MHP - Ready for the Shock

Financial markets seem to have calmed down over the past two weeks, which has even allowed for some spread tightening, as investors started to pick up the bonds of companies considered the least exposed to the economic downturn. In the FSU space, there are few opportunities to add risk, but we believe MHP would be a good place to start. The company is among the least exposed to the downturn in the region, while it has almost no upcoming maturities, a prudent capital allocation policy, reasonable governance standards and a track record of meeting its liabilities in difficult times. We generally prefer staying on the safe side in this environment, so among Ukrainian corporates, we would recommend overweighting only MHP bonds.> Sales volumes do not seem to be at high risk. We believe food producers should be relatively immune to the negative effects from Covid-19, as we doubt that the reduction of out-of-home consumption will seriously dampen overall demand. Meanwhile, import restrictions slapped on MHP by the EU and Saudi Arabia following a bird flu outbreak in Ukraine in January have already been lifted. While there is still downside risk for poultry prices from global oversupply and weakening EM currencies, it seems well mitigated by higher demand for poultry as a substitute for pork in China due to an African swine fever outbreak and the fact that at current prices some producers are already making losses.> Profitability has fallen, but hryvnia depreciation to mitigate pressure. MHP's profitability has fallen over the last couple years, with the EBITDA margin falling from around 35% in 2016-17 to 20% in 2019. Driving this was a combination of hryvnia strengthening, lower poultry prices and significantly higher payroll expenses after Ukraine started a visa-free regime with the EU. Since the start of the year, however, the hryvnia has weakened from 23-24 to the dollar to over 27, which, should boost profitability and compensate for the soft prices - almost 60% of revenues come from exports whereas costs are predominantly in hryvnia (MHP is vertically integrated: it produces its own key FX-based raw materials, grain and fodder).> Focus on bringing leverage back in line with covenants. At the end of 2019, MHP's leverage ratio crossed above the 3.0 threshold set in its Eurobond covenants, meaning that the company is prohibited from taking on new debt in excess of $100 mln or paying out dividends of more than $30 mln per year. The management's 2020 guidance suggests prudent capital allocation with the aim of bringing leverage back in line with the covenants. Net debt/EBITDA is guided at 2.7 at year-end, while EBITDA (net of the IFRS 16 effect) is projected in a range of $400-420 mln. Capex is to be cut to $100 mln, which will be just for maintenance and boosting efficiency. Because of grain purchases, working capital is expected to build.> MHP enjoys comfortable liquidity position. MHP has managed to extend its debt maturity profile thanks to a number of liability management exercises in previous years, and at end-2019, it had almost no debt maturing in the near term, while keeping over $0.3 bln in cash. Excluding capitalized leases, over 90% of its debt falls due in 2024 or later. > Land reform not a risk to cash flows anymore. In April, the Rada passed a long-awaited land reform bill, which had been substantially amended compared with the one approved in a first reading last year. Starting July 1, 2021, a previous moratorium on individuals trading land will be lifted and they will be allowed to acquire up to 100 ha of land. Starting in January 2024, legal entities will be allowed to buy land, with the limit set at 10,000 ha. Whether foreigners will be allowed to participate in the land market is to be decided in a referendum slated for 2024. The new law represents a political compromise, as land market liberalization had little support among the Ukrainian public but had been a prerequisite for Ukraine unlocking a new IMF program. For MHP, if at the beginning of the legislative process the reform had been a factor to consider in terms of the company's capital allocation, now we believe it is unlikely to have any impact at all. > MHP bond spreads lowest in Ukraine, yet offer decent premium to EM protein producers. The valuations of Ukrainian corporate bonds look stretched, with all but MHP's offering double-digit yields. We, however, prefer to stay on the safe side, and believe MHP is the first name to consider in this environment thanks to its being least exposed to the economic downturn, combined with the absence of upcoming debt maturities, a prudent capital allocation policy, reasonable governance standards and a track record of meeting its liabilities (in the 2014-16 crisis it was the only Ukrainian entity with publicly-traded debt that did not have to restructure).Compared with those of other EM protein producers, MHP bonds offer a considerable yield pickup and trade at spreads substantially wider than they had been in recent years. A certain amount of confidence is required to get excited about a mono-protein producer from Ukraine versus diversified producers (in terms of both products and geography) like JBS, BRF or Marfrig. We are, however, comfortable with MHP given its lack of short-term maturities, higher level of integration in raw materials and higher profitability (relative to peers).