Dragon Capital 200906

EQUITY RESEARCH

Food & Beverage/Vegetable Oil

INITIATION OF COVERAGE June 5, 2009

Analyst: Tamara Levchenko (+380 44) 490 7120

Email: [email protected] www.dragon-capital.ua

Kernel Holding

The Sun in a Bottle

June 5, 2009

Kernel Holding: The Sun in a Bottle 2

Fair Value ($) 15.71Upside (%) 60%

Kernel Holding: Initiation of Coverage

Highlights Sell Hold Buy

Company DataMarket Price ($) 9.83 Market Cap ($m) 675 Enterprise Value (09FY; $m) 824Free Float (%) 40.97% Free Float ($m) 276.2 Shares Outstanding 68,741,010 Nominal Value (UAH) - Bloomberg Code KER PW DR Ratio - Number of Employees 3,785

Shareholder Structure

Namsen Ltd. - 59.03%

Free Float - 40.97%

12-month Price Performance ($)

Initiation of coverage. We initiate coverage of Kernel Holding, one of Ukraine’s largest sunflower oil producers, with a Buy recommendation.

Valuation implies 60% upside. Our DCF and comparative valuations put Kernel’s fair value at $15.71/share, suggesting a 60% upside to the stock’s current market price.

Profile. Established in the mid-1990s as an exporter of Ukrainian agricultural commodities, Kernel is a vertically integrated agro holding that processes sunflower seeds into bulk and bottled oil, cultivates land, operates grain storage facilities, exports crops and sells its own agricultural produce. Kernel is the second-largest domestic producer of crude sunflower oil (17% of Ukraine’s total crushing capacities). Kernel also holds a 35% share of the domestic bottled oil market. The company is one of the largest exporters of bulk sunflower oil from Ukraine with a share of about 11%. Besides, Kernel is among the ten largest exporters of grain from Ukraine (9% share). In June 2008, Kernel acquired a modern grain terminal in the Ukrainian port of Illichivsk, planning to export 3.5 Mt of grains in the 2008/09 marketing year. The company also operates inland grain storage facilities with combined capacity of 1.7 Mt and cultivates 85,000 ha of land in central Ukraine, having produced 265 kt of crops in 2008.

Strong 2009E financials. We expect Kernel to increase net sales by 73% y-o-y to $1.1bn in 2009FY (ending June 30th) and boost EBITDA by 65% to $204m, posting EBITDA margin of 17.7% and net margin of 10.6%. We expect a slight y-o-y decline in net margin due to the revaluation of bank debt caused by hryvnia depreciation. In 9M09FY, Kernel Holding reported net sales of $865.9m (+75% y-o-y), EBITDA of $160.5m (+109%) and net income of $110.3m (+174%). The company posted 9M09FY EBITDA margin of 18.5% (+3.0pp y-o-y) and net margin of 12.7% (+4.6pp).

Outlook. Kernel continues building a greenfield multi-seed crushing plant in Mykolayiv region with planned processing capacity of 510 kt of seeds p.a. to be commissioned in fall 2009. The company also plans to expand the crushing capacity of its Prykolotne plant by 153%, to 430 kt of seeds p.a. in 2011FY. This will substantially increase the company’s seed crushing capacity, to 1,680 kt p.a. from 930 kt currently, making it the No. 1 domestic producer on this measure.

Valuation Summary

048

12162024

Jun-08 Aug-08 Sep-08 Nov-08 Jan-09 Mar-09 Jun-09

Kernel KP-Dragon (rel.)

Year (ended June 30)* 2007FY 2008FY 2009FYE 2010FYF 2011FYF 12-month Performance (34%) Net Sales ($m) 350.4 663.1 1,148.7 1,263.5 1,408.0 12-month Rel. Perform. (KP-Dragon)* 135% EBITDA ($m) 46.4 123.2 203.7 154.3 185.4 12-month Low/High 3.93/17.30 Net Income ($m) 18.6 82.2 122.2 90.0 120.1 All-time Low/High 3.93/17.30 P/E 36.3 8.2 5.5 7.5 5.6 12-month Trading Volume ($m) 1.8

EV/EBITDA 17.1 6.5 4.0 3.9 3.0 Note: *Relative to KP-Dragon Index

EV/Sales 2.27 1.21 0.72 0.47 0.39 P/Book 8.69 1.53 1.85 1.06 0.89

Note: * The company reports its operating and financial results in marketing years, each ending on June 30. Thus all results and forecasts in this report are stated in financial years ending in June (e.g. 2008FY).

June 5, 2009


Table of Contents

Kernel Holding Overview 4

Sunflower Oil Production, Refining, Bottling and Export 4

Grain Export, Silo Services and Farming 11

2008FY and 9M09FY Financials Overview 14

Operating & Financial Outlook 17

Sunflower Oil Division 17

Grain Trade, Transshipment and Silo Services Outlook 19

Farming 20

Kernel Net Sales and Profitability Forecast 20

Valuation 21

DCF Model 21

Comparative Valuation 22

Recommendation 22

Risks 23

Operating & Financial Summary 25

Appendix 1: Kernel Holding Management Team 26

Appendix 2: Ukraine’s Vegetable Oil Market 27

Appendix 3: Kernel Site Visit (Apr. 2-3, 2009) 31

June 5, 2009


Kernel Holding Overview SUNFLOWER OIL PRODUCTION, REFINING, BOTTLING AND EXPORT

Started in the mid-1990s as an exporter of Ukrainian agricultural commodities, Kernel was originally an asset-light trading company. It later acquired grain silos in support of grain origination and started to expand into other businesses, in particular vegetable oil production, to become a leading diversified agro holding in Ukraine.

• In 2002, Kernel acquired a sunflower seed crushing plant in Poltava, thus expanding into the oil processing business. Concurrently, the company started to accumulate an agricultural land bank, usually close to its grain silos.

• In 2004, Kernel acquired domestic oil brand Shchedriy Dar (Generous Gift), together with crushing, refining and bottling facilities located in the eastern region of Luhansk.

• In 2006, Kernel acquired another bottled oil brand, Stozhar, as well as the production assets of Evrotek, its major domestic competitor active in both the bottled oil business and agribusiness and benefiting from a dominant market position in Kharkiv region, which borders on Poltava region. As a result, Kernel became a leading producer and seller of sunflower oil in Ukraine.

• In 2007, Kernel acquired exclusive rights to produce and sell bottled sunflower oil under another well known domestic consumer brand, Chumak.

Started in the 1990s as a grain exporter…

Today Kernel is a diversified agro holding that cultivates land, processes sunflower seeds into bulk and bottled oil, operates grain storage facilities, exports crops and sells its own agricultural produce. In November 2007, the company completed an IPO on the Warsaw Stock Exchange, raising $221m.

…Kernel has since grown into a vertically integrated holding

Kernel Business Structure* Note: *Revenue-driving segments are marked in bold; Source: Company

Grain & oilseeds purchase Farming

Logistics & Storage

Sunflower seed crushing

Sunflower oil refining

Sunflower oil bottling

Bottled sunflower oil sales & exports

Bulk crude sunflower oil exports

Meal exports

Bulk refined sunflower oil exports

Grain exports

Grain Trade

Grain Port Transshipment

Services

June 5, 2009


Kernel Holding operates three sunflower seed crushing plants: Poltava Oil Extraction Plant (OEP) with annual operating capacity of 430,000 tonnes (430 kt) of sunflower seeds), Prykolotne OEP (operating capacity of 170 kt/year) and Volchansk OEP (330 kt/year). The three plants’ combined capacity of 930 kt/year accounted for 21% of Ukraine’s total in the 2008/09 season, making Kernel the second-largest domestic seed crusher on this measure. However, the company is set to become the largest in this industry already this fall when it launches a greenfield multi-seed crushing plant in Mykolayiv region with planned processing capacity of 510 kt of seeds p.a.

Kernel’s sunflower seed crushing capacity totaled 930 kt/year as of

March 2009

Others29%

Bunge11%

Allseeds15%

Kernel Holding21%

Cargill24%

Ukraine Seed Crushing Capacity Breakdown (2007/08) Source: Company

Kernel’s Seed Crushing Capacities Source: Company

Oil Extraction Plant Capacity (kt/year) Poltava 430 Prykolotne 170 Volchansk 330 Total 930

Kernel also operates two oil refining and bottling facilities installed at its Poltava and Prykolotne crushing plants, capable of producing about 135 kt of bottled sunflower oil annually. The company markets its bottled oil under the brands Shchedriy Dar, Stozhar, Chumak Domashnya, Chumak Zolota and Lyubonka, holding a 35% market share domestically.

The company can bottle more than 135 kt of sunflower oil per

year

In Ukraine, Kernel’s oil can be found in over 45,000 points of sale. The company also exports about 20% of its bottled oil output. Kernel has produced bottled oil under the private label Natura Verde for Metro Cash & Carry since 2005. It also bottles oil under the private label Premiya for another large domestic retailer, Fozzy Group (since 2006). Additionally, Kernel has private label agreements for bottled oil with Velyka Kyshenya and Tavriya-V retail chains.

A wide distribution network

Others1.0%

Russia2.0%

Middle East6.0%

CIS10.0%

Ukraine81.0%

Kernel Bottled Oil Sales by Destination (2007/08) Source: Company

Others33%

Slaviya5%

Bunge27%

Kernel Holding35%

Bottled Sunflower Oil Sales in Ukraine (volume; 2007/08)

Source: Company

June 5, 2009


Kernel is one of the largest exporters of bulk sunflower oil from Ukraine with a share of about 11%. The company exports oil to the CIS, the EU, Asia and North Africa.

One of the largest sunflower oil exporters in Ukraine

Others39.0%

Bunge9.0%

Kernel Holding11.0%

Allseeds13.0%

Cargill28.0%

Bulk Sunflower Oil Exporters in Ukraine(2008/09E) Source: Company

Egypt8%

CIS10%

Others22%

Turkey 12%

India18%

EU30%

Ukraine Bulk Sunflower Oil Export Destinations (volume; 2008/09E)

Source: Company

Kernel’s closest competitors include local subsidiaries of Cargill and Bunge as well large domestic oil processor Allseeds. Cargill operates two crushing plants, in Donetsk and Kakhovka (Kherson region), with total estimated crushing capacity of 950 kt of seeds p.a. but no refining or bottling facilities. Bunge operates a crushing, refining and bottling plant in Dnipropetrovsk and a crushing plant in Illichivsk (Odesa region). The Dnipropetrovsk OEP has annual crushing capacity of 450 kt of seeds while the Illichivsk plant can process about 400 kt of sunflower seeds annually. Bunge produces bottled sunflower oil under the brand Oleina, accounting for an estimated 27% of the domestic retail market. Allseeds operates two crushing plants in Kirovohrad and Mykolayiv with total estimated crushing capacity of 600 kt of seeds per year and no refining or bottling facilities.

Competitors

Lyubonka (Kernel)2.0%

Dykanka (Ukroliya)

3.0%Private Label

(Kernel)2.0%

Others25.0%

Stozhar (Kernel)7.0%

Slaviya (Pology)7.0%

Slavoliya (Slavoliya)

3.0%

Schedry Dar (Kernel)11.0%

Chumak (Kernel)13.0%

Oleina (Bunge)27.0%

Top Ukrainian Bottled Oil Brands (2008/09E) Source: Company

HoReCa5% Traditional Retail

24%

Open Markets27%

Supermarkets44%

Kernel Domestic Distribution Channels (2008/09E) Source: Company

June 5, 2009


Kernel’s produced goods are moved by rail and road. The company owns a fleet of over 40 trucks, which covers 20% of its road transportation needs, and also outsources vehicle transportation from more than 10 providers. Trucks mainly deliver oil seeds to crushing plants and bottled oil to domestic distributors, with an efficient radius of transportation of up to 300 km.

Logistics

3rd Party Trucks80%

Own Trucks20%

Truck Transportation

30%

Railway Transportation

70%

Kernel Holding Transport Usage Source: Company

Kernel’s logistics center is located in Poltava and has a total storage area of 8,000 m2. The company operates through a nationwide distribution network that consists of 60 regional distributors. Kernel also works directly with the eight largest Ukrainian retail chains. It pursues the same pricing policy with respect to distributors and retail chains regardless of their location, setting recommended prices for end-consumers. Kernel estimates distributor mark-ups on bottled sunflower oil at 5-8% and supermarket mark-ups at 15%. Open markets and other retail outlets set a mark-up of about 20%.

Kernel works directly with leading retail chains

Kernel Holding marketed 171 kt of bulk crude sunflower oil, up 18% y-o-y in the financial year ended June 2008. Its bottled sunflower oil sales totaled 95.1 kt over the period (+42% y-o-y thanks to the acquisition of brands Chumak Zolota and Chumak Domashnya), which allowed the company to both satisfy domestic market needs and export about 15% of total output. Sales of refined oil, left after bottling and exported, reached an est. 25 kt in 2008FY (-38% y-o-y).

Kernel Holding bottled oil sales reached 95.1 kt in 2008FY

2535

74

95

72 76

0

25

50

75

100

2005 2006 2007 2008 9M08 9M09

Bottled Oil Sales (kt)

Kernel Holding Bottled Sun Oil Sales Dynamics (2005-1H09FY) Source: Company

79 68

1451719

4025

0

50

100

150

200

2005 2006 2007 2008

Refined Sun Oil Sales (kt )Crude Sun Oil Sales (kt)

Kernel Holding Crude & Refined Sun Oil Sales Dynamics (2005-08FY) Source: Company

June 5, 2009


Prices for sunflower oil and sunflower seeds peaked in February 2008 at $1,639/t (net of VAT; +207% y-o-y) and $747/t (+258% y-o-y), respectively. The difference (net of crushing and transportation costs) reached $800-815/t over the same period. As of end-April 2009, sunflower oil traded at $595/t (net of VAT; -60% y-o-y), while sunflower seeds were marketed at $243/t (-65% y-o-y), implying a net difference of $280-305/t (-65% y-o-y). However, the gross margin on sunflower oil production remained flat y-o-y last month at an est. 20-25%.

Gross margin on sunflower oil ranges 20-25%

0

250

500

750

1,000

1,250

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1,750

2,000

Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09

Bulk Crude Sun Oil Pr ices ($/t ; incl. VAT, EXW)

Sunflower Seed Pr ices ($/t ; incl. VAT; EXW)

Ukraine Sunflower Seed and Oil Avg. Price Dynamics (2008-May’09) Note:*Net of VAT and seed crushing costs ($20-35/t) and delivery to Illichivsk sea port ($25-35/t); Source:

UkrAgroConsult

Sunflower meal, a byproduct of sunflower seed crushing, currently trades at $131/t (EXW; incl. VAT), down from an est. $412/t in February 2008. Kernel burns 100% of its sunflower husk (another byproduct of sunflower seed crushing) for heating purposes.

Sunflower meal currently trades at $131/t (EXW)

0

250

500

750

1,000

1,250

1,500

1,750

2,000

2,250

Jan-08 Mar -08 May-08 Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 Apr-09

Bulk Sunflower Oil Prices ($/t, incl. VAT, EXW)Sunflower Seed Pr ices ($/t , incl. VAT; EXW)Sunflower Meal Prices ($/t , incl .VAT; EXW)

Ukraine Sunflower Seed, Meal and Bulk Sunflower Oil Weekly Average Prices (2008-May ’09) Source: APK-Inform

Bottled sunflower oil currently sells for $1,235/t (-50% y-o-y; EXW, incl. VAT) and crude sunflower oil for $826/t (-57% y-o-y). Kernel thus can earn an extra $350-400 per tonne of bottled sunflower oil vs. crude oil sales. In 2008, the company was earning $640 per tonne of bottled sunflower oil on average. Kernel’s costs of sunflower oil refining average $15-20 per tonne of refined oil while bottling costs range $112-115 per tonne of bottled oil. The company’s net gain on bottled oil thus totals $220-265/t.

Kernel earns $350-400 more per tonne of bottled oil vs. bulk oil

$800 net difference*

$280 net difference*

June 5, 2009


250500750

1,0001,2501,5001,7502,0002,2502,5002,750

Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09

Bottled Sunflower Oil Prices ($/t, incl. VAT; EXW)Refined Sunflower Oil Prices ($/t, incl. VAT; EXW)Crude Sunflower Oil Prices ($/t, incl . VAT, EXW)

Crude, Refined and Bottled Sunflower Oil Weekly Prices in Ukraine (2008-May ’09) Source: APK-Inform

Kernel’s major production cost component is sunflower seed, which accounts for more than 90% of crude oil costs and up to 80% of bottled oil costs. All the company’s production costs except for overheads are variable. The share of energy-related expenses (electricity, steam, diesel etc.) is not significant and constitutes less than 5% of total production costs.

Sunflower seeds account for more than 90% of crude oil

production costs

Other 0.3%Labor

0.9%

Utilities2.3%

Overheads5.7%

Sunflower seeds90.8%

Kernel Holding Crushing Costs (2008/09E) Source: Company

Overheads4%

Crushing4%

Refining2%

Labor4%

Bottling9%

Sunflower seeds77%

Kernel Holding Bottled Oil Production Costs (2008/09E) Source: Company

In absolute terms, Kernel’s seed crushing costs average $20-35 per tonne of crude sunflower oil. Delivery costs range from $35/t (FOB Illichivsk) for crude sunflower oil to $20-30/t (DAF Belarus) for refined oil in bulk and to $50-55/t (DAF Belarus) for sunflower meal.

Delivery costs

June 5, 2009


Payroll12.0%

Utilities24.0%

Direct materials64.0%

Kernel Holding Refining Costs (2008/09E) Source: Company

Utilities2%

Payroll4%

Direct materials94%

Kernel Holding Bottling Costs (2008/09E) Source: Company

In 2008, bulk crude sunflower oil and fodder meal accounted for the largest share of 49% of Kernel’s total revenues (+3.5pp y-o-y). Grain exports contributed 26% of total (-8.2pp y-o-y) and bottled sunflower oil 22% (+6.0pp y-o-y). Overall, Kernel derived 71% of its 2008FY revenues from the sunflower oil segment.

Crude sunflower oil and meal accounted for 49% of Kernel’s

2008FY sales

Bulk Crude Sunflower Oil &

Meal49.0%

Grain Trade25.8%

Bottled Sunflower Oil

22.2%Grain Silo Services2.8%

Other 0.2%

Kernel Holding Revenue Structure (value; 2008FY) Source: Company

Other 0.9%

Rental Payments0.3%

Depreciation1.9%

Payroll & Related Costs

3.2%

Cost of Goods for Resale &

Raw Materials Used

93.7%

Kernel Holding COGS Structure (value; 2008FY) Source: Company

The cost of goods for resale and raw materials used constituted the lion’s share of Kernel’s COGS in 2008 (94%; +2.7pp y-o-y). Payroll and related costs accounted for 3% (-1.9pp y-o-y) of total costs.

Cost structure

Kernel’s customers for bulk oil products are primarily international trading houses or wholesalers and processors in importing countries (the EU, Mediterranean basin and Middle East), such as Glencore of Switzerland, Nidera in the Netherlands, Alfred C. Toepfer in Germany, Bunge in the USA. Kernel sells bulk oil to refiners and bottlers producing for their home markets, such as SOS Cuetara and Migasa in Spain and Diem SA in Greece. The company also sells oil to producers of bio-fuels such as Saipol in France. In addition, Kernel supplies protein meal to feed compounders such as Agro Supply A/S and DLA Agro in Denmark and Ravagricola in Italy. The company sells bulk grain or oilseed cargo to wholesalers and processors in Israel, Spain and Greece. Kernel’s customers for bottled oil products are Ukrainian nationwide retailers such as Fozzy Group, Metro Cash & Carry, ATB Market, Intermarket, Furshet. None of Kernel’s customers accounts for a significant portion of the company’s annual sales.

Customers

June 5, 2009


GRAIN EXPORT, SILO SERVICES & FARMING

Kernel Holding is among the ten largest exporters of grain from Ukraine. The company exports wheat, barley and corn, which jointly account for about 80% of its total grain exports, as well as soya beans, rapeseed and peas. Key destinations are the CIS, the EU, Asia and North Africa.

Kernel is one of the ten largest grain exporters in Ukraine

Nibulon16%

Alfred C. Toepfer Int.

15%

Glencore13%

Kernel 10%

Cargill11%

Bunge 11%

Louis Dreyfus9%

Other15%

Ukraine’s Major Grain Exporters (volume; 2008/09E) Source: Company

Berdyansk9%Yuzhny

12%Mariupol

6%

Mykolayiv (Nibulon)

17%

Odessa22%

Illichivsk (Kernel)

34%

Breakdown of Ukrainian Grain Exports by Sea Port (volume; 2008/09E)

Source: Company

In the marketing year 2007/08 (July-June), Kernel exported 317 kt of grains, down from 550 kt in 2006/07. Such a relatively low volume was largely due to the grain export ban imposed by the Ukrainian government and is therefore not representative. Kernel delivered and exported 1.8 Mt of grain in 9M09FY. Grain export volumes targeted for 2009FY have already been largely achieved.

Grain exports surged to 1.8 Mt in 9M09FY

520710

550317

1,801

0

500

1,000

1,500

2,000

2005 2006 2007 2008 9M09

Grain Sales (kt)

Kernel Holding Grain Sales Dynamics (2005-08FY) Source: Company

Other 35% Milling Wheat

11%

Corn25%

Barley29%

Kernel Holding Grain Export Breakdown (2008FY) Source: Company

In June 2008, Kernel acquired a grain terminal in the port of Illichivsk for $95m. The Illichivsk terminal is Ukraine's second-largest modern grain port terminal after the Odesa terminal. Illichivsk can handle over 4.5 Mt of crops a year and its capacity can be expanded. It has a storage capacity of 200 kt of crops. Two 11.5 meter deep moorings allow simultaneous loading of two deep-sea vessels at a rate of 900 tonnes per hour. The terminal offers a gateway for 20% of Ukraine’s grain exports.

Recent grain terminal acquisition

In 9M09FY, the Illichivsk terminal handled 51% of Kernel’s grain trade volume in value terms. The company exports grain via other major grain terminals in Ukraine depending on the location of grain purchases and delivery costs.

Kernel sells about 50% of its grain volume through Illichivsk

June 5, 2009


Kernel’s terminal handled 2.3 Mt of grain in 9M09FY and with 6-7 Mt of grain to be exported from Ukraine in 4Q09FY, the terminal might exceed throughput of 3.3 Mt in 2009FY, according to company estimates.

Total grain throughput may top 3.3 Mt in 2009FY

Grain prices have recovered slightly since the beginning of 2009 after plunging in 4Q08. As of May 29, milling wheat (4th grade) traded at $128/t (EXW, incl. VAT), down 53% y-o-y but up 16% YTD. In July 2008-May 2009 (Kernel’s 11M09FY), milling wheat (4th grade) prices averaged $163/t (EXW, incl. VAT). Corn traded at $143/t (EXW, incl. VAT) at the beginning of May (-42% y-o-y and +77% YTD) and averaged $138/t (EXW, net of VAT) in 11M09FY.

Grain prices have recovered slightly since the beginning of

2009

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300

Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Feb-09 Apr-09

Wheat 4th Grade Avg. Weekly Prices in Ukraine (EXW; VAT incl., $/t, 2008-May’09)

Source: UkrAgroConsult

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50

100

150

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300


Corn Avg. Weekly Prices in Ukraine (EXW; VAT incl., $/t, 2008-May’09)


Barley traded at $115/t (EXW, incl. VAT) as of May 29, down 50% y-o-y and +26% YTD. In 11M09FY, barley prices averaged $138/t (EXW, incl. VAT). Respective soybean prices (current and 11M09FY) total $472/t (EXW, incl. VAT), down 32% y-o-y and up 82% YTD, and $423/t (EXW, incl. VAT).

Barley currently trades at $118/t

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Barley Avg. Weekly Prices in Ukraine (EXW; VAT incl., $/t, 2008-May’09)


0100200300400500600700800


Soybean Avg. Weekly Prices in Ukraine (EXW; VAT incl., $/t, 2008-May’09)


Ukrainian agro producers are not selling rapeseed currently, waiting for the next spike in prices. The crop peaked at $610/t (EXW, incl. VAT) in July 2008 and plunged to $292/t (EXW, incl. VAT) in December last year.

Rapeseed is traded seasonally

June 5, 2009


0100200300400500600700


Rapeseed Avg. Weekly Prices in Ukraine (EXW; VAT incl., $/t, Jan. 11, 2008-May. 15, 2009)*

Note: *Rapeseed trades seasonally; Source: UkrAgroConsult

In 2008FY, Kernel Holding exported grains for $171m (+44% y-o-y) and reported an EBIT margin of 19.6% (+11.5pp y-o-y) in this segment. In 9M09FY, the company’s EBIT margin on grain exports went down to 13.4% as average grain sale prices declined to $274/t (incl. carriage and freight costs) from $540/t in 2008FY. Kernel’s carriage and freight costs totaled about $30-35/t in 9M09FY.

Kernel earns 13% EBIT margin on grain exports

Kernel Holding owns and operates one of the largest networks of grain elevators in Ukraine consisting of 25 grain silos with total storage capacity of 1.7 Mt of crops (est. 6% of Ukraine’s total grain storage facilities). The location of silos in the Poltava and Kharkiv regions ensures the most efficient sourcing of oilseeds for Kernel’s crushing plants and a commanding position for the origination of grain. Flexible storage conditions ensure fast and efficient grain intake and delivery for shipment. In 2008FY, capacity utilization of Kernel’s silo network averaged 50-60%, while in 9M09FY the company reported a utilization rate of 106%.

Silo network

In 9M09FY, Kernel reported a 37.8% EBIT margin on silo grain storage services, with total revenues from the silo segment of $37m (+85% y-o-y). The company’s storage costs (drying, cleaning, etc.) are estimated at $10/t, while the storage fee averaged $15/t in 9M09FY.

Kernel’s EBIT margin on silo storage averages 35-38%

Kernel currently leases 85,000 ha of agricultural land and continues expanding its land bank. The company plans to increase its land area to 100,000 ha in 2010FY (+28% y-o-y) and add another 50,000 ha in 2011FY. Kernel’s land lease contracts average 5 to 10 years. While own production is not intended to render the company self-sufficient in grain, Kernel plans to continue expanding into farming business due to its intrinsic profitability.

Kernel operates 85,000 ha of land

Kernel Holding Leased Land and Crushing Plants Location (2009FY) Source: Company

Other6.4%

Peas9.2%

Corn10.1%

Spring barley9.1%

Soy16.3%

Sunflower seeds20.0%

Winter wheat28.8%

Kernel Holding Acreage Breakdown (2008FY)

Source: Company

19%

19%

40% 19%

3%

June 5, 2009


Kernel’s farming operations are concentrated in five regions of Ukraine, all providing prime soil conditions for sunflower seed cultivation: Poltava region (40% of Kernel’s total land area), Cherkasy, Kirovohrad and Kharkiv (19% each) and Odesa (3%). The company has focused on land lease in regions close to its crushing capacities (Poltava and Kharkiv). In 2008FY, Kernel harvested 68 kt of grain and oil crops, which generated 3% of its revenues for the period. In 9M09FY, Kernel harvested 265 kt of grain and oil crops, exceeding its target of 255 kt. About 85% of Kernel’s farm produce is sold at market prices to the company’s grain export division.

Kernel harvested 265 kt of grain and oil crops in 2009FY and sold

it to its own export division

2008FY AND 9M09FY FINANCIAL OVERVIEW*

Kernel Holding increased its net sales by 89% y-o-y to $663.1m in 2008FY. The significant price increases on both grain and oil crops markets in the first three quarters of 2008FY helped Kernel improve margins and earnings in absolute terms. The company’s 2008FY EBITDA margin increased by 5.4pp y-o-y to 18.6% and EBIT margin totaled 16.8% (+5.8pp y-o-y).

Kernel reported 2008FY net sales of $663.1m (+89% y-o-y)...

663.1493.6

865.9

16.2

78.1

5.70

200

400

600

800

2005FY 2006FY 2007FY 2008FY 9M08FY 9M09FY

0%

5%

10%

15%

20%Net Sales ($m; lhs) EBITDA margin (%; rhs)Net margin (%; rhs)

Kernel Holding Revenues and Profitability Margins (2005FY-1H09FY) Sources: Company, Dragon Capital estimates

In 9M09FY, Kernel Holding reported net sales of $865.9m (+75% y-o-y), EBITDA of $160.5m (+109%) and net income of $110.3m (+174%). Kernel’s 9M09FY gross margin increased by 8.2pp y-o-y to 30.9% thanks in part to the hryvnia depreciation and its effect on hryvnia-denominated costs. The company posted 9M09FY EBITDA margin of 18.5% (+3.0pp y-o-y) and net margin of 12.7% (+4.6pp). This significant increase in margins is essentially a consequence of the hryvnia depreciation in 2Q09FY: as the value of inventory bought previously is converted back from hryvnia into dollars at a new and lower exchange rate, the cost of goods delivered in 3Q09FY, in execution of oil and grain export contracts, is correspondingly lower, leading to a substantial increase in profitability margins. Additionally, the company said its net debt decreased to $158m as of Mar. 31, 2009, from $245m on Mar. 31, 2008.

...and 9M09FY sales of $865.9m (+75% y-o-y)

Note: * The company reports its operating and financial results in marketing years, each ending on June 30. Thus all results and forecasts in this report are stated in financial years ending in June (e.g. 2008FY).

June 5, 2009


16% 17%9%

14%

25%

38%

13%

(7%)

51%

23%21%

(25%)

0%

25%

50%

75%

Bulk

Oil&M

eal

Bottle

d Oil

Grain

Trans

shipm

ent

Farm

ing

Grain

Trade

Silo S

ervice

s

EBIT Margin (%; 9M08FY) EBIT Margin (%; 9M09FY)

Kernel Holding EBIT Margin Breakdown by Product (9M08FY-9M09FY) Sources: Company, Dragon Capital estimates

Kernel’s grain transshipment services and in-country silo services gave the company the highest EBIT margins of 51% and 38%, respectively, across all its business segments in 9M09FY. Kernel’s farming division, however, performed worse at -7% EBIT margin and about 0% EBITDA margin over the period. This was caused by low soft commodity prices and high production costs incurred during the 2008 sowing season.

Grain transshipment and silo services were the most profitable

in 9M09FY

Grain Handling & Transshipment

2.2%

Grain Silo Services3.3%

Farming0.6%

Bottled Sunflower Oil

12.4%


Meal23.6%

Grain Trade57.8%

Kernel Holding Revenues Breakdown (value; 9M09FY) Source: Company

Grain Handling & Transshipment

11.7%

Grain Silo Services8.4%Bottled

Sunflower Oil14.2%


Meal26.0%

Grain Trade39.6%

Kernel Holding EBIT Breakdown (9M09FY) Source: Company

In 9M09FY, Kernel exported 1.8 Mt of grain, earning $493m, or 58% of its revenues over the period. Grain handling and transshipment services for other grain traders in the port of Illichivsk generated $19m (2.2% of total revenues). Sunflower oil revenues were $307m in 9M09FY (both bulk and bottled oil; 36% of total revenues).

Grain trade accounted for the largest share of 58% of Kernel’s

9M09FY revenues…

Grain trade also brought the largest share (40%) of Kernel’s operating profit in 9M09FY, or $66m in absolute terms. The sunflower oil division reported EBIT of $67m over the period, contributing 40% of total operating profits.

…and 40% of operating profit

Kernel Holding outperforms its international peers based on 2009FY EBITDA margin of 17.7% (we restated peers’ profitability margins to match Kernel’s financial year ending in June). Large global grain traders such as ABB Grain, Graincorp, Vittera and Archer-Daniels-Midland expect 2009FY EBITDA margins of 5.5-7.1%, while large international vegetable oil producer and grain trader Bunge, Kernel’s closest peer, expects 3.9%.

Kernel Holding outperforms international peers on 2009FY

EBITDA margin

June 5, 2009


3.9%

5.5%

5.6%

6.7%

7.1%

17.7%

0% 5% 10% 15% 20%

Bunge

Archer-Daniels-Midland

Vittera

Graincorp

ABB Grain

Kernel Holding

EBITDA Margin: Kernel Holding vs. International Peers (2009FYE)* Note:*Peers’ margins were restated to match Kernel’s financial year ending in June;

Sources: Company, Bloomberg, Dragon Capital estimates

June 5, 2009


Operating & Financial Outlook SUNFLOWER OIL DIVISION

This fall (2010FY), Kernel plans to complete the construction of a greenfield multi-seed oil extraction plant (OEP) with annual crushing capacity for 510 kt of seeds in Mykolayiv region. The new plant was almost 50% complete as of May 15, 2009. The company also plans to expand the crushing capacity of its Poltava OEP by 72% to 430 kt of seeds p.a. in 2009FY. This capacity upgrade was almost 90% complete as of May 15. Kernel’s Prykolotne OEP is scheduled to be upgraded in 2011FY, to 430 kt of seeds p.a. The company’s total seed crushing capacity would thus amount to 1,680 kt p.a. by 2012FY, or an estimated 38% of Ukraine’s total crushing capacities as of end-2008, up from 930 kt currently (21% of total). As of end-May 2009, Kernel planned to complete all aforementioned capacity upgrades on time.

Capacities upgrade and Bandurka greenfield project

250430

170

430330

510

430 430

170170

330330

330

510

0

500

1,000

1,500

2,000

2008FY 2009FYE 2010FYF 2011FYF

Poltava Prykolotne Volchansk Bandurka (multi-seed)

Kernel Holding Crushing Capacities (2008FY-2011FYF) Sources: Company

We expect Kernel to be able to load its projected new crushing capacities in the future based on the following reasoning. First of all, the new 510 kt crushing facility is a multi-seed plant, allowing Kernel to process not only sunflower seed but also soybean and rapeseed. Secondly, to load a large crushing facility one would need a developed infrastructure for purchasing and delivering raw materials. Kernel Holding owns 1.7 Mt of inland storage capacities, particularly near its oil extraction plants and all over Ukraine, which ensures fast and efficient seed intake and delivery and thus provides an advantage over small domestic crushers who have limited access to storage and are forced to buy seeds off-season at high prices. Last but not least, small crushers could face working capital problems in terms of limited credit resources, thus might even idle their plants in the medium term.

Ability to load new capacities

We estimate the planned capacity expansion will enable Kernel to increase its bulk crude sunflower oil production at an 11% CAGR in 2009-16FY, bringing it to 689 kt of oil and 558 kt of fodder meal in 2016FY. However, such growth is subject to raw material supply risk, as Kernel purchases more than 98% of sunflower seeds from farmers, who in turn are exposed to weather risk. Kernel’s sunflower oil extraction and fodder meal rates are forecasted to average 45% and 36.5%, respectively, over the period.

Production of crude bulk sunflower oil is estimated to

increase at 11% CAGR in 2009-16FY

June 5, 2009


419517

621 677 689

930

1,149

1,505 1,530

339419 504 549 558

1,381

0

200400600

8001,0001,200

1,4001,6001,800

2009E 2010F 2011F 2012F 2013F

Fodder Meal Output (kt)Bulk Crude Sunflower Oil Output (kt)Sunflower Seeds Crushed (kt)

Kernel Holding Crude Sunflower Oil & Meal Production (2009FY-2013FYF) Sources: Company, Dragon Capital estimates

In the refined sunflower oil segment, we estimate Kernel’s capacity to increase from 138.5 kt in 2009FY to 156.5 kt by 2013FY. We forecast the company to increase refined oil production at a 3% CAGR over 2009-16FY, to 148.7 kt in 2016FY. We project the company will bottle almost 85% of its refined oil output and market it domestically, with the remaining sunflower oil volume to be exported.

Bottled oil production to grow at 3% CAGR

111 113 122 123 123

23 2325 26 26

0

25

50

75

100

125

150

175

2009E 2010F 2011F 2012F 2013F

Bottled Oil Sales (kt) Refined Oil Sales (kt)

Kernel Holding Refined & Bottled Oil Sales (2009FY-2013FYF) Sources: Company, Dragon Capital estimates

We estimate Kernel’s bulk crude sunflower oil price to average to $925/t in 2009FY (incl. VAT; -29% y-o-y), above Ukraine’s estimated average of $866/t (incl. VAT; -43% y-o-y) because the company was pre-selling its future sunflower oil output before 2009FY started in July at peak prices of $1,600-1,700/t (incl. VAT). In 2010FY, we expect Kernel’s bulk crude sunflower oil price to decline by 5% y-o-y to $879/t, which basically reflects current market prices. We projected Kernel’s crude sunflower oil prices to stay unchanged y-o-y in 2011-16FY as agro markets’ high volatility and cyclical nature preclude a more accurate price forecast. We estimate Kernel’s refined sunflower oil prices at $1,010/t in 2009FY (-32% y-o-y), $960/t (-5% y-o-y) in 2010FY and unchanged afterwards. Prices of bottled oil, Kernel’s top value added product, are less volatile than crude sunflower oil prices. We forecast them to average $1,300/t ($1.5/liter) in 2009FY (-16% y-o-y), $1,235/t in 2010FY (-5% y-o-y) and remain unchanged over 2011-16FY. Finally, fodder meal, a byproduct of sunflower oil, should be priced at $155/t in 2009FY (-40% y-o-y), $147/t in 2010FY (-5% y-o-y) and stay unchanged afterwards.

Sunflower oil price assumptions

June 5, 2009


0200400600800

1,0001,2001,4001,6001,8002,000

2008 2009E 2010F 2011F

Bulk Crude Oil Avg. Annual Price ($/t) Refined Oil Avg. Annual Price ($/t)Bottled Oil Avg. Annual Price ($/t) Fodder Meal Avg. Annual Price ($/t)

Kernel Holding Prices (2008-2013FY) Sources: Company, Dragon Capital estimates

GRAIN TRADE, TRANSSHIPMENT AND SILO SERVICES

In 2009FY, Kernel Holding plans to export 3.5 Mt of grain following the acquisition of the Illichivsk terminal in June 2008. The company exported 2.9 Mt as of end-9M09FY, including 1.8 Mt of own exports and 1.1 Mt of grain transshipped through the port of Illichivsk. We estimated the average purchase price of grain crops for Kernel at $180/t (-31% y-o-y) in 2009FY and set it unchanged afterwards. Freight costs were estimated at $30/t in 2009FY with subsequent annual increases of 2% in the 2010-16F marketing years. Finally, we project Kernel’s transshipment fee at $63/t on average in 2009FY and $30-32/t in 2010-16FY.

Kernel plans to export 3.5 Mt of grain crops in 2009FY

2,2502,813 2,953 3,101 3,256 3,386 3,488 3,557

0

1,000

2,000

3,000

4,000

5,000

6,000

2009E 2010F 2011F 2012F 2013F 2014F 2015F 2016F

0%

25%

50%

75%

100%

125%Grain Trade (kt; lhs) Grain Transshipment (kt; lhs)Si lo Storage Utilization Rate (%; rhs)

Kernel Holding Grain Trade, Transshipment and Silo Service Volumes (2009-2016FY) Sources: Company, Dragon Capital estimates

Kernel owns 1.7 Mt of silo storage capacity inside the country and 200 kt of storage elevators at the port of Illichivsk. The usual capacity utilization rate of those stood at 65-70% in 2005-07FY but jumped to 105% in 2009FY thanks to a bumper harvest of grain crops in Ukraine (48 Mt). We forecast Kernel’s storage capacity utilization rate to average 70% in 2010FY based on satisfactory harvest projections and total 65% in 2011-16FY, reflecting historical cyclicality of grain crop harvests. We estimated Kernel’s silo service fee (storage, drying, fungiciding, etc.) at $20/t in 2009FY and at $19/t over 2010-16FY.

Full utilization of grain silos reported in 2009FY

June 5, 2009


FARMING

As of May 15, 2009, Kernel completed crop sowing on 85,000 ha of land for this year’s harvesting, with 30% of the total area allocated for wheat and 20% for sunflower seed. In 2008, the company harvested 265 kt of grain and exported almost all of it through its grain trading division. In 2009, we forecast Kernel to harvest about 280 kt of grain crops (+6% y-o-y), including 40 kt of sunflower seeds.

Kernel planted 85,000 ha of land for 2009 harvest

In 2009FY, we estimate Kernel’s average crop prices at $165/t for wheat (net of VAT; -28% y-o-y), $145/t for rye (-15%), $175/t for barley (-12%), $217/t for peas (-13%), $267/t for buckwheat (-27%), $85/t for corn (-62%), $355/t for soybeans (-21%) and $225/t for sunflower seeds (-59%). Kernel’s farming division sells all its crops within two months during and after the harvesting period to its own grain trading division at average market prices. We projected its crop prices to be unchanged in 2011-16FY to reflect the net effect of agricultural markets’ cyclicality.

Crop price assumptions

REVENUE AND PROFITABILITY FORECASTS

Based on the operating assumptions described above, we forecast Kernel to increase net sales by 73% y-o-y to $1.1bn in 2009FY and record a 5% sales CAGR in 2010-16FY, to $1.6bn in 2016FY. We estimate the company’s EBITDA margin at 17.7% in 2009FY (-0.9pp y-o-y) thanks to a positive effect of hryvnia depreciation on the company’s hryvnia-denominated production costs. In 2010-16FY, we expect no depreciation-related impact due to a stable outlook for the hryvnia and forecast Kernel’s EBITDA margin to fluctuate around 13%. We expect its net margin at around 9% over the forecast period.

We forecast Kernel to increase net sales at a 5% CAGR

in 2010-16FY

0

500

1,000

1,500

2,000

2009E 2010F 2011F 2012F 2013F

0%

5%

10%

15%

20%

Net Sales ($m; lhs) Net Margin (%; rhs)EBITDA Margin (%; rhs)

Kernel Holding Net Sales & Profitability Forecasts (2009-2013FY)

Sources: Dragon Capital estimates

28% 33% 37% 38% 37%

13%11% 11% 10% 10%

54% 52% 49% 48% 49%

0%

25%

50%

75%

100%

2009E 2010F 2011F 2012F 2013F

Bulk Crude Oil & Meal Bot tled Oil Silo ServicesGrain Trade Grain Transshipment Farming

Kernel Holding Revenues Breakdown by Products (2009-2013FY)

Sources: Dragon Capital estimates

We expect crude sunflower oil/fodder meal and grain trade to remain the major revenue contributors for Kernel over the forecasted period, each accounting for about 35% and 50% of total sales, respectively.

Bulk crude sunflower oil and grain trade to remain the largest

revenue contributors

June 5, 2009


Valuation DCF MODEL AND SENSITIVITY ANALYSIS

We based our valuation model for Kernel Holding on the operating and financial outlook described above. Our DCF valuation yielded a fair value estimate of $10.39/share, or 6% above the stock’s current market price.

DCF implies a fair value of $10.39/share

DCF Valuation ($m) Year* 2009E 2010F 2011F 2012F 2013F 2014F 2015F 2016F Sovereign Risk Free Rate 10.0% 10.0% 9.7% 9.1% 8.5% 7.9% 7.3% 7.0% Equity Risk Premium 10.0% 9.7% 9.0% 8.3% 7.6% 6.9% 6.5% 6.5% Company Risk Premium 2.5% 2.3% 2.0% 1.8% 1.5% 1.3% 1.3% 1.3% Cost of Equity 22.5% 21.9% 20.7% 19.1% 17.6% 16.0% 15.1% 14.8% Debt Premium 13.0% 13.0% 13.0% 13.0% 12.8% 12.6% 12.4% 12.2% Effective Tax Rate 10.0% 10.0% 10.0% 15.0% 15.0% 15.0% 15.0% 15.0% After-tax Cost of Debt 11.7% 11.7% 11.7% 11.1% 10.9% 10.7% 10.5% 10.4% Weight of Equity 57% 72% 76% 82% 87% 91% 93% 94% WACC (%) 17.9% 19.1% 18.5% 17.7% 16.7% 15.5% 14.7% 14.5%

Year* 2009E 2010F 2011F 2012F 2013F 2014F 2015F 2016F EBIT Corrected for Tax 163.5 116.3 143.0 146.1 150.0 152.4 154.6 157.4 Depreciation 21.9 25.1 26.5 26.5 26.0 25.5 25.0 24.7 Change in Working Capital 47.3 (43.1) (51.1) (44.2) (37.2) (9.1) (7.7) (5.6) CAPEX (70.2) (73.8) (45.2) (41.2) (40.8) (20.4) (20.0) (19.8) Free Cash Flow to Firm 162.6 24.4 73.3 87.2 97.9 148.4 151.9 156.8 Discount Factor 0.85x 0.71x 0.60x 0.51x 0.44x 0.38x 0.33x 0.29x Present Value of FCFF 137.9 17.4 44.0 44.5 42.9 56.2 50.2 45.2 PV of FCF ($m; 2009-16F) 438.4 FCF Growth Rate Beyond 2016F 3.0% Terminal Value ($m; 2016F) 1,404.4 Fair Value ($m) g=1.0% g=2.0% g=3.0% g=4.0% g=5.0% PV of Terminal Value ($m) 405.1 WACC-2.0% 796.6 845.0 903.6 975.9 1,067.6 Enterprise Value ($m) 843.5 WACC-1.0% 715.8 754.1 799.6 854.7 922.9 Net Debt (09E; $m) 129.3 WACC 647.4 678.1 714.1 757.0 809.0 Equity Value ($m) 714.4 WACC+1.0% 588.9 613.8 642.7 676.6 717.1 Shares Outstanding (mil.) 68.7 WACC+2.0% 538.2 558.7 582.2 609.4 641.4 Value per DR ($) 10.39 Note: All calculations are made for financial years, ended June annually

We tested our DCF valuation model for sensitivity to a 1% change in the free cash flow to firm (FCF) growth rate beyond 2016 and a 1% change in WACC over 2009-2016. The sensitivity analysis yielded a fair value range of $538.2m-$1,067.6m.

Sensitivity to changes in FCF growth beyond 2016 and WACC

June 5, 2009


COMPARATIVE VALUATION

Our comparative valuation of Kernel Holding, based on 2009E-2010F EV/EBITDA and P/E of the company’s foreign peers, yielded a fair value estimate of $21.03/share, or 114% above its current market price.

Comparative valuation implies a fair value of $21.03/share

Comparative Valuation: Kernel Holding vs. International Peers Company Price* Currency MC EV/EBITDA P/E

$m 2009FY 2010FY 2009FY 2010FY Kernel Holding 9.8 USD 675 4.0 3.9 5.5 7.5 Premium(Discount) to DM Peers' Median (85%) (39%) (38%) (55%) (46%) Premium(Discount) to GEM Peers’ Median 786% (57%) (52%) (61%) (56%) Developed Market Peers

ABB Grain (AU) 9.2 AUD 1,261 12.8 9.0 26.5 15.7 Graincorp (AU) 7.5 AUD 444 7.6 6.2 14.7 10.1 Vittera (CA) 9.3 CAD 1,999 5.7 3.8 15.2 11.7 Andersons (US) 26.5 USD 482 7.2 6.4 13.5 11.5 Bunge (US) 64.1 USD 7,823 7.7 6.2 11.9 9.5 Archer-Daniels-Midland (US) 27.8 USD 17,848 6.2 7.7 8.9 11.3 DM Peers’ Average - - 4,976 7.4 6.3 14.1 11.4 Emerging Market Peers

China Foods (HK) 4.8 HKD 1,729 10.0 8.2 19.9 16.5 Elstar Oils (PL) 5.4 PLN 81 10.4 8.1 11.6 10.4 EM Peers’ Average - - 905 10.2 8.2 15.7 13.5

Notes: *Prices as of June 5, 2009. Source: Dragon Capital, Bloomberg, Companies

RECOMMENDATION

The average of the DCF and comparative valuation estimates put our fair valuation of Kernel at $15.71/share, or 60% above the stock’s current market price. We thus assign a Buy recommendation to Kernel Holding.

We rate Kernel Holding as a Buy

10.399.83

21.03

114%

6%0%

0.0

5.0

10.0

15.0

20.0

25.0

Current Price DCF CV

Share

Price

(USD

)

0%

25%

50%

75%

100%

125%

150%

Upsid

e Pote

ntial

(%)

Share Price (lhs)Upside Potential (rhs)

Kernel Holding Fair Value Estimates Source: Dragon Capital

June 5, 2009


Risks

Kernel’s ability to obtain raw materials in a timely manner and in sufficient quantities may be affected by natural conditions, including among others, drought, flood, unexpected or heavy frost and hurricanes, and other unpredictable factors such as crop allocation, plantings, government farm programs and policies. Such factors may cause deliveries of raw materials to be delayed or unavailable to Kernel and may adversely affect its business, results of operations and financial condition.

Weather risk: moderate

Selling prices for Kernel’s oils and grain products and operating costs associated therewith are volatile and are determined by market conditions. Among the key factors affecting the market are the availability and supply of raw materials, the weather, crop yields and governmental regulations. If any or all of these factors depress selling prices or increase Kernel’s operating costs and business, results of operations and financial condition may be adversely affected.

Prices fluctuation risk: moderate

Kernel Holding is subject to risks relating to food, grain, oil and protein meal quality requirements and regulations which include, but are not limited to, product spoilage or contamination, industry or government regulations, including processing and labeling regulations, and which may result in potential product liability claims. These matters could adversely affect Kernel’s revenues and operating results.

Product quality requirements: low

Due to the seasonal nature of Kernel’s business, the company requires high levels of financing in the period immediately following the harvest to support the purchase of raw materials as they become available. Kernel fulfills its seasonal financing requirements by obtaining short-term credit lines from commercial banks, which are repaid in the course of the financial year on the condition that Kernel’s sales to customers are timely settled. If the majority of the company’s customers were unable or unwilling to fulfill their payment obligations in a timely manner, Kernel would be forced to repay its short-term credit lines from other resources, thus jeopardizing its liquidity.

Financing risk: moderate

Fluctuations in the value of USD, Kernel’s reporting currency, against other currencies, such as UAH and EUR, have in the past had, and may have in the future, an adverse effect on Kernel’s results. Approximately 70-80% of Kernel’s sales are invoiced in USD for goods sold on the international markets. The remaining 20-30% are sales of bottled oil and domestic agro services. The results of domestic operations are reported in UAH and then converted into USD at applicable exchange rates for inclusion in the company’s consolidated financial statements. Moreover, although the vast majority of loan facilities extended to Kernel Holding are denominated in USD, some loan facilities are also denominated in UAH and EUR. A decline in the value of these currencies compared to USD would have a negative effect on Kernel’s results.

F/X risk: high

Under Ukrainian law, producers of agro products are permitted to choose between general taxation regime (income tax rate of 25%) and special taxation (fixed agricultural tax (FAT)). FAT is paid in lieu of corporate income tax, land tax, duties for special use of water objects, municipal tax, duties for geological survey works and duties for trade patents. Kernel Holding is a FAT payer. If the FAT regime is lifted, Kernel Holding would pay corporate income tax at the standard rate of 25% currently, as well as other tax and duties listed above, which would have a material adverse affect on Kernel’s financials.

Tax exemption regime cancellation risk:

low

June 5, 2009


Agricultural markets and agricultural production generally are subject to prevailing political and social policies. At times, governments impose production and selling restrictions and limitations in the form of quotas, tariffs and other mechanisms to protect national producers both at international and domestic levels. These restrictions and limitations can affect volumes and prices in national, regional and world markets. There is no guarantee that the Ukrainian government will impose protectionism measures. Any change in government regulations or legislation in Kernel’s market, the markets in which the company competes, or in the markets of Kernel’s competitors could adversely affect the business, results of operations and financial condition.

Political risk: high

June 5, 2009


Financial & Operating Summary Operating Summary

Period 2008FY 2009FYE 2010FYF 2011FYF 2012FYF Bulk Crude Sunflower Oil (‘000 t) 304 419 517 621 677 Growth (%, y-o-y) 38% 24% 20% 9% Bottled Oil (‘000 t) 95 111 113 122 123 Growth (%, y-o-y) 17% 1% 8% 1% Grain Trade (‘000 t) 317 2,250 2,813 2,953 3,100 Growth (%, y-o-y) 610% 25% 5% 5% Transshipment services (‘000 t) 1,617 1,500 1,500 1,500 Growth (%, y-o-y) (7%) 0% 0% Farming (‘000 t) 150.4 265 282 423 563 Growth (%, y-o-y) 121% 76% 6% 50% 33%

Profit & Loss Statement ($m)

Period 2008FY 2009FYE 2010FYF 2011FYF 2012FYF Net Sales 663.1 1,148.7 1,263.5 1,408.0 1,504.0 EBITDA 123.2 203.7 154.3 185.4 198.4 Depreciation (11.6 ) (21.9 ) (25.1 ) (26.5 ) (26.5 ) EBIT 111.6 181.7 129.2 158.9 171.9 Net Financial Income (Loss) (23.5 ) (36.0 ) (29.2 ) (25.5 ) (23.8 ) NIBT 91.2 135.7 100.0 133.4 148.1 Taxes 9.0 13.6 10.0 13.3 22.2 Net Income (Loss) 82.2 122.2 90.0 120.1 125.9

Balance Sheet ($m)

Period 2008FY 2009FYE 2010FYF 2011FYF 2012FYF Total Assets 755.6 718.6 972.6 1,084.9 1,167.0 Fixed Assets 378.3 330.3 344.1 362.8 377.5 PPE 108.4 110.1 110.9 111.8 112.6 Current Assets 377.3 388.2 628.5 722.1 789.5 Inventories 144.7 105.1 119.7 132.9 142.1 Accounts Receivable 48.7 36.2 51.9 57.9 61.8 Cash & Cash Equivalents 88.5 122.2 323.5 363.9 387.3 Total Liabilities & Equity 755.6 718.6 972.6 1,084.9 1,167.0 Total Liabilities 315.2 354.3 334.4 326.6 282.8 Accounts Payable 5.5 9.7 11.6 12.9 13.8 S/T Debt 126.7 163.9 150.0 158.6 126.9 L/T Debt 91.1 107.0 96.3 77.1 61.7 Equity 440.4 364.3 638.2 758.3 884.2

Financial Ratios

Period 2008FY 2009FYE 2010FYF 2011FYF 2012FYF Sales Growth (y-o-y) 89% 73% 10% 11% 7% EBITDA Growth (y-o-y) 166% 65% (24%) 20% 7% Net Income Growth (y-o-y) 342% 49% (26%) 33% 5% EBITDA Margin 18.6% 17.7% 12.2% 13.2% 13.2% Net Margin 12.4% 10.6% 7.1% 8.5% 8.4% Net Debt/Equity 29% 41% (12%) (17%) (22%) ROE 10.9% 17.0% 9.2% 11.1% 10.8%

June 5, 2009


Appendix 1: Kernel Holding Management Team

Founded Kernel in 1995 and has since held various executive positions at the company. In his current capacity of Chairman of the Board of Directors Mr. Verevskyy oversees the strategic development and overall management of the Group. He is the majority shareholder in the company (59.03%) through his wholly-owned subsidiary Namsen Limited. Mr. Verevskyy has been a member of Ukrainian parliament since 2002. He is a graduate of the Ukrainian Agrarian University and speaks fluent Russian, Ukrainian and English.

Mr. Andrey Verevskyy, Honorary Chairman

Mrs. Usacheva is responsible for financial reporting and auditing, budgeting, capital resources planning and financial risk assessment. Prior to joining Kernel in 2003, for eight years Mrs. Usacheva was a chief financial officer of United Grain Group, a Kyiv-based grain trading company. In 1993 she graduated from the department of physics/mathematics at Poltava University and in 1994 from the High School of Entrepreneurship at Kyiv Economic University with a diploma in international business administration. In 2000 Mrs. Usacheva completed a professional re-training program Practical Finance Management for Finance and Credit program at the Russian Government Finance. She speaks fluent Russian, Ukrainian and English.

Mrs. Anastasiya Usacheva, CMA, CFM, Director of Financial

Department

Mr. Conrad joined Kernel in January 2003 and has since devoted his time primarily to business development and relations with Kernel’s various international commercial and financial partners. Prior to joining Kernel, Mr. Conrad was head of corporate banking at HVB Bank Ukraine. Mr. Conrad graduated from HEC Lausanne University with a degree in economics. He is a citizen of Switzerland and speaks fluent French, Russian and English.

Mr. Patrick Conrad, Investor Relations and Business

Development Director

Before joining Kernel in 2005, worked for the Ramburs company. 1994 - graduated from Odessa Naval Engineering Institute, major: Engineer for shipment arrangements and management on sea transport. 1998 - graduated from the College of Central London, Sea Management program. Fluent in Russian, Ukrainian, English Responsibilities: export of grain crops, export of sunflower oil, elevator operations, logistics, procurement of grain crops and sunflower seeds.

Mr. Konstantin Litvinski,

Director of Trade Department

June 5, 2009


Appendix 2: Ukraine’s Vegetable Oil Market

The world market for vegetable oil continues to grow dynamically. According to the U.S. Department for Agriculture (USDA), global vegetable oil production expanded by 62% over the last decade and is expected to reach 133 million tonnes (Mt) in the 2008/09 marketing year (September-August).

A steadily growing market

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Palm Oil Soybean oil Rapeseed oil Sunoil Other

World Production of Major Vegetable Oils* (Mt) Note: *Coconut, cottonseed, olive, palm, palm kernel, peanut, rapeseed, soybean and sunflower seed oils.

Source: USDA

World vegetable oil production is dominated by palm oil with 32% of total output in 2008/09. Soybean oil follows with 27% and rapeseed and sunflower oils account for 15% and 9%, respectively.

Sunflower oil accounts for 9% of world vegetable oil production

The leading vegetable oil producers globally include Indonesia, Malaysia, China, the EU, the United States, Argentina, India, Brazil, Russia and Ukraine. The main consumers are largely the same: China, the EU, India, the U.S., Indonesia, Malaysia, Brazil, Russia, Pakistan and Japan. In 2008/09, global vegetable oil exports are expected to increase by 2% y-o-y to 53 Mt (40% of global production). According to USDA, in 2008/09 the group of leading exporters is expected to include Indonesia (31% of global exports), Malaysia (29%), Argentina (12%), Brazil (4%), Ukraine (3.3%) and Canada (2.8%).

Ukraine is the second-largest sunflower oil producer

globally…

Others19.9%

Turkey4.8% Argentina

12.5%

EU-2720. 1%

Ukraine20.7%

Russia22.1%

World Sunflower Oil Producers (2008/09) Source: USDA

Ukraine is one of the largest sunflower oil producers in the world. In 2008/09, global sunflower oil output is projected at 11.4 Mt, 21% of which is expected to be produced in Ukraine. The country is also expected to rank first among world sunflower oil exporters with 46% of total exports (1.7 Mt) in 2008/09.

…and top exporter

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Producers ‘000 tonnes % of total Russia 7,350 22.8% EU-27 6,750 20.9% Ukraine 6,500 20.2% Argentina 2,500 7.8% Turkey 830 2.6% Others 8,291 25.7% Total 32,221 100.0%

Exporters ‘000 tonnes % of total Ukraine 450 23.9% EU-27 350 18.6% Russia 250 13.3% Argentina 45 2.4% Turkey 5 0.3% Others 781 41.5% Total 1,881 100.0%

World Sunflower Seed Production in 2008/09 Source: USDA

World Sunflower Seed Exports in 2008/09 Source: USDA

Producers ‘000 tonnes % of total Russia 2,520 22.1% Ukraine 2,369 20.7% EU-27 2,290 20.0% Argentina 1,425 12.5% Turkey 544 4.8% Others 2,277 19.9% Total 11,425 100.0%

Exporters ‘000 tonnes % of total Ukraine 1,700 43.0% Argentina 1,040 26.3% Russia 670 16.9% EU-27 130 3.3% Turkey 100 2.5% Others 313 7.9% Total 3,953 100.0%

World Sunflower Oil Production in 2008/09 Source: USDA

World Sunflower Oil Exports in 2008/09 Source: USDA

Sunflower has historically been a major oilseed crop in Ukraine thanks to the country’s favorable weather conditions, fertile soil and high profitability of this crop. The area under sunflower increased to 4.3 million ha (25% of the total area sown) in 2008/09 from 1.6 million ha in 1990/91 (5% of total arable land at the time). Ukraine’s 2008/09 sunflower acreage accounted for 18% of the global area sown with sunflower seed over the period. Annual sunflower crop yields in Ukraine have varied widely, with the lowest level of 0.89 t/ha registered in 2004/05 and the highest, 1.5 t/ha, in 2008/09. This compares poorly with the performance of world leaders such as Austria (up to 2.5 t/ha).

Ukraine more than doubled the area under sunflower in the last

15 years

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Ukraine Sunflower Seed Production and Exports Source: UkrAgroConsult

Despite all the advantages of growing sunflower, local agricultural producers have been increasing acreage under soybean and rapeseed due to natural constraints on further expansion of sunflower cultivation. The problem is that sunflower exhausts soil, and the same land can be used for sunflower cultivation every 6-7 years only, making this business highly dependent on productivity enhancement. At the same time, land under soy and rapeseed requires much less time for renewal (two and three years, respectively). In 2008/09, soybeans in Ukraine were sown on 0.54 Mha (almost flat y-o-y). Rapeseed occupied over 1.4 Mha in 2008/09 (+72.5% y-o-y), reflecting increased demand for biodiesel.

Production of soybean and rapeseed is increasing

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Only a small volume of sunflower seed harvested in Ukraine is exported (est. 7% of the total harvest in 2008/09). The rest is processed domestically for sunflower oil and oil cake.

About 95% of sunflower seed produced in Ukraine is processed

domestically…

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Export (Mt; lhs)Area (Mha; rhs)

Ukraine Rapeseed Production and Export

Source: UkrAgroConsult Ukraine Soybean Production and Export


Prior to Ukraine’s accession to the WTO last year, exports of sunflower seeds from the country had been limited by a high export duty of 17%, in effect since 2001, and minimum indicative export prices set by the government. The export barriers were intended to support local vegetable oil producers and encourage exports of higher value-added products (i.e. vegetable oil instead of sunflower seed). While such restrictions benefited oil producers, they hurt agricultural companies’ margins. As part of its WTO commitments, Ukraine undertook to reduce the sunflower seed export duty by 1.0pp annually until it reached 10%. The government also abolished minimum indicative export prices for sunflower seeds.

…as exports are regulated…

Unlike sunflower seed, about 30-40% of soybean and 85-90% of rapeseed crops collected in Ukraine are exported as local demand is currently weak. We expect new domestic capacity for deep soybean processing to encourage agricultural producers to increase their share of domestic sales.

…but large volumes of soybean and rapeseed are exported

International trader Cargill exports almost 30% of Ukraine’s sunflower oil, followed by domestic sunflower oil producer Allseeds with a 13% share. Another vertically integrated Ukrainian company, Kernel, is third with 11%.

Major sunflower oil exporters in Ukraine

Others39.0%

Bunge9.0%

Kernel Holding11.0%

Allseeds13.0%

Cargill28.0%

Others30%

Egypt 8%

Turkey14%

India19%

EU-2729%

Bulk Sunflower Oil Exporters in Ukraine (2008/09E)

Source: Kernel Holding Ukraine Bulk Sunflower Oil Export Destinations

(volume; 2008/09E) Source: SSC

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The EU is the largest importer of Ukrainian sunflower oil with a 29% share in total exports in 2008/09. The Netherlands alone consumed 6.3% of Ukrainian sunflower oil exports in the previous season.

The EU is a major importer of Ukrainian sunflower oil

Domestic sunflower seed producers, similar to grain growers, continue to enjoy government support, including tax benefits and subsidized loans. Additionally, parliament recently refused to allow duty-free exports of sunflower seed, which is positive for domestic sunflower oil producers. We expect no new restrictions on exports of sunflower oil from Ukraine following the country’s entry to the WTO.

Preferences from the state

Domestic sunflower oil producers are expected to benefit from the hryvnia depreciation as they are predominantly exporters and 90-95% of their costs are denominated in hryvnia. Domestic sunflower seed prices follow respective world prices with a few months’ delay, implying a time advantage for local vegetable oil producers. We thus expect domestic sunflower processors to enjoy stable profit margins in 2009 provided that export conditions are favorable

2009 outlook

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Appendix 2: Kernel Site Visit (April 2-3, 2009)

Myrhorod Elevator Source: Dragon Capital






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Poltava Oil Extraction Plant Source: Dragon Capital






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Illichivsk Grain Transshipment Terminal Source: Dragon Capital





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Silo in Kirovohrad Region Source: Dragon Capital

Silo in Kirovohrad Region Source: Dragon Capital

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Farming Machinery Source: Dragon Capital



Winter Wheat Field Source: Dragon Capital



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DRAGON CAPITAL EQUITY RESEARCH COVERAGE POLICY Investment Recommendations Dragon Capital employs three basic recommendations to rate stocks under coverage: Buy, Hold and Sell. The recommendations are assigned according to the table below.

Fair Value Upside to Current Market Price Recommendation >50% Buy 0% – 50% Hold <0% Sell

In addition, we may rate a stock as a Strong Buy in case its valuation upside exceeds 100%, there are no material risks that could jeopardize our valuation and we see a high probability for the stock to outperform the market in the short-term perspective based on available information and our fundamental valuation. Stocks that are either suspended from trading or do not have a recommendation assigned by Dragon analysts are designated as Not Rated. In case an analyst’s individual rating of a stock (please see definition below) is low, leaving it outside his/her top five recommendations, this stock can be assigned only a Hold or Sell recommendation regardless of its upside suggested by fundamental valuation. We put a stock Under Review if its fair value and/or recommendation are subject to change based on latest financial results, newly arisen risk factors, or other important events. We make all reasonable effort to reinstate recommendations and fair values on stocks under review in the shortest possible time. Finally, we suspend a traded company from coverage in case Dragon Capital signs an investment banking services mandate with such company (for example, to place its shares on the market). Coverage is reinstated after the relevant investment banking transaction is closed. Current Distribution of Investment Recommendations

Recommendation Companies Covered

Buy Hold Sell Under Review Not Rated Suspended 119 9 23 16 0 68 3

% of Total 8% 19% 13% 0% 57% 3% Dragon Capital also structures its universe of covered stocks using three parameters: liquidity, risk level and analyst’s view. The ranking based on liquidity is used to select stocks that are assigned investment recommendations in addition to the three above parameters. Analyst’s View In order to provide for our analysts’ views on the stocks they cover, each analyst ranks all stocks in his or her coverage universe (usually for stocks from more than one sector), assigning #1 to his/her top pick, #2 to the next-best pick and so on. In addition to pure financial modeling, such rankings are based on the analysis of a broader set of factors that may not be captured by valuation, including relative comparison of company-specific opportunities, threats, etc. Liquidity We split our coverage universe into three tiers: 1) Relatively liquid stocks 2) Less liquid stocks 3) Illiquid stocks We determine the liquidity rank based on available historical trading statistics and our estimates of trading activity not reported officially (e.g. over-the-counter transactions). Stocks on the third (illiquid) list are not assigned recommendations and are designated as Not Rated. The composition of liquidity tiers is subject to a semiannual review but substantial market-wide or company-specific developments may warrant a more frequent revision. Risk Grade We apply two risk measurements: higher risk (HR) and lower risk (LR). We assign the higher risk grade to a stock in case of a substantial degree of uncertainty in relevant valuation assumptions and volatility in valuation estimates (i.e. when different valuation approaches result in divergent recommendations). Conversely, we consider a stock to be in lower-risk territory if relevant valuation assumptions are more certain, different valuation methods suggest uniform recommendations and the analyst covering the stock in question does not see significant short-term risks attached to it.

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RESEARCH Director, Research Andriy Bespyatov, PhD, CFA [email protected] Economics Electricity

36D Saksahanskoho, 01 033 Kyiv, Ukraine Tel.: (+380 44) 490 7120 Fax: (+380 44) 490 7121 www.dragon-capital.ua Olena Bilan Dennis Sakva [email protected] [email protected] Managing Director Tomáš Fiala Politics Oil & Gas [email protected] Viktor Luhovyk Dennis Sakva [email protected] [email protected] Andriy Bespyatov SALES Banking, Insurance [email protected] Vitaliy Vavryshchuk Managing Director, [email protected] Fixed Income Head of Trading and Domestic Sales Olga Slyvynska Dmytro Tarabakin Metals & Mining [email protected] [email protected] Sergiy Gayda [email protected] Editing Managing Director, Viktor Luhovyk International Equity Sales Chemicals, Food & Agriculture, [email protected] Peter Bobrinsky FMCG [email protected] Tamara Levchenko Research Assistants [email protected] Volodymyr Skepskiy Managing Director, Fixed Income [email protected] Dray Simpson Machine-Building, Real Estate, Olga Slyvynska [email protected] Telecommunications [email protected] Taisiya Shepetko Director, Equity Sales [email protected] Andriy Dmytrenko, CFA [email protected] Director, Trading and Domestic Sales Denis Matsuyev [email protected] Senior Associate, International Sales Fyodor Bagnenko [email protected] Fixed Income Trading Svitlana Rusakova [email protected] DISCLAIMER This report has been prepared by Dragon Capital for information purposes only and is not an offer or solicitation to deal in any security. The opinions, forecasts and estimates in this report reflect our good-faith judgment as of the date of publication, and may change without notice. Although the information in this report comes from sources we believe to be reliable, and although we have made every effort to ensure its accuracy at the time of publication, we make no warranty, express or implied, of this report's usefulness in predicting the future performance, or in estimating the current or future value, of any security. Nor should this report be regarded as a complete description of the securities or markets referred to herein. Any opinions expressed herein may differ from opinions on the same subject expressed by other business departments of Dragon Capital as a result of employing different assumptions or methodology. Any investment decision made on the basis of this report shall be made at the investor's sole discretion, and under no circumstances shall Dragon Capital or any of its employees or related parties be liable in any way for any action, or failure to act, by any party, on the basis of this report. Nor shall Dragon Capital or any of its employees or related parties be liable in any way for any loss or damages arising from such action or failure to act. Dragon Capital does and seeks to do business with companies covered in its research reports. Investors should therefore be aware of a potential conflict of interest. Additional information on securities or companies discussed in this report is available upon request. This report may not be reproduced without the prior written permission of Dragon Capital; when quoting, please cite Dragon Capital.

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