Bannari Amman Sugars

A steeper-than-expected downward revision in sugar output estimates has made the outlook for domestic prices quite bullish over the medium term.

Despite policy intervention to curb prices, sugar prices, over the next few quarters, are likely to respond to the extremely tight demand-supply situation.

Higher realisations on sugar are likely to reflect in improving profit margins and expanding earnings for select sugar producers which have access to adequate cane supplies over the next two years.

Bannari Amman Sugars, an integrated sugar producer with cane crushing capacities of 14,000 tcd spread over Tamil Nadu and Karnataka, appears a good investment bet in this scenario.

Lower cane prices in the southern markets, the company’s ability to weather deficit situations in the past and its integrated operations, suggest that it may be among the sugar players better placed to capitalise on the favourable turn in the sugar cycle.

At the current price of Rs 661, the stock trades at just six times its estimated earnings for 2008-09, at a discount to peers such as Balrampur Chini Mills and Bajaj Hindusthan.
Buoyant price outlook

Following three downward revisions in output in March alone, the current sugar season (October 2008 to September 2009) is expected to close with a domestic sugar output of 145 lakh tonnes, a 45 per decline from the 264 lakh tonnes produced last year.

After considering imports of 15 lakh tonnes, that is likely to leave closing inventories at just 12 lakh tonnes, a precariously low stock of just one month’s consumption. Even a higher output of 200 lakh tonnes for next year may just about balance supplies with demand.

These trends suggest that domestic sugar prices may remain upward bound over the next few quarters, even after the 30 per cent jump in prices since July 2008.

Given the political sensitivity of the issue, spiralling sugar prices have attracted policy curbs in the form of permission for duty-free raw sugar imports (under advance licences), stock holding limits on the sugar trade and higher free sale releases of sugar for this quarter.

But moves such as the imposition of stock holding limits and higher free sale releases may only give a short-term boost to supplies and are unlikely to have any lasting impact on prices.

Yes, duty-free raw sugar imports have the potential to impose a cap on any significant price rise in the domestic markets. However, imports are not an attractive proposition at current global price levels and prices will have to weaken substantially to make imports viable.

Even if raw sugar imports do become attractive later this year, players such as Bannari Amman Sugars are positioned to turn this into a revenue opportunity, given their sugar refining capacities (800 tcd post-expansion) that enable processing of raw sugar into white sugar for domestic sales.
Integration helps

Having steadily increased its crushing capacities over the past three years, Bannari Amman Sugars has also invested in forward integration projects, by adding to power cogeneration (currently 56 MW) and alcohol capacities. These have ramped up their contribution and helped the company remain profitable during the recent downturn in the sugar cycle.

Plans are on the anvil to expand the acquired (and relocated) 2,500 tcd Modhali sugar unit to 6,000 tcd, while setting up a 28.3 MW cogeneration plant. Regulatory approvals have also been obtained for a new 5,000 tcd integrated unit at Tiruvannamalai in Tamil Nadu.

Revenue contributions from these expansion projects may not flow in the near term, given the severe constraints in cane availability and higher competition for its procurement this year.

However, over a two-three year time-frame, as the company invests in cane development in the new command areas, these expansion projects may contribute not only to better volumes but also to a more diversified profile.

Escalation in cane prices and shortfalls in cane availability pose the key risks to the company’s earnings over this year and the next. However, cane prices in the southern states are still well below SAPs in States such as Uttar Pradesh.

Raw sugar imports and by-products such as power, alcohol and ethanol allow mills such as Bannari Amman to improve overall realisations. That may allow sufficient room for the company to earn a reasonable margin, even after shelling out higher cane prices this year.

Though crushing volumes are likely to be sharply lower than last year, it may be compensated by a sharp improvement in sugar realisations.

The first nine months of 2008-09 saw a sharp expansion in the company’s net sales (up 38 per cent to Rs 638 crore) and net profit (Rs 8.5 crore to Rs 84.6 crore), helped by liquidation of inventories and the sugar business’ return to profitability. The per share earnings stood at Rs 101 for the trailing 12-month period.

Bannari Amman Sugars

The sugar cycle is on the verge of an upturn, with the sharp contraction in sugarcane acreage pointing to lower sugar output and tighter supply over the next couple of years. With sugar prices already beginning their ascent, producers can look forward to a sharp improvement in realisations and profitability over the next couple of years.

The stock of Bannari Amman Sugars (Rs.824), offers a good investment opportunity for those looking to take advantage of the likely earnings momentum in the sugar sector. Facilities located mainly in Karnataka and Tamil Nadu and a history of good relations with farmers ensure that Bannari Amman Sugars enjoys access to adequate quantities of cane even in a deficit year.

The location of its mills in the southern States also ensures procurement of cane at more competitive prices compared to players in UP — for whom rising State ‘advised’ cane prices present a key risk. Bannari Amman’s integrated manufacturing model, with capabilities to produce power from baggase, refine imported sugar and process molasses into spirit and ethanol, make for better utilisation of capacities and a longer crushing season.

Despite these advantages, the stock (PE of about 8 times estimated FY-09 earnings, without factoring in contributions from capex) is trading at a discount to frontline sugar companies such as Balrampur Chini Mills and Shree Renuka Sugars.

Bannari Amman’s cane crushing capacities, which stood at 9,000 tcd (tonnes crushed per day) in 2007 rose to 11,500 tcd in the 2007-08 season with the acquisition of Maheshwara Sugars at a nominal cost to the company.

The acquisition was financed through an issue of preference shares worth Rs 18.5 crore, with an additional issue of equity shares worth Rs 1.9 crore, resulting in a marginal dilution of equity base to Rs 11.4 crore.

With statutory approvals received in June 2008 for relocation of this unit, plans are on the anvil to expand the facility to 6,000 tcd and add a 28.3 MW power cogeneration unit. Bannari Amman also proposes to set up a 5,000 tcd integrated sugar plant with cogeneration, distillery and bio-fertiliser units at Tamil Nadu, for which the command area has recently been demarcated.

Together, these expansion plans have the potential to scale up crushing capacities by 70 per cent. Assuming it takes two years for these units to be commissioned and for cane supplies to stabilise, a 20 per cent addition to crushing volumes should be possible by the next sugar season, commencing October 2009.
Realisations may drive margins

Even without factoring in volume increases, Bannari Amman’s profitability and earnings may improve over the next couple of years, thanks to rising sugar prices.

Current forecasts suggest a 17 per cent decline in domestic sugar output to 220 lakh tonnes in 2008-09 and a further decline to 187 lakh tonnes in 2009-10. Opening stocks for the coming season stand at a fairly tight 90 lakh tonnes. This puts the stocks-to-use ratio at 2004 levels, when sugar prices began their march during the previous upward cycle.

Reflecting the prospect of tighter supplies, domestic sugar prices have already climbed 22 per cent from their January levels and are now ruling 25 per cent higher than the same time last year; further increases are expected over the next few months.

Improving realisations on sugar are already reflected in Bannari Amman’s June quarter results, which showed a 25 per cent expansion in sales, with a three-fold expansion in per share earnings to Rs 18.1 for the quarter, compared to 2007.

Operating profit margins rose to 16.8 per cent (10.7 per cent), as losses from sugar operations shrunk sharply and power and distillery operations made positive contributions.

Though the September quarter may not be noteworthy, a sharp expansion in sales, profitability and earnings is likely from the December quarter with the commencement of the new crushing season.

While improvement in the profitability of the sugar business will be the key earnings driver, contributions from by-products — power and ethanol — may provide stability to the company’s earnings, even if sugar price increases are capped at a particular level.
Policy risks limited

Delays in contributions from expanded capacities and inadequate cane availability are the key company-specific risks to Bannari Amman’s earnings at this juncture. The risk of policy intervention to cap any runaway rise in sugar prices is a live one, given that the commodity is a key contributor to the inflation index. Going by history, these policy measures may take the form of additional releases of free sale sugar or buffer stock, ban or removal of incentives to exports or moves to facilitate imports, to moderate domestic prices.

Buffer stock releases can only temporarily quell prices, as sugar prices in the medium term will continue to be dictated by the actual supply equation.

A ban on exports or removal of export subsidy will curtail opportunities on this front for South-based players such as Bannari Amman But these are not a major concern in a deficit year, when better realisations are possible from domestic sales. A firm trend in global sugar prices and a depreciating rupee, also increase the shelter for domestic sugar producers against imports.

As the stock has thin trading volumes and is subject to large intra-day spikes, purchases should be carefully timed to obtain a good price.