Weak sugar price. Raw sugar, MSM's key raw material component, has seen prices plunge this year following expectations of improved harvests in Brazil, China and Australia. Raw sugar prices have fallen by 15.5% since the beginning of the year, making it the third worst performing agricultural commodity tracked under the S&P GSCI commodity index. Coffee and cotton saw the biggest plunge, underperforming the index's agricultural sub-segment's 15.1% rise. Palm oil, which has declined by 23.1% YTD, is not covered by the index. India is expected to be the only major producer to see sugar production shrink this year as the International Sugar Organization forecasts production surplus to reach 5.9m in the 2012-2013 season.

Used to help, but not anymore. The 2009-2011 long term contract (LTC) meant that approximately 50% of MSM's raw sugar needs are sourced at market rates. The company has thus, in the past, managed to reduce its costs when there was a decline in raw sugar prices. As 80% of MSM's total sales volume was derived from the domestic market and sold at a fixed price, this meant that 30% of its total sales volume was exposed to a fixed selling price in a variable cost environment. That 30% of active exposure has narrowed to just 6%-10%, as 13 of the largest domestic F&B industrial players are no longer entitled to fixed-price, subsidised sugar since Jan 2011. Together with the new 2012-2014 LTC locking in 64% of MSM's total volume (which translates to 80% of its domestic volume) for 2012, the company's exposure to varying raw sugar prices has effectively been wiped out.

Exposure again next year. The unique condition about the 2012-2014 LTC, however, is that it allows MSM to reduce raw sugar sourced from the contract to just 48% of total volume (60% of domestic volume) starting in 2013. This exposes 8%-12% of MSM's total volume to a fixed price and varying cost situation again. The current LTC cost stands at USD0.26 per lb. In comparison, raw sugar spot prices, including the freight cost of USD0.02 per lb, is hovering around USD0.22 per lb.

Sugar prices will get support from ethanol. There will be a price floor for raw sugar, nonetheless, as large declines in raw sugar prices will motivate Brazilian cane farmers to switch to ethanol production. This base price is expected to be USD0.175 to USD0.19 per lb.

Widening refining spread. In the nearer term, a widening spread between refined sugar and raw sugar prices in recent months will provide MSM some lift in profitability. The premium that refined sugar commands has risen to USD129 per tonne this quarter, compared to USD108 per tonne in 1HFY12. The increasing spread should give MSM better profit margins for volumes with floating prices (i.e. volumes from the 13 F&B players and for export).

Maintain NEUTRAL. Our FV is unchanged at RM4.95, based on 13.0x FY13 PE. FY12 and FY13 dividend yields stand at 3.7% and 3.9% respectively.

Source: OSK