An employee displays raw sugar granules at a processing plant in Russia. (Photographer: Andrey Rudakov/Bloomberg)  

Sugar Millers Say Higher MSP Will Stabilise Margins Despite A Glut

As the sugar industry battles a supply glut, millers expect the increase in factory-gate minimum support price to stabilise margins.

“Finally, we have a constant-margin business that we have been asking for,” Narendra Murkumbi, non-executive director at Shree Renuka Sugars Ltd., told BloombergQuint in an interaction. “The government has managed to stabilise the margin despite a large surplus. As long as that can continue, and that will continue until the surplus is unbearable, I think we have the industry in a sweet spot.”

The government increased the MSP for sugar producers by Rs 2 to Rs 31 a kilogram. That may help companies sell more locally as stockpiles exceeded local demand on a twofold rise in output from a year earlier to 15.4 million metric tonnes as of Dec. 31, according to the Indian Sugar Mills Association data. Higher MSP will also help repay part of the cane growers’ arrears that stood at around Rs 20,000 crore at the end of January.

Murkumbi and Vivek Saraogi, managing director at Balrampur Chini Mills Ltd., estimate a lower sugar output for the next year.

“For India, the output would come 4 million tonnes less due to reduced planting in Maharashtra and Karnataka,” Murkumbi said. If the monsoon isn’t good, it will go even lower, according to Saraogi.

Ethanol Impact

Increase in factory-gate prices for sugar millers comes when the high-margin ethanol business has started providing a support to sugar companies. The distilleries business—that contributes 7-14 percent to the revenue of India’s three large sugar makers—accounted for 51-56 percent of their profit before interest and tax in the first nine months of the ongoing financial year, according to exchange filings.

Still, Murkumbi doesn’t see ethanol production to make a significant impact across the industry. A miller needs about Rs 5,000 crore to Rs 7,000 crore worth of capital expenditure to start new ethanol capacity. While the companies already doing it would see higher ethanol production and an increased contribution to the overall margin, the impact would be limited for the overall industry.

Watch the full interaction here:

Edited transcript of the interaction

Profit of Balrampur Chini Mills Ltd. doubled in Q3. Is this the start of a long-lasting trend? With the minimum selling price being hiked, will the downside be capped? Ethanol adds additional revenue and there are talks that sugar output could fall...

Vivek Saraogi: I do agree that the move could be a lot more sustainable. This is backed by not only the MSP (minimum selling price) but by the ethanol pricing on C-heavy and B-heavy (types of molasses). We must appreciate the central government’s initiative to announce the minimum indicative export quota of Rs 50 lakh and fund the entire loss there. Mills can hold the sugar, get the interest reimbursed, not sell excess into the market, be in quota system and send on in MSP basis. Our personal estimates at Balrampur is that the production could be 31.5 million tonnes and we still have an excess. B-heavy and MIEQ is continued for another year. We do hope next year’s production will be lower and therefore the entire move is sustainable for the industry.

How are the investors viewing it? Post 2008, the issue for any investor in the sugar industry would have been that cyclicity and volatility is high, and downsides erode any upcoming upside. With the MSP being raised to Rs 31, does it cap that issue or is it too soon to say right now?

Vivek Saraogi: Last year, it has been highest excess (production) and highest inventory (of sugar) in the history of the industry. This year, with these measures, we can see the results. So, the choice is, with the people who invest, to understand the highest level of downcycle, because of government support and practical policies of states and centre, this is where we are.

Do you think there’s more predictable earnings growth that can be translated in sugar companies? If that’s the case, then the investor will have greater confidence in predictability and structural nature of revenues.

The biggest change is, historically, we’ve volatile sugar prices and raw material prices have been constantly rising. We have been agitating to link raw material prices to finished products. Not having managed to get a market price in raw material, we manage to convince the government to have fixed price on finished products. So, finally we have constant margin business that we have been agitating for. That’s the biggest fundamental change in sugar industry in the last two years. This government has managed to stabilise the margin despite a large surplus. As long as that can continue, and that will continue until the surplus is unbearable, I think we’ve the industry in a sweet spot. We finally locked in the margin between raw material and finished goods. Whatever was the increase in fair and remunerative price for sugarcane this year, we’ve got corresponding increase in sugar price. That is why margins are looking very predictable. Ethanol, etc. are secondary in my opinion. The biggest success of this policy is to stabilise the sugar margin.

With MSP at Rs 31, is it comfortable to cover most of the cost? Or do you feel it could have been slightly more higher?

Narendra Murkumbi: The industry was asking for Rs 34-35. But the fact that it has kept pace with the increase in sugarcane price this year is encouraging.

Has the differential been taken care of?

Narendra Murkumbi: Yes, according to me, largely.

Ethanol is a very high margin business for the sugar industry. When do you see momentum gaining, which people are anticipating? Once the ethanol announcement was made that excitement made investors come into sugar counters and hoping they’ll start ramping up and they will start ethanol production in big way. Are you seeing it happening in a material fashion?

Narendra Murkumbi: It’s selective. To have a substantial effect on combined bottomline of a sugar company, you need larger ethanol per company and only some companies can make it. Rs 5,000-7,000 crore of capex is going on in terms of new ethanol capacity. The companies who were doing it, will start showing significant increase in ethanol production and margin contributions in the next couple of years. It won’t be across the industry as it needs more capex.

How optimistic are you about the kicker coming in from the ethanol side to continue?

Vivek Saraogi: I agree with locking in on final product, recoveries this year are better all over the country. There is a positive impact on cost which would be lower. I think the policy to be continued on B-heavy, especially is because:

  • You are saving foreign exchange.
  • This helps answer the surplus without giving any cash subsidy by the government.

It’s a brilliant and laudable initiative from the central government. Having seen the benefit all around, I don’t see any reason why this could be discontinued.

Are we to presume that the revenue and bottomline contributions of ethanol over the next two years, as you mentioned that the policy is likely to continue, for all the companies would only increase over the next two years?

Vivek Saraogi: To increase the ethanol business, there’s a restriction in availability of molasses. We, at Balrampur, are adding 5.5 crore capacity in one of our factories called Gularia and we should go on-stream on Jan. 1, 2020, taking our overall capacity to about 18 crore litres.

What happens to the output over the next 18 months? Does it come off materially?

Narendra Murkumbi: It is fairly clear that in India, next year we will have lower crop. Also, with the new Brazilian season of 2019 which starts in April now, the cane there is lower than last year. Sugar production in the year will depend on relative prices of sugar and ethanol. Oil prices are upwards by $65, even there we have fair bottom for the world sugar market of around 13-14 cents. For India, the output would come 4 million tonnes less due to reduced planting in Maharashtra and Karnataka.

Vivek Saraogi: It would be 4 million (tonnes) lower. If monsoons wouldn’t play ball, it will go even lower. We’d have an accurate idea in May-June. Maharashtra and Karnataka are lower. UP will wait to answer in April-May. Even Thailand is lower and E.U. is also having lower yields. So, the global surplus is coming off.

What is the potential upside you see on sugar millers? Is this a win-win scenario for you? What happens to prices?

Narendra Murkumbi: Since prices are regulated, I don’t see prices being very volatile domestically. We do see world prices to improve from here. It has bottomed at around 11-12 cents in last quarter. Now, it should be in 13-15 cent range. Domestically, the government decides prices. Given all these factors, results should improve, and balance sheets should strengthen. The bankability of the sugar industry should improve going forward if these conditions continue for 1-2 years.

Do you envisage any material risk?

Vivek Saraogi: There could be plethora of it if we get into the policy. Having seen the logic and arrears have started to come off after the MSP phase. Rationally, I don’t think policy may harass us. The global market may go higher, if India goes lower next year.

If there could be global output cut and if prices move up, the export potential for India will be a lucrative proposition or is that not a factor under consideration?

Vivek Saraogi: We are very far from it. Right now, we’re talking about exports being made with substantial support from the government. To get to a level where export without any support makes sense is a long way off.

Narendra Murkumbi: The support which has been already announced is in place for this season up to September. We are already in halfway mark in terms of commitment of 2.5 million tonnes. These factors make it possible that we’ll reach closer to the target though we may not cross the 5 million target. 3-4 million tonnes can be the figure of exports and it will improve the stock situation.

Do you reckon that you or any of your peers looking at a more structural nature, as things stand by, would be enthused to set up ethanol capacity or otherwise by taking additional money from the market or will it depend on flows from natural business?

Vivek Saraogi: I don’t think there’s a need to pick up money from market. Balance sheets are good enough and you get loans from banks. Government is come up with schemes where they give you interest subvention on loan you take for setting up ethanol capacity.