Fixed Income Analysis /
Ukraine

Kernel: Leverage to peak in FY 20, then normalise

  • In H1 20, profitability increased despite lower revenues

  • Leverage increased, but is not as high as it looks; deleveraging likely in FY 21

  • We downgrade KERPW 24s to Hold and reiterate Hold on KERPW 22s

Tellimer Research
2 March 2020
Published byTellimer Research

We downgrade KERPW 24s to Hold and reiterate Hold on KERPW 22s. In June-December 2019 (H1 20), Kernel reduced trading activity, which visibly affected the top line, but profitability of the business increased driven by high crushing margins and performance of the grain storage and export infrastructure. An optically significant increase in leverage is largely explained by non-cash accounting changes and seasonal accumulation of working capital, as well as higher inventory due to increased throughput, which will reverse towards the end of the financial year (June 2020). Having said that, we expect leverage to peak in FY 20 as the company is in the final stages of a large-scale investment programme. Most Ukrainian corporate bonds dropped 2-4ppts in price on the coronavirus-driven sell-off. The situation remains fragile and the Ukrainian corporate sector does not look cheap, yet with most bonds – including the long end – indicated above par. We downgrade KERPW 24s to Hold.

Profitability increases despite lower revenues. In H1 20, The company reported US$1.9bn in revenues, posting a 17% yoy decline mainly due to lower physical volumes of the grain-trading subsidiary Avere. EBITDA came in at US$216mn, a 6% yoy decline, mainly explained by weaker profitability in the farming segment and partially offset by improving margins of the oilseed processing and infrastructure and trading segments. EBITDA margin increased to 11.6% in H1 20 from 10.2% in H1 19. In FY 20, management expects weak performance from farming, the most profitable part of the business, due to lower corn yields, inflationary pressure on costs and UAH appreciation diluting export profitability. On the positive side, management expects strong results from the infrastructure and trading segment, which is set to become the main EBITDA driver. We estimate Kernel’s FY 20 EBITDA at US$330mn.

Leverage increase, but is not as high as it looks. In H1 20, Kernel’s debt increased to 1.7bn, up 55% yoy, and net leverage ratio reached 5.0x. Both the absolute level and the leverage ratio look unexpectedly high. However, if we look beyond the headline numbers, it appears that out of US$600mn additional debt, US$320mn came from implementation of IFRS 16 and is a matter of accounting; US$213mn came from change in readily marketable inventories (RMIs) reflecting c30% increase in export capacity and leaving US$70mn to capex. We estimate Kernel’s net leverage adjusted for IFRS 16 leases at 3.7x and net leverage adjusted RMIs at 2.1x. Net leverage covenant on bank facilities is tested at the end of the financial year in June, when the level of inventory seasonally drops. Fixed charge coverage tested quarterly for the purpose of bond covenants is calculated excluding the effect of IFRS 16 and, according to the company, was within the 3x incurrence test threshold.

Deleveraging likely in FY 21. According to our estimates, the company’s net leverage before the effect of IFRS 16 could increase to 2.7x (or 3.7x post-IFRS 16) in FY 20. Other things being equal, we expect Kernel to start deleveraging in FY 21 as capex decreases and investments made in FY 18-FY 20 maximise EBITDA. The company plans to spend US$325mn on capex and acquisitions in FY 20, and US$186mn in FY 21.