Ultrapar Participações S.A.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

Ultrapár Participações S.A. (UGP) is a Brazilian company with over 85 years of history, involved primarily in the distribution of liquefied petroleum gas (LPG) via its Ultragaz brand, fuel distribution through its Ipiranga brand, and in specialty chemicals through Oxiteno.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Ultrapár, founded in 1937, has a diverse portfolio, however, it recently divested the Oxiteno business, focusing now solely on the energy distribution and retail sectors.

Business Overview

Ultrapar’s operations are primarily concentrated in Brazil, with some international presence. The company operates through two main business segments:

  1. Ultragaz: This segment is primarily engaged in the distribution of liquefied petroleum gas (LPG). Ultragaz serves residential, commercial, and industrial customers, utilizing a broad network of distribution channels. Notably, the brand operates in the Southeast and Northeast regions, which are considered the strongest markets in Brazil for LPG.

  2. Ipiranga: This segment involves the distribution of gasoline, ethanol, diesel, and other fuels. Ipiranga’s network includes fuel stations across the country, catering mainly to individual consumers and fleets. In addition, Ipiranga has a large distribution presence for fuel to various businesses, particularly industries.

Ipiranga is the second largest fuel distributor in Brazil by sales volume and market share, but ranks third on profitability due to less strategic locations.

  • Revenue Distribution: In 2022, UGP generated 54.8 billion in revenues from sales and services. Ultragaz contributed 12.4% to this figure, while Ipiranga contributed a much larger share of 87.6%—highlighting Ipiranga’s dominance in the revenue mix.

It’s crucial to understand UGP has become mostly a fuel distribution company after the divestment of Oxiteno.

  • Industry Trends:
    • LPG: The Brazilian LPG market is characterized by high consumption rates. The industry is influenced by factors such as the size of the population, price sensitivity, and seasonal demand. While largely predictable, this market is also subjected to some influence from government policies.
    • Fuel Distribution: The fuel distribution industry in Brazil is highly competitive. Competition centers around price, brand image, and the extent of distribution reach. Major players often engage in promotions and discounts to attract customers. However, government regulations and tariffs are relevant as well.

There is a trend of increased competition in both LPG and Fuel distribution sectors as new players enter the market, especially in the low end of the market.

  • Competitive Landscape:
    • LPG: Ultragaz faces competition from other LPG distributors, as well as from alternative energy sources like natural gas. Their ability to generate a moat lies primarily on their extensive and efficient logistics network, and their brand image.
    • Fuel: Ipiranga competes against other fuel distributors, which are usually large national or global companies, like Petrobras, Raizen, and Vibra Energia. Competitive advantages in the industry hinge on location, pricing strategies, and distribution.

With high interest rates and low economic growth, fuel distributors have been struggling with lower margins and lower ROIC, therefore, a focus on profitability over volume will be important.

  • What Makes UGP Different:
  • Strong Brand Recognition: Ultragaz has built a strong reputation over several decades.
  • Extensive Distribution Network: Both Ipiranga and Ultragaz have significant reach across Brazil, giving them an advantage.
  • Operational Efficiency: Both businesses are able to achieve above-average operating margins relative to peers.

UGP has made a significant investment in their logistics to reduce costs and improve reliability. They have one of the largest fleets in Brazil with over 18000 trucks for delivery.

  • Margins: In 2022, Ipiranga had a gross margin of 7%, while Ultragaz had a gross margin of 17.5%. Overall operating margins have been improving as a result of efficiencies and cost management.

Management is focused on boosting margins by lowering their costs and growing revenues in value-accretive segments like the value-added service business.

Financial Analysis

  • Profitability:
    • UGP has had fluctuating results over the years, especially due to macroeconomic factors. However, margins have improved in the last few years.

Net operating profit adjusted for recurring and nonrecurring items was a positive RS 650 million in 2022 but dropped to RS 458 million in 2023, mainly due to higher financial expenses (interest paid on their debt).

  • ROIC is below the company’s cost of capital which has been the main point of concern by management.

  • Balance Sheet Health:

  • UGP’s balance sheet is relatively healthy with a current ratio of 1.46, implying that it has more current assets than current liabilities. A quick check to see if there are any problems.

Working capital is mostly funded by trade payables and cash, while debt has been declining with higher returns on invested capital. * Debt is relatively high but manageable at 15 billion reais, with a debt-to-equity ratio of 0.87.

Despite some increase in debt to finance the acquisition of a new pipeline for natural gas, which increased debt-to-ebitda from 1.7x to 2.4x, it’s still a stable level. Company is focused on deleveraging in future years. * The increase in their equity in the last year comes mainly from currency translation adjustments.

  • The company has a total of 12 billion in cash, indicating that they can weather a sudden slowdown in the market.

  • Cash Flow:

    • UGP generates positive cash flows from operations. However, investments in new assets are high and sometimes offset the cash generated.

Free cash flow was also negatively affected by higher tax payments in the last year.

Moat Assessment

Ultrapar’s moat is considered to be weak, meriting a rating of 2/5. Here’s the breakdown:

  1. Ultragaz’s Brand: It has a brand advantage in the regions where it operates, which gives the company some pricing power. But, it’s not a very strong brand advantage, as most consumers will still switch based on price.
  2. Ipiranga’s Distribution Network: An important economic asset is their distribution network. Ipiranga’s vast network of fuel stations and infrastructure creates a barrier to entry for other competitors, however, not an insurmountable one.
  3. Switching costs are generally low: Due to the nature of retail industry, it is easy for people to switch fuel stations or LPG distributors. Therefore, no real switching costs are present.
  4. Economies of scale: Both the fuel and LPG businesses benefit from scale and provide some benefit of scale, however, this advantage is not high enough to provide them a wide moat, and it’s not a very strong competitive advantage.
  5. Lack of unique resources- neither of UGP’s businesses own unique resources that would give them a competitive advantage, such as a unique access to a particular raw material.

All in all, while Ultrapar does possess some operational advantages, it’s hard to define them as having a real moat, they are more akin to the benefits derived from a well-established and big business with existing scale.

Risks to the Moat and Business Resilience

The moat faces risks stemming from competition, economic fluctuations, and regulatory changes:

  1. Increased competition: New competitors, particularly in the low end of the market, may drive price competition and pressure margins. This is especially true in the LPG market, which is also susceptible to alternative energy sources.
   Management recognizes that competition is increasing and therefore is trying to improve operational performance and efficiency. They have also mentioned a focus on value over volume. 2.  **Macroeconomic factors:** Volatility in the Brazilian economy, coupled with high inflation and interest rates, can impact profitability and demand for the company’s products.

In the last year, high interest rates hurt the company’s financial profits considerably.

  1. Regulatory changes: Changes to government regulations, tariffs, or taxes can drastically affect its business operations.
   Government regulations on fuel prices and taxation are of great importance to the profitability of the business. 4.  **Decreased pricing power:** A shift in the consumers behavior towards a focus on the lowest price may negatively affect the profitability.

Management has stated that they are trying to make better service-oriented offers in an attempt to curb this.

  1. Technological change: With the rise of alternative energy sources (electric vehicles) and delivery methods, the company needs to adapt their models to the changes in consumer behavior.
  2. Geopolitical instability: Volatility in prices of international commodities can influence the performance of UGP’s businesses.

The company has shown some resilience over the years with a diversified business model. The company has some geographical diversification with investments in other South American countries. However, most of its earnings come from Brazil and therefore can’t truly be called a geographically diversified company. UGP is also trying to diversify into clean and renewable fuels, which will add to their energy mix.

Understandability Rating

I have given the company an understandability rating of 3/5. It’s not very easy to understand as there are multiple moving parts, and they are all subject to different external pressures. Additionally, the fuel distribution sector is a bit complicated to truly understand, with many moving pieces. The company is also involved with financial instruments which makes things even more difficult.

Balance Sheet Health Rating

The balance sheet health is good, but not great, it earns a rating of 4/5. Despite high debt, the debt has been decreasing recently and is at a manageable level. Cash on hand is also good, which implies the company has good liquidity to weather bad times.