UPL Initiating Coverage Research Report By Motilal Oswal

UPL is the second largest post-patent global player in crop protection. It has evolved from a crop protection chemicals company into a complete agro solutions provider, offering seeds, crop protection chemicals, biologicals, soil nutrients and post-harvest solutions. It is well diversified across geographies, with revenue contribution of 32% from Latin America, 20% from India, 17% from North America, 13% from Europe, and 18% from Rest of the World.

Reaping growth

Generic pesticides, backward integration to drive profitability

 A multitude of products going off-patent would unleash a generics opportunity of ~USD3b over CY17-20. With strong R&D and integrated manufacturing facilities, UPL is in a sweet spot to grab the impending opportunity in the generics market.

 The company is also set to benefit from the increasing phenomenon of pest resistance across crops with its broad array of products, which enables it to launch new combinations to tackle resistance.

 Pest resistance to major agrochemical ‘glyphosate’ (market size of ~USD5b) could provide UPL with its next key growth driver – its variant, ‘gluphosinate’.

 We expect UPL to clock ~12% revenue CAGR and ~14% PAT CAGR over FY18-20 and value the company at 17x FY20E EPS of INR55.6, arriving at a TP of INR945. Initiate coverage with Buy.

Strong R&D, backward integration to help grab fungicide opportunity

UPL possesses in-house manufacturing expertise, reducing its dependence on third-party partners. Backward integration enables 70-75% of its manufacturing to take place in-house (50-55% in India and 20% overseas). It imports 10-15% from China and Europe (France and UK). Its gross margin was at 53% in FY17 against domestic player average of 43.6% (FY17) and global player average of 35.6% (CY16). The size of the global fungicides market is USD15b (CY17) and its share in the global agrochemicals market has increased from ~20% in CY00 to 27% in CY17. Given the high growth expected in fungicides, UPL too has aligned itself with the industry – the contribution of fungicides to its revenue has increased from 5% in FY03 to 29% in FY17. With just ~4.5% share in the global fungicides market, UPL has immense growth opportunity in the segment.

Products worth USD3b going off-patent – opportunity unleashed for UPL

Products worth USD3.7b have already gone off-patent over CY15-17. This has led to a shift from the use of high value patented products to generic agrochemicals, enabling 16% CAGR for UPL over FY15-17. The multitude of products going off-patent is expected to create ~USD3b opportunity for the generics industry over CY17-20. UPL is adept at identifying and registering products attracting robust demand even after going off-patent and is therefore expected to leverage the impending opportunity well. The generics opportunity has been supported by subdued farm income, which should continue, as higher closing stocks would keep prices of agricultural commodities in check.

‘Gluphosinate’ herbicide likely to be a boon for UPL

In CY14, UPL launched two brands of the herbicide, gluphosinate in the USA for soybean and corn to fill gaps in its portfolio both from a crop and regional perspective. One brand, Lifeline is targeted at regions outside the Midwest. The other brand, Interline is solely for the Midwest, given the quantum of area under soybean and corn cultivation in the region. The company has gradually established presence of gluphosinate in markets across geographies and now competes directly with glyphosate, the size of which is estimated at ~USD5b. Additionally, glyphosate has been facing headwinds, as the targeted herbs have gradually developed resistance against it and the active ingredient is also under evaluation by WHO for being carcinogenic in nature. Given the headwinds surrounding glyphosate, gluphosinate could be the next key growth driver for the company.

New launches and branded products to drive growth

UPL has been continuously investing in brand building and innovation, and this has paid rich dividends. Its EBITDA margin has improved from 15-16% over FY09-10 to 19-20% over FY16-17. Branded and innovative products command higher margins than commoditized products. The revenue share of branded products has gradually increased from 75% in FY14 to 86% in FY17. The company has launched over 240 products and filed 195 patents over FY15-17. Its global product registrations have increased from 4,692 in FY15 to 5,934 in FY17. The revenue contribution from innovative products launched in the past three years has grown from 5% in FY15 to 15% in FY17. Revenue from innovative products is likely to improve further, aided by products launched in the last 2-3 years and by planned product launches across the globe in the next 2-3 years. Rising contribution of new products is likely to improve the revenue mix; higher share of value-added products will aid revenue growth.

Valuation and view

We believe UPL is one of the best bets on the global agrochemicals industry, as it offers (a) a robust product pipeline, (b) an integrated business model (backward integration of 70-75%), (c) a broad product portfolio covering various crops across seasons, (d) geographical diversification, and (e) scope to gain further market share (from the current ~4%). The stock has re-rated from a one-year forward P/E of 7x (FY14) to a one-year forward P/E of 16x (FY18E). We expect the re-rating to continue on improving fundamentals coupled with healthy earnings growth. At the current market price, average free cash flow yield works out to 4.3% over FY18-20 against the last three years’ average of 4%. We estimate ~12% CAGR in sales and ~14% CAGR in PAT over FY18-20, with EBITDA margin expanding 80bp to 21.2%. We value UPL at 17x FY20E EPS of INR55.6, arriving at a TP of INR945. We initiate coverage with Buy.