Wednesday, June 10, 2009



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