The Rangarajan committee’s recommendations on deregulating the sugar sector will replace the current rules with a more benign set of regulations. Investors need to determine how beneficial these proposed changes are. Any deregulation that improves profitability should benefit valuations, but the sting lies in the implementation.
Just as the goods and services tax has been held by the opposition of state governments, the risk is present here, too. Let’s look at the key proposals, their probability of going through and the impact on the industry.
Among the short-term benefits derived from doable proposals, ending the levy sugar mechanism is one. At present, 10% of sugar production is set aside for the government and sold at a fixed rate. That rate is Rs.19 a kg, while market ranges are around Rs.30 a kg. The government also tells companies how much sugar to sell every month, and how much to export, ostensibly to prevent hoarding by traders and iron out seasonal kinks in demand and supply.
If companies earn market rates on their entire output, both revenues and profits will benefit. At current rates, both sales and pre-tax profits can increase by about 4% on the removal of levy. But that is not as significant as the other proposals.
In the longer term, the committee has recommended ending the state advised price (SAP) mechanism. Some large sugar-producing states fix the SAP higher than the centrally-fixed minimum price (the so-called fair and remunerative price). Instead, sugar mills will have to share 70% of revenues from sugar and from the sale of by-products with the farmers. The proportion appears fair to both farmers and mills.
Sharing will be done based on mill-wise prices declared by state governments. The role of state governments continues as they will announce benchmark product-, mill-wise prices. A market-determined transparent mechanism may have been better. But the bigger issue is political, and whether producer states such as Uttar Pradesh will agree to relinquish their right to fix SAP. If this recommendation is watered down to make it politically acceptable, it can significantly reduce the benefits to mills.
Deregulation can be a double-edged sword, as is visible, when it comes to aspects concerning cultivation of cane and trade in sugar. The committee has said that companies should be free to set up factories anywhere and not be bound by distance restrictions between two factories. And, farmers should be free to sell their cane to any factory and not be attached to any particular mill.
Both recommendations should benefit farmers but it can mean higher competition for cane. The entry of new mills and firms in cane-rich areas is a threat to existing mills. The committee also recommends free export and imports with a marginal tariff. Imports can be a threat if the landed price of white sugar imports becomes cheaper than domestic prices. It is also an opportunity for standalone sugar refineries, which can import raw sugar at coastal areas, refine it and sell it in the market.
The really long run is when the committee’s recommendations may change the face of the sugar industry. Trading in sugar will become a big business opportunity as mills will be free to sell their output any time during the year.
Elimination of levy will benefit all mills. But the remaining recommendations are likely to see the large players benefit more. They can edge out smaller players by setting up mills in new locations, eat into their cane area, and economies of scale will see them earn more profits (relative to smaller companies), even after sharing 70% of revenues with farmers. This may see lead to consolidation in the sugar industry, and large mills may buy out smaller mills. This may even see the entry of new players, including foreign investors, in the Indian sugar market.
Of course, this will all be mere daydreaming if state governments turn their back on these recommendations. That’s a big risk for investors, who have already revised their outlook on the sector, seeing how shares rose after the committee’s recommendations were announced.