How real is the sugar rally?

A 24% rebound in prices and reports pointing to a fall in international and domestic output have boosted stocks but it might be a bit early to rejoice

After a nine-year downtrend, sugar stocks are seeing increased activity on the bourses, also reflecting in the bounce many of these have recently seen from multi-year lows. Since end-August, those of Balrampur Chini and Bajaj Hindusthan have gained 56 per cent and 47 per cent, respectively, to Rs 61.60 and Rs 18.23. Shree Renuka has risen 36 per cent to Rs 10.12.

The trigger for this started building after the Uttar Pradesh government in early September adhered to a promise of a Rs 40 a quintal incentive for mills. A fortnight earlier, the Union government provided an export incentive. The latest buzz of lower production here and abroad has further boosted sentiment.

Prices have risen sharply since their lows in July. The M-30 variety has risen 24 per cent from Rs 2,307 a quintal on July 31 to Rs 2,856 a quintal on Tuesday, good news for profitability. The latter had been on a downward trend and high sugarcane costs had led to most manufacturers reporting a loss in the previous two years.

Investors, however, will have to keep a close watch on how events unfold. With realisations improving and assuming exports take place, the surplus of 9.8 million tonnes at the end of Sugar Year (SY) 2014-15 (the season begins every October) might come down bit not disappear. Each sugar year has, on average, ended with slightly over 28 mt of production, against consumption of around 24 mt. With talk of lower cane production impacting sugar output, production in SY16 is pegged at close to 27 mt. To reduce the domestic surplus, export is the only viable option.

However, some issues on export need clarity. In February, the central government had announced an incentive of Rs 4,000/tonne for export of raw sugar; the Maharashtra government said it would give an additional subsidy of Rs 1,000 a tonne, valid till end-September. No subsidy has been announced since. In mid-September, the central government announced a factory-wise minimum export indicative quota (MIEQ) under the tradable export scrip scheme that requires mills to compulsorily export about four mt but there is no clarity on the incentives for millers.

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Also, if export does take place, analysts expect the benefit to accrue for millers close to ports, with UP millers selling their quota to the former. Achal Lohade at JM Financial anticipates the ex-mill realisation to go up by Rs 2-3/kg from Rs 22.5 a kg (in Maharashtra) and Rs 24.5-25 a kg in UP in the near term, as domestic supply is being artificially reduced by four mt.

Further, more upside in sugar realisation is crucial for companies to make meaningful profits, as at current prices, the mills might break even, at best, feel experts.

If the cycle turns favourable, Balrampur Chini, having the least leverage (debt-equity ratio of 0.39) remains the preferred bet. For Bajaj Hindusthan, interest costs will remain high, looking at its long-term debt to equity ratio of 2.2, which will limit its profit growth. For this UP-centric company, the state government-set cane price will have a bearing on profitability.

Shree Renuka might benefit from export but about 60 per cent of its operations are in Brazil. Its subsidiary there has been unable to service debt and recently filed for judicial protection, which might prove an overhang for the stock. At a standalone level, too, the company’s long-term debt to equity ratio stood at 1.08 at the end of March, which is on the higher side.