A Fresh Look at Ukraine: Ukrainian Corporate Leaders Investment Attractiveness

A Fresh Look at Ukraine: Ukrainian Corporate Leaders Investment Attractiveness

On October 28-29, SP Advisors hosted an international investment conference titled "A Fresh Look at Ukraine".

The conference featured over 400 guests including key Ukrainian politicians, business leaders, representatives of international financial institutions, and more than 100 portfolio investors from the UK, the US, Sweden, Finland, Switzerland, Brazil, and other countries. Below we provide key takeaways from the keynote addresses and brief summaries of the one-on-one meetings between leading Ukrainian companies and portfolio investors.

Keynote addresses

Olexandr Shlapak, Minister of Finance

  • The parliamentary election was the final stage of the reshuffling of Ukraine's central government after the Euromaidan. The election outcome is broadly positive and optimistic; parliament is overwhelmingly pro-European, and this is the first time the Ukrainian parliament will not be divided into (roughly equal) pro-Russian and pro-European parts. Another positive fact is the arrival of new and young faces in parliament.
  • The war has revealed all of the economy's weaknesses, which now must be addressed. Despite all of the difficulties, the government has managed to keep the economy afloat. Ukraine has secured full-fledged support from IFIs and has kept current on all of its debts.
  • Ukraine's reform agenda is overflowing and it will definitely be started/accelerated already this year.
  • When the new government was appointed it had less than USD 10K in its accounts. The government now has enough cash to cover all current expenses and debt costs. This is in large part thanks to a successful cooperation with the IMF and World Bank and other IFIs.
  • Russia has been actively implementing import-substitution policies over the past decade, which hurt Ukrainian producers substantially. Ukraine has lost more than USD 3 bln in trade turnover with Russia YTD and total losses will equal about USD 5 bln for the full year. The losses are mainly concentrated in agriculture, food-processing, and machine-building. Nevertheless, there are many products Russia can only buy in Ukraine (e.g. airplane engines, electricity generating turbines, compressor stations). Ukraine has already lost all it can in terms of trade turnover with Russia and there are no risks of a further contraction of bilateral trade.
  • Not more than 20% of companies in Luhansk Oblast and just above 20% in Donetsk Oblast are currently operating. Infrastructure is destroyed. 58% of all Ukrainian coal production in 2013 was in the territories that are currently in the war-hit zone. It is hard to estimate war-related losses at this point, but they are massive.
  • Ukraine continues to collect taxes from companies in the Donbas, but the collection rate is down by 2/3. The government has halted pension payments to the war-hit region because it technically has no way to distribute the payments as the banking sector is not functioning.
  • Ukraine has three big court suits currently active against Russia related to Crimea. Moving on with these cases should be one of the new government's priorities.
  • Ukraine is still supplying gas to the Donbas, but is not receiving payments for it. The government can't simply turn off the taps as that would cause a humanitarian catastrophe.

Geoffrey R. Pyatt, US Ambassador to Ukraine

  • Ukraine is a country at war and is facing a campaign of hostility from its largest neighbor. In a tough environment, however, it conducted a successful election that adhered to international standards. The election has delivered an absolutely unambiguous message of change - a message in favor of Europe and in favor of reform.
  • Most of the new MPs are not there to protect their interests but to build a new Ukraine, which is a large step forward.
  • Corruption has been and remains the key issue for Ukraine; Ukraine's potential hasn't been reached because of corruption.
  • Total US financial assistance to Ukraine this year is nearing USD 300 mln, and an additional USD 1 bln loan guarantee was critically important for the economy.
  • The IMF program was initially drafted on an assumption of peace, but Russia's military campaign has changed the macroeconomic environment.
  • Ukraine has in the past adopted many good laws, but their implementation has always been a problem. Ukraine has to focus primarily on implementing legislation.
  • The Ukrainian energy system hasn't been optimized for efficiency in the past - it has been optimized mainly for the profits of gas traders. The challenge now is to optimize it for economic competitiveness.

Ihor Bilous, Head of Ukraine's State Fiscal Service

  • The tax system remains repressive but all the necessary preconditions are in place to modernize it. A new draft legislation aimed at simplifying Ukraine's tax system will be submitted to parliament the first day after it reconvenes.
  • Ukraine should reduce the tax burden on business and the focus should be on taxing consumption and property, as well as on reducing the number of taxes, a simplification of tax administration, and a reduction of the income tax burden.
  • The tax administration estimates about 50% of all wages are in the shadow and are paid in cash. A key initiative of the tax administration aims to reduce the social tax rate by 2/3 to bring the economy out of the shadows.
  • Real estate, land tax, and fixed agricultural tax revenues will be directed to local budgets and tax rates will be set by local authorities.
  • The tax burden is distributed unevenly across sectors of the economy. Processing and extraction industries and the energy sector account for 21% of GDP and 51% of taxes. Meanwhile, the agro sector, transportation, and real estate contribute 30% to GDP but only 9% of total tax collections. The issue of inequality should be addressed in the future.
  • The agro sector's key tax privileges include the fixed agricultural tax and VAT subsidy (agro companies retain the difference between output and input VAT). Thanks to these privileges, agro enterprises enjoy a low effective tax burden. Discussions are ongoing over whether to preserve a special tax regime for agriculture or move the sector to a general regime. Under preliminary talks, the special regime will be maintained until 2017/18 and then the sector will be moved to a general tax regime.

Jerome Vacher, IMF Resident Representative in Ukraine

  • The economic situation in Ukraine is challenging. The IMF needs to revise the assumptions of its program to take into account the effects of the conflict in the east. The conflict is having a material impact on the real economy, the fiscal situation, and the financial sector, and it has created a unique set of challenges for the country.
  • Many economic adjustments are ongoing, in particular an adjustment on the current account side. This mainly reflects the gains in competitiveness due to the hryvnia's depreciation.
  • There has been no lack of commitment from the authorities to move on with the program, which was a serious pitfall of the two previous programs. The current authorities are entirely reform-oriented and Ukraine has a unique reform momentum.
  • Bank supervision needs to be strengthened. The NBU has been quite active in addressing problems related to weak banks.
  • Many foreign banks pulled out of Ukraine as a consequence of the 2008/09 crisis and because of a lack of reforms and dim prospects for improvement. The problem was not only a lack of reforms in the financial sector but a weak business environment in general.
  • Lending to related parties by Ukrainian banks is a key issue that must be addressed.

Georgy Zvonkov, IFC Senior Investment Officer

  • Agro, energy-efficiency, and the financial sector are the three lending pillars for the IFC office in Ukraine. The entire World Bank Group's exposure to Ukraine is currently about USD 4 bln, with slightly more than USD 1 bln from the IFC. In the last fiscal year, which ended June 30, IFC invested about USD 470 mln in Ukraine. IFC is planning further investments despite the difficulties being experienced by the country.
  • The risks and challenges currently facing Ukrainian banks are high. IFC is now working on supporting short-term liquidity, even though its normal practice is to focus on long-term funding.
  • In the coming year and beyond, Ukrainian banks will face difficulty securing wholesale funding from abroad. IFC is one of the few lenders ready to support the banking sector by providing wholesale funding.

Oschadbank (oschad)

  • The results of a recent stress test accounted for potential losses in Crimea and the Donbas, but management declined to reveal the full results at this point for confidentiality reasons.
  • The government stands ready to increase Oschadbank's capital increase by the required amount; the NBU is also supporting the bank's capitalization program. A new capital injection may take place via an exchange of newly issued shares for government T-bills.
  • The lender's exposure to Naftogaz has decreased materially to 19.4% of the gross loan book, down from a peak at 58%.
  • NPLs have grown to 20% due to the potential loss of Crimean assets that have been classified as NPLs and partially provisioned.
  • Deposit outflows have stopped and funding from customers is gradually growing. Individuals and businesses treat Oschadbank as a safe haven and are reallocating savings and current accounts from some private banks.
  • PwC has been retained to help the bank design a new development strategy until 2018. The strategy seeks to make the bank commercially driven, address current shortcomings, and to capitalize on the bank's strengths and take advantage of currently untapped opportunities. Some elements of the restructuring are already being implemented: modern branches are being opened nearly every day, the SME business is growing, and risk management and IT systems are being improved. The bank plans to present its new development strategy by the end of this year.
  • The bank is increasing its cooperation with IFIs: it has drawn down a second tranche of the ElB's EUR 220 mln credit line and is in active talks with the EBRD and IFC for new financing.

 Astarta (ast pw)

  • No assets located in Crimea and the war-hit eastern regions, but the conflict is affecting the company's markets. Some of the company's clients (7% of total revenues in 2013) are from Donetsk and are slowing purchases. Astarta is redirecting sugar sales to retail chains whose share in total sales will increase as direct sugar consumption grows yoy.
  • The sugar market should not experience any major supply/demand shocks this year. The current market is conformable for the company, not least due to the fact that Astarta is more than 80% self-sufficient in sugar beets.
  • Net debt/EBITDA is reasonable at 2.0x as of end-1H14. Excellent relations with banks and IFIs - EUR 50 mln loan contract signed with the European Investment Bank in October. No plans to raise debt via bonds.
  • The sugar business is dependent on the availability of natural gas. Astarta aims to decrease consumption of gas by shifting to coal and also by constructing bio-gas stations.
  • Further development plans are focused on i) the expansion of the agro and processing businesses; ii) the expansion of storage facilities - 300 kt of new storage capacity will be added to the current 400 kt; iii) new bio-energy projects like bio-gas and bio-ethanol. The implementation of all three is dependent on the stabilization of the political situation in Ukraine.
  • The company doesn't expect significant benefits from its facilitated access to the EU market after the DCFTA is enacted: the EU's sugar import quota for Ukraine is negligible. However, Astarta's clients have some potential to expand into the EU, which could translate into secondary growth for Astarta.

Ukrlandfarming (ukrlan)

  • Management expects the 2014 crop harvest at 4.1 mmt, virtually flat yoy. Corn accounts for c. 65% of the total volume.
  • Nearly all large CAPEX programs have been postponed as a consequence of the current challenging funding environment. The Group now only plans to build 12 new silos with a combined capacity of c. 2 mmt of grain and is budgeting USD 100­120 mln per year for maintenance CAPEX. In the longer term, the company's key priority is the construction of a new port terminal to enhance grain export capacities.
  • The company is well-protected against a hryvnia depreciation - exports made up 40% of 1H14 revenue. Its reliance on imports (machinery and raw materials) is less significant.
  • An IPO is not expected over the next three years due to the unfavorable macro environment and investors' risk aversion towards Ukraine. The company is scouting the London Stock Exchange and Hong Kong Stock Exchange for a future listing.
  • The company believes most of its lenders are ready to extend the maturity of loans once they expire. ULF has not experienced major problems rolling over debt over the past months.
  • ULF does not plan to buy back its Eurobonds.

 Avangard (avgr li, avinpu)

  • The company will continue to focus on expanding export sales (close to 40% in value terms in 1H14). Exports to Syria and Iraq have been hurt due to the military conflict in the region, and the company does plan to diversify markets in the future.
  • Margins have been squeezed (1H14 EBITDA margin down 14ppts yoy) primarily due to the hryvnia's weakness - domestic sales fell in USD, while about 70% of total costs are linked to the USD.
  • Domestic demand has suffered from a decline in disposable income (a direct consequence of the GDP contraction and inflation) and the war in the east (deliveries to the occupied territories have been halted). Egg consumption is therefore unlikely to recovery to 2013 levels in the near future.
  • At the moment, Avangard plans to keep all of its assets that are located in the war zone operational but can't fully control them currently. As of end-2013, about 22% of the total laying hens flock was in the Donetsk and Luhansk Oblasts (not all of them are in the war zone now), while Crimea accounts for an insignificant 0.3% of assets.
  • The company is determined to move forward with plans to buy back Eurobonds, as announced at its AGM, and a full redemption of the Eurobond remains the base case. If the military conflict were to escalate and the economic environment were to deteriorate further, liquidity may suffer and a portion of the Eurobond could be restructured.

MHP (mhpc li, mhpsa)

  • The company is benefitting from the ongoing change in consumer preferences: as disposable incomes fall, pork and beef are being substituted with cheaper chicken meat.
  • The domestic chicken meat price is currently 35% yoy higher in UAH terms, and MHP expects the price will grow a further 15-17% yoy in 2015.
  • The Shakhtarska hatching egg farm, located in the conflict zone, which had provided up to 30% of hatchery eggs to the group, is still not operational. As a result MHP has had to import more expensive hatching eggs from the EU. Meanwhile, MHP has modernized and re-equipped one of its smallest broiler farms into a breeding farm that will start production of hatching eggs in December 2014.
  • CAPEX is expected at USD 120 mln in 2014 and USD 250 mln in 2015, mainly related to the construction of the Vinnytsia poultry production complex and maintenance. At the Vinnytsia site, Phase 1 will is completed and the construction of the 1st slaughter line at Phase 2 will be started in 2015.
  • Operations at MHP's Crimean production facilities are continuing (annual production capacity of 60 kt of chicken meat).
  • The IFC recently approved a USD 250 mln loan, which will be used to redeem the USD 235 mln Eurobond due in April 2015. MHP doesn't foresee any problems with redeeming the paper.
  • No problems with rolling over bank debt - the company is one of the country's highest-quality borrowers.

Ovostar (ovo pw)

  • Management expects revenue will remain largely flat yoy in USD terms despite this year's hryvnia depreciation thanks to larger volumes and higher prices in UAH. In 1H14, revenues came in at USD 34.9 mln (+6% yoy).
  • The company estimates its CAPEX program for the next two years at USD 45 mln, mainly related to the modernization and expansion of its farm in Stavysche.
  • Ovostar may consider expanding production in Europe in the longer-run, but the company sees no high-quality M&A targets in Ukraine.
  • No plans to enter other business segments. The production of shell eggs (with a focus on branded eggs, including private labels) and egg products will remain the only business lines.
  • The company's largest lender is Landesbank Berlin AG, which accounts for c. 90% of a total USD 13.0 mln in borrowings.
  • Plans to start exporting to the EU in 2015 - all necessary permits have already been secured. On the downside, the EU's zero import tariff quota for Ukraine is minimal at just 3 kt of eggs and egg products, a production volume that Ovostar alone can deliver within 3-4 months.
  • All production assets are located in the Kyiv region and the company has never exported to Russia.

Kernel (ker pw)

  • Plans to crush 2.4-2.5 mmt of sunflower seed in FY2015 (ends June 30, 2015) vs 2.3 mmt in FY2014, with healthy margins (last year's USD 164 per ton of sunflower oil reflected a poor 1Q).
  • Management is guiding FY2015 grain export volumes at 4.5-5.0 mmt vs. 4.2 mmt in FY2014. Growth will be driven by internal grain production and the expansion of a grain terminal facility in Taman. Silo services and export terminals' throughput are expected to track this growth trend.
  • Farming segment crop yields are up 20-30% yoy in FY2015 (started July 1), with the net corn yield at 7.2 tons/hectare, sunflower seed at 2.5 t/ha, soybean at 1.9 t/ha, and wheat at 5.4 t/ha. The growth in crop yields reflects operational changes implemented by a new management team in the farming division (from May 2013). Production costs per hectare are expected to decline by double digits yoy in FY2015. Weakness in global agriculture commodity prices is likely to mitigate some of the benefit, but farming is expected to be profitable in FY2015 vs. negative USD 44mn EBITDA in FY2014.
  • With 90% of sales and 80% of costs linked to the US dollar, the company is largely neutral with regards to a hryvnia depreciation. Most losses (from VAT receivables and intragroup revaluation of liabilities) are booked immediately (a USD 100m FX loss in FY2014), while the cost benefits are booked gradually.
  • The company renewed all of its short-term debt facilities used for working capital financing in August (one-year, total c. USD 750m limit). While costs are higher this year, they are more than compensated by wider margins caused by a lower amount of financing available for Kernel's smaller competitors.
  • The pace of VAT refunds has improved slightly over the historical average. The company now gets refunded its export VAT within 6-12 months on average.
  • Sunflower seed and grain is bought on spot and sold forward, which helps mitigate commodity price risks as margins are locked-in at the moment of purchase.
  • The company does not trade between Ukraine and Russia, but does export from both countries to international markets. Its Russian assets account for c. 10% of total assets and the company has no assets in Donetsk, Luhansk, or Crimea.
  • The long-term strategy remains in place: the consolidation of the sunflower seed crushing industry in Ukraine (favoring M&A over greenfield), organic growth in grain exports with a goal of reaching 6 mmt in the mid-term, and a focus on cost and yield improvements in own crop production.

UkrProduct (ukr ln)

  • Management estimates the company accounted for 17% of soft cheese and 20% of packaged butter production in Ukraine YTD, with an insignificant market share in hard cheese products. Sells soft cheese and packaged butter through all of Ukraine's major retail chains. In retail the company is focusing solely on the middle and premium product segments.
  • Exports will account for 20-25% of total revenues this year; skimmed milk powder is the key export commodity.
  • EBITDA margin expected at 9% in 2014.
  • Milk processing capacities are loaded on average 50% during the year (75% during the high season and 25% during the low season).
  • Total debt of around GBP 8 mln, split between EUR-denominated facilities (2/3) and UAH borrowings (1/3). A EUR 11 mln credit line from the EBRD is open, but the company hasn't fully tapped it yet due to revision of the second stage of the project.
  • The production process for skimmed milk powder is energy-consuming. UkrProduct plans to further improve energy efficiency to reduce consumption of gas that will be replaced with biomass-based energy.
  • Aims to start selling products to the EU by mid-2015.

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