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UPL: Higher interest cost a Q1 spoiler, margin may feel the heatqrcode

Aug. 5, 2019

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Aug. 5, 2019
>  Weak operating performance with weakness in demand across US, Europe and India
>  LatAm business reports decent growth
>  Unfavorable geographical mix impacts operating margin
>  High interest and depreciation costs post acquisition eat away profitability
>  Despite weakness, management maintains annual guidance
>  Steep correction in stock post results
Amid a challenging global agrochemical market, UPL Ltd (CMP: Rs 573; Mcap: Rs 44,351 crore) reported a disappointing set of Q1 FY20 results, marred by poor operating performance and acquisition related adjustments. While performance in Latin America remained steady, other geographies reported weakness. The stock saw substantial correction in trade, post the subdued results.
Key Highlights
>  The quarter saw a weak performance on both consolidated and standalone basis. Gross margin saw a substantial contraction owing to an unfavorable regional mix with higher sales in low-margin geographies.
>  The burden of higher debt taken for the Arysta acquisition led to an increase in interest costs. High depreciation and interest costs ate away the company’s profitability during the quarter.
>  Performance in LatAM (low-margin geography) remained healthy with around a 25 percent year-on-year (YoY) growth in revenue driven by Brazil with higher demand for herbicides and insecticides. Growth momentum is expected to continue in the region. Moreover, one of the company’s fungicides has been put on the priority registration list by the regulator, which will bring added demand.
>  Delayed and erratic monsoon in India led to delayed sowing and postponement of the entire season. This led to weak placement of products in June and domestic business remained under pressure with a substantial 5 percent YoY decline in sales.
>  Despite flooding in some regions in the US, UPL’s North American business grew by 6 percent YoY due to benefits from the US-China trade war and uncertainty in supplies from China.
>  Dry weather led to weakness in offtake in eastern and western Europe. However, this was partially mitigated by the decent performance in the Mediterranean region, thereby leading to only around 3 percent YoY decline in the revenue from the region.
>  Rest of the world sales grew 7 percent YoY, driven by growth in South and West Africa. Irregularities in supply from China and delayed rains impacted the business in South East Asia.
Despite the weak performance in Q1, UPL has maintained its FY20 guidance. The company plans to reduce debt by $500 million in FY20. This debt reduction will largely be funded through internal cash flow generation and decreasing the working capital of Arysta.
UPL has seen a noticeable correction in the past months. The stock is now trading at 18x 2020e price to earnings.
The operating performance (ex-Arysta) during the quarter appears relatively better and costs due to the Arysta merger have impacted net profit. We expect the performance to improve owing to the attractive line-up of product portfolio.
However, the company has substantial exposure to various geographies, and anomalies related to weather conditions and exchange rates bring uncertainty to the company’s performance. While the synergies related to the Arysta deal will start benefiting the performance after 1-2 years, we see expenses and higher leveraging to impact margins in the near term.

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