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Sugarcane turning into prominent energy crop…

We initiated coverage on the sugar sector with our ‘August 2019 sector report’ on the premise of rationalising sugar inventory levels in the country and possibility of significant sugarcane diversion toward producing ethanol. Our view is materialising given sugar inventory levels are coming down from the peak of 14.5 million tonnes (MT) in September 2019 to ~8 MT in September 2021. Further, in the current sugar season, the industry would be diverting (sacrificing) 2 MT of sugar for ethanol production. With the government’s aggressive stance on increasing ethanol blending with petrol to levels of 20% by 2025, the industry is undertaking huge capacity expansion programmes to meet the ethanol requirement of 10 billion litre by 2025. We believe this distillery capacity addition to utilise the B-Heavy & sugarcane juice route to produce ethanol, would be earnings accretive after the significant increase in ethanol prices in last two years. Also, higher sugarcane diversion towards ethanol production would keep sugar inventory levels in check, significantly de-leveraging industry balance sheet.

Ethanol blending programme to rationalise sugar inventories

With the aggressive capacity addition by sugar companies in the next two to three years, the industry would be able to sacrifice 5-6 MT of sugar by 2025 to produce ~600 crore litre of ethanol. We believe the government’s target of 10% ethanol blending by 2022 can be easily achieved with the commissioning of many distilleries between October 2021 and March 2022. Further, to achieve 20% ethanol blending programme, ~300-400 crore litre of ethanol is required to be produced through grain based distilleries. We believe this has also opened one more revenue stream for sugar companies given some of them are setting up grain based distilleries as well.

Domestic sugar prices to move northwards

Sugar inventory levels are expected to come down to ~8 MT by September 2021 with the aggressive exports & diversion towards ethanol. We believe the industry would be able to maintain sugar inventories at 6-8 MT in future with increasing sugarcane diversion towards ethanol. This would result in domestic sugar prices moving up to reasonable levels. We believe higher domestic prices would also improve the profitability of sugar companies, going forward.

Improving profitability; attractive multiples

Given sugar companies would be commissioning or completing capacity addition in the next two years, the industry should see considerable improvement in earnings trajectory. We are incorporating FY23E numbers for sugar companies under coverage. We expect sugar companies to be able to completely de-leverage their balance sheet (including working capital debt) in the next two years and generate sustainable cash flows, going forward. Sugar stocks are trading at attractive multiples. We believe a multiple re-rating is imminent.

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