Let Them Eat Cake, While It’s Still Cheap

Europe’s sugar industry is at a turning point as many companies are facing a severe drop in sales and profitability after the sugar price plummeted as a result of production quotas being removed by the European Union.

How it all started

Production quotas in Europe were introduced back in 1968, along with a support price for producers at a level significantly above the world market price. At the time, the recently introduced Common Agricultural Policy (CAP) had as one of its main objective the self-sufficiency of the continent for its food production by encouraging agricultural production with remunerative and stable prices for farmers. Quotas, together with a support price, gave a welcome incentive to achieve these goals in the sugar sector.

The first signs of cavity 

Over time things began to change and so in 1992 a shift from product support (through prices) to producer support (through income support via direct payments) occurred, before an additional reform in 2003 consolidated this transition by decoupling the direct payments from the production of any particular product. Following this important decisions, Member States agreed upon ending the quota system in 2015, which was latter rescheduled to 2017.

Following the abolishment of sugar beet production limits, which occurred at the end of September 2017, Europe’s sugar production surged as companies were looking to reduce production costs through economy of scale by processing more beet and producing more sugar. However, the production boost came at a time when an increasingly health-conscious consumer is wary towards sugar consumption. As a result, supply exceeded demand and the global inventories were stacking up, eventually causing the price of sugar to plummet. The price fell so low that in August of 2018 it reached its 9 year low of USD 303.7 per ton.

Source: Bloomberg, InterCapital Research

Low prices are expected to discourage some companies from producing the same amount of sugar as they did in previous years which could lead to a shortfall in 2019 and help to somewhat decrease the high global stockpile.

In a conference call held recently, during which they discussed their Q3 2018 results (this is the end-Dec period), Agrana’s Management stated that the production expectations of the European market for this year were lower than in the year before due to drought and poorer yields in the large European beet-growing regions, mainly in Northern Europe and also in Western Europe. The production is now expected to go from 22m down to 19m tonnes of sugar within the European Union. As a result, one might expect that the price development should be favourable for the manufacturers. However, price increases will be modest as supplies are expected to remain abundant following high prices in recent years.

Source: F.O. Licht (20 December 2018), InterCapital Research

Finally, the companies…

European sugar manufacturers have been hit hard by the plummeting sugar price with many of them posting a double digit decrease in sales and profitability.

Croatia’s only listed sugar manufacturer, Viro, posted a 33% YoY decrease in sales in Q3 2018 (end-Sep period) while loss went up 46% YoY. Other European manufacturers were hurt as well, albeit now as much. For example, Agrana’s sales in the first three quarters of 2018 were down 7% to EUR 1.9bn while net profit was slashed to EUR 37m (just one quarter of 128m recorded in the previous year). Meanwhile Sudzucker, one of Europe’s largest sugar manufacturers also recorded a slight decrease in sales (-2.1% YoY), while their net profit plummeted 86% YoY to EUR 36m. Finally, Associated British Foods recorded a 15% YoY decrease in sales from their sugar segment, while the segment’s net profit fell -51% YoY. Meanwhile, overall results on the Group have actually slightly improved (note that ABF already posted their FY 2018 report due to a different calendar year).

The reason why Viro’s top line decrease at such a higher amount than other manufacturers lies in the fact that other producers have a diversified portfolio of products ranging from fruit to beverages which served them as a safety net.

On the chart below, we present you with the key multiples of some European sugar manufacturers. Note that Viro was excluded, as they have recorded both a negative EBITDA and net income.

Source: Bloomberg, InterCapital Research

In an attempt to cope with the situation on the market Viro recently announced a joint venture with another Croatian sugar manufacturer. This serves as a perfect example of just how important the economy of scale has become in the sugar industry. Furthermore, the industry is currently in danger of losing many of its current members who don’t have a strong enough balance sheet which would enable them to wait for the sugar price to recover, to invest into diversification or to acquire other competitors.

However, there is a silver lining here and that is the positive effect which lower sugar prices have on the production costs of companies who use sugar as an input. Many companies in the food industry have seen improved margins as a result of decreasing sugar prices (e.g. Altantic Grupa, Podravka), once again proving the old proverbial saying that one man’s loss is another man’s profit.

Filip Gracin
Category : Blog

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