ICICI Securities re-rates sugar stocks, sees up to 52% upside
The sugar sector has seen a turnaround from being cyclical to a structural growth sector backed by government’s aggressive ethanol blending programme
Sugar stocks have become the talk of the town ever since the government in June released a roadmap for an ethanol blending programme. This decision has helped India’s sugar sector drift away from cyclicality (in terms of sugar prices) as well as from partial deregulation.
“Despite sugar stocks have seen 2-4x run-up in four months while valuation multiples have been re-rated from 3-5x to 8-10x PE (price to earnings ratio). The sector has seen a turnaround from being cyclical to a structural growth sector backed by government’s aggressive ethanol blending programme,” wrote Sanjay Manyal, Research Analyst at ICICI Securities in a report.
According to the brokerage firm, in the current ethanol procurement cycle, OMCs (oil marketing companies) would be procuring more than 300 crore litres of ethanol vs. 180 crore litre last year, which is closer to ~8% blending levels. It believes more than 15% blending levels would help the sugar industry to divert 6 million tonnes (MT) of excess sugar produced every year.
Improving profitability
ICICI Securities is of the opinion that with the massive increase in distillery capacities by sugar companies, ethanol sales are likely to double. Going forward ethanol sales would contribute 25-30% to revenues of major sugar companies by FY24. Moreover, reducing sugar inventories in the system are likely to push domestic sugar prices upwards. Both these factors would boost earnings for sugar companies in the next three years.
“Given the strong earnings growth visibility, sugar stocks are likely to command higher valuation multiples,” added Manyal.
Citing this the brokerage firm has a buy rating on these sugar stocks.
Balrampur Chini Mills | Rating: Buy | Price target: Rs 515 | Upside: 52%
Balrampur Chini is the second-largest and one of the most efficient sugar companies in India. It has announced a 320 KLD distillery expansion, which would increase distillery volumes to ~30 crore litre. Out of total volumes, ~6 crore litre would be produced through grains (broken rice).
With an increase in distillery capacities & an expected increase in sugar prices, ICICI Securities estimates a 17.7% earnings CAGR (compounded annual growth) in FY21-24E. It estimates free cash flow above Rs 500 crore every year for the next three years, which is likely to increase payout (dividend, buy-backs) to 60%.
Dwarikesh Sugar | Rating: Buy | Price target: Rs 110 | Upside: 48%
Dwarikesh Sugar is one of the most efficient sugar companies with the highest recovery rate in UP & ample sugarcane availability. It has a distillery capacity of 160 KLD, which can produce 5.5 crore litres of ethanol every year.
With the possibility of higher exports and domestic sales quota, Dwarikesh Sugar would be able to liquidate its excess inventory. The company would be able to increase its distillery volumes close to 3x in the next three years, which would help it to improve its operating margins by ~750 bps. With high earnings growth & inventory reduction, it would be able to generate an operating cash flow of Rs 150-300 crore every year.
Dalmia Bharat Sugar | Rating: Buy | Price target: Rs 650 | Upside: 44%
Dalmia Bharat Sugar would be the fastest in increasing its distillery capacity from 8.5 crore litre to 15-16 crore litre by March 2022. The company is expanding all its existing distillery capacities to utilise sugarcane juice & B-heavy route to produce ethanol.
With the strong cash flow generation and light balance sheet, the company would be able to increase its payout in future. We also believe small sugar mills or single unit sugar mills could be a potential acquisition target for the company given its de-leveraged balance sheet.
Avadh Sugar & Energy | Rating: Buy | Price target: Rs 685 | Upside: 43%
Avadh has a sizable sugar & ethanol capacity and is also further increasing its distillery capacity to utilise B-heavy route for producing ethanol. With the increasing clarity on global sugar prices and ethanol blending programme, a sugar inventory reduction is imminent. The company also has sufficient sugarcane availability to further expand distillery capacity in future. The brokerage firm has changed its cautious stance on the company given strong earnings growth and free cash flow visibility.
Triveni Engineering | Rating: Buy | Price target: Rs 270 | Upside: 38%
Triveni Engineering (TEL) is also one of the major beneficiaries of the ethanol blending programme given large availability of sugarcane in western and central UP. The company has produced more than 9.4 lakh tonnes (lt) in the current sugar season (larger than Balrampur) and has remained largely unaffected by the drop in sugarcane output in the state. Also, its distillery volumes have increased from 8.5 crore litre to 10.4 crore litre in FY21.
ICICI Securities believe sugar companies would be able to generate 25-30% of sales from the distillery segment. With strong earnings growth, cash flow generation, the company would not only be able to deleverage its balance sheet but is also expected to increase shareholder’s payout (dividend, buybacks) to ~40%.
Dhampur Sugar | Rating: Buy | Price target: Rs 500 | Upside: 37%
Dhampur Sugar has announced a demerger of the business to create two separate entities consisting of two equal sugarcane crushing, distillery & power capacities. The company is increasing its distillery capacity by 100-kilo litres per day, which would be commissioned in December 2021. Dhampur would be able to clock distillery volumes of ~17 crore litre after the capex. After the capex, the distillery segment would contribute 25% to revenues.
Dhampur has been quick to expand its distillery capacity to utilise the opportunity of 20% ethanol blending programme. ICICI Securities believe the company would be able to generate sustainable cash flows in future and increase its dividend payout. However, de-merger of the business into two separate entities would be an overhang in the medium term.