Date: 22.12.2007 The sugar sector has witnessed increased news flow with the recent announcements of government subsidies and the interim order of Allahabad HC. However, we believe, a better macro picture would emerge only after clarity in cane pricing in Uttar Pradesh for the 2007-08 season. Alternatively, south based companies like Shree Renuka Sugars, with an ethanol centric business model, look better placed in the current downturn.
Optimism on cane pricing but risks remain
Post the interim directive of the Allahabad HC, sugar mills have started crushing from end of November by paying cane price of Rs1,100/MT.
HC has reserved its judgment on the directive for final cane price payable; key thing is UP government reserves right to set cane price, a right affirmed by the Supreme Court.
Market feels UP based players may have to pay less in cane costs in the ongoing season on the back of the interim HC order thereby improving margins.
However, final cane price for the current season is likely to be in the region of Rs1,150-1,200/ MT, according to our interaction with UP based players and marginally lower than Rs1,250/MT paid last year (although arrears of Rs14bn have built up).
Production may not be as per estimates but inventory overhang a concern
Due to late start to the crushing season, expectations are sugar production may be lower than initial estimates of 29-30mn tons which would support prices.
Even then, assuming 27mn tons of output and 10mn tons of opening stock, next year inventories could reach about 15-16mn tons thereby suppressing sugar prices-these are expected to remain range bound over the next 6-8 months.
Moreover, high carrying costs (Rs1.2/kg of sugar) and debt burden imply that interest costs would eat into any operational improvements on the sugar front.
South based mills better placed on lower cane costs
As compared to UP, South based players like Renuka Sugars who pay SMP prices (about Rs900/MT) and have sizable ethanol revenues over the next few years would be a better play on the sector than UP based companies like Balrampur Chini, who would continue to face losses in sugar business.
Triveni Engineering, although UP based, may also be better insulated due to its engineering business (which contributed nearly 90% of EBIT in FY07; and has current turbine order book of Rs5.4bn) and any value unlocking due to demerger
Most UP based players to incur losses in sugar business.
Below we have attempted to model a typical UP based integrated sugar company’s per MT of cane and other conversion costs along with sugar and co-products revenue mix.
As can be seen, current landed costs of cane in Uttar Pradesh imply that most sugar companies would incur an operational loss or at least losses in the sugar segment.
Operating profitability returns if cane costs decline below Rs1,200/MT or sugar realizations improve to about Rs14,500/MT.
As compared to our estimates, actual operational losses are higher since some alcohol is sold as RS and ENA which fetches lower prices and some sugar is held in inventories.
Apart from operating loss, industry also bears high inventory carrying costs (typically Rs1,200/MT of sugar in current scenario).