UPL faces near-term growth headwinds over European concerns, Arysta buy

After a 24 per cent run-up on the bourses from its October low, the stock of UPL fell about 3 per cent on Tuesday. Fresh concerns over growth in Europe (due to drought there) has the Street worried over the agrochemicals and industrial chemicals entity.

European sales have been sluggish for most of this year and after completion of the acquisition of Arysta, its dependence on Europe is expected to increase. The region contributed about 24 per cent to UPL’s sales in 2017-18.

Analysts see an impact on demand for fungicide in Europe, given lower rainfall and higher temperatures, leading to fewer attacks of fungus. They also see some pricing pressure for UPL’s products.  Analysts at CIMB say the company faces volume and pricing risk for Mancozeb, a fungicide. Over the past few years, significant incremental revenue in UPL’s agrochemical division was derived from Mancozeb. 

The molecule is now up against new formulations from Bayer and DowDuPont, which are under patent periods. Hence, UPL could lose market share, they say.

Latin America (LatAm) is also an important region for UPL, being 41 per cent of overall revenue in the September quarter. 

In 7th quarter, the LatAm business grew 25.8 per cent, seeing momentum across countries, except for Argentina. Brazil remains the mainstay and UPL primarily engages in soybean and maize crops there. Analysts believe the growth prospects in LatAm sales are robust — Brazil is likely to see seven per cent growth in soybean acreage and Argentina about 16 per cent. Amid trade war concerns and severed ties between China and the US, Brazilian farmers are enjoying strong demand for soybean. 

However, there are worries in this region, too. Adoption of Intacta soybean technology is likely to have increased the bean’s plantation and analysts at CIMB say this could put pressure on insecticide sales in the coming quarters.

With all these concerns, the stock might see only a limited rise and the Street will watch the impact on performance in the next couple of quarters. The management has maintained its earlier 10-12 per cent growth estimate and on margins; an analyst says he will await the quarterly performance to take cues.  

Sarabjit Kour Nangra at Angel Broking says the European weakness will play out in a few quarters and she is not concerned at UPL’s longer term growth prospects. However, for the stock to get upgraded, improvement in return ratios is key. 

Since the company made a large acquisition recently, improvement in these will take some time. The acquisition of Arysta will support growth in Brazil (catering to sugarcane and cotton crops), beside driving its footprint in Africa, Russia, and Eastern Europe. 

However, it will lead to higher leverage on the books and pressure on the balance sheet, impacting the return ratios. 

Analysts at Motilal Oswal Securities, who remain positive on UPL’s overall growth prospects, say the only concern from the Arysta acquisition is the highly leveraged balance sheet in the near term. This is likely to mean a higher net debt to equity ratio (1.5 in FY20 versus 0.4 in FY18), pressure on the return ratios (return on equity at 21.3 per cent in FY20 vs 26.9 per cent in FY18, and return on capital employed at 16.2 per cent in FY20 vs 19.8 per cent in FY18) and higher exposure to foreign exchange risk.