Reiterating a Hold. Kernel reported strong FY financial results and confirmed its intention to print a new bond this week. Expansion of grain trading and a good year in farming helped the company to substantially increase its revenues and EBITDA without additional borrowings. As a result, net leverage before adjustment for readily marketable inventory decreased to 2x (from 2.8x in FY 18). According to management, the purpose of the new bonds is to optimise the debt portfolio, taking advantage of low interest rates, and replace some of the short-term debt funding with long-term bonds at attractive interest rates. In 2020, capex, cost inflation and subdued soft commodity prices could take net leverage to 2.5x or slightly higher. We believe Kernel is a strong credit within Ukraine’s corporate bond universe, but we do not see it outperforming its peers.
Strong FY 19 driven by grain trading and farming. As of 30 June, the end of Kernel’s financial year, the company reported US$4bn in revenues, posting impressive 66% yoy growth, driven by expanding grain-trading operations (Table 1). EBITDA increased by 56% to US$346mn on the back of the excellent performance of farming and the recovery of oilseed-processing businesses. Cost pressure reduced the EBITDA margin slightly to 8.7%. Total debt was unchanged, net leverage decreased to 2x and interest coverage reached 4.5x. Peak US$300mn capex budgeted for 2020 is expected to mark the end of the current investment cycle. Further investments could be associated with the acquisition of farmland once the relevant legislation is passed.
Capex, inflation and soft commodity prices to push leverage up again. Kernel has come to the final stages of its investment programme, with US$300mn capex (incl. US$68mn for maintenance) guided in FY 20. The company expects to keep net debt unchanged over the year, suggesting that capex will be self-funded. The debt structure, however, could change if Kernel replaces part of its revolving short-term bank debt with new bonds, which would improve its funding profile. The company could see increasing pressure on margins from UAH appreciation (8% yoy in July-September) as a substantial part of its revenues are earned in hard currency (exports), while costs are largely incurred in UAH. Softening wheat, corn and sunflower seed prices could affect the profitability of farming, particularly now, when the company holds significant unsold inventory.
Mixed 2020 outlook. We expect revenues to continue growing at double-digit rates as a further 2mt of export capacity is set to come on stream in 2020, enabling Kernel to handle 11mt (+20% yoy) of grain and oil seed a year and export 8mt (+30%). Flat margins in grain exports and infrastructure, tightening pressing margins, the normalisation of crop yields after a record harvest and overall inflationary pressure is likely to take FY 20 EBITDA to cUS$300mn (c-13% yoy), according to our estimates. Management provided no EBITDA guidance for FY 20, but one can mathematically derive it from leverage and the debt outlook as being somewhat shy of US$300mn.
Farmland reform could present a sizeable land acquisition bill. It is the view of Kernel’s management that the farmland reform bill will be passed before end-19. MHP’s management has communicated the same view at the recent investor presentations. Lifting barriers for trade in agricultural land is an opportunity for Kernel to convert some of its leased land into ownership. The company has over 500,000 hectares under cultivation, for which it pays, on average, US$150-170 per hectare annually. If the market adopts the cap-rate approach to land valuation, the price could come to US$1,500-2,000 per hectare. Kernel expects no more than 10-15% of its cultivated land to come to the market initially, representing state-owned plots, followed by another 10-15% of privately held land. This takes the potential land acquisition price to US$150mn-300mn. The first transactions could come through in 2020.