2023-12-11 10:14:02 ET
Summary
- Ultrapar's gross margin in its fuel distribution segment improved in Q3 due to Petrobras' new price policy.
- The company now seems to be fairly valued, in line with my previous valuation.
- Ultragaz and Ultracargo could provide additional upside for Ultrapar as they account for a growing portion of total EBITDA, but that may not be enough to create an upside.
- The stock has seen a 40% return since July and more than 100% YTD, the timing seems right for investors to start taking profits.
I first wrote about Ultrapar ( UGP ) at the start of Q3, one month after Petrobras' ( PBR ) announcement of its new price policy . In my first article, which I encourage you to read as I'll leverage a lot of it during this one, my main line of reasoning was that due to this new price policy from Petrobras, gasoline prices would stabilize and thus support Ultrapar to improve its Gross Margin in its fuel distribution segment (Ipiranga). Remember: the prior price policy stated that prices would fluctuate (almost daily) due to exchange rate appreciation/depreciation and the Brent Crude Oil Price, whereas the new one simply says that Petrobras will tend to adjust prices based on those two variables, but it is not mandated to do so.
In July, I presented two possible scenarios for Ultrapar: a Conservative and an Aggressive. The Conservative scenario had a price target of $5.3, which is very close to where we are today. The Aggressive scenario had a price target of $6.6. For those who bought the stock back in July, the Total Return was close to 40%, while the S&P 500 returned less than 4%. However, I do have to be transparent and say that I didn't expect the market to react so fast and in such a short period of time.
My Hold rating is driven by the achievement of my price target for the Conservative scenario. Investors could start selling their position in Ultrapar as the upside for the $6.6 is less than 30% from where it stands today and somewhat less certain than the run-up from $3.8 to $5.3. For those still interested in the stock, I'll provide an update of Ultrapar's valuation and some upsides and risks that I see going forward.
A Recap on Gross Margin
Let's go straight to it and update my graph showing the Gross Margin for Ipiranga and its two main competitors Vibra (former Petrobras) and Raízen/Shell.
Historical Gross Margin % 2012-2023 YTD (Ultra IR, Vibra IR, Raízen IR)
Due to a great performance in Q3, all three gasoline distributors saw an improvement on gross margin performance. I'm inclined to attribute this strictly to the new price policy from Petrobras. Given a massive upshot in gross margin for all three competitors in Q3 (the first full quarter of the new price policy), it is definitely something in the competitive environment rather than an improvement in-house. Plus, during Q3 even though the USD/BRL exchange rate remained fairly stable, the Brent Crude Oil Price increased from less than $75 to almost $100 and then back to less than $80.
This is the kind of volatility in the Brent Crude Oil Price that would have demanded Petrobras to adjust its gasoline prices daily before this new price policy. With the new one, gasoline prices surged less than 10% during Q3 while Brent Crude Oil Price was up by almost 30%. This lower volatility shielded gasoline distributors from inventory losses and allowed them to post higher gross margins in Q3.
Average Price of Gasoline Liter in BRL (ANP)
If Ipiranga Gross Margin of 7% in Q3 is here to stay, it means that Ultrapar is achieving a Gross Margin even higher than in my conservative scenario. So the next step is to evaluate how this influences Ultrapar's valuation.
An Update on Valuation Given The New Gross Margin
The same DCF model I presented in my last article is also reviewed here. The main differences in the model are:
- Lower Revenue in Year 1 as gasoline prices have decreased versus 2022.
- A flat 7% Gross Margin across all years, reflecting the good performance in Q3'23.
Ultra's Financial Modelling (Numbers in '000 BRL) (Author)
Using the same 10% discount rate I used to set the initial price target, it seems that Ultrapar is fairly valued as its current market cap in USD is close to $28 billion BRL and my model is calculating almost $27 billion BRL. Therefore, this supports my idea that investors could start selling their shares in Ultrapar as the 40% run since July has brought it to fair value.
Still, the same way I presented an aggressive scenario in my first article, I think it's valuable to do the same exercise again and see if there is any upside left in Ultrapar. The only difference versus the prior one is that Gross Margin is at 8% now throughout the years. In this scenario, Ultrapar could be valued at almost $40 billion BRL, which is a 35% upside from where it currently stands. Also, assuming a Revenue on Year 1 of $140 billion and Gross Margin at 7% yields the same $40 billion BRL in total value.
Ultra's Financial modelling (Numbers in '000 BRL) (Author)
The main difference from my first article is that previously my conservative scenario had an upside of 60% where now it has zero. The aggressive scenario is similar to the one in the previous article, suggesting that there is still room to be valued at almost $40 billion BRL. Still, my takeaway is that the odds are now not as good as in July, so investors would be prudent to start taking profits.
Ultragaz and Ultracargo Could Be An Upside
There is a reason why the main focus of my articles about Ultrapar has been its gasoline distribution segment called Ipiranga: It represents more than 90% of Revenue. If Ipiranga is in bad shape, the other two businesses (Ultragaz and Ultracargo) won't be able to hold the stock price. However, if Ipiranga is looking good (which is now), the other two segments could help push the stock further. Ultragaz is known for its distribution of Liquified Petroleum Gas ((LPG)) cylinders and has been pretty stable throughout the years, while Ultracargo is focused on energy storage and transportation and has seen some M&A and more focus from Ultrapar due to its better margins. Both have a CAGR that is higher than Ipiranga's.
Share of Revenue by Segment, 2016 x 2023E (Ultra IR)
Although no shocking information is inferred from the revenue segment, I consider the EBITDA breakdown quite interesting. Ultragaz and Ultracargo were close to 17% of total EBITDA in 2016, but I expect them to account for almost 40% at the end of 2023. To me, this showcases that even though these businesses have been hiding inside Ultrapar due to lower revenue share when compared to Ipiranga, they have become considerable sources of EBITDA for Ultrapar. EBITDA CAGR for these two units has outpaced revenue CAGR, meaning that either margins expanded or they allocated capital towards initiatives that had a better profitability than what they had in 2016.
Share of EBITDA by Segment, 2016 x 2023E (Ultra IR)
Table below clarify the two graphs above and shows Revenue and EBITDA in nominal terms. As you can see, margin compression in Ipiranga made Ultra less profitable in terms of EBITDA%, but did hide the great improvement in Ultragaz and Ultracargo.
Revenue, EBITDA and EBITDA% by Segment, in Billions BRL (Ultra IR)
Ultragaz works distributing LPG, be it through gas cylinders or bulk. Its core business isn't very appealing and the volumes of LPG have been stable for the last decade. Ultragaz did try to buy competitor Liquigás , but the transaction was rejected by the CADE (similar to the DOJ) on anti-trust allegations. Only real action that happened in the last decade is that price pretty much tripled from ~2k BRL to ~6k BRL, improving Gross Margin a bit and creating positive leverage over fixed costs. By itself, it's not an attractive business, but I think it's important to highlight three future possibilities for this business:
- The purchase of a startup called Stella for $63M BRL could be very transformative. Stella connects individuals or companies that are not able to generate renewable power (but would like to have savings on their electricity bills) with a partner that generates renewable power and is interested in selling it. Thus, by paying Stella (now Ultrapar) a monthly fee, they get "exposure" to renewable energy (which is communicated to their utility operator) and thus have a lower electricity bill. This shows that Ultrapar is trying to leverage its huge customer base with new product offerings.
- The LPG market is very stable with five competitors each holding roughly 20% of the market. There are few incentives to open new distribution centers where your competitors dominate because customers are price-driven and the incumbent will likely have a price differential for being in the area for so long. However, with Stella (and, hopefully, other products), Ultrapar may finally have a differential and could start expanding regionally by offering not just LPG, but also renewable energy through Stella. This would increase volume and drive revenue up.
- Piped LPG isn't very common in Brazil, mainly in a handful of big cities. However, if it increases in importance or any opportunity on existing infrastructure appears, the company could make a move to enter this market. This would be more mid to long term.
As for Ultracargo, the company reported pretty much stable m³ storage of around 600,000 to 700,000 between 2012 and 2018, but has since increased to almost 1,000,000 during 2022. Increased storage and some pricing power have allowed Ultracargo to more than double its revenue since 2016. Their storages are focused on fuels, biofuels, oils, chemicals and petrochemicals, so I'd expect it's demand to be aligned with Brazil's GDP. If the economy avoids some fiscal pitfalls and eventually resumes growth, Ultracargo could see more demand and even more pricing power.
It has operations in six ports, which means there are more ports that it could expand in Brazil. Also, it recently won a bid for expanding its storage facilities in Itaqui/MA, which will add some 80,000 m³. They also announced the acquisition of 50% of Opla , a joint venture with BP, that will add 180,000 m³ to their storage capacity and mark their entrance in the countryside. Probably the best part of Ultracargo is its 63% EBITDA, which could support not only its expansion but also provide capital for Ipiranga, Ultragaz or other initiatives.
Risks & Opportunities
In sum, I still see some opportunities for Ultrapar that could merit an investor to continue to hold the company for a little longer. Mainly, the possibility that Ipiranga continues to improve its margin past the 7% mark and that Ultracargo continues to expand storage and profitability could be two catalysts for Ultrapar in the short to mid term.
However, there are risks associated with Ultrapar current valuation. First of all, the gross margin expansion in Ipiranga is entirely in the hands of Petrobras price policy decision. It has served Ipiranga well in the first months after implementation, but that could not be the case in the future. If the brazilian government decides it needs to boost gasoline prices to generate cash via Petrobras to fund dividends or public spending, it could again compress Ipiranga's margins. Also, more than once Petrobras has clearly stated that it wants to come back to the gasoline distribution business, either by reacquiring Vibra or by renegotiating the contract that allowed Vibra to use Petrobras brand for 10 years. The creation of a fourth competitor (who would be full of cash) is a negative for the companies in the sector.
Final Thoughts
My recommendation to investors in Ultrapar is straightforward: start taking profits after this 40% run since July (and 100% YTD). Although my article showed that there is still reasons to think Ultrapar could go further, I believe odds of market-beating returns are lower then they were at the beginning of the year or in July. If you are a happy shareholder that is not yet convinced the upside has ended, I'd advise to watch the stock closely. If price action continues to be positive, that's fine, but if it suddenly turns negative, then swift action may be required.
For further details see:
Ultrapar: It Seems Time To Move On (Rating Downgrade)