Sugar In A Sweet Spot: Is This Time Different?
Bullocks haul carts laden with sugarcane in the district of Hapur, Uttar Pradesh. (Photographer: Kuni Takahashi/Bloomberg)

Sugar In A Sweet Spot: Is This Time Different?

BloombergQuintOpinion

Sugar might be the investing “white gold”, proclaims one research report. Old-time watchers of this sector may yawn at this claim. Its history is replete with instances where the sector has just flattered to deceive. Sugar production is so intertwined with electoral interests that it is rather difficult, if not impossible, to have an element of predictability. This has been a deeply cyclical business on the operational front even without the impact of election cycles and political decisions aimed at vote banks.

That said, the last few months have brought in some changes on the horizon that are worth assessing. Do they help reduce the cyclical nature of the sector? Yes. Are the offshoot businesses higher-margin accretive and ones with better return ratios? Yes. Does the business have a moat around itself? Largely yes.

The puzzle that any investor will have to try and grapple with is whether the factors discussed in this article are strong enough to offset the legacy baggage, the risk of political intervention, and the cyclical nature of the business.

MSP: Alleviating Pain Of Large Price Movements

The minimum support price for sugar has curbed losses during periods of surplus. In the earlier sugar surplus cycle of 2015, domestic sugar prices corrected sharply – to a low of Rs 23 per kilogram from levels of over Rs 30 per kilogram. Presumably, in order to remove the vagaries of the pricing, which led to the mill owners being unable to pay the farmers' dues on time, from June 2018, the central government fixed an MSP for mills to sell sugar in the domestic markets, which acts as a benchmark. As a result, sugar prices in the current surplus scenario have remained stable at higher levels, with the support of MSP for the domestic market at Rs 31 per kg.

Sugar mills are now able to realise significantly higher prices for sugar in the domestic market, despite India having high sugar inventories in the current season. Had there not have been an MSP in place, sugar millers would have been reeling with losses, as prices would have dropped considerably. This move singlehandedly helps a highly cyclical business offset the price pain to a large extent.

The key other and opposite variable in this is the price of the raw material. In the past, the setting of the state-administered price of sugarcane or SAP used to be the determining factor of profitability. The final product price was always volatile, and often, significantly below the cost of production because of a steadily increasing SAP. Now, not only does the MSP put a predictable floor on the final product price, some states have now adopted a practical approach to cane pricing as well, which is a very welcome move.

Uttar Pradesh SAP Unchanged For Third Year

The Uttar Pradesh government has declared to keep the sugarcane SAP unchanged for the third year in a row. This comes at a time when sugar production in central and eastern U.P. has been hit by red rot fungus attack on the cane crop, which has affected yields. Mills are not able to segregate the crop fully and thus end up having to discard some of the purchase which was virus-infected. For the U.P.-based sugar mills, due to the lower yields, the cost of production would have moved up, even as some recovery is already underway in Q4FY21.

At a time like this, the state government has not chosen to play to the gallery by appearing to extract the maximum price from millers in favour of farmers, with just a year to go for assembly elections. Investors in sugar companies will take heart from such an approach by the administration.

Surplus Addressed By Exports Plus Ethanol

Can there be a scenario in the coming years, that with more distillery capacities coming up, the country directs more sugar towards the production of ethanol for blending with auto fuel, and ease the reliance on exports as the sole channel to clear surplus production? That is a key question. There's visible action from the government on this front. The price of ethanol to be procured by oil marketing companies is fixed, irrespective of the price of crude, which means that even if crude prices were to correct substantially, the sugar companies will continue to get a reasonable price for its ethanol. Keep in mind, we are not seeing the advent of direct manufacture of ethanol from sugarcane juice in its entirety.

For now, the ethanol that is being manufactured is from B-Heavy and C-Heavy molasses, which are the #2 and #3 variants in the molasses chain, getting formed as a byproduct of the sugar manufacturing process. However, if the mills are able to divert some of the B-Heavy molasses towards ethanol for a proper price and off-take guarantee, one is looking at a scenario of sugar production coming off marginally. Courtesy of the ethanol programme, some brokerages estimate that the closing stock of the industry could come down sharply to around 8.2 million metric tonnes as of September 2021, from 10.5 MMT in September 2020. Various estimates say that India is expected to produce nearly 30 MMT of sugar in the current year compared to an average annual consumption of 25-26 MMT.

Higher Global Prices, While Valuations Moderate

International sugar prices have seen an uptick. If the prices stay higher, it will help in the export realisations. While lower global prices do not impact millers as MSP protects the downside, higher prices overseas help in the export realisations.

Sugar In A Sweet Spot: Is This Time Different?

The problem is that the sector has had a lot of false starts in the past, not just because of cyclicality but also because of political and administrative intervention. The question that an ardent bull will have to grapple with is whether this time is really different, both in terms of political intent and cyclicality, and will the markets recognise and reward this?

Niraj Shah is Markets Editor at BloombergQuint.

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