Hopes shift to decontrol as fundamentals deteriorating

Due to higher costs and lower prices, analysts are bearish on most north-based companies like Bajaj Hindustan, Balrampur Chinni and Dhampur Sugar Mills

Worries that sugar companies will make lesser profits, as costs are rising and sugar prices falling, have led to a sharp correction in their share prices. Stocks of Bajaj Hindusthan, Balrampur Chinni, Shree Renuka Sugars and EID Parry are down between 17-30% in the last three months as compared to Sensex’ 5.6% rise.

What’s worse is that the near to medium term prospects of most sugar companies aren’t sweet. The only hope for now and which could possibly revive sentiments is if the government goes ahead with the decontrol of the sugar industry.

Sugar prices have fallen from their peak of around Rs 39 a kg in August 2012 to current levels of Rs 34 a kg. And to make things worse, the cost of sugarcane procured by the companies has gone up 16-17% compared to the last sugar season. This happens to come at a time when there is surplus sugar in the country and it is also difficult to sell in the export markets given the lower international prices.

A Fitch group company, India Ratings in its note said that it has negative outlook for sugar manufacturing companies for 2013 considering a further deterioration in their financial profile. The rating firm said that operating margins of companies in 2013 are likely to be below the 2012 levels (of 13%), as sugar margins (October 2012-September 2013) may fall to Rs 1 a kg or lower. Thus, the financial leverage (debt to EBITDA of 4.8 times in 2012 and 3.9 times in 2011) is expected to worsen. This is based on financial statements of 18 listed sugar companies.

The concerns for North India based sugar companies are more. Recently, Uttar Pradesh chief minister Akhilesh Yadav announced that State Advised Prices (SAP) for sugarcane have been increased by Rs 40 a quintal (100 kgs) to Rs 280 a quintal. This is the highest in India and even far more than the Central government’s fair and remunerative price (FRP) of Rs 170 a quintal.

Uttar Pradesh is estimated to produce 33% of India's production in sugar season 2013, and is the home for companies like Bajaj Hindusthan, Balrampur Chini and Dhampur Sugar Mills among the major players in the country. Sugar cane accounts for 85-90% of the operating cost and based on the new SAP the cost of producing sugar is likely to be around Rs 33-34 a kg, which is far more than the ruling sugar price (on an average, companies are able to recover 1 kg of sugar from every 10 kg of cane).

No wonder, analysts have downgraded most north-based sugar companies in the last 2-3 months. "Higher cane cost at Rs 280 per quintal and sugar prices at par with the cost of production (Rs 33 a kg), we believe earnings from the segment (sugar) for the Bajaj Hindusthan would continue to remain dismal," said Sanjay Manyal analyst at ICICI Direct in a note this month.

The analyst is expecting the company to report Rs 153.4 crore loss in the sugar season ending September 2013. Similarly, in the case of Balrampur Chini, HDFC Securities’ analyst has reduced the EBIDTA estimates by 39.4% and profits by 83% for FY14 due to higher cane cost. Dhampur Sugar, too, is expected to report a loss in its sugar business.

At this juncture, given the surplus situation in global and domestic market, the chances of a recovery in sugar prices are diminishing. The Indian sugar industry is expected to produce 24.3 million tonnes of sugar in season 2013 as against the consumption of 22.5 million tonnes, which leaves a surplus of 7.8 million tonnes (considering opening stock of 6 million tonnes), which is not small at a third of annual consumption. However, in this situation, Maharashtra-based companies like Shree Renuka Sugars as well as South-based players like EID Parry could be in a better position.

In Maharashtra, the cost of production is in the range of Rs 30-32 a kg.
Companies like Renuka are much more diversified with large exposure to sugar refining where margins and volumes are still comfortable. However, for Renuka Sugars the worry stems from its high debt levels and not from the operating performance, as about half its operating profit goes towards paying interest cost.

In this backdrop, the only hope for companies is decontrol of the industry. Led by news of a possible decontrol in the offing, share price of sugar companies have risen in the last two days. If sugar decontrol is implemented in the manner in which the industry is hoping (removal of levy sugar), it could help reduce the companies’ pressure on the working capital and inventory fronts, thereby strengthening their finances in the long-run and improving market sentiments.

Linking of cane costs to realisation will only make things better, but given that it is a sensitive issue any resolution to this issue is unlikely anytime soon.