Weak Q1 margin show, lack of triggers to limit upsides in UPL

While debt levels increased in Q1, the company maintained its FY22 guidance

India’s largest agrichemical stock UPL shed over 2 per cent in trade due to a weak operating performance in the June (Q1FY22) quarter. A slight increase in debt, concerns over weather-related disruption in key markets and lack of near term triggers could cap upsides in the near term. Most brokerages have a buy rating on the stock which has gained 70 per cent since January this year.

The June quarter miss on the revenue and operating profit margin fronts are near term dampeners for the stock. Sales growth of 9 per cent led by volume and pricing gains was a tad disappointing. While its bigger markets of Latin America, India and North America grew 19-27 per cent, Europe and rest of the world markets saw a 11-14 per cent decline in sales. The dip in these markets were due to bad weather, competitive pressures and supply constraints. Though price hikes contributed about 2 per cent to the revenue growth, the full benefit will accrue to the company in the current quarter as they were initiated only in June.

A larger miss for the agrichemicals major was on the operating profit level. Even as gross profit margins increased 180 basis points on the back of higher realisations, improved product mix, the same did not reflect at the operating profit margin level. This metric slipped by 80 basis points to 21.9 per cent due to a 12-18 per cent increase in employee costs and other expenses including freight. The management however indicated that margins would improve going ahead due to price hikes and advanced orders from Brazil at fixed prices which would reduce going ahead aiding profitability.

The company’s net debt increased by Rs 2,600 crore on a sequential basis to just under Rs 21,500 crore due to higher working capital requirements with working capital days up by 7 days to 91. While the company ended FY21 with net debt to operating profit ratio at 2.2 times, it has maintained its earlier guidance of bringing down leverage on this metric to under 2 times for FY22.

While weather disruptions in US and Brazil remain a major worry, analysts at Motilal Oswal Research led by Sumant Kumar believe that the global agrochemicals market is set to gain from better farm economics on account of firm/rising global agri commodity prices, which would in turn drive agrochemical consumption. Realisations going ahead on the back of higher prices and product mix are expected to be strong.

While prospects remain firm, analysts do not see new rerating triggers for the stock which is trading at 14 times its FY22 earnings estimates. Say Ritesh Gupta and Prasenjit Bhuiya of Kotak Institutional Equities, “We struggle to identify near-term catalysts which will get the stock get re-rated from the current 7 times FY2023 enterprise value to operating profit, apart from gradual debt reduction driving multiples closer to FMC or even UPL’s pre-Arysta multiples.”