as of MY19 (MY18: Rs37 billion), and assets of Rs 48 billion (MY19: Rs57 billion). AKT Sugar and JK Sugar mills are not directly owned subsidiaries of JDW holding.

While sugar manufacturing is the core business, contributing 80 percent (MY18: 75 percent) of topline the company has also diversified its revenue stream to other related segments, generating revenue from sale of electricity, molasses, and bagasse led by corporate farming (2 percent), and co-generation divisions (9.2 percent); whereas remainder is contributed by sale of by-products such as molasses, agri-inputs to growers, and bagasse.

In corporate farming, the company has established efficient and ecofriendly farms with higher yields, building the capacity of its farmers and giving an improved cane supply. For co-generation, the company has set up two bagasse-based, high-pressure co-generation power plants with a total capacity of approximately 53 MW, both of which were inaugurated in 2014.

Like rest of the sugar mills in the sectors, JDW’s marketing year starts in October and ends in September 30^th. This is in line with historic practices marking beginning of the crushing/harvest season of sugarcane in the country.

Pattern of shareholding

Three directors/dependents own close to 43 percent of the company: these include ex-Governor Punjab Mukhdoom Syed Ahmed Mahmud at 26.5 percent, followed by Jahangir Tareen at 16.4 percent and Mrs. Tareen at 3.8 percent. All in all, over 48 percent of JDWS stock is thus in the hands of the directors and their dependents.

Mr. Tareen’s son Ali Tareen also holds an additional 13.6 percent; however, does not hold any official position in the company. Substantial shareholding of 7.4 percent is held by an individual M/s Rana Nasim, whose related party status or relationship to sponsor family is not disclosed (7.42 percent). Company executives also 8.8 percent. All figures quoted are as at September 30, 2019.

After netting off shareholding held with sponsor family and related parties, general public/free float comes out at less than 10 percent; however, stock exchange lists free float of fifteen percent which may include some of the shareholding by substantial individual shareholders such as company executives.

Five percent share is also held with a foreign company whose name is not disclosed. Undisclosed joint-stock companies also hold close to four percent share. Share of banks and financial institutions is negligible.

Historical Performance

Sugar milling industry recorded a difficult period between MY16 and MY18, when margins suffered due to surplus in domestic market, export ban, low domestic retail price, and exorbitant pricing of raw material sugarcane at Rs180 per 40kg.

Given this level of support price and average national sucrose recovery rate of 10 percent, cost of sugarcane required for production of 1kg white sugar comes out at Rs45 (this has now increased to Rs47.5 per kg for MY20).

Due to average carry forward stock (at the beginning of crushing season) of between 1.5 – 2 million tons for past three years, the industry claimed that ex-mill price of sugar hovered between Rs45 – Rs50 per kg, which is insufficient to cover production costs and overheads. As a result, most midsized mills with limited diversification of revenue streams suffered.

However, given its diversified revenue stream, JDW has been able to keep its head above water. The company has been on a growth momentum for past several years, with 5 years sales CAGR at 10.9 percent between MY12 and MY17.

One of the secrets to JDW’s success has been high recovery rates and high yield. The company claims that it has enjoyed high yield on cultivation due to two factors. One, over the years, the company has increased investment in corporate farming, thus using modern farming techniques such as precision agriculture to maximize output. Second, since the scale of corporate farming is insufficient to meet demands of installed crushing capacity, it procures gain from independent farmers and growers from land leased or on share-cropping basis.

The management claims that it is one of the few mills in the country that procures sugarcane from farmers at minimum government set rate to incentivize farmers to invest in efficient agricultural practices.

As a result, historically, one of company’s three units has delivered highest sucrose recovery rate in Pakistan; well above the national average.

MY19 saw very high recovery rates by company’s Punjab based units: JDW 1 and JDW 2, and 11.6 percent and 11.30 percent, respectively. However, weighted average sucrose recovery rate was lower due to poor performance by JDW 3, at 10.60 percent. Whether these were the highest recovery rates in the industry is unclear as industry report published by Pakistan Sugar Mills Association is yet to be published for marketing year 2018-19.

This is also because southern Punjab region has historically been more climatically conducive for sugarcane crop, where recovery is more than two percent on average compared to central Punjab and KP.

JDW’s sugar production maintained an upward trend till MY18 (although it dropped in MY15 owing to unfavorable crop conditions caused by lack of rain and non-availability of irrigated water). The company’s hold on the domestic market remains strong; exports form less than fifteen percent of JDW’s sugar division sales historically; however, this share grew to close to 50 percent during MY18 thanks to announcement of generous export quota by the government at the time. Share of exports once again fell below 17 percent during MY19 as supply-demand equilibrium was restored in the domestic market due to lower national output during that season.

A cursory look at JDW’s segment sales confirms that the company has been earning most of its money from sugar. However, the recent improvement in margins over the past couple of years could be due to the activity seen in the electricity segment, which saw two plants come online in 2014. Segment wise profitability analysis is not shared in financial disclosures.

Analysis of subsidy

A cursory analysis of peer annual accounts published on PSX reveal that MY19 proved to be a year for recovery for the sugar sector. Mills such as Al-Noor Sugar, and Al-Abbas Sugar have done well for themselves compared to last year by availing the subsidy on export, in addition to recovery of sugar prices in domestic market beginning April 2019, as surplus in the domestic market was diverted toward exports.

Subsidy of Rs10.7 per kg was announced on export of up to two million tons of white sugar in October 2017; on first come first basis. The export quota was extended by an additional one million in 2019 with subsidy of Rs 5 per kg by Punjab government. This subsidy was announced keeping in view millers’ refusal to begin procurement of sugarcane for two subsequent seasons from growers well into December.

Millers refusal to procure sugarcane stemmed from carry forward stock of over two million tons as reported by industry association, PSMA. Furthermore, millers noted that the government set indicative price of sugarcane was artificially high at Rs180 per 40kg.

In addition, due to the high cost of production in the domestic market, as well as a surplus of white sugar globally due to high levels of output by countries such as Brazil, domestic sugar mills were unable to export competitively without government support. As millers blame support price for their lack of competitiveness in export market, government had to announce a subsidy in order to ensure that crushing began before widespread protest by farmers broke out.

Mills that were able to secure export orders, thus recorded a jump in revenue and profitability over previous years. As peer SBP disclosures, JDW also secured orders for export of close to 200,000 tons of sugar during MY18 resulting in subsidy entitlement of about Rs2 billion. In the following year, the company applied for export quota of close to 120,000 tons of sugar, half of which was against subsidy availed from Punjab government (Jan-Jun 2019).Although the company did enjoy subsidy on exports for six months of MY19, its effect appears to be marginal due to lower per kilo quantum.

Financial Performance

As sugar price improved in both domestic and international market, especially beginning June 2019, the company was able to command improved selling prices, which translated into better profitability compared to MY18 season.

However, both EBIT and PBT margins are still second lowest for the decade; this appears to be a function of higher cost of production due to decline in supply of cane, and higher interest cost. Higher cost of production stems from economies of scale, as a drop in output means that fixed cost component increased per unit of output. Total crushing for the year was lower by 33 percent, and while some respite was received due to recovery rate for 11.3 percent – highest in six years – cost of production leaped forward in tandem with revenue due to low capacity utilization reflecting in poor economies of scale.

Margins received further battering at the hands of increased interest expense, that grew on the back of what appears to be an increase in average debt for the period – the increase in debt servicing costs at the hands of higher discount rate. And were it not for a reversal of tax liability, bottom line for the year may very well have been in red. However, interest cover restored over 1x times, indicating that profitability may increase substantially once discount rate falls.

MY20 outlook

The industry dynamics are expected to receive a fillip during the ongoing MY20. On the one hand, increased average selling prices for primary- and by- products sugar and molasses means that revenue is on substantial recovery. During 1QMY20, topline grew by a massive 62 percent; however, the growth is expected to taper off in coming quarters.

On the one hand, average cost of production will also see a massive rise during the year, as raw material cost is expected to average close to Rs220 per 40kg compared to below Rs180 per 40kg in previous years. This is on the back of serious shortfall in raw material cane availability, backed by increase in minimum support price of sugar by provincial governments.

On the other hand, beginning February 2020, export of sugar has been banned; meaning large scale players such as JDW will no longer be able to benefit from the reversal in international sugar price trends. The increase in sales tax on sugar from 8 to 17 percent in the last budget will also begin to show its full effect in the ongoing marketing year and may result in demand compression from buyers in FMCG segment.

However,  as the discount rates are expected to stay stagnant till September, sugar sector’s working capital borrowing will continue at the higher markup till the end of current marketing year; that will erode before-tax margins; even as core and operating margins continue their strong recovery of 4pp as indicated in the financials for first quarter.