Rating Criteria for Sugar Industry February 2018
Criteria contacts Pawan Agrawal Chief Analytical Officer CRISIL Ratings Email: pawan.agrawal@crisil.com Sameer Charania Director Rating Criteria and Product Development Email: sameer.charania@crisil.com Somasekhar Vemuri Senior Director Rating Criteria and Product Development Email: somasekhar.vemuri@crisil.com Manish Kumar Gupta Director - CRISIL Ratings Email: manish.gupta@crisil.com In case of any feedback or queries, you may write to us at Criteria.feedback@crisil.com 2
Executive Summary Sugar is the most important agriculture-based industry in India after textiles. India is the largest producer, after Brazil, and the largest consumer of sugar. Sugar production depends on sugarcane output, which depends on rainfall. Moreover, sugarcane prices are regulated by the government while sugar prices are market-driven. Also, the industry is cyclical and is susceptible to price fluctuations and trade regulations. While cane production is concentrated between September and April, demand for sugar lasts through the year. CRISIL's approach to rating sugar companies involves an evaluation of their financial position and cash flow in the context of their ability to withstand cyclical downturns. In CRISIL's experience, companies with strong businesses and operational efficiency, and low interest cost, have consistently withstood sugar price downturns. Scope While the broader criteria for manufacturing companies 1 applies to all sugar companies, this article 2 details the industry-specific factors impacting the credit risk profiles of sugar producers. Business Risk Government policies The sugar industry is regulated extensively by the government. Hence, CRISIL believes a sugar company's credit risk profile is significantly vulnerable to government policies. These policies influence cost through cane pricing and cane availability through the command area concept. The government also controls import/export of sugar through imposition duty. Consequently, sugar companies do not have much control over the quantity, quality, or cost of sugarcane they procure, or the quantity of sugar they sell. These factors significantly affect the economics of their operations. Market position In the highly fragmented sugar industry, size is an important determinant of a company s market position. Large companies typically have greater ability to withstand external shocks, easier access to capital markets, and greater bargaining power, and consequently, tend to have strong credit risk profile. However, the benefit of size may be nullified by a weak capital structure or poor cost position. 1 The detailed criteria is present on the CRISIL website under the Criteria and Methodology section Rating Criteria for Manufacturing and Services Sector Companies and CRISIL s Approach to Financial Ratios. 2 For accessing the previous published document on Rating Criteria for Sugar Industry, kindly follow below mentioned link: https://www.crisil.com/content/dam/crisil/criteria_methodology/consumer-staples/archive/crisil-ratings-crieria-sugarindustry_2007.pdf 3
Other factors affecting market position Location Freight is an important cost element. Companies with factories close to sugar-deficit regions command a better price and save on freight costs. Factories close to high-yielding sugarcane farms are also in a better position. Similarly, the longer crushing season in southern India enables better utilisation of fixed assets. Proximity to ports is also a critical factor. Easy accessibility to ports enables import of raw sugar for processing during cyclical upturns, when sugarcane availability is expected to be lower. It also provides companies with greater flexibility to export during periods of low domestic prices. Customer profile Traditionally, sugar sales have been routed through dealers. Relationships with institutional customers may be viewed favourably, partly due to the benefits of regular liquidation of inventory outside the government's release mechanism. Relationship with farmers Variability in monsoon and changing crop patterns impact cane output and consequently sugar production. This makes healthy relationship with farmers a crucial requirement for sugar companies, to ensure availability of cane. Hence, investments in sugarcane development activity and timely payments for sugarcane are considered prerequisites for timely and adequate availability of cane. Operating efficiency With prices of sugarcane being regulated through fair and remunerative price (FRP) mechanism, operating efficiency (determined by recovery rate) and processing cost will determine ability to withstand downturns. CRISIL believes larger plants are better placed, as their conversion cost will be low. Level of Integration Optimal utilisation of by-products such as molasses (used to produce ethanol) and bagasse (used to generate power), is another key differentiating factor. It will enable companies to capture value across the production chain. Integrated sugar mills with biomass power plant are more likely to be successful. An integrated sugar company functions on a de-risked model, which results in higher revenue and stable profitability. Working capital management While cane production is concentrated between September and April, demand for sugar lasts through the year. Therefore, sugar producers have to efficiently manage their seasonal working capital requirements amidst fluctuating prices, a crucial credit differentiator. 4
Financial risk For the analysis of the financial risk of a sugar company, CRISIL follows the standard criteria used for all manufacturing companies. This criterion is presented in detail in our publications, 'Rating Criteria for Manufacturing and Services Sector Companies' and 'CRISIL's Approach to Financial Ratios'. Management risk For analysing the management risk of sugar manufacturers, CRISIL follows the standard criteria used for all manufacturing companies. This criteria is presented in detail in our publication, Rating Criteria for Manufacturing and Services Sector Companies. Conclusion Thus, in CRISIL's opinion, the key success factors for sugar companies include: Scale of operations, recovery rate 3 Forward integration into power and distillery operations Location of plant and relationship with farmers Diversity in client base and geography 3 Recovery rate is defined as the amount of sugar produced per unit of sugarcane. 5
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