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Equity Market Insight-Industrial Milk Company: Target price lowered on government interference

Target price lowered on government interferenceThe Cabinet of Ministers has revised the normative value of land from the current average of US$1,485 to US$2,515 per hectare, starting from January 2012. Such a regulation prompted us to revise our model on Industrial Milk Company and revise downward our target price by 18% from PLN18.87 previously to PLN15.50 per share.

New rules of agribusiness enter the market. The Ukrainian State Agency for Land Resources (USALR) reported on 12 August that the government had revised the normative value of land from an average US$1,485 to US$2,515 per hectare. In light of adoption of the new Land Market Law, which is likely to pass Parliament's approval in October 2011, and will go into effect starting in January 2012, the minimum level of the annual land lease fee for agricultural companies is set at 3.5% of the normative value of land. Accordingly, the minimum land-lease fee will increase from the current US$22.3 to US$75.5 per hectare. Such a regulation will undoubtedly negatively affect agricultural companies, as well as IMC, which will bear higher operational costs per hectare.

IMC will pay a land-lease fee of US$81.80 per hectare starting from 2012, we assume. IMC is currently operating 23,000ha in Chernigiv and 29,500ha in Poltava regions. According to the USARL, the current normative value of land is US$1,170 in Chernigiv and US$1,660 in Poltava. A 70% increase in normative land value should result in US$1,980 per ha in Chernigiv and US$2,810 in Poltava. The average current annual land-lease fee for IMC is US$53.2 per ha, which is 3.69% of the average land value of US$1,440. With the increased value of land and minimum land-lease rate, we assume IMC will pay US$81.8 per ha, which will be 3.35% of the average land value of US$2,447. We believe an upside lies in the assumption that IMC can pay a part of its annual land fees in kind and negotiate effectively lower lease payments.

Regulation has no impact on 2011 financials. Since the legalities of the regulation do not come into force until 2012, they will not adversely affect the forecasted financials of 2011, but their negative impact on financials will be noticeable starting from 2012. Thus, we calculate that the new regulations will decrease our previous 2012 EBITDA forecast by US$2.1m to US$58.6m, and 2013F EBITDA by US$3.8m to US$64.3m (see Table on pp. 2 for deeper insight).

Target price revised downward to PLN15.50 per share, BUY reiterated. Given the aforementioned changes in Ukrainian agribusiness, we have revised downward our previous target price of PLN18.87 by 18%, to PLN15.50 per share. Despite this, we believe IMC is strong fundamentally and is well on track to achieve its operational and financial targets; our BUY rating and TP of PLN15.50 implies a 72.2% upside potential to yesterday's closing price of PLN9.00.

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