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Sugar in India has remained a supply side story for the past many years and was facing twin issues i.e. surplus production and highly regulated sugarcane prices. The key for this industry was to control supply in order to improve profitability of the sector.

Let’s have a look at domestic balance sheet of Sugar industry

Particulars (MT)	SY 16-17	SY 17-18	SY 18-19	SY 19-20	SY 20-21 (E)	SY 21-22 (E)	SY 22-23 (E)
Opening Balance	7.8	4.0	10.7	14.5	10.5	8.2	8.5
Ethanol Diversion	–	–	–	0.8	2.0	3.0	4.0
Net Sugar Production	20.7	32.6	33.3	27.4	30.2	30	28
Sugar Availability	28.5	36.6	44	41.9	40.7	38.2	35.5
Domestic Consumption	24.5	25.4	26	25.7	26.5	27.2	27.8
Exports	–	0.5	3.5	5.7	6.0	2.5	–
Total Offtake	24.5	25.9	29.5	31.4	32.5	28.7	27.8
Closing Stock	4.0	10.7	14.5	10.5	8.2	8.5	7.7

Let us understand the constraint on supply side?

1. Sugarcane has higher farm profitability vs other competing crops (income for farmers from sugarcane cultivation is almost 2x vs that of paddy or wheat vs no major difference in cost + offtake is assured).

2. Demand growth lagging supply:-

In the years of excess production of sugar, the inventory levels reach to very high levels on account of average demand.

The higher production results into high inventory levels and high working capital cycle as well as lower margin as price of sugar is not aligned with price of sugarcane. It is interesting to impacy on P&L in years of excess production on top 3 companies in sugar sector.

	FY12	FY15	FY19
Sugar EBIT Loss	Sugar EBIT Loss	Sugar EBIT Loss
Balrampur Chini	22.17 Cr	278.54 Cr	166.17 Cr Profit
Dhampur Sugar	36.63 Cr Profit	90.91 Cr	30.67 Cr Profit
Dwarikesh Sugar	28.03 Cr	100.73 Cr	12.03 Cr Profit
	FY12	FY15	FY19
CFO	D/E	CFO	D/E	CFO	D/E
Balrampur Chini	195.48 Cr	1.64	-76.32 Cr	1.49	-523.01	0.82
Dhampur Sugar	51.65 Cr	2.05	-80.71 Cr	4.16	-203.10	1.49
Dwarikesh Sugar	7.79 Cr	4.20	-150.68 Cr	6.01	-250.37	1.41

*These were the 3 best and most integrated companies in the industry

Government policies and its impact on industry – A key reason for a Turnaround

Introduction of MSP = Reduction in losses during surplus years

Historically, in a high supply and inventory levels scenario, sugar prices have corrected to below cost of production. For SY 2018-19, the industry witnessed highest ever closing stock of 14.5 MT i.e. almost equivalent to 200 days of sugar consumption. However, due to introduction of MSP (Minimum Selling Price) and controlled sugar supply, prices were steady (which meant no losses in sugar segment).

Eg – In earlier sugar surplus cycles, sugar prices have fallen to a low of Rs 22/kg also vs COP of Rs 31-32/kg.

Dealing with surplus = Exports vs Ethanol

Export Incentives

In earlier years, exports had reduced to almost NIL due to low global sugar prices which were significantly below India’s cost of production. Hence, in order to tackle the huge build up in inventory, government realised exports would be key and hence, they provided an export subsidy of Rs 10.45/kg with an exports quota of 6 MT. This subsidy meant companies could export sugar at cost price (including subsidy) and resulted in industry exporting 5.7 MT in SY19-20.

The quota for SY 20-21 has been reduced to Rs 6/kg due to rising global sugar prices and the industry is confident of achieving the target of exporting around 6 MT of sugar. This should result in inventory levels falling to ~8 MT (~3 months consumption) and going forward, the government aims to discontinue exports subsidy (from FY23 as per WTO guidelines) and compensate the fall in exports via higher diversion towards ethanol.

Ethanol – Success story in the making

Ethanol blending programme was started as early as 2003 and despite that ethanol blending in petrol has reached only 5-6% penetration in the last 16-17 years. This is largely due to volatile sugarcane availability. Moreover, ethanol production was only allowed through ‘C’ heavy route (produced through molasses, which is a sugar by-product).

The government has fast forwarded its 20% ethanol blending target from 2030 to 2025 which will require additional distillery capacity of 3x additional capacity as well as diversion of cane juice directly into ethanol. The industry will supply 3.5 bn litres of ethanol for SY20-21 which will achieve blending rate of 8.5% whereas to achieve 20% blending rate, industry will have to supply more than 10 bn litres of ethanol.

For achieving the above, the government has taken various measures as follows:-

1. Upward revision in ethanol prices for SY20-21

2. Interest subvention scheme wherein the government would bear interest subvention for 5 years including 1-year moratorium @ 6% p.a. or 50% of the rate of interest charged by banks, whichever is lower.

3. Economical model – Increase in B-Heavy and Sugarcane Juice ethanol changes dynamics

4. Grain based ethanol – Another Revenue Stream

The government is targeting 20% ethanol blending by 2025, which would require 1000 crore litre of ethanol. We believe diversion from sugarcane juice & B-heavy ethanol would only suffice for ~600-700 crore litre & rest 300-400 crore litre of ethanol would be produced through grains. The grain-based ethanol would add one more revenue stream for the industry and contribute to the revenue & profitability.

Many sugar companies are planning to set up grain-based distilleries to tap this opportunity (the 1^st one being Balrampur who is the process of setting up 320 KLD distillery plant which would use both sugarcane juice as well as grains to produce ethanol). This diversification will help sugar companies to build a sustainable business around core product of sugar and help them to move away from cyclical tailwind to more sustainable growth industry.

Why this time will be different?

The steps from Government this time were focused on addressing the issue and policies are designed to benefit both i.e. Sugarcane producers (Farmers) as well as sugar manufacturers (Mills).

The impact of this changes are clearly visible on ground

1. Ethanol production doubled from 170 Cr litres in 2019-20 to ~350 Cr litres in 2020-21 (major via B-Heavy route) which should lead to increased diversion of sugar from 0.8 MT in 2019-20 to 2 MT in 2020-21.
2. As of December 2020, a total of 368 distilleries have applied for soft loan of about 19000 Cr. In the last 2 years, 76 projects have been sanctioned (12 projects were approved in Q3’21) which will add around 200 Cr litres by 2022.
3. Praj Industries (leading player in ethanol machinery manufacturing) has seen inquires rising by 2x over the last couple of quarters whereas their order book is also up by 30-40% vs last year.

The best Company in the Business – Balrampur Chini Mills Ltd

As we understand, the sector and companies always plagued with inconsistency and higher working capital requirement on account of high inventory. If we review, Balarampur Chini’s financials of last 3 years, we can see advantages of early adoption of ethanol across all its plants in their profitability as well as lower inventory levels.

	FY19	FY20	H1’21
Cash Flow from Operations	-523.01	849.61	1498.70
Short-Term Borrowings	1394.66	1058.69	NIL
Inventories	2315.89	2294.97	883.96
Dividend + Buyback	55 Cr	55 Cr Dividend + 150 Cr Buy-back	180 Cr Buy-Back

*FY19 was the year when India has highest ever inventory of 14.5 MT

Further, In FY 20, Company has diverted 1^st time sugarcane towards B-Heavy (35% of total ethanol volumes via B-Heavy route) which should increase to more than 70% via B-Heavy route in FY21. Additionally, new distillery capacity of 160 KLD commenced production in December 2019 and hence, the major impact on financials (in terms of cash flow generation and debt repayment) can be visible in H1’21 figures.

In addition to the above, the company plans to commission new 320 KLD distillery capacity by November 2022. They would be producing ethanol directly from sugarcane juice during season and broken rice during off-season which will lead to additional sugar sacrifice. Hence, in total after this capex, the company would be able to sacrifice almost 20% of sugar for ethanol production which means that they will be able to sell their entire sugar production irrespective of India-level surplus and NIL exports.

Further, in last 3 years, contribution of distillery business to profitability has increased from 20% to ~40% and we should see this trend continue for next 3-5 years as company is focussed on expanding capacity of Ethanol. We are confident that, company will deliver consistent earnings growth in next 3-5 years and will emerge as a strong brand in Sugar sector and can command much better valuation multiple compared to past which will help investors to generate better returns on their investment capital.

These is a clear example of how long-term sustainable government policies can create a positive environment for businesses and help them to deliver sustainable growth over a longer period.

We strongly believe “Sugar will become White gold” in this decade and investors will be benefited by investing in good companies operating in these sector.