In accordance with our criteria, a company’s local currency long-term rating may exceed the level of the long-term rating and T&C assessment on the related sovereign only if in our opinion the company is significantly sheltered from sovereign and country risk factors (see “2008 Corporate Criteria: Analytical Methodology,” published April 15, 2008, and “Methodology: Criteria For Determining Transfer And Convertibility Assessments,” published May 18, 2009. We take the view that UAI is not sufficiently well-insulated from sovereign and country risks to achieve local currency ratings that exceed our T&C assessment on Ukraine. We base our opinion on the concentration of the company’s operating assets in Ukraine and its inability, in our view, to repay foreign debt with cash flow generated by offshore subsidiaries or through foreign parent support. Although we see UAI’s relatively high export-to-sales ratio as a mitigating factor, the various government-imposed export embargoes and UAI’s dependence on public infrastructure (port and railways) to access customers increases its exposure to country risk.
The rating on UAI continues to reflect our assessment of the company’s business risk and financial risk profiles as “weak” and “highly leveraged,” respectively. Our assessment of UAI’s business risk primarily reflects its participation in the volatile agricultural industry and the high risk, in our view, of doing business in Ukraine. Moreover, there’s a history of Ukrainian government intervention in UAI’s markets. We think UAI’s sales, profitability, and cash flow could weaken if the Ukrainian government were to interfere in agricultural markets in the future, including by imposing new restrictions on export sales. In addition, the highly seasonal nature of UAI’s business (entailing fluctuations in working capital) and the unpredictability of weather patterns are key risks for the company and the rating. Many of these risks are largely out of the company’s control. The risk of government restrictions on exports is limited in the near term, though, in our view, given its need for hard currency.
Still, we believe that UAI benefits from its lease rights to high-quality farmland, low production costs, the currently favorable trading environment (in terms of pricing and demand) for its crops, and a natural hedge against weather risk with 64 farms spread all over Ukraine. A few years ago, the company decided to switch a significant amount of its production to corn. We consider that this decision has so far been a good one.
We assess UAI’s financial risk profile as highly leveraged, primarily due to the volatility in profit and cash flow that is inherent to the agricultural industry; UAI’s reliance on short-term debt; and its expansion program, which will likely consume most of its free cash flow. We currently assume that the favorable trading environment will continue and that the significant EBITDA growth of about 20% we forecast in 2012 should enable UAI to extend its short-term debt next year. However, liquidity problems could develop if conditions for crop producers in Ukraine deteriorated significantly, and if the company was unable to extend its debt that matures in the first half of 2013. Nevertheless, we forecast that UAI’s credit metrics should remain stronger than typical levels for corporate issuers in the “highly leveraged” financial risk category.
We currently view UAI’s liquidity as “less than adequate” under our criteria, primarily due to the high amount of short-term debt in the company’s capital structure. Although we forecast a ratio of cash sources to cash uses of about 1.4x in 2012, it is possible that UAI’s inability to renew its short-term debt in 2013 or after could result in the ratio falling to less than 1x. In addition, we note UAI’s history of technical defaults under some of its debt agreements.
Our estimate of cash sources includes $65 million-$70 million of annual funds from operations. UAI also has about $100 million of biological assets and produce inventories on its balance sheet. In addition, we understand that the company has $50 million of committed short-term working capital credit lines that expire in the first half of 2013, in line with local agribusiness practice to finance working capital with short-term facilities, including a fully-funded $40 million line with the European Bank for Reconstruction and Development (not rated). We believe that availability under the $50 million lines will fluctuate throughout the year due to seasonality, but will generally be moderate. As of March 31, 2012, availability totaled about $10 million, and UAI had about $7 million of cash.
We also understand that UAI has already raised $28 million of new working capital credit lines and seeks to establish new lines of an aggregate $45 million during the second half of 2012, which we do not factor into our liquidity calculations. UAI has also indicated it’s considering prolonging EBRD working capital facility.
Estimated cash uses include:
-- Debt maturities (including about $50 million in 2013, assuming fully drawn credit lines);
-- About $15 million-$30 million of peak-to-trough working capital requirements; and
-- Maintenance capex of about $2 million.
It is our understanding that although negative covenants exist in UAI’s credit agreements, there are no maintenance financial covenants, with the exception of a 1x minimum current liquidity covenant at the Ukrainian operating company level. We also believe that UAI’s primary credit arrangements include material adverse change clauses.
The negative outlook on UAI mirrors that on Ukraine. Under our criteria, the long-term sovereign rating and T&C assessment on Ukraine constrain the rating on UAI, based on our view that the group’s cash flow generation is sensitive to country risk.
A downgrade of Ukraine to ‘B-’ or lower would trigger a downgrade of UAI by a similar number of notches.
We could also lower our rating on UAI if:
-- It faced unexpected and far-reaching regulation changes that undermine its business or financial risk profile.
-- We anticipated deterioration in its profitability and credit metrics, including leverage (debt to EBITDA) of more than 4x. This could result from a potential poor future harvest due to extreme weather conditions, or a steep drop in crop prices, especially corn. We estimate that leverage would exceed 4x if EBITDA fell by 40%.
-- We projected a reduction in liquidity, which could occur if UAI were unable to renew its short-term credit lines.
Ratings stability for UAI, all else being equal, would depend on a revision of the outlook to stable on Ukraine.
Related Criteria And Research
-- Long-Term Rating On Ukraine Lowered To ‘B’ On External Financing Needs; Outlook Negative, Dec. 7, 2012
-- Methodology: Criteria For Determining Transfer And Convertibility Assessments, May 18, 2009
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
-- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Principles Of Credit Ratings, Feb. 16, 2011
-- Use Of CreditWatch And Outlooks, Sept. 14, 2009
Ratings Affirmed; Outlook Action
Ukrainian Agrarian Investments S.A.
Corporate Credit Rating B/Negative/-- B/Stable/--