Russia: blue ocean or exaggerated expectations?
Figure 20 . Kernel’s goals in Russia
Source: KNU estimates Figure 21. Kernel’s share price and goals complition PLN
Source: KNU estimates | In 2011, after it has depleted all the worthwhile opportunities for development in the Ukrainian market, Kernel has entered the neighboring country of Russia by acquisition of Russkie Masla Group. In the September of 2012 the company has strengthen its position by acquiring Taman Transbulk terminal and announced its strategic goals in Russia. However, the results of their implementation is still involves a considerable deal of uncertainty. The situation is deteriorated by the results of 2012 which wasn’t as successful as anticipated and missed the management guidance by 6% in sales and 13% in net income. There are several points of concern in the company’s entrance to the new market of Russia, that is, although quite familiar to Ukrainian one, is still new for the company. Yet, management is rather optimistic about the growth perspective, expecting to double grain sales and significantly increase oil output by creating new crushing capacities. However, our analyze suppose that the company may face several significant obstacles, such as: · Lack of seed supply. As the company expands to the Russian market the primary objective is to find the suppliers of the raw material needed for production. Considering the fact that seed is usually sold by small farming households, ensuring their willingness to work with the company becomes the issue of major importance. The worst case scenario may lead to smaller than expected sales of grain and insufficient oilseed supply which results in waste of crushing capacities · The high pressure of the competitors who have already been established on the market. The previous item may be worsened by the fact that there are several companies which will protect their share in the resource market. These competitors in the Black Sea region, such as RosAgro, Black Earth Farming and Pava will not easily give their business ties which provide them an access to grain and oilseed. · Reduce in EBITDA margin is expected. The growing capacities require additional costs to maintain them. Given the aggressive plan of their acquisition and creating, we expect the EBITDA margin to fall in the subsequent years. This fact increases the requirements to the company’s sales performance and decreases cash flow available for future investments. · The demand may be weaker than anticipated. The fall in EBITDA margin may be successfully be compensated with the increase in revenues. However, if the sales won’t grow with the faster rate than capacities, the result may be quite deplorable Even if we assume the full utilization of new capacities, the menace may be located on the consumer side: Kernel may not be provided with enough demand to realize its production. According to our estimations, the future Russian projects accounts for approximately 31% of the target price obtained using DCF method. The evaluated price is situated near the one we’ve got using peers comparison. We also made a sensitivity analysis of the target price with respect to the percent of completion of Kernel’s goals in Russia (Figure 21). |
Valuation
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Figure 22. Revenue breakedown
Revenue by segment breakedown, Ths USD
Source: KNU estimates
| DCF Valuation To estimate the fair price of Kernel we used the discounted cash flow model and applied discounted cash flow to firm approach. The company’s strategy disclosure is limited with 3-4 years, accounting for the expansion in the Russian market. We think that after this crucial period company’s figures will reach relative stability. This fact denoted the forecasting period of 5 years. Revenue. The revenues are calculated on the segment basis. On the volume side, the bulk oil volumes are expected to grow up on par with the company’s crushing capacities. The 2013 stands out, representing appreciable 41%yoy leap, 13% of which accounts for the weak sales and high inventories in 2012. We think that the bottled oil segment has moderate market capacity, and therefore the rise of 12% in 2012 and 7% in 2013 is to be replaced by stagnation at 1-2%yoy. Considering inspiring industry outlook, our analysis suggest that Kernel will be able to accomplish its goals in Russia to the full, and both the grain sales and export terminal throughput will grow for additional 2.5mt up to 2016 (see Apendix 4)
The prices for the oil and grain products are calculated using the FARPI-ISU 2012 World Agricultural Outlook. The discount rate was applied to the forecasts, obtained by comparing historical FARPI prices to the Ukrainian grain and oil price indices reported by the UkrAgroConsult. The revenues from the export terminals, silos and farming are going up extremely slowly as we mainly suppose them to benefit to the intersegment sales of fast-expanding grain segment. We also supposed that the sugar beet plant will be sold in the nearest future, and therefore, will not bring additional revenue after first quarter of 2013. Costs. The raw material used accounts for around 71% of the sales. We expect this ratio to stay constant as we are sure that Kernel will be successful in passing COGS increase on the final consumer. Rental expenses are based on the land lease rights the company poses and calculated with respect to them. The payroll and other expenses are supposed to grow with the rate of company’s asset expansion. Change in working capital. We projected the inventories using the inventory turnover ratio (6.0), obtained on the basis of company’s historical data with adjustments made to 2012 because of the unusual record-high values. More than 95% of biological assets consist of crops, beans and seeds. So, we assume that their value is mostly preconditioned by the land the company rents. Other components of the working capital were calculated with an assumption of constant WC/Sales proportion. | |||||||||||||||||||||||||||||||||||||
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