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Company Background

Avadh Sugar & Energy Ltd. (Avadh) was incorporated in 2015, pursuant to business re-alignment of Oudh Sugar Mills Ltd. (OSM) and Upper Ganges Sugar and Industries Ltd. (UGS). 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 integrated sugar factories located in U.P. having an aggregate sugar crushing capacity of 31,800 TPD, distillery capacity of 325 KLPD and co-generation capacity of 74 MW. A slew of structural reforms undertaken by the GoI in recent years has positively changed the fortunes of the sugar industry from its erstwhile morass.

Investment Rationale

Stable quarter led by better distillery performance and higher sugar realisation

* During Q1FY23, Avadh’s sales increased by 11.2% y-o-y at Rs 6,880.7 mn led by better distillery performance and sugar realisation. Sugar sold during the quarter was lower by 6.6% y-o-y at 138.8 mn kg, led by lower sugar exports by 11.1 mn y-o-y at 21.1 mn kg, while domestic sugar release remained stable. Average sugar realisation improved by 6.4% y-o-y to Rs 34.7/kg. Sugar segment reported an EBIT profit of Rs 165.7 mn vs. Rs 140.3 mn reported in Q1FY22 owing to better realisation. Though, sugar segment in Q1FY22 included export subsidy income of Rs 193.4 mn, which was not there in Q1FY23. Sugar inventory as on June, 2022 stood at 241.3 mn kg

* During FY22, sugar sales volume declined by 10.4% y-o-y at 620.9 mn kg led by lower domestic sugar release and lower exports, while average realisation improved by 6.4% y-o-y at Rs 33.9/kg. Sugarcane crushed during FY22 was lower by 8.9% y-o-y at 526.36 lakh quintals, while sugar recovery based on B-heavy molasses was down by 43 bps y-o-y to 10.27%, owing to adverse weather conditions and red rot disease. For Q1FY23, crushing went up by ~8.7% to 89.17 lakh quintals; but net recovery, post B-heavy molasses diversion was down by 100 bps y-o-y to 9.88%.

* Distillery segment revenue increased by ~47.3% y-o-y to Rs 1,616.9 mn during the quarter, led by a higher contribution from B-heavy ethanol and direct sugarcane juice. Ethanol volume improved by ~41% y-o-y to 26.7 mn liters while realisation increased by ~4.5% to Rs 60.5/lt. Segment EBIT margin decreased by 1,783 bps y-o-y to 24.7% or Rs 400 mn vs. Rs 467.3 mn reported in Q1FY22, mainly due to lower molasses transfer price and ethanol production from direct sugarcane juice.

GoI Ethanol play supporting sugar industry (SI), sustaining sugar prices

* Indian SI has been, till recently, known for its cyclical nature and volatility. With an intention to change the fortunes of SI, keeping farmers’ interest in mind, GoI announced a slew of positive measures in 2018-2019 which have started reaping benefits.

* All India sugar production in SS 21-22 is expected at 35.8 mn tn, after considering diversion of 3.4 mn tn of sugar equivalent into ethanol. Till date, it is estimated that industry has ended doing physical sugar export of ~10 mn tn. Further, Government has allowed an additional 1.2 mn tn of sugar exports for SS21-22 which will result in total exports of ~11 mn tn for SS21-22. Domestic sugar consumption is also on an increasing trend. Thus, with higher diversion of sugarcane towards ethanol, higher exports and consumption, we expect a decline in inventory levels for SS22E (closing inventory expected at ~5.5 mn tn), resulting in firm domestic sugar prices going forward. Sugar prices are expected to remain strong till Mid-November 2022, post which prices are likely to soften with the onset of new crushing season i.e. SS22-23. Recently, the GoI has increased Fair and Remunerative Price (FRP) by Rs 15/quintal to Rs 305/quintal (effective hike after basis recovery adjustment is Rs 7.5/quintal), which will not have any impact on Uttar Pradesh (UP) sugar mills, as UP sugarcane prices are determined from SAP, which we expect to remain unchanged for SS22-23. SAP was hiked by Rs 25/quintal in SS21-22. However, with an increase in FRP, we expect an upward revision in ethanol prices, which if happens, will result in better earnings for Avadh. In our FY23E & FY24E assumptions, we have not factored higher ethanol prices.

* For, SS22-23, ISMA expects net sugar production at ~35.5 mn tn, while consumption is expected at ~28 mn tn. Therefore, India needs to export ~7 mn tn of sugar for SS22-23 in order to keep domestic sugar inventory under comfortable levels.

Distillery segment to steer profitability…

* To have greater participation in EBP and better utilization of molasses, Avadh increased its distillery capacity by 20 KLPD to 240 KLPD in FY21 and installed incineration boiler and turbine at Hargaon & Seohara distilleries, enhancing operational days from 270 to 330 days.

* During Q3FY22, the Company further enhanced its ethanol capacity to 325 KLPD, with a capex of ~Rs 1.35 bn, funded through a mix of debt/equity of 7:3. The new distillery will divert excess sugarcane for ethanol production through B-heavy and sugarcane juice and we expect Avadh to produce ~11 mn litres of ethanol each during FY23E and FY24E respectively.

* With expansion of new distillery, we expect Company to divert ~90 mn kg of sugar towards ethanol, resulting in lower sugar production at ~570 mn kg and ~600 mn kg for FY23E and FY24E respectively. Given the current scenario, we expect Avadh to report net sales of ~Rs 29.2 bn and Rs 28.7 bn in FY23E and FY24E respectively, with strong operating cash flow generation of ~Rs 4.3 bn and ~Rs 3.5 bn during FY23E and FY24E respectively.

Valuation

Presently, the sugar industry is recovering from its recent troughs, through timely and game changing policy intervention related to sugar MSP, higher ethanol pricing, blending mandates, favourable export policy etc., thereby, moderating sector cyclicality and improving profitability, leading to structural rerating of the sector. We have valued the stock on the basis of P/E valuation method and assigned a P/E multiple of 7x FY24E EPS of Rs 107.8/share, lowering it from 8x last quarter, on account of company’s reliance on exports to liquidate inventory, and recommend a BUY on the stock with a target price of Rs 754/- in 18 months (45% upside).

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