Unique opportunities in CEE agriculture
Rising global demand and improvements in productivity will transform the agriculture sector in CEE in the coming years. With effective financing, companies from the region can play a leading role in the evolving global agriculture market.
By Pieternel Boogaard, Head of Agricultural Finance CEE at ING Structured Finance
Food, and therefore agriculture, is becoming an ever more important issue for the world. Global grain consumption is expected to grow by 250 million metric tonnes over the next ten years. Population growth, a changing diet – especially in emerging markets – with increasing meat consumption (which requires more grain for animal feed), and the growing use of grains in biofuels are all driving demand.
Production cannot keep pace with rising demand. Globally, there is a shortage of suitable land while yields per hectare are levelling off in the US and Europe. As a result there are huge opportunities for agricultural producers in suitable locations.
CEE – already a major producer of grain, wheat, corn, barley, vegetable oil and sugar – has large quantities of potentially productive land, enormous potential to improve yields from naturally fertile land (especially in Russia and Ukraine) and low labour, fertiliser and diesel costs. Moreover, it is in close proximity to some of the world’s largest importers of grains in North Africa.
Increasing support in Russia
Support for agriculture varies across CEE. In Russia, the government has significantly increased its focus on agriculture as it seeks to diversify the country’s economy. Russia, which joined the World Trade Organisation (WTO) in 2012, sees huge opportunities for its agriculture sector.
Russia’s agricultural goals are twofold. Firstly, it is committed to self-sufficiency in its food production by 2020. While Russia exports large quantities of grain, it wants to reduce imports of sugar (it is currently one of the world’s largest importers), poultry and pork. Russia’s second objective is to broaden its economy and increase exports to reduce its dependence on revenue from metals and oil and gas.
The drive for self-sufficiency will not crowd out the goal of increased exports because Russia has such large amounts of land to be brought into production. The country has 120 million hectares of available land – 8% of the global total – while yields remain well below the world average.
A huge improvement in production and productivity is therefore achievable. Russia is supporting the expansion of agriculture primarily through the provision of subsidies for interest on bank loans. Around two-thirds of interest costs are paid by the government. Loans are available through all banks licensed to operate in Russia (including ING) and loan growth has been significant.
The Russian government has allocated around USD 10 billion a year for loan subsidies to farmers. While the WTO is working to reduce agriculture and other subsidies – and Russia has agreed to these goals – Russia’s current level of subsidies has been approved by the WTO. Russia is likely to continue to support its farmers extensively even after 2020.
Dynamic companies in Ukraine
In contrast to Russia, Ukraine has little government support for agriculture and no subsidies. Perhaps as a result of this lack of official support, the agricultural sector is dominated by competitive, large, well-managed companies – such as poultry producer MHP, Kernel and Mriya Agro Holding – that have made significant advances in achieving international standards of efficiency, corporate governance and productivity.
International investors are often cautious about Ukrainian companies because of the country’s macro-economic and political risks: the government’s rating was downgraded to Caa1 from B3 and placed on review for downgrade in September. However, the agri-business sector in the country remains competitive and dynamic.
Ukrainian agriculture companies can withstand the country’s turbulent macro-economic backdrop because of the strength of their market positioning. Companies such as soft commodity producer Kernel Holding are strongly export-focused while others, such as MHP, are positioned in markets – such as poultry – where domestic demand remains strong even during difficult times.
Furthermore, many Ukrainian agriculture companies are strengthening their position by becoming vertically integrated. For example, Kernel began as a sunflower trading company before adding crushing capacity (increasing its margins). The company has since added ports and silos and is now also one of Ukraine’s largest farm operators. Similarly, Astarta, which listed in Warsaw in 2006 via ING, started as a sugar beet producer but has moved into soy production and crushing to produce soy oil and meal and also into dairy production.
Companies are now also expanding cross-border and larger players are emerging that could change the dynamics of the business. Russian companies are expanding into Ukraine, for example, while Kazakh companies are moving into Russia. Hampered by logistical problems when selling globally, Kazakh companies are also expanding their regional sales. Ukrainian companies are eager to avoid the high funding costs (due to elevated credit and transfer risk) associated with companies operating solely in Ukraine and are also diversifying geographically.
It is now possible for international companies to own land in Russia through a Russian company. In Ukraine land can currently only be leased. However, while there may be a legal right to buy land in Russia, in practice it remains impossible given the absence of a land registry. The greatest opportunities for foreign investors therefore lie in the provision of silos (which provide access to grain supplies), crushing plants, sugar plants and logistical capabilities. In these areas, foreign investment – notably from Asia – continues to enter CEE.
Decreasing market intervention
In recent years, both Russia and Ukraine have intervened in the market. In 2010 Russian exports were restricted by the government following a poor harvest and consequent high prices. Similarly, in 2011 the Ukrainian government, which previously subsidised exports by refunding VAT, decided not to return VAT to traders given what it viewed as high prices (which it believed removed the need for a subsidy) and the difficult economic outlook.
In 2012 there was a poor harvest in both Russia and Ukraine but despite high prices neither government introduced an export ban. Both governments appear to have recognised that export bans are unhelpful for producers and consumers. Instead, there is an encouraging trend of increasingly relying on voluntary export limits and agreements between government and companies to supply local markets. Likewise, the Ukrainian government has not re-instated VAT refunds for exports, which the market has now accepted as the status quo.
Servicing the agriculture sector
Across the region – but especially in Ukraine given the political risk – the role played by the European Bank for Reconstruction and Development, the International Finance Corporation and the European Investment Bank has increased significantly. These multilateral lenders typically lend with a longer tenor than commercial banks (although they also compete – and cooperate –with commercial banks to lend at shorter tenors).
Overall, credit has continued to flow sufficiently to allow investment in agriculture to continue across CEE. Russian state-owned banks – prompted by the government – have expanded credit provision not only in Russia but also in Ukraine and elsewhere.
A tailor-made solution
ING continues to play a leading role in the agricultural market in CEE: in the past year it established a USD $100 million bilateral facility with MHP to fund oil seed purchases. The deal represents an expansion of ING’s relationship with MHP, which also has working capital facilities with the bank.
ING has played a leading role in many landmark agricultural transactions in CEE. In August 2011, ING arranged a USD 500 million pre-export lending facility – the largest ever from the region – for Kernel. The syndicated loan achieved a 100% hit rate and closed oversubscribed. Having long been focused on pre-export financing, ING has also expanded into capital expenditure financing for agricultural companies and short-term local working capital financing (repaid from local sales).
Both international and domestic companies active in agriculture in CEE need a partner with sector expertise. Only by understanding the seasonal dynamics of agriculture – high seasonal leverage, a sharply differing need for credit depending on the outcome of the season and a long asset conversion cycle – can companies be assured that they will get the support they need to achieve their goals.
ING focuses on the top five players in each sector in each country. It offers a strong combination of structuring capacity and network breadth across CEE. While some banks have multiple departments pitching different products, ING puts the client first and considers its needs before delivering a coordinated offering. ING’s flexibility is important given the challenges of financing agriculture in CEE.
ING has a proven track record in agriculture in CEE. Its use of local staff in Kazakhstan, Russia and Ukraine to structure and originate its financial solutions means that it really understands the companies it works with, their business models and the dynamics of the agricultural market. It is therefore able to align its strengths to support agricultural companies in a wide range of areas.
ING tailors solutions in corporate finance, including IPOs and mergers and acquisitions advisory. It offers lending with great flexibility: to local entities and/or offshore; provided from Amsterdam or locally; in foreign or local currency; short or long term; committed or uncommitted; syndicated or bilateral; and multipurpose. ING can also provide additional FX, interest, commodity hedging and trade financial services (documentary services).