Indian sugar mills face 140-160 bps margin squeeze as ethanol earnings dry up

New Delhi: Indian sugar mills are staring at a 140-160 basis-point contraction in operating margins this fiscal as restrictions on ethanol production from sugar-based feedstocks erode a key source of higher-margin earnings, while rising sugarcane costs and increased funding requirements add to the pressure, according to Crisil Ratings.

Operating margins are expected to decline to around 6 percent this fiscal, despite an anticipated 4-5 percent growth in operating income, as firm sugar prices and steady demand prove insufficient to offset the adverse product mix, higher input costs and increased interest burden.

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The analysis covered 55 sugar mills, accounting for nearly a fourth of India's sugar production in the previous season.

The squeeze follows a significant policy shift. For ethanol supply year (ESY) 2027, ethanol production from sugarcane-based feedstocks has effectively been restricted to C-heavy molasses, sharply curtailing mills' ability to divert sugar towards higher-margin ethanol production. In recent years, nearly 10 percent of gross sugar output was routinely diverted to ethanol, according to Crisil.

The sector is also facing higher cane procurement costs. The Centre has raised the fair and remunerative price (FRP) of sugarcane by about 3 percent to Rs 365 per quintal for sugar season (SS) 2027. Any increase in Uttar Pradesh's state advisory price (SAP) would add further to the cost burden.

Sugar exports have also been curtailed following limited export permissions last season, restricting mills' ability to tap overseas markets.

Gross sugar production is expected to fall to around 29 million tonnes in SS 2027 from 31.1 million tonnes a year earlier, largely because of weather-related concerns affecting cane yields in key producing states. With consumption expected to broadly match output, the domestic supply-demand balance is likely to remain tight.

In a bid to shore up supplies, the government has permitted imports of 1 million tonnes of sugar between August and December 2026, marking India's return to sugar imports after nearly a decade. The additional supplies, along with other measures to maintain domestic availability, are expected to cap significant price increases even as sugar realisations remain firm.

"The earnings profile of sugar mills is undergoing a structural shift. Higher sugar prices will not fully compensate for the loss of higher-margin ethanol volumes and rising cane costs. As dependence on sugar and extra neutral alcohol (ENA) sales increases, operating margins are expected to decline by 140-160 basis points to around 6 percent this fiscal," said Anuj Sethi, Senior Director, Crisil Ratings.

Ethanol production from C-heavy molasses will offer only limited relief, with administered prices remaining unchanged over the past three years. The growing contribution of relatively lower-margin ENA sales is also expected to weigh on overall profitability.

The pressure is likely to extend beyond earnings to mills' credit profiles. Higher sugar prices will increase the value of inventories and, consequently, working-capital requirements, pushing up borrowings. The combination of higher debt, elevated interest costs and weaker operating profitability is expected to erode debt-servicing capacity.

"Credit pressure will be driven by moderating cash flows and higher funding costs. Interest coverage for sugar mills rated by Crisil Ratings is expected to decline to about 2.7 times this fiscal from 3.7 times last fiscal as profitability weakens.

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"While capital expenditure remains modest, mills with sizeable debt repayments and limited financial flexibility will face heightened refinancing risks," said Poonam Upadhyay, Director, Crisil Ratings.

The sector's outlook for fiscal 2028 will depend largely on the trajectory of sugar prices relative to cane costs, changes in ethanol pricing and monsoon performance. These factors will determine the pace of earnings recovery and the extent of credit stress across sugar mills.

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