Sugar Sector Sep 06 Edel

Executive Summary

Executive Summary Best case supply; demand contours remain strong Domestic sugar supply is likely to catch up with secular demand after soft supply in SS04 and SS05 due to nature-led disruptions. Domestic sugar production has increased from ~12.6 MMT in SS05 to ~18.9 MMT in SS06. As per industry estimates, sugar production is set to increase further to ~22.4 MMT in SS07 with large capacity expansions kicking in. Sustained demand growth of 3% plus is likely to yield a tight demand-supply scenario by SS08. We believe, India’s demand–supply balance will hinge on a supplydeficient Asia-Oceanic arc. The region, constituting ~40% of world sugar consumption, has been import dependant, led by prominent consumers like China, Pakistan, Bangladesh, and Indonesia. Strong regional demand is likely to be the key in deciding India’s domestic supply part of the equation. After two successive seasons of sugar deficit, world sugar production trend is likely to reverse in SS07E. Globally, this USD 53 bn industry is on the threshold of witnessing remarkable structural transition. EU agreeing to cut sugar subsidies by 36% over next four years will turn the region from an exporter to a likely importer over the next few years. Ethanol is emerging as a fuel-additive leading to significant diversion of sugarcane away from sugar, which is likely to keep sugar supply constrained over the medium term. Delicate inventory levels likely to keep prices stable Resurgence in domestic and global sugar supplies countered by strong demand is likely to marginally impact inventory levels. With a higher global sugar production in SS07E, we expect closing stock to be ~32 MMT, equivalent to 77 days of inventory, which is lower than the historical average of 90 days. Given that the composition of sugar producing and exporting nations varies significantly, we believe that exportable sugar available is likely to decide the direction of world sugar prices. India’s inventory levels adjusted for Advanced Licensed Scheme (ALS) exports, are likely to be far below historical averages. We believe that such delicate global inventory levels do not provide a cushion to supply side disruptions from secular phenomenon like ethanol as well as from any natural calamity-led supply side shocks. Despite recent drop in realization by ~5-10% at the mill level, we believe the pricing scenario in the domestic market will be stable for the next 12 months, with upside potential likely from supply side disruptions. Co-products adding higher margin of safety to cyclical risks Sugar sector players in India are witnessing a prodigious change in the context of the commodity business. Emergence of cogeneration of power and ethanol as a mainstream business segment in place of by-products as molasses and bagasse is increasingly driving commodity businesses like sugar towards secular growth businesses with significantly higher returns. With growing popularity of co products in an integrated sugar business model, we see rising resilience to commodity risks from raw material as well as price realization. This changing face of an integrated sugar business in the Indian context reposes our faith in the secularity vis-à-vis a commodity business of the past. Current valuation do not discount business model change In the backdrop of ad-hoc government intervention in recent times and sentimental weakness in global sugar prices, stock valuation of domestic companies have reacted disproportionately in the negative direction. We believe that current valuations post the recent crack, do not capture deeper and wider business model move by players. On the back of our positive stance on sugar sector, we initiate coverage on BCML, SSL with ‘BUY’ recommendation, re-iterate our ‘BUY’ recommendation on SRSL. Given that relatively purer sugar plays are more exposed to cyclical risks, we initiate coverage CCUMULATE with ‘A ‘ACCUMULATE CCUMULATE’’ recommendation on DSIL and with ‘BUY’ recommendation on OSM . Despite BHL being the largest sugar producer in the domestic market, we believe that current stock valuation does not leave much on the table for investors adjusted for commodity related risks and initiate coverage on the stock with a ‘REDUCE’ ‘REDUCE’. 2