Shares of sugar mills are reaching new highs every other day. Last Friday, these shares rose between 7% and 15%, with no specific news supporting the gains. Investors’ gains have been enormous in the past six months. Shares of Balrampur Chini Mills Ltd, for instance, have doubled in this period.
The moot question is if investors are riding their luck too far. The assumption behind the rally is that production will fall this year, and support the rally in sugar prices. Data on production, however, thus far does not show a decline.
The Indian Sugar Mills Association (Isma) said last week that sugar production thus far in the current season (that is, from 1 October till 29 February) was at about 20 million tonnes (mt), compared with 19.6 mt for the same period a year ago.
It added, however, that a fifth of the total sugar mills had ceased crushing sugar cane as of 29 February, compared with only 13 that had shut last year. This year, sugar crushing began earlier compared with last year, when it was delayed.
The expectation in the markets is that more mills will shut operations earlier, and production will taper. If so, sugar output could still come in at the projected level of 26 mt in the current season, down from last year’s level of about 28 mt.
Output estimates may still be met if sugar output declines as expected. If not, then there is an upside risk to output which could pose a downside risk to sugar prices. Investors in sugar mills’ shares need to watch this closely.
Of course, this is not to say that the rally is entirely unjustified. Domestic wholesale sugar prices are up by 6.6% since January and up by nearly a fifth over a year ago. A similar trend is reflected in international prices too.
Globally, major sugar growing regions are seeing weather—the El Niño effect—affecting crop output. Crop estimates are being revised downwards. Bloomberg reported on 23 February that the International Sugar Organization, a global industry association, has said the supply deficit in 2015-16 will be 5.02 mt compared with its November estimate of 3.5 mt. Brazil’s output has been revised down further due to more heavy rains, adding to lower production in countries such as India and Thailand.
On the export front, Isma said that 1.25 mt of sugar has been contracted for exports. That will partially fulfil the industry’s commitment made to the government to export 4 mt of sugar by September. Exporting sugar in an environment of rising prices is a good thing for sugar mills.
The March quarter should see the full benefit of sugar output and higher prices reflect in their performance. That should also give investors a better picture. Right now, while cane procurement prices are still high, mills are hoping to make money from higher realizations and a patchwork of government incentives for both domestic sales and exports. The increase in valuations suggests investors are already confident of a sharp recovery in earnings. Any upset on that front will reverse those gains.
Apart from higher-than-anticipated domestic output in the current season, another risk to watch for is if weather conditions improve in the next season. That may see sugar output rising both in India and in global markets and put pressure on prices. Another risk, at least as far as the domestic markets are concerned, is that if sugar prices keep increasing, there could be a public outcry which may lead to a government clampdown. If food inflation picks up from its current low levels, this risk increases. For the moment though, sugar shares are basking in the warmth of investor attention.
The writer does not own shares in the above-mentioned companies.