October 1, 2014 / 2:12 PM / 3 years ago

Fitch Affirms Kernel at 'CCC'

(The following statement was released by the rating agency) MOSCOW/LONDON, October 01 (Fitch) Fitch Ratings has affirmed Luxembourg-based Kernel Holding S.A.'s (Kernel) long-term foreign and local currency Issuer Default Ratings (IDRs) at 'CCC'. A full list of rating actions is below. The affirmation reflects the political and economic uncertainty in Ukraine, where Kernel's assets and operations are mainly based, which may ultimately threaten its financial flexibility and ability to meet its debt obligations. Kernel's ratings are based on our expectation of weak credit metrics in FY14 (fiscal year-ending June 2014), its high reliance on working capital financing, dependence on grain and sunflower seed availability in Ukraine, vulnerability to soft commodity price risk and tax and export regulation. Currently we expect Kernel's leverage and interest cover metrics to return to pre-FY14 levels only by FY16-FY17 subject to a successful turnaround in its loss-making farming segment and reduced capex. The ratings continue to reflect Kernel's position as the largest sunflower seed processor and exporter of bulk sunflower oil in Ukraine and a top four grain exporter and farming operator in the country. Kernel's presence across the agriculture value chain, limited FX risk and maintained access to international bank's funding also support the ratings. KEY RATING DRIVERS Linkage to Sovereign Rating Kernel's ratings are constrained by Ukraine's Country Celling of 'CCC', reflecting the ongoing heightened uncertainty regarding the political and economic situation in the Ukraine, which may ultimately threaten the ability of Ukrainian corporates to meet their debt obligations. With zero exposure to Crimea, Donetsk and Lugansk regions, Kernel is removed from the military conflict in the Eastern part of the country and Ukraine-Russia tensions. Turnaround of Farming Critical for Deleveraging We expect Kernel's FFO to decrease to around USD85m in FY14 (FY13: USD116m) as a result of the lossmaking farming segment and lower sunflower oil prices. This would result in FFO adjusted leverage reaching 5.3x in FY14 (2013: 4.1x). We believe that turnaround of farming operations in FY15 is critical for Kernel's deleveraging in the medium term. Giving credit to management's efforts towards yield improvement and reduced capex plans, we expect FFO adjusted leverage to decrease to 4.2x-4.0x in FY17-FY18. This is also based on our assumption of declining soft commodity prices in FY15 and their stabilisation thereafter. Less Aggressive Growth Plans Fitch understands that after increasing leverage in FY14, Kernel will stick to a less aggressive growth strategy. Consequently, we expect the company to grow organically over the medium term with capex not exceeding 2.5%-3.0% of revenues. This should enable the company to generate positive FCF, despite expected dividend payments, and lead to a gradual improvement in credit metrics. High Dependence on Working Capital Funding As a soft commodity trader and sunflower seed processor, Kernel strongly depends on the availability of working capital financing, which is usually extended for one year. This leads to a high proportion of short-term debt, reaching 50-70% depending on season and high refinancing risks, which the company faces in July-August when its major trade finance facilities mature. We positively view Kernel's recent renewal of pre-export financing (PXF) facilities, which should fully cover the company's needs for FY15. This also proves the company's ability to maintain access to international banks' funding, despite the challenging economic environment in Ukraine. Diversification and Upper-end Integration Add Stability Kernel benefits from integration into processing and soft commodity trading and well developed infrastructure (silos and port terminals). Integration towards the upper end of the value chain ensures a higher stability of margin compared with pure farmers in the event of wide grain price fluctuations. Kernel's revenues from its Russian procurement and processing facilities, which we estimate at 16% in FY14, also provide some diversification benefit. Limited Hryvnia Depreciation Impact The recent sharp depreciation of the hryvnia should not jeopardise Kernel's capacity to service its debt, which is entirely foreign currency-denominated. Although the company's FY14-15 operating cash flow may be negatively affected by a lower amount of hryvnia-denominated VAT refunds when converted into US dollars, in the longer term we consider the company's operations as naturally hedged as dollarised revenues are well matched with US dollar-based operating and interest costs. RATING SENSITIVITIES Negative: Future developments that could lead to negative rating action on the foreign and local currency IDR include: - A liquidity shortage caused by limited available bank financing of working capital investments or by refinancing at more onerous terms than expected. - A severe shock from soft commodity prices, export restrictions, material reduction in VAT refunds or limited crop availability in Ukraine leading to material deterioration of Kernel's credit metrics. Positive: An upgrade of the local currency IDR would only be possible if Fitch considers there has been a sustained improvement in the issuer's operating environment. An upgrade of the foreign currency IDR would only be possible if Ukraine's Country Ceiling was raised. LIQUIDITY AND DEBT STRUCTURE Adequate Short-Term Liquidity, Refinancing Risks Adequate liquidity is supported by available cash of USD99m as of March 2014 together with recently re-established PXF facilities with a maximum limit of USD600m and expected positive FCF in FY15 assuming Kernel maintains control over its capex and working capital spending. Highly marketable inventories could further support liquidity (estimated at around USD450m as of March 2014). However, we note Kernel's refinancing risks, which could arise next summer when PXF facilities need to be renewed. FULL LIST OF RATING ACTIONS Long-term foreign currency IDR affirmed at 'CCC'. The rating is constrained by Ukraine's Country Ceiling of 'CCC' Long-term local currency IDR affirmed at 'CCC' National Long-term rating affirmed at 'A(ukr)' with Stable Outlook Contact: Principal Analyst Anna Zhdanova, CFA Analyst +7 495 956 9901 Supervisory Analyst Tatiana Bobrovskaya Associate Director +7 495 956 5569 Fitch Ratings CIS Ltd 26 Valovaya Street Moscow 115054 Committee Chairperson Pablo Mazzini Senior Director +44 20 3530 1021 Media Relations: Julia Belskaya von Tell, Moscow, Tel: +7 495 956 9908, Email: julia.belskayavontell@fitchratings.com; Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. Additional information is available on www.fitchratings.com. For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary. Applicable criteria, 'Corporate Rating Methodology', dated 28 May 2014, are available at www.fitchratings.com. Applicable Criteria and Related Research: Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage here Additional Disclosure Solicitation Status here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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