Sugar: A sweetened package?

Anup Menon

THE FORTUNES of the sugar industry appear to have turned sweeter especially in the last few months. A higher tariff level on import and a reduction in the levy quota imposed on domestic producers has made the policy environment distinctly favourable to domestic producers.

Complementing this turn of events, is a recent recovery in international sugar prices, spurred by an expected decline in world sugar output which could take the pressure off domestic producers on the price front. So, are these changes likely to perk up the now lukewarm stock market sentiment towards sugar stocks?

Maybe not. In fact, the gains in some of the stocks recorded at the beginning of this year, just after the policy announcements, have not held in to the middle of the year. The reason can attributed to various factors. For one, though the threat from imports is no longer as serious as it was a year ago, domestic prices could still be impacted by the comfortable supply situation arising from a record sugar output for the 1999-2000 sugar season.

Secondly, given that the majority of the listed companies in the business are still struggling in the aftermath of depressed prices and high carry-forward stocks, it may be some time yet before their financials present a picture of health.

Though most of the recent policy changes have been favourable for the companies, their ability to translate these into profits has not been very evident. This is apparent from the performance of the one of the major listed players in the industry -- Dhampur Sugars. The company declared losses for the first quarter of fiscal 2000-01. In fact, in the first quarter of 2000-01, while some companies such as Balrampur Chini Mills and Thiru Arooran Sugars performed well, the performances of other majors such as Dhampur Sugars and Sakthi Sugars have not been very impressive.

This could be one reason why the stock of Thiru Arooran Sugars and Dhampur Sugars, amongst the biggest players in the industry, have lost around 11 per cent and 5.80 per cent over the last year. The stock of Balrampur Chini Mills, appears to be the rare exception. The stock gained around 30 per cent in value last year.

Consumption and production trends

The demand for sugar is likely to increase in the near term, with the festival seasons imminent. The long-term outlook too is good as sugar forms an important ingredient in various foodstuff, especially bread, and the demand is unlikely to slacken so long as the population, and by corollary food requirement, keeps growing. In the immediate context, however, demand lags production. This may be a primary cause for concern for the industry.

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The installed capacity has been growing steadily over the years. But a cause for concern would be the average production per unit. Also worrying is the trends in consumption, though the per capita figure has gone up from 11.1 kg in 1985-86 to 15.5 kg now. For 1999-2000, the production is expected to be around 170 lakh tonnes. This may exceed the demand by around 15 lakh tonnes compared to 5.4 lakh tonnes the previous year. As India has no long-term export policy, it faces the pressure of excess stocks when there is excess production. But, then, since it is a cyclical industry, and India has often been an importer of the commodity, export commitments are perhaps best not made.

The consumption of gur and khandsari, sugar substitutes manufactured largely by the unorganised sector, has been declining over the last few years. For instance, the per capita consumption of gur and khandsari has declined from 11 kg in 1985-86 to around 10 kg. But that of sugar has risen.

Implications of sugar cycle

The question whether the current level of sugar production will sustain over the next couple of years depends on various factors. The increased production and stock this fiscal means prices may come under pressure. This could delay payments to cane farmers and may lead to their shifting from cane to other crops the next year. Farmers may think twice before they doing this, as sugarcane is more profitable compared to the other crops, but if they do so, the cane output for the next fiscal will be lower, affecting sugar production.

Import of sugar

From March 1994, sugar can be imported on Open General Licence (OGL). Apart from a bound duty rate of 60 per cent, importers also have to pay Rs 850 per tonne as countervailing duty. In the latest Budget, the Finance Minister stated that there was room to increase the bound rate to a maximum of 150 per cent.

Given that the price of sugar has risen from around $170 a tonne to around $270 a tonne, the cost per kilogram of sugar after adding duties would work out to around Rs 20. This is higher than the domestic price of around Rs 15 (S-30 variety, July prices in the Mumbai market).

Controlled environment

India is the second largest producer of sugar. Like many other agro-based commodities, distribution of sugar is controlled by the Essential Commodities Act, 1956. In 1997, sugar mills were exempted from the licensing obligation. But the fixation of prices both for cane, and sugar, its export/import and levy quota are all controlled.

However, the industry is slowly being moved out of the control arena, though the performance of the players still depends considerably on the Central policy. This means that, unlike in other controlled industries, companies cannot hide their inefficiencies behind policy issues.

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Key policy considerations

The key policy considerations are likely to be predicated on the recommendations of the Mahajan Committee. One major reform suggested by the Committee is the reduction of the levy quota for domestic producers. The Committee had suggested a 20 per cent levy for 1998-99. However, in December 1999, the Government decided to reduce the levy quota from 40 per cent to 30 per cent. A further reduction may be in the offing.

Another major recommendation of the Committee is delinking cane prices from sugar prices. This calls for a more objective pricing based on the cost of producing cane. The government is considering setting up an independent authority to be responsible for fixing cane prices and gradually do away with the statutory minimum price. This will also help remove the disparity of cane prices among States.

This move is likely to have a long-term impact on the performance of companies. For instance, cane accounts for around 60 per cent of the raw material cost. Hence, a more objective and definitive pricing mechanism would reduce the uncertainty on cane prices and at the same time help lower the overall cost of production. The Mahajan Committee had suggested the removal of sugar from the PDS and its de-licensing.

The outlook for the industry in the near term looks stable. But there may not be any significant improvement in profits. The crucial factor would be the price trends. The global shortage may have helped firm up sugar prices but the key is in the sustenance of these price levels over the near term.

A complete decontrol of the sugar industry may also not be favourable in a short term. The basic problem with sugar mills is that they are usually located near cane growing areas. This geographical segmentation leads to concentration of plants in certain areas. Thus Tamil Nadu, Karnataka, Andhra Pradesh, Maharashtra and Uttar Pradesh constitute the core production areas of sugar. The North-East are deficit States.

Mills in the North, such as Balrampur Chini and Dhampur Sugars, have an advantage as they have access to the deficit eastern regions. But firms in the South face a lot of internal competition. To add to the pressure in the event of decontrol, freight costs are likely to go up. This may bring further pressure margins.

The industry's operations will also need to change, if the mills are to remain competitive, post-decontrol. For instance, there are a number of marginal units with low capacities and recovery rates. These units may become unviable in a decontrolled environment. Post-decontrol, high recovery rates and large capacities may become mandatory for survival. Hence, the industry may go through a consolidation with some major players trying to improve marketshare by increasing capacities.

The other important aspect for the improvement of the industry would be raising the operational efficiencies of the players. Sugar entails a high cost of production. The companies can do little about this. Then they face the problem of working capital. Sugar is working capital intensive. The basic problem is that sugar production is for around five months whereas the distribution takes over the year. This seven-month time lag results in high inventory costs. Corporates that manage their working capital better are likely to be more profitable than those that do not do so.