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Ukrainian agricultural sector: KSG Agro – buy recommendation

Ukrainian agricultural sector: KSG Agro – buy recommendation

Lack of government support, hindered access to bank loans, adverse weather conditions in summer 2020, African swine fever (ASF), and, finally, the coronavirus quarantine. It seems that the Ukrainian agricultural business has many reasons to feel the cool-down of the investment interest. And yet, the agro-industrial complex continues to remain one of the most investment-attractive sectors of the domestic economy. However, one should invest in promising and high-potential players – namely in agricultural holdings, which have taken market conditions and trends into consideration and correctly set their strategic priorities.

After a large foreign fund addressed our agency, wishing to invest in the shares of one of the players at the Ukrainian agricultural market, we, Market.info Agency, have conducted an exclusive research this summer and identified the TOP-3 most investment-attractive Ukrainian agricultural companies. KSG Agro agricultural holding got into the TOP-3 list and our agency gave the client an unambiguous recommendation to buy its shares on the Warsaw Stock Exchange (WSE). It wasn’t long until an article appeared on the well-known agrarian website Latifundist, where, from the very beginning, there was a talk about the “decline” of KSG Agro. But after all, our analytics is not some kind of fortune-telling based on reading coffee grounds and it testified to the opposite. The conclusions of our agency were confirmed by the November almost threefold growth of the agricultural holding the share price on the WSE. And then I realized that we should share our analytical conclusions about why KSG Agro was and remains one of the most interesting objects for investors.

KSG Agro: a prosperous start

For the founding father and co-founder of KSG Agro Sergiy Kasianov, the history of entering the big business began in 2001, when, together with his partners, he sold a very successful company specializing in household chemicals. After that, he decides to try his hand at politics and runs for a Member of Parliament post in the 37th electoral constituency in the Dnipropetrovsk region.

Kasianov had a lot to “demonstrate” to his fellow countrymen: in the city of Ordzhonikidze, where he and his partners built a factory for the production of laundry detergents, a promising enterprise with many new jobs was created, and the company became a leading taxpayer. But this is an industrial city, and the district, where Sergiy decided to become a people’s deputy, was predominantly rural. The situation for agriculture at that time was not the best: purchase prices were low and wheat cost $ 50 per ton. Nevertheless, in order to better know the life and interests of voters, Kasianov decides to plunge into the agricultural business and acquires a farm with a land bank of 5 thousand hectares. He won the elections by more than a two-fold lead over the nearest challenger. So, in parallel with the first steps in big politics, the businessman gradually delved into the agricultural specifics.

Little by little, his business developed, and the trend for the arrangement of agricultural holdings appeared from about 2005-2006. Experts actively talked about the fact that the world's population is increasing and the figures of the cultivated land areas are getting lower, resulting in a food shortage. The answer to this public demand was the appearance of the first large agricultural formations in Ukraine, which we now habitually call agricultural holdings. However, at the very beginning of this process they were much smaller in size than they are now, because it was quite difficult to subdivide the lands. At first, enterprises appeared that cultivated 2 thousand hectares. Subsequently, they grew to 10-20 thousand hectares. Just for a comparison: at present, medium-sized agricultural holdings are considered to be economic entities that cultivate 20-30 thousand hectares. Realizing that it is necessary to develop, Sergiy Kasianov begins to consider options for consolidation.

For the sake of fairness, it should be said that the businessman had other investment interests. The real estate market was extremely attractive in those days – square meters were expensive and grew in value constantly. However, starting in 2008, this alternative disappeared, because the mortgage bubble burst – first in the United States and then all around the world. The financial crisis broke out, and the dollar exchange rate in Ukraine almost doubled. “Now these numbers seem ridiculous, but in November 2008 we fell asleep with the rate of 5 hryvnya, and woke up in the morning when the dollar was already worth 8 hryvnya. We had to forget about the real estate, but the agrarian line, on the contrary, became a trend, and we purposefully began to develop the agrarian business to the maximum and started the IPO in 2011,” Sergiy Kasianov later recalled.

For KSG Agro, the IPO was successful and timely. Figuratively speaking, the company managed to backdoor its way into it. If back in March-April 2011 it was possible to carry out an initial public offering profitably, then in May-June investors lost their interest in the shares of Ukrainian companies. By the way, many Ukrainian businesses were actively preparing for an IPO at that time, but they simply got their timing wrong. And KSG Agro raised $ 43 million for 30% of its shares. At that, the overall value of the company was $ 120 million.

What were investors expecting at that time? First of all, a growth in the land bank and volumes. It was some kind of dominant misconception at the market, transformed into a race for quantity and not quality. From the standpoint of today's experience, Kasianov considers such a strategy to be a mistake – the holding too quickly sought to satisfy the IPO requirements for expanding the land bank. As a result, from 30 thousand hectares, it rapidly jumped on to 90 thousand hectares.

Crisis 2014 as the start of new opportunities

The expansion of the cultivated land areas in the subsequently annexed Crimea had fatal consequences (but who in those days could have predicted such a fate?). As a result, in 2014, KSG Agro lost 30 thousand hectares in the Crimea. This was a serious loss, because the agricultural holding had been developing intensive technologies on the peninsula since 2012, arranging 1,100 hectares of irrigated areas for maize. Kasianov himself actively worked to attract Chinese investors to the Crimean agricultural sector. In January 2014, as part of a delegation organized by the Crimean government, he negotiated the use of Chinese irrigation technologies. Then a memorandum was even signed stating that the Chinese side would invest half a billion dollars in the development of agriculture in the Crimea to organize irrigation on 100 thousand hectares. The plans were more than ambitious, and the Chinese promised to supply state-of-the-art technologies and equipment. But they were not destined to come true, since already in February 2014 the notorious "little green men" appeared in the Crimea.

The situation with the Crimea turned out to be a black page in the development of the agricultural holding, because the peninsula still does not have a clear legal status, and it was necessary to fulfill all obligations towards the state and investors. The last debts, including the cost of the crop remaining on the peninsula (which was 1.5 million euros), were closed by KSG Agro only in 2019.

According to the most conservative estimates, the agricultural holding lost $ 20-25 million due to the annexation of the Crimea. You can add to this the losses due to changes in the currency exchange rate, and shares of KSG Agro, as a public company, are quoted on the WSE, and all indicators are calculated in dollars only. But that's not even the main thing. Like many Ukrainian agricultural holdings, at one time KSG Agro got too carried away with bank lending. Now Kasianov admits that it was not necessary to take such a pace and use the borrowed capital that extensively. At KSG Agro, the ratio of the borrowed funds to the equity capital was 30% to 70% in favor of loans. But at that time Kasianov was sure that agricultural products would continue to rise in price, and banks constantly came with offers to lend, so it was difficult to resist against the background of the opening prospects. “The bankers simply corrupted us; we didn’t turn to them – they themselves stood in line. And if money can be easily obtained, grandiose development plans immediately appear. Now I am sure that the conservative way of development is the right thing,” recalls the Chairman of the KSG Agro Board of Directors.

Be that as it may, but by 2014 the debt burden of the agricultural holding reached an impressive $ 100 million. In fairness, it should be said that the situation was difficult, but not catastrophic. Judge for yourself: KSG Agro's Net Debt to EBITDA ratio in 2012 (before the crisis) was 1.97. At the agricultural market in the same period, some other agricultural holdings had even higher figures. For example, for IMC this ratio was 3.4, for Astarta – 2.8, and for MHP 2.8 as well. There were also the ones with figures similar to KSG Agro – Kernel had 1.9. Trust me as a business analyst, Net Debt \ EBITDA up to 3 is considered absolutely normal.

However, against the backdrop of the skyrocketing exchange rate, the debt problem still needed to be solved and Kasianov was making clear volitional steps in this direction. To say that it was difficult for him means to say nothing. The burden in the form of losses on the Crimean assets and the credit debt was very heavy. Suffice it to say that in such a situation, some agricultural holdings simply abandoned their business (went bankrupt and fudged on their debts) and left the market. Others, such as the notorious "Mriya", withdrew all funds and disappeared, leaving partners and customers with debts and bad memories.

In the most difficult conditions, KSG Agro decided to fight. The holding could not let down its investors, who trusted it by investing in the shares. Leaving the market would mean deceiving them, forever losing both the company’s reputation and investor funds. And Sergiy Kasianov, as a businessman responsible for his words and deeds, acted differently. His first decisions appeared to be very unpopular. Sure enough, they related to a sharp reduction in costs, and in this area you cannot be soft and complaisant by definition.

KSG Agro carries out an internal optimization. As a result, the management company itself was cut in half, and part of the land bank had to be abandoned. Sergiy Kasianov introduces a strict management regime and controls all financial costs, and the holding minimizes investments by switching to the average price group of seeds, plant protection agents, and equipment.

In parallel, difficult negotiations with creditors were underway. Kasianov's position was firm: the situation was complicated, but the holding continued to confidently look into the future and work.

At the risk of jumping ahead, I will say that 2019-2020 were the turning point for KSG Agro in finding a common language with all creditors. They all agreed to a credit restructuring. Part of the indebtedness was paid off in cash, while another part was offset with the company's assets. For example, the agricultural holding closed up to 80% of the debt to UniCredit Bank with its property. In particular, it transferred the ownership of its flour-milling enterprise – Pererobnyk Kryvyi Rih – to the bank. At the same time, KSG Agro currently rents it (and on very favorable terms) and continues to produce flour.

Over the past two years, the debt load of KSG Agro towards foreign creditors has decreased in total by $ 16 million. At the moment, there are only $ 2 million to be paid to foreign banks.

At present, the agricultural holding has positive equity. This was preceded by effective negotiations with creditors. For instance, a $ 3.6 million payment obligation was settled with USEXIM Bank (USA). The balance of the 8.3 million euro debt to Landesbank Baden-Wuerttemberg (Germany) and of the 4.8 million euro debt to Big Dutchman (Germany) was paid off. Deals on U.S. EXIM Bank, Big Dutchman, and Landesbank Baden-Wuerttemberg debts are physically closed.

Reaching agreements with creditors and the latters’ writing off 67-70% of the original debt amount, helped to stabilize the financial component of the agricultural holding. Ultimately, this opened the way for the release of funds that are directed to new projects and contribute to the sustainable development of the holding. I think you would agree that only few companies in Ukraine, including in the agricultural sector, have succeeded in doing this.

All this time (and this is another recipe for KSG Agro's success) Kasianov adheres to the principle of transparency and never for a moment stops an active and honest dialogue with investors. The founder of the agricultural holding is well aware that trust and reputation are assets that are created over the years, and you can lose them in an instant. Therefore, he could not do otherwise. As we have managed to notice, KSG Agro became one of the few companies that communicated with Polish investors in the crisis years of 2014-2015, and is doing it now. Both the director of the company and the Chairman of the Board of Directors Kasianov met face-to-face with shareholders in Warsaw and held online conferences, where they answered all questions of interest to investors. And the last such meeting took place through a Zoom conference (after all, we live in quarantine time!) in early October of this year.

But let’s get back to the numbers. The company emerged from the crisis vagaries with a much smaller land bank. If we talked about 90 thousand hectares in the boom years, then at present the farms included in the agricultural holding cultivate more than 20 thousand hectares. By the way, it is the land bank of 20-30 thousand hectares that Sergiy Kasianov rightly considers the most optimal from the point of view of manageability and effective management. Be that as it may, the holding's land bank really shrank... The key factors here were the loss of the land bank in the Crimea, and another part of the land was transferred to the company’s partners in the process of debt restructuring.

Against this background, Kasianov initiates the adoption of a new development strategy. KSG Agro is moving from the model of a universal agricultural holding with a large land bank, vegetable growing, pig farming, and a dairy herd to a vertically integrated agricultural holding, at the end of the chain of which there are end products with high added value. In short, in 2014 KSG Agro decided to focus on a segment where they had a really compelling competitive advantage – namely, the swine husbandry. By 2017, the agricultural holding managed to establish the operation of a pig farm in the village of Nyva Trudova (Apostolove district of the Dnepropetrovsk region). Interestingly, in 2020, pig breeding allows the company to generate more income than the crop farming segment. And the plant growing business is viewed primarily as a base for the production of feed ingredients for pigs. That is, as we can see, the formula of a vertically integrated holding company, well tested at the international markets, has been embodied by KSG Agro not on paper but in real life.

Scale or financial efficiency?

Debt reduction freed up the financial resources of the agricultural holding and gave it the opportunity to invest in the top-priority areas of development. And, as our readers have already understood, the swine husbandry was recognized as such.

The holding has very good performance in pig breeding. In July-August of this year, it pushed up the sales of pigs in live weight by 24% as compared with June 2020. If in June the average monthly sales were approximately 5 thousand pigs of various conditions (slaughter conditions, for fattening, and raising sows), then in In July-August, the volume of sales was already at the level of 7 thousand heads per month. At the same time, the volume of sales in monetary terms in the same period was raised by 30%.

It is essential to recall the increased role of KSG Agro in the food security of the country, because its production capacities cover 50% of the needs for pork in the Dnipropetrovsk region, which is home to 4 million people. For more than 7 years the holding has been actively cooperating with the SILPO retail store chain.

The current realities in domestic pig farming are characterized by great demand for high-quality pork, which means new opportunities for the holding to boost its market share. And it has every reason for this. KSG Agro breeds pigs of the Danish genetics, considered as the best in the world. From the very beginning, the holding purchased Danbred and continued to improve the genetic features of the livestock, complying with all technological requirements for the breeding process. Now Kasianov is going to go even further by creating, together with partners, a pedigree breeding unit – and not just somewhere, but here in Ukraine. Together with its partners, the holding will invest five million euros in the development of a genetic reproducing facility at the pig-breeding farm in the village of Nyva Trudova (Apostolove district of the Dnipropetrovsk region). Thanks to these investments, it is planned to increase the number of raising sows to 500 at the first stage and to 2 thousand heads at the second one.

Speaking about the development of the pedigree breeding unit for purebred sows, the holding analyzes two directions of operations. Firstly, to work with the already proven remarkably effective Danish genetics, and, secondly, to supplement it with the Swiss genetics from the SUISAG company. Both options are quite worthy and allow boosting the productivity of raising sows, both for the KSG Agro reproducing facility and for the needs of other Ukrainian livestock breeders.

Kasianov's fixation on pig breeding turned out to be more than correct. This was clearly demonstrated by the quarantine crisis, which for all types of businesses has become a kind of a “roadside check”. You can also add a fact that it has not been easier before, because in recent years we have been living in conditions of an actual state of emergency associated with the ASF epidemic. As a result, the pig population in our country has been decreasing on a systematic basis. The output of those producers who, like KSG Agro, invest in technologies to protect pigs from ASF and breed products with good genetics, are in high demand. And the quarantine crisis has virtually no effect on this. Therefore, even during the quarantine period, we observe a consistently high strong for pork. And the fact of the matter is that pig products are among the priorities of people. You can do without expensive outfits and budget-unfriendly tours abroad, but you need to eat every day. The current situation, in which the coronavirus has driven us, determines the trend for an increase in the price of pork, since food becomes a priority now. That is why the demand for high-quality pork will continue to remain consistently strong, which will allow KSG Agro to gradually increase its market share.

It is no coincidence that, according to the Performance Rating of public agricultural holdings, compiled on the basis of stock exchange reports, KSG Agro is the one to have the highest EBITDA margin among Ukrainian agricultural holdings (40%) and the highest return on sales (26%), also being second in terms of return on assets – 10.1%.

 

 

Performance rating of public agricultural holdings

 

 

 

 

 

 

 

 

 

 

 

Revenue, $ million

Net income for 2019, $ million

EBITDA , $ million

Operating profit, $ million

Net worth, $ million

Assets, $ million

Net debt, $ million

Debt load (Net Debt/EBITDA)

EBITDA margin, %

 Return on equity, %

Return on assets, %

Return on sales, %

 

1

KSG Agro

23.9

6.2

9.6

7.9

13.4

76.8

29.0

3.0

40.1

46.4

10.3

26.1

 

2

Agroliga Group

50.4

6.7

11.2

8.0

31.6

66.9

21.5

1.9

22.2

21.3

12.0

13.4

 

3

*Agromino 

36.6

3.0

10.9

6.6

58.7

125.9

16.7

1.5

30.1

5.1

5.2

8.1

 

4

MHP

2055.9

215.3

379.0

215.5

1595.9

3690.5

1139.0

3.0

18.4

13.5

5.8

10.5

 

5

Kernel

3992.1

178.5

346.0

269.2

1346.0

2463.6

694.0

2.0

8.7

13.3

10.9

4.5

 

6

IMC

169.6

7.3

39.3

15.2

133.2

298.4

156.8

4.0

23.2

5.5

5.1

4.3

 

7

*Astarta

499.7

1.9

86.9

16.5

489.5

847.0

307.7

3.5

17.4

0.4

1.9

0.4

 

8

Ovostar

104.7

-20.0

-15.5

-19.4

121.0

145.8

5.9

-0.4

-0.1

-16.5

-13.3

-19.1

 

9

*Agrogeneration

34.1

-30.8

-1.3

-22.2

31.1

78.0

39.8

-30.1

0.0

-99.1

-28.4

-90.3

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

* Data are presented in US dollars at the exchange rate of the National Bank of Ukraine as of December 31, 2019.

 

 

 

 

 

 

 

 

 

 

                                               

Indeed, compared to the pre-crisis 2013, the land bank of the agricultural holding has been cut down significantly: there were more than 80 thousand hectares at that time, with more than 20 thousand hectares now. But business is, first of all, efficiency, which is measured by such an indicator as EBITDA. According to the definition, EBITDA (Earnings before interest, taxes, depreciation and amortization) is profit before interest, income tax and depreciation of assets. The company's management calculates EBITDA to illustrate the holding’s financial position and uses it to analyze its creditworthiness. And you know what? In 9 months of 2020, KSG Agro's EBITDA has risen by 3.8 times compared to the same period last year – from $3.9 million to $14.7 million. This has become the evidence of the company's operating efficiency and a natural result of the restructuring of the loan debt – with the considerable reduction of such debt to foreign creditors. It is noteworthy that the holding's EBITDA has been growing steadily for several years in a row.

A look into the future

I think that the figures and facts that have already been given above are enough to, according to our agency's research, give a hedge fund client an unambiguous buy recommendation for KSG Agro shares on the WSE. The basis was not only the dynamics of numbers. The main thing, in our opinion, was the successful change of the agricultural holding's business model and, once again, its focus on the pig breeding.

The dynamics of KSG Agro shares on the Warsaw Stock Exchange proved our correctness. After the publication of the next report, the share price rose by 3 times over four trading sessions – from 1.16 PLN to 3 PLN. We predicted this – however, with a different multiplier. During December prices were 2,5-2,9 PLN. As I can judge now, the active communication of the owner in Poland played its role: Kasianov is an active participant in international conferences (in particular, in Polish Rzeszow), and his management team meets with investors (a meeting with investors was held in Warsaw in June 2019). Moreover, even in the times of market instability and pandemic he confidently looks into the eyes of investors (in particular, during the Zoom conference on October 8, 2020).

Additional factors behind the positive dynamics of the growth in KSG Agro shares were the statement by Kasianov during the October Zoom conference that based on the results of 2021 the company intends to consider the possibility of paying dividends; as well as the development plans based on the opportunities appearing after the release of funds following a significant reduction in the debt burden:

  • Continued investment in the swine husbandry. The agricultural holding has completed the modernization (de facto – the construction) of the feedlot at the pig breeding complex. In particular, the arrangement of an additional fattening unit, which will provide a modern production facility for 2,340 heads for pig fattening – piglets from 30 kg and pigs of slaughter condition up to 100-110 kg. In addition, Kasianov's statement on investing in the development of the genetic reproducing facility at the pig breeding farm in order to further develop the genetic aspect is important for both investors and partners. It is planned that there will be 500 raising sows at the first stage and 2000 heads at the second one.
  • The response to climatic changes in the Dnipropetrovsk region, where dry winds have become more frequent and the climate has become drier, was the stake on such a new crop in the holding's crow-growing basket as sorghum. In general, the dynamics of the farms included in the agricultural holding is as follows: in 2018, they increased the cultivation acreage for sorghum by 43%. If at the beginning of 2017 the area for sorghum was 637 hectares, then in 2018 it was 911 hectares, while in 2019 it is already 932 hectares. In 2020, they have decided to concentrate on 548 hectares in order to "test" new technologies and approaches and get higher yield indices. Still, sorghum is not an easy crop, and in order to obtain decent yields, one needs to experiment and work hard. So far, KSG Argo has managed to get good results. Sorghum is a very interesting crop for the arid zone, which is the Dnipropetrovsk region. At the same time, the yield of sorghum is quite high: you can get something like 6-8 tons – that is, approximately similar to the maize level. But the difference is that this crop requires half as much moisture as maize, and its presence in the composition of the feed concentrates used at the pig breeding complex allows reducing their cost.
  • High-quality pork "made by KSG Agro" allowed the agricultural holding to start thinking about its own meat brand and establishment of a chain of its own supermarkets. The implementation of this plan will allow the company to boost its income, because it will get a chance to less share the proceeds from the sale with retail chains.

All these factors allow us to speak with optimism about the further dynamic development of KSG Agro, and unambiguously recommend buying its shares.

Oleksandr Golisdra, Deputy Chairman of the Commission for the Analysis of Securities Markets at the Ukrainian Society of Financial Analysts (USFA), analytical group expert at Market.info Agency

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