Higher sugar prices make cane price increase palatable
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Sugar mills in Uttar Pradesh will have to pay 8.9% more to sugar cane farmers in the current season, after the state hiked the state advised price (SAP). The move was not a surprise, with elections round the corner as also because of a sustained increase in sugar prices. The increase does mean that profit margins will be lower but if prices increase further or mills get any state-funded concessions, then the impact may be less. One thing mills will find difficult to implement is the state’s decision to ask mills to pay farmers in one shot rather than in instalments, as was the practice.
After its September quarter results, Balrampur Chini Mills Ltd said average sugar realization during the quarter was 36.1/kg, up by 48.6% over a year ago. Its inventory at the end of the quarter was valued at Rs27.5/kg. That gives it headroom to absorb higher costs. Rating agency Icra Ltd has estimated the industry’s sugar production costs are likely to increase by Rs2.5 a kg. Healthy recovery rates are expected to see mills extract more sugar from cane, according to Icra, in the range of 10-11.5% from sub-10% levels in recent years.
Sugar prices have risen on the back of tight supply conditions globally, mainly due to the impact of weather on the crop in India and Brazil. Although the government had taken measures to rein in sugar prices, they have not had much impact, with wholesale sugar prices gaining 17% in 2016 so far.
Industry estimates suggest that the current year’s crop will be lower than last year’s, which should support higher prices. More clarity will emerge as the year progresses and data regarding the international sugar supply situation becomes available. Mills are happy with the current prices, reflecting in an early start to crushing in UP, with 55 mills working as of 15 November, compared to six mills a year ago. The enthusiasm to crush cane is also a risk to keep a watch on, to see if output exceeds expectations.
In the near term, the goods and services tax is a risk, depending on which tax bracket sugar is placed in. The Indian Sugar Mills Association has recommended it be placed in the lowest 5% bracket. The taxation of sugar and its by-products is an important factor to watch for, as also any threat to rising sugar prices from higher global output. Mills are likely to lobby against the decision to pay the entire sugar cane dues upfront. If they don’t succeed, then they may have to borrow, which then results in higher interest costs.
For now, the increase in sugar prices has lifted sugar stocks all around. The increase in SAP also sends a signal for prices to remain high. Sugar division profits are looking better while the distillery and cogeneration businesses continue to provide support. While conditions look good, investors have already marked up sugar shares considerably in the past one year.