Radio Mayak. Business Program “Office. Interview”

May 14, 2015

HOST: Dear friends, today is Thursday, and on Thursdays we usually follow our tradition of meeting with people who talk about the secrets of success at a particular company. Our guest today is Alexander Kostikov, Head of Investor Relations of Cherkizovo Group. Alexander, welcome.

ALEXANDER KOSTIKOV, HEAD OF INVESTOR RELATIONS OF CHERKIZOVO GROUP: Hello.

HOST: I think nearly Russian knows about Cherkizovo.

CO-HOST: First, it’s the area.

HOST: Of course, first it’s the area, and first it’s sausage. You’re Russia’s largest manufacturer of meat products, and also the country’s largest feed manufacturer, on top of everything else. Alexander, guests on this show usually start by talking about the history of their company, that is, how it started. For example, as someone not involved in the business, I can imagine, let’s say, two cows that live in a stall on my property, and two haystacks for them to eat, so that they give me milk and I use them for meat some day. Of course, I realize your company is on a totally different scale.

ALEXANDER KOSTIKOV: Yes. Nearly 2 million pigs per year, 250 million birds per year... So, yes. It’s on another scale.

HOST: Let’s start from the beginning. How everything started, and how things turned out the way they did.

ALEXANDER KOSTIKOV: It started quite a long time ago, almost 40 years. The Cherkizovsky Meat Processing Plant was built in Moscow. Our origins probably go back to it. Then Igor Babaev came to work at the plant in the 1990s. He is still Chairman of the company’s Board of Directors. We usually just call him the “founder”. He started working as chief engineer. He put a lot of effort into making the plant a modern facility. Back in the 1990s, when workers elected their directors, he was elected director of the Cherkizovsky Meat Processing Plant. Then there was privatization, and Igor Babaev became the owner of a controlling interest in the plant. The crisis of 1998 followed, and it became obvious that it was impossible to operate when meat processing depended on imported raw materials. That’s because after the USSR collapsed, agriculture also collapsed. There was nothing, and all meat was imported from abroad. What happened when the rouble crashed? Chicken prices rose by 2-3 times in 3 weeks, because we didn’t have our own chicken. It was all imported, and everything depended on the dollar. Back then we saw this as a source of supplies for meat processing and started buying up some pork complexes and poultry factories that were either bankrupt or at the pre-bankruptcy stage. Actually, we began to understand how the agribusiness worked. That is, how to breed and produce poultry and pigs. Then it became clear that we needed grain for this and started buying...

HOST: Wait. Let’s do things in order. You began to understand how to work in the agribusiness. How did this happen? Did certain people have to work on certain tasks to make this happen? Was it a certain group of people who searched for these bankrupt or pre-bankrupt plants?

ALEXANDER KOSTIKOV: There were full-time employees, and a lot of regional leaders and governors helped. They realized they had this headache. There was a large poultry factory in one of the regions in Central Russia. It was half dead. They just asked: “Come and take over the factory and do something with it, because there’s no money to pay the employees.” So the team arrived...

HOST: There, how the team arrived? What exactly did they do? Let’s imagine that each of our listeners is a new business owner or someone who wants to start a business. They have to know how to come to a factory and save it from ruin. What do you need to do?

ALEXANDER KOSTIKOV: You need to have some kind of vision, a talent for business and a lot of experience. Speaking about Igor Babaev in particular, at that time he already had several decades of experience in various large meat processing plants across Russia. He’d lived through everything. He’d been in a situation where the plant had to be revived, which was the case with the Cherkizovsky Meat Processing Plant. Because when they arrived at the plant, there were some crumbling buildings and half-ruined equipment. And there were problems with goals, vision and employee morale. Because Mr. Babaev had always worked from early morning to late at night. So, this is how. He came, realized what had to be done and how to build on this.

HOST: But he didn’t travel around the regions himself to take a look...

ALEXANDER KOSTIKOV: He actually did, and as he said, he met with the employees who worked at these pork complexes and poultry factories simply to motivate them, to start the ball rolling, and he succeeded.

HOST: Well, in order to motivate people you usually have to pay their salaries, right?

ALEXANDER KOSTIKOV: Of course, and when a plant starts operating, when it starts growing, and when some new facilities are built, it starts expanding and people get paid.

HOST: So, today you have poultry and pigs...

ALEXANDER KOSTIKOV: We have nearly all the links in the agricultural chain. First of all, we have our own grain division. Fields. This year, we’ve already sowed nearly 90,000 hectares in Lipetsk, Voronezh, and Tambov Regions. That is, in the Central Black Earth region, which has the most fertile land. We plant wheat, corn, soy, and various forage crops. The next step is feed production. We have 6 feed mills where we make high-quality feed for poultry and pigs. The next step after that is breeding and producing poultry and livestock. We have 8 poultry production clusters for that. The poultry clusters have production capacity of more than half a million tonnes per year. More than 500,000 tonnes. These are also mainly in Central Russia and the Volga Region. Plus in Moscow Region there is the Petelinskaya Poultry Factory in Odintsovo District for Petelinka chicken, which is known to everyone. This is also part of Cherkizovo Group. Our 15 pork complexes are also mainly located in Central Russia, where we raise pigs. We have meat processing plants as well. They have livestock slaughtering facilities. There are meat processing plants that produce sausages. Cherkizovsky Meat Processing Plant is the best known one. It is located on Permskaya Street in the North-East near Rokossovskogo Boulevard metro station. Finally, we have our own distribution. We deliver our products to all major chains. So you can find Cherkizovo sausage and Petelinka chicken everywhere. It turns out we have this really long production chain.

CO-HOST: So you have a nearly full cycle. From growing fodder to...

ALEXANDER KOSTIKOV: Yes. That’s absolutely right. We still aren’t completely self-sufficient in grain; it’s somewhere around 25 per cent. But we’re working on covering at least half of our demand, because we need a million tonnes of grain annually for feed.

CO-HOST: Do you raise cattle to use beef for sausages?

ALEXANDER KOSTIKOV: We have beef, but we outsource it.

HOST: It’s not profitable to produce beef in Russia?

ALEXANDER KOSTIKOV: As far as beef is concerned, it’s very hard to compete with countries like Argentina and Brazil, which have huge amounts of grassland and vast experience, and cattle can graze year round...

HOST: Can you explain why you can set up grain farming, feed production, farms, slaughtering facilities, and distribution in Russia, but you can’t produce beef?

ALEXANDER KOSTIKOV: One issue is money; it’s a question of how exactly long money you need. A chicken grows in 35-37 days. After only 35-37 days, we slaughter it and get the meat. Then we can sell it and make money. With pigs, this takes about a year. A piglet grows into a 120-kilogram pig, which goes for slaughter. It takes a lot longer for cattle. A cow has a long pregnancy and gives birth to one or two calves, not 10 piglets, and a calf grows for a long time before reaching slaughter weight. So the production cycle here is more than ten years. Unfortunately, we don’t have this kind of long-term money in Russia.

HOST: It just boggles the mind how you can manage to arrange grain farming alone, for example. It’s not a garden in your back yard, but somewhere else altogether. This involves some kind of logistics in order to... Everything is managed from Moscow. Is that right?

ALEXANDER KOSTIKOV: If it’s a question of our agro division, which combines our feed production, grain and pork divisions, the headquarters are in Lipetsk. When the time was right, we moved it closer to the fields and swine houses. What’s interesting is that a lot of foreigners work in our agro division. That’s because a certain amount of know-how was also lost after the Soviet Union collapsed, but in the West they continued to develop them. For example, an American who worked in America for 20 years and then came here heads our pork division. We also brought in American agronomists to our grain division. We have Brazilian and Venezuelan veterinarians.

HOST: How many employees do you have altogether?

CO-HOST: After all, we have the Timiryazev Academy.

HOST: The voice of the people, if you will. What’s your answer to that?

ALEXANDER KOSTIKOV: There is the Academy, but some practical skills have been lost, because certain know-how has moved way ahead. Take a look at these same pork complexes built in Soviet times: high rise buildings, which was actually totally wrong. Everything should have been on one level to avoid excess logistics, so that animals of different generations weren’t kept in the same facility. If they’re kept on different floors, there’s a risk of transmitting some infection from adults to young ones, for example. Facilities should be at least 5-10 kilometres away from one another so they don’t come in contact. It means a lot of science and a lot of practice. That’s why we search around the world for the best know-how, we find and bring in people to train our specialists. We’re already developing our own generation of specialists who also know how to do this right.

HOST: If you think about it, brains are one of the key components of success. You’re saying that you look for them and they come. Where do you find pig breeding experts?

ALEXANDER KOSTIKOV: There are a lot of first-rate experts in the U.S.

HOST: OK, in the U.S. So do you phone and say: “Hello, is this the U.S.? Can we speak to the chief pig breeding expert?” How do you do this?

ALEXANDER KOSTIKOV: There are recruiting agencies involved in agribusiness and head-hunters who know everyone in this sector. We place an order. We need a specialist in breeding and fattening pigs from companies like Smithfield, for example. They know everyone, so they call and ask: “Would you like to go to far-off, snow-covered Russia and build up the pork industry there?”

HOST: What kind of salary brings someone to Russia?

ALEXANDER KOSTIKOV: One that’s quite good by American salary standards.

HOST: Name a figure.

ALEXANDER KOSTIKOV: I can’t give any specific salaries, but they’re good ones. You have to interest a specialist so that he or she would come here to another country.

HOST: I am going to ask you a lot about how much things cost. Not just because I’m envious and curious. I repeat, it’s for our listeners who are thinking about their business or starting their own business. It’s just to get some idea of prices, because everyone has to get paid.

ALEXANDER KOSTIKOV: Agribusiness isn’t for novices or for individuals. It involves huge capital investments. If you look at pork production, for example, half a billion dollars were invested somewhere in order to...

HOST: Does that include grain farming, feed production, farms, and slaughtering facilities?

ALEXANDER KOSTIKOV: It means farms. It means breeding and fattening, without grain farming. Some feed production. It actually means we started from scratch. So you have land plot you can build on. Of course we get some help from the administration. They’re building a road for us, they’re helping by bringing in utility and power lines, and so on. Building this box from scratch and then buying livestock for it takes a huge amount of money. And this is money you won’t get back quickly. That’s because it takes 2-3 years to build the box, and then...

HOST: 2-3 years? They build skyscrapers in China in a year.

ALEXANDER KOSTIKOV: Yes, maybe in China. There are a billion Chinese there. But in our experience, we need about 2-3 years to build a pork complex with a standard module of 37,000 tonnes. And it doesn’t earn money until it’s done. It doesn’t earn money in the first year of operation either, because you have to launch the production cycle. Sows have to give birth to piglets, the piglets have to grow and go for slaughter, and only then you get some money.

HOST: Where do the first pigs come from?

ALEXANDER KOSTIKOV: Today we have our own swine nucleus unit where we raise purebred pigs. They initially came from abroad as well.

HOST: How many pigs do you need to bring from abroad in order to start breeding?

ALEXANDER KOSTIKOV: I can’t say exactly, because some part is being bought here. The genetic line is mainly abroad to maintain the purity of the breed. So in general, the boars we need to keep the breed pure arrive by plane.

HOST: Alexander Kostikov, Head of Investor Relations of Cherkizovo Group is in the Mayak studio today. We’ll take a break for a short news bulletin. Friends, if you have any questions, please write at 5533. Don’t forget to put the word “Mayak” at the start of the message.

<NEWS BULLETIN>

Alexander, in the last half hour you told us about the general structure of a giant agro holding that includes grain farming, feed production, farms, slaughtering facilities, and distribution, and of course the sausage factory. There’s something else I’m interested in. Since you’re the head of investor relations, our listeners would like to know where you get the money for all this, from the first to last stage. You’ve already named a few figures. Half a billion dollars, right?

ALEXANDER KOSTIKOV: If you look at how much we’ve invested altogether during this time, it’s probably more than one and a half billion dollars, more than 50-60 billion roubles.

HOST: Where do you get this much money?

ALEXANDER KOSTIKOV: According to classical economics, there are two ways to attract investments: shared equity financing and debt financing. Shared equity financing is when you already have a company, and you go on the market and offer investors a part of your company. It’s called an IPO, to use the trendy word. We’ve also done this.

HOST: What were you offering? What were you when you entered this market?

ALEXANDER KOSTIKOV: The company was actually still small at that time. We had the Cherkizovsky Meat Processing Plant. And by that time we had bought and started to upgrade the Petelinskaya Poultry Factory in Moscow Region and the Vasilievsky Poultry Factory in Penza Region. The pork division was still at a very early stage. We had no grain division. We entered the market and the London Stock Exchange in 2006 with this. There was a lot of interest in Russia back then. Russia was a very hot market. And the placement was quite successful. We received investments worth more than 200 million dollars, which allowed us to take the next steps. We bought Kurinoe Tsarstvo in 2007. The company has assets in Bryansk and Lipetsk Regions. Then in 2011, we bought Mosselprom from Sergei Lisovsky. The company used this money to expand further.

HOST: I understand why you’re buying. You need factories. Why are they being sold?

ALEXANDER KOSTIKOV: Some need factories, and others need money. It’s very simple. If there is some mutual interest, a deal is made. That’s how we bought the Lisko Broiler poultry factory in Voronezh last year. It was a decent, interesting asset at a good price. The owner had a lot of businesses, and poultry production wasn’t a core business, so at some point he decided to sell it.

HOST: I’d like you ask you again. You were talking about some stage, like grain farming, feed production, whatever... Isn’t it easier to simply buy feed?

ALEXANDER KOSTIKOV: Unfortunately, it isn’t easier, because...

HOST: Well, it might be a little more expensive, but less risky...

ALEXANDER KOSTIKOV: There are more risks, because feed can spread some diseases. So there must be very strict control over the feed composition.

HOST: Wait a minute. There’s exactly the same risk if you grow your own feed.

ALEXANDER KOSTIKOV: We try to minimize it, because there are standards. Everything is inspected at each stage, and so we try to minimize the risk. And the cost as well, because feed production generates a certain margin that remains in the company. Finally, it’s about stable supplies. We know this business well, and one of the difficulties is that poultry and pigs constantly have to be fed. You can’t tell them that the supplier went out of business or didn’t deliver feed on time. You can’t explain this to a pig. If it goes 3-4 hours without feeding, it starts to bite off the ears of its neighbours.

HOST: Right. They can gobble each other up. They’re cannibals.

ALEXANDER KOSTIKOV: Yes. And a chicken just lies down and dies. So you have feed them continually. You can’t have the slightest interruption when it comes to feed.

HOST: Are your chickens free run or in cages?

ALEXANDER KOSTIKOV: They’re not in cages. We keep them in bird houses. These are buildings that hold 30,000-40,000 birds. They arrive there when they’re still young chicks, and they’re kept in the bird houses until they grow to slaughter weight.

HOST: OK. Now let’s return to investments. First stage. You’ve gone on the stock market and attracted 200 million, more than 200 million dollars, and invested this money in various production cycles. But you can’t stop there. How much do you need to attract?

ALEXANDER KOSTIKOV: The entire agribusiness exists on borrowed money. We’re very heavily indebted. We have debt financing. That is, we go to the bank and ask for money. It’s interesting that Russian agribusiness, especially poultry production, soared when subsidized long-term money appeared. That happened about 10 years ago. Boosting the agricultural industry became one of Vladimir Putin’s priorities, so that we would be self-sufficient in meat and not have to depend on foreign supplies. An interest subsidy system was created starting in about 2004.

HOST: What does it look like?

ALEXANDER KOSTIKOV: It looks like this. An agricultural enterprise gets a bank loan at the rate set by the bank. This is usually more than 10%, 12-14% or maybe 16%.

HOST: Well, this is reasonable in our conditions.

ALEXANDER KOSTIKOV: It’s still difficult for agribusiness, because you’ll see hard cash in 2 years if you’re lucky, but you have to pay interest from somewhere today. And there are a lot of different risks — crops fail, birds start dying, and so on. There’s a system for reimbursing interest expenses; that is, the government reimburses part of the interest payments, which reduces the cost of debt from 12-14% to 2-3-4%. That’s not bad. You can live and grow with that.

HOST: Do you get debt relief for a certain period, say the first year?

ALEXANDER KOSTIKOV: No. There’s nothing like that but there is a zero income tax rate for agricultural enterprises. This includes pigs and poultry. There’s nothing similar for sausage, since we don’t consider sausage as agribusiness. So you have the standard income tax rate there.

HOST: OK. Where and how else do you attract investments?

ALEXANDER KOSTIKOV: There are two classic and two key methods: shared equity financing, which probably doesn’t work very well today, because the stock market isn’t interested in Russia, the Russian market isn’t growing, and investors are very wary about this state of affairs. Everything exists on debt and loan financing today.

HOST: OK. Your job title is Head of Investor Relations. Who are these investors?

ALEXANDER KOSTIKOV: Our company is public, it’s traded on the Moscow Stock Exchange, which means you can go and buy shares of Cherkizovo Group and then receive dividends on them, because we pay dividends, and depository receipts are traded on the London Stock Exchange. About 35% of our equity capital is on the market, and various investors buy it, like funds, banks and insurance companies, and as a public company we have an obligation to report to them. So four times a year, every quarter, we publish full financial statements and talk about what’s going on. Our department, the Investor Relations Department, has the task of presenting the statements, showing them to investors, meeting with investors, and answering all questions and requests from investors and analysts. The status of a public company commits us to this.

HOST: It’s hard to take all that in. How you organize and handle all this, and how you manage it! How many people work for your company, how any managers do you need? How many employees do you have altogether?

ALEXANDER KOSTIKOV: We have about 20,000 employees.

HOST: Twenty thousand people!

ALEXANDER KOSTIKOV: We’re talking overall. This includes all our farms, all our meat processing plants, that is, the whole Cherikizovo Group. These are all our companies and plants.

CO-HOST: And who are the brains of the company?

ALEXANDER KOSTIKOV: Who are considered the brains?

HOST: You.

CO-HOST: Others like you.

ALEXANDER KOSTIKOV: Thank you. Well, there are probably a few hundred people, our key management. We recently held a strategic session for management, and there were about 120 people there.

HOST: There’s another thing we forgot to talk about, as our listeners have reminded us. What issues of food safety and certification are being discussed? What’s happening... I don’t know if this is in your area of expertise. Food safety and certification.

ALEXANDER KOSTIKOV: I probably can’t talk about it as fully as an expert in this field.

HOST: Well, in a few words. There’s likely a special department responsible for this issue.

ALEXANDER KOSTIKOV: Of course. In general, Russia has a very strict system of veterinary security. So if you’re talking about live poultry and pigs, control is really strict and extensive, and of course everything is inspected. If you go to the Cherkizovsky Meat Processing Plant, each carcass has a veterinary security stamp on it. There is a government veterinary inspector who checks the carcasses when they come in.

HOST: Each one?

ALEXANDER KOSTIKOV: Batches are usually inspected. There’s a random inspection, accompanying documents are verified, and random samples are taken.

HOST: OK. What happens when carcasses arrive from abroad? Is there the same kind of strict control? It’s just that you said there was a risk of infection...

ALEXANDER KOSTIKOV: Imports of livestock have already been closed for 3 years. You can’t import, period.

HOST: What about frozen products? Can’t frozen products be infected?

ALEXANDER KOSTIKOV: Some infections may survive. That’s why there’s a ban on imports from Europe, where outbreaks of African swine fever were discovered in several countries. Rosselkhoznadzor had closed meat imports to Russia about a year and a half ago, before the sanctions were introduced.

HOST: Kemerovo Region wants to know why you started your agribusiness in Lipetsk. Why not in Moscow?

ALEXANDER KOSTIKOV: We actually started in Moscow and nearby areas. That’s because we had the Cherkizovsky Meat Processing Plant in Moscow and Petelinskaya Poultry Factory in Moscow Region. Farther out, there’s the Central Black Earth, that is, Lipetsk, Tambov, and Voronezh. These are very good, very interesting regions in a number of ways. First, there’s land, black earth, the most fertile soil. Second, they’re close to Moscow. That’s because however you look at it, there are 15 million people in Moscow and Moscow Region by the most conservative estimate, and this is the most affluent market, where people will always buy. Plus, the regional governments, no matter which region you look at, have governors who deeply understand the need to expand the agricultural sector, and who help and support us.

HOST: Alexander, thank you very much. Unfortunately, we’ve run out of time. Thank you.