UPL share price: Uncertainty for investors after whistleblower complaint, even as management scrambles to do damage control

UPL Share price took a tumble and it has caught the attention of investors. Kotak Institutional Equities report reiterates SELL rating on UPL and reduces the target price to Rs 375. Report says that frequent governance issues for UPL, third time within a year, is worrying. UPL management has clarified their position on each instance, albeit it seems to provide lesser comfort to investors for now. Recurring downgrades on consensus estimates amid limited conviction on optimistic guidance led forecasts, low FCF (free cash flow) generation, high effective leverage and a few other issues have kept Kotak cautious on the stock. Inexpensive headline valuation as the only rationale to invest in UPL shares has limited merit given several intricacies and uncertainties.

Kotak says UPL has witnessed its third governance related issue in CY2020, as an unauthenticated media article pointed out a whistleblower complaint suggesting siphoning of funds by the promoters, which was filed in June 2017 but not disclosed earlier by the company. Earlier in January 2020, there was a search conducted by the income tax department in the company’s premises and recently it was asked to file IT returns for the past six years. Subsequently in October 2020, the statutory auditor of UPL Corp., a material subsidiary based out of Mauritius for overseas business, tendered resignation. In each of these instances, Kotak acknowledges that the UPL management has been forthcoming in issuing clarifications to allay investor concerns; however, uncertainty around such issues remains as overhang on the UPL stock.

Kotak says UPL may find it difficult to reduce its ‘reported’ net debt to 2X EBITDA by end-FY2021, without issuance of perpetual bonds or receivables factoring given unlikely material upside to Kotak’s below consensus estimates and limited scope of cash flow release from working capital, which was substantially below peer group, in terms of days as of endFY2020. In the conference call organized to allay investor concerns on recent issue, UPL management indicated that business momentum is fairly robust amid healthy end-market demand environment and favourable agri-commodity prices; however, we will await actual delivery and watch out for sustainability of strong earnings, if at all, to review their estimates.

UPL share price: Kotak sees limited merit in that rational to invest as -

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(1) UPL headline valuation overlooks several intricacies such as value of minority interest, large receivable factoring and seasonally lower end period
(2) lower than historical multiple may be warranted, as acquisition of Arysta has nearly doubled UPL’s market share and reduced the headroom for long term growth
(3) UPL lower multiple compared to peers like FMC despite similar revenue/growth profile, may again be warranted due to low FCF conversion, return ratios and several uncertainties.