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Drought in EU unlikely to hinder deleveraging.

Although the current drought-like conditions in Europe could impact summer crops, winter crops would benefit from this situation, per several reports. On the other hand, Brazil is likely to post a record corn harvest and is also expected to post a jump in its soybean production. Hence, for UPL, any weakness in the European region should be more than offset by strong demand from the Latin American region. Moreover, as per our calculations, UPL would be able to achieve its net debt to EBITDA target of below 2x assuming a) 15%/18%/14% YoY EBITDA growth in 2Q/3Q/4QFY23E, b) reduction in net working capital to 77 days at end-FY23, c) capex of INR 30bn, and d) debt repayments of ~INR 65bn over the next 3 quarters (refer Exhibit1). We retain our estimates and maintain BUY with an unchanged Sep’23 TP of INR 1,060..

* In EU, harvesting of winter crops has benefited from current dry weather: According to a European commission study (click here), due to the exceptionally hot and dry weather conditions in major parts of Europe, the yield outlook for EU continues to reduce. However, these conditions seem to have benefited winter crops’ harvesting. As a result, there has been an improvement in the yield forecast of these winter crops in Europe. For UPL, the Jul-Sep quarter anyway tends to be a seasonally weak quarter. Hence, in our view, this dry spell along with seasonal weakness is likely to be more than offset over OctMar on account of the decent outlook for winter crops in the EU.

* Latin America region likely to provide the necessary boost: As per several reports, Brazilian farmers are expected to harvest a record total corn crop in the first corn crop (click here). Moreover, harvesting of Brazil’s second corn crop has reached 89.5% of the planted area. Brazil is also expected to post a huge jump in its soybean production in CY23 compared to CY22, based on USDA estimates. This means a staggering plantation is on its way during Sep’22, which should result in a robust demand for agrochemicals in UPL’s most important region.

* Journey to Net debt to EBITDA below 2x: Keeping in mind the strong soybean production in Brazil in CY23, a possible benefit for winter crops in Europe, and decent demand in India and other regions, we believe that UPL would be able to register ~17% YoY EBITDA growth in FY23 (company’s guidance of ~15-18%). This implies it will have to post 15%/18%/14% YoY growth in 2Q/3Q/4QFY23E assuming 11%/11%/9% YoY revenue growth and a slight margin improvement. Further, we estimate that the company will have to reduce inventory days to 112 (vs. 128 in 1QFY23) and receivable days to 114 (vs. 125 in 1QFY23), keeping the payable days similar to 1QFY23. This will lead to net working capital days at 77 (vs. 69 in FY22 and 108 in 1QFY23) (refer Exhibit 2). In our view, since a bulk of the inventories get released in the second half, it should not be a daunting task for the company. With this EBITDA and net working capital change, UPL should be in a comfortable position to pay off INR 65bn debt over 2Q-4QFY23E, bringing down its net debt position to INR 209bn and net debt to EBITDA to 1.9x.

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