Procurement prices key hangover for sugar makers

While sugar & ethanol realisations have improved, rise in cane procurement prices in current season and expected further increase in next sugar year act as dampeners

The rally in sugar stocks at the start of the sugar season in October 2012 in the back of higher sugar realisations fizzled out after state governments increased sugarcane procurement prices. While hopes were raised on complete decontrol of the sugar sector, the government agreed to partial decontrol only. This added to the underperformance of the stocks in the sector.

Moving forward, do not expect any respite for sugar players as far as sugarcane procurement prices are concerned. With elections approaching, state governments are likely to increase the procurement prices further in the new sugar year (SY) starting October 2013. The government will also not allow sugar prices to rise much to control inflation and on account of elections. The only respite integrated sugar players can get is from the sale of ethanol at higher realisations.

Balrampur Chini remains top pick
Amongst the top three players in the sugar space, Balrampur Chini remains the top pick among analysts. Analysts at ICICI Direct observe that the company is one of the most efficient plays in the sector with a lighter balance sheet, strong by-product sales and low overhead expenses.

For Bajaj Hindusthan the key issue is debt. It has a debt of Rs 5,919 crore at the end of March quarter, which would continue to hamper its earnings growth. It has already expanded its equity by three times (Rs 22.8 crore in SY11 to Rs 63.9 crore in SY12) through a rights issue, further diluting its earnings. After dilution, though, the debt to equity of Bajaj Hindusthan has decreased. Going ahead the high equity base would cap the benefits to shareholders even when the company earns profits.

Shree Renuka Sugar, too, has high debt and looking at the weakness in its Brazilian operations, analysts see its turnaround taking a few more quarters. According to Bloomberg data one year consensus target price for Balrampur Chini stands at Rs 60 (Rs 49.80 now).

Sugarcane procurement prices impact profitability
Sugar realisations remained better in SY 2013 compared to 2012. Higher realisations were negated by cane procurement prices announced by the UP government. Uttar Pradesh saw the State Administered Price (SAP) going up Rs 40 a quintal to Rs 280 a quintal. Maharashtra, too, saw the procurement prices higher by 10 per cent to an average of around Rs 2,400 a tonne. These were much higher than the central government's Fair and Remunerative Price (FRP) - the price determined by the central government which is linked to the basic recovery rate of sugarcane - of Rs 170 a quintal. Given this, the profitability of sugar producers was bound to get impacted.

The financial results for the march 2013 quarter declared by Balrampur Chini Mill show the impact of the same. While sugarcane availability remained good in UP unlike Maharashtra and Karnataka, the company crushed 86.4 million quintals of sugarcane against 86 million quintals in the last year with better recovery rates (9.56 per cent vs 9.55 per cent last year). Thus, the company saw revenues surge 28.9 per cent y-o-y in the March 2013 quarter. However, with higher cane costs leading to raw material costs surging, Ebitda margins halved as compared to the year ago quarter. Margins came in at 16.6 per cent in the March 2013 quarter compared to 33.5 per cent in March 2012 quarter.

Bajaj Hindusthan too, saw sugar sales improve by 2.8 per cent largely due to higher realisation at Rs 31.3 a kg though volumes remained lower at 320,000 tonnes as compared to the year-ago quarter number of 340,000 tonnes. Analysts at ICICI Direct observe that though losses have come down, the higher cost of production (around Rs 33 a kg) for UP mills on the back of higher cane cost could keep earnings from the segment under pressure.

Higher ethanol prices to provide some respite
With the news of oil marketing companies (OMCs) accepting a base price of Rs 34 a litre for procuring ethanol, the benefits are likely to accrue to integrated players. This price is around 26 per cent higher than what sugar mills were offered till now. Sanjeev Kumar Singh at Centrum observes that this should improve profitability of sugar players. He estimates 30 per cent and 37.8 per cent increase in FY14 and FY15 profitability for Balrampur Chini, respectively.

Analysts at ICICI Direct too observe that Balrampur Chini Mills would benefit from higher sugar realisations (estimated to be Rs 35a kg) after the removal of levy obligation and substantial increase in ethanol prices (Balrampur has been awarded a contract to supply 25 million litres at Rs 35 a litre by OMCs). This would aid earnings in FY14 and FY15. However, higher sugarcane prices and muted global prices would limit this benefit.