Healthy global demand to keep UPL's sales growth trajectory strong

Despite rising debt, margin pressures, the company has maintained its FY22 guidance

September quarter results of India’s largest crop protection company, UPL were largely in line with brokerage estimates barring the pressure on gross margins and rise in debt. The two factors led to a downward revision of earnings estimates for FY22 leading to a two per cent decline in the stock price.

In a tough environment, the company posted a better than expected revenue growth with most markets posting double digit growth. Sales growth in Latin America, its largest market was a robust 20 per cent led by both higher volumes and realisations in Brazil which was up 27 per cent. Growth in North America and Europe too were strong at 24-31 per cent; the company indicated positive triggers for the North American market including improved commodity prices, tight supply for key products and favourable channel stocks. India was the only disappointment registering a growth of 5 per cent YoY on muted demand due to erratic rainfall.

Overall revenue growth of 18 per cent was largely volume-led despite disruption in the supply chain. Given its backward integration, the company was able to handle the disruption better than peers. Say Ritesh Gupta and Prasenjit Bhuiya of Kotak Institutional Equities, “Strong 2QFY22 volume growth of 15 per cent indicates UPL’s supply-chain capabilities and ability to benefit from the ongoing disruption.”  

While revenue growth remained strong there was pressure on gross margins due to higher raw material costs and inferior geographic mix. Gains on the gross margin front were limited to 100 basis points y-o-y while sequentially it was down 592 basis points to 50.6 per cent. While gains over the year ago period were on account of improved product mix with higher share of differentiated products and improvement in pricing environment, sequential compression was due to the fact that the full impact of the price hikes was not reflected in the quarter; the same will get passed on by the March quarter.

An area of worry is the increase in debt. The company’s gross debt increased from Rs 23,770 crore at the end of FY21 to Rs 27,150 crore due to the increase in short term borrowings. Analysts point out that the rise in debt was on account of seasonal increase in working capital in the first half of FY22 with the net working capital days increasing by 8 to 114. Kotak Institutional Equities believes that higher working capital days as well as raw material inflation would drive higher working capital investments this year, limiting free cash flows.

The company has, however, maintained its FY22 guidance targets related to debt as well as growth. It continues to guide for a net debt to operating profit of less than 2 times, while revenue and operating profit growth (on the back of strong global demand)  would be in the 7-10 per cent and 12-15 per cent bands.

Given the Q2FY22 performance, analysts at Motilal Oswal Research have cut their FY22 earnings estimates by 4 per cent. At the current price, the stock is trading at 11.7 times its FY23 earnings estimate. While prospects are robust, any increase in debt and pressure on margins would impact the stock negatively.