OREANDA-NEWS. February 21, 2012. Fitch Ratings has affirmed Luxembourg- based Kernel Holding S.A. (Kernel) Long-term foreign and local currency Issuer Default Ratings (IDRs) of 'B' and 'B+', respectively. Fitch has also affirmed Kernel’s National Long- term rating of 'AA+'(ukr). The Outlooks for the Long-term IDRs and National Long-term rating are Stable.

The ratings affirmation reflects Kernel’s leadership positions in fairly consolidated industries of operations, high degree of vertical integration, itsconservative approach to managing price risk in the sunflower oil production segment and adequate matching between debt and sales/profits by currency. Additionally, the group’s moderate financial leverage and strong liquidity backed up by an improvement in the debt maturity profile also supports the current ratings.

Among Kernel’s negative rating factors are its aggressive acquisition ambitions that have recently involved entering new industries (such as sugar production with Ukrros) and markets (Russia via Russian Oils) and increased its working capital requirements along with making them even more seasonal due to synchrony in purchasing raw materials for oil and sugar crushing businesses  Kernel’s sales are dependent on a few number of large customers in bulk oil and grain trading business, and on farmers of a single country – in its sourcing of grains, oilseeds and sugar.  Kernel’s business location  mostly in  Ukraine, with the  government’s proven interference in agribusiness via the introduction of exports controls or taxes also has a bearing on the current rating.

In fiscal-year ended 30 June 2011 (FY11), Kernel continued to expand its business organically and through acquisitions. Active M&A has been financed both by incremental debt and new equity issuance, allowing gearing to  remain balanced. FY11 lease-adjusted netdebt/  Op. EBITDAR dropped to 1.2x from 1.8x as EBITDAR rose by 60% despite weakening operating margins.

Fitch expects lease-adjusted net leverage in FY12 will deteriorate towards 1.8x due to larger debt and working capital investments mostly as a result of the latest acquisitions. However, Kernel exhibits improved debt maturity profile and adequate liquidity sources. Subject to management maintaining a conservative stance over future M&A opportunities, and the pace of integration of the latest business additions delivering at least stable operating margins, this should ensure a smooth de-leveraging profile from FY13.

Kernel’s local currency IDR remains, however, constrained by the group’s M&A appetite, by event-risks linked to its dependence mostly on Ukrainian suppliers and to its exposure to the Ukrainian government, which has a track record of introducing export restrictions or levies to the farming sector to address its perennial budget deficits. This has translated into large volatility in sales and profits for entities in the sector, as Kernel has shown in the Q112 results for its grain segment.

A negative rating action could follow if Kernel’s lease-adjusted net leverage is above 2.5x or if there is insufficient liquidity to cover projected peak working capital requirements throughout the  year.  Pressureon  Kernel’s  freecash  flow  frombusiness  growth  can  be  generally considered acceptable. However, large and recurringly negative free cash flow margin (in excess of minus 5%), the introduction of harsh export market regulations that cause losses to the company’s bulk oil or grain trading operations, or uneven treatments of market participants (for example via the introduction of differential export quotas) that adversely affect Kernel, will also be considered by Fitch as negative rating factors.