Sugar Report

"In Pakistan, agriculture plays a crucial role in the overall economic development as the sector contributes around 20% to the GDP and employs around half of the employed labor force. The sector also contributes heavily in terms of generating foreign exchange earnings for the country, as most of the major crops, i.e., wheat, sugar, cotton, corn, and rice, are produced in exportable surplus quantities. This makes effective management of the sector both in terms of government policies and private sector input extremely important to not just maintain (if possible, enhance) its share in the GDP but also in terms of national food security.

However, the reality is very different from what should be the case – the contribution of agriculture to the country’s GDP has been consistently declining; due to lack of investment in agro-research and inefficient use of water, Pakistan has one of the lowest crop yields (productivity) in the region. The Economist Intelligence Unit (EIU) currently ranks Pakistan at 77 (out of 109 countries) in terms of food security and going forward the challenges will only exacerbate due to a growing population, climate changes, and rising water scarcity.

Pakistan is the 6th largest producer of sugarcane in the world with an area under cultivation in excess of 1 million hectares. Sugarcane yield in Pakistan has consistently been lower than the world average of 70 t/h and currently stands at around 62 t/h. Sugarcane in Pakistan is categorized as a major Kharif crop where cultivation starts from Feb and extends till April, and harvesting is done between October and December. Most of the area under cultivation is in Punjab (65%) followed by Sindh (25%) and KPK (10%). Sugarcane farming is still an extremely labor-intensive process in Pakistan, as modern farming techniques are yet to be adopted. Sugarcane is primarily used for the production of sugar; other uses such as Gur production also occupy a healthy share. Pakistan is the 9th largest producer of sugar, with much of the production done through sugarcane, while a small amount, less than 1%, is also produced from beet. There are currently around 89 mills producing sugar with an average crushing capacity of less than 6,000 TCD. Average sugar recovery in Pakistan is still lower than 10%, with Sindh offering better recovery rates than other provinces.

Sugarcane cultivation and sugar production in the past few years have been on a constant ascent as better indicative pricing on sugarcane by the government lead farmers to plant more sugarcane, resulting in more sugarcane being crushed and more sugar being produced. In MY17, a record production of 73.6 million tons of sugarcane and 7 million tons of sugar was witnessed. Domestic consumption has been growing modestly and currently stands at around 5.5 million tons. Sugarcane pricing in Pakistan is a provincial subject, and the provincial governments are responsible for setting the procurement price of cane from growers for the mills, while sugar pricing is based on market dynamics which are broadly dependent on international prices. Due to consistent surplus globally and locally, sugar prices have been on a consistent decline while sugarcane procurement cost has been kept constant. This one-sided policy has been detrimental for the industry, as sugarcane constitutes around 90% of the cost of producing sugar, and in some instances, the cost of sugar production went higher than the domestic selling price. This, in turn, led to a lot of quandary between sugarcane growers and sugar millers, and payment delays were witnessed as millers challenged the legality of higher fixed sugarcane pricing. The government controls the domestic availability of sugar and sets export quotas for the export of any surplus. In the past 2 years, the government's dealing with sugar surplus resulting from bumper crops can only be described as a failed attempt. Against a record production of 7 million tons and surplus of around 2 million tons, less than 0.5 million tons could be exported in MY17, as the time delay between request-approval, phased approval without any understanding of international outlook and dynamics led to lower exports. The timeline below depicts how the policy failed surplus management and led to a hit on the national exchequer, both in terms of the loss of precious foreign exchange and footing a heavy subsidy to exporters, as by the time bulk quantities were approved, international prices had already come off substantially, and exports without a subsidy were not viable.

However, with subsidies in place in MY18, a record quantity of around 1.5 million tons was exported, leaving the ending surplus stock as of September 2018 to around 1.9 million tons. Sugar Outlook Payment scuffle between growers millers in the previous year has led to lower area under cultivation for the produce of MY19. As per USDA review, sugarcane cultivation area has declined by around 10% as farmers have moved towards other crops. This along with the export of existing surplus will ease off surplus pressure on sugar pricing going forward. Globally the situation is similar as output from big producers such as Brazil, India, and Thailand is also expected to decline (see our section on global dynamics and outlook), which is expected to lower global surplus stocks in MY19 while in MY20 a deficit of around 2 million tons is expected. These factors bode well for the sugar pricing outlook as at current exchange rates Pakistan's cost of production is around 0.15-0.16 ct/lb while the top producer's cost is around 0.10-0.11 cts/lb. The ECC in its recent decision after keeping a domestic strategic stock of around 0.8 million tons have allowed export of 1.1 million tons without any subsidy support with the rationale that due to more than 20% devaluation in rupee no such subsidy is required. The math, however, does not support that as at $338/ton per kg international price is $0.34/kg which at exchange rate of around 139 works out to be Rs 46.98/kg which is below ex-mill price of Rs 50-52 based on our channel checks.

Economics of sugar production is quite simple as sugar being a commodity is always subject to price risk and most of the bigger producers globally have ventured into more efficient utilization of byproducts to diversify their earnings risk. Sugar byproducts i.e. molasses, bagasse, and press mud have their use in multiple industries such as power, chemicals, food, fiberboard, etc. to the extent that sugar byproducts are now termed as co-products. Pakistan has done quite well in the usage of molasses for ethanol production. Due to Ethanol - the real value driver Our Investment Hypothesis and Top Picks 0 123,750,000 247,500,000 371,250,000 495,000,000 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 Ethanol Exports - Pakistan /ltrs low domestic use most of the ethanol is exported out of the country. Pakistan's export of ethanol has increased from around 100 million liters in 2009 to over 300 million liters in 2018, although there is a lot more potential as based on molasses production, Pakistan can produce around 800 million liters of ethanol. For sugar producers, ethanol is the savior as a) it is a dollar-based export-oriented higher margin product and b) they do not have to get export quotas from the government for export of ethanol. Our Investment hypothesis for the sugar industry is broadly based on the following two factors: Our top picks from the listed part of the sector is given below: Better sugar prices outlook and stagnant prices of sugarcane can turn sugar earnings in miller's favor Export-based earnings from ethanol will continue to enhance margins.

BYPRODUCTS Sugarcane is a C4 plant with efficient photosynthesizing characteristics as it can convert up to 1% of incident solar energy into biomass. It is a rich source of food, fiber, fodder, fuel and chemical. A mature sugar cane stalk comprises of 11-16% fiber, 12-16% soluble sugars, 2-3% non-sugars and 63-73% water. The main byproducts of high economic value are bagasse, molasses, and press mud. Other byproducts are of less commercial value such as green leaves and tops, trash, boiler ash, and effluent.

Many economies have diversified their earnings from sugar by setting up industries based on by-products. Every ton of sugarcane crushed produces around 250-280 kg of bagasse, 23 liters of molasses and 7-9% of press mud (carbonation) and 3-5% of press mud (sulphitation). Bagasse is produced at the cane milling/crushing stage, primarily used as a fuel source for power generation for sugar mills, additional major use is by the pulp and paper industry. Sugar press Mud (SPM) is created at the filtration of cane juice stage and is used in multiple areas like fertilizer, animal feed, and industrial use. Molasses is a viscous liquid separated from massecuite during the centrifuging process; it can be fermented in a distillery to form ethyl alcohol (ethanol).

Sugarcane is the world’s largest crop by production quantity as it is produced in over 100 countries. It is considered one of the best converters of solar energy into biomass. It requires plenty of sunshine and water typically for a continuous period of 6-7 months. The life of the crop ranges from 10 months to 2 years globally but on average 5-6 months is sufficient as the sucrose content reaches its highest level. Sugarcane is primarily harvested for its sucrose content for sugar production but over time its byproducts such as bagasse and molasses are being used as a fuel source and production of ethanol among other uses. Sugarcane is a high-value cash crop of Pakistan. Its cultivation has grown significantly over the years from under 1 million hectares of area under cultivation in 2008-09 to over 1.3 million hectares in 2017-2018. In terms of production, a record 82 million tons were produced in 2017-2018 against 50 million tons produced in 2008-09. The change can be primarily attributed to the higher indicative sugarcane procurement price set by the government to support the farmer. However, sugarcane yield has been consistently lower than other agriculturally developed countries. Pakistan’s sugarcane yield was around 62 t/h which is much lower than the average of 70t/h of other top producers. Among the provinces, Punjab holds a lion’s share of around 65%, while Sindh and Khyber Pakhtunkhwua account for 25% and 10% respectively in the overall area under cultivation. Sugarcane in Pakistan is categorized as a major Kharif crop where cultivation starts from Feb and extends till April, harvesting is done between October December.

Major challenges facing the sugarcane farmers can be classified as economic and technical: Economic Due to inequitable distribution of agricultural land in Pakistan, a majority of the farmers have smaller land holdings (average farm size of around 5 acres) and thus do not make enough money to invest in proper farming. They generally depend on a middleman for money and inputs, who exploit them by charging higher markups and more price on inputs. On the sales side, farmers face problems in getting the minimum support price prescribed by the government as mill owners discount their produce based on quality and other factors and bargain 30-40% than the support price. A lot of farmers end up selling their produce to a middleman at a much lower rate to avoid transportation charges and price negotiation with mills directly. Sugarcane cultivation is labor-intensive, and each process i.e. planting, weeding, earthing up, fertilizer application and harvesting requires high man-hours. In agriculturally developed countries much of this process is mechanized through modern farming techniques which not only reduce human input requirement but also ensure better care for the produce which has led to higher yields. In Pakistan, the process is still by and large traditionally done which in large part is because of farmers limited financial capability of investing in modern technology. In addition, the lack of research organizations spreading awareness is also seen as a limiting factor. In a country where water scarcity is an imminent threat, the drip-irrigation system which reduces water requirement by almost 40% and increases yield per acre is still not widely known and applied. High-yielding varieties of sugarcane are another area which needs massive work as farmers who are only concerned with getting the set price against the weight of their produce are quite oblivious to how shifting to another variety can enhance their yields per acre.

SUGAR Pakistan is the 9th largest sugar producer in the world. The majority of the sugar in Pakistan is produced through sugarcane and only a small percentage, i.e., less than 1%, is produced through beetroot. Sugar beet industry in Pakistan is very small and present only in KPK. In tandem with rising cultivation area of sugarcane, sugar production has also surpassed record levels in recent years. In FY17, Pakistan achieved the highest-ever sugar production of 7 million tons, which is almost double of what we produced in 2009-2010. This trajectory has, however, marginally declined in FY18 as total sugar production was only around 6.5 million tons. There are 89 sugar mills operating in the country with the majority, i.e., 50%+, situated in Punjab and around 26 of these are listed (actively) on the Pakistan Stock Exchange. In terms of consumption, Pakistan is the 8th largest consumer with per capita consumption of around 25.7 kg, which is the highest in the region. Annual local demand stands between 5-6 million tons. Barring the initial two years in the last decade, Pakistan has been self-sufficient in sugar as domestic production is exceeding domestic consumption." which not only reduce human input requirement but also ensure better care for the produce which has led to higher yields. In Pakistan, the process is still by and large traditionally done which in large part is because of farmers limited financial capability of investing in modern technology. In addition, the lack of research organizations spreading awareness is also seen as a limiting factor. In a country where water scarcity is an imminent threat, the drip-irrigation system which reduces water requirement by almost 40% and increases yield per acre is still not widely known and applied. High-yielding varieties of sugarcane are another area which needs massive work as farmers who are only concerned with getting the set price against the weight of their produce are quite oblivious to how shifting to another variety can enhance their yields per acre.

SUGAR Pakistan is the 9th largest sugar producer in the world. The majority of the sugar in Pakistan is produced through sugarcane and only a small percentage, i.e., less than 1%, is produced through beetroot. Sugar beet industry in Pakistan is very small and present only in KPK. In tandem with rising cultivation area of sugarcane, sugar production has also surpassed record levels in recent years. In FY17, Pakistan achieved the highest-ever sugar production of 7 million tons, which is almost double of what we produced in 2009-2010. This trajectory has, however, marginally declined in FY18 as total sugar production was only around 6.5 million tons. There are 89 sugar mills operating in the country with the majority, i.e., 50%+, situated in Punjab and around 26 of these are listed (actively) on the Pakistan Stock Exchange. In terms of consumption, Pakistan is the 8th largest consumer with per capita consumption of around 25.7 kg, which is the highest in the region. Annual local demand stands between 5-6 million tons. Barring the initial two years in the last decade, Pakistan has been self-sufficient in sugar as domestic production is exceeding domestic consumption."

In Pakistan, agriculture plays a crucial role in the overall economic development as the sector contributes around 20% to the GDP and employs around half of the employed labor force. The sector also contributes heavily in terms of generating foreign exchange earnings for the country as most of the major crops i.e. wheat, sugar, cotton, corn, and rice are produced in exportable surplus quantities. This makes effective management of the sector both in terms of government policies and private sector input extremely important to not just maintain (if possible enhance) its share in 0%, 5%, 10%, 15%, 20%, 25% FY13 FY14 FY15 FY16 FY17 AGRICULTURE CONTRIBUTION TO GDP (%) the GDP but also in terms of national food security. However, the reality is very different from what should be the case – the contribution of agriculture to the country’s GDP has been consistently declining; due to lack of investment in agro-research and inefficient use of water Pakistan has one of the lowest crop yields (productivity) in the region. The Economist Intelligence Unit (EIU) currently ranks Pakistan at 77 (out of 109 countries) in terms of food security and going forward the challenges will only exacerbate due to a growing population, climate changes, and rising water scarcity. Pakistan is the 6th largest producer of Sugarcane in the world with an area under cultivation in excess of 1 million hectares. Sugarcane yield in Pakistan has consistently been lower than the world average of 70 t/h and currently stands at around 62 t/h. Sugarcane in Pakistan is categorized as a major Kharif crop where cultivation starts from Feb and extends till April and harvesting is done between October and December. Most of the area under cultivation is in Punjab (65%) followed by Sindh (25%) and KPK (10%). Sugarcane farming is still an extremely labor-intensive process in Pakistan as modern farming techniques are yet to be adopted. Sugarcane is primarily used for the production of sugar, other uses such as Gur production also occupy a healthy share. Pakistan is the 9th largest producer of sugar with much of the production done through sugarcane while a small amount less than 1% is also produced from beet. There are currently around 89 mills producing sugar with an average crushing capacity of less than 6,000 TCD. Average sugar recovery in Pakistan is still lower than 10% with Sindh offering better recovery rates than other provinces.

Sugarcane cultivation and sugar production in the past few years have been on a constant ascent as better indicative pricing on sugarcane by the government lead farmers to plant more sugarcane resulting in more sugarcane being crushed and more sugar being produced. In MY17, a record production of 73.6 Mn tons of sugarcane and 7 Mn tons of sugar was witnessed. Domestic consumption has been growing modestly and currently stands at around 5.5 Mn tons. Sugarcane pricing in Pakistan is a provincial subject and the provincial governments are responsible for setting the procurement price of cane from growers for the mills, while sugar pricing is based on market dynamics which are broadly dependent on international prices. Due to consistent surplus globally and locally sugar prices have been on a consistent decline while sugarcane procurement cost has been kept constant. This one-sided policy has been detrimental for the industry as sugarcane constitutes around 90% of the cost of producing sugar and in some instances, the cost of sugar production went higher than the domestic selling price. This, in turn, led to a lot of quandary between sugarcane growers and sugar millers and payment delays were witnessed as millers challenged the legality of higher fixed sugarcane pricing. The government controls domestic availability of sugar and sets export quotas for export of any surplus. In the past 2 years government's dealing with sugar surplus resulting from bumper crops can only be described as a failed attempt. Against a record production of 7 Mn tons and surplus of around 2 Mn tons less than 0.5 Mn tons could be exported in MY17 as the time delay between request-approval, phased approval without any understanding of international outlook and dynamics lead to lower exports. The timeline below depicts how the policy failed surplus management and lead to a hit on national exchequer both in terms of loss of precious foreign exchange and footing a heavy subsidy to exporters as by the time bulk quantities were approved international prices had already come off substantially and exports without a subsidy were not viable.

However, with subsidies in place in MY18 a record quantity of around 1.5 Mn tons was exported leaving the ending surplus stock as of September 2018 to around 1.9 Mn tons. Sugar Outlook Payment scuffle between growers millers in the previous year has lead to lower area under cultivation for the produce of MY19. As per USDA review sugarcane cultivation area has declined by around 10% as farmers have moved towards other crops. This along with export of existing surplus will ease off surplus pressure on sugar pricing going forward. Globally the situation is similar as output from big producers such as Brazil, India and Thailand is also expected to decline (see our section on global dynamics and outlook), which is expected to lower global surplus stocks in MY19 while in MY20 a deficit of around 2 Mn tons is expected. These factors bode well for the sugar pricing outlook as at current exchange rates Pakistan's cost of production is around 0.15-0.16 ct/lb while top producer's cost is around 0.10-0.11 cts/lb. The ECC in its recent decision after keeping a domestic strategic stock of around 0.8 Mn tons have allowed export of 1.1 Mn tons without any subsidy support with the rationale that due to more than 20% devaluation in rupee no such subsidy is required. The math, however, does not support that as at $338/ton per kg international price is $0.34/kg which at exchange rate of around 139 works out to be Rs 46.98/kg which is below ex-mill price of Rs 50-52 based on our channel checks.

Economics of sugar production is quite simple as sugar being a commodity is always subject to price risk and most of the bigger producers globally have ventured into more efficient utilization of byproducts to diversify their earnings risk. Sugar byproducts i.e. molasses, bagasse and press mud have their use in multiple industries such as power, chemicals, food, fiber board, etc. to the extent that sugar byproducts are now termed as co-products. Pakistan has done quite well in the usage of molasses for ethanol production. Due to Ethanol - the real value driver Our Investment Hypothesis and Top Picks 0 123,750,000 247,500,000 371,250,000 495,000,000 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 Ethanol Exports - Pakistan /ltrs low domestic use most of the ethanol is exported out of the country. Pakistan's export of ethanol has increased from around 100 mn ltrs in 2009 to over 300 mn ltrs in 2018, although there is a lot more potential as based on molasses production, Pakistan can produce around 800 Mn ltrs of ethanol.

It is one by-product against which most of the value addition has occurred, as there are now around 19 distilleries in the country converting molasses into ethanol. Traditionally, molasses was exported at lower prices without converting it into a higher-margin product, i.e., ethanol. Between 2000-2009, 16.5 million tons of molasses were produced, out of which 9.2 million tons were exported, and only 237 million liters of ethanol were exported. While between 2010-2017, 18.1 million tons of molasses were produced, out of which only 1.7 million tons were exported, and a substantial 2.2 billion liters of ethanol were exported. There is still a huge potential for Pakistan for more ethanol production as the typical yield of ethanol per ton of molasses is 5:1, which means 3 million tons of molasses should yield around 600,000 tons or around 800 million liters of ethanol, which is almost 2 times what we exported in MY17.

There are 19 distilleries operating in the country, as per PEMA (Pakistan Ethanol Manufacturers Association), producing different grades of ethanol with a total capacity to produce around 600,000 tons per annum. Out of the total, 11 distilleries are located in Punjab, 7 in Sindh, and only 2 in KPK. Some of the sugar mills have set up these distilleries on their own, while others have created Joint Ventures with other sugar mills. As there is not much ethanol use domestically, much of the ethanol produced is exported. As per transparency market research, the global demand for ethanol stood at $71.8 billion in 2017 and is expected to cross $100 billion by 2022. The demand is emanating from multiple end-use industries, specifically automobiles and alcoholic beverages. Due to its export potential, local distilleries are also expanding their capacities. Our channel checks suggest that last marketing year the industry produced around 400,000 tons of ethanol, and this year a 15-20% growth is expected even though the prices have come down significantly since last year and currently trading around $630-640/metric ton (FOB Karachi bulk - ENA anhydrous).

Bagasse is an extremely rich renewable source for power generation, and for a country like Pakistan where the energy mix is still heavy towards imported fuel, proper utilization of bagasse can help save a lot of foreign exchange. As of 30th June 2017, the total installed capacity of bagasse-based generation was only 280 MW, which is around 1.06% of the total energy mix and 19.11% of the renewable energy mix of Pakistan.

Most of the bagasse produced in Pakistan is used by the sugar mills to fulfill their energy needs, and only a few sugar mills have set up co-generation plants and supplying electricity to the grid. For Pakistan, bagasse-based generation has three major advantages: a) as it is internally sourced, there is no need for foreign exchange to be spent on its procurement, b) the cost of production is lower as bagasse is a byproduct, and c) Bagasse-based generation can be directly provided to settlements near the sugar mill, thereby not making it go through the inefficient distribution system. As per NEPRA, total bagasse-based generation will increase to over 1,000 MW by FY20, which is still lower than the actual potential. Other byproducts processing such as press mud composting to be sold as a rich organic fertilizer is done at a decent scale at some mills but the overall quantum is low.

Brazil is not just the number one producer of sugarcane in the world but has also become a case-study for other sugarcane-producing countries in terms of efficient use of sugar byproducts to create a significant economic impact. Brazil is a pioneer in using ethanol as a motor fuel, with annual production now in excess of 30.23 billion liters. The country has been using ethanol as motor fuel since the 1920s, but since 2003, the pace picked up significantly with the introduction of flex-fuel vehicles which run on gasoline and pure ethanol. Due to increasing consumer demand in less than 15 years, the country revolutionized this space and now more than 70% of LCVs in Brazil are flex-fuel vehicles. The country has replaced 42% of its gasoline needs with sugarcane ethanol, making it a key component of its energy mix. Ethanol reduces carbon emissions by 90% on average and is a high-octane fuel which reduces engine knocking. Brazilian consumers have a choice at the pump, and most of them are choosing ethanol because of its lower price point and environmental benefits. The country is now going one step further, as the process of making ethanol only taps one-third of the energy sugarcane can offer, the remaining two-thirds are trapped in the cane fiber i.e., bagasse. Brazilian scientists have discovered new techniques to produce ethanol called cellulosic ethanol from bagasse.

Global production of sugar is dominated by Brazil, India, China, and Thailand which constitute around 40% of the total world production. Countries with high growth rates in the population are working more aggressively to increase their production through working on the increasing area under production and improving yields. Like any commodity world, sugar prices are dependent on the demand-supply balance. For the past two years, the world sugar cycle has been in a surplus state which is expected to wear off in MY 2018-2019 and may even create a marginal deficit in MY 2019-2020 as per the latest forecast by the International Sugar Organization (ISO). The organization has forecasted global production in 2018/2019 to be around 180 million tons which are almost 8% lower than the previous year.

GLOBAL DYNAMICS AND OUTLOOK The major drag will be due to lower sugar production in Brazil – due to lower yields and more sugarcane being diverted towards ethanol production, Thailand – due to lower yields on account of lower-than-expected precipitation and lower consumption from the industrial sector due to new sugar excise tax on beverages, India – lower yields due to lower rainfalls and grub infestations, Pakistan – due to reduced area as farmers have shifted to other crops with better prices and faster return on investment, and modest growth in consumption. ISO has said that such large-scale downward adjustments cannot be offset by smaller increases for other producers.

International sugar prices in the past one year made a low of $0.1009 per pound and then increased to $0.1401 per pound and now consolidating near $ 0.1290 level. The dampen outlook of sugar production will positively affect prices going forward and if as forecasted by ISO a deficit is created of around 2 million tons between global demand-supply in 2019-2020 the prices may then follow a similar upward trajectory as in 2016 when a 3-4 million tons deficit led to prices rising from $0.1044 per pound in August 2015 to a high of $0.2342 per pound in Oct 2016. As prices increase, export of sugar will become a competitive space as all major producers have devalued their currencies by at least 20% against the greenback in the past 1 year.

There are around 26 mills (active) listed on the Pakistan Stock Exchange representing around 29% of total mills and around 30% of the crushing capacity in the country. Most of the mills listed are based out of Sindh and Punjab. Total cane crushed and sugar produced by the listed sector was 32.5 MT and 3.2 MT respectively in MY17. The total listed sector’s market cap as of 26-12-2018 was Rs 77.9 Bn ($556 Mn).

Most of the listed sugar mills have a capacity greater than the national average of less than 6,000 TCD. Higher recovery rates are evident in mills located in the province of Sindh, especially mills located near cane harvesting areas have a higher recovery and comparative advantage.

There are multiple reasons for low interest in this sector from the investment industry's standpoint, we highlight some of these below: Industry dynamics - As much of the industry earnings are dependent on government policies which remain inconsistent in terms of sugarcane price control and untimely decision on exportable surplus creates uncertainty for any forecast of earnings Industry perception – one of the key perceptions about the industry is weak corporate governance practices and high involvement of politicians rather than professionals which keeps investors away Investable float and Access – as depicted in the table above free float of most of the listed mills is less than 10 Mn shares and investable float is much lesser, which is why Average Daily Traded Volume (ADTV) is extremely low for this sector. Moreover, unlike other sectors, there are hardly any analyst briefings or presentations by the industry to create more understanding about the current and future dynamics amongst the investor community which makes the sugar industry one of the least covered sectors and hence the low probability of any reasonable price discovery

Our Filter Based on our understanding of the industry dynamics both globally and locally, we have applied the following filters to short-list sugar mills which we find to offer the highest value: Crushing capacity – it is one of the most important criteria as mills of lower crushing capacity will always have higher fixed cost/ton which becomes specifically challenging in times of lower sugarcane cultivation as utilizations are lower. We have only selected companies which have a crushing capacity higher than 7,000 TCD Capacity utilization – Higher capacity utilization leads to lower cost/ton and firms who have consistently increased their utilization with the increasing availability of sugarcane have passed through the second filter of our analysis Recovery rates – sugar recovery rates are a significant factor when it comes to producing sugar, a mill which is achieving higher recovery rates either based on its location or better technical efficiencies will always have a lower cost of production. Our benchmark is sugar mills with recovery rates of 10%+ Cost control - in an industry where the biggest cost of production cannot be controlled and passing on cost increases is not much of an option, the remainder costs require very prudent management to enhance margins. Lower procurement cost and fixed cost per ton is an essential filter especially in a rising interest rate environment whereby high finance costs can potentially eat up any improvement in the top line An aggressive focus on value addition – Our understanding of the sugar industry is that diversification of earnings is very essential for any sugar mill as commodity-based earnings are always subject to price risk. Our final filter is of firms which have consciously and consistently made efforts towards better utilization of by-products either by converting molasses into ethanol and earning export based earnings or efficiently using bagasse and generating additional power to be sold outside.

Noon Sugar Mills Ltd. commenced sugar production in 1966 with a cane crushing capacity of 1,500 TCD and over the years the company has increased this capacity to 9,000 TCD. The company realized the value in by-products processing early on and had set up alcohol distillery in 1986 with a capacity to produce 50,000 LPD and since then has expanded this capacity to currently 130,000 LPD. The company is owned by Noon Group of companies which has stakes in textiles, power and engineering among other interests. The mill is located in Bhalwal, District Sargodha in Punjab.

Noon sugar’s sugarcane procurement cost/kg in MY2017 was one of the lowest in Punjab amongst the listed mills and fixed cost per kg was also lower than the average fixed cost per kg of the listed mills in Punjab

The company has been making continuous efforts towards enhancing capacity utilization and other measures to bring per ton cost of sugar production down. As a result of these efforts, sugar production has significantly increased and cost per ton has gone down. Further specific upgradations in the production process such as the installation of Falling Film Evaporators which significantly contributes towards the steam economy and leads to energy savings and more efficient use of bagasse, and planned major up gradation in the process house will further rationalize the production cost. Investment Hypothesis Further cost saving efforts to bode well for sugar division Expansion in ethanol production – step in the right direction Noon sugar is currently expanding its distillery division’s capacity from 80,000 LPD to 130,000 LPD, this expansion is expected to be online within the current crushing season based on last reported results. Ethanol business has consistently supported the bottom line even in years when sugar business has made losses. Both rising ethanol fuel demand globally and PKR devaluation will bode well for the company’s earnings from ethanol

Mehran Sugar Mills was established in 1965 with an annual crushing capacity of 1,500 TCD and since then has continuously increased its capacity over the years to 11,500 TCD currently. The mill is situated in the cane growing area of Tando Allahyar (Sindh) and is owned by the Hasham Group who has diversified interests in sugar, power, warehousing, real estate development, food and education. Under Mehran Sugar Mills the group has invested in Mehran Energy (100% owned subsidiary) – 26.5 MW Baggasse based co-gen power plant, Unicol Limited (JV – 33.33% holding) – 200,000 lpd ethanol plant, Unienergy Limited (JV – 20% holding) – 50MW wind power plant Unifoods Limited (JV – 24% holding) – packaged cakes plant.

Mehran Sugar has the highest sugar recovery rate in the country of more than 11% against Sindh’s average of 10.16% in MY17 and Pakistan’s average of 9.87% in the same year. Higher recovery is due to the sugar mills location which is situated amongst a dense sugarcane harvesting area in Sindh. This has led the company to consistently achieve lower production cost/ton compared to other mills in the region. Investment Hypothesis Valuation 33 High sugar recovery – a significant advantage against peers Diversification in Ethanol and Foods business bearing fruits The company has diversified into other businesses i.e. Ethanol, Foods and Power by forming JVs with other sugar players. Merhran Sugar also holds 100% of Mehran Energy which is a 26.5 MW bagasse based co-gen power plant and 20% of Uni-Energy which is a 50MW wind power plant. Both these projects are currently non-operational and under regulatory and tariff approval stage. Unicol Limited - A leading manufacturer of ethanol from cane molasses with a capacity of 200,000 LPD and food grade CO2 supplier with a capacity of 18,000 metric tonnes. Entire ethanol sales are exports based on 70+ countries while CO2 is supplied to the local food and beverage industry. The company is a JV with Faran Sugar Mills and Mirpurkhas Sugar Mills. Unicol’s contribution to MRNS’s earnings was Rs 266 Mn in 9M18 (8.31/share) highest since the formation of JV.

Habib Sugar Mills was established in 1962 in Nawabshah Sindh with a crushing capacity of 1,500 TCD and over the years with multiple B.M.R activities the company has increased its capacity to 7,000 TCD. In 1976-78 ethanol distillery was established which currently has the capacity to produce 142,500 LPD. The company later diversified into textile and liquid storage terminal which handles bulk storage cargo such as molasses, edible oil and ethanol. The company also produces liquefied CO2 with a production capacity of 18,000 metric tons per annum. The textile division is engaged in manufacturing of terry towels and other value-added textile products.

Company’s core earnings are generated from 4 divisions i.e. sugar, distillery, textiles and trading. 90% of the earnings compose of sugar and distillery division’s performance out of which quality of distillery earnings is better. The mill’s presence in Sindh enables it to achieve higher sucrose recovery rates, however depressed sugar pricing has been hurting the division’s profitability. The company has recently increased the crushing capacity of the sugar division to 11,000 TCD through BMR which will enhance sugar production capacity and help lower sugar processing cost/ton. The textile division produces terry towels for exports but has been struggling for the past few years, however in 9MFY18 as reported by the company the division has earned an operating profit of Rs21.48 Mn (highest in 3 years) due to higher volumes, price and rebate availability for exporters under the textile package. We believe this division will continue to add support to the earnings base going forward. Trading division trades sugar and molasses and in a stable, to rising prices environment the division adds to the bottom line.

Strong Investment Book Company’s investment comprises of HSM Energy Limited (100% owned subsidiary) – 26.5 MW Baggasse based co-gen power plant and a portfolio of financial assets which includes equity investment in Unifoods Limited (15.33% holding) - packaged cakes plant, Limited (12.5% holding) – 50MW wind power plant and listed securities portion which is valued at Rs16.77/share as on 31/12/2018. HSM energy and Unienergy are not operational currently and under regulatory and tariff approval stage. Unifoods has turned profitable and over time we expect sales to pick up due to underway marketing efforts. We have done SOTP based valuation of Rs 47.10 offering 27.29% from LDCP