There seems to be some good news for investors in sugar stocks. Over the next two years, a supply constraint and rising demand are expected to boost sugar prices to about Rs 18-20 per kg. This will increase profits of sugar manufacturers. Besides, farmers have shifted to other cash crops due to the lower prices of sugarcane, thus impacting supply. A report by Morgan Stanley Research says that “the area under sugarcane cultivation is expected to fall by around 19 per cent in 2008-09 leading to our view that the domestic sugar balance will move into a deficit of 2 million tonnes by September 2009”. On the other hand, sugar companies are increasingly shifting their focus to new areas in order to de-risk their businesses.
They are now investing in ethanol blending and power generation to reduce the impact of cyclicality in the sugar price movements. This should also help improve their profitability. On the flip side, sugar companies have been constrained by price controls and government interventions. And it’s unlikely that the government will allow prices to shoot up beyond Rs 20 per kg—it has a buffer of sugar stocks, from which it can release additional sugar to control prices. Besides, the sugarcane procurement price has always been a bone of contention for sugar companies.
Recently, the Supreme Court came to the rescue of sugar mills in Uttar Pradesh when it fixed the procurement price of sugarcane at Rs 110 per quintal, overturning the Rs 125 per quintal price fixed by the state government. While sugar stocks initially reacted positively to the news, they have been largely stable over the last month. But over the last one year, sugar stocks have performed well on the bourses. The top five companies in the sugar space saw their stock prices rise 47 per cent in the year to September 5, 2008.
The sugar industry is highly cyclical and usually has a two-year up and down cycle. Besides, it is also seasonal as the crushing commences in October, depending on cane availability, and continues till April-May. The current turnaround in the sugar cycle has just begun, which bodes well for the sugar stocks. But investors must tread with caution while selecting individual stocks. Sugar companies have expanded their capacities over the last two years, which can increase their depreciation costs, and, thus, hurt profitability. Besides, most sugar stocks have run up in anticipation of an increase in sugar prices. Says Vikram Suryavanshi, Research Analyst, Karvy Stock Broking: “Sugar stocks have already risen.
This time around, costs have increased as the companies have expanded their capacities.” Though there are many positive cues for the sector, its profitability this year is likely to be less spectacular compared to 2005-06, when a rally in sugar prices helped drive up sugar stocks. Those companies that have diversified into other areas such as ethanol blending and power generation and those that have a strict control over their costs may be better placed to ride out the cyclical swings in sugar prices. For now, sugar prices should remain firm over the mediumterm, but sugar stocks may not reflect the same buoyancy.