Sugar 2022: Sweet dreams are made of ethanol for this sector

The sugar industry is on the cusp of a mega transformation. The government's initiative to tie this sector with the need for clean energy is driving a structural change in this industry. Additionally, over the last few years, the government’s initiatives have changed the fundamentals of the sugar industry.

The oil marketing companies (OMCs) have started issuing multiyear ethanol tenders which give the sugar mills long-term visibility. Also, the government increased the ethanol price in line with the FRP (fair & remunerative price) prices, which also increases the ethanol realisation. Additionally, to encourage new capex in distilleries, the government gives loans at lower interest rates. In fact this year itself, 228 ethanol projects have got loans of more than Rs 18,500 crore.

Government Initiatives:

1. Multiyear ethanol tenders issued by OMC’s – Estimated Ethanol quantity to be procured by CY20-25

2. Higher realisations for ethanol: Ethanol prices for sugarcane route

*EY – Ethanol Year

3. Higher loan available at lower interest rates for setting up a distillery: 6 percent per annum or 50 percent of the interest rate offered by the bank whichever is lower.

The sugar sector is primed for sustainable and green growth. The ethanol market is pegged to be valued at $16.5 billion by 2030. To meet all the increased demand, the ethanol capacity needs to grow 3x by 2030. Ethanol production is expected to increase to 1,500 crore litres by 2026. In this year itself, the ethanol capacity has increased to 947 crore litres from 680 crore litres in the previous year. Some of the listed companies are doubling their capacity in the next two years with a capex of close to Rs 1,300 crore.

Industry Capacity Augmentation:

Ethanol capex on track:

Why Ethanol diversion makes sense?

Higher demand for ethanol and better realisations have ensured that the excess cane is diverted towards more profitable products. This makes more sense as well as it yields better returns. The increasing proportion of B-heavy ethanol (which is the co-product of sugarcane juice) has better RoE (return on equity) as well. The RoE on new ethanol plants with B-heavy molasses is much higher at 146 percent against the direct route, where its only 47 percent; also the payback period is only two years against five years.

Source: Systematix

In the last five years, the revenue from the distillery segment has grown anywhere between 25-60 percent and the profitability has seen similar growth. In the next two years, expect the revenue to grow at 15 percent CAGR (compound annual growth rate) and profitability to grow in the range of 25-30 percent. With this, the distillery segment will contribute close to 50 percent of the profits by FY25 against 35 percent currently and just 9 percent in FY17.

Revenue contribution by ethanol

EBIT contribution of Ethanol

EBIT Contribution of Ethanol (for the industry)

Diversion into the ethanol segment also helps companies deleverage their balance sheet. In the last couple of years, the combined net debt of sugar companies has increased by Rs 100 crore only, despite a capex of Rs 1,340 crore. Higher profitability has also had a positive impact on the company's cash flows. The net debt/EBITDA is likely to see significant improvement from its current levels of 1.3x in the next two years.

The sugar sector appears to be powering forward with sustainable growth, which would eventually re-rate the sector.