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FINAM - Daily Market Watch - Nov 10, 2010.

Market Roundup

Russian equities extended gains on Tuesday, shrugging off negative signals from abroad, as rallying commodity prices fuelled an upside in most liquid names. In the upshot, the MICEX index added 1.7% and the RTS index advanced 1.9%. Gains were lead by the metal sector, as NLMK hiked 6.1%, Severstal surged 3.8%, Norilsk Nickel jumped 3.7% and Polymetal spiked 5.7%. Oil & gas plays slightly underperformed the market: Gazprom rose 1.1%, Rosneft climbed 1.3% and Lukoil ended 1.4% higher. Liquid banking stocks showed mixed trends: Sberbank corrected down 0.2% whereas VTB advanced 1.2%. Similar trends were seen in the power utilities sector, where RusHydro gained 0.8% in value and OGKs traded mixed. Uralkali acted as a top gainer on Tuesday, adding a solid 7.3% on news that FAS has backed potash market deregulation. US equity benchmarks came under pressure yesterday from news about a build up in the warehouse inventory and investor concerns about prospects for economic recovery. The S&P 500 finished the session 0.8% down.

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Financials underperformed, shedding an average 2.1%. Asian stock markets are mostly bearish this morning after Chinese authorities have taken measures to curb price growth on the real estate market. However, the Japanese Nikkei 225 index is trading 1.1% up at the moment on a weakening yen. Oil prices are paring gains, with WTI trading at USD 86.4 per barrel and base metals are trading mixed. In our opinion, most of the factors this morning spell downside on the Russian equity market at the open. However, an array of metal companies still retains good prospects for growth. Trading today could be impacted by the release of US applications for mortgage loans in the week ended on November 5 (due at 3:00 pm), the US trade balance for September and labor market statistics figures (4:30 pm) and September data on industrial production levels in France and Italy (due out at 10:45 am and 12:00 pm, respectively).

Breaking News

Oil falls from 2-year high on stronger dollar. US crude for December delivery dropped 34 cents to settle at USD 86.72/bbl, retreating from an intraday peak of USD 87.63/bbl, while ICE December Brent crude fell 13 cents to settle at USD 88.33/bbl. Crude-oil futures eased on Tuesday, pressured by a rise in the dollar and a downturn in US equities after inflation concerns had pushed oil to a 2-year peak. The single European currency moved lower against the US dollar a third straight session as investors fretted about Eurozone debt and hedged bets against the greenback. Oil received a boost in early trading from the long-term energy outlook of the International Energy Agency. The Paris-based agency said global oil supplies will approach a peak by 2035 and oil prices might exceed USD 100/bbl in 2015 and USD 200 in 2035. Oil prices have been attempting to consolidate above the USD 87 mark after the Fed's monetary easing and a better-thanexpected US jobs report last week drove prices above the previous 2010 high reached in May. The American Petroleum Institute came out with its weekly inventory report late last night. The API reported crude stocks fell 7.4 mn bbl in the week to November 5, while gasoline stocks decreased 3.4 mn barrels and distillate stocks fell 4.0 mn bbl. If the API figures are confirmed in the EIA report later today prices could test the USD 90 level. Oil prices are down this morning after the US dollar gained almost 0.5% against a basket of currencies and China's crude imports fell almost 30% in October to 16.39 mln tons, the lowest monthly average in 18 months. Moving ahead, even though the market seems to be feeling quite comfortable close to USD 90/bbl, we think prices could be in for further correction unless today's EIA inventory figures turn out to be strongly bullish.

MDM Bank cuts equity by 11% y-o-y in 3Q2010. In 3Q2010, MDM Bank reduced equity by 11%, or RUB 5.6 bn, after introducing RUB 5 bn to the share capital of its subsidiary, the Moskvichka garment factory. According to MDM's issuer report, its equity as of 1 October 2010 totaled RUB 46.47 bn, in contrast with RUB 52.11 bn as of July 1. MDM Bank currently controls 98.94% of Moskvichka. In March 2009, the FAS upheld MDM's motion for the purchase of 100% in the factory.

Deposit insurance fund up 26% in 9M2010. The compulsory deposit insurance fund expanded by 26% in 9M2010, up to RUB 118.3 bn, the Deposit Insurance Agency reported. Inflows to the fund rose by the same 26% y-o-y and totaled RUB 25.7 bn in 9M2010, including RUB 22.7 bn in the form of insurance premiums from banks. In addition, the fund was replenished by 1/3 of the proceeds that the Deposit Insurance Agency got from the placement of the fund spare cash in 2009, worth RUB 1.8 bn. Another RUB 1.2 bn came from bank liquidation procedures. As to the fund allocations, some RUB 1.1 bn were allotted to insurance indemnities, 49% was invested in corporate bonds (up 5 pp YTD), 36% was directed to Treasury bonds issued by the Russian Federation and its regions (down 1 pp), 8% was in invested In CBR deposits (down 2 pp), 6% in stocks (down 2 pp). The weighted average yield, net of security revaluation, was 8.5% pa, and 13.2% including security revaluation proceeds.

Western High-Speed Diameter to hold 5 bond issues worth RUB 25 bn. The BoD of Western High-Speed Diameter (WHSD) has decided to issue 5 bonds, each RUB 5 bn in size. The bonds are secured by state guarantees, will be floated by open-subscription and mature in 20 years. The par value of RUB 1000. Premature redemption is possible in case the issuer fails to fulfill its obligations or the security is delisted. In addition, bondholders will be able to claim for premature redemption on 21 January 2016, and their requirement should be met the same day. The bond arrangers are Troika Dialog and Sberbank. The proceeds are to be used to fund the construction of the southern and northern stretches of the speedway. The construction of the most complex central stretch, which is to cross the Gulf of Finland, is to be based upon the public-private partnership. A tender for the election of a concessionary company is to be announced by the end of the year.

Uralsib: loan portfolio up 8.4% y-o-y in 9M2010. In 9M2010, Uralsib Bank saw its RAS loan portfolio before provisions increase by 8.4% to RUB 218.6 bn. The corporate loan portfolio surged by 12.6% to RUB 148.25 bn, the retail portfolio grew by 0.4% to RUB 70.29 bn. Income from provision discharge totaled RUB 2.1 bn, compared with a RUB 9.3 bn provision charge a year earlier. The bank assets totaled RUB 390.27 bn as of October 1, up 3%. Customer accounts added on 11.7% to RUB 265.23 bn, of them 57.6% accounted for corporate accounts and 42.4% for retail accounts. The security portfolio totaled RUB 90.66 bn as of October 1, down 3% from RUB 92.81 bn y-o-y. Equity totaled RUB 56 bn.

Oil and gas

Gazprom may sell 10% in Novatek

After the sale of the stated block of shares, Gazprom is to have less than 10% in Novatek, which could spell risks to Novatek in the form of a stiffer competition with Gazprom and increased difficulties in access to the gas transport infrastructure and gas markets.

On November 10, Kommersant cited Gazprom sources as saying that Gazprom is moving to sell 10% in Novatek before the year-end. Gazprom currently owns a 19.58% stake in Novatek. The price of the transaction is to be in line with the market price of Novatek GDRs traded on the LSE on the date of the sale. The potential buyers of the shares have not yet been disclosed. In our opinion, the reduction in the Gazprom stake in Novatek could adversely affect the latter company's business in the long run. Firstly, both companies operate on the same market and a weaker control on the part of Gazprom could spell a stiffer competition between the two companies.

Should this be the case, Gazprom could find itself in a advantageous position, due to its size. In particular, Novatek's wide-scale Yamal LNG project, with which Gazprom is directly involved as a co-investor, could be hurt. Moreover, looser ties between the two companies could negatively affect the possibility and terms of Novatek's access to the Gazprom-run gas transportation network. As it is, transportation costs are the biggest item in the Novatek spending budget. After lowering its stake in Novatek, Gazprom could make it harder for Novatek to access its pipeline network, which could result in further growth of transportation costs. In our opinion, the news could impair quotes for Novatek shares, mainly in the long term.

Power utilities

OGK-2 reports upbeat financials in 3Q2010, amid continuing market liberalization

The genco's 9M2010 RAS key financials showed robust upward dynamics in comparison with the year-earlier period. In our opinion, the upbeat results reflect benefits the company has derived from the continuing liberalization of the Russian electricity market.

On November 9, OGK-2 (RTS: OGKB) released a 9M2010 RAS financial statement. Along with previously known information about 3Q2010 net profit, the genco disclosed data on revenue, gross and operating income. In particular, OGK-2's revenue rose by 31% y-o-y in the reporting period, up to RUB 38.2 bn, gross income grew by 34.8% to RUB 5.04 bn, and sales advanced by 43.3% to RUB 4.43 bn. Net income soared almost 3x y-o-y from RUB 1.39 bn to RUB 3.95 bn; as a result, net margin almost doubled, up to 10.3%. No other details were revealed, and we are waiting for the publication of the company's 9M2010 financial report, due November 13.

In late October, OGK-2 reported 9M2010 operating data, showing just 0.3% surplus in electricity output and a 0.8% y-o-y growth in heat production. The dynamic upturn in financials was mainly related to a rise in product prices, caused by the continuing energy market liberalization, particularly, a surge in energy sales on the deregulated market in OGK-2 operating regions. Though the appeal of OGK-2 securities is to depend largely on the information about the company's possible merger with OGK-6, its terms and dates unknown so far, we believe investors should also pay attention to the genco's newly published financials. Our DCF fair value of OGK-2 as of year-end 2011 is USD 0.09 per share with a 65% upside and a BUY rating.

Mechanical engineering

UAC completes additional share issue in favor of RF

By placing an additional share issue in favor of the Russian Federation, UAC has raised funding for its investment program. The placement plays into the hand of UAC minority shareholders, as the emission price is more than double the current market price.

United Aircraft Corporation (UAC) has completed an additional share issue, the company said in a press release on November 9. In all, the company has floated 14.3 bn shares at a RUB 1 (USD 0.033) per value. The newly-issued shares were placed by closed subscription in favor of the Russian Federation. We estimate the news as moderately positive, which, however, should have already been factored into the market price of the shares, as plans to place the additional issue were unveiled at the end of June.

As the emission price (of RUB 1 or USD 0.033) is more than double the current market price (RUB 0.44, or USD 0.014), minority holders stand to gain from the placement of additional shares. The high emission price was conditioned by Russian laws, which state that an emission price for additionally issued shares cannot be below par value, which for UAC shares is RUB 1.

An additional share issue is to allow UAC to raise funding for its investment program. The shareholder structure has undergone no drastic changes in the wake of the issue: the state holding has increased from 80.3% to 81.8%.

GAZ boosts LCV sales in October

We estimate the rapid upsurge in GAZ Group's LCV sales in October to be related to the closure of government orders and expect the company to keep sales high till the end of the current year.

On November 9, AEB reported on Russian passenger car and LCV sales in 10M2010. In the reporting period, GAZ Group sold 55 300 LCVs, up 31% y-o-y. LCV sales in October jumped by 59% y-o-y to 7700 vehicles. We are upbeat on GAZ Group's October operating data. The car maker sold 7700 LCVs in October, compared with 6200-6600 per month in 9M2010. Therefore, sales added on 59% y-o-y in October, by contrast with 29% in September.

We believe the sales upsurge was related to the completion of government orders and forecast the car maker's sales to advance at an accelerated pace till the end of the year. Recovery in capital investments in fleet renovation at transportation companies is to have an upward impact on GAZ sales, and the company is bound to become one of the key beneficiaries of this recovery. The fair value of GAZ Group (RTS: GAZA) is USD 42.90 per share with a 53% upside and a BUY rating and USD 21.50 per preferred share.


Economic Development Ministry committed to halt interregional telecoms merger with Rostelecom until definitive shares of united company primary holders are known

Despite the Ministry's firm stand, we assess the chance of the reform being stopped and its terms revised as relatively small.

At a meeting arranged by the vice-PM Sergei Ivanov on 12 October 2010, the Ministry for Economic Development put forward a proposal to halt the merger of Rostelecom and interregional telecoms (MRK), until at least several various scenarios in calculating the distribution of primary holders' stakes in the united company were considered, several leading Russian media reported November 10. In addition, the Ministry insisted that the correctness of MRK-Rostelecom swap-ratios should be verified. Reportedly, the Ministry fears that, following the restructure of the Svyazinvest assets, the state may not receive a controlling stake in the united company, as a risk exists that Rostelecom Treasury bonds, which may be found on the company books after the liquidation of Svyazinvest (a blocking package in Svyazinvest was acquired by Rostelecom, not VEB), will be paid off.

Though Ivanov seems to have taken notice of the EDM's initiative, the Svyazinvest restructure is still progressing, which has been asserted by several spokespersons affiliated with the holding. The process is unlikely to stop, as the reform was affirmed by all of the companies involved, advanced in conformity with law and has already come to RUB 40 bn: more than RUB 14 bn were used to buy out shares from dissenting shareholders and RUB 26 bn to purchase a blocking stake in Svyazinvest from Sistema. Moreover, VEB could potentially purchase Svyazinvest equities from Rostelecom, as was initially planned, which is to minimize the chance of the Rostelecom Treasury shares being paid off, and hence eliminate the risk of the government's not getting control over united Rostelecom. However, the risk that the restructure terms could be revised is still intact, which could place pressure on Rostelecom and MRK shares. The news is moderately negative for the above companies' stock valuations.


UTAir boosts revenue 23% in 9M2010

The 23% revenue growth posted by UTAir for 9M2010 under RAS has resulted from significant growth in operating indicators. However, revenue grew slower than operating results, which we attribute to low tariffs, a factor that is exerting pressure on UTAir profitability.

On November 9, UTAir released RAS financials for 3Q2010. The company saw revenue climb 23% in 9M to RUB 30.35 bn, while operating income dipped 30.6% to RUB 1.58 bn. Net income dropped 26.9%, from RUB 276.9 mn to RUB 202.3 mn. As the airline conducts operations through a group of companies, data on its RAS net income is not fully revealing, in our view. At the same time, the revenue and operating income figures adequately reflect the situation with the company's core business, in our opinion. We estimate the financials released as moderately positive.

The 23% revenue growth shown by UTAir was driven by a 46.6% surge in passenger turnover y-o-y and expanding helicopter cargo operations, which picked up 15.1% y-o-y. In 3Q2010, revenue shot up 28.8% y-o-y. We note that the upturn in operating results was achieved through tariff cuts, a factor behind slower revenue growth (up 23%) and the 31% decrease in operating income yo- y in 9M2010. In our view, low tariffs will continue to put pressure on the company's financial results this year and the next. Our target price for UTAir is USD 0.69 per common share, with a 36% upside and a BUY rating.

FESCO buys 12.5% in Transcontainer at IPO

We regard the acquisition of a 12.5% stake in Transcontainer during an IPO as a neutral factor for FESCO, as the shares will not permit the buyer to have a say in the day-to-day management of the company and should be viewed as a financial investment. We do not rule out, however, that the holding could be raised to a blocking stake in the future.

FESCO on November 9 reported the acquisition of a 12.5% stake in Transcontainer during an IPO. The share package is estimated at USD 138.9 mn. According to CEO Sergei Generalov, the shares were bought with an eye to establish closer ties in railway container shipments, and are also regarded as an investment in the promising asset with growth potential. We regard the acquisition of the stake as a neutral factor for FESCO. We estimate the shares acquired as a financial investment, not permitting FESCO to participate in the day-to-day management of the company and only allowing it to place one representative on the Transcontainer BoD.

As to closer ties in operating activities, the goal could be achieved without buying the shares, in our view. We do not exclude, however, that FESCO could raise its holding to a blocking interest in the future, thereby gaining the right to take part in the day-to-day management of Transcontainer and producing a synergy effect. In our view, the purchase of the shares was triggered by the spare cash FESCO has at its disposal after the sale of a stake in the National Container Company for USD 900 mn. Our target price for one common share in FESCO is USD 0.58, which implies a 27% upside and corresponds to a BUY rating.

Grigory Yudashkin

Deputy Head

Private Investments Department

Finam Investment Holding

Daev Plaza Business Center

Daev Lane 20, office 209

Moscow, 107045, Russia

Tel: +7 (495) 604-8168

Fax: +7 (495) 604-8107

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Publication:Russian Banks and Brokers Reports
Geographic Code:4EXRU
Date:Nov 10, 2010
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