Saving Earth With Alcohol ?

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Founder’s Recap

Looks Like Its Going To Be Soft ??

No, that’s not what she said. It’s what the street is saying in the US right now.

The Fed raised rates last week by 25 bps, after a temporary pause before that. This brought interest rates to 5.25-5.50%, which is the highest they’ve been in almost 25 years. And yet, it doesn’t look like the Fed is done. The Fed Chair, Powell, said another rate hike could still be on the cards for this year.

But something interesting has been happening. Unlike earlier when the markets dreaded each rate hike, and feared commentary on what would happen next, the atmosphere has become rather relaxed now.

Picture this, last October, a Bloomberg survey of economists indicated a 100% chance of a recession in the US. What’s going on now? The US markets are on a two-week winning streak, and are just about 5% away from their all-time high.

What’s keeping the US markets pumping?

1. Inflation is under control - Last month, CPI fell to 3%, which has been a big relief. Yes, it is still above Fed’s target of 2%, which is why the Fed is still raising rates. But, it is much lower than the 9% it was in June last year
2. The economy is blazing - The US economy expanded at an annualised rate of 2.4% last quarter, as consumer spending remained buoyant. A super-low unemployment rate, and wages exceeding inflation have kept growth high despite expectations of a recession

What does this mean?

The resilience of the US economy, and cooling inflation are signs that things are on the right track. Given that the rate hike cycle was the fastest and steepest, most were expecting a ‘hard’ landing, aka a recession. However, a combination of cooling inflation, and strong economy are now tilting market expectations towards a ‘soft’ landing, which has also been responsible for the 44% YTD rise in Nasdaq.

Any impact on India?

India has been in a better place throughout the mess US went through. India’s superior position was led by more structural growth factors, high-impact reforms, favourable demographics, controlled inflation, and consequently increasing investor preference. Two dimensions of spill-over impact for India that we see are:

1. Foreign money moving out of India as the US, or other economies offer better risk-reward in the short-term. If global investors get an improving economic situation for lower valuations and higher upside elsewhere, they would trigger an allocation change, especially with India’s valuation premium being at its highest ever.
2. With the economy doing well, and the outlook getting better, corporate America might just start spending more money, and the hurt Indian IT sector might finally gain some visibility on turning the corner. Anyway, the stocks have been beaten down massively, and any visibility improvement here could make them good bets, with the rest of the market being expensive.

Market Stories

Praj Industries: Fuelling The Future ?

Picture this: it is the early 2000s and you’re on a plane that’s about to take off, but just before you do, the cabin crew makes the following announcement - “We’d like to disclose that the fuel used to run this plane is not entirely jet fuel, but is mixed with some grains that the team found lying around, but we should reach our destination!”

Everyone would freak out!

Yet, this actually became a reality in May 2023 when Air Asia took off from Pune to Delhi in the first ever commercial flight in India that used a blend of Sustainable Aviation Fuel (made of agricultural and forest waste) mixed with jet fuel, which does the same job but has the potential to reduce emissions by 65%!

If saving the world from emissions and reducing global warming is your jam, then boy do we have an interesting stock for you today - the mastermind behind the Air Asia flight’s success and a company that is contributing to India’s net-zero emissions goal in a rather unique way - Praj Industries.

Up 5x in the past 5 years, this company is among the top 10 Hottest Companies in the world in the sphere of low-carbon fuels, renewable chemicals and bio-engineering - all fancy words that we’re going to boil down into 2 main themes that will possibly propel Praj into the future even more!

Theme #1: Just Blend It

While we already saw the potential with aircrafts, with the global airline industry accounting for about 3% of all emissions, there is larger fiend that may hit more close to home - passenger vehicles, accounting for more than 15% of all emissions across the globe!

Back home in India, the story remains the same, with a heavy dependence on fossil fuels at around 90% for road transport. While one way to reduce this dependence is by shifting to Electric Vehicles, the emission from petrol/diesel vehicles can also be reduced by simply blending the fuel with ethanol.

• Ethanol is basically a biofuel that is made by fermenting sugar, whether that is through sugarcane or various food grains, like wheat or rice or maize
• When the ethanol molecules in the blended fuel come in contact with oxygen, the combustion process is more efficient for the engine, to the tune of a 50% reduction for 2-wheelers and 30% for 4-wheelers

Additionally, with more than 80% of India’s fuel needs being import-dependent, the government already pays a hefty price so cars can run. Ethanol also turns out to be cheaper than petrol and diesel, and a blend results in an overall reduction in fuel costs.

At a 20% blending ratio, flex fuel (a combination of ethanol and petrol) can be cheaper to regular petrol by at least Rs. 8-10/litre

??The National Policy for Biofuels 2018 aims to aid ethanol blending goals and reduce India’s dependence on fossil fuel imports to less than 60% over the coming years (from the current 80-85%), by increasing ethanol blending to 20% by 2026.

What Does Praj Have To Do With This?

• Praj’s job is basically setting up these ethanol manufacturing plants. With a 60% market share in India and a 10% global market share, being the patent holders to key, proprietary tech with regards to ethanol production, Praj is an expert here
• With an esteemed clientele like Balrampur Chini, Godavari Biorefineries, Indian Oil, HPCL and BPCL, the company has been instrumental in the ethanol-blending story over the past 5 years
• Praj’s revenue from this segment of the company has grown by 5x in the past 5 years, going from 52% of the revenue mix to 75% now

?? With the 20% blending target set for 2026, the country needs an additional 700 crore litres of capacity. With Praj’s established expertise, this can be a 1.5x opportunity for Praj on its current revenue base.

Theme #2: 2G > 1G

No, we aren’t talking about your network options, but the fact that there are actually 2 dominant types of ethanol that are manufactured - 1G and 2G. While the country’s bioethanol needs are currently met almost entirely by 1G, 2G is an up-and-coming alternative that may work in tandem with 1G to increase efficiencies and overall output.

But what is the difference between the two?

While 1G ethanol is currently cheaper, not just to set up but to buy as well (with 1G being around Rs. 65/litre while 2G is Rs. 95/litre), the 2G opportunity provides better cost efficiencies and further reduction in emissions in the longer run.

To work around the cost dilemma, the GoI and various entities involved in the movement are retrofitting existing 1G plants with additions to utilise the waste that comes from it to create 2G ethanol, instead of setting up new 2G plants altogether.

This also gives producers of 1G ethanol the ability to use waste, and further enhance ethanol production, yielding higher output from the same inputs.

Furthermore, the GoI had also sanctioned about Rs. 2,000 crore between FY19 and FY23 to set up demo plants for 2G technology to truly witness the benefits of a more sustainable option, the success of which can entail further monetary support from the government!

What Does Praj Have To Do With This?

• Praj is the first company in South Asia to set up a demo 2G plant, proving that its proprietary tech of using rice straw and feedstock works
• After proving itself, it then proceeded to set up and kickstart Asia’s first full-fledged 2G plant with Indian Oil in FY23, costing Rs. 900 crore and spans over 35 acres (yikes). The plant used crop residue that would normally be burnt, increasing emissions tremendously. In this way, this one plant reduced emissions to such an extend that is equivalent to taking 63,000 cars off Indian roads annually!
• Combined with Praj’s patented tech, proven history and general prowess in bioenergy, HPCL and BPCL also intend to partner with the company to set up 2G ethanol plants in the near future, with interest coming in from foreign players in Egypt and the US
• Praj is also entering into a joint venture with Indian Oil (50:50 split) to further improve biofuel capacities and work closely on other renewable sources of fuel (Compressed Bio Gas, Sustainable Aviation Fuel)
• Additionally, the company is also investing about Rs. 200 crore via capex (about 6% of FY23 revenues) into further experimentation in the fields of biofuels and biodegradable plastics, adding onto its vast list of patents

?? 2G ethanol is likely to pick up given (i) the government’s push (and parallel agenda of food security), and (ii) adoption by 1G ethanol maker (to increase yield). Praj’s first-mover advantage further increases its potential of gaining from the ethanol uptrend.

The Math For Praj

While the entire story does sound great, has it “fuelled” the company’s financials? Well, you tell us!

Currently, with expectations of a multitude of orders coming in to satisfy the goal of 20% blending by 2026, Praj may just witness more years of glory! Furthermore, while bioenergy does make up for 75% of its revenues, the rest of the 25%, which is the creation of water treatment plants and breweries (yes, the beer ones), the company’s overall prospects look great to us!

With the stock trading at Rs. 414 (as of July 28, 2023), it stands exactly at its historical one-year forward average PE of 24x. Taking all the sucrose-filled goodness into consideration, the stock could just trade at higher multiples of 34x based on FY24 estimates (assuming the ethanol story plays out), giving Praj’s investors the possibility of a continued ride on this gravy train.

So look out for the ethanol blended petrol in your nearest stations, and if you still haven’t seen it, Praj’s zeal might just make it happen sooner than you think!

We’ve discussed this and more on the latest episode of Common Cents by Rupeeting so do check it out:

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