Sugar stocks no more a ‘le phataphat, de phataphat’ story. Here’s why

NEW DELHI: When does a commodity stock start rallying? The typical answer is when the price of the underlying commodity starts inching upwards.

Well, stocks of sugar mills might soon turn out to be an exception to this market basics, as the segment is gradually shifting away from being a cyclical to a structural play, all thanks to the government’s push for ethanol-blended petrol in India.

For many sugar-producing factories, ethanol was so far just a byproduct for generating additional revenue. The equation now seems to be reversing in many plants.

“About 85 per cent of revenues of the sugar companies come from the sugar segment and the remaining 15 per cent from ethanol. As the blending mix goes up, the revenue contribution of ethanol to the company's sales will improve to nearly 30 per cent. Ethanol is a higher ROC (return on capital) business,” says Pankaj Pandey, Research of Head at ICICIdirect.

The government has a target of improving ethanol blending mix from 7.2 per cent at present to 10 per cent in 2022 and then scale it to 20 per cent in 2025.

Brokerage Motilal Oswal Financial Services said demand for ethanol is expected to increase to 10 billion litres in CY25 from 3.5 billion litres at present.

Veteran fund manager Nilesh Shah of Kotak Mahindra AMC said very few sugar companies have created shareholder wealth in the long run, as their stock prices went up and down along with sugar price.

“Now with ethanol blending, a fundamental change is happening in the profitability of sugar companies. Ethanol will give them stability in cash flows. Sugar prices will continue to move up and down in a cyclical manner, but that will be the icing on the cake. A bulk of the profit will continue to come from ethanol on a steady state basis,” Shah told ETNow.

He said this is the transition of sugar companies from cyclical stocks to structural stocks. “Their volatility in profitability could come down dramatically, courtesy ethanol blending. So when you enter a sector, which is moving from cyclical to structural, P/E multiples would get rerated and you will see a spurt in shareholder value or share prices,” Shah said.

The current leg of gravity-defying rally in sugar stocks was fuelled partly by a surge in global sugar prices due to weak production in Brazil and Thailand. In the last one month, shares of at least two sugar producers –

Bajaj Hindusthan Sugar and Ugar Sugar Works – have more than doubled.

Other sugar stocks like Dhampur Sugar Mills, Rana Sugar Mills, Uttam Sugar Mills, Balrampur Chini Mills, EID Parry and KM Sugar Mills have gone up between 40-90 per cent.

Independent market analyst Anand Tandon said sugar has suddenly become more of an ethanol play than a sugar play in the stock market.

“As ethanol mix goes up, margins will become fairly stable and predictable. More importantly, sugar mills can now operate round the year. So, there may be a case for re-rating by looking at factories that produce ethanol with sugar as a byproduct,” he said.

That may make sugar stocks more than a ‘le phataphat, de phataphat’ trading opportunity for shareholders.