accretion, activist investors, Avangardco, Cal-Maine Foods, corporate governance, eggs, enhanced EPS/NAV, free cash flow, intrinsic value, Iryna Marchenko, lowest cost producer, M&A, majority control, minorities, Nataliya Vasylyuk, Oleg Bakhmatyuk, P/E ratio, P/S Ratio, Return on Equity, risk aversion, share buyback, technical analysis, Ukraine, Ukrlandfarming
Here’s a copy of a recent letter to the CEO & CFO of Avangardco.
Note I’ve updated all figures, as appropriate, to reflect today’s $10.50 closing price – otherwise, the text remains unchanged. For reference, I’ll also include Word copies of the original below. The letter speaks for itself, and is also a great reminder to readers of AVGR‘s extraordinarily cheap valuation! So, without further ado:
‘November 05, 2012
Nataliya Vasylyuk, CEO, &
Iryna Marchenko, CFO
121 V Prospect Peremohy
Dear Nataliya & Iryna,
First, I believe (from your website) you are already familiar with the Wexboy blog. Second, my congratulations on your recent results! To report a 27% yoy increase in revenues, +36% on operating profit (to reach a 43% margin), and +47% on EPS is most impressive. I didn’t post a write-up, as I had flagged up excellent results to come, but I hope you’ll find my recent AVGR post interesting.
I remain an enthusiastic shareholder, with a 2.6% portfolio stake. To see the market rewarding your recent performance with a $10.50 share price, a 1.1 price/sales ratio, and only a 3.0 P/E ratio seems ridiculous. My personal estimate of AVGR’s intrinsic value is at $31.83 per share, which offers a 203% upside potential! That equates to a 3.3 P/S ratio & a 9.1 P/E ratio – quite conservative in light of recent margins & earnings growth. Ideally, I’d increase my stake, but I’ve limited my risk for the moment due to current stock volatility & sentiment. I’m writing to you now with a number of recommendations. These are unrelated to your business performance – your operational execution has been flawless:
i) Avangardco is now the #1 & #2 egg producer in Eurasia & the world, and aims to become the #1 global producer, which should offer further economies of scale. For investors, though, focusing on the largest companies is no guarantee of investment success. However, identifying & investing in the lowest cost producers is often a far more reliable & rewarding strategy. This is a specific focus for many well respected hedge fund investors.
I believe a greater emphasis on your low cost structure & advantage(s) will attract increased investor interest. Personally, I’ve assumed AVGR is already (one of) the lowest cost global producers (and noted your significant cost advantage vs. Cal-Maine Foods). However, most of your competitors are unlisted, so a more comprehensive analysis is beyond my scope.
Will you consider researching your global production cost ranking & emphasizing this cost advantage in your future Investor Relations materials?
ii) There is continued uncertainty re a potential merger with Ukrlandfarming plc (wholly-owned by your Chairman, Oleg Bakhmatyuk, who also owns a majority stake in Avangardco). This speculation has been rife in the media for a significant period now, you have acknowledged it as a potential corporate strategy, but essentially no further details have been provided. This information vacuum has clearly penalized AVGR’s valuation & has presumably deterred new shareholders from investing.
I believe a more fairly valued AVGR market cap., and equitable & transparent treatment for all shareholders in the event of a merger (or other transaction), is vital to the long term success & investor support for a potentially enlarged group. I understand market & corporate circumstances can change rapidly, but it should be possible to provide more detail on potential merger/related strategy alternatives. For example, this could include a possible timeline, how AVGR shareholders might be rewarded and/or participate in a transaction/merger, and/or some idea of the benefits & scale resulting from (say) a merger.
Will you provide enhanced commentary & info. on these potential strategy alternatives, or commit to providing a more comprehensive investor presentation by a certain date?
iii) I believe there are certain other factors negatively affecting AVGR’s share price, including:
a) Oleg Bakhmatyuk’s 77.5% majority stake: A dominant shareholder is always a concern for minority investors, but there has been no actual justification for such anxiety, and your IR strategy & disclosure has been exemplary. This is about sentiment – investors display little concern, for example, over poor corporate governance (like dual-class share structures) in many US tech & (social) media companies. The only concern that can be realistically addressed here is highlighted in ii) above.
b) The political, economic & governance risks of investing in a Ukrainian company: Obviously, these risks concern you from an operational perspective. But worrying about their impact on the share price seems rather pointless – continued execution of your growth strategy is the only sensible solution.
c) Share price technicals & investor aversion to risk: The ultra-cheap AVGR share price & valuation seems to bizarrely encourage some investors to panic-sell! Which prompts other investors to sell – a negative feedback loop! It may also discourage new investors. Absurd, of course – AVGR’s cheap price, margins & accelerated earnings growth more than compensate for any (perceived) risk. There is little that can be done about this – continued execution of your growth strategy is, again, the solution.
Overall, as long you continue to execute, poor sentiment & a low share price will prove to be a temporary phenomenon. In fact, it’s something to embrace & exploit! A share buyback is a marvelous way to offer reluctant shareholders an exit, and to enhance intrinsic value for remaining shareholders. The current $10.50 share price offers a v cheap opportunity to implement the 5 million GDR share buyback that was already approved in Dec-11.
In the past year, AVGR’s generated $327 mio from operations, while free cash flow (after net interest, taxes & capex) amounted to $138 mio. This is excellent news, and Avangardco now holds gross cash of $333 mio & net cash of $4 mio. A 5 mio share buyback at (say) an average 10% premium will only cost $58 mio. AVGR’s current cash position (& future cash generation) offers generous funding & capacity for a buyback, and your current growth & capex plans. A buyback would ideally absorb any ongoing investor share sales & push the share price higher, reverse the current poor technicals & sentiment, and send a v positive corporate governance signal to current & prospective investors.
Most importantly, buybacks at a significant discount (to any reasonable estimate of intrinsic value) are a v effective way to enhance shareholder value. I’m sure this is an ongoing discussion with your advisors, but perhaps I can illustrate the potential impact of a full buyback in 3 different ways:
a) Investment Perspective: Investment in your business offers high growth/return, but an investment in AVGR shares is even more attractive. Based on current earnings & a 3.0 P/E ratio, any buyback is basically an investment that offers a net 30.2% return on equity.
b) Earnings Perspective: Of course, bought back shares will be cancelled. But loss of interest income on the utilized cash is negligible, so net income remains virtually unchanged. With the outstanding share count reduced by 7.8%, the buyback provides an 8.3% increase in EPS.
c) Valuation Perspective: As a high growth company, I expect most investors (like myself) value AVGR based on appropriate P/E and/or P/S ratios. Post-buyback, cash is reduced, but revenues & earnings remain virtually unchanged. Factor in the reduced share count and you arrive at a higher intrinsic value per share. I calculate my estimate would increase by 8.4% to $34.50 per share.
Will you consider launching a full 5 mio GDR buyback program as soon as possible?
I’m available at email@example.com, or by conference call, if you wish to discuss further. I’d like to thank you in advance for your consideration of these recommendations. I’d appreciate your immediate reply just to acknowledge receipt of this letter, and to confirm when you expect to be able to respond properly. Please note I intend to publish this letter on the Wexboy blog in due course.
Avangardco Letter (28 Oct 2012) (docx file)
Avangardco Letter (28 Oct 2012) (doc file)