Investment Case

We initiate coverage of KSG Agro with a HOLD recommendation and target price of PLN 27.9/share, upside of TT%. We believe the company’s cost advantage to peers, which allowed it to post higher than market average margins, is priced in to the company’s share price. At the same time, management’s presentation as a growth story is chaotic and unrealistic, in our view and justifies a HOLD recommendation even at current upside levels.

Lowest cost producer

With an average USD 115-228 spent per ha in 2010 (the latest reporting period), KSG Agro was the lowest cost producer among Ukrainian agriculture names (though we failed to find a meaningful explanation why, especially given that 2010 costs were below 2009, unlike for its peers). This allowed the company to post the highest EBITDA margins in the sector, 44%-64% in 2009-10. In terms of crop yields, KSG Agro is generally in line with its region.

Though there is inherently no way to check KSG Agro production costs, we note that the story of low pre-IPO costs resembles the IPO wrapping shown by Agroton, which showed a lowest production costs in IPO prospectus which in later years changed to one of the highest in the sector.

Production costs, USD/ha, 2010, sunflower		wheat		barley
Source: Company data, State Statistics Committee of Ukraine

Located in sunflower-favourable region, meaning high-risk high-return operations

Of the company’s 59 ths ha, 52 are located in Dnipropetrovsk region, which has the highest share of sunflowers, one of the top-3 crops grown in Ukraine by profitability, in its crop structure (29% vs. Ukraine’s average of 16%). The region’s yields are generally on par with Ukraine’s average for sunflower, wheat and rapeseed, but 33% lower for corn and soybean. For the last four years, KSG Agro has had a heavy bias toward sunflowers: it accounted for 46%, 38%, 61% and 37% of planted land, well above the region’s average and normal crop rotation practices. We attribute this to the company’s focus on profitability ahead of its IPO in May 2011 and expect a decrease of sunflower share in crop structure to 25% in future periods.

Only listed company to invest in pork, though the project is larger than the company itself

With its purchase of a 50% stake in a large underutilized Soviet-era pig farm in Dnipropetrovsk region, KSG Agro became the first listed Ukrainian company to invest in pork. While we generally believe the pork story is next-it for Ukraine, we note this farm requires a complete renovation, with CapEx estimated by the company at up to USD 100 mln (3.5x and 7.0x larger than our estimate for KSG Agro’s revenues and EBITDA in 2012, respectively). At this point, we do not account for this project in our valuation. We deem this acquisition more a mechanism for financial engineering than an investment due to the unrealistic amount of CapEx required; the company’s guidance that this acquisition will add USD 5 mln to its bottom line solely on revaluation supports this view.

Scattered and overambitious growth strategy

KSG Agro announced ambitious plans to grow its landbank 5x within five years at IPO in May 2011: from 33 ths to 150 ths ha. As of April 2012, KSG Agro had increased its landbank to 59 ths ha and the most recent guidance aims for leasing 110 ths ha by yearend, a highly ambitious figure given the company’s cash position of USD 5.5 mln at end-2011. Notably only half a year since its IPO, KSG Agro added chaos to its already aggressive growth strategy: the company acquired a 50% stake in a Soviet-era pig-farm in Dnipropetrovsk region in October 2011 and initiated construction of a 60-90 kt pellet production plant in January 2012.

Business directions
Announced projects	CapEx required, (our estimate)	Status
Landbank expansion from 33 ths ha to 160 ths ha within three years	USD 50 - 130 mln	25 ths ha acquired
Acquisition of the pork production facility	USD 40-100 mln	A 50% stake in old facility acquired in October 2011, no update on the modernization plans
Pellet production plant	USD 5 - 20 mln	Signed a letter of intent with Polish Energy Partners, production at the facility should commence already in 2012
Silo construction	USD 4 - 25 mln	Nothing clear
Machinery purchase	USD 25 mln within three years	Attracted USD 10.9 mln loan from Deer Credit
Vegetables production	USD 1 - 10 mln	Nothing clear

Source: Company data, Concorde Capital