UPL gives investors a pleasant surprise

Update shows 24% fall in debt; Arystra merger synergies a key re-rating trigger

During the current lockdownled disruption in business, cash is king and a decline in debt is a pleasant surprise. And, if these come along with news that business is near normal, it would be taken pretty well by investors.

It is in this backdrop that UPL’S stock jumped 16.5 per cent on Thursday. In an update on debt reduction on Thursday, which also mentioned that demand for its products was normal, UPL stated that it had cash and cash equivalent of $875 million (~6,600 crore) as of March 31.

The company sees its net debt falling by 24 per cent to $2.9 billion at the end of March, from $3.8 billion a year-ago. The announcement removes a major overhang on the stock, and hence, surprised the

Street.

UPL had guided for debt reduction of

$500 million during financial year 2019-20 (FY20). However, it had seen a jump in net debt to $4.2 billion by December, because of a rise in working capital. This led to concerns on UPL.

The reduction of $1.3 billion in overall debt, analysts say, was largely led by improvement in working capital. Typically, the last quarter sees lower working capital requirement, and an analyst at a domestic brokerage said the lockdown and plant closures might have helped. Nonetheless, it is positive.

On the business front, too, conditions were better. While the lockdown might have had some impact on near-term revenues, UPL’S facilities were seeing normalised production with agri products being classified as essential commodities.

Even rabi crop harvesting was picking up pace and kharif prospects had improved further with the forecast of a normal monsoon. Concerns over supply disruption in international markets, especially developed regions such as Europe were easing with some relief in lockdowns. While the US and Europe have seen soft performance in the past few quarters, much of UPL’S growth came from Latin America, which had not seen disruption. Analysts, thus, anticipate only a 10-15 per cent impact on earnings.

Further, synergy benefits from the Arysta merger should improve in FY21 and FY22. Analysts at Emkay Global had anticipated UPL’S return ratios to improve by 224 basis points over the next two years to 12.8 per cent led by 11.2 per cent per annum earnings growth with merger synergies playing out.

All this should reflect positively on the stock, which had corrected by more than half, from February highs to March lows, on concerns of supply disruption led by Covid-19 outbreak. With most concerns easing, analysts see decent upside for the stock, which at ~420 levels is still trading at 10x FY22 earnings estimates, a 13-14x discount to its historical valuations.