Investment Risks

Our conservative estimation of Kernel is backed up by the uncertainty which is generated by the following risks:

• Uncertainty of Russian expansion

• Supply chain disruption risk

• Weather risks

• Regulatory risks

• Other risks

Figure 37: Risks Impact on Kernel’s Supply Chain

*Kernel’s sugar business is expected to be sold in 2013/2014

** Weighted on a share in EBITDA ( 2012)

Source: KNU analysis

□□□□ - no effect

■□□□ - negligible impact

■■□□ - middle impact

■■■□ - substantial impact

■■■■ - critical influence

Figure 38: Risk Matrix

Source: KNU analysis

Figure 39:Impact of Ukrainian yield

Source: KNU analysis

Figure 40: Regulatory risks

Source: KNU estimates

Uncertainty of Russian expansion. Kernel’s expansion on the Russian market of sunflower oil and grain trade have to compensate the fall in the company’s profitability in 2012 and the lack of massive perspective of development in Ukraine. Nevertheless, we are taking into account the risk of achieving poorer results than the ones presented by top-management of the company. We will attribute to this risk:

• Lack of seed supply from local suppliers

• The high pressure of the competitors

• Reduce in EBITDA margin after starting in new businesses

• Weaker than anticipated demand

Supply chain disruption risk. The full production-supply chain increases the effectiveness, hedges company’s price risk and generate additional profit due to synergy effect. But there is the other side of the coin: some force majeure circumstances such as destruction of cultivated areas, temporary unavailability of means of transportation and handling, could cause risk’s spread on the other links of the chain which may result in critical or even catastrophic losses for the company (see Apendix 8). Right now there is a risk of sunflower oil shipment failure because of the shortage of rail cars provided by government entity Ukrzaliznytsia. Poltava oil-crushing plant (owned by Kernel) asserts that the situation is so bad that even there is even a possibility of total plant stoppage.

Weather risks. The decline of company’s key crops due to unfavorable weather conditions will result in the following changes:

• Raw materials: the deficit on the inner market will cause the boost of the raw materials prices (Kernel purchased 94.4% of oilseed and 78.4% of grain for its own needs in 2012) and margin shrinking. This impact is leveled by the high probability of export quotas introduction by government in case of the bad harvest scenario (which is quite common for Ukraine). This regulation method would alleviate the shortage of supply of raw materials and reduce the pressure on Kernel’s margin.

• Silo’s loadings: if Kernel’s farms and company’s potential suppliers are suffered from serious crop failure, this will cause the decrease in silos’ network turnover and the growThs in the cost of goods. However, the losses are considered to be quite petty.

• Export prices: Ukrainian goods accounts for significant share in world markets of both sunflower oil and grain (54% - sunflower oil, 14%-corn, 12%-barley). Therefore, the drop of Ukrainian supply will cause the increase in world prices (estimated elasticity of the world prices with respect to Ukrainian yields is -1.06 for sunflower oil and -0.52 for corn). This fact implies that the decline in volumes will be offset by the growth in prices. To sum it up, weather doesn’t pose a significant influence on company’s operating activities; this argument is confirmed by the absence of interconnection between yields and EBITDA margin.

Regulatory risks. Ukrainian legislation in agro segment is insufficient and mercurial. Government actions often pose strict limitations on the market participants and reduce their attractiveness to investors. For example, there is a well-established practice of export quotas and duties introduction, application of price control instruments. Moreover, the obligatory conversation of 50% currency earnings was set by National Bank of Ukraine in order to maintain exchange currency rate. Also, the land market is expected to be installed in 2016 (permission of land trading) which will force agricultural companies to significantly transform their business model. But we estimate that the regulations listed won’t seriously harm the company: Kernel’s perfect record of getting quotas and long-term land lease contracts mitigate the threat.

Other risks which should be mentioned:

• external risks:

• translation risk

• increase of competitiveness in the industry

• inner risks:

• decrease in financial flexibility due to strategy of extensive investments

• growth in costs of production caused by possible fertilizers and gas prices boost

FY2011

FY2012

FY2013E

FY2014F

FY2015F

FY2016F

FY2017F

FY2018F

ASSETS

Cash & equivalents

115,897

82,529

128,042

197,673

348,686

558,632

810,089

1 065 315

Trade accounts receivable, net

111,586

146,362

160,618

190,707

208,166

227,889

236,772

246 775

Prepayments to suppliers & other current assets, net

81,334

90,335

112,634

131,997

143,233

155,926

161,642

168 079

Taxes recoverable & prepaid, net

221,274

238,294

238,294

238,294

238,294

238,294

238,294

238 294

Inventories

183,668

410,182

414,130

493,849

540,586

593,770

617,849

645 052

Biological assets

95,961

153,338

160,068

185,787

204,480

217,871

227,378

234 087

Total current assets

809,720

1,121,040

1,213,786

1,438,307

1,683,444

1,992,383

2,292,023

2,597,602

PP&E, net

502,752

728,371

858,102

930,303

1,001,015

1,039,483

1,079,256

1 120 632

Intangible assets, net

65,563

91,087

106,858

117,854

125,519

130,863

134,589

137 186

Goodwill

85,989

137,227

137,227

137,227

137,227

137,227

137,227

137 227

Deffered tax assets

10,723

21,502

21,502

21,502

21,502

21,502

21,502

21 502

Other non-current assets

97,862

19,805

19,805

19,805

19,805

19,805

19,805

19 805

Total non-current assets

762 889

997,992

1,143,495

1,226,691

1,305,068

1,348,880

1,392,379

1,436,352

 TOTAL ASSETS

1,572,609

2,119,032

2,357,280

2,664,998

2,988,512

3,341,263

3,684,402

4,033,954

LIABILITIES

Trade accounts payables

27,055

25,490

31,750

37,720

41,185

45,098

46,861

48 845

Advances from customers and other current liabilities

102,029

157,338

172,272

204,633

223,410

244,622

254,176

264 934

Short-term borrowings

234,514

167,348

296,298

333,938

376,033

421,810

468,174

515,234

Current portion of long-term borrowings

31,392

98,622

-

-

-

-

-

-

Total current liabilities

394 990

448,798

500,320

576,291

640,628

711,531

769,211

829,014

Long-term borrowings

152,684

414,238

462,912

523,320

590,880

664,349

738,759

814,287

Obligation under finance lease

3,373

12,622

12,622

12,622

12,622

12,622

12,622

12,622

Deferred tax liability

24,119

26,356

26,356

26,356

26,356

26,356

26,356

26,356

Other non-current liabilities

153

6,317

6,317

6,317

6,317

6,317

6,317

6,317

Total non-current liabilities

180,329

459,533

508,207

568,615

636,175

709,644

784,054

859,582

SHAREHOLDERS' EQUITY

Share capital

1,945

2,104

2,104

2,104

2,104

2,104

2,104

2,104

Share premium reserve

321,556

463,879

463,879

463,879

463,879

463,879

463,879

463,879

Subscrived capital

137,354

-

-

-

-

-

-

-

Additional paid-in capital

39,944

39,944

39,944

39,944

39,944

39,944

39,944

39,944

Equity‑settled employee benefits reserve

1,211

1,211

1,211

1,211

1,211

1,211

1,211

Revaluation reserve

15,049

15,049

15,049

15,049

15,049

15,049

15,049

15,049

Translation reserve

-162,152

-167,082

-167,082

-167,082

-167,082

-167,082

-167,082

-167,082

Retained earnings

617,878

824,578

962,631

1,133,968

1,325,587

1,533,965

1,745,014

1,959,235

Shareholders' equity

971,574

1,179,683

1,317,736

1,489,073

1,680,692

1,889,070

2,100,119

2,314,340

Minority interest

25,716

31,018

31,018

31,018

31,018

31,018

31,018

31,018

Total shareholders' equity

997,290

1,210,701

1348754

1,520,091

1,711,710

1,920,088

2,131,137

2,345,358

TOTAL LIABILITIES & EQUITY

1,572,609

2,119,032

2357280

2,664,998

2,988,512

3,341,263

3,684,402

4,033,954