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Sunday, February 13, 2011

How Regulation impacts the Indian sugar industry

This series aims to explore how regulation significantly impacts industry prospects and what investors should know before taking positions on stocks in the industry. After all, in many of these industries, changes occur at sea change and before getting seduced by analyst reports, the investors should not lose track of reality. 

The first industry covered is sugar. An annual drama is enacted involving global scenario(Brazil rainfall, global demand), cane recovery rates(% of sugar obtained from crushing 1 quintal of cane-around 8%-12%), procurement price(Union Govt 'Fair and Remunerative Price' or State Govt 'State Advisory Price') and export/import policy. When there is an uptrend, investors are asked to buy stating stocking position etc but on downtrend still people point to low valuations(P/BV, dividend yield etc) to recommend 'buy'!!  Before analyzing the merits of these positions, we should realize that there is no free market at all in this industry.

  1. On the buy side, state Government decides at what price sugarcane will be produced and what will be the area from which sugarcane will be procured. However, these areas are often violated by both farmers and mills. 
  2. On the sell side, Central Government decides the quantity of sugar that each sugar mill will sell every month. 
  3. The situation is complicated by the requirement that industry must subsidize the sale of sugar in public Distribution system(PDS). 10% of production of every sugar mill is required to be offered for PDS at significantly below cost of production. 
  4. There is neither scope for smart buying nor scope for smart selling. Also, the commodity futures market has experienced suspensions in this commodity and is uncertain. 
  5. This being an 'essential commodity', exports are often capped. The high prices paid by the customer often end up as 'super normal profits' of retailers-not the mills or farmers. 
Given all this, sugar perhaps remains the only regulated industry in the Country whose fortunes can significantly fluctuate as per the regulatory policies. To be fair, mills are doing all they can to reduce dependence on these vagaries like
  1. Recycling their waste into energy(co-production), byproducts(industrial alcohol etc) or building materials production. Like how Jindal Steel had diversified into power and spun off the SPV, the next big trigger for sugar mills could be launch into power. While the cap on power trading margins(few paise) deters super profits like Rs 13-14/unit rate, profits can still be made here. Also, these projects could accrue carbon credits(doubtful now but still may be extended beyond 2011) 
  2. Improving their own production efficiencies and helping farmers improve yield

1 comment:

Dwivendu Kumar said...

Thanks for sharing the important points of view with us. It is really very nice blog which describes how to SAP in sugar industry