Figure 23. FCFF valuation summary

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Revenue	*2010/11*	*2011/12*	*2012/13E*	*2013/14F*	*2014/15F*	*2015/16F*	*2016/17F*	*2017/18F*
Revenue	1,899,118	2,157,441	2,535,981	2,982,421	3,241,458	3,534,093	3,665,888	3,814,298
Gross profit	1,408,706	1,634,094	1,930,497	2,268,788	2,464,545	2,684,096	2,783,793	2,896,162
EBITDA	308,153	318,844	361,865	436,763	480,543	528,644	548,486	569,389
EBITDA margin	16.2%	14.8%	14.3%	14.6%	14.8%	15.0%	15.0%	14.9%
EBIT	277,268	256,470	270,602	335,141	373,493	407,925	423,146	439,229
Net Income	226,047	210,782	197,218	244,767	273,741	297,684	301,498	306,030
net margin	11.9%	9.8%	7.8%	8.2%	8.4%	8.4%	8.2%	8.0%
NOPAT	257,881	257,389	252,848	317,387	355,739	390,171	405,392	421,475
D&A	*32,361*	*65,505*	*91,263*	*101,622*	*107,049*	*120,719*	*125,341*	*130,160*
Change in WC	*-180,109*	*-242,134*	*-26,038*	*-116,559*	*-71,883*	*-73,866*	*-36,868*	*-37,610*
CapEx	*190,646*	*319,516*	*236,766*	*184,818*	*185,427*	*164,531*	*168,839*	*174,134*
FCFF			81,307	117,632	205,478	272,493	325,025	339,892
PV FCFF			71,428	90,783	139,310	162,296	170,062	156,232

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 around 100USDM on the acquisition/constructions of new silos and approximately 120USDM. for building a crushing plant in Voronezh. The acquisition of Taman terminal has brought135M.USD CapEx in 2013 and infusion of 20USDM. is expected annually for the two subsequent years aimed at its expansion. On the other hand, Kernel has announced the plans of selling sugar plants. According to our estimation will be sold approximately at their book value, which will create an additional cash inflow of 60USDM.

Therefore, considering the estimated expenses on maintaining the PP&E, we suppose CapEx in tangible assets accounts for 200USDM. in 2013 and 150USDM. 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) plus additional 34% (calculated on the basis of historical data) spent on building of new capacities which are then transferred to constructions and production equipment at 2:1 ratio.

Increase in intangible assets is supposed to stay constant, equal to 37USDM. spending on purchase of land lease rights and 0.5USDM. on other assets annually.

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

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

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

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

*approximately calculated on basis of EBIT margin

Source: KNU estimates Source: KNU estimates

We understand that the result can 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 market is a subject of appreciable volatility, we provide the sensitivity matrix for the changes in costs of raw materials and the external price of grain and oil.

Figure 27. WACC sensitivity
				WACC
		12.5%	13.0%	13.5%	14.0%	14.5%	15.0%	15.5%
	1.5%	80.15	74.58	69.48	64.81	60.50	56.53	52.85
	2.0%	83.92	77.95	72.50	67.53	62.96	58.76	54.87
TGR	2.5%	88.08	81.64	75.80	70.48	65.62	61.16	57.05
	3.0%	92.67	85.70	79.41	73.71	68.52	63.76	59.40
	3.5%	97.77	90.19	83.39	77.24	71.67	66.60	61.95
	4.0%	103.47	95.18	87.78	81.13	75.13	69.68	64.72
	4.5%	109.88	100.75	92.66	85.43	78.93	73.07	67.74

Source: KNU estimates

Figure 28. Price-COGS sensitivity

P rices

-1.5%

-1%

-0.5%

0.0%

+0.5%

+1%

+1.5%

-1.5%

58.09

59.11

60.14

61.16

62.18

63.21

64.23

-1%

62.82

63.87

64.92

65.96

67.01

68.06

69.11

COGS

-0.5%

67.55

68.62

69.70

70.77

71.84

72.92

73.99

0.0%

72.28

73.38

74.48

75.57

76.67

77.77

78.87

+0.5%

77.02

78.14

79.26

80.38

81.50

82.62

83.74

+1%

81.75

82.89

84.04

85.18

86.33

87.48

88.62

+1.5%

86.48

87.65

88.82

89.99

91.16

92.33

93.50

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

Source: KNU estimates

Peers Valuation

Clearly, not all agro holdings can be directly compared with each other because of great product differentiation, operating margins discrepancy & different production capacity (including landbank). We compare Kernel Holding S.A. with its domestic and Russian peers in terms of 2011/12 EV/EBITDA, EV/Sales and P/E multiples. We think peers comparison may provide some extra perspectives on our analysis. Also some specific production multiple like EV/Landbank was analysed, but any received result wasn’t obtained, because of higher than market medium Kernel crop yield.

The most expensive Ukrainian agro holding. According to peers valuation, Kernel Holding S.A. trades with attractive 12,1% discount on EV/EBITDA, 39% discount on EV/S & premium 55% on P/E to its main peers. The aggregate discount/premium to comparables equals to 19.3% was calculated with weighting each premium/discount on appropriate weight (methodology of calculation of weight - see Appendix 6), depend of useful multiples in investment analysis. Company is stable little overvalued by the market, cause of high growth rate performance during last year & resilient position (full operating & delivery cycle) on the investment attractive industry. Positive expectation bases on high investment perspective in oil & grain trading segments of company in Russia (Krasnodarskiu krai and Black Sea bank). Using the peers comparison method we’ve obtained the price of 55.32 PLN.

Financial analysis

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.

Permanent income 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 season features, 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). 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, we expect a 9% CAGR of the company’s income.

Figure 30 Net income, ROE & ROA

Solid long-term profitability . The holding’s net income varied from USD 18.6 M in 2007 to USD 226.0 M in 2011 and USD 213.8 M in 2012. This trend ensured increase in a net margin 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 due to 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). Tax and loan interest rate impacts 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

Source: Company data, KNU estimates

Figure 32 Main Net income drivers

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.

Company’s cashflow exceeds operational and capital expenses . Noticeable operational cashflow of the company allows it 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 84 M 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 did not reach 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 due to 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

Source: Company data, KNU estimates

Figure. 34 CapEx financing

Source: Company data, KNU estimates

Practically a total sum of debt is denominated in USD. Nevertheless there are debts in RUB and EUR which allows to minimize 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 a 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 183.4 M in 2011/2012 comparing to analogical figures of – USD 38.2 M in 2008/2009 and – USD 150 M 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 755.6 M in 2008 to USD 2119 M in 2012. Such growth took place due to increase in PP&E, namely expansion of the land bank and processing capacities (plants) mostly carried out by M&A (see Figure 34). Profitability of invested capital is directly proportion to capital expenses. Should investment opportunities in Russia be fully realized, we expect stable profitability of invested capital.

Figure. 35 Asset growth from M&A activity

Source: Company data

Key financial figures of the company’s activities used to perform financial analysis are represented in Figure. 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

		FY2010/11	FY 2011/12	FY 2012/13	FY 2013/14	FY 2014/2015	FY 2015/16	FY 2016/17
Liquidity	WC/Revenue, %	21.84%	31.16%	19.7%	21.5%	25.7%	30.9%	37.2%
	WC/Assets, %	26.37%	31.72%	22.3%	48.0%	31.2%	36.3%	40.8%
	Current ratio, (х)	2.1	2.5	2.4	2.6	2.15	2.76	2.53
Solvency	Net debt/EBITDA	0.98	1.86	1.76	1.53	1.32	1.04	0.78
	Debt/Equity, (х)	0.59	0.77	0.56	0.56	0.56	0.57	0.57
	Financial leverage ratio, (х)	1.62	1.80	1.75	1.75	1.75	1.74	1.73
	CF to debt, (х)	0.139	x	0.11	0.14	0.21	0.25	0.27
	Interest coverage ratio, (х)	7.3	5	3.69	3.71	3.74	3.70	3.48
Profitability	Gross profit margin, %	24.20%	21.37%	20.28%	20.52%	20.67%	20.64%	20.64%
	EBITDA margin, %	16.30%	14.93%	14.3%	14.6%	14.8%	15.0%	15.0%
	EBIT margin, %	14.60%	11.89%	10.7%	11.2%	11.5%	11.6%	11.5%
	Net profit margin, %	11.90%	9.77%	7.8%	8.2%	8.5%	8.5%	8.3%
	ROA, %	16.76%	11.42%	8.37%	9.18%	9.16%	8.91%	8.18%
	ROE, %	23.27%	17.87%	14.7%	16.2%	16.2%	15.9%	14.4%
	ROIC , %	465.5%	214.9%	12.0%	13.4%	13.4%	13.2%	12.3%

Investment Risks

Our conservative estimation of Kernel is backed up by the uncertainty which is generated by the following risks:

· Uncertainty of Russian expansion

· Supply chain disruption risk

· Weather risks

· Regulatory risks

· Other risks

Figure 37: Risks Impact on Kernel’s Supply Chain

Risk	Farming and purchasing			Processing		Supply chain				Total**
Risk	Sunflower seed	Grain seed	Sugar beets*	Sugar*	Oil	Oil Sales	Grain Sales	Sugar sales*	Silos and transportation	Total**
Uncertainty of Russian expansion	□□□□	□□□□	−	−	■■■□	■■■□	■■■□	−	■■□□	■■□□
Supply chain disruption risk	■■□□	■■□□	−	−	■■■□	■■□□	■■□□	−	■■■□	■■□□
Weather risks	■■■■	■■■■	−	−	■□□□	■□□□	■■□□	−	■■□□	■■□□
Regulatory risks	■□□□	■□□□	−	−	□□□□	■■■□	■■■■	−	■■□□	■■□□
Other risks	■□□□	■□□□	−	−	■□□□	■■□□	■■□□	−	■□□□	■□□□

*Kernel’s sugar business is expected to be sold in 2013/2014

** Weighted on a share in EBITDA ( 2012)

Source: KNU analysis

□□□□ - no effect ■□□□ - negligible impact ■■□□ - middle impact

■■■□ - substantial impact ■■■■ - critical influence

Figure 38: Risk Matrix

●	Uncertainty of Russian expansion
●	Regulatory risks
●	Supply chain disruption risk
●	Weather risks
●	Other risks

Source: KNU analysis

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