Equity Research Agriculture Zimbabwe

Hippo Valley Estates Limited

Rooting for sweet returns
Major Zimbabwean sugar producer with room for growth
Hippo Valley Estates Limited (HIPPO:ZH) is one of only two sugar producers in Zimbabwe and in the 2011/12 season, contributed approximately 170k tons of sugar (46%) to the countrys total sugar production of 372k tons. Its largest shareholder, Triangle Sugar Corporation Limited (unlisted), holds a 50.3% stake and is the only other Zimbabwean producer. Triangle is a wholly-owned subsidiary of South African based Tongaat Hulett Limited (TON:SJ). Hippo Valleys operation is situated in the southeast lowveld of Zimbabwe where the topography, climate and established water storage and irrigation infrastructure render the area ideal for sugar cane cultivation. The majority of cane milled by the company is grown by Hippo itself (77% in 2011/12) with private farmers supplying the balance. However their contribution over the next few years is expected to become more significant following the initiation of the Sustainable Rural Communities (SusCo) project in 2010/11. This involves the replanting of the entire 15,880 ha farmed by private growers across the industry with the goal of increasing private farmers cane deliveries, recorded at approximately 532k tons in 2011/12, to around 1.4mn tons by 2015. This will go a long way to optimising the capacity utilisation of the Hippo Valley mill which has the potential to produce 300k tons of sugar per annum i.e. currently only operating at about 57% capacity.

Market Data
Report Date Bloomberg Ticker Rating Current Price $ Target Price $ M arket Cap $mn EV $mn M arket Weight Common Shares Outstanding mn Freefloat Average Daily Value Traded $000s Last Dividend declared PER (+1) EV/EBITDA (+1) Share price performance YTD 7-Aug-2012 HIPPO: ZH BUY 1.03 1.33 198 231 5.3% 193 26.3% 61 31.12.04 7.4 4.7 -10.9%

Recent earnings point to improved profitability

In May, Hippo Valley released results for the year ended 31 March 2012 which showed significant growth in revenue and profitability. A 30% increase in the companys total sugar production, from 131k tons in FY11 to 170k tons in FY12, together with favourable realisations on raw sugar exports to the EU drove revenue up 46% to $128.9mn from the prior years $88.4mn. EBITDA almost doubled, rising from $20.8mn to $40.1mn, with a 7.5% improvement in the EBITDA margin, up from 23.6% to 31.1%. PBT rose 198% from $9.4mn to $27.9mn while PAT rose 138% from $8.8mn to $20.9mn. EPS registered a corresponding 138% increase from 4.6 cents to 10.9 cents. Recent refurbishment of the mill and an on-going cane re-establishment programme means the level of net debt has remained relatively high at $32.8mn as at the end of March 2012, however this has come down from $37.6mn as at 31 March 2011 and the borrowings are now all short term. Continued net reductions in debt are expected going forward and the company became FCF positive in FY12. In light of the cash required for mill refurbishment and cane re-establishment, the company did not declare a dividend for FY12 however based on our forecasted future cash flows we expect to see the resumption of dividends in FY13.

12 Month Share price performance

1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0 Jul-12 Jan-12 Jun-12 Oct-11 Apr-12 Aug-11 Sep-11 Nov-11 Dec-11 Feb-12 Mar-12 Aug-12 May-12

Attractive valuation
We estimate that Hippo Valley trades on a P/E (+1) of 7.4x and an EV/EBITDA (+1) of 4.7x. This places the stock at a discount to comparable sugar companies with average P/E and EV/EBITDA estimates for 2013 of 13.6x and 6.5x respectively. With continued increase in cane supply and consequent increasing sugar output, we forecast 2013 EBITDA of $47.2mn and 2014 EBITDA of $50.9mn, representing Y-o-Y increases of 18% and 8% respectively. We anticipate a 27% rise in net income to $26.6mn in 2013, followed by an 11% increase in 2014 to $29.6mn. Using a weighted combined multiples valuation method (P/E & EV/EBITDA), we have arrived at a blended 12m target price for Hippo Valley of $1.33, implying upside of 30%. We therefore initiate coverage of Hippo Valley with a Buy recommendation.

Disclaimer
This document has been prepared by IH Securities to provide background information about the securities and (or) markets mentioned herein, the forecasts, opinions and expectations are entirely those of IH Securities. This document was prepared with the utmost due care and consideration for accuracy and factual information; the forecasts, opinions and expectations are deemed to be fair and reasonable. However there can be no assurance that future results or events will be consistent with any such forecasts, opinions and expectations. Therefore the authors will not incur any liability for any loss arising from any use of this document or its contents or otherwise arising in connection therewith. Neither will the sources of information or any other related parties be held responsible for any form of action that is taken as a result of the proliferation of this document.

Research Team
Dzika Danha +263(772) 573 083 ddanha@ih-group.com Christine Mhongo +263(774) 171 262 cmhongo@ihsecurities.com Lloyd Mlotshwa +263(772) 936 677 lmlotshwa@ihsecurities.com Kate Rowland +263(778) 300 345 krowland@ih-group.com

Contact Details
IH Securities (Pvt) Ltd 4 Fleetwood Road Alexander Park Harare Zimbabwe Tel +263 (4) 745119/133 Fax +263 (4) 745879

Equity Research Hippo Valley

Executive Summary
In this report, we initiate coverage of Hippo Valley Estates, one of Zimbabwes two major sugar producers (total capacity: 300k tons per annum), with a BUY rating and a one year target price of $1.33, based on our estimates of Hippos future performance and the average P/E and EV/EBITDA multiples of selected comparable listed peers. In the 2011/12 season, Hippo Valley contributed approximately 170k tons of sugar (46%) to the countrys total sugar produ ction of 372k tons. Its largest shareholder, Triangle Sugar Corporation Limited (unlisted), holds a 50.3% stake and is the only other Zimbabwean producer. Triangle is a wholly-owned subsidiary of South African based Tongaat Hulett Limited. Hippo Valleys operation is situated in the southeast lowveld of Zimbabwe where the topography, climate and established water storage and irrigation infrastructure render the area ideal for sugar cane cultivation. The majority of cane milled by the company is grown by Hippo itself (77% in 2011/12) with private farmers supplying the balance. Our investment thesis is centred on the recent and on-going revival of the Zimbabwe sugar industry following the Lost Decade, being driven by initiatives instigated by Tongaat Hulett in co-operation with government and the lowveld communities; from 2009/10 to 2011/12 total national production rose 44% to 372k tons, with Hippos sugar output registering a 93% increase from 88k tons to 170k tons. Figure 1: Hippo Valley Valuation Table
Revenue ($mn) 2011 2012 2013E 2014E 2015E 2016E 2017E 88.4 128.9 153.7 168.0 175.2 181.9 182.0 EBITDA ($mn) 20.8 40.1 47.2 50.9 52.9 54.6 54.8 Net Income ($mn) 9.0 20.7 26.6 29.6 31.4 33.1 33.6 EPS ($) DPS ($) 0.05 0.11 0.14 0.15 0.16 0.17 0.17 0.00 0.00 0.03 0.05 0.07 0.07 0.07 EBITDA Margin 23.6% 31.1% 30.7% 30.3% 30.2% 30.0% 30.1% EV ($mn) 235.4 230.7 222.0 207.2 192.4 176.5 159.7 Net Debt ($mn) 37.6 32.8 24.1 9.3 -5.5 -21.4 -38.2 EV/Sales 2.7 1.8 1.4 1.2 1.1 1.0 0.9 EV/FCF EV/EBITDA -11.6 48.5 14.5 8.4 7.0 6.0 5.3 11.3 5.8 4.7 4.1 3.6 3.2 2.9 P/E 22.5 9.4 7.4 6.7 6.3 6.0 5.9 P/Bk Div yield 1.1 1.0 0.9 0.8 0.8 0.7 0.7 0.0% 0.0% 3.4% 5.0% 6.4% 6.7% 6.8%

Source: Company Reports, IH Estimates

Investment Case
Increasing cane supply yielding aggressive income growth and greater FCF From 2009/10 to 2011/12, the Hippo Valley mill s sugar output rose by 93% from 88k tons to 170k tons, resulting in a 99% increase in revenue to $129mn. The major drivers behind this growth have been increased cane supply and an improvement in the companys cane-to-sugar ratio; total cane milled rose by 58% to 1.38mn tons while the companys cane-to-sugar ratio improved from 9.98 to 8.15. In terms of cane production, the companys own harvest grew by 47% to 1.07mn tons while private farmers combined cane deliveries rose 72% to 312k tons . Going forward, the company has reached its capacity in terms of land use with the area planted currently standing at around 12,000 ha but significant continued increases in cane production are expected from the private farmer sector. Replanting of the entire 15,880 ha of cane land farmed by private growers across the industry is currently underway as part of a private cane farmer rehabilitation programme, initiated in 2010/11 under the Sustainable Rural Communities (SusCo) project. A $30mn four-year revolving finance facility was secured for the project through BancABC (ABCH:ZH). Over the 2011/12 season, 3,476 ha of private cane farmer land was replanted under the SusCo project, with a further 874 ha replanted by Chipiwa farmers financed by the EU-funded Canelands Trust. Private farmers independently ploughed out and replanted an additional 1,914 ha during the same period, with input support from Tongaat Hulett. As a result, private farmers collective cane deliveries increased from 4 13k tons in 2010/11 to 532k tons in 2011/12 (of which Hippo Valley received 312k tons), representing a year-on-year increase of 29%. It is anticipated that completion of the rehabilitation programme will see private farmers cane production reaching 1.4mn tons by 2015. This will go a long way to optimising the capacity utilisation of the Hippo Valley mill which has the potential to produce 300k tons of sugar per annum i.e. at an average cane-to-sugar ratio of 8, there is scope for a further 74% increase in cane supply to 2.4mn tons from the current 1.38mn tons before the mills full production potential is reached. Figure 2: Hippos sugar production, 2009/10 2014/15(E)
300 250

Tons (000s)

200 150 100 50 0 2009/10 2010/11 2011/12 2012/13 (E) 2013/14 (E) 2014/15 (E)

Source: Company Reports, IH Estimates

Equity Research Hippo Valley

Executive Summary
The improvement in Hippos cane-to-sugar ratio, from 9.98 in 2009/10 to 8.15 in 2011/12, is attributable to the extensive refurbishment of the mill undertaken over the last two off-crops. To this end, the companys capital expenditure in FY11 amounted to $19.9mn with the majority of this ($18.6mn) spent on the sugar factory buildings and plant. However this completed the major refurbishments and total capex in FY12 came down to $10.3mn, resulting in a positive free cash flow. Hippos cane-to-sugar ratio is now expected to remain level around 8 and management has budgeted for maintenance capex of $10mn per annum going forward. Continued increases in cane production and sugar output and the consequent growth in income should therefore see significant improvement in the companys future operating and free cash flows. Figure 3: Operating cash flow, Capex & FCF, 2009/10 2014/15(E)
50 40 30 20

$mn

10 0 (10) (20) (30) 2009/10 2010/11 2011/12 2012/13 (E) 2013/14 (E) 2014/15 (E)

Operating cash flow

Capex

FCF
Source: Company Reports, IH Estimates

Improving yields Although Zimbabwes average sugar cane yield over the last 3 years is on a par with the global average, yields are improving. Hippos own yield improved from 83.5 tons/ha in 2010/11 to 89.6 tons/ha in 2011/12 and over the course of the 2011/12 season, 3,263 ha of company land was ploughed out and replanted as part of an on-going cane re-establishment programme aimed at correctly positioning the crop for a full return to optimal yields of 105-110 tons/ha by 2014/15. Yields achieved by private farmers in the Hippo Valley mill group improved from 38.1 tons/ha in 2009/10 to 51.4 tons/ha in 2010/11 while those of the Mkwasine outgrowers rose from 22.3 tons/ha to 39.0 tons/ha. Figures for 2011/12 are not yet available however it is understood that yields for these private farmers and outgrowers are expected to rise to around 90 tons/ha over the next few years. Figure 4: Cane yields (3-year averages, 2009/10 2011/12) & Zimbabwes expected yield in 2012/13
140 120 100

tons/ha

80 60 40 20 -

Source: USDA, Company reports

Equity Research Hippo Valley

Executive Summary
Key risks
Global sugar prices weakening on surplus production After 2009/10, global sugar production has slightly exceeded consumption and ending stocks have been on the rise. Global sugar prices have come under pressure on the back of the increase in surplus and trended downwards in recent months as a result. Although Hippo Valley enjoys a premium on its sugar exports to the EU, this could see a reduction in the value of its exports. Debt Hippo Valleys net debt ballooned from $17.2mn as at 31 March 2 010 to $37.6mn as at 31 March 2011 to support the reestablishment of cane supply and refurbishment of the mill. As a result, cost of borrowings rose to $3.7mn versus $799k the previous year. High finance costs continued to impact negatively on the company s profit in FY12, rising to $6mn, however it is encouraging to note that total borrowings were reduced by $1.8mn over the course of the year. Given our estimates of the companys free cash flows going forward, we anticipate cont inued reductions in debt and further improvement in the companys gearing as a result. Net debt to equity came down from 21.3% in FY11 to 16.6% in FY12 and our forecasts suggest that this will decrease further in FY13 to around 11%. Indigenization With a 50.3% stake in Hippo Valley effectively held by South African-based Tongaat Hulett through its 100% ownership of Triangle Sugar Corporation Limited and an additional 10% held by Tate & Lyle of Great Britain, the companys current shareholding structure falls in breach of Zimbabwes indigenization regulations requiring 51% local ownership. However the SusCo project initiated by Tongaat Hulett represents the single largest empowerment programme in the agrarian sector and is being backed by Zimbabwes Vice President, Joice Mujuru. Under the project, loans are being granted to resettled farmers who have entered into cane supply agreements with Tongaat Hulett and participating farmers are also being assisted with technical support. As a result, sugar cane production has begun to recover from the decline that initially followed land re-allocation.

Share price performance

The release of Hippos September 2011 interim results in November saw the market responding to the companys first signs of recovery. Following a dip in the share price to $0.80 in November 2011, it recovered to $1.15 by the start of 2012. Since then, it has declined slightly back to $1.00 and remained relatively stable around that level. Given our estimates of the companys future performance, we feel it has the potential to move towards the level attained in Feb/March 2011 of $1.40. Although it has registered a marginal decline of 5% over the last 12 months, it has outperformed the ZSE Industrial Index which recorded a 19% drop over the same period. Figure 5: Hippo Valley share price performance, Y-o-Y
1.4 1.2 1.0 4.0 6.0

5.0

0.8 3.0 0.6 2.0 0.4 0.2 0.0 Oct-11 Dec-11 Aug-11 Sep-11 Feb-12 Aug-12 Jul-12 Jan-12 Jun-12 Apr-12 May-12 Nov-11 Mar-12 1.0

0.0

Hippo Turnover ($mn)

Hippo Price ($)

ZSE Industrial (Indexed to Hippo)

Source: ZSE

Turnover ($mn)

Price ($)

Equity Research Hippo Valley

Valuation
Selected Sugar Comparables
Company Name Illovo Sugar Ltd. Tongaat-Hulett Ltd. Zambia Sugar PLC Suedzucker AG Cosumar Cosan S/A Industria e Comercio Sao Martinho S/A Average P/E 2012 29.05 16.92 14.40 10.50 10.71 4.39 17.90 14.84 P/E 2013E 14.26 12.15 12.03 11.32 11.05 17.27 17.35 13.63 P/E 2014E 11.59 9.95 10.68 12.19 9.37 17.50 12.85 12.02 EV/EBITDA 2012 9.13 10.21 7.7 8.31 -8.53 6.12 8.33 EV/EBITDA 2013E 6.51 6.58 7.57 5.79 6.72 7.19 5.03 6.48 EV/EBITDA 2014E 5.50 5.55 7.53 5.60 5.78 6.80 4.57 5.90

Source: FactSet, Bloomberg

EV/EBITDA Valuation
2013E 6.5 0.80 47.18 245 24.11 221 1.14 1.16 2014E 5.9 0.80 50.93 241 9.31 231 1.20

P/E Valuation
2013E 13.6 0.80 26.59 290 1.50 1.49 2014E 12.0 0.80 29.63 285 1.48

International comps Premium/discount Forecast EBITDA ($mn) Implied EV ($mn) Net debt ($mn) Market Value ($mn) Target price ($) Blended 12m TP ($)

International comps Premium/discount Forecast Net Earnings ($mn) Implied Market value ($mn) Target price ($) Blended 12m TP ($)

Source: IH Estimates

Source: IH Estimates

Weighted Valuation
Weighting 50% 50% Weighted 12m TP ($) 0.58 0.75 1.33 30% BUY

EV/EBITDA P/E Hippo weighted valuation ($) Implied upside/downside Rating

1.16 1.49

Source: IH Estimates

Equity Research Hippo Valley

Global Sugar Market

Global production and consumption
Global sugar consumption has grown at an annual average of 2% per annum over the past decade. Production has typically been slightly higher than consumption with the gap between the two widening since the 2010/11 marketing season. Global consumption, expected to end the 2012/13 marketing year at 160mn tons will once again lag behind production, expected to come in at 171mn tons. Ending stocks have therefore been on an upward trend, rising from 26mn tons in the 2009/10 season and expected to end the 2012/13 season at 33mn tons. Figure 6: Global Production and Consumption, 2001/02 2012/13(E)
200,000 180,000 160,000 140,000 120,000 100,000 80,000 60,000 40,000 20,000 2001/2002 2002/2003 2003/2004 2004/2005 2005/2006 2006/2007 2007/2008 2008/2009 2009/2010 2010/2011 2011/2012 2012/2013E 20,000 15,000 10,000 5,000 45,000 40,000 35,000 30,000 25,000 Ending stocks '000 tons EU-27 11% India 17% Other 51% China 9% Brazil 7%

Production and consumption '000 tons

Ending stocks (RHS)

Production (LHS)

Consumption (LHS)

Source: USDA

The top 5 sugar producing countries in the world are Brazil, India, EU-27, China and Thailand. These countries account for 62% of the worlds sugar production and 67% of international exports. Brazil is the largest producer, contributing 21% to global production and 43% of world sugar exports. Africa has produced approximately 5% of world sugar between 2009 and 2011. African producers include Mauritius, South Africa, Zambia, Mozambique, Malawi and Zimbabwe. The worlds largest consumers of sugar include India, the EU-27, China, Brazil and the United States. Figure 7: World Sugar Production, 2011/12 Figure 8: World Sugar Consumption, 2011/12

Brazil 21% Other 39%

India 16%

Thailand 6%

China 7%

EU-27 10%

United States 6%

Source: USDA

Source: USDA

Equity Research Hippo Valley

Global Sugar Market

Sugar pricing
As shown in Figure 9, the world sugar price has been quite volatile since the beginning of 2009. Shocks to the price during that period have largely been the result of production shocks, some speculative behaviour by hedge funds and index funds, along with some currency volatility in the major sugar producing countries. After peaking around 26 cents/lb in February 2012, prices have trended downwards this year on the back of increased production and yields in most of the large producing countries. More of the sugar cane harvested in Brazil is expected to be diverted to sugar production versus ethanol. We believe the long term outlook for sugar prices is positive, influenced by growing demand in emerging markets, changes in the EUs policies regarding the commodity, as well as the diverting of sugar cane to the production of ethanol. Figure 9: World sugar prices, May 2007 May 2012
40 35 30

cents/lb

25 20 15 10 5 0 Aug-07 Aug-08 Aug-09 Aug-10 Aug-11 Feb-08 Feb-09 Feb-10 Feb-11 May-07 May-08 May-09 May-10 May-11 Feb-12 May-12 Nov-07 Nov-08 Nov-09 Nov-10 Nov-11

Source: Bloomberg

EU trade agreement
Hippo Valley has benefited from preferential EU prices which are at a premium to the world price. In 1975, the EU signed bilateral agreements with African Carribean and Pacific states including Zimbabwe, known as the Sugar Protocol alongside the first Lome convention. Under the Sugar protocol, the EU would import 1.3mn tonnes a year from these countries duty free, and at a guaranteed price in line with prices received by EU farmers. However, as a result of pressure from the WTO, the EU then embarked on a reform of its sugar regime, which had guaranteed minimum prices to EU producers in 2006. The EU also signed an Economic Partnership Agreement with countries of the Caribbean region in October of 2008. The sugar protocol was inconsistent with both of these reforms and was replaced by new market access agreements in October 2009. The price payable to suppliers of sugar to the EU was reduced by 36%. However, it gave free market access to Least Developed Countries. For the ACP non-LDC countries a safeguard clause was put in place until 2015, triggered if more than 3.5 million tonnes of sugar are imported into the EU in a single year.

Equity Research Hippo Valley

Zimbabwean Sugar Market

Production
Zimbabwe is a minute player within the global sugar market producing only 4.6% of the total production in Africa, which itself produces 4.6% of world sugar. Zimbabwe therefore produced a negligible 0.21% of world sugar and has no real impact on the market dynamics. The amount of land under sugar has barely seen any change since dollarization of the Zimbabwean economy. A total of 35,380 ha were under sugar in the 2007/08 marketing year. This is partly the result of limited financing available to private growers. Private growers and newly resettled farmers have therefore been restricted to 11,230ha of an available 15,880ha of land. There are currently initiatives in place, however, aimed at rehabilitating and restoring cane production on this private farmer land. These are in part funded by the European Union Adaptation Funding program, through which Zimbabwe was allocated $58mn. Another initiative is the Sustainable Rural Communities (SusCo) project by Tongaat Hulett, aimed at assisting and accelerating private cane replanting in order to increase sugarcane output to the potential of 1.4 million tons from the entire 15,880 hectares by 2015. Tongaat Hulett has partnered with a local bank, BancABC, to provide a four year $30mn revolving facility to enhance production. As a result the biggest jump in harvested area so far is expected in the 2012/13 marketing year with growth of 6.26% to 37,500 ha. Figure 10: Zimbabwe Area Harvested, 2005/06 2012/13(E)
50 45 40 35 30 25 20 15 10 5 0 2012/2013(E) Source: FAO 2005/2006 2006/2007 2007/2008 2008/2009 2009/2010 2010/2011 2011/2012

Yields have been somewhat unstable in the local market, until the 2010/11 season in which they started to rise. They are expected to continue to improve in the 2012/13 marketing season, rising to 93.3 tons/ha, up 9.76% from 2011/12 and a cumulative 44.4% since the 2009/10 season. Figure 11: Zimbabwe National Sugar Production and Yields, 2005/06 2012/13(E)
500 450 400 350 300 250 200 150 100 50 2005/2006 2006/2007 2007/2008 2008/2009 2009/2010 2010/2011 2011/2012 2012/2013(E) 100 90 80 70 60 50 40 30 20 10 -

Sugar Production ('000 tons)

Area Harvested ('000 ha)

Sugar production

Yield

Source: FAO

Yield (tons/ha)

Equity Research Hippo Valley

Zimbabwean Sugar Market

The aforementioned SusCo project is expected to contribute to this by providing inputs to newly resettled sugarcane growers, assistance with tillage services, replanting of cane and extension services. Changes in yields have been a significant determinant of changes in production as shown in Figure 11. The rise in yields to 93MT/ha is therefore expected to lead to additional growth in sugar output, which in combination with the aforementioned 6.26% increase in Area harvested is expected to result in a 16% increase in cane volumes to 3.5mn tons. As shown in Figure 12, Zimbabwe sugar cane yields are average on a global scale, and relatively low compared to other players in the region, such as Malawi and Zambia where yields go as high as 108 and 125 tons/ha. However yields are expected to rise to 93.3 tons/ha in 2012/13 and Tongaat Hulett is anticipating company yields of 105-110 tons/ha and private farmer yields of 90 tons/ha by 2015 which would bring the average local yield closer to the highest yields in the region. Figure 12: Sugar Cane Yields (3-year Averages, 2009/10 2011/12)
140 120 100

tons/ha

80 60 40 20 South Africa Zimbabwe Mozambique Thailand Swaziland Zambia Thailand India Brazil Malawi Mozambique

Source: USDA, Company reports

The countrys cane-to-sugar ratio of 8.0 compares relatively well to those regionally, with ratios as high as 9.1 in Mozambique. Regional leaders Zambia and Malawi, however, outperform the Zimbabwean crop with cane-to-sugar ratios of 6.9 and 7.0 respectively. Figure 13: Cane-to-Sugar Ratio (3-year Averages, 2010/11 2012/13)
12.0 10.0 8.0 6.0 4.0 2.0 Australia Zambia Brazil Zimbabwe South Africa Swaziland Malawi

Source: FAO, Company reports

Recent events in the local cotton industry have demonstrated that there is political will to intervene when farmers and processors are in disagreement over crop prices. This development suggests farmers now have increased bargaining power. W e believe that this puts local companies trading in commodities and acquiring significant volumes from out growers at risk of margin compression in unfavourable market conditions. This is less of a concern in the local sugar industry, however, because private growers and newly resettled farmers only produce approximately 20 percent of the countrys sugarcane crop, (albeit a percentage that will rise over the next few years).

Equity Research Hippo Valley

Zimbabwean Sugar Market

Local sugar consumption
Zimbabweans are estimated to consume 25kg of sugar per capita annually, ahead of the global average of 23.75 which is weighed down by relatively low per capita consumption of sugar in Asian countries. This also compares favourably to average consumption of 13kg on the African continent, but is trailing the 30kg average in Southern Africa. Countries such as Botswana, Swaziland and South Africa have higher consumption of sugar in the region, estimated at 32kg, 32kg and 35kg respectively. These fall short of consumption in regions like the EU-27 and South America, where per capita consumption is estimated at 36kg and 51kg respectively.
Figure 14: Annual Sugar Consumption, 2011/12 70 60

kg per capita

50 40 30 20 10 0 Zambia Asia-Oceania North America Africa Zimbabwe Thailand South Africa Australia China Southern Africa South America Botswana EU-27 India Swaziland Malawi World Brazil

Sources: Population (World Bank and UNPF), Consumption (FAO, USDA, company reports)

With the exception of a significant dip in consumption per capita at the height of the countrys economic meltdown and food shortages in 2008, Zimbabwean sugar consumption has been fairly stable over the last 32 years. An average annual growth rate of 2.3% was achieved in the 20 years between 1980 and 2000. The most significant increase was achieved between 1993 and 2000, with consumption increasing 34% during that period and returning to relative stability until 2008. In our view, whilst consumption is lower than in other markets in the region and other producer countries, Zimbabwes per capita sugar consumption is likely to continue on a path of relatively stability. Sugar substitutes are unlikely to cause a significant decline in loc al sugar consumption in the short to medium term as levels of concern over consumer health continue to lag those in wealthier, developed nations. A growth rate of between 2% and 3%, similar to that achieved over the last 32 years is likely. There is upside potential resulting from the limited use of sugar in value added products in Zimbabwe. These may present an opportunity for higher growth in consumption as the countrys income levels increase. Triangle and Hippo produce 100% of locally produced sugar and imports make up a relatively low 14% of total sugar consumed in the country, a figure expected to decline to only 7% in the 2012/13 marketing year. We therefore believe that there is limited room for growth for these players in the local market and that they will have to look to regional and international markets for significant growth in sales volumes in the longer term. Figure 15: Zimbabwe Annual Sugar Consumption, 1980 2017(E)
35 30

kg per capita

25 20 15 10 5 0 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013E 2014E 2015E 2016E 2017E Source: FAO, USDA

Equity Research Hippo Valley

Company Profile
Overview
Hippo Valley Estates Limited (HIPPO:ZH) is one of only two sugar producers in Zimbabwe and in the 2011/12 season, contributed approximately 170,000 tons of sugar (46%) to the countrys total sugar production of 372,000 tons. Its largest shareholder, Triangle Sugar Corporation Limited (unlisted), holds a 50.3% stake and is the only other Zimbabwean producer. Triangle is a wholly-owned subsidiary of South African based Tongaat Hulett Limited (TON:SJ). Figure 17: Zimbabwe Sugar Production, 2009/10 2011/12

Figure 16: Ownership Structure

400

Tongaat Hulett Limited

350 300

Tons (000s)

100%

54%
250

61%
200

Triangle Sugar Corporation Limited

66%
150 100

50.3%

50 0

39% 34%
2009/10 2010/11

46%

Hippo Valley Estates Limited

2011/12

Hippo

Triangle
Source: Company reports

Details of operations
The companys operation is situated in the southeast lowveld of Zimbabwe where the topography, climate and established water storage and irrigation infrastructure render the area ideal for sugar cane cultivation. The company grows its own cane and augments supply with cane from private farmers, who grow specifically for either Hippo Valley or Triangle, and outgrowers on Mkwasine Estates, in which Hippo Valley and Triangle each have a 50% interest. In the 2011/12 season, the company milled approximately 1.38mn tons of cane of which 1.07mn tons (77%) came from its own harvest, up 24% from the 865,676 tons produced the previous year. Private farmers in the Hippo Valley Mill Group supplied 217,119 tons of cane and the Mkwasine outgrowers 94,568 tons, representing increases of 36% and 20 % respectively from the previous seasons deliveries. The companys average yield improved from 83.5 tons/ha in 2010/11 to 89.6 tons/ha in 2011/12 while yields achieved by the private farmers and Mkwasine outgrowers of 51.4 tons/ha and 39.0 tons/ha respectively in 2010/11 are estimated to have remained around these levels, still with huge room for improvement. Refurbishment of the mill, which began in the 2009/10 off-crop, saw the companys cane-to-sugar ratio (tons of cane milled to produce 1 ton of sugar) improve from 9.98 in 2009/10 to 7.72 in 2010/11. Although this has dipped slightly back to 8.15 in 2011/12, it remains close to the targeted ratio of around 8. Hippo Valleys total sugar production of 170,000 tons in the 2011/12 season remains well below the mills output capacity of around 300,000 tons of sugar per annum. At an average cane-to-sugar ratio of 8, this implies scope for a further 74% increase in cane supply to 2.4mn tons before the mills full production potential is reached.

Equity Research Hippo Valley

Company Profile
Table 1: Hippo Valleys cane supply & milling statistics, 2009/10 2014/15(E)
2009/10 Company Area cut (ha) Yield (tons/ha) Cane harvested (tons) Area cut (ha) Yield (tons/ha) Cane harvested (tons) Area cut (ha) Yield (tons/ha) Cane harvested (tons) 7,978 91.48 729,856 3,539 38.08 134,776 2,100 22.32 46,863 911,495 0 (11,075) (24,300) 876,120 9.98 87,750 2010/11 10,371 83.47 865,676 3,111 51.40 159,898 2,014 39.02 78,591 1,104,165 0 (95,386) 0 1,008,779 7.72 130,647 2011/12 11,950 89.60 1,070,700 4,207 51.61 217,119 2,610 36.24 94,568 1,382,387 0 0 0 1,382,387 8.15 169,618 2012/13 (E) 2013/14 (E) 2014/15 (E) 12,000 95.00 1,140,000 4,904 65.00 318,760 3,605 50.00 180,250 1,639,010 0 0 0 1,639,010 8.00 204,876 12,000 100.00 1,200,000 5,600 70.00 392,000 4,100 55.00 225,500 1,817,500 0 0 0 1,817,500 8.00 227,188 12,000 105.00 1,260,000 5,600 75.00 420,000 4,100 60.00 246,000 1,926,000 0 0 0 1,926,000 8.00 240,750

Private farmers

Mkwasine Estate

Total cane harvested (tons) Used for seed purposes Milled at Triangle Dumped cane Total cane milled (tons) Cane-to-sugar ratio Total sugar produced (tons)

Source: Company Reports, IH Estimates

Figure 18: Breakdown of Hippos cane supply, 2009/10 2014/15(E)

2,500 2,000

Tons (000s)

1,500 1,000 500 0 2009/10 2010/11 2011/12 2012/13 (E) 2013/14 (E) 2014/15 (E)

Company

Private farmers

Mkwasine Estate
Source: Company Reports, IH Estimates

Figure 19: Hippos sugar production, 2009/10 2014/15(E)

300 250

Tons (000s)

200 150 100 50 0 2009/10 2010/11 2011/12 2012/13 (E) 2013/14 (E) 2014/15 (E)

Source: Company Reports, IH Estimates

Equity Research Hippo Valley

Company Profile
Sales markets and pricing
The Zimbabwe sugar industrys domestic market sales for the 2011/12 season amounted to 247,000 tons, equivalent to 66% of the total 372,000 tons produced. The remaining 125,000 tons was exported to the European Union under preferential market arrangements at favourable prices. There is currently no incentive to export regionally as domestic prices are in line with regional prices and domestic demand remains firm. Domestic sales have been on the increase over the last three years, rising from 151,000 tons in 2009/10 to 184,000 tons in 2010/11 and now 247,000 tons in 2011/12. Zimbabwes per capita consumption, currently estimated at around 25kg, has the potential to rise to the consumption levels of neighbours Botswana and South Africa of 32kg and 35kg respectively. However we expect the increase in total sugar produced to exceed the increase in domestic consumption which should see domestic sales as a percentage of total sales starting to decline marginally while the exports proportion goes up. Shortages in the EU market saw the 27-nation bloc accepting bids to import a total of 399,014 tons of sugar (384,000 tons raw, 15,014 tons white) in the 2011/12 season at reduced duty levels. Hippos proportional sales profile, in te rms of domestic sales versus exports, is estimated to match that of the Zimbabwe sugar industry as a whole. The local pric e went up from $545 per ton to $600 per ton in October 2011 while EU exports are estimated to fetch in the region of $800-$1,000 per ton. Table 2: Zimbabwe sugar production & sales, 2009/10 2012/13(E)

Zim sugar production (tons) Hippo's sugar production (tons) Hippo's production as % of total Zim domestic sales (tons) Zim export sales (tons) Zim total sales (tons) Zim domestic sales as % of total

2009/10 258,000 88,000 34% 151,000 123,000 274,000 55%

2010/11 333,000 131,000 39% 184,000 133,000 317,000 58%

2011/12 372,000 170,000 46% 247,000 125,000 372,000 66%

2012/13 (E) 430,000 205,000 48% 285,000 160,000 445,000 64%

Source: Company Reports, IH Estimates

Figure 20: Zimbabwe sugar sales profile, 2009/10 2012/13(E)

500 450 400

Tons (000s)

350 300 250 200 150 100 50 0 2009/10 2010/11 2011/12

36% 34% 42% 45% 66% 55% 58% 64%

2012/13 (E)

Zim domestic sales

Zim export sales

Source: Company Reports, IH Estimates

Equity Research Hippo Valley

Company Profile
Increasing cane supply to drive revenue growth
With regards to its own cane production, the company has reached its capacity in terms of land use with the area planted currently standing at around 12,000 ha so the strategy is to improve yields. Over the course of the 2011/12 season, 3,263 ha of company land was ploughed out and replanted as part of an on-going cane re-establishment programme aimed at correctly positioning the crop for a full return to optimal yields over the next three years. The target is to increase the companys average yield from the current 89.6 tons/ha to 105-110 tons/ha by 2014/15. However the real increase in production is expected to come from the private farmer sector. The Zimbabwe sugar industrys recent and on-going recovery continues to be underpinned by the private cane farmer rehabilitation programme, initiated in 2010/11 under the Sustainable Rural Communities (SusCo) project. A $30mn four year revolving finance facility was secured for the project through BancABC (ABCH:ZH). Of the 15,880 ha farmed by private growers across the industry, 3,476 ha were replanted under the SusCo project over the 2011/12 season, with a further 874 ha replanted by Chipiwa farmers financed by the EU-funded Canelands Trust. Private farmers independently ploughed out and replanted an additional 1,914 ha during the same period, with input support from Tongaat Hulett. As a result, private farmers collective cane deliveries increased from 413,000 tons in 2010/11 to 531,990 tons in 2011/12 (of which Hippo Valley received 311,687 tons), representing a year-on-year increase of 29%. It is anticipated that completion of the rehabilitation programme will see private farmers cane production reaching 1.4mn tons by 2015. There is also scope for massive improvement in out-growers yields, with the 51.4 tons/ha achieved by private farmers in the Hippo Valley Mill Group in 2010/11 and 39.0 tons/ha achieved by the Mkwasine outgrowers expected to rise to around 90 tons/ha over the next few years. Table 3: Planned replanting schedule of private cane famer land (ha)
2011/12 Ratoon crop 2,849 3,034 1,357 7,240 2012/13 Ratoon crop 3,546 5,025 1,495 10,066 2013/14 Ratoon crop 4,242 6,015 1,633 11,890 2014/15 Ratoon crop 5,047 7,378 1,875 14,300

Mill Group Hippo Mkwasine Triangle Total

Plant crop 1,358 2,185 447 3,990

Total 4,207 5,219 1,804 11,230

Plant crop 1,358 2,185 447 3,990

Total 4,904 7,210 1,942 14,056

Plant crop 1,358 2,185 447 3,990

Total 5,600 8,200 2,080 15,880

Plant crop 553 822 205 1,580

Total 5,600 8,200 2,080 15,880

* The plant crop is new cane which has been planted and not yet harvested.
* The ratoon crop is cane which has been harvested at least once and regrows in time for the next harvesting cycle. Source: Company Report

Majority shareholder Tongaat Hulett Ltd

Tongaat Hulett Ltd is an agricultural and agri-processing company headquartered in South Africa, with operations in South Africa, Zimbabwe, Mozambique, Botswana, Namibia and Swaziland. Its focus is on sugar production (cane cultivation, milling and refining) although it also produces speciality starches and sweeteners and has a land conversion and development division. It effectively controls the Zimbabwe sugar industry through its 100% shareholding in Triangle Corporation Ltd and consequent 50.3% stake in Hippo Valley. Its total sugar production for the 2011/12 year grew by 14% to 1.15mn tons, including increases of 42% in Mozambique, 12% in Zimbabwe and 7% in South Africa. Total revenue rose 25% on the prior year to R12.081bn, mainly as a result of the increased sugar production together with improved realisations in the regional and EU sugar markets. The Zimbabwean sugar operations contributed a significant R2.266bn (19%) to total revenue and provided the largest contribution to the groups profit from operations, generating R621mn (32%) of the consolidated total of R1.921bn. Tongaat Hulett has a prima ry listing on the Johannesburg Stock Exchange (TON:SJ) and a secondary listing on the Frankfurt Stock Exchange. Table 4: Top 10 Shareholders

Rank Account Name 1 2 3 4 5 6 7 8 9 10 TRIANGLE SUGAR CORPORATION LIMITED OLD MUTUAL LIFE ASSURANCE COMPANY OF ZIMBABWE LIMITED TATE AND LYLE HOLLAND BV NATIONAL SOCIAL SECURITY AUTHORITY - NPS STANBIC NOMINEES (PRIVATE) LIMITED (NNR) NATIONAL SOCIAL SECURITY AUTHORITY STANDARD CHARTERED NOMINEES (PVT) LTD - NNR OLD MUTUAL ZIMBABWE LIMITED NATIONAL SOCIAL SECURITY AUTHORITY (W.C.I.F) MINING INDUSTRY PENSION FUND Other TOTAL

Shares 97,124,027 25,863,722 19,314,480 5,014,301 4,136,982 3,573,683 3,048,379 2,793,220 2,446,872 1,705,544 27,999,354 193,020,564

% of Total 50.32 13.40 10.01 2.60 2.14 1.85 1.58 1.45 1.27 0.88 14.50 100.00

Source: First Transfer Secretaries (Pvt) Ltd

Equity Research Hippo Valley

Financials
Hippo Valley Income Statement
2012 Revenue Fair value gain on biological assets Turnover EBITDA D&A EBIT Net finance income/(expense) Share of profit/(loss) of associate PBT Taxation PAT Other comprehensive income Total comprehensive income Dividends paid out Retained earnings Weighted average shares in issue Basic EPS (cents) Dividend per share (cents) Operating margin EBITDA margin Net margin Effective tax rate Dividend ratio 128,915,000 15,163,000 144,078,000 40,081,000 (7,693,000) 32,388,000 (5,999,000) 1,479,000 27,868,000 (6,922,000) 20,946,000 (250,000) 20,696,000 20,696,000 193,020,564 10.8517 25.1% 31.1% 16.1% 24.8% 0.0% 2013E 153,738,687 5,000,000 158,738,687 47,178,190 (7,784,910) 39,393,280 (5,055,720) 1,479,000 35,816,560 (9,222,764) 26,593,796 26,593,796 (6,648,449) 19,945,347 193,020,564 13.7777 3.44 25.6% 30.7% 17.3% 25.8% 25.0% 2014E 168,033,243 168,033,243 50,928,601 (7,872,551) 43,056,050 (4,635,720) 1,479,000 39,899,330 (10,274,077) 29,625,253 29,625,253 (9,875,084) 19,750,168 193,020,564 15.3482 5.12 25.6% 30.3% 17.6% 25.8% 33.3% 2015E 175,221,906 175,221,906 52,854,763 (7,956,724) 44,898,039 (4,035,720) 1,479,000 42,341,319 (10,902,890) 31,438,430 31,438,430 (12,575,372) 18,863,058 193,020,564 16.2876 6.52 25.6% 30.2% 17.9% 25.8% 40.0% 2016E 181,853,186 181,853,186 54,634,774 (8,037,567) 46,597,207 (3,435,720) 1,479,000 44,640,487 (11,494,926) 33,145,562 33,145,562 (13,258,225) 19,887,337 193,020,564 17.1720 6.87 25.6% 30.0% 18.2% 25.8% 40.0% 2017E 182,046,640 182,046,640 54,761,988 (8,115,211) 46,646,777 (2,835,720) 1,479,000 45,290,057 (11,662,190) 33,627,867 33,627,867 (13,451,147) 20,176,720 193,020,564 17.4219 6.97 25.6% 30.1% 18.5% 25.8% 40.0% -1% 10% 5% 6% 1% 8% -14% 0% 10% 11% 10% CAGR 7%

Source: Company Reports, IH Estimates

Equity Research Hippo Valley

Financials
Hippo Valley Balance Sheet
2012 PPE Biological assets Investments in associates Non-current assets Biological assets Inventories Trade and other receivables Deferred plant maintenance costs Current tax asset Bank balances and cash Current assets Total assets Share capital Non-distributable reserve Retained earnings Shareholders' equity Provisions Long-term borrowings Deferred taxation Non-current liabilities Short-term borrowings Trade and other payables Current liabilities Total equity and liabilities 196,761,000 35,600,000 3,164,000 235,525,000 46,381,000 19,912,000 14,318,000 9,635,000 359,000 10,319,000 100,924,000 336,449,000 15,442,000 128,299,000 53,386,000 197,127,000 11,419,000 59,964,000 71,383,000 43,131,000 24,808,000 67,939,000 336,449,000 2013E 198,976,090 38,100,000 4,643,000 241,719,090 48,881,000 20,772,866 17,075,053 9,635,000 359,000 17,024,875 113,747,794 355,466,884 15,442,000 128,299,000 73,331,347 217,072,347 11,419,000 59,964,000 71,383,000 41,131,000 25,880,537 67,011,537 355,466,884 2014E 201,103,539 38,100,000 6,122,000 245,325,539 48,881,000 21,729,653 18,662,684 9,635,000 359,000 26,816,220 126,083,557 371,409,096 15,442,000 128,299,000 93,081,515 236,822,515 11,419,000 59,964,000 71,383,000 36,131,000 27,072,581 63,203,581 371,409,096 2015E 203,146,815 38,100,000 7,601,000 248,847,815 48,881,000 22,659,273 19,461,096 9,635,000 359,000 36,587,167 137,582,536 386,430,351 15,442,000 128,299,000 111,944,573 255,685,573 11,419,000 59,964,000 71,383,000 31,131,000 28,230,778 59,361,778 386,430,351 2016E 205,109,248 38,100,000 9,080,000 252,289,248 48,881,000 23,516,814 20,197,602 9,635,000 359,000 47,507,419 150,096,835 402,386,083 15,442,000 128,299,000 131,831,910 275,572,910 11,419,000 59,964,000 71,383,000 26,131,000 29,299,173 55,430,173 402,386,083 2017E 206,994,037 38,100,000 10,559,000 255,653,037 48,881,000 23,541,831 20,219,088 9,635,000 359,000 59,305,016 161,940,935 417,593,972 15,442,000 128,299,000 152,008,631 295,749,631 11,419,000 59,964,000 71,383,000 21,131,000 29,330,341 50,461,341 417,593,972 0% 0% -13% 3% -6% 4% CAGR 1% 1% 27% 2% 1% 3% 7% 0% 0% 42% 10% 4% 0% 0% 23% 8% 0%

Source: Company Reports, IH Estimates

Equity Research Hippo Valley

Financials
Hippo Valley Statement of Cash Flows
2012 EBIT D&A Profit on disposal of PPE Fair value gain on biological assets Cash generated from/(used in) operations Change in WC Deferred plant maintenance costs Provisions Net cash generated from/(used in) operations Net interest paid Tax paid Operating cash flow Capex Proceeds from disposal of PPE Dividends received Investing cash flow FCF Dividends paid Debt issued/(repaid) Equity issued Financing cash flow Change in cash Cash bop Cash eop 32,388,000 7,693,000 34,000 (15,163,000) 24,952,000 412,000 (1,886,000) (3,544,000) 19,934,000 (5,999,000) 13,935,000 (10,282,000) 233,000 872,000 (9,177,000) 4,758,000 (1,817,000) (1,817,000) 2,941,000 7,378,000 10,319,000 2013E 39,393,280 7,784,910 (5,000,000) 42,178,190 (2,545,382) 39,632,808 (5,055,720) (9,222,764) 25,354,324 (10,000,000) (10,000,000) 15,354,324 (6,648,449) (2,000,000) (8,648,449) 6,705,875 10,319,000 17,024,875 2014E 43,056,050 7,872,551 50,928,601 (1,352,374) 49,576,227 (4,635,720) (10,274,077) 34,666,429 (10,000,000) (10,000,000) 24,666,429 (9,875,084) (5,000,000) (14,875,084) 9,791,345 17,024,875 26,816,220 2015E 44,898,039 7,956,724 52,854,763 (569,835) 52,284,928 (4,035,720) (10,902,890) 37,346,319 (10,000,000) (10,000,000) 27,346,319 (12,575,372) (5,000,000) (17,575,372) 9,770,947 26,816,220 36,587,167 2016E 46,597,207 8,037,567 54,634,774 (525,652) 54,109,122 (3,435,720) (11,494,926) 39,178,477 (10,000,000) (10,000,000) 29,178,477 (13,258,225) (5,000,000) (18,258,225) 10,920,252 36,587,167 47,507,419 2017E 46,646,777 8,115,211 54,761,988 (15,335) 54,746,654 (2,835,720) (11,662,190) 40,248,744 (10,000,000) (10,000,000) 30,248,744 (13,451,147) (5,000,000) (18,451,147) 11,797,597 47,507,419 59,305,016 59% 32% 45% 42% 22% 2% 45% 24% -1% 22% -14% 17% CAGR 8% 1%

Source: Company Reports, IH Estimates

Equity Research Hippo Valley

Disclaimer
Research Team
Dzika Danha +263(772) 573 083 ddanha@ih-group.com Christine Mhongo +263(774) 171 262 cmhongo@ihsecurities.com Lloyd Mlotshwa +263(772) 936 677 lmlotshwa@ihsecurities.com Kate Rowland +263(778) 300 345 krowland@ih-group.com

Contact Details
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Certification The analyst(s) who prepared this research report hereby certifies(y) that: (i) all of the views and opinions expressed in this research report accurately reflect the research analyst's(s) personal views about the subject investment(s) and issuer(s) and (ii) no part of the analysts(s) compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed by the analyst(s) in this research report. Ratings Definition Buy - Expected 1 year return is at least 20% Hold - Expected 1 year return of between 0% and 20% Sell - Expected 1 year return of 0% and below Disclaimer This document has been prepared by IH Securities to provide background information about the securities and (or) markets mentioned herein, the forecasts, opinions and expectations are entirely those of IH Securities. This document was prepared with the utmost due care and consideration for accuracy and factual information; the forecasts, opinions and expectations are deemed to be fair and reasonable. However there can be no assurance that future results or events will be consistent with any such forecasts, opinions and expectations. Therefore the authors will not incur any liability for any loss arising from any use of this document or its contents or otherwise arising in connection therewith. Neither will the sources of information or any other related parties be held responsible for any form of action that is taken as a result of the proliferation of this document.