Ind-Ra has published the first quarterly edition of its credit news digest on the sugar sector where it has said that aggregate EBITDA margin of major sugar companies improved to 10 per cent in 1QFY20 (1QFY19: 5 per cent) on account of 11 per cent yoy increase in sugar prices as a result of the minimum selling price (MSP) being fixed by the government in June 2018. Besides, the distillery segment also witnessed an improvement in profitability with an increase in ethanol prices as well as increas in sale volume.

 

The report says that distillery segment is increasingly seen as the potential solution to the cyclicality and volatility in earnings of sugar companies in the medium-term on account of the short supply situation, coupled with the government’s focus to incentivise ethanol production. Distillery has historically been the most stable performer of the three segments, consistently yielding profits even in the seasonally-weak first and second quarters in the past 10 years. Aggregate distillery segment EBIT for major entities grew 40 per cent yoy to around INR4 billion in 1QFY20, accounting for 65 per cent of the total EBIT.

 

Ind-Ra expects aggregate EBITDA margins from the cogeneration segment to decline in FY20 as Uttar Pradesh Electricity Regulatory Commission has reduced power tariffs by as much as 35 per cent in its new draft policy and most large companies have operations in Uttar Pradesh. Companies with power operations in Maharashtra and Karnataka could, however, witness stable-to-improved pricing.

 

Median interest coverage of major sector remained comfortable at 2.6x, although it fell yoy from 3.2x in 1QFY19 (FY19: 4.5x). Median interest costs increased to around 4 per cent of the revenue (1QFY19: 3 per cent) on account of increase in inventory under the regulated release mechanism and distillery expansion projects underway. While the median interest coverage of smaller companies increased to 1.4x in 1QFY20 from sub-1x in 1QFY19, most of them remained vulnerable (interest coverage of less than 1.5x).

 

Ind-Ra believes that the increase in buffer stock subsidy by Rs 5 billion is likely to reduce the inventory-carrying costs while an increase in exports and higher ethanol sales will improve the cash flows of sugar companies.

 

While India’s sugar production is likely to decline to around 27 million tonnes (mnt) in SS2019-20 (SS2018-19: 33mnt) on lower acreage, flooding/drought in different areas of Maharashtra and diversion of around 0.5mnt-1mnt to ethanol, it will remain higher than the projected domestic consumption of around 26.5mnt. Besides, the high carryover stock of 14.5mnt (against normative carryover requirement of around 5mnt) will add to the surplus. As a result, it is imperative to export 6mnt of sugar in SS2019-20 (SS2018-19 E: 3.5mnt) to achieve demand-supply balance which appears unlikely despite the lower production in Brazil.

International prices could bottom out in September, but sustained price recovery would remain elusive due to the high inventory position, despite muted production outlook. Any significant decline from hereon could impact the viability of exports.