Sweet Prospects
 

The medium-term outlook for the sugar sector looks positive. But investors need to keep an eye on policy announcements that may change the scenario

Indian sugar companies faced a margin squeeze with declining product prices and higher raw material costs in the last sugar season (October 2009-September 2010). This has changed for the better in the past five months as sugarcane cost has moderated and prices have firmed up marginally with expectations of lower than projected production.

This has reflected in better sequential financial performance of domestic firms. But the worst may not be over yet, since sugar price may remain range bound. There could be a decline in the second half of the current season that ends in September 2011. Also, an upward revision in the production estimate may provide a new trigger for sugar prices.

Financials

A set of top five sugar companies reported a net profit of Rs 179 crore on an aggregate basis for the three months ended December 2010, compared with a loss of Rs 35 crore in the quarter ended September 2010.

This is due to lower increase in the raw material expense, which accounts for 70-80% of the total operational cost. The downward revision in the cost of cane by 20% to approximately Rs 20 per kg, helped companies boost their operating margins by 300 basis points (bps) for the quarter ended December 2010 on q-o-q basis.

Operating margin of sugar mills based in southern India is expected to be better compared with peers in the north. This is because firms in the south have bought sugarcane at lower price. These firms are also geographically better placed to export, compared with Bajaj Hindusthan, the largest sugar firm in the north. (This is due to lower price of buying sugarcane by firms in the south, such as Shree Renuka Sugar and Sakthi Sugar, that are also geographically better placed to export compared to Bajaj Hindusthan).

The picture at the net level will depend on debt in the books of individual firms. Among the large players, Bajaj Hindusthan and Shree Renuka Sugar could continue to report lower net profit due to high interest cost outlay in the coming quarters despite better topline.

A positive trigger for sugar companies could be the roll back of the levy quota that mandates a certain proportion of sugar produced by companies to be sold at a price less than the market price through the government's public distribution system. This was raised from 10% of the production to 20% of the total produce by all sugar mills last season and had added to the pressure on operating margins.

Current scenario

Sugar prices have risen 16% since last August due to estimates of lower-than-expected production of 24 million tonne as against the earlier projection of 26 million tonne for the current sugar season.

On the international front, raw sugar futures touched a 30-year high on February 2, 2011, due to a cyclone in Australia. But production in the world's biggest source of sugar, Brazil, is in line with estimates and international prices are expected to fall when Brazil's final production numbers are out in May 2011. This is visible in raw sugar futures for October 2011, which is trading at discount of 15% to that of March 2011, according to a report by rating and research agency Crisil.

Either way, the rise in international sugar prices is unlikely to benefit Indian companies significantly as the exports of 0.5 million tonne of sugar for the current season is yet to get release order.

Outlook

Sugar companies expect total domestic production to exceed demand in the next sugar season starting October 2011, if sugarcane plantation continues in the next season with better cane prices. As per brokerage report estimates, sugar production is expected to be 24-26 million tonne in the next season.

Sugar price is expected to remain in the range of Rs 28-30 per kg in the near term and is unlikely to crash unless there is any upward revision in the sugar production estimates in the domestic markets. Although y-o-y sugar realisation will be lower in the current quarter as also the three months to end-March 30, sugar companies can generate better sequential earnings performance due to lower sugarcane procurement cost.

Moreover, companies are also expected to benefit from the upward revision in price of ethanol - a byproduct of sugar mills - by 28% to Rs 27 per litre for the current season. This means value added from the allied products can also support companies from churning out net profit in the near term.

The medium-term outlook for the sector looks positive, but investors need to keep an eye on policy announcements that may change the scenario.

 
Shikha Sharma
 
shikha.sharma@timesgroup.com