sugar sector report1

8/4/2019 Sugar Sector Report1

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HDFC Securities Limited, Trade World, C. Wing, 1st Floor, Kamala Mills Compound, Senapati Bapat Marg,

Lower Parel, Mumbai 400 013 Phone: (022) 66611700 Fax: (022) 2496 5066

India

Research

Sanju VermaExecutive Director& Head - Institutional [email protected] 1859

September 12, 2008

Initiating Coverage

Sugar Sector

Sweet Revenge...

Sugar

Mukesh [email protected] 1753

Pranika [email protected] 1919


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Sugar Sector

September 12, 2008 Page 2

Table of Contents

Page No.

Executive Summary .......................................................................................................................................................................... 3

Snapshot and View .......................................................................................................................................................................... 6

Peer Comparison ........................................................................................................................................................................... 10

Factors Impacting Sugar Prices .................................................................................................................................................... 12

SWOT Analysis ............................................................................................................................................................................... 13

Porters Five Forces Model ............................................................................................................................................................. 14

Key Government Regulations ........................................................................................................................................................ 15

Indian Sugar Industry ..................................................................................................................................................................... 18

Ethanol Blending ............................................................................................................................................................................ 24

Global Outlook ................................................................................................................................................................................ 30

Companies

Triveni Engineering & Industries .................................................................................................................................................... 35

Balarampur Chini ........................................................................................................................................................................... 48

Bajaj Hindustan .............................................................................................................................................................................. 59


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Executive Summary

We initiate coverage on Bajaj Hindustan (BHL), Balrampur Chini Mills (BCML), and

Triveni Engineering & Industries Ltd (TRIL). Our Top picks in the sugar sector are Triveni

Engineering & Industries Ltd with a target price of Rs 178 (upside of 100% from CMP)

followed by Balrampur Chini Mills Ltd. with a target price of Rs 126 (upside of 39% from

CMP) and Bajaj Hindustan Ltd with a target price of Rs 224 (upside of 38% from CMP).

TRIL has a different product mix including engineering and sugar business hedging the

revenue model .We expect the companys top line to grow at 27% and bottom line at

76% CAGR over CY08E-10E. We believe the sugar industry will benefit from the positive

impact of both structural and operational changes in the international and domestic

markets and the turnaround in the sugar cycle. Higher crude prices, low domestic

inventory and lower production will ensure stable prices in the domestic market. Going

forward, we believe that the favorable dynamics of the sugar industry will prevail in the

coming two-three years.

Favorable outlook on domestic sugar scenario

Indian sugar industry is showing an up-trend. There is a significant improvement in

sugar price due to favourable demand-supply situation. Sugar prices have been

increasing from July 2008. Last year, prices had fallen nearly 28% to less than

Rs. 13 per Kg due to a surplus in the sugar market.

Higher competing crop prices, lower sugar prices during the last two years and

delayed payments to sugar growers by millers in CY07-08 will result in domestic

sugar production of ~21million tonnes (down by 20% YoY) for CY2008-09. Moreover,

the cyclic nature of Indian sugar production coupled with, tightness in domestic

wheat balance prompted the government to raise the minimum support price (MSP)

for the grain by 43% to Rs 1,000 per quintal in CY07-08 from 700 per quintal in

CY05-06, encouraging sugar farmers to switch to wheat planting.

Delayed monsoons in some parts of the country, mainly in Maharashtra has

contributed to a drop in sugar production of ~37% from 9.2 million tonnes to 6.2

million tonnes in CY08-09E. This figure can go as low as 5.2-5.7 million tonnes.

In UP too production is expected to drop by ~15% to 6.2 million tonnes in CY09E

from 7.3 million tonnes in CY08, mainly due to diversion of some cane growing

areas to other crops. This was due to arrears in payments and better realizations

from alternate crops, indicating the start of an up-trend in the sugar cycle. The

two states jointly account for ~60% of the sugar production in India.

Triveni Engineering & Industries

CMP Rs. 89.2

Target Rs. 178

Recommendation BUY

B loomberg Code TRE IN

Market Cap (Mn US$) 547.7

Balarampur Chini Mills

CMP Rs. 90.5

Target Rs. 126

Recommendation BUY

Bloomberg Code BRCM IN


Bajaj Hindustan

CMP Rs. 162.8

Target Rs. 224

Recommendation BUY

B loomberg Code BJH IN


Summary Valuations

Sales (mn) EBITDA margin% EV/EBITDA

CMP TP (Rs) Upside % Ratings CY08E CY09E CY10E CY08E CY09E CY10E CY08E CY09E CY10E

BHL 162.8 224 38% Buy 20182 29359 35430 19.1% 20.9% 22.4% 15.6 8.9 5.9

BCML 90.5 126 39% Buy 15338 18363 20982 23.1% 23.8% 24.7% 10.3 7.4 5.2

TRIL 89.2 178 100% Buy 17069 22707 27707 19.7% 23.6% 24.4% 9.9 5.6 3.6

Source : Company, HDFC Sec. Research


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Sugar Sector


World sugar production to decline in 2008-09

In 2008-09, world sugar production is forecast at 161.6 million tonnes, down 7.4

million tons YoY. It is expected to be short by 3.9 million tonnes against an

estimated consumption of 165.5 million tonnes. Higher sugar production in Brazil

of 16% (35.5 mn Tonnes in CY08-09E) and Thailand will be more than offset by

lower production in the rest of the world, particularly in the European Union and

India. Brazil, India, Thailand, and China together account for 50-55% of global

production and trade.

2008E

9.2

7.3

2.5

2

1

4.5

Maharashtra UP Karnatka

TN AP Others

2009E

6.2

6.2

2.8

2.5

1.32

Maharashtra UP Karnatka

TN AP Others

Total production 26.5 mn tonne Total production 21 mn tonne

Region-wise production

Share of global sugar production

0

20

40

60

80

100

120

140

160

180

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08E

2008-09P

(Mn.tons)

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

Global Production India Production India as % of Global Prod.

Sources: Crisil Research, USDA and Company research

Source : HDFC Sec. Research


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Sugar Sector


EV/EBITDA Band

0

5

10

15

20

25

30

2006 2007 2008 2009E 2010E

BCML BHL TRIL

Compelling Sector Value

With favorable industry dynamics going forward, we expect sugar prices to stay

firm.

We believe the sugar sector valuations do not factor in the favorable industry

dynamics going forward. Given this, we believe the valuation gap should converge

to its historical level during the peak of the cycle. With an improved businessoutlook for their business streams and by-products, we expect sugar companies

to outperform the market.

Value chain

Sugarcane

Juice Bagasse - 33% Press Mud - 2%

Sugar - 10% Molasses - 5% Exportable Power Bio Fertilizer

Rectified Spirit Biogas

Fuel Ethanol Industrial Alcohol Potable Alcohol

Primary by products

Emerging businesses

Levy Sugar Quota

(10 % of produce)

Free Sale Quota

(90% of produce)


Source : CRISIL, HDFC Sec. Research


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Sugar Sector


Snapshot & View

Triveni Engineering & Industries Ltd.

The company generates its income from different revenue streams including sugar,

distillery, cogen and engineering, enhancing its profitability during good market conditions

while protecting downside during troughs. We have valued the stock on EV / EBIDTA forsugar and engineering businesses separately. We have calculated our target price of

Rs 178 based on 7x EV/EBITDA for the sugar business and 7x EV/ EBITDA for the

engineering business on CY10E basis (9.87 x EV/EBITDA for CY09E), an upside of

100% over its CMP. At the current market price of Rs. 89.2, the stock is trading 8.3x

CY09E at EPS of Rs. 10.7 and 5.8x CY10E at EPS of Rs. 15.26.

We have based our valuation on a) Revenue growth at a CAGR of 27% in its

engineering business b) Revenue from different business segments that helps

to protect the margins of the company c) The up-trend in the sugar cycle d)

Healthy net profit growth at a CAGR of 75.8% in CY08-10E e) Significant

improvement in the debt-equity ratio of the company to 0.2x by CY10E from1.32x in CY08E, on the back of strong cash flows from operations

Key Assumptions

YE Sept 2008E 2009E 2010E

Cane crused (mn tonnes) 58.6 59.8 64.0

Sugar Bagged (LMT) 5.81 6.04 6.46

Sugar Sold (LMT) 5.51 6.54 7.45

Cane cost/ton(Landed) 1220 1370 1420

Avg Sugar prices(Rs/kg) 14.9 17.9 18.8

Recovery(%) 9.9% 10.0% 10.0%

Sales ( Mn ltrs)* 33.4 38.5 40.4

Distillery Realizations (Rs per litre) 21.5 24.5 25.5Unit Sold (Mn Kwh) 199 221 237

PPA (Rs /Unit) 3.01 3.05 3.09

Scenario analysis - CY09E

YE Sept Bear Base Bull

Cane Cost/ton(Rs) 1350 1250 1100

NSR(Rs/kg) 16.99 17.88 18.77

PAT (Rs in Mn) 1918 2759 3835

EPS in CY09E 7.44 10.7 14.88

Target Price 135 178 233

CMP 89.2 89.2 89.2

Upside (%) 51% 100% 161%Source : Company, HDFC Sec. Research


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Balrampur Chini Mills Ltd.

We expect net sales to increase by 20% and 14% to Rs.18, 363 and 20,982 million

with net profits of Rs.1, 611 mn and 2,606 mn in CY09E and CY10E respectively.

As cane costs are expected to increase going forward, we believe that firm

sugar prices, higher realisations from distillery products and higher capacities

would enable the company to improve profit margins. At the current market

price of Rs. 90.5, the stock is trading 14.9x CY09E at EPS of Rs. 6.1 and 9.2x

CY10E at EPS of Rs. 9.8. We have valued the stock on 7x EV / EBIDTA for CY10E

(9.6x CY09E) respectively with a target price of Rs. 126, an upside of 39% over its

CMP. We have based our valuation on a) Up-trend in sugar cycle resulting in

higher price realisation of sugar and by products b) Lower interest and

deprecation burden c) Strong EPS growth of Rs 4.7 to 9.8 from CY08E to CY10E

at a CAGR of 44%.

Key Assumptions

YE Sept 2008E 2009E 2010E



Sugar Sold (LMT) 7.70 8.11 8.92



Recovery(%) 10.1% 10.0% 10.0%

Sales ( Mn ltrs)* 78.6 80.0 84.0

Distillery Realizations (Rs per litre) 21.0 24.0 25.5

Unit Sold (Mn Kwh) 570 513 549

PPA (Rs /Unit) 3.03 3.07 3.11

Scenario analysis - CY09E



NSR(Rs/kg) 16.99 17.88 18.77

PAT (Rs in Mn) 592 1612 2900

EPS in CY09E 2.23 6.07 10.92


CMP 90.5 90.5 90.5

Upside (%) -15% 39% 108%



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Bajaj Hindustan Ltd.

We expect the revenue of BHL to grow at a CAGR of 26% over CY08-10E from Rs.

20,182 mn in CY08 to Rs 35,430 mn in CY10E due to increasing sugar prices, higher

realisations from distillery products and higher capacities that would also help improve

profitability margins.

At the current market price of Rs. 162.8, the stock is trading 23.7x CY09E at EPS

of Rs. 6.88 and 9.4x CY10E at EPS of Rs. 17.39. We expect revenues to grow by

a CAGR of 26 % in CY08-10E. We have valued the stock on 7x EV / EBIDTA for

CY10E and 10.34x for CY09E respectively with a target price of Rs. 224, an upside

of 38% over its CMP. We have based our valuation on a) Higher cash flows from

operations in CY09E and CY10E that will result in paying off existing debt and

lower the interest burden b) Higher operating profit growth at a CAGR of 43.5%

in CY08-10E c) Improvement in ROE and RoCE going forward. However, with

almost double the plant size of any other company, Bajaj Hindustan is the largest

sugar manufacturer in India with a capacity of 136,000 TCD. But, during the

current year, the sugar production of the company decreased in spite of an

increase in plant capacity by 40000 TCD. We believe that at this point when

availability of cane for crushing is expected to be lower for next season, there

could be lower utilisation of plant capacities with the higher fixed cost expenses,

which may impact the profit margins of the company.

Key Assumptions

YE Sept 2008E 2009E 2010E

Cane crused (Lac tonnes) 117.6 122.2 130.8

Sugar Bagged (LMT) 11.87 12.22 13.08

Sugar Sold (LMT) 10.77 12.89 14.67


Avg Sugar prices(Rs/kg) 14.9 17.9 18.8Recovery(%) 10.1% 10.0% 10.0%

Sales ( Mn ltrs)* 130.0 136.5 146.1



PPA (Rs /Unit) 3.01 3.05 3.09

Scenario analysis-CY09E



NSR(Rs/kg) 16.99 17.88 18.77

PAT (Rs in Mn) -488 1050 3013

EPS in CY09E -3.2 6.88 19.73


CMP 162.8 162.8 162.8

Upside (%) -61% 38% 164%



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Capacity expansion ramp up to capture value of top eight companies:

Sugar (TCD) Disti llery (KLDP) Cogen (MW)

Bajaj Hindustan Ltd. 1,36,000 800 184

Balrampur Chini Mills 76,000 320 164

Triveni Engineering & Ind. Ltd. 61,000 160 68

Dhampur Sugar 39,500 140 125Bannari Amman Sugar Ltd. 14,000 60 56

Shree Renuka 25,500 450 104

Shakti Sugar Ltd. 18,500 200 120

EID Parry (India) Ltd. 24,500 240 127

Global Peer Revenue Mix Comparison

Company Name Sugar Distillery Power Other

Brazilian players

Cosan SA 61.4% 32.9% 5.7% -

Sao Martinho SA 38.4% 56.6% - 5.0%

Acucar Guarani 77.1% 16.3% 1.3% 5.3%

Indian Players

Balrampur Chini Mills Ltd 78% 10.8% 11.2% -

Bajaj Hindustan Ltd 82.1% 13.8% 2.2% 2.0%

Triveni Engineering & Industries Ltd 51.6% 4.2% 4.8% 39.4%


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Sugar Sector


CompanyName

MarketC

ap

(mn)

Sales(mn)

EBITDA

Margin

EV/EBITDA

P/E

Current

2007

2008

2009E

2010E

2007

2008

2009E

2010E

2007

2008

2009E

2010E

2007

2008

2009E

2010E

Brazilian

players

CosanSA

2851.88

1680.00

1498.00

2054.90

27

09.82

30%

11%

19%

26%

7.44

26.72

11.44

6.17

19.441

51.78

41.05

19.24

SaoMartinhoSA

1286.57

356.08

383.66

512.93

6

47.78

14%

-9%

25%

31%

NA

22.32

14.64

9.32

NA

NM

NA1100.00

AcucarGuarani

593.03

375.1

458.78

648.86

7

45.14

18%

-3%

14%

18%

NA

NA

11.33

7471.00

NA

NM

63.70

45.50

Indian

Players

BalrampurChiniMills

550.5

331.36

365.19

437.21

4

99.57

7%

23%

24%

25%

3

8.80

10.30

7.43

5.18

NM

19.2

14.9

9.2

BajajHindustan

548.1

423.93

480.52

699.02

8

43.57

11%

19%

21%

22%

2

9.39

15.60

8.93

5.901194.6

NM

23.7

9.4

TriveniEngineering&

Industries

547.7

454.10

406.40

540.64

6

59.69

13%

20%

24%

25%

1

3.39

9.95

5.58

3.61

NM

18.1

8.3

5.8

G

lobalPeerComparision

Source:Bloomberg&HDFCresearch


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Sugar Sector


Peer Comparison

Balrampur Chini Bajaj Hindustan Triveni Engineering

CMP (Rs.) 90.5 162.8 89.2

Target price 126 224 178

Upside 39% 38% 100%

No. of shares (Mn) 255.5 141.41 257.88

Mkt Cap.(Rs bn) 23.1 23.0 23.0Rating BUY BUY BUY

Crushing capacity(TCD) 76,000 136,000 61,000

Distillery Capacity ('000) 320 800 160

Exportable Cogen Capacity (KL/day) 126 105 44

Sales (Rs. Million)

CY07 13,917 17,805 19,072

CY08E 15,338 20,182 17,069

CY09E 18,363 29,359 22,707

CY10E 20,982 35,430 27,707

CAGR (CY08-10E) % 17.0% 25.6% 27.4%

EBITDA (Rs.Million)

CY07 923 1,907 2,447

CY08E 3,538 3,855 3,357CY09E 4,378 6,148 5,350

CY10E 5,187 7,939 6,764

EBITDA margin(%)

CY07 6.6% 10.7% 12.8%

CY08E 23.1% 19.1% 19.7%

CY09E 23.8% 20.9% 23.6%

CY10E 24.7% 22.4% 24.4%

PAT (Rs. Million)

CY07 (418) 21 754

CY08E 1,207 (124) 1,274

CY09E 1,612 1,050 2,759

CY10E 2,722 2,656 3,981

CAGR (CY08-10E) % 47% NM 75.8%

EPS (Rs)

CY07 (1.69) 0.14 2.92

CY08E 4.72 (0.81) 4.94

CY09E 6.07 6.88 10.70

CY10E 9.82 17.39 15.26

EV/ EBITDA

CY07 38.1 29.4 13.4

CY08E 10.3 15.6 9.9

CY09E 7.4 8.9 5.6

CY10E 5.2 5.9 3.6

ROCE (X)

CY07 1.0% 1.2% 9.7%

CY08E 10.0% 3.1% 13.9%

CY09E 13.9% 7.6% 25.3%CY10E 20.6% 12.6% 34.2%

RoE

CY07 -4.7% 0.1% 11.2%

CY08E 12.2% -0.9% 15.9%

CY09E 13.6% 7.1% 26.4%

CY10E 18.9% 15.3% 27.9%

Debt-Equity ratio

CY09E 0.85 2.31 0.67

Replacement Cost (Rs Bn) 44.3 81.9 31.9

EV/ Replacement Cost 0.83 0.74 1.05



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Sugar Sector


Lower area under sugar cane culivation

Arrears in payments

Dependence on Monsoon

Increase in sugar consumption

Government intervention to control prices

World sugar production to decline

Brazil shifting more & more cane to ethanol

Withdrawal of EU subsidy

Factors Impacting sugar prices

View

Drop in area under sugar cane cultivation expected from 52.4

lakh hectares in CY08E to 42 lakh hectares in CY09E due to

farmers switching to other crops

Arrear in payments to the farmers results in diversion of cane

growing areas to other crops resulting in less cane avaliabilty for

crushing next season and lower production

Being an agricultural commodity, sugar cane is exposed to

adverse weather conditions, pest attacks and crop failures.

Therefore, any significant change in production estimates due to

poor monsoons among other things, can decrease inventory and

increase sugar prices and vice versa

Expected growth in sugar consumption at a CAGR of 5% and

drop in production by 20% in CY08-09E will reduce the stock to

use ratio

Risk of government intervention to control the prices to curb

inflation and stablise the sugar prices in the domestic market

Lower production is forecast at 161.6 million tons, down 7.4

million tons YoY and is not expected meet consumption, falling

short by 3.9 million tons in CY08-09.

Brazil, the largest producer of sugar, is expected to divert more

sugarcane in 2008-09 to produce ethanol rather than sugar, due

to strong demand for ethanol in the domestic and international

markets. In, 2008-09 Brazils sugar-ethanol mix is expected to be

43% and 57% percent, respectively, compared to 46% and 54%

percent for CY2007-08

In view of the structural changes in the global white sugar trade

with the exit of the EU, India has a strategic advantage of

location for exporting to new markets

Impact on Sugar prices

Global Factors

Domestic Factors


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Sugar Sector


Swot Analysis

S

W

O

T

A

N

A

L

Y

S

I

S

Strengths

India is unique because if its large domestic market and low dependence on exports

Signs of up-trend in the sugar cycle

Focus on the socio-economic development of rural India

Low domestic inventory to ensure stable prices in the country

Integrated business model of the mills helps them earn higher margins due to value addition

and mitigates the risk of a downturn in the sugar business

Better prices for sugar and its by-products

Weaknesses

Highly exposed to sugar price volatility: ~30%, 14% and 66% EPS sensitivity to 5% change

in prices for Balrampur, Triveni and Bajaj Hindustan respectively in CY09E.

Volatility in sugarcane prices with ~21%, 10% and 51% EPS sensitivity to 5% change in

sugar cane prices in Balrampur, Triveni and Bajaj Hindustan respectively in CY09E

Opportunities

Growth in consumption to drive the demand for sugar

Formula based cane pricing will provide stability to the companies on the issue of cane

cost which accounts for ~70% of its operating cost

Dismantling of the 10% levy imposed on mills along with the monthly release mechanism

regulating the balance 90% free sale quota

Export opportunity to new global markets - Pakistan, Indonesia, Bangladesh, Middle East,

Sri Lanka and other Asian countries

Increasing demand for ethanol due lower prices at Rs 21.5 per litre and higher petrol prices

currently at ~ Rs 50 per litre (~ 133% costlier than ethanol)

Threats

Government regulation is a key risk to the industry

Lower sugarcane drawal rate by millers - drawal rate is expected to be as low as 45-50%

in CY08E Dependence on ground water for irrigation.

Diversion of cane area to alternate crops due to arrears in payments

The government capping sugar price increases, or curtailing exports can depress the domestic

price of sugar

Governments attempt to control rising inflation by curbing sugar prices .

Fall in the sugar prices in both international and domestic markets


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Sugar Sector


Porter's Five Forces Model

Barriers To Entry

Medium

Integrated business model and increasingcapital requirement in the industry restrict new

entrants. The Govt. used to give incentives

to set up new plants by granting higher free

sales quota for the first five to eight years of

operations that had led to mushrooming of

small units. This incentive has been

withdrawn and the new sugar units are

required to comply with the levy quota

regulation from first year of operations.

Bargaining Power of

Suppliers - High

Allocation of the area from where

the sugarcane can be procured is

allocated by the govt. The millers

have no choice but buy from those

farmers. Moreover, the purchase

price (SMP/SAP) is decided by the

govt. to protects the interest of the

sugar cane farmers.

Threats of Substitutes

Low

Being an essential commodity the

demand for sugar is not elastic.

Alternate sweeteners to refined

sugar in India are gur and

khandsari. Share of gur and

khandsari is declining due to more

uti l isation of sugarcane for

production of sugar

Inter Firm Rivalry

High to Intense

With around 400 units engaged in

production of sugar, the industry is

highly fragmented. Private Individual

players do not have big market share.

Cooperatives are relatively high as

they account for more than 50% of

the industrys production.

Bargaining power of Buyers

Low

Indian sugar market is highly regulated bythe Govt. influencing distribution, purchase

price of levy sugar and the free sale quota

releases for sugar.


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Sugar Sector


Current Government Regulations

The current regulatory environment in India for sugar has five major aspects. These are:

Reservation of cane area- The command area allocates a specific area to a mill

for cane procurement. Farmers within the allocated area have the option of registering

with the mill for cane supply. In case the farmer registers a specific quantity or

acreage of cane, he is legally bound to deliver that quantity of cane from the

registered acreage to the mill after harvest. If the farmer does not register, he is

free to sell the cane to any buyer. The mill cannot register cane from outside the

allocated area. The command area is allocated on a permanent basis though the

government may re-allocate the area, if required. At present, the mandatory distance

between mills is set at 15 km. No new mill can be set up at a distance of less than

15 km from an existing mill.

Our View: we believe that the long term allocation of command area will incentivize

the development of a long term relationship between farmers and millers and

government should continue with the mandated command area. However, cane

requirements for capacity expansion under implementation should be taken into

account for defining a command area

Cane pricing- The cane pricing mechanism determines the cane price that the

farmer receives. In some states, sugar mills pay the (Statutory Minimum Price)

SMP announced by the Central Government, while in others, mills pay on the

basis of the (State Advised Price) SAP declared by the State Governments. Though

the SAP is significantly higher than SMP, the key difference is that in SMP, there

is a linkage between cane price, recovery rate of cane, and the price of sugar, but

in SAP, there are usually no such linkages.

Our View: We believe that the state government should come up with a formulabased pricing, linking cane prices to the price of sugar, byproducts and other

factors affecting the sugar industry to determine cane prices to enable equitable

distribution of profits and to share the risk between farmers and millers. Depending

on the structure of the formula, it could also incentivize efficiencies both at the mill

and farm levels. It could act as an effective price signal to farmers if there is a

strong linkage with output prices

Monthly release mechanism- monthly release mechanisms are monthly releases

given by the government to each mill that determine the quantity of sugar that

must be sold by the mill in the release period. At present, releases are given on amonthly basis to mills across India. In the recent past, several mills have sought

legal intervention to sell sugar over and above the release quantities in the free

market. The release mechanism enables the government to influence prices in

the domestic market by regulating supply, and is aimed at ensuring consistent

availability of sugar throughout the year at a balanced price.


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Sugar Sector


Our View: We believe monthly release mechanism should be removed. Mills

should have the freedom to sell any quantity of sugar in the free market. The

decision of the mills to sell sugar should be determined by their view of current

and future prices and the cost of holding inventory. We believe that strategic stock

should to be used for market intervention to maintain sugar price within a sustainable

band

International trade regulations - regulations for international trade include tariff-

based restrictions like import duties and export subsidies as well as non-tariff

restrictions like export bans. In the past, India has successfully been able to

address domestic shortages through raw sugar imports, which were refined by

mills for sale in the domestic market. In the future, these can be considered in

case of domestic supply shortages, due to production variations. International

trade restrictions enable the government to influence prices and availability in the

domestic market through supply control.

Our View: Indias credibility as a global trading partner could be enhanced,enabling the industry to enter into long-term commitments. Industry players would

be able to leverage exports opportunities for for managing domestic surplus. But,

the removal of non-tariff restrictions could lead to the risk where attractive export

opportunities may be tapped reducing domestic supplies leading to high prices.

Given a stable tariff policy, domestic prices would tend to move in tandem with

world prices and would be contained within the band of export parity price and

import parity price

Levy sugar - Levy sugar is procured by the government where 10 percent of the

mills production is earmarked for supply through the Public Distribution System

(PDS). The levy sugar is procured at the levy price that is set by the government

based on the cost of production and allowing a reasonable margin for the mills.

The levy price has typically been lower than the free market price in the past. The

current subsidy for levy sugar is made up of various components and is shared

between the mills and the government. The difference between the levy price and

the free market price is borne by the mills. Levy sugar enables the government to

supply sugar through the PDS and ensure the availability of sugar at affordable

prices.

Our View: We believe that Levy sugar should be discontinued and sugar for PDS

should be procured through the free market. Ending the practice will increase the

economic benefits of the sector, while addressing the social objectives of consumer

protection. It will also help sustain both mills and farmers by shifting the subsidy

cost from them to the government.


17/72

Sugar Sector


Key Risk

Highly regulated industry: Although export restrictions and duties have gradually

been relaxed, the government still largely controls the industry, particularly the

pricing of sugarcane and allocation of land designated for cane growing. This is

because sugar has been classified as an essential commodity. This policy has

in turn affected the economics of sugar production in India.

Governments attempt to control prices: Government attempt to control the

sugar prices mainly due to rising inflation may adversely affect the industry.

Mismatch between SMP and SAP: As an essential commodity, the government

continues to regulate the sugar industry. The pricing and supply of cane is regulated

through reservation of cane area and the government fixes the mandatory cane

price. In some states, sugar mills pay the (Statutory Minimum Price) SMP

announced by the Central Government, while in others, mills pay on the basis of

the (State Advised Price) SAP declared by the State Governments. Though the

SAP is significantly higher than SMP, the key difference is that in SMP, there is a

linkage between the cane price, recovery rate of cane, and the price of sugar, but

in SAP, there are usually no such linkages.

Cyclical commodity: Sugar is a cyclical industry and volatile in nature. In India,

sugar production follows a two-four year cycle. Higher production leads to increased

availability of sugar thereby declining the sugar prices. This leads to lower

profitability of the companies and delayed payment to the farmers. As a result of

higher sugarcane arrears, the farmers switch to other crops thereby leading to a

fall in the area under cultivation for sugar. This leads to lower production and lower

sugar availability. This is then followed by higher sugar prices, higher profitability,

lower arrears and thus this cycle continue

Delay in judgment: Delay in judgement on the Sugar Cane Pricing issue in UP

can affect the next cane crushing season SS09, due to the uncertainty over cane

prices to farmers and millers alike.

Climatic uncertainty: As an agricultural commodity sugar cane is exposed to

adverse weather conditions, pest attacks and crop failures. Therefore, any

significant change in production estimates due to better monsoons among other

things, can increase inventory and suppress sugar prices.


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Sugar Sector


Indian Sugar Industry

Sweet reversal for sugar

Higher competing crop prices, lower sugar prices during the last two years and delayed

payments to sugar growers by millers in CY07-08 will result in domestic sugar production

of ~21million tonnes (down by 20% YoY) for CY2008-09.Moreover, the cyclical nature of Indian sugar production, coupled with tightness in

domestic wheat balance, prompted the government to raise the minimum support price

(MSP) for the grain by 43% to Rs 1,000 per quintal in 07-08 from 700 per quintal in 05-

06,

Delayed monsoon in some parts of the country including Maharashtra contributed to

the drop in sugar production. A drop of ~37% in production is expected in Maharashtrafrom 9.2 million tonnes to 6.2 million tonnes in CY08-09E. This can go to as low as 5.2-

5.7 million tonnes mainly due to poor monsoon and diversion of cane crop for non-sugar

use. In UP also, production is expected to drop by ~15% to 6.2 million tonnes in

CY09E from 7.3 million tonnes expected in CY08 mainly due to the diversion of area

under cane to other crops due to arrears in payments and better realizations from

alternate crops. The states jointly account for ~60% of the sugar production in India.

Increasing sugar prices, lower availability of cane and lower than expected sugar

production are clear indicators of the up turn in the sugar cycle which we expect to stay

for at least 2-3 years

Sugar Industry Cycle

Source : Crisil

Rs per quintal 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 CAGR 06-08

Wheat (MSP) 620 630 630 640 700 750 1000 61%

Sugarcane (SAP) 95 95 107 107 115 118 110 16%

Trend of Wheat and Sugarcane Prices

Source : ISMA & Industry


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Sugar Sector


Sugar prices moving northwards

Sugar prices have recovered significantly in the last two-months due to a shift in

the demand-supply dynamics, both at the international and national levels for

2008-09 and 2009-2010.

World sugar prices will firm up due to the diversion of more and more cane to the

production of ethanol by Brazil, EU reforms, lower sugar production and highercrude prices. Low domestic inventory will ensure stable prices in the country.

We have assumed ex-factory sugar price of Rs17.90/kg in our CY08E-CY09E earnings

estimates for BJH, Triveni Engineering and BRCM on a conservative basis, though we

expect prices to be higher than this level.

Domestic Demand - Supply

0

5

10

15

20

25

30

2003-04 2004-05 2005-06 2006-07 2007-08E2008-09P2009-10P

mntons

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

Production Off-take Stock-to-use(%)

Source: ISMA, Crisil Research and HDFC Research

Domestic Sugar Prices

-

500

1,000

1,500

2,000

2,500

Oct-99

Feb-00

Jun-00

Oct-00

Feb-01

Jun-01

Oct-01

Feb-02

Jun-02

Oct-02

Feb-03

Jun-03

Oct-03

Feb-04

Jun-04

Oct-04

Feb-05

Jun-05

Oct-05

Feb-06

Jun-06

Oct-06

Feb-07

Jun-07

Oct-07

Feb-08

Jun-08

Mumbai M-30 Delhi M-30

Govt. raisedthe import dutyto 60%

Production ofsugar droppedby 31%

World sugarsupply deficitfor 3rdconsecutiveyear

Stock to useratio droppedto 18% from24% last year

sugar surplusin the market

Source : Bloomberg, HDFC Sec Research


20/72

Sugar Sector


Source: CMIE

Difficult two years for the industry

Two years ago, being a sugar company in India was a bland proposition. Two consecutive

years of record sugar production (2005-06 & 2006-07) resulted in abnormally high stocks

and low sugar prices, leading to a financial crisis in the sugar industry. This crisis

manifested itself in payment delays to cane farmers with the cane arrears ballooning to

Rs. 25.5 billion ($ 638 million) by the end of 2006-07.

Although the government initiated a series of fiscal relief measures like offering a subsidy

on sugar exports and easing the working capital requirements of the sugar mills, they

were inadequate in mitigating the situation as mills continued to be under pressure to

clear cane price arrears.

Sugar Consumption To Grow at 4%-4.5%

Indian sugar consumption is expected to grow steadily at 4%-4.5% per annum. Sugar

consumption is primarily driven by population growth and rise in per capita consumption

which is expected to increase at 1.51% and 2.1% CAGR respectively. In 2008-09 SS

domestic sugar consumption is projected to touch 23.5-24 million tonnes.

As the worlds largest consumer and second largest producer of sugar, any major

development in India (as in Brazil) can have a significant impact on the global sugar

market.

Production Production Exports Exports Imports Imports Prices Prices

(small grade(small grade

Mumbai) Mumbai)

( 000 tonnes) (% change) ( 000 tonnes) (% change) ( 000 tonnes) (% change) (Rs/quintal ) (% change)

Jul-07 224.20 35.06 311.49 62.11 0.05 24.32 1372.51 -26.75

Aug-07 210.40 2.14 380.86 1515.06 0.04 -93.75 1327.72 -29.00Sep-07 239.00 16.02 304.19 383.55 0.02 -37.50 1356.49 -24.94

Oct-07 326.20 6.36 353.95 2126.37 0.02 214.29 1379.02 -22.52

Nov-07 1450.30 -40.17 252.25 811.41 0.01 -51.61 1358.04 -22.71

Dec-07 4656.30 0.27 411.25 3821.90 0.02 120.00 1356.28 -17.49

Jan-08 5359.80 7.86 554.85 1074.50 0.01 650.00 1421.85 -8.76

Feb-08 5145.10 11.17 496.56 241.69 0.02 340.00 1410.36 -4.47

Mar-08 4627.90 -2.95 654.14 111.72 0.02 -63.64 1509.12 -0.16

Apr-08 2552.10 -29.63 1500.12 3.90

May-08 1313.00 -25.48 1478.93 10.65

Jun-08 386.00 -22.97 1478.54 10.81

Jul-08 1579.68 15.09

Oct-Jun Oct-Jun Oct-Mar Oct-Mar Oct-Mar Oct-Mar Oct-Jul Oct-Jul

2006-07 27630.10 47.84 555.58 94.01 0.10 -98.48 1521.42 -19.51

2007-08 25816.70 -6.56 2722.99 390.11 0.11 13.13 1447.19 -4.88

Apr-Mar Apr-Mar Apr-Mar Apr-Mar Apr-Mar Apr-Mar Apr-Mar Apr-Mar

2007-08 28128.90 16.71 4641.14 182.41 0.51 -51.15 1383.84 -21.17

Sugar Statistics : Production, Exports and Prices


21/72

Sugar Sector


Consumption

5,000

10,000

15,000

20,000

25,000

30,000

2004

2005

2006

2007

2008E

2009F

2010F

2011F

2012F

2013F

MillionT

onnes

Source: FAPRI 2008 Agricultural Outlook (Figures for 2007-08)

Per capita sugar consumption in India among the lowest:

Sugar consumption per capita is determined by the real consumer price of raw sugar

and income per capita. Total demand is the product of per capita consumption andpopulation. Per capita consumption of sugar in India is among the lowest in the world.

It is expected to be around 20 kgs per annum in 2007-08, far below the per capita

consumption for Brazil, which is around 58 kgs per annum.

We believe that with rising income levels and growing demand for sugar by retail producers

(mainly the processed food industry), the consumption of sugar will increase.

Per Capita Consumption 2007/08 E

0

10

20

30

4050

60

70

Brazil

Mexico

Australia

Thailand

EU

USA

SADC

India

China

Kilogramsperan

num

Source: Illovo Sugar


22/72

Sugar Sector


Inverse relation between Stock-to-use Ratio and sugar prices:

0

200

400

600

800

1,0001,200

1,400

1,600

1,800

2,000

2004 2005 2006 2007 2008E 2009F 2010F

0%

5%

10%

15%

20%

25%30%

35%

40%

45%

50%

Sugar Prices Stock-to-use(%)

Sugar prices are inversely proportionate to the Stock-to-use Ratio. Prices tend to increase

with a drop in Stock-to-use Ratio, and vice versa. As the inventory level starts to deplete,

sugar prices start to move up with the expectation of lower supply in future.

International trade

India is unique because of its large domestic market. While all major sugar producers

rely on exports, Indias dependence on the world market is marginal and its is largely

insulated from global price movements.

The Brazil and EU dominate the world sugar trade. Brazil, Australia and Thailand are

the major sugar exporting countries. While Brazil exports ~55% of its production,

Australia sells ~ 71% of its production in the international markets. India has mainly

used the world market to balance its surplus and deficit, as it is self sufficient in sugar.

Great potential for India

India has a huge opportunity to export to the new global markets that emerged after the

withdrawal of EU subsidy, making exports from EU countries less competitive. Moreover,

increasing diversion of cane for ethanol in Brazil will provide India an opportunity to

stabilize its position as a credible exporter in the global market. In 2008-09 EU countries

are expected to be net sugar importers of 2 million tonnes. India is well positioned to

export to major Indian Ocean markets including Pakistan, Indonesia, Bangladesh, Middle

East, Sri Lanka and other Asian countries due to its freight competitiveness over Brazil

or Thailand due to its geographical proximity. India can exploit these opportunities

through strengthening its export infrastructure.

Source : ISMA & Industry


23/72

Sugar Sector


Integrated sugar model

A new transformation is taking place in sugar companies as they are exhibiting a

Darwinian ability to adapt, morph and survive by exploring different product mixes and

alternate sources of revenue. So much so that many of these are looking less like

traditional sugar companies and more like alternate energy companies of the future.

The companies are looking forward to have a balanced portfolio of sugar, alcohol and

power, which will enable factories to be profitable, offer stable revenue streams and pay

farmers a remunerative price on time. By opting for an integrated business model, the

mills earn higher margins due to value addition and partially mitigate the risk from a

downturn in the sugar business and price volatility.

Sugarcane

Extraction of juice

Clarification of juice

Evaporation

Pan-boiling

Crystalisation

Centrifugation

White Sugar

Pressmud

Bagasse

Recovery Molasses

Co-generationof power

Industrial andpotable alcohol

Production process

Source : CRISIL


24/72

Sugar Sector


Ethanol blending program and India

India has the potential to expand its ethanol biofuel production using its vast sugar

cane resources, but many challenges lie ahead.

India is the worlds second largest producer of sugarcane, but remains a marginal

producer of fuel ethanol, which is derived from biomass such as sugarcane, and

relies heavily on expensive fossil fuel imports.

Soaring crude oil prices offer strong incentives to investors to seek cheap alternative

forms of energy, such as ethanol. The Central governments Gasohol Programme

of blending 5% ethanol in petrol has increased the scope of the ethanol industry in

the country. The central government has endorsed the increase of the ethanol-

blending mandate from 5% to 10 percent in October 2008. The country is scheduled

to move to E10 in October 2008 at the beginning of the next sugar season.

We feel India is far from ready for the E10 mandate unless Indian policy gives

strong incentives for biofuel investments. Oil companies were directed to begin

blending E5 in October 2006 but have not procured enough ethanol to meet the

mandate due to low production of ethanol by sugar companies. Following the

imposition of an E5 mandate in October, oil companies have blended only 58

million gallons, compared to the 145 million gallons required under the mandate.

Prices for other molasses based products have increased significantly in last 3-4

months while ethanol prices have been fixed at Rs 21.5 per liter for three years.

We believe, unless ethanol prices are allowed to rise, sugar companies will not be

too keen to produce ethanol.

The companies are willing to renew their contracts for ethanol supply with oil firms

only at increased prices. Moreover, with lower sugar cane availability in the coming

years, the chances of the success of 10% blending at the current price of Rs 21.5

per litre will further reduce.

The government of India has also allowed producing ethanol directly from sugar cane

juice. This will provide flexibility to change the product mix from sugar to ethanol by the

companies on the basis of demand and realization for the products. But the direct route

to produce ethanol is not feasible currently due to higher cane price of Rs 1200-1400

per tonne in India. In Brazil, ethanol is produced directly from sugarcane due low cane

and processing costs. We believe there will be a potential rise in ethanol prices to meet

the demand-supply situation that will offer more revenues to sugar companies.

Ethanol Demand in India

in miliion Litres 2006-07 2007-08E 2008-09E

Demand for industrial use, Potable alcohol 1, 477 1,515 1,550

Demand at 5% blend in gasoline 682 741 808

Demand at 10% blend in gasoline 1,364 1,482 1,616

Total demand @5 per cent 2,159 2,256 2,358

Total demand @10 per cent 2,841 2,997 3,166

Source: Industry and Global Agriculture Information on Network, USDA


25/72

Sugar Sector


World Ethanol Production

-

10,000

20,000

30,000

40,000

50,000

60,000

2001 2002 2003 2004 2005 2006 2007

Brazil US China India EU Others

The global food dilemma along with the increase in demand for sugar ethanol will quickly

diminish the surplus in sugar. The Brazilian government adopted an aggressive bio-fuel

policy mandate over 30 years ago. Today, some 40 percent of its total transport fuelcomes from locally grown sugar cane turned into fuel for 75 percent of Brazils total

automobile fleet. Brazil produces ethanol at an impressive 40% of the cost that it takes

to produce costly corn ethanol in America. The demand for sugar ethanol is expected to

increase dramatically as people shy away from food based fuels. The growing interest

and demand for sugar based ethanol and worldwide food shortages are expected to

boost sugar prices.

Brazil shifting more & more cane into ethanol production

Brazil, the worlds second largest producer of ethanol, is expected to divert more

sugarcane in 2008-09 to producing ethanol, due to strong demand for ethanol in the

domestic and international markets. In, 2008-09 Brazils sugar and ethanol mix is

expected to be 43% and 57% percent respectively, compared to 46% and 54% percent

for 2007-08.

Ethanol and sugarcane yield evolution in Brazil

40

50

60

70

80

90

75/76 79/80 83/84 87/88 91/92 95/96 99/00 03/04 07/08E

Tonnes/hectare

2

3

4

5

6

7

0

00'sliters/hectare

Sugarane Production (ton/hec) Ethanol Production (ltr/hec)

Source: UNICA

Source: UNICA


26/72

Sugar Sector


Brazilian ethanol production is expected to reach 22 billion liters in the 2007- 08 and

46.9 billion literes in 2015-16, up 23% and 162% from 2006-07 respectively. Total ethanol

production for 2008/09 is projected at 25.7 billion liters (8.5 billion liters of anhydrous

ethanol and 17.2 billion liters of hydrated ethanol), up 3.7 billion liters from 2007- 08 (8.4

billion liters of anhydrous ethanol and 14.3 billion liters of hydrated ethanol).

Brazilian ethanol exports have a great window of opportunity due to the rising prices of

ethanol in America and weather problems in the USA.

Less sugar from more cane

World sugar production and consumption in 2008-09 are expected to be more evenly

balanced than in 2007-08, despite a 16 per cent increase in sugar cane production in

Brazil in 2008-09. This closer balance reflects an increasing proportion of Brazilian

sugar cane being diverted to ethanol production, rather than sugar production. A number

of major sugar producing countries are also expected to produce less sugar in 2008-09.

Worlds ethanol production for 2008-12

Ethanol production is expected to grow in 2008 - 2012 with a CAGR of about 5-

6%.

Worlds ethanol production is expected to pass 20 bn gallons by 2012.

New ethanol producers will emerge in Asia

Factors driving ethanol market:

High oil prices

Environmental concerns Lower cost of ethanol production

National energy security considerations

Renewable and clean source of energy

Source: UNICA

Brazil Sugarcane: Revenue Breakdown

56%

32%

42%

51%

1%16%

0%

20%

40%

60%

80%

100%

120%

2006-07 2015-16E

Sugar Ethanol Bioelectricity


27/72

Sugar Sector


World Ethanol Production Forecast 2008 - 2012 by Country,

Millions of Gallons 2008 2009 2010 2011 2012 CAGR, %

Brazil 4,988 5,238 5,489 5,739 5,990 2.80%

U.S. 6,198 6,858 7,518 8,178 8,838 5.70%

China 1,075 1,101 1,128 1,154 1,181 1.40%

India 531 551 571 591 611 2.20%

France 285 301 317 333 349 3.20%

Spain 163 184 206 227 249 6.90%

Germany 319 381 444 506 569 9.70%

Canada 230 276 322 368 414 9.90%

Indonesia 76 84 92 100 108 5.60%

Italy 50 53 55 58 60 2.80%

ROW 2,302 2,548 2,794 3,040 3,286 5.70%

World 16,215 17,574 18,934 20,293 21,653 4.60%

Source: USDA, Company Research

Growing focus on power

While Indias power requirements are growing by leaps and bounds, capacity additions

are lagging far behind. Co-generation of electric power through the by-product, Bagasse,thus offers an excellent opportunity for sugar mills to expand their earnings potential.

As Indias power requirement continues to surge, the sugar companies have discovered

that co-generation is a perfect way to balance their products and add to their revenue

base.

Moving into the power arena makes sound business sense. Companies will be getting

Rs 3.05-3.10 for every unit of electricity they generate. India currently suffers from a

power deficit and needs to enhance power generation capacities by 11% per annum to

support its economic growth. Therefore there is a ready market for the power generated

by sugar mills.

Major benefits

Stability to the companies revenue stream due to the non-cyclicality of the venture.

Availability of long duration, low cost loans from the Sugar Development Fund

(SDF)

Margins for power from bagasse is more than 30 per cent

Revenue from cogen is exempted from taxes and the business is eligible for carbon

emissions reduction benefits.

Fulfilling their own captive requirements

Decontrol still unlikely?

The Street is awash with speculation over a possible decontrol of the industry by October.

According to media reports, the decontrol of sugar industry is set to happen in phases.

The levy and the monthly release mechanism will be done away with in the first phase,

beginning October 1, this year. The draft note is reported to be under consideration

before the Food Ministry. The final draft will be forwarded to the Cabinet Committee for

consideration after getting inputs from the relevant ministries. But, given the 3.6% share

of sugar in the wholesale price index (WPI) in the manufactured food category, the

government, fearing further increase in the inflation rate will try to curb it in every possible

manner. Under the circumstances, we feel decontrol in near term will not be possible.


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Sugar Sector


Key Concerns for the Industry

Mismatch between SMP and SAP

As an essential commodity, the government continues to regulate the sugar industry.

The pricing and supply of cane is regulated through reservation of cane area and the

fixing of the mandatory cane price by the government.

In some states, sugar mills pay the Statutory Minimum Price (SMP) announced by the

Central Government, while in others, mills pay on the basis of the State Advised Price

(SAP) declared by State Governments. Though the SAP is significantly higher than

SMP, the key difference is that in SMP, there is a linkage between the cane price,

recovery rate of cane, and the price of sugar, but in SAP, there is usually no such

linkage.

Difference per quintal

SS SMP SAP Difference SAP Higher

than SMP %

2001-02 62.1 95.0 33.0 53%

2002-03 69.5 95.0 25.5 37%

2003-04 73.0 95.0 22.0 30%

2004-05 74.5 107.0 32.5 44%

2005-06 79.5 115.0 35.5 45%

2006-07 80.3 118.0 37.7 47%

2007-08 81.2 110.0 28.8 36%

Source: ISMA & industry


29/72

Sugar Sector


UP cane pricing Issue- more to pay

On Sep 8, 2008, the Supreme Court in its interim judgment ordered to pay Rs. 1100 per

tonne for sugar cane for CY07-08 . The judgment has come up as a relief to the mills in

UP. However, UP sugar units still face uncertainty in cane pricing until the courts final

verdict on the issue. This is because there are two conflicting High Court Judgments,

one relating to the quashing in 2006-07 of the SAP declared by UP government andanother of 2007-08, in which the SAP declared was upheld by the Lucknow bench of

Allahabad High Court. The judgment is expected to come soon by the Supreme Court,

as the pending issue of cane pricing will affect the next crushing season also. Pending

final verdict in this matter, cane price of Rs 1100 per tonne has been considered by the

companies for the season 2007- 08 subject to final adjustments following the Supreme

Court verdict. The companies favour a formula where cane price is explicitly linked to

specific parameters, i.e. prices of sugar and by-products, quality of cane and mill efficiency

where the framers and mills will benefit from the certainty in the prices and share the

burden in case of a downturn in the industry.

Another issue pending final order by the Supreme Court is the transportation rebate to

companies for cane purchased from other regions. In April 2008, Allahabad High Court

decided that the deduction should be revised from Rs. 5.75 per quintal of cane to Rs.

10.58 per quintal.

After final orders from the Supreme Court both framers and millers will get clarity on

cane prices for CY 07-08. But, the cane-pricing policy is influenced as much by political

as economic considerations. For instance, in the past, the UP government has raised

the SAP independent of sugar price levels. We expect to get more information on any

potential revision before the onset of the new crushing season. However, we have seen

that cane prices have shown an upward trend over the years whenever there was a

shortage in UP, which can significantly alter the demand-supply dynamics of the industry.

The difference between SMP and SAP for most states would not be significant, giventhe high price of sugar now and expected in CY09.

Though unlikely, any unfavorable judgment by the Supreme Court on the SAP issue will

affect margins of these companies.

Risk of Government intervention

The risk of government intervention if sugar prices rise as in July 2006 cannot be ruled

out. Government will keep a close watch on the domestic prices and will use its powers

to keep it at reasonable levels.

Climatic uncertainty

As an agricultural commodity, sugar cane is exposed to adverse weather conditions,

pest attacks and crop failures. Therefore, any significant change in production estimates

due to better monsoons among other things, can increase inventory and suppress

sugar prices.

Higher transport cost

Rising petrol and diesel prices can lead to higher cane prices due to higher cost of

transportation of sugarcane.


30/72

Sugar Sector


Global Outlook

Global sugar production for 2007-08 is expected to be around ~169 million tons, up by

around 2 million tons (or 1.20% YoY) and world consumption at 158 million tons (up

2.53% YoY). The production is 1.1 million tonnes less than anticipated earlier and

almost 2 million tonnes above the previous season. In CY2008-09 world production is

forecast at 161.6 million tons, down 7.4 million tons YoY and is not expected meet

consumption, falling short by 3.9 million tons. The downward revision is based on lower

than expected sugar output in Australia, China and India. (Source: Abare estimates)

World sugar production to decline in 2008-09

World production of sugar is forecast to decline to 161.6 million tonnes in 2008-09, after

169 million tones expected in CY2007-08. Higher sugar production in Brazil and Thailand

is forecast to be more than offset by lower sugar production in the rest of the world,

particularly in the European Union and India. Brazil, India, Thailand, and China account

for 50 percent of world production and trade.

Brazil

Brazilian sugar cane production is forecast to increase by 16 per cent in CY2008-09.

However, high world oil prices, favorable incentives for the use of ethanol as fuel and a

rapidly increasing fleet of flexi fuel cars in Brazil, mean the proportion of the cane

harvest going to ethanol production is forecast to increase to 57 per cent in CY2008-09,

compared with 53 per cent in CY2007-08. This implies an increase in Brazilian sugar

production of only 2.1 million tonnes in CY2008-09.

India

Indian sugar production is forecast to decline by 20%, in CY2008-09. This results from

widespread payment delays to sugarcane growers with the CY2007-08 crop and higherreturns for alternative crops, particularly rice, wheat, corn and pulses. The forecast

decline also reflects expected drop-offs in sugar yields related to the planting cycle for

Indian cane production.

European Union

Production of sugar from sugar beet in the European Union is forecast to fall to 15.6

million tonnes in CY2008-09, down from 17.7 million tonnes in the CY07-08. The main

cause of this decline is renunciations of quotas for sugar beet production, brought

about by incentives provided under the reform arrangements for the European Unions

Common Agricultural Policy for sugar. The level of quota renunciations had reached

5.65 million tonnes in May 2008, just short of the target 6 million tonnes.

China

Sugar output for CY2008-09 is forecast to reach 14.4 million tons, one percent lower

than in CY2007-08. Moreover, there is uncertainty because freezing temperatures

could have affected the sprouting rate of the new crop in CY2008-09. The industry and

farmers have not experienced such a prolonged freezing period in the past 50 years. So

no historic records or research findings are available for evaluating the situation.


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Sugar Sector


Thailand

Thailand is also forecast to increase sugar cane production in CY2008-09, boosted by

government policies aimed at expanding the industry. However, Thai sugar production

could decline by up to 5 Lac tonnes in CY2008-09 if targets are met using sugar cane

for ethanol production.

Russian Federation and the Ukraine

Lower sugar production is also expected in the Russian Federation and the Ukraine in

2008-09, because of relatively favorable returns for grains and some redirection in

government policies arising from relatively abundant supplies of sugar.

Pakistan

Pakistan sugar production is forecast to decline by 12 per cent in CY2008-09, because

of low returns to cane growers, despite government efforts to meet a widening domestic

shortfall in sugar production.

ZambiaThe Zambian government has directed Zambia Sugar Company to stop exporting its

sugar, as there was still a severe shortage of sugar in the country. The sugar shortage

in the country was due to the torrential rains, which caused floods and disturbed smooth

production. The countrys sole sugar producer was unable to reach the target of 2.65

Lac tonnes to meet the local demand.

United States

In the United States, sugar production from sugar beet is forecast to fall by 0.3 million

tonnes in CY2008-09, while sugar from cane production is forecast to remain at the

CY2007-08 level. Sugar beet that is genetically modified to be herbicide tolerant will begrown commercially in the United States in 2008 for the first time, following approval for

food use in key world markets.

Australia

Australian plantings of sugar cane are estimated to be down by 0.5 per cent in CY2008-

09. However, reasonably favorable conditions have prevailed in most growing regions

since early 2008, raising the possibility that Australian sugar production in CY2008-09

will be around the same level as in CY2007-08.


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Sugar Sector


Global Demand - Supply

125

130

135

140

145150

155

160

165

170

175

2004-05 2005-06 2006-07 2007-08E 2008-09P

mntons

0%

5%

10%

15%

20%25%

30%

35%

40%

45%

50%

Production Consumption Stock-to-use(%)

Source: ISO, Abare Estimates, Crisil & HDFC Sec. Research

World raw Sugar Prices

Global sugar prices have been under significant upmove in the last couple of months

due to large buying interest and improved fundamentals arising from revised surplus

outlook. World sugar prices are extremely volatile. Due to the bigger share in the

international trade, raw sugar prices are more volatile than that of refined sugar. In the

recent past, there has been a significant increase in futures prices for both raw and

white sugar. Against the background of a record global sugar surplus of nine million

tons in 2006/07, world raw sugar prices in 2007 traded in a relatively narrow but volatile

range, between US 9.00 cents/lb and US11.00 cents/lb. However, as the result of

significant trading activity by global investment funds in the sugar market in December

2007, futures prices lifted significantly reaching a high of US15.02 cents/lb in March

2008.

However, in the long term, it is expected that substantially reduced sugar production

from Brazil, high global crude prices, lower sugar production from India, increasing

global demand etc., should see international sugar prices rising in the future.

International Sugar Prices

-

100

200

300

400

500

Jul-00

Jan-01

Jul-01

Jan-02

Jul-02

Jan-03

Jul-03

Jan-04

Jul-04

Jan-05

Jul-05

Jan-06

Jul-06

Jan-07

Jul-07

Jan-08

Jul-08

New York White FOB London

Source: Bloomberg and Crisil


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Sugar Sector


Brazil shifting more & more cane into ethanol

The worlds second largest producer of ethanol Brazil is expected to divert more sugarcane

in 2008-09 to produce ethanol rather than sugar, due to strong demand for ethanol in the

domestic and international markets. In, CY2008-09 Brazils sugar-ethanol mix is expected

to be 43% and 57% percent respectively, compared to 46% and 54% percent for CY2007-

08.

Ethanol and sugarcane yield evolution in Brazil

40

50

60

70

80

90

75/76 79/80 83/84 87/88 91/92 95/96 99/00 03/04 07/08E

Tonnes/hectare

2

3

4

5

6

7

000'sliters/hectare

Sugarane Production (ton/hec) Ethanol Production (ltr/hec)

Source: UNICA

Brazilian ethanol production is expected to reach 22 billion liters in the CY2007- 08 and

46.9 billion litres in 2015-16, up 23% and 162% from 2006-07 respectively. Total ethanol

production for CY2008/09 is projected at 25.7 billion liters (8.5 billion liters of anhydrous

ethanol and 17.2 billion liters of hydrated ethanol), up 3.7 billion liters from CY2007/08

(8.4 billion liters of anhydrous ethanol and 14.3 billion liters of hydrated ethanol).

Brazilian ethanol exports also has a great window of opportunity due to the rising prices

of ethanol in America and weather problems in the USA

Fuel Flex Market Shines in Brazil

According to Brazils National Association of Automotive Vehicle Producers (ANFAVEA),

by December of 2007 there were 4.5 million FFVs on Brazilian roads, some 20% of all

light vehicles. ANFAVEA predicts there will be 10 million FFVs by 2010, when national

ethanol consumption is likely to surpass that of gasoline.

% of New Light Duty Vehicle Sales

3.7%

21.6%

50.2%

78.1%86.0%

0%

10%

20%

30%

40%

50%

60%70%

80%

90%

100%

2003 2004 2005 2006 2007

Source: UNICA


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Sugar Sector


Projections for the Brazilian sugarcane industry

2007-08* 2010-11 2015-16 2020-21

Sugarcane Production (mt) 487 601 829 1038

Cultivated Area (m hectares) 7.8 8.5 11.4 13.9

Sugar (mt) 30.6 34.6 41.3 45

Internal Market 10.4 10.5 11.4 12.1

Surplus Export 20.2 24.1 29.9 32.9

Ethanol (billion liters) 22 29.7 46.9 65.3

Internal Market 18.4 23.2 34.6 49.6

Surplus Export 3.6 6.5 12.3 15.7

Bioelectricity (MWa) 1800 3300 11500 14400

Bioelectricity in Brazilian Energy Matrix (%) 3% 6% 15% 15%

Source: UNICA, Copersucar and Cogen


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Sugar Sector


Investment Rationale

Synergistic business model to contribute

The company generates its income from different revenue streams including sugar,

distillery, cogen and engineering, enhancing its profitability during good market conditionswhile protecting downside during troughs. The company has comparatively low volatility

in the earnings due to the robust order book growth of its engineering business at 25%

CAGR. Its engineering business posted a strong order book of Rs 6679 million as of

June 2008, an increase of around 17% from last year.

Lower debt burden and ROCE and ROE to improve

We expect a significant reduction in the debt burden of the company due to healthy

earnings and cash flows from its operation in CY09E and CY10E and repayment of the

debt. The debt-to-equity ratio is expected to fall from 1.45x in CY07 to 1.32x, 0.67x and

0.20x in CY08E, CY09E and CY10E respectively.

We expect the ROE and RoCE ratio to improve from 15.9% and 13.9% in CY08E to

26.4% and 25.3% in CY09E and 27.9% and 34.2% in CY10E respectively due to high

ner profit margins.

Outlook and Valuation

We have initiated coverage, on Triveni Engineering with a buy rating and target price of

Rs. 178 on the stock. We have valued the stock on EV / EBIDTA for sugar and engineering

business separately. We have calculated our target price of Rs 180 based on 7x EV/

EBITDA for sugar businesses and 7x EV/ EBITDA for engineering business on CY10E

basis (9.96 x EV/EBITDA for CY09E), an upside of 100% over its CMP. At the current

market price of Rs. 89.2, the stock is trading 8.3X CY09E at EPS of Rs. 10.7 and 5.8X

CY10E at EPS of Rs. 15.26. Our bull case target is Rs 233 (upside of 161%) and bear

case target price is Rs.135 (upside of 51% from current levels).We have based our

valuation on a) Revenue growth at a CAGR of 27% in its engineering business b) Revenue

from different business segments that helps to protect the margins of the company c)

The up-trend in the sugar cycle d) Healthy net profit growth at a CAGR of 75.8% in

CY08-10E e) Significant improvement in the debt-equity ratio of the company to 0.2x by

CY10E on the back of strong cash flows from operations

Triveni Engineering & Industries Ltd

Valuation summary

BUY

Key Stock Data

Sector Sugar

Reuters Code TREI.BO

BLOOMBERG Code TRE IN

No. of Shares (mn) 257.88

Market Cap (Rs bn) 23

Market Cap ($ Mn) 547.7

Avg. 6m Vol.(000) 406.44

Stock Performance (%)

52 - Week high / low Rs.195/64.53M 6M 12M

Absolute (%) -22 -20 11

Relative (%) -11 -14 15

Sharehold ing Pattern (% )

Promoters 66.94

FIs & Local MFs 6.76

FIIs 18.01

Public & Others 8.3

Sensex and Stock Movement

Nifty 4290

Sensex 14324

Source : Company

CMP Rs. 89.2

Target Rs. 178

Stock Return 99.8%

Capital Appreciation 99.13%

Dividend Yield 0.67%

YE Sept 2006 2007* 2008E 2009E 2010E

Net Sales 11920 19072 17069 22707 27707

EBITDA 2112 2447 3357 5350 6764% Margin 17.7% 12.8% 19.7% 23.6% 24.4%

PBT 1612 807 1592 3679 5391

PAT 1315 754 1274 2759 3936

% Margin 11.0% 3.9% 7.4% 12.1% 14.2%

EPS 5.9 2.9 4.9 10.7 15.2

% Chg YoY 23% -50% 69% 117% 43%

PE(X) 15.2 NM 18.1 8.3 5.8

RoCE 20.2% 9.7% 13.9% 25.3% 34.2%

RoE 24.8% 11.2% 15.9% 26.4% 27.9%

EV/EBITDA 11.2 13.4 10.0 5.6 3.6

D/E 0.8 1.4 1.3 0.7 0.2

* 18 months period Source : Company, HDFC Sec. Research

050

100150200250

Sep-07

Oct-07

Nov-07

Dec-07

Jan-08

Mar-08

Apr-08

May-08

Jun-08

Aug-08

0500010000150002000025000

Triveni Sensex


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Sugar Sector


Swot Analysis

S

W

O

T

A

N

A

L

Y

S

I

S

Strengths

Income from different revenue streams including engineering makes the company less

vulnerable to changes in sugar cycle

Third largest producer of sugar in the country

Strong order book in the engineering business and revenue growth at CAGR of 24-26%

Lower working capital requirement due to lower inventory build up will reduce the interest

burden.

Weaknesses

Exposed to Sugar price volatility with ~14% change in EPS sensitivity to 5% change in

prices.

Volatility in prices of key raw materials, especially sugar cane to be an area of concern

(EPS for CY09E is impacted by ~10% for every 5% change in sugar cane prices)

Opportunities

Dismantling of the 10% levy imposed on mills along with the monthly release mechanism

regulating the balance 90% free sale quota, if implemented, will significantly alter the nature

of the industry

If formula based cane pricing is ordered by the Supreme Court, it will provide stable cane

cost which accounts for ~70% of its operating cost

Indian sugar consumption is expected to grow steadily at 4% -4.5% per annum which is a

demand driver for sugar.

Lower SAP (cane price) fixation by state government for CY08-09 can further increase the

profit margins for the company significantly.

Increase of the ethanol-blending mandate from 5% to 10% from October 2008, and potential

rise in ethanol prices will offer more revenue

Threats

Government intervention is a key structural risk to the company. Sugar industry is highly

regulated, so if sugar prices rise, the government may cap it or curtail exports depressing

the domestic price of sugar.

Unfavorable judgment by the Supreme Court on the UP cane pricing issue (SAP) can

suppress the profit margins of the company

Slowdown in economic growth could adversely impact the growth and revenue of its

engineering business.


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Sugar Sector


Key Concerns

Government attempt to control sugar prices, mainly due to rising inflation.

Any slowdown in the capital goods industry may adversely affect the engineering

businesss performance.

Delay in order execution in the engineering business may affect revenues as it

accounts for ~35-40% of the companys revenue.

Fall in sugar prices in international and domestic markets could impact earnings

Delay in judgment on the sugar cane pricing issue in UP can affect the next cane

crushing season SS09, due to uncertainty in cane prices.

Higher cane prices (SAP) fixed by state government for CY08-09 can supress the

profit margins of the company.

One year forward EV/EBITDA chart

0

1000

2000

3000

4000

5000

6000

7000

Dec-05

Feb-06

Apr-06

Jun-06

Aug-06

Oct-06

Dec-06

Feb-07

Apr-07

Jun-07

Aug-07

Oct-07

Dec-07

Feb-08

Apr-08

Jun-08

Aug-08

6x

8x

10x

12x

14x



38/72

Sugar Sector


EPS Sensitivity- CY 09E and CY10E

a) Sugar prices and cane cost

CY09E

CY10E


NSR(Rs/kg)

16.99 7.44 9.18 11.7817.88 8.96 10.7 13.31

18.77 9.62 12.22 14.88


NSR(Rs/kg)

17.83 11.78 13.59 17.21

18.77 13.44 15.26 18.87

19.71 15.11 16.92 20.54

Scenario Analysis-CY09E

Bear Base Bull


NSR(Rs/kg) 16.99 17.88 18.77

PAT (Rs in Mn) 1918 2759 3825

EPS in CY09E 7.44 10.7 14.88


CMP 89.2 89.2 89.2

Upside (%) 51% 100% 161%



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Sugar Sector


Operational Overviews

Sugar Business- Turn around in Cycle

We expect Triveni to reap huge profits from the turnaround in the sugar business cycle.

The sugar business will grow at a CAGR of 31% over CY08-10. Trivenis sugar

manufacturing capacity is the third largest in the country at 61,000 TCD. The companyis expected to crush ~58.6 LMT of sugarcane in CY08 and produce 5.81 LMT of sugar.

The company has expanded its sugar divisions production from 25250 TCD in 2004-05

to 61000 TCD in 2006-07. We believe the company will benefit from this expansion due

to the improved outlook on the sugar industry in CY09 and CY10. The company has

seven mills in operation at Chandanpur, Raninagal and Milak Narainpur (In central UP),

Khatauli, Deoband, Sabitgarh (in Western UP) and Ramkola (in Eastern UP).

Three units of Triveni in Western UP cater to the sugar deficit markets of Delhi, Rajasthan

and Punjab, helping it to get higher prices for its sugar.

Key assumptionsSugar Business 2008E 2009E 2010E



Sugar Sold (LMT) 5.51 6.54 7.45



Recovery(%) 9.9% 10.0% 10.0%

We believe that with the prices remaining firm, Triveni is well positioned to grow at a

CAGR of 27% between CY08-10E. Also, the company has a track record of timely

payment to the farmers for sugar cane through the Cane Development Programme,which will help it to procure cane more easily than others and better utilize its crushing

capacity.

Distillery Business

The distillery segment is expected to contribute Rs 719million, Rs 942 million and Rs

1030 million to the revenue in CY08E, CY09E and CY10E respectively. While the revenue

from distillery will also increase in CY09E and CY10E, its share of the total revenue will

remain stable on the account of an increase in revenue from the sugar business. The

average distillery realization per litre is expected to be around Rs 24.5 in CY 09E and

Rs. 25.5 in CY10E. The company is not presently supplying fuel ethanol to oil marketing

companies, which will help it to enjoy better average realization from the distillery

business in CY09, as the prices for rectified spirit and ENA are expected to be much

higher than that of ethanol at Rs 21.50 per litre.



40/72

Sugar Sector


The company has a distillery capacity with 160 kilo litre per day at Muzaffarnagar which

is equidistant from two sugar manufacturing facilities of Khatauli and Deoband. This

ensures availability of molasses.

Revenue for the distillery business mainly from rectified spirit, SDS and ENA is expected

to rise due to better price realization of products and increase in the blending level of

ethanol to 10%.

Cogen Business

Key assumptions

Cogen Business 2008E 2009E 2010EExportable Capacities- MW's) 44 44 44


PPA (Rs /Unit) 3.01 3.05 3.09

We expect Triveni's power division to grow at a CAGR of 8% from CY08-10E and

contribute Rs 813 million in CY08E, Rs 875 million in CY09E and 951 miilion in CY10E.

The revenue from cogen business also includes income from carbon credits.

Revenue Growth in Sugar Business Group

91938227

10345

14254

16788

0

2000

4000

6000

8000

10000

12000

14000

16000

18000

2006 2007 2008E 2009E 2010E

(RsMillion)

Key assumptions

Distillery Business 2008E 2009E 2010E

Installed Capacities-(KL's) 160 160 160

Sales ( Mn ltrs)* 33.4 38.5 40.4






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Sugar Sector


Engineering business group

The engineering business segment of Triveni consists of steam turbines, high-speed

gears and water & water waste treatment solutions. ~40% of the companys revenue

comes from the engineering business, which also provides a hedge to the companys

revenues during downturns in the sugar business.

The engineering business is expected to grow at a CAGR of 27% in CY08-10E.

Steam turbines

The company is the domestic market leader with a market share of ~75% for high and

low pressure turbines up to 20MW. But, we believe lower growth in the index of industrial

production (IPP) in the recent past and other microeconomic factors, could affect the

growth plans of the company. However, the company is focusing on expanding its

market share both in both domestic and international markets through its high pressure

range of turbines. The refurbishment business is also scaling up with the installation ofvacuum balancing tunnel in terms of orders.

Major opportunities

Agreement with Beijing Beizhong Steam Turbine Generator Co. Ltd. (BZD) for

marketing and distribution of steam turbines up to 330MW in India.

Tie-up with GE Oil & Gas Operations LLC, USA for packaging and marketing of

high speed reciprocating compressors in India and its after-market sales services.

Tie-up with Schlumberger, USA and France for manufacturing precision components

for its customers.

The turbine business had an outstanding order book of Rs. 4,640 million as on 30th

June2008.

3368

5590

6724

8453

10919

0

2000

4000

6000

8000

10000

12000

2006 2007 2008E 2009E 2010E

Source : HDFC Sec. Research


42/72

Sugar Sector


High speed gear and gear boxes

The business forey into high power hydel gear boxes is in place to achieve its growth

and to expand its product profile into areas such as hydel gears, niche low speed gears

etc to capitalize on its manufacturing capabilities. The company manufactures grearboxes

of upto 70MW capacity and sppeds of 50,000 rpm and enjoys a market share of 80% in

the below 25MW segement. Leading turbine manufacturers like BHEL and Siemensare among the major customers of the company.

Major opportunities for the business

Technology Licencse agreement with Lufkin Industries, USA will allow the company

to address the needs of the customers with high power requirement

Expansion in the high power hydel segment will help the company to increase its

market base

Focus on retrofitting and OEM exports

We expect the revenue from this business to grow in line with the growth in the power

generation equipment industry both domestically and aborad. The gear business hadan outstanding order book of Rs. 489 miilion as on 30 th June 2008.

Water & wastewater treatment

Trivenis water & waste water treatment business has shown significant growth in the

last few years, which we believe will continue in the future. The company provides

customized equipment and solutions for water & waste water treatement to its customers.

The company has continued to leverage its existing engineering relationships with

industrial sector customers. The company recently bagged a single order of Rs 600

million to set up a sewage treatment plant for a m

sugar sector report1

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