What’s behind the recent rally in sugar stocks and is it sustainable?
Sugar stocks were beaten down even while the markets went up during the early part of the year. So what has changed in the last three months for this sector…
The industry was doing fine from April 2017 to Dec 2017. Average sugar prices @ ex-mill level were Rs. 37/kg. The Sugar Season 2017-18 started with a bang. Not only did cane production touch an all time high but yields also significantly improved on the back of good rainfall in Maharashtra (Sugarcane growing areas in UP, the other major producing state, is largely irrigated). On the back of a huge sugar production, sugar prices crashed. From Jan 2018 to Mar 2018, the price of sugar fell to Rs.31/kg at the mill level. In April and May, prices fell to as low as Rs.26/kg ex-mill.
The sugar season 2017-18 ended in June 2018 and India produced a record 32.5 mn MT of sugar. With domestic consumption at around 26mn MT and an opening stock of the previous years, mills got stuck with an inventory of nearly 10mn MT before the beginning of the new sugar season 2018-19.
As a consequence, sugar stocks crashed. From a high of Rs.180 in November 2017, Balrampur Chini hit a low of Rs. 60 in May 2018. Incidentally, the company has executed two buybacks during the last two years (1 crore shares @ Rs.175 and 66 lac shares @ Rs.150).
The stock price of another major sugar company, Dhampur Sugar fell from a record high of Rs.306 in Nov 2017 to Rs.72 in Jul 2018.
And what about these companies’ performances? Sugar companies were sitting on reasonably large profits from April to Dec 2017. So, Balrampur Chini took a huge inventory loss of Rs.320cr (against a production cost of Rs.31/kg, the company valued its closing stock at Rs.25.5/per kg). The company ended FY 2017-18 with a PAT of Rs.232cr (down from Rs.593cr in FY2016-17).
Similarly, Dhampur Sugar took an inventory loss of Rs.180cr (closing stock was valued at Rs.27/per kg). The company ended FY 2017-18 with a PAT of Rs. 151cr (down from Rs.230cr in FY2016-17).
What really saved the day for sugar companies inspite of losses in the sugar segment?
Integrated sugar mills produce power from bagasse and ethanol from molasses (considered as by-products but ironically, contribute a steady but consistent source of income and profits). Sugar companies have long-term PPAs with discoms, whereby the excess power after use in the sugar factory is sold to the state grids. Similarly, to encourage the blending of ethanol with petrol, Oil Marketing Companies float yearly contracts for their ethanol purchases at a fixed price for a contract period from December to November.
Also, since sugar companies had a larger crushing season and higher than normal yields, their sale of power and production of molasses (used in making ethanol) was higher than normal. The below table reflects the disproportionate contribution of profits from power and ethanol segments as compared to sugar
To mitigate the problems of the sugar industry and to help clear high levels of outstanding dues of sugar mills to farmers, GOI announced various steps for the sugar season 2017-18…
So why does the government care so much for the sugar industry? For starters, GOI fixes the price of sugarcane every year (called FRP). In addition, some state governments have their own price (called SAP). These prices are increased every year, for political considerations rather than due to any economic logic. Also, sugarcane is the only produce where farmers are assured of prices; this leads to an increase in the cultivation of sugarcane every year.
For SS 2017-18, the FRP was Rs.255/quintal and the UP government SAP was Rs.315/quintal. Due to the record sugarcane crushing and consequent high production of sugar, leading to a huge inventory, sugar mills were unable to clear their outstanding dues to farmers.
So what has changed the outlook for the sugar industry?
Even after SS 2017-18 ended, sugar mills continued to have large outstanding dues to farmers as inventory liquidation takes time.
To help clear dues and prevent the same happening during the next sugar season, GOI and the Government of UP came out with new a package for the sugar industry for sugar season 2018-19…
So how did sugar companies perform during the half-year, ending Sept 2018 and what is their future outlook?
1. Balrampur Chini
Balrampur carried long-term debt of only Rs.82cr on its books as on 30.09.18. The company is putting up a new distillery, which will be ready by the next sugar season in 2019. In its analyst meet, the management has indicated a higher yield and higher crushing season. This should enable the company to comfortably report a Rs.18-20 EPS for the full year ended 31.03.19.
2. Dhampur Sugar
A look at the half yearly results of Dhampur Sugar reveals that it can easily make a PBIT of Rs.350cr for the full year only from power and ethanol. With the cost of production of sugar @Rs31/kg, the company can make a PBIT of Rs.75cr from the sugar segment, assuming a price of Rs.32/kg. Further, the company has expanded its ethanol manufacturing capacity from 3,00,000 ltr to 4,00,000 ltr from this season onwards. It has also valued its closing stock more conservatively (Rs.29.47/kg). On an equity base of Rs.66.3cr, the company can easily report an EPS of Rs.45-50 for the full year.
In conclusion, the nature of the industry is changing from a cyclical industry to a more predictable industry. Will the markets give it a better PE? Only time will tell.
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