Avangardco 1H14: Weakening Macro Fundamentals Weigh on Financials

The heavy hryvnia depreciation and sinking domestic demand had a major negative effect on Avangard's 1H14 financials. We expect the 2H will be even more challenging, with a further decline in revenues and margin weakness ahead. Nevertheless, operationally the company remains healthy, and liquidity and solvency are not at all concerns. Avangard's cyclical downturn should reverse course once Ukraine resolves its key economic problems.

Revenue falls, margins decline on sharp hryvnia depreciation

Avangard's revenues slid 14% yoy to USD 263 mln in 1H14, mainly due to the substantial hryvnia depreciation (UAH 10.3/USD in 1H14 vs. UAH 8.0/USD in 1H13). With 61% of 1H14 sales coming domestically, the USD equivalent technically fell 22% yoy. Weaker pricing of exported dry egg products (81% of the total output sold abroad in the 1H) is another major issue. Avangard priced its dry egg products at an average USD 6.7/kg in 1H14, down 12.5% yoy. Avangard sold 12,400 tons of dry egg products, well below production of 14,000 tons, meaning the company may be pressed to make further price concessions in the 2H to unload inventory.

Margins suffered as costs dropped insignificantly – some 70% of costs (mainly grains and oilseeds) are indirectly linked to the US dollar. Operating profit and EBITDA declined 44% and 41% yoy, respectively, as they were hit additionally by a USD 29 mln FX loss. Meanwhile, operating cash flow (before changes in working capital) declined just 11% yoy to USD 102 mln. The company also released some USD 9 mln in cash via a reduction in working capital (vs. the USD 30 mln cash used in 1H13). In contrast to its usual procurement policy, Avangard did not make advance payments for raw materials in 1H14 in expectation of lower prices for grains and oilseeds. The strategy proved correct and we expect Avangard's cost of raw material purchases will be over 10% lower in US dollar terms vs. last year's.

The 2H will be no less challenging

While all of Avangard's facilities remain operational, those in the conflict area may be idled when the current flock's production cycle ends. With this in mind, the company expects egg production will decline 10% in the 2H vs. the 1H and remain flat yoy in 2014 at 7 bln (vs. total capacity of 8.6 bln). We expect egg prices will recover in the local market in hryvnia terms (we see 7% yoy growth for FY14) but this increase will be fully offset by the hryvnia depreciation that has continued into the 3Q. We currently forecast full-year revenue of USD 507 mln (-23% yoy) and EBITDA of USD 146 mln (-51%).

Dividend payout depends on economy; Eurobond payback not in question

Avangard will hold an EGM in September to decide on a dividend payout (25% of 2013 net income, as previously announced). During a conference call management suggested the final decision is uncertain due to the ongoing and unprecedented economic crisis. We do not rule out the possibility that the company could delay the dividend payout for 2013 until the economy stabilizes and prospects for a resolution to the crisis become clearer. We believe the redemption of the Eurobond is a certainty and will remain so unless Ukraine experiences a major escalation of the military conflict.

Target price lowered, recommendation downgraded to HOLD

We incorporate the weaker production and price outlooks into our valuation model and also increase the WACC following the substantial rise in the risk profiles of Ukrainian issuers. We downgrade out target price (50% DCF-based and 50% peer-based) for Avangard to 12.7/DR (vs. 16.4/DR previously). Even though the TP implies a hefty upside of 45% to the current price we assign a Hold recommendation to the stock due to huge non-economic risks.

Please contact our Sales & Trading (tchub@spadvisors.eu) or Research (v.vavryshchuk@spadvisors.eu) for more information.