Ind-Ra: Sugar Industry Gets Breather; Additional Government Support Required

India Ratings and Research (Ind-Ra) believes that the sugar industry faces headwinds in the near to medium term in view of a surplus sugar scenario in sugar season (SS) 2017-18, as domestic production is likely to be significantly higher than the earlier estimate.

Recent government measures are a shot in the arm for sugar millers and will uplift depressed sugar prices to a certain extent and curb distressed selling. However, they could stretch the liquidity and credit profiles of the smaller/standalone players.

Furthermore, the measures do not address the underlying problem of surplus sugar. While exporting surplus sugar is an alternative, it would be challenging as Indian sugar is uncompetitive in the global market.

Sharp Fall in Sugar Prices in First Four Months of SS 2017-18: Ex-mill sugar prices plummeted to about INR31/kg in February 2018 from about INR36/kg at the start of the season. Higher-than-expected production, sluggish sugar offtake, increased competition due to the reopening of closed sugar mills, distressed selling by mills with weak liquidity to clear cane dues (14-day regulation), stockholding limits on dealers in the early part of the season, threat of cheaper imports from Pakistan, speculation about significant sugar surplus in SS 2018-19 and dealers capitalising on multiple factors at play have led to a downtrend in sugar prices.

While Ind-Ra drew comfort from a balanced demand-supply scenario, depleted opening stocks and high import duties, and expected sugar price to remain stable at about INR35/kg, the developments during the season have resulted in sugar prices falling much below the expected levels.

According to Indian Sugar Mills Association (ISMA), domestic sugar production was 17.07 million tonnes (SS 2016-17: 20.3 million tonnes) as on 31 January 2018.

ISMA expects domestic sugar production to increase to 26.1 million tonnes in SS 2017-18 compared with an earlier estimate of 25.1 million tonnes. With over two-fifths of crushing yet to be completed, domestic sugar production is on course to surpass revised estimates.

Operating Margins Squeezed; Credit Profiles to Moderate: The steep fall in sugar prices, along with higher cane costs, has squeezed the operating margins of sugar millers in the first four months of the season. The impact has been sharper on states following state advised price (SAP), where cane costs are not linked to recovery. Furthermore, the decline in prices of molasses, a key by-product, has affected the operating margins of standalone sugar millers.

Operating margins of millers in the sugar segment in Uttar Pradesh (state advised price state) is estimated to have declined by about 10-12 percentage points in the first four months of the season. Millers across Maharashtra (fair and remunerative price state) witnessed a similar decline in operating margins. Moreover, they have rolled back the premium offered to farmers above the fair and remunerative price at the start of season until sugar prices improve.

Although the margins are set to improve with the imposition of stockholding limits, the credit profiles of sugar millers are likely to moderate in the near-to-medium term in view of a decline in operating profitability and a rise in working capital requirements due to stockholding limits.

Government Intervention to Support Prices, May Stretch Liquidity Position of Standalone/Small Millers: To arrest a sharp fall in sugar prices and curb distressed selling, the government increased the import duty on all types of sugar to 100% from 50% and re-imposed stockholding limits on domestic sugar millers in February 2018.

The increase in import duty all but eliminates the possibility of subsidised sugar imports from Pakistan that could have led to a fall in domestic sugar prices much below the cost of production of domestic sugar millers. The supply squeeze due to the re-imposition of stockholding limits for two months (February-March 2018) will uplift sugar prices, which are precariously close to the cost of production. However, a significant recovery in sugar prices will remain elusive as supplies are likely to be adequate to meet demand during February-March 2018.

Although the stockholding limit provides adequate liquidity, the impact of supply squeeze on the liquidity position of millers could vary according to available credit lines, debt obligations, size and nature of operations (integrated or standalone).

Sugar millers with a weak liquidity position that have inadequate credit lines to meet working capital requirements may not be in a position to clear cane dues due to the limits imposed on sugar sale. Furthermore, a section of sugar millers were holding onto stocks in anticipation of an improvement in sugar prices once the distressed selling in the early part of the season subsided. With the utilisation of available credit lines already high among these millers, as they cleared dues for cane purchased earlier in the season, sugar sale restrictions may limit their ability to pay for the cane to be purchased in February-March 2018. Stockholding limits may also affect millers that may have considered selling sugar even at the expense of lower profit to meet debt servicing obligations.

The supply squeeze will affect standalone sugar millers more, considering they do not have the cushion of cash flows from distillery and/or co-generation operations to withstand the liquidity pressure in the sugar segment.

Additional Government Support Required: Although government measures provide temporary respite from distressed selling, they do not address the underlying problem of surplus sugar. In the event of the lifting of stockholding limits after March 2018, the possibility of sugar prices remaining stable looks grim. Sugar millers may rush to liquidate stocks, given the possible stretched liquidity position of small players at end-March 2018. Furthermore, it appears that the market is already discounting a significant sugar surplus for SS 2018-19, given the higher-than-warranted decline in sugar prices in the current season.

In the current scenario, Ind-Ra opines that exporting surplus sugar could support sugar prices this season and avert a crisis in the sugar industry. However, high cost of production of domestic millers, 20% export duty, low global sugar prices and subsidised exportable surplus in competitor countries such as Pakistan result in an uncompetitive Indian sugar in the global market.

Therefore, Ind-Ra believes that the sugar industry requires further government assistance, which could be in the form of subsidising exports, removal of export duties, creation of buffer stock or any other measure to address surplus sugar and support sugar prices this season. Failure by the government to provide timely and adequate support will negatively affect the credit and liquidity profiles of sugar millers.

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