Sector Specific - Sugar Stocks

Sugar stocks still bullish in long run (updated - 18 Nov 2009)
Sugar stocks have run up significantly due to higher sugar price outlook based on tighter supply side conditions. Earnings estimates for FY10 have been upgraded by about 75-200% depending upon the individual company’s profit-gearing to higher sugar prices, according to HSBC research.

Sugar prices, which rose from Rs 17.50 per kg to Rs 30 per kg in the last year and now are expecting to cross Rs. 40 per kg levels by Mar 2010. Supply side dynamics are expected to keep prices at these levels till 2011, according to a BoA- Merril Lynch research report on the sector. HSBC has upgraded FY11 earnings estimates by 40-140% based on this strong outlook.

India sweeter
Sugar inventories in India are at a 10 year low with stocks at levels of 1.7 months of consumption against a desired level of three months, according to HSBC research and India will need to import 6-7 metric tonnes in order to maintain this inventory level. Prices should, therefore, remain firm.
The key risks are higher than expected production costs because of higher cane costs - due to under-production and stock loss in flood-hit areas and excessive losses in conversion of raw sugar to white sugar. Government reaction, in terms of levy quota hikes or lower levy prices as well as a possible cap on sugar prices if shortages become acute, is another worry.

About Sugar Stocks

Some terms to understand
EV/EBIDTA - EV stands for Enterprise value and EBIDTA stands for Earnings before Interest, Taxes, Depreciation, and Amortization.
The lower ratio indicates the lower valuation of the company.
BoA- Merril Lynch - Bank of America Merril Lynch.

This premise is based on an anticipated production shortfall of 30% likely in India this year, given the deficient monsoon. Cane cultivation area may not increase in the next year as demand for food grains will increase given the drought situation this year. Finally, a global shortage is possible because of under-production in Brazil this year, adds the BoA-MLreport.

Bajaj Hindustan
The company has improved its balance-sheet quality by raising funds through a QIP (Qualified institutional placement) and issuing promoter warrants recently. Its debt to equity ratio is down to1x from a peak of 4.7x in FY08. It is most sensitive to a hike in sugar prices and a 1% rise in sugar prices boosts EPS by 5.4% according to BoA-ML research. The stock closed at Rs 221.90 on 11 November, 09 (up 4.6% in the day) and trades at a valuation of 7.3x EV/ Ebitda estimates for FY10 by HSBC research. The ratio is higher than peer companies on account of its higher debt levels.

Balrampur Chini
A 1% rise in sugar prices boosts EPS by 3% for Balrampur Chini. It also stands to gain from the change in the UP government’s change inpolicy allowing sugar mills to open power sales outside the state grid and allow sales to other states. The company is likely to distribute one-third of its profits as dividend, according to HSBC research, enhancing shareholder value Merger and acquisition rumours are strong triggers for the stock which recently soared and dipped as rumours of a promoter stake sale to Bajaj Hindustan started and then fizzled. The stock ended flat in day’s trading and closed at Rs 143.40 on 11 November, 09. It trades at a valuation of about 7.4x EV/ Ebitda estimates for FY10 by HSBC research.

Shree Renuka Sugars
Shree Renuka Sugars contracted raw sugar imports at a competitive rate, according to HSBC research, and stands to gain significantly on its operating margin front from higher refined sugar prices. A 1% rise in sugar prices boosts its EPS by 4%, according to BoA-ML.
The company is expected to be debt-free by the end of FY10, according to HSBC, given the sharp rise in earnings. It currently enjoys the highest RoE and RoIC of 41% among peers.

Triveni Engineering
Triveni Engineering is the country’s third largest sugar manufacturer and has historically traded at a premium to UP based peers because of its diversified business model where about 40% of revenues come from its Engineering segment. The higher return ratios mainly because of its engineering segment and less geared balance sheet are key positives for the company. A 1% rise in sugar prices boosts its EPS by 4%, according to BoA-ML. The stock closed at Rs 107.30 on 11 November, 09. It and trades at a valuation of about 5.5x EV/ Ebitda estimates for FY10 by HSBC research.

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