Gains in UPL hinge on reduction of debt, improved cash flow generation

Higher demand to keep revenue growth strong in the second half of FY23

The country’s largest agrochemical player, UPL, beat revenue growth expectations in the July-September quarter (second quarter, or Q2) on the back of higher realisations. While volumes in the quarter declined 7 per cent, a 21 per cent jump in prices and favourable foreign exchange led to an 18 per cent year-on-year growth in the top line.

This is the fourth consecutive quarter of double-digit pricing growth. While Europe disappointed with a growth of 1 per cent, most large geographies, such as Latin America, India, and North America, outperformed with growth of over 20 per cent each.

On the profitability front, while gross margins beat estimates, profitability at the operating level was impacted by higher expenditure/staff costs. The company reported a 320-basis point (bp) uptick in gross margins to 53.8 per cent, while profitability at the operating level was higher by 290 bps at 22.1 per cent.

Although volumes declined for the first time in at least nine quarters, it was the result of a focus on higher margin products. The company indicated that with orders in hand and gains on the supply-chain front, volume and margins should get a boost in the second half (H2) of 2022-23 (FY23).

UPL maintained its revenue and operating profit growth guidance of 12-15 per cent and 15-18 per cent for FY23, given the demand conditions and improved realisations.

While the company’s Q2 performance ticked most boxes, rising debt levels continue to remain a thorn in the side. While gross debt increased by Rs 2,400 crore to Rs 32,600 crore, net debt was higher by Rs 2,000 crore at Rs 28,500 crore on a sequential basis due to increased working capital requirements.

The company indicated that rising working capital in the first half (H1) of FY23 was on account of a 22 per cent growth in sales during the period and the need for short-term inventory building, given the strong demand in H2FY23 and also due to uncertainties in the supply chain.

Finance costs rose 74 per cent to Rs 640 crore as a result of rising interest rates. Rising working capital needs led to pressure on cash flows. There was a cash outflow of Rs 4,594 crore in H1FY23, compared with Rs 2,415 crore in the year-ago period.

Analysts, led by Sumant Kumar of Motilal Oswal Research, believe cash-flow generation and debt repayment remain monitorables amid a high inflationary environment in FY23.

The company seeks to reduce debt by $400-500 million in the current year, aided by cash inflows of $259 million after the recent business restructuring.

Last month, UPL had announced stake sale in two entities with a view to creating distinct platforms to accelerate growth and unlock value.

Elara Capital’s Prashant Biyani and Vatsal Vinchhi believe that the valuation benchmark emerging from the stake sale is expected to cap the downside for the stock. But gains from the stock are hinged on the trajectory of leverage, working capital, and interest rates.

At the current price, the stock is trading at 10x its 2023-24 earnings estimates.