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Company Background

Dhampur Sugar Mills Ltd. (DSML), promoted by Mr. Ashok Kumar Goel, Chairman and Mr. Gaurav Goel, Managing Director, is one of India’s largest integrated sugar business engaged in the manufacturing of sugar, ethanol and power. It has two sugar factories located in UP having an aggregate sugar crushing capacity of 23,500 tonnes per day, distillery capacity of 250 KL/day (based on C-heavy molasses route) and co-generation capacity of 121 MW. In May 2022, the business of DSML (pre-demerger) has been equally split between DSML and Dhampur Bio Organics Ltd. (DBOL) to enable succession planning in the promoter family, where shareholders have been given one share of DBOL for every share held in DSML. 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

Subdued quarter led by multiple one-offs

 * During Q2FY23, DSML net sales increased by 41.5% y-o-y at Rs 6,442 mn led by 52.5% yo-y increase in domestic sugar volumes at 93 mn kg on back of higher domestic sugar release. Domestic sugar realisation improved by 4.6% y-o-y to ~Rs 35.4/kg. Sugar segment reported an EBIT profit of ~Rs 100.4 mn against Rs 286.6 mn reported in Q2FY22 owing to additional cost primarily related to previous periods amounting to ~Rs 90 mn on account revision in wages w.e.f. October 2018 as well as increase in molasses quota from 18% to 20% for Sugar Season (SS) 21-22. Sugar inventory as of September 2022 end is 42 mn kg valued at an average rate of Rs 31.55/kg.

* Distillery segment revenue decreased by ~11.7% y-o-y to Rs 1,008.5 mn during the quarter, on account of production disruption due to technical reason. Ethanol volume declined by ~17.9% y-o-y to 15.7 mn liters while average realisation increased by ~2.8% yo-y to Rs 58.9/ltr. Segment EBIT margin decreased by 963 bps y-o-y to 26.9% or Rs 270.9 mn against Rs 416.6 mn reported in Q2FY22, mainly due to higher molasses transfer price lower ethanol sales volume.

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, keep farmers’ interest in mind, GoI announced a slew of positive measures in 2018-2019 which have started reaping benefits.

* For, SS 22-23, ISMA expects net sugar production at ~36.5 mn tn, after considering diversion of 4.5 mn tn of sugar equivalent into ethanol, while consumption is expected at ~27.5 mn tn. The sugar export policy for SS22-23 is expected anytime, which might result in exports of ~8-9 mn tn, thus keeping a check on closing inventory as on September 2023 at ~6 mn tn. Higher international crude prices and lower global sugar production have resulted in firm international sugar prices. Further, Rupee depreciation has been a blessing for domestic sugar mills, thus, exporting ~8-9 mn tn is not a concern. Domestic sugar prices which are stable at ~35-36/kg is expected to soften to ~Rs 34-35/kg with onset of current crushing season, which has already started in Maharashtra and Karnataka while Uttar Pradesh mills are expected to start crushing post-Diwali.

 * 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 Dhampur. In our FY22E & FY23E assumptions, we have not factored higher ethanol prices.

Distillery segment to steer profitability..

* To have greater participation in ethanol blending program, the Company is increasing its ethanol capacity from 250 KLPD (C-heavy molasses route) to 380 KLPD (including 100 KLPD on grain), with a capex of ~Rs 1.6 bn, funded through a mix of debt/internal accruals of 75%:25%, which is expected to commission during January/February 2023. The respective capacity under B-heavy molasses route post expansion stands at approx. 500 KLPD including 100 KLPD on grain.

* The new distillery will divert excess sugarcane for ethanol production through B-heavy and sugarcane juice and we expect DSML to produce ~9 mn liters and ~140 mn litres of ethanol during FY23E and FY24E respectively.

* With expansion of new distillery, we expect Company to divert ~90 mn kg and ~120 mn kg of sugar towards ethanol, resulting in lower sugar production at ~350 mn kg each for FY23E and FY24E respectively. Given the current scenario, we expect DSML to report net sales of ~Rs 23.2 bn and ~Rs 24.6 bn in FY23E and FY24E respectively, with strong operating cash flow generation of ~Rs 3 bn each 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 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 10x FY24E EPS of Rs 32.6/share and recommend a BUY on the stock with a target price of Rs 326/- in 18 months (~58% upside).

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