While sugar prices are likely to stay at high levels, stock valuations reflect most of the positives.
The twin-impact of a decline in sugar production in India and subdued output in Brazil (among the largest producers of sugar globally) and a gradual growing global consumption have led to a sharp rise in sugar prices, globally and in India. The situation would also entail various global consumers dipping into their inventories or importing sugar to meet their consumption needs, which in turn will mean a dip in global inventory levels. Thus, the stocks-to-consumption is expected to dip from 44.74 per cent (or 5.4 months) in 2007-08 to 31.79 per cent (3.8 months) in 2009/10, as estimated by International Sugar Organisation (ISO), which is the lowest in 20 years. In India’s case, analysts are projecting inventory levels to dip from 4.3 months to a mere 1.14 months during the same period.
The prospects of any commodity are dependent on four key parameters viz., demand, supply, inventory levels and costs. In the case of sugar, the dynamics indicate an upward bias in prices. For domestic sugar producing companies though, their business model including the kind of input and cost structure is estimated to influence their fortunes and thus, stock valuations which in most cases have factored in the likely upsides.
Production blues
As the chart World Sugar Trends shows, global production of sugar is expected to fall short of consumption by 10.4 million tonnes (mt) and 8.4 mt in 2008-09 (sugar season is from October to September) and 2009-10, respectively. The resultant impact on inventories (and the stocks-to-consumptions ratio) is a decline of 13 mt over two years, by the end of September 2010. While Brazil’s production is expected to be lower due to excess rains led by the effect of El Nino impacting yields and harvest, India’s production is expected to fall to 15 mt in 2008-09 while staying flat at 15.5 mt in 2009-10 due to poor monsoons. Thus, inventory levels may drop to a month’s consumption. This would mean the country needs to import raw sugar of 2.5 mt and 8-9 mt, respectively leading to pressure on world trade given that the annual trade ranges 45-50 mt.
Prices spike
The markets have already sensed this, which is reflecting in sugar prices, both locally and internationally. While domestic prices are up 130 per cent since their lows of Rs 13.5 per kg in September 2007, international prices are near their three decade highs. For the way ahead, says Sergey Gudoshnikov, senior economist, International Sugar Organisation, “the distinctive deficit phase, characterised by a significant excess of global consumption over production, as well as a significant reduction in stocks and tightness in the global trade balance, is expected to continue for at least 12 more months. The supply tightness is likely to increase as most of the sugar stocks accumulated during the earlier surplus seasons have been already used during the first deficit season. Lower stocks are expected to further support world market prices.”
While the downside risk to global sugar prices stem from the actual sugar output by Brazil turning out to be higher than the estimated 32-33 mt, the upside domestic risks include extreme government regulations pertaining to pricing caps, higher levy quota and hike in sugarcane prices. Analysts believe that smaller intermediate interventions will continue such as a cap on sugar stocks with traders and industrial users, which was introduced recently. One risk that looks more prominent is that cane availability could get impacted due to poor monsoons, low acreage (shift to other crops) and diversion of cane to other uses.
Conclusion
Analysts believe that companies with higher dependence on cane-based sugar (like Bajaj Hindusthan and Balrampur Chini) are more vulnerable to sugar prices and cane availability, while companies like Shree Renuka Sugar, which has a refinery-based business model, are comparatively better placed. In the long-run, analysts believe that the current uptrend in sugar prices if sustained, along with negligible capex, the larger companies will end up with lower debt on their books (over two-years) making their balance-sheets stronger. For now, with valuations largely reflecting most of the positives, there seems little room for stocks to appreciate significantly. Hence, further upsides will largely depend on the movement in sugar prices. Among the larger stocks, analysts prefer Shree Renuka Sugar and Balrampur Chini with expected returns of 15-25 per cent.