Tuesday, September 17, 2013

Buy Sugar Stocks for Sweet Gains !! Wait for dips, buy and Hold !!

The government recently announced its decision to partially decontrol the sugar sector. This announcement brought cheer to the sugar industry. In fact, the Sugar Index outperformed the CNX Nifty 50 index by more than 10% in the first week of April, the week the news became public.

The Sugar Index, comprising frontline sugar stocks, gained close to 9% during 11 trading sessions ending 12th Apr '13. During this time period, the broader market remained in the red. The CNX Nifty 50 Index fell by approximately 2% in the corresponding time period. In view of the structural change in the industry, investors from this sector need to keep a close eye on the upcoming developments and could consider going long in selective sugar company stocks.

After years of reluctant hope and months of speculation, the Indian government's Cabinet Committee on Economic Affairs finally approved the partial decontrol of the sugar industry. The proposal seeks to abolish the levy-sugar mechanism, under which private millers have to sell a specified quantity of the sweetener to the government at concessional rates.

As per the new policy, the quarterly release mechanism of sugar has been dropped, which allows sugar mills to sell sugar into the domestic market or to export at will. The move is expected to free up cash flows for mills and allow them to better meet their cane payments to farmers, thus removing one of the major barriers to good farmer-miller relationships, which may in the end lead to less of a swing in cane plantings and more steady sugar production.

Obviously, the dropping of the levy obligation will boost profit margins of sugar companies significantly. Industry pundits estimate total savings to be in the range of `3,000 crore. The Indian Sugar Mills Association says that the two decisions combined could lead to an additional growth of 20% to 25% for the industry. Sugar production in the country is estimated to touch 24.6 million tonnes in 2012-13 marketing season ending 30th September with the cumulative turnover of `80,000 crore.

Currently, major players in the sugar industry are all domestic firms such as Bajaj Hindhusthan , Shree Renuka Sugars  , Dhampur Sugar  , Balrampur Chini  , EID Parry  and Mawana Sugars  , among others. After the decontrol policy of the government, the sector is likely to see more merger and acquisition activities.

Overseas players like Olam International, Cargill and Noble Group are looking at occupying a bigger pie of the Indian sugar industry. Foreign firms have been calling top industry people as they are lured by the size of the `80,000 crore market, which is expected to double up in five years. Trade sources say potential investors are eyeing opportunities in detail and have a preference for business in top producer Maharashtra although they are suspicious of politically meddlesome UP. As a result of all these positive developments, sugar stocks have surged upwards, beating negative trends of the overall market in the month of April.

Bajaj Hindusthan, Shree Renuka Sugars and Balrampur Chini Mills shares surged by 7.30%, 7.07% and 4.02%, respectively on the day the news was made public. Part of the overall impact had already been factored in before the news. Some momentum gained in stock prices after the news. Though the positive news will boost investor sentiments in the sugar industry, there are some concerns that need to be looked at carefully.

The relaxation in levy regulation is applicable only for two years and it is not clear what will happen from the third year onwards. Secondly, the control of sugarcane pricing still rests in the hands of select states. Depending on the political as well as investment-friendly situation of the individual states, companies' benefits would vary. Hence, investors need to carefully look at the plant location of individual sugar companies and its existing relationship with the government, among others. This means that the full benefit of a free market is yet to be realized for sugar investors.

For risk takers our recommendation - Buy Bajaj Hindustan below Rs.10 Shree Renuka below Rs.15 holding period 12-18 months

For long term our recommendation - Buy Dhampur Sugars below Rs.30 and Balrampur Chini below 36 holding period 18 - 24 months

Smart Investor
Equity Research Division

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