Shree Renuka Sugars Ltd.

I had written about the sugar stocks here nearly a year back. Since then the bunch has steadily trailed the indices (SENSEX, NIFTY) not doing anything exciting. But now I am wondering if enough is enough and its time for the Indian sugar scene to pick up. I have plonked down a smallish packet on Shree Renuka Sugars (SRS) and the position is up 20% already. The real test will come in the near future where the scrip first tests its 50 SMA and then the 200 SMA in quick succession. If it cuts through, then maybe there is a case to load up on the sugar. So my hunch is that breaking 80-85 is going to be key for the stock. SRS’ FY ends in September, so that will also be a good time to take ‘stock’.

This Belgaum, Karnataka born company is the only sugar/ethanol producer in the world with a year-long cane crushing activity due its footprint in Brazil and of course, India. It’s production facilities are located on opposite sides of the planet really and therefore SRS can take advantage of complementary crushing seasons and ride out the seasonality which usually applies to the India only producers. There’s another benefit of this geographical spread. The Indian Government very actively intervenes in the markets to regulate the price of sugar. The Government stipulates export quotas on the sugar producers so that they do not end up dunking their stocks on the highly lucrative global sugar market. While international sugar prices have dropped hugely of late, the export market still commands a premium (and therefore higher realizations). Click here to see how international sugar prices have moved over the past 30 years. In the medium term, the investment logic seems to be solely centered around better numbers from their Brazilian units.

Over the last 4 – 5 years, the company has done well. It has upped the scales and managed to transform itself into a global giant throwing up an average Return on its Equity of 32% and a CAGR EPS growth of nearly 20%. SRS is amongst the top 10 sugar producers in the world. Also note that SRS is NOT a media, software, banking industry company. It operates in a very cyclical industry. So to have such figures in the CAGR leaderboard is very noteworthy and impressive and picking up the Brazilian units shows a lot of foresight and conviction on the part of the owners. I am ploughing trough the latest annual report as I type – reading some bits from it, watching YouTube videos of the founder and looking at some sundry opinion available on the net, it does appear that the management is quite level-headed (read small investor friendly/neutral).

I seem to be veering towards taking a long-term view on this company. In the short to medium term the company may not may not provide succor. International sugar prices rose sharply in June and are likely to remain flat for the remainder of the year. The Indian government is certainly doing its bit it in terms of keeping the international prices down by relaxing the export restrictions in place for domestic sugar millers. Check out this recent article in the Business Line which explains the impact of Government’s intervention in the domestic market and the changes anticipated. There is a word of caution though – this year the Government did relax the export restrictions on domestic sugar producers but I did read somewhere that SRS does not seem to have met its full export potential. Full decontrol and therefore letting market forces dictate prices means that the Indian sugar producers will have to become more nimble in production and mechanize/automate the way the Brazilian industry has done. Which would mean more capital investments.

The last point above brings me to one of my key concerns here: how will SRS handle its debt. While the Brazilian units that SRS acquired give a far better realization than its Indian factories, the acquired units had loads of debt on their books which came into SRS’ fold. The key is for the international sugar prices (and also oil prices) to hold high enough for a quick surge of cash flows into SRS’ Brazilian ops so that much of that debt can be retired quickly. The debt driven acquisition of Brazilian operations resulted in an increase in interest outgo by around seven times and also increased the depreciation charge five times over.

At a market price of INR 70, the stock representing a discounting of 7 – 8 times its trailing 12 month earnings. Other domestic India producers are currently trading at higher comparable discount factors. The reason why it has been hammered down considerably more as compared to the North Indian sugar companies is because its high-margin Brazilian ops did not contribute as much as they were expected to do. Net, net I think SRS could be a nice compounder and give a decent α above market returns over a 3 – 5 year period. But I am guessing that there will be a lot of swings on this counter. Hopefully 50 – 55 is a support level and therefore presents a good entry point.