>India Sugar Outlook 2010: Supply/Demand Mismatch to Benefit Sugar Mills

Summary: Fitch Ratings expects the liquidity position of sugar mills to improve significantly in the Indian sugar season 2010 (SS10, October 2009‐September 2010), mainly due to an increase in profitability and free cash flow (FCF). Enhanced liquidity should in turn be utilised for debt reduction, thereby resulting in an overall boost to credit profiles.

This trend should continue into SS11, with the sugar cycle continuing to remain positive. Thus, on the back of comfortable credit profiles due to lower leverage and financial costs, sugar companies should be in a much better situation to handle the downward pressures in the next down‐cycle.

However, Fitch notes that any improvement in credit profiles would be limited in the short‐ to medium‐term for companies incurring significant capex which would be partly funded by debt.

Bright Prospects for SS10
High sugar prices should be sustained — a result of a significant shortage in sugar cane production and, to a lesser extent, ongoing demand growth. During SS09, the poor monsoons, coupled with a reduction in the acreage of sugar under cultivation, resulted in insufficient sugarcane relative to overall sugarcanecrushing capacity. This led to India’s widest‐ever sugar deficit, which Fitch expects to be extended, although to a more moderate extent, during SS10 — and SS11 as well. During the first three months of SS10 (Q1SS10), sugar prices — factoring in the supply/demand situation — increased by 88%, to INR32 per kg from INR17 per kg in
Q1SS09.

Although rising sugarcane acreage will mean a higher cane supply during this timeframe, the growth is unlikely to fully meet the current deficit (as of February 2010). Market estimates indicate that cane supply will increase by around 3% in SS10, from around 155mt (million tonnes) in SS09, whilst growth in demand is likely to remain stable. The resulting deficit is likely to keep sugar prices high during much of SS10 and SS11. However, prices could ease towards H2SS11, with better visibility of cane output and a declining supply deficit, although Fitch does not expect the low prices of SS08 and H1SS09 to be repeated. The global price outlook for sugar also remains strong, with other major sugar‐producing regions such as Brazil also seeing a drop in production during SS09.

Fitch expects sugar mills’ profitability to continue to be strong during SS10 and SS11, as the higher prices would more than offset the lower output due to cane shortages. While margins could be trimmed due to the higher cane procurement costs, they will still improve liquidity and cash flow for most sugar companies. Fitch does not expect the industry to witness large‐scale increases in sugar‐crushing capacity, due to the excess capacity built up over the past two to three years. The ongoing capex plans mostly include investments in refined sugar capacities (either forward integration for existing capacities, or for imported raw sugar) and captive cogeneration or bio‐fuel power plants, which (once operational) would add incremental margin.

Indian Sugar: NearTerm Deficit

Continued Supply Shortage; Cane Prices to Remain High

Sugar production has typically been affected by shortfalls in sugarcane availability — an outcome of the relative sugarcane price paid to farmers, substantial disputed sugarcane arrears payable by the mills to the farmers, and better prices from other cash crops. Adverse weather conditions are clearly also a major factor in sugar supply — with a direct impact on sugar yields and recoveries. Fitch notes that the industry has traditionally followed a pattern whereby the cycle seems to turn every two years.

During SS09, a significant 17% drop in sugarcane acreage cultivation — in addition to a drop in sugar recoveries from over 10% in earlier years to 9.5% in SS09 — resulted in a 44% drop in total sugar production.

Fitch expects sugarcane acreage to partially increase in SS10, resulting in a continued shortage in cane supply. The shortfall will lead to further competition between sugar mills to obtain a share of the cane produced, which will put pressure on the capacity utilisation of most mills — as well as a sharp rise in cane procurement costs. During SS10, sugar mills have procured sugarcane at a price per quintal of INR200‐205, as against the announced State Advised Price of INR165‐175 per quintal — a difference of over 40%. Fitch expects these rates to further increase during SS10 and SS11, and a part of this increase will be to motivate farmers to increase cane acreage.

To read the full report: SUGAR OUTLOOK