What Is Buzzing For The Sugar Stocks?
Of late, sugar stocks are showing strength after underperforming for years. Shohini Nath analyses the reasons behind the rally in sugar stocks.
Sugar stocks use to be the darling of retail investors, but after years of underperformance, the investors had more or less lost appetite for the sugar stocks. Lately, however, the stocks in the sugar sector have witnessed a bounce even as the sugar prices remain under pressure – globally. The demand-supply mismatch has triggered softness in sugar prices globally and the situation is the same in India as well. The oversupply of sugar has been affecting the sugar factories profitability for years now. Globally, the sugar prices remain lower than the prices in India. Indeed, the decisions taken by the Modi government are triggering interest in sugar stocks.
The Modi government has tried to counter the growing import oil bill and cut down the excess sugar supply by simply hiking the price of ethanol, a byproduct of sugarcane. Generally, cane-based ethanol can be produced in three different ways, directly from cane juice or from B-grade molasses as well as from C-grade molasses. Till 2017-18 sugar season, ethanol was only allowed to be produced from ‘C-heavy molasses’ which has minimum sucrose content and its price was fixed atRs.40.85 per litre.
In September 2018, the Centre not only raised the price of ethanol produced from C-heavy or C-grade molasses, but also fixed a price for ethanol produced from B-heavy molasses and sugarcane juice for the first time. The price of ethanol derived from 100 per cent sugarcane juice was raised fromRs.47.13 to Rs.59.13. The rate for ethanol produced from B-heavy molasses has been raised to Rs.52.43. However, the rate of ethanol produced from C-heavy molasses, which has no sugar, has been marginally increased to Rs.43.46.
The price difference between ethanol production from 100 per cent sugarcane juice and from the B and C categories clearly shows that the Centre has given the sugar mills a clear incentive to increase ethanol production from sugar. The oil marketing companies (OMCs) have been told to prioritise ethanol from 100% sugarcane juice followed by B-heavy molasses.
OMCs will procure ethanol from the sugar mills and blend them with petrol. The government has planned scaling up the blending to 10 per cent in the next couple of years from the current of 4-5 per cent.
The ethanol procured by the public sector OMCs has increased from 38 crore litres in ethanol supply year 2013-14 to estimated 140 crore litres in the year 2017-18.
The government has taken yet another step to push the sugar mills production by deciding to raise the amount of subsidised loans to sugar mills as a helping hand to expand their ethanol production toRs.6,139 crore, up by 3 per cent from Rs.4,440 crore.
The attraction of subsidised loans and the hike in the prices of ethanol as a petrol blend has influenced several sugar companies to plan capacity expansion to produce more ethanol. Around 114 sugar units have been selected by the food ministry for providing the subsidised loan. There is a huge potential for the sugar mills to make good profits and clear their arrears to farmers, which stand at more than Rs.13,000 crore. More than hundred applications from leading sugar companies for setting up new boilers and distilleries have been approved. Some of the leading sugar companies have sought approval for setting up additional capacities to make 1.25 billion litres of ethanol. These companies include Triveni Engineering, Dhampur and DCM Shriram, Renuka Sugars, EID Parry and Dwarikesh Sugar and the applications involve subsidised loans worthRs.62 billion. In most cases, leading companies have sought to set up or expand at more than one location. India currently owns around 2.75 billion litres of ethanol capacity. To fulfil the mandatory 10 per cent blending, it needs an ethanol capacity of 3.25 billion litres.
Reasons for government's measures
It is a known fact that the sweet taste is the only taste that humans are born craving. So, to fulfil the needs, sugar production hits high levels every year trying to match the consumption. In the past, the Indian sugar industry has commendably kept pace with the growing domestic sugar demand. As a result, India today is the second largest producer of sugar after Brazil. Maharashtra and Uttar Pradesh are the highest sugar producing states in India. The sugar sector is of significant importance to the national economy. Although consumption has been growing historically, the production of sugar cane is cyclical. Presently, the sugar industry is regulated across its value chain. Investments in byproducts are at a nascent stage and the sector has struggled to produce a return on invested capital in excess of its cost of capital in most years. This is primarily due to a highly mandated fixed cane price and a volatile sugar price across the world.
With the increasing levels of health consciousness among people, sugar consumption levels started sloping downwards. The sugar industry has faced many issues in all stages of production. The regulatory challenges have affected the entire value chain of the sector--farm side, mill side as well as market side. These challenges act as hurdles and not only impact the sugar business, but also affect the high potential byproducts businesses. The sector, thus, always required a comprehensive road-map to guide it towards achieving its true potential. The farmers aspire for increasing yields and the millers aspire for increasing profit through higher availability of cane, flexibility to export sugar and higher value-addition from byproducts, including alcohol. Sugar is regulated at both the Central and state levels. Hence, it is subject to quite a few conflicts that arise from diverse perspectives at the two governance levels. Some of these conflicts relate to the announcement of the Statutory Minimum Price (SMP) and State Advised Price (SAP), incentive schemes, molasses control and cogeneration (MNES Act). These conflicts need to be resolved. Mindful of all these issues, the government has sought solution in ethanol to fix some of the glitches in the sector.
The falling sugar prices and norms and restrictions imposed by the previous governments, among other reasons, have resulted in huge losses for the sugar industry. The sugar industry has gone through turbulent times due to various reasons, and hence the government intervention now. It is evident from the Sugar stocks valuations table that the PAT growth of the companies has been in the negative. Among them, companies such as Dalmia Bharat Sugar, Dhampur Sugar Mills and DCM Shiram have still reported better numbers than the others in the group. Balrampur is the clear winner in terms of dividend yield, closely followed by Dharampur and DCM Shriram at 3.33 per cent, 2.46 per cent and 2.32 per cent, respectively. On the other hand, KM Sugar Mills has generated the highest ROE of 25.17 per cent.
Dwarikesh Sugar Industries may not benefit much from the ethanol business as its production capacity is much lower (30,000 litres per day), but it could benefit from higher sugar prices. Even if the MSP for sugar is not revised, the lowering of supply could lead to sugar prices going upwards. For Balrampur and Dhampur, on the other hand, ethanol capacities are quite high – expected to be 3.6 million and 4 million litres per day by the end of FY19. The operating margins and return ratios in the ethanol business are much higher.
What to expect in the upcoming quarters…?
With the latest development, the sugar stocks could continue the good momentum in the coming quarters with rise in sugar prices owing to a drop in supply of sugar and rise in ethanol production, which would help the mills to generate substantial profits. The financial numbers of the sugar companies should improve in the coming quarters. But, on the downside, the ethanol fix will only be a short term one.
Firstly, mills will have to invest in distillery capacity and will also require investments in pollution control, storage and logistics. This would require a good amount of capital for the debt-burdened companies. India's climate is erratic and a bad weather can damage the cane crop, and if that occurs, sugar output would decline and market prices will increase. Hypothetically, if companies now continue to divert 100 per cent of their sugarcane juice to ethanol, sugar supply position will be tight and cause a spike in prices, but the government would not want to go in that direction. Faced with a spike in prices, the government may simply mandate mills to use all sugarcane juice to produce sugar, or worse, it could lower the price of ethanol. This means the sugar industry would be back to square one. An investor must remember that the sugar industry is cyclical and sugar scrips are thus cyclical stocks and they swing wildly up or down, depending on external factors as well as government policies.
Conclusion
Sugar sector in an important part of the Indian economy. As the sector itself is cyclical in nature, the sugar stocks behave in a cyclical manner, thus making them a little bit more volatile than the markets. Excess volatility and government interference makes it a difficult sector to invest in.
Having said that, the recent government decision on ethanol pricing has certainly created positive traction in the sugar stocks. Only those investors who have a deeper understanding of the sector should venture into investing in sugar stocks. Only time will tell how long the sugar industry can enjoy the benefits of ethanol pricing.