I’ve decided to start a new series every Friday, entitled Weekend stock pick. The idea is that I will post an analysis of a stock that I think will be of interest to readers, and one that I haven’t covered before. Whilst I will most certainly aim to find great value investments every week, I can’t say that finding one so often will be possible. However even if I can’t find a stock of great value, I will at least try to highlight strong companies to add to the watch list.
The rationale for posting it late on a Friday is to give readers time to research the stock themselves and stop them being tempted to jump straight in. You may think my disclaimer blurb at the bottom is for show, but I firmly believe everyone should do their own research before investing, even if they read a very convincing argument. So as the markets are closed at the weekend, you may as well do some reading into the company yourself.
Without further ado, this is the first stock I’ll be looking at in this series. Not long ago I wrote a post on an ethical dilemma relating to the company Avangardco (LSE:AVGR). Today I am going to look at the same company from a purely investment viewpoint. I will warn you now, this is a long post but I like to be thorough. If you want to test the waters first you could start by reading the Valuation and Conclusion section at the end.
The business
Avangardco is one of the largest agro-industrial companies in Ukraine, specializing in the production of eggs and egg products. Based on figures for the year 2012, the Company holds a 33% share of the Ukrainian egg market (52% of the industrial egg market) and an 88% share of the Ukrainian egg products market. As of 31 December 2012, the total poultry stock of the Company was 27.5 million heads. The Company’s plants are located in 14 regions of Ukraine and the Autonomous Republic of Crimea. In 2012 the Company exported its products to 32 countries, generally to the Middle East, Asia and CIS. As of 31 December 2012, revenues amounted to US$629.3 mln (2011: US$553.3 mln) and EBITDA was US$ 279.8 mln (2011: US$245.8 mln).
Majority shareholder
One of the most important things about this company is that it has a majority owner, Oleg Bakhmatyuk, who owns 77.5% of the company. I don’t see this automatically as a problem but it is worth doing some research on him. Here is a quote from an article in the Kyiv Post.
“Back in 2005, Bakhmatyuk was hired as an adviser at Ukraine’s state oil and gas company Naftogaz Ukraine – long known as a feeding trough for bureaucrats. In 2006, he was promoted by then Naftogaz chief Oleksiy Ivchenko, who also hails from western Ukraine, to deputy CEO of the strategically important company. It was around this time, in 2006, that Bakhmatyuk even made an unsuccessful bid for parliament on the losing ticket of current parliamentary speaker Volodymyr Lytvyn.
Bakhmatyuk finally left Naftogaz in 2007, selling off his assets in a string of lucrative regional gas distribution companies, a sector of Ukraine’s economy where the line between profit and politics is often blurred.”
There is little other information about him, which could be seen as good, or bad. However what is clear that in the Ukraine, it’s all about who you know, not your ability. He has appointed his sister as chairman, who has in turn hired a couple of young women as CEO and CFO. It’s hard to say whether they will be up for the job or not. One good thing about a majority owner however is that if they damage profits, you’d expect something will be done.
Financials
Despite some corporate governance issues, we can have some faith in their financial statements; they are audited by KPMG and investor relations seems to be quite thorough.
The table below shows a summary of their historical financial information.
I will point out a few things of interest. First are the government grants and income from special VAT treatment. Revenue is quoted net of VAT, but they can reclaim VAT for exports.
“There are two rates of value added taxes: 20% – on import and sales of goods and services in the territory of Ukraine and 0% – on export of goods and rendering of services and works outside Ukraine.
The VAT liability is equal to the total amount of VAT accrued during the reporting period and arises at the earlier of goods shipment to the customer or at the date of receipt of payment from the client.
VAT credit is the amount by which a taxpayer is entitled to reduce his/her VAT liabilities in the reporting period. The right to VAT credit arises on the earlier of the date of payment to supplier or the date of receipt of goods by the company.
The Group’s entities apply the special VAT taxation treatment prescribed by the Tax Code of Ukraine, which entered into force on 1 January 2011, regarding the agricultural activities, which provides preferential VAT treatment to support agricultural producers.”
The Ukrainian government plans to abandon these VAT rebates from 2018 onwards. The company’s report warns of frequent changes to the Ukranian tax system so this could come in sooner. That would reduce profits by 18% and can be seen in the highlighted profit row. I have also excluded profits from revaluation of biological assets. I don’t believe this is a true profit, merely a paper profit, and while I don’t have a problem with how they have revalued their assets, as an investor it doesn’t benefit me in cash terms.
Avangardco’s operating margins are still high even accounting for this (24% pre-tax). That makes me nervous. To understand why, lets take a look at another big egg producer, in the US, Cal-Maine (NASDAQ:CALM). It has seen its gross margins deteriorate from 2008 onwards as the financial crisis takes its toll. They have only half Avangardcos margins, 12.4% pre tax and have significantly less leverage. Even though they operate in a different market, could the same thing happen to Avangardco? Absolutely, there are few barriers to entry in this market and their huge gross margin makes it vulnerable, competitors will be eyeing up these large margins and good returns on investment. The only thing standing in the way of a competitor entering the market and driving down margins appears to be the difficulty of doing business in the Ukraine. Can that last forever?
Cal-Maine, even with lower margins, is still a strong business. It has a return on assets of around 10% and sells for 2x book value. This suggests that even if competition increases for Avangardco it will still remain a strong business.
Another thing to note is that Avangardco pay no tax. Profits from agricultural business are taxed by Fixed Agricultural Tax, rather than income tax. I’m no expert on Ukrainian tax laws but I would want a margin of safety to protect me from possible income taxes being introduced.
Cyprus
One important thing about this company is they bank in Cyprus. A few months ago, we probably would have said ‘who cares!?’ but obviously now we have to look at how the deposit ‘tax’ could affect them. Most of their cash is held in the bank, but the annual report doesn’t disclose where. It does however say in their latest financial statements:
“BANKERS:
TD Investments Limited
2-4 Arch.Makarios III Avenue
Capital Center
9th floor
1505 Nicosia
Cyprus”
I think it’s better safe than sorry, best to write off 60% of those bank deposits, or $122m (that’s the highest estimate of the tax I’ve seen). Besides affecting value this also hurts their liquidity, their short term borrowings are no longer adequately covered by cash. Moreover, if their cash is in Cyprus they can’t get to it. I don’t foresee a bankruptcy as it’s a temporary annoyance and they will surely be able to find financing to cover the short term.
Risks
- Their liquidity is at risk if their cash is frozen in Cyprus. They already have large outstanding borrowings from banks. Loans due within one year stand at $151m. Including lease payments, they also need to pay $45m in interest. They would need to find new financing or put all capital expenditure on hold.
- I will be performing some checks of financials such as those detailed in my article on manipulating financials. These are too lengthy to include here but if I find anything suspicious I’ll post a new article about it.
- Fitch has given Avanagardco a stable B rating, which is non-investment grade and means ‘financial situation varies noticeably’. The interest rate on their US$ bank loans is 11%, their 5 year bonds yield 10%. This gives us an idea of how the banks view the risk of this company, i.e. high. It’s also worth noting these are secured loans against assets and most of the debt is at a fixed interest rate which is good.
- Their loans are also mainly denominated in foreign currencies, US$ and Euro. This exposes them to risk if their operating currency (UAH) depreciates against them. A 15% adverse movement in currency rate reduces shareholders equity by $36m.
- The company operates in the Cypriot tax jurisdiction, and it’s very possible that tax laws could change unfavourably in the near future given Cyprus’ financial problems. It is also subject to Ukraine tax laws, which can change frequently and suddenly.
- One important note I came across in the financial statements relates to poultry purchase prices. They have been receiving them at fixed prices since 2009 but this contract has now expired. It is possible there will be a large increase in Cost of Sales if the new prices are above the fixed prices they were previously paying. However, could this be what the ‘revaluation of biological assets’ refers to? A bargain purchase of chickens? In which case I’ve already adjusted for it.
“On 28 November 2009 the Group signed new exclusive distribution agreement according to which the Group has an exclusive rights to purchase Hy-Line W-36 and Hy-Line Brown Parent Stock at a fixed price. The minimum quantity of purchases is not stated in the agreement. The term is three years to November 2012.
The financial effect of changes in contingent and contractual liabilities is not possible to be calculated as at the reporting period.”
- The companies management seem to be fairly relaxed about debt and are expanding rapidly. This isn’t automatically a bad thing as we have seen that investments have been wise, but it is unclear in the future whether they will continue to invest money in the name of expansion or return money to shareholders when it becomes advantageous to do so. I don’t foresee any dividends or share buybacks on the horizon given their increasing debt levels and continued capital investment.
Valuation
Adjusting profits for VAT relief and biological asset revaluation, returns on investment and equity are high. Book value grew at 24% last year and I think even under a worst vase scenario e.g. government assistance removed and margins pressured by competition, this business is worth book value. In the interim, we can rely on them earning similar returns to 2012 for the next year or two, perhaps slightly lower if the price they pay for chickens increases. That would see book value increase by over 20% a year. That seems a reasonable return considering the risk in this investment. The business doesn’t currently produce any free cash so book value growth is all we really have to go by for valuation.
I would normally re-value book firstly to write down the cash due to Cyprus, and then remove recoverable taxes as it’s just an accounting adjustment. However I’m going to be generous and only write off the cash as I think that gives a reasonable proxy for the value of this company given its growth potential. Hence I would value Avangardco at $1bn. It’s interesting to note that’s similar to Cal-Maine’s current valuation and it earns roughly the same pre tax as Avangardco (adjusted). Of course Avangardco doesn’t pay income tax and currently has the VAT refunds, arguably offsetting risks over its base of operations.
Conclusion
I would value Avangardco conservatively at $1bn, slightly under book value. I would expect book value to grow at circa 20% over the next couple of years and hence the intrinsic value to grow also. As such I don’t necessarily believe a catalyst is essential for this to be a good investment. The current market cap is $505m, around a 50% margin of safety.
There are clear risks to this investment both in the short and long term (increased competition and majority shareholder). Their bonds are yielding 10% which means equity investors should be seeking in excess of this if valuing by discounted cash flows.
At this point it’s worth noting that I have focused on conservative estimates, there is also significant upside to this investment which would see its intrinsic value exceed book value. Wexboy gave a good explanation of the potential growth from exports to the EU which the current welfare laws have enabled. But given it is already at a 50% discount today I’ll leave that analysis until the price advances (its got to surely..?)
I’ve not put my buy order in yet, I’ll first read the financial notes thoroughly and search around for any news I haven’t yet come across. If I don’t find anything to put me off, I’ll be a buyer.
Investing Sidekick
Founder of Investing Sidekick. Works as a research analyst and is an avid value investor, always searching for undervalued shares.
There is a statement on the Avangardco website to the effect that the company holds no bank deposits in Cyprus and is unaffected by any potential haircuts.
Thanks Brendan I seemed to have missed that.
Here’s the link to the press release in case anyones interested http://avangard.co.ua/eng/press-centre/press-releases/e/year/2013/id/233/
Interesting information about Avangardco and Bakhmatyuk is circulating around the world.Here are only several links http://online.wsj.com/article/PR-CO-20130513-911656.html, http://www.dailystar.co.uk/news/view/314267/Online-petitition-sees-Everton-fans-beg-Sir-Paul-McCartney-to-buy-club/
Local Football Fans to Target One Million Signatures on Petition to Get Sir Paul McCartney to Buy Historic Football Club
LONDON, May 13, 2013 /PRNewswire/ — Gino Clarke, a lifelong Liverpool football fan has organized an effort to have Liverpool native and Beatles legend Sir Paul McCartney save a legendary British Everton football team from falling into the wrong hands.
A Ukrainian billionaire who has put thousands of American and European farmers out of business through bankruptcy and is one of the largest egg producers in the world is attempting to buy the Everton Soccer Club, a founding member of the British Premier League.
Mr. Clarke is trying to gather one million signatures throughout England and the United States where Sir McCartney has residences. Names will be gathered online and at football stadiums every weekend and rallies and protests will be held worldwide at every location where McCartney appears during his concert tour. McCartney is now on a worldwide concert tour which kicked off last week in Brazil and has dates throughout summer 2013.
Everton was approached by an investment group led by Ukrainian billionaire Oleg Bakhmatyuk with intent to buy it. Scandals have erupted around the world tied to Bakhmatyuk’s nefarious business dealings and connections to a slew of dubious companies, most notably the acquisition of a poultry manufacturing plant in North Carolina (U.S.) that fell into bankruptcy less than six months later, causing thousands of farmers and plant workers to lose their jobs.
Check out link below to the TMZ exclusive report:
http://www.tmz.com/2013/05/12/paul-mccartney-soccer-everton
Founded in 1878, Everton Football Club is a member of the English Premier League and has competed in the top division for a record 110 seasons and have won the League Championship nine times. The club’s supporters are known as Evertonians.
SOURCE Save Everton Soccer Club
In addition to articles in the UK and USA, interesting information on Bakhmatyuk and his company Avangardco in other countries has appeared during last days. Here are only a small number of them
– in this spanish article is written amongst other things that Bakhmatyuk wants to buy the club for save bankruptcy through financial machinations http://www.nescafe.cl/Detalle.aspx?id=631183
– the German media writes: “It is obviously that the fans of Everton appealed to ex-Beatles screaming to help: he (Paul McCartney) should buy the club established in 1878 and save it from Ukrainian billionaire Bakhmatyuk… The fans of the club warn about Bakhmatyuk’s anti-social practice. Thousends of Ukrainians and Americans have already lost their jobs.” http://www.welt.de/newsticker/leute/stars/article116121969/Paul-McCartney-soll-Fussballklub-retten.html
-Italians publish “Back home, Mr. Oleg” http://calcio.fanpage.it/i-tifosi-dell-everton-chiedono-aiuto-a-paul-mccartney/
-here is an article http://www.kckrs.com/everton-supporters-start-petition-for-paul-mccartney-to-buy-the-club/ where Bakhmayuk is called “potential cancer” for Everton FC
The article published in US Business Journal informs that farmers from North Carolina sued Bakhmatyuk and his US company Omtron for breach of the contract. A lot of farmers stayed without job.“He was filthy rich and had no idea what he was getting into; that’s exactly what it sounded like,” said Mickey Bowman, a third-generation chicken farmer told the News & Observer in Raleigh, North Carolina. “He didn’t care who he hurt along the way over here. It was nothing to him to close this down.”Unfortunately for him, doing business in the U.S. and the global market was much harder than grabbing land in the Ukraine by taking advantage of local land laws.Five months after the purchase, Bakhmatyuk announced that Omtron would shut down all its North Carolina operations. Last November the company declared bankruptcy and Omtron’s managers vanished, leaving leases and other debts unpaid and 130 angry chicken farmers who are still trying to collect their money. Five months after the purchase, Bakhmatyuk announced that Omtron would shut down all its North Carolina operations. Last November the company declared bankruptcy and Omtron’s managers vanished, leaving leases and other debts unpaid and 130 angry chicken farmers who are still trying to collect their money.
http://www.corpwatch.org/article.php?id=15838
On the end of March 2013, in the German Parliament broke out a scandal relating Avangardco, its products and owner, Bakhmatyuk ( http://www.gruene-bundestag.de/parlament/bundestagsreden/2013/maerz/legehennen_ID_4387868.html). Mr. Friedrich Ostendorff said, that Grünen 90 have got news about mass protests against Avangardco relating air and water pollution (in Ukraine). He calls Avangardco as „an outrider in terms of cruelty to animals”, the company was compared with „immoral businesses”. „This is a scandal!”,- said Mr. Harald Ebner (Grünen90) relating Avangardco and Bakhmatyuk. The German Assotiation of Poultry demanded adoption of effective measures against cheap imports of dubious egg products to Germany. The representatives of German Bundestag called also to discuss the issue in the European Parliament for proper regulation of egg products’ import to the EU countries from such companies as Avangardco.
interesting video on YouTube about Avangardco and Bakhmatyuk http://www.youtube.com/watch?v=PXfZEJ2tQjs&feature=youtu.be.
According to latest news of Forbes, wealth of Bakhmatyuk is USD 609 million http://forbes.ua/persons/543-bahmatyuk-oleg-romanovich, this is almost twice less than data of Forbes announced in 2011.
The debts of only one company of Bakhmatyuk is USD 1.3 billion http://www.cbonds.info/cis/eng/news/index.phtml/params/id/642433 (You have option to have English version of this site). That means that this man is not a billionaire but a desperate debtor. It seems to me clear now why he is fighting for credits even with Libor of 10%: he needs to cover existing debts, otherwise the pyramid collapses.
Fitch have just upgraded Avangardco’s debt to B+
http://www.londonstockexchange.com/exchange/news/market-news/market-news-detail.html?announcementId=11592200
Standard&Poor’s has affirmed rate ‘B-‘ for Ukrlandfarming IPL and has based its decision on lack of director’s independence, dominance of majority owner Oleg Bakhmatyuk, material related-party transactions, limited information as to the credit quality of the private financial institutions and other assets owned by Mr. Bakhmatyuk ( please see website http://www.cbonds.info/cis/eng/news/index.phtml/params/id/639085).
In Ukrainian press appeared an article inconnection with Bakhmatyuk”s name http://sprotiv.org/2013/05/23/oleg-baxmatyuk-cenzura-deneg/. Here is translation into English:OLEG BAKHMATYUK. CENSORSHIP OF MONEY
Internet has a great advantage – if You once mark a person with a certain label, Google will remember it – says Victoria Syumar, executive director of the Institute of Mass Information. – Looking for this certain person You can get all information, and then You can not prove that you (for instance) “do not have a daughter”. Therefore, cistern for gathering such information in Ukraine proved to be internet! “.
But some journalists will not write criticism, if they were well paid for it. A strike example for it is a story with Mr. Oleg Bakhmatyuk. This man is literally ready to do anything to avoid bad words about him and his empire in the media.
“The media have opened a special kind of business – says Victoria, a journalist of one of the (TV) channels. – They (journalists) make money on businessmen. For example: information policy of agricultural holding “Avangard”. This company has a lot of problems in the environmental area, it is famous for corruption and well known for various scams.
A lot of intrigues drag around this company.
But this information does not get to the media. And if some information appears (in media), then it will be immediately removed. Let’s say, You’ve seen yesterday in the Internet criticism about Avangard. And if You try to search for this information today – You will not find it. Because journalists have been paid money for removing of this article. A lot of money. This is – a real tough censorship. Censorship of money – it can be called only this way.
That is, journalists have built a business empire on Bakhmatyuk. And they made it very well. Avangard – this is just a real subject for mockery.
If a reporter calls the press service of Avangard and asks uncomfortable questions or requests for comments about a problem, he has been simply offered money. Good amount of money. You can find a video film online, when a journalist has been offered a few thousand dollars for similar services.
That is, the bribery of media representatives- now it seems to be quite a common thing. ”
So it turns out, that it is impossible to determine whether political censorship takes place or not. Because the media space fills another kind of censorship, tough and cynical censorship of money. You can buy or sell any information.
Deutschlandfunk and DerStandard writes about Bakhmatyuk:
http://www.dradio.de/dlf/sendungen/europaheute/2158825/
A village community fights back against a chicken factory
By Florian Kellermann
Ukraine sets when exporting mainly on agriculture. Production and animal welfare standards often play only a minor role. An example of this is the chicken farm of millionaire Oleg Bakhmatyuk in Makariv in Kiev (region). The residents have been unsuccessful protesting for its closure.
Nina Solomenko speaks on her behalf and on behalf of her neighbours in Makariv, village located 50 km west from Kiev. She is a member of village council and has taken a fight against the operator of a poultry farm (Avangardco IPL) using the (banned in EU) cages. The 55-year-old goes to a three meter high wall, it was built directly on the fields of the villagers. With each step, the acrid smell in the air is stronger. “Gateway to the chicken farm is located just 30 meters from the nearest residential house, according to the law it would have to be at least 1,200 meters. Where the wall is, ones were the gardens. The driveway to our fields has been cut. It became impossible to get through here with a combine. ”
The poultry is built on a site of the former collective farm of Makariv, in the rear part of site, which was previously housed cattle. Since there have even smelled bad from time to time, says Nina, but that was nothing compared to today. Especially late at night when the stables are ventilated, the stench was unbearable.
During past 40 years, the member of village council lives in her house. Her parents built it then after they as an employee of the kolkhoz were granted the stead. Today Nina would like to move, but she can not afford. After the dissolution of the collective farms, she also lost her job. The small house to sell is as good as impossible. Prospective buyers reject the possibility to buy the house, when they find out where it is located.
“No wonder”, – Nina says,- “ The “bird factory” as it is called in Ukrainian is dangerous”. She believes that some neighbours would get cancer because they live very close to the farm. It shows the results of a study of the air in Makariv, made by the State Sanitary Authority. The permissible standard for hydrogen sulfide is temporarily exceeded by 15 times in the village.
“But that is not the only evil. The administration (of the poultry) leaves fallen chickens directly burried on the grounds. I have myself seen it, once when I was there with representatives of the veterinary supervision. There was a pile of dead chickens, crawling worms were around the carcasses. The resulting toxins penetrate into the soil and contaminate our ground water, what has been proved. ”
Repeatedly villagers demonstrated unsuccessfully against the chicken farm. The (Ukrainian) sanitary authority wanted to close the facility ones already. But this decision took the Administrative Court in Kiev back. Nina Solomenko believes that the judges were bribed. The owner of the company Oleg Bakhmatyuk is an influential man, the Ukrainian edition of the business magazine “Forbes” leads him in the list of the richest Ukrainians in 15th place – with a fortune of 460 million Euros. He was not ready for an interview about the chicken farm in Makariv. The company of Bakhmatyuk made last year in Germany headlines: it bought here used hens equipment, that have been banned in the European Union, with purpose to install them in Ukraine . The German Federal Government took even a guarantee of the business, i.e supported the export of the controversial cage. Nina Solomenko scratched her head thoughtfully. She fears that the eggs king could declare German equipment in Ukraine even as technological progress. “But we need here not a new technology, we have long before lost our trust in the investor (Bakhmatyuk). (There are two outcomes in the situation) :Either the poultry will be closed, or we end up very soon all on the graveyard. “
I enjoyed reading your article and bought into a very small position early this year (at $8). With the ongoing violence in Ukraine, loss of two poultry farms and the 50% currency drop, the shares are now at $2.51. I am considering doubling my stake.
Do you have a new perspective on their current valuation? Their cash levels ($157M on Sept 30, held in USD I presume?) appear high enough to ensure no problems with their $200M debt. Also exports appear to be still growing (although feedstock prices also increased).
Thanks
Hi Rich
I’m not sure their cash is held in USD, it was always earmarked for investment in the business so could actually be in the Ukraine. The bonds in Euros are a worry as free cash flow turned negative. But we know what its worth as at 30th September at least.
Given the exchange rate change, that has wiped 50% off the shareholders equity (in USD) immediately. But its down another 50% on that due to profits collapsing. I thought this was originally worth around book value, and its currently trading at 20% of its new book so I have been tempted to buy some more, but I’m still holding out to see how things go. I’m glad I didn’t average down in the $4-5 when its dividend yield looked attractive. Now I’d be surprised if they paid another dividend next year.
I want to see some end to the current situation or get a better idea of their profitability under this pressure before I buy more shares.
Did anyone already receive the dividend payment? I thought they were gonna do that on 30/12/2014.
No I haven’t received it, and my broker doesn’t usually delay in crediting my account. Was supposed to be paid before 31 Dec 2014.