Sugar cycle enters bull phase

Despite recent rally, experts advise buying shares of firms with a longer term perspective

The share prices of many sugar companies have scaled to 52-week highs on improving prospects of the industry and the companies. After a bad phase in the past few years, some companies did turn around in the March quarter. And, hopes have increased that their financial health will strengthen further, led by higher sugar prices due to a fall in production, both in India and other major producing countries.

The sugar season (SS) in India starts in October and ends in September the following year. Not only is output in SS 2015-16 estimated to fall nearly 10 per cent to 25.1 million tonnes compared to SS 2014-15 but if the government's initial estimates are anything to go by, output at 23.5 mt for SS 2016-17 will fall another six per cent year-on-year.

Industry officials fear that if yields (finished sugar output from cane) come lower than expected, production might fall further. This would help prices stay at elevated levels, which means companies will first generate a good amount of profit and cash to pay arrears and then repay debts. Not surprisingly, analysts are bullish on sugar companies from a long-term perspective. Deven Choksey, managing director, KR Choksey Shares and Securities, says: "Globally, sugar prices' forward curve indicates strength. In India, companies are holding stock which will fetch higher prices and the industry has entered a three-year bull cycle which began in January 2016. Stock prices have reflected this in advance but we see a time to buy sugar stocks with a three-year perspective." He likes south-based companies more, as their balance sheets are comparatively clear. While gains for the industry will accrue over the next three years, the sugar cycle has changed for the better, reflecting in the rise in share prices of companies.

Prices in the past year are up 45 per cent to levels where mills are not incurring cash losses by selling sugar. While withdrawal of the export subsidy last month has confined sugar exports to 1.6 mt as compared to the earlier mandate of four mt, it is unlikely to have a significant impact on domestic prices.

Ajit S Shriram, joint managing director of DCM Shriram, says sugar companies have started turning around. For long-term health, "there should be no cane arrears to farmers, which will be positive for all stakeholders and rural prosperity".

According to the food ministry, cane payment arrears for SS 2015-16 have come down to Rs 6,225 crore (based on fair price declared by the Centre). As on Wednesday, 87 per cent of cane dues had been paid for the season. During the corresponding period of last year, these dues were Rs 19,437 crore. The next move will be to repay bank debt. The comfort also stems from the collateral (sugar stock) with banks, whose value has risen due to higher prices.

According to the Indian Sugar Mills Association, the stock with mills as on end-May was around 15 mt, versus 18.1 mt a year before. At prices that are 45 per cent higher compared to last year, the value of stocks is higher. Notably, the road ahead in terms of prices looks favourable.

Abinash Verma, director-general of the Association, says: "Next season's production is expected to fall because of lower water availability and lower cane area. While a healthy opening balance of seven mt will help take care of the domestic requirement during 2016-17, prices are expected to be stable in the next year."

The current ex-mill price just about covers the costs and gives a margin to millers, good enough news as it follows three bad seasons. Experts suggest a global deficit in the current and next season will provide an opportunity to India to export sugar in SS 2017-18, if the need arises.

Expecting a deficit situation globally, investors have also taken long positions. Rabobank said in its sugar quarterly (released on Thursday) that long positions of funds in New York sugar futures had reached a record level, equivalent of 12 mt. It forecasts 5.5 mt of global deficit for SS 2016-17. International futures prices are flirting with a 20 cents a pound level, remunerative for Indian exporters. However, if the government imposes an export duty to ensure domestic retail prices stay around Rs 40 a kg, it could cap the gains.