OREANDA-NEWS. Fitch Ratings has affirmed Ukraine-based poultry and agricultural producer MHP S.A.'s (MHP) Long-term foreign currency Issuer Default Rating (IDR) at 'CCC'. The rating is capped by Ukraine's Country Ceiling of 'CCC'. Fitch has also affirmed the company's Long-term local currency IDR at 'B-' with a Negative Outlook.

The ratings reflect the uncertainty regarding the political and economic situation in Ukraine, which may ultimately threaten MHP's ability to meet its debt obligations. They also reflect the company's exposure to FX and upcoming refinancing risks. Nevertheless, we note that MHP's business and financial profile remains strong relative to close peers, supported by growing exports, and more commensurate with the 'B' rating category. This profile might only be reflected in the event of a normalisation in the operating environment.

KEY RATING DRIVERS
Strong Business Model
MHP is the leading poultry producer in Ukraine and benefits from a strong market position with about half of the domestic market for industrially produced chicken. Its business model is supported by high vertical integration into grain sourcing and expansion of export markets. However, despite the increasing diversification from value-added products (meat processing and convenience foods) the group remains focused on poultry, grain and sunflower oil as a by-product of the crushing capacities in place.

Foreign Currency Rating constrained by Ukraine's Sovereign Rating
MHP's ratings are constrained by Ukraine's Country Celling of 'CCC' reflecting political and economic instability in the country. Any upgrade of the foreign currency IDR is contingent on an upgrade of Ukraine's sovereign rating. At present we view MHP's business and financial profile as commensurate with the mid-to high 'B' rating category with no visible corporate governance issues albeit constrained by the difficult operating environment in Ukraine.

Currency Devaluation Vulnerability
There is a material, but improving mismatch between MHP's hard currency debt and profits that are still mainly derived from domestic operations. However, over the past few years MHP has increased its hard currency-denominated proceeds from exporting sunflower oil, grain and frozen chicken (USD571m combined in 2013 or 38% of group sales). In view of the capacity added by the Vinnytsia complex, we expect increasing poultry exports in 2014-2016.

Challenges to Maintain Profitability
In 2013 both the poultry and grain segments delivered lower profits and the total EBITDA margin decreased to 25% from 32% in 2012. Although in 2014 margins are expected to return to pre-2013 levels, as a result of cheaper cost base for all segments and recovery in world grain prices, we expect operating margins to be pressured again post-2014.

The key driver for margin compression is growing exports of low value-added products (frozen chicken) and cost inflation spurred by hryvna devaluation. In the domestic market, while higher (dollarised) grain prices could dampen profitability in the poultry segment, this will be mitigated by lower cost of grain carried forward from last year's stocks in 2014. MHP's ability to raise prices domestically as a pass through from the currency depreciation remains another important driver of profitability for its domestic poultry operations after 2014.

Limited Further Deleveraging
MHP's FFO-adjusted net leverage decreased to 3x in 2013 (2012: 3.3x) due to better FFO generation and despite higher debt resulting from its new bond issue. Fitch considers there is some scope for slight deleveraging in 2014 due to positive free cash flow (FCF) driven by muted capex and better operating profits. However, we expect MHP to increase leverage in 2015-2017 driven by investments under the second phase of the Vinnytsia poultry farm. As a result, leverage could rise temporarily to 4.1x by 2017. However, Fitch notes that expansion capex is scalable. As a result, MHP's debt burden and corresponding leverage could be maintained below 3x should MHP decide to postpone the project.

High Distributions to Shareholders
Additional pressure on FCF and, thus, credit metrics could arise from dividend distributions of up to 50% of net income. These distributions could absorb substantial amounts of cash (between USD80m- USD120m) although Fitch understands that management would maintain a reasonable financial policy so as not to jeopardise its credit metrics and financial flexibility. A debt incurrence covenant test of net debt/EBITDA below 3.0x would further constrain MHP's ability to distribute money to shareholders in the event of weak profit or cash flows generation.

Adequate Near-Term Liquidity, Refinancing Risks in 2015/2016
Adequate liquidity is supported by USD172m of cash and short-term bank deposits (mainly foreign currency-denominated) and USD288m available committed bilateral bank lines at end-2013. Short-term debt was USD126m, just below 10% of total debt at end-2013 thanks to refinancing of maturing bank facilities with a new seven-year bond issue in 2013. Fitch acknowledges that some refinancing risks may arise by end-2014 in view of forthcoming bond maturity in April 2015 (USD235m). Although MHP currently has access to various sources of external and internal liquidity, the current political and economic instability in Ukraine may limit the access of Ukrainian issuers to bank debt and capital markets.

RATING SENSITIVITIES
Positive: Future developments that could lead to positive rating actions on the Long-term local currency IDR include:
Provided Fitch sees a sustained improvement in the issuer's operating environment.
- Evidence of sustained improvement in free cash flow generation ability whilst maintaining high profit margins.
- FFO adjusted net leverage consistently below 3x.
- FFO fixed charge cover strengthening above 4.5x.

An upgrade of the foreign currency IDR would only be possible if the Country Ceiling for Ukraine was upgraded (currently 'CCC').

Negative: Future developments that could lead to negative rating action on the Long-term local currency IDR include:
- FFO adjusted net leverage rising above 4.5x on a continuing basis due to sustained operational underperformance, aggressive capex plans or share buy-backs/dividends, or prompted by a sharper than expected further depreciation of the hryvna.
- FFO fixed charge cover weakening below 2x.
- Tightening liquidity position in the face of maturing outstanding bond in April 2015.