Long-term investors can retain their exposure to the stock of Praj Industries, a leading solutions provider for ethanol plants, worldwide. The enhanced interest in bio-fuels the world over, thanks to a firm price outlook for crude oil over the medium term, and the mandatory ethanol blending in petrol in countries such as the US offer a robust demand scenario for Praj Industries.
Back home, Praj is also likely to benefit from the Government's proposal to enhance the ethanol-blended petrol programme to 10 per cent from the current 5 per cent. However, despite such a healthy growth environment, the valuation appears stiff.
At the current market price, the stock trades at about 31 times its FY-08 expected per share earnings on a fully diluted basis. Short-term investors can consider booking partial profits and re-entering the stock at lower levels. Medium/long-term investors, however, can hold on to the stock.
Scaling up globalLY
Revenue contribution from the export market is likely to scale up, given the increasing business opportunities in Europe and the UK, the US and Brazil. World ethanol production, as per industry estimates, is expected to surpass 90 billion litres by 2010. Globally, over 300-400 ethanol plants are likely to be installed over the next three-four years.
Given that Praj figures among the top five global companies involved in supplying equipment for distillery projects over the past two years, its ability to benefit from such a healthy demand scenario appears promising. It is also likely to capitalise on any opportunity that could arise from the ramp-up in corn ethanol capacities in the US.
The acquisition of the US-based CJ Schneider, an equipment provider, is also likely to expand the client base of American operations. However, it could well be two-three years before the investment in this acquisition starts to pay back.
In the European market, the EU member-states' proposal to reduce carbon emission by 8 per cent by 2012 also offers a substantial growth potential. Envisaging the upcoming demand, Praj has entered into a joint venture with the Netherlands-based Aker Kvaerner. Praj could leverage Aker's execution capabilities and the extensive European market knowledge, while using its own technology to cater to the European market.
Encouraged by the ethanol production scenario in Brazil (estimated to double production by 2010), Praj is scouting for acquisitions to set up an operational base in the country. This, when it happens, is likely to help Praj tap the huge ethanol production market in Brazil. Praj's ability to break into new markets also lends more visibility to its earnings. However, it could face stiff competition from established players in the respective markets.
Domestic ethanol scenario
Keeping in mind the current sugar glut, the Government's decision to blend ethanol with petrol is a welcome move. With sugar prices in a downturn, sugar companies could rely to a greater extent on by-products such as ethanol for revenues and profits; capex in this segment is, therefore, likely to continue. The introduction of ethanol blending is likely to prompt sugar mills to invest additionally in improving technology and infrastructure and in setting up appropriate processes. This would be a positive for Praj.
Additionally, any policy move allowing sugar companies to directly process sugarcane juice into ethanol, would improve the economics of ethanol production and generate additional orders for Praj.
However, given that the sugar industry is subject to various policy controls ranging from the Sugarcane Control Order to the Essential Commodities Act, the ethanol-blending programme is likely to remain heavily reliant on government policies. Furthermore, licensing and procedural requirements, levy of a plethora of taxes and restriction of inter-State movement of industrial alcohol also remain challenges for the smooth implementation of this programme.
The R&D wing of Praj, dedicated to ethanol technology, offers it a competitive advantage over other players. Its foray into biofuels technology could also offer a sizeable potential growth, given that most countries are major diesel consumers and nearly 60 per cent of the incremental growth in world transport fuel is diesel-based.
Additionally, the strategic setting up the Kandla SEZ, for the manufacture of large equipment is also encouraging.
Financials
For the quarter ended March 2007, Praj reported a 111 per cent increase in revenue on year-on-year basis, whereas the overall FY-07 revenues grew by about 127 per cent.
Operating profit margin stabilised on a year-on-year basis with a marginal 40 basis points jump to 13.7 per cent. However, the operating margins witnessed a decline of 10 per cent on a sequential basis, on account of a differing product mix.
This can be attributed to the realisation of a higher proportion of equipment technology revenues (during the third quarter), which yield better profitability for the company. The overall FY-07 earnings expanded more than doubled, aided by a higher volume growth and lower tax incidence.
Concerns
Since the European and American markets are likely to drive Praj's growth, any slowdown in the capacity expansion plans in these countries could affect the earnings for Praj.
This apart, any steep decline in crude oil prices could temper the interest in ethanol, which is mainly owed to its favourable cost economics. This could, in turn, discourage companies from setting up newer capacities for ethanol.
Global technology advances in biofuels could undermine Praj's competitive edge, if it does not keep up; this remains a key risk.
On the domestic front, any adverse changes in the government policy relating to export, import or pricing of sugar could have a negative impact on the company's earnings.