Ethanol story intact; sugar prices to move up…
In our March 2021 Sector Report, we had reiterated our positive stance on sugar sector along with an imminent re-rating. It is important to note that sugar stocks have seen 2-4x run-up in four months while valuation multiples have been re-rated from 3-5x to 8-10x PE. The sector has seen a turnaround from being a cyclical to a structural growth sector backed by government’s aggressive ethanol blending programme. In the current ethanol procurement cycle, OMCs would be procuring more than 300 crore litre of ethanol vs. 180 crore litre last year, which is closer to ~8% blending levels. We believe more than 15% blending levels would help the sugar industry to divert 6 million tonnes (MT) of excess sugar produced every year. With aggressive distillery capacity addition in India, our coverage sugar companies would see strong earnings growth over the next three years.
Clear roadmap for 20% ethanol blending
In June 2021, the government released a roadmap for ethanol blending programme that clearly set forth all important factors & guidelines for OMCs, auto OEMs, sugar and other related industries. We believe this depicts the government’s seriousness to implement the programme. With increasing molasses & grain based ethanol capacity, 10%, 20% ethanol blending by 2022, 2025, respectively, is achievable. The industry would divert 6 MT of equivalent sugar toward producing ethanol. This would reduce the sugar inventory to rational levels and drive domestic sugar prices upwards. We expect sugar prices to move towards | 36-37/kg by September 2022.
Increasing global sugar prices to smoothen exports
Global sugar prices have moved up 50% in last one year on the back of two consecutive years of lower sugar production by Thailand (major sugar exporter). Moreover, despite ongoing Brazilian crushing season, sugar prices have been firm considering expected 5-6 MT sugar production decline due to severe drought & crop destruction due to frost in many areas in south central Brazil. We expect global sugar prices to cross 20 cents/lb in the next one year, which would help the Indian sugar exports to the tune of 6 MT in 2021-22 season. Sugar exports are important given industry wise distillery capacities would take two years to get commissioned.
Improving profitability; attractive multiples
With the massive increase in distillery capacities by sugar companies, ethanol sales are likely to double for most of our coverage companies. We believe ethanol sales would contribute 25-30% to revenues of major sugar companies by FY24. Moreover, reducing sugar inventories in the system are likely to push domestic sugar prices upwards. Both these factors would boost earnings for sugar companies in the next three years. We estimate 15- 40% earnings growth for our coverage companies. Despite, the huge run up in the sugar stocks, valuation multiples are still 5-10x FY23 PE. Given the strong earnings growth visibility, sugar stocks are likely to command higher valuation multiples. We remain positive on the sector.
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