Sugar profitability to decline in SY2012-13: ICRA

For SY2012-13, the domestic sugar production is marginally higher than domestic sugar consumption (estimated at around 23-23.5 million MT) which together with imports of 0.5 million tons has resulted in a modest surplus, although sugar stocks still remain satisfactory at 6.5- 7.0 million MT or 3 months domestic consumption. The domestic free sugar realisations, which had shown an upward trend between May 2012 to November 2012 (peaking at around Rs.36,000/MT2), have since shown a declining trend falling to around Rs. 31,000/MT by May and June 2013. Competition from sugar produced by processing raw sugar (whose prices remained weak globally because of supply pressures) also continued to prevent any rally in sugar prices.

While prices have remained at around Rs 31,000/MT in July 2013, ICRA expects a marginal improvement by around Rs 1,000/MT in the next few months following abatement of supply pressure with end of crushing and also reduced competition from imports following increase in duty from 10% to 15% and also sharp devaluation in rupee which renders imports uncompetitive. In addition, rupee depreciation has also made export realization marginally competitive for South and West based sugar mills and ICRA anticipates some sugar exports which will partly relieve pressure on stocks.

For SY2013-14, ICRA expects the domestic sugar production to remain subdued in relation to the domestic sugar consumption following a significant decline in new cane plantations in key sugar producing states of Maharashtra, Karnataka and Tamil Nadu due to water shortage.

Further, lower harvest from the main crop in SY 2012-13, will also result in lower availability of the ratoon crop from the last season’s harvest (which usually accounts for a third of the total cane production). This is expected to lead to further decline in crushing volumes. However, given poor availability on crop data and given that the key crop parameters such as final yield and sucrose content will continue to remain dependent on weather conditions over the duration of the sugar crop, it is too early to project the final sugar production for SY 2013-14.

On Apr. 4, 2013, the Government of India announced a partial decontrol of the sugar industry by removing levy obligations on sugar and abolishing the release mechanism. The abolition of the levy obligation, which ICRA estimates would have caused a financial burden to the sugar industry to the tune of Rs. 30 billion for the sugar year 2012-13, is likely to improve the profitability of the sugar mills in the long-term, although the same has actually impacted the prices in the short-term with several cash strapped mills liquidating their sugar stocks in order to meet dues, including cane arrears to farmers.

The abolition of the monthly release mechanism would also benefit sugar mills in the medium to long-term by enabling them to manage their working capital requirements better while also enabling financially stronger sugar mills to capitalize on better sugar realizations.

As far as the global supply-demand position is concerned, the sugar industry witnessed a surplus. The world sugar balance for SY2013-14 is expected to remain in surplus following a bumper cane crop in Brazil, expectations of increased output from Thailand and only modest decline expected in production from India and China. This is likely to result in international sugar prices remaining under pressure.

As far as the domestic free sugar price outlook is considered, ICRA expects an increase in import duty from 10% to 15% together with a sharp depreciation of the rupee is likely to provide a marginal upside to current sugar prices in the next three months. In the medium-term, the sugar price trends will continue to be determined by the following three factors. Firstly, the domestic sugar balance. Secondly, the international crude oil prices, which will determine the raw sugar: ethanol mix in Brazil, the world’s largest producer and exporter; and finally, the Government of India's policies regarding exports of sugar and import duties.

ICRA estimates that cane cost increases have outstripped realization growth in SY 2012-13 in most regions and thus created pressures on conversion margins. The drop in conversion margins is sharpest in Maharashtra and Karnataka. In absolute terms however, these states are still likely to witness the healthiest conversion margins followed by Tamil Nadu (TN). UP is likely to have the weakest conversion margins given the high cane cost of production, mainly because of low recovery rates coupled with high cane prices.

ICRA observes that a very significant part of the total revenue and profits of sugar mills comes from by-products, especially in the case of forward integrated entities. Although there are concerns pertaining to timely collections of receivables from state owned utilities especially in the states of UP and Tamil Nadu, ICRA notes that lately there has been some improvement in the payment receipt from these utilities. ICRA believes that forward integration will remain crucial for improving profitability and riding through the cyclicality of the sugar industry.

ICRA expects weak profitability performance for sugar mills in Q3 SY 2012-13 (quarter ending June 30, 2013) given low prices coupled with the fact that sales for the quarter is being made out of relatively higher cost stocks produced during the current SY 2012-13. For SY 2012-13 as a whole, while the overall realizations are likely to be higher by about 10% over SY 2011-12 due to steady realizations and abolition of levy obligations, growth in cane prices is expected to impact the profitability of sugar mills adversely . UP would be the most impacted although other states too such as TN, Maharashtra and Karnataka too will see an adverse impact. While margins are likely to deteriorate for UP based mills largely because of higher cane costs (offsetting impact of higher volumes and improved recoveries), in Karnataka and Maharashtra reduced crushing is expected to impact profits for most mills. ICRA also notes that profitability pressure has also created liquidity pressures with the industry having significant cane dues as on June 30, 2013 with UP based mills accounting for the largest chunk.

As far as the medium to long-term outlook is considered, as in the past, the long-term prices and profitability of Indian sugar companies would remain highly cyclical and dependent on domestic and international supply-demand trends. Government/court action in ensuring a complete decontrol of the sugar industry and a rational linkage between cane prices and sugar prices will also be a key to long-term viability of sugar operations, especially in states governed by SAP. Within the sugar industry, however players who enjoy the benefit of high operating efficiencies, forward integration and a strong capital structure will be best placed to ride out the cycles.

source: myiris