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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 325 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

Robust quarter led by better sugar realisation and inventory gain

* During Q3FY22, Avadh net sales increased by 7.2% y-o-y at Rs 7,465.2 mn led by better sugar realisation. Sugar sales volume declined by 3.7% y-o-y to 168.9 mn kg while domestic realisation was up by a whopping ~11.6% y-o-y to Rs 35.5/kg. During the quarter, the Company exported 38 mn kg of sugar. Sugar segment reported an EBIT profit of Rs 350.5 mn against a loss of Rs 3.1 mn reported in Q3FY21 owing to better realisation and inventory gain. Sugar inventory as on December, 2021 stood at 178.6 mn kg.

* Distillery segment revenue increased by ~9.8% y-o-y to Rs 1,037.6 mn during the quarter, led by a higher contribution from B-heavy ethanol. Ethanol volume declined by ~8.5% y-o-y to 17.93 mn litres while average realisation increased by 19.9% to Rs 57.9/lt. Segment EBIT margin decreased by 766 bps y-o-y to 25.1% or Rs 260.8 mn against Rs 309.9 mn reported in Q3FY21, mainly due to lower ethanol sales and higher molasses transfer price.

GoI initiatives 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, GoI announced a slew of positive measures in 2018-2019 which have started reaping benefits.

* With higher diversion of sugarcane towards ethanol and exports, pan-India sugar inventory at the end of Sugar Season (SS) 21 was 8.3 mn vs. 10.7 mn tn in SS20. Severe drought followed by frost in Brazil, resulted in firm international sugar prices, which encouraged domestic sugar mills, especially from Maharashtra and Karnataka to enter into an agreement to exports ~4.5 mn of sugar for SS22E till date, of which ~2.5 mn tn is already exported. Thus, we believe, exports from India are likely to be ~6 mn tn for SS22E. With more ethanol capacities coming on stream, we expect higher sugarcane diversion towards ethanol production, leading to further decline in inventory levels for SS22E (closing inventory expected at ~7 mn tn), resulting in firm domestic prices going forward. As per ISMA, sugar production for SS22E is estimated at ~31.45 mn tn.

* SAP prices for SS21-22 is increased by Rs 25/quintal. However, impact of a higher SAP hike will get negated with better domestic sugar prices. On account of increase in FRP for SS22E, the Government has increased Ethanol prices for EY21-22, which augurs well for SI in general and Balrampur in particular.

Distillery segment to steer profitability going forward

* To have greater participation in EBP and better utilization of molasses, Avadh increased its distillery capacity by 20 KLPD in FY21 and 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.

* During the quarter, the Company has further enhanced its ethanol capacity from 240 KLPD 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 ~90 mn litres and ~113 mn litres of ethanol during FY22E and FY23E respectively.

* With expansion of new distillery, we expect Company to divert ~71 mn kg, ~98 mn kg and ~98 mn kg of sugar towards ethanol, resulting in lower sugar production at ~550 mn kg, ~560 mn kg and ~590 mn kg for FY22E, FY23E and FY24E respectively. Given the current scenario, we expect Avadh to report net sales of ~Rs 26.5 bn, ~Rs 28 bn and ~Rs 28.6 bn in FY22E, FY23E and FY24E respectively, with strong operating cash flow generation of ~Rs 4.2 bn, ~Rs 2.9 bn and ~Rs 3.5 bn during FY22E, 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 re-rating of the sector.

* We have valued the stock on the basis of P/E valuation method and assigned a P/E multiple of 8x FY24E EPS of Rs 118.3/share, on account of visibility in both inventory liquidation and debt repayment going forward, and maintain BUY on the stock with a target price of Rs 947/- in 18 months (51% upside).

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