Executive Summary

Executive Summary

Best case supply; demand contours remain strong

Domestic sugar supply is likely to catch up with secular demand after soft supply in SS04 and SS05 due
to nature-led disruptions. Domestic sugar production has increased from ~12.6 MMT in SS05 to ~18.9
MMT in SS06. As per industry estimates, sugar production is set to increase further to ~22.4 MMT in SS07
with large capacity expansions kicking in. Sustained demand growth of 3% plus is likely to yield a tight
demand-supply scenario by SS08. We believe, India’s demand–supply balance will hinge on a supply-
deficient Asia-Oceanic arc. The region, constituting ~40% of world sugar consumption, has been import
dependant, led by prominent consumers like China, Pakistan, Bangladesh, and Indonesia. Strong re-
gional demand is likely to be the key in deciding India’s domestic supply part of the equation.

After two successive seasons of sugar deficit, world sugar production trend is likely to reverse in SS07E.
Globally, this USD 53 bn industry is on the threshold of witnessing remarkable structural transition. EU
agreeing to cut sugar subsidies by 36% over next four years will turn the region from an exporter to a likely
importer over the next few years. Ethanol is emerging as a fuel-additive leading to significant diversion of
sugarcane away from sugar, which is likely to keep sugar supply constrained over the medium term.

Delicate inventory levels likely to keep prices stable

Resurgence in domestic and global sugar supplies countered by strong demand is likely to marginally
impact inventory levels. With a higher global sugar production in SS07E, we expect closing stock to be
~32 MMT, equivalent to 77 days of inventory, which is lower than the historical average of 90 days. Given
that the composition of sugar producing and exporting nations varies significantly, we believe that export-
able sugar available is likely to decide the direction of world sugar prices. India’s inventory levels adjusted
for Advanced Licensed Scheme (ALS) exports, are likely to be far below historical averages. We believe
that such delicate global inventory levels do not provide a cushion to supply side disruptions from secular
phenomenon like ethanol as well as from any natural calamity-led supply side shocks. Despite recent
drop in realization by ~5-10% at the mill level, we believe the pricing scenario in the domestic market will
be stable for the next 12 months, with upside potential likely from supply side disruptions.

Co-products adding higher margin of safety to cyclical risks

Sugar sector players in India are witnessing a prodigious change in the context of the commodity
business. Emergence of cogeneration of power and ethanol as a mainstream business segment in
place of by-products as molasses and bagasse is increasingly driving commodity businesses like sugar
towards secular growth businesses with significantly higher returns. With growing popularity of co
products in an integrated sugar business model, we see rising resilience to commodity risks from raw
material as well as price realization. This changing face of an integrated sugar business in the Indian
context reposes our faith in the secularity vis-à-vis a commodity business of the past.

Current valuation do not discount business model change

In the backdrop of ad-hoc government intervention in recent times and sentimental weakness in global
sugar prices, stock valuation of domestic companies have reacted disproportionately in the negative
direction. We believe that current valuations post the recent crack, do not capture deeper and wider
business model move by players. On the back of our positive stance on sugar sector, we initiate
coverage on BCML, SSL with ‘BUY’ recommendation, re-iterate our ‘BUY’ recommendation on
SRSL. Given that relatively purer sugar plays are more exposed to cyclical risks, we initiate coverage
with ‘ACCUMULATE
CCUMULATE’’ recommendation on DSIL and with ‘BUY’ recommendation on OSM . Despite
‘ACCUMULATE
BHL being the largest sugar producer in the domestic market, we believe that current stock valuation
does not leave much on the table for investors adjusted for commodity related risks and initiate
coverage on the stock with a ‘REDUCE’
‘REDUCE’.