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| Not a sweet ride |
| Jitendra Kumar Gupta / Mumbai Jan 17, 2010, 00:47 IST |
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Ii can give high profits, but the sugar industry is volatile and influenced by many factors
If one had invested Rs 1,000 in sugar companies in the year 2003, it could have become Rs 25,000-35,000 by 2006. During this period, Balrampur Chini witnessed its share prices moving up from a mere Rs 11 to Rs 197; Dhampur Sugar went from Rs 10 to Rs 257.
Over the past 50 years, India's consumption of sugar has grown 3.5 per cent annually. However, irrespective of demand, the pattern noted earlier is what generally happens in cyclical industries. At the bottom of the cycle, share prices trade at a very depressed level and at the top, they command significant premium, leading to bumper profits. The sugar cycle may take six to seven years to complete a full round from boom to bust and boom again. Timing is important for investing in such companies.
Typically, a boom starts when there is less sugar cane, low sugar production compared to consumption, followed by lower inventory or stock, higher imports and higher sugar prices, leading to bumper profits. But, once prices reach high levels, farmers find it attractive to grow cane, which leads to increased availability, surplus sugar production and thus lower sugar prices, making it difficult to make profits.
India is in one such cycle. At the outset of the 2008-09 sugar season, we had a comfortable stock of 10 million tonnes; as much as five million tonnes were exported. However, sown area dropped, as did production; unfavourable weather added to the drop in output. The gap between production and demand in 2009-10 is going to be at least seven million tonnes and prices have been surging. The mismatch is multiplied by diverse political factors: sale, cane crushing and prices, both of cane and sugar, are controlled by both central and state governments to various extents. The state government may not act in tandem either; UP, for instance, has banned sugar coming into the state and the central government says it disagrees and has announced some countervailing measures. Be that as it may, raw sugar futures are currently at their highest level in close to three decades. The stage, in sum, is set for the next round of bust.
DEMAND/SUPPLY
It is important to understand the demand-supply situation, not only here but globally. Brazil and India are the two largest producers of sugar and both markets are closely watched globally. Irrespective of how good the company is, performance will be driven by the industry fundamentals. For instance, during the sugar season from October 2009 to September 2010, world production is estimated at 159 million tonnes, while consumption will be close to 170 million tonnes.
This global deficit, along with the one in Indian markets, is good news for sugar companies. Low supply means higher sugar prices and better profits for companies. For instance, after the 2006 season, when India's production was equal to consumption, sugar prices hit a low of Rs 13.85 per kg. Compare that with today's price over Rs 40 a kg.
 COST OF PRODUCTION
For every tonne of sugar production, the companies require about 10 tonnes of cane, procured from farmers at a government-fixed Fair and Remunerative Price (FRP). Currently, companies are paying higher than the FRP, which is Rs 157.5 a quintal. The price at which cane is procured will determine the company's margin. At current cane and sugar prices, companies are making profits of more than Rs 10 for a kilogram (kg) of sugar sold. Investors should check the recovery ratio, margins and volume growth of the company.
DIVERSIFICATION
Diversification is an important aspect of business model, specially with the industry's volatile nature. Generally, every tonne of cane crushed will result in 100 kg of sugar, 53 kg of molasses, 13 litres of alcohol, 300 kg of bagasse and can also be used to generate power. Sugar companies sell these residues either directly or after converting. That's why many sugar companies own distilleries, ethanol and power generation units. This helps in better margins and in dealing with the cyclical nature of the industry.
OTHER PARAMETERS
Equally important is the company's management and policies towards procurement of raw material, depreciation and inventory management. Sometimes, companies have very high debt, raised in good times to expand capacities. That becomes a burden in bad times, including depreciation of the new capacities which never go on stream, leading to significant erosion in profitability. Relationship with farmers, payment of their dues, component of institutional sales in overall sales are other factors.
Among risks, the sugar industry is closely monitored by government policies as sugar is an essential commodity. Government policies aim to tame inflation and keep farmers' interest in view.
VALUATION
In most cases, these companies are valued based on the price/earnings multiple. But, if a company has a diversified and integrated model, valuations could be higher. Companies whose new capacities are about to go on stream may command higher valuations. It is difficult to value companies during downturn. So, check if the market capitalisation is lower than the value of assets (manufacturing plants). This indicates an investment opportunity.
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