Jitendra Kumar Gupta Moneycontrol Research
Highlights: - Praj Industries commands a leading position in the growing ethanol business - The company has diversified away from ethanol - Opportunities exist in the new businesses too - The company has cash to fund growth
For Praj Industries (CMP: Rs 138, market capitalisation: Rs 2,518 crore), the December 2018 quarter was one of the best quarters in the recent past. The company posted a marked improvement in its business, particularly in its ethanol operations, which had been an area of concern. Order inflows saw a 68 percent increase and its order book swelled by 32 percent.
The government’s focus on increasing ethanol blending is once again yielding good results for Praj, which commands a leading position in the market.
So, what’s happening with ethanol? Ethanol supply has gone up in the recent past. During FY18, the industry supplied about 1.5 billion litres of ethanol to the oil companies, which is equal to five percent of blending and the highest in the recent history.
To incentivise sugarcane growers and help stressed sugar manufacturers deal with the supply glut in the market, the government has asked sugar mills to prepare for 10 percent blending by 2022, requiring a supply of close to three billion litres of ethanol, and to 20 percent, or 4.5 billion litres, by 2030.
To achieve these objectives, the government has already raised ethanol prices, provided interest subsidy and pressed for faster sanction of loans.
Praj, which has about 70 percent market share in the domestic ethanol plant installed capacity, has been the front runner in the sector. In the December quarter, order inflows saw a 68 percent increase and ethanol formed close to 70 percent of the total inflows as against 42 percent in the corresponding quarter of the previous year.
Not just an ethanol story Praj was always an ethanol play, but due to policy hiccups it rarely met investor expectations. Thankfully, the company started to tap the export market and gradually shifted to related businesses.
The company is no longer just an ethanol story. It has successfully developed and demonstrated engineering capabilities in waste water treatment, critical process equipment, biogas plants, breweries etc.
Today ethanol, which used to be 80 percent of revenue in FY12, has come down to 50 percent as other emerging businesses take over and make a meaningful contribution to de-risking its business.
Its engineering business, which supplies process equipment to industrial clients in the oil & gas, petrochemicals, fertilisers, biotechnology and other industries, is well established. The segment is sitting on an order book of close to Rs 200 crore, or 21 percent of the total order book.
The company has recently developed compressed biogas plants and bagged three trial orders from Indian Oil Corporation.
The Ministry of Oil & Gas has recently said it wants to establish 5000 biogas plants by the end of 2025. These plants would be used for extracting the gas from agriculture residue, cattle dung, municipal solid waste etc. This will entail an investment of close to Rs 1.75 lakh crore and companies such as Praj, because of its know-how, would have an early mover advantage.
The company has also built a strong position in the breweries industry, accounting for 65 percent market share. This is a growing business, where the company provides customised plants and solution to brewery companies.
Industrial water purification and waste water treatment has also turned out to be a big area. Its Praj HiPurity Systems (pure water) is established with almost all major pharmaceutical companies in the country. Consolidation in the pharma industry, focus on exports and stringent regulatory oversight, including USFDA, have emerged as an opportunity for Praj. This business accounts for 14 percent of revenue and seven percent of the order backlog of the company.
What are the risks? While business risks are adequately addressed, investors should be mindful of the cyclical nature of the industry. Government policies on ethanol and other programmes undertaken by the oil PSUs have a huge bearing on its financial performance. In the event of a slowdown in the end-user industry, Praj could face challenges both on the operating front and in scaling up the business. If that happens, its valuation premium too could disappear.
Enough ammunition for growth At its current market price, the Praj Industries stock trades at 20 times FY21 estimated earnings, slightly on the higher side, largely reflecting a strong turnaround in the business and industry. However, investors should wait for a better entry opportunity.
The business is growing, backed by a strong order book and timely diversification. A key trigger would be improvement in capacity utilisation from the current about 65 percent, boosting profitability and margin.
In FY18, the company earned an EBITDA margin of 5.6 percent, which is expected to double by FY21. What is more, the company is sitting on cash and cash equivalent of close to Rs 350 crore, which is 30 percent of the capital employed in the business. This not only eliminates the balance sheet risk, but provides ammunition for growth if the opportunities open up on expected lines.
Note: This article was originally published on 26 March 2019 for our premium subscribers. After this, the stock has moved up marginally and thus the valuation data shown in the graphics is only for the information purpose and needs to be adjusted in the current context
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Disclaimer: Moneycontrol Research analysts do not hold positions in the companies discussed here
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