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Identifying a sugar stock: Do's and Don'ts

Mar 8, 2007

Sugar being a commodity, the sugar industry is cyclical in nature. It is a typical cycle which is affected by cane supply and sugar demand. In this article, we take a look at how to identify a good sugar stock. Currently, with the sector looking bitter, it is even more important to identify the right stocks to sweeten the gains. Profile
Sugar is a cyclical and a highly regulated industry. Trade barriers, including production quotas, guaranteed prices and import tariffs, impart a significant degree of distortion to international prices. The relatively longer plantation cycle, coupled with restrictive trade practices, has imparted a fair degree of volatility to sugar prices. In India, sugar production follows a three-five year cycle. Higher production leads to increased availability of sugar thereby declining the sugar prices. This leads to lower profitability for the companies and delayed payment to the farmers. As a result of higher sugarcane arrears, the farmers switch to other crops thereby leading to a fall in the area under cultivation for sugar. This then leads to lower production and lower sugar availability, followed by higher sugar prices, higher profitability and lower arrears and thus the cycle continues.


The production of sugar is seasonal. Sugarcane is crushed from November to April. The critical growth driver for the industry is consumption based on the population growth rate. The supply of sugar is dependent on a number of factors including sugarcane production (area under cultivation, yield), sugarcane utilisation for sugar production, duration of the sugar season, sugar recovery rates and cane pricing.

By-products – Additional revenue


Due to this cyclical nature, sugar manufacturers are vulnerable to industry oscillations. However, sugar by-products like molasses (ethanol, ENA and rectified spirit) and bagasse aid the sugar producers in diversifying risks and lending stability to their revenues.

Products Quantity Revenue (Rs)
Stand-Alone Mill    
Sugar (Kg) 100 1,750
Total Revenue   1,750
Cane price   1,150
Contribution 600
     
Integrated sugar Mill    
Sugar (Kg) 100 1,750
Ethanol (litres) 10 180
Power (kwh) 114 330
Total   2,260
Cane price   1,150
Contribution 1,110

As can be evinced from the above table, if 100 kg of sugarcane is crushed, an integrated sugar mill will generate revenues of around Rs 2,260 versus the standalone sugar mill, which will earn Rs1,750. Net contribution for the same will be around Rs 1,110 for the integrated sugar mill and Rs 600 for the standalone sugar mill. So the more integrated the firm is, the better is the cushion.

Key financials and ratios to look at…

Revenue breakup: The sugar industry is closely linked to the sugar price cycle. Higher cane and sugar production results in a decline in realisations for companies. Due to this cyclical nature, sugar manufacturers are vulnerable to industry oscillations. However, sugar by-products like molasses (ethanol, ENA and rectified spirit) and bagasse aid the sugar producers in diversifying risks and lending stability to their revenues. The company that has an integrated business model stands to survive the downturn cycle. The margins of the byproducts are higher than that of the sugar segment. So companies with an integrated model are a better play.

Recovery rate: This plays an important role for a sugar company. If the recovery rate is higher than its peers, it shows the efficiency levels of the company. Higher recovery rate leads to higher volumes thereby increasing the sales.

Operating margin trend: The sort of margins that a company has vis-a-vis its peers is an important factor that needs to be looked at i.e. whether the trend is improving or is there a continuous decline. By products have higher margins than the sugar segments. Those companies that have an integrated model stand to benefit in terms of higher margins.

Cash flows: A look at the company's cash flows and the working capital efficiencies will give an idea of the company's bargaining power as well as its ability to utilizeits resources and supply chain.

It is also important to look at the P/E (price to earnings multiple) which the company is trading at vis-a-vis its peers. Companies with an integrated model, larger capacities, better relations with farmers, contracts with power and oil companies will most likely be trading at a premium to peers based on these parameters. If so, then one has to gauge whether that premium is justified. Stocks trading at an unrealistic premium will not be a good option to invest in. After all, valuations have to justify the company's growth prospects.

Above all this, look at the past record of the management, its vision and its integrity. The management is responsible for the survival of the company and enhancement of the shareholders' return. If the management has a track record of being on the sly or slow to react to market conditions, then even if the company is the largest or the most efficient, it may not give you your rightful share of the company's growth and profits.

Click here to identify stocks from other sectors.

Related Links for Sugar Sector: Quarterly Results  NEW | Sector Quote


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2 Responses to "Identifying a sugar stock: Do's and Don'ts"

Ramprasad

May 14, 2016

I need to know, as of now which sector is best for investment and earn good returns?

Like (2)

D.K.Kaushal

Nov 26, 2013

Equitymaster's analysis on 'Identifying a sugar stock: Do's and Don'ts'is quite useful.

Like (2)
  
Equitymaster requests your view! Post a comment on "Identifying a sugar stock: Do's and Don'ts". Click here!

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