James Marson in Kyiv -

Ukraine's rich, fertile soil has for centuries earned it the epithet of "the breadbasket of Eastern Europe." And while agricultural production fell sharply after the break-up of the Soviet Union, a record harvest this year, rising food prices and a growing national market are making the sector an attractive prospect.

"There's plenty of room for growth," says Sergei Evlanchik, founder and CEO of dairy producer Ukrproduct. "The market challenge was to achieve Soviet levels of production, and then increase efficiency."

Evlanchik knows all about growth and efficiency. In 1995, OJSC Molochnik was a cheese warehouse and production workshop in decline. After taking a toehold stake in 1997, Ukrprodukt gained 50% of the voting rights in 2001. Over the next three years, eight trading subsidiaries were acquired across the country, before 27.2% of the company's share capital was floated on London's Alternative Investment Market, or AIM, in 2005.

"Penetration" is a key word in Evlanchik's vocabulary, especially given the disparate nature of the Ukrainian dairy sector in terms of production and retail. The company has 75 regional collection centres for raw milk and a large distribution network, set up in 2002 to supply retail and wholesale customers across the country. "We realised that establishing our own distribution was a vital move," Evlanchik said. "We couldn't outsource countrywide distribution to a reliable third party, as there is still none in Ukraine."

With an annual production capacity of around 70,000 tonnes, Ukrproduct is the market leader in processed cheese and butter, with shares of 21% and 13% respectively. Like-for-like branded sales were up 50% in the first half of this year.

Evlanchik sounds optimistic; and he has every reason to be. Per capita consumption of milk and dairy products rose by over 5% from 2003 to 2007, but Ukrainians still lag behind other European countries in annual per capita cheese consumption at under 4 kilograms (the French eat over 25 kg). That's an enormous potential market waiting to be tapped. But Evlanchik warns of a need for realism in the agriculture sector as a whole. "It's important not to be over-optimistic. People expect to become very profitable in two years, but the focus in that time should be on improving operations."

This prudence was the key to the development of Ukrproduct. "We took our time while our competition was learning lessons. From the beginning, we established efficient management accounting procedures, while our competition was less focused on the financial side."

This prudence has served Ukrproduct well since Russia's decision to ban the import of dairy products from Ukraine in January 2006. Although Ukrproduct's exports were not focused on Russia, their competitors' were, which led to dumping on the Ukrainian market and a 10% drop in prices.

The company's response was to focus on widening its export market for skimmed milk powder. On a national level, the decision was taken to launch a new premium brand hard cheese to capitalize on the movement towards higher-quality products - a result of an annual increase in private consumption of over 10% for the past four years, according to the Economist Intelligence Unit.

Obstacles

The outlook for the sector may be positive, but there are still many obstacles to overcome. Land reform in Ukraine since the fall of the Soviet Union has been slow and remains a major stumbling block. In 1999, a presidential decree on the privatization of agricultural land abolished collective farms and transferred ownership to rural residents. Sale of the land, though, is prohibited under a moratorium, which was extended in December last year.

Companies are, therefore, forced to lease land off the private owners. "The majority of land is leased on terms from three to five years," Evlanchik explains. "This means there is no long-term confidence. There is no guarantee that the land will eventually be sold to the people who operate it currently."

"This has been back and forth in parliament," he added. "It's been delayed again because of the dissolution of the Rada [parliament]."

Evlanchik is, nevertheless, positive about the often seemingly turbulent political situation in Ukraine. "The trend since the Orange Revolution is for business to be distanced from politics. Government regulation has been lightened and significant progress has been made in terms of more business-oriented governmental policies."

Arguments between Viktor Yushchenko and Prime Minster Yulia Tymoshenko are widely seen as slowing the reform process and putting off foreign investors, but Evlanchik says it should be put context. "In this regard I would compare Ukraine to Poland, which is an EU country. They have the same issue of political show. Their president and prime minister also argued over the use of an aeroplane recently. We're a learning democracy, and committed to joining the EU."

And Evlanchik is not expecting the recent financial turmoil to have a significant effect on growth. "The increase in consumer lending has caused an increase in non-food consumption. The crisis will put an end to this, but the food business will be the last to be affected."

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