Ultrapar: It Appears Time To Transfer On (Ranking Downgrade) (NYSE:UGP)

I first wrote about Ultrapar (NYSE:UGP) in the beginning of Q3, one month after Petrobras’ (PBR) announcement of its new value coverage. In my first article, which I encourage you to learn as I am going to leverage loads of it throughout this one, my predominant line of reasoning was that as a result of this new value coverage from Petrobras, gasoline costs would stabilize and thus help Ultrapar to enhance its Gross Margin in its gasoline distribution section (Ipiranga). Bear in mind: the prior value coverage acknowledged that costs would fluctuate (nearly every day) as a result of change fee appreciation/depreciation and the Brent Crude Oil Worth, whereas the brand new one merely says that Petrobras will have a tendency to regulate costs based mostly on these two variables, however it isn’t mandated to take action.

In July, I introduced two potential eventualities for Ultrapar: a Conservative and an Aggressive. The Conservative situation had a value goal of $5.3, which could be very near the place we’re at present. The Aggressive situation had a value goal of $6.6. For individuals who purchased the inventory again in July, the Complete Return was near 40%, whereas the S&P 500 returned lower than 4%. Nevertheless, I do need to be clear and say that I did not anticipate the market to react so quick and in such a brief time frame.

My Maintain ranking is pushed by the achievement of my value goal for the Conservative situation. Traders may begin promoting their place in Ultrapar because the upside for the $6.6 is lower than 30% from the place it stands at present and considerably much less sure than the run-up from $3.8 to $5.3. For these nonetheless within the inventory, I am going to present an replace of Ultrapar’s valuation and a few upsides and dangers that I see going ahead.

A Recap on Gross Margin

Let’s go straight to it and replace my graph exhibiting the Gross Margin for Ipiranga and its two predominant opponents Vibra (former Petrobras) and Raízen/Shell.

As a result of an amazing efficiency in Q3, all three gasoline distributors noticed an enchancment on gross margin efficiency. I am inclined to attribute this strictly to the brand new value coverage from Petrobras. Given a large upshot in gross margin for all three opponents in Q3 (the primary full quarter of the brand new value coverage), it’s undoubtedly one thing within the aggressive atmosphere quite than an enchancment in-house. Plus, throughout Q3 despite the fact that the USD/BRL change fee remained pretty steady, the Brent Crude Oil Worth elevated from lower than $75 to nearly $100 after which again to lower than $80.

That is the type of volatility within the Brent Crude Oil Worth that will have demanded Petrobras to regulate its gasoline costs every day earlier than this new value coverage. With the brand new one, gasoline costs surged lower than 10% throughout Q3 whereas Brent Crude Oil Worth was up by nearly 30%. This decrease volatility shielded gasoline distributors from stock losses and allowed them to submit increased gross margins in Q3.

If Ipiranga Gross Margin of seven% in Q3 is right here to remain, it implies that Ultrapar is reaching a Gross Margin even increased than in my conservative situation. So the following step is to guage how this influences Ultrapar’s valuation.

An Replace on Valuation Given The New Gross Margin

The identical DCF mannequin I introduced in my final article can also be reviewed right here. The principle variations within the mannequin are:

Decrease Income in Yr 1 as gasoline costs have decreased versus 2022. A flat 7% Gross Margin throughout all years, reflecting the great efficiency in Q3’23.

Utilizing the identical 10% low cost fee I used to set the preliminary value goal, it appears that evidently Ultrapar is pretty valued as its present market cap in USD is near $28 billion BRL and my mannequin is calculating nearly $27 billion BRL. Subsequently, this helps my concept that buyers may begin promoting their shares in Ultrapar because the 40% run since July has introduced it to honest worth.

Nonetheless, the identical manner I introduced an aggressive situation in my first article, I believe it is worthwhile to do the identical train once more and see if there’s any upside left in Ultrapar. The one distinction versus the prior one is that Gross Margin is at 8% now all through the years. On this situation, Ultrapar may very well be valued at nearly $40 billion BRL, which is a 35% upside from the place it at present stands. Additionally, assuming a Income on Yr 1 of $140 billion and Gross Margin at 7% yields the identical $40 billion BRL in whole worth.

The principle distinction from my first article is that beforehand my conservative situation had an upside of 60% the place now it has zero. The aggressive situation is much like the one within the earlier article, suggesting that there’s nonetheless room to be valued at nearly $40 billion BRL. Nonetheless, my takeaway is that the percentages at the moment are inferior to in July, so buyers could be prudent to start out taking income.

Ultragaz and Ultracargo Might Be An Upside

There’s a cause why the principle focus of my articles about Ultrapar has been its gasoline distribution section referred to as Ipiranga: It represents greater than 90% of Income. If Ipiranga is in unhealthy form, the opposite two companies (Ultragaz and Ultracargo) will not have the ability to maintain the inventory value. Nevertheless, if Ipiranga is wanting good (which is now), the opposite two segments may assist push the inventory additional. Ultragaz is thought for its distribution of Liquified Petroleum Fuel (LPG) cylinders and has been fairly steady all through the years, whereas Ultracargo is concentrated on vitality storage and transportation and has seen some M&A and extra focus from Ultrapar as a result of its higher margins. Each have a CAGR that’s increased than Ipiranga’s.

Though no surprising info is inferred from the income section, I contemplate the EBITDA breakdown fairly attention-grabbing. Ultragaz and Ultracargo have been near 17% of whole EBITDA in 2016, however I anticipate them to account for nearly 40% on the finish of 2023. To me, this showcases that despite the fact that these companies have been hiding inside Ultrapar as a result of decrease income share when in comparison with Ipiranga, they’ve turn out to be appreciable sources of EBITDA for Ultrapar. EBITDA CAGR for these two models has outpaced income CAGR, that means that both margins expanded or they allotted capital in the direction of initiatives that had a greater profitability than what that they had in 2016.

Desk beneath make clear the 2 graphs above and reveals Income and EBITDA in nominal phrases. As you possibly can see, margin compression in Ipiranga made Extremely much less worthwhile by way of EBITDA%, however did disguise the good enchancment in Ultragaz and Ultracargo.

Ultragaz works distributing LPG, be it by gasoline cylinders or bulk. Its core enterprise is not very interesting and the volumes of LPG have been steady for the final decade. Ultragaz did attempt to purchase competitor Liquigás, however the transaction was rejected by the CADE (much like the DOJ) on anti-trust allegations. Solely actual motion that occurred within the final decade is that value just about tripled from ~2k BRL to ~6k BRL, bettering Gross Margin a bit and creating optimistic leverage over mounted prices. By itself, it is not a horny enterprise, however I believe it is vital to focus on three future prospects for this enterprise:

The acquisition of a startup referred to as Stella for $63M BRL may very well be very transformative. Stella connects people or firms that aren’t in a position to generate renewable energy (however want to have financial savings on their electrical energy payments) with a associate that generates renewable energy and is focused on promoting it. Thus, by paying Stella (now Ultrapar) a month-to-month payment, they get “publicity” to renewable vitality (which is communicated to their utility operator) and thus have a decrease electrical energy invoice. This reveals that Ultrapar is making an attempt to leverage its large buyer base with new product choices. The LPG market could be very steady with 5 opponents every holding roughly 20% of the market. There are few incentives to open new distribution facilities the place your opponents dominate as a result of clients are price-driven and the incumbent will probably have a value differential for being within the space for therefore lengthy. Nevertheless, with Stella (and, hopefully, different merchandise), Ultrapar could lastly have a differential and will begin increasing regionally by providing not simply LPG, but additionally renewable vitality by Stella. This might improve quantity and drive income up. Piped LPG is not quite common in Brazil, primarily in a handful of huge cities. Nevertheless, if it will increase in significance or any alternative on present infrastructure seems, the corporate may make a transfer to enter this market. This might be extra mid to long run.

As for Ultracargo, the corporate reported just about steady m³ storage of round 600,000 to 700,000 between 2012 and 2018, however has since elevated to nearly 1,000,000 throughout 2022. Elevated storage and a few pricing energy have allowed Ultracargo to greater than double its income since 2016. Their storages are targeted on fuels, biofuels, oils, chemical compounds and petrochemicals, so I might anticipate it is demand to be aligned with Brazil’s GDP. If the economic system avoids some fiscal pitfalls and finally resumes development, Ultracargo may see extra demand and much more pricing energy.

It has operations in six ports, which suggests there are extra ports that it may increase in Brazil. Additionally, it lately gained a bid for increasing its storage services in Itaqui/MA, which can add some 80,000 m³. In addition they introduced the acquisition of fifty% of Opla, a three way partnership with BP, that may add 180,000 m³ to their storage capability and mark their entrance within the countryside. In all probability one of the best a part of Ultracargo is its 63% EBITDA, which may help not solely its enlargement but additionally present capital for Ipiranga, Ultragaz or different initiatives.

Dangers & Alternatives

In sum, I nonetheless see some alternatives for Ultrapar that would benefit an investor to proceed to carry the corporate for a bit of longer. Primarily, the likelihood that Ipiranga continues to enhance its margin previous the 7% mark and that Ultracargo continues to increase storage and profitability may very well be two catalysts for Ultrapar within the quick to mid time period.

Nevertheless, there are dangers related to Ultrapar present valuation. To start with, the gross margin enlargement in Ipiranga is totally within the fingers of Petrobras value coverage determination. It has served Ipiranga nicely within the first months after implementation, however that would not be the case sooner or later. If the brazilian authorities decides it wants to spice up gasoline costs to generate money through Petrobras to fund dividends or public spending, it may once more compress Ipiranga’s margins. Additionally, greater than as soon as Petrobras has clearly acknowledged that it desires to come back again to the gasoline distribution enterprise, both by reacquiring Vibra or by renegotiating the contract that allowed Vibra to make use of Petrobras model for 10 years. The creation of a fourth competitor (who could be full of money) is a unfavourable for the businesses within the sector.

Closing Ideas

My suggestion to buyers in Ultrapar is simple: begin taking income after this 40% run since July (and 100% YTD). Though my article confirmed that there’s nonetheless causes to suppose Ultrapar may go additional, I imagine odds of market-beating returns are decrease then they have been at first of the 12 months or in July. If you’re a contented shareholder that’s not but satisfied the upside has ended, I might advise to observe the inventory intently. If value motion continues to be optimistic, that is effective, but when it instantly turns unfavourable, then swift motion could also be required.