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Company Background

Avadh Sugar & Energy Ltd. (Avadh) was incorporated in 2015 pursuant to business re-alignment 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 220 KLPD and cogeneration capacity of 74 MW. A slew of structural reforms undertaken by the GoI in recent years have positively changed the fortunes of the sugar industry from its erstwhile morass.

Investment Rationale

Weak quarter led by muted realisation, recovery and inventory drawdown

* During Q3FY21, Avadh net sales declined by ~20% y-o-y to Rs 6,936.2 mn, mainly on account of muted sugar realisation and lower recovery. Sugar sales volume declined by whopping 27.1% y-o-y to 175.3 mn kg while average domestic realisation was down by ~2.6% y-o-y to Rs 31.8/kg. Sugar segment reported an EBIT loss of Rs 3.1 mn against profit of Rs 143.4 mn reported in Q3FY20 owing to muted realisations, lower recovery and sugar inventory drawdown. Sugar inventory as on December 31, 2020 was 300.5 mn kg valued at an average rate of Rs 31.52/kg. Distillery segment steering profitability

* Distillery segment revenue increased by ~52.4% y-o-y to Rs 945 mn during the quarter, led by higher contribution from B-Heavy ethanol. Ethanol volume was up by ~41.8% y-o-y to 19.58 mn litres while average realisation was up by 7.5% to Rs 48.3/litre. Segment EBIT margin decreased by 600 bps y-o-y to 32.8% or Rs 309.9 mn against Rs 240.5 mn reported in Q3FY20, mainly due to higher cost of molasses.

GoI initiatives supporting sugar industry (SI), sustaining sugar prices

* Indian SI has been known for its cyclical nature and volatility. With an intention to change the fortunes of SI, the GoI announced a slew of positive measures in 2018/19, which has started reaping benefits. To stabilize sugar prices, GoI introduced Minimum Selling Price (MSP), reintroduced sugar selling quota to control supply, provided export incentives to reduce inventory levels, created buffer stocks, provided soft loans etc. and re-introduced new National Biofuel Policy and new Ethanol Blended Petrol Program with an aim to reach 10% and 20% ethanol blending by 2022 and 2030 respectively. The 20% blending target is preponed by five years to 2025. Hence, sugar companies are making positive profit margins even with high sugar inventory levels.

* Continuing the Policy, with increase in FRP and sugar selling price, the Government has increased ethanol prices for EY20-21 and to balance surplus sugar announced exports policy for SS20-21. The Group of Minister (GoM) has proposed to increase sugar MSP from Rs 31/kg to Rs 33/kg, which is yet to get a Cabinet approval. Any positive development on sugar MSP hike will result in upward revision in domestic sugar prices and Avadh’s profitability. Further, SAP prices for SS20-21 are kept unchanged.

* To have greater participation in ethanol blending program and better utilization of molasses, Avadh has recently increased its distillery capacity by 20 KLPD (had environmental approval for 50 KLPD). Further, the Company has successfully installed incineration boiler and turbine at Hargaon & Seohara distillery, enhancing 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 a mix of debt and equity in a ratio of 70:30. Going forward the management expects to have greater participation in B-Heavy ethanol and targets to sell total ethanol ~85 mn litres in FY22E.

* Given the current scenario, we expect Avadh to report net sales of ~Rs 28.5 bn and ~Rs 27.5 bn in FY21E and FY22E respectively, with strong operating cash flow generation of ~5.2 bn and ~4 bn during FY21E and FY22E respectively. This will be used to repay debt of ~2.5 bn and ~2 bn during FY21E and FY22E.

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 re-rating of the sector.

* 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 4x FY22E EPS of Rs 67.2/share and P/BV multiple of 0.8xFY22E BV of Rs 394/share, lower than industry average on account of high sugar inventory and high debts, and maintain BUY on the stock with a target price of Rs 292/- in 12 months (55% upside).

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