Case: Nghe an Tate & Lyle Sugar Company (vietnam)

Case: Nghe An Tate & vLyle Sugar Company (Vietnam)                                    

1. How attractive is the project from the sponsor’s perspective?

The project seemed very attractive from the sponsor’s perspective. The intend of the sponsor was to capitalize on the rapid growth in domestic demand for sugar forecast in Vietnam. Vietnam was an attractive market for several reasons. First, it had a large population, approximately 70 million people and was expanding. Second, current sugar consumption was quite low but the sponsors expected it to grow to 14 kg by 2005. At the same time, the domestic production was approximately 360,000 tons of sugar while domestic demand for sugar was estimated at 700,000 tons in 1997. The difference was imported; therefore, Vietnam was a deficit country. In addition, Vietnam had a strong tariff system that made profitable the domestic production. Finally, the project would be significant enough to receive attention at the highest levels within the Vietnamese government, thereby guaranteeing decisions could be made rapidly. Based on these crucial elements, the sponsors could estimate rosy projections. From the projected Free Cash Flows (Exhibit 10-A), the calculated IRR for the lifetime of the project was about 18% (see excel file). Comparing it with sponsor's cost of capital of 10%, we see that project largely covered its cost of capital. For all the above-mentioned reasons, the sponsors found the project very attractive and started the construction of the sugar mill even without the support of the IFC.

2. What are the risks facing the project?

Ewen Cobban, an IFC agricultural specialist, identifies three risks (p1):

1.     Supply risk. NATL is a sugar mill whose production depends entirely on local feedstock. Without any fields of its own, NATL must acquire 900,000 tons of sugarcane from nearby farmers each year to operate at capacity. Three barriers prevent NATL from capturing this large quantity of inputs. First, in the late 1990s, very few smallholders in Nghe An province, a poor region in northern Vietnam, grow sugarcane. They could be convinced to do so. But this would require both community outreach and credit facilities. It is more expensive, and therefore much riskier, to grow cash crops like sugarcane rather than subsistence crops like peanuts, maize, or rice. Second, farmers that do have the wherewithal to cultivate cane sell their produce to “handicraft mills” who pay upfront in cash. Nghe An Tate Lyle’s model for purchasing cane from smallholders may offer greater total compensation. But it only offers a percentage upfront followed by additional payments later on. Farmers don’t understand this foreign approach and hence are unwilling to sell NATL their sugarcane. Changing this perception would require time, education, and training. Third, transporting cane from field to factory presents a logistical challenge. Again, NATL offers a unique approach here of covering all trucking costs for contracted smallholders. However, without explaining this plan to the community and building trust, farmers won’t engage it.  

2.     Infrastructure risk. The Vietnamese government has promised to deliver electricity and roads to the NATL sugar mill. It has also agreed to upgrade transportation arteries in the province to facilitate speedy, low cost sugarcane delivery. However, when NATL approaches COD in 1998, this work is not done. Dirt roads require paving; rivers and streams and gullies require bridging.

3.     Revenue or commodity risk. As a lender, this point concerns me most. NATL proposes selling into the domestic merchant sugar market without a contractual offtaker. Most DFIs would see insecure future cashflows like this as a definite deal breaker. While Vietnam’s protection of its domestic sugar industry offers some reassurance, sugar is still a volatile commodity subject to wild price swings: $480/ton in 1995 to $260/ton in 1997. In the wake of the Asian Financial Crisis, I find NATL pricing forecasts are extremely rosy. Moreover, if Vietnam ever decided to apply for WTO membership, artificial tariff shields would disappear and NATL would have to compete on its own two feet with highly efficient global sugar giants, like those in Brazil. Revenue risk calls the project’s entire economic viability into question.  

4.     Foreign exchange risk. Most lenders expect debt to be dollar or Euro denominated. To hedge against forex risk, the project would need to invest in a currency swap, which would considerably raise transaction costs. Otherwise, an appreciating dong, which would inflate debt, or a depreciating dong, which would deflate debt and lead to de facto default, could derail debt service.    

3. Are farmers likely to convert to cane?

Not without extensive stakeholder engagement and easily available credit. See above.

4. What are the trucker Incentives to participate?

The truckers would only be needed for six months during the harvesting season. During this time, NATL is expected to operate 24/7 and would require deliveries of cane sugar from farmers around the clock. This would guarantee the truckers a certain level of income during these 6 months and allow them to work in another area for the remaining six months of the year. Given that the transportation price will influence the price the farmers can charge NATL, it is possible that farmers would invest in trucks and operate their own deliveries.

5. Will the government support the project?

Yes. There is little risk here. The Vietnamese government sees the countryside as its core constituency. NATL will deliver roads, economic opportunity, and at least 525 permanent jobs to rural residents in a poverty-stricken part of the country. When you count truck drivers, construction workers, seasonable laborers, and new suppliers, the project will generate even more employment. NATL will also remedy the country’s sugar deficit. The Ministry of Agriculture and Food Industry (MAFI) wants to achieve self-sufficiency in sugar production. In 1997, Vietnam makes 360,000 tons but imports 340,000 tons to meet 700,000 tons of consumption --- a figure that is expected to surpass 1m tons by 2000. Finally, Hanoi is embracing its northern neighbor’s model of FDI-driven growth. Keep in mind that Vietnam’s senior leadership is trained at the Central Committee Party School in Beijing. Attracting overseas capital is a critical piece of Vietnam’s development strategy.

6. Who will be affected by the project and how large are the costs and benefits to each group?

The project affects several stakeholders: project employees, customers, suppliers, sugarcane farmers, truck haulers, competitors, the society at large and the government.

NATL is expected to employ 525 workers permanently and additional 200 workers during crushing season. NATL is expected to pay its workers double the salary they would be able to command at a similar job at a different facility. This is a clear benefit to the potential employees at NATL.

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