The exposure of UPL’s agrochemical business to Europe, which is facing drought, will rise after the Arysta acquisition. Graphic: Mint
UPL Ltd’s $4.2 billion purchase of Arysta LifeScience Inc. avoided the typical investor scepticism associated with large acquisitions. With the management convincing investors about gains from synergies, the stock has gained 36% since the acquisition announcement on 20 July. Part of the gains can be explained by the recovery in Latin America, a large market for UPL.
The Arysta acquisition is expected to drive up the leverage, thanks to borrowing of $3 billion, while synergies estimated at $205-255 million per annum are expected to create value from the first year of amalgamation itself.
However, these assumptions are at risk as challenges are emerging for the combined entity. The drought in Europe is one, points out CGS-CIMB Securities (India) Pvt. Ltd. Sparse rain and high temperatures impacted farm productivity. So much so that fodder for cattle is falling short in some regions. Besides, the heat waves can lower the attacks of fungus, impacting agrochemicals sales in the region, warns CGS-CIMB. “The recent heat waves have meant bad news for agrochemicals, and particularly fungicides Even Bayer in its recent conference call had highlighted that the European drought will likely impact fungicide and insecticide sales in the region,” adds an analyst at CGS-CIMB.
The situation can pose a major challenge for UPL. Post the Arysta acquisition, the contribution of Europe to UPL’s revenue will rise from 13% to 24%. As much as 39% of Arysta’s business comes from Europe. The drought is expected to have knock-on effects next year, such as weak farmer sentiments and low replenishments. Further a drought year usually leads to inventory pile-up at the distributor level, leaving limited window for a sales push next year.
The concerns emerge as North America, another important business region for UPL, is seeing a sluggish recovery. Last quarter, revenue in North America grew just 2% compared to company average of 13%. According to Sharekhan Ltd, UPL management expects strong performance in Latin America to mitigate some of the impact of the expected weakness in Europe. Even so, a notable slowdown in agrochemical sales in Europe can weigh on the combined entity’s growth, given Arysta’s greater exposure to the region. This can impact the expected earnings accretion. Further, UPL is expected to continue to account for the Arysta acquisition-related expenses, which had slowed profit growth last quarter.
“We see some challenges in the near term. Slower offtake in Europe and possible further expenses related to integration could dent its performance,” Sharekhan said in a note.