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Avadh Sugar & Energy Limited (Avadh) was incorporated in 2015 pursuant to business realignment of The Oudh Sugar Mills Limited (OSML) and Upper Ganges Sugar and Industries Limited (UGSIL). Originally, a part of the erstwhile K.K. Birla Group, it is now being led by Mrs Nandini Nopany, Chair Person and Mr Chandra Shekhar Nopany, co-Chair Person. It is engaged in the manufacturing of sugar, ethanol and power. It has four sugar factories located in U.P. having an aggregate sugar crushing capacity of 31,800 TPD, distillery capacity of 200 KLPD and co-generation capacity of 74 MW.
Well placed to capitalise on the positive structural changes in sugar industry (SI)
* Indian SI has been known for its cyclical nature and volatility. With an intention to change the fortunes of SI, the Government (GoI) announced slew of positive measures, which augurs well for it over the longer term. Due to a bumper production in Sugar Season 2018 (SS18), sugar prices slid from a peak of ~Rs 36/kg in November 2017 to below Rs 26/kg during March 2018, resulting in huge losses for sugar mills. To stabilise sugar prices, GoI introduced minimum selling price (MSP) for sugar at Rs 29/kg, later increasing it to Rs 31/kg. Hence, sugar companies are estimated to make positive profit margin even in a year of surplus. Also, GoI reintroduced sugar selling quota to control supply, provided export incentives to reduce inventory levels, created 3 mnt buffer stocks and provided soft loan to the industry.
* Further, to tackle mounting cane arrears, escalating oil imports bill and plaguing environmental concerns, the GoI is promoting and encouraging the use of ethanol, derived from molasses, for blending with petroleum. It increased both, ethanol prices and blending mandates. To augment ethanol output, the GoI so far has announced a soft loan of ~Rs 200 bn and provided an interest subvention of ~Rs 47 bn to sugar mills, and, to incentivise molasses based standalone distilleries, allocated Rs 26 bn.
* These steps will moderate the cyclical nature of the sector and will make it more predictable going forward. With recovery rate being ~11.8% for both the years, we expect Avadh to produce 0.68 million tonnes (mnt) and 0.67 mnt of sugar and sell 0.56 mnt and 0.58 mnt in FY19E and FY20E respectively. Avadh sugar sales realisation for FY19 stands at Rs 30.6/kg, while the Company is currently selling sugar at ~Rs 32/kg which is higher than the cost of production of ~Rs 30/kg. The recent hike in MSP will partly benefit the Company in Q4FY19 and fully in FY20E.
Distillery segment to steer profitability
* With a target to reach 10% and 20% ethanol blending by 2022 and 2030 respectively, the GoI re-introduced new National Biofuel Policy and new Ethanol Blended Petrol Program. It linked ethanol prices to sugarcane fair and remunerative price (FRP) and increasing ethanol procurement prices. India is expected to reach 7.5% of blending rate in SY19E. At 10% ethanol blending rate target, overall saving to the import bill would be ~USD 1.7 bn, 1.9% of India’s oil trade balance.
* With higher ethanol blending and procurement prices, ethanol business has proved to be a boon for the sugar producers in a period of ample sugarcane production. To have greater participation in the ethanol blending programme and better utilization of molasses, Avadh has planned to increase its distillery capacity by 50 KLPD, which is expected to get commissioned by September 2020. Further, the Company is setting up boilers which will increase its distillery unit’s operational days from 270 days to 330 days, thereby increasing the overall efficiency and scale of operation of the distillery. The cumulative capex for both stands at ~1.35 bn, funded through mix of debt and equity in ratio of 67:33.
* The Company is expected to sell 56 mn litres and 58 mn litres of ethanol in FY19E and FY20E respectively (against 49.5 mn litres in FY18). The GoI has revised the ethanol prices produced through conventional route with effect from December 2019 to Rs 43.46/litre compared to current Rs 40.85/litre. Benefits of rise in sales volumes and realisation will be partly seen in Q4FY19 and fully during FY20E. With continued improvement in realizations in both sugar and ethanol division and lower sugar production cost, we expect EBITDA margins to improve by 344 bps over FY18-20E to 15%. Further, profitability of the Company is expected to grow at ~31% CAGR over FY18-20E to Rs 1,521 mn.
* Presently, sugar industry is recovering from its recent troughs, through timely and game changing policy intervention related to sugar MSP, higher ethanol pricing, blending mandates etc., thereby, moderating sector cyclicality and improving profitability, leading to structural rerating of the sector. Avadh is well placed to capitalize on the positive structural changes led by firming sugar prices and highest ever recovery rates.
* We have valued the stock on the basis of consolidated approach of P/E and P/BV valuation method, assigning equal weights to P/E multiple of 5x FY20E EPS of Rs 152/share and P/BV multiple of 1.2x FY20E book value of Rs 648/share and recommend a BUY on the stock with a target price of Rs 769/- in 12 months (73% upside).
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