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CSR – a growth ASX-listed renewable energy company?

October 27, 2009

Greater detail of the proposed demerging deal structure of ASX-listed building materials and agriculture group CSR has been revealed.  It promises to create a new, large Australian listed industrial with a more substantial emphasis on renewable energy.

The plan to demerge into the two entities has been known for some time.  There will be a building products company, and a ‘sugar and renewable energy’ business.  Despite the predominant business of raw sugar production of the entity, management explicitly emphasise the renewable energy aspect of the latter business. 

The renewable energy in question is ethanol fuel, and bagasse-fired cogeneration. 

In 2008 CSR was the sixth largest sugar producer in the world.

Clearly, management are thinking that the climate change, low-carbon, ‘wow’ factor might lead to an ability to secure greater interest in the listing.

Branding and detail is to yet to be developed, but for clarity here I will call the latter entity SugarCo, to use the terminology from the half-year results. 

I thought it interesting to consider what prospects might be afoot for this new renewable energy business.

SugarCo will consist of production of raw sugar from production and refining, as well as ethanol and liquid fertiliser from process waste (molasses), and renewable energy production (cogeneration) fuelled by bagasse (can trash).

A point of interest is the relatively small contribution, relative to revenue, that the sugar business has historically contributed to CSR.  According to company presentations, earlier in the year, while the sugar contributed 39% of revenue to CSR, it contributed only 18% of EBIT.  In contrast, building products and aluminium contributed twice, and three times respectively as much as the sugar business in terms of EBIT over revenue coverage.

However, there is the potential for growth in the main product areas of SugarCo – fertilizer, ethanol, and renewable energy.  According to management, raw sugar and refining prospects also look strong, but it’s not a subject I know anything about so I’ll avoid all speculative comment.  What is true is that EBIT contribution from sugar in the last period has increased over 300%, apparently due to improvements in refining and world sugar prices.  The 2009 half-year results demonstrate this remarkable change..

Management see substantial relative EBIT growth going forward for SugarCo – with EBIT expanding from $82m over $1,411 YEM09 revenue to $113 over $1,050 YEM10 revenue next year, representing a move from a 5.8% EBIT margin to 10.8%.

The CSR Sustainability report gives a view on the actual and potential renewable energy production from their assets:

CSR is Australia’s largest renewable energy producer from biomass. We currently generate enough renewable electricity, which, together with a small amount of external fuel, is sufficient to operate each of our seven sugar mills in North Queensland. We have two mills, Invicta and Pioneer, where a significant surplus is produced.

That surplus, which is approximately 300 Gigawatt hours (GWh) per annum is exported into the National electricity grid and is enough to power approximately 80,000 homes.

The availability of large amounts of bagasse (waste sugar cane fibre) and cane trash provides CSR with the potential for producing significant additional generation capacity. An additional 1100 GWh of renewable electricity (enough to support ~170,000 households) could be produced from identified bagasse fuelled projects, while a further 800 GWh of renewable electricity (enough to support ~120,000 households) could be produced from cane trash fuelled projects.

It will be interesting to learn about the Levelised Electricity Cost for any marginal increase in electricity production capacity.  While there is technical potential, the economic potential is not clear from available documentation.  The financial feasibility will be dependent upon additional investment cost, and power and REC prices under the newly expanded Renewable Energy Target.

Unfortunately, in view of the current REC price trend, CSR’s earnings from the renewable energy component of the business looks like taking a hit in the short term – if the price doesn’t improve – out to 2015.  

According to their statements last year:

Approximately 75% of CSR’s REC production is exposed to market price, with the balance contracted at fixed prices until 2015

If, on average, 285 GWh of electricity is exported, then an approximate contribution revenue of REC sales at an average historic REC price of $45/MWh would normally generate $12,8m for SugarCo.  At $30 per REC for 75% of their generation and $45 for the remaining fixed 25% (these are just approximations), this revenue would fall to $9.6m annually – a ‘loss’ on Business as Usual revenue of $3.4m.

Potentially more importantly, the REC price modelling on SugarCo presentation prospects indicates a rosier view of the REC market than many currently anticipate – reflecting the moment of optimism pre-passage of the RET legislation when many foresaw a potentially booming REC price (which may explain why such a high proportion of the SugarCo REC production is taking market risk).  The implication is that forecast esimates of revenue and EBIT growth for the cogeneration part of the refining business may be misplaced in the short term at least.

However, with SugarCo YEM09 Revenue of $1.41 billion this price decline is hardly noticeable as a revenue impact – but may show up more in EBIT.

Irrespective, CPRS legislation, and wholesale volatility and price increases in the future, will be major underpinning determinants of profit growth in this area.  The fact that SugarCo is not negatively exposed to this price volatility, due to consumption of on-site generation, will in any case mean that SugarCo refining and milling is not exposed to these energy market risks.

Whether the new entity will foray into further renewable energy power generation opportunities, thus expanding the contribution of renewable energy generation to revenue and EBIT, is not yet clear.

As far as ethanol is concerned, SugarCo would have a 38 million litres fuel-grade production capacity, with a further 22 ml added potential upon completion of dehydration unit (assuming all current industrial ethanol production is converted).  The ethanol production capacity is 1.1 billion litres from molasses and cane. 

There has been substantial and rapid growth in the groups fuel ethanol sales recently. However, Ethanol still is the smallest sub-group EBIT contributor.  In YEM09 Ethanol EBIT represents 12% of SugarCo EBIT (compared to 49% contributed by Refining, and 39% from Milling (including Cogeneration).  EBIT/Revenue coverage of the sub-groups is not clear.

CSR argue a 50% CO2 greenhouse gas emission reduction on a lifecycle basis on conventional petrol. 

As the Carbon Pollution Reduction Scheme (CPRS), in its current format, proposes to include transport fuels within its coverage, ethanol will benefit from a relative competitive price advantage.  The relative impact will be largely dependent upon the carbon price, but an increase in interest from large fuel users is likely.  However, the price impact difference is likely to be only a few cents a litre, leaving underlying fundamental energy market price and volatility issues as a more substantial market driver.  CSR see continued growth in demand for fuel ethanol globally and in Australia.

Lastly, the liquid fertilizer product is certified as organic.  The future continued success of this product stream will obviously be largely dependent upon trends in the agriculture sector.  It is possible that the nutrient-enriching and organic characteristics may also assist in soil carbon sequestration depending upon application – which could drive additional sales and value should such carbon sequestration offset projects be deemed eligible under the CPRS.  In the short-term, this is unlikely due to the multiple technical issues in measurement, monitoring and verification (not to mention the market impact potentiality and potentiality for conflict with international trade policy).

In conclusion, it is not clear that either the Renewable Energy Target or CPRS will substantially drive growth in EBIT or revenue in the SugarCo business in the short-term.  Conventional underlying market fundamentals in agriculture, global raw sugar, and ethanol will prove more influential. 

To understand plans for the distribution of future EBIT growth, it will be instructing to see further detail in the information memorandum.

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