2023-09-11 17:24:55 ET
Summary
- Ultrapar, a major Brazilian business group, operates in cyclical industries, focusing on core businesses like Ipiranga, Ultracargo, and Ultragaz.
- The company faces uncertainty in Brazil's fuel market due to Petrobras' independent pricing, increased Russian oil imports, and oversupply of diesel.
- Ultrapar's recent financial results for Q2 2023 showed a decline in net profit and revenue, primarily attributed to lower turnover at Ipiranga and decreased EBITDA in challenging market conditions.
Ultrapar ( UGP ) is one of Brazil's leading business groups, with operations in the fuel distribution sector through Ultragaz and Ipiranga. Additionally, it is involved in the liquid bulk storage segment with Ultracargo.
The company operates in highly cyclical industries and has recently undergone significant management improvements. These efforts have been focused on enhancing internal processes and strategies while emphasizing its core business. A critical issue involving its chemical unit, Oxiteno, and its pharmacy division, Extrafarma, both underperforming and consuming substantial resources, was addressed by selling the pharmacy division last year.
Throughout this year, Ultrapar has benefited from a solid increase in its value, coinciding with the rally in the Brazilian stock market and improved financial results, primarily driven by favorable fuel prices. However, the most recent quarterly results for the second quarter revealed a decline in profit margins due to the decrease in fuel prices.
Although there remains uncertainty in Brazil concerning fuel pricing, caught between Petrobras' pricing and international import prices, Ultrapar has other subsidiaries like Ultragaz and Ultracargo that could potentially unlock long-term value.
Despite trading below its historical valuation multiples, the outlook for Ultrapar in the second half of 2023 appears uncertain, primarily due to the volatility of fuel prices in Brazil.
Brazil's fuel price landscape shrouded in uncertainty
Since the beginning of the year, there has been an increasing influx of Russian oil into Brazil due to sanctions imposed by the European Union and the United States in response to the war in Ukraine. This influx has created an imbalance in the Brazilian fuel distribution market.
Both internal and external factors have contributed to intense volatility in the sector's profit margins and have created a complex operating environment. There is now an oversupply of diesel, and macroeconomic factors are impacting Latin America. Additionally, successive price declines for all petroleum products have affected inventory levels.
One significant change in May of this year was the discontinuation of Petrobras' ( PBR ) ( PBR.A ) International Pricing Policy ('IPP'), which had been in place since 2016. This change resulted in a disconnect between the international prices and the prices practiced by Petrobras in Brazil. The president of Ipiranga, a subsidiary of Ultrapar, even referred to it as a local "deficiency" that the company continues to import oil products without specifying their origin.
As of September 8, even after Petrobras' price adjustment, a gap still exists, with diesel prices being 14% higher and gasoline prices 7% higher, as the Brazilian Association of Fuel Importers (ABICOM) reported.
Meanwhile, smaller distributors, who rely more on imports than larger ones with more extended contracts and guaranteed delivery from Petrobras, increased their market share in diesel by 3 percentage points in the last quarter.
Although Ipiranga emphasized that it has yet to face supply issues with its regular customers, it is evident that in the current supply scenario in Brazil, the spot market is much more exposed to international prices.
This is because purchasing fuel from Petrobras, with prices no longer aligned with international rates and being lower, creates pressure on the imported product (traded on the spot market). As a result, many choose to buy from the state-owned company, which strains its supplies.
A likely scenario is that pricing in the Brazilian market will shift towards a model that combines Petrobras and import prices.
Recent financial performance affected by declining fuel prices
Ultrapar's recent financial results for the second quarter of 2023 presented challenges in a more difficult fuel pricing environment. The company reported a net profit of R$239 million for this quarter. In comparison to the same period last year, when the net profit was R$460 million, there was a significant decline of 48%.
Regarding net revenue, Ultrapar generated R$29.6 billion between April and June, which marked a 21% decrease compared to the same period in 2022. This decline was primarily attributed to lower turnover at Ipiranga.
Adjusted EBITDA for the second quarter of 2023 reached R$964 million, marking a 35% decline compared to the same period in 2022. This decrease in EBITDA can be attributed to several factors, including poor results from continuing operations, a capital gain from the sale of Oxiteno in Q2 2022, and higher depreciation and amortization costs and expenses despite lower net financial expenses.
The Ipiranga subsidiary reported an adjusted EBITDA of R$448 million, representing a 41% decrease compared to Q2 2022. This decline is primarily attributed to more pressured margins resulting from reductions in fuel costs during Q2 2023, leading to inventory losses and a challenging commercial environment due to increased offerings of imported products and higher local production. This contrasts with the situation in Q2 2022 when there were increased fuel costs and inventory gains despite lower expenses.
Ultragaz, on the other hand, reported an adjusted EBITDA of R$405 million, reflecting a 55% increase compared to Q2 2022. This improvement can be attributed to initiatives aimed at enhancing efficiency and productivity, higher sales volume with a more favorable sales mix, and the ability to pass on inflationary pressures despite higher expenses.
In terms of the company's financial performance, there was a negative financial result of R$217 million, which marked a 57% reduction compared to the same period in 2022.
Turning to the balance sheet, Ultrapar closed the second quarter with a net debt of R$8 billion, compared to R$8.172 billion a year earlier. The financial leverage indicator, measured by net debt/adjusted EBITDA, stood at 2.1x in June 2023, a decrease of 0.1 percentage points compared to the same period in 2022.
During the second quarter of this year, Ultrapar invested R$385 million, representing a 6% decrease compared to the amount invested during the same period last year. CEO Marcos Lutz commented that the company remains open to potential acquisitions in the market but is currently focused on accelerating its existing businesses within the portfolio, which includes Ipiranga, Ultracargo, and Ultragaz. However, the company does not rule out the possibility of pursuing larger-scale opportunities if they arise shortly.
For the second half of 2023, Ultrapar's primary focus remains on strengthening its balance sheet and improving operations, particularly in light of the volatile situation regarding fuel prices, notably affecting Ipiranga. The restructuring of Ipiranga has been progressing across four strategic pillars: pricing, logistics, negotiation, and network engagement. Efforts are expected to increase within the negotiation pillar, and the management of Ultrapar has emphasized a complete overhaul of the pricing area.
As part of the restructuring process, inefficient stations were closed in the third quarter of 2023, following the removing of over 1,000 units from the portfolio. This move is anticipated to result in a potential 20% reduction in logistics costs over three years.
However, the expectation is that the worst is over, according to the company's executives in their earnings call with analysts, who emphasized that July's performance was already marginally better than June's, although still recovering. Ultrapar also sees fuel prices for Q3 going "in the opposite direction" of Q2 2023 and volume recovery.
Furthermore, Ultrapar approved the distribution of R$273.8 million in dividends, equivalent to R$0.25 per common share.
Exploring the Brazilian agribusiness industry
As revealed by Ultrapar's management during the latest investor day, one of their recent innovations involves providing logistical support to the agricultural sector through their subsidiary, Ultracargo. This initiative combines one of the company's core businesses with Brazil's robust agribusiness sector.
To kickstart their agri-logistics strategy, there are plans to establish storage terminals for distributing corn-based ethanol from the Midwest region. This was chosen as the initial step because it promises quicker returns, thanks to a more rapid turnover in the storage tanks.
In addition to this agricultural initiative, Ultrapar's management highlighted the growing demand for fuel handling as an opportunity for Ultracargo. This increased demand stems from Petrobras' reduced share of fuel imports and the expansion of independent players in the market.
The company pointed out that fuel imports in Brazil are projected to rise by approximately 25% in 2023 compared to 2021. This growth is primarily driven by private companies, expected to expand their imports by 44% in the same period.
To expand this subsidiary's operations, there are plans to extend into the interior regions of Brazil. Opportunities for domestic market growth are expected to arise from increased demand for biofuels and the expansion of the biofuel industry.
For this reason, Ultracargo is investing in logistics bases along this corridor to distribute fuel to the heart of Brazil's agricultural sector, with the potential to benefit from reverse logistics related to grains in the future.
Risks
The primary risks in my analysis encompass several factors: lower-than-anticipated economic activity, elevated Brent oil prices, weaker-than-expected demand for fuel, and potential government intervention in gasoline and diesel prices.
While there is potential for a comprehensive transformation within the group, mainly focusing on Ipiranga's ongoing turnaround and business-friendly initiatives involving Ultracargo, it's essential to acknowledge that this process will likely be protracted.
The bottom line
Ultrapar operates in highly cyclical industries, and the company has faced challenges in increasing its EBITDA due to the thin profit margins in its businesses. It has achieved EBITDA growth by divesting from subsidiaries like the sale of Extrafarma last year and the closure of inefficient stations at Ipiranga.
However, I appreciate the current strategic direction of the company's management, which focuses on its core competencies, specifically Ipiranga, Ultracargo, and Ultragaz.
Nonetheless, significant short-term risks could cast doubt on an investment in Ultrapar. If Petrobras decides to set its own prices for fuel and doesn't strictly adhere to international parity, it could introduce volatility and unpredictable fluctuations in fuel prices in Brazil. This could disrupt Ultrapar's business planning and impact its ability to forecast consistent profit margins.
Furthermore, Petrobras' shift to independent pricing could intensify competition among fuel distributors in Brazil. This heightened competition might lead to aggressive pricing strategies from Ultrapar and other sector companies, affecting prices and profit margins.
Ultrapar's stock has experienced significant growth, driven by a robust Brazilian stock market and Petrobras' record profits and dividend payouts, buoyed by surging commodity prices. Year-to-date, Ultrapar's shares have risen over 66%, resulting in a current forward P/E ratio of 15.7x, roughly 10% below its historical average but approximately 50% above the industry average.
When factoring in Ultrapar's debt, the company's forward EV/EBITDA ratio of 11x is 21% below its historical average, making it appear attractive. However, it is trading 15% above the industry average.
While I see a positive outlook for Ultrapar as it focuses on its core business to achieve stability, it still has some way to reach its pre-2018 levels when it traded above $10 per share. The uncertainty surrounding international fuel imports and Petrobras' imposing fuel prices cast a shadow on the company's profit margins.
Considering the substantial share price appreciation in the year's first half, I view its medium-term performance as somewhat speculative, even with a valuation below historical levels. Therefore, I prefer to wait to invest in Ultrapar until there is a clearer insight into fuel price adjustments in Brazil.
For further details see:
Ultrapar: Caution Amidst Brazil's Uncertain Fuel Pricing