UPL: Q3 correction may be a good entry point as prospects remain firm

UPL’s performance for the December quarter (Q3) was lower than expectations due to softer-than-anticipated sales in Latin America. As a result, its stock corrected about 12 per cent in the past fortnight. However, considering future growth prospects of UPL, which has a diversified geographical presence, established portfolio with branded products aiding margins, and pending launches, analysts said the correction offered a good entry point.

In Q3, UPL’s sales were up 7 per cent at Rs 41.94 billion mainly due to a tepid 5 per cent increase in Latin American sales. Analysts said this geography, which contributes over 40 per cent to UPL’s top line, saw sluggish sales due to low-to-moderate disease pressure on soybeans, delayed planting, high inventory levels at the start of season and low commodity prices. Exchange rates, too, had been unfavourable led by the appreciation of the rupee. 

UPL’s management had already cut growth guidance to 8-10 per cent. It now maintained revised guidance for FY18, which was somewhat comforting according to analysts. Positively, volume growth of 12 per cent was strong, considering that 2017 was the third year of the global industry decline. India, the US, and rest-of-the-world markets, which contribute 15-17 per cent each to top line, grew 10 per cent, while Europe (10 per cent of sales) grew 14 per cent year-on-year (y-o-y) in Q3. 

Operating profit grew 9 per cent at Rs 8.3 billion, and was marginally lower than the double-digit growth anticipated, but the 20-60 basis point expansion in gross and operating profit margins is positive. Net profit was up 25 per cent y-o-y at Rs 5.74 billion and was aided by Rs 620 million mark-to-market gains on derivatives and slightly lower tax rates.

Overall, looking at the sub-par performance, appreciating rupee, weak industry pricing, analysts might have tweaked their forward earnings estimates but they still saw strong growth ahead. Morgan Stanley said the inventory situation for crop protection had improved, and expected revenue to grow by 12 per cent and operating profit margins to rise by 160 bps over FY19-20. They added that consolidation in the industry was underway, and UPL had the potential to surprise positively on profitability. And at a PE of 16x, based on FY19 estimates and an 18 per cent compounded growth (CAGR) in earnings  in FY18-20, the risk-reward is compelling.

Another foreign brokerage said market share gains will continue, driven by launches of new formulations, as it sees robust 20 per cent (CAGR) earnings during FY18-20. Moreover, there were some signs of pick-up in commodity prices indicating the pricing environment was likely to improve and UPL might benefit from it. A few days ago, CLSA had initiated coverage on UPL, estimating 18 per cent CAGR in earnings and a target price of Rs 960.