Calling all risk takers, a Ukrainian investment at 2x earnings and 45% of book value

"The time to buy is when there's blood in the streets." - Baron Rothschild

Investors who venture into risky markets can realize either fantastic returns, or encounter losses to be written off at tax time.  Right now feels like one of those times where a fortune could be made or lost by investing in the Ukraine or Russia.

I haven't spent any time looking at Russian companies, but I have seen a Ukrainian company written up on a number of blogs that I felt merited a further look.  The company is Avangardco (AVGR.London), an egg producer.  They are the number one egg producer in the Ukraine and in Eurasia.  If you're reading this and live in Europe you've probably consumed Avangardco eggs.

The company is compelling due to their extremely low valuation.  They trade for slightly over 2x earnings, and about 45% of book value.  This is a really low valuation for a company with a considerable market position.  Usually a valuation this low can be attributed to one time earnings, or another non-repeatable event.  That's not the case for Avangardco, the company's earnings appear relatively stable.  The company's book value is well supported by earning power.  Book value is close to five times net income.  This is clearly a two pillar stock.

When a stock is trading for such a low multiple an investor doesn't need to spent a lot of time considering whether it's good business, or if they have a moat, or if can earn acceptable returns on equity.  If you are interested in exploring those issues I'd recommend you read Dave Waters' writeup of the company from January.

In my view there are only two questions that need to be answered about the company, and if both can be answered conclusively then this is an incredible investment.  The first is will the company's business going forward resemble business the past, secondly is there a risk of permanent capital loss from some event or incident?

Back before Putin began to reassemble the Soviet Union the biggest risks outlined for an Avangardco investment were related to its billionaire majority owner.  A noted but not emphasized risk was that the company operates out of a politically unstable country.  That previously minor risk has come to the forefront lately.

To consider Avangardco as an investment we need to rule out two potential outcomes: that the company will disappear, and that their business is permanently impaired.  If both of these risks can be eliminated buying a company at 2x earnings and 45% of book value has a great chance of generating a return.

Let's tackle the first issue, that they will completely disappear.  I can see this happening under two or three circumstances.  The first is that Russia launches an all out war against the Ukraine and either destroys all of Avangardco's facilities, or re-collectivizes them.  I think this is the most remote possibility, I'd assign a very small probability of this happening.  There's a chance Russia might invade the Ukraine, but given how Ukraine resisted in Crimea I'm not sure there would be much fighting.

Hens are going to continue to lay eggs regardless of whoever is in control of the country.  As long as the eggs can get to a customer, and the customer as the ability to pay the company should continue to make money.

The second potential risk is that even if the company can conduct operations going forward it will be at a reduced level.  I'd consider this the best argument for the low valuation.  Some of Avangardco's facilities are in Crimea, maybe those will have to be abandoned.  If Russia invades Eastern Ukraine then maybe the company will lose half of their facilities or critical infrastructure.

If the company were to lose half of their earning power they would still be trading at a very low valuation of 4x earnings.

I think there's another alternative that investors should consider as well.  Prior to Ukraine's recent unrest they weren't known for having the most transparent or honest government.  Even in those conditions Avangardco was able to flourish under the control of their billionaire owner.  My thought is that the owner knows how to grease the political wheels to get favorable treatment.  Considering that the Russian economic system seems to be run by in a similar manner it's likely that Avangardco's owner will find a way to work in whatever new political system emerges.

The question to ask regarding Avangardco is if the worst case doesn't happen then what does the future look like?  If their facilities aren't destroyed in a war or collectivized in a communist revival, and the hens continue to lay eggs is it worth more than the current valuation?

If you think the worst case is a likely outcome then this is an investment to avoid at all costs.  If you don't think the worst case is likely then the company could return multiples once the political environment begins to settle.

I think Avangardco illustrates a few things about buying cheap companies and margin of safety concept.  If an investor is buying companies without much room for error their assumptions and estimations need to be very accurate to realize a return.  The cheaper a company gets the less accurate assumptions or estimations need to be.  At a certain point, as in Avangardco's case, as long as the company survives and is able to find a way to make money investors will most likely realize a return.

Disclosure: No position