Hitting the sweet spot: What is fuelling the rally for sugar stocks?

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Sugar stocks have been buzzing for some now on Dalal street with Magadh Sugar & Energy, Avadh Sugar & Energy, Uttam Sugar Mills, DCM Shriram Industries, Rana Sugars, Triveni Engineering & Industries, Dalmia Bharat Sugar & Industries, Ugar Sugar Works, KM Sugar Mills, Dwarikesh Sugar Industries and Balrampur Chini Mills, soaring over 30% alone in the month of April, whereas benchmark indices Sensex and Nifty lost around 2.5%.

Opportunity in adversity:

India’s sugar sector has drifted away from cyclicality (in terms of sugar prices) as well as from partial deregulation. This has been led by a) structural oversupply in terms of sugar production b) the government’s efforts on the Ethanol Blending Program (EBP; from 0.8% to almost 8% now; 20% target EBP in 2025) through robust ethanol prices and c) the government’s objective to ensure sugarcane farmers are paid without significant arrears, said JM Financial in a report.

The brokerage firm believes it bodes well for the sugar sector as government policies would ensure survival of the weakest. Hence, well-managed sugar companies could generate enormous earnings/cash flows in the process.

Brazil’s loss can be India’s gain

The harvest season has commenced in Brazil and initial trends point to a lower crop yield this year, owing to less sowing and unfavourable Monsoon conditions. Sugarcane yield is likely to drop this season and its quality also is likely to go down, which could impact recovery rates in Brazil. Also, other key sugar-producing countries, such as Thailand, & the EU, not expected to produce higher output leading to a tight global demand-supply scenario.

“International sugar prices have started to firm up and crossed 16.5 US cents per pound. This augurs well for India’s sugar industry, which has a surplus inventory of 10.5mn tonne. India’s sugar industry will achieve 6.0mn tonne exports target set by the government at the start of the year on highly remunerative international prices.,” said a report released by Elara Securities.

Forecast by Brazilian Sugarcane Industry Association – UNICA of lower sugar output from Brazil has driven prices higher, and with ~55% of exports target of 6.0mn tonne achieved by April, we believe India’s millers will look to export an additional 1.0mn tonne this year. This would further reduce carry-over inventory.

Sweet stocks

Now that you have understood what’s fuelling the rally in sugar stocks and want to sweeten your portfolio. Here are recommendations by Elara Securities.

Balrampur Chini Mills | Target price: 335 | Upside: 9%

Balrampur Chini Mills is well-positioned to capitalize on the government’s call to increase ethanol blending in petrol to 20% by CY25 as it will increase ethanol capacity by 60% to 300mn litres pa by October CY22, resulting in a distillery EBIT CAGR of 30% over FY21-24E. Robust free cash flow of Rs 2,570 crore over FY21-23E on higher contribution from ethanol and improved sugar performance. This should lead to a further reduction in debt with a gross debt-equity of 0.2x in FY22E vs 0.6x in FY20 and net cash of INR 2.5bn

Dwarikesh Sugar | Target price: 50 | Upside: 6%

Dwarikesh Sugar expanded ethanol capacity from 30 KLPD to 130 KLPD in FY21, resulting in a 4x increase in the company’s ethanol capacity. Higher realization in B-Heavy would drive ethanol segment EBIT CAGR to 16% over FY21-23E while firm sugar prices would result in a 31% EBIT CAGR in the sugar division over the same period. With no major CAPEX, the company is likely to generate a healthy free cash flow of Rs 750 crore in the next two years, which will help to deleverage the balance sheet.

(Disclaimer: The recommendations in this story are by the respective research and brokerage firm. Money9 & its management do not bear any responsibility for their investment advice. Please consult your investment advisor before investing.)