Sugar: Prices at new highs

Although sugar companies are expected to deliver robust profits in 2009-10, stock valuations are not cheap.

With sugar prices scaling new highs, it is apparent that the prospects of producing companies have only turned sweeter. Domestic wholesale sugar prices in Delhi reached a historic high of Rs 44.50 a kg yesterday. Over the past month, these have gone up by 19.2 per cent; over a year, they are up by 91 per cent. The trend is not surprising, given that two of the world’s largest producers (India and Brazil) have reported a sharp drop in output. The global deficit for the sugar season (October 2009 to September 2010) is estimated to be 8.45 million tonnes. In India, estimates suggest the deficit for the season will be about 7-7.5 million tonnes. Notably, the global sugar inventory to consumption ratio, at around 33-35 per cent (or about four months of consumption), is the lowest in nearly 20 years.

For Indian companies, who procured sugarcane at Rs 2,000-2,200 per tonne, the trend looks favourable. Considering a 10-11 per cent recovery rate from sugarcane (translates into a cost of Rs 20-22 per kg), companies will make a profit of more than Rs 10 per kg, the highest in recent history. The ex-mill sugar prices are currently trading at Rs 35-37 per kg, which are expected to move up further if wholesale prices continue to trade at high levels. In this case, analysts believe companies will report bumper profits and, hence, their earlier earnings’ estimates might also get revised upward and provide support to share prices. Bajaj Hindusthan is reckoned to have the highest earnings sensitivity, of about 5 per cent for every 1 per cent change in prices, followed by Renuka Sugar’s 4.2 per cent. In other words, these two companies will be the biggest beneficiaries of any rise in sugar prices.

Meanwhile, Bajaj Hindusthan announced its results for the quarter ended December 2009 yesterday. The company reported a 70 per cent growth in revenues and net profit of Rs 85.2 crore, as against a loss of Rs 55.94 crore in the December 2008 quarter. Going ahead, analysts expect the company to report an EPS of about Rs 21 for the year ending September 2010, which translates into a P/E of 11. Shree Renuka Sugar, too, is expected to report strong growth in revenues and profits in 2009-10. Analysts are expecting it to report an EPS of Rs 27, which works out to a P/E multiple of 9.

Although the fundamentals of most sugar companies will improve significantly, investors need to be cautious, given that their share prices have risen substantially, reflecting the optimism surrounding the sector. At current levels, the stocks are trading at a P/E of over 8 times forward earnings, which is not cheap.

One risk that could also emerge next year is that higher sugarcane prices will attract more farmers to grow cane and hence, higher production. Eventually, the sugar cycle could reverse, leading to pressure on sugar prices and, simultaneously, higher costs for companies. Hence, analysts say, companies may report lower profits in 2010-11, which will reflect on stock valuations.