Morgan lowers the target price to Rs. 590 and downgrades UPL to equal weight

 Morgan lowers the target price to Rs. 590 and downgrades UPL to equal weight

The original 3-7% estimate for EBITDA forecast for FY24 was changed to 0 to -5%.

Reducing its target price from Rs 762 to Rs 590, global brokerage Morgan Stanley, among others, downgraded UPL Ltd in 'overweight' to 'equal weight'.

The agrochemical business said on October 30 that it had lost Rs 189 crore for the July-September quarter, a considerable decline from the Rs 996 crore profit it had made the previous year. In the prior year, the company's sales decreased by 18.70 percent to Rs 10,170 crore, mostly as a result of persistent inventory destocking and muted worldwide demand. The company revised its FY24 sales growth estimate downward from 1–5% to flat as a result of this poor performance.

Geographic mix and currency issues also had a detrimental effect on margins; for example, EBITDA margin fell to 15.5% in Q2 from 22.5 percent in Q1 of last year. The initial 3–7% percent estimate for FY24's EBITDA outlook was changed to 0 to minus-5 percent.

The Q2 profits of UPL were well below estimates. Their updated estimate calls for robust increase in both sales and EBITDA over the second half of the year, which might be difficult if Q3 continues to be dismal. In the second half, Morgan Stanley anticipates more restrained growth of minus 1% for sales and 6% for EBITDA due to the competitive environment and discounting patterns. For FY25–26, they predict growth in sales of 9% and EBITDA of 12%. Morgan Stanley has thus lowered its profit projections for FY24–26 by 34%, 26%, and 22%.

Through increased Q4 volume growth, $41 million in cost reduction in H2, decreased capex ($50 million compared to FY23), considering receivables of $1.4 billion (H1: $730 million), along with achieving approximately 65 days of net working capital by the end of FY24, UPL hopes to reduce gross debt by $500 million and net debt by $300 million.

Depending on cash flow and loan length, a mix of bonds and loans will be used in the debt reduction approach, even though UPL's bonds offer lower interest rates than Libor-linked loans. UPL anticipates that interest rates will stay high in the near future, with the average cost of borrowing now hovering about 7%, up from around 4% the previous year. The business is still dedicated to keeping its investment-grade rating.

"To reflect our adjustments in profits, we have lowered our DCF-derived PT 23 percent to Rs 590 (from Rs 762). The following are the main hypotheses: (1) a higher risk-free rate of 7.35 percent (13.7 percent earlier) that drives a cost of equity of 14 percent (13.7 percent earlier); and (2) terminal growth of 4 percent (unchanged). Since we are approaching the seasonally significant time for profits and cash flows and growth is still unknown, we think that at this point, markets will be wary about net debt reduction. We are not UW since the company has strong value support and is now selling at a 29 percent discount to its global rivals (5-year average discount: 18 percent), or 6.5x/5.9x FY24/FY25 EV/EBITDA. Given low earnings visibility and increasing debt, the discount is less likely to close in the short term, according to Morgan's analysis.