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Uralsib - Russia Daily Equity Update - Dec 16, 2009.

Market Overview

Inflating risks

Stronger recovery leads to rate fears. Yesterday's wholesale inflation and industrial production numbers in the US have raised fears that the US Fed will start to reduce stimulus measures earlier than expected. Today, those fears will be very focused on the US consumer inflation number and the statement by the members of the Fed's FOMC committee. The dollar and equity markets will react swiftly to any clear comments on interest rate intent. In reality, most investors will hope for the clarity of vagueness so that they may get on with holiday preparations. Domestically, the Federal Statistics Service is not expected to release the end of November macro report until tomorrow so equities and the ruble will move with the dollar, oil and global equities. The safe performance bet over the remainder of the month is the fixed-line telecom sector. With Svyazinvest restructuring moving ahead our preferred stock picks are Volga Telecom, Sibirtelecom, Far East Telecom and Uralsvyazinform.

(To view the full report please click here:

Nymex oil above $70/bbl again. Moscow's bourses opened with a small burst of unsustainable enthusiasm yesterday. The positive industrial production growth (year-on-year) number provided the basis for that hope, while the global markets trend brought the reality check. But, hope was not forsaken as a jump in the oil price late in the day helped the oil stocks, Gazprom and Sberbank to gain and that was enough to push the indices positive for the session.

The RTS closed 1.0% better at 1,396.3, while MICEX, which jumped 1.5% in the closing hour, ended the day 1.1% better at 1,332.3. The ruble reflected the action on the international money exchanges where the dollar index rose 0.8% to its highest level in two months.

The ruble lost 13 basis points against the US currency and closed at RUB30.19/$, while gaining 7 basis points against the euro to RUB43.97/EUR. In the local market, Sberbank and Gazprom, the traditional Russia proxies, were the two main beneficiaries of oil back above the $70/bbl on Nymex. Sberbank prefs added 4.5% on MICEX, while the latter climbed 3.15. Transneft preferred shares also rose through the day, closing 6.2% on MICEX. In London, The two main oil majors, LUKOIL and Rosneft, each rose close to 1.5% with the crude price, and Sberbank added 2.0%. NOVATEK, the more domestic play in the sector, ended 0.8% down at $62.50 on negligible volumes. TMK joined the oil theme, rising 2.8% to $18.50, outpacing the other steel sector names. Magnitogorsk Steel fell 3.0% to $10.89. Evraz did manage another 1.6% gain, to $27.84, to bring its five-day rally to a strongly out-performing13.7%.


Russian industry posts first YoY growth in a year

In the new coordinates. In November 2009, Russian industrial output increased by 1.5% YoY, according to Rosstat. This is significantly better than the decline of 11.2% YoY posted in October 2009. We had forecasted a slightly higher rebound of 2.9% YoY for November, while the consensus estimate was for a decline of 2.5%. Apart from the weak base factor - that from now on will put Russian macro statistics into a new set of coordinates with most indicators showing YoY growth rather than falls - the most important driver behind the change was the continued improvement of output dynamics in the food industry and the natural resource sector. The recent spell of abnormally cold weather in large parts of Russia is likely to push up output of natural gas and output of electricity, which implies a more significant increase in industrial dynamics in December. We retain our forecast that industrial production will decline 10.4% YoY in 2009 and return to growth of 8.2% YoY in 2010.

Utilities sector posts the second-highest YoY growth in November. Growth rates in the natural resource sector turned positive in YoY terms in October, and last month the rate of growth increased to a respectable 4.9% YoY, mostly driven by an increase in the volume of produced natural gas (up 8.2% YoY), crude oil (up 3.2%YoY) and iron ore (up by 62.8%YoY). Steady improvements in economic output have started to push up weekly electricity production output already in late October. As a result, the utilities sector last month posted its first YoY growth in 13 months (up 1.4% YoY).

Manufacturing output down by just 0.8%YoY vs a fall of 17.5% in October. In November 2009, automotive production remained the main drag in the manufacturing segment of industry, with car output down by 46.1% YoY. However, these statistics are bound for a massive improvement in December- January, as the weak base factor will lead to a rapid shift from deep falls to significant growth rates in the car industry. Dynamics in other segments of the manufacturing industry last month showed some visible improvements with food-processing (meat, dairy produce) and production of consumer goods (fabrics, footwear) leading the rise. Production of fertilizers (up 87.5% YoY) and steel (up 56.5% YoY) have also increased significantly, not least from rising global demand.


3Q09 US GAAP review: taxes erode margins

Above consensus, but in line with the industry trend. Yesterday, Tatneft (TATN - Hold) released 3Q09 US GAAP results, which were above consensus, but in line with the industry trend. Revenues grew fuelled by higher commodity prices, while margins were squeezed by higher taxes other than income tax (MET and export duty) and ruble appreciation. In 3Q09, revenue climbed by 24.7% QoQ to $3.5 bln, 0.9% and 5.5% above the consensus and our estimates, due to higher growth of petrochemicals and other sales, whose share in total sales accelerated from 9.1% in 2Q09 to 12.7% in 3Q09. EBITDA of $788 mln, up 3.3% QoQ, exceeded both our (4%) and consensus estimates (5.4%). On the negative side, operating expenses grew 46.1% QoQ to $556 mln, significantly outpacing ruble appreciation and 1.5% QoQ production growth. All items below the operating line were lower than we had anticipated (including a currency gain of just $31 mln, versus $54 mln projected), resulting in lower than forecast net income of $566 mln, down 16.8% QoQ. As a result, EBITDA and net margins contracted by 4.7 ppt QoQ and 8.1 ppt QoQ to 22.5% and 16.2%.

Positive free cash flow for the first time this year. On 30 September 2009, the company's net debt rose by 16.8% QoQ to $2.6 bln, implying a comfortable 2009E net debt/EBITDA ratio of 0.9. Operating cash flow soared by almost 20% QoQ to $776 mln, while capex was down 30% QoQ to $588 mln, which is in line with our expectations, leading to positive free cash flow of $189 mln, for the first time this year. This was due to the company accelerating construction of the Nizhnekamsk oil and petrochemical complex in 1H09, which raised capex; in 3Q09, the situation was opposite, as Tatneft management reduced spending on the refinery. We expect a further capex reduction in 4Q09, and expect about $550 mln of capex.

Neutral for the stock, and industry as a whole. Although the results were stronger than consensus, we believe they will have no effect on the company's stock performance. Tatneft financials provided another reflection of inefficient taxation and ruble appreciation, which undermined and eroded revenue growth, and which is the reason for our neutral view on the sector as a whole. In the absence of company specific drivers (like those which improved the financials of Gazprom Neft), we do not see fundamental drivers for Tatneft stock. Thus, we retain our Hold recommendation on the stock with a target price of $4.7/common share, implying 4.4% upside to the market price.

Inter RAO

Rising new power - initiation of coverage

Prospects in Russia outweigh external risks. Inter RAO (IRAO - Buy) is an electricity integrated company which has a monopoly on the electricity export/import market in Russia, owning 6.4 GW of capacity in Russia and the CIS. The company has the potential to rapidly expand into the Russian generation segment and increase its market share from 0.8% to 6.5% through the acquisition of OGK-1 and TGK-11. It is one of the most liquid stocks in the Russian utilities universe and is now a member of MSCI Russia. State support coupled with ongoing liberalization of the electricity market means that Inter RAO has strong domestic growth prospects, which outweigh the company's less predictable international electricity business. We are initiating coverage of Inter RAO, assigning it with a Buy recommendation, to reflect the company's strong growth prospects, and a DCF-based target price of $0.0018/share, which implies 20% upside to the current market price.

North-West Telecom

9M09 IFRS results: high OIBDA margin

Accounting effects pushed OIBDA margin to 48%. Yesterday, North-West Telecom (SPTL - Buy) released 9M09 IFRS financials. This was the first time the company released nine month figures under IFRS, so comparable data for 9M08 and 3Q08 is not available. Revenue amounted to RUB19.7 bln ($510 mln), while OIBDA reached RUB9.4 bln ($288 mln), resulting in an impressive OIBDA margin of 47.9%. The high margin is due in part to an accounting effect, where RUB3 bln ($92 mln) in revenue for rendering universal telecommunication services was included under operating income instead of top line. In 9M09, net income reached RUB2.2 bln ($68 mln), implying a solid net margin of 11.3%.

Operational improvements in 3Q09. The third quarter was very positive for North-West Telecom, with the company showing strong control over costs. OIBDA margin reached a solid 50.3% in 3Q09, up QoQ from an OIBDA margin of 46.2% and above our projected 2009E OIBDA margin of 41.9%. A 6% QoQ drop in net income to RUB996 mln ($32 mln) was mainly due to a forex loss of RUB238 mln ($8 mln) in 3Q09, compared to a forex gain of RUB654 mln ($20 mln) in 2Q09. North-West Telecom increased its total debt to RUB18.2 bln ($605 mln) from RUB16.1 bln ($548 mln) at the end of 2008; however, the company's financial position is still safe in our view.

Slightly positive news flow. We believe the release of these results will generate only marginal support for the company's share price. As Svyazinvest restructuring approaches, strong 2009 numbers may result in a better swap ratio, which would allow the company to enter the new Rostelecom with combined inter-regional telecoms assets. North-West Telecom is fundamentally undervalued, trading with 68% upside to its target value of $0.77/share. We reiterate our Buy recommendation for North-West Telecom.

Mobile sector

New band width frequency renews interest in sector

Possible distribution of new frequency band ... Yesterday, Sergey Sitnikov, head of Roscomnadzor, said the agency has a 15 MHz band width frequency available, in a range of 1700-1800 MHz, covering all regions of Russia, Vedomosti reported today. This band width is sufficient for the rollout of a new GSM network, or even 3G or 4G networks across Russia. A government committee will make a decision on the tender for the frequency, as well as terms, in 1Q10. This could lead to development of a fourth federal mobile operator to compete with MTS (MBT - Buy), VimpelCom (VIP - Buy) and MegaFon.

a[bar] awakes interest in mobile sector. One of the potential beneficiaries of the possible frequency distribution is Svyazinvest, which could launch a new national mobile operator in the new band. This would save the time and expense required to purchase mobile operators. Recently, Svyazinvest management announced plans to develop cellular operations on the base of the mobile assets of inter-regional telecoms, and contemplated cooperation with MegaFon, the third-largest Russian mobile operator. If granted to MTS or VimpelCom, they would be able to extend the capacities of their networks. However, we consider this scenario as highly unlikely.

May be slightly negative for MTS and VimpelCom. The news can be considered as slightly negative for the current market leaders MTS and VimpelCom as the most probable recipient of the new frequencies will be Svyazinvest. Even so, if Svyazinvest receives sufficient frequencies for a nationwide GSM network, it will still be not easy for it to undermine the market position of the Big-3, given their market power and the high saturation in the Russian mobile market. We thus recommend to use any potential weakness in MTS and VimpelCom share prices to increase positions in both names, which look undervalued trading at a 2010E EV/EBITDA of 3.9 and 5.0, offering 62% and 42% upside, respectively, to their 12-month target values of $79/ADR and $27/ADR. We reiterate Buy recommendations for both MTS and VimpelCom.

Fertilizer Producers

Domestic price increases for agriculture producers

Price revision for NPK producers possible following the increase in prices for domestic agriculture producers. Yesterday, several fertilizer producers in Russia announced new prices for domestic agriculture producers for 1H10, based on an agreement signed between the Russian Association of Fertilizer Producers and Agropromsoyuz in October 2008. Silvinit (SILV - Buy) announced a 23% HoH increase (the same as that announced by Uralkali last Friday) for 1H10 domestic prices for agriculture producers to RUB4,550/ton (up 20% HoH in dollar terms). Acron also increased its 1H10 prices for ammonia nitrate and urea for domestic agriculture producers by 11% and 10% HoH, respectively, to RUB 5,570/ton (or $198/ton) and RUB 8,470/ton (or $301/ton), while leaving its price for NPK unchanged at RUB10,200/ton (or $363/ton). Following a series of price increases for agriculture producers, we expect Uralkali (URKA - Buy) and Silvinit to also increase potash prices for 1H10 for NPK fertilizer producers (up from the current price of RUB3,995/ton or $130/ton). The list of major potash consumers includes EuroChem and PhosAgro for Uralkali, and Acron (AKRN - Hold; the only public name among NPK fertilizer producers) and UralChem for Silvinit.

Negligible effect on financials. Despite the fact that the increase in domestic prices is slightly above our model assumptions for potash producers, such a difference will have a very minor effect on their projected financials (less than 0.5% for 2010 revenues and EBITDA). For Acron, the price increase will be neutral for its revenues (as the announced increase came in line with our model assumptions). However, the company's EBITDA may fall 3% below our current estimates, which nevertheless is a very limited effect, and the potash price increase for NPK producers is still subject to approval (as only domestic agriculture prices have been announced).

Negative sentiment for Acron. We view this news as potentially negative for Acron's NPK business, as higher potash prices will weaken its cost advantage over its European peers. Hence, once the price increase is finally agreed, this should add negative sentiment to the stock. We view this news as neutral for potash producers' stocks as it is already priced in by the market.

Bank St Petersburg

9M09 IFRS preview: mixed bag expected

Growth in core income against NPLs to exceed 9.5%. Bank St Petersburg (STBK - Buy) will release 3Q09 IFRS results tomorrow at 10.00 Moscow time. The conference call discussing the results is scheduled for 16.00 Moscow time. We expect the bank to post a 3Q09 loss of RUB218 mln ($7 mln), down 25% QoQ. This is mainly due to a 3Q09 non-performing loans (NPL) ratio of almost 9.5% (up from 7.5% in 2Q09) and high provision charges. In 2Q09, the bank's coverage ratio fell to 97% from above 130% in the previous quarter. We expect the bank to post provisions of RUB2.6 bln ($83 mln), up from RUB2.4 bln ($72 mln) in 2Q09, which should allow it to sustain a coverage ratio of around 100%. Operating income is to increase 5% QoQ, due to the stabilization of the bank's net interest margin, a result of reduced exposure to CBR funding in 3Q09 as well as trading gains. If the bank posts a loss, the market may react negatively, however, we would use this as a buying opportunity, as we expect the bank's profitability to recover strongly in 4Q09 and 2010.

Attention will be focused on the outlook and 4Q09. In 4Q09, Bank St Petersburg successfully raised $200 mln through a preferred shares placement, and thus we believe its TIER-1 capital ratio is set to exceed 12% by the end of 2009 (up from below 9% in 3Q09), supporting growth in loans, which we expect to grow by 5% in 4Q09 and become even stronger going forward. While the quality of the bank's assets is likely to further deteriorate, we expect NPLs to peak in 1Q10, and the outlook on this development will be of particular interest during the conference call.

Cheapest Russian bank. Bank St Petersburg shares are the cheapest in the sector, trading at a 2010E P/BV of 1.1, with a 15% discount to VTB. Regarding the overall Russian banking sector, we expect bank's NPLs to peak in 1Q10, and the cost of risks to begin to decline in 4Q09, which together with a growth in loans should provide strong support for banks' bottom lines. We retain our Buy recommendation for the bank's shares, with target price of $4.1/share, implying a 43% upside.

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


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Publication:Russian Banks and Brokers Reports
Date:Dec 16, 2009
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