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Uralsib - Russia Daily Equity Update - Dec 14, 2010.

A drop of optimism

Attention is on the Fed's meeting. Markets will likely hunker down ahead of the Fed's meeting today, although no big changes are expected. The main focus will be on comments surrounding the current situation with interest rates, as the Fed is still not able to drive rates substantially lower, with yields on Treasuries up to 3.4% from 2.6% a month ago. Yesterday was a lackluster day with the Dow Jones up just 0.2%, while the S&P hardly moved. Retail sales, PPI and the NFIB Small Business survey are scheduled for release today in the US. There is also a bunch of financial reports due in Russia today, with Mechel, Bank St Petersburg and probably Tatneft (today or tomorrow) set to report 3Q10 IFRS results. Markets in Asia are trading in the positive territory this morning, although shares of exporters are weak on the back of a strengthening yen. Oil prices are slightly weaker and we expect Russia to open flat especially after yesterday's strong gains.

(To view the full report please click here:

Strong gains for blue chips on thin volume. A winning performance from our market proxies kept us afloat yesterday. MICEX closed 40 bps to the good for the session. Gazprom and Sberbank both climbed more than 2% cementing the gain on MICEX. Several names intent on spoiling the party pushed us down in the close but there was enough meat still on the bone. Russia's biggest retailers X5 Retail Group and Magnit fell 4% and 5%, respectively, as Walmart shut its doors in Russia for the time being. NOVATEK's recent downgrades are making an impact. Another 2.5% lost today drags it back towards $100/share, where there may be buyers. AFK Sistema and Uralkali waded in with 150 bps losses on hefty volume to help balance the books marking what was a very mixed session indeed.


3Q10 US GAAP preview: ahead of its peers again

EBITDA to rise by 10% QoQ to $610 mln. Today Mechel (MTL US - Buy) plans to release 3Q10 US GAAP financial results, which we expect to be strong due to improvements across key segments. We expect to see modest growth QoQ in revenues and profits, which would be in contrast to the average sector trend in 3Q10 (drops of 15-20% QoQ). We expect revenue to rise 9% QoQ to $2.6 bln driven by growth in volumes and prices in the mining sector. EBITDA is expected to rise by 10% QoQ, driven by good cost control in mining operations, as volumes recovered to pre-crisis levels in 3Q10. On the bottom line, Mechel should post net income of $211 mln versus $38 mln in 2Q10, as the company is likely to reverse part of the 182 mln forex loss, received in 2Q10, into a forex gain in 3Q10. We believe the results could be a positive short-term driver for the stock. (Please see our desk note published yesterday.)

Short-term positive driver for the stock. The difference in the dynamics of Mechel's profits in 3Q10 and the average sector trend should come as a positive surprise for most investors, and thus the results could become a short-term driver for the stock. The company will host a conference call at 18.00 Moscow time; we expect management to provide a 2011 outlook for the coal and steel markets. Of particular interest during the conference call will be progress on development of the Elga coal deposit, railway construction, and cost performances in the mining segment. Mechel remains our top pick in Russia's metals and mining universe for 2011 and we reiterate our Buy recommendation.


Iron ore funding unlocks hidden upside

IRC gets $340 mln loan from Chinese partner. Yesterday Petropavlovsk's (POG LN - Buy) iron-ore subsidiary IRC announced that it has reached an agreement with the China's ICBC bank to finance its major greenfield project - Kimkan and Sutara (K&S). The maturity of the loan is eleven years with an annual interest rate of LIBOR plus 2.8%. Having previously signed a construction contract for $400 mln and raised roughly $200 mln during the IPO several months ago, the company has all the necessary funding in place to start construction there in early 2011.

Positive developments at Kuranakh reported. Together with the loan announcement, the company has announced achievements at other operations, namely the Kuranakh mine. The mine has successfully completed the test period and is scheduled to produce 130 kt of titanomagnetite and 3 kt of ilmenite concentrate this year. In 2011, iron ore concentrate production is planned to be 800 kt, and ilmenite concentrate at 65 kt (representing a small downside to our assumptions). The current selling price of iron-ore concentrate is reportedly $125/ton, which is only 25% below the spot price of $165/ton. Next year IRC anticipates its pricing to be equal to spot market prices in Asia.

Key driver for iron-ore business. As long as the company is able to complete the first stage of its major K&S project with 10 mln tons of iron ore volumes, the market might start feeling more upbeat on the name, pricing in the value of this mine. This in our view should boost IRC's capitalization greatly, which is also positive for Petropavlovsk as the core shareholder. We reiterate our positive view on the name following this announcement.


BPC signs next five-year contract with Yara

Long-term contract with supplies of 5 mln tons of potash until 2015 signed. Yesterday, Uralkali (URKA LI - Buy) announced that Belarusian Potash Company (BPC), the joint export trader for Uralkali and Belaruskali, had signed the next long-term potash supply agreement with Yara, one of the largest nitrogen and NPK producers in the world. According to the contract, BPC will supply a total of 5 mln tons of potash from 2011 until 2015 or 1 mln tons per annum. The prices in the contract are not fixed, and will depend on market conditions (no details have been provided regarding the exact price adjustment periods). The terms of the new contract are similar to the previous five-year contract.

Developing markets to remain the key driving force. Our current model for Uralkali implies total sales of 32 mln tons in 2011-15; it implies Uralkali is likely to supply at most half of the announced BPC contract volumes and sales (the rest will be supplied by Belaruskali), while supplies to Yara could contribute up to 8% of Uralkali's total sales during this period. We note that developing markets, including India, China, Brazil and South-East Asia are likely to remain the key focus for Uralkali and we expect sales to these markets to contribute nearly 60% of the company's total sales in the foreseeable future.

News marginally positive. We view the news as fundamentally positive for Uralkali as signing the next five-year long-term agreement points to the continuation of the practice of long-term agreements, which should be supportive for export prices. However, we do not expect the news to be a trigger for the stock, as the volumes of the contract are similar to the previous contract and thus, unlikely to surprise the markets. We also note that forthcoming contracts with China and India are of greater importance for potash market participants, with pricing likely to set a new (potentially higher) benchmark for the market. We maintain our Buy recommendation on Uralkali.


3Q10 IFRS results: new revenue drivers

Stronger QoQ financials. Yesterday Rostelecom (RTKM RX - Hold) released 3Q10 IFRS results that showed stronger QoQ - but weaker YoY - financials for the period. Revenue grew 5% QoQ in rubles to RUB15.8 bln ($517 mln), supported by 7% higher QoQ data transmission revenues, but declined 1% YoY due to the loss of traditional voice revenues. OIBDA increased 4% QoQ and fell 15% YoY to RUB3.2 bln ($105 mln), due to higher payments to Russian operators, while net income was 30% lower YoY due to a hike in D&A due to a 87%YoY increase in capex in 9M10.

Modern services remain a key issue for the company. Rostelecom saw YoY declines in most of its business lines, despite the QoQ improvements. DLD revenue was 7% YoY lower at RUB6 bln ($197 mln). Outgoing ILD revenue fell 18% YoY to RUB2.4 bln ($78 mln), reflecting a decline in long-distance traffic due to strong competition in the segment as integrated operators (MTS and VimpelCom Ltd) are transmitting an increasing share of their customers' long-distance traffic through their own networks. Data transmission revenue jumped 40% YoY and 7% QoQ in 3Q10 to RUB3.3 bln ($107 mln), almost compensating for the loss of traditional revenues and bringing the share of VAS (data transmission, line leasing and intelligent network services) to 37% in 3Q10, up from 32% in 3Q09.

No impact on valuations. The results are in line with our model for Rostelecom on standalone basis. Thus, we do not see any reason to make changes to our valuation of the company. The stock remains indifferent to operational data, as it is only driven by newsflow on the ongoing consolidation. We do not see any upside in the consolidated Rostelecom and after the recent rally in shares of inter-regional telecoms, we do not see any material upside in IRs valuations relative to the valuation of the consolidated Rostelecom and believe the Svyazinvest consolidation play is over for now. We reiterate our Hold recommendation on Rostelecom. We assume that the consolidated Rostelecom will be less attractive than integrated providers MTS and VimpelCom Ltd. Of these MTS is our top pick, as it represents a clear Russia/CIS growth story.


Government will retain control following the restructuring

Consolidation is on track ... Yesterday VEB Capital presented calculations confirming that the government will retain control over the consolidated Rostelecom (RTKM - Hold) following the restructuring of Svyazinvest, Kommersant reported today. According to the report, the government economic interest in the consolidated Rostelecom may fall below 50%, however, it will still be able to maintain operational control over the company. The report's finding are hardly a surprise for the market, yet they confirm that it is highly unlikely that at this stage the consolidation of Rostelecom and inter-regionals will not go through, or that any key terms (such as swap ratios between shares of IRs and Rostelecom) will be reconsidered.

a[bar] despite questions from the Ministry of Economy and Trade. The basic scheme of restructuring Svyazinvest was approved back in 2009 and swap ratios were announced in the first half of 2010. However, recently the Economy Ministry questioned whether the state will retain its control over the company, particularly after Rostelecom has acquired the 25% plus one share in its parent company Svyazinvest from AFK Sistema. Deputy Prime Minister Sergei Ivanov appointed VEB Capital to prepare a report on the issue.

Slightly positive for Rostelecom and IRs shares. VEB Capital's confirmation that the government will retain control over Svyazinvest following its consolidation is slightly positive for the shares of IRS and Rostelecom. Rostelecom is set to become a new Russian blue chip in the telecoms sector, however, we see no significant fundamental upside in the name, even in the case of entry through the shares of IRs. We confirm our Hold recommendations for Rostelecom and inter-regionals.

URALSIB Capital, 8, Efremova St, Moscow, Russia,119048,


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Publication:Russian Banks and Brokers Reports
Geographic Code:4EXRU
Date:Dec 14, 2010
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