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Sunday, August 16, 2009

Praj Industries - Is It A Multibagger Stock To Buy?

Our fellow investor, an investor by profession, Mr. Ramesh Hariharan, Director, Leadcap Ventures (Leading Market Research organisation) asked me few days back to opine on Praj Industries. I had posted a note and research report on Praj earlier on this blog. I would have simply redirected all of you to earlier posts if I would not have something new and interesting about Praj this time around. Here is something that could prove a precious piece of input for your decision making.

Before moving forward, I would like to recap what information we all had on Praj industries and it's ethanol initiatives. Go thru these earlier posts to get a glimpse.

PRAJ INDUSTRIES - Safe Investment for 2009
Praj Industries- Giant in making - Bio-Diesel segment

The most enticing aspect of this company is the name of some of its shareholders. JM Financial Mutual Fund stake at 5.25%, Tata Capital holds 7.33%, Rakesh Jhunjhunwala has a 7.3% stake and Vinod Khosla holds 6.15%. Morgan Stanley holds 2.77%. This makes one wonder what is so special about the company?

Pramod Chaudhary, founder of Praj Industries, is ostensibly in the middle of a mad race to change the world we live in. And he hopes to be the first to reach the finish line. At stake is a market estimated at 189 billion litres by 2020 according to a US government study. Chaudhary wants to take a good shot at being remembered by history textbooks as one of the men who weaned the world away from fossil fuels like petrol and diesel.

I want to draw your attention towards a few facts that I read thru recently. I want you to read this with atmost attention.

On the face of it, Praj seems to have done well for itself. Over the last six years, it built a presence on five continents and accounts for a 50 percent market share in the Indian sub-continent, South and Central America (except Brazil), a quarter of the market in Europe and a fifth in the US. To that extent, the trust investors have reposed in Praj stands vindicated. It would also seem Chaudhary is the kind of man who takes nothing for granted. He has a team of 60 scientists and Rs. 60 crore working on second generation biofuels from ethanol. It is tempting, therefore, to imagine a world Chaudhary and Praj Industries will change. That assumption, however, is a few miles away from truth.

A few years ago, some smart entrepreneurs, Chaudhary included, had figured out how to isolate ethanol from food crops like sugarcane, wheat, soya and palm oil. With a large addressable market, businesses were quick to latch on to the men who ran these businesses and exploited every edible commodity they could to extract ethanol out of it.

They were wrong. As demand from the biofuel ndustry accelerated, commodity prices shot through the roof, endangering availability of food to vast populations. Between January 2002 and February 2008, the World Bank Food Price Index went up 140 percent. “The increase was caused by a confluence of factors. But the most important was the large increase in biofuel production…” concluded a World Bank report. Add one more variable to this situation and what emerges is a Molotov cocktail — an explosive, ironically created by lighting petrol in a glass bottle.

Innovators thought hard for a workaround. Some researchers and entrepreneurs saw the writing on the wall early and started shifting their focus to research on extracting ethanol out of non-food resources like algae, wood chips, redundant corn stalk, and everything else the industry calls biomass. For instance, there are universities in the US and Europe researching simpler and more efficient ways to make ethanol from waste like bagasse — the leftover pulp from sugar cane. The Michigan State University is giving switch grass — a kind of grass that grows abundantly in the wild — a shot. In the United States alone, 23 new companies are tinkering around with second generation technologies to extract ethanol.

But the Holy Grail remains elusive. The problem is a technical one. It essentially involves breaking down the lignin component in biomass like the wood chips researchers are experimenting with. An excellent source of energy, lignin is a complex chemical compound, integral to wood and the secondary wall in plants. But there seems to be no quick and efficient way to break lignin down. “Everything depends on the ability of companies to effectively and economically break down lignin,” says Sudarshan Ananth of Wipro Ecoenergy.

And this is precisely where Praj finds itself on the horns of a dilemma. To maintain its position as one of the leaders in the ethanol business, it needs the breakthrough by 2010. That will give the company just enough time to demonstrate its capabilities and get into business by 2012 — a deadline, which the American government has set ethanol producers doing business in the US to start making the transition to second generation biofuels. Not meeting the deadline will involve ceding ground to competitors from other parts of the world desperate for a slice of America — potentially, the largest and most lucrative biofuel market.

People who have evaulated Praj from close quarters don’t think much about its prospects. Praj hasn’t invented anything, says the representative of a leading corporate, which had once considered an investment in the company. The only reason, he says, Praj has gotten as far as it has in the ethanol business is because it had the good sense to tie up with Vogelbusch, an Austrian company that was a pioneer in this area. “At best, Praj is a project engineering company. But it is definitely not a research and development company,” he says. “I didn’t find that kind of depth,” he adds, even as he insists he remains unnamed.

Kishore Chaukar declined comment and Vinod Khosla did not return calls or emails on Praj. “In any case, Mr. Khosla is not going to be their business development head. I can see intent, but no game plan,” said an investor who had decided against betting on Praj. He too, did not wish to be named. To queer the pitch for Praj further, a few companies in other parts of the world have made significant progress. Verenium, a Massachusetts-based company, is leading the cellulosic biofuels race in North America. It already has a demo plant in place and will begin construction on commercial facilities next year. That is expected to go on-stream in 2011— just in time to meet the 2012 deadline the American government has set itself to start transitioning to second generation biofuels. Verenium has managed to keep production cost down at $2 to the gallon (one gallon equals 3.79 litres). This does not include profits, amortisation and cost of annuity.

I had taken up excerpts from Forbes India magazine in which their research team had published a detailed story on Praj industries and it's prospects. You can read the entire story here: Praj Industries analysis in Forbes India

So what should be our take on Praj? Should we buy stocks or not? If you look at the high level picture, it seems Praj have some definite targets to meet by next year to have early movers advantage in their business of Ethanol extraction technoogy. If they succede to do so, definitely they would have advantage against many more such companies who are working on the same.

At the same time, I would want to draw your attention towards technology itself. The drive behind Ethanol and bio diesels has been at it's peak in past few years due to higher oil prices and finite oil reserves. This Oil movement lead the research towards alternative energy sources. I am not sure if you had read a news flashed 3 days back in all newspapers about a car being launched by General motors which gives you mileage of almost 100 KMS/LTR. It is an hybrid car which uses electricity and petrol as combination of fuels to run. Solar energy and Hydrogen cell powered energy sources are under research. One would argue that these technologies are very expensive and so not feasible for mass production. But the answer lies in the statement itself. The day it comes under mass production, prices would automatically get reduced drastically. Remember the example of CD/DVD's? I remember a dvd used to cost Rs. 500 few (5) years back and it comes at Rs. 25 only now. LCD TV's used to cost above a lakh around 3 years back, now it is almost at 15-20K levels.

The car mentioned above costs around US $40000, so approx. 20 Lakhs. Such options could cost like a normal car in next few years. So would Ethanol and bio diesel be as precious and lucrative businesses at that time as they are now? They don't seem to be. And what if tomorrow a scientist succedes to run a car which is Hydrogen fuelled? Meaning it would not need petrol/diesel at all. European countries and USA are working day and night to invent such options that would reduce their fuel dependancy on Arabic countries. And it is not only about cars. If car can run; any such engine can run on alternative fuels. In such scenarios, Ethanol and Bio diesel would remain just an additive in conventional fossil fuels and nothing more than that.

Coming back to our question of "To buy stocks or not?" ;)

There is no harm in being part of a business which have potential to grow at good rate for some time ahead till it gets competition discussed above. But I would recommend to have little portion only of your investment portfolio occupied by this stock and not to bet entirely on it. Don't forget Golden rule of investment: Never put all your eggs in one basket!

This is entirely my opinion and would love to hear your take on this.

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