MSM ... Sep11

It is relatively recession-proof business — sugar is a staple product with few substitutes. However despite its dominant market position as the largest sugar refiner in the country, few were overly excited over MSM’s growth prospects. Domestic sugar consumption is forecast to grow in the low single-digit pace annually, going forward.

MSM has adopted a dividend policy to pay out at least 50% of its annual net profits.

On the other hand, investors should bear in mind that while demand for sugar is expected to be fairly recession-proof, MSM’s margin and profits could still be hit by rising costs. In particular, the company is exposed to fluctuations in prices of imported raw sugar while the price of refined sugar in the country is controlled by the government.

Sugar is a staple food product consumed by all households. It is also widely used in the food manufacturing and processing industry — for example in the manufacturing of carbonated soft drinks, non-carbonated drinks, biscuits and cookies, bread and bakery products, chocolate products and sugar confectionery, etc. In short, sugar demand and MSM’s customers hail from a broad cross-section of the economy.

Currently, MSM owns two of the four refineries in the country — Malayan Sugar Manufacturing Company (MSM) in Prai, Penang and Kilang Gula Felda Perlis (KGFP) in Chuping, Perlis. Tradewinds (M) owns and operates the other two refineries, Central Sugar Refineries in Shah Alam, Selangor and Gula Padang Terap in the northern state of Kedah.

Even though sugar demand is expected to grow at a steady pace and there are limited competitive pressures, at least for now, MSM’s earnings are exposed to cost inflation, in particular fluctuations in raw sugar prices. Raw sugar is the company’s single largest cost component, accounting for nearly 87% of cost of sales in 1Q11.

The company owns and leases a sugar cane plantation totalling 5,698ha and operates a sugar cane mill in Chuping, Perlis. However, the bulk of its raw sugar requirement — about 97% of the total consumed in 2010 – is imported mainly from Australia and Brazil.

About half of the company’s raw sugar purchases is sourced under fixed price three-year contracts while the balance is bought from the spot market. The current (Sept 2011) long-term supply contracts were signed in early 2009 at roughly 17.5 sen per pound. Prices under the new contracts are expected to be significantly higher after the current contracts expire at end-2011.

Prices of raw sugar have been trending up over the past few years. Rising raw sugar prices will translate into higher costs for MSM while refined sugar in the country is a price-controlled item. Following the price hike in May 2011, refined sugar now retails at RM2.30 per kg. To make up for the difference between market and domestic selling prices, sugar refiners currently get an additional 20 sen per kg subsidy from the government. But there is no guarantee that selling prices and subsidies will fully cover the higher cost of raw sugar in the future.

Sugar refining is energy intensive. As such, MSM’s margins and profits are also exposed to rising fuel — primarily natural gas and electricity — costs as well as foreign exchange fluctuations.

MSM reported a net profit of RM138.9 million in 1H11, up sharply from RM58.5 million in the previous corresponding period despite a 1.8% drop in revenue. The higher margin was due primarily to fair value gains in derivatives.

The company has net cash totalling RM141.7 million at end-June 2011, including proceeds from its IPO. The strong balance sheet will support future capital expansion plans and dividend payments. About RM320 million of the RM425 million proceeds from the IPO have been earmarked for capital expansion over the next two to three years.

It is also planning to expand the storage capacity for raw sugar and warehouse capacity for refined sugar products as well as increase the raw sugar melt capacity. MSM is also on the lookout for strategic investments, including upstream sugar cane plantation and investments overseas.