>Sugar Sector (MERRILL LYNCH)

SUGAR CYCLE GETTING SWEETER


Raising sugar price, EPS, PO & rating on leading cos - Buy
The sugar price in India could jump 20% in next six months and remain strong for next three years, in our opinion. Key drivers for such a strong up-cycle are (1) very low production in current season and forth coming season compared to consumption (2) lack of scope for further reduction in dealer stock level and (3) increased cost of production as well cost of imports. Hence, we upgrade Balrampur (leveraged play on sugar price) to Buy. Maintain Buy on Renuka (higher PO) and Triveni. Maintaining Underperform on Bajaj Hindusthan due to high debt and forex loan loss.


Supply shock sets the stage for stronger sugar cycle
We expect sugar production in the current and next season starting Oct09 to fall short of demand by 35% and 16% respectively due to cost pressures. Such a shortfall is likely to drive up the sugar price by another 20%, on top of the 54% rise seen so far since Aug07 trough. Our expectation of trough to peak price rise of 74% is higher than 52% rise seen in last cycle. However, our peak price estimate for the current cycle is only 20% higher than the previous peak and is driven by 48% higher cost. We expect price to remain high till imports falls to zero i.e till end of FY11E.


Bigger earning boost to UP based mills
The higher sugar price is likely to benefit Uttarpradesh-based Balrampur, Bajaj and Triveni the most as they have higher fixed cost. Renuka, has higher variable cost and hence lesser leverage to sugar price, but is likely to see strong volume growth courtesy its refinery which will import raw sugar and meet India’s growing sugar deficit. We raised earnings estimate up to 26% in FY10E and 96% in FY11E for UP based producers. We increased Renuka Sugar’s EPS estimate by 6%.


Prefer Balrampur, followed by Renuka & Triveni - Buy
Our order of preference is (1) Balrampur (best play on sugar price leverage) (2) Renuka Sugar (best play on supply shortfall) and (3) Triveni Engg (most attractive valuation). Our PO is based on long term average EV/EBITDA of 6x applied to FY10E earnings, which to us, is mid-cycle.


Bajaj Hindusthan most leveraged, but too risky – U/P
Maintain Underperform on Bajaj Hindusthan, despite its highest leverage to sugar price as it has (1) very high debt and (2) very low ROE. We raised FY10E EPS by 26%, but kept PO unchanged based on 6x FY10E EV/EBITDA.
Key risks- 1) bumper crop in Brazil 2) lack of sugar
Key risks to our assumption is higher production in Brazil which could depress international price and make imports more attractive. Also UP-based mills may not benefit from higher sugar price next year if they see another production failure.

Sugar price ripe for a flare up
We are now more positive about the prospects of Indian sugar manufacturers following indications of sharper than expected production shortfall in current season. Consequently we raised our EPS estimates, PO and ratings for most companies except for Bajaj Hindusthan, which is saddled with excessive leverage and low ROE. Key drivers for upgrade are the following.
* Significant upside to the price of sugar given the shortage and cost push
* Likelihood of an extended period of shortage driven by lack of new investments both by sugar mill and cane growers
* Limited impact of government intervention due to (1) limited ability to import (2) inelastic demand and (3) government prerogative to balance the need of farmer and consumer.
We show below our earnings and rating changes; and the sensitivity to price movements. While Bajaj Hindusthan is the most sensitive to sugar price, we believe its risk reward is unfavourable as it has 3x debt to equity and the only Underperform in our coverage universe.


To see full report: SUGAR SECTOR