Tuesday, June 10, 2014

Avangardco: one stock to avoid

Avangardco is a Ukrainian egg producer. It trades at a low multiple of reported earnings, and that's attracted a lot of attention from value bloggers-- see here, here, here, and here. These blogs all acknowledge that Avangardco has risks, such as insider control of the company and the political situation in Ukraine, but none mentions what I consider the biggest risk: that the company is a fraud.

Soon after Avangardco went public, a Russian bank claimed that the company had tried to weasel out of its debts:
"Russian VTB Bank's Ukraine subsidiary went public over the summer with complaints that LSE-listed egg producer Avangard was trying to wriggle out of a total $27m debt held by a number of subsidiaries. Avangard is owned by Oleg Bakhmatyuk, former deputy chairman of gas monopolist Naftogaz. 'VTB Bank is considering appealing to the London Stock Exchange and the British Financial Services Authority to exclude the shares of Avangard from the listing, as a company violating the principles of civilized conduct of business,' the company threatened June 22. But VTB now says it has refrained from appealing to the LSE after Bakhmatyuk returned to the negotiating table. Bakhmatyuk disputes the debts."

Assuming the bank's claims are true-- and I believe they are, because it would seriously damage its lending franchise by falsely making this kind of claim-- I see a couple of possible explanations:
1. Avangardo tried to defraud its lenders by tunneling assets out of its borrowing subsidiaries.
2. Avangardco had trouble paying its debts, and its IPO was motivated by financial necessity, implying that its reported profits are inflated.

I lean toward 2. because I don't think Avangardco's financial statements are believable. The company reported an 46% EBITDA margin last year while Cal-Maine, America's largest egg producer, reported a ~10% margin. Cal-Maine has never achieved an EBITDA margin above 30%.

Avangardco also has a weird management structure: Bakhmatyuk, who owns 77.5% of the company, isn't CEO or even chairman. Instead, he's a director, his sister is chairman, and the CEO is a young woman who has no job experience outside of Avangardco. She joined the company out of grad school, became CFO after working there for two years, and became CEO a few years after that.

In my experience, weird business or management arrangements are a sign of fraud even when it's not clear how they abet fraud. Avangardco reminds me of ACLN, where the CFO was a 25-year-old who drew no salary from the company and there was a bizarre stock-ownership arrangement between the CEO and the chairman.

Even if Avangardco isn't a fraud, VTB's claims and Bakhmatyuk's investments in the US raise serious questions about his integrity. This is not someone I'd ever want to do business with, no matter how seductively cheap the stock looks.

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