A Breed of its Own

Rajnikant Shroff started off his business on an explosive note, literally. A 36-year-old Shroff, a chemistry graduate from Gujarat, as the R&D head at his family-owned unit was mixing various chemicals in search of a formula that would enable him to manufacture red phosphorus at low cost. Unfortunately, that exercise led to an explosion at the plant. A very worried uncle asked him to stop his risky experiment, but Shroff was obsessed about his idea. He chose to start his own venture, UPL, to continue with his dream.

In 1969, he set up a red phosphorous factory in Vapi. The company started production with a paltry sum of Rs.4 lakh with over 25 employees. In those days, a Swedish company that went by the name of Wimco made matchboxes and used red phosphorus for its matches. When Wimco heard of Shroff’s venture, it couldn’t digest the news. By any measure, phosphorus production was considered an expensive energy-intensive process. Energy costs could account for as much as one-third of production. However, against all established notions, here was a small company that was producing phosphorus at a fraction of the costs prevalent in the industry.

Wimco sent a letter to the Indian government, alleging some mischief at the Vapi-based company. According to them, manufacturing red phosphorous required at least Rs.4 crore (100x the money Shroff had invested) and an extensive knowledge of the sector. A team of Director General of Technical Development and the National Research and Development Corporation landed at Vapi to solve this mystery. But they found nothing wrong after investigation. They sent a report to Delhi declaring the plant safe and project perfect. Far from penalising the company for its low-cost red phosphorous production, the government instead awarded Shroff a gold seal to recognise his company’s R&D efforts — a first of its kind award for a small-scale factory in India.

Since then, Shroff has come a long way. He went on to successfully create a low-cost manufacturing base in India and through product registrations (6,000 pesticide registrations at last count) and wide-reaching distribution across the world, entered the global supply chain of agrochemicals. Today, UPL is the eighth-largest agrochemical player in the world and the second largest generic player with a turnover of over Rs.17,000 crore.

The Mumbai-based company has 33 manufacturing units across 12 countries. As many as 14 units are in India, while 19 are abroad. UPL’s product portfolio includes crop protection chemicals such as fungicides, insecticides and herbicides. The company also makes industrial and specialty chemicals, bulk of which are used for captive consumption.

Since it is 30-40% cheaper to set up a plant in India compared to other countries, a majority of UPL’s bulk chemical units are located in the country. The formulation plants that warrant lower capex are set up overseas closer to its clients. “The basic manufacturing is done in India and the last level of manufacturing is done closer to market. This hub-and-spoke distribution model ensures faster reach to markets,” points out Dhananjay Sinha, head of research at Emkay Global Financial Services.

A steady affair
Agriculture is dependent on the vagaries of nature. Good monsoons typically bode well for agriculture-related industries such as agrochemicals and poor rainfall works the other way round. Even though UPL’s business has a certain seasonality to it, by diversifying into multiple geographies, the company has brought stability to its earnings. Overseas markets account for 80% of UPL’s revenue, while the balance 20% comes from India.

In India, the peak season lasts from May to September when monsoons are in full swing. Meanwhile, the rainy season in Brazil falls in the third quarter of a fiscal year. “Different regions see rainfall at different times, which means there is a market for UPL’s products round the year. Another benefit of having a large global presence is that if rain disappoints in one region, another place can make up for it. For instance, while the occurrence of El Nino will cause drought in India, it will have an opposite effect in Brazil,” explains Mehul Thanawala, oil & gas and chemicals analyst at JM Financial.

UPL’s financial performance reflects the stability in the company’s operations. Over the past five years, UPL’s revenue has grown at a CAGR of 16%, while profits have grown at an average of 25.5% during the same period (See: In full bloom). During the five-year period, the domestic business has grown by an average of 14.8%, but its international business has grown at a faster rate of 17.8%, as it has successfully turned around its overseas acquisitions.   

UPL has scaled up its international presence on the back of more than 25 acquisitions over the past two decades. “We were doing well in India, but after liberalisation we wanted to enter the global market as the size of opportunity was much larger. About 23 years back, we entered the world market and since then, we have scaled up without compromising on profitability. The geographical diversification helped us de-risk our earnings and sustain our growth momentum,” mentions Shroff, chairman, UPL. 

Latin push
Latin America is the biggest revenue contributor, accounting for 33% of the overall revenue. Within LatAm, Brazil has the biggest share as it accounts for over 60% of sales, as per analysts’ estimates. North America and Europe account for 17% and 13% of the sales, respectively.  

The Latin American markets have played a key role in driving the growth of the company with revenue compounding at an annual rate of 26% CAGR over the past three years. The food production in Latin America market is much less compared with India, but their consumption of pesticides is around $12.6 billion. In comparison, the consumption of pesticides in India is around $2.5 billion. Revenue from India has grown at 13% CAGR over the same period. Going ahead, analysts expect Latin America to be a key growth driver (See: Doing the samba). “Substantial growth in the Latin American markets has come from the success of its fungicide portfolio in Brazil. An increase in fungi-resistance to established products with single mode of action has resulted in farmers adopting more of UPL’s products with multi-mode of action such as Mancozeb,” says Vishnu Kumar AS, analyst, Spark Capital. 

Mancozeb is a fungicide that is used in protecting crops such as soybean from the Asian rust disease. Over the past two years, the fungicides market has grown significantly in Brazil. The fungicides market (33% of total) has overtaken the insecticides market (29%) making it the largest segment, explaining why UPL has been focusing on a fungicide in Brazil. Mancozeb contributes 12-13% to the overall sales of UPL and remains its largest revenue-generating product. As on FY17, fungicides accounted for 29% of UPL’s revenue; insecticides, herbicides and seeds accounted for 23%, 29% and 10%, respectively. The rest came from ‘others’ category, which includes plant growth nutrients.    

Of all UPL’s acquisitions, the foray into Brazil has been the most rewarding one. UPL do Brasil generates annual revenue of $500 million, almost tripling its revenue over the past three years. The company has launched 13 molecules during this period and expects good additions to its product portfolio across various crops in the foreseeable future.

In FY12, UPL bought a 51% stake in DVA Agro Brazil for $185 million to widen its presence, in the world’s largest market for agrochemicals. The acquisition helped UPL gain access to DVA Agro’s product portfolio (a differentiated line of post-patent crop protection agrochemicals and nutrition products) and leverage its distribution network. The acquisition had come close on the heels of UPL’s buyout of a 50% stake in Sipcam Isagro, a manufacturer and distributor of formulations in Brazil in 2011.

UPL management expects revenue from Brazil to touch $1 billion (doubling from FY17) over the next two to three years and is building a new agrochemical plant in the country for a total investment of $300 million over the next two to three years. The company expects to fund the expansion with a mix of internal accruals and debt. 

Ploughing the soil
While acquisitions have been instrumental in accelerating UPL’s growth (revenue grew eight-fold between FY06 and FY16), the inorganic route has not been without hurdles. The series of acquisitions took a toll on company’s profitability — the Ebitda margin reduced from 28% in FY06 to levels of 19% during FY10-13. 

The working capital also got stretched. As revenue share from the fast growing long credit Latin American markets (300 days cycle in Brazil) went up, net working capital jumped 93% to Rs.245 crore in FY12. Since then, UPL has improved its operational performance — the net working capital cycle has reduced to 90 days. Operating margins have inched back to 20.8% in FY17. 

Sinha believes UPL has been successful in improving operations of its acquired assets by getting the right people in key positions. “UPL has managed to successfully turnaround its acquisitions. Some of them were loss-making, while some were not so profitable. However, UPL has been able to integrate these businesses well and draw synergies from them. Typically, absorbing new assets take time, but UPL has done it at a faster pace. They have been able to do this by retaining executives in the acquired assets and bringing in regional talent,” he says. UPL’s management has kept a close watch on their acquired assets. The acquired entities had a payback period of three years with synergy effects quantified and post-acquisition profitability being continuously tracked by the CFO and his team.

UPL’s first international acquisition — the UK-based MTM Agrochemicals which was bought for £10.5 million in 1994 — serves as a good example of the company’s ability to turnaround acquisitions. MTM had gone bankrupt when UPL had bought it. However, it had a good line of organophosphate products, rich technology and product approvals. UPL retained the British CEO of MTM and commissioned a team to turnaround MTM through prudent investments in plants, processes and people. Within 18 months, MTM reported a surplus. 

The acquisition of French company Cerexagri in 2007 is another case in point. UPL reduced overheads and streamlined production across Cerexagri’s factories (three in France, one in Holland and one in Italy). Besides, UPL leveraged Cerexagri’s Mancozeb competence, increased the product’s capacity within its Indian plants and acquired a Colombian Mancozeb unit from DuPont in 2010. “After acquiring the company, we had professors from Indian universities visit these plants and then our engineers and scientists tried to find solutions with them. This approach helped us improve efficiencies in our acquisitions,” says Shroff. When the company bought the Colombian plant, it was producing Mancozeb at $3 a kilo. Today, the capacity of the plant has increased over four times but the cost has gone down to $1.8 a kilo. These initiatives enabled UPL to emerge as one of the world’s largest producers of Mancozeb. 

Sunny-side up
Shroff seems to have found the right formula for success. UPL is also getting benefits of a favourable environment. For instance, weak farm incomes have led farmers to down trade to branded generics. “Agricultural commodity prices have been weaker which has led to lower farm incomes. When farmers’ incomes fall, they tend to downtrade and that is what has happened. Farmers have switched from specialty players to branded generics. UPL benefits from this trend as it may be difficult to convince farmers to uptrade once they switch to a good generic product and are satisfied with its performance,” says Thanawala. As much as 86% of UPL’s sales come from branded generics.  

Even in a de-growing global agrochem market, UPL has seen its market share rise from 3% in FY14 to 4% in FY17. In recent years, the crop protection chemical industry’s growth was hit owing to high grain inventory levels, but that hasn’t affected UPL. The company’s revenue grew by 17% in FY17 even as the global crop protection chemical industry contracted 2.5% in CY16.

With more molecules going off-patent, players such as UPL stand to gain. “Molecules worth $5 billion to $6 billion are estimated to go off patent between 2014 and 2020. While innovators continue to maintain a stronghold on these molecules even after patent expiry, it eventually leads to 30-40% market share grab by generic players over a period of time. At this rate, it could lead to $2 billion of incremental opportunity for players like UPL,” says Kumar. 

In FY17, UPL filed for 19 patents and registered for 427 products across 72 countries. Going ahead, analysts expect UPL’s revenue to increase by an average of 14% every year over FY17-19 and profit to grow 22% CAGR over the same period. “Having a globally diversified business gives UPL a competitive edge over its domestic peers and having a low-cost manufacturing base gives it an edge over its global players,” says Abhijit Akella, analyst at IIFL Institutional Equities. The stock currently trades at an attractive 15x its one-year forward (FY19) earnings (See: Pick of the lot). Going ahead, analysts expect the company’s return on capital employed (ROCE) to improve to 19-20% from its 17-18% average as asset utilisation continues to improve. They expect the stock to trade at 20x FY19 earnings over the next 12 months, which pegs the target price at Rs.1,020 a share. That is a 24% upside from the current market price. With a diversified product portfolio, geographical presence and a favourable external environment, UPL should continue to grow its earnings at a steady space, which makes it an attractive ‘buy’ at current valuation.