UPL Rating: Buy; a few bright spots in challenging scenario

Q4 is likely to be subdued; FY20-22 EPS down 3-12% to factor in Covid-19; stock’s attractively priced; TP cut to Rs 450 from Rs 680

We test UPL on two-bear case scenarios that suggest it would remain cash flow positive.
We test UPL on two-bear case scenarios that suggest it would remain cash flow positive.

UPL’s stock price has been under pressure (-50% YTD) due to COVID-19 potentially weakening demand and impacting supply chains. While impact remains a blind spot, there are a few bright spots: (i) USDA surveys suggests US farmers are looking to sow 10% more corn and soybean in 2020, China soybean demand remains strong; (ii) agriculture related inputs classified as essential products in many countries minimising disruptions; (iii) manufacturing in India should continue despite lockdowns due to product classification under essentials; (iv) in testing times when the industry has faced pressure, UPL has markedly outperformed due to high-quality, low-priced products.

Stock is pricing in no growth and lower margins: We test UPL on two-bear case scenarios that suggest it would remain cash flow positive. Bear case I assumes a 17% y-o-y revenue decline, core margins at 18%, and no incremental cost synergies. Under this scenario, it would still generate Ebitda of Rs 57 bn and EPS of Rs 17/share. This implies PE of 18.6x (5-yr average 14.5x) and EV/Ebitda of 8.7x (5-yr average 10.8x). Bear case II (0% revenue growth, other assumptions same) suggests that it would generate Ebitda of Rs 67 bn and EPS of Rs 26/share, implying PE of 12.2x and EV/Ebitda of 7.2x.

We expect net debt to be lower at end-Q4FY20 as we estimate lower working capital could release Rs 15 bn of cash flows. Also, a recent quasi debt bond issue of $400 m could be partially used for debt repayment. For FY21, on conservative assumptions, cash flow should be comfortable for debt-related obligations.

Q4FY20: Expect a subdued quarter with revenue growth of <5% y-o-y. However, as agriculture-related inputs are classified as essential products, disruptions could be limited. Also, Q4 is a major placement season in US and Europe and relatively leaner period from an agricultural activity point of view. Progress on cost synergies should continue and support profitability. We now estimate FY20 revenue growth of 6% y-o-y (lower than guidance of 8%-10%) and similar Ebitda growth.

Stock attractively valued, TP lowered to Rs 450 (down from Rs 680). We cut our FY20e-FY22e EPS forecasts by 3%-12%. The stock trades at an attractive FY21e PE of 8x given the share’s five-year historical mean of 14.5x.

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