Investment case

We initiate coverage of Agroton with a SELL recommendation (target price of PLN 7.8/share, downside of 31%) prompted by the low profitability of its farming operations and high company-specific risk related to large receivables qualified by auditors. Though its location in Luhansk region allows Agroton to have a higher-than-average share of highly-profitable sunflowers, this advantage is eaten out by high costs/ha and close-to-zero profitability on other crops.

A low margin producer

Agroton earned a gross margin of 28% in 2010 and 47% in weather-favourable 2011, net of biological revaluations. SG&A ate out 15 pp from the gross margin in 2010 (7 pp in 2011) and other operating loss 4 pp in 2010 (15 pp in 2011), resulting in a 9% EBITDA margin in 2010 and 25% in 2011. We expect Agroton`s EBITDA margins to stay in the 20%-24% range over the next ten years. We believe this level barely covers interest costs associated with Agroton`s longest cash operating cycle among Ukrainian agribusiness and leaves little to payback its shareholders.

Business model: focus on sunflower, other crops for rotation purpose only

Agroton’s 170 ths ha landbank is located in Luhansk region in Eastern Ukraine. This continental climate region is known for its focus on sunflowers, one of the most profitable crops in Ukraine: the region’s average share of acreage under sunflower has been 33%-34% in the last five years. Agroton’s ability to grow more sunflowers is counterbalanced by: (1) the company’s average costs per ha for sunflower being higher than the Ukrainian average and (2) profitability of other crops being close to zero, as yields are significantly lower than elsewhere in Ukraine and crops are grown primarily for rotation purposes. In addition, ~15% of Agroton’s landbank has to remain fallow due to low precipitation levels in the region.

Sunflower production costs, USD/ha, 2010		Wheat production costs, USD/ha, 2010
Source: Company data, State Statistics Committee of Ukraine		Source: Company data, State Statistics Committee of Ukraine

Overly aggressive CapEx plans

Apart from landbank expansion, which we moderately expect to stop at 180 ths ha, from the current 171 ths ha, key investment projects are greenfield storage facilities: 82 kt in 2012 (with CapEx estimated at USD 8.5 mln or USD 104/t) and another 180 kt in 2013-14. We believe Agroton`s heavy investments in storage facilities do not match its cost of capital, as payback for these kinds of projects typically exceeds ten years.

Once known as a low cost producer Agroton turned out to be a high-cost one

Agroton`s management provided different figures on cost per ha for its key crops (sunflower and wheat) in 2010 (IPO prospectus) and 2011 (Eurobonds prospectus), turning from low-cost producer to a high-cost one. We stress again that inherent dispersion of production process both over time and space makes it impossible to check costs figures nor to investors nor to auditors. We base our analysis on the figures provided in Eurobonds prospectus, the latest ones.

Agroton`s sunflower production costs, USD/ha		Agroton`s wheat production costs, USD/ha
Source: Company data		Source: Company data

Little visibility on where IPO and bond proceeds have gone

Agroton completed a PLN 153 mln IPO in October 2010 (net proceeds of USD 50.2 mln) and a USD 50 mln bond placement in July 2011. To date, progress on fulfilling pre-IPO and pre-bond commitments has been poor.

Proceeds utilization
	Intended use of proceeds		USD mln		Status
IPO	Net IPO proceeds		51.4
	Silos capacity expansion by 82 kt		8.5		No progress visible
	Landbank increase by 16 ths ha		4.0		Landbank increase by 20 ths ha for USD 15 mln
	Machinery purchase for 32 ths ha		16.0		No progress visible
	Acquisition of 130 kt of storage facilities		13.0		Facilities continue to be leased from the state, the same as pre-IPO. The company paid USD 10 mln for “the right to secure use of this elevator”.
Bond	Eurobonds placement proceeds (2011)		50.0
	Repayment of other loans		19		USD 4 mln repaid
	Landbank increase, machinery purchase, general corporate needs		31		No progress visible

Source: Company data, Concorde Capital

Red flag: 2/3 revenues in 2011 are qualified by auditors

The company’s auditors failed to find adequate evidence for USD 66.2 mln in revenues in 2011, or 2/3 of the total, issuing a qualified opinion. Of its sales, USD 44.9 mln stood as receivables at the end of 2011 and USD 41.1 mln were still outstanding as of end-April 2012.

The company explains that auditors issued qualification due to the lack of shipment documentation for export sales. The company says it started export sales in 2011 selling to its foreign subsidiary in 2011 as it believed that higher share of dollar-denominated revenues will decrease the cost of capital. As export duties and quotas were in place for ¾ of 2011 the company says it was not able to obtain shipment documentation for export destinations. Following the release of 2011 report Agroton has changed its auditor to KPMG from Baker Tilly previously.

Though if the company collects all receivables as it promises until the end of June this will nullify the qualification issue and result in reversal impairment of USD 9 mln (booked in 2011), this failed financial engineering attempt doesn’t add much to management credibility.

Overvalued via DCF; SELL

While our feeling is that the company’s assets are worth more than currently priced by the market (target EV of USD 1,100/ha for Agroton’s land plus USD 29 mln for its supplementary business results in a PLN T.T/share fair price), we do not see management willing/able to achieve its asset-based value. Our 12M target of PLN 7.8/share is based on DCF valuation which accounts for current low margins, high cash cycle and CapEx-intensive operations, which is reflected in our DCF valuation. SELL, downside of T%.

Valuation summary, PLN per share

Source: Concorde Capital estimates

Risks

Agroton’s key risks, except the collection of outstanding USD 41 mln in receivables, are a decline in sunflower yields due to its high share in the crop rotation, and overaggressive CapEx. We also note a high sensitivity to general weather conditions and crop prices, as higher costs per ha make the company more sensitive to top line variability.