Pakistan’s sugar industry, the second largest agro-based industry in the country after textiles, is in the process of restructuring itself with companies investing in new technology and ethanol production, as well as diversifying into power generation, food and wood-making business in order to boost profits.

As global supply overhang starts melting away, the sustained rise in international prices has afforded producers an opportunity to export a portion of their inventories during the present harvest, without the government having to subsidise the sweetener’s overseas shipments, as in the past couple of years.

Surging primary margins of the firms listed on the Pakistan Stock Exchange seem to have renewed investors’ interest in sugar stocks as is reflected by rising prices, increased market capitalisation and relatively higher number of shares traded over an extended period of time.

Rebounding local and global prices, inventory build-up hinting at better earnings going forward, substantial protection against imported sugar and export subsidy during the last two harvests are among the factors that have helped attract investors to sugar stocks over the past year.

The industry appears to be out of the tight spot it had found itself in due to a decline in prices since 2011. “Despite challenges in the past several years, companies have enhanced output, improved sucrose recovery, developed in-house distilleries for ethanol production, as well as diversified into the baggasse-based power generation and wood-making business. A few have also expanded into solar and wind, as well as the food sector,” according to Fahad Irfan, analyst at Alfalah Securities.

Yet, sugar stocks remain undervalue and investor activity is confined to the top few, quality shares out of the 31 listed companies with ‘reasonable liquidity, better fundamentals, good management and relatively stronger future outlook’.

“The sector is illiquid, highly leveraged and doesn’t believe in profit-sharing. Moreover, discrepancies in sugarcane prices every year, as well as political influence, are major investment risks,” says Afaq Nathani, analyst at Insight Securities.

Analysts expect earnings of the industry as a whole to continue to grow as domestic and international prices move up. The International Sugar Organisation says global sugar inventory is expected to significantly fall with a drop in sugar production and rise in consumption, strengthening prices.

Indeed, mills that are more energy- efficient and/or have already diversified into power generation, ethanol production and wood-making businesses to reduce their reliance on the sweetener’s sales are billed to reap much bigger, sustained dividends.

Pakistan is the fifth largest sugarcane grower and seventh biggest refined sugar producer in the world. Annual domestic consumption estimated at 4.9m tonne makes it the eighth largest consumer of refined sugar.

The industry is important for the country’s economy, according to the Pakistan Sugar Mills Association Chairman Javed Kayani, owing to its impact on agriculture and large scale manufacturing growth. “Last year the industry, which directly and indirectly employs over a million people, pumped Rs230bn into the rural economy. This year, we are going to pay around Rs250bn to growers besides saving $2.5bn in import substitution.”

Thanks to the generous export subsidy allowed by the government to stabilise domestic prices amid bumper harvests during 2014/2015 and 2015/2016 and the spike in international prices, the country has become a net exporter of raw and refined sugar. The industry supported by the Rs10 per kilo subsidy exported half a million tonne sweetener in 2015.

The millers exported just half of the 0.5m tonne — the quantity the government had allowed it to export during the last harvest — in spite of a subsidy of Rs13 per kilo as the doubling of sugar import duty to 40pc sharply spiked domestic prices and made local sales much more attractive than overseas sales.

The government has so far allowed export of 0.225m tonne sugar this year against an estimated surplus of 1.5m tonne. Producers estimate that at least half of this surplus quantity will be available for exports even after setting aside the other half for building a strategic reserve to protect domestic consumers.

Mills export almost their entire ethanol production worth $350m-$400m a year. Millers say the government should bind the oil marketing companies to encourage ethanol blending with oil in order to reduce greenhouse gas emission and cut its oil import bill.

Historically, Pakistan’s domestic market has remained overpriced owing to rising sugarcane prices because of the government’s minimum support price for protecting growers, which has helped substantially increase the area under cane cultivation over the years, and protected against imported sweetener. An overpriced domestic market has helped the government build up the necessary reserves as a buffer against global price shocks and for years of shortage, analysts say.

Kayani is supportive of an annual fixation of a minimum support price for cane growers as it has helped bring more area under cultivation and created surplus for exports and buffer stocks. But at the same time he adds that the government should also ensure stability of domestic sugar prices by procuring sweetener for buffer stock and encouraging exports.

“Price stability is crucial for the industry’s economic viability and timely payments to growers,” Kayani contends.

Published in Dawn, Business & Finance weekly, January 30th, 2017