Sugar stocks have rallied more than 300% since the beginning of this calendar year (CY) till 22 June 2016 on hopes of strengthening financials of sugar companies as sugar prices have shot up due to expectation of a fall in domestic as well as global production.
Domestic sugar medium-grade prices have surged 22% up to June 2016 from January 2016 and 47% from June 2015 to around Rs 3670 per quintal, a four-year high. International sugar prices have touched a new 30-month high of US 17.50 cents per pound due to the lowest global sugar inventory level of 8 million tonnes (mt) since the fiscal ended March 2011 (FY 2011).
The sugar sector comprising 30 listed companies advanced 45% since the beginning of CY 2016 compared with the 3% gain in the headline Nifty 50 index and 3.5% appreciation by the Nifty FMCG index. The addition in market value has been dominated by small players such as KK Birla group-owned Upper Ganges Sugar & Industries (up 365%), Karnakata-based Ugar Sugar (223%), Punjab-based Rana Sugar (216%), and UP-based Mawana Sugar (188%). Large players such as Bannari Amman climbed up 87%, Balrampur Chini 57% and Triveni Engineering 26%.
Industry players fear that if the recovery rates (finished sugar output from cane) come lower than expected, production might fall further. This will help prices stay at elevated levels. This means companies will first generate a good amount of profit and cash to pay cane arrears and then repay debts.
Prices in the past year are up 45% to levels where mills are not incurring cash losses by selling sugar. While withdrawal of export subsidy in May 2016 confined sugar exports to 1.6 mt (from October 2015 to June 2016) compared with the earlier mandate of 4 mt, it is unlikely to have a significant impact on domestic prices.
After falling from its September 2012 high of Rs 39.25 a kg, domestic sugar M grade prices have risen 61.5% from a low of Rs 23.07 a kg in July 2015 to Rs 40 a kg currently, a big relief for sugar companies, most of which have been reeling under debt. Although all sugar manufacturers will benefit, companies with lower debt, better interest coverage ratios, as well as low cane arrears have an edge. Among the top five by market capitalization, Balrampur Chini and EID-Parry have lower debt and better scope for profitability improvement. Other large players Bajaj Hindusthan and Shree Renuka Sugars also stand to benefit from revival in the sugar cycle. However, higher debt servicing (interest costs) will keep the bottom-line expansion limited. The key risk, especially for Uttar Pradesh (UP)-based players, is the possibility of cane procurement prices being revised upward, with the approaching state elections.
Among south-based players, KCP Sugar has low net debt and Andhra Sugar has cost advantage. Andhra Sugar especially is in a better fiscal environment compared with peers in Tamil Nadu (TN) as the state saw a surge in cane procurement prices due to elections, Andhra Pradesh (AP) still offers a cost advantage. According to industry estimates, sugar recovery rates from sugarcane in AP are much higher compared with TN. TN Chief Minister Jayalalithaa had in January 2016 announced state-advised price (SAP) at Rs 2850 a tonne. This is Rs. 550 a tonne more than the statutory fair and remunerative price (FRP) of Rs 2300 set by the Central government. The SAP includes Rs 100 per tonne as cost for transporting sugar.
India is the second-largest producer of sugar after Brazil, but is the biggest consumer. Most of the sugar production is used domestically, resulting in miniscule exports. Indian sugar production is highly dependent on rainfall. Low or irregular rainfall affects sugarcane output and, thereby, sugar production. Sugar output is estimated to have declined to about 25 mt in sugar year ending September 2016 (SY 2016) from 28.3 mt in the previous SY. Indian sugar exports were 1.1 mt in SY 2015. Sugar exports in SY 2016 up to June 2016 were over 1.6 mt, up 46% from the whole of previous year, according to industry body Indian Sugar Mills' Association (ISMA). Production might drop to 23-24 mt in SY 2017 year due to drought in Maharashtra and Karnataka: the two major sugarcane and sugar producing states.
To restrict exports and, thus, keep a check on the domestic sugar prices, the government has proposed imposition of 20% export duty on sugar to ensure sufficient supply in the domestic market. Prices of sugar in the international markets are rising and Indian traders will look to increasing the export to maximize profits. Sugar exports had become viable now as global prices have increased by about 50% in the last three months due to disruption in supply from Brazil. However, exports will become unviable after the imposition of export duty. Even though lower domestic production is expected, total availability will be 30-31 mt due to opening stocks of over seven mt. With retail prices crossing the Rs 40 per kg mark, the government has imposed stock holding limit on traders and withdrawn export-linked production subsidy to control prices.
Industry players believe that the government's decision on export duty may not significantly dent the domestic surge in sugar prices and will have a marginal downward impact. Even before the government's decision on sugar export duty, sugar exports from India since April-May had started falling due to strengthening of domestic prices on expectations of lower output in coming season.
According to the Ministry of Consumer Affairs, Food, and Public Distribution, cane payment arrears for the sugar season ending October 2016 (SY 2016) have come down to Rs 6225 crore based on the FRP declared by the Central government). As of first week of June 2016, 87% of cane dues had been paid for the season. During the corresponding period of last year (SY 2015), these dues were Rs 19,437 crore.
Consecutive years of surplus domestic sugar production since SY 2013 had caused a surplus in the domestic sugar market, with stocks increasing to 9.5 mt by September 2015. This was around 4.6 months of consumption as against a preferred norm of three-four months of stock position. This coupled with the international sugar surplus scenario and muted international sugar prices had led to sugar price reaching a three-year low of Rs. 23000 per tonne in July 2015. Lower prices resulted to significant losses for most sugar mills, resulting in stagnation in cane prices and build-up of cane dues to farmers.
The next move from the sugar companies will ideally be to repay bank debt. The comfort also stems from the collateral (sugar stock) with banks, whose value has risen due to higher prices. According to ISMA, the stock with mills was around 15 mt end May 2016 versus 18.1 mt end previous year. At prices that are 45% higher compared to last year, the value of stocks is higher.
According to the United States Department of Agriculture, global sugar production in SY 2016 is expected to fall by three mt to 172 mt. Sugar consumption is projected to reach a record 173 mt, bringing the end-season stock down by 4 mt to 40 mt. Further, the International Sugar Organization has raised the world sugar production deficit to 3.53 mt for SY 2016 from its earlier estimate of 1.04 mt and six mt for SY 2017. Brazil, the world's largest sugar producer, is expected to have 9% lower sugar production of 35 mt due to El Nino and mandatory ethanol conversion. This coupled with fall in global sugar inventory to 67 days (as against 75 days in the previous year) will keep international sugar prices stable to buoyant. Whenever Indian and global sugar industry has fallen into a deficit, sugar prices tend to jump in the domestic and international markets.
The Union government, too, announced in CY 2015 some steps to help the sugar industry and sugarcane farmers to come out of the financial crisis. As much as Rs 6000 crore of soft loans at a minimal 3% interest rates were approved for the sugar industry. The government mandated compulsory export quota of four mt of all grades of sugar and offered an export subsidy of Rs 45 per tonne for SY 2016.
Consequently, substantial exports took place in the four-five months immediately succeeding the government directive. However, with a significant upswing in domestic prices stemming out of concerns of lower-than-expected output because of drought, exports became less attractive for mills even after the export incentives. Sugar exports, thus, dwindled by end May 2016.
Also, FRP of Rs 230 per quintal of sugarcane procurement was not hiked compared with the previous year to support sugar millers. Further, a waiver of excise duty of Rs 5 per liter on sales of ethanol from new molasses to oil marketing companies was also announced. With this support from the government, the Indian sugar industry is expected to recover from the recent troughs. Also, the government's proposal to link sugarcane prices (raw material) with sugar prices (end product), will aid further profitability of the millers.
Stock prices of large sugar companies have shown a divergent trends so far in CY 2016. Balrampur Chini has surged 57% and Bannari Amman Sugar 79%, while Triveni Engineering is up 26%, Bajaj Hindusthan 18%, Shri Renuka Sugar 17%, and EID Parry 15%. Although the latter four outperformed the frontline indexes, they have underperformed their larger peers. Almost all the listed sugar stocks have more than doubled (up 100% or more) in the past 12 months, except EID parry (up 62%) and Shri Renuka Sugar (up 46%).
A total of 30 sugar companies posted an aggregate profit after tax (Pat) of Rs 1408 crore in H2 of FY 2016 as against a combined net loss of Rs 1700 crore in H2 of FY2016. These companies had losses of Rs 1268 crore in H2 of FY 2015 and Rs 979 crore in H1 of FY2015.
Balrampur Chini is expected to benefit more than competitors from the rising sugar prices as it is the third largest integrated sugar player with sugarcane crushing capacity of 76,500 tonnes per day (tcd) and the cane arrears to annual cane procured ratio of 21%.
A recovery rate (sugar produced as a percentage of the cane crushed by weight) was a strong 11.3% in Q4 of FY 2016. Sugar realizations were up 19.7% to Rs 31.4 per kg. Net sales grew 17% to Rs 770.60 crore and Pat 30% to Rs 98.78 crores. Excluding exceptional cost of Rs 163.48 crores on account of write-off of claims receivable under the Sugar Industry Promotion Policy, 2004, and staff VRS cost, adjusted Pat surged 245% to Rs 262.26 crore. The sugar segment performance, contributing 92.6% of the total revenues, remained impressive on higher realizations and better recovery rate, resulting in 9.1% growth in sugar production. Pat turned around to Rs 99.30 crore versus a loss of Rs 57.95 crore, while net sales declined 8% to Rs 2756.67 crore in FY 2016.
The Central government's emphasis on ethanol blending and waiver of excise duty on sale of ethanol out of molasses produced during SY 2015-16 aided enhanced volumes and realizations. Ethanol sales stood at13,237 kilo liters (kl) and realizations further improved to Rs 44.7 per liter in Q$ of FY 2016 as government exempted ethanol from Central value-added tax (Cenvat).
Bids have been won to supply 70 million liters of ethanol over the next 12 months. Integrated players stand to benefit immensely due strong sugar prices coupled with improving ethanol dynamics as the Central government is encouraging ethanol production to blend it with petrol. The debt-equity (D/E) ratio stood at a low 1.2x versus average industry D/E of 3x end March 2016. The stock, which has spiked 178% in the past 12 months, commands a P/E of 28x and a P/BV of 2.3x.
Shri Renuka Sugar has the second largest crushing capacity of 1,01,520 tcd after Bajaj Hindustan ( 1,36,000 tcd of sugarcane). Pat jumped to Rs 220.20 crore inQ4 of FY 2016 compared with just Rs 4.3 crores in Q4 of FY 2015 on higher operating profit and tax credit of Rs 150 crore. Net sales grew 8% to Rs 1817 crore. Net loss marginally narrowed to Rs 285.30 crore in FY 2016 from Rs 295.10 crore in FY 2015, while net sales grew 2.1% to 5862.10 crore. Consolidated loss was a huge Rs 1802 crore.
Although up 42% in the last 12 months and 12% in CY 2016, the stock has significantly underperformed its peers due to high debt on its books, significant high-risk overseas acquisitions and reports of its Brazilian units filing for bankruptcy protection. The Mumbai-based company had in CY 2010 entered Brazil, the world's largest sugar producer, by investing Rs 1765 crore to acquire stakes in Renuka do Brasil and Renuka Vale do Ivai. Consolidated total debt was Rs 5700 crore and there was a negative net worth end March 2016.
To reduce the debt pile, the board approved grant of an option to the lenders to convert a part of their loans into equity shares. There are plans to sell its 5% stake in commodity exchange National Commodity and Derivatives Exchange (Ncdex) for Rs 55 crore, valuing Ncdex at an estimated enterprise value of Rs 1100 crore. SRS held 4.45% stake in Ugar in March 2016. 40% of the 4.45% stake was sold for Rs 7.5 crore.
EID Parry, a Murugappa group-owned company, reported profit in Q4 of FY 2016 after losses for three consecutive quarters. The sugar business contributed 72% of the total revenues. Net profit was up 59% to Rs 267.04 crore and revenues 21% to 4405.69 crores. Among the leading sugar manufacturers in India, with nine sugar mills spread across Tamilnadu, Puducherry, Andhra Pradesh and Karnataka, including a standalone distillery in Sivaganga, crushed 24 lakh tones of cane, with a recovery rate of 10.8% in Q4 of FY 2016.
Sales tonnage stood at 1.4 lakh tonnes. The average sugar realizations stood at Rs 28.5 per kg. Cogeneration power export volume stood at about 220 million units and distillery sales volume stood at about 200 million liters. The sugar refinery loss nearly halved to Rs 78 crore in FY 2016 as against Rs 1 45 crore in FY 2015, boosting the stock. The refinery was positive at profit before tax (PBT) level in Q4 of FY 2016 and is expected to continue to contribute positively to PBT in FY 2017.
Though the fourth quarter performance was marginally better, it was not sufficient to make up for the losses posted in three quarters. Net D/E was at 0.9x on consolidated basis end March 2016. There is 62% stake in chemicals and fertilizers maker Coromandal International. The stock jumped 62% in the past 12 months and 15% in CY 2016, commands a P/E of 51x and P/BV of 1.8x.
South-based diversified group KCP Sugar operates various businesses including cement (53% of the total revenues), engineering (11%), hotel (new business) and sugar (31%) in Vietnam. Revenues grew 23% and earnings before interest, tax, depreciation and amortization (Ebitda) 50% in FY 2016, driven by better cement realizations in Andhra Pradesh and higher execution in the engineering segment. The sugar subsidiary in Vietnam registered better performance, with Ebitda rising to Rs 87 crore from Rs 72 crore in FY 2015. The operating profit margins jumped to 17% from 11%, supported by higher international sugar prices.
The expansion in sugar business to 8,000 tpd from 6,000 tpd is complete and the impact of higher volume from new capacity will be realized from FY 2017. With expectation of sustained higher sugar prices, FY 2017 is likely to be much better for the sugar subsidiary. Sugar commands a 38% share in operating profit of the group. Consolidated debt was Rs 350 crore and D/E ratio 1:0.4 end March 2016. The stock, which has gained 113% in the past 12 months, commands a
P/E of 10x and a P/BV of 1.7.
Dwarikesh Sugar, with sugar mill in Uttar Pradesh (UP), reported more than four-fold jump in Pat to Rs 53 crore in Q4 of FY 2016 on account of firming up of sugar prices. Net sales grew 15% to Rs 231 crore. From a low of around Rs 2200 per quintal in August 2015, the price of sugar started surging from November 2015. Currently, ex-mill sugar price is at reasonable Rs 3350 per quintal.
The Central government's decisions in CY 2015 such as onus of compulsory export of sugar on all the sugar mills to the extent of four million tones, leading to absorption of excess availability of sugar in the market, likely resulted in improvement in sugar prices. Exemption from excise duty on supply of ethanol to oil manufacturing companies for blending with petrol led to the stock multiplying nearly 9x in the past 12 months and doubling in CY 2016. The average recovery rate rose to 11.73% in FY 2016 from 10.78% in FY 2015. With impro ing cash flows, management intend, to reduce long term debt from current Rs 250 crore level to Rs 180 crore-Rs190 crore in FY 2017. It commands a P/E of 10x and P/BV of 3x.
Karnataka-based Ugar Sugar Works's net sales doubled to Rs 371.38 crores and Pat increased more than 1.5 times Rs 61.64 crore in Q4 of FY 2016 .The recovery rate was an impressive 13%. The inventory was at Rs 26 per kg. The aim is to reduce the debt pile of Rs 93 crore by 15-120%. The stock multiplied 5x in the last 12 months and 2.5x in CY 2016 on impressive sugar operations and higher sugar prices. It commands a P/E of 48x and P/BV of 5.76.
UP-based Triveni Engineering reported Pat of Rs 44.1 crore in Q4 of FY 2016 compared with a loss of Rs 85.6 crore in Q4 of FY 2015 due to improved sugar operations on high recovery rates (10.8% in SY 2015-16 as against 9.57% in SY 2014-15) and better realizations (Rs 31299 per tonne in Q4 of FY 2016 compared with Rs 27172 in Q4 of FY 2015). Nearly 78,745 tonnes of sugar were dispatched in Q4 of FY 2016 as against 78,553 tonnes a year earlier. The average realizations were Rs 31.3 per kg compared with Rs 27.17 per kg in Q4 of FY 2015. Net loss, too, reduced to Rs 9.8 crore in FY 2016 from a loss of Rs 152 crore in FY 2015. Sugar inventory stood at 4.14 million quintals valued at Rs 29.25 per kg end FY 2016. The current average sugar realizations are at Rs 33-34 per kg.
With sugar cane crushing of 4.5 mt and sugar production of more than 4,88,000 mt in FY 2016, one of the largest sugar manufacturers in the country had D/E of 2.4 and consolidated debt of Rs 1706 crore end FY 2016. This was higher by 16% in comparison with the previous year primarily due to higher utilization of cash credit for accelerated and timely cane payments. The term loan was Rs 544 crore (including Rs 238 crore loan with interest subvention) while the cash credit amounted to Rs 1162 crore end FY 2016. A 22% stake is held in industrial turbine maker Triveni Turbine. The stock surged 265% in the past 12 months and 26% in CY 2016 on reports of value unlocking of the sugar business after decision to demerge the sugar and engineering business. It commands a P/BV of 2.4x.
Outlook
The rally in sugar shares in the past one year has multiplied investors' wealth. For example, Ugar Sugar Works, which produces both sugar and ethanol, has delivered close to 500% returns in the last 12 months. Sugar shares have already run up huge in the past one year and investors need to exercise caution and pick companies with stable balance sheets.
Sugar is a cyclical sector that has created and destroyed wealth due to various factors such as arbitrary cane pricing from state governments, leading to higher cane arrears by sugar manufacturers and resultant high debt, and extreme volatility in international and domestic prices. This sector also faces a continuous threat of export dumping from high sugar producing nations such as Brazil.
According to ISMA, sugar prices might continue to remain firm over next 12-18 months. However, it does not expect the rally in sugar prices to continue as a good monsoon might lead to higher production of the commodity in SY 2017 season.
According to Bombay Sugar Merchants Association, India may become a net importer of sugar in SY 2017 as two consecutive drought years, dry irrigation channels and ravaged cane fields have led to output in the country's biggest producing state, Maharashtra, to drop over 45%. Preliminary estimates by the Maharashtra State Federation of Cooperative Sugar Factories suggest state production of 4.5 mt in SY 2017 as against 8.4 mt in FY 2016 and 10.5 mt in FY 2015. The fall is attributed to drought in cane growing districts.
The federation has projected a decline in cane production to 46 mt in SY 2017 as against 74.3 mt in SY 2016. Of the 13.5 million hectares (ha) under kharif crop in the state, sugarcane is grown on 10.25 million ha. The sharp fall is attributed to severe drought in sugarcane-growing districts, leading to a decline in plantation.
The Western India Sugar Mills' Association, too, has predicted Maharashtra's production to fall below five mt. This might pull down the total output to 22.5 mt in SY 2017. Domestic consumption in the next season is pegged at around 26 mt. The global supply deficit is going to rise with the Indian shortfall and this might trigger a further rally in sugar prices, as Indian imports have in the past boosted global sugar prices. India has already 40% import duty in place on raw sugar. A cut in duty or even duty-free imports might be required to arrest any steep price rise.
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