A Tongaat Hulett shareholder believes the group is taking the wrong tack as it battles the "strong headwinds" facing sugar producers‚ and that it should shift more effort to developing and retaining its valuable KwaZulu-Natal property holdings.

In the six months ended September 2013‚ Tongaat's vast land holdings once again proved to be a fillip for the group‚ with the sale of a small portion of its portfolio accounting for more than one-third of operating profit.

While land is not Tongaat's core focus‚ the sale of 174ha in the period generated R512m in operating profit.

The group has a further 8‚300ha earmarked for conversion for sale — which involves planning‚ installing some infrastructure and carrying out impact assessments.

Meanwhile‚ Tongaat's sugar operations have been less buoyant‚ weighed down by low international sugar prices and rising imports.

Global sugar surpluses have seen the world price of sugar tumble from a high of about 34 USc/lb at the start of 2011 to just under 17 USc at the moment — though fluctuations are common in line with variable supply.

The sugar price in South Africa remains higher than the world price‚ attracting a spike in imports, but South African producers are expecting an imminent change to import tariffs‚ which will see an existing tariff come into effect to shelter local producers from what is seen as "dumping".

Chris Logan of Opportune Investments‚ which is a minority shareholder in Tongaat Hulett‚ believes a number of factors should prompt Tongaat to reduce its relative exposure to sugar‚ while rather keeping land on the balance sheet and developing it.

These include "rampant cost" rises in sugar production‚ including "a 57% increase in the salaries and wages bill over the past two years".

The growing awareness of health concerns could also see future demand reduced‚ he says. New draft guidelines published by the World Health Organisation this month recommend people slash their daily sugar intake to curb a number of health problems.

Mr Logan says that after increasing for a number of years‚ per-capita consumption of sugar in South Africa fell in 2012-2013‚ while production is expected to rise this year.

"Players like Tongaat have invested a lot of capital into producing more sugar‚" he says. "As local production picks up‚ the increase gets channelled into the export market‚ where prices are low‚ and that will become all the more prevalent if local consumption starts falling."

Mr Logan says Tongaat's return on capital employed‚ a key ratio for shareholders‚ has fallen from 19.3% in the 15 months to March 2010‚ to 12.8% in its financial year ended March 2013.

He says this negative trend is expected to continue in the 2014 financial year‚ despite "a marked increase in sugar production"‚ unless there is another sizeable land sale.

"Instead of taking capital out of land and putting it into sugar‚ keep it in land — there's no shortage of sugar in the world‚" he says.

However‚ he praises Tongaat for a " drive to reduce costs" that is yielding substantial savings. Abdul Davids‚ head of research at Kagiso Asset Management‚ is more optimistic about Tongaat's sugar operations.

"We recognise that the sugar industry is cyclical — currently world prices are low due to an oversupply and surplus sugar emanating from Brazil and India.

"However‚ recent adverse weather in Brazil should be supportive of pricing in 2014-15‚" Mr Davids says.

Additionally‚ the group's "optimisation efforts" in South Africa and a recovery in Zimbabwean sugar volumes "will drive the company's profitability in the medium term".

Mr Davids says while the Tongaat land earmarked for development is valuable‚ "the value needs to be realised through a managed disposal process — which is the process Tongaat has undertaken".

"Tongaat is best evaluated on a portfolio basis‚ with the valuation underpin of the extensive property portfolio and highly profitable starch business complementing the cyclical but recovering Southern African sugar operations‚" Mr Davids says.

Tongaat CEO Peter Staude says global sugar consumption has risen each year for the past decade and most analysts forecast this trend to continue at about 2% a year.

The supply of sugar has been more volatile than demand due to fluctuating weather conditions and investments by farmers. With surplus output in recent years‚ sugar producers have not invested materially in new milling capacity.

"It is a volatile‚ surplus-to-shortage market. At the moment there has been very little investment taking place for some time in the milling side‚ and if anything over the next 10 years we believe there's a likelihood that there will be a shortage of sugar."

Standard Chartered this month recommended buying March 2015 sugar futures on expectation of shortages‚ mainly due to anticipated lower production in Brazil.

Tongaat has the milling capacity to produce 2.1-million tonnes of sugar‚ and expects its production this year to rise to 1.4-million tons from 1.3-million in the 2013 financial year.

Mr Staude says the company expects to grow its sugar production by about 100‚000 tonnes a year‚ and therefore investments in new milling capacity will be needed only in about seven years.

As much as 90% of Tongaat's overhead costs are fixed and 80% of its milling costs are fixed‚ which means "as we are growing volumes‚ our sugar production costs are coming down quite substantially".

Meanwhile‚ Tongaat is likely to convert its remaining 8‚300ha of land earmarked for development at a rate of 200ha-300ha a year — "a step up from the pace that we were at previously" — mainly due to more demand for developments.

This is being driven by the growth of the area between Ballito and Umhlanga‚ as well as an area called Cornubia‚ "where there's a lot of interest in the retail‚ industrial and housing space".

The land conversion strategy is a 20-year project‚ with a likely increase in the current pace of conversion.

Mr Staude says Tongaat's Zimbabwean operations are the reason for the company's fall in return on capital employed between 2010 and 2013.

This was because the Zimbabwean assets were fully included on Tongaat's balance sheet only from 2011‚ resulting in an inflated return on capital in 2010.

The fall in return on capital was accentuated by Tongaat reinvesting in its Zimbabwean assets as the country's economy stabilised — which was also behind the spike in the wage bill — as well as from a longer 2010 financial year due to a change in Tongaat's year-end.

"We have improved operating profits in eight of the past nine years‚" Mr Staude says. "As we grow sugar production‚ we obviously face the volatility of the price‚ but we have leverage through our high fixed-cost base and the volume growth.

"Over a period of time‚ without having to invest new capital in mills‚ our return on capital employed will improve quite substantially."

Source: BD