Brazil's Sugar Shrink: Right Around the Corner

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Buying low and selling high applies to the commodities market in more ways than just the actions of the individual investor.  Bigger fish are attracted to ailing industries or companies in the search of good value, leading to market takeovers as companies become corporations and corporations become mega-corporations.  The direction taken by some of the largest companies in the world will dictate the price of the commodities they control, directions that may be ruthless like clamping down on existing supply or uplifting like looking for eco-friendly solutions.  Cargill Inc will make huge waves through the sugar industry in the upcoming months as they enter into negotiations to purchase two of the largest sugarcane mills in Brazil, adding tremendous prospects to a market where the commodity has had no net gain in the past year of trading.

The Sweetest Thing

The degree to which Brazil controls global sugar production gives them an influence in almost every product on the grocery store shelves.  From ice cream to Dr. Pepper, the sugar we happily chow or slurp down comes from Brazilian cane farms due to the abundance of water and sunlight needed to grow the notoriously fickle crop.  Brazil harvests as much sugar as the next five nations combined, a number that seems high but represents a decline over the past 100 years as the Brazilian monopoly gave way to new sugarcane plots in southeastern Asia.  The first sugar boom took place soon after the colonization of central and south America by the Spanish conquistadors.  Sugar, considered a spice like pepper or cinnamon, proved to be all the rage in Europe during the 1600s and 1700s, leading to massive cultivation practices in the Caribbean and Brazilian coastline.  While Americans associate the history of slavery with cotton, the infamous Triangular Trade displaced ten times as many Africans to work on sugarcane farms, where the harsh work and working conditions led to huge demand for new laborers for centuries, with the slave trade abolished only as recently as 1888.  Indeed, Brazil today has a higher population of blacks than any other nation in the world after Nigeria.  Many labor still on the sugarcane fields: while Brazil weighs in with the 7th-highest GDP in the world, one in seven Brazilians work in the agricultural sector today. 

Going Up, Coming Down

With a long history of production on their side, what's caused the downturn in the Brazilian sugar industry?  Competition, for one.  The southeastern Asian states of Thailand, Vietnam, India, and the Philippines began aggressively cultivating sugar during the commodities boom, when sugar traded for thirty cents per pound, three times the value of the commodity today.  The increase in supply forced some Brazilian mills, including the two that Cargill may snap up, to take on massive debt even as they broke processing records to put out nearly four million tons of sugar per year.  The Paraiso Mill and the Monterrey Mill, both located in Sao Paulo, sit at around 700 million Brazilian reals in debt (just shy of $200 million) thanks to difficulty in financing operations in tandem with plummeting prices for sugar as well as corn.  Given the high dependence Brazil places on ethanol, with sugarcane ethanol powering about a quarter of the nation's transportation, government subsidies kept both mills functional, if not profitable.  Cargill, which would be the ninth-largest corporation in the United States if it were traded publicly, has made the move to swoop in and snap up both Paraiso and Monterrey, provided the merger goes through with both mills.  With the company offering financial solvency, it's hard to see how the Brazilian sugar producers can possibly turn down the offer. 

Competing Plans

How does Cargill intend to turn this sow's ear into a silk purse?  For one, they want to strike while the iron is hot.  It's hard to find a better time to buy than today, since Brazil's currency is trading on 13-year lows while sugar is sitting on its worst performance in nearly a decade.  Furthermore, the company intends to use each mill as a holding facility as well as a processing site.  After a notorious fire in the Santos docks of Sao Paulo last year consumed 50,000 tons of Cargill sugar, the company decided to take steps towards securing the transportation of their supply.  Cargill believes that creating vertical assimilation throughout their operations will decrease such accidents and inefficiencies.  As cane producers report that revenue no longer exceeds costs in Brazil, Cargill gets the advantage of being one of the few buyers in town.  That'll cut down operating costs, but also cut down available sugar supply by edging out the competition.  While the company itself has little interest in seeing the price of sugar rise -- Cargill produces food, after all -- it's sure to be a side-effect of the pruning process as the two mills turned over to private interests reduce unprofitable measures.

  • The Takeaway: sugar for delivery in 2016 looks pretty good at the moment.  Diminished capability to harvest sugarcane in Brazil will lead to lower output, while the Cargill purchase of the two mills puts a clamp on sugar output that previously inflated global supply by pushing out smaller producers.  Investors should look to short-sell sugar for delivery in the next six to twelve months.
  • Sugar as a long-term investment doesn't look terribly appealing at the moment.  The continued global demand for sweets will keep the price stable, but too few factors are putting any type of pressure on the commodity.  The only other outlet for growth would be a poor growing season, and the predicted El Nino pattern should provide good harvests by this time next year.  Don't hold on to sugar for long.

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