SPECIAL

REPORT
SUGAR - "Regaining Sweetness"
S E C U R I T I E S P V T. L T D.

Date: 8th May 2008

SECTOR BIAS: POSITIVE

Sugar Cycle entering into the regime of “Low Sugarcane Production High Sugar Prices”

Domestic sugar cycle follows a 5-7 year cycle. The down trends in the sugar cycle starts with improved profitability of sugar mills,
with higher and prompt payment to the farmers and hence low sugarcane arrears to the cultivators, higher area under sugarcane
cultivation and bumper sugar production. All these lead to drop in sugar prices. Up trend in sugar cycle starts with increased
availability of sugar, decline in sugar prices, lower profitability for mill owners, delayed payment to farmers; high sugarcane arrears &
thus farmers switch over to other crops resulting in lower cane production. All these factors result in higher sugar prices and again
cycle turns around. Below chart depicts the same. The area under red round marking represents situation through which sugar cycle
is likely to undergo in SS-09.

s
year
2-3
decline in sugarcane
lower sugarcane
utilisation for sugar
production
production lower sugar
decline in the area
under sugarcane production
cultivation
lower sugar
high sugarcane arrears availability
delayed payments increase in
to farmers sugar prices
lower profitability
Time improved
decline in sugar profitability
prices
higher and prompt
payments to farmers
increased availability
of sugar low sugarcane arrears

higher sugar
production increase in the area
higher sugarcane under sugarcane
utilisation for sugar cultivation
production higher sugarcane
production
ye ars
3-4

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Research Desk Sugar: Regaining Sweetness

Sugar Production to witness negative growth after two years of bumper production

Sugar Season SS 00-01 SS 01-02 SS 02-03 SS 03-04 SS 04-05 SS 05-06 SS 06-07 SS 07-08E SS 08-09E
Area (Million Hectares) 4.2 4.3 4.4 4.5 3.9 3.7 4.2 4.2 3.6
Cane Production (Mln Tons) 299.3 296 297.2 287.4 233.9 237.1 281.2 280.9 238.8
Yeild (Tons/Hectare) 70.9 68.5 67.4 63.6 59.5 64.8 66.9 66.9 66.9
Production (million Tonnes) 18.5 18.5 20.1 14.0 12.5 19.2 27.5 25.3 21.5
Recovery Rate (%) 6.2 6.3 6.8 4.9 5.3 8.1 9.8 9 9
(Source: AASPL Research)

As seen from the above table the sugar production is likely to witness negative growth for the first time in SS-08E & SS-09E after
two year's robust growth rate. Sugar production grew at robust 53.6% & 43.2% to 19.2mt and 27.5mt in SS-06 and SS-07, but
in SS-08 and SS-09, the sugar production is estimated to drop by 8% & 15% to 25.3mt and 21.5mt respectively. This is mainly
due to likely drop in area under cultivation for sugarcane (down 15%) amidst mounting arrears and alternate rich crop substitute
(Wheat, Paddy). Also recovery rate is likely to decline from 9.8% in SS-07 to 9% in SS-09E amidst delay in lifting of canes by
millers, which would yield lower sugar production.

Closing Stock -Consumption Ratio to drop in SS-09E

Demand and Supply situation in India

Million Tons SS 00-01 SS 01-02 SS 02-03 SS 03-04 SS 04-05 SS 05-06 SS 06-07 SS 07-08E SS 08-09E
Opening Stock 9.3 10.7 11.3 11.6 8.5 4.5 4.4 10.5 13.3
Production 18.5 18.5 20.1 14 12.5 19.2 27.5 25.3 21.5
Imports 0 0 0 0.4 2 0 0 0 0
Total Consumption 17.2 17.9 19.9 17.5 18.5 19.6 21.4 22.5 23.9
Domestic Consumption 16.2 16.8 18.4 17.3 18.5 18.5 19.8 20.5 21.2
Exports 1 1.1 1.5 0.2 0 1.1 1.6 2 2.7
Closing Stock 10.7 11.3 11.6 8.5 4.5 4.4 10.5 13.3 10.9
Closing Stock / Consumption 66.05 67.26 63.04 49.13 24.32 23.78 49.07 59.06 45.54

(Source: EsugarIndia & AASPL Research)

Indian sugar economics have improved significantly over the past six months. Sugar prices made bottom of Rs.12,000/tonne (ex-
factory in U.P) last year, but since last six months prices are showing strength with improvement in reliasations by ~ Rs.3,000 -
3,500/tonne. Demand-supply dynamics in the sector are now changing in favor of the sugar manufacturers with expected fall in
sugar production in the next season SS-09E, which is likely to bring closing stock-consumption ratio at some comfortable levels
of 45% after hitting high of 59% in SS-08. During bottom of previous sugar cycle in SS-02 & SS-03, this ratio was as high as 67%,
which eventually fell to 49% in SS-04 (the year of bottom-in earlier sugar cycle) followed by just 24% in SS-05 (the year in which
sugar prices had hit the roof). There is inverse correlation between closing stock/consumption ratio & sugar prices. So lower the
ratio better are the sugar price realisations.

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Research Desk Sugar: Regaining Sweetness

Improving closing stock-consumption ratio is mainly due to (1) Lower Area under cultivation (2) Lower Recovery Rates

Closing Stock to Consumption Ration vc Average Realisation (ex factory)

18000 67.3 70
66.0 17220
63.0 65
17000
59.1
16070 60
16000
15030 15090 55
15000 49.1
14230 45
Rs per Ton

14000
13210 40
13000
13000 12680
35
12000
30
11190
11000 25

10000 20

Avg Realisation (Ex Factory) Closing Stock/Consumption

Lower cane Lower Recovery

Cultivation Rate

Substitute Mounting
for Cane Arrears
Cultivation

1) Lower Area under cultivation for sugarcane: -

Avg Realisation (Ex Factory) vs Area Under cane Cultivation

18000 5.0
17220
17000
16070
16000 4.5
15030 15090
Million Hectares

15000 4.4 4.5 14230

Rs per Ton

4.2 4.3
14000 4.2 4.0
13210 13000 4.2
13000 12680 3.9
12000 3.7 3.6 3.5
11190
11000
10000 3.0
SS 00-01 SS 01-02 SS 02-03 SS 03-04 SS 04-05 SS 05-06 SS 06-07 SS 07-08E SS 08-09E

Avg Realisation (Ex Factory) Area Under Cane Cultivation

(Source: AASPL Research)

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Research Desk Sugar: Regaining Sweetness

With huge inventories piling up at mills due to excess production and lower profitability, sugar companies make delay in payment
to farmers for sugarcane, which in turn makes cultivation of sugarcane less profitable for farmers. Also other crops, which
provide better return also replaces sugarcane from farmer's list for cultivation (Refer below table). Under this scenario our studies
expects ~ 15% drop in area under cultivation for sugarcane in SS-09E to 3.6 mn hectares from 4.2 mn hectares of SS-08.

Crop Dynamics for alternative crop to the Farmer

Yeild Price Total Cultivation Net earnings Earnings as %
Crop (Qtl/Acre) (Rs/Qtl) earnings Cost (Rs/Acre) (Rs/Acre) of total cost

Sugar Cane 250 110 27500 17215 10285 60%

Wheat 20 1000 20000 7029 12971 185%
Paddy 20 800 16000 8500 7500 88%
(1 Wheat + 1 Paddy) 36000 15529 20471 132%
Note: - 1 Wheat & 1 Paddy crop can be done in a year, Wheat: Nov-Apr, Paddy: July-Spt
(Source: Presentation by Bajaj Hindustan)

(2) Low Recovery Rate: -

For SS-08 many sugar millers have delayed the cane crushing (which normally begins in mid October). Also there are millers
which are not crushing at their optimal level, which ultimately reduces lifting of canes at appropriate time, resulting in low
recovery rate for sugar.

By-products are in Good Demand

Major by products arising out of the factory of an integrated sugar manufacturer would include Molasses, Bagasse and Ethanol.
Quality and Quantity of byproducts would depend on the recovery rate of sugar from cane. Molasses are further fermented to
manufacture Alcohol for portable and industrial purposes.

Output per ton of Sugarcane Crushed Qty Units

Sugar (assuming 11% recovery rate) 11 Kgs

Molasses 50 Kgs
Bagasses 333 Kgs
Power 133 KwH
Ethanol 10 Litre
(Source: AASPL Research)

Well placed capex plans by major breweries would increase demand for alcohol significantly. In FY08E & FY09E alcohol
production would not be matching with galloping demand, which in turn would create deficit of 700mn liters and 890 mn liters
in FY08E & FY09E, respectively.

Alcohol Production/Demand - all India basis (Million Litres)

Particulars FY07 FY08E FY09E

Alcohol Production 2600 2100 2100

Demand:
Portable 1000 1080 1170
Industrial 1100 1160 1220
Blended with Petrol @ 5% level 500 560 600
Total Demand 2600 2800 2990
Surplus/(Deficit) 0 -700 -890
(Source: Bajaj Hindustan Annual Report)

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Research Desk Sugar: Regaining Sweetness

Demand for Ethanol is expected to rise further on the back of increase in mandatory levels of blending from 5% to 10%.

Particulars 5% Blending 10% Blending

Petrol Consumption (Mln Litres) 11200 11200

Ethanol Requirement 560 1120
Sugar Foregone (Mln Tonnes) 0.8 1.7
Production 25.3 21.5
% of Production 3.2 7.9
(Source: AASPL Research)

World Sugar Dynamics

World Sugar Production (MMT, Raw Value)

Country/Region FY04 FY05 FY06 FY07 FY08E

Brazil 26.14 27.73 32.64 32.77 34.23

India 14.74 13.8 20.94 30.6 27
EU 20.2 21.95 21.02 17.05 17.45
China 10.9 9.86 9.58 13.04 13.59
USA 7.85 7.15 6.71 7.7 7.66
Thailand 7.28 5.43 5.08 6.98 7.89
Mexico 5.36 6 5.39 5.43 5.58
Total of Top 7 producers 92.47 91.92 101.36 113.57 113.4
% of Total World Sugar Production 63% 65% 66% 68% 68%
Others 53.72 49.18 51.22 53.72 53.98
World Total 146.19 141.1 152.58 167.29 167.38
Source: F.O Litch's International Sugar & Sweetner Report dated 24.7.07& & AASPL Research)

The world sugar production in SS-08E is expected to reach 167.38 mn tone in which top seven producers contributes 68%
of the production.

World Ethanol Production

Country %Share
Brazil 36
USA 32
China 9
India 5
EU 6
Russia 2
South Africa 1
Saudi Arabia 1
Others 8
(Source: KPMG report)

With lower sugar prices & continuous higher oil prices, sugar manufacturers in Brazil have diverted cane juice towards Ethanol
manufacturing rather than Sugar production. That is expected to reduce the over all sugar availability in the world, resulting in
hardening of sugar prices the world over. However, the prices in India are nowhere in comparison with global prices mainly due to
bumper production and less diversion of sugarcane towards producing ethanol. (See chart below)

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Research Desk Sugar: Regaining Sweetness

Global Sugar Price Comparison

India 19
Argentina 25
Barzil 27
Malawi 31 prices in India Lowest in the World
Swaziland 34
South Africa 43
USA 51
Australia 55
United Kingdom 60
64
France
78
Japan
15 25 35 45 55 65 75 85

Cents/Pound

Despite of second largest sugar producer of the world, India's per capita sugar consumption is amongst lowest in the world.

Per Capita Sugar Consumption in Top 7 Countries

65 57.6 Huge Potentail

47.8
55 43.8
38.1
45
Kilograms

31.4
35
18.6
25
8.6
15
5
Brazil Mexico Russia EU USA India China

Consumption

(Source: Presentation by Bajaj Hindustan)

ISSUES FACED BY THE INDUSTRY

Price at which cane to be procured by Sugar manufacturer is influenced by the Govt. Central Govt. influences the sugar
procurement price by deciding SMP (Statutory Minimum Price). Currently, SMP decided by Central Govt. is at Rs 80.25 per quintal
linked to 9% recovery rate followed by Rs 0.90 payable for every 10 basis points rise in incremental recovery.
State Govt. influences the cane prices by deciding SAP (State Advisory Price) which is always higher than SMP. Highest SMP in the
country are in the state of Uttar Pradesh at Rs 125 per quintal linked to 9% recovery rate followed by Rs 0.90 payable for every 10
basis points rise in incremental recovery.
UP based sugar manufacturers have filed case demanding reduction in SAP from Rs 125 per quintal to Rs 105 per quintal for
2007 and 2008 sugar seasons. The issue continues to be sub-judice and based on the interim order of the Lukhnow bench of the
Allahabad High Court. With respect to 2007 sugar season Supreme Court has directed to settle cane dues at Rs 118 per quintal.
In another judgment, Allahabad High Court has given decision to increase the transport rebate for the UP based sugar
manufacturers from Rs 5.75 per quintal to Rs 10.58 per quintal. Companies would be allowed to deduct this amount from the
arrears payable to the cane farmers.
Cane pricing for sugar manufacturers in Maharashtra is decided on the basis of SMP. SAP is not implemented in the state of
Maharashtra. Cane cost for Maharashtra based sugar factories range between Rs.110 Rs.115 per quintal. That gives
Maharashtra based sugar companies an edge over their UP based rivals.

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Research Desk Sugar: Regaining Sweetness

KEY RISKS
Inflationary pressures: Current high level of inflation is the prime concern for the ruling government and in order to ease
inflationary scenario govt. has taken harsh steps as well. This year is the last term of central government and if sugar prices are
higher, Govt. can take fiscal action against the fortunes of the industry. Also it has been observed in the past, the government
could take drastic measures like banning sugar exports or abolishing the export subsidy, which could be a negative for the sector.
Higher cane costs: UP is the largest sugar-producing state in the country, contributing 34% of the production. Next year Govt.
might decide farmer friendly cane prices in order to allure huge vote bank in Uttar Pradesh.

However rise in sugar prices should not be a big concern over rising inflation. See table below.

Impact of Sugar
price Increase
Assumptions Amt

Per Capita Income (US $/Annum) 797

Per Capita Income (@ Rs 40 / $) (Rs/Annum) 31880
Per Capita Income (Rs/Month) 2657
No of members in Family 5
Family Income (Rs/Month) 13,283

Per capita Sugar Consumption (Kgs/Annum) 18.6

Per capita Sugar Consumption (Kgs/Month) 1.55
Family's Sugar requirement (Kgs/Month) 7.75

Retail Sugar price 18

Family's Total Expenditure (80% of income) (Rs/Month) 10,627

Family's Expense on Sugar (Rs/Month) 140
which is (%) of Family's expenditure 1.3%

If sugar prices increase by (Rs/Kg) 0.5------ 1----- 1.5--- 2---

Impact on Family's Expense Budget

Rs per Month 3.88----- 7.75-- 11.63- 15.50
Monthly Exp up by (%) 0.04----- 0.07-- 0.11-- 0.16-

Impact on Wholesale Price Index

Sale Price increase by (%) 2.78 5.56 8.33 11.11
Weightage of Sugar in WPI (%) 3.62 3.62 3.62 3.62
WPI up by (points) 0.1 0.2 0.3 0.4
(Source: Presentation by Bajaj Hindustan)

As seen from the above table even if sugar prices goes up by Rs.2 per Kg (up 15%), WPI goes up by just 0.4 points, which is
negligible by impact. Also it can be seen from the table that sugar accounts just 1.3% of family's monthly expenditure (Average
family size assumed 5 members). So even if sugar prices go up by Rs. 2 per Kg, it would translate into additional Rs.15.50 burden
in family's total monthly expenditure making it up by just 0.16%.

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Research Desk Sugar: Regaining Sweetness

No threat of import
Threat of dumping of imported sugar is not prevalent. The current duty structure is 60% on imported sugar. As can be seen
from the table below even if government reduces import duty to 0% landed sugar prices are much higher than current
prices of Rs.15000 per tone.

Import Dynamics of Sugar

Import Dynamics - Per MT Sugar
0% Duty 10% Duty

Base price (US $ FOB) 320 340 360 320 340 360
Freight* 45 45 45 45 45 45
C&F price 365 385 405 365 385 405
Import Duty (%) 0 0 0 0.1 0.1 0.1
Cost with Duty 365 385 405 401.5 423.5 445.5
Port and Incidentals 10 10 10 10 10 10
Inland Transportation 33 33 33 33 33 33
Importer Margin (%) 30 31.6 33.2 32.92 34.68 36.44
Landed Cost (US $) 438 459.6 481.2 477.42 501.18 524.94
Rs/US $ 40 40 40 40 40 40
Landed Cost (Rs) 17520 18384 19248 19097 20047 20998
* Import from South East Asia
Volumes in the blue indicate current FOB prices
(Source: presentation by Bajaj Hindustan)

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