United Phos has a generic advantage in agri play

United Phosphorus Ltd (UPL), a global generic crop protection, chemicals and seeds company, is a good play on the agricultural growth story. Also, with a thrust on generics globally, the company is well poised to gain market share through its wide reach and inorganic growth.

Business:  UPL produces crop protection products, intermediates, specialty chemicals and other industrial chemicals. It has presence across value-added agri inputs ranging from seeds to crop protection and post harvest activity.

The company offers a wide range of products that includes insecticides, fungicides, herbicides, fumigants, PGR and rodenticides. UPL is the largest manufacturer of agrochemicals in India and ranks among the top 5 post-patent agrochemical manufacturers in the world.

It generates about 80% of its revenues from international markets, with the low-margin domestic market contributing the rest.

The company relies on backward integration in agrochemicals leading to reliable raw material sourcing for its multi-site manufacturing. UPL is one of the world’s few companies to manufacture complex organo-phosphorus compounds starting from the basic raw material, rock phosphate ore.

The company has a wide presence with operations in almost every continent and customer base in 86 countries. UPL has 21 manufacturing sites including 9 in India, 4 in France, 2 in Spain and one each in UK, Vietnam, Argentina, the Netherlands, Italy and China.

UPL had a disappointing last quarter as revenues grew only 6% year on year on account of decline in price realisations by 13% in spite of an 18% volume growth. The international business declined due to drop in revenues from North America and Europe while domestic business grew 25%, helped by a stronger winter crop.

The net profit margins were hit by forex losses and from losses from its subsidiary company Advanta.

Investment rationale: The demand for food crops is expected to remain robust globally on account of rising population and increasing per capita consumption due to higher income.

However, there are supply-side constraints like availability of limited cultivable land and low yields leading to mismatch in demand-supply equation. This would benefit crop protection companies like UPL which play an important role in improving yields. The increasing need to protect farm produce from pests, higher farmer affordability and lucrative farm produce prices also offer upside for the agrochemical industry.

The agrochemicals industry is generic in nature with 70% of the molecules being off-patent. In spite of this, the top 6 global payers control 75% market share. In 3-5 years, more than 35 molecules are expected to go off-patent, opening further oportunity for generic players.

With big global players concentrating on biotechnology products, this opportunity will benefit larger generic players such as UPL which have gained credibility with the multinationals and are in a position to negotiate licence deals.

As the US and European markets have matured, UPL continues to focus on the high growth Latin American markets, where the company has also increased its presence by securing a few registrations.

Restructuring at the Spain and Rotterdam facilities of Cerexagri, a company it acquired in 2007, is underway and is expected to be completed by the first quarter of FY11. The restructuring would lead to about 1% margin improvement on account of better efficiencies and synergies.

UPL would benefit from inorganic growth opportunities as management continues to search for acquisitions at reasonable valuations.

Concerns: UPL faces typical industry-specific risks related to adverse weather conditions, higher raw material costs, lower demand due to low crop prices and increasing use of biotechnology products, which may affect the sales of its products and its margins. UPL also faces regulatory risks and forex risks as majority of its revenues come from overseas markets.

Valuations: The revenues over the last two quarters have been hit on account of lower realisations in spite of volume growth, which would lead to marginal yearly growth of around 10% in revenues and 3% in net profit margins. Volume growth would continue to drive UPL’s growth, both in domestic and international markets.

With prices likely to stabilise in coming quarters leading to better realisations, revenues are expected to grow at CAGR of 13% over FY09-FY11E and net profit at CAGR of 18% between FY09-FY11E.
At current market price of Rs 158.40, the stock is available at P/E of 13.89x and 10.27x its FY10E and FY11E earnings,
respectively.

Though UPL does not offer any immediate strong upside, long-term outlook remains positive on account of its global diversified presence, low-cost advantage and opportunity to cash in on substantial patent expiries and inorganic growth. Investors with long-term perspective can keep an eye on the stock.

Disclaimer: The writer does not hold any share in the company