MHP (MHPC: LSE) is a vertically integrated poultry company based in Ukraine. The company grows its own grain on land it owns, which is primarily used to raise poultry. The poultry is then sold to global food markets, along with the leftover grain as well as prepackaged meats. It is Ukraine’s largest poultry producer and is among the top producers in the world, generating nearly 60% of its revenues from export markets, primarily the EU and MENA. The company has three primary operating segments 1) Poultry and Related Operations 2) Grain and 3) Other (Packaged Meats).

MHP is currently trading at $11.20, but should be valued lower given the poultry industry’s limited growth prospects, poor management, and the untenable macro situation in Ukraine.

Poultry: an uncertain industry

According to OECD and FAO data, poultry consumption growth across the world is slowing down after a decade long surge in growth. Traditional poultry is facing threats from several angles. First, there is the threat of substitution from clean meat or plant-based meat products. The IPO of Beyond Meat (which soared 163% in one day) is part of a wider trend: as consumers are beginning to turn to substitutes for traditional animal products, so too are investors. Some industry rivals like Tyson are heavily invested in clean meat substitutes, while MHP is not. As replacements become cheaper and taste continues to mirror traditional meat products, poultry companies that stick to the old ways may become an anachronism.

The increasing likelihood of disease may also undermine the industry’s revenues. We saw it before in 2014-2015, when in a 6-month period, more than 50 million chickens and turkeys in the US died of avian flu (about 15% of total population). As viruses and bacteria continue to build up resistance this threat becomes even more salient. MHP claims to be working to become antibiotic-free (without any date deadline), but that policy would not save the company’s revenue in the case of an outbreak.

Further, the company’s EBITDA margin has been steadily shrinking over the last five years, revealing that its vertically integrated business model may not be completely insulated from outside variability affecting feed and related factors.

The company’s P/E relative to some EM and DM counterparts demonstrate that MHP’s stock is cheaper compared to other poultry producers. However, the poultry industry’s prospects do not provide enough downside protection to justify investment.

Company Name Exchange Market Cap (billions USD) P/E Yield ROE ROA
MHP LSE $1.21 10.1 6.60% 14.9% 4.80%
Charoen Pokphand Foods PCL BK $7.25 15.5 2.30% 9.6% 1.72%
Kernel Holding S.A. WSE $1.14 21.4 1.63% 11% 8.00%
RosAgro LSE $1.54 8.07 6.80% 13% 5.00%
BRF SA NYSE $6.46 N/A 3.42% -22% 0.27%
Tyson NYSE $27.43 14.2 2.00% 15.4% 6.30%

Poor Management

MHP’s management has allocated capital suboptimally over the past several years. After initiating a dividend in 2014, the company has distributed $80M to shareholders for the past three years, and looks to follow this trend moving forward. In the past five years, the company has not engaged in net buybacks. MHP’s ROE has been volatile – ranging from -23% in 2015 to 30% in 2017 – and reflects poor capital allocation.

Although it has distributed some cash back to shareholders, investors are justified in desiring higher yields given the somewhat misguided Capex decisions management has made. The company has invested heavily in the EU and MENA through acquisitions over the last 3 years, despite most projections showing chicken consumption and consumption growth stemming from East, South East, and South Asia as well as Latin America in the next two decades. While focusing on the EU and MENA, MHP still has very little exposure to these growth markets (less than 5% of its total exports go to these regions). The EU’s chicken consumption is only projected to grow about 1% by 2027. Favorably, MHP is exposed to two major growth sites in MENA, Saudi Arabia and Egypt, but its investments in Europe at the expense of creating deeper distribution channels in Asia will likely be proven ill-advised.

Though the company invests in cutting edge technology, all investments are designed to improve operational efficiency, rather than in response to potential disruption. Tyson and Cargill allocate significant resources to research and develop clean meats, which, if ever successful, would be more sustainable, cheaper to produce, and better for the environment. Without some investment into clean meat technology, MHP may be completely left behind if there is ever a breakthrough.

In addition to poor capital allocation, the company has revealed itself to be untrustworthy. For many of past several years, MHP’s CEO and founder, Yuriy Kosyuk, has clearly stated that increasing land reserves is a top priority for the company. In 2014, he said he wanted to expand the landbank to 450,000 hectares (HA). In 2015 the goal was to increase the land bank by 50,000 HA to 420,000 HA. And finally in 2018, he stated that the goal was to increase the landbank to 500,000 HA. Through all this, the land bank has remained the same 370,000 HA, though there has been no acknowledgement of MHP’s inability to achieve its goals.

The company also has a tendency to over-project future production without any acknowledgement of previous error. For example, in the 2012 Financial Reports Press Release, the company stated that, by 2018, it expected the Vinnytsia complex to produce 800,000 tons of poultry per year. Six years later, Vinnytsia fell 23% short of the stated goal. Missing projections happens, but never acknowledging mistakes and then boldly announcing more aggressive objectives for 5 years into the future is problematic: it demonstrates a lack of reflection and willingness to adjust future plans.

Even more troubling is that in the 2016 year end report, the company misrepresented the previous year’s production to inflate y/y growth numbers. In 2016, the report stated “Poultry production volumes reached 573,003 tonnes, up by 10% year-on-year (12M 2015: 519,495 tonnes),” and yet in the 2015 report, it was reported that  “Poultry production volumes increased by 4% to 566,600 tonnes.” No accounting changes could alter how the company measures metric tons.

Finally, all of the annual reports for the last several years discuss human rights as a priority, yet MHP has been caught on at least four occasions committing direct human rights abuses, one involving framing a protestor, and three involving beatings. Again, there was no acknowledgement of wrongdoing in any official statement and no policy change.

Ukraine – the source of 41% of the company’s revenues – has a risky outlook

Ukraine’s macroeconomic environment is volatile and uncertain, which does not bode well for MHP, since nearly half (41%) of its revenues originate in Ukraine. According to Morgan Stanley, Ukraine’s GDP growth is set to slow to 2.7% and 2.6% in the next two years, down from 3.3% last year. On a more positive note, CPI is expected to fall to 7% this year and 6.7% in 2020, down from over 40% in 2015 and 14.4% in 2017.

Though the projections are neutral, outcomes may be much more negative. Currently, Ukraine is overly reliant on IMF loans, but is inconsistent in obeying the IMF’s terms of engagement. Any breakdown in relations with the IMF could trigger market panic, yet it appears that neither president-elect Volodymr Zelenskiy nor Prime Minister Volodymr Groysman are particularly worried by this possibility. Groysman’s insistence that gas continue to be heavily subsidized by the government directly contradicts a previously-adopted (and IMF required) government resolution that would push gas prices toward real market levels. If the Rada and Zelenskiy refuse to allow gas prices to normalize, IMF assistance will likely come to a halt, and Ukraine’s development will stagnate or reverse. Meanwhile, Kyiv faces $36B worth of debt obligations over the next three years. This debt mountain will be nearly impossible to pay back without IMF assistance.

Concurrently, the fight against corruption continues to backslide in the courts. In February, Ukraine’s Constitutional Court struck down a law criminalizing illegal enrichment. Passing the law in 2015 had been a condition on which Ukraine was able to receive previous bailout loans from the IMF. Further, the court’s ruling that the nationalization of PrivatBank was illegal, despite massive theft and fraud, is unlikely to give investors more confidence in a country so infamous for its corruption.

Right now CFR’s Sovereign Risk Tracker ranks Ukraine the third most likely country to default, behind only Lebanon and Argentina. In the case of sovereign default, Ukraine’s economy will be shattered and domestic consumption should fall precipitously. The devaluation of the hryvnia should make up for some of the lost revenue as exports will likely increase, but not enough to offset rising costs and depressed domestic demand.

The last time the NBU was faced with a crisis in 2015, it raised interest rates to 30%, which negatively impacted MHP, dragging net income into the red. Currently, the company has the same leverage levels as it did then, and is therefore at risk in the case of central bank tightening. A leverage ratio of 2.5 is not ominous in isolation, but in the context of the uncertain Ukrainian economy and dysfunctional political system, such leverage could be cause for concern.  

Upside Risks

There are three primary upside risks related to MHP.

  1. The poultry industry is stable and will continue to grow at the rates we saw over the last decade. There is a chance that clean meats make little progress over the coming years in cost and quality terms, African swine flu decreases global supply of pork over the long term and raises poultry demand, and consumption growth numbers outperform projections. In this case, poultry companies, including MHP are set to profit handsomely.
  2. Capital allocation has been increasingly friendly. The company’s free cash flow is healthy – investors can therefore be assured they are being compensated for the risk of investing in a company with flawed management.
  3. Ukraine isn’t going to default and is strengthening its corruption laws. Kyiv and the IMF will continue to work together and Ukraine pays down all its debt on time. Gas prices normalize to market levels because of IMF cooperation, and rise slightly further because of Gazprom’s refusal to supply more gas to Ukraine. MHP’s profit margins shrink, but Ukraine’s economic outlook looks increasingly bright. Meanwhile the anti-corruption court becomes Poroshenko’s long-lasting legacy and corruption levels slowly decrease , thus oiling the gears of the Ukrainian markets even further.

Bottom Line

MHP’s main downsides stem from the poultry markets it has chosen to pursue, weak management, and the country it resides in. At its current price, MHP does not provide enough of a margin of safety to be worthy of investment in such uncertain times.