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Sugar: What's so sweet? - Views on News from Equitymaster
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  • Aug 20, 2004

    Sugar: What's so sweet?

    The best performers during the 1QFY05 were not tech, banking or auto stocks sectors, but textile, steel and sugar. Backed by strong demand led hike in prices, the silver metal stocks enjoyed robust profits during the quarter, while textile stocks witnessed a jump in prices on account of the nearing of the WTO quota deadline. While the two sectors have an international event to back up high growth, what led to a rise in sugar stocks? Let us have a look at the sector:

    Indian sugar is the second-largest agro-processing industry in the country. The country has the distinction of leading the ranks of global producers in 7 out of the last 10 years. Sugarcane is generally more profitable relative to other crops. However, only 4% of the cultivable area is under sugarcane production, thereby providing immense scope for expansion. The sugar industry has been, to a large extent de-controlled in FY98. But the industry is still bearing the after effects of the same, as regulations ranging from procurement of raw material to the end-level distribution are still in the hands of the government.

    After effects of the license raj
    Initially, the government permitted units with a capacity of 1,250 TCD (tonnes crushed per day), which was later increased to a minimum economic size of 2,500 TCDs. Any further capacity expansions were allowed upto 5,000 TCD. However, these limits were withdrawn in 1990. As a result, the Indian sugar industry witnessed horizontal growth, as against the backdrop of consolidation and larger capacities in the global arena.

    Country Units Avg. crushing/day
    Avg. prod/day
    Thailand 45 10,307 140,540
    Australia 28 9,216 183,321
    Brazil 213 9,168 64,018
    South Africa 13 6,877 137,769
    Mexico 67 4,749 71,015
    Colombia 10 4,590 214,900
    Cuba 156 4,229 45,538
    India 507 2,527 35,000

    Source: High Power Committee

    Procurement of raw material (Sugarcane)
    The central government announces an annual statutory minimum price (SMP) for the sugarcane being procured by the sugar mills. This SMP is taken as a benchmark, on the basis of which, the state level governments declare the state advised prices (SAP). In some states, the difference between the SMP and SAP is to the tune of nearly 20% to 25%. It should be noted, that off late, the SAP is used as a tool to woo the farmer vote bank, many a times, rendering the sugar industry's performance uneconomical. As a result, high sugarcane prices on the back of low realizations have led to the sugar mills defaulting in payment to farmers. Due to such defaults, farmers usually shift to other crops resulting in scarcity of sugarcane, driving prices higher and the vicious cycle continues. The following table gives a perspective of the role played by SAP in terms of the actual prices paid by the mills vis-a-vis the SMP announced by the government.

    Years SMP (Rs/Qtl) APP (Rs/Qtl)
    1991-92 26 45
    1995-96 43 71
    1998-99 53 80
    2001-02 60 90
    2002-03 70 NA
    2003-04 73 NA

    * APP -Actual price paid
    Source: www.indiansugar.com

    Sugar Development Fund (SDF)
    The government enacted the SDF Rules, which provide for a levy of Rs 14 per quintal of sugar known as the Sugar Development Fund. This amount is used for granting term loans to sugar mills for modernization and expansion projects, besides help create buffer stocks so as to ensure price stability.

    On the consumer side
    The government has allowed the sugar mills to sell 90% of their produce in the free market, while 10% (levy sugar) is purchased by the government at pre-determined prices (currently, nearly 20% discount to cost) for distribution through the PDS (public distribution scheme). Therefore, the sugar mills make profits only on the 90% of their produce. High procurement prices have often resulted in defaults on the part of the mills towards payment to farmers, which have resulted in shortage of the crop. This has led to a price rise and as such, India's sugar industry has witnessed extreme swings with surplus in a year often followed by imports. As a result, the production pattern in India is volatile as compared to a steady rise in consumption of sugar.

    Current Scenario
    At present, the government is planning to come up with a special package for the sugar industry. This move is likely to help consolidation and also help ailing companies revamp businesses. Also, the recent MERC decision to allow direct sale of electricity without the mediation of the state electricity board is a positive move, as the sugar mills can now utilize their excess co-generation capacity for power supply to the hitherto power deficient nation. Further, the move to mix ethanol (a by-product of the sugar industry) in petrol is also likely to help the companies fair better. No wonder, with such positives in the anvil the sector is in the limelight.



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