United Phosphorous: In every long-term investor's portfolio

United Phosphorous

One-year beta 0.78
Institutional holding 55.61%
Current dividend yield 1.0%
Current P/E 13.5
Current m-cap Rs 6555.9 cr
Current market price Rs 149.15

United Phosphorous (UPL), with its wide product portfolio and worldwide presence, appears well placed to benefit from a boom in agriculture over the next few years. Long-term investors should consider including this evergreen stock to their portfolio.

Business:

Incorporated in 1969, United Phosphorous today is among top five generic agrochemicals manufacturers in the world. It has 23 manufacturing sites (nine in India, four in France, two in Spain, one each in UK, Vietnam, Argentina, Netherlands, Italy, Colombia and China) with a customer base spread across 86 countries. The company manufactures a wide spectrum of generic agrochemicals and specialty chemicals.

During FY09, the company derived 22% of its sales from North America, 21% from India, 32% from Europe and 25% from other countries, with all the regions reporting double-digit growth.

It has a wide domestic and global distribution network for the sale of its products worldwide and boasts of the largest agrochemical product portfolio in India. The company carried out a series of big-ticket buyouts during FY05 and FY08 to expand its geographical reach and product portfolio.

In November 2004, it bought US-based AG Value for $36 million, followed by Spanish company Cequisa and Indian Shaw Wallace Agrochemicals in Jun 05. In Nov 05 it bought Argentinean Reposo and Dutch seed manufacturer Advanta in Feb 06. Acquisition of South African Crop Serve was followed by French company Cerexagri in Nov 06. The Argentina-based ICONA in July 07 and Colombia-based Evofarms in Feb 08 were its recent most acquisitions. UPL has also purchased various agrochemical products from a number of global leaders such as Bayer, Dow Agrosciences and Du Pont.

Growth Drivers:

After several years of aggressive inorganic growth, UPL has settled into consolidation. In FY09, the company didn’t make any significant buy-outs and is not likely to go in for one in FY10 either. At a time when the growth in demand for food has outstripped the growth in supply, the pressure on agriculture has increased to improve farm yields the world over.

Higher commodity prices have also resulted in higher liquidity in the hands of farmers, increasing their ability to invest in agriculture. This augurs well for the global agrochemicals industry, which after several years of single digit growth, witnessed over 10% of real growth in FY09. In fact, the global economic slowdown is unlikely to take a toll on agriculture.

United Phosphorous, with a wide product portfolio and expansive geographical reach, is well placed to benefit in this scenario. The company has a healthy track record of sales and profit growth, while maintaining strong operating margins over the past five years. The company has been regularly introducing new products to its various markets and has earmarked a capex of Rs 300 crore for FY10 on plant expansions and new product registrations.

Financials:

During the FY09, UPL reported a 37% spurt in its net sales to Rs 4,802 crore, out of which 8% was from rupee depreciation, 15% due to higher prices and 14% due to an increase in quantity.

The company’s borrowing in FY09 increased by Rs 504 crore to Rs 2,073 crore as on March 31, 2009 mainly due to loans given to group company Advanta, repricing of forex loans and rise in working capital. To fund its inorganic growth, the company had raised $225 million through the issue of FCCBs in FY05 and FY07. Of these, FCCBs worth $157.1 million have been converted into equity shares and $67.9 million are outstanding.

Valuation:

At the current market price of Rs 149.15, the scrip is trading at 13.5 times its earnings for the year ended March 2009. We expect the company to end FY10 with an EPS of Rs 13.1, which discounts the current price by 11.4 times. Its peers like Bayer Crop science and Rallis India are currently trading at P/E of 11-13.

United Phosphorus - Harvesting growth

A robust business model, improving margins and healthy growth prospects make United Phosphorus a good investment case.

United Phosphorus, one of the leading players in the global agrichemical market, is incidentally among the few companies which are least affected due to the global crisis and domestic economic slowdown. Although global agriculture commodity prices have come down, these are still higher compared to prices two-to-three years back.

Even at current levels, farmers (globally) are estimated to be making profits for every crop they are sowing. United Phosphorus which operates in two segments (crop protection and seeds) is among the key beneficiaries of this underlying trend having presence in over 80 countries, including India.

Notably, this trend of high growth is likely to continue (except for some impact on realisations) in the future as well along with additional benefits accruing on account of improving margins and integration of some of its subsidiaries.

Multi-pronged strategy

The most important factor, which has helped the company to grow fast, has been its strategy to diversify into different regions and products. Its strategy of pursuing acquisitions in the international markets has seen UPL acquire 18 companies in the last six years.

This has worked in many ways as it has not only given the company a controlling market share in some of the major markets as well as access to newer markets, but it has also helped expand into newer product categories.

Today, international markets account for 79 per cent of UPL’s consolidated revenues, and have been the key growth driver for the company. For instance, during Q3FY09, domestic revenues grew by about 15 per cent, whereas its international business saw revenues grow at a robust 43 per cent.

Notably, the company is also well diversified in terms of regions. Revenues from the US markets (23 per cent share of international revenues) grew by mere 9 per cent, which however was compensated by the 60 per cent growth in European markets (36 per cent share) and 53 per cent growth from rest of the world (42 per cent share).

After the acquisition of European company, Cerexagri, in Q4FY07, UPL has emerged as the 11th largest player globally (in revenue terms) in the agrichemical business as against 16th earlier. Cerexagri, which has an annual turnover of Rs 1,250-1,300 crore, has strong hold in the markets like Europe and US.

On the other hand, UPL has also diversified its product portfolio and enhanced its presence in the agricultural value-chain by acquiring a 49.9 per cent stake in Advanta India (in 2006). Advanta, a listed company, reported revenues of Rs 430 crore and net profit of Rs 43.63 crore in CY07. Advanta has given UPL significant presence in the fast growing seeds market.

It is a leading supplier of seeds and has a well-diversified portfolio consisting of seeds for crops like rice, cotton, canola, corn, sunflower, sorghum and wheat. Today, Advanta has operations in Australia, Argentina, Thailand and India. Together, they are taking the benefits of synergies of common distribution network to grow.

Vast global opportunity

Off-late, while the growth has been faster in these international markets, the decline in agriculture commodity prices has resulted in lower realisations for agrichemical companies. Although analysts say since agrochemicals account for a very small portion (7-8 per cent) of the total cost of crop, the volumes should still be growing at 5-6 per cent. Also, the US and UK markets are relatively larger markets, as about 75 per cent of the market is off-patent. This enables UPL to spread its reach and introduce new products to garner higher growth–UPL’s revenues have grown at about 28 per cent annually during 2002-08 in these markets.

Improving margins

Cerexagri specialises in plant protection products, where fruit and vegetable segment account for about 80 per cent of the sales. As of now, the company enjoys EBIDTA margins of about 10 per cent as against the UPL’s EBIDTA margins of 17.5 per cent. However, the margins are expected to improve as UPL is restructuring the business of Cerexagri.

The company plans to outsource its products to take the advantage of India’s low cost manufacturing and also leverage its international distribution network. Overall, it is estimated that the company will be able to improve its operating margins by about 250-300 basis points to about 21.5 per cent by FY11. The improvement in the margins also includes the impact of falling input cost.

MARGIN GAINS
in Rs crore	FY08	FY09E	FY10E
Sales	3730	5020	5300
EBITDA margin (%)	19.8	18.6	21.0
Net profit	395	530	710
EPS (Rs)	9.0	10.9	13.9
PE (x)	9.8	8.2	6.3
E: analyst estimates

The international agrochemical prices have come down in the recent past, but due to the lag effect the impact of lower raw material prices is yet to seen. Analyst’s estimate that about 100 basis points improvement in the operating margins in FY10 will be on account of falling input cost.

The lower input cost will also mean that UPL will require lower working capital in FY10. The working capital days, which were at 120 in FY08 and estimated to go up to 165-170 days in FY09, are also seen declining by about 20-25 days in FY10, due to lower input prices and inventory days. Thus, indicating that UPL may see its interest cost decline partly in FY10. The interest cost for nine months ended December 2008 was up by 185 per cent to Rs 197 crore. Investment rationale

UPL is seen growing at a healthy pace, both in agrichemical as well as seeds, over the next few years. While the revenue growth could be lower (due to decline in agrichemical realisations), margins are likely to improve and boost profit growth.

A robust business model helped by a diverse presence across regions and product categories provides comfort, as well as cushion during any slowdown.

At Rs 88, UPL’s stock is trading at 8.2 times FY09 and 6 times FY10 estimated earnings, which is reasonable and can yield over 30 per cent returns in a year’s time.