After much deliberation, the government has finally announced a partial decontrol of the sugar sector, which is hoped to make the business more viable and attract large scale investments too, says Nirmal Bang research report.
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.
The policy also aims to end the levy for sugar whereby mills are no longer required to sell 10% of their sugar production at a 40% discount to market price to supply to subsidized stores set up by the government.
However, there is a catch here. The government has mentioned that levy obligation has been dropped only for two years. Obviously the new central government that will come to power in 2014 will take a final call on this. And the political situation at that point in time will decide the fate of this particular rule.
The decision taken on 14th Apr '13 will eliminate the levy obligation from the current season. So, sugar produced after September '12 is not subject to the levy. It also sets up a new tendering system whereby states will buy sugar for the Public Distribution System (PDS) from mills through a transparent process, but prices are capped at `32.
As PDS sugar is sold at Rs 13.50, the central government will offset the Rs 18.50 difference for two years. Though it was discussed that the finance ministry might increase excise duties on sugar at the mill gate to help compensate for the government's new financial burden that will pay to keep, that decision has not been made yet. Therefore, the government must shoulder the burden of the extra Rs 2,500 crore per year to subsidize PDS sugar.
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. "The current sugar market has the potential to double up and reach `1.6 lakh crore in the next five years," says an industry expert.
India's sugar sector is gearing up for a surge in mergers and acquisition activities, big investments and exciting retail products as the government's decision to ease controls has revved up the world's biggest market for the sweetener.
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.
Source: Nirmal Bang's Beyond Market
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