| Downgrading all but Renuka to Underperform on downcycle
Jump in sugar production to 18mt in FY10e contrary to our view of 14mt coupled with prospect of another 40% rise in FY11e has made us bearish. We downgrade Bajaj Hind, Balrampur and Triveni to fall as (1) sugar price could fall 25% more on rising supply and hurt margin; (2) P/B could de-rate to trough level on decline in ROE. Even though stocks have fallen over 35% from peak still could fall till Feb 2011 before which clarity on peak production won't emerge. Maintain Buy on Renuka with a lower PO of Rs80 based on P/B of 1.8x FY11e owing to strong growth in distillery, power & refinery volume (70% of FY11e total EBIT).
Cycle has reversed on excess supply and state intervention
Sugar price is falling since Feb 2010 driven by concern of excess supply along with host of government initiatives to reign in price rise. Excess supply fear could continue owing to (1) lesser diversion of cane towards non-sugar usage from 47% in FY09 to 26% in FY12e due to higher price sugar mills are required to pay; (2) increase in sugar per tonne of cane on better monsoon as forecasted by govt; and (3) rise in inventory to consumption ratio to 21% by Sep11 from 17% now driven by 20% rise in crop area planted by farmers this year.
Cutting EPS and PO upto 83% on declining sugar price
We have cut FY11e EPS estimates of all sugar stocks under coverage by 50-83% driven by cut in margins owing to forecast decline in sugar price vs cane cost. We have cut PO by 38-65%. We now base PO on P/B of 1.6-1.8x FY11e (YE Sep) equivalent to trough P/B in previous down cycle. However, Bajaj Hindusthan PO is based on 0.8x P/B owing to inferior ROE. (We have ignored the distressed PB level of 0.4x during subprime crisis).
Buy Renuka on diversified business and ethanol price hike
Renuka is unique in having trough ROE of 17% in previous downturns owing to cost flexibility and diversified business. We maintain Buy as Renuka could limit its ROE decline yet again to 17% driven by (1) 3x jump in distillery volume owing to jump in molasses supply in addition to 29% increase in ethanol price as decided by govt recently; (2) around 60% increase refining volume led by commissioning of 1mt Mundra refinery in Dec10; and (3) 2x jump in power sales driven by higher utilization. Our PO of Rs80 is at 1.8xFY11e P/B owing to 17% trough ROE.
Cycle to turn up once production peaks off
Historically sugar price bottoms out once production cycle peaks off. There is a risk of production to peak off by Feb 2011 as (1) delay in payment to cane farmer as being reported recently could lead to crop area reduction; and (2) rise in oil price and ethanol outlook could prompt Brazil mills to reduce sugar production. Safe Harbor Statement: Some forward looking statements on projections, estimates, expectations & outlook are included to enable a better comprehension of the Company prospects. Actual results may, however, differ materially from those stated on account of factors such as changes in government regulations, tax regimes, economic developments within India and the countries within which the Company conducts its business, exchange rate and interest rate movements, impact of competing products and their pricing, product demand and supply constraints. Nothing in this article is, or should be construed as, investment advice. |
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