Monday, November 27, 2017

Understanding India's Sugar Sector.

Sometimes there exists a situation which becomes difficult for the human mind to comprehend. The sugar sector in India is one such where it is difficult to understand why such a dire situation exists for a sector which forms a backbone for the agrarian economy in the country.
This has been proven time and again that for anything to flourish the entire ecosystem has to benefit. We cannot expect to compensate one part of the value chain by squeezing the neck of the other. However this is what existed in the sugar sector as early as 2015. Have a look at what the biggest sugar miller in India had to say in 2015….
This is an extract from the annual report of Balrampur Chini in 2015. We cannot expect to hold one part of the value chain at ransom to over compensate the requirements of another. This is simply not sustainable, especially in a sector which is so important to the ecosystem of the country. Let’s have a look at some simple facts of the sugar economy in India
Facts about the Indian Sugar Industry
  • Aggregate demand of 25MT with a population of 1.32 billion as on 2016
  • Per capita consumption of around 20kg per year
  • India is the world’s largest consumer and second largest producer in the world



However in 2017 the company had a different tone
The profits have shot up
This is an exercise in finding out what changed and foremost what ails this sector so deeply that it forms a part of the untouchables for many. To understand that we tried to dig deep into the workings of the sugar sector and this is Part 1 of our exercise which will be followed by much deeper understandings of how this industry works and is anything changing?
Let’s first understand how sugar is made…
The process of making sugar starts at the farmland with the sowing of the sugarcane crop. Sugarcane is a water-intensive crop (1 kg of sugar production in Maharashtra requires around 2300 liters of water) and any shortage of the same significantly inhibits growth.
In India, there are three variants of the same namely –
  • The spring crop sown in March,
  • The Adsali Crop sown in July and
  • The Autumn Crop sown in September

The adsali and the spring Crop take 18 months to mature while the autumn crop takes 12 months to mature before they can be cut and sent to sugar mills for further processing.
The cultivation of sugarcane happens through the age old ‘ratooning’ method in which subterranean buds on stubble  (the part of cane left underground after harvesting plant cane), gives rise to succeeding crop stand which is usually referred to as ‘ratoon’ or the ‘stubble crop’
Now that we know how sugarcane is cultivated & harvested let’s understand what happens next…
Once the cane is harvested, it is then taken to the sugar factory for conversion. The sugar mill needs to be in very close proximity to the sugarcane farms.
Let’s understand why…..
  • A longer distance between farm and mill would increase the cost of production
  • The sucrose content in cane rapidly declines after harvesting hence time between harvesting and conversion needs to be minimized

The conversion process
Let us first present a flow chart that depicts how sugarcane is converted among the many products
https://1.bp.blogspot.com/-j8vEx-nviPA/WgkyOezOQDI/AAAAAAAADC0/MGs-u2aoJNgGQyaFHJSwNyecBXLuE58NACLcBGAs/s640/Sugar%2Bproduction%2Bprocess.PNG
(Source: Dwarikesh Sugar)
  • A sugar mill can be a standalone facility where the output is only sugar or an integrated facility producing other by products as well
  • By products of crushing sugarcane are sugar, molasses & bagasse
  • While molasses are used to produce ethanol & alcohol, bagasse is used to generate power
Let’s understand how an integrated facility helps…
  • Bagasse used to generate power is used for own production as well as sold in open market
  • Ethanol is mandated to be used as an additive in fuel
  • Molasses are sold to the alcohol industry
All of this helps in managing realizations as sugar production is weighed down by high fixed costs, volatile realizations & vagaries of government policies. Let us try an understand each of these point in details
High Fixed Costs
For any commoditized business, having low cost production and optimizing usage of by-products are imperative for sustaining profitability. In this case, optimizing output from each ton of cane procured is an absolute necessity for an integrated mill to ensure maximum production of both sugar and its associated by-products.
This variable is measured by tracking the recovery rate. The recovery rate is the quantity of sugar that is retrieved from processing one tone of sugarcane. Let us explain how this works. For eg: If the recovery rate is 11.5% that means for every tone of cane processed you get 115 kilograms of sugarcane.
The recovery rate is not standard across regions. It depends on soil, climatic conditions, variety of crop used, etc.
Let us now show you how the recovery rate affects all the byproducts of sugarcane conversion assuming 1 tonne of sugarcane
https://lh5.googleusercontent.com/pZFTQ92WcN1Z0bjkd4ieT_XFQiYu2lE-Kq7EhCkuh76jHJ3Tdyytmht3eLThSxAunjNBZoEBsKjfgkhrO3i1W6W3hYiWlRsCTdC0EQCCqqTRj2dj3Ko9_YiuKJpSBlCuucuh6eBv3kloVfu1KA
Vagaries of Government Policies
To understand how the government policies affect the sugar sector first let us understand why the sugar sector is so important for the government:
  • With 5 million hectares of land under cultivation the industry supports over 50 million farmers
  • The three big states of Uttar Pradesh, Maharashtra & Karnataka produce over 75% of the production
  • While Uttar Pradesh is dominated by private companies, Maharashtra is dominated by co operative mills belonging to state government
  • The production capacity in the country is roughly distributed equally among private and co operative entities
Thus the Central Government sets the Fair Remunerative Price (FRP) each year, which is the minimum price the sugar mill has to pay the farmer while procuring cane. On top of this sugar producing states set their very own State Advised Price (SAP) which many a times is much higher than FRP for reasons best known by the State Governments themselves
Let us have a look at how the mood of the government decides the pricing of sugarcane in the market…
C:\Users\user\Desktop\FRP SAP.PNG
The blue line shows how SAP has moved over the years while the pink line shows the gap between SAP and FRP in Uttar Pradesh
Have a look at how the SAP more than doubled in 5 years during 2009-14. This was the period when Mayawati governed Uttar Pradesh as the Chief Minister while there was a Congress led government at the Centre
While the SAP decides the cost of procurement for the mills the final selling price depends upon various factors viz. export quota, domestic demand, government controlled levy.

Let us understand each of these in detail…
Domestic demand
C:\Users\user\Desktop\Domestic production and consumption.PNG
This is the demand supply situation in the domestic market. The supply depends not just on the production but also the opening stock for that year. The demand for sugar being a basic necessity remains constant and keeps inching up every year. Since demand is relatively inelastic pricing should remain more or less stable. However, the supply is very volatile, which means it is not the demand which is the problem but what moves supply.
Let’s have a look at how ex mill sugar prices have moved over the last decade
C:\Users\user\Desktop\Ex mill price.PNG
As we can see the current ex mill prices are the highest in over a decade. As we write ex mill prices for sugar trade in the same range as of FY17.
Government controlled levy
This regulation that the government used to impose on sugar companies was called the monthly release mechanism by which the Government controlled the quantity that Mills could 'release' into the open market. In addition to the release mechanism, sugar mills had to sell 10% of their produce to the Central government under the levy quota at subsidized rates.
Exports/Imports
The government controls import and export of sugar in the country
The prices of sugar have kept falling in the international markets over the last year. However, the government incased import duty to the already existing 40% by another 10% to stop cheap global sugar from flooding the Indian markets. Similarly when prices increase in global market sugar companies can only export on a pre fixed quota mechanism thus not allowing domestic pricing to be affected by global volatility


Let’s see how all of this interference affects the sugar economics in the country
We use Dwarikesh Sugar as a case study to understand how companies operating in sugar sector were affected
https://1.bp.blogspot.com/-7UiUUpOiEeg/WglVBjRVs4I/AAAAAAAADDQ/R5TBWcgLS6UwLdY1Gyk6lfpt0b2s2IDZgCLcBGAs/s640/e.PNG
Notice the difference between SAP and the cost of raw materials booked by the company
https://1.bp.blogspot.com/-4wok3XN11T8/WglaPph0-lI/AAAAAAAADEA/jS9TRL4D7EwaYKTlOZ0rTwCAHS5uCOOeACLcBGAs/s640/daw.PNG
Notice the way realizations moved in relation to cost
https://4.bp.blogspot.com/-LlcZgDdwqhk/WglXmRiOhqI/AAAAAAAADDo/Ax8eSFDCBvAAqsMANgm09T5B_KINuPOkgCLcBGAs/s640/rr.PNG
This led to gross margins falling from a high of 58% to negative 4%
Here is a case explaining how FRP & SAP affect pricing for sugar companies in Uttar Pradesh
The FRP set by the central government entails a base price with benchmark recoveries of 9.5%. For every additional recovery that mills make out of their cane, they have to pay the farmer an incentive of Rs 2.68/quintal for every 0.1% of additional recovery.
https://1.bp.blogspot.com/-FjgwuPT8NlU/WgmKLrSSx_I/AAAAAAAADFs/yJgpS5L1h34I5hKRrmA7f_E3BtgkxYnrwCLcBGAs/s400/CP2.PNG

We use another case study of Ponni Sugars to show the attitude of the government while the companies were bleeding
https://1.bp.blogspot.com/-nlNFjdVk1JU/WgldgRE3FzI/AAAAAAAADEY/kT21Pm5ED0c-6HvcAoOo4ZrqqGxrvBDZwCLcBGAs/s400/rew.PNG

Now let us see what the biggest sugar producer in India had to say two years ago…
This is what the MD of Balrampur Chini Mills had to say in the Annual Report of 2015. The industry was dying. He suggested a solution. Most of the steps advocated were similar to what the Rangarajan Committee had recommended noted as under:
  • De regulation of Indian sugar sector
  • Linking cane procurement price with market pricing of sugar
  • Abolishment of monthly release mechanism and levy sugar quota
  • Revenue sharing with farmers from processing of other by products of sugarcane
  • Stable external trade policy with moderate tariff levels

So what has the Government done…?
  • The state governments of Karnataka and Maharashtra have approved the implementation of the Rangarajan committee recommendations
  • The central ministry has written to the Uttar Pradesh government to implement Rangarajan committee recommendations (central and state governments in Uttar Pradesh are similar)
The situation today
India is expected to produce around 25.5mt of sugar this year, primarily led by significantly higher output from Maharashtra and Karnataka. With domestic demand being stable around that 25mt mark, there shouldn't be a need for imports into the market. With demand and supply being in equilibrium and the central government pushing the implementation of the cane pricing formula of the Rangarajan committee in U.P, prices could be stable moving ahead. Stability in prices will lend themselves to a stream of free cash for companies as growth capex isn’t on the anvil yet.
De-leveraging balance sheets and subsequent conversion of debt into equity has been one of the prominent highlights of corporate India in recent times and the sugar sector is no exception to that. In the past couple of years, most sugar companies have diverted all of their cash flows towards debt repayment and have healthier balance sheets
The following is an extract from Ind-Ratings highlighting the opening stock for FY2018 which should keep the prices stable as the opening stock is lower than the typical buffer kept by companies
Important understandings
  • Financial condition of sugar mills on a much better footing than 2-3 years ago
  • Most of the cash flows generated over last two years have been utilized in debt repayments
  • No growth capex done. However, once situation improves many mills now closed can soon start operations
  • Government has implemented structural changes in the sector and states are now more pro active towards plight of mills
This is a part of the series in which we have tried to understand sugar sector. In the next part we will have a look at individual companies across different regions to understand how companies have evolved over the last two decades in different regions

33 comments:

  1. great insights sir. Keep us inspiring and giving us knowledge. thanks a lot

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  2. Very well analysed, profound article, thanks for the good work, Sir

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  3. Excellent work and articulation by the writer... Thanks

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  4. A very detailed analysis, along with a crisp writing style makes this article on the sugar sector one of the best I've read. Keep up the good analysis! Looking forward to your next article.

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  5. Nice Article but would like to point out one thing. In Northern India, sugarcane crop normally takes between 4 to 6 months to mature. Hence the figures of 18 and 12 months given for the various varieties seems incorrect and should be 180 and 120 days respectively IMHO.

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    Replies
    1. In every part in India it takes around 12-18 months to mature depending upon the upon the variety and sowing time. Here we maturing means from planting to harvesting.

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  6. can i get same type of analysis for basmati rice!!

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  7. Brilliant brilliant article on the sugar industry.. i have been invested since many years in Ponni and Bajaj Hindustan.. cannot wait to read the next part of your blog on the individual companies.

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  8. Great Insights. Thank you for the article.

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  9. Great job! very well articulated

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  10. Thanks for this MRI Report on Sugar Industry. By the way, I feel that every region will have its own inherent plus and minus from pulling in raw material to pushing out sugar unless that region has more integrated sugar complexes. In this background, I am anxiously awaiting your next article.

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  11. Dhruv! Proud of you buddy for such a brilliant article. Congratulations to you and the team! Very well done! Gave massive insight to a sector which is so highly complex with such regulations. At least now a reader will surely be able to take decisions on the fate of the sugar companies whenever more relaxation of rules come. Kudos and keep the good work coming! Cheers!

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    Replies
    1. Thank you so much Jeete! Expect a lot more from us going forward :)

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  12. im looking forward for the part-2 ...dont keep us waiting...

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  13. im looking forward for the part-2 ...dont keep us waiting...

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  14. Very insightful write-up. Could you provide a little information about your data sources?

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  15. In your above analysis if FRP is 295 and SAP is 305 then cost for mill will be 305 but your calculation shows its 295.coudnt understand.please guide

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