Description

Thesis

MHP is the largest poultry producer in Ukraine and one of the world’s low-cost producers (depending on exchange rates, at times the lowest-cost producer). The company is vertically-integrated, led by a talented and aligned management team, has Western-style corporate governance, and is serving a growing share of global exports. MHP has a market cap of only $1.3b, despite generating $250-300m of annual free cash flow which is being re-invested at very attractive returns. The company also has a dividend yield greater than 6%.

History and management

In 1998, current CEO Yuriy Kosyuk purchased a number of grain elevator silos out of bankruptcy and founded MHP as a grain trader following the collapse of the USSR. MHP had also acquired a feed mill and began to supply feed to Peremoga poultry farm. In 1999, the farm defaulted on its payment and MHP acquired Peremoga through bankruptcy, beginning to produce chicken meat and export grain. In 2000, the company decided to focus more on poultry production, which at the time was an unpopular decision given how lucrative grain trading was (evidenced by the entry of such companies as Glencore and Louis Dreyfus). In 2002, MHP launched its Nasha Riaba brand of chicken – the most popular brand in Ukraine. In 2003, MHP was the first Ukrainian company to receive a loan from the IFC. In 2006, MHP raised a $250m bond and in 2008 filed for an IPO and became listed in London as a GDR.

Relative to Ukraine’s youth as a country, MHP has a long history with the capital markets. Investors can review financials since 2003 (from the 2006 issuance of 2011 maturity bonds) and follow the evolution of the company’s growth and governance. CEO Yuriy Kosyuk is a very talented leader and has a ROIC-driven capital allocation philosophy. Upon his request, a Western style board of directors was formed and has historically been independent. With the recent addition of Roberto Banfi to the board (formerly from Brazil Foods and now a consultant for MHP), the board is technically not independent. The former Chairman of the board was Charles Adriaenssen from InBev, and the Chairman since 2016 has been John Rich – an expert in poultry and agriculture that has consulted extensively for the IFC.

MHP has been the only Ukrainian issuer to have honored all its financial obligations throughout its history, including during the economic and geopolitical crisis in 2014-2016 (during which time, MHP continued paying its dividend). The company’s largest shareholder is Kosyuk with nearly 70% of the shares, followed by Prosperity, a highly successful Russia and FSU-focused fund, with over 10% of the shares.

Background

Poultry is the low-cost protein. As a general heuristic, it requires 2 kg of feed to generate 1 kg of chicken, 4 kg of feed to generate 1 kg of pork, and 6kg of feed to generate 1 kg of beef. In addition, poultry requires the least amount of time to raise as well as the least capital (e.g., cows need to graze on larger plots of land). Given its low costs and health benefits, poultry has been gaining share among proteins. Around the year 2000, global poultry consumption overtook beef and in the near future it will also overtake pork. Given the price/demand function, one would expect pork to fall between poultry and beef, but the Chinese skew the equation. China accounts for around 11-12% of global poultry and beef consumption but around 50% of global pork consumption.

Ukrainian poultry production has soared in the past two decades. The majority of the growth has been from MHP and off a non-existent base. Global production between 2000-2016 has grown 1.6x whereas Ukrainian production has increased 50x, and the majority of production has been consumed internally. With a population of 45 million, protein consumption is 2.3 million tonnes (2001: 29kg/capita, 2016: 52kg/capita), of which 1.1 million tonnes is poultry (2001: 6kg/capita, 2016: 24kg/capita). Ukraine’s 52kg/capita poultry consumption is on the low-end compared to other countries (Russia 62kg, EU 76kg, Brazil 96kg, US 113kg).

Competition

MHP has significantly increased its capacity in the past decade.

It has also significantly increased its market share. In 2006, the company had ~35% share of production compared to Agromars at around 22%. In 2016, the company has nearly 60% compared to Agromars ~10%.

Unlike the typical poultry company, which sends the feed and chicks to third-party farmers who will grow the chickens until they are picked up again and taken to the slaughterhouse, MHP is unique in its vertical integration given the cost advantages it has in Ukraine. The company has nearly 1m acres of farmland on which it generates approximately 2m tonnes of grain, making it 100% self-sufficient in corn, 60% in soybean/wheat, and 25% in sunflower. It produces sunflower protein and fodder, raises parent stock, hatches the eggs, raises the chickens, processes them, then distributes them. Domestically, a third of the chicken is sold through its franchise network of 2,000 retail stores.

MHP has several competitive advantages:

1. Ukrainian soil, which has 25% of the world’s chernozem or “black soil”

2. Use of sunflower protein in addition to soybean protein in its fodder. Sunflower is around 20% cheaper than soybean, and the sunflower seeds can be processed into sunflower oil to be sold for additional revenues.

3. Lower labor costs (Brazil is 1.5x and USA is 7x)

4. Lower land costs (Brazil is 3x and USA is 10x)

5. Lower transportation costs (300km average distance to ports vs. 900km Brazil and 1,500km USA)

6. Captive customers (Nasha Riaba chicken is priced 5-10% higher than competitors)

7. Economies of scale in production, distribution, etc.

These competitive advantages lead to among the lowest production costs globally. I have adapted the following (a few months ago) from a study on global production costs produced by Wageningen University & Research (“Competitiveness of the EU sector”). The recent decline in the Brazilian real likely implies that the advantage has reverted to the Brazilians but the difference is not great. On the poultry side, the composition of costs is roughly: 40%-50% grains, 15% protein, salaries 13%, utilities 15-17%, and the remainder packaging. On the grain side: 20-25% fertilizer, 15% seeds, 12% fuel, 12% plant protection, 13% salaries, leases 15%.

These production costs lead to the highest margins in the industry. The difference compared to competitors is primarily due to growing own feed and raising own chickens and selling sunflower oil, followed by land and labor cost advantages, and finally government subsidies that are being phased out. At the same time, as a vertically-integrated company MHP is a lot more capital intensive, so from a return on capital perspective the difference is less drastic.

Growth

MHP will grow in two ways: 1) increasing consumption per capita in the home market of Ukraine, and 2) taking market share of global exports. The former relies on growth in income per capita, whereas the latter is reliant on the company’s low production costs and growth in capacity.

Approximately 60% of MHP’s poultry production goes to the domestic market, while the other half is exported. Given the different pricing in export markets, 55-60% of revenues and a third of costs are USD or USD-linked, which acts as a natural hedge to the company’s USD-denominated debt.

MHP currently exports to 70 countries globally and is focused on increasing its exports into Europe. The EU imports approximately 900k tonnes of poultry, the majority of which come from Brazil and Thailand. Brazil has a 230k tonnes quota, while Thailand has 150k tonnes. Because of Europe’s higher cost of production and higher incomes, the prices for poultry are higher and are therefore attractive to MHP. Unfortunately, MHP only has quotas for 16k tonnes of fresh chicken and 20k tonnes of whole frozen chicken. The latter is hardly relevant because the European preference is for breast fillet whereas the Middle East markets prefer small whole chickens.

Despite the import levy past these quotas, MHP is still competitive and profitable in Europe. Ukraine has been markedly increasing its share in Europe given its low production costs and ability to send fresh chicken compared to frozen or fully cooked chicken (and in much less time). The Brazilians have faced recent problems including deception of inspectors and lack of Halal standards, and over time Thailand will face weakness due to its lack of feedstock advantage that countries like Ukraine and Brazil have.

MHP is also focused on increasing its share of exports to the Middle East. Like Europe, Saudi has implemented some bans on Brazilian poultry and is willing to pay a premium for Ukrainian chicken given that the Brazilians allied themselves with the Qatari sovereign wealth fund (SWF) to buy Banvit in Turkey. The Brazilian supply chains are best of breed, but over time Ukraine will improve, particularly in light of the 2-3 weeks transportation time to Saudi compared to the 4 months from South America.

Capital allocation

MHP currently pays an $80m dividend (>6% yield) with around 30% of its cash flow. The majority of cash flow is funneled into growth capex to expand its Vinnytsia farm. Phase 1 resulted in 270k tonnes of capacity at a cost greater than $750m, whereas Phase 2 will nearly double this capacity (260k additional tonnes) at a cost of around $380m as a result of the overall infrastructure costs from Phase 1. The incremental returns on capital will be between 30-50%, which will result in an additional $100-175m of earnings (based on a sales price of 1.3/kg and approximately 55c/kg profit).

The company is also considering acquisitions to diversify away from Ukraine risk. By having such a concentration in Ukraine (and highly concentrated areas of production with millions of chickens), bird flu is also a significant risk. The company is willing to have lower margins but diversify away from Ukraine but has proven to be very disciplined in M&A, having walked away from many deals that were too expensive (recently including Doux in France).

Valuation

Share price: $12.05

Shares outstanding: 107m

Market cap: $1.29b

Net debt: $1b

EV: $2.3b

The company’s debt is due in 2024 (500m) and 2026 (500m) and was issued at just over 7%.

Risks

Needless to say, there are various risks in this investment.

Company management believes that biosecurity is the biggest risk given that so many chickens are grown together. There is also a risk of other Ukrainian poultry companies having lax standards which would result in bans on all poultry exported from Ukraine.

The company has been led be a very talented CEO. If something were to happen to him, this would be a big loss for the company.

Ukraine has many macro and political risks. In the past few years, the company has shrunk its current account deficit and fiscal deficit and is currently on the path to many reforms (which will likely lead to continued support from the IMF).

Ukraine is a highly-corrupt country. Many investors were caught in the Mriya fraud. There is always the chance that corruption exists in the company, despite the Western corporate governance and high standards, including in-depth background checks by the IFC, EBRD, and several well-known, large institutional investors.

The Ukrainian currency could further devalue. Although this would increase the attractiveness of exports, it would likely mean that the local economy is in malaise. The company has more revenues than costs in dollars thanks to its exports and is therefore not at significant currency risk.

Russian interference is another risk, particularly if there were to be any action that affected the exports out of Odessa. This is difficult to handicap.

Catalyst

Increased Vinnytsia capacity

Increased FCF and dividends

Improved Ukraine macro