Analyzing Praj Industries – A Leading Ethanol Plant Supplier : Stock Analysis November 2023

Disclaimer:

The analysis and opinions provided are for educational and informational purposes only. They should not be construed as specific investment, accounting, legal or tax advice. 

Vital Company Ratios for a Layman

• Debt to equity ratio: 0.03 (low)
• OPM (Operating Profit Margin): 10.0% (fair)
• EPS (Earnings Per Share): 14.77 (high)
• Dividend Yield: 0.72% (low)
• Book Value: 60.6 (fair)
• Industry PE: 38.0 (fair)

Praj Industries boasts of lean operations as visible from its double-digit operating margins of 10% which betters its peers and reflect operational efficiency. This allows the company to generate healthy cash flows from the business.

A key metric that depicts the balance sheet strength is the debt-to-equity ratio which stands at an extremely low level of 0.03x. This highlights that the business is run in a conservative fashion without excessive leverage and reduces financial risks even in periods of slowdown.

The company is sitting on huge cash reserves of Rs 240 crores further boosting its stability during adverse scenarios. This cash can also be utilized for funding upcoming capex plans.

The 35% higher capital work-in-progress reflects rising investments behind scaling up production capacities across its plants to cater to strong order inflows. This bodes well for long-term growth.

The EPS has grown in a healthy manner to Rs 14.8 indicating that shareholders are benefiting from Praj’s growth. Return on equity is stable at 24% which betters its peers. The management has maintained dividend payouts with a yield of 0.7% despite industry volatility showcasing their confidence in consistent performance.

However, valuations seem expensive as the CMP is 10 times the book value compared to the industry average of 6 times book value. But growth prospects justify higher multiples.

Whether CMP Is More or Less Than 50 DMA and 200 DMA

Analyzing the short-term moving averages provides insights into price momentum and trend. As per the latest data till November 28, 2023:

• The 50-day moving average (DMA) is at Rs 598
• The 200-day moving average (DMA) is at Rs 628
• The current market price (CMP) is Rs 622

Here, we can observe that the CMP has crossed over the 50-DMA from below and is trading slightly below the long-term 200-DMA level. This indicates a short-term uptrend backed by increasing participation from investors. However, the uptrend needs to sustain over the 200-DMA for confirming long-term strength.

The positive crossover over the 50-DMA and the rising gap between the two averages points toward the emergence of an upward price momentum. Overall, the price action is tilting on the positive side in the near term.

Is This Stock Overvalued or Undervalued?

The stock is currently trading at a P/E ratio of 42.07, which is higher than the industry PE of 38.0. This suggests that the stock may be slightly overvalued. However, the company’s strong growth prospects and low debt levels could justify the higher valuation.

Valuation analysis is key while evaluating any stock as it depicts what is the fair value to pay for future earnings growth.

Praj Industries currently trades at a P/E multiple of 42x which seems elevated compared to its 3-year EPS CAGR of 53% and industry average P/E of 38x. Typically high growth stocks command premium valuations and the company has lived up to it by its strong fundamentals.

However, the company operates in a growing niche within the energy and environment sector which expands its addressable market size. This provides revenue visibility for years ensuring earnings growth continues at a healthy pace.

Moreover, metrics like double-digit margins, excellent return ratios of 30% ROCE and 24% ROE, debt-free status, and robust cash flows support the case for premium multiples to some extent.

The company has levers in place to sustain growth momentum with rising investments into capacity expansion and also venturing into new businesses. Execution track record also remains strong.

Considering these positive factors, we can conclude that Praj Industries is fairly valued currently despite higher P/E multiples compared to peers. The premium is justified to some extent owing to its leadership, growth prospects in niche areas, stable margins and prudent capital allocation policy. The long-term outlook remains constructive.

Should We Buy This Stock and Why?

• The company has a strong track record of growth.
• The company has a low debt-to-equity ratio.
• The company has a high EPS.
• The company is in a growing industry.

Yes, investors can consider Praj Industries stock at current levels from a long-term investment perspective of 3-5 years. The rationale behind investing in the company is solid:

1. It operates in an industry with high growth potential: The bio-energy, renewable energy and waste management spaces are witnessing strong policy support globally aiding double-digit growth. This expands Praj’s target market providing multi-year revenue visibility. New order inflows remain robust acting as a growth driver.
2. Dominant market position: Praj enjoys a leading position in industrial wastewater management and 2G/2G+ ethanol plants with unmatched execution capabilities. This results in client stickiness and repeat business. The company has also forayed into promising areas to tap upcoming opportunities.
3. Strong financial health: Robust balance sheet, excellent working capital management and high cash reserves help tide over industry cycles smoothly without impacting growth plans. Rising profits have allowed 30%+ ROCE and 20%+ ROE consistently.
4. Growth levers in place: investments into capacity expansion, venturing into new businesses and strong order book sets the stage for 20%+ growth in the medium term. Margin expansion also likely owing to operating leverage benefits.
5. Attractive valuations: Despite premium valuations, the stock trades at par with tier-1 engineering peers while enjoying higher earnings growth. Market leader status in niche areas also commands higher multiples.

To summarize, Praj Industries makes for a good bet for investors willing to hold over 3-5 year period to enable healthy compounding at 20%+ CAGR.

Should We Sell This Stock and Why?

• The stock is currently trading at a high valuation.
• The company’s dividend yield is low.

Investors shouldn’t consider selling shares of Praj Industries at current levels despite valuations seeming stretched after the recent upmoves. There remains merit in staying invested from a long-term perspective:

1. Strong industry tailwinds to persist owing to the structural nature of growth drivers. Government policies continue favoring growth of renewables, ethanol blending and waste management aiding order flows.
2. Within the industry, Praj enjoys a market leading position in certain niche segments like 2G ethanol plants, industrial wastewater management etc. This makes it a key beneficiary of upcycle conditions likely ahead.
3. The company has built resilient capabilities to handle downcycles in the past without growth/margins getting majorly impacted. Leverage levels are comfortably low providing stability. Management has maintained 50% dividend payouts reflecting their earnings confidence even in periods of moderation.
4. Praj has been consistently reinventing itself to tap opportunities in emerging areas which opens up sizeable target market (~$30 bn). Investments into building capacities also aid in keeping growth momentum steady by targeting larger size projects.
5. Valuations seem high due to recent upmoves but they have been supported by equally strong earnings delivery of 30%+ growth. ROE and ROCE also remain at healthy levels of 24% and 31% respectively. Premium multiples are thus justified.

Therefore, a temporary phase of consolidation or minor corrections after the surge should not worry long-term investors. Praj’s structural growth story remains intact making it a good portfolio stock to hold. Booking profits now could lead to missed opportunities later.

How Is the Industry of This Company Growing?

The capital goods industry is expected to grow at a CAGR of 12-15% over the next five years. This is due to factors such as increased government spending on infrastructure, rising disposable incomes, and urbanization.

Praj Industries operates within the new energy and environmental solutions spaces which are witnessing exponential growth aided by certain structural trends:

1. Government regulations and ESG momentum driving demand: Stricter environmental norms, policy support for renewable energy adoption, prominence of ESG investing etc are necessitating industries to adopt sustainable solutions. This is opening sizeable opportunities for companies like Praj.
2. For instance, policies around higher ethanol blending in fuels, tax incentives for setting up renewable energy capacities, penalties on industrial pollution etc would compel businesses to invest in bioenergy or wastewater treatment or cleaner technology – areas where Praj specializes in.
3. Addressable market size expanding rapidly: The addressable market for Praj is forecasted to expand at a 15-20% CAGR over the next decade to around $30 billion currently. Growth areas include 2G & advanced biofuels, pharma & F&B industry’s rising purity requirements, reinventing water utilities amidst scarcity etc.
4. Emergence of outsourcing partners: Inner expertise needed within the new energy and environment solutions space requires process know-how which makes players like Praj crucial partners for industries looking to transition towards sustainability. Specialized knowledge positions them strongly to tap opportunities.

Thus, the operating landscape for Praj offers significant growth potential owing to rising ESG focus and the renewables-driven energy transition gaining more prominence after the pandemic. Order inflows expected to remain robust contributing to 20%+ growth.

How This Company Is Going to Perform Long Term

The company is well-positioned for long-term growth due to its strong track record, focus on innovation, and expanding global presence. The company’s growth is expected to be driven by its focus on the renewable energy and environmental sectors.

Praj Industries is strongly positioned for healthy long-term growth and returns over the next 5-7 years based on:

1. Favorable industry dynamics with rising global demand for renewables, biofuels, and sustainable solutions help expand their addressable market providing revenue visibility. Government support through incentives & norms also continues aiding growth.
2. Market leadership within specialized segments like 2G ethanol plants, HiPurity water systems, and wastewater treatment systems provides an edge. Strong execution track record results in client stickiness, aiding overall leadership. New business forays also boost growth outlook.
3. Strong balance sheet (near zero debt) and robust cash flows generation lend stability to navigate industry cycles smoothly while keeping expansion plans on track. Allows them to target larger size projects confidently.
4. Investments in capacity augmentation across plants to cater to rising orders provides operating leverage benefits supporting margin expansion plans. Also allows them to diversify their clientele as well as geographic mix.
5. Innovation-focused culture that enables the company to stay ahead of the curve when it comes to providing cutting-edge domain expertise and technical know-how to clients. Also aids in expanding its capabilities into new adjacencies on the technology front.

How This Company Is Going to Perform Short Term

The company is expected to continue to grow in the short term due to strong order inflows and new project wins. However, the company’s margins could be impacted by rising input costs.

Analyzing Praj Industries’ recent operating metrics as well as management commentary provides clues into its expected short-term performance over the next 2-3 quarters.

On the business front, the company reported record revenue and order intake figures in FY22 signaling the strong momentum in its core offerings especially across bioenergy, sustainability solutions and pharma sectors. Order backlog remains healthy providing near-term revenue visibility.

Margins improved by 180 bps to 10% in FY22 courtesy operating leverage gains from rising scale. However, some pressure on margins seen in the recent quarter owing to high input costs and supply chain issues which might continue for a few more quarters before improving. Yet, margins expected to remain in double-digits.

Capex plans are underway as evident from the sharp jump in CWIP spends to augment capacities across plants. This positions them well to target and efficiently execute larger size contracts while diversifying client mix further. Benefits likely to accrue with a lag over the medium term.

On the financial front, the balance sheet continues to remain robust with net cash position aiding stability in times of uncertainty. High cash balance also provides ammunition for funding growth. Return ratios have also improved in tandem with profit growth while free cash flow generation also remains healthy.

Technically, the stock has given a breakout above 600 levels after consolidating for 8-9 months signaling bullishness backed by volumes. The uptrend is in its early stage and requires holding above 50 & 200-DMA for further upsides.

Considering the positive industry backdrop with government policy support, strong order pipeline, capacity addition plans and technical breakout – Praj Industries is positioned strongly to deliver good bit of outperformance over the next 2-3 quarters. 20-25% upside possible over this period.