A sugary deal

SPECIAL REPORT

For sugar stocks, it has been a sweet story so far. Led by fabulous profit growth in the fourth quarter and improving business prospects, sugar scrips surged significantly over the past year.

The biggest gainer amongst the major players is Bajaj Hindustan which recorded a 201.5 per cent increase in its stock price to current levels of Rs 45.5 in the past six months.

Following it is Bannari Amman Sugars which registered a rise of 83.13 per cent to levels of Rs 298.5. Others, too, had their share of ascend: Balrampur Chini Mills - up 78.37 per cent to Rs 313.3, EID Parry - up 53.83 per cent to Rs 209.6 and Dhampur Sugar Mills - up 30.07 per cent to Rs 30.75.

Industry observers and some analysts say sugar companies are now in for good times, thanks to the favourable demand-supply situation which in turn should lead to straightening of sugar prices.

Till last year, sugar prices remained either stable or declined while the price of its key raw material - sugarcane - increased steadily. Both sugar and sugarcane prices are determined by the government.

With little opportunity to export sugar, manufacturers suffered losses till last year. However, this is set to change. Sugar companies are likely to benefit from better and improving operating efficiency.

Some more
Industry observers say volumes will be a key factor in driving profit growth of sugar mills. This year sugar volumes are likely to grow around 3.5-4 per cent.

Yet, sugar production is likely to be lower by 15-20 per cent. Analysts expect lower production combined with consumption growth to correct the extra inventory built-up and curtail the excess supply in the market.

India began the sugar year in October 2003 (that is the time when the government takes stock of the sugarcane/sugar and releases the prices for the year) with a carryover inventory of about 11.6 million tonnes according to Indian Sugar Mills Association (ISMA).

Due to lower sugarcane production in major sugarcane growing areas of Maharashtra and Tamil Nadu, the output this year (till October 2004) is likely to be around 14.5 to 15.0 million tonnes against 18.5 million tonnes last year (October 2003).

This in effect should lead to stable to rising sugar prices, making sugar companies more profitable. Moreover, analysts expect that the utilisation of by-products such as molasses and bagasse to improve profit margins. While molasses is used to produce ethanol, bagasse is used for production of power and paper.

Industry observers point out that the sugar business is really a volume play. Even a slight rise in prices increases revenues immensely. However, this time around sugar mills will be happier with lower production since their huge pile of inventories is getting offloaded in the markets only now.

In the past, the sugar industry has been reeling under the pressure of rising sugar cane prices with no commensurate increase in sugar prices.

Analysts blame the intervention by state governments as one of the reasons for the sugar industry's woes. Ideally, sugar companies would do much better without the government control. But that is a far cry.

Currently, sugar as well as sugarcane prices are controlled by the government. The central government decides the statutory minimum price (SMP) for the sugarcane. This price is fixed every year based on the recommendations of the Commission for Agricultural Costs and Prices (CACP).

In 2003-04, the government announced Rs 73.00 per quintal linked to a basic recovery rate (recovery is the amount of sugar obtained from sugarcane) of 8.5 per cent. For every 0.1 per cent increase in recovery, the grower gets a premium of Rs 0.85 per quintal.

In other words, the ability of a sugar mill to earn a premium beyond the government determined price is directly linked to its productivity.

In addition to this, some state governments also decide a state advised price (SAP) for sugarcane, usually higher than that of SMP, to ensure better realisation for farmers in their respective states. In the last decade, the actual price paid by sugar mills has been higher than the SMP by Rs 28 per quintal on an average.

Besides, sugar prices are not a function of demand and supply either. They are controlled by the central government. The wholesale price of sugar declined from Rs 13.20 in 1998-99 to Rs 11 in 2002-03.

During the period SMP jumped from Rs 52 to Rs 69.50. This affected the profitability of sugar companies till fiscal 2002-03. The situation got correctly partly in fiscal 2004.

While SMP of sugarcane was up from Rs 69.5 per quintal in fiscal 2003 to Rs 73 per quintal in fiscal 2004, sugar prices increased from Rs 11 per kg to Rs 15-15.5 per kg during the same period.

This aided sugar companies to come back to the black. "We expect sugar prices to stabilise at current levels without any major up or downside," says an analyst from a domestic research house.

In fact, sugar companies recorded good growth in profits on the back of rising prices and lower production levels (see table). Most major companies reported triple-digit profit growth during the year. Bajaj Hindustan registered a profit growth of 532 per cent to Rs 10.37 crore in the quarter ended March 31, 2004.

Meanwhile, Balrampur Chini recorded a profit growth of 254.48 per cent to Rs 10.28 crore and EID Parry recorded a profit growth of 168.08 crore to Rs 2.52 crore for quarter ended December 31, 2003.

Then again, sugar companies have had limited opportunities to make money by selling outside the country. This is because international sugar prices are lower than domestic realisations.

The international sugar scene is dominated by Europe and the United States. Even though India is the second-largest producer of sugar (Brazil is the first), it does not have a say in international prices. Analysts believe that its the developed economies that control the market.

Last year, Indian companies exported 1.7 million tonnes of sugar. This year, exports are likely to be even lower. ISMA expects exports of 300,000 to 400,000 tonnes with the domestic market looking more attractive compared to international markets.

Overall, integrated sugar mills are expected to be the big beneficiaries. Here are the five sugar companies analysts seem to be bullish on.

The sweet renderers

Bajaj Hindustan
The company is the largest sugar manufacturer in the country with a capacity of 38,000 tonnes a day (after the acquisition of 24 sugar mills in Uttar Pradesh).

It is in the process of increasing its crushing capacity to 31,000 tonnes from 24,000 tonnes. It also plans to set up a 7,000 tonne unit in Meerut which is expected to be operational from December 2004.

For second quarter ended March 31, 2004, the company's net profit increased to Rs 10.37 crore from Rs 1.64 crore on better realisations. The stock currently trades at 10.2 times at a price of Rs 45.5.

Balrampur Chini Mills
The company is one of the largest and efficient sugar players in the industry. It has an integrated sugar facility with a distillery for ethanol production and a co-generation facility for power.

This makes Balrampur Chini slightly less vulnerable to an extent to the cyclical nature of sugar industry. For the quarter ended December 31, 2003, the company reported a net profit of Rs 10.28 crore, up from Rs 2.9 crore in the previous year. The stock currently trades at 11.5 times at a price of Rs 313.3.

EID Parry
EID Parry is the flagship company of Rs 5,000 crore Murugappa group and one of the largest sugar producers in southern India. The company has exhibited imperative preference towards the sugar business by demerging its farm input division.

Going forward, analysts believe that the company would put up much better performance with improving sugar industry scenario and continuing growth in its parryware business.

"The ongoing deregulation process in fertiliser industry will further boost EID's performance on a consolidated basis," says an analyst with a domestic brokerage.

The company reported a net profit of Rs 2.52 crore for quarter ended December 31, 2003, against Rs 0.94 crore. The stock currently trades at 12.8 times at a price of Rs 209.6.

Bannari Amman Sugars
Bannari Amman is a part of the Bannari Amman group, one of the largest industrial conglomerates in southern India engaged in a wide spectrum of manufacturing, trading, distribution and financing activities.

It is an integrated sugar player having a distillery as well as a co-generation plant. The prospects of domestic sugar industry appear to be healthy going forward which will improve the company's performance in the future.

Capacity addition would further drive earnings growth as volume increases. The company reported a net profit of Rs 9.18 crore in the quarter ended December 31, 2003, against a loss of Rs 5.16 crore. The stock currently trades at 10.17 times at a price of Rs 298.5.

Dhampur Sugar Mills
Dhampur Sugar is amongst the largest sugar companies in the country. It is working hard on its debt restructuring programme in order to deal with heavy outstanding debt in the books.

"Successful debt restructuring may cut down interest cost substantially," says an analyst with a domestic brokerage. Improving sugar prices too is expected to augur well for profit growth of the company.

Dhampur recorded a net profit growth of 81 per cent to Rs 8.22 crore for second quarter ended March 31, 2004. The stock currently trades at 6.2 times at a price of Rs 30.75.

About sugar

Sugar was first extracted in West China in the early 1700's. Cultivation later spread into northern India, and then westward along the trade routes.

Eventually Spaniards spread the cultivation of sugar across the Atlantic Ocean to the West Indies, the region that is often thought to be the birth place of sugar.

Sugar originates from two distinctly different plants - cane and beet. The cane plant is a grass and is grown in tropical climates mainly in the southern hemisphere, whereas the beet plant is a tuber and is grown in cooler climates.

White sugar can be produced from both cane and beet - the only difference is in appearance. White sugar from beet tends to be produced in slightly smaller and more uniform crystals than that from cane. There is no difference in taste between the two.

There are four stages in the production of white sugar from cane - juice extraction, purification, crystallisation to raw sugar and refining. By-products of cane include bagasse and molasses.

White sugar made from beet undergoes only three stages of production as no raw sugar is produced. Beet by-products are beet pulp and beet molasses.

Utilisation of sugar industry by-products
Molasses
Molasses is an important by-product of the sugar industry, constituting about 4.2 to 4.5 per cent on cane utilised for sugar production. During 1998-99, the molasses production was 7.0 million tonnes. About 295 distillery units with a capacity of 27,000 lakh litres per annum are operating in the country.

Annually about 15,000 lakh litres of alcohol are produced from molasses. Molasses is also utilised in the manufacture of animal feed. About 90 per cent of molasses is utilised for alcohol production and the balance for cattle feed and other purposes.

Bagasse
Bagasse is the other major by-product of the sugar industry. It is used for generation of steam and power required for the processing of sugarcane.

With energy-saving measures, 5 to 10 per cent of bagasse is saved by a majority of the units and is utilised for production of paper and cogeneration of power.

The domestic sugar sector is amongst the most diversified industries in the world, with an installed capacity to produce 750 mw cogenerated power against a potential of 5,000 mw.

Every sugar factory has a power house for generating renewable power for its own requirements while some co-generate and export power to the grid.

Fifty more units with a capacity of 750 mw are in the process of putting up plants. The cogeneration of power is faced with problems in regard to tariff fixation, third party sale and timely payments.

According to ISMA, India consumes around 1.5 million tonnes of sugar every month and analysts expect demand to rise by 3.5-4 per cent. Given this, India currently does not need to import any sugar as there is enough supply.

However, any decline in production levels may see some imports. At present, there is a customs duty of 60 per cent levied on the import of sugar which may be reduced if we have to import sugar.