Sugar stocks have started rising on hopes of decontrol, higher ethanol supply at better prices, and a narrowing global surplus. The narrowing surplus and cheap valuation could be the best reason to buy into these stocks at the moment

Stocks such as Shree Renuka Sugars, EID Parry, Triveni Engineering, Balrampur Chini, Bajaj Hindusthan and Bannari Amman have moved up quite a bit in the last week or so. Shree Renuka has risen from Rs65 to Rs75, Balrampur Chini is up from Rs85 levels to Rs92, and Triveni Engineering has risen from Rs95 levels to Rs107.

Decontrol: Still not a sure thing

The whole buzz stems from a high-level meeting on decontrol of the sugar sector which was held last week and which apparently included prime minister Manmohan Singh, finance minister Pranab Mukherjee, food minister Sharad Pawar and Planning Commission deputy chairman Montek Singh Ahluwalia. The latest news on this front is that the centre has decided to take views of the state governments before taking a final call on decontrol. The food ministry has recommended decontrol from October (the start of the new sugar season) and has gone as far as to say that not only should mills be given freedom to sell sugar in the open market, but that the Centre should buy sugar from such open markets (for its public distribution system). One thing is for sure, if the states are going to have a say, the move gets complicated and may not happen so soon.

Under the current system, the sugar sector is totally under the government's control. The Centre fixes the quantity of sugar that mills can sell in the open market as well as through ration shops. The mills have to sell 20% of their produce to the government (for the PDS system). The government also fixes the minimum support price of sugarcane for farmers.

Ethanol supply

The other positive news for the sector is that the oil ministry indicated that oil marketing companies will issue supply orders for 860 million litres of ethanol at the interim price of Rs27/litre. Accordingly, sugar mills have committed to supplying one billion litres of ethanol to OMCs for blending with petrol. Media reports suggested 120 million litre commitment came from Renuka Sugars, 100 million from Bajaj Hindusthan, and 40 million from Balrampur Chini. The minimum purchase price of ethanol was recently raised to Rs27/litre from the earlier Rs20/litre - a good positive for sugar companies. If the OMCs do pick up 860 million litres of ethanol, Credit Suisse expects impact on FY11 EPS to be 20% for Renuka and Balrampur. Despite the positives, CS remains cautious on the sector.

Sugar prices have probably bottomed out

Yet another factor driving sugar stocks is Brazil's agriculture ministry's declaration last week that sugar output in Brazil, the world's biggest producer, will rise less than previously forecast this year as dry weather may hurt crops. Consultancy firm Kingsman cut its global sugar surplus estimate by a third for the year that began in April due to adverse weather in several regions (crop damage in Russia and Pakistan) including top producer Brazil. It believes that the world sugar market would now see a surplus of 3.52 million tonnes vs. 5.17 million tonnes forecasted earlier.

This lower global surplus will balance out India's higher-than-expected production, market players believe. The government recently allowed Indian mills to export 250,000 tonnes of sugar over the next 3 months. Mills had imported 2.1 million tonnes of sugar in the 2004-05 crop year under the Advance Licence Scheme, which makes it mandatory for them to export an equal quantity later. Under this, mills are yet to export almost 1 million tonnes before March 2011. If the global surplus narrows further, Indian mills could gain via further exports and higher international sugar prices.

The sugar crop for the 2010-11 season starting in October is expected to be a bumper one - 25-26 million tonnes. Sugar prices have also come down from above Rs50 levels to the present below Rs30 levels.

Bumper crop or not, these prices are likely to see a short term spike as festival demand picks up. Besides, the reducing global glut will lend support to prices.

Most brokerages tend to agree that Shree Renuka is the best bet among sugar stocks - it trades at less than 7-8x P/E and 6-7x EV/EBITDA and stands to gain due to its operations in Brazil and global trading. Bajaj Hindusthan's high debt and power foray are a worry. Balrampur Chini is also considered a good bet with its high cash flow and no capex.