UPL's turnaround script for FY19: It hasn't been the best of starts, indeed

It has not been the best of starts for UPL. The company (earlier known as United Phosphorus and in the businesses of agrochemicals, industrial chemicals, and chemical intermediates) failed to hit its annual revenue growth expectation of eight to 10 per cent for 2017-18. This is the first time it happened in the last five years.

This, with concerns on high raw material costs, falling prices in the key markets of Brazil and North America, and currency fluctuations, besides continuous capital expenditure, has led to muted sentiment for the stock. It has shed about eight per cent in a week and is down almost 23 per cent since its high earlier this calendar year.

The bad news ends there. Brokerages believe the situation is changing and the steps the company is taking on raw materials would bear fruit.

The key trigger for the stock is the outlook for its major markets of Brazil and India, together with a little over 70 per cent of consolidated revenue. Analysts at SBICAP Research say the pick-up in soybean and maize prices in Brazil, coupled with a depreciating Brazilian currency, puts more money in farmers’ hands, boding well for agri-input companies such as this. In addition, India’s monsoon forecast is normal and so the demand for agrochemicals seems positive in the April-June quarter, they add.

What should keep demand elevated, believes Sharekhan, are the lower stock to consumption ratio for soybean, maize, wheat, cotton, and rice, unlike in the past, when higher inventories had kept their prices muted. The other price trigger could be a US-China tariff war, which could keep crop prices elevated — China is a major importer of soybean and maize, while the US and Brazil are major exporters.

The other worry for the Street has been higher raw material costs and the company’s decision to invest in building new capacities. UPL is planning to invest Rs 2.5 billion in an intermediate plant to reduce its dependence on Chinese raw materials, which have turned costlier. Raw material costs as a percentage of sales increased by 600 basis points sequentially to 51 per cent in the March quarter, due to supply issues and higher costs. The increase in costs is partly due to China; 25-30 per cent of UPL’s cost of goods is from there. The new plant is expected to mitigate sourcing risk.

Though UPL outperformed with seven per cent year-on-year growth in FY18, against an industry growth average of only 0.2 per cent, this was a bit short of its own eight to 10 per cent growth forecast. Analysts, however, note the contrast with the rest of the sector. UPS is confident of good growth for FY19, saying it expects 10-12 per cent more. The management confidence comes when the overall agrochemical industry is expected to grow by only two to five per cent this calendar year, after three years of flat or falling growth.

Operating profit is also expected to increase, by 12-15 per cent, which should improve its margins by 50 basis points in FY19, from 20.2 per cent in FY18, via higher-margin products and a larger proportion of branded sales.