Harendra Kumar, MD- Institutional Securities, Elara Capital in conversation with Editor, N Mahalakshmi on why Balrampur Chini is his best investment pick for 2021.
For more insights, log on to www.outlookbusiness.com
#Investing #Stockstowatch #Strategy #Business #OutlookBusiness #OutlookMagazine #OutlookGroup
For more insights, log on to www.outlookbusiness.com
#Investing #Stockstowatch #Strategy #Business #OutlookBusiness #OutlookMagazine #OutlookGroup
Category
🗞
NewsTranscript
00:00 [MUSIC PLAYING]
00:20 Outlook Business Investment Summit 2021
00:22 is brought to you by icicadirect.com.
00:26 Welcome, ladies and gentlemen, to the next session
00:28 of Outlook Business Investment Summit.
00:30 We have with us Harendra Kumar, Managing Director
00:32 Institutional Equities, Ellara Capital.
00:34 He has more than 25 years of experience
00:36 in the industry, tracking capital markets.
00:39 And he's been a regular writer in the My Best Pick
00:42 special edition of Outlook Business
00:44 with a stellar track record.
00:46 Thank you so much, Harindra, for joining me
00:49 on this discussion today.
00:50 Please go ahead.
00:51 You can present your investment case.
00:54 Thank you, Mahalakshmi.
00:56 The idea that we have selected is Balrampur Chini.
01:00 And I think what it has is many triggers
01:03 for the story that is unfolding for the company as a whole.
01:06 While many people just focus on the company,
01:09 we would like to start off with the compound approach
01:11 to why the triggers are going to be long, enduring,
01:15 and sustainable.
01:17 So it comes back from what Mr. Modi has set out
01:20 as doubling of farmers' income.
01:22 If you understand, two or three big states,
01:26 like Uttar Pradesh, Maharashtra, and Karnataka,
01:29 have a lot of sugar farmers.
01:30 And they are a very large political constituency.
01:34 And what we've seen over the years
01:35 is that you have this game pricing that goes up,
01:38 and there are arrears.
01:39 And there is a continuous cycle of good debts, bad debts.
01:45 And that's how these companies would operate.
01:49 That is one issue.
01:50 Number two is the government has a very large import bill
01:55 in terms of crude oil imports.
01:58 And then in the second term, the government
02:00 has given a clarion call of Atmanirbhar Bharat,
02:04 where we are looking at reducing our import dependency
02:09 on different countries.
02:11 So you put these two together, and you
02:14 see that the government has come up with a phenomenal biofuel
02:17 policy, which basically says that the oil marketing
02:22 companies will take x number of ethanol from sugar companies
02:27 and blend it with petrol and sell it.
02:31 So here you're coming up to strategic objectives
02:33 of the government with one policy.
02:35 And this is just the beginning.
02:37 So the policy was rolled out a couple of years ago.
02:40 And you are seeing that the industry is adapting
02:44 to this change that the government has put forward.
02:46 So this is the overall construct of what
02:49 we're going to see over the next 10 years
02:51 as enduring policy and change for the sector.
02:55 So number one.
02:56 Coming to point number two is you have always
02:58 seen that the sugar cycle used to go up and down
03:01 with level of sugar production.
03:03 You had boom years where sugar would go up,
03:05 your inventory would build up, and prices would correct.
03:08 So you had these cycles which were going up and down.
03:11 And the prices would also reflect in a similar fashion
03:13 with strong prices.
03:14 So what this ethanol policy does is
03:16 it takes away a certain portion of the sugar
03:19 and gets diverted towards ethanol,
03:21 where you have a guaranteed offtake by the OMCs.
03:25 So the inventory, which used to play a large part of the cycle,
03:28 now becomes a non-variable.
03:31 It is not such a big variable.
03:32 So the cyclicality of the industry goes away, number one.
03:37 Number two, obviously, this is very good for the farmers
03:41 because the sugar prices eventually
03:43 go up with lower inventory.
03:45 And the sugar companies will get an additional revenue stream.
03:49 Now, the beauty of this is the policy
03:52 has been designed that the break-even
03:53 for a sugar manufacturer who's producing ethanol is two years.
03:58 So this incentivizes sugar mills to go out and produce,
04:01 set up ethanol plants.
04:03 It's very aggressive blending targets.
04:06 One is 2022, '25, and then it's 2030.
04:11 Initial two years, a lot of companies
04:13 are circumspect that the government will honor this one.
04:16 But over the years now, they've seen
04:17 is that the OMCs have done a guaranteed
04:21 offtake for the next five years.
04:22 Now, this has brought a lot of confidence into the sector,
04:25 and many people are investing towards this.
04:27 So what you're going to see is now a normalized inventory
04:30 cycle, which used to play havoc with the sector.
04:33 And there's arrears, et cetera, which
04:35 is going to get normalized.
04:36 You're going to get an additional revenue stream, which
04:38 is higher on the margins, higher on return on capital employed.
04:43 And given that the inventory is going to be low,
04:45 the returns on sugar are also going to go up,
04:47 because the prices are likely to remain firm.
04:49 So erstwhile sugar companies, which are cyclical,
04:52 now become steady compounders over the next three, four,
04:57 or five years.
04:59 So this is just the beginning of the cycle,
05:02 and this has a long way to go from here.
05:05 A few questions come to mind, Arendra.
05:08 One is that, how credible is this change
05:12 that we are talking about?
05:14 You're saying that this whole industry, driven
05:17 by government regulation, is moving
05:19 from being a cyclical industry to a structural change.
05:24 How much credibility do you give to the changes that are brought
05:28 in by the government first?
05:30 So this is a very good question, because this
05:34 is what all the investors had in mind when we started
05:36 talking about the company.
05:38 And credit to the government that they
05:42 have played their part with a very good policy,
05:46 and they have pushed the OMCs for the offtake.
05:48 So even in terms of payments, the government's on time.
05:51 The offtake is on time, and there is no policy flip-flop.
05:55 Now that the new government is going
05:56 to continue for another four, five years,
05:58 so at least you know that visibility is going to be there.
06:01 The offtakes are happening, the blending is happening,
06:03 and there is zero hiccup.
06:04 So it's only now that the confidence of the players
06:09 have come in that we can go and set up a new ethylol plant.
06:13 So prior to this, only Balrampur Chilli,
06:15 which was cash-rich, or some of the other players
06:18 had expanded capacities.
06:20 Now is when the industry will start to catch up and set up
06:23 more capacities.
06:24 That actually brings me to the next question, which
06:27 is there is a lot of sugar capacity,
06:31 mill distillery capacity in India, which means that--
06:35 and this sector has been ailing for quite some time
06:38 because of all the government policy with respect
06:40 to exports and minimum support price and all of that.
06:44 Now everybody looks at this opportunity,
06:46 and you also have mentioned that the margins in this business
06:51 are fairly high.
06:51 The ethanol margins are in the range of 40% to 50%,
06:55 and new capacities take about two, two and a half years
06:58 for a payback.
07:00 What is the risk to ethanol pricing,
07:03 considering that so much capacity will come in?
07:07 And secondly, can you give some insights into the price
07:11 discovery for ethanol itself?
07:13 Right now, I presume it is determined by the OMCs
07:16 and they get into long-term contracts,
07:18 and the government pegs the price.
07:23 What are the downsides to price and profitability
07:26 in this segment?
07:27 OK.
07:28 So Malakshmi, whenever the government fixes policy--
07:31 and it is very typical to a power sector, utilities--
07:35 they work not on absolute pricing mechanism,
07:38 but on a return on capital impact.
07:40 So they expect that what is a reasonable return on equity
07:44 that our industry is what we can offer,
07:47 and which makes it viable for companies
07:49 to invest in this space.
07:51 So what they have done is-- so the pricing
07:53 is always reverse calculated.
07:56 So in terms of what?
07:57 They would have, in their own wisdom,
07:59 come up with a return on capital employed of 40%,
08:01 45% to incentivize quick CAPEX cycle.
08:06 So a lot of people will come in, they will see the money,
08:08 and they will invest in the sector.
08:11 So that the government can reach its blending target of 10%
08:16 by 2022, 20% by 2025, and maybe higher.
08:21 See, Brazil runs at 100% ethanol.
08:24 But India has a long way to go.
08:26 So as long as India's vehicle population and petrol sales
08:31 are going on, the blending targets can keep on increasing.
08:35 So currently, it is a very small number of 8%
08:38 that is being blended.
08:39 Then you add the regular 5%, 6% demand tiger in petrol,
08:44 and an increased blending target.
08:46 So we don't see that this policy will undergo any change,
08:51 at least for the next five, six years.
08:53 Because the government has to give a long rope to the sector
08:56 before they achieve their blending targets.
08:59 So are you assuming that prices will remain stable
09:02 and these kind of return on capital employed
09:05 can be maintained over the next three to five years?
09:07 Yes, because it's not what you're giving,
09:10 because it's a very small sum that you're
09:12 giving to the sugar sector.
09:13 But what you are gaining in terms of import substitution,
09:19 in terms of reducing the volatility,
09:20 in terms of getting substitutions within India,
09:23 and what you're doing for your farmers.
09:25 See, you're writing off debts, plus the political risk
09:29 that you carry because of the volatility.
09:31 You're eliminating several things at one go.
09:34 So it's a small price to pay to sugar mills
09:37 with wide varied benefits.
09:39 So I don't think any political dispensation
09:42 will change given the benefits attached to this.
09:45 But Harindra, tell me if the solution was so simple,
09:49 why is it that it has taken so long for any government
09:53 to recognize this?
09:56 I think it fundamentally comes from the context
09:58 of a headline target that the government had
10:01 of doubling of farmers' income.
10:03 I don't think that people ever thought
10:06 that we wanted to uplift farmers and double their incomes.
10:09 If you see, the underlying change
10:11 has been that the government is saying,
10:13 unless I put in certain capital, there
10:15 is no return on capital from the farmers.
10:17 So over the last 20 years or 30 years,
10:19 the farm sector has been extremely under-invested.
10:23 It is only over the last four or five years
10:25 that people are saying, I need to give more
10:27 in terms of fertilizers, more in terms of insurance,
10:31 more in terms of certain policies,
10:33 and then you get a return.
10:34 Without investment, you don't get a return.
10:36 I think that's the fundamental change, number one.
10:39 Number two is you don't have one golden arrow
10:41 that I'm going to resolve all the farmer's issues.
10:43 There is a lot of small initiatives,
10:47 like the fisheries, pig farming, bamboo farming, poultry,
10:53 this biofuel.
10:54 So there are several initiatives around this
10:56 which are looking to double the farmer's income.
10:59 So there is a holistic headline thought,
11:01 and there are these micro measures
11:03 that the government is doing.
11:04 So the final question of valuation--
11:07 so on what metric and how do you value this company?
11:12 And in the historic context, where
11:14 does this valuation really sit?
11:17 Are you looking at earnings or EV by EBITDA or whatever?
11:21 Yeah, so Varnakshmi, my fundamental view
11:23 is there is only one valuation matrix.
11:27 It's basically 10 binomial in the elephant.
11:30 You look at one variable, and you put different variables
11:32 around it--
11:33 BPE, EV by EBITDA.
11:35 So my fundamental premise is you get a value for a company,
11:40 and the other all ratios are ways to interpret the--
11:44 Right.
11:45 Right.
11:45 So what is fundamentally changing
11:47 is from a cyclical company, it is
11:49 becoming a structural company.
11:52 So the sugar companies, metals, et cetera,
11:55 traded low PEs even on high-earning cycles,
11:59 they traded low PEs.
12:00 On low-earning cycles, they traded high PEs
12:02 because of subdued earnings.
12:05 This will change now.
12:08 Because the earnings will become sustainable and endure.
12:11 Just to interrupt you, so when you
12:13 say that this is moving away from cyclical,
12:15 what kind of revenue contribution
12:17 are you seeing from the ethanol business,
12:19 as opposed to the sugar contribution
12:22 in the overall revenue?
12:24 I think it is small.
12:25 It is around 20%, right?
12:26 Around that much.
12:27 It will keep increasing, right?
12:29 Plus, you will have cogent.
12:31 Plus, you will have--
12:32 they are using a different rise way of making ethanol as well.
12:37 So that whenever they don't have sugar--
12:39 so the companies will find ways and means
12:41 to keep the ethanol business going.
12:43 So the ratios will change.
12:45 The sugar business per se will not show high growth.
12:48 The rest of the high-return on capital
12:49 will come from the ethanol business.
12:51 Sure.
12:51 Right.
12:52 So what it is doing is the company's ROC
12:55 is moving from maybe 16%, 17%, to 22%, right?
12:59 So it is getting a spread of possibly 7% to 8%
13:03 on its cost of capital.
13:06 Right.
13:06 So I would assume that the company, which
13:09 is possibly trading at a 2x price-to-book now,
13:13 over the next three years, should start to trade at 3x
13:15 to 4x price-to-book, given the high return on equity,
13:18 and high return on capital employed,
13:20 and sustainable earnings.
13:22 So the risk, which was priced into a cyclical stock,
13:25 maybe--
13:26 that's why it was trading at mid-single-level PEs--
13:29 will start to go away.
13:30 Sure.
13:30 So I would guess that possibly at 250 rupees book value,
13:36 we should trade at 500, maybe 600 rupees stock.
13:40 Right.
13:41 If all the things that we are assuming play off, right?
13:45 And given the pedigree of the management,
13:47 the track record of buybacks and long cash flows,
13:50 I would say it's a very safe wager at the moment,
13:54 given the construct of the macro.
13:56 Right.
13:57 Tell me, the floor for this stock
13:59 is already set at 180, which was the buyback price.
14:03 And I presume it's 70%, 80%, or maybe, I don't know,
14:07 double of that right now.
14:09 So is that a good entry point, considering
14:11 that you've already run up in one, one and a half years
14:14 from 100 to wherever we are right now?
14:18 I think this is the beginning.
14:20 What it does, I think people have to understand
14:24 is the stock has been in a consolidation
14:26 phase for 10 years.
14:28 The price is only a reflection of the underlying
14:29 stock price, which means to say that the market was not
14:34 seeing anything new in the company.
14:36 At around 220, it breaks out of a 10-year zone.
14:41 So this is shifting orbits.
14:43 When you shift orbits, the possibilities are untested.
14:48 Right.
14:49 And it is obviously an appreciation
14:50 the market is recognizing that something dramatic
14:54 is underlying, and the underlying is changing.
14:56 Right.
14:57 So generally, people get really worried when stock prices
15:00 break out and they double.
15:03 The thumb rule should be buy at new 52-week highs,
15:07 because historically, stocks go on to set up new 52-week highs
15:10 after that.
15:12 It is a reflection that something big
15:14 is changing in the stocks.
15:16 And you could see this in numerous number of stocks
15:18 in the market today, Balrampur, Chile being one.
15:22 So you could time it, you could wait for it,
15:24 but the point is you could miss out on a larger rally.
15:28 Sure.
15:29 Final question.
15:31 There are a whole bunch of sugar stocks
15:33 which, if we were to just go by this theme,
15:35 the whole sector could be interesting.
15:38 And would you suggest a portfolio approach to--
15:42 usually, a portfolio approach sort of
15:45 minimizes or optimizes your risk when you are playing a theme.
15:50 Is that a strategy that you would propose?
15:54 Or stick to the--
15:56 So we've seen it many times in the past.
16:02 So typically, the head, the main company of a sector,
16:05 will start to rally and read it a lot.
16:07 You see that in Tata Steel now.
16:08 You see that in Balrampur, Chile, in the sugar space.
16:11 The tail will contribute.
16:13 There is no two ways about it.
16:14 So you will have--
16:16 you've seen people-- there is a Dwarkesh,
16:19 or there is a SriRenukasan.
16:23 Bajaj Hindustan attempted to rally.
16:26 But that is bereft with risk.
16:29 We don't know what the management's are thinking,
16:31 how they will participate, what they will do.
16:34 So as a portfolio, the best stock, yes.
16:37 As tactical allocation, you could possibly
16:44 pick a few, maybe a couple of more.
16:47 And I'm sure they will also pay off.
16:50 But that you need to be quick in your entry and exit
16:54 while you could hold on to your portfolio.
16:56 Sure, sure.
16:57 Thank you, Harindra.
16:58 It was really insightful.
17:00 Thank you so much.
17:01 And it's a refreshing change from all the things
17:04 one has heard of.
17:05 And especially in times like this
17:06 where people like to play it safe,
17:10 look at more predictable earnings, et cetera,
17:12 this transition story is particularly interesting.
17:15 So thank you so much.
17:16 [MUSIC PLAYING]
17:19 (upbeat music)