Over the last year, high cane prices and weak domestic sugar prices weighed on sugar stocks; the market shrugged off positive developments such as abolition of levy quota and freeing up of global trade in sugar.

As a result, almost all sugar company stocks in the country took a beating. The stock of Balrampur Chini Mills (Balrampur), despite being one of the few sugar companies with low debt and a healthy balance sheet, too, lost almost 15 per cent in the last year. This presents an opportunity for investors with a long-term perspective.

After a tough year, the company’s business prospects look brighter now. Among the factors which will help is stability in domestic prices due to lower-than-expected sugar output in the country during the sugar season 2013-14 and interest-free loans of up to Rs. 6,600 crore for sugar mills to clear cane arrears to farmers. Besides, possible reforms in the cane pricing mechanism and higher ethanol purchase by oil refiners may spell relief for sugar stocks. In addition, the Government’s special export subsidy of Rs. 3,333 a tonne for February and March 2014 may help reduce surplus inventories and provide a lift to domestic prices of sugar. Valuations are not demanding even though the Balrampur stock has recovered 27 per cent from its January 2014 lows. At Rs. 48, the stock still trades at a steep 75 per cent discount to the replacement value of the company’s sugar mills. .

Even assuming a 50 per cent discount to the replacement value, the stock has the potential to deliver a healthy 20 per cent-plus return over a two-year time frame. With the sugar cycle now near the bottom, investors with a one-to-two year horizon can consider buying the stock to play the recovery.

Tide turning

In Uttar Pradesh (UP), the State Government fixes the state advised price (SAP) for sugarcane which is paid to farmers. A sharp increase in the SAP to Rs. 280 a quintal for the current sugar year was a big dampener. This is because all its 11 sugar plants with a total crushing capacity of 79,000 tonnes a day are located in UP. This resulted in a stand-off between the mills and the Government, further delaying crushing and resulting in a sharp decline in sugar output. The company crushed just 1.36 crore quintals of sugarcane in the current quarter, compared with 2.27 crore quintals during the corresponding period last year.

Troubles were aggravated by the weakness in domestic sugar prices, which fell almost 10 per cent in the last six months.

Finally, following the announcement of relief measures, such as tax breaks amounting to nearly Rs. 8 a quintal of sugarcane, sugar mills commenced crushing by early December 2013.

Lower volumes due to delayed crushing, higher costs and weak sugar prices led to an operating loss of over Rs. 219 crore in the company’s sugar segment during the last nine months, compared with a profit of over Rs. 115 crore last year.

But changes in the cane pricing mechanism are afoot. Other key cane growing States — Maharashtra and Karnataka — have enacted legislation to link cane prices to the realisation of sugar and its by-products. This follows the recommendations of the C Rangarajan committee on sugar decontrol. Taking cue from this, the UP Government has appointed a committee to look into the cane pricing formula. Should this happen, and state intervention in cane pricing be done away with, it will be a game-changer for the company.

Other positives

In the short term, lower-than-expected sugar output in the ongoing crushing season due to delayed production may hold sugar prices firm. A record 720 million litres of ethanol purchased by oil refining companies so far in 2014, out of the total requirement of 1 billion litres, will help Balrampur’s performance in the current quarter.

Balrampur is also expanding the capacity of its co-generation capacity by 12.7 MW at a cost of Rs. 59 crore. This will help the company generate steady cash flows from sale of surplus power to the grid. Balrampur’s overall revenue declined 22 per cent in the last nine months largely due to challenges in the sugar business, which contributed to a loss of Rs. 186 crore against a profit of Rs. 91 crore last year. A turnaround may be on the cards.