Ferrexpo auditor gives reasons for resignation, two directors out

Deloitte, the auditor of Ukraine’s largest iron ore pellet
exporter Ferrexpo (FXPO LN), provided to the company its two reasons for its Apr. 26 resignation from its
office as statutory auditor, Ferrexpo reported in its Apr. 29 release.

 

Deloitte said that Ferrexpo’s delayed launching an
independent review of Blooming Land, a charity that was supposed to
independently manage Ferrexpo’s corporate social responsibility program, and
this review had not been completed by Apr. 23, on which date Ferrexpo released its 2018 financial statements.

 

As a result, Deloitte was unable to obtain
satisfactory audit evidence or explanations in respect of two key audit matters
that were the basis for its qualified opinion on Ferrexpo’s 2018 financial
statements. Ferrexpo’s response to the situation and the resulting Deloitte’s
having to qualify its audit opinion, were incompatible with Deloitte’s
remaining as Ferrexpo’s auditor, Deloitte said.

 

The first key audit matter was whether Ferrexpo’s
donations to Blooming Land, were expended by Blooming Land on legitimate
business payments for charitable purposes. The auditor noted several related
risks to Ferrexpo’s presentation in its financial statements, particularly
omitting potential liabilities for breaches of laws and regulations.

 

The second key audit matter was the auditor’s
inability to establish whether or not Blooming Land was a related party of
Ferrexpo. Deloitte noted that the investigation into Blooming Land has
identified a significant number of potential associations and linkages adjacent
to Ferrexpo’s CEO, Kostyantyn Zhevago.

 

Ferrexpo commented on Deloitte’s reasons for
resignation saying that it tried to engage with Blooming Land, a third party,
from September 2018 until Feb. 3, on which date it decided to commence the
independent review of the charity. However, Ferrexpo had obligations before its
bank lenders, and also as a listed company, to publish its 2018 results by Apr.
30, and could not delay with releasing its 2018 results beyond Apr. 23.

 

In the same Apr. 29 release, Ferrexpo reported that
two of its independent non-executive directors have decided to resign with
immediate effect.

 

In an interview on Apr. 29, as cited by Bloomberg,
Ferrexpo’s board chairman Steve Lucas defended Ferrexpo’s approach, saying
“We’re talking about a third party here and we had no ability to compel
Blooming Land to provide Deloitte with the information they were looking for”.
Lucas said he hoped that the independent review of Blooming Land will last no
more than one or two months, Bloomberg reported.

 

Dmytro Khoroshun: It is
simply difficult to imagine a definitive outcome of the independent review that
would fully exonerate Ferrexpo and Zhevago in relation to the second key audit
matter noted by Deloitte, namely, whether Blooming Land, Zhevago and Ferrexpo
are all related parties. As Deloitte said in relation to this second key audit
matter, the investigation has already identified potential linkages between
Blooming Land and Zhevago, and it is very difficult to understand why Zhevago
has been unable to dispel doubts of his being related to Blooming Land.

 

We agree that whether and how exactly Blooming Land
misapplied fund donated by Ferrexpo (the first key audit matter) might indeed
be very difficult to establish without the charity’s cooperation if it is a
party independent from Ferrexpo. Nevertheless, we think that Zhevago could have
already facilitated a resolution of the issue of his links to Blooming Land.

 

We therefore expect further turbulence for
Ferrexpo, especially if the matter attracts regulatory or legal attention.
Nevertheless, we note that fundamentally, Ferrexpo is very strong, and that the
recent plunge in its stock price presents a buying opportunity. Namely, we
estimate – based on its 2019 EBITDA of USD 650 mln (conservatively below the
USD 700-750 mln we expect using the recent management outlook) and EV/ EBITDA multiple of 4.0x – that Ferrexpo’s
shares are worth at least GBp 288 each, 33% above the current price of GBp
216/share.