Heading into FY22, India’s largest agrochemical company UPL was looking up at the sky - not in hope, but in expectation of favourable weather, particularly in its Indian and Latin America (LATAM) markets. The weather gods were good to UPL in some geographies but in others, they were less kind.

As India dealt with the second wave, agricultural activities carried on unabated. Farmers in the regions of the south and east of the country were sowing crops for the upcoming monsoon season which helped UPL’s Indian sales. The company’s other large market of Brazil led a recovery in revenues from LATAM, even as other countries like Mexico performed poorly.

With frost in Brazil, floods in Europe, and heavy rainfall in India and China, the outlook for agrochemicals is looking bleaker in Q2 and Q3. UPL is also struggling to pay off debts from the ArystaLifeScience acquisition from FY19. The next few months will be crucial for the agrochemical giant, as monsoon season beckons in many of the markets it operates in. Will UPL be able to weather the tide?

Revenues up in Q1FY22 as sales in India and North America rise

In Q1FY22, UPL’s revenues were Rs 8,515 crore, a 9% rise YoY due to a 26% growth in Indian agrochemical sales and a 31% growth in North American sales. Due to unfavourable weather conditions and supply chain disruptions, European sales dropped by 11% and the rest of the world’s revenues by 32%.

Net profits rose by 44% YoY to Rs 750 crore. However, net profits declined by 45% sequentially due to a 14% rise in fuel costs and a 10% increase in interest expenses.

The company’s EBITDA margins fell by 3.3 percentage points YoY to 20.3% in Q1FY22 due to rising fuel expenses, supply chain constraints, and currency devaluation of the Brazilian Real. UPL hiked prices by 5-7% in the Indian and LATAM markets in Q1FY22 to improve realizations. 

India in focus for one final quarter of FY22 

Being an agrochemical company, UPL’s revenues are seasonal in nature. But since the company caters to four primary markets - LATAM, India, North America, and Europe, each with varied seasons, the company’s revenues are fairly consistent all year round. India is UPL’s only market that generates more revenue in the first half than the second half of a fiscal year.

In Q1FY22, revenues from India were Rs 1,914 crore, a 26% growth YoY. This revenue growth was despite the second wave disrupting its supply chains and agricultural activities. Compared to Q1FY20, revenues rose by nearly 61%. In previous years, the share of Indian revenues in UPL’s total revenue doubled in Q1 from Q4. This is because agrochemicals consumption in India increases when sowing for the Kharif crop season in Q2 and Q3. In Q1FY22, Indian revenues jumped to 22% of UPL’s quarterly revenue, the highest in three years.

Heavy rainfall in Madhya Pradesh, Uttar Pradesh, Assam, and Arunachal Pradesh is expected to lower the production of soybean. This is because soybean requires moderately moist and not damp conditions for growth. Farmers in these regions preferred to grow soybean as the legume’s price is up by nearly 30% in 2021. UPL’s Chief Commercial Officer Farokh Hilloo in the Q1FY22 earnings call said farmers are switching to niche crops like groundnuts and pomegranate from soybean, which will help the company’s agrochemical sales.

Another crop that faced lower production in Q1FY22 albeit due to poor demand conditions, not adverse weather, was cotton. Due to the second wave and statewide lockdowns, outdoor movement fell resulting in lower demand for cotton textiles. Restrictions on commercial activity and reverse migration of labourers to rural areas capped cotton mills capacity at 25-30% between April to May. 

In June, with lockdowns easing and economic activity improving, cotton prices bounced back sharply. Cotton prices are measured in units called ‘candy,’ one candy is equal to 356 kg of cotton. In March, before the second wave began, cotton was priced at Rs 47,000 per candy. In July, after the second wave, cotton prices rose by 15% to Rs 54,000 per candy. On a one-year basis, cotton prices are up by 42%. 

On the export front, Indian cotton demand will benefit from lower production in Pakistan and Africa. Pakistan’s cotton production was low in Q1FY22 and is expected to remain muted low profitability, forcing farmers to shift to maize, paddy, and sugarcane. Higher domestic and export demand for Indian cotton will likely benefit UPL’s herbicides segment (40% of Q1FY22 revenue).

LATAM market set for difficult Q2 due to unfavourable weather

UPL’s revenues from LATAM, its biggest revenue contributor, rose by 24% YoY to Rs 2,507 crore, driven by sales in Brazil. The company’s Mexico market was impacted by a drought in the country towards the end of the quarter. The weather conditions in Mexico are expected to remain subdued in Q2FY22 and since the country’s monsoon season lasts between June to September, and this will likely adversely affect UPL’s sales in the region.

In previous years, LATAM revenues rose sequentially in Q2 by nearly 50% as farming began ahead of the coming monsoon season. Central American countries’ monsoon season lasts from July to October and South American countries from October to January. However, this year, the central and southern regions of Brazil are impacted by frost, which lowers temperatures and impacts the production of sugar, coffee, and orange production. According to meteorologists, coffee farmers will be the worst hit as the bean requires hotter temperatures to grow. Reports suggest that nearly 20-30% of coffee crops will be hit by adverse weather.

If the weather conditions improve, Brazilian farmers may prefer growing soybean, corn, and cotton. This is because the price of these crops rose between June to August as Covid-19 cases in many LATAM countries dropped and economic activity improved. Further, Indian soybean farmers in certain regions have also shifted to growing other crops due to heavy rainfall.

Two of the company’s smaller markets in terms of revenue contribution - Europe and Southeast Asia also performed poorly in Q1FY22. Sales in Europe declined by 11% YoY to Rs 1,520 crore, whereas the rest of the world sales were lower by 23% to Rs 1,210 crore. China is experiencing heavy rainfall since June, impacting orange production and causing supply disruptions. Japanese sales were lower due to lower realizations and the devaluation of the Japanese yen. European agricultural production was lower due to heavy rainfall in northern European countries like Germany and Belgium and frost in southern European countries like France. 

Debt remains elevated, UPL maintains debt reduction guidance

Another concern for UPL’s investors is debt on the company’s balance sheet. Debt increased after UPL acquired Arysta LifeScience, a Japanese agrochemical company for $4.2 billion (Rs 30,000 crore); 73% of this sum was financed through debt. 

Investors expected the company to benefit in FY20 following the acquisition. And Arysta initially helped the company’s revenue grow by 38% YoY in FY20, led by higher sales due to favourable weather conditions in LATAM and India. However, due to the pandemic in FY21, revenues fell by 12%, with all of UPL’s markets posting lower revenues.

In FY21, the company paid back debt worth Rs 5,100 crore, reducing its total borrowings by 18% and bringing down its debt-to-equity ratio to 1.4 from 1.7 YoY. However, due to the second wave in India and Brazil, the company’s debt rose by Rs 1,500 crore in Q1FY22, a 6% sequential rise. UPL borrowed sustainability loans worth $250 million (Rs 1,856 crore). The company borrowed to pay off the Arysta LifeSciences acquisition debt which stands at $1.5 billion (Rs 11,410 crore).

Rising debt levels are already taking a toll on the company’s profitability. Interest expenses rose 44% sequentially to Rs 602 crore. In Q1FY22, the company’s interest coverage ratio (a measure of operating profit available to cover interest costs) dropped to its lowest level in over two years.

The management said that debt levels will remain elevated in Q2FY22 through Q3FY22, and would drop in Q4FY22 as collections increase following monsoons in LATAM. The company guided for a net debt to EBITDA ratio of two times at the end of FY22. UPL’s net debt to EBITDA ratio was 2.6 in Q1FY22.

Once again, the weather will be the primary concern for UPL and its investors. India will be the main market in Q2 as much of the country is expecting normal monsoons in Q2 and Q3. Brazil’s sowing season will face a difficult period especially for high-temperature crops like coffee. Demand from winter crops like soybean and corn is likely to rise given the colder temperatures in the South American country. If these unfavourable weather conditions remain, UPL’s debt burden will weigh heavily on its books and its guidance of 7-10% revenue growth and 12-15% EBITDA growth in FY22 will be out of reach.