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Ethanol capex on track; margins to inch up...

The sugar sector has come out of the bitter cyclicality it used to witness before 2018. In the last four years several government decisions have improved the fundamentals of the sugar sector. On the one hand, floor price of sugar & monthly quota mechanism helped sugar millers to sell sugar above the cost of production while on the other hand sugar exports & sugarcane diversion towards ethanol led to the reduction in sugar inventories. Moreover, increasing proportion of B-heavy & sugarcane juice ethanol would result in significant improvement in margins for sugar millers. Despite record sugar production of 36 million tonne (MT) in 2021-22 sugar season, sugar inventories are going to be at a four-year low of 6.4 MT by the end of September 2022 mainly on account of record exports of 10 MT during the season. This has kept sugar prices firm at ~| 35/kg. Moreover, increasing distillery capacities would result in more diversion towards ethanol, which, in turn, would improve margins of sugar millers and also help in keeping sugar prices firm above the cost of production. It would also help in achieving 20% ethanol blending with petrol by 2025.

Sugar inventories at four year’s low of 6.4 MT

With the record 10 million tonnes (MT) of sugar exports in 2021-22 sugar season, sugar inventories on October 1 would be 6.4 million tonnes (MT). The government is ensuring the country meets minimal sugar inventory of ~6 MT on October 1 by regulating exports given India requires that much sugar for consumption before the new season sugar arrives by December 1 (sugar crushing starts in November). Considering this maths in mind, the government would allow export of 6-7 MT in 2022-23 sugar season. We expect global raw sugar prices to remain firm above 18 cents/lb. Moreover, white sugar prices have also been much more remunerative for Indian millers, which makes it easier for Indian millers to export sufficient quantities. Given the inventory levels of 6.4 MT as on October 1, domestic sugar prices to remain firm between | 34 /kg and | 38 /kg. These prices result in sugar margin of | 1 to | 3 /kg (3% - 6%). Sugar companies with distillery expansion are likely to see strong earnings growth backed by increasing ethanol volumes & debt reduction.

Ethanol capex on track; lifetime margins in next two years

Given aggressive capacity expansion for distilleries in last three years, ethanol blending levels have reached 10% in 2022. We believe current capex announced by sugar companies & grain based manufacturers would take ethanol supply to 6.5-7.0 billion (bn) litre in the next two years, which would be sufficient for 15-16% blending levels. We believe sugar companies are further required to divert more sugarcane towards ethanol to reach the level of 20% ethanol blending by 2025. With gross sugar production reaching at 39 MT, there is sufficient availability of sugarcane for ethanol production. However, sugar companies still need to take further distillery capacity expansion for achievement of 20% or more ethanol blending. Sugar companies in our coverage universe are aggressively expanding their distillery capacity. Most companies in our coverage universe would be diverting ~10% of its sugarcane towards sugarcane juice ethanol & rest towards B-heavy ethanol (except mandatory levy requirement towards ENA). This would lead to considerable margin improvement in next two years. Moreover, sugar inventory levels would come down significantly resulting in lower working capital debt and, in turn, reduction in interest costs. We remain positive on sugar sector & sugar companies under our coverage universe. After recent correction, sugar stocks are trading at 4-10x FY24 earnings. Within our coverage universe, we like Dalmia Bharat Sugar given it is most aggressive in ethanol capacity expansion & it has sizable refined sugar capacity for exports. We also like Dwarikesh Sugar given it has abundant availability of sugarcane in its catchment area & highest sugar recovery among UP sugar millers. Dalmia Bharat Sugar & Dwarikesh Sugar remain our Top Pick in the sector.

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