Morgan downgrades UPL to equal weight, cuts target price to Rs 590

The EBITDA guidance for FY24 was revised to 0 to -5% from the earlier 3-7% projection.

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Global brokerage Morgan Stanley has downgraded UPL Ltd to ‘equal weight’ from ‘overweight’ and cut its target price to Rs 590 from Rs 762 earlier.

On October 30, the agrochemical company reported a net loss of Rs 189 crore for the July-September quarter, a significant drift from the Rs 996-crore profit a year back. The company’s revenue fell 18.70 percent to Rs 10,170 crore in the last one year primarily because of subdued global demand and ongoing inventory destocking. This weak performance led to a downward revision of its FY24 revenue growth guidance from 1-5 percent to flat.

Margins were also negatively impacted by geographical mix and currency challenges, with EBITDA margin dropping to 15.5 percent in Q2 from 22.5 percent in the previous year. The EBITDA guidance for FY24 was revised to 0 to minus-5 percent from the earlier 3-7 percent projection.

Read: MC Pro Inside Edge | Desi Soros, King Tring, a fund manager’s flight, value signalling, and Catch-22

UPL earnings in Q2 fell significantly short of expectations. Their revised guidance suggests strong revenue and EBITDA growth in the second half of the year, which might be challenging if Q3 remains weak. Morgan Stanley, being cautious given the competitive landscape and discounting trends, projects more modest growth of minus-1 percent for revenue and 6 percent for EBITDA in the second half. They anticipate 9 percent revenue and 12 percent EBITDA growth for FY25-26. As a result, Morgan Stanley has reduced their earnings estimates by 34 percent, 26 percent, and 22 percent for FY24-26.

UPL aims to cut gross debt by $500 million and net debt by $300 million by the end of FY24 through increased Q4 volume growth, $41 million cost reduction in H2, reduced capex ($50 million compared to FY23), factoring receivables of $1.4 billion (H1: $730 million), and achieving around 65 days of net working capital by the end of FY24.

While UPL’s bonds have lower interest rates than Libor-linked loans, the debt reduction strategy will be a combination of bonds and loans, depending on cash flow and loan duration. The average cost of borrowing stands at around 7 percent (up from about 4 percent last year), and UPL expects interest rates to remain high in the short term. The company remains committed to maintaining its investment-grade rating.

“We lower our DCF-derived PT 23 percent to Rs 590 (from Rs 762) to reflect our earnings changes. Key assumptions: (1) cost of equity of 14 percent (13.7 percent earlier) driven by higher risk free rate of 7.35 percent (7.1 percent earlier), and (2) terminal growth of 4 percent (unchanged). We believe at this stage markets will be skeptical on net debt reduction as we enter the seasonally important period for earnings and cash flows with continued uncertainty on growth. We are not UW as stock has valuation support, trading at 6.5x/5.9x FY24/FY25 EV/EBITDA, a 29 percent discount to global peers (5-year average discount: 18 percent). The discount is less likely to narrow in near term given poor earnings visibility and higher leverage,” Morgan said in its report.