The evolving Biofuel Policy, infrastructural support and incentives from the government have turned the spotlight on Ethanol manufacturers so much so that the sugar companies have started seeing ethanol production as a structural and stable profit making business as compared to sugar whose cyclic pricings has its regular ups and downs. 

As per Harendra Kumar, Managing Director, Institutional Equities, Elara Capital, the investors have grown a positive outlook about the sector. “In the backdrop of changes in Biofuel Policy, the industry has made its adjustments. Since sugarcane is used in ethanol, the increase or decrease in production gets reflected in the change in prices. Sugar companies get additional revenue while farmers get definite prices. This encourages new players who have the possibility of reaching breakeven in two years. They were skeptical about the change in policies with the change in guard at the government level but with a stable government at the helm, everything has got normalized.” 

Investors who earlier weren’t much interested in sugar due to its cyclic nature are now looking for companies that have sustainable Return on Capital (RoC) and growth prospects. Apart from a good season of sugar production, companies are now also increasing the Ethanol capacities. 

With ethanol blending in India reaching more than 7.2% (first time ever to reach this level), in the first four months of the ethanol supply year 2020-21, there is a strong possibility that India will meet the target of 10% blending with petrol by 2022 and 20-25% blending by 2025 respectively. The regular blending will encourage the players to set up more plants. While earlier there were select players, now more are joining in due to the promise of higher returns at 40-60% that ethanol offers to them. 

Among the five top performing sugar stocks during 2021 include Rana Sugars Limited with price gain of 130.99% price gain, Dalmia Bharat Sugar and Industries Limited with price gain of 127.45%, Kothari Sugars and Chemicals at 122.48% price gain, Bajaj Hindusthan Sugar Limited at 100% price gain, and Dhampur Sugar Mills Limited at 99.67% price gain. The valuation of these companies as indicated by their market capitalization has increased substantially over the last financial year. 

Way Forward

In keeping with the long term benefits, the union government has offered a long rope to the sector before blending targets are achieved. While critics might flay the extra attention, Kumar feels that it is the right step in the right direction. “Government is making investments to pay off debts of farmers and incentives to sugar mills. It might appear huge and way too much but is actually a small price to pay for the wider benefits to stakeholders and returns it will bring for the overall economy.” 

Many are also questioning the delay in reaching the current blending targets. “Perhaps the lack of will by the successive governments, policy lag and under invested farmers were the reasons. Without investment, it is not possible to get returns. Be it fisheries, bamboo, poultry and biofuels which have emerged as new hotspots on investor maps, all have a certain gestation period which will get shorter due to holistic thought process and measures that the government is already ensuring now,” mentions Kumar at the recent Outlook Business Investment Summit held on 21-22 May through a virtual platform. 

So far the bigger chunk of revenues of the sugar companies, close to 85-90% used to come from the sugar segment and the rest would be from Ethanol. Since the latter is higher RoC business, it is expected to fetch more than 30% revenue to such companies which can now operate throughout the year. With little more predictability in revenue, the sugar company stocks will soar higher, resulting in better returns. 

On the question of valuation of companies for investments, Kumar puts the onus on continuity of business by sugar companies. “Investors will get a value for the company based on the continued production. Whenever they don’t have sugarcane, they must find other ways to produce ethanol. A company with RoC 16% to 20% will be a good bet. Such a company will trade 3-24 times on capital employed. For example Rs. 250 book value will be traded at Rs. 600,” concludes Kumar.