UkrProduct Group

I recently bought shares in this company at 17p. I think it could be a very lucrative investment.

What is it?
The company claims to be the leading branded dairy producer in the Ukraine with over 20% market share. Most of the revenue and profit comes from branded sales. They also have a skimmed milk business, which appears to be considerably lower margin and much more commoditised. The company’s stated strategy is to focus on the branded part of the business. They have historically recorded very respectable EBIT margins and ROCEs and CRFOIs in the 10-15% region. The company is AIM listed, with a current market cap of just under £8m. The balance sheet is strong with a net cash position as at the half year end in June.

Why I am buying it?
Valuation. The shares cropped up on both my deep value screen (shares trading below book value) and my more general Greenblatt screen (shares with high CFROIs on low valuations). This is a fairly unusual occurrence, as deep value ideas tend to be deep value for a reason – i.e. they are loss making or the margins/returns are heavily depressed.

This company trades on 2.6X historic EV/EBIT. However profits will be down this year due to the Ukrainian economy. In the first half, they generated £1.1m of EBIT, which was 11% lower than the same period last year. If I assume a similar level of EBIT in the second half then the valuation multiple would rise to a whopping 3.6X EV/EBIT. Cash flow has been even stronger due to a working capital inflow. Management actually expect an improvement in trading in the second half as the Ukrainian economy appears to have bottomed and they have launched a series of marketing initiatives for their major products.

In the UK the closest comparative company I can think of is Dairy Crest, which is valued at nearer to 9X EV/EBIT. If I put UkrProduct on even half that valuation I get over 40% upside. Interestingly the company has in the past traded on multiples considerably higher than this, suggesting that a valuation closer to Dairy Crest it is not unreasonable for the company’s assets.

Worth noting that a pure balance sheet valuation also suggests considerable upside. At the year end for 2008, the company was carrying £13.3m in inventories, receivables and cash. They also had property, plant and equipment valued at £10.5m. Of this, the depreciated Land and Buildings amounted to £5.3m (last re-valued in 2005), whilst the depreciated vehicle fleet was valued at £1.9m (they appear to own their own vehicles according to the conference call). Excluding all other assets, and subtracting total liabilities of £6.5m leaves an NAV of £14m, versus a current market cap of just under £8m. Therefore, assuming the reported numbers are correct, this investment has considerable margin of safety.

What are the risks?
Two main issues::

1) There are a number of company-specific issues affecting the company this year. Firstly, the depreciation of Hryvnia as the Ukrainian economy crashed has adversely affected the reported GBP numbers this year. Secondly, local producers of hard cheeses cut prices in order to stimulate demand. This has been negative for the company’s sales of processed cheese as consumers have switched from one to the other. Thirdly, Russia implemented a ban on diary imports from Belarus, which has had the effect of directing Belarusian dairy exports to Ukraine instead (particularly butter). To my mind, most of these are temporary issues which, at the very least, should not be expected to negatively impact profits further. The Hryvnia has stabilised, while the Ukrainian economy appears to have bottomed out. I have been unable to find much information on the Belarusian situation, although I cannot imagine that the Belarusian dairy export market is sufficiently large to destroy UkrProduct’s business.

2) The company is AIM listed and does not operate in the UK. Therefore, there is always a chance that it is one big scam. Against this I am encouraged by the company’s disclosure (numerous investor presentations, a results conference call etc.). The management team also own a lot of stock and appear to have a reputable business track record.

All in all, valuation (potential 3-4X upside) appears to more than offset the risk.