UPL: Steady outlook after transient hiccups

Analysts see earnings growth driving stock price higher, but any big buy may stretch balance sheet

UPL’s performance for the June quarter (Q1) might have been impacted by many factors but 10 per cent volume growth was still encouraging. Revenues were disappointing; domestic growth came at just four per cent year-on-year (y-o-y), despite the launch of three new products. This was due to goods and services tax (GST)-led destocking. 

Its Latin American business grew by six per cent, but was hit by poor commodity prices, high channel inventories, and the drought in Mexico. The European business grew four per cent and was impacted by hot weather in southern Europe despite an improvement in beet acreage. UPL’s overall revenue growth of six per cent was supported by seven per cent growth in North American business and nine per cent growth in the rest of the world.

Earnings before interest, tax, depreciation and amortisation (Ebitda), thus, was up 7.3 per cent. But, adjusted net profit surged 26.8 per cent, supported by higher other income, lower interest expenses, lower depreciation, and lower tax rate.

The problems faced in Q1 are temporary in nature and growth is expected to be much better in the coming quarters with a good monsoon supporting the demand. Further, in India, four new products would be launched soon. New launches in Latin America will also drive the company’s growth. 

The management offered a positive outlook for both geographies and maintained FY18 revenue forecast of 12-15 per cent, 50-75 bps Ebitda margin expansion, and a 20-22 per cent effective tax rate. Analysts at Morgan Stanley said they would not extrapolate trends from the June quarter. 

UPL is seeing debt reduction as well, and decline in interest costs should add to earnings. Analysts at IIFL Institutional Equities have raised their FY18/19/20 earnings per share (EPS) estimates for UPL by 5/3/2 per cent, respectively to Rs 44.2/52.0/61.9, mainly to reflect lower interest expense going forward. Not surprisingly, despite the subdued performance, the stock continues to inch higher.

Analysts such as Himanshu Nayyer at Systematix Shares said at current valuations, the stock looks fairly valued and returns will be in line with earnings growth. Nayyer remained watchful on growth of innovator companies that can impact UPL’s generic sales. 

Nevertheless, for now, most analysts including those at Morgan Stanley, Edelweiss and IIFL have a target price in the range of Rs 965-1,026 for the stock trading at Rs 880.

UPL is said to be looking for an acquisition to boost growth. Analysts at Edelweiss say UPL continues to hold cash of Rs 2,600 crore in anticipation of any potential acquisition. 

The firm has a history of successfully turning around acquisitions. The only risk, analysts say, is the acquisition should not be too big to stretch the balance sheet. Deutsche Bank analysts say while it is still early days, the likelihood of a mega acquisition may emerge as an overhang on the stock, given potential equity dilution to fund it.