Dwarikesh Sugar Industries: Sweet recovery

This sugar manufacturer should benefit from a revival in sugar cycle

Investors with an appetite for risk can consider buying the stock of Dwarikesh Sugar Industries. The stock has been beaten down over the last seven months with surplus sugar production and falling market prices pushing sugar manufacturers into losses.

The year 2017-18 has been a period of bumper production for sugar in India as well as globally, with the market moving into surplus.

India’s output for the 2017-18 sugar season is expected at around 31 million tonne, a 50 per cent jump from last year. Sugar prices in the domestic market have crashed from ₹36-37/kg in September 2017 to about ₹26/kg now.

As mills have to pay an FRP (fair and remunerative price) of ₹290/quintal of cane (for recovery rate is 10.8 per cent), which brings cost of cane per kg of sugar produced (9.26 kg of cane) to ₹26.8, they are making losses.

However, given that the Centre is taking efforts to reduce losses of mills and those in Brazil are shifting to ethanol, it is a good time to do bottom fishing in sugar stocks.

If global prices recover, sugar companies in the domestic market may start to export, which will reduce the pressure on sugar prices here.

Among sugar stocks, Dwarikesh Sugar Industries is a good buy at the current market price of ₹24 a share. Based out of UP and with a strong balance-sheet, this company will be among the first few to benefit when the sugar cycle recovers. The stock trades at a price-earnings multiple of 4.5 times its earnings for 2017-18, which is at the lower end of its PE band for the last three years (3-12 times).

 

 

Sugar outlook

While in the global market, sugar prices have been ruling low since 2011, in India, the prices decoupled from the global market and moved higher from August 2015, with supportive measures from the government, including a mandate of compulsory sugar exports.

Prices moved from ₹23/kg in August 2015 to hit ₹37/kg in August 2016 and ₹37-38/kg last August. However, prices have since declined, with surplus sugar production.

This is thanks to the favourable monsoon and a yield much higher than expected. With crude prices rising above $70/barrel, and dollar gaining muscle against other currencies, oil imports have become expensive and buyers are looking to blend more ethanol in petrol.

Brazilian sugar mills have already started shifting more capacity to ethanol. In April, a UNICA (Brazil’s sugar industry association) report shows that mills used 66 per cent of their capacity to make ethanol and 34 per cent for sugar. If more cane is moved towards ethanol production, and Brazil’s sugar output drops, sugar prices can go up in the global market.

The other positive news is that nine sugar mills in Brazil are likely to close down in 2018-19, as they have run into losses and debt. This may also help tighten supply and push prices higher. If export prices turn remunerative, the Indian sugar mills may increase their exports which will reduce supply available domestically and push up prices.

The Indian government is also mulling several measures to reduce woes of the sugar industry and settle arrears of farmers. The measures include thrust for higher ethanol production, besides a MSP for sugar and creating a buffer stock in sugar to suck the excess supply.

 

 

Business

Dwarikesh Sugar has a cane crushing capacity of 21,500 tonnes per day. It is also engaged in ethanol (30,000 litres per day) manufacturing and co-generation (86MW).

Over the last five years, the company has de-risked its portfolio by increasing non-sugar revenues. The power segment contributes 14 per cent of revenue.

Dwarikesh uses bagasse (the residue left after juice extraction from cane) to generate power, 40 per cent of which goes into captive consumption and the rest is sold to the Uttar Pradesh State Electricity Board.

The company produces about 82 lakh litres of ethanol in a year. The segment contributes about 2-3 per cent of revenue.

Ethanol, a by-product (made from molasses), is one of the additives in petrol. The government has made the mixing of ethanol with petrol mandatory as it substantially reduces vehicular emissions and pollution.

The government allows blending of up to 10 per cent of ethanol in petrol; it intends to increase this to 20 per cent by 2020, which presents a lucrative opportunity for players.

Good financials

In 2016-17, Dwarikesh achieved strong sales (up 51 per cent) and profit growth, helped by higher sugar prices and improved profit margins, thanks to better logistics management and cost control. In 2017-18, while the first nine months were good, the last quarter saw erosion of profit margins on inventory write downs.

For the full year 2017-18, revenue was ₹1,458 crore, up 16 per cent and PAT was ₹101.45 crore, down 35 per cent. The operating profit margin for the year was 11.19 per cent, sharply lower from 24 per cent in the previous year.

Note that the company is one of the most efficient mid-sized sugar mills in the country. In 2016-17, it saw sugar recovery of 11.7 per cent. Unlike some sugar players, Dwarikesh doesn’t have a large outstanding debt. As of end-March 2018, the company had an outstanding long-term debt of ₹51.98 crore, down from ₹117.9 crore the previous year.

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