The Hindu Business Line : Balrampur Chini Mills: Buy

The prospect of an earnings slowdown for sugar companies due to weakening sugar prices has triggered a 60 per cent decline in the Balrampur Chini Mills stock since April 2006.

This has trimmed the price-earnings multiple for the stock from about 15 times the FY-07 earnings to about 8.5 times, presenting a good buying opportunity for long-term investors at the current price level of Rs 84. A significant slowdown in earnings growth from a scorching pace during the past two years is already factored into the stock price.

Going forward, Balrampur Chini Mills appears on course to deliver double-digit earnings growth over the next couple of years. The company's ongoing capex programmes, which will bolster volume growth, and an increasing contribution from power and distillery operations, are likely to offset the impact of flat or marginally lower sugar realisations on earnings. The lifting of the export ban on sugar is likely to lead to a tighter domestic supply scenario and provide support to domestic sugar prices at current levels.

Sugar scenario

Expectations of comfortable sugar supplies in the sugar season 2006-07 (October-September) have triggered a 15 per cent decline in sugar prices over the past couple of quarters. With sugar output expected to recover to about 227 lakh tonnes in the current season on top of opening stocks of about 36 lakh tonnes, total sugar availability is expected to be of the order of 263 lakh tonnes. Assuming domestic consumption of about 200 lakh tonnes and no exports, this would have resulted in the closing stock of about 63 lakh tonnes or four months' consumption by end of this season, a much higher inventory than in 2005 or 2006. However, the lifting of the export ban may lead to a significant draw down in the forecast inventories. The re-export obligations of mills and the freight advantages of shipping to neighbouring markets suggest that exports of about 20 lakh tonnes are likely, though they may not fetch a significant premium to domestic realisations. Sugar prices may find support at Rs 1,700-1,750 a quintal, on the back of higher consumption due to a buoyant economy, combined with depleting inventories due to exports.

Upside from diversification

Among the frontline sugar companies, Balrampur Chini Mills appears better placed to deliver reasonable earnings growth in a scenario of flat or marginally declining sugar prices. The company controls cane crushing capacities of 57,500 tcd (tonnes crushed per day) spread over seven locations in Eastern Uttar Pradesh, distillery capacities of 320 kilolitres per day and generates about 86 MW of surplus power from baggase.

For one, the company has managed to rein in increases in procurement costs over the years by virtue of its location. With few large players in this belt, Eastern Uttar Pradesh has not witnessed the intense competition for cane seen in the other belts. The sharp expansion in cane acreage in the current season could thus reduce procurement costs and provide relief on margins, while expanding revenues from by-products such as power and ethanol.

Second, significant capacities in downstream products have enabled the company to diversify its revenue stream outside of its sugar operations; this makes earnings less sensitive to small swings in sugar prices. Co-generated power and alcohol alone contributed 23 per cent of Balrampur Chini's operating profits in 2005-06 and this proportion is likely to rise over the next couple of years on the back of expansion projects.

Third, the company has already made significant investments in fresh capacities for sugar and by-products, which may boost volumes and revenues over the next couple of years. The ongoing projects are expected to expand sugar capacities by about 50 per cent, power generation by about 80 per cent and double distillery capacities by FY-08; a big portion of the earnings from these projects will flow in during the current financial year ended September 2007.

Though the undemanding valuation for the stock (at eight times forward earnings) reduces the downside risk at current levels, investors in the stock should take note of the risks arising from the commodity nature of the business. An upward revision in domestic sugar production estimates and any further policy intervention to curtail sugar prices are the key sector-specific risks, while any delays in stabilising production at the new facilities would be the key company-specific risks to earnings.

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