Sweet no more

The medium-term outlook for the sugar sector seems bleak, but there could be hope two years hence.

The top 10 sugar companies hit their one-year low in terms of market capitalisation last week.

On an average, they have lost 26 per cent in the last six months, when the Sensex gained around 45 per cent. So, is it time to indulge into some value buying or to take a final call that sugar stocks are best left aside?

After enjoying a good run for around two-three years, sugar stocks have lost their sweetness. A downturn in the commodity cycle and too many government regulations are being totted as the culprits.

The sugar cycle lasts for about five-seven years. A good crop in October 2002 to September 2003 resulted in higher production of sugar and consequently, lower prices of sugar.

Rising sugarcane prices in the same period led to large sugarcane arrears for sugarcane growers. This, in turn, led to farmers shifting to other crops which meant lesser sugarcane production in 2003-04. As a result domestic sugar prices rose in tandem with global sugar prices.

Thus goes the cycle. A good crop in the first period means more revenues to farmers (since cane prices are typically fixed), which in turn translates into more cultivation.

This leads to a fall in prices of sugar in the next period due to an excess supply and thus scarcity of cane in the next period as farmers earn less, while mills make merry.

But what is happening now is different. In 2003-04, as supply could not meet demand, sugar prices shot up. So, sugar companies started expanding capacities.

Also, to attract further investment in the state, the Uttar Pradesh government announced various benefits for mills that were willing to expand capacities.

Subsequently, sugarcane became expensive as these incremental capacities had to be fed with the same amount of cane. Last year, sugar mills had to pay a premium over the state advised price (SAP) of Rs 115-120.

On one hand, sugar prices, both globally and in the domestic market, have plunged since their high in February 2006, but on the other hand, cane prices have gone up. Sugar prices have fallen from Rs 20 a kg in June to Rs 17.08 a kg now. This decline is squeezing margins of sugar companies.

As a result, the weaker companies may delay payments to sugarcane growers, which in turn could impact sugarcane acreage in the next season.

On the global front, after two years of sugar deficit, now the scenario has changed to surplus.

As per International Sugar Organisation (ISO), world production for sugar for October 2006-September 2007 will be a record 158 million tonne. This makes world production 5.8 million tonne higher than world consumption. 
 

THE SURPLUS EFFECT
Quarter ended September	OPM (%)			NPM (%)
	2006	2005	Change (bps)	2006	2005	Change (bps)
BajajHindustan*	24.44	22.35	208.69	14.37	14.70	-33.47
Balrampur Chini	15.20	19.48	-428.38	8.30	12.04	-374.54
Triveni Engg.	18.53	22.71	-418.55	10.62	14.52	-389.28
EID Parry	12.11	13.25	-114.19	16.54	13.86	268.17
Shree Renuka	8.30	9.39	-108.59	6.05	6.33	-28.40
Bannari Amman	23.81	31.92	-811.51	15.11	16.74	-163.05
Dhampur	4.98	13.22	-823.76	0.94	3.63	-268.68
Sakhti	17.32	15.44	187.35	5.27	4.68	59.11
Mawana	-14.25	10.64	-2489.01	-13.54	6.55	-2008.58
Dwarikesh	-0.57	17.36	-1792.58	-7.02	5.65	-1267.26
*Quarter ended June

ISO's first tentative indications point toward another world production surplus as against consumption at a level of about 2.5 million tonne. Therefore, the surplus phase in the world sugar economy may continue for one more year till October 2008.

This trend follows in India too. Production for October 2006-September 2007 is pegged at 22.7 million tonne while our consumption is just around 19 million tonne.

Thus, sugar prices in India are expected to remain weak. "I see no upside in sugar prices going forward. A lot of capacity is coming up making the demand-supply equation comfortably balanced with supply being more than demand," says Utpal Choudhury, a senior analyst at IDBI Capital.

But chief general manager-corporate affairs at Dwarikesh Sugar Industries, Jagadish Kumar Banka's views differ.

In the analyst conference call, he mentioned that he doubts the production estimates given as there were heavy rains in Andhra Pradesh and parts of Maharashtra which contribute substantial quantity to the domestic production.

The losses to the crop are yet to be assessed and, therefore, the estimates need to be revised. He expects that in the coming sugar season, production will nearly match consumption and that it may not be substantially higher as is expected in earlier estimates.

Even though we mirror the global trend, it would not be apt to say that we are being impacted by global factors. At present, we neither export nor import any sugar and so global trends do not influence the price behaviour much in India.

The government had banned exports of sugar in June 2006 to curb prices and check inflationary pressure. There has been a lot of hue and cry over this decision from the mill owners. Companies are of the opinion that they have lost considerable business in the process.

"The export ban has continued much beyond required," says Narendra Murkumbi, managing director, Shree Renuka Sugars.

"Domestic sugar prices move in a narrow range. Whereas internationally, sugar prices are very volatile and there can be a fluctuation of $50 in a month (around $350 a tonne now). So, opportunities do exist and arise," he adds.

Lifting the ban on exports will impact sentiments on the bourses and will trigger stock prices for a short while, feel analysts. But it is unlikely to make much of a difference beyond the short-term, they believe.

With a supply glut already in the international markets, where are the takers for our sugar, they say. "At present, crude prices are low. If they rise, more cane will go towards production of ethanol internationally. This will result in a supply scarcity of sugar. If both things"�increase of crude prices and lifting of the export ban, happen simultaneously, then the scenario could turn positive," feels Choudhury.

Fluctuations in crude price actually play a good role in determining the course of sugar prices. They are crucial in deciding Brazil's sugar-ethanol mix decision which in turn impacts sugar supply globally.

"If exports are allowed, companies should be able to achieve volumes. Sugar being a controlled commodity, if exports rise, the government starts duty-free imports," says an analyst from a leading broking house. Thus it would not help better the domestic scenario. Government regulations play havoc with this sector and lead to a lot of uncertainties pertaining to the future.

Going forward too, the government will continue to exercise its powers to keep a check on sugar and sugarcane prices as sugar comes under the essential commodities and thus is exposed to a potential political outcry. Sugar has a 3.6 per cent weight in the wholesale price index.

So, any increase in sugar prices increases the average price inflation rate for essential foods. Thus, analysts feel that the government will not let prices of sugar go beyond Rs 21 a kg.

The export ban is expected to be lifted by the end of this month. Yet there is no clarity on the issue and the government has been prolonging the decision since October.

Also, to stabilise prices, the government increases the supply of sugar in the market under the free-sale quota. The government has released 41 lakh tonne of non-levy quota or free sale sugar for the October"�December quarter this year as against 37 lakh tonne released last year for the same period.

Elections in Uttar Pradesh early next year would have implications on the state advised price for cane. Cane procurement prices in Uttar Pradesh might go up to appease the farming community.

But Banka says "Last year whatever was the SAP announced by the state government, the mills ended up paying slightly higher, and now if the SAP is increased, we do not see anybody paying a premium over SAP. Therefore I see no difference in the impact on the cane price paid by the Uttar Pradesh mills last year and cane price payable this year. It may be slightly lower, I believe."

In such a situation of lower realisation from sale of sugar, revenues of sugar companies can be cushioned by higher revenues from co-generation of power and distillery.

But the uncertainty as regards to pricing of ethanol is delaying implementation of the ethanol-blended programme even though the government has revised its recommendation to 10 per cent from the earlier 5 per cent.

"From the Indian perspective, the ethanol story is not strong," says Vikram Suryavanshi, an analyst at Karvy Stock Broking. "It will take around three-five years for the ethanol market to mature," he adds.

Further, even if the ethanol programme achieves scale and the companies earn the desired realisation, the proportion of revenues from ethanol and power would continue to be small.

The outlook on sugar stocks remains bearish. "As stock prices of sugar companies have a strong correlation with sugar prices, they are not doing well. But now there would not be much downside as stocks have already corrected," feels Suryavanshi.

But besides, a short-term bounce, not much can be expected from sugar stocks at present. Choudhury feels a good time to pick up sugar stocks is when crude prices start rising.

For the fundamental investor, the story will change once the cane acreage declines, which should happen about two years from now.