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Candy crush: What's driving the sweetness in sugar stocks
Publish Date: September 21, 2018
Sugar stocks are on a high. Try sifting through the BSE 500 gainers over the last one week. You will see sugar companies like Bajaj Hindusthan Sugar, Shree Renuka Sugars, and Balrampur Chini right in the top 10. A good thing too, for the double-digit percentage gains have come after a protracted lull.
Sugar stocks have been in the limelight post the ethanol price hike. Recently, the Union Cabinet approved an increase in ethanol price by up to 25%. Is this what is driving the sweetness of sugar stocks? Let us find out.
Business model
Integrated sugar companies in India are typically preferred by investors. These crush large volumes of sugar per day and have a certain kilolitre per day distillery capacity. Some sugar firms also have saleable co-generation power capacity.
Sugar is a cyclical commodity. At present, it is going through a phase of excess production and lower prices. The supply glut has led to a drop in sugar prices. But with a significant increase in sugarcane crushing capacity, many believe sugar firms will be able to increase their distillery volume. Also, higher availability of bagasse is expected to help the firms to generate more power. These are positives that are helping change the sentiment around sugar stocks.
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Ethanol excitement
The bigger factor driving sugar stocks up has been a government announcement. To incentivise ethanol production, the government has increased the procurement price of ethanol produced from B-heavy molasses. The price has been hiked to Rs 59 per litre, up from Rs 47.1 per litre. The rate for ethanol produced from C-heavy molasses has also been pushed up to Rs 53 per litre from the earlier Rs 43.46 per litre.
It is clear that the government is aggressively pushing for 10% ethanol blending. This move comes in the wake of extremely high crude prices and local currency depreciation against the US dollar.
It is estimated that the sugar industry could supply over two billion litres of ethanol to oil marketing companies. While the industry does not currently have the capacity to supply those volumes, new capacities could surely be built to further increase the ethanol volumes of sugar companies.
The cost of building new capacities would not be a strain. From a balance sheet point of view, in the previous cycle the sugar industry has largely been able to de-leverage its balance sheet. This resulted in a significant decline in interest cost. Now, companies can take on some debt load if required and still remain stress-free.
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MSP hike, Brazil factor
Another series of incentives for sugar mills may be on the cards. There could be a hike in the minimum selling price (MSP) of Rs 4–5/kg. If this were to materialise, it would provide a leg up to the sugar mills. According to media reports, the package could include raising the MSP of sugar manufactured by mills to Rs 34. Loan restructuring and other such incentives may be provided for sugar mills in the cooperative sector.
This could lead to an increase in the open market price of sugar in the wholesale and retail segments. Plus, it may help the mills pay off farmers' cane dues. The government had announced incentives for sugar mills in early June. So, it would be interesting to see if the government announces MSP ahead of the big festival season, when sugar consumption typically goes up.
India follows the Brazil agri-commodities pattern, but this year has been slightly different. A bumper sugar crop from India this year is more than making up for the lowest output in a decade from central Brazil.
Indian investors must note that producers in Brazil have switched to using sugar for ethanol. The production of ethanol from sugarcane in Brazil has not influenced the price of sugar.
The regulatory landscape for the sugar industry is markedly different here. For instance, the sugar industry virtually has no control over raw material price. The government often intervenes to check sugar prices in India.
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Sweet corner
Sugar companies with a higher by-product capacity and a lighter balance sheet are being chased by investors because they would not be incurring losses. Rather, sugar prices at the current level could result in better earnings. Many feel that this alone is a stark deviation from the previous sugar cycle, when the supply glut resulted in heavy losses for sugar companies.
At Kotak Securities, we maintain a ‘buy’ rating on sugar shares like Bajaj Hindusthan Sugar, Dhampur Sugar Mills, and Praj Industries with target prices of Rs 30, Rs 250, and Rs 225 respectively.
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