Fitch ratings has affirmed Avangardco Investments Public Limited's (the parent company of Avangardco agroholding) Long-term foreign and local currency Issuer Default Ratings (IDRs) at 'B'.
According to a Fitch report, Fitch has also affirmed Avangardco's National Long-term Rating at 'A+(ukr)', foreign currency senior unsecured rating at 'B' and Recovery Rating at 'RR4'. The Outlooks for the Long-term ratings are Stable.
Avangardco's Long-term IDRs reflect its average business risks and concentration on one product line (primarily eggs and egg products) mitigated by partial vertical integration (mainly into fodder production).
However, the single business concentration is mitigated by opportunities derived from increasing market shares in the Ukrainian eggs market from household production, despite the high penetration of egg consumption per capita, and from export markets.
Avangardco's ratings continue to be limited by its narrow product portfolio and exposure to potentially high feed costs as Avangardco does not cultivate grain in any large amounts, unlike MHP ('B'/Positive), as animal feed accounts for a significant portion of the cost of production of eggs.
Fitch acknowledges the efforts made by management to unwind most related-party transactions, in particular with the bank Finansova Initsiatyva LLC, controlled by the ultimate shareholder of Avangardco, Oleh Bakhmatiuk, and the appointment of a new independent director to the board. However, the controlling shareholder continues to exert significant power in the group's main decisions.
Further progress in corporate governance and transparency is envisaged by setting up an audit, nomination and remuneration committee in the near term. On 29 August 2011, the board will also seek approval of shareholders on the appointment of KPMG Limited, as new auditors of the company.
Fitch recognizes the increasing domestic market shares, the development of the group's customer base towards retail clients and exports of eggs and dry egg products to Middle East, North Africa and Asia, among other destinations.
Furthermore, given its competitive cost structure and focus on operational efficiency, Avangardco's EBITDA and margin remain high compared to peers (FY10: $137.6 million or 31.3% margin - excluding non-cash revaluation income from changes in biological assets and interest rate subsidies).
The ratings are constrained by expected negative free cash flow generation in 2011 and 2012 driven by large capital investment plans. Capex could be adjusted depending on market conditions.
However, increased capacity will likely be directed to exports that are considered more volatile than domestic consumption despite Avangardco's defensive demand product characteristics.
If higher capex is not supported by expected sales uplifts, profits and cash flows, this could put pressure on Avangardco's creditworthiness driven by a downward price pressure in the domestic market due to over capacity.
Therefore, the current rating and Outlook provide some financial headroom despite the expected moderate total adjusted debt to EBITDAR of around 2.0x (FY10: 1.83x).
A negative rating action could follow in the event of sustained deterioration of profit margins or total lease-adjusted debt to EBITDAR consistently above 3.0x, especially if combined with continuing negative free cash flow weakening the group's liquidity profile.
A positive rating action depends on the combination of the following factors: diversification of the company's revenue streams to include additional sustainable export sales, maintenance of conservative financial policies with total adjusted debt to EBITDAR below 2.0x, positive free cash flow along with operating EBITDAR to fixed charges above 5.0x and further strengthening of corporate governance principles.
The 'B' senior unsecured rating reflects average recovery prospects for noteholders in the event of default.
Recoveries are supported by the moderate level of indebtedness and the existence of upstream unsecured guarantees (which are suretyships under Ukrainian law) from several operating subsidiaries currently representing around 75% of consolidated net sales, operating profits and group assets.
However, the Recovery Rating is capped at 'RR4', reflecting recoveries between 31% and 50%, due to the Ukrainian jurisdiction of the guarantors.
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