Easing investor concerns, improving fundamentals fire up UPL stock

Cash flows in the March quarter and debt reduction are key triggers

After a sharp decline to its lows in November last year, India’s largest agrochemical stock has seen a sharp recovery. The UPL stock is up 56 per cent since the start of November, after the company tried to assuage investor concerns on corporate governance and high debt on its books. There were sharp price corrections between October and December last year after KPMG Mauritius resigned as auditors of UPL Corporation and whistle-blower claims.
 
In addition to management clarification on issues, what helped was the improvement in fundamentals. There has been a sharp rise in global prices of major crops over the last three months which has supported the agrochemical market. Prices of soybean, corn, cotton, and wheat are up 27-70 per cent over the year-ago levels.
 
Analysts at Edelweiss Research say: “Such a spurt in crop prices is likely to result in higher cash flows for farmers yielding strong agri-input demand globally, benefiting players such as UPL.” Demand revival across the Latin American market after weakness in the December quarter should also aid the company’s sales. At 34 per cent of overall sales, Latin America is the single-largest geography for UPL.
 
In addition to higher crop prices, the forecast of normal monsoon by Skymet should aid the prospects in the domestic market. Improved farm incomes helped by increasing yields in the rabi season, higher offtake by government agencies, and good water reservoir levels are positive for the domestic farm input segment.

 
What should add to incremental revenues for the company are strategic collaborations, such as the one the company entered into with FMC Corporation for manufacture and supply insecticide Rynaxypyr to FMC in India. Analysts at Motilal Oswal Research expect toll manufacturing and supply of Rynaxypyr to FMC in India to lead to a long-term opportunity for UPL to the tune of Rs 700 crore-Rs 800 crore.
 
In addition to the strong base business, the company’s focus on innovation and research and development is helping it increase the pace of new launches. Its innovation rate, which captures the revenue contribution from new products, has increased from 2.5 per cent of sales in FY14 to 20 per cent in FY20.
 
The rising share of off-patent products, its product portfolio across segments, and geographic presence should help the company grow its revenues 9-10 per cent annually over the next three years. Analysts expect the company’s presence across the value chain, pricing power, and synergies with Arysta to aid in the improvement in operating profit margins by 130-180 basis points over the next two years.
 
Further, Probal Sen of Centrum Institutional Research believes the combination of increasing revenue and higher operating profits helps reduce leverage, and hence, interest costs, resulting in other income also witnessing a boost from better cash flows.
 
The company’s gross debt stood at Rs 27,837 crore at the end of the December quarter; it reduced debt by Rs 3,980 crore. The company has a target of reducing debt by $700 million (Rs 5,070 crore) in the second half of FY21. Further debt reduction, led by improvement in cash in the March quarter and lower leverage ratio, will be a key trigger for the stock. While the prospects for the company are bright, the surge in stock prices leaves little upside from the current levels. Investors can add the stock to their portfolios on dips.