India has set an ambitious target of achieving carbon neutrality by 2070. To reach here though, several dimensions will have to fall in place, and result in structural changes, which span over multiple decades.
Albeit the nascency, it has been encouraging to see several of these initiatives seeing the light of day, and marking an entry into the list of investing buzzwords. Amongst these, one that has gained popularity is of biofuels - especially ethanol.
The government has set an aggressive target of achieving 20% ethanol blending by FY26. And sugar being one of the key feedstocks for making ethanol, it should make the sector a great investment, isn’t it? But, no!
As inflation worries crept in over the last two years, the government directed sugar companies to stop channeling sugar for ethanol production. And there! Food was chosen over fuel, and sugar stocks underperformed.
However, just last week, the government lifted those restrictions, resulting in a spike in sugar stocks. Now that the problem is solved, do sugar stocks make for a good investment? Well, we don’t find the deal that sweet!
But there could be an interesting-looking alternative in the form of Praj Industries, which might just make a better cut as an investment option.
Sugar for Ethanol Is a Problem
The inherent problem with biofuels is that the primary raw material for making them is crop. And in a country like India, where ensuring food supply (both quantity, and at an affordable price) is an essential mandate for the government, it is often caught at crossroads.
And in such a conflict, moral high-ground will award food the de facto standing. And its not just about sugar - last year, the government had also imposed a ban on the purchase of rice from the FCI (Food Corporation of India) for grain-based ethanol distilleries.
Now that inflation worries have eased out considerably, just last week, the government lifted both restrictions - and it has now allowed sugarcane juice, B-Heavy and C-Heavy molasses to be used for, and 2.3 million tonnes of FCI rice to be permitted to be bought for ethanol production.
Sugar by Itself Is a Problem Too
Even an argument that sugar stocks would have the cushioning of its core business of sugar when ethanol dynamics are unfavourable would quickly deflate given the government’s price and supply control mechanisms.
In 2018, the government introduced an MSP (minimum support price) for sugar. However, sugar prices have been consistently higher than the MSP, forcing the industry body to request the government to increase the MSP by as much as 35% - which is yet to be acted upon.
Moreover, sugar companies can’t even take advantage of a global surge in prices, fuelled by droughts and wildfires in Brazil, which is the largest producer of sugar in the world. Because, to save our domestic stock, the government indefinitely banned sugar exports since 2022.
How to Invest in the Ethanol Theme Then?
An interesting investment idea in this chaos is a company called Praj Industries, which manufactures and sets up plants for making ethanol, biogas and beer - basically everything that needs micro-organisms to process.
In ethanol production solutions, Praj has a 60% market share in India and 10% globally, and it is a patent-holder to key, proprietary tech. It boasts of a clientele that includes the likes of Balrampur Chini, Godavari Biorefineries, Indian Oil, HPCL and BPCL.
This makes for an interesting idea because:
Starch > Sugar - Ethanol can be made not just using sugar, but also using grains like rice and maize. In fact as per management commentary, starchy feedstock has been making up for 75% of Praj’s domestic order book
Blending Ecosystem - Given India’s ethanol-blending targets, oil makers themselves are setting up ethanol plants too, and not completely relying on sugar makers. This means more equipment ordering from Praj
2G Picking Up - Tech advancement is resulting in viable production of ethanol not just from grains (1G), but also from inedible parts, bagasse and waste (2G), which further reduces waste, and further improves yield for manufacturers
Significant International Presence - Exports make up for 25% of Praj’s revenue, and ethanol being an equally high-growth industry, the geographic spread provides healthy diversification as well an advance testing ground
Other businesses - Praj also gets 25% of its revenue from other businesses like manufacturing critical engineering equipment for various industries, and supplying water systems for the healthcare sector
What Next for Praj?
At Rupeeting, we had invested in Praj Industries in the Value Migration smallcase in April 2022 at a price of Rs. 395 per share. However, when the government barred sugar companies from making ethanol, we exited the stock in December 2023 at Rs. 550 per share.
Post government restrictions, the stock saw considerable pain, especially in the last quarter:
The company’s order intake has declined by 20% YoY
Revenue declined by 5% over the last year
Revenue from the Bio Energy segment (ethanol) declined by 14% YoY
However, over the last couple of months, the stock has performed exceptionally given a healthy order backlog, new contracts from alternate feedstock, and strong performance of other businesses.
Of course, the government’s restriction-lifting paves the way for the stock to be back on its previous trajectory. But, we at Rupeeting, have been actively avoiding putting up with regulatory risk.
We are on a diet when it comes to investing in a business which has a high exposure to a sensitive area like food security, and hence unpredictably high regulatory risk. But if you’ve got the stomach for it, binge on!
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