Anton Khmelnitski writes: Ukraine is missing opportunity to develop its stock market as others, including Polish pensioners, benefit.
Food prices look set to rise again this year. Production yields are near peak, and stock levels are low. This is combined with increased weather instability, population growth in emerging markets as well as changes in food habits in China.
Ukraine should be a major beneficiary and now offers liquid exposure for investors through agriculture companies listed on European markets. With the end of the 10-year moratorium on land sales expected on Jan. 1, 2012, Ukraine is likely to have the foundation to enter a new decade of fast growth to realize its agriculture potential.
Today, listed farming-food companies are generally difficult to find. Agriculture equity investments often consist of indirect plays such as fertilizers, tractors or seed producers, most of which trade in developed markets.
Ukraine is offering a new way to invest in agriculture with a rapidly rising number of real land-farming operations coming to the public markets. Over the last three years, more than $10 billion of capitalization and 15 firms have been successfully listed, despite difficult conditions, with several names delivering triple-digit returns.
These companies typically have 100,000 hectares under operation through lease agreements. They represent less than 10 percent of a total land bank of 32 million hectares available.
The average quality of the agribusinesses is in many ways superior to what Ukraine has been used to offer to investors, which was typically a handful of non-transparent, old legacy asset companies with poor disclosure and liquidity.
Ukraine is seeing a boom in new agribusinesses seeking to list abroad, particularly in Poland. Warsaw has recently become the new magnet for Ukrainian companies and this is now also starting to attract companies from other sectors.
The Warsaw stock exchange, unlike the Ukrainian one, has strict requirements and quarterly International Financial Reporting Standards statements as well as an established $87 billion pension fund industry. This has facilitated capital raising for Ukraine companies and allowed investors to reinvest in Ukraine following the crisis.
Sadly, Ukraine is again missing out on one of the biggest opportunities to develop its stock market and more importantly to offer its population the possibility to own shares in a key strategic sector such as agriculture, which employs more than 20 percent of the population. It is instead Polish pensioners who benefit from growth.
The strategic importance is obvious. Ukraine’s territory has a large network of rail transport, covering 70 percent of the land with strategic access to the Black Sea and large port operations capable of handling nearly 35 million metric tons of grain exports – nearly as much as total annual production.
Ukraine could in theory produce 100 million tons of grain, more than double today’s 40 million tons. This would represent 16 percent of the world market.
The structure of the agri-food companies differs as well from other countries, as they fully integrate the land in their operation unlike Brazil or North America where contract farming is more common practice. Ukrainian food-processing companies have therefore a natural hedge against rising input price as well as land appreciation upside.
The business model also differs from other classic producer models with vertical integration and specialization rather than horizontal business segmentation. This important value added element is realized through further integration in high margin food processing.
In the longer run the gross domestic product and export structure of Ukraine could be transformed.
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For example, today the world chicken trade is only 12 percent of global production, of which Brazil and the U.S. are the leaders. Ukraine continues to narrow its gap of imported chicken, which still stands at 200,000 tons per year.
An industrial agri-food producer such as Ukraine’s MHP listed in London, representing already 50 percent of the local production, will be able to meaningfully export starting in 2015. For that purpose, the largest and most modern European chicken processing plants are currently being built in the Vinnytsya Oblast.
This model can also be replicated for other types of food products such as egg, meat, dairy products and high margin vegetables.
Another specific element to Ukraine is land reform. Today, Ukraine values its land at a fraction of its fair value. This is the result of a law enforcing a moratorium on land sales, which was activated in 2001. It is expected that this will be lifted as soon as next year.
The impact here as well is significant, as financing through land collateralization will become possible, which should facilitate bank lending.
Ukrainian agriculture companies historically used mostly equity financing, but with lands on the balance sheet, companies will be able to get better financing terms, freeing up resources for acquisitions of machinery and working capital.
The structure of the Ukrainian economy would evolve with the gas and steel industry seeing a gradual reduction in their dominance. Banks would also find new sources of growth, providing much needed diversification and stability to a system still ravaged by a property bubble.
If global soft commodity prices continue to grow, it will accelerate the entire process and improve further the attractiveness of these companies. Nonetheless, inherent risks such as government intervention, a relatively weak judicial system and political instability could mitigate the investment appeal for foreigners.
For investors willing to get exposure to Ukraine agriculture, it still seems safer to invest with well established, large companies listed abroad, where interests between managements, minorities and owners are better aligned and transparency is higher.
Ukrainian agribusinesses remain the best way today to capitalize on rising global soft commodities prices, as well as playing the upside in land appreciation in one of the most fertile and large land banks in Europe.
Anton Khmelnitski is the managing director of Kyiv-based Elbrus Capital, a fund management group. He has more than 12 years of experience investing in Eastern Europe and can be reached via [email protected]
