The Covid-19 pandemic is expected to exert downward pressure on the credit quality of sugar mills by eroding operating profitability and shoring up debt in fiscal 2021 (April 1, 2020 to March 31, 2021), an analysis of 26 CRISIL-rated sugar companies, which carried debt of over Rs 11,000 crore as on March 31, 2020, shows.

The operating profitability is expected to decline by 150-300 basis points (bps) due to a troika of factors namely, reduction in industrial usage of sugar, lower demand for sugar mills derivative - ethanol and fall in exports. Consequently, lower accruals and higher inventory are expected to lead to elevated debt levels and deterioration in the credit metrics of sugar firms.

First of these factors is the expected reduction in industrial usage, which accounts for nearly two-thirds of the annual demand of ~26 million tonne, as several food manufacturing units – including soft beverages, chocolates, confectionery, bakeries, hotels, restaurants and cafes – are either shuttered or running at low capacities. As a result, overall domestic demand is expected to be lower by 1.5-2 million tonne in the current sugar season, as reflected in softening prices over the past few weeks.

Second, oil marketing companies would reduce ethanol off-take because the lockdown has lowered demand for fuel. Besides, they have limited storage capacity available. Production of potable alcohol from ethanol would also be impacted because demand from distillers would have declined.

Third, international sugar prices have fallen ~23% between January and April as large supplier-nations, including Brazil, are switching from ethanol to sugar due to slack global oil demand and low crude oil prices. Thus, exports from India are likely to remain flattish compared with a 25-30% growth expected earlier.

In the milieu, sugar inventory becomes the key monitorable. India had started the current sugar season (October 1, 2019 – September 30, 2020) with an opening stock of 14.5 million tonne. However, despite ~20% lower production (refer Annexure), the closing inventory is likely to be high at 12.8-14 million tonne – that’s equal to six months’ consumption – because of slack industrial demand and exports.

Says Gautam Shahi, Director, CRISIL Ratings, “The expected decline in operating profitability of millers this fiscal is despite sugar production declining by a fifth in the current sugar season. Sugar millers could thus be looking at operating profitability of 7.5-9.5% in the current fiscal, down from 9.0-12.5% in the last fiscal.”

The saving grace for domestic sugar mills is the minimum selling price of Rs 31 per kg fixed by the government. But for this, sugar realisations would have fallen further, given high stocks, leading to a sharper decline in profitability.

For sugar mills, debt levels in March are typically elevated, given the need to maintain inventory during the lean production season that continues till September.

Says, Kiran Kavala, Associate Director, CRISIL Ratings, “The current sluggishness in sales due to the pandemic will push up inventories, resulting in elevated debt levels this fiscal. This, coupled with lower profitability, will moderate the ratios of cash accruals to total debt and interest coverage¹ to 0.09 time and 1.6 times for the sample set, from 0.13 time and 2 times, respectively, in fiscal 2020 – indicating downward pressure on credit metrics.”

Integrated mills, however, will fare better than those with semi-integrated or standalone sugar operations.

¹earnings before interest, depreciation, taxes and amortization (EBIDTA) divided by interest & finance cost.