Profiting From Emerging Middle Class Demand For Sugar

| About: Cosan Limited (CZZ)
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This time of year brings back memories of my grandfather. It was on cool autumn mornings that he and I would climb into his old, brown truck with the faulty horn and head off to one of his favorite fishing holes down in south Louisiana.

Along the back roads we’d pass mile after mile of verdant sugarcane standing in leafy green rows. He’d always stop somewhere along the road, hop a ditch, pull out his pocket knife and slice off a stalk … and we’d continue our trip to the lake gnawing on sweet cane.

I was reminded of my grandfather’s habit of cutting me an early-morning piece of cane while I was driving along a back road near my house recently. Cane remains an integral part of Louisiana, and throughout the state these days farmers are preparing to bring in their crops.

Indeed, across the semitropical zones farmers from Louisiana, to Thailand, Brazil, to Tanzania, are moving into the cane-harvesting and crushing season that will last through spring. The folks who track sugar the closest, a sugar merchant known as Czarnikow Group, predicted earlier in the year that the supply-demand ratio would swing back toward supply for the new season – a move that might finally take some of the pressure off sugar prices that are up nearly 600% from lows earlier this decade.

But now that view could be changing… and in that lies investment opportunity.

Brazil, the world’s largest sugar producer, has announced that its production will fall relative to last year. Pressure once again is settling on the sugar market – and that means opportunity for those who understand the trends driving the sugar trade.

Elevated Sugar Price for Years

Sugar is such a common commodity in America that restaurants and diners essentially give it away in little packets on the table. That might not last much longer, given the rising demand for sugar and robust prices that could go even higher.

Behind the demand sits China - and Indonesia, India, Malaysia, and the Middle East, among others. Throughout the developing world, the new-consumer class is gobbling up bushels of sugar as it escalates its consumption of processed foods and beverages.

It’s one of the hallmarks of increasing wealth. Those who pull themselves out of poverty and move into the middle class always pursue better and more-convenient food with the first discretionary dollars they earn.

Sugar plays a role in many of those products – from soda to packaged foods to baked goods (and bakeries are on the rise all across the Middle East and Asia).

In the last two decades, Asia doubled the demand for sugar, and organizations that track sugar, such as Czarnikow and Agrimoney, now project that sugar prices will remain at elevated levels for several years to ensure that producing countries ramp up production to meet demand that is expected to grow by 50% over the next two decades.

Alongside that growing demand for edible sugar in much of the Middle East and Asia, we also have surging demand across Western and emerging economies for sugar as fuel substitute. Strong oil prices and a push toward greener energy sources have had a massive impact on the sugar industry, since cane is a leading source of ethanol.

As a result, sugar demand has risen from about 127.4 million metric tons in 1999/2000 to what will top 162 million metric tons in 2011/12.

Production, however, has struggled to keep pace.

Indeed, the stocks-to-use ratio for sugar, a market measure of supply and demand, has fallen to less than 20% from more than 30% earlier in the decade. That’s an indication that demand is running hotter than supply – which, of course, means stronger pricing.

A factor in the supply/demand equation is a series of funky weather events and other production snafus in recent years that have hampered the industry’s effort to produce more sugar. Floods in Thailand; droughts in Brazil, and South Africa. All have had their impact on global sugar prices.

Brazil is one of the most important. As the world’s largest sugar producer, it’s the country the world relies on to provide the additional supply necessary to meet demand. But Brazil could see sugar production for the 2011/12 season fall for the first time in a decade, in part because of port issues and in part because of a late start for the crop.

Moreover, estimates are that Brazil needs as much as $500 billion in new investment to keep up with soaring demand for sugar and ethanol – and whether that much cash flows into Brazil’s sugarcane fields remains uncertain at this moment.

Without it, though, sugar prices have nowhere to go but up.

A Potential 50% Gain in the Coming Year

Clearly, investors have an opportunity in sugar.

Demand shows no sign of abating for at least two decades as the new-consumer emerges and as ethanol requirements ramp up. And supply, growing at a slower pace than demand, faces challenges ranging from weather to infrastructure.

That means sugar is a good place to be a long-term investor. The market will bounce around, as all commodity markets do, but the trend is moving in the right direction.

Because of the long-term positive trends that define the sugar market, I recently put my EMS members into an undervalued Southeast Asian sugar stock that will ride the sugar market to highs starting in 2012. But you don’t have to go to Southeast Asia to play sugar. You can go to Brazil – and you don’t have to leave the States to do so.

Brazil is a lynchpin in the sugar trade, and Sao Paulo-based Cosan Ltd. is one of the world’s largest and low-cost sugarcane processors.

Cosan (NYSE:CZZ), traded on the New York Stock Exchange as an ADR, is a major player in both sugar and ethanol. It operates 24 sugar/ethanol mills across Brazil, as well as sugar refineries and port terminals. The company recently partnered with oil giant Shell (NYSE:RDS.A) to create a joint-venture that will produce more than two billion liters of cane-based ethanol every year, and which operates some 4,500 gas stations.

Because of its span across sugar and ethanol, the company is insulated to some degree from volatile commodity prices. If sugar prices weaken, fuel sales will help stabilize revenue and earnings. And as sugar prices rise, Cosan benefits directly since it is a key grower and exporter of sugar.

To meet demand growth, Cosan is adding roughly 22 million tons of cane-crushing capacity to its operations, increasing its current capacity by nearly a third. That will drive production growth – exactly what a sugar-hungry world needs – and push revenue higher over the next couple of years.

The shares currently trade at about $10.70. As cane production grows in Brazil, as Cosan’s capacity increases, and as demand for sugar/ethanol continues to escalate, I expect we’ll see Cosan’s stock move into the mid- to high-teens in the coming year.

For patient investors, Cosan is one of the best plays on sugar you can make without going directly overseas.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.