The chemical business produces chemicals such as chlorine, caustic soda, chloromethane, chloroform, polyethylene, etc. Its growth in the chemicals business, primarily in North America, saw its volumes rising 8.6% to 13.3 million tons.
Growth was driven by sales of chlorinated organics, chlorine derivatives, chlorine, chloroacetic acid and ethylene dichloride. UPL’s earnings per ton fell slightly to $18.2, while its margins narrowed sharply from 19.5% to 12.3%. The decline in chemical earnings was due to the higher feedstock costs, especially ethane prices.
The metals and mining business is mainly a gold mining business. It produces gold from its South Africa mines. UPL has been spending heavily in developing its mines, to generate better margins. The mines haven’t been as successful as expected, and the precious metals business generated only $5 million in EBITDA in the past quarter. However, the company continues to spend on developing its precious metals business. The company is planning a $130-million investment to develop gold mines in the Eastern Cape of South Africa, at a time when gold prices are relatively low.
The company has started listing the chemical and metals divisions separately in its balance sheet. UPL’s Q2 EBITDA dropped from $73.8 million to $68 million, due to the much lower volumes sold and lower average selling prices.
Growth engines
UPL’s growth engines are expected to drive its earnings growth over the next several quarters. The chemical and metals businesses will benefit from higher volumes and lower commodity prices. Further, the metals and mining business will grow on higher volumes. Although the spending on the mining business will hurt its margins, higher volumes will help the company generate higher EBITDA and earnings.
Apart from UPL’s growth drivers, the risk is around the commodity prices. The commodities market has been weak over the last few years. While the energy markets, including oil and gas, have been weak, the metals and mining markets have been weaker than expected. The copper and nickel prices are extremely low. Similarly, oil prices have seen a sharp decline over the last year. However, energy, steel and metals prices are all recovering, which will help boost the earnings growth for UPL in the near future.
Is UPL cheap?
Looking at UPL’s current valuation, we expect the stock to provide returns of 17% to 19% in the next one year. While UPL has shown strong growth, it has always been cheap compared to its peers. Therefore, the price is reflecting the fact that there’s less growth ahead for UPL in terms of earnings and dividends. We expect earnings growth in the chemicals and metals businesses, to help boost the company’s earnings, and higher commodity prices to boost the company’s profits.
Looking at the valuation of UPL, it has been trading at 5.3x its FY2017 EBITDA. It has been more than 16% cheaper than its current peer UPL. We expect the shares to trade at 5.5x its FY2018 EBITDA, in line with its peers. However, UPL’s high payout ratio of 92% has restricted its growth potential. However, the high payout ratio is unlikely to continue, as UPL’s growth engines are expected to show strong earnings growth. Further, UPL’s management has indicated that its stock buybacks would be lower going forward.
Therefore, even if the stock trades at 5.5x its FY2018 EBITDA, it will still return more than 15% in the next one year. It is worth noting that UPL’s dividend is currently yielding 7%.
Considering the company’s valuation, its growth prospects and current dividend yield, we expect UPL to deliver strong returns in the next year. As the company’s earnings growth picks up in the near future, the stock is likely to move towards a higher valuation, and provide strong returns for investors.
Disclosure: As of August 29, 2017, Akshay Asthana is not a shareholder in any of the aforementioned securities.
Neil Brinsden is an investor in the securities mentioned. He may buy or sell shares in any of the aforementioned securities in the next one year. He is not affiliated with any firms mentioned in this article.
The views expressed are the author’s and do not constitute an endorsement of the views expressed.
Neil Brinsden owns shares of UPL.
The author is a BSc. in economics and has been working in the financial sector for nearly 14 years. The information is provided to the readers as a service from FastMoney.com, which is a subsidiary of Thomson Reuters.