ICRA LIMITED 1

INDIAN SUGAR SECTOR

Steady near term profitability likely for sugar industry; past losses and debt levels will continue to impact balance sheets

June 2016

Contacts: Sabyasachi Majumdar

+91 124 4545304

sabyasachi@icraindia.com

Avneet Kaur

+91 124 4545319

avneetk@icraindia.com

Anupama Reddy

+91 40 40676516

anupama.reddy@icraindia.com

ICRA RESEARCH SERVICES

ICRA RATING FEATURE

ICRA LIMITED 2

WITH RANGE BOUND SUGAR REALIZATIONS, RATIONALIZATION OF CANE PRICES TO DETERMINE FINANCIAL PERFORMANCE OF SUGAR INDUSTRY IN 2014-15

CONTENTS

1. Summary Opinion 3

2. Domestic Demand-Supply Scenario 5

Trends in domestic sugar production, consumption and closing stock over the years

Domestic & State wise expected sugar production during SY2016

Expected domestic sugar production during SY2017

3. Trends in Domestic Sugar Prices 9

4. International Scenario and Price trends 11

Supply-demand scenario in major sugar producing countries

International price trends

5. Domestic Cane Pricing and Conversion Margins 14

Trends in SAP and FRP cane prices over the years

State wise cane pricing for SY2016

Impact assessment of sugar prices and cane costs on conversion margins for SY2016

6. By-products: Alcohol and Power 18

By-product revenue contribution to total revenues

Distillery segment – challenges and outlook

State wise cogeneration tariffs

Power tariff and volume trends in short term trading market

7. Segmental Profitability Analysis 24

Financial performance of the Cogeneration division

Financial performance of the Distillery division

8. Financial Performance of Sugars Mills 27

9. Outlook for Sugar Industry 30

10. Company Section

Bajaj Hindusthan Limited 33

Balrampur Chini Mills Limited 35

Dalmia Bharat Sugar and Industries Limited 37

Dhampur Sugar Mills Limited 39

Dwarikesh Sugar Industries Limited 41

EID Parry India Limited 43

Shree Renuka Sugars Limited 45

Triveni Engineering & Industries Limited 47

11.

12.

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Summary Opinion ICRA estimates domestic sugar production at around 25.2 million metric tonnes (MT) during the sugar year1 2016 (SY2016), a decline of 11% over the previous year. Lower production along with

exports of around 1.6 million MT, is likely to bring down the closing stocks to around 7.6 million MT in SY2016 from around 9.5 million MT in SY2015. The decline in sugar stocks is a positive and has resulted in an improvement in domestic sugar realisations since August 2015. While it is too early to estimate the sugar production for SY2017 season, based on the cane plantation and monsoon levels, ICRA expects the sugar production to decline between 4-8% to 23-24 million MT range during SY2017. This is expected to largely sustain the improved sugar prices in the near term. However, any substantial downward revision in import duties on sugar could dampen prices. While the cane prices (net of our estimate of applicable subsidies) for SY2016 are higher than the previous year, the increase in sugar realisations is expected to improve the contribution margins for sugar in SY2016. These factors, together with the higher recovery rates, are expected to drive a significant improvement in profitability for sugar mills based in Uttar Pradesh (UP). Profitability improvement is likely to be relatively more modest for mills based in Maharashtra and Karnataka, given the lower cane availability, coupled with the increase in cane prices in SY2016. This apart, profitability is also likely to be supported by improved realisations for by-products. While better profitability and stock reduction are expected to result in improved liquidity and debt coverage metrics for sugar mills in the near term, the same would continue to be weighed down by high amounts of debt outstanding and/or cane dues incurred to cover losses in the previous sugar years.

After five years of surplus sugar production, ICRA estimates domestic sugar production in SY2016 to be marginally lower than domestic consumption by around 0.3 million MT. The decline in production has mainly been driven by a severe drought in the largest sugar-producing state, Maharashtra, which impacted sugar cane availability, and therefore, the production in Maharashtra is estimated to decline by 20% to around 8.4 million MT. In UP, production during SY2016 is estimated to decline by 4% to around 6.8 million MT and in Karnataka by 16% to 4.1 million MT while production is expected to marginally increase in Tamil Nadu. During 7M SY2016, domestic sugar production at around 24.6 million MT, 11.0% decline over the corresponding previous period. While the SY2016 season commenced with relatively a high opening stock of around 9.5 million MT, decline in sugar production, along with exports, is likely to result in a closing stock of around 7.6 million MT, a significant 20% YoY decline. However, the stocks would still be around 1.2 million MT higher than the normative sugar stock of around 6.4 million MT (based on the assumption of requirements of 3 months’ domestic consumption).

While it is too early to estimate the sugar production for the SY2017 season, based on the cane plantation and expectations on monsoons, ICRA estimates the sugar production to decline by anywhere between 4-8% to 23-24 million MT range during SY2017. This is driven by the decline in the availability of cane in Maharashtra and Karnataka on account of lower rainfall. However, the decline in sugar production from these states is expected to be moderated to an extent by the expected increase in the sugar production in Uttar Pradesh and Tamil Nadu.

Consecutive years of surplus production from SY2013 had led to surplus sugar in the domestic market, which, along with the international sugar-surplus scenario and muted international sugar prices, had caused prices to come under pressure and reach a three-year low of Rs. 23,000/MT in July 2015. However, sugar realizations have been on a rising trend since August 2015. This trend was driven by a number of factors which included: first by a government notification on mandatory exports in month of September 2015 followed by announcement of cane production subsidy in December 2015; market anticipation of supply correction driven by drought conditions in certain key growing region; and impact of global sugar deficit scenario. Thus, the prices climbed to close to Rs. 34,000/MT levels by May 2016. Given the supply correction which has happened in SY2016 and given the expectations of further production decline, ICRA anticipates prices to remain steady in the near term. In the next 2-3 quarters, any further increase from current levels would depend upon the following factors: (i) expectations for sugar production during SY2017; and (ii) sugar mills own actions on supplies depending upon their inventory holding capacity. On the other hand, government action such as any substantial reduction in import duty on sugar or other price control measures could dampen price trends. In the medium term, the trends in sugar price will continue to be determined by the three factors: the domestic sugar balance; international crude oil prices, which will determine the raw sugar-ethanol mix in Brazil, the world’s largest producer and exporter of sugar; and the GoI’s policies regarding exports of sugar and import duties.

Over the medium term, international sugar prices will be largely determined by fluctuations in world sugar production (as consumption growth has largely been steady) as well as crude oil prices, which determine the raw sugar-ethanol blend in major exporting countries like Brazil. In the medium term, lower sugar prices will boost consumption, but on the supply side, farmers are likely to shift to other crops, which in turn would reduce the sugar output, leading to a supply correction. However, with a decline in the output of major supplying nations, including India and Brazil, and

1 Sugar year is from October to September

INDIAN SUGAR SECTOR

Steady near term profitability likely for sugar industry; past losses and debt levels will continue to impact balance sheets Industry Update June 2016

ICRA LIMITED 4

the resultant lower supplies to the world market, a supply deficit appears likely in 2015/16. Nevertheless, significant accumulated stocks would provide insulation from any sharp spikes in international sugar prices in the near to medium term.

For SY2016, the Commission for Agricultural Costs and Prices (CACP) has recommended Fair and Remunerative Price (FRP) of Rs. 230/quintal of cane, linked to 9.5% recovery, which is an increase from Rs. 220/quintal for the previous year. The state-advised price (SAP) fixed by the UP Government for cane remains high at Rs. 280/quintal for SY2016. The UP Government has also announced a subsidy of Rs. 23.30/quintal in addition to exemption from certain taxes/commission linking the amount of subsidy to the actual average sugar prices between October 2015 and May 2016. In addition, society commission, purchase tax and entry tax amounting to Rs. 11.70/quintal have been waived. However, it is unlikely that the sugar mills would be entitled to receive any UP government subsidy (of up to a maximum of Rs. 23.30/quintal) given that average realisations during 8M SY2016 are likely to be above the benchmark realisations. In UP, despite higher cane costs while not considering the subsidy, improvement in recovery rates along with higher sugar realisations is likely to result in an increase in the conversion margins in SY2016. In Tamil Nadu, the State government increased the SAP to Rs. 285/quintal in SY2016 from Rs. 265/quintal in SY2015, which, along with low recovery rates, would have a negative impact on the profitability of mills for the SY2016 season. Hence, the industry’s ability to secure a linkage between cane price and sugar realizations is critical for its long-term sustainability.

The prices of by-products such as bagasse and molasses remain remunerative, driven by a healthy demand from the consuming sectors such as power, paper and alcohol. Further, forward integration into distilleries and power generation continues to yield healthy returns, given the supporting regulatory framework and healthy off-take and pricing for alcohol and power. ICRA observes that a very significant part of the total revenue and profits of sugar mills comes from by-products, especially in the case of forward integrated entities. Although there are concerns over timely collection of receivables from state-owned utilities, especially in UP and Tamil Nadu, ICRA notes that lately there has been a substantial improvement in payments from these utilities. Further, with renewed focus on the ethanol blending programme (EBP) and mandatory ethanol blending been revised from 5% to 10%, the new fixed pricing mechanism for ethanol supplied to OMCs and removal of central excise duty is expected to augur well for the profitability of the industry as a whole through higher realizations for ethanol. Thus, ICRA believes that forward integration will remain crucial for the industry to improve profitability and ride through the business cycles that characterise the sugar industry.

The revenues of most sugar mills increased in FY2016 on a YoY basis on account of higher sugar and by-product sales vis-a-vis FY2015. The operating margins of most UP-based mills, although still moderate, were on the higher side during FY2016 on a YoY basis because of the increase in sugar realisations, improvement in recovery rates during Q3 FY2016 and Q4 FY2016, and higher inventory valuation as on March 31, 2016. Most South-based sugar mills in Tamil Nadu reported low operating margins during FY2016 following an increase in the cane cost of production. The improvement in the operating margins of UP-based mills supported the interest coverage of mills in FY2016 which is higher on a YoY basis. The weak operating performance of south-based companies led to interest coverage less than 1x during FY2016, as it had during FY2015. While sugar prices have improved, the sugar mills’ liquidity is likely to remain under some pressure in the near term as they have to start making debt repayments against the soft loans availed of during 2014 and 2015 from this year, which implies additional cash outgo for them. Going forward, the profitability of the mills is dependent on the control over operating expenses and the control over interest expenses by appropriate leveraging.

As far as the medium- to long-term outlook is considered, in ICRA’s view, the long-term prices and profitability of Indian sugar companies will remain highly cyclical and dependent on domestic and international supply-demand trends. The latter in turn would hinge on agro-climatic conditions in the major sugar-producing countries and the trends in crude oil prices (which determine the diversion of cane crop to ethanol). The price trends in the international markets will be one of the key determinants of future profitability. Further, government/court action in ensuring removal of mandatory crushing by sugar mills for the entire cane offered to them by farmers in the command area and a rational linkage between cane and sugar prices will have a critical bearing on the long-term viability of sugar operations, especially in the states governed by SAP. Within the sugar industry, however, players with high operating efficiencies, forward integration and strong capital structure will be best placed to ride out the cycles. In this context, ICRA takes a favourable view of the support extended by the Central Government and some State Governments during 2014-2015 to support sugar companies by way of export subsidy, renewed emphasis on EBP, and the linking of cane prices to sugar prices (in some states like UP).

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