After 45 years of enjoying a chunk of the 'sugar' pie in Malaysia, Robert Kuok suddenly exited the business, with the sale of Malayan Sugar Manufacturing Co to Felda. Why did he quit? Was he forced out or was the controlled environment too restrictive? Will Felda be able to give a similar stellar performance?
The fading façade of Malayan Sugar Manufacturing Co Bhd’s (MSM) sugar refinery along the Prai River in Penang belies its historical significance to Malaysia.
It is a facility that goes back 45 years and was established by “Sugar King” Robert Kuok as part of a process to ensure the production and control of sugar was in the hands of Malaysians, post-independence. Prior to Kuok’s efforts, Tate & Lyle, a world leader in the production of sugar, monopolised the supply of the essential good to Malaysia.
But Kuok convinced the newly minted government under Tunku Abdul Rahman then that the sugar business could be in the hands of a Malaysian company and went about the task. He not only ensured the business came under Malaysian control but also played a role in keeping prices steady in the domestic market despite the volatile international raw sugar prices over the years.
After establishing a refinery, the Kuok Group formed a partnership with Felda to establish a sugar cultivation plantation in Chuping, Perlis. Kuok, via PBB Group Bhd and Felda, also set up a sugar refinery — Kilang Gula Felda — which is still profitable despite two other refineries in Malaysia having closed shop over the years.
“There was a refinery in Negri Sembilan many years ago that the Kuok Group rehabilitated, but management could not run the business profitably. It went down,” says an industry player. “It is not an easy business to run because of price controls in the local market.”
But after 45 years of being a fixture on the Malaysian sugar scene, Kuok is exiting the business in Malaysia. Two weeks ago, PPB Group, which holds all of Kuok’s sugar interests in Malaysia, announced the sale of its wholly-owned subsidiary MSM to Felda Global Ventures Holdings Sdn Bhd for RM1.22 billion cash.
On top of that, PPB Group is selling its sugarcane cultivation farm in Chuping for RM45 million and its 50% equity interest in Kilang Gula Felda Perlis Sdn Bhd, which does sugarcane milling and raw sugar refining, for RM26.3 million. In addition, PBB is disposing of its 20% interest in Tradewinds (M) Bhd that controls Central Sugar Refinery, the other sugar facility in Malaysia.
The asset sales mark the tycoon’s departure from Malaysia’s sugar business, which is considered Kuok’s core investment in his home country.
Such news may have come as a shock to many, including the company’s long-serving staff, but those familiar with the industry say Kuok’s divestments had long been anticipated and were bound to happen sooner rather than later.
It is speculated that the Kuok Group had been under pressure to hive off MSM which controls 60% of the domestic sugar supply. However, those close to the group deny the fact.
“That’s not true,” says an executive in the Kuok Group.
But those in MSM and its holding company PBB Group must have had an inkling of the impending major corporate exercise last year. MSM had declared a net dividend of some RM375 million or net dividend per share (DPS) of RM10.32 for FY2008 ended Dec 31. This was a big jump from the DPS of RM3.25 in FY2007 and RM1.608 in FY2006.
The dividend was probably the highest MSM had declared over the past decade. On hindsight, the hefty dividend was a strong hint of Kuok’s intention to sell MSM.
The rationale behind the deal
Decades of hard work have made MSM the biggest sugar refinery in the region, producing 750,000 tonnes of sugar annually. And that won Kuok the nickname “Sugar King”. Apart from Malaysia, the Kuok Group has extensive sugar businesses around the region — from Indonesia to Sri Lanka — which it is not divesting.
So, why exit the business in Malaysia?
If he was not forced out, as some executives close to Kuok say, what could be the reason? Is the domestic operating environment, where sugar is a controlled item, the major factor that prompted Kuok to call it a day in the sugar refinery business in Malaysia?
Sources in the Kuok Group could not agree more. They say the operating environment is not so conducive to businesses that are controlled and owned by non-government entities such as the Kuok Group.
Malaysia is one of the few countries in the world where sugar is a price-controlled item. Other such items include gasoline, diesel, wheat flour, white bread and cooking oil.
The price of sugar is fixed by the government at RM1.45 per kilo, which is substantially lower than the prices in neigbouring countries. For instance, the price in Singapre is RM3.43 per kilo, Thailand (RM2.35), Indonesia (RM2.98) and China (RM5.69).
Nonetheless, sugar refiners had found the operating environment conducive to do business in the past years. They sourced their supply of raw sugar via long-term contracts that the government negotiated for them with the suppliers. Despite the fixed retail selling price, sugar refiners were profitable.
The industry landscape changed drastically when the price of raw sugar started to surge on the international market this year.
Raw sugar futures prices doubled this year to a 28-year high when India, a major exporter, became a net importer after dry weather affected harvests. Meanwhile, Brazil, the biggest raw sugar producer, is exporting less as excessive rainfall has reduced its production.
Raw sugar prices are trading at 22 to 24 US cents per pound compared with 12 US cents per pound in December last year. They are expected to trade in the same range next year.
During a media briefing on its half-year results, PPB Group said MSM has a long-term contract with the government to supply raw sugar. Between 2009 and 2011, MSM will get its supply of raw sugar at 17.5 US cents per pound no matter what the international price of raw sugar is during this period. It will also get a 60-sen subsidy from the government for every kilo of sugar produced for domestic consumption, something that started this year to subsidise refiners’ losses.
However, this supply of raw sugar only accounts for 70% of MSM’s requirements. The company has to source the balance from the international market at prices that are generally higher if it is to ramp up production to meet demand.
The same applies to the other sugar refiners in the country.
To maintain the fixed price at RM1.45 after raw material costs spiked, the government has had to step in with a subsidy for the sugar refiners.
So long as the controlled price mechanism is in place, there will be government control in the sugar-refining industry.
Not many entrepreneurs like to operate in such a regulated environment because they lose flexibility on decision-making. Kuok is possibly one such entrepreneur.
Profitable in a rigid environment
But to MSM’s credit, it has been performing well. In fact, the sugar refiner’s constant dividend payout speaks volume for its profitability (see table).
For FY2008, MSM recorded a pretax profit of RM203.5 million, up slightly from RM197.2 million in FY2007, although revenue was lower at RM954.65 million against RM1.07 billion previously.
During the commodity boom in 2005 and 2006, MSM’s profit margin seems to have been squeezed by a rise in raw material costs. Its gross profit margin narrowed to 18.6% in FY2005 and 15.6% in FY2006, versus 26.2% in FY2004. But its pretax profit was still above RM120 million for the two years.
In the past 10 years, MSM has been operating at an average pretax profit margin of about 19%. Considering the high teens pretax profit margin, which is rare in the manufacturing sector, many parties could be eyeing a slice of the sweet pie that Kuok has enjoyed for so long.
In the minds of the critics, MSM’s steady earnings are being fed by government subsidy but industry observers say Kuok and his team’s expertise in commodity trading played a crucial role in boosting its earnings. Apart from sugar, the Kuok Group’s commodity businesses include grains, edible oils and flours.
Being a commodity giant in the international market, the Kuok Group apparently has economies of scale and synergistic advantages for procurement.
Soon, Felda will be the dominant player in the domestic sugar industry. To rural folks and settlers, Felda may have done a good job in terms of rural development in the country.
But running a sugar-refining business is a different kettle of fish. Hence, whether MSM can continue to produce stellar numbers under Felda without raising the price of sugar is left to be seen.
Felda could always hire professionals — local as well as foreign — to manage the sugar business. Should the earnings be maintained or improved, this will a big income stream for the government organisation.
In fact, Felda can churn out higher numbers if it is able to negotiate a bigger supply of raw sugar from the government, meaning a bigger subsidy. Alternatively, if Felda is able to negotiate a revised price control mechanism that will give more leeway to increase sugar prices, it will bode well for the group.
Who got the best of the deal?From the plantation land sales and disposal of the entire equity stake in MSM plus the 50% stake in Kilang Gula Felda, PPB Group will receive a whopping RM1.29 billion cash. On the face of it, the deal is sweet for PPB Group since it is realising a total net gain of RM1.217 billion from the divestments.
But some argue that Felda got the better deal. MSM’s earnings per share came in at RM4.38 for FY2008. By paying RM1.22 billion, Felda is getting all 36.36 million MSM shares at RM33.60 each, which translates to a price-earnings ratio of only 7.67 times. A business that promises steady income and the lion’s share of the domestic sugar market — sounds like a good bargain for Felda.
This will not be music to the ears of PPB Group minority shareholders. More so when the sugar-refining business generates one-third of the group’s revenue — the second biggest income contributor. There will be a gap in PPB Group’s income stream after the divestment.
For the record, in FY2008, the sugar refining and sugarcane plantation segment registered a revenue of RM973.5 million versus the group’s total of RM3.46 billion and operating income of RM156.9 million or 38% of the grand total of RM411.5 million.
The bright spot is that with more than RM1 billion cash in hand, the group has built up a war chest for an acquisition, locally or abroad, that could potentially yield better returns.
Speculation is rife that PPB Group may use the cash proceeds to expand its shareholding in Wilmar International Ltd, which specialises in edible oils downstream activities. PPB Group holds an 18.22% equity stake in Wilmar after the injection of its oil palm plantations into the Singapore-listed entity two years ago.
But sources close to the Kuok Group say it is expensive to buy more shares in Wilmar at its current price.
According to OSK Research, with the cash, PPB Group will only be able to buy an additional 1.3% based on S$6.29 per share. This will raise the group’s pretax profit by RM59.5 million, much lesser than the contribution from the sugar business.
“We suspect that the proceeds would most likely be invested in Wilmar China, which is to be listed on the Hong Kong Stock Exchange, which will probably give it a bigger bang for the buck,” says OSK Research.
The broker’s hunch does make sense. PBB Group could mitigate its losses from foregoing the lion’s share of the Malaysian sugar market by taking up a stake in Wilmar China which monopolises the cooking oil market in the world’s fastest-growing economy that has 1.3 billion consumers.
Coincidentally, Wilmar International has delayed the listing of its China operation. Hence, PPB Group will still get a chance to catch that boat.
After scrutinising the intricacies of the sugar business in Malaysia, it seems Kuok has done his maths well.
This article appeared in the Cover Story page of The Edge Malaysia, Issue 780, Nov 9-15, 2009.