Stock Call. Dwarikesh Sugar Industries offers a sweat deal for investors

Investors with a medium-term view can buy the stock of Dwarikesh Sugar Industries , an Uttar Pradesh-based sugar mill. Higher revenue from the sugar and distillery segments in the 2020-21 sugar season is expected to augur well for the company’s earnings in the current fiscal.

At the current price, Dwarikesh Sugar Industries discounts its estimated earnings of 2020-21 by 3.8 times.

This is at the lower end of its PE valuation of 4-13 times in the past five years .

Favourable dynamics

The demand-supply dynamics is favourable for the firm currently. While in the initial days of the lockdown it was feared that sugar demand in the 2019-20 season (October-September) would drop sharply, demand destruction has not been that bad so far.

In the past few months, with strong demand for Indian sugar emerging from Iran and Indonesia, excess supply in the domestic market has also been absorbed. The Indian sugar mill industry may export at least 5.5 million tonnes (mt) of sugar this year (October 2029-September 2020) against 3.8 mt last year.

Sugar output in the current year, as per the estimates of the Indian Sugar Mills Association (ISMA), is likely to be around 27.2 mt, up from the earlier estimate of 26.5 mt but still significantly lower than the 32.9 mt in 2018-19.

Sugar prices, which were ₹31-31.5/kg in March, have since recovered and are quoting at ₹33-33.5/kg now. The international price of raw sugar has also recovered from 10 cents per pound in March to about 11.5 cents per pound now.

In the sugar season 2020-21, there may be a jump in output to about 30 mt(estimate of ISMA based on acreage till June).

Given the strong prospects for exports (Thailand, a major sugar exporter, is likely to see a sharp fall in output), demand-supply will be favourable in the domestic market, supporting prices.

The Centre may, by next month, announce its export policy for 2020-21 — compared with the 6 mt export quota for the industry last year, the quota for 2020-21 may be higher.

Performance in FY20

Dwarikesh has three business segments — sugar, power co-generation and distillery. While the sugar segment contributes 75 per cent to revenue, the power segment’s (capacity is 86 MW, of which 56 MW is surplus and is sold to State grid) share is about 20 per cent. The balance 5 per cent comes from ethanol.

In sugar, the profit margin is 3-4 per cent; in distillery, it is a tidy 43-45 per cent.

The power segment gave a profit margin of over 40 per cent in 2018-19 , but now it is 30-32 per cent as the UP government reduced the tariff rate on bagasse-based power from sugar mills.

In the March 2020 quarter, Dwarikesh recorded sales of ₹461 crore, up 119 per cent (y-o-y), thanks to higher revenues from sugar (on account of higher domestic sales quota and exports).

An increase in distillery sales, following new capacity addition of 100 kilo litre per day (KLPD) in December 2019, also helped.

The net profit for the quarter was up 37 per cent ( y-o-y). For the full year 2019-20, the overall sales growth was 23 per cent. The net profit, however, was down to ₹73.45 crore due to a fall in operating profit margin to 10.6 per cent vs 15.2 per cent in 2018-19.

This is despite better realisation in sugar (₹2,967.8/tonne vs ₹2,962.8/tonne) and distillery (₹48.4/litre vs ₹40.3/litre) segments. Profits were marred by a drop in realisation in the power segment — ₹2.9/unit vs 5/unit.

Margins in the distillery business reduced compared with last year’s despite higher realisation following an increase in the price of molasses.

Outlook for FY21

In 2020-21, the prospects for sugar export revenues are strong. Demand will be upbeat as Indian mills can fill the void created by the absence of Thailand mills.

The revenue from the distillery business is also expected to scale higher as an old unit of 30 KLPD, which is not operating currently, will also start to run, and the newly added 100 KLPD capacity will also function fully.

The company is expected to produce a total of 3.5-3.75 crore litres of ethanol in 2020-21 compared with 1.3 crore litres in 2019-20. The government has made the mixing of ethanol with petrol mandatory as it reduces vehicular pollution.

A target of 10 per cent ethanol blending in petrol by 2022 and 20 per cent by 2030 has been set; currently, the blending is about 5 per cent.

Given the continued good demand from oil marketing companies for ethanol, the capacity addition at Dwarikesh will help it benefit from the increased demand. The firm has also entered the hand sanitiser business.

On the margins front, higher contribution from the distillery segment and the impending hike in sugar MSP should help.