Concerns easing for UPL

Steps to improve profitability and working capital cycle are yielding results

As UPL (erstwhile United Phosphorus) takes corrective action to arrest some of the Street's worries, it has started to gain investors’ confidence, especially after the recently concluded buyback.

Share buybacks help improve cash utilisation and reward shareholders with better valuations and return ratios. However, the biggest worries were about how the company was going to turn around the business it acquired earlier and, second, ease concern on cash flows because of the acquisitions.

“Growing debt and capital misallocation had adversely affected its valuations in the previous two to three years. However, improved focus on cash flow generation and reward to shareholders are likely to trigger a re-rating in the stock,” said Rohan Gupta of Emkay Global.

An analyst at Axis Capital said the key takeaway from their management interaction is that having acquired global scale, the company is increasingly focusing on improving profitability and generating free cash. “Market concerns on capital allocation have ebbed after the management reiterated in the annual analyst meet that cash generated from business operations is likely to be utilised for further debt reduction and higher dividend payout or buyback,” he adds.

The company has been restructuring some of its international operations, in the European and Latin American markets to consolidate manufacturing units and improve profitability. Notably, a focus on better management of debtors and inventories have started to yield results and are easing pressure on working capital, beside raising cash flow. In FY14, the working capital days have dropped to 85.2 as against 100 days in FY13. The management expects the working capital cycle to improve further, as it is focusing on crop diversification and launching more products for the short crop and high margin business. This will help reduce debt further and expand the operating margins and return ratios.

Analysts believe the operating margins will improve in the coming years by another 60-100 basis points (bps) from the current 18.8 per cent and boost return on equity by another 100 bps from 21.4 per cent currently. These moves should lead to re-rating of the stock, trading at about 10 times its FY15 estimated earnings, below the valuations that global peers enjoy. In this backdrop and considering the estimated 20 per cent annual growth in earnings over the next two years, the valuations are attractive.

The earnings expectations come on the back of higher revenue growth, to be driven by both domestic and international markets. “In FY15, UPL will work towards launching two or three new products each in the US and the Europe and 12-15 products in Brazil. The planned launch of mancozeb formulation (fungicide) for the soybean crop in Brazil is a potential game-changer, according to the management. The latter (expects) 12-15 per cent revenue growth in FY15, excluding the currency impact,” said Amit Murarka, who tracks the company at Deutsche Bank.

While concerns about the India growth came up recently due to expectations of a below-normal monsoon, the impact for UPL should be limited, as it is diversified well, generating 81 per cent of revenue from export markets.