Fitch Rates UPL Corp First-Time 'BBB-'; Bond 'BBB-(EXP)'
Fitch has also assigned UPL Corp's proposed US-dollar senior unsecured notes an expected rating of 'BBB-(EXP)'. The final rating is subject to the receipt of final documentation conforming to information already received.
KEY RATING DRIVERS
Diversified and Competitive Player: UPL Ltd is one of the largest post-patent crop protection chemical producers globally, with sales presence in more than 120 countries and 28 manufacturing facilities in India and abroad. It is well-diversified geographically, deriving around half of its revenue from the growing markets of Latin America and India and 35% from the developed markets of US and Europe. UPL Ltd's product portfolio spans across the value chain, starting from seeds and seed treatment to conventional crop protection and post-harvest solutions, and caters to more than 10 major crop sectors. Conventional crop protection chemicals - herbicides, insecticides and fungicides - form around 80% of the company's revenue, with roughly equal contribution from the three. The diversification helps UPL Ltd tide over factors that affect sectoral demand, such as seasonality, unpredictable weather patterns, volatile crop prices and varying protection needs.
UPL Ltd's revenue growth has been one of the industry's fastest, at 11% per year in US dollar terms over 2011-2015. The company has also improved its global market share from 2% in 2010 to 4% in 2015 and generates 85% of its sales from branded products. UPL Ltd has invested in product registration capabilities in key markets and has increased its registration portfolio by 10% per year on average over the past five years, indicating its growth momentum is likely to be sustained.
Robust Industry Prospects: The global crop protection market has grown by 4.4% per year over 2011-2015, despite shrinking in 2015 due to exchange-rate volatility, adverse weather conditions and lower crop prices. Longer term, Fitch expects the market to continue growing, led by fungicides, due to an increased focus on food security for the world's growing population and the need for higher-yields, especially in developing markets. The crop protection industry also enjoys high barriers to entry, as significant investments are needed in registrations, sales and distribution channels and manufacturing facilities. The market is highly regulated and registrations have a long gestation period of several years. These factors also hinder potentially disruptive technologies.
Prospects for post-patent players, such as UPL Ltd, are bright, despite the industry being highly concentrated, with innovators (such as Syngenta AG and Bayer AG, among others) taking up 77% of total market share. Products in which post-patent players compete have been steadily gaining market share, forming 58% of the global market in 2014 (2000: 30%), while share of products exclusive to innovators has fallen, with less new products being introduced compared with previous years. The trend is likely to continue, with over USD6bn worth of products, or around 13% of current market size, coming off-patent until 2020. The innovators are also in the midst of significant consolidation, presenting opportunities for post-patent players to enhance their portfolio by acquiring specific products and optimising their product offerings.
Cost-Efficient Manufacturing: UPL Ltd's manufacturing operations are centred in Gujarat, India, where two sites - Ankleshwar and Jhagadia - provide over 70% of the capacity for the company's main product, Mancozeb, an agricultural fungicide. UPL Ltd derives benefits from a low-cost base and continuous process improvements, having operated the sites for more than 20 years. The company's efficient production process drives its robust EBITDA margins, which compare favourably with post-patent crop protection market peers. In addition, reliance on in-house manufacturing results in better process control and more stable margins compared with competitors that use contract manufacturing.
Healthy Financial Metrics: Fitch believes UPL Ltd's operational strengths translate into an ability to sustain profitability and generate consistently positive free cash flow. We estimate the company's FFO-adjusted net leverage will remain at around 2.2x over the next three years, while its FFO-fixed charge cover will be over 4x. We have modelled for a slight moderation in revenue growth and EBITDA margins, factoring in a high-base effect and competition. A major acquisition is a risk to our estimates. However, the risk is mitigated by management's record of prudent acquisitions and a commitment to an investment-grade credit profile.
Rating Based on Consolidated Profile: We have rated UPL Corp based on the consolidated credit-profile of UPL Ltd, as per Fitch's Parent and Subsidiary Rating Linkage methodology. Fitch deems the linkage between UPL Ltd and UPL Corp as strong due to the high degree of operational and strategic integration. UPL Ltd, which focuses on efficient manufacturing in India, and UPL Corp, which provides access to overseas markets, are effectively parts of one business. In addition, loans at UPL Corp have cross-default provisions spanning the consolidated group, providing a legal linkage.
Fitch's key assumptions within the rating case include:
- Revenue CAGR of 9% over the financial years ending-March 2017 (FY17) to FY20, led by growth in Latin America.
- Average EBITDA margin of 19% over FY17-FY20 (FY16: 20%)
- Annual capex of around USD170m
- Annual spending on acquisitions of USD25m.
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- FFO-adjusted net leverage above 2.5x on a sustained basis (FY16: 2.3x)
- FFO-adjusted gross leverage above 3.0x on a sustained basis (FY16: 2.8x)
- EBITDA margin dropping below 15%, reflecting weaker competitiveness.
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- FFO-adjusted net leverage below 2.0x on a sustained basis
- FFO-adjusted gross leverage below 2.5x on a sustained basis
- A significant increase in scale.