The India sugar industry has seen many bitter battles, between cane growers and the sugar mills, the sugar mills and the government, and GoI and the other governments. The uncertainty and cyclicality of the sector had put many investors off sugar mills. But now it looks like this might change. The government’s recently set ethanol-blending targets have sweetened prospects of the mills. As more sugarcane is diverted towards ethanol, surplus sugar in the country will reduce and the commodity’s price will stabilise.
In the coming years, we believe the Indian sugar industry will follow the Brazilian model, in which companies produce sugar only to meet the domestic demand, and excess cane will be used for more profitable ethanol production. This will reduce the uncertainty in sugar sector’s earnings and lead to its structural rerating. Balrampur Chini Mills (BRCM), as one of the largest player in the sector, is expected to benefit from this.
BRCM has a fully integrated ethanol distillery and power-generation (cogeneration) capacity using by-products. With the government’s thrust on achieving 25% blending target by 2025, the company has expanded distillery capacity by 50%, from 360 kilo litres per day (KLPD) to 520 KLPD. It has announced a further capex of Rs. 4 billion for direct-juice/grain-based ethanol facility of 320 KLPD. This will take the total capacity to 840 KLPD by November 2022. The new plant will generate an ROCE of 30%+ with a payback period of around two years at full capacity.
Led by ethanol division, the company’s EBITDA margin is expected to increase to 16.5% in FY22E from 14.4% in FY20, and its RoCE is expected to improve to 24% from 16.1% over the same period.
One of its strengths is its operational integration — sugar plus ethanol plus co-generation. Therefore, end-product of one vertical becomes raw material for the other efficiently. This allows the company to maximise value for every cane stick crushed.
BRCM has sugarcane crushing capacity of 76,500 tonne per day, distillery capacity of 520 KLPD and a saleable co-generation capacity of 165.2 MW. Installed co-generation capacity is 268.41 MW. The integrated business model helps derisk from sugar cyclicality and helps maximise returns during the upcycle.
Rewarding shareholders
Due to prudent cashflow management, BRCM has been generating steady free cashflow for the past several years and it has been distributing cash back to the shareholders via buyback or higher dividend (See: Sweet symphony).
Over the past five years, the company has bought back 25 million equity shares for an aggregate amount of Rs. 4.2 billion. In July 2020, the Board of Directors approved buyback of 10 million shares via tender offer route for total amount of Rs. 1.8 billion for Rs. 180 a share. The buyback was completed in August 2020. BRCM has also paid dividend for the past seven out of 10 years — Rs. 3.6 billion (excluding dividend tax) over FY09-19.
Ethanol: booster shot
For the company, the ethanol segment would be a key growth driver. It will benefit from higher production as well as realisation.
The government has increased ethanol price 4x over the past three years, to incentivise new capex. Cumulatively, over FY19-21, it has hiked procurement prices of ethanol by 10%-25%. Ethanol price is dependent on prices of sugar, sugarcane and cost of production. With increase in sugar price in the last two years and sugarcane price last year, the commensurate increase in ethanol price has been timely. Along with government’s proactiveness in increasing ethanol price, the delinking of its price from crude oil and instead linking it with the raw material has given assurance to the industry of making healthy margins in ethanol. In fact, margins of 45-50% are sustainable in the foreseeable future. New capex in ethanol has a payback of two to three years and an ROCE of over 40%.
We expect revenue CAGR of 28% and an EBIT CAGR of 27% over FY21-23E. With abundant supply of molasses, contribution from B-heavy (the intermediate stage of molasses) is likely to be higher at 80%, resulting in higher blended realisation of Rs. 53.4 per litre. Besides, OMCs have provided the much-needed visibility on demand and revenue front by issuing a new five-year ethanol tender which will now encourage the company to further expand its ethanol capacity (See: Problem of plenty).
There is a huge demand for ethanol in the offing, with OMCs’ contracts and ethanol production capacities way behind the blending targets set — of 10% by CY22 and 20% by CY25. During 2020-21, this measure of blending would require 3,800 million litres of ethanol. But, contracts entered into by OMCs were for 3,250 million litres, for around 8.5% blend levels.
With new ethanol production capacities being set up, we expect 4,500-5,000 million litres of ethanol production by CY21-22E, equivalent to 10-11% blend levels only.
BRCM has seized the opportunity by expanding its distillery capacity. With an estimated capex of Rs. 3 billion, a new plant is coming up in Uttar Pradesh, which will have the flexibility to switch between direct sugarcane juice and broken rice which would help operate the plant round the year. The new plant will generate an ROCE of 44% with a payback period of a mere two years.
Apart from adding new capacity, debottlenecking of old plants has also increased operational days from 270 to 330, giving higher operating leverage since molasses is available in plenty.
Lower sugar for health
We expect BRCM to divert more sugarcane to make B-heavy molasses, one tonne of which produces 320 litres of ethanol on an average. This would lead to lower sugar production by 4% CAGR in FY21-23E.
Sugar recovery rate is expected to reduce from ~11.4% in FY20 to 10.2% in FY23E. Thus, we expect revenue growth to remain muted over FY21-23E. However, BRCM’s sugar division is likely to post 6% EBIT CAGR over the same period due to several policy interventions and higher sugar prices (See: Much to celebrate), led by increase in sugar MSP by Rs. 2 per kg.
Sugar prices stabilising around Rs. 34 per kg may aid in EBIT margin improvement by 110bp to 6.5% in FY23E, from 5.4% in FY21.
Cyclical no more
The Indian government has over the past few years announced various initiatives to support the profitability of the sugar industry such as offering minimum support price (MSP) of Rs. 31 per kg for sugar and stable cane price that offers a floor to sugar prices particularly in surplus scenario; a bio-fuel policy that enhances operating flexibility in ethanol manufacturing; a subsidy that encourages sugar exports and helps reduce oversupply; and creation of a buffer stock. With these measures, the industry has now entered a structural uptrend as earnings have now become less volatile.
Financials
The company has generated cumulative free cash flow (FCF) of Rs. 12.2 billion over the last five years. Over FY21-23E, we expect robust FCF at Rs. 24.8 billion, due to higher profitability in the ethanol segment and improvement in sugar segment performance. Therefore, gross debt is likely to reduce to Rs. 5.4 billion in FY22E from Rs. 13.9 billion in FY20, while the company will turn net cash in FY22. Gross debt-to-EBITDA will drop to 0.6 in FY22 much lower than the 2.1 in FY20, and gross debt-to-equity will fall to 0.2 from 0.5 over the same period (See: Liquid gold). We expect ROCE to improve to 24% from 16%.
There are many factors working in BRCM’s favour and, the company has the ability to expand without adding any undue stress on its balance sheet.
