Sugar Industry: the ethanol story
@Aarti looking forward to you critiquing my view on sugar industry
Would like to begin by saying as sugar inventories are increasing, we are late into the cycle, before trouble breaks out for the weaker balance sheet players. Ethanol revenues continue to rise as a percentage of names like Balrampur chini and I expect this to play out over next few years also. However rising sugar inventory will lead to rising debts for sugar mills
Will Ethanol production end the cyclicality in the sugar industry causing a higher PE rating for the sugar industry of India?
The Nomenclature is such that 20% blended Ethanol with Petrol will be labelled as E20. - Target for 2025, earlier it was 2030, but the corporate capex and industry speed helped government prepone the target. So not seeing a long runway on this. 13.9% ethanol blending was achieved as of November 2024, rest of year target 15%. Now the question is how much more sugar company revenues can come from ethanol production in the medium term? How much ethanol revenue to expect for current 20% blend target?
For Balrampur Chini(Crores)
Expected Expected
FY20 21 22 23 24 15% target 20% Target
Revenue from ethanol 566 842 1001 1164 1689 2109.4 2812.6
Revenue from sugar 4423 4352 4263 4339 4697 4697 4697
Total revenue 4989 5194 5264 5503 6386 6806.4 7509.6
% REV FROM ETH 11.3% 16.2% 19.0% 21.2% 26.4% 31.0% 37.5%
Cr BL-ethanol 10.66 12.76 17.06 16.31 21.49 26.84 35.78
Cr BL for industry 189 173 290 434 506 631.97 842.63
Blend achieved 5.00% 5.10% 8.00% 10.02% 12.01% 15% 20%
Some quick calculations I ran, Balrampur chini currently has 26.4% revenue from ethanol, target of 20% blending will not be achieved over next few year, so we have crossed halfway mark of this, at 20% blend , Balarampur should have a 35%+ revenue from ethanol sales at a bare minimum. This is a very conversative estimate, company claims 50%, one can take a 40% estimate.
Some cyclicality is being reduced on the revenue side, possibly by half. Though, in no way in this sector cyclicality is coming down on Sugarcane(raw material) side, cane cursed is a function of produce, Agriculture commodities like sugar are always cyclical, some years more, some years less. In years we have low sugarcane produced – less is available for ethanol and sugar produce and revenue is down, and those years government would want to focus on food security than energy security – ethanol. Sugar prices are always above MSP of Rs. 31kg. On years when more is produced export is allowed of excess sugar after adequate reserve is maintained in country. That is a great revenue for the mills provided international sugar prices are holding above local mill costing. As you can imagine food security and stability of sugar prices is a primal aim here in this heavily regulated sector. As of now no sugar export allowed
State governments fix prices of Sugarcane awarded to farmers.
The Sugarcane cycle(which management wants you to believe is about to end and become straight line):
Stage1: Sugar prices are high, Sugarcane cultivated area is low, Sugarmills give out farmers payments on time.
Stage2: Sugar prices are not increasing, Sugarcane cultivated area increases because of timely payments last year, Sugarmills give out timely payments to farmers
Stage3: Sugar prices are low, Sugarcane cultivated area has increased further, Sugar mills are in trouble, they have to payout a government fixed price and sugar prices are low because of existing inventories
Stage4: Some sugar mills have filled bankruptcy, area under cultivation has reduced because farmers were not paid on time or not paid at all last time.
This typical cycle lasts 5-7 years. Now the new variable is Ethanol. The excess Sugarcane produce will be absorbed here till we do not meet targets. A bad year in our Sugarcane farms because of pest, draught, disease will be bad year for the industry as well. Revenues should be down. Although talking to farmers I have realized sugarcane is considered a very robust crop. It is not like cotton where you could end up with zero revenue after an year in a bad year. Even in bad years, some returns to be expected.
We have a requirement of 1016 crore litres of ethanol to meet 20% blend target. We produced for FY23-24 506 cr liters. In my estimate we have a few good years ahead till we reach excess again. However one must consider reserves, we will for sure as a nation start keeping ethanol reserves, although not sure how much will come from sugar ethanol. This increases the estimate to 5-7 years. Given we keep a sugar reserves.
Lets not get ahead of ourselves, At the end of the day, sugar and ethanol are both commodities, they will both be cyclical in the long run. No pricing power for the producers. Margins could come down sharply once we reach required production.
Now coming to the DCF part, projecting it out five years. Conservative margin should be 10-15% range going forward. Holding sugar revenue constant and Ethanol for a 20% blend Balrampur chinin for current market share would have a revenue of 7509 crore, Profit of 1126 crore. We should get a 17,000 crore valuation at 15 multiple. When will we reach this valuation is much harder to predict. Currently company market cap at 10,636. I have a small position in Balarampur Chini
Are we nearing the peak of the business and valuation cycle ?
We certainly have accomplished a lot since 2018 in sugar industry and investors have been rewarded a fair deal, so on the business cycle keeping new opportunities like bio plastics and export of ethanol out of the equation, we are in late cycle. In my humble opinion conservatively speaking 1-2 years left for investors to hit the eject button for ethanol play, but sugar seems to be done for now. if inventories keep on increasing. Valuation does not seem very high now, 15 is the median pe of the last 10 years, we at 24.6. Given TTM profit of 531, I’m buyer around 8000 crore Market cap. We will buying the sugar business at its Average Valuation, while not paying premium valuation for the ethanol hope case scenario.
