Interpretation of Mumias Sugar Financial Results for the year 2014

1. THE KIANGOI REPORT
Interpretation of
Mumias Sugar
Financial Results
for the year 2014

2. Financial Review & Analysis of Mumias Sugar Ltd
The World of Sugar: A global perspective of the sugar market
The sugar market is one of the most protected and highly distorted agricultural commodity
markets. The market is characterised by significant and widespread domestic support and
trade distorting policies, such as guaranteed minimum payment to producers, production &
marketing controls (quotas), state regulated retail tariffs, import quotas and export subsidies.
80% of world sugar is consumed in its country of origin or moved from one country to
another following long-term supply trade agreement or preferential trade deals. This makes
sugar a residual market- a market where freely traded sugar is only a fraction of world
production. What this essentially means is that any slight change in world production or
consumption could translate to a much larger change in free market sugar supply. The
delicate supply/demand balance is the main reason behind historical world sugar price
volatility.
According to a study commissioned by the World Bank1
world sugar prices on the residual
free market have normally been so low that even the world’s lowest cost producers have had
to find ways to subsidise their exports mainly by blending higher prices achieved through
domestic markets with those available through exports.
Assessing the competitiveness of a country’s sugar industry in a global context remains a
challenge given the managed nature of the international sugar industry. Competition in this
market can be analysed in terms of production costs. Countries are therefore ranked as either
low cost or high cost producing nations. The cost of production is further influenced by a
country’s natural, economic & political environment in which the firms operate. It can
therefore be argued that government intervention & regulation is essential & critical for the
survival & development of a nation’s agricultural industry.
The Kenyan Sugar Industry: A Sweet Relationship Turned Sour:
The Kenyan Industry supports both directly & indirectly about 6 Million people; 16% of the
Kenyan population. It contributes 7.5% to the GDP and has a major impact on the economies
of Western, Nyanza & Coast regions. This in part is the reason governments the world over
protect the sugar industry as it serves as a strategic sector for employment creation & rural
development.
Sugarcane is a low value, high volume, and bulky crop. High quality cane has good juice
content with high sugar levels. The efficiency with which juice can be extracted from the
cane is limited by the quality of cane delivered and the technology used. Kenya has a total of
11 sugar mills which produce roughly 500,000 tonnes of sugar per annum. This does not
meet local consumption said to be at around 800,000 tonnes per annum. The deficit of 300k is
then supplied by our trading partners under COMESA as we will see below.
1
All African Review of Experiences with Commercial Agriculture-The African Sugar Industry: A Frustrated
Success Story

3. As mentioned earlier in order to understand the sugar industry an analysis of location factors
is required, this can further be split into both factory & field specific. In this section I will
concentrate on the field factors comparing Kenya to Zambia, Malawi & South Africa.
Factory factors tend to be firm specific and will be analysed with the financials.
Production, Consumption & Prices:
Data from the graphs below comes from the FAOSTAT website and highlight the following:
 Area Harvested: The data refers to the area on which the crop is gathered. South
Africa has the largest area with about 310K hectares followed by Kenya with an area
of about 85K, Zambia about 39K while Malawi has 27K.
 Sugarcane Production: Again South Africa has the highest harvested cane with about
18M tonnes Kenya follows with 5M, Zambia with about 4M and Malawi with 2.9M
tonnes.
 Sugar Produced Vs. Yield: Yield refers to the tonnes produced per hectare farmed.
Going by available data. Malawi leads with 107t/ha followed by Zambia at 103t/ha,
Kenya at 69t/ha and lastly SA with 55.3t/ha as of 2013. This graph is interesting
because it shows Zambia & Malawi are able to produce roughly the same output of
cane with half the area when paired with Kenya. It also shows that SA compensates
for the low tonnage per hectare by utilizing a larger acreage.
 Sugar Produced Vs. Producer Prices: Producer prices are prices received by farmers
for their produce or essentially to the millers it is the cost of acquiring cane. The
graph shows that Malawi & Zambia are low cost producers at $15 & $ 24 per MT.
South Africa & Kenya are high cost producers at $ 47 & $45 per MT respectively.

4. As mentioned earlier about 80% of sugar produced is consumed in the country of origin. As
can be seen in graph 5 below Kenya is the only country with a 300K tonne deficit of sugar.
To meet the deficit Kenya needs to import sugar from COMESA net exporter countries.
Graph 6 shows a comparison of domestic sugar prices vs production costs vs. the price of
sugar cane per country. The graph further reinforces the view that sugar prices in domestic
markets are driven by other factors other than the free hand of demand or supply side
economics. Graph 6 shows the relationship between domestic prices, production cost & cost
of sugar cane. The variance between the cost of production2
and domestic selling prices is
wider in low cost cane producers; Malawi & Zambia with 57% & 48% above cost of sales.
Whereas Kenya & South Africa having a variance of 16% & 5% respectively. However it
should be noted that South African millers are heavily diversified & operating margins from
their domestic sugar portfolio fluctuates between 5-20%.
COMESA- FTA: Kicking the Trade Liberalisation Can Down the Road
Kenya is a member of the COMESA Free Trade Area. The FTA obliges the country to allow
duty & quota free access for products such as sugar from its members into her market. It also
provides for the imposition of safeguard measures that will insulate the local industry over a
period of time to enable the local industry to become more competitive. Kenya was granted a
further one year extension set to lapse in 2016 provided Kenya adheres to certain terms &
conditions as spelt out by the council.
These conditions have largely shaped the sector’s development policy in recent years and
include the following:
 Rising duty free import quota in tandem with a declining tariff
 Adoption of a privatization plan
 Implementation of a sugarcane payment system based on sucrose content as opposed
to weight of the cane
 The adoption of a product diversification policy (co-generation & bio-fuel)
 Increase funding for research into new early maturing cane & high sucrose content
cane
 Increase funding for road infrastructure
2
Cost of production is taken as Cost of Sales

5. In approving the one year extension the council noted that during the safeguard period
Kenya’s sugar industry composition had changed to about 70% (2014) private sector holding
compared to the initial 33% in 2004.The council however mooted & supported the idea of
scrapping the permit system and replacing it with a equitable country specific quota system
allocated between member states to help Kenya meet the sugar deficit and therefore
eradicating one country getting the lion share of the lucrative Kenyan market (see graph
below).
Trade liberalisation has its fair share of challenges which has resulted in the importation of
cheap sugar from outside member countries and has spawned corruption that is hurting
farmers & consumers alike. For example in their report to parliament the committee for
agriculture noted that net deficit sugar countries had exported substantial amounts of sugar
with disregard to the rules of origin. Egypt for example despite being a net importer of sugar
was a major supplier of sugar into the Kenyan market.
To understand how Kenya is adversely affected by FTA in relation to sugar, one needs to
look at country’s importing into Kenya. According to available data3
Egypt & Swaziland
accounted for 87% of imported sugar into the country, a report by USDA (US Department of
Agriculture) indicates that Egypt produces about 2.17M MT of sugar annually and consumes
roughly 2.9MMT. It makes up the deficit by importing a further 1.3MMT from Brazil & the
EU. The government of Egypt provides a subsidized supply price for beet & sugar cane in
order to support farmers’ income, while at the same time reducing the price of local sugar to
compete with imported sugar. Local sugar costs the government $ 671 per tonne versus
imported sugar which goes for $ 443 per tonne. Going by the basis of price Egyptians
purchase the cheap sugar, leaving the government with unsold stocks of roughly 280K MT.
This is the sugar that is then sold into Kenya, given that Egyptian sugar is still cheaper than
Kenyan sugar.
On the one hand it can be argued that the Kenyan consumer is supporting the Egyptian
government subsidies program but on the other hand it should be noted that the balance of
trade is in Kenya’s favour as Egypt buys a lot of high value Kenyan tea. Herein lies the
difficulty of balancing national interests with international commerce.
3
Analysis of Incentives & Disincentives for sugar in Kenya-FAO 2013

6. FY14 Financial & Operational Review
In this review we will look at Mumias Sugar’s financial performance going back 5 years and
do a comparative analysis of the company’s performance against its competitors, comparing
the company’s FY 14 results with that of low cost producers Zambia Sugar & Illovo Malawi.
In doing this it is hoped that there shall be some lessons learnt from the experience of these
companies given the similarities in the environment in which they operate.
Key Stats, Comparatives & Trends:

7. Revenue Analysis:
In FY 14 gross revenue was up 9% when compared to PY 13. As seen in the table below the
increment was due to the production of ethanol which increased by 68%. Sugar sales
contributed to 90% of the sales in the year under review. Over the 5 year period the company
has lost a net amount of Kes 2.5 billion overall of revenue, however the sugar segment shed
off some Kes 3.5 billion. The decrease as seen below is due to the reduction in the amount of
processed cane as plant capacity utilization went from 91% in 2010 to 67% in 2014. Over the
same period the selling price of sugar increased by 24%. The impact of this drop in revenue is
bound to have a major implications on the company’s bottom line and put into question the
company’s viability as a going concern as will be seen in our analysis below.
A comparison of FY 14 with Zambia Sugar and Illovo Malawi shows that both Illovo & ZSC
recover more sugar per tonne of cane processed meaning the cane quality in these countries
are better than Kenya. Revenues in these countries are driven by tonnage as opposed to price.
Looking at 2010 numbers one can that MSC has over the years grown inefficient in the
farming area, farmers are not delivering enough cane for crushing therefore the plant is
underutilized which over time has a cascading effect as it eats into profits & negatively
impacts the company’s cash flow making it hard to meet their obligations as they fall due.
Operating Costs:
52% of cost of sales is made up cane cost this has remained relatively constant over the years
as seen in the table below. Compared to 2010 we see that the cost has remained consistent
with the cost of cane ranging from around Kes 3000 to 3700 per MT. The other revenue
streams came fully on board in FY13 and contributed 11% to COS. The cost of sugar
production increased by 57% from Kes 45K per MT in 2010 to Kes 70K per MT in 2014 this
again can be attributed to the underutilization of the plant and the absorption of fixed costs
which remained unchanged over the same period.

8. A comparison with our sampled companies shows that MSC cost of sugar is roughly double
that of ZSC & triple that of ILV Malawi (MSC $710; ZSC $ 388 and ILV $ 272 per MT).
This is again consistent with the review in the field factors which identified Zambia &
Malawi as low cost producers of the sugar cane crop and sugar product. Because of the
shrinking production numbers MSC has seen its sales contribution drop from 32% in 2010 to
8% in 2014. Whereas ZSC & Illovo Malawi are extracting a gross profit of 36% and 47%
respectively.
Profitability:
With Gross profit at 8% MSC has fallen prey to what I have come to term as the
“Manufacturers Disease”: There is a series of events that takes place to get to the point of
declaring a net loss of -ve 26%. The Manufacturers’ disease narrative goes something like
this: Farmers did not supply enough cane leading to the company to process less tonnage
which in turn affected the sales figures hence the 8% gross profit which is not enough to
cover realization & fixed costs. This lack of cash means the company cannot pay its suppliers
some of whom supply critical spares & other major suppliers (farmers) needed to guarantee
plant uptime. This leads to forced shutdowns as the company now has a limping plant.
Because of the shutdowns farmers are then forced to divert their cut cane to other factories in
the area or result in planting other crops causing the drop in tonnage. The company then has
to borrow to fund its operations and when banks credit limits are exhausted management
starts borrowing from its distributors, who demand discounted prices for sugar causing a
further dip in achieved sales. This chain of events is in part the reason MSC finds itself in the
position it is today.
We turn our focus on net profit where we undertake a variance analysis comparing a
profitable year 2010 versus a loss making year ending 2014.

9. In the last five years since declaring a profit revenue dropped 16% from Kes 15.6B to 13B.
COS increased by 14% from Kes 10.6B to Kes 12.2B an indication that there is a mismatch
between the diversified revenue streams (electricity co-gen, ethanol & water bottling) and
their related cost of sales. Admin costs went up by 71% from Kes 1.9B in 2010 to Kes 3.2 B
biggest contributor to this spike in cost is listed as “other cost” of about Kes 0.9B. This line
item requires full disclosure where management need to explain whether it was a one off or
recurring expense. Finance costs went up by Kes 372M over the period under review, this
was driven by loans taken to finance the revenue diversification projects.
The variance analysis clearly shows that revenue took a nose dive due to factors listed above.
MSC will have to address this revenue leakage in order as to remain a going concern. They
will also need to put a tight hold on fixed costs to avoid unnecessary cost escalations as seen
on the waterfall graph above.
Financial Strength, Management Effectiveness & Shareholder Value:
We now turn our attention to the balance sheet as we try to establish the financial strength of
the company and how well management put to good use the assets of the company with the
underlying objective of increasing shareholders value. To do this we look at five ratios as
listed on the financial highlights summary:
Current Ratio: This ratio is also known as the liquidity ratio it measures a company’s ability
to pay its short term commitments over the next business cycle (12 Months). A current ratio
of 2:1 is considered acceptable meaning the company has the ability to pay its short-term
commitments. A current ratio below 1(current liabilities exceed current assets) means that the
company may have problems paying its bills on time. MSC has a ratio of 0.41 in FY-14
versus 2.06 when compared to the profitable period 2010. ZSC & Illovo Malawi have 2.7 &
2.14 respectively.
Debt to Equity: This is a long term solvency ratio that indicates the soundness of long-term
financial policies of the company. It shows the relation between the portion of assets
provided by the stockholders and the portion of assets provided by creditors. It is
calculated by dividing total liabilities by stockholder’s equity. MSC has a ratio of 1.21.
It means the creditors provide Kes 1.2 of assets for each Kes 1 provided by shareholders.
This means shareholders will have to wait out on dividends as interest payments take
precedence. ZSC also has roughly the same ratio 1.4 whereas as Illovo Malawi has 0.94
Net Free Cash Flow: This ratio takes focus away from earnings/profits & looks at the cash
the business generates from its operations. It is gotten by subtracting capital expenditure
(cash from investing activities) from cash from operating activities. Free cash flow is
important as it allows the company the opportunity to seek out & enhance shareholder value.
MSC has a free cash flow of Kes 308M versus Kes 2.6 B in 2010 which is roughly what ZSC
& Malawi reported in FY14 with Kes 2.2 B & Kes 2.1B respectively.
Return on Assets: This is an indicator of how profitable a company is relative to its total
assets. It is a measure of management effectiveness in the use of company assets to generate
earnings. MSC’s ROA is –ve (11.5%) in FY-14 versus 8.85% in 2010 again this positive
result is at par with what ZSC & Malawi reported in FY14 with 5.7% & 16.6% respectively.

10. Return on Equity: This is also another measure of the company’s profitability it is gotten by
dividing net income over shareholder’s equity. MSC’s ROE is –ve (25.45%) in FY-14
versus 14.76% in 2010 again this positive result is at par with what ZSC & Malawi reported
in FY14 with 13.76% & 32.33% respectively.
Going Forward: How Does MSC Stop The Bleeding:-
We have seen that the sugar industry is a managed market; one cannot rely entirely on market
forces to solve problems in this sector. The government ought to intervene in the sector given
the importance of the industry in alleviating rural unemployment. Given that the Kenyan
government is the largest investor in MSC; with a shareholding of 20% it would be in its
interest to add back Kes 3 Billion back into MSC’s books and return the company back to
profitability. The government will benefit from taxes (VAT & income tax), share price
appreciation & dividends
As identified earlier the company suffers from the Manufacturer’s disease, which is cyclical
in nature the logical step to take would be to break the chain. The factory has to operate at
near full capacity to return to its profit making days. It is that simple. I will now highlight
some out of the box short term solutions that could help the company regain favour with
investors & the public alike.
1. Cancel import licences held by traders & issue them to sugar millers, allowing millers
to bring in sugar on a pro-rata basis based on their production volumes. Which means
that if MSC produces 60% of the sugar produced by Kenyan millers? They will be
allowed to buy in 60% of the imported sugar from COMESA exporting countries. The
company can then blend or repackage the imported sugar with locally produced sugar.
This will have the effect of adding much needed revenue into the company’s books
enabling them to meet their debt & creditor obligation in essence breaking the cyclical
chain.
2. The Kenya Sugar Board can borrow a leaf from their Energy Regulatory Commission
counterparts and set prices of sugar on a monthly basis based on the mix between
local & imported sugar. This will have the effect of reducing the price of sugar sold in
the country there by reducing or eradicating the arbitrage opportunity that makes
Kenya an attractive market for cheap sugar.
3. The government can consolidate or mothball some of the government owned
factories. Allowing cane to be channelled in the most efficient factories thereby
reducing the cane poaching incidences and costs associated with running several
limping plants that are under-utilized.

11. Appearing before the parliamentary departmental committee on agriculture the cabinet
secretary for agriculture gave the following recommendations on how to streamline the sugar
industry (It should be noted that these recommendations are in line with the COMESA
conditions). Some of the recommendations include:
 Investment in infrastructure to reduce the cost of transporting cane
 Diversified product base to reduce dependency on the sugar revenue stream
 Bulk procurement of inputs & machinery
 Modernization of factory technology
 Land policy that introduces mandatory block farming to mitigate against diminishing
land sizes
 Development of seed cane policy that will guide the industry on high yielding, early
maturing, disease resistant certified cane
The Kenyan sugar industry is at the crossroads as the government juggles with how to
compete in a managed market while meeting the expectations of various trade agreements
entered between countries whilst protecting the local industry & securing the future of
millions of Kenyans whose livelihoods are derived from the sector. I believe the success of
MSC will only come from capacity utilization as outlined and discussed above. The company
has the ability to return to profitability but requires the support of the government to get
there. If this happens then MSC ticker on the NSE bourse will live up to its natural Kenyan
sweetness.