Why stock prices of Ukrainian agricultural companies drop on European stock exchanges

Kernel Agro Holding, having been listed on the Warsaw Stock Exchange since 2007, plans to exit the Polish exchange. Yaroslav Serputko, Audit Director at Deloitte Ukraine, explains the situation with the stock market capitalization of Ukrainian agricultural companies and whether there are any prospects for growth.

Kernel’s intentions to delist from the Warsaw Stock Exchange and buy back shares from shareholders have stirred the market. Among the reasons why the major shareholder is proposing delisting are poor liquidity of the shares and significant undervaluation of the company by investors on the stock exchange.

The exit may be due to a full-scale war launched by Russia, which devastated Kernel’s operations.

However, the problems with poor liquidity and low valuation of Ukrainian agricultural companies began even before Russia’s active hostilities against Ukraine, and even before the quarantine restrictions were imposed due to the COVID-19 pandemic. It is important to understand the underlying factors when predicting the prospects for the recovery of the market value of Ukrainian issuers.

Why the situation was better before 2020

Let’s analyze the market capitalization to cost of capital ratio (price-to-book ratio) of the leading public agricultural holdings at the end of 2019.
Market capitalization is calculated based on the number of issued shares and the price (quotation) per share, whereas the cost of capital (intrinsic value) is defined as the value of assets less liabilities (net assets) and is derived from published financial statements of companies.

The P/B ratio of all Ukrainian agricultural holdings was below 1, meaning that the market valued these companies below the cost of their capital. However, MHP’s data presented below shows that the situation was better in previous years.

What could be the reason for the drop in the P/B ratio at the end of 2019?

In terms of market capitalization, most analysts agree that investors did not react well to the decline in profitability of Ukrainian agricultural holdings, as they had been enjoying high operating profits as export-oriented companies for several years before, mainly due to the devaluation of Ukrainian Hryvnia back in 2014-2015.

In 2018-2019, this effect wore off, while the production costs started to rise: wages – due to the outflow of labour migrants – and land lease costs. Furthermore, in 2019, investors feared that the expected land reform would encourage agricultural holdings to invest in land, including at their own expense, which would significantly weaken their ability to pay dividends to shareholders.

As for the cost of capital, its change was primarily of an accounting nature. For example, the increase in capital gain of MHP by almost one and a half times was explained by the revaluation of property, plant and equipment, foreign exchange gains, and the positive effect from translating financial statements into the presentation currency (the latter two were closely related to the strengthening of Ukrainian Hryvnia at the end of 2019).

The same was observed in financial statements of most agricultural holdings.
At the start of 2020, the COVID-19 quarantine aggravated the situation with low market values. The P/B ratios of MHP, Kernel, Astarta and IMC declined, whereas Ovostar showed a slight increase.

The varying behavior and depth of changes in share prices of agricultural companies could be related to the following factors:

• size and business models of the companies, in addition to being listed on different stock exchanges (LSE and WSE);
• comparison base;
• profitability and debt burden (presented below are the data as of the end of 2019).

Starting from 2020, considering the change in P/B ratio, the situation was as follows:

The highest share prices of the above companies for the last five years were in October-November 2021, when market participants reasonably expected to see record financial performance.

The year 2019 was truly a remarkable one: a record high harvest, high prices for agricultural products, and low interest rates. However, even under such favorable conditions, the market capitalization of MHP, Kernel, and Astarta remained significantly below their cost of capital.

Present situation

In 2023, market capitalization of Ukrainian public agricultural holdings is massively below the book value of their capital.

For example, Kernel’s equity capital, with a current price of around PLN 20 per share, is valued at PLN 102 per share. At the same time, the usual EU public companies’ multipliers, where the value of a company may exceed its EBITDA by 5, 7 or 10 times, are still a distant dream for our companies.
Let’s assume that the war in Ukraine is finally over. Will the value of Ukrainian public agricultural holdings increase after that? There will be a positive short-term effect due to reduced country risk.

However, there are fundamental issues that limit their value:

• Limited effectiveness of managing the size and cost of the debt burden in a high-interest rate environment and a narrowing list of alternative financing instruments.
• Unstable financial performance and limited forecast ability due to the seasonal nature of business, fluctuations in international commodity prices, as well as sharp changes in hryvnia exchange rate and interest rates. While ensuring the macro-financial stability is the state’s prerogative, the initiative to hedge financial risks should come directly from companies.
• Lack of a clear dividend policy. After going public, very few companies demonstrate regular and predictable dividend payments, as profits are mostly reinvested in business expansion. However, long-term investors expect to see a predictable dividend stream, while speculative investors are motivated by the share price fluctuations.
• Gaps in the corporate governance system. Many Ukrainian companies are not ready to adopt a collegial approach to governance after an IPO, which negatively affects their investment attractiveness.
• Uncertainty about the functioning of a fully-fledged agricultural land market. Access to the land market for law firms, especially for overseas companies, remains an open question. Without this, it is difficult for companies to develop an investment strategy, and for investors – to predict future capital expenditures and dividend potential of companies.

Unless these issues are addressed, the capitalization of Ukrainian public agricultural holdings is unlikely to increase in the future.

This article was prepared for Forbes Ukraine.