Sugar industry under short-term pressure but with a positive medium-term skew; Sao Martinho remains the preferred exposure

Overview

This report centers on Morgan Stanley's global sugar view after New York Sugar Week. Its core view is that the market understands the broad direction of a gradually tightening sugar balance in 2026/27, but is underestimating the timing mismatch between near-term weakness and medium-term upside risk. In the near term, faster Brazilian harvesting, ethanol inventory rebuilding, government intervention in gasoline prices, and mills' bias toward sugar production will weigh on sugar and ethanol prices; in the medium term, weak margins leading to insufficient cane renewal, El Nino disruptions to production execution in Asia and Brazil, and demand support from ethanol-blending policies could tighten supply and demand again.

Core views

The report's core view is that short-term price weakness does not mean the cyclical thesis has broken down. Brazil can release more supply in the near term and cap prices, but that supply buffer comes from lower renewal rates and an older cane profile, which may weaken future yields and tighten the 2027/28 balance. The market is currently pricing more of Brazil's spot supply ceiling and modest tightening, but has not fully reflected the upside risks from El Nino, potential production losses in India and Thailand, acreage contraction in Europe, and policy-driven ethanol demand. Given this skew in risks, Morgan Stanley continues to view Sao Martinho as the clearest listed equity exposure.

Analysis framework

The report uses a top-down analysis of the global sugar supply-demand balance, combined with the relative economics of Brazilian sugar and ethanol, ethanol-versus-gasoline parity, inventory changes, weather scenarios, policy constraints, and the company's risk/reward framework. At the company level, it assesses Sao Martinho's target price under base, bull, and bear scenarios, incorporating sugar prices, ethanol prices, BRL exchange rate, diesel and input costs, leverage, and the valuation of the corn ethanol business.

Methodology notes

• commodity_supply_demandglobal sugar balance and stock-to-use analysis

  Global sugar supply and demand and stock-to-use ratio

  The report uses production, demand, ending inventories, surplus/deficit, stock-to-use ratio, and NY#11 sugar price forecasts to assess the position of the sugar price cycle and the degree of medium-term tightening.

• scenario_analysisrisk reward framework

  Stock risk/reward scenarios

  Sao Martinho's risk/reward framework includes a R$24 base target price, a R$38 bull case, and a R$12 bear case to capture the impact of changes in sugar prices, the ethanol business, and valuation multiples on the share price.

• weather_riskEl Nino monitoring framework

  El Nino weather risk monitoring

  The report focuses on El Nino's effects on India's monsoon, Thai cane development, crushing days in Brazil's Center-South, and ATR/TRS quality, and treats it as an important variable supporting price floors and medium-term upside optionality.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• Sao Martinho SA (SMTO3.SA)

  The report's main company coverage; rated Overweight

  Strengths

  Low-cost, high-quality assets; strong operating leverage to a recovery in sugar and ethanol prices; valuation below replacement cost; corn ethanol business may be undervalued.

  Weaknesses

  Near-term results are weighed down by lower ethanol prices, inventory rebuilding, BRL strength, and higher diesel and input costs.

  Comparison

  The report views SMTO as the clearest listed exposure to capturing the sugar-ethanol cyclical inflection and asymmetric risk/reward.

  Risks

  Petrobras gasoline price intervention, further BRL appreciation, weaker-than-expected hydrous ethanol demand, and a faster shift by Brazil toward sugar production.

• NY#11 sugar

  Key commodity price variable

  Strengths

  Medium-term tightening, weather risk in India and Thailand, and Brazil production costs above the near-month contract price provide support for a price floor.

  Weaknesses

  A larger and faster Brazilian harvest, mills' tendency to maximize sugar output, and high ethanol inventories will weigh on prices in the near term.

  Comparison

  The market has partially priced in a modest tightening, but the report believes weather- and policy-driven upside risks are not fully priced in.

  Risks

  Slower demand growth, larger-than-expected Brazilian supply release, and lower oil prices that weaken ethanol support.

• Brazil ethanol

  Key variable influencing Brazilian mills' sugar-versus-ethanol decision

  Strengths

  After inventory normalization, distributor margin recovery, the seasonal narrowing of the ethanol discount to gasoline, and blending policy could support prices.

  Weaknesses

  Rapid inventory growth, gasoline price policy pressure, and weak demand are delaying a near-term recovery in ethanol prices.

  Comparison

  The report says the pace of ethanol price correction is faster than previously expected, which is the main change versus its prior view.

  Risks

  The government continues to manage gasoline prices, subsidies or tax cuts offset oil-price increases, and hydrous ethanol demand does not recover enough.

Key data

• Target price changeR$22.00 -> R$24.00Morgan Stanley raised the Sao Martinho SA target price to R$24.00.
• RatingOverweightThe report maintains an Overweight rating on SMTO3.SA.
• Risk/reward scenariosR$38 bull / R$24 base / R$12 bearUpdated risk/reward framework for Sao Martinho.
• Near-term sugar price pressure levelaround 15c/lbThe report believes prices may remain under pressure near roughly 15c/lb.
• Medium-term sugar price assumption17c/lbThe report raised its medium-term sugar price assumption to 17c/lb.
• Brazil production costabove 16c/lbThe report says Brazil production costs are above the roughly 15c/lb level of the latest NY11 contract.
• El Nino probability82% May-Jul emergence; 96% persistence through Dec-26/Feb-27The May update from NOAA/CPC shows a high probability of El Nino formation and persistence.
• Potential loss in India1-2 mnt in 2026/27El Nino may lead to a loss in India's 2026/27 sugar output.
• Historical yield loss in Thailand7-13%Historical yield-loss range under El Nino scenarios in Thailand.
• 2026E adjusted EBITDAR$3.4bnSao Martinho 2026E adjusted EBITDA forecast.
• 2027E adjusted EBITDAR$2.9bnSao Martinho 2027E adjusted EBITDA forecast.
• 2028E adjusted EBITDAR$2.9bnSao Martinho 2028E adjusted EBITDA forecast.
• 2027E leverage1.9x ND/EBITDAThe report expects leverage to rise to 1.9x in 2027E before easing.
• Sugar price sensitivityabout R$180mn or USD 30mn EBITDA per 1c/lbEquivalent to about 3.1% of current market cap.

Impact & implications

For investors, the report emphasizes that short-term weakness in sugar and ethanol prices should not be linearly extrapolated into long-term fundamental deterioration. If El Nino, Asian supply, European acreage contraction, or ethanol-policy demand materialize, the sugar price floor and medium-term upside could be stronger; Sao Martinho may benefit from the cycle turning point because of its low-cost assets, operating leverage to a recovery in sugar and ethanol prices, and the still underappreciated value of its corn ethanol business. However, near-term earnings and cash flow will still be weighed down by weak spot ethanol prices, a stronger BRL, and higher diesel and input costs.

Risks

• A larger and faster Brazilian harvest in the near term could continue to weigh on sugar prices.
• Rapid ethanol inventory rebuilding weakens ethanol prices and reduces mills' incentive to divert output into ethanol.
• Petrobras or the government may continue to suppress gasoline prices, limiting support for ethanol prices.
• Further BRL appreciation would reduce export revenue and compress Sao Martinho's margins.
• Higher diesel and agricultural input costs could weigh on cash flow.
• Hydrous ethanol demand could come in weaker than expected.
• Sugar demand growth could slow further.
• A faster shift by Brazil toward sugar production could increase near-term sugar supply.
• If El Nino does not create visible crop damage, weather risk may support only the price floor rather than drive a new rally.
• Morgan Stanley discloses that it has or seeks business relationships with covered companies, and investors should consider potential conflicts of interest.

What to watch

• India's July-to-September monsoon, reservoir levels, soil moisture, and cane growth.
• Thai cane development and the impact of El Nino intensity on yields.
• Harvest progress in Brazil's Center-South, crushing days, field accessibility, and ATR/TRS quality.
• Changes in Brazilian ethanol inventories and the recovery in hydrous ethanol demand relative to gasoline.
• Petrobras gasoline pricing and government subsidy or tax policy.
• Whether global ethanol blending ratios and enforcement increase.
• The pace of acreage contraction for sugar beet or sugar production in Europe under a low-price environment.
• Whether NY#11 sugar prices remain below Brazil's production cost.
• Whether Sao Martinho's corn ethanol business margins outperform expectations.
• SMTO's 2026E-2028E EBITDA, leverage, and free cash flow delivery.