Emitents -> Kernel (WSE:KER)

Latest News
• As expected Fitch upgraded Kernel Holding credit rating to B+
• Polish TFI PZU increases its stake in Kernel
• Kernel Holding held a conference call with investors
• Kernel Holding plans to issue Eurobonds?
• Kernel Holding announced dividends of USD 0.25 per share
• Kernel Holding is about to start new grains terminal construction

Latest Reports
• Kernel reports financials Q2 FY2017
• Kernel publishes operating results for Q2 FY2017
• Kernel reports financials for Q1 FY2017
• Kernel reports financials for financial year 2016
• Kernel publishes operating results for Q4 FY2016

Upcoming
• 20 April 2017 - Q3 FY2017 operating report
• 30 May 2017 - Q3 FY2017 financial report

Analytics
• Kernel: strong results in FY2015, question is how far they are sustainable

Business description

Kernel is the largest sunflower oil producer in the region, one of leading grains exporters from Russia and Ukraine and also one of the largest Ukrainian farming groups. The company owns and operates extensive agricultural logistics assets base including silos and port terminal facilities, its land bank is 390k ha.

Total sunflower seeds (SFS) crushing capacity of the company is about 3.5M tons per annum (8 crushing plants). After purchase of a new crusher in Ukraine and sell of two crushers in Russia, at the moment all crushing facilities of Kernel are located in Ukraine. Crusher purchased in FY2016 - asset which belonged to bakrupted group Kreativ. Kernel purchased debt of one of Kreativ entities to state-owned Ukrgasbank (with crusher as collateral), transaction can be seen as not fully transparent.

In FY2016 (July’15-June’16) total crushing volume made 2.7M tons, sunflower oil (SFO) production – 1.2M tons (more than 7% of total world SFO production). 90% of total SFO produced is exported in bulk to India, China, Middle East and other destinations, sunflower meal (SFM) is exported mostly to EU countries (For information: on average 1 ton of SFS contains 440kg of SFO and 390kg of SFM). Approximately 10% of Kernel SFO production is bottled and realized in Ukraine by three own brands and private labels.

In Grains trading positions of Kernel are also quite strong, as with 4.4M tons of grains exported in FY2016 the company accounts for 9-10% of total export from Ukraine and 4% from Russia. In Ukraine Kernel owns grain export terminal with annual capacity of 4M tons, while in Russia it owns 50% stake in Taman grain terminal (Kernel’s share of capacity – 2.0Mt; partner for this project is Glencore). Both ports are deep water facilities.

With land bank of 390k ha (FY2016), Kernel is number two farming company is Ukraine (after Ukrlandfarming, with MHP close behind). Main cultivated crops are corn (40-50% of total), sunflower seeds, soybeans and wheat. Because of natural restrictions on maximum share of sunflower seeds in total sown area (up to 20%), Farming division provides only 6-7% of total SFO production division necessity in raw materials. Along with it with close to 1.6M tons of grains produced, own crop production secures more than 35% of total annual grains export. In addition, 2.8M tons of silo capacity provide significant support to both farming division and in grains trading business as origination units.

As for geography of business, large oilseeds crushing plants are situated in Poltava, Kharkiv, Mykolaiv, Kirovograd and Odessa regions, land bank – mainly in Kharkiv, Poltava, Khmelnitskiy, Chernigiv and Kiev regions. The company has no assets in zone of conflict in the East of Ukraine.

Since November’07 Kernel has been listed on WSE under the ticker symbol KER. Current free float is – 61%. Shares of Kernel Holding are included into main index of WSE - WIG30.

Operating Figures

	H1 2017	H1 2016	..	2016	2015	2014	2013
SFS crushing volumes, k tons	1 188	1 333		2 685	2 523	2 315	2 300
Sales of bulk SFO, k tons	503	455		984	1 030	920	1 040
Grains export sales, k tons	2 706	2 250		4 409	4 744	4 244	3 022

Sown area distribution and yields for main crops are represented in table below:

Season	2016/2017	2015/2016	2014/2015	2013/2014	2012/2013	2011/2012
Corn
Sown area, ha	138 300	157 112	185 016	162 000	57 000	27 500
Yield per 1 ha, tons	8.9	7.3	7.1	5.5	4.6	7.1
Wheat
Sown area, ha	82 000	72 808	30 792	34 000	60 500	53 400
Yield per 1 ha, tons	6.0	5.1	5.4	4.3	3.4	3.7
Sunflower seeds
Sown area, ha	81 400	57 480	69 744	103 000	38 000	28 000
Yield per 1 ha, tons	3.0	2.7	2.5	2.1	1.7	2.1
Soybeans
Sown area, ha	58 200	65 144	66 544	61 000	54 000	29 000
Yield per 1 ha, tons	2.8	1.8	1.8	1.4	1.3	1.9
Total sown area, ha	380 400	383 200	372 852	389 000	246 776	182 333

Kernel is middle-cost producer with average cost per 1 ha and therefore average yields, basing on company information focus of Farming division is on cost efficiency.

Land bank of the company increased substantially in FY2013 following acquisition of sizable Ukrainian farming producer Druzhba Nova (with close to 110k ha land bank).

Financial information

USD k	H1 2017	H1 2016	..	2016	2015	2014	2013
Sales	1 043 344	998 693		1 988 520	2 329 507	2 393 251	2 796 752
Gross Profit	251 792	239 796		460 180	512 234	408 167	450 621
EBITDA	202 200	200 200		346 400	396 600	223 000	287 500
EBITDA margin, %	19.4%	20.0%		17%	17%	9%	10%
Net Profit	161 298	141 817		226 844	95 533	-107 406	105 253
	31.12.16		..	30.06.16	30.06.15	30.06.14	30.06.13
Total Assets	1 920 548	-		1 509 355	1 465 618	1 919 022	2 361 632
Fixed Assets	765 497	-		788 888	807 060	1 046 493	1 271 547
Current Assets	1 155 051	-		720 467	658 558	872 529	1 090 085
Inventory	644 066	-		390 525	305 327	482 363	517 229
Cash	68 906	-		60 372	129 121	65 400	78 819
Equity	1 091 972	-		997 055	890 844	1 030 686	1 352 269
Debt	619 183	-		319 666	462 518	743 167	725 244
	H1 2017	H1 2016	..	2016	2015	2014	2013
Net Operating CF	-217 619	-100 730		133 723	404 723	82 472	303 871
Financing CF	273 050	113 257		-134 469	-309 824	6 868	-47 432
Dividends paid	0	0		-19 921	-19 921	0	0
Net Borrowings	266 793	113 257		-114 548	-289 903	6 868	-45 061
Investing CF	-50 441	-23 761		-60 732	-24 305	-83 210	-266 053

Latest financial report of the company

Comments to financials:

• During last three years Kernel revenues have been declining (main reason of this fact – decrease of grains&oilseeds prices on the world market, while in natural terms volumes of operations grew).
• Oilseeds crushing and Grains trading directions remain main revenues generators of Kernel (more than 90% of total proceeds of the company are export sales), but during last period of time changes happened in the structure of profit centers:

  USD mln	H1 2017	H1 2016	..	FY2016	FY2015	FY2014
  Oilseeds crushing
  Sales	544	541		1 134	1 214	1 211
  EBITDA	47.4	68.3		128.8	213.1	177.8
  EBITDA margin, %	9%	12%		11%	18%	15%
  Grains trading
  Sales	477	435		822	1 053	1 053
  EBITDA	15.3	21.6		46.3	59.4	59.4
  EBITDA margin, %	3.2%	5.0%		5.6%	5.6%	5.6%
  Farming
  Sales	271	342		358	310	290
  EBITDA	133.6	90.2		146.0	97.9	-44.3
  EBITDA margin, %	49.3%	26.4%		40.8%	31.5%	-15.3%
  Export terminals
  Sales	28.9	26.6		57.3	55.3	45.5
  EBITDA	24.0	17.0		37.5	36.8	27.3
  EBITDA margin, %	83.0%	63.9%		65.4%	66.5%	60.0%
  Silo
  Sales	42.7	31.2		38.2	42.4	74.5
  EBITDA	30.1	20.6		23.4	18.3	39.2
  EBITDA margin, %	70.5%	66.0%		61.3%	43.2%	52.6%

• Despite record-high crushing volumes in FY2016 (reached due to purchase of ex-Kreativ crusher), sales of sunflower oil in bulk decreased vs. previous year (from 1 030k tons to 984k tons). Main reason – management decided to shift realization of oil from Q4 FY2016 to Q1 FY2017 (so in Q4 FY2016 sunflower oil sales in tons declined by 26% y-o-y). Total segment’s revenues in FY2016 made USD 1 134M vs. USD 1 214M in previous year.
• Because of significant competition among crushers which led to shortage of raw materials (sunflower seeds) on the market, in the first quarter of new financial year crushing volumes of Kernel have been rather low. In Q2 situation improved – with new harvest of sunflower seeds coming to the market (sunflower seeds in Ukraine are mainly harvested in September-October), raw materials supply largely increased, so that total volume of sunflower seeds crush has been close to record-high level of Q2 FY2016:

  

• In last quarter crushers of the group worked with almost 100% capacity utilization. Segment’s revenues in H1 FY2017 remained on the level of previous year (at slightly above USD 540M).
• High competition among crushers for raw materials (in current marketing year crushing capacities in Ukraine are estimated at above 18M tons, while record-high sunflower seeds harvest in Y2016 made 13.6M tons) led to decrease of margins as well. In FY2016 segment’s EBITDA margin made 11% vs. 17% a year ago, in Q1 FY2017 – 7.2%, which is the lowest margin for the last years. In Q2 after new sunflower seeds crop came to the market, margin grew up to 9.4%, but we do not expect its further growth.
• Management of Kernel as well expects that margin is to be low for extended period of time until small producers will be forced to leave the market (factually Kernel plans to participate in market consolidation process, intending to purchase additional crushing capacities of up to 1.5M tons). On the other side, as raw materials stock of the company as of 31.12.16 has been significantly higher vs. last year’s (USD 237.2M vs. USD 113.3M), we expect that crushing volumes in Q3 can be better y-o-y, which should provide for general improvement of operating performance.
• Volume of Kernel grains realization in H1 FY2017 made 2 707k tons, by 20% higher y-o-y. It positively influenced sales volume in money terms as well – they made USD 476.8M (by 9.6% higher y-o-y), though EBITDA margin decreased to 3.2% vs. last year’s 5%. Grains sales dynamics in Ukraine has been better vs. Russian one (despite record-high grains crop in Russia, pace of export is below expectations, largely because of RUR revaluation, which led to decline in grains prices nominated in RUR).
• Results of Terminals business direction during last reporting periods have been good, they represent stable source of income for the company. In H1 FY2017 total export terminal throughput volume of the company made 3.055M tons of grains (2.863M tons a year ago). Dynamics during last years looked as follows:

• As for financial results, segment’s EBITDA in H1 FY2017 made USD 24M, by 41% higher y-o-y. In general we expect certain decrease of port terminals profitability in Ukraine, as quite a lot of new capacities is to be launched in short- and middle-term. Despite this fact terminals remain key for grains trading business and despite expected decrease of margins this business segment remains attractive for new investments in Ukraine. Kernel itself starts large expansion projects for its facilities, aiming to double capacities of its terminal in Chernomorsk from current 4.0M tons of grains per annum.
• Good results were shown by silo segment as well (in H1 FY2017 EBITDA made USD 30M vs. USD 20.6M a year ago), reasons – good grains&oilseeds harvest in Ukraine in current season along with more rainfalls during harvesting period vs. previous seasons.
• Because of good harvest Farming division will be main profits-generator of the Group in the current financial year. During H1 FY2017 sales of the segment have been somewhat slower vs. previous year (USD 271.2M vs. USD 341.5M in H1 FY2016). Despite this fact EBITDA was higher – USD 133.6M (vs. USD 90.2M a year ago).
• On positive side for the company is the fact that it sold part of its harvest before start of the season on forward terms (as an example, pre-season corn prices have been by USD 10-20/t higher vs. prices during the season), which should positively influence profitability of operations. On negative side – as of 31.12.16 16k ha of corn (more than 10% of total corn planted area) has not been harvested yet, which can negatively influence segment’s financial performance. In any case we maintain our view that EBITDA margin of Kernel Farming segment in current season will be not lower than 40%. EBITDA of the segment in money terms is to make about USD 160-170M.
• We also expect that total EBITDA of the company in new financial year is to make close to USD 350M. For the future we expect some worsening of Farming division performance (vs. current season records), terminals performance can also somewhat worsen, along with it, in medium-term oilseeds crush margin can increase. As a result, under base case conditions in FY2018 we can preliminary forecast EBITDA at about USD 300-320M.
• Main y-o-y changes in Kernel assets structure in last reporting period were related to higher Inventory and VAT Receivables volumes. As of 31.12.16 Inventory (including biological assets) made USD 644M vs. 463M a year ago, main reason of increase - higher sunflower seeds stock (most likely as a reaction to increased competition for raw materials among Ukrainian oilseeds crushers). VAT Receivables grew by close to USD 50M y-o-y (up to USD 200M), mainly as a result of changes in Ukrainian VAT legislation in Y2016.
• Other important constituents of Current Assets as of 31.12.16 were Trade Receivables (USD 125.4M) and prepayments to suppliers (USD 81.2M).
• Important for assets quality estimation is the fact that as of 31.12.16 non-current assets of the company included about USD 120M of goodwill.
• Financing structure of the company remains quite good. After recent Eurobonds issuance (USD 500M with 5 years tenor) maturity profile of Kernel debt improved as well. Current Debt/Equity ratio (noting debt is on its seasonal peak level) of Kernel is close to 0.6x, Equity (USD 1 091M as of 31.12.16) exceeds Fixed Assets and is main source of assets financing in general, financial position of the company is clearly good. In addition current adjusted Net Debt/EBITDA ratio Is close to 1.6x.
• The company is well-posed for new investments (plans involve twofold increase of grains terminal capacities, land bank extension (up to 200k ha), purchase of new oilseeds crushing capacities).

As a summary, we see current financial standing of Kernel as acceptable. On positive side – good balance sheet structure and quality, dominance of export proceeds in total sales (hedging FX risk), good fixed assets base. Main risks are increase of competition between Ukrainian crushers, volatility of crops yields in future years and country risk.