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Sugar in a sweet spot

A combination of falling production and rising prices is likely to translate into big profits for sugar producers over the next two years, finds out R Sree Ram.

How do you find a sureshot winner in a bear market? One way is to pick a company whose products enjoy a robust demand even as supply constraints keep the prices buoyant. The sugar sector is precisely in such a sweet spot right now. The demand for sugar is expected to zoom in the coming months because even as the consumption is growing at a steady rate, the production is falling.

The drop in sugar production is because of a sharp 17.5% dip in sugarcane cultivation over the past year, the sugar year being from October to September. Two consecutive years of bumper crops have brought down cane prices, prompting the farmers to shift to more remunerative food grains. According to the Agriculture Ministry, the area under sugarcane has fallen from 5.3 million hectares last year to 4.37 million hectares this year. Analysts expect sugarcane acreage to further drop 10-12% this year (see graph).


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As a result, the production too has declined—from 28.3 million tonnes last year to 26 million tonnes this year. It is estimated to decline further to 20.1 million tonnes in 2008-9. On the other hand, consumption has been rising. India will consume an estimated 21.8 million tonnes of sugar in 2007-8 (Oct-Sept), and in 2008-9, this figure could touch 22.8 million tonnes. The mismatch in the demand and supply will cause prices to shoot up further and deplete the sugar buffer stock to 6 million tonnes from 9.6 million tonnes now. Analysts expect the prices to move up by 20% in the next one year.

“The inventories in 2008 and 2009 are expected to be lower compared with that in the past two years. This will drive the sugar prices higher,” says Bhavesh Gandhi, sugar analyst at India Infoline. The crunch period will start from September 2009 and continue till 2010.

Importing sugar may not help stabilise prices. The global prices of sugar are likely to stay firm because the largest producer, Brazil, is diverting most of its cane to ethanol blending. This will shrink global sugar production to 164 million tonnes next year from an estimated 168.4 million tonnes this year, even as global sugar consumption rises from 159 million tonnes to 164.5 million tonnes. So the landed cost of imported sugar may be the same as the domestic price. What does the rise in prices mean for sugar companies? For one, fatter bottom lines. Two months ago, sugar was selling at Rs 14.50 per kg. Now, the price has touched Rs 19.65. “The companies are pocketing at least Rs 3 per kg which will be transferred to their bottom lines. This scenario will continue till September 2010,” says Anil Advani, head of research at SBICAP Securities.

That’s not all. Large sugar producers have invested heavily in horizontal integration by setting up distilleries, power plants and ethanol blending facilities, which open up new streams of revenue. According to an estimate by Credit Suisse, selling alcohol and power to other user industries has the potential for these companies to earn Rs 6 more per kg of sugar.

Shree Renuka Sugars, for example, has steadily shifted its focus to allied products like biofuels. With 20% market share in the ethanol fuel market, the company will gain once the government mandates 10% ethanol blending in petrol from October 2008 as against 5% now. Power is an important revenue generator. Bajaj Hindusthan (BHL) generates 115 MW of power, of which about 90 MW is sold to the Uttar Pradesh power grid. “Sugar companies are benefiting from peripheral products. So sugar is the icing and other things are adding to the bottom lines,” says Advani. However, investors need to be cautious because the entry price has become critical. Analysts feel that most sugar stocks have already run up by over 15-25% and a correction is expected. “Sugar stocks seem to be trading at over 10 times their expected September 2009-10 earnings and have factored in most of the upside. We should wait for a correction in the sugar sector,” says Waqar Naqvi, CEO of Taurus Mutual Fund.

There are two major risks associated with the sugar sector. Firstly, it is a sensitive commodity in an inflationary environment. The government might import sugar and sell it at subsidised rates to garner votes in the coming polls. Secondly, the support price of cane may also be raised to appease the farmers. That might change the dynamics of the sugar industry. But for now, analysts say that Shree Renuka and Balrampur Chini are good picks. “Shree Renuka is the best stock to be invested in because its financials are better than that of others,” says Gandhi. The company’s sales rose 174% in the previous quarter even as Bajaj Hindusthan and Balrampur Chini saw a 4% and 13% drop in sales, respectively.


How they stack up
 Balrampur ChiniBajaj HindusthanShree Renuka Sugars
Valuation metrics2008-9E*
P/E (times)21.8
EPS (Rs)4.39.4-0.413.66.99.6
ROE (%)9.818.2-
EBITDA margin (%)21.72516.721.417.619.1
Analyst comments“Operational risks are lower as it has expanded less aggressively, is more integrated and has lower leverage.” Credit Suisse“The company’s sugar division reported 8% EBIT losses in June quarter, while its peers reported profits.” Edelweiss“It’s the best stock for the long term because its financials are better than those of other UP-based mills.” India Infoline
* E: Estimated                                                                                           Data source: Credit Suisse


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