Published on 13/03/2019 10:39:47 AM | Source: Motilal Oswal Securities Ltd

Buy UPL Ltd For Target Rs.1,035 - Motilal Oswal

Posted in Broking Firm Views - Long Term Report| #Broking Firm Views Report #Motilal Oswal #Quarterly Result #Chemicals Sector #UPL Ltd

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On a firm footing in North America

Changing crop mix and favorable positioning to augur well

The North America — a key market for UPLL – is the third largest agrochemical market after LATAM and Europe. North America contributed 18% to UPLL’s annual revenues, while it contributed 23% to revenues in 4QFY18. Further, 42% of UPLL’s total revenue from North America in FY18 was realized in 4Q. In this report, we analyze the North American agrochemical market and crop mix from UPLL’s perspective. We also met UPLL’s management to better understand the company’s position in North America (primarily the US), outlook for ongoing season and update on the Arysta consolidation. Key highlights from the analysis and management interaction:

* The acreage in the US is likely to shift towards maize/cotton from soybean owing to high closing stock of soybean. This should augur well given that maize constitutes 24% of the total agrochemical market in North America v/s soybean’s share of 15% despite similar acreage in both crops.

* Glufosinate is the highest revenue contributor for UPLL in North America. Since glufosinate targets crops that constitute 66% of the total acreage in the US (maize and soybean), therefore growth is likely to be driven by glufosinate-based products.

* The integration of Arysta with UPLL is on track with a likely integration cost of USD40-60m, spread out over FY20. So far, transaction cost (legal fees, etc.) of INR1,520m has been incurred in 9MFY19.

* The integration would aid in realizing cost synergy of USD100-110m in the first year (FY20) and thereon, an additional USD100-150m per year. Further, revenue synergy to the tune of USD350-400m is expected over a period of three years.  


* Acreage shift from soybean to maize/cotton to augur well:

The closing stock of soybean in the US touched a record high of 26m tons (+118% YoY) in 2018- 19. This was largely a result of record production (~125m tons, +4.3% YoY), driven by both rise in acreage and yield, but offtake was restricted from China owing to the prevalent trade war between the two countries. On the other hand, closing stock of maize was down to 45.2m tons (-17% YoY) in 2018-19, thereby supporting firmer prices. Further, as per the National Cotton Council (NCC), US cotton producers intend to plant 14.5m acres this spring, up 2.9% YoY. Therefore, an acreage shift is expected from soybean to maize/cotton, which is likely to augur well as UPLL has an equally strong presence in soybean and maize. Maize constitutes 24% of the total agrochemical market in North America compared to soybean’s share of 15%, despite acreage of both the crops being similar. The investment in chemicals and seeds in the US is expected to remain on the rise, despite an anticipated decline in farm income. 

* Glufosinate driving growth in the region:

Glufosinate is the highest revenue contributing active ingredient for UPLL in the region, growing at healthy rate of 18-20%. The company launched its products with glufosinate as active ingredient three years ago when its market size was 3m gallons. Since then, the market has evolved to reach 11m gallons. Glufosinate’s primary target crops are maize and soybeans, which collectively form 66% of the total acreage in the US, therefore, going forward, growth is well poised to be driven by glufosinatebased products. Apart from glufosinate, the key AIs are mancozeb, metribuzin, propanin, which target fruits & vegetables in addition to maize and soybean.

* Arysta amalgamation on track; paddling hard to overcome challenges

Post the closure of Arysta’s acquisition on 31st Jan’19, UPLL is in the process of integrating Arysta with itself. But, the biggest challenge is the transition of Arysta’s subsidiaries’ operations into UPLL’s single holistic ERP package, as Arysta has over 140 subsidiaries functioning on over 60 different ERP packages. In order to overcome this, the company has decided to begin invoicing under UPLL’s name geography-wise on behalf of Arysta via its system, which would ensure a smooth and cost-effective transition but would take 6-8 months. Upon successful transition, management has guided for cost synergies of USD100- 110m in the first year (FY20) and then additional USD100-150m per year from thereon. Further, the total revenue synergy is expected around USD350-400m, 30% of which is expected in the first year (FY20); 70% of the total should be completed by the second year, with the balance coming in the third year. An integration cost of USD40-60m will be incurred to achieve the UPLL-Arysta synergies, which would be spread out over the next year (FY20). So far, transaction cost (legal fees, etc.) of INR1,520m has been incurred in 9MFY19.

* Valuation and view:

UPLL has established itself as a strong player in the North American market, especially with the introduction of glufosinate-based products, which have been posting higher growth. The company’s growth prospects have been enhanced post Arysta amalgamation, as it does not just strengthen UPLL’s position in Europe (~21% of global agrochemical market), but also plugs loopholes, which UPLL has in its portfolio globally (for example – wheat in Europe and North America). Near-term pressure is expected on account of Arysta acquisition, in terms of highly leveraged balance sheet, which would likely lead to (a) higher net D/E ratio (1.7x in FY20 v/s 0.4x in FY18), (b) pressure on return ratios (RoE at 20.6% in FY20 v/s 26.9% in FY18, and RoCE at 15.8% in FY20 v/s 19.8% in FY18), and (c) higher exposure to forex risk.

* We remain positive on UPLL’s holistic growth prospects and maintain our estimates (revenue/PAT CAGR of 32%/19% over FY18-21) and value UPLL at a P/E of 14x (~10% discount to its three-year average trading multiple, primarily due to the highly leveraged balance sheet). Our TP of INR1,035 implies 15% upside. Maintain Buy.


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