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Uralsib - Russia Daily Equity Update - Dec 17, 2009.

Market Overview

The warm glow of rising crude

Oil closed $2/bbl better. The US Fed yesterday promised to keep interest rates exceptionally low for an extended period. Along with further evidence of growth in the US economy, this has caused some concern that inflation may become a problem in early 2010. But, it is a positive driver for commodity themes in the meantime and that helps further improve the investment appeal of Russian assets. Global equity markets will likely stay range bound through the holiday period, but Russia is well placed to continue outperforming.

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Monday's sudden drop in temperatures resulted in a jump in Gazprom's share price. The forecast is for even lower temperatures into next week (-31C on Monday with wind chill), which is a good for Gazprom shares and should push them higher. The oil stocks and the banks will likely also benefit from the recovering oil price. WTI closed up $2.0/bbl at $72.66/bbl on Nymex after a better-than-expected inventory report and a slide in the US dollar.

Banks and Oils lead. VTB and Bank St Petersburg are scheduled to release nine-month IFRS reports today. In the current environment, both may produce positive surprises. The main economic report due in the US today will be the Leading Indicator for November. That is again expected to show a positive trend, with a rise of 0.7% from a 0.3% gain in October.

In Russia, the Federal Statistics Service may issue its main end-November macro report today or tomorrow, and the main interest in that will be to see whether the improvement in the macro picture (Finance Minister Alexei Kudrin said he expects 2% YoY growth this quarter) has extended across all sectors, and which are still struggling. Prices on Moscow's bourses moved positively off the starting blocks yesterday morning as the oil price gained and cold winter temperatures increased the appeal of Gazprom shares.

A generally better session in Europe's markets and indications of an opening gain in the US helped the RTS and MICEX accelerate upwards as the session progressed. The upbeat assessment of economic prospects from the Finance Minister also improved investor confidence. At the

close, the RTS had added 3.8% to 1,449.0 while MICEX closed up 4.2% to 1,388.6. The ruble did not share in that sense of elation and fell against both the dollar and the euro. Against the US currency, the ruble closed its MICEX session down 5.7 bps to RUB30.25/$, and against the euro it closed at RUB44.01/EUR, down 4.7 bps.

Economics

PPI falls for the second month in a row

Last month producer prices continued to fall ... In November, producer prices fell by 0.5% MoM, Rosstat reported yesterday. We expected a decline of 0.2% MoM, while the market consensus called for a decline of 0.6%. On a 12- month rolling basis PPI was up by 6.5% YoY - its first growth after 12 months of decline. This change in PPI trend was driven mostly by the base factor.

a[bar] driven by a decline in prices in three sectors. On a MoM basis, November PPI dynamics have shown increases in almost all price segments. Significant exceptions were wholesale prices for the liquefaction of natural gas for transportation (down by 6.7% MoM), electricity wholesale prices (down by 0.1% MoM) and producer prices in metals industry (down by 1.1% MoM). On the other hand, the largest increases in PPI were recorded in the oil refining industry (up 4.1% MoM), coal production (up 6.3% MoM) and meat processing (up 4.1% MoM).

PPI trend may reverse this month. We expect to see even more dramatic growth in PPI in December (up 15.2% YoY), driven by a combination of the base factor and a reversal in the monthly trend in producer prices. We forecast PPI to break away from its downward trend in December and grow by 1.2% MoM.

Economics

Government becomes expectedly optimistic

Old habits are hard to break. A mere two weeks after the 2010 budget was signed into law by President Dmitry Medvedev, the Economy Ministry announced a major upward revision of its macroeconomic forecast. Not surprisingly, the fact that the Cabinet's view is now based on a much better outlook does not entail any adjustments to the new budget, which was based on a far more conservative outlook. This development - which we have been expecting for several months - opens the way for the government to significantly improve its finances while keeping its expenditures low. The same policy was successfully carried out by the Putin-Kudrin team during the early years of this century, allowing the Cabinet to build up a substantial sovereign fund.

Russia's fiscal situation set for a big improvement in 2010. Announcing the change yesterday, Deputy Economy Minister Andrei Klepach specifically stressed that the new forecast would not have immediate implications for the budget. He added that the Cabinet might revise major budget parameters when it starts the new 2011 budget process in late March or April 2010. In our view, this revision is unlikely to lead to any major changes in government expenditure, which allows us to confirm our bullish view of the 2010 budget: we expect next year to end with a budget surplus of 1% of GDP instead of the estimated 6.8% deficit included in the current version of 2010 budget bill.

Economy Ministry turns bullish on the ruble. The Economy Ministry has upgraded all macroeconomic indicators for 2010 and subsequent years (see the table). Of these the most important were an upward revision of the official 2009 growth forecast (from 1.6% to 3.1%; Klepach also did not rule out 5% growth next year); the ruble rate (the Ministry now expects to see a RUB/$ exchange rate that is on average 17% stronger next year) and the price of crude oil (the Urals price has been upgraded by 12% to $65/bbl in 2010).

November macro data confirms gradual recovery. Klepach also released some preliminary estimates of November macro data, which shows that the contraction in the economy has slowed compared to October in fixed investment (to negative 14.8% YoY), construction (down 13.2% YoY) and retail sales (down 6.4% YoY). Last month positive MoM growth rates were recorded in GDP, real incomes, transport and agriculture, according to Ministry estimates.

MMK

3Q09 IFRS preview: focus on company guidance

In line with management guidance. Magnitogorsk Steel (MMK - Buy) is scheduled to release 3Q09 IFRS results tomorrow at 10:00 Moscow time. We expect the numbers to be in line with management guidance provided in September, which assumes 3Q09 EBITDA growth of 50% QoQ to $310 mln, with an EBITDA margin of 22% (up from 20% in 2Q09). Revenue should rise 36% QoQ to $1.4 bln, driven mainly by a 31% QoQ increase in steel production for the period as well as a slight increase in steel prices. On the bottom line, we expect net income to increase 25% QoQ to $74 mln, including some forex gains (around $30 mln) stemming from ruble appreciation. The company's management will hold a conference call discussing the results on Friday.

One-offs may distort 3Q09 profits. The overall profitability of Russian steel companies continued to improve in 3Q09, due to higher capacity utilization rates and firmer export and domestic steel prices. At first glance, the expected 50% QoQ EBITDA growth may not impress the market, given the recent strong 3Q09 results from Novolipetsk Steel (whose EBITDA doubled QoQ to $466 mln). We understand the relatively weak profits that are anticipated could result from inclusion of some one-off items from MMK's traders, thereby distorting 3Q09 profits for MMK Group. At the same time, MMK's profitability is expected to remain one of the highest in the sector.

Focus on strong 4Q09 and beyond. We would focus on the company's guidance, which in our view, should indicate higher growth in profits and margins. However, management's profit guidance for 4Q09 and its outlook for 2010 - during the conference call - should be a major short-term driver for the stock. We note that while profits for Russian steel companies are likely to peak in 3Q09, with some seasonal softening in 4Q09, MMK's performance in 4Q09 could run counter to the industry trend. We expect that the consolidation of Belon and higher 4Q09 domestic steel prices could contribute to a strong growth in profits. We think that our 2009 EBITDA estimate of $1.1 bln is entirely achievable, while the Bloomberg consensus of $1.0 bln suggests some upside risk. MMK remains our top pick in Russian steel sector with a target price of $15/GDR. Another successful bond placement

Yield on MMK 2-year bonds set at 9.7%. Yesterday, MMK successfully placed RUB10 bln in three-year bonds with a two-year put/call option. The coupon rate was set at 9.7%. The total demand from investors participating in the auction (held on MICEX) was around RUR15 bln, which corresponds to a bid-to-cover ratio of 1.5. The coupon rate for the two-year bonds is the lowest among MMK's Russian peers, who have issued ruble bonds since the beginning of the financial crisis. The proceeds from the placement will be used to refinance Belon's substantial debt (estimated at around $500 mln), which is mainly in ruble-denominated loans from Russian banks at interest rates averaging 16- 17%. We view this news as generally positive for MMK shares.

Helicopter Producers

Rotating upwards - demand boosts valuations

Promising industry trends. We expect a significant increase in demand for Russian Mi-family helicopters over the medium-term, which may exceed 100% of the current sales of about 180 units per annum, driven by domestic and export markets. Domestic demand is to be boosted by the need to upgrade and expand the helicopter fleet of the Russian Air Force and the Emergency Situations Ministry, as well as by orders from the largest helicopter operators in Russia - Utair and Gazpromavia. To meet higher demand, the state, a major shareholder in the industry, is targeting a significant helicopter production capacity upgrade of more than two-fold by 2015 to as much as 500 units per annum. The planned upgrade in production will require investment of $5 bln, which could be funded by the state as well as by private investors and funding from a potential IPO of Helicopters of Russia, the center of consolidation in the industry.

Buy Kazan helicopters and Ulan-Ude aviation plant; hold Rostvertol. Our current assumptions based on the existing order books of the producers imply a 13% increase in 2010 revenue for Kazan helicopters (KHEL), a 7% decrease for Ulan-Ude aviation plant (UUAZ) and a 33% increase for Rostvertol (RTVL). We also project respective revenue growth of 4%, 16% and 18% in 2011. Our EBITDA margin projections for all helicopter producers are conservative, implying no major margin improvements in 2010 or 2011. Our multiple-based target prices for year-end 2010E are $2.4/common share for Kazan helicopters, $1.3/share for Ulan-Ude aviation plant and $0.037/share for Rostvertol, which represent 140%, 51% and 1% upsides to the market. We therefore assign Kazan helicopters and Ulan-Ude aviation plant shares Buy recommendations and Rostvertol a Hold recommendation.

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Publication:Russian Banks and Brokers Reports
Date:Dec 17, 2009
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