The bitter truth about Sugar

The new sugar season begins on Monday. From all evidence, one can only approach it with trepidation. However, sugar shares got a sudden adrenaline when food minister Sharad Pawar said mills would be allowed to make ethanol directly from cane. I have only one question to put before that enthusiastic crowd: Have you done the maths?

Back-of-the-envelope calculations show that with cane in Uttar Pradesh priced at Rs 13, if a mill only makes ethanol, it would cost about Rs 26/l. Without any sugar or other by-products to share the cost of manufacture, the same ethanol becomes more expensive. But the most that oil marketing companies are willing to pay for it is just Rs 21.50/l.

So any local mill which decides to only make ethanol from cane is obviously headed for further financial disaster. Brazil, on the other hand, can do it is because with cheaper cane, the cost of its ethanol is only around Rs 16/l.

Now it's not the minister's job to do these calculations while making politically correct announcements. Neither is he investing his own cash. But surely investors need to delve a bit deeper.

Ethanol is important because it can help offset losses from sugar on a company's balance sheet. But not every company has large ethanol capacity. In fact, the share of ethanol in the total revenue stream of even the largest companies is not sufficient to make a significant dent.

In Bajaj Hindusthan, India's largest sugar company, for instance, the share of ethanol, co-gen and other by-products together is unlikely to exceed 15% of total revenue in fiscal 2008.

This means more than 80 paise out of every rupee earned by the company would still come from sugar. In Balrampur Chini, ethanol and the rest add up to 25% of total revenue. That may be better but with 75 paisa of every rupee depending on sugar, it is kind of tough to get overjoyed over ethanol. Ethanol has its uses. But in a market with limited demand, monopolistic buyers and government-negotiated prices, the upside is severely limited, at least for the foreseeable future.

Industry watchers also went dizzy with delight at news of interest-free loans to sugar mills. While that sounds good, I'm not sure people are yet aware of the enormity of the problem. The numbers are crazy. At the end of this sugar year, the total debt of the industry may touch Rs 230-250 billion. By next year it would need to borrow about Rs 350-400 billion.

This debt includes money mills need to carry unsold sugar, pay for cane, and expand capacity. Just paying the interest on these loans may well be enough to bring the average factory down to its knees. But it is still too early to tell how far the government will go to provide succour.

To an industry with a net worth of about Rs 100 billion, banks have already lent Rs 230-250 billion, which is enough to give any CFO sleepless nights. So lenders may become extremely reluctant to double that figure in the new season. In such a scenario, mills would have only one option. Cut down on their single biggest cost, namely purchasing cane.

In all likelihood, 10% of the new season's cane could be left standing forlornly in the fields with no takers. That means 30 million tonnes of cane, worth Rs 27 billion, may be burnt in the fields. That is a genuinely scary number because it hides within it the enormity of the humanitarian crisis that could swathe cane fields across the country. Can you imagine the repercussions if polls are announced as well?

Meanwhile, the government's desperate attempt to keep the industry afloat may well fan the fire. Cane arrears are estimated to touch around Rs 150 bn by the end of the 2008 season. If the government provides support, it will be stepping into a bigger financial trap than it can handle.

Of course, the fate of individual companies would wary considerably depending on the health and life-sustaining capability of their balance sheets. But that is even more reason to be cautious of the sector as a whole. You need to carefully pick out the cherries from the lemons in the basket.

India is poised to become the largest sugar producer in the world. The International Sugar Organisation has now pegged India's output in the new season at 33.2 mn tonnes. That should be enough to make us pause. Those pinning their hopes on crude oil prices going on overdrive and Brazil pumping more ethanol to end sugar's troubles forget one important fact.

Between 1999 and 2006, Brazil's cane acreage has increased by 16%, cane output by 31%, ethanol output by 31% and mark this one, sugar output by 47%. With cane acreage of around 6 mn hectares, Brazil will start producing sugar the minute prices become attractive. That means India has no option but to remain a price taker for a long while to come.

The corporate suffering is pretty much global. Shares in Tate & Lyle slumped to a three-year low on Friday as the sugar and sweetener multinational forecast among other things, a half-year loss for its sugar trading business after a previous profit of 15 million pounds.
Truth is that the sugar sector's agony is unlikely to abate before 2009, when lower cane output, lower sugar production and lower inventories may provide a modicum of relief. Any celebration before that is certain to be short-lived. Irving Berlin in his song Let's Face the Music and Dance says:

"There may be trouble ahead... Soon/ we'll be without the moon/ humming a diff'rent tune/ and then There may be teardrops to shed". It may well be the theme song of India's new sugar season.

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