Fitch Places Kernel's IDRs on RWP; Rates Planned Eurobond 'B+(EXP)'


17 Jan 2017 6:49 AM


Fitch Ratings-Milan/London-17 January 2017: Fitch Ratings has placed Kernel Holding S.A.'s Long-Term Local-Currency (LC) and Foreign-Currency (FC) Issuer Default Ratings (IDRs) on Rating Watch Positive (RWP). The agency has also assigned Kernel Holding S.A.'s planned benchmark USD unsecured Eurobond an expected rating of 'B+(EXP)'.

The RWP reflects the scope for improvement in the company's liquidity if Kernel successfully refinances a substantial portion of its debt with the planned Eurobond and potentially a lengthening of pre-export financing (PXF) facilities. If successful, this could lead to a one-notch upgrade of Kernel's LC IDR to 'B+' (from 'B') and its FC IDR being rated above Ukraine's 'B- 'Country Ceiling and be aligned with the company's LC IDR.

The final ratings of the bonds are contingent upon receipt of final documents conforming to the information already received by Fitch. A full list of rating actions is detailed below.

KEY RATING DRIVERS
Potential LC IDR Upgrade
Kernel intends to improve its debt structure by substituting its mostly short-term debt with a five-year benchmark Eurobond issue and/or new three-year PXF facilities. As a result, post-refinancing most of Kernel's current debt (approximately USD600m as of January 2017) would carry maturities of between three and five years and there will be sufficient, long-dated extra resources to cover working capital peaks.

Kernel's LC IDR is currently capped at 'B' by liquidity risks due to a high proportion of short-term debt and the company's dependence on one-year PXF facilities to fund seasonal procurement of sunflower seeds and grain. Should the refinancing complete successfully, we expect an improvement in Kernel's liquidity ratio to 1.5x-1.8x (0.8x as at end-September 2016). An enhanced financial flexibility would allow an upgrade of the LC IDR by one notch to 'B+'.

FC IDR Likely Above Country Ceiling
We also expect to upgrade Kernel's FC IDR above Ukraine's Country Ceiling of 'B-' due to the improvement in the company's hard-currency external debt service ratio upon successful refinancing.

Assuming the refinancing of most of Kernel's current debt (approximately USD600m as of January 2017) with a five-year bond issue and new three-year PXF lines, Fitch expects Kernel's hard-currency external debt service ratio to be sustained above 1.5x for between 18 months and two years to be commensurate with ratings above the Country Ceiling by up to two notches at 'B+'. This would enable us to align Kernel's FC IDR with the LC IDR.

Rating Sustainability Above Country Ceiling
Our projections are premised on the expectation that the company will maintain substantial off-shore cash balances and a comfortable schedule of repayments for its foreign currency debt over financial years ending 30 June 2017-2020. Moreover, since the company does not rule out investments (capex, M&A and higher working capital to support its suppliers) that could require raising further debt over this period, maintaining the FC IDR on a par with the LC IDR will also be premised on Kernel obtaining long-term funding of at least three-year tenor for any such investments if not covered by internally generated cash flow.

Adequate Recovery for Unsecured Bondholders
The proposed Eurobond is rated in line with Kernel's expected FC IDR of 'B+' after the refinancing, reflecting average recovery prospects given default. The Eurobond will be issued by the holding company Kernel Holding S.A. but rank pari passu with other unsecured debt, which is raised primarily by operating companies, due to suretyships from operating companies, altogether accounting for more than 80% of the group's FY16 EBITDA and assets. Our recovery analysis also takes into account potential significant prior-ranking debt up to USD300m, should the company sign new secured PXF facilities.

Moderate Reliance on Domestic Environment
Kernel's LC IDR remains above Ukraine's LC IDR of 'B-', reflecting the company's limited reliance on Ukraine's banking system and Fitch's assessment that the company's moderate dependence on the local operating environment is not prejudicial to its performance. Kernel performed strongly over the last two years and had healthy access to external liquidity despite economic and political turmoil in Ukraine. This is due to its substantial export-oriented operations (FY16: 96% of revenue) and therefore limited exposure to recessionary pressures in its domestic market.

Profits May Slide
We expect Kernel's Fitch-adjusted EBITDA in FY17 will be supported, as in FY16, by healthy yields in the farming segment and enlarged crushing capacity following the acquisition of Creative's sunflower seed-crushing plant. However, a decrease in EBITDA to USD250m-USD260m is possible from FY18, due to higher crop-growing costs, assuming no material hryvnia depreciation, and more conservative crop-yield assumptions for the farming division. Nevertheless, operating cash flows should remain sufficient to cover expected capex and dividends.

Re-leveraging Appetite
Kernel plans to increase net debt/EBITDA to 1.5x-2.0x through bolt-on acquisitions and investments in terminal capacity and its land bank in Ukraine, after reducing it from to 1.0x in FY16 from 3.6x in FY14. This would correspond to similar net readily marketable inventories (RMI)-adjusted funds from operations (FFO)-adjusted leverage in FY17-FY19, which is conservative and in line with the 'BBB' median for commodity trading and processing companies.

We also believe that investment plans are largely scalable and management will not jeopardise Kernel's financial standing and access to liquidity if operating cash flows are weaker than expected.

Moderate Commodity Diversification
Kernel is focused only on few commodities, primarily sunflower oil and meal, corn, wheat and barley, and remains largely reliant on Ukraine for sourcing them. This exposes it to risks of a contraction in the Ukrainian harvest, but so far these have not materialised despite a weakening in farmers' access to external financing over the past three years. However, even if the harvest declines, we believe Kernel would be able to manage the risks due to its leading market position, ownership of port and other infrastructure assets and its better access to external liquidity than many of its Ukrainian competitors.

Adequate Sales Diversification
The rating benefits from Kernel's healthy diversification by destination countries and adequate customer concentration. Some diversification benefit is also provided from its Russian grain trading operations, which we estimate will contribute 10%-15% to Kernel's revenues in FY17-FY19, after the recent increase in capacity at the Taman port terminal.

Asset-Heavy Business Model
Kernel has a stronger FFO margin (FY16: 11%) than global agricultural commodity processors and traders. This is due to Kernel's asset-heavy business model with substantial processing operations (relative to trading) and infrastructure assets, and integration into farming. Kernel's asset structure and integration within operating segments allows the company to retain leading market positions in sunflower oil and grain exports and are positive for the credit profile.

DERIVATION SUMMARY
Kernel has smaller business scale and diversification than international commodity traders and processors. This is balanced by the company's conservative credit metrics and leading market position in Ukraine's agricultural exports. The operating environment in Ukraine contributes to lower ratings than Kernel's international peers.

Post refinancing, Kernel's ratings will likely be above Ukraine's Country Ceiling of 'B-' due to improvement of the hard-currency debt service ratio (as calculated in accordance with Fitch's methodology Rating Non-Financial Corporates Above the Country Ceiling).

KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
- Refinancing of most of USD600m debt outstanding as of January 2017 with new five- year bond and/or three year PXF facilities; full refinancing process to be completed by September 2017;
- Capex at around USD100m-USD120m a year, including construction of new terminal capacity and expansion of land bank by 150,000 ha;
- USD60m-USD70m pre-crop financing of farmers in FY17 and USD100m-USD120m in FY18-FY20;
- Stable dividends of USD20m a year;
- M&A spending not exceeding USD400m in total over the period;
- USD65m-USD80m of annual cash interest paid;
- EBITDA of USD255m-USD285m a year;
- Potential medium-term funding needs related to capex, acquisitions or working capital requirements covered by new secured debt of at least three-year tenor;
- Maintenance of substantial offshore cash balances to service hard-currency external debt;
- Internal liquidity ratio maintained at between 1.5-1.8x (defined as unrestricted cash plus RMI plus accounts receivables divided by total current liabilities)

RATING SENSITIVITIES
Future Developments That May, Individually or Collectively, Lead to Positive Rating Action
Fitch is likely to upgrade Kernel's IDR to 'B+' upon completion of the contemplated refinancing under the following conditions:
-Eurobond issue with maturity of five years and amount of no less than USD355m
-Prospective peak working capital requirements over FY17-FY19 covered by PXF facilities with no less than three-year tenor

The resolution of the Rating Watch could extend beyond the typical six-month horizon.

Should the company not be able to procure the proposed refinancing, ratings will be removed from RWP and affirmed.

LIQUIDITY
Assuming refinancing completes at the expected terms, we project a liquidity ratio improving to 1.5x-1.8x (from 0.8x as at end-September 2016).

FULL LIST OF RATING ACTIONS

Kernel Holding S.A.
-- Long-Term Foreign Currency IDR: 'B-'; placed on RWP;
-- Long-Term Local Currency IDR: 'B'; placed on RWP;
-- National Long-Term Rating: 'AA+(ukr)'; placed on RWP;
-- Senior unsecured rating: assigned at 'B+(EXP)'/RR4

Contact:

Principal Analyst
Anna Zhdanova, CFA
Associate Director
+7 495 956 2403

Supervisory Analyst
Giulio Lombardi
Senior Director
+39 02 8790 87214
Fitch Italia S.p.A.
Via Morigi 6, 20123 Milano

Committee Chairperson
Pablo Mazzini
Senior Director
+44 20 3530 1021

Media Relations: 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.

Summary of Financial Statement Adjustments
Leases: Fitch has adjusted FYE16 debt by applying a multiple of 5.0x of yearly operating lease expense related to long-term assets (USD35m for FY16).

Cash: Fitch adjusted available cash at FYE16 by deducting USD30m to reflect working-capital requirements throughout the year.

RMI: Fitch calculates Kernel's credit metrics by excluding the debt and the interest costs (the latter reclassified as operating cost) used to finance RMI for which the agency has reasonable assurance from management that they are protected against price risk. In FY16 Fitch judged USD129m of Kernel's inventory as readily marketable, based on USD184m of reported RMI. Therefore Fitch adjusted the group's debt and gross cash interest down by USD129m and USD12m respectively.

Applicable Criteria
Country-Specific Treatment of Recovery Ratings (pub. 18 Oct 2016)
Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)
National Scale Ratings Criteria (pub. 30 Oct 2013)
Rating Non-Financial Corporates Above the Country Ceiling (pub. 21 Jun 2016)
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers (pub. 21 Nov 2016)

Additional Disclosures
Dodd-Frank Rating Information Disclosure Form
Solicitation Status
Endorsement Policy


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