Indian Sugar Industry

February 2011

CONTENTS Production process of sugar ....................................................................................................................................... 2 Demand Supply levels ................................................................................................................................................... 4 Key regulations ................................................................................................................................................................ 7 Characteristic .................................................................................................................................................................... 9 Global scenario ............................................................................................................................................................. 10 Segmentation and Peer comparison .................................................................................................................... 10 Financials ......................................................................................................................................................................... 10 Key Concerns in the Industry ................................................................................................................................... 11 Critical Success Factors .............................................................................................................................................. 11 Outlook ............................................................................................................................................................................ 12

Sugar industry comprises of manufacturers of Crystal sugar, Gur and Khandasari. This report will be on crystal sugar manufacturers. Crystal sugar refers to edible crystalline product. Chemically Sugar contains over 99% sucrose. Sugar variants for industrial applications contain glucose, fructose, maltose and lactose. Going by history, technology of converting cane to raw sugar was invented in 5th century AD. FY 10 sugar production in the world was 160 million tonnes. Top ten producer (includes Brazil and India) account for about 75% of total production. India is the largest consumer of sugar at 22 metric tonnes. Exports are usually minimal due to strong domestic demand. Per capita sugar consumption of India is lower than the global average. Only 30% of total output is traded across nations. Indian sugar industry has turn over of Rs. 5000 crs. 500 mills are spread across Public (30 mills), Private (250 mills) and Cooperative (220 mills). While it is optimal (cost wise) to have large capacity mills, due to government policies which encourages new sugar plants when compared to capacity additions, there are large number of small capacity units. Average capacity is 3510 tonnes crushed per day (tcd). Optimal global standard is above 10000 tcd. PRODUCTION PROCESS OF SUGAR About 70% of global sugar production is from Cane and 30% from Sugar beet. Beet is the root of the crop and is grown in temperate climates (like USA). In India sugar is produced from canes. Process of sugar production is as shown below,

Source: Process Flow chart, Renuka Sugars Limited

In a typical Indian sugar plant, a. Bagasse is used as fuel to burn water into steam which in turn produces power. This power can be captively consumed or sold to state electricity boards. Alternately bagasse is sold as raw material in paper factories. A part of bagasse is also used to boil sugar syrup. b. Ethanol can be produced from Molasses c. Press mud is used as manure Capacity of plant is a function of tonnes crushed per day and number of crushing days per year.

DEMAND SUPPLY LEVELS Estimated SY 11 Indian production is 25 MT of crystal sugar. SY 10 sugar output was 18.5 MT. Sugarcane in India is grown in 9 states, Andhra Pradesh (AP 10%), Bihar, Gujarat (GJ 7%), Haryana, Karnataka (KA 11%), Maharashtra (MH 31%), Punjab, Uttar Pradesh (UP 28%) and Tamil Nadu (TN 10%). Of this 6 states of UP, TN, MH, GU, AP, KA produce about 90% of total sugar production. Supply of sugar in a given year is a determined by following factors a. Land under production b. Land Productivity (sugar cane yield per hectare) c. Cane crushed per year (of the total crop produced) d. Recovery rate (% yield of crystal sugar per unit of sugar cane by weight) Land under production follows cyclical pattern as shown below,

In Sugar Year (SY- October to September) 10, 45.32 lakhs hectare of land was devoted to sugar cane cultivation. The total land has been growing over the past five decades though the trend follows cyclical pattern. Land productivity is impacted by water availability and pest attacks (2002-03 was affected by pests) to the crop. Rainfall received in the geography (Sugar cane requires huge amount of water) is critical and India has vagarious monsoon. Thus there is natural cyclicality in this factor. Cane crushed per year as a fraction of total crop produced is about 60-70% in India. Recovery rate is the quantity of sugar produced per kg of cane crushed. Recovery rate in India is one of the lowest in the world at 10-12%. Thus supply of sugar is limited by these four factors. Sugar production in India has grown at CAGR of 4.9% from 1961 to 2007. The cyclicality in the output can be seen in the production trend over these years.

Source: KPMG Report

Demand (by quantity) growth is driven by population growth and growth in real income. This is also influenced by competition from alternative sweeteners. Domestic SY 10 demand was 23 MT. From 1996 to 2006, Consumption grew at CAGR of 3.5%.

10% of mills annual production is purchased by government for sales through public distribution system. Amongst the non levy sugar, Industrial and Small business entities account for 61% of consumption, while retail consumers (B2C) account for 39%. Dairy, Confectionary and carbonated beverages are key consumers of sugar. Demand is expected to grow at around 4% over the next five years. As the trend implies, supply is cyclical while demand grows linearly. Resulting supply demand imbalance is the key characteristic of this industry. During the past decade country has been a net exporter as well as net importer on different seasons.

Supply Demand difference

10 8 6 4 2 0 -2 -4 -6 -8 -10 SY 03 SY 04 SY 05 SY 06 SY 07 SY 08 SY 09 SY 10 10 5 0 SY 03 SY 04 SY 05 20 15 30 25

Demand

Supply

SY 06

SY 07

SY 08

SY 09

SY 10

Source: ICRA Research

Pricing of non levy sugar is determined by supply demand scenario prevailing. However government through its regulations intervenes to control the prices to benefit the stake holders in the industry. Key drivers of domestic sugar pricing are, a. Expectations of demand supply deficit b. Sugar futures trading to an extent indicates the sentiments regarding the demand supply balance

c. Sugar prices tend to be stable when the inventory in the system is between 25 and 25% of annual consumption. They tend to fall when inventory increases above 35% and tend to raise when inventory falls below 25%. Sugar prices are market determined and hence are not linked to cane pricing. This affects the profitability of sugar producers. Millers carry price risk as crystal sugar is saved as inventory because sugar production is seasonal but demand is through out the year.
40 30 20 10 0 SY 07 SY 08 SY 09 SY 10
Average medium grade sugar (in Rs. per kg) price in Mumbai

Source: Capitaline

KEY REGULATIONS Key Stake holders in the industry

Farmer

Miller

Retail Consumers

Government regulations intend to protect the interest of all these stake holders. Current, regulations governing the sector are, a. Statutory Minimum Price (SMP): Minimum price miller has to pay to buy cane sugar from the farmer (Protects interests of farmers). This is decided by the central government. However several states have State advised price (SAP) usually is greater than SMP, advised by individual states. In SY 10, GOI introduced Fair and Remunerative Price (FRP). Computation of FRP was takes into account return from alternate crops to farmer and margin earned by miller. FRP was greater than SMP but less than most State advised prices. Government mandated that in states where SAP exceeds FRP, the difference will 7

be borne by the state government and miller has to pay FRP to the farmer. However most state governments opposed this, hence government went ahead with FRP dropping the clause of SAP. FRP for SY 10 is just an academic number and in most cases, miller pays the farmer SAP or more. b. Command area for procuring for each plant (protects interests of both farmer and miller) c. Millers cannot own the land (protects the interests of farmers) d. Minimum distance of 15 kms between the mills. (Protects the interests of miller) e. 10% of output of each plant has to be sold to government under levy. The price paid to the miller is less than the prevailing market price (protects interests of consumers). During SY 10 20% of output had to be sold by millers to the government. The same was brought back to 10% for SY 11 on account of expected decrease in prices due to increase in production. f. Taxes are charged differently by different state governments.

g. During SY 10, during decline in cane supply, (accompanied by high prices and better profit margins to millers) government imposed upper limit on storage per private player to control price rise. There was also an embargo on sugar futures to prevent price rise on speculative basis (To protect interests of consumer). h. Restriction of export and import: Government controls exports and import (raw sugar) through duties. Objective is to keep the domestic prices low and profitability of millers at economically sustainable levels. a. In case of total production exceeding domestic demand, (domestic prices will be low and profitability of sugar mills will also be low) government allows export and bans import. Import is banned to avoid millers from importing raw sugar, purifying and then exporting the same. Stress here is to maximize profit opportunities to millers b. Conversely when production falls short of domestic demand, (domestic prices would be high and profitability of sugar mills will also be high) government stops export and encourages import of raw sugar. Focus here is to meet the domestic demand and bring domestic prices down. 8

CHARACTERISTIC a. Sugar is the second largest agro based industry in India. Sugar cane production is severely impacted by climatic variations. b. Cyclicality of EBITDA margins from sugar production on stand alone. Following factors are cyclical a. Land devoted to sugar cane cultivation b. Sugar cane production for the season c. Sugar production for the season d. Average sugar prices e. EBITDA margins from sugar on stand alone basis Factors (a) and (b) move together. Factors (c), (d) and (e) move together along opposite direction. products. c. Seasonality: Demand is through out the year, but supply is only during a particular season of the year. Hence the industry becomes working capital intensive d. Capital intensive. However fresh capacity additions have slowed down e. Working capital intensive: Sugar mills are working capital intensive. Production is for 4 to 5 months while demand is uniform through out the year. This results in 70% of debt on books of sugar millers being working capital loans. The extent of Cash credit facilities extended to an extent adds comfort to liquidity position of a miller. f. Degree of fragmentation: Indian mills are fragmented. 500 mills at average capacity of 3000 tcd. Optimal capacity per mill is above 5000 tcd. g. In India, each farmer has smaller land area under production in comparison to the global average. This sub optimal land per farmer ends up in a high average production h. Brand has a little significance. Prices are determined by market. This is mitigated through sales of by

GLOBAL SCENARIO

Source: Fitch Indias Sugar sector outlook 2011

Globally only 30% of production is traded across borders. Brazil and India are the top two producers of sugar in world. Regulatory scenario prevailing ensures domestic industry is fairly insulated from global markets. SEGMENTATION AND PEER COMPARISON Segmentation of sugar industry millers has to be on the basis of the location of mills. This is because, a. Crushing days per sugar year varies across states b. State regulations impact the taxes and sugar cane procurement prices. c. Climatic conditions determine the yield from cane. 10% in temperate regions and 11% in tropical regions d. Agro climatic cyclicality differs across states FINANCIALS Following are the aggregated financial ratios of sugar companies from 2004 to 2009.
Ratios Debt-Equity Ratio Working capital debt/total debt Fixed asset turnover ratio EBITDA margins ROCE 2009 1.63 37% 0.98 22% 13% 2008 1.99 37% 1.02 13% 6% 2007 1.51 30% 1.26 11% 6% 2006 1.3 27% 1.79 18% 21% 2005 1.86 37% 1.66 16% 17% 2004 2.2 40% 1.31 13% 10%

Source : Capitaline

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The key observations are, a. Raw material is the key cost header constituting about 60 to 70% of total sugar plants costs b. Working capital loans contribute about 35 to 40% of total debt on books. c. EBITDA margins follows cyclical pattern. Typically range is between 6% and 18% d. ROCE ranges between 5% to 20% e. Average leverage ratio is less than 2. KEY CONCERNS IN THE INDUSTRY a. Average return (FY 06 to FY 10) on capital invested for sugar industry is 8.5%. ROCE during the same time lines for other industrial sectors like Paper (10%) and Cement (above 25%) are much better. b. Sugar cane prices (government decided) are not linked to the sugar prices in the market. It is difficult to predict as sugar cane prices are determined during the beginning of season and sugar prices are for the next one year. However to avoid sugar mills from making losses, it is necessary to set sugar cane prices above sugar prices. c. Government control, restricts the manufacturers from earning huge economic profit (Profit after required return) d. Absence of foreign investments in the industry is largely due to profitability concerns e. Performance is impacted by agro climatic cycle. Predictability of these cycles is difficult. CRITICAL SUCCESS FACTORS a. Higher proportion of institutional mix in the sale adds comfort to the financiers b. Integrated sugar mills, tend to have more stable margins than stand alone ones. c. Size of the company: In a down cycle, large size companies, have better ability to withstand the external shocks. d. Leverage levels will be critical amongst the financial parameters. A comfortably leveraged company will be able to survive the down cycle better by raising more debt.

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e. Relationship with farmers is critical. This by timely payment to farmers thus ensuring adequate supply of cane f. Location: Sugar being freight sensitive, location is a critical factor. Following locations are beneficial, a. Close to high sugar yield farms b. Near Sugar deficit states c. Proximity to port (helps during export or import depending on demand supply) d. Location in long sugar crushing season state. Southern states tend to have longer crushing days (more than 120 days) when compared to UP and Maharashtra due to favorable monsoon. OUTLOOK a. In line with the historical trend domestic demand is expected to grow at 4% per annum over next few years. b. Average up cycle lasts for 3 years. We are currently 30 months into the current up cycle. Down cycle to the industry is fairly close. c. SY 11 estimated production is 25 MT. 13.5 MT has been produced till February 15 2011. There is possibility of downward revision in the production estimates to about 23 MT. d. With an upward revision in cane prices in January 2011, the cost of sugar production has risen to Rs 29 per kg and Rs 27.5 per kg in Uttar Pradesh and Maharashtra, respectively. But the realization is Rs 28 per kg and Rs 26 per kg. Millers incur a loss of Rs 100-150 per qtl produced. Although there have not been reports of delay in payments to farmers so far, arrears will build when the sanctioned working capital limits from banks of the miller gets over. e. As a result profitability margins are likely to be squeezed for sugar players, unless there is price increase in domestic. f. Indian Sugar Manufacturers Association has requested to allow exports of 5 lakh tonnes of sugar to take advantage of global price of $ 760 per ton. Government will be waiting till April first week, to get clarity on SY 11 production. 12

g. By product sales would contribute to contribute to the profitability of the millers. h. No significant changes can be expected over the next one year on regulatory front.

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