Sugar stocks: Sweet only in the medium term

Financial package will only provide a near term relief while Profitability boost will come not before next sugar year

The sugar industry that has been bleeding with losses got some respite with the recommendation of a financial package and doubling the ethanol blending in petrol to 10%.

The industry facing a cash crunch had unpaid cane price arrears of Rs 2,400 crore from sugar year 2012-13 in Uttar Pradesh. (Sugar year starts from October when fresh cane crushing starts and ends in September next year). With the UP government maintaining the cane prices at similar levels (Rs 280 a quintal) in SY13-14 as seen in Sy12-13, the arrears were likely to cross Rs 12,000-13,000 crore in March-April 2014 as per ISMA. Thus, the government’s decision to provide Rs 7200 crore loans for paying cane arrears with 12% interest subsidy ( 7% to be paid by sugar development fund and five% by the government) bodes well in the near term. This leads to cane crushing by UP sugar mills that had already been delayed by more than a month starting in December’13. The industry will also be provided a moratorium of two year on repayment of loans.

Further, the government is also looking at restructuring the existing loans.

While all this is positive for short term and will lead to sugar mills starting production in UP as well as farmers getting the arrears,  however,  the real issues on profitability are still to be addressed. The industry was demanding cane procurement price of Rs 225 a quintal which as per them were viable prices. However, sugar manufacturers in UP will still have to pay a cane procurement price of close to Rs 270 even after taking into consideration the Rs 11 discounts that the millers are likely to get as declared by the state government. Adding to this, the conversion cost of around Rs 34 a quintal, the cost of production would come at around Rs 304. Whereas the selling price for sugar is also hovering around the same levels i.e Rs 30-31 a kg. Hence, profitability will still remains under pressure.

The major positive to be watched for will be the decision on formation of committee by the government that will look at linking the cane procurement prices with output prices for the industry. The developments on the same will have to be watched for. However for this season as the crushing has started the upside on realisations is likely to remain capped. The benefits from formation of committee and its recommendations therefore is not likely to be seen before next sugar year.

Ethanol blending in petrol being increased to 10% should accrue benefits if implemented properly. The 10% ethanol blending will require higher molasses for ethanol production and thus reduction in sugar production and hence better realisations. Achal Lohade at JM financial estimated that this could lead to 1-2 MT reduction in sugar production and in due course of time would wipe out entire sugar surplus. Abhinash Verma, DG ISMA also feels that 10% blending can reduce 1.7-1.8 MT of surplus sugar production.

 
Nevertheless considering the historical events/trends, Lohade believes it is unlikely to be implemented fully in the near term. There is uncertainty over timing as well as quantum (last OMC tender finalisation took 7 months, and second tender is still awaited. In addition there will be significant protest by chemicals/alternate customer industry (as higher ethanol prices will raise their raw material cost). Further the operational issues (inter-state movement, tax structure, logistical movement) will have to be looked at.
 
Looking at the above factors, the sugar stocks that saw a strong momentum on Friday lost steam on Monday. Amongst the same Balrampur Chini holds maximum promises. Having distillery capacities, it the least leveraged company compared to its larger peer Bajaj Hindusthan. Shree Renuka too holds promises as it does not face problems in Karnataka, while committee on sugar cane pricing mechanism has already been formed benefits of which will accrue next year.

Rohit Agarwal at SPA securities adds that the international sugar surplus of 10.1 MT  is likely to reduce to 3.5 MT moving forward which will benefit Shree Renuka in the international market. Further the company having refining capacities on the ports continues its sugar refining business around the year unlike its peers that see seasonal operations. Thus at current valuations Rohit sees the Sugar stock as Shree renuka and Balrampur chnini being a good medium to long term bet. Out of Five analysts polled by Bloomberg during the month of November’13 have BUY ratings on Larampur chini with target price of Rs 51.40 (CMP Rs 44.90). For Shree Renuka, out of the four analysts polled by Bloomberg in last six months three have hold with one sell rating and target price of Rs 26 for stock trading at Rs 21.50.