>SUGAR SECTOR (CLSA)

SWEETLY POISED

We anticipate sugar inventories falling to an all time low of 1.3 months of forward demand in SY10; our assumptions of a 30% rebound in sugar production and an unprecedented 3mt of imports notwithstanding. The tight demand supply should last well into SY11; UP based players are best bets in the upcycle given strong leverage to sugar prices. We initiate on Bajaj Hindusthan (+47%) and Balrampur Chini (+46%) as BUYs and on Shree Renuka Sugars (+25%) as OUTPERFORM.

India’s tightest sugar demand-supply
■ We expect India’s sugar production to rebound 30% to 19mt in SY-Sept-10 after falling 44% in SY09 underpinned by a 0.5m ha increase in cane acreage (the second highest YoY increase ever) and a 90bps rise in sugar recoveries to 10.1%.

■ We also anticipate increased imports of 3mt (an all time high) on the back of the recent decision of the government to allow duty free imports.

■ Sugar inventories will continue to fall, nonetheless, to 2.6mt by Sep-10. At only 1.3 months of forward demand, this will be its lowest level in the last three decades.

■ Demand-supply will remain tight in SY11 as well implying a 24-30 month up-cycle.

Stronger balance sheets.
■ The last down-cycle has dented investor confidence but this was accentuated by rapid expansions and the resultant higher capital charges (depreciation, interest).

■ With the companies out of the capex cycle and profitability rebounding, free cashflow should rise and balance sheets will get stronger; the net debt/ equity for the three companies under our coverage will fall to 50% by SY11.

■ Further, by-product integration projects would also reduce future cyclicality.

Sugar gross margins to rise above Rs8/kg
■ The tight demand-supply should reflect in higher sugar prices but the underlying cyclicality is reflected more in sugar gross margins (sugar price – cane costs).

■ This allows the players to pass on higher cane costs in an up-cycle; this should dampen the impact of irrational cane cost increases over the next two years.

■ Our regression model suggests normative margins rising to Rs8/kg in SY10; this is 15-20% higher than the previous up cycle given the tighter demand-supply.

We prefer leveraged plays
■ The UP based players are best placed to ride the up-cycle given their higher leverage to sugar margins. BJH and Balrampur are the largest players here.

■ We initiate on BJH with a BUY and a target of Rs240 (+47%); its balance sheet concerns will also abate as profitability rises accentuating the operating leverage.

■ We initiate also BRCM as a BUY and a target of Rs135 (+46%); we also like its integrated model (power, alcohol) which cushions the down-cycle support.

■ We rate Renuka an O-PF (TP: 165, +25%) due to its relatively lower leverage.

■ The key risk to our view is irrational government action capping sugar prices.

To see full report: SUGAR SECTOR