S&P’s downgrade casts shadow on UPL’s Brazilian quest

The fear is that the ratings cut will put further pressure on the Brazilian currency, the real, which lost 33% of its value against the Indian rupee last year

UPL Ltd lost 3.5% after ratings agency Standard & Poor’s (S&P’s) downgraded Brazil, citing challenges the country is facing in pursuing policy measures. Brazil is one of the biggest users of agrochemicals and is the key market for UPL.

In 2013-14, 15% of the company’s revenue came from Brazil. Country-specific revenue is available for the previous fiscal. But the Latin America region generated 3,406 crore, or 28% of UPL’s revenue, last fiscal. According to some estimates, three-fifths of this revenue came from Brazil, which works out to around 16% of the total revenue.

The fear is that the ratings cut will put further pressure on the Brazilian currency, the real, which lost 33% of its value against the Indian rupee last year. “The said downgrade can lead to depreciation of domestic Brazilian currency," ICICI Securities Ltd said in a note.

More depreciation will complicate things for UPL. Distributors are already delaying purchases due to a continuous fall in currency value. While a weak currency will raise the cost of imports, it will be difficult for UPL to fully recover costs as farm incomes are under pressure due to weak agriculture produce prices. Also, due to their large land holdings, the farmers’ lobby is said to be strong in Brazil and they will resist any kind of sharp price hikes, said one analyst.

According to a recent note from Investec Securities, business in northern Brazil is linked to the US dollar rate. The billing is done in Brazilian real, linking it to the going exchange rate, where the currency risk is borne by the customer, the report says.

The trouble is in the southern part of the country, where 40% of UPL’s Brazil sales take place. Here, the business is done in terms of the real and the onus is on the company to pass on the rate increases.

“The ability to do this is limited by the market’s ability to absorb such hikes. One concern is that UPL’s new launch Mancozeb is sold in greater proportion in the south," Investec Securities adds.

Thanks to its investments in local distribution firms, UPL has managed to avoid a slowdown in Latin America till now. Revenue from Latin America increased 29% in the March quarter and 21% in the June quarter, and the region was the best performing one. Strong growth in the region is helping the company post decent growth rates. With a wide basket of generic products and farmers looking for cheaper options, UPL was expecting to maintain the revenue momentum. But a weak currency and the resultant pressure on realizations can upset calculations.

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