Fitch Downgrades Kernel Holding to ‘CC’

Fitch Ratings has downgraded Kernel Holding S.A.’s Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDR) to ‘CC’ from ‘CCC’. Fitch has also downgraded the company’s USD300 million senior unsecured notes due 2024 and USD300 million senior unsecured notes due 2027 to ‘C’/RR6/0% from ‘CCC’/RR4/50%.

The downgrades reflect the difficult operating conditions Kernel has been facing since the beginning of the Russian invasion, the severe disruption in export activities, the potentially weakening liquidity profile and our understanding that it has submitted waiver requests connected to delaying repayment of its bank facilities. We believe these events have led to a higher level of credit risk. The ‘CC’ IDR indicates that default of some kind appears probable, despite management’s efforts to inject liquidity via the divestment of certain assets to the main shareholder. Failure to obtain lenders’ consent to delay payments would likely lead to a downgrade.

KEY RATING DRIVERS

Imminent Significant Senior Secured Maturity: Kernel is seeking to postpone repayment of drawings, mostly under its senior secured bank debt due between March and September 2022 for a total USD880 million. This represents 52% of its total financial obligations. The borrowings include drawings under pre-export facilities (PXF; USD420 million sunflower oil pre-export credit facility and USD200 million grain PXF) pledged against commodities as well as other bilateral secured and unsecured loans. Negotiations to finalise the new terms and extend maturities are on-going, but we understand from management that the company has made some progress.

Repayment of these facilities is reliant on proceeds from exports that have been constrained. Also, the facilities are secured against inventories, which we believe could start losing value if not exported in the next few months.

Disrupted Export Operations: Since the Russian invasion, Kernel’s business has been heavily affected by the inaccessibility of Black Sea ports. Consequently, Kernel stopped procurement of grain and oilseeds from farmers and substantially reduced export volumes. Since the domestic market of grain and oil remains low, unsold volumes are safely stored, with only USD41 million book value of inventory located on occupied territory as of end-March. The group remains focused on establishing alternative export routes via Ukraine-EU land borders by the group’s own railway wagons, cargo cars and renting third-party transportation, but there has been limited progress so far due to numerous bottlenecks along these routes.

Divestment of Farming Assets: To de-risk the business and improve liquidity, on 26 April 2022 Kernel entered in a USD210 million agreement to sell 134,000 hectares of land with related infrastructure, machinery and working capital. We believe the disposal will take time and is subject to some execution risk since completion of the transaction is also conditional on filing at the registration office, which has been gradually reopening after a temporary closure due to martial law. USD20 million of the selling price was received in advance but the remaining amount will be received 90 days after completion. We expect proceeds to be used for repayment of outstanding debt or investments.

Russia’s Invasion of Ukraine: Russia has launched missile, ground and sea operations across multiple fronts, including Kyiv. There is high uncertainty about the extent of Russia’s ultimate objectives, the length, breadth and intensity of the conflict, and its aftermath. However, multiple infrastructure and industrial facilities have already been damaged and the risks to employee wellbeing, severe disruption to operations or plant and equipment are high.

DERIVATION SUMMARY

Kernel compares well with Moldovan agro-industrial business trader Trans-Oil (B), due to their similar operations and vertically-integrated models, which include sizeable logistics and infrastructure assets. The main difference in business models is Kernel’s integration into crop growing, which limits sourcing and procurement risk, and a wider and diversified customer base. Kernel also enjoys greater business scale and a larger sourcing market, which before the war provided greater protection from weather risks.

KEY ASSUMPTIONS

KEY RECOVERY RATING ASSUMPTIONS

The recovery analysis assumes that Kernel would be considered a going concern in bankruptcy and that it would be reorganised rather than liquidated. We have assumed a 10% administrative claim.

Kernel’s going-concern EBITDA is based on 2020 EBITDA, i.e. before both the Russian invasion of Ukraine and the high point of the agricultural commodities cycle initiated in 2021. We have discounted this by around 50% to reflect disruptions in exports and local operations resulting from Russia’s invasion, vulnerability to FX risks and the volatility of grain and sunflower seeds prices. The USD200 million GC EBITDA estimate reflects our view of a sustainable, post-reorganisation EBITDA level, upon which we base the valuation of Kernel.

We use an enterprise value/EBITDA multiple of 4x to calculate a post-reorganisation valuation and to reflect a mid-cycle multiple. The multiple is the same as that for MHP, a Ukrainian poultry processor.

We do not consider Kernel’s PXF as fully drawn in our analysis but have assumed the amount outstanding as of end March 2021 remains unchanged. Unlike a revolving credit facility, a PXF has several drawdown restrictions and the availability window is limited to only part of the year. Senior unsecured Eurobonds rank after senior bank loans secured by property plant &equipment and short -term debt incurred at operating companies, i.e. mostly PXF secured by inventories.

The principal waterfall analysis generates a ranked recovery for the senior unsecured debt, in the ‘RR6’ category, leading to a ‘C’ rating for senior unsecured bonds. The waterfall analysis output percentage based on current metrics and assumptions is 0%.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

– An upgrade is unlikely at this point. The resumption of export activities, an improved liquidity position and a relaxation of the restrictions on cross-border FX payments would be positive for the rating

Factors that could, individually or collectively, lead to negative rating action/downgrade:

– Evidence of a default or default-like event including, entering into a grace period, entering a temporary waiver or standstill following non-payment of a financial obligation, announcement of a distressed debt exchange or uncured payment default.

BEST/WORST CASE RATING SCENARIO

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

LIQUIDITY AND DEBT STRUCTURE

Potentially Weakening Liquidity: As of March 2022, the company had USD372 million of cash (largely held offshore) on balance sheet, which the company aims to utilise for its agricultural operations, together with expected proceeds from asset divestment of USD210 million. We believe there should be sufficient liquidity to cover the USD40 million coupon payment on senior unsecured bonds due in October 2022 and continue operating during 2022. However, if export flows remain subdued, inventories backing PXF start losing value and lenders do not accommodate the extension request on USD880 million bilateral loans, we expect the company to face liquidity tensions. We also believe that the company’s access to the undrawn facilities is compromised.

ISSUER PROFILE

Kernel is the world’s largest sunflower oil producer and exporter.

Tags: Ukraine, sunflower oil, Kernel, war