Covid-19 hasn’t turned sugar outlook sour

Many sugar stocks have been falling since the beginning of the year. The decline has been sharper since March, with the Covid-19 lockdown impacting demand. 

Market concerns about demand destruction, however, appear a little overdone, given that restaurants, cafés and bakeries have resumed operations across States, reviving the demand for the sweetener.

Also, despite lower prices globally,  Indian sugar mills have been receiving a premium  for their sugar from Indonesia and Iran.

Therefore, the current sugar season — October 1, 2019 - September 30, 2020 — is likely to finish with a lower closing stock than in the previous year.

Reduced inventory, higher exports and the minimum support price (MSP) on sugar, which will protect margins, are, in fact, positives for sugar mills.

Limited demand destruction

As per the estimates of the Indian Sugar Mills Association (ISMA), between  October 1, 2019, and April 30, 2020, the output of sugar mills was 25.8 million tonnes (mt), down 20 per cent from 32.17 mt in the same period last year.

This can’t be blamed on the lockdown. Even before March, it was evident that in the current sugar season, mills would report a sharply lower output as cane production was less. By September 2020, mills are expected to produce a total of 26.5 mt of sugar (against 32.95 mt in the last season).

This drop in output would reduce the inventory at mills.

The current season opened with a stock of 14.5 mt. Consumption this season will be lower than that in the previous  year, but won’t fall sharply. In the first five  months of the season (till February 2020), despatches by sugar mills were higher by 10.24 lakh tonnes over last year.

This offsets the drop in sales in March and April (by about 10 lakh tonnes over last year), according to ISMA.

In the next two months, as and when the lockdown is lifted across States, sugar consumption should pick up. Sugar is an essential commodity and demand can’t lie low for long.

Export opportunities

With shortage of packing materials and labour at ports, there were problems in shipping sugar consignments to export markets in April. According to ISMA data, as of April 30, sugar mills had entered into contracts for exporting 4.2 mt sugar and had exported 3.6 mt. That said, the situation has improved in the last 10-15 days. The demand from Indonesia and Iran for Indian sugar has been good.

Though international prices are lower, from about 15 cents a pound in February to about 10.5 cents a pound now, prices paid by Iran and Indonesia for Indian sugar are  higher. According to data collected by BusinessLine,  prices mills receive from buyers in Iran and Indonesia come to ₹20-21/kg. Add the subsidy, which is ₹10.4/kg (announced in September 2019 by the government under the Maximum Admissible Export Quota scheme), and the total realisation comes to ₹31/kg, which is equal to the price they get in the domestic market.

Given that mills were exporting sugar at prices lower than the domestic market rates in the past, the current trend is heartening.

The Indian sugar mill industry may export at least 5-5.5 mt of sugar this year against 3.8 mt last year.

Thailand, which is a large exporter of sugar, is having  lower supplies this year as cane output dropped due to drought conditions.

Hence, key markets, including Indonesia, are now looking for supplies from India.

Also, while  Indian mills couldn’t sell  sugar in Indonesia, the latter recently modified the quality requirements and extended Indian mills a concessional import duty.

What’s ahead for stocks

Given the above-mentioned positives, it may be a good time to hold on to sugar stocks. In particular, Balrampur Chini Mills, Dwarikesh Sugar Industries and Dhampur Sugar Mills appear a sound bet over the long run.

The MSP (₹31/kg) protecting margins, government’s order on EBP (ethanol-blended petrol programme) and a gradual pick-up in demand post-lockdown should augur well for these stocks.

On the ethanol front, OMCs (oil marketing companies) will continue to place orders with sugar mills, and given that the ethanol price is fixed (annually) by the government (not linked to crude oil price), sugar mills should continue to have decent realisations. Ethanol demand from hand sanitiser makers is also helping sugar mills.

Balrampur Chini Mills, Dwarikesh Sugar Industries and Dhampur Sugar Mills got new distillery capacities commissioned recently. As more cane gets diverted to make ethanol, it will improve the mills’ margins.

Higher cash flows will reduce working capital requirement and borrowings.

The stock of Balrampur Chini made significant gains in the last week of March on ICRA reaffirming its long-term rating as stable.

However, in the last one month, most of the gains have been eroded. In the December 2019 quarter, Balrampur Chini recorded a strong sales growth, helped by higher domestic demand and export sales. However, the operating margin was hit due to downward revision in power tariffs in Uttar Pradesh and lower sales of ethanol; the net profit, too, dropped.

For Dwarikesh Sugar Industries, while revenue growth was good in the December quarter (thanks to sugar sales), lower margins in the power segment and a drop in contribution from the distillery business saw net profit drop.

Dhampur Sugar, also a UP-based mill, reported a similar trend in the December quarter.

The outlook for FY21 for UP-based mills appears quite sanguine, with the government continuing to support the EBP programme. Added capacities and higher margin (ethanol margin is 40 per cent or even higher compared with 7-8 per cent for sugar), bodes well for these companies.

There are talks of an MSP increase in sugar, which can also aid margins.

At the current market prices, these stocks are trading at 3-4 times their FY20 earnings. Investors with a high risk appetite can hold on to these stocks.

A key risk to earnings could be the lack of continued support from the Centre on export incentive. This could lead to a rise in inventories. In the 2020-2021 season, the sugar output is expected to be around 30 mt.

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