Indian sugar industry- Can ethanol be a game changer?

Indian Sugar Industry-Can ethanol be a game changer?(Part-1)

June 13, 201910:17 am

Sugar has been a widely talked about sector, given the general election which concluded recently. While analyzing the Indian Sugar Industry, I felt I am late by six months but its better late than never. 

The kind of attention that the Indian sugar industry gets from politicians is because of the size of the sector. You can make a sense of that by understanding that India is the second largest producer and the largest consumer of sugar in the world. The scale of Indian sugar production impacts the global sugar industry. Also, coming to vote banks, about 5 crore farmers + their families are dependent on this sector.

The Indian Sugar industry is highly regulated. The industry’s fortunes are correlated with the mother nature(rains) and Indian govt’s policies. So, any investment in this sector should be actively tracked following news and policies surrounding it.

With the NDA govt coming with a greater majority, continuity in the Ethanol policy is expected. Otherwise, all the hard work and capital spend by both the govt and the industry will go in vain.

NOTE: IN MANY PLACE I HAVE USED FY(FISCAL YEAR) IN PLACE OF SUGAR SEASON. PLEASE CONSIDER THAT ACCORDINGLY.

The biggest problem with any sector dependent on Govt policies is you never know when the govt change its policy. And it has happened time and again. Be it the renewable energy sector or be it other similar sectors where govt gave its push. 

ONE NEEDS TO BE VERY CAREFUL WHILE TAKING ANY lONG TERM INVESTMENT POSITION IN THE SECTOR. SUCH SECTORS ARE IDEALLY SUITED IDEALLY  FOR SHORT to MEDIUM TERM INVESTMENT.

Indian Sugar Industry- Sugar Cycle

Indian sugar industry is highly cyclical as depicted in the image below. This cyclicality is in addition to natural ones. After every bumper sugarcane season, there were sops announced and post that things went to normal. But the NDA govt under the ‘Vibrant Ethanol policy’ is trying to incentivize the production of ethanol. This policy gained momentum since mid-2018 when the sugar prices dropped to a low of ₹27/kg(Production cost=₹35/kg) and the 2019 general elections were around the corner. It might also be an effort by the govt of their promise of doubling farmers income by 2022. 

In order to end the ever repeating cycle, the govt is trying to artificially put a break to it by taking a number of steps which will make all stakeholders happy, be it Sugarcane farmers, Sugar mills and the govt itself. In terms of consumers, the increase in sugar prices doesn’t really have any impact whatsoever on the consumer monthly budget.

Earlier, the sugar mills were dependent on Sugar production as the only means of revenue & profit. Ethanol & power generation formed a very small part of the business. Now, with the govt incentivizing the industry via a number of policy support, the revenue streams are getting diversified and possibly can be a structural change in the Indian sugar industry which is possible only with continued govt support.

Also, when there is govt push towards a sector, the size of the market grows exponentially.

Indian sugar industry- Can ethanol be a game changer?
Sugar Cycle. Source: KPMG report, my own analysis
Indian sugar industry- Can ethanol be a game changer?
Govt steps to help the Indian sugar industry

Few more point adding the image on the top of the steps taken by the govt to support the Indian Sugar Industry:

  1.  Earlier the prices of ethanol were decided on the basis of bidding. Now, it has been fixed.
  2.  The govt has de-linked the prices of ethanol from crude oil prices.
  3.  In the global market, the prices of Sugar is ₹10 per kg lesser than India. To encourage export i.e. to sell at a loss, the govt is providing subsidies to the sugar mills.(To get rid of excess sugar)
  4.  Sugar mills are required to pay the farmers within 2 weeks of harvesting.
  5. Excise duty on ethanol was removed in 2016-17
How govt steps is likely to break the sugar cycle
Indian sugar industry- Can ethanol be a game changer?
Sugarcane value chain

Before the Ethanol push, almost all the molasses were going towards the production of drinkable alcohol(extra neutral ethanol ‘ENA’). But with such a remunerative price for Ethanol, mills are diverting molasses to produce ethanol. The shift in production from drinkable alcohol to ethanol in distillery can be done quite easily.

Prices set by govt for different product in the value chain

Indian Sugar Industry- Ethanol

I have created a separate blog for Ethanol in particular as the length of the article got a bit lengthy.

Indian Sugar industry- ethanol game changer

Indian Sugar Industry- Sugar

Indians have a sweet tooth. They are the largest consumers and second largest producer of sugar in the world.  Indian sugar industry’s growth is driven by GDP & population growth. In India, sugar consumption is around 26MT and is growing at 2 %. Of the total consumption in India, about 60% goes to the industrial application(Dairy, confectionary, baking, soft drinks etc) and the remaining 40% is used up by consumers.

Coming to its raw material, Sugarcane, is a water-intensive crop, perishable and can’t be transported to long distances. In order to extract the maximum sucrose from sugarcane, the turnaround time from cut-to-crush should be minimized. So, the proximity of the mills to sugarcane growing areas is a must. That is the reason, one can find multiple plants of a single company.

And 80% of sugar is produced in UP, Karnataka & Maharashtra. India has a market share of 15% of world production. Manufacturing sugar is a very straight forward process but highly capital & labour intensive. Around half the ethanol is made in the northern state of UP.

Sugar season: Oct to April(Sugarcane is crushed)

The world has moved towards sugar surplus & in particular India(8 consecutive year of surplus produce) . So, excess capacity is increasingly finding its place in the manufacturing of ethanol.

Since sugar is produced only for a few month but consumed year long, working capital management is of prime importance.

Despite all the incentives by the govt, there is something which makes Sugar mills unhappy. In terms of pricing of sugar by the govt, there is a mismatch as Sugarcane prices are determined by Minimum support/FRP(Fixed remunerative price) whereas Sugar prices were market determined to cause a very highly skewed dynamics. Globally, sugarcane prices are determined as a percentage of sugar prices. 

Now, let us look at how the demand-supply scenario plays out:

There is a simple math to calculate the future supply-demand scenario using the below formula which I learned during the research: 

Sugar surplus for any year is determined by using the formula(Expected sugar surplus for FY20)= Sugar production(FY19) – Sugar consumption(FY19) – exports (FY19) + Last year’s closing stock

                                       = 32.8MT-26MT-3.5MT+10.2MT =13.5MT

For FY20, the surplus is already 13.5MT which is more than 6 months of consumption. 

 

Indian sugar industry- Can ethanol be a game changer?
Sugarcane manufacturing process
Indian Sugar industry: Why is Sugarcane farmers' favorite?

Despite all the arrears, why is the area sown under sugarcane is increasing:

1. Sugarcane is a cash crop

2. It is a tough crop. Requires a lesser amount of fertilizers & pesticides.

3. Assured returns, minimum losses

4. Also, among other crops, sugarcane farmers are the most respected ones.

5. Robust, requires lesser maintenance, lesser labor intensive but needs larger land parcel.

Indian Sugar Industry- Power

Sugarcane waste(Bagasse) is also made use of and is used in power production. This power is used to generate steam for internal consumption as well as sold in the market(Co-generation). The current tariff is around ₹4.5/unit of power sold. 

UP govt has recently suggested a draft regulation to reduce power price by ₹2/unit. The industry is trying hard to fight this and the expecting if not zero reduction, it won’t be more than ₹1/unit. In case the price is dropped by ₹2, it will be a significant hit on the company’s power p&l.

In case the power rate goes down, the industry has the option to convert bagasse to pulp used in the paper industry.

Because the company manufactures power from green source i.e. bagasse, it earns Renewable energy certificate for each unit priced at a lower end of ₹1500/unit.  

Indian Sugar Industry-Key Pointers

For any sugar mill, integrated production is very important. The close proximity of sugar mills & distillery maximizes product utilization and reduces high transportation cost.

In other cane producing countries, ethanol is directly produced from sugarcane juice. In Brazil, the entire ethanol is made from sugarcane juice. 

The sector which has seen a turnaround in its performance owe it totally to the Indian government. As of now, the govt seems pretty serious about its target and let us see if there are any more incentive for the industry in the coming budget on 5th July 2019. 

If anyone wants to take a position in the sector, one needs to closely follow news around the sector. Farmers arrears are still high to the tune of ₹20,000-25,000 Cr.

FY20 is expected to be deficit year for sugar. Maharashtra has sown 40% lower crop this year, implying there might be a positive upside for sugar prices along with other incentives.

If one is able to understand the cycle and keep a tab on the developments, can make a good amount of money. Veteran investor Anil Kumar Goel has made a huge bet on the sector, which has given him handsome returns.

There is some negative impact of such a massive push. It is likely that with remunerative prices, farmers are likely to increase the area under sugarcane, thus creating imbalance for other crops. Also, India is a water deficit country and since a lot of water is required for sugarcane growing, it might aggravate the problem further. And if the govt changes its policy for worse, it will bring the industry on its knees.

Another big concern for the industry is the quota based release mechanism i.e. govt. fixing the maximum amount of sugar that can be released into the market every month. Even if the demand is more, the mills cant sell more than the fixed amount and vice-versa.

Indian Sugar Industry- Key pointers to understand the sector

The key to understanding the sector is:

  1. Prices of raw material is fixed(Fixed sugarcane price)
  2. Price of end product i.e Sugar is fixed at the lower end- If lower rainfall, it implies higher prices for sugar and is a good sign for these companies.
  3. Price of end product i.e. ethanol is fixed
  4. It is left to the company how they manage their working capital, inventory & debt. Also, how well integrated are the company’s facilities. Now, with Ethanol prices going up, it is important to know the capacities of these plants. 
  5. The most important what you can never anticipate is what govt is going to do next.
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Shekhar Yadav

I am a full time stock market investor. The blog is an extension of my research, thoughts & opinion. Please don't consider anything on this website to be an investment advise.

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