Russian Agriculture Requires a Leap of Faith

Capitalists are coming to Russia’s once-collectivized agricultural sector. Already-sizable private companies are looking to Western markets for equity capital to fund ambitious expansion plans: Rusagro, a sugar and meat producer, hopes to raise $300 million through an initial public offering in London, and more could follow this year.

A plausible growth story for the Russian agriculture sector exists. But high debt levels, unproven management teams and climatic vagaries leave plenty of room for doubt.

Russia certainly doesn’t lack space. The country’s arable land stretches to about 120 million hectares, the world’s third-largest amount. But a lack of investment since the early 1990s has proved harmful. An estimated one-third of arable land lies fallow. Wheat yield, at 1.85 tons per hectare in 2010, was far below the 5.25 tons/hectare in the European Union, according to the International Grains Council.

That, at least, provides the chance for a catch-up story. Rusagro, for example, wants to invest in farm modernization and acquisitions, potentially of now-fallow land. Since 2003 reforms, land trading has become easier: Companies like Rusagro have been able to steadily buy up land parceled out to rural dwellers after 1990. Its 380,000 hectares of land, an area almost equivalent to Switzerland’s agricultural land, makes it one of 10 Russian firms with more than 300,000 hectares.

The bet for investors is such companies can pursue ambitious growth plans while improving returns. Rusagro’s financial details are scarce, but its posttax profit margin, on $183 million of earnings, improved to 16.7% in 2010 from 9.7% in 2009. Razgulay Group, a listed sugar producer, wants to increase its 324,000 hectares of land in cultivation by 50% in five years, while tripling earnings before interest, taxes, depreciation and amortization. Its return on invested capital should be 18.9% by then, from 2.7% in 2009, according to Renaissance Capital.

But there are plenty of risks. Company managements may not be able to handle rapid growth. Razgulay’s earlier expansion up to 2008 left it heavily indebted, and its net debt is still 5.9 times expected Ebitda. Its share price is a quarter of that from February 2008.

The Russian farm sector relies heavily on continuing government subsidies for bank lending; Cherkizovo, a London-listed meat producer, would have seen profit 25% lower in the first nine months of 2010 without such aid. And companies remain vulnerable to the weather. Rusagro’s ability to convert beets to processed sugar dropped 13% in 2010 because of the drought.

With opportunities to invest in large European agricultural stocks rare, investors prefer stocks like Astarta, operating in Ukraine’s more fertile, temperate conditions. Its enterprise value is 12.6 times expected Ebitda, compared with Razgulay’s 6.9 times and Cherkizovo’s 6.7 times.

Despite some favorable tailwinds, investors in Russian agricultural companies still require a leap of faith.