Download Rating Criteria for Sugar Industry

Rating Criteria for
Sugar Industry
Sugar is the most important agro-based industry in India after textiles. India
has emerged as the largest sugar producing country in the world after Brazil.
Sugar production is dependent on sugar cane output, which is, in turn,
dependent on the rainfall in the cane growing areas. Hence, the industry is
cyclical and exposed to price fluctuations. The sugar industry is also seasonal in
nature, with cane production concentrated between September and April;
demand for sugar, on the other hand lasts through the year. Therefore, the
sugar industry is working capital intensive. Also, input costs (sugar cane
prices) are regulated by the government and bear no relation to the sugar
prices. In such a scenario, CRISIL's approach to rating sugar companies
involves an evaluation of their financial position and cash flows against the
context of their ability to withstand cyclical downturns. In CRISIL's experience,
only companies with strong businesses and operational efficiencies, and low
interest costs have consistently withstood sugar price downturns.
CRISIL considers the following key parameters in evaluating a sugar
company's business risk profile: the firm's market position and operating
efficiencies. The key elements in CRISIL's rating assessment model for sugar
companies are:
BUSINESS RISK ANALYSIS
Government Policies
CRITERIA - Corporate Sector
Traditionally, the sugar industry has been highly regulated by the government.
Hence, CRISIL believes that a sugar company's credit risk profile is
significantly vulnerable to government policies. These policies influence costs
through cane pricing, cane availability through the command area concept and
distribution controls through levy sales and release mechanisms. The
government also discourages the import of sugar by imposing high import
duty on white sugar, rendering imports unremunerative.
The net effect of these government policies on the sector is that sugar
companies do not have much control over the quantity, quality, or cost of sugar
cane 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, a company's size is an important
determinant of its market position. Larger companies typically have greater
ability to withstand external shocks, easier access to capital markets and greater
bargaining power. Consequently, companies with a large size tend to have
strong credit profiles; however, the benefit of size may be nullified by a weak
capital structure or poor cost position.
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Other Factors Affecting Market Position
Location
Sugar being a bulky commodity, freight
constitutes an important cost element. Hence,
companies with factories located close to sugar
deficit regions command a better price and also
save on freight costs. Factories located close to
high-yielding sugarcane farms are in a better
position. Similarly, the longer crushing season in
the southern region enables a better utilisation of
fixed assets.
Proximity to ports is also a critical factor. Easy
accessibility to ports will enable 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 lower
domestic prices.
Customer Profile
Customer profile also has some impact on a
company's business position. Traditionally, sugar
sales have been routed through dealers.
Relationships with institutional customers may
also be viewed favourably, partly owing to the
benefits of regular liquidation of inventory levels
outside the government's release mechanism.
Relationship with Farmers
CRISIL considers a healthy relationship with
farmers as a crucial requirement for sugar
companies. Hence, investments in sugarcane
development activity and timely payments for
sugarcane are considered pre-requisites in
ensuring timely and adequate availability of cane.
Operating Efficiency
With prices of sugarcane being regulated,
operating efficiencies and processing costs will
determine companies' ability to sustain
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themselves during a cyclical downturn. In this
regard, CRISIL is of the opinion that larger plants
are better placed, as their conversion costs would
be lower.
Level of Integration
Optimal utilisation of by-products such as
molasses (that are used to produce ethanol) and
bagasse (that is used to generate power), is
another key differentiating factor. This factor will
enable companies to capture value across the
production chain. Integrated sugar mills are more
likely to be successful than other sugar
companies. An integrated sugar company
functions on a de-risked model; it results in higher
revenues and stable margins.
FINANCIAL RISK ANALYSIS
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 Companies'
and 'CRISIL's Approach to Financial Ratios'.
CONCLUSION
Thus, in CRISIL's opinion, the key success factors
for the sugar industry include the presence of:
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Size of operation, recovery rates
Forward integration with power and
distillery
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Location of the plant and relation with
farmers
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Diversity in client base and geography