Short-term bitterness for sugar

Since our last Big Story on sugar published in July 2022, sugar stocks have managed a bitter-sweet performance.

Triveni Engineering and Industries has been the best performer with up to 47 per cent gains till date, while others such as Balrampur Chini Mills, EID Parry and Bannari Amman saw their stock price rise by 6-20 per cent since July 2022. The broader market, however, measured by the Nifty 50 performance, has been on a new high, raking in gains of over 40 per cent. Relative underperformance of the sector to the broad market has been due to a combination of global sugar scenario and adverse policy moves.

Falling production

In the sugar year 2021-22 (October-September), India produced a record 39.4 million tonnes of sugar, overtaking Brazil (32 million tonnes) to become the world’s largest sugar producer. Strong demand from global market, coupled with lower output from Brazil, helped India set a new record in exports as well. India exported 10.9 million tonnes that year, which was over 57 per cent higher than in 2020-21. Record production alongside firm sugar prices globally helped Indian sugar makers’ stock performance in FY23. About 3.6 million tonnes of sugar was diverted for ethanol production.

While global sugar prices continued to rule high in 2023, before moderating towards the fag end of 2023, India’s cane and sugar production was marginally lower in the following sugar year 2022-23 at 36.62 million tonnes.  The reduction was on account of inadequate monsoon rainfall. Hence, in order to ensure availability of sugar for domestic consumption, the Government had to restrict the total exports to 6.1 million tonnes. With strong global prices, Indian companies had to settle for lower exports due to the precautionary measure by the government. Sugar diverted for ethanol stood at 3.1 million tonnes in sugar season 2022-23.

In the current sugar season (October 2023–September 2024), sugar production is expected to decline further to about 33 million tonnes, about a 9 per cent fall compared to the previous year.  This is primarily on account of lower-than-expected rainfall in the main cane-growing states Maharashtra and Karnataka, due to which cane production took a beating. While higher production in Uttar Pradesh — the other key cane growing state — may partially compensate for this, Maharashtra is a crucial market for raw sugar, which is  primarily exported.

Brakes on ethanol diversion

Maharashtra accounts for almost half of the country’s exports.  Lower production in Maharashtra, as also  government’s concerns over availability for local consumption, led to an unprecedented policy move in early December 2023 — the  banning of sugar diversion for ethanol,  and also use of B-heavy molasses and cane juice for production of ethanol. Expectation of lower sugar production and rising demand led the government to play it cautiously, given that sugar is an essential commodity and it can have a snowballing effect on the food and beverage industry.

However, the government soon reversed its ban on diversion of cane juice and B-heavy molasses but has capped the diversion of overall sugar for ethanol at 1.7 million tonnes for now. This is half of the total sugar that was available for ethanol in sugar year 2022-23. Industry sources expect the government to review the situation over the next few months and accordingly modify the current cap.

But is the knee-jerk reaction to fall in estimated production warranted, despite the opening stock being comfortable at 5.6 million tonnes and consumption estimated at 28.5 million tonnes? While on the face of it , the move by the government to apply brakes on ethanol diversion may seem unnecessary, it is important given that the margins in ethanol are much more stable and attractive as compared to sugar.

In order to deter the industry from profiteering from the ethanol opportunity at the cost of sugar availability, and ensure that the price equilibrium for sugar is maintained, the government possibly intervened well ahead of time.

Impact on sugar companies

What will be the impact of the above move on sugar producers? Well, clearly the effect will be negative since the margins on distillery segment are significantly higher for sugar makers and hence with the sugar available for ethanol production being cut by more than half, this will translate into revenue and profit cut for sugar and ethanol producers.

For instance, Triveni Engineering’s distillery segment margins have been upwards of 20 per cent even in years when the sugar segment reported losses. Though it is possible that the cane cost (raw material) is captured fully in the sugar segment and hence the distillery margins are higher, curbs on sugar availability for ethanol will, nevertheless, affect distillery segment and, hence, overall profitability.

Also, from an end-product price perspective, the realisation on ethanol is much higher than sugar. While minimum support price is fixed at ₹31 a kg, ethanol from C-heavy molasses fetches ₹49.41 a litre, while C-heavy molasses and sugar juice-based ethanol will be procured by oil marketing companies at ₹60.73 and ₹65.61 a litre respectively.

However, companies that operate dual feed plants, such as Balrampur Chini and Triveni, have the flexibility to switch between feedstocks depending on availability. But even for these distilleries, the challenge remains with respect to availability and pricing of alternate feed such as corn, rice and other feedstocks. For instance, maize MSP went up from ₹19 to ₹25 a kg last quarter, while the same has not been fully priced into the end-product price, leading to lower margins.

That said, the importance of sugarcane-based ethanol cannot be undermined as molasses-based ethanol accounts for almost two-thirds of the country’s total ethanol capacity, while the rest comes from grain-based distilleries.

As of November 2023, the ethanol production capacity in the country stood at 1,380 crore litres of which about 875 crore litres is molasses-based while the balance 505 crore litres is grain-based. The total capacity requirement by 2025, to achieve 20 per cent blending, is estimated at 1,700 crore litres. The incremental 400 crore litres of capacity, according to ISMA (Indian Sugar Mills Association), will entail investment of ₹17,500 crore.  

Leading players such as Balrampur Chini Mills and Triveni Engineering and Industries have been in expansion mode over the last two years. In the last quarter of this fiscal year, Triveni is commissioning a distillery in Rani Nangal (Uttar Pradesh) with a capacity of 225 KLPD. However, the company has put on hold its distillation capacity expansion at its Sabitgarh (Uttar Pradesh) unit from 660 KLPD (kilo litres per day) to 1,100 KLPD. This is largely due to the current regulatory landscape and challenges in availability of grains/feedstock at viable price points. However, the company has all the necessary approvals and also the overall design and vendors finalised to a large extent. With a more stable environment, Triveni will be able to complete the expansion in about a year’s time.

Government’s initiatives such as PLI scheme for new investments, interest subvention scheme — where the government provides subsidy of 6 per cent or half the cost of bank interest whichever is lower — have helped generate investment interest. However, long-term viability is key to ensure that capacity for 20 per cent blending target is made available by 2026. Investments so far in new distillery capacity, according to the government, stand at ₹40,000 crore. Any knee-jerk move such as banning juice and B-heavy molasses for ethanol, and a cap on the sugar diversion for ethanol, may be negative for the Industry.

Outlook

With Brazil gearing up for higher production in sugar season 2023-24, global prices will likely continue to moderate as incremental sugar supplies start entering the market. Given that globally the supply situation is expected to ease further, timing exports (by capitalising on higher global prices) from India will be critical to ensure that Indian companies benefit from the healthy market prices.

That said, while it is important to ensure adequate stock availability for domestic consumption, industry participants we spoke to, feel that India will close this sugar year with about 6 million tonnes of inventory and are hoping for a favourable policy directive over the next few months, as clarity emerges over production and consumption for the current season.

For Indian sugar producers, FY24 and first half of FY25 may remain a muted year, should the current cap on ethanol diversion continue. However, we believe that in the medium term, the ethanol blending programme will remain a critical tool to contain subsidy bill on crude oil imports. Incentivising sugar molasses and grain-based players to invest in capacity will be the only medium-term solution to address this. While we believe that directionally the policy and government initiatives are aligned with that of the industry, short-term changes and/or tightening may be inevitable in order to keep inflation under check.

Sugar stocks: What’s in store?

While 2023/24 has been a stellar year for the equity market broadly, sugar stocks have delivered 6-46 per cent returns over the last 18 months, and  have been underperformers on a relative basis, barring Triveni Engineering, which gained about 46 per cent.

On the revenue and profit front too, the growth has remained subdued. Raw material price increase in the sugar business has put pressure on the margins. Sample this — Triveni’s sugar segment margin declined from 11 per cent in FY22 to 7 per cent in FY23. Similarly, on the distillery front too, operating profit margin declined from 14 per cent to 11 per cent. This was on account of lower recovery on cane, higher cane costs and higher cost of grains/other feedstock. Raw material cost as a proportion of revenue rose from 67 per cent in FY22 to 73 per cent in FY23.

Similarly, for Balrampur Chini also, the overall operating margin declined from 15 per cent in FY22 to 11 per cent in FY23. Raw material as a percentage of revenue rose to 73 per cent versus 71 per cent in FY22.

Interestingly, companies that have a higher skew towards cogeneration power, such as Bannari Amman Sugars, have fared well in FY23. From 11 per cent in FY22, operating margins have expanded to 12 per cent in FY23. Strong demand for power and attractive pricing helped the 40 per cent jump in operating profit. We believe that the power segment will continue to grow at a healthy pace and sugar producers, while taking advantage of the ethanol opportunity, are also looking beyond sugar and ethanol.

Balrampur Chini Mills has announced foray into bio plastics with an investment of ₹2,000 crore over the next few years, for setting up a green field manufacturing plant close to its current facilities, in UP. These products have potential to replace the single-use plastic market, which is currently being phased out in India.   

While the government is expected to work out a favourable strategy for ethanol in the medium term, companies are also de-risking their business by focusing on other value-added products — which could  go a long way in lending stability and sustainability to their existing business models.