Durban - Illovo Sugar's plans to spend about R6bn expanding sugar production in Africa, which will increase capacity by about two-thirds to 2.7 million tonnes per annum, may entail some risk.

Like all commodities the world sugar price, though it has been fairly high and stable the past year, can be volatile. Will Illovo be caught offside with tonnes of sugar it cannot sell at a decent margin?

"They are backing on the European Union sugar reforms. Probably all the additional sugar Illovo will produce will go into Europe," said Mohamed Loonat, a portfolio manager at Element Investment Managers.

He pointed out this means much of the sugar from Africa will be exported to the European Union (EU) at preferential contract prices instead of the volatile world price, and will be aided by majority shareholder Associated British Foods' distribution network in Europe. "For me, the risk in Africa is more about political risk, not the world sugar price."

However, Illovo seems to be boxing clever on this front. Its expansion into African countries - six already and more in terms of the ongoing plan - is often accompanied by teaming up with the relevant African government as a partner.

African countries 'a good market'

For example, the R1.6bn it has already spent in Zambia was with the Zambian government as a partner. Growing sugar cane and milling sugar creates jobs, so governments in Africa tend to welcome foreign investment in the sugar industry.

The EU sugar reforms, which came into effect in October, remove much of the export subsidies and farmer support European producers have enjoyed. The bottom line is that about 6 million tonnes of sugar has been taken out of the EU market, swinging it into deficit.

That gap will be made up by exports, much from Africa, where Illovo is already established as the largest sugar producer on the continent.

But African countries are also a good market for Illovo's sugar. An investment note by Francesco Sturino of BP Bernstein late in 2009 said Illovo attracted much better margins outside South Africa, as much as 36.4% (operating profit margin) in Malawi and 20.9% in Mozambique compared to 6.4% in SA.

Illovo also has a war chest that should at least be able to fund the outset of its African expansion plans, following its R3bn rights issue last year.

Some of this was applied to reducing debt - MD Graham Clark said Illovo wanted to reduce gearing from the then-70% to within its target range of 40% - but the rest will be available for new investments.

- Fin24.com