Indian Sugar Industry

Transcription

1 Indian Sugar Industry

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3 TITLE Indian Sugar Industry YEAR September, 2013 AUTHORS COPYRIGHT Food and Agribusiness Research Management (FARM) Group, YES BANK Food and Agribusiness Strategic Advisory and Research (FASAR) Group, YES BANK No part of this publication may be reproduced in any form by photo, photoprint, microfilm or any other means without the written permission of YES BANK Ltd. DISCLAIMER This report is the publication of YES BANK Limited ( YES BANK ) and so YES BANK has editorial control over the content, including opinions, advice, statements, services, offers etc. that is represented in this report. However, YES BANK will not be liable for any loss or damage caused by the reader's reliance on information obtained through this report. This report may contain third party contents and third-party resources. YES BANK takes no responsibility for third party content, advertisements or third party applications that are printed on or through this report, nor does it take any responsibility for the goods or services provided by its advertisers or for any error, omission, deletion, defect, theft or destruction or unauthorized access to, or alteration of, any user communication. Further, YES BANK does not assume any responsibility or liability for any loss or damage, including personal injury or death, resulting from use of this report or from any content for communications or materials available on this report. The contents are provided for your reference only. The reader/ buyer understands that except for the information, products and services clearly identified as being supplied by YES BANK, it does not operate, control or endorse any information, products, or services appearing in the report in any way. All other information, products and services offered through the report are offered by third parties, which are not affiliated in any manner to YES BANK. The reader/ buyer hereby disclaims and waives any right and/ or claim, they may have against YES BANK with respect to third party products and services. All materials provided in the report is provided on As is basis and YES BANK makes no representation or warranty, express or implied, including, but not limited to, warranties of merchantability, fitness for a particular purpose, title or non infringement. As to documents, content, graphics published in the report, YES BANK makes no representation or warranty that the contents of such documents, articles are free from error or suitable for any purpose; nor that the implementation of such contents will not infringe any third party patents, copyrights, trademarks or other rights. In no event shall YES BANK or its content providers be liable for any damages whatsoever, whether direct, indirect, special, consequential and/or incidental, including without limitation, damages arising from loss of data or information, loss of profits, business interruption, or arising from the access and/or use or inability to access and/or use content and/or any service available in this report, even if YES BANK is advised of the possibility of such loss. Maps depicted in the report are graphical representation for general representation only. CONTACTS YES BANK Ltd. Registered and Head Office th 9 Floor, Nehru Centre, Dr. Annie Besant Road, Worli, Mumbai Tel : Fax : Northern Regional Office 48, Nyaya Marg, Chanakyapuri New Delhi Tel : sumit.gupta@yesbank.in nitin.puri@yesbank.in Website :

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5 FOREWORD The sugar industry is an important agro-based industry that extensively impacts livelihoods of about 60 million sugarcane farmers and around 5 lakh workers involved directly in the sugar mills. It has significant impact on the socio-economic development of India s rural population. With an average sugar production capacity of around 26 million MT, the Indian sugar industry is the world s second largest after Brazil, contributing to around 15% of the global sugar production. In addition to traditional white sugar coming from the organized sector, the country also produces around 7 million MT of alternate sweeteners (solid, liquid and powdered jaggery and khandsari) through the unorganized sector. The sector is one of the key drivers of rural development fostering economic growth and contributing close to 1% to the national GDP. The Indian sugar industry is transforming gradually to leverage opportunities created by the global market dynamics in sugar trade as well as the emergence of sugarcane as the source of energy through ethanol and other value added products that could be used subsequently for electricity. The country consumes close to 24 million MT of sugar annually. More than 60% of the sugar is consumed by bulk consumers primarily industries such as beverages, biscuits and confectionery. Most of the sugar mills are located in the rural heartland, directly contributing to rural economic development and employment. The industry has enormous transformational opportunities that will facilitate the serving of domestic markets as well as the emergence of India as a significant contributor of carbon credits. The sugar industry also has the potential to supplement power production and acts as a source of fuel through Ethanol Blending Programme (EBP). This will make the sector more sustainable and economically viable where productivity and recovery levels are low. At the same time, this is also a step in enhancing national energy security by way of substitution of the imported energy commodity basket requirements. The industry has previously been under tight Government control and the recent developments on decontrol of sugar will provide an opportunity for key players in the industry to optimally leverage the market dynamics for direct and indirect benefit of the entire sugar value chain. These developments will also help the industry in curbing cyclicality of sugarcane production to a great extent. As per the recommendations of the Rangrajan Committee, the sugarcane prices should be linked to sugar prices. Once implemented, the industry will be able to realize better revenues by inducing efficiencies, which in turn, will reflect in timely payments to the farmers. Some of the States have already taken steps to follow the committee s recommendations. These steps will pave the way for a financially sustainable and prosperous sugar industry. In the light of the foregoing, I am pleased to present the YES BANK Knowledge Report Indian Sugar Industry which outlines the current industry scenario and provides a snapshot of the regulatory environment, challenges and opportunities. I am confident that the contents of this knowledge report will provide important insights to policy makers, industry leaders and stakeholders in the sugar industry towards achieving sustainable development of the Sugar sector in India. Thank you. Sincerely, Rana Kapoor Managing Director and CEO

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7 Table of Contents Executive Summary Evolution of Sugar Industry Historical Perspective Global Scenario Domestic Scenario Sugar Industry and Indian Economy Structure of the Sugar Industry Segmentation of Sugar Industry Business Models in Domestic Sugar Mills Comparison with Oilseed Industry Manufacturing of Sugar Trends in the Sugar Industry Cane Prices in India Sugar Production Cycle Factors affecting Financial Performance of Sugar Factories Indicative Costing of Sugar Production Domestic Demand of Sugar

8 4. Regulations in the Sugar Industry Essential Commodities Act in Sugar Sugar & Sugarcane Pricing Policy Sugar Policy for Regulating Sales Other Regulations in Sugar Industry Partial Decontrol in Sugar industry Conversion of Cane to Ethanol Current Scenario: 5% Blending Realistic or Not Consolidation of the Sugar Industry in India Key Players' Profile Financing Perspective in Sugar Value Chain Way Forward Entry of Organized International Players in Sugar Sector Sugar Stocks: From Industry to Trade Roadmap: Business opportunities 5 years down the line Holistic and Integrated approach

9 Executive Summary From the very beginning sugar industry as a whole was kept under the guardianship of the Government. Both Central and State Governments exercised control over various matters, starting from planting of cane to final release of sugar to end consumers. Sugar continues to be an essential commodity which continues to be supplied through Public Distribution System (PDS) as well. During the last decade, the sugar industry has undergone significant changes in terms of government's regulation & policies and it has rationalized the regulatory environment in order to bring in efficiencies into the industry- with benefits across the value chain, right from the farmer to the consumer. The Indian domestic sugar market is one of the largest markets in the world both in volume and value terms. This is among one of the few industries which have directly or indirectly contributed to the growth of rural economy by engrossing rural resources and manpower and also by fulfilling both domestic and global demand of sugar. Global sugar production is expected to be 175 million MTs this year and in which India will be contributing around 15% of global production after Brazil (22%). India still tops the chart in human domestic consumption of sugar followed by European Union and China. Also the prices of sugar and consumption pattern vary from geography to geography across globe. The sugar industry is very fragmented in India in terms of ownership model. The industry is quite dispersed among co-operatives (45%), public (6%) and private (49%) players based on the ownership model which varies from state to state. For instance, the industry is majorly dominated by co-operatives in Maharashtra & Gujarat while in UP, Karnataka, Tamil Nadu etc it is majorly dominated by private players. In recent times, we have witnessed consolidation in the industry in the backdrop of decontrol regulation. Once fully decontrolled, capacity consolidation across the value chain can be expected. 03 Indian Sugar Industry

10 The industry is facing various challenges and deficiencies in the current scenario. On one hand, it is surrounded by stringent government regulations which were there to protect the interests of consumers and farmers while on other hand many of the operating mills are financially weak, unviable and loss making with inefficient operations. Cyclicality of sugarcane dynamics, and poor conditions of plant & machinery further complicate the matter. Steps have been taken from time to time to revive the industry in an integrated manner benefitting stakeholders across value chain. Even after relieving the millers from levy quota regulation recently, raw material prices and export- import regulations are still regulated. Banks and Financial Institutions are initiating various structures and models for financing farmers/ growers by synchronizing with millers. There are some covert opportunities to finance the sugar value chain which needs to be addressed by joint efforts of government, private players/ FIs and enabling framework by RBI. There is mandatory ethanol blending programme run by government where it is must to mix fixed proportion of ethanol along with automotive fuels. But some shortcomings in the system are restricting to fulfill this requirement. However, once implemented uniformly across nation, it will create a win- win situation for both Oil Marketing Companies (OMCs) and Sugarcane millers. Recently, few of the state governments have initiated some changes in the industry from their end which can see major reorganization in coming future after limelight of Rangarajan Panel report & recommendations. Apart from suggesting complete decontrol of cane industry the panel has also suggested revenue sharing formula and linking sugarcane prices with revenue realization from sugar. For Example, Karnataka has formed a Sugarcane Control Board to link prices of cane with sugar. Other states will also come forward and take steps to revitalize the industry which will help in increasing the production & productivity, controlling cyclicality and decreasing arrears. The entry of foreign players and organized firms in recent past will see a complete makeover of the industry in future and change the dynamic rules of operating the business. The sector today has transformational opportunities that would enable it to continue to service not only domestic sector but also emerge as surplus power producer nation and fuel generator by Ethanol Blending Programme (EBP). 04 Indian Sugar Industry

11 1. Evolution of Sugar Industry 1.1. Historical Perspective Since ancient times, the farming community has been cultivating sugarcane in the Indian sub continent. Sugarcane was originally grown for the sole purpose of chewing in Southeastern Asia and the Pacific region. Indians discovered how to crystallize sugar during the Gupta dynasty, around 350 AD. It is widely believed that sugarcane originated from tropical South Asia and Southeast Asia. Different species likely originated in different locations with S. barberi originating in India and S. edule and S. officinarum coming from New Guinea. Indian sailors, consumers of clarified butter and sugar, carried sugar by various trade routes. Traveling Buddhist monks introduced sugar crystallization methods to China. During the reign of Harsha ( AD) in North India, Indian envoys in Tang China taught sugarcane cultivation methods after Emperor Taizong of Tang ( AD) made his interest in sugar production and cropping of sugarcane. China soon established its first sugarcane cultivation in the seventh century. Chinese documents confirm at least two missions to India, initiated in 647 AD, for obtaining technology for sugar-refining. In South Asia, the Middle East and China, sugar became a staple of cooking and desserts. Later on in the year 1792, sugar prices rose by large amounts in Great Britain. The East India Company was called upon to lend their assistance for lowering the price of sugar. On March 15, 1792, his Majesty's Ministers to the British Parliament presented a report related to the production of sugar in British India. Lieutenant J. Paterson, of the Bengal 05 Indian Sugar Industry

12 establishment, reported that sugar could be cultivated in India with several advantages and at less expense than in the West Indies. This led to fledgling steps being taken to establish the sugar industry in the country. Early refining methods involved grinding or pounding the cane in order to extract the juice and then boiling down the juice or drying it in the sun to yield sugary solids that looked like gravel Global Scenario Globally, sugar is produced from both beet and sugarcane. However, sugar produced from sugarcane comprises 80% of the total output and the rest is produced from beet. The world sugar market constantly experiences volatility in prices. According to an OECD (Organization for Economic Cooperation and Development) outlook report, Brazil is one of the lowest cost sugar producers and has considerable scope for expansion of its sugarcane crushing capacity. Globally, it will be a major determinant of the total sugar production in the coming years. Exhibit 1: Top Sugarcane Producing Countries, 2012 (in MMT) Brazil India China Thailand Pakistan Mexico Philippines USA Indonesia Australia Argentina Guatemala Colombia South Africa Vietnam Source: Food and Agricultural Organization (FAO) Statistics, YES BANK Analysis Brazil, India, China, Thailand and Pakistan are the major cultivators and producers of sugarcane. These countries account for almost 70% of the sugarcane production. While the production figures are much higher in the case of Brazil and India, their productivity is lower than Thailand as depicted in the following exhibit. 06 Indian Sugar Industry

13 Exhibit 2: World's Top Sugarcane Producer along with their Productivity (2012) Countries Production (MMT) Productivity (MT/ Ha) Brazil India China Thailand Pakistan Mexico Philippines USA Indonesia Australia Argentina Guatemala Colombia South Africa Vietnam Source: Food and Agricultural Organization (FAO) Statistics, YES BANK Analysis Globally, around 105 countries are involved in the production of sugar. Of these countries, 79 produce sugar from cane and rest 26 from beet. Sugar produced from cane is less expensive as compared from beet. Brazil is the world's largest sugar producer and also the world's largest sugar exporter. The strength of the Brazilian Sugar Industry is founded upon many years of strong Government interventions. The Government transfers the cost of pension liabilities to other economic agents, provides soft loans to agriculture, forgives and reschedules agricultural debts at very favourable terms. It also facilitates arbitrage between sugar and ethanol markets, mandates blending of anhydrous ethanol into gasoline, encourages the sale of hydrous ethanol, and has created economies of scale by providing for the doubling of the industry. (Source: GSBSI Report, Patrick H. Chatenay). 07 Indian Sugar Industry

14 Exhibit 3: Contribution of Sugar Production ( ) Pakistan 3% Rest of the World 23% Brazil 22% Australia 2% India 16% Russia 3% Mexico 4% USA 5% Thailand 5% China 8% EU-27 9% Source: US Department of Agriculture (USDA), YES BANK Analysis Sugar production is influenced by Government interventions in most of the countries of the world. The usage of the products is the main deciding factor for crushing of the sugarcane. In Brazil, sugar and ethanol are given equal importance. However in India, the crushing has been largely dedicated to sugar production only. Sugar production figures for different countries have been increasing over the years due to rising demand and efficient usage of other products such as ethanol. The top 10 sugar producing countries are depicted in the exhibit below. Exhibit 4: World Centrifugal Sugar Production, Raw Value (in million MTs) Countries (P) Brazil India EU China Thailand USA Mexico Russia Australia Pakistan Source: US Department of Agriculture (USDA), YES BANK Analysis, P Provisional 08 Indian Sugar Industry

15 Sugar prices globally are a major point of debate among researchers due to its vital importance. The best indicator for fluctuation in sugar prices is the stock-to-use ratios which also account for the growth in consumption. This stock-to-use ratio is inversely proportional to prices. Also demand-supply gap is the deciding factor in determining international prices. There is more volatility in prices of raw sugar as compared to refined sugar due to higher trading of raw sugar in comparison to refined sugar. The table below indicates international sugar prices (both raw and refined): Exhibit 5: International Sugar Prices (Average) Year Raw Sugar (USD per tonne) Refined Sugar (USD per tonne) Source: CRISIL Research and YES BANK Analysis The following factors are responsible for volatility in international sugar prices: Sugar production cannot change dramatically on prices of raw material and sugar both. It is not price responsive. Export of sugar is concentrated at some pockets of the world. For example, Brazil, EU, Australia and Thailand contributed to more than two thirds of the total world sugar exports in Thus any bumper crop or devastated poor crop in these countries will affect the sugar prices globally. The rate, pattern and quantity of sugar consumption vary from one country to another. Trends suggest that there is an increase in sugar consumption in the developing world over time. Domestic regulations are also subject to change and they vary from country to country. Most of the exports take place after meeting the domestic demand. High level of trade distortion in the international sugar market like lenient domestic support (in form of guaranteed prices), presence of import barriers, restriction of market access etc. 09 Indian Sugar Industry

16 Presence of quota system in some countries. This quota is fixed by the government of one country that fixes the amount of sugar to be exported to a particular country at a predetermined price. For example, the USA distributes quotas to certain countries of its choice and also dictates the price at which these countries should export sugar. Sugar trading in many developed countries is in the hands of one or two players (monopolized) which keeps the prices of domestic sugar very high Sugar production from sugar beet has come down from around 40% in the 1990s to around 22% presently on a global level. Diversion of sugarcane towards production of ethanol influences the availability of cane and sugar prices. It does not have much effect on volatility but when prices go down, more ethanol is manufactured and vice versa. Volatility is highly dependent on the commodity funds. When prices of sugar are low in the international markets, most of the players tend to dump sugar and prefer other commodities Domestic Scenario The sugar industry is an important agro-based industry that extensively impacts livelihoods of about 60 million sugarcane farmers and around 5 lakh workers involved directly in the sugar mills. It has significant impact on the socio-economic development of the rural population. With an average sugar production capacity of around 26 million MT, the Indian sugar industry is the world's second largest after Brazil, contributing to around 15% of the global sugar production. In India, sugarcane is the key raw material, planted once a year in majority of the areas. It is the major cost driver for the production of sugar. The sugarcane growing areas may be broadly classified into two agro-climatic regions sub-tropical and tropical. Sub- Tropical zones Exhibit 6: Zone wise sugarcane producing states Tropical zones Uttar Pradesh (UP) Maharashtra Uttarakhand Andhra Pradesh (AP) Bihar Tamil Nadu (TN) Punjab Gujarat Haryana Karnataka Source: YES BANK analysis About 50% of the sugar capacity is controlled by Cooperatives & Public sector mills. Almost half of the total operational sugar cooperatives are in Maharashtra alone. Though, most private players have been moving towards larger integrated complexes, cooperatives are still much smaller in capacity and are standalone sugar mills. This has resulted in them becoming uncompetitive as compared to private mills. 10 Indian Sugar Industry

17 Exhibit 7: Indian Sugar Industry at a glance Sr. No. Particulars Crushing Season Number of Sugar Factories in Operation Crushing Capacity (million TCD) Sugarcane Crushed (million tonnes) Sugar Produced (million tonnes) Recovery percentage of Cane Yield of sugarcane (tonnes per hectare) Source: Vasantdada Sugar Institute, Pune From the pre-independence times, sugar processing industry has witnessed Government interventions in the form of regulations. During the 1920s, a number of sugar mills started operating in Uttar Pradesh and Bihar. Their case against Japanese sugar, then commanding the Indian market was referred to the Tariff Board and the 1st Sugar Industry Protection Act was passed by the Indian legislature in Under this particular act, protection was granted to the indigenous sugar industry for an initial period of fourteen years till The main objective of the above act was to regulate the prices of sugar intended for use in sugar factories and assure the sugarcane growers a fair price for their produce by adoption of the following measures: Imposition of Excise Duty on factory-produced sugar Enforcing a minimum price to be paid by the sugar factories to the cane growers The enforcement of protection in Sugar Industry led to an increase in the number of sugar factories from 32 units in to 130 (equivalent to 9.5 lakh tonnes of sugar production) by almost a world record in the rate of expansion. By , the volumes rose to lakh tonnes. But due to emphasis of the Government on food crops before the inception of the First Five Year Plan, the production fluctuated between 9-11 lakh tonnes on account of instability in cane supplies. Year April, 1942 Major Developments Statutory Control on Sugar was first imposed under the Sugar and Sugar Products Control Order, Formulation of Sugar Control Order 1966 st 1 October, 1967 Govt. adopted a policy of Partial Decontrol on Sugar th 25 May, 1971 Govt. decontrolled Sugar 1st July, 1972 Exhibit 8: Major developments in Sugar Industry Govt. imposed dual control in Sugar 1974 (Fifth Five Planning Commission set up Task Force for Sugar Industry during the Year Plan) 5th Five Year Plan period, Indian Sugar Industry

18 Year Major Developments Exceeded Plan target with record production of 64.7 lakh tonnes in Govt. decontrolled sugar from 16th August 1978 and withdrew monthly release of sugar th 17 December, 1978 Govt. imposed partial decontrol in Sugar 1980 (Sixth Five Constitution of High Level Committee. Basis their recommendations Year Plan) cost of levy sugar was fixed on the basis of Statutory Minimum Cane Price without any linkage with free sale sugar on actual cane price paid Govt. announced a pragmatic sugar policy with increase in Statutory Minimum Price basis recommendations of Commission for Agricultural Costs and Prices (CACP) and a change in the levy free ration Policy of Partial Decontrol continued with the levy free ratio unchanged. Sugar production reached 134 lakh tonnes Production reduced to 97.5 lakh tonnes. Govt. decided to allow import under Open General License (OGL) at nil rate of duty 1995 Central Govt. permitted exports and sanctioned an export quota of 5 lakh tonnes May, 2001 December, Sugar Industry and Indian Economy Govt. issued a notification under the Forward Contracts (Regulation) Act, 1952, allowing futures/forward trading in sugar Govt. decided to create a buffer stock of 20 lakh tonnes of sugar. Govt. also passed the Essential Commodities (Amendment)Act, 2003 Union Budget, Finance Ministry announced that sugar factories that were operational in will be assisted to restructure and NABARD in consultation with State Govt., RBI & other Financial Institutions The Govt. amended the Essential Commodities Act, 1955 and Sugar Control Order 1966 and started fixing FRP (Fair & Remunerative Price) for sugarcane instead of SMP. January, 2012 October, 2012 April, 2013 PM approved the constitution of a high power committee under the chairmanship of Chairman, EAC to the PM Committee submitted its report on The committee interalia recommended decontrol of sugar sector. Cabinet Committee on Economic Affairs led by Prime Minister Manmohan Singh approved partial decontrol of the sugar industry. Source: YES BANK analysis The sugar industry is amongst the largest agro-processing industries in India. It contributed around 2.76% of annual industrial production during More than 50 million farm families and agricultural labourers are involved in the overall cultivation and harvesting operations. Some of the major players in the sugar industry in India are Triveni Engineering & Industries Limited, Balrampur Chini, EID Parry, Andhra Sugar, Mawana Sugars, Bajaj Hindustan, Shree Renuka Sugars, Dalmia Sugar, Dhampur Sugar etc. Many farming communities are dependent on the industry for earning their livelihoods. Production of sugarcane in different states in the country is depicted in the following exhibit. 12 Indian Sugar Industry

19 Exhibit 9: State wise Sugarcane Production (in MMT) State Sugarcane Year Sugarcane Year Uttar Pradesh Maharashtra Karnataka Tamil Nadu Gujarat Andhra Pradesh Bihar Haryana 7 7 Uttarakhand 7 7 Punjab 5 6 Madhya Pradesh 3 3 Others 5 8 Total Source: Indian Sugar Mills Association (ISMA), Indiastat & YES BANK analysis Sugarcane is an important cash crop for farmers. Its cultivation has a direct impact on prodction of sugar. Maharashtra (~ 34%), Uttar Pradesh (~ 27%), Karnataka (~ 15%) and Tamil Nadu (~ 9%) are the major sugar producers. The shares of sugar produced from different states is depicted in the exhibit below. Exhibit 10: Share of sugar production of major states in India (Crushing season ) Andhra Pradesh, 4.31% Tamil Nadu, 9.03% Haryana, 1.87% Gujarat, 3.80% Punjab, 1.48% Uttarakhand, Bihar, 1.71% 1.26% Other States, 1.29% Maharashtra, 34.09% Karnataka, 14.70% Uttar Pradesh, 26.47% Source: Vasantdada Sugar Institute, Pune 13 Indian Sugar Industry

20 Sugarcane crops occupy significant agricultural area for their cultivation. Out of the total sugarcane cultivation area in the country, Uttar Pradesh accounts for more than 40% of the area, followed by Maharashtra which contributes close to 21% of the sugarcane cultivation area. Considering the decontrol of the sugar industry, the area and production under sugarcane, is expected to increase in the coming years, basis market dynamics. Area wise contribution of major sugarcane producing states is depicted in the exhibit below. Exhibit 11: Sugarcane Area contribution of Major Sugarcane Producing States in India (Crushing season ) 3.97% Andhra Pradesh, 4.01% Tamil Nadu, 7.51% Gujarat, Haryana, 1.87% Bihar, 4.62% Punjab, 1.57% MP, 1.36% Other States, 1.89% Maharashtra, 20.10% Karnataka, 8.46% Uttar Pradesh, 42.52% Source: Vasantdada Sugar Institute, Pune As per the USDA, Foreign Agricultural Service estimates in May 2013, India's production is forecasted to be 2 million tonnes lower at 25.3 million tonnes due to lower sugarcane yields. Also, processors are expected to divert more sugarcane from centrifugal sugar to gur, a crude non-centrifugal lump sugar, in response to rising gur prices. Declining production and lower global prices are expected to push imports higher to 1.5 million tonnes to augment supplies for the world's largest sugar consumer. Exports are expected to remain at 6,00,000 tonnes. The Government has deregulated sugar sales and eliminated the levy on sugar mills, giving the industry more flexibility to react to market dynamics. 14 Indian Sugar Industry

21 Exhibit 12: Sugar Production during current season ( , Estimated) Sugar Production Production (lakh tonnes) Maharashtra 80 Uttar Pradesh 75 Karnataka 34 Tamil Nadu 18 Gujarat 11 Andhra Pradesh 10 Haryana 5 Bihar 5 Punjab 4 Uttarakhand 3 M.P 2 Others 1 Total 249 Source: Indian Sugar Mills Association (ISMA) 15 Indian Sugar Industry

22 2. Structure of the Sugar Industry It is one of the primary industries which has witnessed colossal interventions from the public as well as private space in India. Before 1956, a majority of the sugar mills belonged to private sector. Only three co-operative mills were present as compared to 140 private ones at that point of time. To encourage co-operative structuring, the Central Government then took some encouraging steps, one of them being, subscribing to the share capital of the co-operatives. It resulted in steep growth of sugar cooperative mills in the country and by the 1990's it formed 55-60% of the total sugar mills in India. The growth took place primarily in the cane producing stated of Uttar Pradesh, Maharashtra, Tamil Nadu, Karnataka, Andhra Pradesh and Gujarat which accounts for 80 to 90% of the total sugar production in the country. These states have significantly higher production of sugarcane in comparison to rest of the country. The sugar industry has always been an enticing sector given its nature of regulation by the Government. At the same time, these regulations are also one of the reasons for low presence of the foreign players in this particular sector. Still, some of the international bigwigs have evinced great interest in the sector. One of the largest sugar producing companies in the world, Tate & Lyle of the UK, had entered into a joint venture with Simbhaoli Sugar and started their operations in However, due to certain reasons, Tate & Lyle exited in October, 2009 and the unit was made 100% subsidiary of Simbhaoli Sugar. Similarly, Cargill also entered the sector in a joint venture with EID Parry and started operations of a sugar refinery at a capacity of 1 MMT per annum at Kakinada during During August 2011, Olam International, a global commodity trader, acquired 100% stake in Hemarus Industries Limited (HIL) for USD 73.8 million. 16 Indian Sugar Industry

23 The structure of the sugar industry in India is highly fragmented in terms of their ownership. Most of the mills operating in Maharashtra and Gujarat are having co-operative structure while it is predominantly driven by private players in the case of other states such as Uttar Pradesh, Karnataka, Andhra Pradesh and Tamil Nadu. Maharashtra alone has 108 co-operative and 64 private sugar mills which have produced lakh tonnes and lakh tonnes of sugar in the last year respectively. Overall productivity, production and area under cultivation of sugarcane have increased over the years. It is interesting to observe that the productivity of sugarcane has become stable during the last few years. For increasing the sugar production, we will have to focus on research and development, particularly taking productivity into consideration. The area, production and productivity of sugarcane during the last few decades have been depicted in the exhibit below. Exhibit 13: Area, Production and Productivity of Sugarcane in India Area and Production Productivity Production (Million tonnes) Area (lakh ha) Yield (tonnes/ha) Source: Indiastat and YES BANK analysis Apart from that, many players are operating in the unorganized space, especially manufacturers of gur and khandsari and constitute a significant part of sugar industry due to high usage of sugarcane. Many operational sugar mills are financially weak, unviable and loss-making due to sub-optimal and uneconomic capacities, inefficient operations, poor management, large manpower and poor conditions of plant and machinery. 17 Indian Sugar Industry

24 Exhibit 14: Sector wise sugar factories in operation Sugar Season Private and Public sector Co-operative sector Total Source: National Federation of Cooperative Sugar Factories (NFCSF) and CRISIL Research It is interesting to observe that most of the sugar factories do not get their raw material supply throughout the year. This is primarily due to the cyclical nature of the sugarcane crop which significantly pushes up the burden on operating costs and other associated costs of the mill due to under exploitation of capacity. Duration of crushing season (in days) of the mills in different states during the two sugar seasons is depicted in the exhibit below. Exhibit 15: State wise average duration of Crushing Season (in days) State Sugar Season Sugar Season Andhra Pradesh Bihar Chhattisgarh Goa Gujarat Haryana Karnataka Madhya Pradesh Maharashtra Orissa Pondicherry Punjab Rajasthan Tamil Nadu Uttar Pradesh Uttarakhand West Bengal All India Source: CRISIL Research and YES BANK analysis 18 Indian Sugar Industry

25 The average crushing capacity of the existing mills and the new players entering in the industry is increasing resulting in increased economies of scale and viability of operations. However, according to the S.K. Tuteja Committee report, a plant size of 5,000 TCD (tonnes crushed per day) would be optimal (minimum 2,500 TCD), taking into account the small size of land holdings in India and infrastructural constraints. Internationally, the minimum economic size is around 7,500 TCD. The presence of large number of mills operating at small capacities may be attributed to the licensing policy of the Government which predominantly encouraged setting up of newer units rather than expanding the capacities of existing ones. Shortage of adequate infrastructure for transportation and storage of sugarcane and inefficient procurement mechanisms from large number of cane producers have also served to restrict the size of sugar mills in India Segmentation of Sugar Industry The industry has flourished over time under the purview of certain regulatory measures taken by the Central Government, resulting in ups and downs in the sugar market basis demand supply scenario. Many private players are looking forward to entering into this industry and existing ones are expanding their crushing capacities in response to decontrol measures taken by the Government. Earlier the sector was primarily dominated by the co-operative mills due to supportive policies of the Government. Private firms are now aggressively looking at the sector and are increasing their presence. The exhibit below gives the categorical distribution of sugar mills operating in India. Exhibit 16: Co-operative, Public and Private Categories of Sugar Mills (2013) Public 6% Cooperative 45% Private 49% Source: Indiastat and YES BANK analysis The region and location of the mills are highly driven by the presence of sugarcane in the area. Major sugarcane producing states are Uttar Pradesh, Maharashtra, Tamil Nadu, Karnataka, Andhra Pradesh and Gujarat. Most of the sugar mills are predominantly located in these states in the vicinity of sugarcane production areas. The state wise distribution of sugar mills in the country with respect to different states is depicted in the following exhibit. 19 Indian Sugar Industry

26 Exhibit 17: State wise distribution of Sugar mills Others 6% Tamil Nadu 7% Punjab 4% Karnataka 10% Uttar Pradesh 23% Andhra Pradesh 6% Bihar 4% Maharashtra 32% Uttarakhand 1% Madhya Pradesh 3% Gujarat 4% Source: Indiastat and YES BANK analysis Looking at the region wise presence of sugar mills, north and west constitute around 33 and 32% of the total mills present in the country, respectively. These figures are significantly higher for the eastern and southern regions of the country which account for 15 and 20% of the total sugar mills, respectively. Exhibit 18: Region wise segmentation of Sugar Industry South 20% North 33% West 32% East 15% Source: Indiastat and YES BANK analysis Apart from these sugar mills, some sugar refineries have also been established in the country, two of them being in the coastal belt of Gujarat and West Bengal, which produce refined sugar from imported and domestically produced sugarcane. Although, the mills are dedicated for 20 Indian Sugar Industry

27 export of refined sugar they do provide back up stocks in case of surges in domestic demand of sugar. The daily sugar production capacity of these refineries is to the tune of 5,000 MT. In India, sugarcane is grown mainly as a cash crop. Many people are dependent on the sugar industry for earning their daily livelihood. State wise production and productivity of sugarcane also varies. Majority of the sugar mills are also concentrated in the sugarcane producing areas and are crushing canes at different capacities as per the availability of raw material. Exhibit 19: State wise Sugarcane Crushed by Sugar Factories (Sugar season: ) Andhra Pradesh 4% Tamil Nadu 10% Gujarat 4% Haryana 2% Bihar 2% Others 5% Maharashtra 30% Karnataka 13% Uttar Pradesh 30% Source: CRISIL Research & YES BANK analysis 2.2. Business Models of Domestic Sugar Mills In the cane or beet sugar industry, co-ordination between growers and millers focuses on the organization and process of the mill supply. Decisions made by millers regarding mill capacity, location of the mill and delivery allocations will directly impact the choices made by growers regarding mechanization and harvest management. In turn, decisions made by growers regarding variety selection, harvest capacity and work organization will impact milling efficiency. Poor cane quality will reduce crushing capacity, while irregular deliveries will disrupt the continuity of mill supply. Domestic sugar companies have been increasingly diversifying their top line through ethanol production from molasses and cogeneration of power from bagasse. Currently, there are 4 types of business models in operation in the country which is discussed below. These models for sugar mills range from the least integrated to most integrated model. 21 Indian Sugar Industry

28 SMB Sugar - Molasses - Bagasse Model Manufactures Sugar By-products like molasses and bagasse are sold without any value addition Least Integrated SEB Sugar - Ethanol - Bagasse Model Convert Molasses to alcohol apart from sugar manufacturing Bagasse sold without any value addition Integration in Ethanol segment SMP Sugar - Molasses - Power Model Convert Bagasse into Power apart from sugar manufacturing Molasses sold without any value addition Integration in Power segment SEP Sugar - Ethanol - Power Model Convert molasses into ethanol and bagasse into Power, sugar manufacturing Highest Integration The SEP (Sugar-Ethanol-Power) model, over a complete cycle, offers higher and more stable average profits as compared to the SMB (Sugar-Molasses-Bagasse) model. This is because earnings from the sale of alcohol or ethanol and power are relatively stable and are non-cyclical as compared to the core sugar business. The integrated model will be the preferred one in order to ensure the viability and profitability of the business Comparison with Oilseed Industry Edible oil and sugar are essential commodities for Indian households. Both the products play an important part in meeting daily food requirement. Prices of theses commodities have a significant impact on the majority of the population. While edible oils has a free market with respect to release in the market and prices, sugar is regulated by the Government for release into the market. Although, both the oilseed and sugar industry are agro-based industries, they share some similarities as well as differences in term of operations and the regulatory environment they are operating in. Oilseed production in the current season is expected to be more than 35 million tonnes while sugar production is expected to be at around 26 million tonnes during the same period. Strong market prices for oilseeds and international demand for animal feed are likely to push the 22 Indian Sugar Industry

29 crushing of oilseeds. At the same time, the sugar market is poised for growth with alternative sweeteners in the unorganized market which also occupies a significant proportion of the total sugar market in the country. Operating margins in both the industries are fairly low as compared to other industries. But it is interesting to observe that the oilseed industry is able to sell their product at a price higher than their cost of production while in case of sugar industry, due to the regulatory environment, at times the product is sold at prices which are lower than the cost of production. This can be as much as INR 4 to 5 per kg lower. A comparative matrix between Oilseed and Sugar industries is depicted below. Exhibit 20: Comparative Analysis of Oilseed and Sugar Industry S. No. Parameters Oilseed Industry Sugar Industry 1 Industry Size 2 Input and other raw material availability 3 Raw Material Pricing 4 Output Prices 5 Government Control 6 Operating margins 7 Industry Structure Edible Oil: Volume Approx. 35 MMT Value Approx. INR 1,25,000 crores Palm oil and some other raw material are imported, rest available within the country. Many companies import raw materials and process it. Crude Palm Oil is imported, while the rest is available within the country. Multi commodity (Sunflower, Groundnut, Palm Oil). Prices are directly influenced by International Crude and Refined Palm Oil prices and there is no Government intervention. Market Driven and variable basis the different commodities. Not applicable. Export and import of edible oil is regulated. Low Dominated by private players Sugar Production: Volume Approx. 26 MMT Value Approx. INR 80,000 crores. Available within the country. Catchment command area concept for raw material within an approved distance of factory and sugarcane production zone Fair & Remunerative Price (FRP) is fixed by the Government every sugar season. Recently decontrolled by the Government. Sugar prices to be range bound. Levy quota gradually reduced from 70% to 10%, but this has also been removed recently Low Dominated by cooperatives and private players as well 23 Indian Sugar Industry

30 S. No. Parameters Oilseed Industry Sugar Industry 8 Products Mostly Branded Products are sold in multiple SKUs. Available in 100 ml to 50 kg SKUs. Majority of the sugar is sold unbranded. Recently, very few players are entering into branded segment. Maximum sold loose. 9 Commodity Stock Majority of the stock is Majority of the stock is carried carried by the traders by mills 10 Demand supply gap Huge gap exists for most varieties. India is an oil deficit country, hence palm oil is imported every year. Gap exists from state to state and stocks are transferred within the country. Imports have not happened recently in spite of decontrol. Export Import takes place on opportunity basis from time to time. Also in times of exportable surplus exports don't take place 11 Industry Characteristics Small to medium to large players. Scale matters, hence medium to big players. Also for profitability, by-products need to be processed like cogen power, MDF and ethanol 12 Variants Many across the country and some specificity in No such specificity - mostly available in small & large grain consumption e.g. Kerala large coconut oil consumer, West Bengal mustard oil. Typically safflower, sunflower, soybean, castor, coconut, gingelly, mustard and olive oil are sold 13 Entry barrier No specific barrier. Can be set Comparatively large capital up with low project costs. expenditure is needed. 15 Price sensitivity at retail Not much overall sensitivity. People shift to blend or other low cost variants but may not reduce consumption. Price elasticity of demand is more prominent Source: YES BANK Analysis 24 Indian Sugar Industry

31 It clearly indicates that in the competitive environment, oilseed industry has flourished well and is growing at a CAGR of 4 to 5%. The Indian sugar industry is undergoing transformations through recent changes in the regulator environment. Since the last decade, the sugar industry has been growing at a CAGR of 3 to 4% and is expected to pick up pace after the decontrol Manufacturing of Sugar Sugar (sucrose) is a carbohydrate that occurs naturally in almost every fruit and vegetable. It is a major product of photosynthesis, the process by which plants prepare food. Sugar occurs in greatest quantities in sugarcane and sugar beets from which it is separated for commercial use. In India, it is majorly separated from sugarcane. Exhibit 21: Manufacturing of Sugar and it's by-products Weighed & Prepared Cane Co- Generation To Grid Cane Milling/ Crushing Boilers Turbine POWER To Factory Juice Defecation & Clarification Press Mud Juice Sulphitation Syrup Boiling Bio Composting Spent Wash Centrifuging Molasses Fermentation Alcohol Factory Raw Sugar Source: Indian Sugar Mills Association (ISMA) The harvested sugarcane crop is transported to sugar mills where the sugar manufacturing process is initiated mechanically. Sugarcane stalks are usually pre cleaned of any foreign matter, such as dirt or insects and then washed with water to make them as sanitized as possible before any physical changes. The cleaning process is undertaken mechanically in most of the cases with the help of high pressure water jets and combing drums that help in separating out larger foreign objects such as rocks. The stalks are then cleaned and milled for extracting the juice. The extracted juice is then filtered and purified. The juice becomes ready for boiling now. 25 Indian Sugar Industry

32 During boiling, as the juice thickens, it crystallizes, becoming raw sugar. The raw sugar is then spun in a centrifuge or rotation chamber, in order to dry it fully and remove all of the wetness, if any. After that, if the product is to be sold as raw sugar, it is packed and sent to distribution channels for further sales through retail channels. Further value addition could be done through refining it. Products and byproducts from during sugar manufacturing are: 100 kg of sugarcane produces approximately 10 kg sugar, 5 6 kg of molasses, kg of bagasse and around 4 kg of press mud Further, 100 kg of molasses produces approximately litres of alcohol and 100 kgs of bagasse can generate 35 units of power 26 Indian Sugar Industry

33 3. Trends in the Sugar Industry The sugar industry in India is highly volatile due to public and private interventions. The country has witnessed wide fluctuations in sugar production over the years. The production plunged to a large extent during but it soon picked up growth during subsequent years. During , total sugar production in the country was estimated at 26 million MT, registering significant growth from the previous years. In the current period, the area under sugarcane cultivation is expected to increase due to rising prices fixed by the Government Cane Prices in India Cane prices are decided by the Government basis recommendations from the Commission for Agricultural Cost and Prices (CACP), known as Fair and Remunerative Prices (FRP, erstwhile Statutory Minimum Price). These prices are decided basis certain factors, some of which include recovery percentage, cost of production, reasonable margins for growers on account of risks and profits and recovery of sugar from cane etc. Area and production of sugar fluctuate considerably from year to year. Due to variations in climatic conditions, the production also varies in different regions, ultimately leading to price fluctuations for mitigating risks associated with crop production. Despite this instability, production of sugarcane has been increasing considerably over the last few years. Recovery percentage is one of the major factors affecting the pricing of sugarcane. On an average, the recovery rate of sugarcane in India is around 10.25% which is quite low as compared to the world average. State wise recovery rate for sugarcane in India is as follows: 27 Indian Sugar Industry

34 Exhibit 22: State wise Sugar Recovery Rate (in percent) State Andhra Pradesh Bihar Gujarat Haryana Karnataka Madhya Pradesh Maharashtra Punjab Rajasthan Tamil Nadu Uttar Pradesh Source: Indian Sugar Mills Association (ISMA), CRISIL Research & YES BANK analysis Unlike other agri commodities, the pricing of sugarcane is regulated and governed by the statutory provisions of the Sugarcane (Control) Order, 1966 issued under the EC Act, Prior to , the Central Government would fix the Statutory Minimum Price (SMP) for the cane and farmers were entitled to share profits of a sugar mill in a fixed proportion. But it was not practiced to a very large extent due to lack of proper monitoring measures. The Sugarcane (Control) Order, 1966 was amended during October, 2009 and the concept of SMP was replaced by the Fair and Remunerative Price (FRP) of sugarcane. The FRP takes reasonable margins into account for arriving at a price in order to offer adequate incentives to cane producing farmers. Through requisite changes, revenue sharing of sugar mills is expected to be reflected in sugarcane pricing. Although the Central Government declares FRP, the States are also free to determine their own prices basis their own criteria. The State intervention in the prices of sugarcane is depicted in the exhibit below. 28 Indian Sugar Industry

35 Exhibit 23: State Advised Cane Price for different years S. No State Rate (INR per quintal) Rate (INR per quintal) Rate (INR per quintal) 1 Punjab Haryana Uttar Pradesh Maharashtra Gujarat Tamil Nadu per per quintal per quintal (linked to (linked to 9.5% quintal (linked to 9.5% recovery) recovery) 9.5% recovery) 7 Karnataka Bihar Uttarakhand Andhra Pradesh Source: Indian Sugar Mills Association (ISMA) Although the margins in the sugar industry are highly dependent on external regulatory environment but some players are running their business sustainably. The operating margins for the last few years have been moderate on account of surge in sugarcane procurement cost. Net margins and RoCE have been fairly low due to high debt levels which were led by large capital expenditures. Due to State interventions in terms of sugarcane prices, many mills are not in a good state. The arrears are mounting and it is difficult to make payments to the farmers in a timely manner Sugar Production Cycle Of all the international commodities markets, the sugar market is one of the most volatile. Policy implications on the production and price regulation are some of the major factors contributing to this volatility, particularly in Asian countries, India being one of them. It is imperative to understand the volatility of the sugar market in India with respect to the cyclical nature of production of sugarcane, where in majority of the cases, surplus years of production are followed by deficit years, alternatively. During recent periods, the cycle has been more apparent owing to larger movements in production and trade of the commodity. The production of sugarcane and trade of sugar generally follow a similar trend with respect to time. Climatic factors play an important role in sugarcane production as it is highly sensitive to the level of rainfall during the monsoons. Domestic sugar policies are critical in view of augmenting the cyclical nature as they incentivize the sugar value chain stakeholders through one or more measures. 29 Indian Sugar Industry

36 Decline in sugar prices Lower profitability Higher Sugar production Higher Sugarcane arrears Higher Sugarcane production Cyclicality in Sugarcane Decline in area under cultivation Lower sugarcane production Improved profitability Low sugarcane arrears Lower Sugar production Low sugar availability Increase in prices Although the Central Government decides the FRP for sugarcane procurement, few states having majority of the sugar mills follow different mechanisms for deciding the prices through State Government interventions in the form of State Advised Prices (SAP, as in case of Uttar Pradesh), or some sort of final 'negotiated price' based on surplus sharing mechanism in the case of Maharashtra sugar cooperatives. In these cases, cane procurement prices are much higher than the FRP decided by the Central Government, which in turn, puts burden on sugar mills in case of low prices of sugar in the market. In this situation, many sugar mills are unable to pay the stated prices to the farmers leading to mounting arrears to be paid to them as and when funds are available. This is one of the most detrimental factors for the sugar industry as it creates a complex situation where both producers and millers are in a situation where one can be benefited only at the expense of the other, resulting in an unwanted situation. It indicates that the mechanism adopted by the Governments (Central and State) for pricing of cane does not address the requirements of the stakeholders. Sometimes, FRP decided by the Central Government is extremely low from the farmers' perspective and prices decided by States are much higher resulting in mounting arrears which results in lack of commitment from all stakeholders. Therefore, it is the need of the hour to devise a mechanism for deciding suitable prices for sugarcane which is mutually acceptable to all stakeholders. 30 Indian Sugar Industry

37 Sugarcane is cultivated in India primarily for producing sugar. The demand supply gap for the sugar in the market largely decides the pricing of the sugarcane in the country. Sugarcane is an important commodity which is cultivated during a particular season but the demand for crushing exists throughout the year. Most of the sugar millers, bulk consumers and traders tend to keep stocks of sugarcane with them in order to meet their year round demand. While the pricing of sugar is partially decontrolled, cane prices fluctuate from region to region to a very large extent. Exhibit 24: Prices for Sugarcane (SMP & FRP) declared by CACP, Ministry of Agriculture, India during different years (in INR per quintal) Prices (INR per quintal) Source: Commission for Agriculture Costs and Prices (CACP), Ministry of Agriculture Factors affecting Financial Performance of Sugar Factories Processing cost plays an important role in financial performance of a company, be it a co operative or private company. As the sugarcane prices are decided by the central and state government, it largely impacts costing of the firm. The financial performance of the mill is primarily dependent on the following factors. Procurement Prices of the Sugarcane Sugarcane is the main raw material for manufacturing sugar. The prices of sugarcane are highly governed by the central and the state government. The sugarcane accounts for 60 to 65% of the total sugar manufacturing cost. Therefore, an increase in the prices of sugarcane directly impacts the operating margins of the mill. Volume and Catchment Production Area The volume at which a mill is operating is very important parameter and is essential for determining the break even for the mill. Although, it doesn't have impact on the 31 Indian Sugar Industry

38 procurement price of sugarcane but conversion price per tonnage of sugarcane reduces significantly in case of large plant size. Apart from that, if a plant is located in an area where sugarcane is easily available, it will be easy to operate. Demand Supply Gap The sugar market is highly volatile in nature. The demand supply position of the sugar in the market is really important in terms of understanding the performance of a mill. The stock to use ratio indicates the demand supply position of sugar in the market. A favourable situation in demand supply will result in higher sugar prices in the market which in turn will improve the financial performance of the company. Products Usage Milling of sugarcane also produces by-products such as molasses and bagasse. These byproducts can be further used to produce ethanol which is essentially required for blending with gasoline as per Government standards. Effective utilization of these products will subsequently improve the performance of the companies in terms of earning more revenue. Other Factors Other factors include the efficient operations of the mills with respect to working capital requirements on day to day basis and credit portfolio of the particular company operating in this space Indicative Costing of Sugar Production Sugarcane is an important agricultural crop as close to 60 million farmers are associated with it directly or indirectly. It is imperative to understand the value chain for appraising the level of value addition to the raw sugarcane and its subsequent conversion into sugar. Sugarcane procurement prices are declared by the government. Further, states declare state advised price for the procurement. Sugarcane constitutes an important part of sugar production, contributing to almost 70% of its cost of production. The indicative costing of producing sugar in the context of Uttar Pradesh is provided in the exhibit below. Exhibit 25: Indicative Costing Sheet for Sugar Production at Uttar Pradesh S. No. Item Price (INR per quintal) 1.1 Cane price Incidence of Premium Purchase Tax + Commission ( or Cess) Harvesting & Transportation Charges Total Cane Prices at factory Gate Indian Sugar Industry

39 S. No. Item Price (INR per quintal) 2.1 Average Season Recovery (%) 9.19% 2 Cane Cost for production of 1 quintal of Sugar 3, Total Conversion Cost Less Credit for By-products Net Conversion Cost Net Cost of Sugar Production 3, Domestic Demand of Sugar Source: Indian Sugar Mills Association (ISMA) The demand for sugar in the domestic market may be divided into two categories households accounting for 40% consumption and bulk consumers (having consumption more than 1 tonne per month) accounting for the rest 60%. According to a CRISIL report, the domestic consumption of sugar is set to increase at a CAGR of 3 to 4% during next few years which is more than the global average owing to lower initial base and increasing disposable income. This growth is expected to be robustly driven by industrial users comprising manufacturers of confectioneries and chocolates, soft drinks, sweets and fruit drinks. While as per capita consumption of the world stands at 24 kg per annum, the per capita sugar consumption in the country is estimated at 18 kg per annum for sugar season in addition to 5 kg per capita consumption of other sweeteners such as gur and khandsari products. Demand for sugar can be categorized under direct demand, arising from households and indirect demand, from industrial users. Exhibit 26: Domestic Demand for Sugar (in million MT) Direct Demand (Households) Indirect Demand (Industrial) P P P P Source: CRISIL Research and YES BANK analysis, P-Projected 33 Indian Sugar Industry

40 The indirect demand is further divided into different segments and is expected to grow at a higher pace in the coming years. Exhibit 27: Division of Indirect Sugar Demand (Industrial) in million MT Bakeries Soft & fruit drinks Tea & Coffee Confectioneries & Chocolates Sweetmeats Others P P P P Source: CRISIL Research and YES BANK analysis, P-Projected Demand for the sugar is primarily dependent on the following factors: Consumer preference towards sugar with respect to other sweeteners Growth in the population of the country Rising future demand of Industrial players 34 Indian Sugar Industry

41 4. Regulations in the Sugar Industry The Government controlled the sugar industry completely even after five decades of independence through different regulations. Over the last decade, some of the controls pertaining to external sugar trade and the percentage of sugar that can be sold in open market, have been relaxed. Some of the regulations like price of raw material (sugarcane) and the area from which mills can procure sugarcane for crushing are still under the belt of regulation by the Government. These regulations are in place to protect the interests of both sugarcane farmers and end consumers Essential Commodities Act in Sugar The Essential Commodities Act 1955: This act was enforced in the interests of the general public for the control of production, supply & distribution and trade & commerce in certain commodities. Under the Essential Commodities Act, food crops also include sugarcane. Under this act the word 'Sugar' signifies: Any form of sugar containing more than 90% of sucrose Khandsari sugar or bura sugar or crushed sugar or any sugar in crushed or crystalline form Sugar in process in vacuum pan sugar factory or raw sugar produced The Central Government is of the opinion that it may provide for regulation or prohibition of the production, supply and distribution of essential commodities if it is necessary for maintaining or increasing supplies of these commodities for securing equitable 35 Indian Sugar Industry

42 distribution and availability at fair prices or securing these commodities for the defense of India or for efficient conduct of military operations. The Essential Commodity Act is being implemented by the State Governments and Union Territory administrations by availing of the delegated power under the act. The government has issued different control orders for regulating various aspects of trading in essential commodities such as food grains, edible oils, pulses, sugar etc. The items declared as essential commodities under this act are reviewed from time to time in the light of liberalized economic policies. For the purpose of understanding: Fair and Remunerative Price means the price of sugarcane fixed by the Central Government and the Commission for Agricultural Costs and Prices (CACP). Manufacturing cost of sugar means the net cost incurred on conversion of sugarcane into sugar including net cost of transportation of sugarcane from the purchase center to the factory gate. Reasonable return on the capital employed means the return on the net fixed assets plus working capital of a producer in relation to manufacture of sugar including procurement of sugar on fair and remunerative price fixed by the Government Sugar and Sugarcane Pricing Policy India is the second largest producer of sugar in the world after Brazil and also the largest consumer of sugar in the world. Today, Indian sugar industry's annual output is worth approximately INR 800 billion. The concept of Statutory Minimum Price (SMP) of sugarcane was replaced with Fair & Remunerative Price (FRP) during and subsequent sessions with the amendment of the Sugarcane (Control) Order, The cane price announced by the Central Government is decided on the basis of the recommendations of the Commission for Agricultural Costs and Prices (CACP) after consulting the State Governments and associations of sugar industry. The amended provisions of the Sugarcane (Control) Order, 1966 provides for fixation of fair and remunerative price of sugarcane taking into consideration, the following factors: Cost of production of Sugarcane Return to the growers from alternative crops and the general trend of prices of agricultural commodities Availability of sugar to consumers at a fair price Recovery of sugar from sugarcane 36 Indian Sugar Industry

43 Price at which sugar produced from sugarcane is sold by sugar producers The realization made from sale of by-products like molasses, bagasse and press mud or their imputed value The new system also assures the margins on account of profit and risk to farmers in all the years, irrespective of the fact whether the sugar mills generate profit or not and is not dependent on the performance of any individual sugar mill. The FRP is linked to a basic recovery rate of sugar, with a premium payable to farmers for higher recoveries of sugar from sugarcane, in order to ensure that higher sugar recoveries are adequately rewarded and considering variations amongst sugar mills. The SMP of sugarcane payable by sugar factories for each sugar season from to and FRP for to has been shown in the following exhibit: Exhibit 28: SMP and FRP of Sugarcane with respect to its recovery rate Sugar season SMP & FRP (INR per quintal) Basic Recovery Level % % % % (FRP) % % % % % Source: Indian Sugar Mills Association (ISMA), YES BANK analysis Prior to Sugar Season (SS) , the SMP used to be linked to a base recovery rate of 8.5%. The millers were paying SMP to farmers up to a recovery rate of 8.5%. For every 0.1% increase in recovery above the base rate, the millers had to pay a premium which was derived from a formula based on SMP and base recovery rate. In SS , the government increased the base recovery rate to 9% and further to 9.5% in SS The FRP for SS had been fixed at INR 170 per quintal, 17% higher than the previous year. The Union Government has announced a higher base price for sugarcane at INR 210 per quintal for sugar season (starting from October 2013). The base price of INR 210 per quintal linked to a basic recovery rate of 9.5% and subject to a premium of INR 2.21 per quintal for every 0.1% increase in recovery above that level. 37 Indian Sugar Industry

44 Sugarcane Control Order 1966 (amended 2006, 2007) Under this Act, the Central Government is empowered to do the following: Fix the Fair & Remunerative Price (FRP) to be paid to farmers. Also payment of interest at 15% per annum on amount due to the farmers beyond 14 days Regulate movement and distribution of sugarcane Issue directions to khandsari units Regulation and distribution of licenses to power crushers It also restricts farmers to supply not less than 85% of sugarcane as committed Levy Sugar Price Equalization Fund Act, 1976 This Act came into place to provide for the establishment of a fund to ensure that the prices of levy sugar would remain uniform across the country. Sugar Cess Act, 1982 and Sugar Development Fund Act, 1982 & 2002 Under Sugar Cess Act, a fee is charged on the sugar sold in domestic market, which directly goes to the Sugar Development Fund. Also the Government charges higher excise duty on the free sale quota compared to levy quota. In this way they recover part of the subsidy provided on sugar distributed by Public distribution System (PDS). Sugar Development Fund Rules, 1983 It outlines various norms and procedures which are to be agreed in making the grants or loans out of the fund. Also it undermines the composition of the committee and the methodology it follows in discharging its duties Sugar Policy for Regulating Sales a) In Domestic Market The Central Government had been following a policy of partial control and dual pricing for sugar. Under this policy, a certain percentage of sugar produced by sugar factories (raised to 20% for sugar season and revised to 10% for season and sugar season and currently removed that 10% criterion also) is requisitioned by the Government as compulsory levy at a price fixed by the Central Government in every sugar season. Levy sugar is distributed under the Public Distribution System (PDS) at a uniform retail issue price throughout the country. The non-levy (free sale) sugar is allowed to be sold as per the quantity released by the Central Government under the regulated release mechanism. During the year , releases were announced on a quarterly basis to give greater flexibility to the sugar mills in their inventory management. 38 Indian Sugar Industry

45 b) In Export Market On an overall basis, India has been a net exporter of sugar. In 1958, the Government promulgated the Sugar Export Promotion Act for export of sugar. This led to an increase in exports of sugar as per the quantity allotted by the Government. Within a short period, India emerged as prominent exporter of sugar. In January 1997, the Sugar Export Promotion Act, 1958, which governed sugar exports and stipulated that the Government could export 20% of the country's sugar production, was revoked. Later on, in the same year the Sugar Export Promotion Act was repealed and sugar exports were de-canalized. Consequently, the Government appointed the Agricultural and Processed Food Products Export Development Authority (APEDA) as the monitoring agency for sugar exports under the new system. In June 2001, the Government removed quota restrictions on exports of sugar and Registration cum Allocation certificates issued by APEDA were also dispensed with. The policy of exempting sugar exports from levy obligation continued during Under the policy, free export of white and raw sugar was allowed. Other policy measures to facilitate exports included Duty Entitlement Pass Book (DEPB) scheme which allowed reimbursement of 4% of FOB price. These incentives were withdrawn later due to lower production of sugar. In later years, export permits were only given to those firms which imported raw sugar earlier and were having export obligations. In 2006, the Government banned the export of sugar altogether. Again in anticipation of higher production in , the Government lifted the ban. From 2006 till 2011, India exported significant volumes of sugar. Sugar exports are exempt from the payment of excise duty. This is an advantage offered to companies exporting sugar. Further, sugar mills enjoy levy exemption on the quantity of sugar exported by them. The sugar released for export is adjusted against the inventory of mills on a deferred basis. Currently, the period for such deferment benefit adjustment is 18 months. c) Regulation on Imports Currently, a duty of 15% exists on sugar imports from other nations which was recently hiked from 10%. This hike in duty is done to clear outstanding payments to sugarcane farmers which have risen to INR 9,000 crores from INR 5,000 crores from last year. The import of duty free white and raw sugar lapsed after June, Sugar imports were brought under Open General License (OGL) in In the past, the Central Government has relaxed the norms for raw sugar imports under the Advanced License System (ALS). In 2004, sugar mills were allowed to import duty free raw sugar under ALS and then process it into white sugar before selling it in the domestic market. Their obligation of exporting white sugar was fulfilled by processing domestically procured sugarcane within a period of 24 months which was further relaxed to 36 months. 39 Indian Sugar Industry

46 Other Regulations in Sugar Industry a) Cost Labour wages are to be paid according to government orders and also specified by wage boards. Mills pay to the farmers as per price fixed by government for the cane supplied to them. Also sugar prices are fixed on sugar recovery level and not linked to the realization of sugar producers. The payment is to be made within 2 weeks of sugarcane purchase. Sugar mills can take loans from the Sugar Development Fund, but the loan have to be spent only with due approval of State Cane Department. b) Capacity and Production Command area to be allotted to each sugar factory is decided by the Cane Commissioner. There is a minimum distance of 15 km after which new sugar mills can be opened from existing sugar mills. In some states like Punjab, this distance is 25 km. Sugar producers have to solely depend on farmers for raw materials as they are not allowed to own cane fields. Thus, it is completely farmers' discretion of growing quantity of crop and thus capacity utilization of sugar mills depends on farmers' preference. Sugar producers have to purchase all the canes sold to them. In case of excess cane production or when alternate sweetener producer do not offer attractive prices, mills receive more canes It is also mandatory to pack a fixed percentage of sugar in jute bags as per Jute Packaging Order. 4.3 Partial Decontrol in Sugar Industry The sugar industry was in the shackles from the very beginning. These restrictions were in place to protect the interest of sugarcane growers and end consumers from the global price fluctuations and interest of sugar mill owners from supply perspective. After independence, the government has been liberalizing the industry from time to time. Recently, it has removed 10% levy criterion for sugar mills for distribution through the Public Distribution System (PDS). The government has completely done away with this mechanism, thus allowing demand-supply forces to determine sugar prices. Even after many regulations are waved off, there exist some regulations on sugar industry as a whole, apart from keeping sugarcane under list of essential commodities. 40 Indian Sugar Industry

47 a) Sugar mills to be benefitted by higher profitability The recent partial decontrol of the sugar industry will improve profitability of sugar mills and will also allow them to use their working capital judiciously. Till now, mills have been bearing a major proportion of the subsidy burden arising out of sugar sold through PDS at a discounted rate. Sugar mills were losing close to INR 30 billion due to this reason. However, by removal of this levy quota, mills are estimated to save INR billion which in turn will increase the profitability by basis points. Mills will get an added advantage of managing working capital requirements by allowing them to sell stocks when prices are high and favourable to them. b) Government's subsidy burden to increase Money saved by sugar mills (INR billion) will be burden on government in form of subsidy because no announcement has been made by government to hike excise duty to compensate for rise in subsidy amount. The combined subsidy burden on Central and State government is estimated to be in the tune of INR 50 billion (sugar year ). c) Unaffected end consumers and sugarcane grower As there is no increase in excise duty thus there will no hike in retail prices for end consumers. Farmers will also be unaffected by the 10% levy quota removal by the government recently. Although, the Rangrajan Committee has recommended certain important measures, the government has not made any announcements regarding cane price determination, cane reservation area or trade policies. 41 Indian Sugar Industry

48 5. Conversion of Cane to Ethanol Ethanol is an agro based product generally produced from molasses (by-product of the sugar industry). Out of total molasses produced 97% goes in production of alcohol and rest 3% in cattle feed. Out of this alcohol produced, 58% goes into potable alcohol (which further goes into making of country liquor), 28% goes to industrial alcohol, 12% for blending and the remaining 1% is exported. During 2002, the Central Government introduced an ethanol blending programme which was essentially meant for standardizing the proportional blending of petrol with ethanol in order to reduce the nation's dependence on imports of crude oil. This move was overtly taken to make fuel prices stable and affordable to the larger mass. The programme also envisaged the quality of blended ethanol to be environment friendly. The move was made to imitate the successful blending programmes in other countries such as Brazil, where about 55% of the country's sugarcane production is dedicated towards this purpose. Along with that, the Brazilian Government also took one step forward by making it mandatory that the petrol which has to be sold to petrol bunkers should have essential blending requirement of 25% ethanol with gasoline. The Government of India has also made it mandatory to blend at least 5% of ethanol with petrol in order to sell it from October 2007 across all the regions except for Northeastern states, Jammu & Kashmir and the union territories of Lakshadweep and the Andaman and Nicobar Islands. The oil companies have been aggressively looking at the sugar industry for supply of ethanol in order to meet the mandatory requirements of blending. During , oil marketing companies issued tenders for entering into a 42 Indian Sugar Industry

49 contract of around 1,000 million litres at a pre stated price of INR 27 per litre. But the final price was decided by the committee setup for linking ethanol realization for Indian sugar industry to global crude oil prices and domestic sugar prices. In India, sugarcane based ethanol can be produced in two ways: a) Directly from sugarcane b) From molasses obtained during sugar production, which can be of two types Type B & C The Cabinet Committee on Economic Affairs (CCEA) considered the recommendations of Group of Ministers (GoM) and approved that the procurement price of ethanol will not be fixed by the Government and will be decided by the oil marketing companies in consultation with the suppliers of ethanol. The Ethanol Blending Programme (EBP), besides lowering pollution levels, is expected to provide another outlet for ethanol use, thus ensuring utilization of molasses produced as a by-product during the manufacture of sugar. This would improve the revenue stream of sugar mills. The Ministry of Petroleum and Natural Gas has issued a gazette notification for implementation of 5% mandatory ethanol blending with petrol across the country. Phases of Ethanol blending in India: Phase 1 ( to ): Lower sugarcane production impacted demand for blending Ethanol blending mandated to 5% in 9 states and 4 Union Territories, which accounted for 65% of domestic petrol consumption in the year In and , sharp decline in sugarcane production put blending on the backburner Maximum blend rate achieved during the first phase remained at only 1% Phase 2 ( to ): Delay in implementation and fluctuation in production led to lower blending Production recovery in led to 5% mandatory blending in 20 states and 8 UTs (excluding Jammu & Kashmir, North East states and Hilly areas). These accounted for 90% of the total domestic petrol consumption. But high excise duties, inter states taxes and higher transportation costs made it commercially unviable to blend ethanol with petrol in many states. Also lower than anticipated production of sugarcane in and in the subsequent year, led to a fall in supply of ethanol for blending purposes. Highest blending rate achieved 2.1% (all India) 43 Indian Sugar Industry

50 5.1 Current Scenario: 5% Blending Realistic or Not In order to maintain competitiveness with other end-user industries, the Government allowed prices of ethanol used for blending to be market driven (Oil marketing companies and Suppliers of Ethanol). As per the new mechanism, OMCs float tenders annually and sugar companies can quote the price at which they are willing to supply ethanol at the depot. Also the Government has permitted ethanol blending up to 10%, which is possible in sugarcane growing areas and has allowed a lower blending rate in other regions. However, the target for all-india blending rate has been maintained at 5%. As per ISMA estimates, there is a demand of approx. 1,050 million litres of ethanol for its blending with petrol in the country. Though, the distilleries in India have capacity to manufacture approximately 1,800 million litres of ethanol annually due to lack of demand, the full capacity of distilleries is not being utilized. The reason for the lower offerings is lack of co-ordination between the different parties. OMCs had floated the tender in January, 2013, at a time when the sugar mills had already crushed about 70% of the sugarcane available. The sugar season starts on 1st of October of each year and goes up to 30th September of the following year. Accordingly the sugar mills start their crushing operation by mid-november to early December every year which generally is over by end of March or mid-april. Before starting their crushing operations, the sugar mills have to plan for disposal of their product as well as the by-products including molasses. The sugar mills having their own distilleries, consume the molasses produced by them whereas the others have to sell it in the open market. Accordingly, the sugar mills had already committed their molasses and alcohol to alternate buyers. The period of supply specified in the tender documents was from March, 2013 to February, This period covers two sugar years i.e and But sugar mills were not allowed to offer any quantity from the sugar year as the tender document did not provide for the same. Having no option, sugar mills had to offer quantities from the production of sugar year , out of which sizeable quantity had already been committed to alternate buyers. Still, the sugar mills managed to offer approx. 550 million litres of ethanol to the OMCs, which fulfilled about 52% of the total requirement. After several considerations, OMCs again floated the tenders during July, 2013 to meet the ethanol demand appropriately. Placement of orders by OMCs is a significant move as additional revenue generated, would rescue sugar mills and compensate their loss from the core activity of manufacturing sugar up to a greater extent. The cost of producing ethanol currently works out to around INR 34 per litre. Deficient rainfall and drought-like conditions in key sugarcane growing regions of Maharashtra, Karnataka and Tamil Nadu have lowered area under sugarcane cultivation. Consequently, alcohol production is expected to decline by 6% Y-o-Y in FY14. Also there is limited alcohol supply to meet demand from industry and for ethanol blending. Potable alcohol industry receives maximum alcohol supply, at the cost of other end users as potable industry offers a higher price compared to other end users in the industry. After this potable alcohol industry, chemical industry takes maximum share (28%). Though both industries (chemical and fuel alcohol) offers 44 Indian Sugar Industry

51 same price but cost of production of fuel alcohol is comparatively more than the chemical industry. As per the study report of IOCL, It has been observed that blending of ethanol in gasoline increase octane number of the blended fuel and will offer other opportunities to the refineries for reducing benzene and efficient burning of petrol. Thus, after meeting the demand of potable alcohol industry and chemical alcohol industry the balance is supplied to fuel alcohol industry for blending. Since ethanol prices will be fixed for a one-year period and petrol prices shall be revised every 15 days, OMCs will need to maintain a certain gap between the two parameters. However, going forward, ethanol prices are more likely to be linked to domestic petrol prices. OMCs are likely to maintain a minimum gap of around INR 6-7 per litre between petrol and ethanol prices. However, share of fuel alcohol over the industrial chemical segment is unlikely to decline, as realizations of the latter also move in line with crude oil prices. Considering the advantages of blending ethanol with the gasoline, some regulatory measures should be undertaken to make it a mandatory requirement for OMCs taking into view their interest. This would result in a win win situation for both the parties, where millers will be benefitted through efficient utilization of their byproducts and OMCs will be able to make significant savings through blending. For sustainable sugar and ethanol production, the mills should focus on becoming energy complexes where alcohol, ethanol, power and other downstream products should be produced along with sugar. Setting up of additional facilities would make them energy hubs and, in turn, will improve the efficiency and returns for all the stakeholders. 45 Indian Sugar Industry

52 Brazilian Sugar and Ethanol Industry Sugarcane was brought to Brazil by the Portuguese colonists five centuries ago. By 1525, Brazilian sugar was being exported to Portugal. Between 1580 and 1640, it was the world's largest exporter of sugar. It was then overtaken by the British West Indies and later by the Spanish Caribbean islands. Today, it is again the world's premier sugar exporter. In 1970, Brazil produced 80 million MT of sugarcane with which it made 5.1 million tonnes of sugar, of which 1.2 were exported, and 168 million gallons of ethanol, practically none of which was exported. In 2012, Brazil harvested some 671 million MT of sugarcane, producing more than 39 million tonnes of sugar, of which majority was exported and 6.2 billion gallons of ethanol of which 0.7 billion gallons was exported. Brazil is now the world's largest sugar producer and the largest source of ethanol from sugarcane industry. Supplying nearly 50% of internationally-traded sugar, it is also the largest exporter of ethanol (most of which goes to the United States). The industry is a domestic powerhouse. It accounts for 1.5% of Brazil's GDP, 6.5% of exports, 4.5 million direct and indirect jobs and 72,000 independent farmers. The Brazilian sugarcane industry's extraordinary growth is often presented as the inevitable consequence of free market forces. Today roughly half of Brazil's sugarcane is used to produce ethanol. Thus, even when directed mainly to the support of its ethanol industry, Brazilian Government intervention affects the unit cost of sugar production. When, as in Brazil today, half the sugarcane is used to produce ethanol and the balance is used to produce sugar, what happens in one of these two markets impacts the other. Not only can mills arbitrage between these markets by choosing to favour the product which momentarily may offer the best returns, but economies of scale and accumulated experience are shared between both products. (Source: Report on Brazilian Sugar Industry by Patrick H. Chatenay and inputs from ISMA) 46 Indian Sugar Industry

53 6. Consolidation of the Sugar Industry in India The size of the sugar market in India is estimated at around USD 13.5 billion and the market is expected to double in the next 5 years. Capital market valuation and stability in the profits are the major driving factors for encouraging the consolidation in the industry. On account of regulatory measures undertaken by the government, the sugar sector has witnessed high degree of volatility in the profits as sugarcane prices (which constitute almost 70% cost of sugar production) are not linked to sugar prices. It has resulted in restricted interest from different entrepreneurs and foreign players in terms of Foreign Direct Investment (FDI) and exploring consolidation opportunities. However, India is the largest consumer of the sugar in the world and is self sufficient in meeting the domestic demand, the sugar industry is undoubtedly an enticing sector for the foreign players. An example is the Brazilian sugar economy post decontrol, where consolidation took place. A similar play will be seen in India if there is full decontrol leading to capacity consolidation and is the need with 650 sugar factories (cooperative and private), mostly in the cooperative sector and sick in nature. The recent removal of the levy sugar obligation and the abolition of the quarterly release mechanism will likely provide immediate relief to the Indian sugar sector. The levy sugar obligation (which required companies to sell 10% of their production to the government for supply to the Public Distribution System (PDS) at a discount of approximately 40%) has ended, freeing Indian sugar mills from the social responsibility. 47 Indian Sugar Industry

54 Most of the sugar mills in the industry will have to look upon other options, apart from producing sugar, to make their business sustainable for long term. Producing sugar alone will not help much due to market dynamics and volatility in the international sugar prices. Consolidation is the need of the hour. Mills will have to focus on other options such as cogeneration plant, ethanol production and value addition in other byproducts for making the venture financially viable. These regulatory changes will invite considerable interest among existing large players to further consolidate their position in the Indian Sugar Industry. Some instances of strategic moves towards consolidation in the Indian Sugar Industry are as follows: 2013: Shree Renuka Sugars is planning to divest its stake in its Brazil Unit - Renuka Brazil Holdings, which houses the two large acquisitions, Equipav SA and Vale Do Ivai SA. The Brazilian operations include four sugar mills and a 300 MW co-generation power plant. Renuka acquired sugar and ethanol producer Vale Do Ivai SA Acucar e Alcool (Renuka Vale do Ivai S/A) for USD 82 million in November 2009 and also bought a majority stake in Equipav SA Acucar e Alcool (now renamed as Renuka Do Brasil S/A) in June 2010 for USD 250 million. 2012: Merger of JK Sugar with Dhampur Sugar Mills Ltd (DSML). JK Sugar has sugarcane crushing capacity of over 4,000 tonnes per day. Dhampur Sugar Mills has capacity to crush 39,500 tonnes of cane per day. 2012: Balrampur Chini Mills (BCM) merged with Khalilabad Sugar Mills (KSMPL) following approval from the Board for Industrial and Financial Reconstruction (BIFR). KSMPL was a sick industrial company having a sugar factory at Khalilabad, Uttar Pradesh with a crushing capacity of 2500 TCD and situated near to BCM Babhnan Sugar Unit. 2012: Chennai based sugar producer, EID Parry signed a deal in 2008 with Cargill India, a major player in the commodities and FMCG sector to set up a processing plant at Kakinada, Andhra Pradesh which they bought out in December, : Olam International Ltd. acquired all the shares of Hemarus Industries Ltd., a company that owns a sugar mill and power plant, for USD 73.8 million. Hemarus owns a sugar milling facility that can crush up to 3,500 metric tonnes of sugar cane per day and a 20 megawatt co-generation plant in Maharashtra. In August 2013, International Finance Corporation (IFC) has signed a five-year loan agreement worth USD 120 million to finance the upgradation and expansion of this factory besides other processing facilities of Olam. 48 Indian Sugar Industry

55 2010: Bajaj Hindustan Ltd. (BHL) merged Bajaj Hindustan Sugar and Industries Ltd. (BHSIL). The new entity has sugarcane crushing capacity of 1,36,000 TCD, Distillery capacity of 800 KL per day and surplus bagasse based co-generation thermal power capacity of 105 MW 2008: Olam International acquired the sugar milling complex from Giridharilal Sugar and Allied Industries in Barwani, M.P for a total consideration of about USD 9.9 million. This has been renamed as 'Barwani Sugars' 49 Indian Sugar Industry

56 7. Key Players' Profile INR MM/ Company Shree Renuka Sugar EID Parry Bajaj Hindustan Balrampur Chini Sakthi Sugars Triveni Engineering Dhampur Sugar Mill Dalmia Sugars Upper Ganges Dwarikesh Sugar Financial Year Exhibit 29: Financial Performance of Selective Companies Revenue EBITDA EBITDA Margin Net Profit Net Profit Margin Long Term Debt Short Term Debt Total Debt 2012 NR NR NR NR NR NR NR NR ,576 15, % (3,740) -3.60% 51,208 14,261 65, ,867 11, % 3, % 13,964 29,814 43, ,829 10, % 2, % 20,159 29,550 49, ,513 5, % (3,201) -7.20% 15,007 60,913 75, NR NR NR NR NR NR NR NR ,361 2, % % 4,977 12,212 17, ,171 4, % 1, % 2,295 12,602 14, ,287 2, % (541) -2.50% 10,562 3,855 14, ,970 2, % (914) -4.00% 10,046 3,685 13, ,923 2, % (523) -2.80% 4,329 4,235 8, NR NR NR NR NR NR NR NR ,363 2, % % 4,262 4,541 8, ,769 2, % % 3,425 7,955 11, , % % 3,639 3,264 6, ,139 1, % % 3,430 4,121 7, , % (214) -3.00% 1,591 3,040 4, NR NR NR NR NR NR NR NR , % (113) -1.60% 2,436 1,933 4, NR NR NR NR NR NR NR NR Source: Company Filing and YES BANK analysis NR-No Results / Reporting Period Change 50 Indian Sugar Industry

57 8. Financing Perspective in Sugar Value Chain Sugar industry is of utmost important to the country. It is a source of livelihood for a significant population of the country, especially the farming community. It contributes significantly to agricultural GDP and wage employment in agriculture which is eventually alleviating rural poverty. Small and medium farmers, many of whom are organized through cooperatives and producer organizations, contribute significantly to sugarcane production in the country. Financing these co-operatives and other farmer associations in the sugar sector is a potentially a useful model for looking at the financing options at different levels. Financing Across Sugar Value Chain Products Term Loan Working Capital Sugar Cooperatives Private Sugar Mills Sugarcane Growers Purposes Term Loan For Expansion of Existing Plant Acquisition of assets of the existing sugar mill Setting up a new sugar mill Sugarcane Collection Centers Value Chain, Storage and Marketing Infrastructure Retail Outlets for sale of sugar and by products setting up plants for by products (ethanol, molasses, bagasse) Working Capital For Loans to Sugar cooperatives and private mills for disposing the produce of the member Commodity Storage 51 Indian Sugar Industry

58 The success of the sugar cane value chain financing model can be streamed well from coordination between lending agencies (financial institutions), farmer associations (cooperatives and producer organizations) and commercial markets (sugar mills). The industry has the potential for leveraging the opportunities through access to lending for different stakeholders in the sugar value chain viz. factories, sugarcane growers etc. Exhibit 30: Value Chain Financing Government / Govt Entily Private Players/ Financial Institutions Joint Initiatives Enabling Framework by RBI Knowledge Banks Short Term Projects Bankable Projects Medium Term Projects Agri/Food Park Terminal Market Contract Farming Sugarcane Farming Microfinance/ SHGs/NGO Source: YES BANK analysis The structure of the Indian agriculture is dominated by smallholders less than two hectares of land. The dominance of small farmers leads to major production of low value crops that leads to low level of income earned by farmers. These small farmers have traditional cultivation, management and seasonal production practice and are independent producers, who sell their produce individually, have little bargaining power with input suppliers, and produce market. To increase the income level, farmers are moving towards commercial crops. Sugarcane, an yearly crop, is normally planted in either March/April or September/October. The farmers harvest the cane, and supply the harvested cane to the sugar factory for crushing and manufacture of sugar. Farmers require funds for land preparation, input requirements and crop management on timely basis. Sugarcane Growers Sugar Mills Sales & Distribution 52 Indian Sugar Industry

59 Most of the farmers who grow sugarcane and the sugarcane millers are in requirement of loan for their working capital requirements such as cultivation of sugarcane & other crops, purchase of agri inputs, Interculture operations, purchase of cattle, construction/maintenance of shed, operating costs etc. Structuring can be exercised by taking into account the interest of all the stakeholders in the sugar value chain. Sugarcane industry is currently practicing tie-up model kind of financing which is very popular in case of sugarcane farmers. Sugarcane factory gives planting and harvesting schedules to farmers. Generally banks/ financial institutions give lending just after germination of crop. Scale of finance varies from INR 35,000 to 50,000 per acre and this financing varies from geography to geography, cost of cultivation and also it depends on whether it is planned normal crop or ration crop. Generally ration crop gets around 10,000 lesser as no seed is required in this case. Also lending depends on duration of crop which varies from 9 months (short duration) to 12 months (long duration). Banks intimate to factories by sending a list of borrowers and the amount borrowed and factories mark a lien. This system is robust enough so that there is no slippage of payments. After crop is harvested as per harvesting schedule given by millers, crop is brought to factory gate by growers. Then, payments are made accordingly by millers which are routed through lending bank to growers. A provisional transaction structure of a financial institution dealing with the sugarcane growers and Sugar millers can be as follows: The sugar company recommends the farmers as per the qualifying parameters of a Financial Institution, willing to lend, in the prescribed format The selected and recommended farmers will execute the simple loan documentation as suggested by the Financial Institution The company will help in the execution of the documents and submit the same to Financial Institution As per the assessment criteria and recommended amount, the loan will be transferred into the savings account of farmer with Financial Institution/Bank as mentioned in the loan documentation through NEFT/RTGS/DD/Pay Order. Once the famers supply the cane to the company, company would pay to the farmers as per their policy and arrangement. The farmer would authorize Financial Institution to debit their savings account on due date to recover the principal, interest and any other charges. 53 Indian Sugar Industry

60 9. Way Forward The sugar industry has been de-licensed in the past and some deregulation measures are being taken from time to time to allow the industry to function well, keeping interests of sugarcane growers and end consumers in mind. The regulations by the government across the value chain include activities like reservation of area for sugarcane production, a minimum distance criterion for setting up of new mills, methodology for determination of cane price via Fair & Remunerative Pricing (FRP), release mechanism for non- levy sugar, trade policy regulating export movement and import duties, regulations related to by-products (molasses for ethanol and bagasse for power generation) and packaging of sugar under Jute Packaging Material act. Rangarajan Committee The Government of India constituted a committee (headed by Shri C. Rangarajan, Chairman, EACPM) to comprehensively look into all the issues related to regulation of the sugar sector, and suggest ways and means to change those regulations in a manner that better promotes efficiency and investments, and sets this sector on a higher growth trajectory, increasing employment in rural areas and enhancing incomes of all those involved in this sector. Sugar industry is one of the few industries that have contributed to the development of the rural economy through utilization of a rural resource. However, the industry has not been able to achieve the growth trajectory that it could have on account of various regulations that span the value chain, ranging from sugarcane production to actual distribution of sugar in the domestic market and its export. Against this background, the committee worked on formulating the issues and arriving at policy prescriptions to address the same. Some of the major recommendations and their implications on the stakeholders are depicted in the following exhibit. 54 Indian Sugar Industry

61 Exhibit 31: Recommendations of the Rangarajan Committee Report on Sugar Decontrol Issues in the report Recommendations Comments Likelihood of Implementation Price of Sugarcane Abolish SAP & allow revenue sharing with farmers (70% realization of sugar & by products) Stable EBIDTA margins for sugar mill owners Not expected to implement in near future. Opposition from farmers will be major issue Regulated release of Non- Levy Sugar Removal of control on Non- Levy Sugar Removal of control on Non- Levy Sugar Demand & Supply dynamics will automatically take control of the market situation. Can be implemented Minimum Distance Criterion Remove mandatory distance of 15 kms (25 kms in some states) between two mills Will improve efficiency by increasing competition among millers Unlikely to be implemented in near future Cane Reservation Area Both farmers and millers can transact (Sell & Buy) from anyone they want. Encourage mills to enter into the contract with farmers according to their crushing capacities before planting the cane. Unlikely to be implemented Trade Policy for Sugar Liberalize trade in sugar Incentivize investments in supply coupled with price deregulation Not expected to be implemented in near future. By Products Regulations Regulation on Molasses Quantitative restrictions by state government should be removed for sale of molasses by mills. Market should determine price of molasses competitively Will help to correct distortions in the market. May be implemented in near future. Regulations of Bagasse All regulatory hurdles that prevent sugar mills for selling their surplus power to any consumer should be removed Prices for movement of by products should be market driven Not expected to be implemented in near future Source: CRISIL Research & YES BANK Analysis 55 Indian Sugar Industry

62 Further interventions in the sugar industry by government must focus on elimination of cyclicality in production, reduction in price volatility and providing an impetus for growth in production of raw material and sugar & by products. Further, the deregulation must focus on protecting interests of both farmers and the end consumers. Some of the ongoing regulations might have outlived their utility and are now responsible for amplifying the cyclicality and price volatility in sugarcane and sugar production. Rationalization of Sugarcane Price There is a need to rationalize the pricing of sugarcane in order to make it a win-win situation for all the stakeholders (sugarcane farmers and mills). Rationalization of prices would be done by sharing of the revenues/value created in the sugarcane value chain between the farmers and the millers in a fair and equitable manner. It would be shared in the ratio of their relative costs. As per the recommendations of Rangrajan Committee, the costs incurred by sugarcane farmers and those incurred by sugar mills suggests that this ratio between farmers and millers, taking a recovery rate of 10.31%, works to be 70:30. Recommendations also suggest that this valuesharing ratio should not only be applied for the revenue generated from sugar but also to that generated from saleable primary by-products produced in the process of sugar production. Therefore, the committee has suggested that 70% of the value of sugar and each of its three major by-products, namely bagasse, molasses and press mud (all ex-mill), be fixed as the cane dues payable to the farmer for the sugarcane supplied. However in all the circumstances, farmers will be paid the Fair and Remunerative Price (FRP) as the minimum and this will be paid up-front. In purview of the above, Karnataka has already passed an act for following the revenue sharing model for sugar mills and formed a Sugarcane Control Board. Maharashtra is also gearing up and will incorporate the recommendations of the Rangarajan Committee report on deregulation of sugar sector by forming an act in the near future. Under the Act, a board would be formed, which will have a mandate to set cane prices and will have supervisory powers over the cooperative sugar mills. The other states are yet to follow the steps as most of them are still in the process of working out percentages for revenue sharing. If implemented by all the states, the linkage formula will be helpful in Controlling cyclicality in sugarcane production Timely payments to the sugarcane farmers from millers Efficiency in sugar production The Commission for Agriculture Costs & Prices (CACP) has made a detailed calculation on farmers' share on total sugar value. On an average, cane farmers would get a better deal in terms of pricing of cane in comparison to the current system. This system will also be more transparent and fair to both farmers and mills. After detailed analysis, in general, sugarcane price accounts for 70% of the ex mill sugar price. Thus, value sharing ratio between farmers and millers work out as 70:30. To calculate this farmers' share in sugar value, capital costs inclusive 56 Indian Sugar Industry

63 of depreciation, interest on debt and 12% post tax return on total capital employed is also included apart from cost of sugarcane and other operating costs. Thus, by adopting proposed cane pricing in the country, farmers would have stability in payment of cane dues at about 70-75% of the value of sugar each year. 9.1 Entry of Organized International Players in Sugar Sector The Government's steps to decontrol the sugar industry have shown a positive outlook in the industry. The sugar sector is gearing up for a surge in the investment activities from major international players as it is one of the biggest markets for sweetener. Some of the international players have already made their entry in the INR 80,000 crores market that is expected to double in next five years. Organized players are seeking their presence in the top sugarcane producer states of India i.e. Uttar Pradesh and Maharashtra. The Government's decision to allow mills to sell their entire sugar production in the open market without restriction is foreseen as a special acknowledgement to the industry which has been under government regulation for so long. There are ample opportunities lying ahead for operating and flourishing in this industry. A large number of small and medium level sugar mills which are operating inefficiently and are making losses could be the food for thought for international players as their merger and acquisition targets. Although, decontrol has paved a way forward for the organized players but at the same time political environment in the region is also one of the important considerations, as the cost of sugarcane is decided by the central government and further through the interventions of the state. Apart from that, regional governments may also undertake certain regulatory measures which may prove adverse to the smooth flow of operations at sugar mills. In 2009, Singapore based Olam International acquired its first sugar mill Girdharilal Sugar & Allied Industries Ltd at Barwani district Madhya Pradesh followed by Hemarus Industries Ltd in Maharashtra (Kolhapur) in Its current production capacity is 800 tonnes sugar per day. Opportunities are still waiting for transformation of the sugar industry from a loss making and non-enticing to a lucrative one. Some of the interventions in transforming sugar industry are as follows. One of the leading specialty sugar producers, Simbhaoli Sugars is working with Londonbased commodity giant ED & F Man to set up a green field sugar refinery at Kandla port in Gujarat Karnataka based Ugar Sugar Works has a technical tie-up with a German company named Fragies Verwaltung GMBH All across the globe, major commodity trading have sugar refining plants in sugar producing countries like Brazil. As these traders are highly active in India for some or the other business, they may always look forward for opportunities in investing in sugar sector in India 57 Indian Sugar Industry

64 During initial phases, foreign investors may prefer investing in stocks of domestic sugar mills listed on the exchange and may subsequently look for the opportunities in setting up mills in India 9.2 Sugar Stocks: From Industry to Trade Considering the low sugar production forecast, India is likely to be the net importer of the sugar in the upcoming sugar season. Exports are forecast at half a million this year contrary to imports forecast which is at 1.5 MMT. As the low international prices prevailed in the international market, India imported around 890 tonnes of raw sugar during first quarter of FY 13 while exports were limited to 340 tonnes during the same period. Looking at the existing trend, commercial exports forecast are likely to be on the lower side, except for sugar reexported under the Advance License Scheme (ALS). Sugar industry is yet to see its maturity level as most of the stock is handled by the industry directly compared to other industries such as oilseeds. The level of regulations and business model of sugar mills operating in the country do not allow direct or indirect influence of external factors affecting trade. In near future also, the sugar stocks control will be driven by the industry only depending upon the demand-supply scenario of the essential commodity. Although, trade channels exist in sugar industry but it is much unorganized. Integrated trade partners in the sugar industry are yet to evolve. Once industry is completely decontrolled by government and all existing regulations are parted then only one can envisage majority of bulk trading moving out of hands of millers to trading partners in organized way. Also entrepreneurs/ national players should come forward towards branding of sugar and orient modern retail partners in the same direction. Entry of foreign players, completely decontrolled environment etc. can thus shift the paradigm with respect to encouraging trade and transforming into a competitive environment. Liberalizing the trade in sugar will entice investments in supply and will eventually reduce the inflationary pressures. This will also reduce the need for short term policy interventions in form of export bans, duty-free imports, etc. for effectively dealing with inflation. 9.3 Roadmap: Business opportunities 5 years down the line The main aim of this roadmap is the transformation of sugar industry to unlock its covert potential by realizing the key opportunities in the sector in coming few years timeframe. Leveraging the opportunities is critical for achieving this vision and also largely untapped sugar sector. a) Cyclicality Management The sugar industry is highly impacted by both natural (environmental changes, pest attack etc.) as well as induced cyclicality. High sugar and sugarcane prices lead to increase in production at the opportunity cost of other crops. The increased production leads to low price for sugar which eventually impact the ability of mills to pay farmers regularly, resulting in arrears. Untimely payment and increasing arrears, in turn, results in decrease in 58 Indian Sugar Industry

65 production of cane during next year. The cycle again leads to high sugar prices and attractiveness of cane. This is induced cyclicality in the industry and thus cyclicality management is the opportunity to minimize arrears to remove any need for financial support from government. In future, this cyclicality can be managed once cane prices and sugar prices are aligned. This will also result in reduction in arrears. b) Domestic Demand There will be a tremendous opportunity from demand side of sugar due to increasing population and past trends of favourable GDP. Also, due to high import tariffs, the country would need to target higher level of production to meet the domestic demand. This can be achieved only by improvement in productivity and increment in milling capacities of sugar mills. Water management will also be a key focal point as sugarcane crop is water intensive. Domestic demand for sugar will increase with passage of time in the absence of alternate sweeteners. It is projected that in next 5 years, around 5 million MT of additional sugar will be required for consumption. It will require investment of another INR 6,000 crores to meet this demand. This will be a key driver for envisaging food security based on Food Security Bill passed recently. In the purview of investments in Research and Development is done and other measures, we can see around 4 million MTs of additional sugar in coming years. c) By- Products Management Ethanol produced from molasses (used in blending with fuel) and power generation from bagasse provides the key by-products related opportunities. In future, demand for power/ energy and fuel will be increasing across the globe. Thus developing power cogeneration unit and fuel ethanol programme with high levels of blending creates more opportunity in the sector in coming future. After relaxing regulatory norms in the industry, it is expected that around 9,700 MW of cogen power can be exported to other countries. Also, there will be additional 3,000 million litres of ethanol production which can be blended with petrol for fuel generation and can be used in chemical industry for different purposes. This will lead to energy security through green sources. d) Export Potential Moving forward, the rise in production of Indian sugar will subsequently increase the export potential of the country. We will be importing more raw sugar from the outside world in case of deficits. Acceptability as a credible exporter will provide ample opportunities to divert the surplus production. Thus, India would need to build the capability to produce both raw & refined sugar of international quality standards in order to leverage the export potential. 59 Indian Sugar Industry

66 e) Development of other value added products Apart from power generation, sugarcane bagasse can also be used to generate Bio-plastic which is bio degradable and completely environment friendly. Also During sugar processing, much water is extracted from sugarcane which us wasted and goes along with liquid effluents. The potential for generating bio-water from sugarcane water will obviously require additional investment in setting up of bio-water facility in sugar mills. It may take a leap in the near future. f) Farm mechanization & Establishment of Farm equipment manufacturing industry Cultivation of sugarcane crop requires sufficient amount of farm machinery equipments. This farm mechanization requires significant amount of improvement in near future to increase the productivity of crop to an optimum level. Both private and public players should come forward to enable the industry for development of high technology farm equipments. Farm equipment manufacturing industry needs a revamp to support production of improved farm machinery units which will, in turn, help in increasing productivity. Snapshot of the opportunities in future: Increment in Production & Productivity Around 4 million MTs of sugar in next 5 years Investment in R&D, infrastructure etc Increase of sugarcane area to 4,65,000 hectares Increase in farm productivity to 75 tonnes per hectare Domestic Demand 5 million MT of additional consumption in next 5 years INR 6,000 crores investment for meeting domestic demand Management of By-Products 9,700 MW of exportable power 3,000 million litres of ethanol Export/ Import Importing raw sugar to manage deficits in Demand - Supply Removal of Import Tariff Issues in Cyclicality Alignment of cane and sugar prices according to international standards Inventory cost savings Lower arrears to farmers 60 Indian Sugar Industry

67 9.3.1 Holistic and Integrated approach Moving ahead, in coming years, all the relevant stakeholders in the value chain of sugarcane, from processing to end consumers of sugar and it's by products must have a common vision. The government must formulate policies which positively influence all the stakeholders apart from meeting consumers demand. Although, voices of complete decontrol of sugar industry are in the air, but the government is and will remain the governing body directly or indirectly for protecting the interest of all the stakeholders. The farmers & millers must work together towards benefit of each other with fair & transparent collaboration for a win-win situation for both the parties. Consumers Farmers & Millers Policy Makers There is a dire need for transformations across the value chain in the sugar industry. All of them must go hand in hand to eliminate the deficiencies in the existing system and shall up-grade themselves with time for a better future of the industry benefitting all stakeholders. A win- win situation for all can be stressed by adopting certain international practices. In that respect, policy makers and government must adopt the policies which can work towards making the country self sufficient in meeting domestic demand, contributing towards country's enhanced energy needs. This would also help in realization of higher economic benefits for all the stakeholders. At the end of the day, these all steps should focus on fulfilling customer needs at affordable price, giving higher economic returns to farmers & millers and benefit entire industry in a holistic manner. 61 Indian Sugar Industry

68 Bibliography 1. Indian Sugar Year Book, , Indian Sugar Mills Association (ISMA) 2. Food and Agriculture Organization (FAO) 3. INDIASTATS 4. U.S. Department of Agriculture 5. Vasantdada Sugar Institute, Pune 6. CRISIL Research Reports 7. Inputs from Indian Sugar Mills Association (ISMA) 8. Brazilian Sugar Industry, Patrick H. Chatenay 9. Report of the Committee on the Regulation of Sugar Sector in India: The Way Forward, Rangarajan Committee 58 Indian Sugar Industry

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