UCT Student Research Agri-Processing Industry...Valuation reveals that Tongaat is trading at a discount. A fair value of R105.02 was determined using a sum-of-the-parts valuation for

UCT Student Research This report is published for educational purposes only

by students competing in the

CFA South Africa Investment Research Challenge.

Important disclosures appear at the back of this report

Ticker: ●TON Recommendation: ● Hold

Price: ● ZAR 91.27 Price Target: ● ZAR105.02

ZAR cps 2006 2007 2008 2009 2010 2011 2012 2013

HEPS 703 61 583 631 840 747 800 843

HEPS Growth 46% -91% 855% 8% 33% -11% 7% 5%

DPS 550 310 310 316 504 448.2 480 505.8

P/E 16.38 157.23 9.07 14.46 10.9 12.2 11.4 10.8

Dividend Yield 4.35 5.64 6.34 3.46 5.52 4.91 5.26 5.54

Highlights

Consolidation of Zimbabwe Operations

Tongaat Hulett (Tongaat) consolidated its sugar operations for the first time in 2009, resulting in a 95%

increase in profit from operations. After removing this impact however, profit from operations increased by

only 26% over the period. As operations in Zimbabwe remain uncertain, and are prone to a number of risks,

it is unlikely that the Zimbabwe sugar operations will continue to add as significantly to Tongaat’s sugar

business in the near term.

Mozambique Expansion

Tongaat completed the expansion of the Mafambisse sugar mill in 2008, and is currently in the process of

expanding operations at the Xinavane mill, in the south of Mozambique. The expansion will allow Tongaat

to realise higher revenues from a favourable sugar price, as well as from the preferential access to the EU

sugar market through Mozambique and Zimbabwe.

Anglo American Disposal of 49.5% stake in Tongaat

The recent disposal of Anglo American’s stake in Tongaat will significantly increase the liquidity and

accessibility of Tongaat shares. The departure of a majority shareholder may provide Tongaat management

with greater control over the long-term strategic direction of the group.

Tongaat Hulett Limited

25 September 2009

[Agri-Processing Industry]

52 Week Price Range R49-103

Average Daily Volume 677000

Beta 0.59

Dividend Yield (Estimated) 2.71%

Shares Outstanding 103m

Market Capitalization R9626m

Institutional Holdings Allan Gray

Book Value per Share R 53.13

Debt to Total Capital 1%

Return on Equity 52%

Market Profile

CFA South Africa Investment Research

Challenge Student Research

25 September 2009

2

Investment Summary

Tongaat has uniquely positioned itself as a diversified agri-processing business in Southern Africa. Key

operations include sugar and starch production, agricultural land conversion and property development, as

well as bio-fuel production and electricity cogeneration.

Tongaat Sugar is competitively positioned in global sugar market.

In recent years, conditions in the sugar market have been buoyant, with prices reaching a peak of

USD23.33c/lb in August of 2009, as a result of supply side constraints. However, the sugar price is

expected to fall to more sustainable levels in the next few years, approaching the long term price of

USD12c/lb. In the meantime, Tongaat’s sugar business is well-positioned to take advantage of positive

market conditions in the short term as expanded capacity in Mozambique and Zimbabwe will allow the

group to increase production to export markets. In addition, through operations in Mozambique and

Zimbabwe, Tongaat Sugar is poised to benefit from preferential access to the EU market at premium prices.

Green shoots in the local property market.

The property development industry has been set back by weak global economic conditions and heightened

risk aversion towards the property market. Although there is still a long way to go before stable economic

fundamentals return to the market as a whole, it is believed that the local property market will recover much

quicker than global markets. This is due to increased development in the run up to the 2010 Soccer World

Cup, as well as Governments commitment to infrastructure and housing spend, which will have a positive

effect on demand for development land in the region. Moreover, lower interest rates will entice investors

back into the market in the near term. With that in mind, much value will be created for Tongaat’s property

business in the short term, especially as much of its developable landholdings are situated in the eThekwini

growth corridor, north of Durban, where extensive industrial and commercial development is set to take

place.

Valuation reveals that Tongaat is trading at a discount.

A fair value of R105.02 was determined using a sum-of-the-parts valuation for Tongaat Hulett. The results

of this valuation are displayed in Figure 1 below.

Figure 1: Fair Value of Tongaat Hulett Summary of the sum of the parts valuation of Tongaat Hulett

Fair value (ZAR per share) Fair PE

Sugar 50.21 11

Property 39.31 5*

Starch 15.5 10

Total fair value per share 105.02 14

Current price 92.5

% discount -11.90%

Recommendation Hold

Source: UCT estimates

*Property DCF valuation

Tongaat Hulett is currently trading at a market price of R92.50, with a P/E multiple of 12.42. It can be said

that that the business, as a whole, is undervalued. The valuation undertaken suggests that Tongaat should be

trading at a P/E multiple of 14, as it is expected that earnings will grow considerably in the near term.

Risks to the investment case:

Since various assumptions have been used in the valuation of Tongaat, a number of risks arise. Moreover,

as Tongaat Hulett is a diversified business, it may be prone to a larger variety of risks than its competitors,

such as Illovo - which is considered a pure play on sugar. Risks to the investment case therefore include:



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3

Exchange rate fluctuations, and in particular, sustained Rand strength against the Dollar;

Commodity price fluctuations;

Adverse climate and weather conditions;

Increasing interest rates as inflationary pressures enter the economy in the long term;

Uncertainty surrounding Zimbabwe sugar operations; and

Prolonged negative conditions in the property market.

Figure 2 below shows Tongaat’s share price movement over the last two years. As is evident, Tongaat’s

share has outperformed the All Share Index (ALSI) in the last few months. It is expected that this trend will

continue in the short term, but that share performance will revert back to the market average in the next year

or so.

Figure 2: Price Performance of Tongaat Hulett relative to the JSE All Share Index Blue: Tongaat

Red: JSE All Share

Orange: Food Production

Source: McGregor BFA

Tongaat Hulett as a Hold.

Given the analysis and valuation, the 11.9% discount on the current market value does not justify a Buy

rating. The target price of R105, suggests a slightly positive outlook for Tongaat in the near term, but not

enough.

Valuation A sum of the parts method using a fair price-to-earnings multiple for each business segment was used to

determine the fair value of Tongaat Hulett. Applying this valuation methodology will allow a comparison to

be made between the sugar, property and starch businesses and to other similar firms in the market, and

furthermore determine which segment is the key driver in the long term value of Tongaat Hulett.



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4

Sugar Business Valuation

Initial Assumptions

Cost of Revenue is split into 50% fixed costs and 50% variable costs. Fixed costs will grow by and

inflation-linked rate while variable costs will vary with production and grow marginally over time

Discount Rate applied of 13.2%

World sugar price declining from the current top of cycle at US23c/lb to a long term normalised price of

US12c/lb

Sales equals Production

ZAR/USD depreciating from current levels to 9.30 in 2013 due to inflation differentials

Production

Tongaat Hulett is poised to take advantage of preferential access into the protected and regulated European

Union sugar market through their operations in both Zimbabwe and Mozambique. Additional production

capacity has been installed in Mozambique and has taken total capacity to 300 000 tonnes/annum for the

2009 year. This has been accounted for in the production forecasts.

The first time consolidation of the Zimbabwe operations is encouraging for the sugar business but a concern

does exist regarding whether Tongaat Hulett will be able to extract cash from these operations. Efficiency

from operations is expected to increase in the next 5 years as management attempts to restore the cane out

grower network. The Zimbabwean operations are expected to be a key driver of future earnings.

Figure 3: Fair Value of Tongaat Hulett Summary of the sum of the parts valuation of Tongaat Hulett

Tongaat-Hulett Sugar (000's) 2006A 2007A 2008A 2009E 2010E 2011E 2012E 2013E

Total Production(Actual) 1067 1119 1106 1226 1333 1416 1497 1557Total Production (Capacity) 1500 1785 1835 1960 1960 1960 1960 1960Capicity Utilisation 71% 63% 60% 63% 68% 72% 76% 79%

South Africa 62% 54% 58% 52% 50% 48% 47% 46%Total (Actual) 666 604 644 640 660 680 700 710Total (Capacity) 1000 1000 1000 1000 1000 1000 1000 1000Capicity Utilisation 67% 60% 64% 64% 66% 68% 70% 71%

Zimbabwe % 22% 31% 27% 24% 27% 30% 31% 33%Total (Actual) 240 349 298 290 360 420 470 520Total (Capacity) 600 600 600 600 600 600 600 600Capicity Utilisation 40% 58% 50% 48% 60% 70% 78% 87%

Mozambique % 10% 10% 10% 20% 19% 18% 18% 17%Total (Actual) 106 108 108 240 257 260 271 271Total (Capacity) 156 156 175 300 300 300 300 300Capicity Utilisation 68% 69% 62% 80% 86% 87% 90% 90%

Other % 5% 5% 5% 5% 4% 4% 4% 4%Total (Actual) 55 58 56 56 56 56 56 56Total (Capacity) 60 60 60 60 60 60 60 60Capicity Utilisation 92% 97% 93% 93% 93% 93% 93% 93%Source: Company Data, UCT Research Estimates

Sugar Price

The value of the sugar business is extremely sensitive to the various effective sugar prices for each of the

markets that Tongaat Hulett supplies. According to an analysis of the global sugar market a view can be

taken that the commodity cycle is near or at its peak and that the sugar price will come off its current high

price and settle at USD12c/lb, which can be considered to be the demonstrated long-term normalised sugar

price. The no.11 Sugar Futures contract prices, obtained from the a daily Czarnikow sugar futures report in

conjunction with the supply and demand factors have been used to forecast the world sugar price into the

future.



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Key Revenue Drivers Forecast

Figure 4: Key Sugar Revenue Drivers Forecast Comprehensive forecast of key drivers of revenue from 2009 to 2013

Tongaat-Hulett Sugar 2009E 2010E 2011E 2012E 2013E

Key Revenue DriversAve ZAR/USD 8.05 8.22 8.50 8.90 9.30World Price (c/lb) 0.23 0.23 0.18 0.16 0.12EU Preferential Price (c/lb) 0.30 0.24 0.24 0.24 0.24Domestic Price (c/lb) 0.22 0.22 0.23 0.22 0.22Regional Export Price (c/lb) 0.23 0.21 0.20 0.20 0.20Variable Cost Growth 1% 1% 1% 1% 1%Fixed Cost Growth 6% 6% 6% 6% 6%Source: Company Data, UCT Research Estimates, Czarnikow Sugar Futures, Stats SA

The Domestic and Regional Export price should theoretically approach the world sugar price, yet the

domestic sugar market is regulated to some extent which does afford protection to local sugar producers.

Due to import tariffs the domestic sugar price is expected to stay a few c/lb above the world sugar price,

which is sold on the open market.

The EU preferential price is fixed at EUR335/tonwhich at the current exchange rate translates into

approximately USD 22c/lb. That approximation has been used going forward to 2013 when the reference

price will be revised. The EU preferential price is a key risk in the sugar business operations. The expanded

capacity in Mozambique and Zimbabwe has been set on taking advantage of the preferential access but if

the preferential price were to approach the world sugar price, a dramatic reduction in earnings would occur.

Outlook for Global Sugar Market

Figure 5: World Sugar Price 1962-2009 Historic world sugar price (Sugar #11) between 1962 and 2009 in US c/lb

Source: McGregor BFA



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According to the International Sugar Organisation, global sugar demand will increase by a wider margin

than it has previously forecasted, due to unusual weather patterns in both Brazil and India - the leading

sugar producing nations in the world. The price of raw sugar is at a 28-year high, due to excessive rains in

Brazil having made it difficult for cane to be harvested, while weak monsoons in India will not allow it’s

industry to fill the deficit left by the Brazilian operations. The no.11 Sugar futures contract price has risen

over 86% this year alone, reaching a peak of US23.33c/lb on 12 August this year. As bio fuel production

gains ground and the demand for ethanol increases it may be the case that there would be use for excess

supply in the context of the world sugar market.

The figure 6 below breaks down the forecast of how sales volumes are allocated by market. Sales into

preferential markets increase while domestic volumes decrease steadily on a relative basis. The shift in

production to supply the preferential markets has been estimated by consulting management regarding their

directives, and a long-term view on the industry.

Figure 6: Forecast Sales Volumes of Sugar per Market Forecasts of the sales volumes of sugar for the years 2009 – 2013 segmented by market

Tongaat-Hulett Sugar 2009E 2010E 2011E 2012E 2013E

Sales Volume by MarketWorld ExportPercentage of Total 20% 19% 18% 17% 16%Tonnes (000's) 245 253 255 254 249

Pref. MarketsPercentage of Total 16% 17% 19% 23% 24%Tonnes (000's) 196 227 269 344 374

Regional ExportPercentage of Total 4% 4% 4% 4% 4%Tonnes (000's) 49 53 57 60 62

Domestic MarketPercentage of Total 60% 60% 59% 56% 56%Tonnes (000's) 736 800 835 838 872Source: Company Data, UCT Research Estimates, Czarnikow Sugar Futures

Rising incomes, larger urban populations in Asia - especially China - should lead to increased sugar use

with rising per capita consumption as the poorer classes ascend out of poverty.



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Figure 7: Tongaat Sugar Valuation Comprehensive breakdown of the valuation of the sugar component of Tongaat Hulett

Tongaat Hulett Sugar 2006A 2007A 2008A 2009E 2010E 2011E 2012E 2013E

Revenue (R000's) 3196000 3824000 4544000 5117425 5432744 5882687 6273948 6639918Domestic 2872024 3188627 3600724 3618681 3932875World Export 1000857 1055629 859716 798930 612916Preferential 1044372 985576 1209971 1621357 1838747Regional Export 200171 202913 212276 234979 255381

Cost of Revenue 2840000 3464000 3938000 4249730 4567290 4872213 5184538 5455200 Fixed 1969000 2067450 2170823 2301072 2439136 2585484 Variable 1969000 2182280 2396467 2571142 2745402 2869715

Profit from Operations 356000 360000 606000 867695 865454 1010473 1089410 1184719Operating Margin 11.14% 9.41% 13.34% 16.96% 15.93% 17.18% 17.36% 17.84%Tax Rate 28% 28% 28% 28% 28%NOPAT 624741 623127 727541 784375 852997Less Minorities 41233 41126 48018 51769 56298NOPAT to Equity 583508 582001 679523 732606 796700

Terminal Value 2013 5355954Fair P/E 11Discounted to 2010 5355954Discounted Oct 2009 5184352WANOS 103247

Value per Share 50.21

Source: UCT Estimates, Company Data, Czarnikow Sugar Futures

A fair value of R50.21 per share has been placed on Tongaat Sugar. A P/E of 11 has been used in

conjunction with the 2013E NOPAT after minorities to calculate a terminal value which would reflect the

long-term normalised operations of Tongaat Hulett Sugar. A discount rate of 13.1% is applied as calculated

by summing the yield on the R157 Bond of 8.1% and the JSE historical market risk premium of

approximately 5%.

Figure 8 shows the long term JSE All-Share P/E data over the last 50 years, averaging 11.72 over the

period. A P/E of 11 has been applied to the terminal value as it is felt that the quality of earnings for

Tongaat is lower than the average JSE business. The uncertainty of the key revenue drivers (being mainly

the world sugar price and the ZAR/USD exchange rate) is driven by factors outside of management’s

control.



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Figure 8: JSE All Share P/E Multiple Long term view of the JSE All Share P/E Multiple from 1964 to 2009

Source: iNet

Margins are expected to come under pressure moving towards 2013E and beyond as the world sugar price

approaches normality. In the near term however the sugar price is expected to remain buoyant. The impact

of the bio fuel industry remains to be seen in South Africa, and may yet add substantial value to the

business.

Starch Business Valuation To a large extent, starch operations are driven by two commodity prices, the maize price - which makes up

the majority of the variable input cost in production - and the average price at which the starch products can

be sold.

Figure 9: Key Maize Revenue Drivers Forecast Historic and forecasted maize revenue drivers

Input Cost 2006A 2007A 2008A 2009E 2010E 2011E 2012E 2013E

Maize price 1250 1722 1831 1800 1750 1700 1700 1700

Revenue

Starch Ave Price 2285 2743 3102 3000 2950 2900 2880 2800

Volume Produced

Total Volumes 576 612 693 684 688.5 693 702 702

Capacity Utilization 64% 68% 77% 76% 77% 77% 78% 78%

Source: Company Data, UCT Research Estimates



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In 2008 the maize price was near import parity and this increase in input costs put pressure on the operating

margins. However looking at the long-term historical trends, this is set to return to normality, trading

midway between export and import parity. This is expected to be around 1700 by 2013.

As far as revenue prices for starch are concerned; they are also expected to decrease below current levels to

some kind of normality over the next five years.

Another driver in revenue generation is the efficiency and productivity of the starch operations. Recently

much focus has been placed on energy efficiency and capacity utilization, with 77% capacity utilization

achieved in 2007. An expected decrease in demand both locally and internationally in the next two years

will result in utilization dropping slightly, but this is expected to bounce back as the demand picks up in

2011.

Figure 10: Tongaat Starch Valuation Comprehensive breakdown of the valuation of the starch component of Tongaat Hulett

STARCH 2006A 2007A 2008A 2009E 2010E 2011E 2012E 2013E

Revenue 1316000 1679000 2150000 2052000 2031075 2009700 2021760 1965600COGS 720000 1053864 1268883 1231200 1204875 1178100 1193400 1193400Gross Profit 596000 625136 881117 820800 826200 831600 828360 772200Operating Cost 500000 520136 641117 595080 578856 562716 566093 550368Operating Profit 96000 105000 240000 225720 247344 268884 262267 221832Tax 27840 30450 69600 65459 71730 77976 76057 64331NOPAT 68160 74550 170400 160261 175614 190908 186210 157501

Fair P/E 10Discounted Value 155179 150349 144512 124629 1025250Terminal Value 1575007Total Value 1599919WANOS 103247Value per Share 15.50

Source: Company Data, UCT Estimates

Given expectations about operating efficiencies and commodity prices, future expected earnings from starch

operations can be estimated between 2009 and 2013. In determining a current value of the starch business, a

discount rate of 13.1 % has been used which is the summation of the risk free rate of 8.1% and a 5% risk

premium. Due to the low quality of earnings delivered by the starch operation when compared to the JSE, a

P/E of 10 has been used in valuing the starch operations. Using the NOPAT of R157 501 000 in 2013 and

an estimated forward P/E of 10 a terminal value of R1 575 007 can be calculated. Applying a discount rate

of 13.1% to the terminal value and earnings between 2009 and 2013 in conjunction with a WANOS of 103

247, a value of R15.50 per share attributable to Tongaat starch operations is achieved.

Property Business Valuation A slightly different approach was used in valuation of Tongaat’s property business. A discounted cash flow

(DCF) methodology was used together with estimates of cash flows expected from developments in the next

five years, and to an average profit figure per hectare on the remaining developable land for a 20-year

period.

Tongaat Developments currently has 8996 ha of developable land in the Kwa-Zulu Natal region. In 2008,

management indicated that 678 ha of developable land would be sold over five years to 2012. This has been

incorporated in the forecast for the next five years, after taking into account actual land sales for 2009. It is

therefore expected that approximately 8400 hectares will be under development over a 20 year period

beginning in 2013.



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Initial Assumptions

60% of management’s expected developments to 2012 will occur by the end of 2010, and 40% will occur

evenly over 2011 and 2012

Revenue from expected developments will comprise 80% from affordable housing land and 20% from

prime land

Revenue per hectare will increase steadily over the next five years, reaching R850000 for affordable

housing land and R11million/ha for prime land by 2013

Average profit of R2million/ha from 2013 onwards

Discount rate applied of 10.28%

Forecasts

Although market conditions in the property sector have been overwhelmingly negative in the last 2 years, a

recovery is anticipated in the local market in the short term. Given the increased property developments in

the run up to the 2010 FIFA Soccer World Cup; the steady decline in interest rates from peak levels since

2008; and positive growth in the affordable housing market, Tongaat Developments is well-positioned to

realise profitable returns from its developable landholdings.

The growth in revenue and operating profit in the next few years is expected to be predominantly from sales

of affordable housing and industrial development land. This is due to weak demand for prime land as a

result of weakened global economic conditions and sustained negative investor sentiment towards the

property market.

In the long term it is expected that Tongaat Developments will be able to realise an average profit of

approximately R2million/ha on the remaining development landholdings over the 20-year period beginning

in 2013, as stability returns to the market.

Figure 11 below illustrates the earnings forecast. It is forecasted that margins will decline to approximately

50% in 2013 as inflationary pressures to return to the market.

Figure 11: Tongaat Land Valuation Comprehensive breakdown of the valuation of the land component of Tongaat Hulett

Tongaat Developments (R000's) 2008A 2009E 2010E 2011E 2012E 2013E

High value land sold (ha) 64 21 21 20

Low value land sold (ha) 256 86 86 80

Total developable ha sold 320 107 107 100

Revenue 412000 428000 780800 280950 304100 288000

Costs -149000 -217000 -273280 -112380 -136845 -144000

Profit from Operations 263000 211000 507520 168570 167255 144000

Operating margin 63.83% 49.30% 65.00% 60.00% 55.00% 50.00%

Tax rate 28% 28% 28% 28% 28% 28%

NOPAT to Equity 189,360 151,920 365,414 121,370 120,424 103,680

Implied PE 5.27

Terminal Value 5052112

Discount factor 0.66 0.975 0.885 0.802 0.728 0.66

Discounted NOPAT to Equity 3333202 148249 323344 97389 87619 684043

Discounted to October 2009 4058297

WANOS 103247

Value per share 39.31

Source: Company Data, UCT Estimates



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A fair value of R39.31 per share is therefore placed on Tongaat Developments. A discount rate of 10.28%

was used, taking into account the 10-year South African government bond yield and applying a 1.5% risk

premium.

Business Description Tongaat has established a formidable presence in Southern Africa, as a diversified agri-processing business,

which includes sugar and starch production, land management and property development. Core divisions

include Tongaat Sugar, Tongaat Starch and Tongaat Developments- each contributing significantly to value

creation for the group.

Tongaat Sugar, however, is by far the key revenue and profitability driver as sugar operations are situated in

prime agricultural locations in Zimbabwe, Mozambique and Swaziland. Sugar operations alone contribute

about 70% of the group’s revenue, and 80% of profit from operations, both taking into account the first

time consolidation of Zimbabwe sugar operations. Tongaat Starch is the largest producer of starch and

glucose related products in Africa, and has benefited from favourable maize price movements in the period.

Tongaat Developments has been affected by the current economic climate, with sales of high value land

dropping significantly, although demand for affordable housing and industrial land remains strong.

Industry Overview and Competitive Positioning Tongaat operations are based mainly in the agri-processing industry and the property development industry,

with meagre earnings from: bio fuel production, animal feed production and the cogeneration of electricity.

These will each be discussed in turn.

Agri-processing Industry - Starch:

The industry was deregulated in 1997 and currently operates in a free-market environment however the

product is a staple good may be subject to food security measures from time to time.

South Africa has produced a surplus of maize in recent years with the excess being exported. Production is

driven mainly by the local price maize, which is determined by both local supply and demand as well as

international maize prices. Locally, the price of maize has remained close to world prices giving Southern

African farmer’s international competitiveness.

Emphasis on the promotion of alternative fuel sources has increased the demand for biofuels, which

indirectly affects the quantity of maize demanded. Maize can be a viable source of energy as long as

traditional sources of energy remain comparably more expensive. The new, lower, oil price has caused this

indirect demand for maize decline in the past few months; however the resurgent world economy should

maintain those higher maize prices in the short to medium term.

Agri-processing Industry - Sugar:

South Africa is one of the most competitive sugar producers in the world. It is one of the cheapest countries

to produce sugar in, and with prices at historical highs, and near export parity, the industry is experiencing a

higher level of profitability than normal. This is expected to last for the next four to five years over which

the sugar price will decline, back to historical levels, if current trends persist.

Even though sugar can be highly profitable export good, periodic subsidy-induced overproduction in many

first world countries can have the effect of causing prices to be volatile. Protectionism in the form of tariff

rate quotas and high tariffs further complicate entrance into major markets, however recourse is available in

various forms being: tariff protection, equitable export obligations and the Sugar Cooperation Agreement

between Southern African Development Community (SADC) members.

Apart from this, the European Union (EU) has pledged a reform of the Sugar Protocol, effective 1 October

2009. Preferential agreements with Least Developed Countries (LDC’s) and certain African, Caribbean and

Pacific (ACP) members like Mozambique allow the sugar to be exported to the EU on a duty free and quota

free basis. This advantage is important given that other sugar producing nations such as Brazil do not have

the same access. Firms have noticed this and many large sugar producers have plans to expand their

operations in these areas.



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The world sugar price has remained well above historical levels in the recent past, largely due to supply side

constraints. This is expected to continue for the next year, and level off over the following 5 years. This

postulation is reinforced by weak production in Brazil, significantly lower production levels in India and

the decline in production in the EU due to the newly reformed Sugar Regime in that area.

Property Development Industry:

Over the past few years the growth in demand for agricultural land coupled with the increased demand for

alternative land usages has lead to property prices in the eThekwini region increasing significantly. This

trend has been mirrored in other areas of KwaZula-Natal too, with prices reaching a peak in mid 2008.

However the global economic climate coupled with lenders reluctance to grant credit has caused this trend

to cease. Prime land in the KwaZulu-Natal area is no longer as demanded, as previously was the case. The

next few years do, however, look more positive. Substantially decreased interest rates will spur investment,

while the expected positive economic cycle is by no means certain in magnitude, but a marked upswing in

the business cycle is probable in the medium run.

The market focus in the region at the current time has in effect shifted away from prime property. The focus

is now on land development in more affordable (non-prime) areas, mainly due to the massive housing

backlog that the government faces. In the latest general election the ruling party won on a ticket of long

awaited service delivery to the masses. Government’s intention for infrastructure spending is well known

and is encouraging for property developers in South Africa – especially for those in more affordable

locations.

Bio-fuels and Electricity Cogeneration:

Internationally, global demand for bio-fuels has risen in the past decade as the cost of fossil fuel increase.

Maize and sugar are both potential sources of energy, as Brazil has demonstrated recently. The South

African government has placed great focus on renewable energy; however they have excluded maize as a

renewable energy source due to food security concerns. As such bio-fuels production from maize is not a

viable source of income in the short run. However over the longer term, more focus may be given to this

income stream. Bagasse and molasses are not excluded from energy production.

The shortage of electricity in the country has not gone unnoticed by the government. They have pledged to

utilise all viable project proposals from the private sector, giving new life to cogeneration projects.

Competitor Analysis - Agri-processing:

Locally, Tongaat competes within the sugar and downstream sugar product industry directly with Illovo

Sugar.

The Illovo business is more of a pure-play sugar producer when compared to Tongaat’s more diversified

operations. Illovo is the global low-cost producer and the biggest sugar producer in Africa with operations

in 6 countries and distribution to many more. Like Tongaat, it too has preferential agreements with the EU

through ACP countries, as well as with the US through Malawi. Over the past few years Illovo has sought

to expand operations throughout the continent and has done so with moderate success.

Tongaat however, differentiates it’s self from Illovo through its active diversification away from being a

pure-play on sugar. They have sought to decrease the effects of the seasonal nature of the agri-processing

industry on their earnings, by entering the land management and property development market. This is

logical since they have substantial land holdings, which are highly valuable in certain circumstances. They

have increased their diversification by not only becoming land dealers and managers but have become

active property developers, further diversifying their operations.

Illovo has undergone significant expansion in sugar production both in terms of tons produced and also in

terms of geographies covered. This is partly driven by the high profitability of sugar production currently

and in the near future, and also due to the preferential trade agreements that certain countries command.

Tongaat has followed closely with expansions planned in most regions, with a focus on Mozambique and

Zimbabwe.

Competitor Analysis – Property Development:

The property development industry in KwaZulu-Natal is characterised by many firms offering similar

services. Market participants only differ in the size of the projects that they are capable of undertaking, and



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the type of developments they undertake. Well-established firms such as Pam Golding and Seeff are able to

manage larger developments, while smaller firms such as Lighthouse and the eLan Group operate in niche,

smaller, mostly residential developments.

Tongaat differs from many other property developers in that they usually control the entire supply chain,

given their vast land holdings. This allows them to circumnavigate the frenzy for prime land that other

developers endure.

The current economic decline has caused demand for new developments stagnate. As such many developers

are cutting back on production, especially in prime locations. Public sector spending may fill this gap in the

short term and medium term as the government increases its level of service delivery, but this has yet to

have a substantial effect on the industry as a whole.

Financial Analysis The consolidation of the Zimbabwe sugar operations (Triangle Sugar and Hippo Valley) has had a

significant, albeit ambiguous, impact on Tongaat’s current financial statements. At first glance, the

consolidation has resulted in Tongaat reporting significantly positive results. However, it is necessary to

strip out the Zimbabwe sugar component in order to obtain a more objective comparison of Tongaat’s

financials with previous years, as well as with competitors in the industry.

Earnings

The 2008 financial generated revenue of R7, 1 billion; an increase of 11% compared to the 2007 year. An

increase of 2% in the operating profit margin of Tongaat from 14% to 16% coupled with the increase in

revenue resulted in profit from operations growing by 35% to R1, 132 billion. The charts below give a

break down of the three main business operations and their respective contribution to revenue and operating

profit.

Figure 12: Revenue and Operating Profit Constituents Breakdown of the components of revenue and operating profit as of interim results 2009

Source: Company Data

On the face of it, the 2009 interim results look impressive from an earnings point of view. Revenue

generated at half year was R3,9 billion (2008: R3,1 billion) and profit from operations was R864 million

(2008: R443 Million). However once the consolidation of Zimbabwe’s profit from operations of R305

million has been stripped out, only a 26% increase in profit from operations remains. In addition headline

earnings decreases from R440 million to R274 million. Given the major outlay of capital expenditure in the

last 2 years, the corresponding increases in revenue have been below expectations.

Cash Flow Conversion Concern

The previous few years at Tongaat Hulett have been characterised by high cash expenditures on capex,

especially for the increase in production capacity for the sugar operations in Mozambique. What is more

worrying is the fact that the company was not able to convert the R188 million in increased headline

earnings from H1 last year into a similar cash flow operating activities figure. Cash flow from operating

activities decreased by R1 million for the 6 months to June 2009.



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Figure 13: Cash Conversion Ability Historical and Forecasted Cash Conversion Ability of Tongaat Hulett

Historical Cash Conversion Ability 2004 2005 2006 2007 2008 2008H1 2008H2 2009H1

Headline Earnings 206 466 703 61 583 252 331 440

Profit from Operations 323 550 726 838 1132 443 689 864

Cash Flow from Operating Activites 442 897 606 383 685 103 582 102

Change in Net Cash 42 -291 -74 174 -231 -119 -112 -41

Cash Flow Conversion Ratio 2.15 1.92 0.86 6.28 1.17 0.41 1.76 0.23

Source: Company Data

Historically, Tongaat Hulett has had a decent cash conversion ratio but has also before poorly in the 6-

month period to the reporting date. Management have attempted to clarify this anomaly by stating that cash

flows come in the second half of the year as more crop is harvested. In the first half of the year, the increase

in profit from operations is attributed to the growth in the cane crop.

Balance Sheet & Financing

In the last two years, Tongaat has spent considerable amounts of capital in the expansion of its operations,

most significantly in its Mozambique operations. PPE was increased by over R1.4 billion contributing to a

total asset increase of R1.9 billion in 2008. However, this increase in the asset base has not generated a pro

rata increase in revenue and as a result Total Asset Turnover, a key driver of Return on Equity (ROE), has

fallen by 10% from 84% in 2007 to 74% in 2008. Furthermore, the consolidation of Zimbabwe has pushed

PPE of Tongaat’s to over R7.5 billion and total assets to R13.4 billion, which is going to apply further

pressure to Tongaat’s turnover of its assets.

Tongaat has historically operated with a debt to equity ratio of around 1.2. However, with the recent outlay

of capital expenditure and the decision to source this capital through debt as opposed to equity, Tongaat has

consequently moved into a far more leveraged position. As a further result, finance costs in the first half of

2009 have nearly doubled to those experienced in 2008.

In addition, a further concern of taking on a more leveraged position is the ability of Tongaat to meet all its

financial commitments. The current ratio assesses the firm’s ability to meet short-term debt obligations.

Tongaat’s current ratio is a slight concern for investors as it has decreased from 1.41 (2007) to 1.07 (2008)

and further to 0.97 (Interim 2009).

However, given Tongaat’s well-established business operations and consistent performance from a financial

point of view, there is not much cause for concern.

Risk Factors There are various factors and risk that affect a complex company such as Tongaat Hulett. The following

risks affect the company and our valuation:

Commodity price fluctuation

The most important determinant of Tongaat Hulett agriculture business is the world commodity price of

sugar and maize (and some extent ethanol). The fluctuation in price is determined by the supply and

demand in these commodities, causing the company to be exposed to cyclical fluctuations. Thus Tongaat’s

profitability depends greatly on the import and export parity prices, especially for maize. Significant

increase in production by Brazil, China or India could cause a serious slump in the price of these goods.

Foreign currency risk

The company is exposed to fluctuations in several currencies: South African Rand, US dollar, Euro and

Mozambique Meticas. As the world sugar price is denominated in US dollars, hence a US/ZAR fluctuation

has a substantial effect on revenue. This causes the sugar and maize price to be even more volatile.



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Even though Hulett only exports about 20% of its production at world prices the exchange rates affects

many various inputs into the company. There will also be an increase to the exposure of the EURO/ZAR

fluctuation with the expansion of Mozambique production and exports to the EU under preferential

treatment. It is expected that translational headwinds from fluctuations in Mozambique foreign exchange,

especially in first half of 2010.

Sensitivity Analysis

The following table shows the sensitivity of estimated fair value of the Tongaat Hulett Sugar business to our

long-term forecasts of the normalised world sugar price as well as the ZAR/USD exchange, the two

fundamental drivers of the business value.

Figure 14: Sugar Valuation Sensitivity Analysis Sensitivity analysis of the sugar valuation to various exogenous factors

Sugar Valuaion Sensitvity

BaseZAR/share -10% -5% 0% 5% 10%

Stronger Rand -10% 19.73 20.90 22.07 23.24 24.24-5% 33.82 35.06 36.29 37.53 38.82

Base ZAR/USD 0% 47.62 48.91 50.21 51.51 52.885% 62.01 63.37 64.74 66.10 67.54

Weaker Rand 10% 75.50 76.93 78.56 79.78 81.28

ZAR/share -10% -5% 0% 5% 10%Stronger Rand -10% -61% -58% -56% -54% -52%

-5% -33% -30% -28% -25% -23%Base ZAR/USD 0% -5% -3% 0% 3% 5%

5% 24% 26% 29% 32% 35%Weaker Rand 10% 50% 53% 56% 59% 62%

World Sugar Price in US cents

Source: UCT Research Estimates

World Sugar Price in US cents

Source: UCT Estimates

The share price is most vulnerable to ZAR/USD exchange rate as this effects the 20% of output sold on the

world price market. The ZAR/EU exchange rate is not as influential as the sugar is sold at a set price. The

graph emphasises the volatile and cyclical nature of Tongaat Hulett.

Supply side risk

The world price of sugar and maize is affected by world supply and demand. One of the biggest supply

factors is the climate. The sugar and maze is vulnerable to droughts or extreme heat. However sugar cane

also is dependent on generous sunlight to grow. Other factors that would affect the crops such as land use,

irrigation, fertilizer and chemical availability, and electricity supply can also cause risks if not properly

managed.

Supply side problems have started to appear in the South African operations and Tongaat has experienced

bellow optimal capacity utilization rates. This is because both land available for cane crops and crop yield

have decreased. This is slowly decreasing efficiency and profits and needs to be addressed by the company.

Legal risks

Land claims in Zimbabwe and South Africa are added risks. Delays or denials of plans and constructions

project by government are another risk to the land development section of Tongaat.

Interest rate risk

This will not only affect the interest expense and income of the company but it will have a great impact on

the property side of business. At present the property development has been favoured by a lowering in

interest rates.



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Political and Social Risks

Sugar is one of the most politically regulated commodities in the world and thus any drastic changes in

regulations or policies could affect the company.

Zimbabwe’s political and economic climate is an important and sensitive issue. The value of the land, as

well as the efficiency of the sugar production is reliant on economic climate improving. This has already

started to take place and partially been included in the price of the share. However there is still much

improvement that needs to take place before full capacity is reached and sustainable returns on assets can be

guaranteed. A big contributor to this succeeding is for out growers to achieve a required yield rate. Lack of

transparency in the country as well as the disclosure in the financial statement also aggravates this risk.

EU New Regime Risks

The new EU preferential treatment towards LDC is a great opportunity however there are also risks

involved. Tongaat has in the past and is currently making large investments into Mozambique with the aim

of utilizing its preferential trade agreement to reach the EU market. However, although Tongaat will gain

access, it still needs to compete with other LDC operating companies as well as negotiate contracts with the

EU countries. Specifically the risk comes mainly from Illovo, its biggest competitor which already has a

good working relationship and reputation with the EU countries and may have an advantage. There are also

risks of not meeting the EU’s quality or safety requirements. And lastly the EU’s CAP is reformed often and

thus this preferential treatment may be changed or taken away.

Property development climate

This is the smallest sales contributor but the largest operating profit contributor; factors influencing this

sector have a big effect on the company. Unfortunately the property environment is going through a

downturn both in South Africa and the surrounding region. This downturn is only seen to rebound in the

next few years.



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Figure 15: Income Statement in millions

Income Statement 2006A 2007A 2008A 2009H1 2009E 2010E 2011E 2012E 2013E

Revenue 5,110 6,395 7,106 3,852 7,597 8,245 8,173 8,600 8,894

Sugar 3,196 3,824 4,544 2,682 5,117 5,433 5,883 6,274 6,640

Starch 1,316 1,679 2,150 1,085 2,052 2,031 2,010 2,022 1,966

Property 598 892 412 85 428 781 281 304 288

Operatin Expenses (Excluding Dep) 4,384 5,557 5,974 2,988 6,293 6,624 6,725 7,081 7,343

Sugar 2,891 3,519 3,915 1,994 4,250 4,567 4,872 5,185 5,455

Starch 1,220 1,574 1,910 973 1,826 1,784 1,741 1,759 1,744

Property 273 464 149 21 217 273 112 137 144

Profit from Operations 726 838 1,132 864 1,304 1,620 1,448 1,519 1,551

Margin % 14% 13% 16% 22% 17% 20% 18% 18% 17%

Other Income/(Expenses) 83 3,012 40 12 25 30 35 28 45

NPBIT 809 3,850 1,172 876 1,329 1,650 1,483 1,547 1,596

Finance Costs 84 -119 -280 -151 -317 -301 -283 -264 -242

PBT 893 3,731 892 725 1,012 1,349 1,200 1,283 1,353

Tax -238 -288 -212 -219 -283 -378 -336 -359 -379

Discontinued operations-Hulamin 69 42 - - - - - - -

Net Profit 724 3,485 680 506 729 971 864 924 974

Margin % 14% 54% 10% 13% 10% 12% 11% 11% 11%

Minority -1 -28 -31 -54 -78 -104 -92 -99 -104

NP Attributable to Shareholders 723 3,457 649 452 651 868 772 825 870

Adjusted (Exceptional item) 723 75 649 452 651 868 772 826 870

Headline EPS (cents) 703 61 583 438 631 840 747 800 843

Source: Company Documents, UCT Estimates



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Figure 16: Statement of Financial Position in millions

Assets 2006A 2007A 2008A 2009A1 2009E 2010E 2011E 2012E 2013E

Non-Current

PPE 4,270 3,210 4,659 7,696 7,969 8,180 8,257 8,424 8,524

Intangible Assets 35 48 105 260 268 272 276 280 296

Long Term Recievable 203 203 196 196 196 196 196 196 196

Investments 320 267 268 7 8 10 10 12 12

Biological Asset 212 353 742 1,517 1,434 1,493 1,578 1,659 1,721

Current Asset

Inventories 1,595 1,331 1,709 1,605 1,899 2,061 2,043 2,150 2,223

Cash& Cash Equivalents 509 396 229 218 149 228 316 340 448

Other Current Assets 33 77 2 22 2 2 2 2 2

Trade & Other Recievables 1,879 1,742 1,647 1,922 1,975 2,144 2,125 2,236 2,312

Total Assets 9,056 7,627 9,557 13,443 13,900 14,585 14,804 15,299 15,735

Equity & Liabilities

Retained Income 3,868 1,796 2,087 4,335 4,744 5,281 5,759 6,270 6,809

Other Equity 1,165 1,162 972 1,160 1,162 1,165 1,170 1,175 1,180

Total Equity 5,033 2,958 3,335 5,495 5,906 6,446 6,929 7,445 7,989

Attributable to Shareholders 4,957 2,735 3,059 4,606 4,961 5,415 5,820 6,254 6,711

Minority 76 223 275 889 945 1,031 1,109 1,191 1,278

Liabilities

Long Term Liabilities 1,451 2,156 2,865 4,089 3,966 3,768 3,542 3,294 3,030

Trade & Other Payables 1,338 1,494 1,849 1,781 1,977 2,145 2,127 2,238 2,314

Other Short Term Liabilities 1,234 1,019 1,508 2,078 2,051 2,226 2,207 2,322 2,401

Total Equity & Liabilities 9,056 7,627 9,557 13,443 13,900 14,585 14,804 15,299 15,735 Source: Company Documents, UCT Estimates



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Figure 17: Statement of Cash Flows in millions

Source: Company Documents, UCT Estimates



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Disclosures:

Ownership and material conflicts of interest:

The author(s), or a member of their household, of this report [holds/does not hold] a financial interest in the securities of this company.

The author(s), or a member of their household, of this report [knows/does not know] of the existence of any conflicts of interest that might bias the content

or publication of this report. [The conflict of interest is…]

Receipt of compensation:

Compensation of the author(s) of this report is not based on investment banking revenue.

Position as a officer or director:

The author(s), or a member of their household, does [not] serves as an officer, director or advisory board member of the subject company.

Market making:

The author(s) does [not] act as a market maker in the subject company’s securities.

Ratings guide:

Banks rate companies as either a BUY, HOLD or SELL. A BUY rating is given when the security is expected to deliver absolute returns of 15% or greater

over the next twelve month period, and recommends that investors take a position above the security’s weight in the S&P 500, or any other relevant index.

A SELL rating is given when the security is expected to deliver negative returns over the next twelve months, while a HOLD rating implies flat returns over

the next twelve months.

Investment Research Challenge and Global Investment Research Challenge Acknowledgement:

CFA South Africa Investment Research Challenge as part of the CFA Institute Global Investment Research Challenge is based on the Investment Research

Challenge originally developed by the New York Society of Security Analysts.

Disclaimer:

The information set forth herein has been obtained or derived from sources generally available to the public and believed by the author(s) to be reliable, but

the author(s) does not make any representation or warranty, express or implied, as to its accuracy or completeness. The information is not intended to be

used as the basis of any investment decisions by any person or entity. This information does not constitute investment advice, nor is it an offer or a

solicitation of an offer to buy or sell any security. This report should not be considered to be a recommendation by any individual affiliated with CFA South

Africa, CFA Institute or the Global Investment Research Challenge with regard to this company’s stock.