Fuelling The Future

Praj Industries Limited (PIL) is a leading manufacturer of ethanol and brewery plants with a domestic market share of 80 per cent and 50 per cent respectively. And with an 8 per cent share of the global markets, PIL is well poised to leverage on the capacity expansion from these segments.

PIL was established in 1984 and became a public limited company in 1993. The company is a technology and solution provider for ethanol, brewery and related bio-cycle solutions. The company is involved in the designing, manufacturing, supplying and commissioning of fermentation and distillation equipment for the manufacturing of alcohol and ethanol.

At present, PIL is in the process of identifying high yielding seeds to produce ethanol. The company is also looking at new ways to produce ethanol and alcohol through new technology for which it has invested Rs. 31 crore towards the expansion of its R&D facilities. PIL has also commissioned a Greenfield plant at the Kandla SEZ by investing an amount of around Rs. 170 crore. In FY07, the company added two new manufacturing facilities, including a unit in the SEZ. This expansion resulted in doubling the company's total manufacturing area to 450,000 squares.

Investment Rationale
Rising Crude Oil Prices
Ethanol is an alternative fuel and the rising crude oil prices will be a key driver in its demand. In the domestic market, petrol demand is expected to increase at a CAGR of 10.2 per cent, taking the demand to 15.2 million tonnes by FY12 from 9.3 million tonnes in FY07. This increase in demand for petrol, and the consecutive decrease in supply, will force the requirement of an alternative fuel and hence, act as a booster for ethanol and increase its demand as well.

In FY07, ethanol's demand was 650 million litres, which is expected to be at around 2139 million litres by FY12. This increased demand will call for a significant amount of capacity additions and PIL is well positioned to leverage upon such opportunities.

Growing Brewery Industry
PIL is amongst the top global companies involved in supplying equipment to distilleries. The company leads the national markets on this front with a share of 50 per cent. The domestic brewery industry is growing at a robust 20 per cent annually and this had induced many domestic and foreign players to announce capacity expansion programmes. By September 2007, 36 new beer and alcohol projects had been announced with a project outlay of Rs. 1488 crore. PIL's ability to benefit from such a healthy demand scenario appears promising.

Strong Order Book
PIL's current order book stands at Rs. 850 crore and a 35 per cent CAGR over the next three years is expected in the order book. The rising demand from the user industries will drive the company's top line growth. Around 60 per cent of the order book comprises international orders, which is equally distributed between Europe, US and South East Asia. Brewery plants account for about 15 per cent of PIL's order book, while out of the balance, 60 per cent is for ethanol plants using grain feedstock and the rest for ethanol plants using no-grain feedstock.

Foray into Bio-diesel Technology Leveraging on its more than two decades of experience of renewable bio-fuels, PIL has developed technologies for bio-diesel production. The company is also in the process of developing technologies for bio-fuels complex, where one can produce both bio-ethanol and bio-diesel. This technology leverage would help the company enter into the bio-diesel plant capacities.

Associated Risks
New Orders Paramount
Going forward, a majority of the order book comprises new capacities and orders and not the replacement of existing facilities as the life of a plant is around 15 years. Any delay or non-execution of proposed new capacities will impact the company's order book, and thereby sales and profitability.

High Raw Material Costs

Any dramatic increase in the cost of raw materials like steel and other metals can put pressure on PIL's margins.

Financials For the twelve months ending March 31, 2008, PIL's net sales grew by 15.4 per cent y-o-y to Rs. 701 crore from Rs. 607 crore. The net profits however increase by 68 per cent to Rs. 145 crore from Rs. 86 crore. The growth in bottom line was supported by higher incomes from the large investment book. The operating profit margin increased from 18.73 per cent in FY07 to 25.65 per cent in FY08.

One other thing that works in the favour of PIL is that it is a zero-debt company and the capex projects are financed through internal accruals only.

Valuations
At the current price of Rs. 134, the stock is trading at 18.6x and 14.1x in FY09E and FY10E, with respective EPS of Rs. 7.2 and Rs. 9.5. Considering the emerging opportunities, mainly from ethanol capacity expansions, PIL's leading position in the domestic markets and increasing reach in the global markets, the stock is trading at attractive levels after the recent dip and deserves higher P/E multiple. The stock has been trading between 14-30 P/E multiple and on a conservative basis, the stock can be valued at Rs. 152, 16x its FY10E EPS. The value of investments comes to Rs. 9 per share, which gives a target price of Rs. 161, an upside potential of 20.1 per cent from current levels.