The sugar sector is being overhauled, as the government and the industry push for more sustainable business models by raising the ethanol-blending target to 10 percent by 2022 and doubling it by 2030, ICICI Direct has said in a report.
The cabinet on August 28 approved Rs 6,268 crore subsidy for the export of six million tonnes of sugar for the 2019-20 marketing year that starts in October.
The move is aimed at liquidating surplus stock and help mills in clearing farmers’ arrears. Industry watchers say the move is positive for the sector and will benefit cane growers.
“With new bio-fuel policy introducing ethanol production through ‘B’ heavy route, most sugar companies are expanding their distillery capacity,” an ICICI Direct report said.
The government has approved a soft loan (interest subvention of 5%) for 114 projects. This would lead to an annual capacity of more than 200 crore litre by 2023. These measures will help escape the sectoral cyclicity and reinstate sustainable earnings for sugar companies.
Sugar companies have seen strong earnings in FY19 but cash flow from operations is still negative, mainly due to high production.
“We believe that with the liquidation of current sugar inventory and diversion of sugarcane towards ethanol, sugar companies would witness higher cash flow from operations in FY20E & FY21E,” the report said.
Sugar stocks are trading at 3-7x one-year forward price to earnings. On a P/BV basis, the stocks are trading at 0.7-1.2x one year forward book value.
ICICI Direct believes that with sustainable earnings, the book value of sugar companies will grow 30-60 percent over the next two years. “Without considering any re-rating, we believe sugar companies would at least command 1.0-1.5x one year forward book value,” it said.
The brokerage firm initiates coverage on the sugar industry, with a buy recommendation on Balrampur Chini, Dhampur Sugar, Dalmia Bharat Sugar, Dwarikesh Sugar, Triveni Engineering and Avadh Sugar.
A list of six stocks where ICICI Direct initiated coverage with a buy rating that could give 20-30% return in the next year:
Balrampur Chini Mills: Buy| LTP: Rs 129.40| Buy| Target: Rs 165| Upside 27 percent
Balrampur Chini is likely to generate Rs 471 crore, Rs 514 crore of earnings in FY20E & FY21E, respectively. The stock is trading at an FY20E price to book of 1.1x and FY21E P/BV of 1x.
On a PE valuation multiple, the stock is trading at 5.7x FY20E earnings and 5.3x FY21E earnings. Considering higher earnings visibility led by its high distillery capacity, A deleveraged balance sheet and historic strong performance in down cycles, ICICI Direct values the stock at 1.5x FY20E book value to Rs 165 per share.
Dhampur Sugar Mills: LTP: Rs 149.35| Buy| Target: Rs 200| Upside 34 percent
Sugar prices have been stable after the government introduced MSP (minimal selling prices) and monthly sale quota. In FY19, the company witnessed strong earnings, however, cash flow from operation still remains negative considering higher sugar inventory led by robust sugar recoveries.
The brokerage firm expects the earnings to grow by 12 percent in FY20E. Also, it would generate positive cash flow from operations in excess of Rs 200 crore in FY20E, which would help the company to deleverage its balance sheet and working capital requirement would come down from Rs 1,100 to Rs 800 crore by FY21E.
The brokerage firm values the stock at 0.9x FY20E book value for the target price of 200 per share.
Dalmia Bharat Sugar: Buy| LTP: Rs 76.35| Target: Rs 100| Upside 30 percent
With stable sugar prices, increasing sugar volumes on account of sugar exports and higher distillery sales, ICICI Direct expects strong earnings for sugar companies.
Dalmia Sugar has a strong balance sheet, considering Rs 700 crore net peak debt (including working capital requirement). Debt to equity for the company remains low at 0.6x.
ICICI Direct values the sugar business at a 5x EV/EBITDA to Rs 91 per share and value of investment (Dalmia Cement) at Rs 9 per share, which is at a 60 percent discount to the current market price.
Dwarikesh Sugar: Buy| LTP: Rs 23.40| Target: Rs 30| Upside 28 percent
The stock is trading at 4.8x & 2.9x its FY20E & FY21E earnings. Moreover, on price to BV, the stock is trading at 0.8x & 0.7x its FY20E & FY21E book value.
ICICI Direct believes that government initiatives will protect sugar segment from losses in an excess production scenario. Further, new distillery capacity would result in strong earnings growth in FY21.
The brokerage expects the company to generate operating cash flow of Rs 37 crore and Rs 104 crore despite increasing inventory levels. Also, at the current price, the stock offers more than 4% dividend yield. Considering better operational parameter & stronger balance sheet, we value the stock at 1.1x FY20E book value.
Triveni Engineering: Buy| LTP: Rs 54.50| Target: Rs 70| Upside 28 percent
Triveni Engineering is third-largest sugar company with more than 60,000 TCD of sugarcane crushing, 320 KLD of the distillery and 103 MW of power capacities.
With stable sugar prices, growing engineering business and increasing distillery capacities, ICICI Direct expects the company to witness a 26.3 percent CAGR growth in earnings to Rs 345 crore. Moreover, higher sugarcane diversion towards B-heavy ethanol would lead to the liquidation of existing inventory and generation of cash flow to the tune of Rs 67 crore & Rs 435 crore in FY20E & FY21E, respectively.
At the current price, the stock discounts FY20E & FY21E earnings at 4.4x and 3.7x. ICICI Direct values the company’s 21 percent stake in Triveni turbine at Rs 14 per share after holding company discount of 50 percent.
Avadh Sugar: Buy| LTP: Rs 219.35| Target: Rs 280| Upside 27 percent
Avadh Sugar is a UP sugar company with a crushing capacity of 31,200 TCD, distillery capacity of 200 KLD and co-generation capacity of 74 MW (salable power 50 MW).
With stable earnings, elimination of cyclicity in sugar stocks is a possibility. At CMP, Avadh is trading at 0.7x its FY20E book value and 0.5x FY21E book value.
Given large distillery capacity, Avadh can utilise excess molasses from other companies to increase revenues and earnings from distillery segment.
However, to reduce its working capital debt, the company will have to divert higher sugarcane towards B-heavy ethanol. ICICI Direct values it at 0.9x its FY20E book value per share for the target price of Rs 280 per share.
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