Valuation

Figure 22. Revenue breakedown

Revenue by segment breakedown, Ths USD

Source: KNU estimates

DCF Valuation

To estimate Kernel’s fair price we used a discounted cash flow model and applied discounted cash flow to firm the approach. The company’s strategy disclosure is limited to 3-4 years taking into account the expansion to the Russian market. We think that after this crucial period the company’s figures will reach relative stability. This fact denotes a forecasting period of 5 years.

Revenues. Revenues are calculated on the segment basis. On the volume side, bulk oil volumes are expected to grow up on par with the company’s crushing capacities. The year of 2013 shows an appreciable 41% yoy leap, 13% of which accounts for weak sales and high inventories in 2012. We think that the bottled oil segment has a moderate market capacity, and therefore a rise of 12% in 2012 and 7% in 2013 is to be replaced by stagnation at 1-2% yoy. Considering the inspiring industry outlook, our analysis suggests that Kernel will be able to accomplish its goals in Russia to the full, and both grain sales and export terminal throughput will additionally grow for 2.5 MMT until 2016 (see Appendix 4)

Prices for oil and grain products are calculated using the FARPI-ISU 2012 World Agricultural Outlook. A discount rate, obtained by comparing the FARPI historical prices to the Ukrainian grain and oil price indices reported by the UkrAgroConsult, was applied to the forecasts.

Revenues from export terminals, silos and farming are extremely slowly going up as we generally expect them to benefit to intersegment sales of the fast-expanding grain segment. We also expect that sugar beet plants to be sold in the nearest future, and therefore they will not bring additional revenues after the first quarter of 2013.

Costs. Used raw materials account for about 71% of sales. We expect this ratio to stay constant as we are sure that Kernel will be successful in passing a COGS increase onto the final consumer. Rental expenses are based on the land lease rights the company possesses and are calculated with respect to them. Payroll and other expenses are supposed to grow at a rate of the company’s asset expansion.

Change in working capital. We projected inventories by using an inventory turnover ratio (6.0), obtained on the basis of the company’s historical data with adjustments made to 2012 due to the unusual record-high values. More than 95% of biological assets consist of crops, beans and seeds. Therefore, we assume that their value is mostly preconditioned by the land rented by the company. Other components of the working capital were calculated with an assumption of a constant WC/Sales proportion.

Figure 23. FCFF valuation summary

Source: KNU estimates

Figure 24. CapEx assumptions

Ths. USD

Source: KNU estimates

CapEx. The company’s CapEx plan has a time horizon of 3 years. Kernel plans to spend about USD 100M on acquisition/construction of new silos and approximately USD 120M on building a crushing plant in Voronezh. The acquisition of Taman terminal will bring USD 135M CapEx in 2013 and an infusion of USD 20M is annually expected for the two subsequent years aimed at its expansion. On the other hand, Kernel announced plans to sell sugar plants. According to our estimation they will be approximately sold at their book value, which will provide an additional cash inflow of USD 60M.

Therefore, considering the estimated expenses on maintaining the PP&E, we suppose CapEx in tangible assets to account for USD 200M in 2013, and USD 150M in 2014 and 2015. We also expect that in 2016-2017 it will represent 105% of depreciation (5% of which accounts for long-term Ukrainian inflation) and additional 34% (calculated on the basis of the historical data) spent on building of new capacities which are then to be transferred into construction and production equipment at a 2:1 ratio.

Increase in intangible assets is supposed to stay constant, and will annually stand at USD 37M of spending on purchasing of land lease rights, and USD 0.5M on other assets.

WACC. A WACC was calculated by using a market Debt/Equity ratio of 2012 which was equal to 0.46. We also expect a book ratio not to change dramatically in the future. A cost of debt was taken as a 9.6% average interest paid in 2006-2012. Taking into account a positive line of the company’s taxes, we are obliged to assume an effective tax rate of 0%. An estimated Cost of Equity is 15.80% (see appendix 11). Thus, we assume the constant WACC of 13.83%.

Terminal growth rate. We assume a terminal growth rate of 3.00%, 1.9% of which accounts for a long-term US inflation and 1.1% for an annual world population growth rate.

Uses of FCF: Kernel approved that the dividends would be paid from 2013. Moreover, the company considers the dividends as the main option to deal with excessive cash. A WIG index presents dividend yield of 3.8%, which approximately accounts for a 30% dividend payment ratio of Kernel in 2013. We assume this ratio will stay constant for further periods.

Figure 25. FCFF inflows summary Figure 26. Price breakdown by segment*

Taman grain terminal acquisition

Taman grain terminal brings first income

Taman terminal reaches its capacity

income

Voronezh plant reaches its capacity

income

Stable growth

Starting the building of new silos

Finishing the Voronezh greenfield plant

Working capital inflows

Inflow of working capital is required

Starting the building of greenfield plant in Voronezh

Expansion of Taman

Sugar beet plants are sold

*approximately calculated on basis of EBIT margin

Source: KNU estimates Source: KNU estimates

We understand that the result might be influenced by a lot of factors which we are not able to take into account. Given the fact that grain and oil prices on both Ukrainian and Russian markets are a subject of appreciable volatility, we provide a sensitivity matrix for changes in costs of raw materials and external prices of grain and oil.

Source: KNU estimates

Figure 29. Main competitors of Kernel Holding S.A.

Source: KNU estimates

Peers Valuation

Obviously, not all agriholdings can be directly compared with each other owing to large product differentiation, operating margins discrepancy and different production capacities (including landbanks). We compare Kernel Holding S.A. with its domestic and Russian peers in terms of 2011/12 EV/EBITDA, EV/Sales and P/E multipliers. We think the peers comparison may provide some extra perspectives on our analysis. A specific production multiplier of EV/Landbank was also analyzed, but no result was obtained, because of Kernel’s higher than market average crop yield.

The most expensive Ukrainian agro holding. According to the peers valuation, Kernel Holding S.A. trades with an attractive 12.1% discount on EV/EBITDA, 39% discount on EV/S and 55% premium on P/E to its main peers. An aggregated discount/premium to comparables of 19.3% was calculated by weighting each premium/discount on an appropriate weight (for the weight calculation methodology see Appendix 6), depended on useful multipliers of an investment analysis. The company is stable, little overvalued by the market due to a high performance growth rate during the last year and a resilient position (a full operating and delivery cycle) in the investment attractive industry. A positive expectation is based on a high investment perspective in the company’s oil and grain trading segments in Russia (Krasnodarskiu krai and the Black Sea coastline). Using the peers comparison method we obtained a price of PLN 55.32.

In this section key financial results of the company’s activities are analyzed. Furthermore, existing and potential factors that might change key financial figures, are determined.

P ermanent revenues growth in the most profitable sectors. In 2008/2012 an average annual growth rate of the company’s income was equal to 38.8% and 30.3% for EBITDA. The 1Q 2012/2013 showed increase in revenues by 32.2 % and rise in EBITDA by 64.2% comparing to the 1Q 2011/2012, in which the EBITDA margin equaled to 14.3% with seasonal features, and there were positive price and demand trends in the main segments. Regular augmentation of the EBITDA margin was also noticed before 2011 (16.3% in 2011 and 15.5% in 2008). This figure slightly decreased in 2012 to 15.0% (see Figure 30). The increase was provided by favorable market conditions and expansion of income in the most margin-generating sectors, namely sunflower production and processing, farming, silo services and port terminals (in 2012 the EBITDA margin stood at 13.4%, 43.1%, 35.9% and 47.3% correspondingly, see Figure 30). We expect a 9% CAGR of the company’s income should an operational margin be at 14.5-15.0% while keeping a business structure of segments and positive synergy effect (USD 30 per ton), and implementation of investment projects be carried out to the full extent.

Figure 30. Revenue growth but stable EBITDA margin

0.2

0.18

0.16

0.14

0.12

0.1

0.08

0.06

0.04

0.02

0.0

Revenue, USD M

2016/17 FY

2011/12 FY

Ebitda margin, %

Source: Company data, KNU estimates

Solid long-term profitability. The holding’s net income varied from USD 18.6M in 2007 to USD 226.0M in 2011, and USD 213.8M in 2012. This trend ensured increase in a net margin up to the year of 2010 (from 5.3% in 2007 to 14.9% in 2010). A growth rate of expenses surpassed a growth rate of income and resulted in reduction of the net income from 11.9% to 9.9% in 2011/2012. A high-level ROE of 37.1% in 2009 confirmed significant profitability of the company’s activities. Yet the ROE figure decreased to 17.9% in 2011/2012 because of the margin fall of grains and increase in fixed expenses while possible ways to raise prices of final output endured limited. According to our estimates key factors that impact on the company’s profit are a level of an EBIT margin and leverage (see Figure 32). Impacts of tax and loan interest rates level and offset each other. Profitability of 14.4-16.2% in 2013/2017 is expected to be supported by growth of production capacities and increase in the operation margin of oil and grains.

Figure 31. Net income, ROE & ROA

0.4

0.3

0.2

0.1

0.0

Source: Company data, KNU estimates

Figure 32. Main Net income drivers

0.25

0.2

0.15

0.1

0.05

0.0

Source: Company data, KNU estimates

Tax burden remains minimal. A majority of the holding’s companies in Ukraine and Russia operates in accordance with a simplified taxation system of agricultural enterprises, thus agriculture contributes more than 75% of the companies’ income. An agricultural tax is solely paid. Furthermore, the agricultural tax rates in Ukraine and Russia (0.15% and 6% correspondingly) are crucially smaller than income tax rates (21% in Ukraine and 20% in Russia). A majority of export-oriented segments creates grounds for VAT reimbursement from the state budget.

The company’s cashflow exceeds operational and capital expenses. The company’s noticeable operational cashflow allows to fund completely its current and capital expenses (see Figure 33). An amount of accumulated retained earnings during 2008/2012 increased by 8 times and was equal to USD 84M in 2012. Hence the company has an opportunity to maintain its target Net Debt/EBITDA ratio of 2.5 in case of further expansion. The Net Debt/EBITDA ratio totaled 1.05 in 2008/2009 and 1.86 in 2011/2012.

Yet opportunities of external financing have not been exhausted. The company’s debt continues to be comfortable and has not reached its critical level. Nevertheless, the company’s debt doubled during the last reporting period. In 2012 own funds stood at 58.3% in the structure of financing (see Figure 34). Indeed, a share of attracted resources grew from 36.6% in 2010/2011 to 42.74% in 2011/2012. An amount of long-term liabilities enlarged to 61.6% in 2011/2012 caused by debts of joined companies. However, short-term attracted resources, which were more expensive, prevailed in the structure of financing in 2008/2011 (60-65%).

Figure 33. Capital structure

0.3

0.2

0.1

0

-0.2

-0.3

Source: Company data, KNU estimates

Figure 34. CapEx financing

2.5

2.0

1.5

1.0

0.5

0.0

-0.5

-1.0

-1.5

Source: Company data, KNU estimates

The total sum of debt is practically denominated in USD. Nevertheless, there are debts in RUB and EUR allowing minimization of losses in case of debt revaluation due to changes in foreign currency exchange rates. Quality of debt service is satisfactory. Moreover, it is planned to achieve the target EBITDA/Interest ratio, which will be greater than 5.0 (this figure varied from 4.4 to 8.3 in 2008/2012). The company’s net financial position amounted to USD 183.4M in 2011/2012 comparing to analogical figures of USD 38.2M in 2008/2009 and USD 150M in 2010/2011 (see appendix 2).

Investment plans meet investment opportunities. During 2008/2012 the company’s total assets grew by 3 times from USD 755.6M in 2008 to USD 2,119M in 2012. Such growth took place due to increase in PP&E, namely expansion of the land bank and processing capacities (plants), which were mostly carried out by M&A (see Figure 34). Profitability of invested capital is directly proportional to capital expenses. Should investment opportunities in Russia be fully realized, we expect stable profitability of the invested capital.

F

Oil:

Transshipment:

Zaliznichni slyakhi JS

Oil:

Allseeds Group

Grain: TBT

Sugar:

Ukrros

Source: Company data

Key financial figures of the company’s activities used to perform financial analysis are represented in Figure 36. Aggregated financial reports of the company and analysis of separate elements of financial standing (such as revenues, net profit, operating margin) are provided in Appendixes.

Figure 36. Key financial ratio

Source: KNU estimates