Balrampur Chini

Company Overview

Balrampur Chini Mills Limited (BCML) was incorporated in 1975. It is the second-largest integrated sugar manufacturing company in India. The principal activity of the company is the manufacturing and sale of sugar.

● Besides this, the allied business activities undertaken by the company primarily
consist of manufacturing and marketing of ethyl alcohol & ethanol generation and
selling of power and manufacturing of agricultural fertilizers.
● The company has 8 plants in Eastern U.P. and 2 in Central U.P., totaling 10 sugar
factories. It has an aggregate crushing capacity of 76500 tones of cane per day, a
distillery capacity of 520 Kilo liters per day, and a saleable power generation capacity
of 168 MW.
● BCML is one of the most efficient integrated sugar producers in the country. The
company has grown its capacity by well-planned capacity expansion projects and the
acquisition of existing companies over recent years.
● In FY20, BCML crushed 10.2 mn tonnes of sugarcane with an adjusted recovery rate
of 11.4% leading to 1.16 mn tonnes of sugar production.
● 1.21 mn tonnes of sugar was sold out of which 0.26 mn tonnes was exported.
● Alcohol production stood at 12.8 Cr lit and 11.9 Cr lit was sold during the year out of
which 10.92 Cr lit was ethanol.
● 90 Cr units of power were generated of which 52 Cr units were exported.
● BCML is expected to gain significantly from the systematic shift that is currently
occurring in the Indian sugar industry.
● It is also expected that the historical cyclicality of the sector will be broken and a
more stable structure will develop going forward.

Government Initiatives Leading To Sector Tailwinds

• In the past, sugarcane prices had risen out of proportion with sugar prices due to Fair and Remunerative Pricing (FRP) for sugarcane, leading to an oversupply of sugarcane in the market which reduced sugar prices below the cost of production for mills. In 2018, the government introduced Minimum Selling Price (MSP) for sugar.

• MSP will stabilize the industry in the short-term allowing mills to maintain cash flows and reduce cane arrears, while a permanent solution is being sought by linking cane prices with sugar and adopting a Revenue Sharing Formula (RSF) to determine the price of sugarcane.

• The government plans to ease the country’s oil import burden by increasing the level of ethanol blended with petroleum. With the blending target of 10% by 2022 and 20% by 2030, the government is aggressively promoting distillery capacity expansion by sugar mills. Ethanol production is not just another vertical for revenue but also a channel for mills to divert sugar production by using B-heavy molasses and direct sugarcane juice for ethanol production, thereby allowing mills to control their inventory levels.
• The government has approved export subsidies of Rs.10.4 per/kg and increased export quotas to clear excess inventory built up by mills in recent years. These and other measures make the sugar industry more attractive for investors.

Strong Operational Capacity Expansion

BCML has had significant capacity expansion to its distillery capabilities taking their current capacity to 520 Kl/day in early 2020, with another 320 kl/day capacity expansion already approved and is expected in 2022/23.

With industry-leading sugarcane, the crushing capacity of 76500 TCD BCML has enough to serve its distillery capacities.

Cash Flow And Debt Levels To Improve

With the release of inventory through exports and sacrifice for ethanol, working capital will reduce leading to cash flow improvements for the company. The subsequent reduction in debt levels will positively impact return ratios in the coming years.

Ethanol Is The Key To Unlock Value

• Ethanol can be used as a fuel additive which reduces the amount of oil required by the country. In turn, it provides significant benefits to the government in reducing the deficit.
• To achieve its target of 10% blending of ethanol in fuel, the Oil Marketing Companies (OMCs) estimate a requirement of 5.1 Bn lit of ethanol.
• Currently, India has a capacity of 3.55 Bn lit of ethanol. This demand-supply gap poses an opportunity for sugar mills which have been tasked by the government to increase their distillery capacities to meet the country’s demand.
• Soft loans to such effect have already been extended to mills by the government.
• Ethanol pricing has also been updated to reflect the desire to promote its production by linking the price of ethanol to sugar realizations and keeping them independent of crude prices.

The government has also mandated that different grades of ethanol will be priced separately. Currently, the pricing stands as follows:

• Ethanol from C-heavy – Rs.45.69/lit.
• Ethanol from B-heavy at Rs.57.61/lit.
• Ethanol directly from sugarcane juice at Rs.62.65/lit.

Managing Sugar Inventory Through Ethanol

• Sugar can be diverted into ethanol by utilizing different production methods, by using B-heavy molasses for ethanol production.
• A mill can reduce sugar yield by up to 2% and if sugarcane juice is used, sugar yield is brought down to 0.
• Mills especially BCML have expanded their usage of B-heavy molasses for ethanol leading to a reduction in recovery rate. This is the key during times of high sugarcane production as it allows mills to manage their sugar production and reduce inventory which frees up working capital and enhances cash flows.
• Following the capacity expansion in 2019/20, BCML currently has 520 Kl/day of distillery capabilities making it one of the highest in the industry.
• Another expansion of 320 kl/day has already been approved by the board taking the total to 840 kl/day.
• Management has indicated that 70% of the ethanol produced by the company will be through the B-heavy route leading to a significant volume of sugar sacrificed for ethanol, causing a reduction in recovery rate by ~1%. Going ahead, we can expect this to be the difference-maker for the company in improving its balance sheet and cash flows.
• The country will require an estimated 13 Bn lit of ethanol by 2030 to achieve the target of 20% blending.
• BCML is leading the way in enhancing capacities to service this demand which puts it in a favorable position.

Sugar Industry Poised To Shed Its Cyclical Nature

• Before the implementation of MSP in 2018, sugar prices were determined by market dynamics namely the supply side as demand had remained steady.
• Supply was determined by various factors of crop yield and remuneration to farmers
• Sugarcane has always been a crop that earned more per hectare than others like wheat and paddy, making it favorable for farmers to cultivate.
• The pricing mechanism was regulated through the Fair and Remunerative Price (FRP) which is a floor price guaranteed to farmers.
• Some states have a State Advised Price (SAP) which is usually higher than the FRP.
• Sugarcane prices historically have risen out of proportion to sugar prices leading to subdued sugar realizations during years of high production, along with the dues to farmers pilling up led to extreme volatility and gave the industry a cyclical nature.
• In 2018, MSP for sugar was set at Rs.29/kg, this allowed mills to maintain sales without facing losses and was the first step in tactically shifting the industry towards a stable future.
• At present, MSP stands at Rs.31/kg with recommendations to increase it further to Rs.33/kg and a long-term view of sustaining MSP at Rs.35-36/kg.
• Along with MSP, the Rangarajan committee has put forth a recommendation to utilize a Revenue Sharing Formula (RSF) for sugarcane pricing which links it to Sugar prices. This will be a major factor for the long-term health of the industry.
• The sales quotas were introduced again in 2018, where the maximum allowed quantity to be sold by mills is decided by the government on a monthly basis, to control supply into the markets.
• While this is currently helping maintain prices above MSP, the long-term de-regulation is necessary for the industry to become a value creator for investors.

Exports Providing Short-Term Relief

• The sugar industry in India is currently unable to compete globally due to our excessive cost of production which is considerably higher than current global sugar prices
• The government has approved an export subsidy of Rs.10.4/kg to allow exports and clear the huge inventory that has built up. However, this is not sustainable for long as objections have already been raised by the WTO and other major sugar producers like Brazil.
• While the government is taking measures to reduce the cost of production, sugar mills are expected to expand ethanol capabilities to sacrifice sugar to make up for the eventual end of the export volumes. BCML is dedicated to achieving this measure to minimize the impact of the export subsidy ending, i.e., the eventual loss of volumes currently being sold through exports will be diverted into ethanol.

BCML With Operational Superiority

BCML is currently the second-largest sugar producer in India, with its excellent cane crushing capacity of 76500 TCD.

• We expect the company to have sugar sales of more than 1.29 mn tonnes in FY21 leading to significant inventory reductions and freeing up of working capital.
• Sugar volumes are expected to keep growing at a consistent rate supplemented in the near term by exports.
• Implementation of RSF and subsequent reduction in the cost of production will benefit high producers like BCML.
• With the new ethanol capacity, BCML’s total ethanol capability will reach 840 KLPD. This will make it well-positioned to divert enough sugar into ethanol that once the export subsidy has lapsed, they will be sacrificing enough sugar to not feel the impact severely.

Key Highlights

• Revenue was up YoY by 50% owing to a revival in industrial demand post-Covid-19 lockdown with continuing export volumes.
• The second quarter is non-operational, where no sugarcane crushing takes place as it is near the end of the SY. The company utilizes its existing inventory to service the demand. Plant maintenance and repairs take place during this time, the cost of which gets debited from the P&L statement during the quarter itself.
• EBITDA margins were down to 9.9% from 15.2% in Q1. This is partly the normal course of the sugar industry, by being a non-operational quarter, and the rest attributed to an increase in the cost of production and its subsequent impact on the inventory pricing.
• The company saw a significant release of inventory allowing it to bring short-term debt to 0 from 1000 Cr in March. Long-term debt saw a reduction as well down to 300 Cr From 340 Cr in March.
• Sugarcane crushing will take place mainly in Q3 and Q4 which will bring short debt back up, however, management is confident it will be well below last year’s levels. We estimate a short-term debt level of 600-700 Cr which should bring the total debt of the company to 900-1000 Cr.

As sugar diversion is expanded and export subsidy continues to hold, for the time being, we believe BCML will continue to reduce its debt level further and enhance its cash flows and return ratios.

Con-call Takeaways

• The main highlight is the announcement of a new distillery to be set up at the Maizapur location. It will have a capacity of 320 KLPD, taking the company’s total to 840 KLPD. The project will cost approximate 320 Cr which will be funded by 70:30 debt to equity.
• This new plant will focus on ethanol production from sugarcane juice. It will also utilize grain for alcohol production during the offseason when sugarcane juice is not available.
• Post the plant coming online, 5% of the overall sugarcane will be diverted to the direct-ethanol route. Currently, 65% of sugarcane is utilized through the B-heavy route. We can expect substantial sugar recovery rate reduction as the Maizapur plant will not be producing any sugar once the distillery is operational.
• Management indicates their desire to divert 20% of their sugar production into ethanol. This will protect the company once export subsidies are lapsed and will prevent significant inventory disruptions as have happened in the past. They believe that others will follow the example set by them in pursuing this solution.
• Management believes that alcohol volumes can reach up to 30 Cr lit once the new unit is fully operational. This is a significant increase from the current level of 17.5 Cr lit.
• High ethanol volumes with prices linked to sugar realizations put BCML in a good position vis-à-vis managing inventory and debt reduction.
• The unit should commence operations in 24 months (FY23).
• Management commentary suggested that the government incentivizes sugar diversion into ethanol among other ways by allotting higher volumes to firms that are sacrificing sugar, which would put BCML in a preferred position.

Valuation And Outlook

• The sugar industry is poised for a systematic shift.
• MSP and exports stabilize the industry in the short term and ethanol production being the value driver for the future.
• A proposed change in the pricing strategy for sugarcane would make the sugar industry less volatile and attractive for investors.
• BCML and its superior sugar capabilities, focus on B-heavy ethanol, planned distillery expansion, and reduced indebtedness put it in a strong position to create value for investors.
• We value BCML at 1.55(x) FY22 P/Bv with a target price of Rs 193 and assign a “BUY” rating.