Buy United Phosphorus - positive move to tap largest Latin American market; Edelweiss

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United Phosphorus (UNTP IN, INR 136, Buy)

n  Acquisition of 50% stake in Sipcam Isagro Brazil SA

United Phosphorus (UNTP) entered into an agreement with Isagro SA to acquire Isagro’s 50% stake in Sipcam Isagro Brazil SA (SIB) for an undisclosed consideration. SIB is a 50:50 JV between Sipcom-Oxon group and Isagro and manufactures and markets agro-chemicals in Brazil. This acquisition is line with UNTP’s strategy to expand operations in the large Latin American market. Brazil is an USD 7 bn market for agrochemicals, where UNTP has limited presence. With this acquisition, the company plans to benefit from access to distribution network and local manufacturing set-up. Although, UNTP has not disclosed the deal consideration, we estimate deal value to be not more than ~USD 50 mn.

n  Dilutive to earnings in short term

We expect JV to contribute ~USD 55-60 mn of revenues to UNTP in FY12 (total JV sales of EUR 81 mn or USD 115 mn in CY09), however, we estimate this acquisition to negatively impact FY12E PAT by 3-4% largely due to breakeven operating margins (2.5% in CY09) and higher financial costs of the acquired entity (Isagro’s share of debt in JV is EUR 25 mn, with annual interest costs of EUR 5 mn). We highlight that JV partner Isagro has reported net loss of EUR 3.1 mn from the JV in CY09, largely due to headwinds faced from destocking, leading to lower price realisations.

n  Scope for turnaround in profitability of acquired business

We view this acquisition to be positive for UNTP, in the long term, given significant scope to improve profitability in the acquired business from positive operating leverage by cross selling of UNTP products in Brazil, thereby utilising existing distribution set-up. We highlight that Brazil has faced significant headwinds during the past two years, led by decline in prices of insecticides and herbicides, reduction in cultivation area and lower exports of agri-commodities, leading to 6% de-growth in crop protection market, which impacted operating margins of JV business (down from 17% in CY08 to 2.5% in CY09).

n  Outlook and valuations: Positive; Maintain ‘BUY’

We remain positive on UNTP’s long-term strategy to pursue buyouts of smaller companies to expand reach, which had historically resulted in strong growth (CAGR of 35% until FY09). However, current investor concerns over decline in base business will remain an overhang on valuations. UNTP is trading at 8x FY12E EPS of INR 17.6, discount to average range of 10-12x. We maintain ‘BUY’ rating on the stock.