MHP - Downgrade on Soaring Soft Commodity Prices, Weak Harvest

The 3Q20 results were largely in line with our forecasts, but the company's near-term outlook is gloomy, in our view: profitability is poised to deteriorate amid a 15% surge in poultry production costs on soared corn, sunflower and grain global prices that has coincided with record low crop yields in Ukraine. Thus, EBITDA per kg in the poultry segment appears set to drop to as low as $0.25 per kg in 4Q20, from $0.38 in 3Q20, and profits generated by the grain-growing division are likely to be lower than we previously expected. We have incorporated the 3Q20 results in our model and updated our price forecasts, which has cut our 2020 and 2021 EBITDA forecasts by 8% and 5%, respectively. We lower our target price from $6.50 to $6.00 per GDR and downgrade our recommendation from BUY to HOLD until we see profitability improve.MHP reported 3Q20 IFRS results yesterday. Consolidated revenues were down 2% y-o-y to $547 mln, which marked an improvement from the 17% decline seen in 2Q20. Export revenues reached $309 mln, or 56% of total revenues, up from $215 mln and 51% in 2Q20, but still below the $317 mln and 57% registered in 3Q19.Poultry division sales rose 6% to $362 mln (after a 16% decline in 2Q20) owing to an 18% increase in poultry sales volumes (mainly additional export volumes) but despite an 11% y-o-y decline in the average poultry selling price due to weak domestic and global demand amid the pandemic (though the average selling price was up 7% Q-o-Q thanks to a more favorable sales mix). Reflecting the drop in poultry prices, cash EBITDA per kg of chicken meat (adjusted for the revaluation of biological assets) sank 22% y-o-y to $0.38 in 3Q20 (but rose from $0.35 in 2Q20), while the segment's cash EBITDA fell 9% to $75 mln for a 21% margin (up from $59 mln in 2Q20).Grain segment revenues tumbled 40% to $24 mln, we calculate, which we attribute to the kryweaker harvest in 2020. Excluding the impact of IFRS 16, the segment's cash EBITDA doubled to $7 mln thanks to higher grain prices. Perutnina Ptuj (presented as MHP's "European operating segment") generated cash EBITDA of $12 mln in 3Q20, for a 13% margin. MHP's consolidated cash EBITDA reached $103 mln, compared with $83 mln in 2Q20 and $106 mln in 3Q19. The company recognized a non-cash FX loss of $61 mln (versus a $109 mln FX gain in 3Q19), resulting in an accounting net loss of $47 mln. The company ended the quarter with a net debt/LTM EBITDA ratio of 3.33, above the Eurobond covenant limit of 3.0 that restricts dividend payments (the maximum allowed is $30 mln), investment, mergers and any kind of financing to third parties.The results were generally in line with our expectations and the company's forecasts, but profitability is set to deteriorate amid a 15% surge in poultry production costs due to a sharp rise in global prices on corn, sunflower and grain, coupled with record low crop yields in Ukraine. Higher production costs should be mitigated somewhat by higher domestic meat prices (as less efficient players will leave the market), but we expect poultry segment margins to come under pressure for several quarters (most notably in 4Q20), which is unlikely to be offset by the grain division due to the disappointing harvest. During the conference call, the management said poultry production costs had increased 15% since October (meaning that poultry segment EBITDA per kg could drop to as low as $0.25 per kg in 4Q20, we estimate). As a result, the management now expects EBITDA to slide 5-10% y-o-y in 2020, compared to previously guided y-o-y flat EBITDA. To mitigate a fodder shortage, MHP plans to procure corn and sunflower seeds for five months (versus previous plans to acquire fodder stock for two months), investing $200 mln in working capital. The management projects the company will end the current year with a net debt/EBITDA ratio of 3.5 (versus our forecast of 3.7).We have incorporated the results, higher production costs and updated price forecasts in our model. Our 2020 and 2021 EBITDA forecasts have come down by a respective 8% and 5%. We therefore lower our target price from $6.50 to $6.00 per GDR and downgrade our recommendation to HOLD.