Kesar Enterprises - Seems Sweet!!

Statutory Warning: Kesar Enterprises is a sugar company!


In spite of this, if you still have any interest left in this post, please read on! :-)


Background:
Kesar Enterprises (KEL) is a sugar company based in UP. It also has small divisions like power generation from molasses, seeds, smart crops, etc. The reason i am writing about this company is because it is demerging one division, which has the potential to create substantial value to the shareholders.


The situation:
Along with the sugar business, KEL also has a liquid storage division. The company had announced the demerger of this division into a separate company, Kesar Terminals and Infrastructure Ltd. (KTIL), which would of course be listed. The demerger has already been sanctioned by the Mumbai High Court and all that remains is for the company to hold a Board Meeting and announce the record date and other details. The ratio for this demerger has been fixed at 7 shares of KTIL for every 10 shares held in KEL.


I have tried to value KEL and KTIL directly on market cap basis, without getting into per-share calculations.  

Valuation of sugar business:
Analysing sugar business and investing in sugar companies is not my cup of tea. I do not like the business at all and have never analysed/studied any sugar company. So i faced a big problem here and i feel this is the weak link in my hypothesis.
So, of course, i had to talk with someone who analysed sugar businesses. After talking with quite a few people, there was consensus that the replacement cost of a plant of KEL's size would be at least Rs.250 crores. KEL has debt of Rs.165 crores for FY09. So that gives us an approximate market cap of (250-165)=Rs.85 crores. This is close to the present market cap of KEL. We can conclude that the sugar business is fairly valued. (Again, i am stressing that this is just a rough calculation. Since i do not like the dynamics of the sugar industry in India, i have not even studied the sector/any sugar company and hence, cannot value sugar businesses properly.)


Valuation of the storage business:
KEL's liquid storage division has become an annuity kind of business for the company. For FY09, the business had a topline of about Rs.14 crores and PBIT of just over Rs.7 crores. After considering interest on debt to be transferred to KTIL Rs.13 crores and taxes, KTIL can have PAT of Rs.5.5 crores. KTIL has plans to grow into an integrated logistics player, from having only storage business. Companies in this sector get valuations in excess of 20x trailing. To be conservative, we will give KTIL a valuation of 10x.. that seems quite reasonable right? Soooo PAT of Rs.5.5 crores and a PE of 10x should give KTIL a market cap of Rs.55 crores at least.


Great!! Now lets summarise...

This demerger could create substantial value for the shareholders. Post demerger, KTIL has substantial growth plans of its own, but lets not get into that, since i am approaching this as a 'special situation' case and not as an investment case.

Now lets take a look at the risks/limitations in this entire exercise:

1. Inability to value sugar business with conviction: As i have already mentioned, its just not something i am particularly good at (like a lot of things!). So if there is anyone out there who can value KEL's sugar business properly, I am more than willing to buy you a nice single malt ka bottle! :-)
2. Time risk: All the legal and procedural formalities for the demerger have been completed. All that is left is for the company to announce the record date and go ahead with the demerger. It is very much probable that the company might declare the record date, along with the results announcement. (before April 2010-end). So in my view, the time risk is not significantly high.

To conclude, it does seem that if one buys shares of KEL at current market cap, it would prove to be a good special situation position. The MOS comes from the current market cap of just Rs.80 odd crores, which is quite near to the value that KTIL could command and the fact that all legal formalities are over. 

Cheers and happy investing!!