Page 1

December 2010


This document is provided to you for informational purposes only and does not constitute an offer to buy, sell or subscribe to investment products described herein. The sources used for this report are believed to be reliable, but TKB Capital makes no representation as to their accuracy or completeness. The views, advice and recommendations contained within represent the analyst’s view as of the publication date. Such views may change without notice and may contradict previously expressed views and recommendations. TKB Capital is under no obligation to bring such previously held views to the attention of the reader. This report is intended for market professionals and institutional investors capable of assessing the risks associated with the securities mentioned herein. TKB Capital shall not be held liable for any losses or other damages which may occur as a result of using this information or investment decisions made on the basis of opinions and recommendations contained in this report. Some Russian equities experience volatility which increases their investment risk, as their value may fall causing losses if the investment is realized. Many Russian equities are illiquid, and some investments are not readily or quickly realizable in good markets, and in times of market duress they may be impossible to realize. Many Russian equities do not trade on a daily basis and thus do not have a daily price quote, giving rise to questions concerning their true value. TKB Capital can give no representation as to the absolute volatility or liquidity of any Russian equity, nor can it give any representation as to the true value of an illiquid security. The value of all rubledenominated Russian equities is also dependent on currency fluctuations in addition to equity market conditions. Investors should conduct their own investigation and research into a given investment and make their own assessment as to the risks involved with a particular investment in Russian equities. TKB Capital may trade for its own account based on any short-term or long-term recommendations or trade ideas. It may also trade in recommended securities in a manner that is contrary to any trade idea or recommendation. This report may not be reproduced, distributed or published without the written agreement of TKB Capital.

www.tkbc.ru


CONTENTS 2011 – Cheer mind, open eyes Right choice makes sense

5

Russian Economy Elections are coming

6

Commodity markets Start Your Engines!

7

Fixed Income Market Rates: Increase with no decrease

11

Stock Market Betting on growth and efficiency in 2011

13

Oil & Gas Uncertainty with taxes remains

17

Power Industry Bet on quality

31 41

Metals & mining Further recovery in 2011 Telecoms Growing beyond traditional mobile services to unlock more value

57

Transport Outpacing economic recovery

75

Consumer and retail Ready, Steady And Go Shopping!

85

Banking sector More loans – less risks

99

Machinery Citius, altius, fortius*

111

Real Estate Sector Footing get stronger, its time to build

117

Infrastructure construction sector World Cup 2018 – next impulse for development

127

APPENDIX

133


2011 - Cheer mind, open eyes Right choice makes sense

2011 - Cheer mind, open eyes Right choice makes sense Choose Profit in 1H11 over Risks in 2H11 We expect that in 1H11 markets will continue positive trend driven by excess liquidity and inflation risks. At the same time fundamental factor are not strong enough to support the current high price levels, European financial risks do exist and China may take further steps in strengthening its monetary policy that will put pressure on the stock and commodity markets. Choose ideas vs. betting on market We expect that 2011 will be characterized by a great number of corporate events to provide various investment opportunities. Interesting ideas will be observed in 3-tier equities, especially on primary market. It is time to get the reliable credit analysis. Besides, short-term (1.5 year) and floating rate bonds will be of high demand on the back of swap cost growth and expectations for key rates increase. Choose Gold in a long-term and Oil in a short-term Oil is expected to continue its positive trend backed by the speculative factors and we see price of Brent at $100 per barrel in 1H11, but this level does not seem sustainable. Average price of gold is forecasted at $1,500 per oz in 2011 as existing risks will increase demand for non-risky assets. Choose Soya and Corn over Sugar and Wheat Declining stocks of corn and soya and expanding consumption of these commodities from the part of China may lead to deficit on the market and price hike. Contrary, sugar currently is strongly overvalued and the market players are betting on correction in a close future. Situation on the wheat market is relatively stable. Choose Efficiency and Growth over Uncertainty Betting on external factors we recommend choosing undervalued stocks, which showed recovery of operating and financial results. Thus, some gas names, coal and non-ferrous metal companies will bring upside. Growing domestic demand, stable ruble and the state support increase attractiveness of domestic oriented players, which deliver strong growth potential. Here we mean retail, construction and banks. Government initiatives create uncertainty in some sectors that make them less promising, for example oil and power names. Choose Retail, Banks, Gas, Constructions over Oil, Steel and Power On the Russian stock market we recommend choosing retail companies, which deliver strong growth profile and allow to capitalize domestic drivers. We bet on Magint and X5. Banks will show stronger performance backed by loans growth and lower credit risks. Fundamental factors will drive price of Sberbank and Bank St-Petersburg, while M&A deals and sale of 10% stake will support VTB. Higher gas prices and tariff revision are not reflected yet in the share price of the gas companies, while Gazprom stocks still look cheap. The state support and recovery of real estate market determines substantial projects portfolio of construction companies (PIK, LSR Group, Mostotrest), that will also support some steel names. New state initiatives regarding taxation in the oil segment create uncertainties for the oil producers that makes these stocks less attractive despite strong oil prices. Doubts regarding tariff regulation in power segment allow choosing only those with set rules and high efficiency ratios (RusHydro). Steel companies look quite expensive at the current level, and in metal segment we prefer the cheapest ones with exposure to favorable metals prices (Mechel, NorNickel).

STRATEGY 2011

5


Russian Economy Elections are coming

Alexander Kovalev, PhD aa.kovalev@tkbc.ru

Russian Economy Elections are coming Inertial motion. In 2011 we expect to see stronger divergence between Russian and the World economies. The World economy will continue confident recovering, irregularly though. Prices on commodity markets are likely to reach new post-crisis highs in 1H11. But positive influence of these factors on the Russian economy will be limited after they have been driving growth over the last 10 years. Lack of structural reforms in Russia, budget deficit and political instability will restrain economic growth. Thus, we would call scenario of Russian economic development as inertial motion. GDP is expected to increase by slow 4.3% despite strong external environment. Nevertheless, a certain number of macroindicators will look quite strong. Investments and consumption to support growth. Investments are expected to show 8% growth especially in 1H11. But the main factors determining high growth rates of investments will be low base and postponing of investment projects. Consumption growth will also support economic recovery backed by higher income of households and higher credit activity. Retail sales are estimated to grow by 6.2-6.6% in real terms. Pensions’ growth and increase in salary paid from budget will also support consumption numbers. Despite positive trend on the oil market, deficit of the Russian budget stays at relatively high level, as coming president elections in 2012 determine realization of significant social programs. Budget issues are getting more important. Thanks to higher oil price in 2010 than expected $65-70 per bbl budget deficit was below the forecasted numbers by Ministry of Finance. Beginning of 2011 is unlikely to change the situation as we will see boosting budget expenses largely compensated by high prices on commodity markets. But we think that risks of this play are significant. In 2011 no deficit budget is possible to reach at average Urals price around $90 bbl. Russian budget is strongly dependent on external conditions, and with the current structure of the Russian economy this trend is impossible to change, while structural reforms during the pre-election years are unlikely. Ruble strengthening is possible, but not sustainable. Level of Russian sovereign debt is significantly lower comparing to South European countries, but high dependence of the budget income items on oil prices means substantial risks in case of changing environment on the external market. That makes ruble more vulnerable. Balance of payment may reduce strongly as a result of capital outflow. Thus, we do not expect ruble strengthening significantly above RUR29.9 even if oil prices stay at high level through 2011.

6

STRATEGY 2011

Macrooutlook OLD

NEW

2010E

2011E

2010E

2011E

Urals crude, $/bbl (avg)

76.5

78.0

78.4

90.0

GDP, % y-o-y

4.1%

3.6%

3.8%

4.3%

CPI, % Dec./Dec.

7.0%

7.5%

8.5%

8.4%

RUR/USD, year-end

28.9

28.6

30.4

29.9


Commodity markets Start Your Engines! Alexander Kovalev, PhD aa.kovalev@tkbc.ru

Urals crude oil, $/bbl Gold, $/once Copper, $/tonne Sugar, $/pound Corn, $/bushel Wheat, $/bushel Soy beans, $/bushel

Current price

Target price f or 2011

Upside

Commodity markets

93.65

95

1.44%

Start Your Engines!

1385.35

1500

8.28%

9393

9240

-1.63%

33.13

22.5

-32.09%

6.09

6.2

1.81%

7.835

7.7

-1.72%

13.2875

14.2

6.87%

*current price on 22.12.2010

China is in a tight corner. We believe that the main risk for world economy and commodity markets is a sharp China cooling down that could lead in the worst case to collapse of Chinese economic growth model. Dramatically growing consumer prices is a significant economic and social problem for Chinese government. Having stable currency rate and expectations of its appreciation in the future, China is an ideal target for carry traders. Concerns of capital inflow intension don’t permit the People Bank of China to increase interest rates noticeably. But the sharp Yuan appreciation that could end speculations on its appreciation is not on the agenda. Therefore inflation will accelerate further, rising costs and wages in a certain point will destroy Chinese export competitive advantage that the authorities protect by currency manipulations. Anyway, the actual Chinese model will disappear soon. If it takes place too soon the commodity markets become turbulent.

Source: Bloomberg, TKB Capital estimates

Inflation pressure in China China CPI, % China Food CPI, %

12 9 6 3 0

31.10.2010

31.08.2010

30.06.2010

30.04.2010

28.02.2010

31.12.2009

31.10.2009

31.08.2009

30.06.2009

30.04.2009

28.02.2009

31.12.2008

-3

Source: Bloomberg

Stock markets volatility VIX Index RTS Volatility Index

54

32 21 26.11.2010

29.10.2010

01.10.2010

03.09.2010

06.08.2010

09.07.2010

11.06.2010

14.05.2010

16.04.2010

19.03.2010

19.02.2010

22.01.2010

25.12.2009

10

Source: Bloomberg

Gold prices and USD dynamics correlation Gold price $/tr. once (lhs) Dollar index (rhs)

Risks are high but not too much. Taking the risks mentioned above into account, we presume that volatility on commodity markets will return to early 2010 levels after half-year of declining. The most vulnerable thereupon, in our opinion, are the base metals, in particular copper that reached all-time high in December. On oil market the trend will probably remain rising. But corrections will occur more often and will deeper than recent months. Among agricultural commodities the grain markets will be strong in the 1H2011, while sugar prices may fall dramatically. Gold doesn’t tarnish. The fact that investment into gold allow to combine the hedge against inflation and safe heaven has become the generality a long time ago. But now this combination is the most actual ever. In spite of 30 percent price growth in 2010, gold will remain attractive for investors till interest rates are near zero and Central banks continue intervention to prevent national currencies appreciation. Besides, the potential risks for commodities that European debt problem or China tightening could carry are not so dangerous for gold.

43

1,500 1,400 1,300 1,200 1,100 1,000 900 800

Bubble with the provisos. The inflationary growth on commodity markets will probably continue. Consumer prices are expected to accelerate not only in emerging economies but also in developed ones. These expectations will carry commodity prices higher in spite of relatively weak fundamentals. We don’t believe that rising global raw materials demand can present a base for sustainable commodity prices growth in 2011. Risk of double-dip recession remains high due to possible China cooling down, European debt problem and sluggish growth in US. It will hamper the impetuous growth. But in the beginning of the year the bubble will be at inflation study and it’s not good idea to withstand this movement.

90 86

Dollar and commodities decoupling. The further weakening of negative correlation between dynamics of commodities prices and US dollar rate will one of the characteristic features of 1H2011. Starting from early 2009 the dollar rate movement was an exact indicator of investor’s risk appetite. Dollar weakening was surely accompanied by commodities growing, while dollar appreciation meant commodities prices falling. European debt crisis escalation has broken this one-to-one correspondence. In 2011 periods of dollar and commodities movement in the same direction will occur more often. But while Fed rate is about zero, carry trade will continue. So the negative correlation between dollar and commodities isn’t completely destroyed yet.

82 78 27.10.2010

27.06.2010

27.02.2010

27.10.2009

27.06.2009

27.02.2009

74

Source: Bloomberg

STRATEGY 2011

7


Commodity markets Start Your Engines!

CRUDE OIL: $100 on the barrelhead!

70

700

40

400

10 16.05.2000 26.12.2000 07.08.2001 19.03.2002 29.10.2002 10.06.2003 20.01.2004 31.08.2004 12.04.2005 22.11.2005 04.07.2006 13.02.2007 25.09.2007 06.05.2008 16.12.2008 28.07.2009 09.03.2010 19.10.2010

100

1,000

Source: CFTC, Bloomberg

Oil consumption in emerging and developed world OECD Oil Consuption Non-OECD Oil Consuption

54 50 46 42 38 34

Sep-10

Jan-10

May-10

Sep-09

Jan-09

May-09

Sep-08

Jan-08

May-08

Sep-07

30

Source: Energy Intelligence, Bloomberg

Speculators on oil market WTI Crude Oil price, $/bbl (lhs) Net speculativ e position (rhs)

02.05.2010

02.03.2010

02.01.2010

02.11.2009

02.09.2009

02.07.2009

02.05.2009

210,000 170,000 130,000 90,000 50,000 10,000 -30,000 02.03.2009

100 90 80 70 60 50 40 02.01.2009

Fundamentals remain weak. Speculators target is $100/bbl and it will probably be reached in 1H2011. But further on a rather deep correction might take place as speculators start to close their positions. From fundamental point of view, the market is not strong enough, the world crude oil consumption forecast, exceeding the pre-crisis level, seem too optimistic to us. Crude oil demand growth not only in Asia, but in the US and EU is a necessary condition for this to happen. One can not count on EU caught in debt crisis trap, and the US is not likely to show a better vs. 2010 fuel consumption dynamics until the unemployment level remains near the 10% mark. Therefore, inventories level is expected to remain at a high level, which doesn’t allow a sustainable price growth.

130

1,300

Jan-07

Speculative race. After Lehman Brothers collapse, the oil market was in stable contango, expectations of the world economy recovery were supporting the far end of the forward curve at a high level and these expectations came true. However, the continuation of this trend is questionable in spite of the mentioned experts’ point of view. By December of 2010, Brent crude oil forward curve became rather flat, and sometimes speculative inflow had been turning it into backwardation. The fact of speculative nature of the price rise is clearly proven by the statistics of the Commodity Futures Trading Commission (CFTC), showing the number of crude oil speculative long positions reached its all time high in the beginning of December.

WTI Crude Oil price, $/bbl (rhs) 1,600

May-07

Deficit ghost. World crude oil consumption has really risen noticeably after the crisis fall, as well as positive macroeconomic data, except for the EU, allow being rather optimistic for the upcoming 2011. As an example, the International Energy Agency has increased their estimates of the world oil demand in 2011 several times, before they finally announced their forecast of 88.8 bln bbl per day. This estimate is approximately 2 bln bbl per day higher than the consumption level in 2010. To meet this demand, OPEC will unavoidably have to pump more, diminishing spare capacity, which in turn could lead to potential supply shortage. Similar situation appeared in the market in 2007-2008, thus price increase conditions were created.

NY MEX Crude oil open interest, thou. contr. (lhs)

02.11.2008

Inflation hedge. Inflation acceleration concerns do have reasonable background. Attempts of covering budget gaps by means of emissions have always in the history affected consumer prices. And while Ben Bernanke is trying to persuade both consumers and investors that should the prices rise up the Fed will be able to control it, nobody is buying this argument – neither the investors, nor - as it looks - Bernanke himself. The situation in the developing countries, where an avalanche capital inflow and currency manipulations have created and explosive mixture which is about to detonate, is even worse. Thus, raising demand for crude oil and other commodities as an inflation hedge looks quite reasonable. Still, reaching even $100/bbl is far ahead of the inflation rate, not mentioning any higher levels. Therefore, there should be other underlying factors.

Investment demand as oil price growth driver

02.09.2008

Way to the top. The market had been waiting for crude oil demand recovery in the developed world for the whole 2010 to justify a sustainable growth, but it has never started. Never the less, plenty of cheap money and the concerns it might get even cheaper, create their own rules. They need no solid fundamentals to start a strong growth, especially if such a growth has a clear target. With respect to that, the mark of $100/bbl getting closer was the very time. Further movement directions will be put on the agenda only after this point is reached.

Source: CFTC, Bloomberg

Oil stockpiles and demand in US US Commercial crude oil inv entories, mn bbl US Crude oil implied demand, mn bbl/day 15.60 15.20 14.80 14.40 14.00 13.60 13.20 04.07.2008 04.09.2008 04.11.2008 04.01.2009 04.03.2009 04.05.2009 04.07.2009 04.09.2009 04.11.2009 04.01.2010 04.03.2010 04.05.2010 04.07.2010 04.09.2010 04.11.2010

400 380 360 340 320 300 280

Source: DOE, Bloomberg

8

STRATEGY 2011


Commodity markets Start Your Engines!

Copper not gold China – the main word copper growth driver China (lhs) World (rhs)

800 750 700 650 600 550 500 450 400

2000 1750 1500 1250 31.08.2010

30.06.2010

30.04.2010

28.02.2010

31.12.2009

31.10.2009

31.08.2009

30.06.2009

30.04.2009

28.02.2009

31.12.2008

1000

Source: Bloomberg

LME base metals inventories LME Cooper inv entories, thou. tons (lhs)

20.11.2010

20.09.2010

20.07.2010

20.05.2010

20.03.2010

20.01.2010

20.11.2009

20.09.2009

20.07.2009

20.03.2009

20.05.2009

LME Nickel inv entories, thou. tons (rhs) 180 165 150 135 120 105 90

600 525 450 375 300 225 150

Source: LME, Bloomberg

China copper imports, thou. tons

01.10.2010

01.08.2010

01.06.2010

01.04.2010

01.02.2010

01.12.2009

01.10.2009

01.08.2009

01.06.2009

01.04.2009

01.02.2009

01.12.2008

Source: Bloomberg

China copper demand elasticity LME Copper price, $/tonne (lhs)

Demand is growing... As supply problems escalate, the growing demand for metals in Asia looks frightening. The market is agreeing to expect the demand exceeding copper supply at the rate of approximately 350 thou tones in 2011, which is in line with the current LME copper inventories level – which means inventories will be able to cover less than one week of consumption in a year. Similar situation took place in 2007 at nickel market, leading to hyperbolic price growth. Concerns of the same scenario occurring at copper market have lead to hectic copper buying ,which in turn allowed the prices to reach all time high in December. But we consider the investors are wrong when extrapolating current copper consumption trends in China even to the nearest future, not mentioning any longer term perspectives.

20% 18% 16% 14% 12% 10% 8% 6%

Chinese power is not unlimited. Many people underestimate the elasticity of copper demand in China, not mentioning the developed economies. China huge currency reserves do not necessarily mean the domestic consumers are ready to pay any price for it. Shanghai inventories, unlike ones in London, are increasing, and this growing intensified in autumn. This means copper demand at the prices close to record can not be stable even in China. Indirectly, demand decline in China is indicated by lower premium in copper tone price in Shanghai vs. London as it is falling since July. This trend has been set up quite clearly, and it is determined by the high prices. China monetary tightening can strike copper demand even more heavily provoking prices drop as much as 20-25%. Nevertheless copper price growth due to capital inflow is not over yet, still it may be risky to take part in it.

11.08.2010 21.08.2010 31.08.2010 10.09.2010 20.09.2010 30.09.2010 10.10.2010 20.10.2010 30.10.2010 09.11.2010 19.11.2010 29.11.2010 09.12.2010

Shanghai v s. London (rhs)

Supply constraints. Most of the market players consider the tendency for copper inventories reduce and prices growth will remain in 2011. And the arguments in favor of this point of view are much more solid than in favor of the consistent crude oil prices growth. It is expected that in copper market the growing demand can face supply shortage. At first, the quality of copper ore at the current mines is declining, and the investments into new mines are insufficient, which is making doubtful an ability to meet the growing prices with production growth. Moreover, union problems, like the one disturbing normal functioning of Collahuasi mine in Chile (the world leader of copper production) for more than a month, are likely to threaten metals supply in 2011.

…for a while. It should be noted that the high copper consumption level in China is partly determined by the realization of the governmental $585 bln program of infrastructure investments. A considerable amount of copper purchases under this program was made in Q2 2009, but there were some purchases in this year, too. Therefore, a certain part of the demand in China is artificial and reducing with time. This may be seen in the copper imports dynamics to China as well: it is significantly lower vs. the previous year and continuing to decline.

400 350 300 250 200 150 100

9,400 9,000 8,600 8,200 7,800 7,400 7,000 6,600

Copper rush. Out of all industrial raw materials, base metals have shown the best performance. Copper prices have grown the most, showing more than 40% jump since June. The factors underlying this growth have very much in common with the ones pushed crude oil prices up. These are inflation concerns, Asian demand growth, inventories decline… In the case of copper, the latest two factors are even more pronounced than in the case of crude oil. The world copper consumption increased more than 5% in 2010 – significantly higher rate vs. crude oil and the most part of this growth was provided by China. Copper production can not match this rapid consumption growth, creating LME inventories decline by 37% vs. the February peak – thus, price growth fundamentals appear.

Source: Bloomberg

STRATEGY 2011

9


Commodity markets Start Your Engines!

Hard grains Wheat: concerns remain. The fact that sharp wheat prices growth in summer kept at a local level is not surprising. Several previous years allowed accumulating huge inventories, protecting from any weather fluctuations in a more or less secure way. Therefore, a correction of August highs is an absolutely natural thing. In a certain sense, the absence of any tight situation in the market had been provided by the fact Russian export ban has not been put into action by the major exporters although it was the main concern in the market. Nevertheless, there is a risk of situation getting worse in 2011. Winter wheat in the US was damaged by dry weather in autumn. La Nina phenomenon is damaging crops in Australia, Asia and South America.

Sugar is at the edge. Sugar market has been in turbulence for more than a year. The 2008 and 2009 production fall in India and world inventories decline led to sugar shortages and prices jump to 29-year maximum in the beginning of 2010. While normalization was expected, the prices dropped more than twice as low, though no normalization occurred. Adverse weather in Asia - and mainly in Brazil - at the end of summer and in autumn raised doubts in the market regarding shortage disappearance. The prices not only returned to the ¢30/pound level but even exceeded it in the beginning of November. During the recent weeks speculations on India export ban lift are supporting the prices as the governmental decision on it is constantly postponing. With high probability, the ban lift will stop rally, and the prices are likely to fall as much as 30-35% by the mid of 2011. Secure bet on sugar fall. Sugar prices are artificially high now, and this level is kept due to adverse weather only, limiting fast production increase. Strong backwardation of the sugar forward curve is clearly showing prices drop expectations. Nevertheless, simple futures sell might be dangerous as speculative growth has its internal logics. Under such conditions we believe the best solution is a bet on reduce of backwardation. This bet can be executed through calendar put-spread sell. An example may be as follows: May put-option buy simultaneously with July put-option with the same strike sell.

Corn 40% 35% 30% 25% 20% 15%

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

10%

Source: USDA

China soybeans and corn imports China soy beans import, mn tons (lhs) China corn import, thou tons (rhs)

01.10.2010

01.01.2010

01.04.2009

01.07.2008

600 500 400 300 200 100 0 01.10.2007

6.00 5.00 4.00 3.00 2.00 1.00 0.00 01.01.2007

Soybeans hunger. The way China can influence agricultural commodities prices can be clearly seen by soybeans prices trend. It demonstrated the most stable performance during the crisis, and now it is closer to 2008 highs, as compared to wheat or corn prices. Strong Chinese demand is keeping inventories under heavy and growing pressure – both the US and the world ones. As the US Department of agriculture (USDA) showed in its December data, the US soybeans inventories are expected to decline to the critical 165 mln bushels. If due to draughts or diseases the Brazil crop is below 67.5 thou tones as it is forecasted now, soybeans market rally to all time high in April-May is almost unavoidable. Still, unlike grains, in long-term perspective soybeans prices can remain at a high level.

Wheat

Source: Bloomberg

Sugar prices in 2010, ¢/pound 35 30 25 20 15 10 31.12.2009 20.01.2010 09.02.2010 01.03.2010 21.03.2010 10.04.2010 30.04.2010 20.05.2010 09.06.2010 29.06.2010 19.07.2010 08.08.2010 28.08.2010 17.09.2010 07.10.2010 27.10.2010 16.11.2010 06.12.2010

Corn at rise. It should be noted that the world performance at the beginning of 2011 is much worse than a year ago. And if wheat stocks remain rather far from critically low level, other grains - and corn mainly - demonstrate reasons for concerns. With respect to that, any kind of yield problems, even less scalefull than in 2010, may lead to prices rally similar to the one happened in 2007-2008. In particular, the main concern now is that La Nina phenomenon can provoke draughts in Brazil and Argentina - a repeat of the 2005 draught, when approximately 15% of soybeans and corn was lost. Further inventories decline can face an intensified import activity of China as the latest is unable to cover its’ growing feed demand.

Wheat and corn Stock-to-use ratio

Source: Bloomberg

Sugar forward curve 34 32 30 28 26 24 22 Mar 2011

May 2011

Source: Bloomberg

10

STRATEGY 2011

Jul 2011

Oct 2011

Mar 2011


Fixed Income Market Rates: Increase with no decrease Dmitry Zak d.zak@tkbc.ru Michael Zak d.zak@tkbc.ru

Fixed Income Market Rates: Increase with no decrease Actual 01.01.11

Forecast 01.07.11

FED rate

0–0.25%

0.25%

ECB rate

1.0%

1.0%

BoE Rate

0.5%

0.5%

15 bps.

10-20 б.п.

3.00%

3.5%

190 bps.

150 bps.

RUS-30 Yield

4.90%

5.00%

CBRF Rate

7.75%

8.00%

Overnight Rate

3–5%

3.5–5%

5.5-8.0%

6.0-8.0%

Second Tier Yield

7.0–10.0%

7.0–10.0%

Other Tiers Yield (1Y)

9.0–12.5%

9.0–12.0%

Indicator

TED-spread (3m UST vs. 3m Libor) UST-7 Yield Spread UST-7 vs. RUS-30

First Tier Yield

Sources: Reuters, TKB Capital estimates

The main risks of 2011 are the worldwide growth of key interests, confrontation of euro and dollar, where the preference in 1H2011 is given for the latter. In this context, there are only several investment vectors into financial markets: short-term fixed income securities to avoid market risk, dollar Eurobonds – the forex risk. On domestic market we recommend primary market offerings. Get the reliable credit analysis and choose investments with higher yield! Third tier is on the way. Euro is not an investment currency in 2011. The best target is dollar and commodities. We expect for several cards from the EU “deck of defaults” to be played in 2011. No doubt that EU collapse and euro immobilization is a kind of fantasy, though the parity is at fingertips.

LIQUIDITY: There is money, there was money… … but with no effect. The bonds of high-quality issuers are completely sold out, the market consists of instruments affiliated with the state. Effective rates are in red, while the funds remained are placed on deposits in Fed and CBs again. Now, when we realize that free provision of financial resources within the context of economic crisis is not a lifelong strategy and can be withdrawn soon, they have to promptly earn. We are in anticipation of investments in risky and anti-inflationary assets. FOREIGN MARKET: Leaving the safe haven We suppose that the stories with spread compression of EM bond against Treasuries are not of topic yet and may be resulted by increased return of underlying asset rather than EM risks revaluation. Growth and weighty primary offering of CDS coupled with inflation expectations in the US will offset Fed manipulations with the curve and permanently falling out “skeletons” from the European “closets”. Such expectations will determine the yield of Tbonds for 1H2011 on the level equal to the current one. CURRENCY MARKET: Euro is at risk UE currency is still at risk as in 2H2010. Poorly thought-out program on assistance to peripheral countries is making gap on the way to dollar parity – no clarity on its further implementation and whether the program will be applied at all. On this background, we bet on riskless US dollar used for carry trade, which is likely to take the lead in terms of investments in 2011 as well. As for ruble, commodities exported by Russia should play supportive for the currency strength, especially on the watch for key rates growth. DOMESTIC MARKET: Gangway for the third tier! Secondary market is not of interest any more as no wish to sell or buy. Only occasional corporate stories are capable to yield. We recommend to pay close attention to the primary market – the most important thing is an accurate credit analysis of issuers. The funds are still available and they will have to be invested – the third tier is likely to find use for the one third of liquidity available. WHAT TO BUY? Bet on ideas! We expect that 2011 will be characterized by a great number of corporate events to provide various investment opportunities. Keep an eye on our special reviews. Short-dated (1,5 year) and floating rate bonds will be of high demand on the back of swap cost growth and expectation for key rates increase.

STRATEGY 2011

11


Fixed Income Market Rates: Increase with no decrease

WHAT TO BUY? As in 2H201, we do not recommend to invest though it was a rather conservative approach. However, it is ideas to be invested in. What kind?

Traditional and conservative Short-dated and high-quality Where is the good of dealing with interest-bearing bonds pending the growth of rates? Minimal credit risk, no market one: short-dated bonds are worth to be considered for repo. We prefer VTB Leasing 3/4, Moscow 45/54, bonds of RSHB, UniCredit bank, etc. However, we are not so pessimistic and suppose that 2011 (at least 1H11) will not demonstrate any drastic changes in long-term ruble interest rates. But we should keep in mind that the state, including quasi-public companies, will have to borrow on domestic market a lot (RUR1.7 bn for the Ministry of Finance and over RUR1 trn for quasi-public structures, especially for the ones with the need in heavy capex (utilities, infrastructure, etc.), giving no free hand to financial authorities in discount rate increase.

Credit and arbitrage МТS vs Vympelcom The current spread between MTS and Vimpelcom is not equal to credit quality difference. We consider long position in MTS_8 vs. short position in Vympelcom invest_6/7 as a safe choice. Besides, uncovered long position in MTS_8/7 is an interesting idea in itself – investor is protected by put option at par (enforcement of investor right only through the court) in case of Comstar merger to MTS (reorganization by way of takeover), which is most likely to occur in 1H2011. St.-Petersburg vs Moscow We suppose that spread between bond yield curves “St.-Petersburg vs. Moscow” should be minimal or even mythic. Given stronger budget framework of St.-Petersburg, historically “neat” debt policy, lack of plans on fold increase in public borrowings in the coming years as opposed to Moscow, out target for SPB-25038 is 101.8% of the par value (7.45% YTM). Federal Grid Company vs RusHydro The current spread of 55 bps between locals of FGC_10 and ruble Eurobond of RusHydro_15 will come to naught soon that is exemplified by negative spread (-40 bps) between RSHB’s locals and ruble Eurobond of similar maturity. The main dogma is ruble bond appeal for a wide range of investors with no need to take risks of Russian infrastructure.

Prospective Floaters We expect the growth of interest swaps, at least its short segment of curve due to pending increase in ruble rates. Coupon rates are tied up to the CB instruments or monetary market, and anticipation of their growth leads floating rate bonds to more interesting levels as compared to the fixed ones that will help to secure against turn in the market. Some of them will provide new arbitrage provisions in relation to its “fixed” analogues.

Corporate Wimm-Bill-Dann Wimm-Bill-Dann bonds are still undervalued after acquisition of the issuer by the global food giant PepsiCo. The issuer rating is to be revised upon acquisition (“A+” rating for PepsiCo), i.e. the yield of WBD issue should not differ from the one of large private payers such as Lukoil. In addition, we do not rule out repurchase of bonds by the issuer on the back of lower cost of capital for PepsiCo. Outrunning VTB… The portfolio of any investor should include the bonds of the Bank of Moscow, TransCreditBank and HCF Bank. Transactions on purchase of assets should be completed within 2011. As a result the holders will get the asset of higher quality with a chance to exercise put option if the issuers are reorganized.

Market Gangway for the third tier! Interesting ideas can be observed in 3-tier equities, especially on primary market. It’s time to get the reliable credit analysis. In our opinion, the new issues of UVZ, Kamaz as well as traded bonds of Citronix, Sollers, ChTPZ offer a goof yield in case of short duration.

12

STRATEGY 2011


Stock Market Betting on growth and efficiency in 2011 Maria Kalvarskaia m.kalvarskaia@tkbc.ru

Stock Market Betting on growth and efficiency in 2011 Russian stock market – leading growth in 2010 World indices dynam ic in 2010 22.12.2010

Max

22% growth in 2010 – outperforming competitors. 2010 was quite successful for the Russian stock market. RTS Index grew by 22% over the year beating most of its counterparts from developed and emerging markets. After reaching 1,676 on RTS Index in April the market went deep to 1,226 points on May 25. Uncertainty regarding further economic recovery, tightening of monetary policy in China, financial risks in Europe – all these factors led to profit taking in risky assets. At the beginning of 2H10 we revised our forecasts for the whole year from 1,900 to the range of 1,650-1,900 on the back of slower economic growth and existing risks on the market. As of December 22 RTS Index closed at 1,764 coming close to the mid of our forecasted range.

Min

RTS MICEX Nikkei 225 Hang Seng Seoul Composite Shanghai Composite

2H10 brought more optimism on the markets. 2H10 was more successful for the Russian stock market bringing it to the growth leaders over the year. Improving macroeconomic situation in Russia, better corporate operating and financial results attracted investors’ interest to the Russian market. Quantitative support from the US government boosted liquidity on the markets, while macro statistics in the US proved continuing economic recovery. China postponed interest rates growth despite higher inflation numbers that added optimism for investors. Commodity markets were posting growth backed by macro data, excessive liquidity and weather conditions that also supported demand for the shares. We consider that growth on the stock and commodity markets in 2H10 was mainly driven by monetary and speculative factors that means higher risks ahead, but upside potential still does exist.

SENSEX FTSE 100 DAX CAC 40 DJIA S&P 500 NASDAQ Bov espa BUSE MERVAL IBC MSCI EM -30%

0%

30%

60%

Source: Bloomberg, TKB Capital estimates

Sector indices dynam ic in 2010 22.12.2010

Max

Min

RTS O&G Telecoms M&M Industrials C&R Utilities Finance -30%

0%

30%

60%

Source: Bloomberg, TKB Capital estimates

90%

Commodity markets in 2H10 – bears have gone. In 2H10 inflation risks together with excessive liquidity drove commodity markets up. If in 1H10 financial risks in Europe, weak signs of economic recovery and Chinese initiative to slow down growth rates in the country hold back prices on commodity markets, then in 2H10 the trends changed. Bad weather conditions determined deficit of soft goods in summer giving a start for price growth. Dollar lost its role of benchmark for the commodity markets, and in 2H10 we saw dollar strengthening on the back of growing risks in Europe together with increasing commodity prices. In order to secure money from inflation and find a safe haven in a risky environment, investor were buying gold, which looks more stable even in case of expanding financial risks in Europe and Chinese monetary policy strengthening. Industrial metals won back their losses over 1H10 and ending the year 20-50% above the levels at the beginning of 2010. Consumer and retail – the best performer in 2010. Among Russian stocks consumer and retail segment was the best performer in 2010. RTS Consumer and Retail Index grew by 85% since the beginning of 2010. Growing domestics demand, strong financials, M&A deals and successful implementation of investment program determined high interest to the segment. Industrial companies took the second place in terms of growth over 2010 adding 55%. Auto and helicopter producers showed better performance on the back of recovery in demand on car market with the government support and substantial contract flows in helicopter industry. Metals&mining segment also showed strong performance above 40% playing out favorable pricing environment on commodity markets. The worst performer during 2010 was oil&gas sector, which ended the year in red. Investors played dividend stories in less liquid stocks, while the largest companies looked worse than the market. Prices growth in December helped to compensate negative dynamics.

STRATEGY 2011

13


Stock Market Betting on growth and efficiency in 2011

2011 – External positive news and domestic recovery to support the stocks, but bear risks in mind Strong commodity markets to support growth. External factors are likely to continue supporting the Russian stock market in 1H11. Excessive liquidity and inflation risks will boost commodities prices up and we expect to see oil at $100 per bbl, new high of nonferrous metals and gold at $1,500 (see the section on commodity markets). Improving economic situation in the World will also determine upward trend on the markets, but fundamental factors are not strong enough to justify high prices, and we see risks of correction in 2H11. In this case we recommend betting on mining companies. Higher oil prices hardly influence financial performance of the Russia oil companies, thus we again prefer gas producers in oil&gas segment. Growing domestic demand as important factor. Strengthening demand on domestic market backed by economic recovery and government support determined favorable conditions for those companies oriented on the Russian home growth. In 2011 we see domestic market as an important driver as well. Consumer and retail segment will keep its leading role betting on growing consumer demand and the governmental social program. Strong financial performance of retail companies allows delivering substantial growth rates that increases investors’ interest to the segment’s companies. State programs on infrastructure projects and higher demand for residential real estate determine better view on development, infrastructure and metal companies, as the construction segment was lagging the market in 2010 on the whole. Recovery of demand for loans with credit risks stabilization will determine faster development of the banking system. M&A deals and placements of the shares will raise interest to the companies. Government initiatives – a ground for selective buys. In 2011 the state continues developing new taxation rules for oil&gas segment, which will mainly affect those companies with higher share of downstream. Special tax regime for greenfield projects will give advantages for particular players. In utilities sector decision on tariff regulation for grid companies and full liberalization of electricity market will set the trend in power segment. At the same time the government program aimed at expansion of domestic demand will support a number of segment oriented on the Russian home market. External risks as the most important. As growth on the stock and commodity markets is not really supported by fundamental factors, higher prices pushed by excessive liquidity and inflation expectations may fall sharply in case of increasing risks. We think that risks may come from China if the country takes further steps to slow down economic growth. Taking profit by speculative players may also cause substantial decline on the market. Weaker growth rates of the Russian economy will also negatively affect financials forecasts and valuation of the companies, but we think that in case of positive external environment Russia will keep on growing. RTS Index – more upside with higher risks. We estimate upside potential of the RTS Index for 2011 at 16-19% from the current level (1,764 as of December 22). Thus, we expect to see RTS index at 2,050-2,100 level. MICEX Index is estimated to reach 1,940-2,000 that means 15-18% potential. As we mentioned above positive external factors will drive the Russian stocks up with stronger upside in 1H11, and we recommend betting on undervalued mining companies playing out positive trends on commodity markets. Domestic factors look more sustainable and will drive the stocks through the year. After reaching new post-crisis highs in 2011 we expect to see correction, which may be used to increase stakes in less vulnerable segments. Companies with stronger growth profile, cheap on multiples relative to their peers and those providing interesting dividend play are to show better performance through the year.

14

STRATEGY 2011


Stock Market Betting on growth and efficiency in 2011

TOP-10 C o mp an y

Ticker

TP 12M, $

U p sid e, %

Gazprom

GAZ P

8.5

33%

R us H y dro

HY DR

0.0735

36%

Mec hel

MTLR

37

25%

N orN ic k el

GMKN

270

22%

MTS

MBT U S

28.0

37%

Magnit

MGN T

162.3

25%

Pharm s tandard

PH ST LI

36.5

28%

Sberbank

SBER

4.6

32%

U -U AZ

U U AZ

2.9

38%

LSR Group

LSR G

50

51%

Stock picking play Oil and gas – focus on gas companies and the oil stocks with strong growth profile. Our top picks: Gazprom (GAZP) – betting on regular tariff growth, the cheapest stock with P/E 2011E at 5, Novatek (NVTK) – an attractive strong growth story, Tatneft (TATN) – improvement on bottom-line with new refinery launching. Power industry – efficient generation is expensive. Out top pick is hydro generation RusHydro (HYDR) to benefit the most from their competitive advantages in light of the electricity market liberalization and rising fuel prices. Bet on «distressed assets» in 2011 may live up, especially in the case of the more radical dynamics of electricity consumption caused by the acceleration of economic recovery or changes among strategic investors of the companies. In this connection we prefer OGK-1 (OGKA) and OGK-3 (OGKC). We like MRSK Holding (MRKH) in grid segment but note that risks are too high.

Metals and mining – steel demand and price growth, strong coking coal market in 2011, optimistic view on copper and nickel prices. Our top picks: Evraz Group (EVR LI) – key Russian long steel producer, lower debt burden, weak stock performance in 2010, Mechel (MTLR) – strong coking coal price, more coal from Elga deposit, MMK (MAGN) – key domestic steel manufacturer, high growth in value added products, Norilsk Nickel (GMKN) – robust copper and nickel prices, shareholder’s conflict as speculative driver, cheapest among global mining companies. Transport – continue outperforming economic growth in 2011, buy on weakness. Top picks: Globaltrans (GLBT) diversified business with presence in the segments with intensive demand. TransContainer (TRCN) bet on economic growth and higher containerization level – new interesting name on the market. The stocks provide strong growth profile, but do not look cheap, so we recommend buying on weakness. Telecoms, Media and IT Sector. In Telecoms – growing beyond traditional mobile services to unlock more value. MTS (MBT, MTSI) is our top pick for its large cash influx from Russian-largest mobile subscriber base and aggressive expansion into regional broadband market via Comstar. Solid fundamentals of Vimpelcom Ltd (VIP), but the stock under pressure from acquisition of assets in Africa and Asia. In 1H11 the market to put operating data of the united Rostelecom (RTKM) under close examination. Media – buying exposure on macro story. We like exposure of CTC Media (CTCM) to the fast growing market and advice making a bet on the sector through this stock. IT Sector – more names and niches to invest. IT sector in Russia is nurturing in sales and a number of trading names. We view Armada (ARMD) as the best choice on growth in the IT sector.

Consumer and retail – we expect generous government social payments in ahead of 2012 presidential elections to support consumers’ readiness to go shopping. Our top picks are Magnit (MGNT) and X5 Retail Group (FIVE) – record pace of store openings, M&As and gains on more operating efficiency, Pharmstandard (PHST) – coming triggers are flu season, budget tenders and strong financials disclosure and Veropharm (VRPH) – niche player with a solid pipeline of medicines.

Banking sector – better performance with growing demand for loans and credit quality stabilization. Our top picks: Sberbank (SBER) betting on strong operating results and growing financials with better credit quality. VTB (VTBR) – a play on corporate events with aggressive strategy and new investors. Bank St. Petersburg (STBK) to prove strong regional positions and high efficiency. Machinery – strong vehicle sales recovery and companies’ financials improvements to support the segment. Our top picks – Sollers (SVAV). Expected IPO of Russian Helicopters in 1H11 will likely be the key event in the sector. Power Machines (SILM) is our bet on huge prospects for capacity installations in domestic utility sector.

Real estate sector – residential real estate construction rates to accelerate, demand remain high. LSR Group (LSRG) and PIK Group (PIKK) are capable to show one of the best rates of recovery in the sector due to growing demand for residential real estate. High readiness of AFI Development project portfolio will provide stable growth of its investment value. Infrastructure construction sector – powerful growth of the sector next year. Mostotrest (MSTT) is successfully positioned for development of the state investments and is one of few companies capable to fulfill their orders with good quality and in a timely fashion. STRATEGY 2011

15


16

STRATEGY 2011


Oil & Gas Uncertainty with taxes remains Evgenia Dyshlyuk e.dyshlyuk@tkbc.ru

Oil & Gas Uncertainty with taxes remains YTD sector dynam ic vs. RTS 22.12.2010

Max

Min

RTS Transnef t Bashnef t

Strong performance of our top picks in 2H10. Looking back, practically all our top picks for 2H10 did very well. Bashneft’s preferred shares rose by roughly 55%. TNK-BP Holding’s ordinary and preferred shares were up by 30% and 44%, respectively. Gazprom’s stock added roughly 30% in value. As an exception, Tatneft’s preferred shares were up by moderate 7%.

TNK-BP Holding

The government approved some of the tax hikes. There is more clarity with taxes now: the state has approved increases of MET for crude oil and natural gas and excise taxes that should impose pressure on profitability of the Russian oil companies. While the first measure will have moderate impact on all producers, higher excise taxes should affect considerably the players with large refining exposure and strong focus on domestic market such as Bashneft and Gazprom neft.

Nov atek SurgutNG Gazprom Alliance Oil Lukoil Tatnef t Rosnef t Gazprom nef t -50%

0%

50%

100%

Source: Bloomberg, TKB Capital estimates

130

RTS Index

RTS Oil&Gas

115 100 85

Crude oil MET to grow at CAGR of 7% in the next five years. The government approved increases in the oil and gas MET. Now, we calculate that crude oil MET rate grow at CAGR of 7% in the next five years vs. CAGR of 3% for Urals price. Meanwhile, the increase in natural gas MET approved by the government is more gradual than we forecasted. Excise tax for oil products to rise significantly. The government also approved increases in excise taxes that came out to be much higher than expected. In the next three years, the excise taxes for gasoline and lubricants will be raised, on average, at roughly 40% p.a. and for diesel – at 100% p.a. Assuming that the Russian oil companies will not make consumers pay this tax hike (perhaps at least before the 2012 elections), this tax change will affect primarily companies with strong focus on refining and domestic sales such as Bashneft and Gazprom neft.

Dec 09 Jan 10 Feb 10 Mar 10 Apr 10 May 10 May 10 Jun 10 Jul 10 Aug 10 Sep 10 Oct 10 Oct 10 Nov 10 Dec 10

70

Source: RTS, TKB Capital estimates

Downgrading target prices for Rosneft, Lukoil and Gazprom neft. We calculate that positive impact of changes in our macroeconomic assumptions will not fully offset the negative impact of higher taxes and other factors. Based on the new macroeconomic and operating assumptions, we revised our financial models for the stocks and downgraded target prices for Rosneft, Lukoil and Gazprom neft. Structural tax changes remain on the agenda in 2011. The government has been discussing possible structural changes of the oil taxation, shifting the burden from upstream to downstream, and is yet to finalize changes of the export duties for crude oil and oil products. The state should also develop special tax regime for greenfield projects in upstream as well as decide on other tax initiatives. Top picks for 2011 – Gazprom, Novatek and Tatneft. Divergence of U.S. and European spot gas prices and widening of the NBP/Henry Hub differential suggest that pressure on the traditional oil-indexed formula in Gazprom’s long-term contracts should diminish. Domestically Gazprom will capitalize on regulated growth of gas tariffs. Gazprom remains one of the cheapest stocks, trading at 2011E P/E of 5.0. Novatek remains a strong growth story. In spite of its double-digit financial multiples, we choose Novatek as a top pick due to its growth strategy. Novatek’s recent acquisitions in Yamal-Nenets autonomous region have substantial synergies with the company’s existing assets and boost its production upside. In a longer-term, Novatek’s growth should be driven by Yamal LNG project. The company’s strong shareholders base and management team should help with gas marketing. Tatneft’s outlook will improve with the launch of the new refinery. The market forecasts Tatneft’s net income to grow by modest 11% y-o-y in 2011. In our view, this is a very conservative estimate, given that Urals price alone is forecasted to increase by 15% y-o-y next year. With the launch of the new refinery scheduled for 2011, Tatneft should deliver stronger bottom-line. Tatneft is also expected to pay attractive dividends for 2010.

STRATEGY 2011

17


Oil & Gas Uncertainty with taxes remains

Strong performance of our top picks in 2H10. Due to uncertainty with oil and gas taxation we advised investors to focus on “safe” dividend plays in 2H10 – ordinary and preferred shares of TNK-BP Holding, preferred shares of Bashneft and Tatneft. We also included Gazprom as a top pick for 2H10: it was the cheapest stock then, trading at 2010E P/E of 4.1 and 60% of BV. Looking back, practically all our top picks did very well. Bashneft’s preferred shares rose by roughly 55% since July, while the company is yet to announce 2010 dividends. TNK-BP Holding’s ordinary and preferred shares were up by 30% and 44%, respectively. As expected, the firm declared generous interim dividends, offering double-digit yields. Most importantly, effective December 1, TNK-BP Holding’s shares have been admitted to trading on MICEX and main platform of RTS – a move that boosted liquidity of the stock. Gazprom’s shares added roughly 30% in value on the back of recovering gas prices in Europe. Finally, as an exception, Tatneft’s preferred shares were up by moderate 7%. The government approved some of the tax hikes. There is more clarity with taxes now: recently the state approved increases of mineral extraction tax (MET) for crude oil and natural gas and excise taxes for oil products that should impose pressure on profitability of the Russian oil companies. While the first measure will have moderate impact on all the oil and gas producers, higher excise taxes should affect considerably the players with large refining exposure and strong focus on domestic market such as Bashneft and Gazprom neft. We calculate that the positive impact of changes in our macroeconomic assumptions (including a roughly 10% increase in forecasted Urals price in 2011-2015) will not fully offset the negative impact of higher taxes and other factors. Based on the new macroeconomic and operating assumptions, we revised our financial models for the stocks and downgraded target prices for Rosneft, Lukoil and Gazprom neft. Downgrading target prices for Rosneft, Lukoil and Gazprom neft. We downgrade the target price for Rosneft (ROSN) from $8.5/share to $8.0/share and change the recommendation from BUY to HOLD. We downgrade the target price for Lukoil (LKOH) from $74/share to $71/share and maintain recommendation BUY. We upgrade the target price of TNK-BP Holding’s ordinary shares (TNBP) from $2.80/share to $2.95/share and change the recommendation from BUY to HOLD. We upgrade the target price for TNK-BP Holding’s preferred shares (TNBPP) from $2.52/share to $2.66/share and change the recommendation from BUY to HOLD. We downgrade the target price for Gazprom neft (SIBN) from $4.5/share to $4.0/share and maintain HOLD recommendation for the stock.

Figure 2. New target prices Target price, $/share Upside, Recommendation Revenue, $ mn % Old New +/Old New 2010E 2011E 2012E 77,200

76,165

EBITDA, $ mn

Net income, $ mn

2010E 2011E 2012E 2010E 2011E 2012E

Rosneft

8.5

8.0

-5.9%

11%

Buy

Hold

62,850

19,259 20,186 17,394 10,511 11,456 9,252

Lukoil

74

71

-4.1%

24%

Buy

Buy

104,889 120,586 116,902 16,069 16,596 16,416 9,492

9,663

9,748

TNK-BP Holding – ordinary shares

2.80

2.95

5.4%

9%

Buy

Hold

40,276

46,823

46,027

6,300

6,965

5,784

TNK-BP Holding – preferred shares

2.52

2.66

5.6%

5%

Buy

Hold

-

-

-

-

-

-

-

-

-

Gazprom neft

4.5

4.0

-11.1%

-5%

Hold

Hold

32,928

38,334

37,600

6,502

7,442

7,492

3,544

4,320

4,260

10,052 11,146 9,797

Source: TKB Capital estimates

Uncertainty with taxes remains. The government has been considering structural changes of the oil taxation, shifting the burden from upstream to downstream and is yet to finalize changes of the export duties for crude oil and oil products. While, for now, the state may hold on to the base-case scenario, which envisages gradual equalization of export duties for oil products to the level of 60% of the crude oil export duty and is mild by impact, re-balancing of the tax burden will remain on the agenda in 2011. Further, the government is yet to develop special tax regime for greenfield projects in upstream, as well as decide on other tax initiatives. Thus, next year we expect performance of the Russian oil and gas stocks, particularly downstream-leveraged players (Bashneft and Gazprom neft), to be volatile on the news regarding possible tax changes.

18

STRATEGY 2011


Oil & Gas Uncertainty with taxes remains

Top picks for 2011 – Gazprom, Novatek and Tatneft. In 2011 we recommend investors to focus on shares of Gazprom, Novatek and Tatneft. Recovery of gas prices in Europe should continue to support Gazprom’s performance. The stock is still inexpensive, trading at 2011E P/E of 5.0 (consensus) and P/BV of 0.8. In spite of its double-digit financial multiples, we choose Novatek as a top pick due to its growth strategy. Novatek’s recent acquisitions of upstream assets (either at late stage of development, or are already producing) boost the company’s production potential. Further, both Gazprom and Novatek are well-positioned to capitalize on the tax breaks for Yamal, development of which the state considers a strategic priority. Tatneft’s operating and financial outlook will substantially improve with the launch of its new refining facility scheduled for 2011. According to the market consensus, Tatneft’s net income will grow by modest 11% y-o-y in 2011, while, in our view, the company should deliver stronger bottom-line. We also expect Tatneft to pay attractive dividends for 2010 (4% and 9% yields on ordinary and preferred shares, respectively). Figure 3. Relative valuation Bloomberg ticker

Target price, $/share

Russian oil majors Rosneft ROSN RX 8.0 Lukoil LKOH RX 71 TNK-BP Holding TNBP RU 2.95 SurgutNG SNGS RX Gazprom neft SIBN RX 4.0 Tatneft TATN RU Bashneft BANE RU Russian oil majors – weight. average International super majors ExxonMobil (US) XOM US RoyalDutchShell (Netherlands) RDSB LN Chevron (US) CVX US BP (UK) BP/ LN Total (France) FP FP ConocoPhillips (US) COP US International super majors – weight. average GEM oil majors Petrochina (China) 601857 CH Petrobras (Brazil) PETR3 BZ Sinopec (China) 386 HK CNOOC (China) 883 HK ONGC (India) ONGC IN GEM – weight. avr. Russian gas producers Gazprom GAZP RX Novatek NVTK RU Russian gas producers – weight. average International gas producers GDF Suez (France) GSZ FP BG Group (UK) BG/ LN Anadarko Petroleum (US) APC US Apache (US) APA US Devon Energy (US) DVN US Encana (Canada) ECA CN Chesapeake Energy (US) CHK US Murphy Oil (US) MUR US Pioneer Natural Resources (US) PXD US Ouicksilver Resources (US) KWK US International gas producers – weight. average Russian crude oil and product pipeline operators Transneft TRNFP RX U.S. crude oil and product pipeline operators Enterprise Products Partners EPD US Kinder Morgan Operating KMP US Plains Pipeline PAA US Magellan Midstream Pipelines MMP US Enbridge Energy EEP US Sunoco Pipeline SXL US U.S. oil and product pipeline operators – weight. average

Upside, %

MCap, $ mn

EV, $ mn

EV/EBITDA P/E P/ 2010E 2011E 2012E 2010E 2011E 2012E BV

11% 24% 9% -5% -

69,303 44,867 41,590 39,944 19,830 10,462 8,842

83,330 56,700 43,380 26,942 26,240 13,378 10,677

4.3 3.5 4.3 3.7 4.0 4.9 4.1 4.1

4.1 3.4 3.9 3.8 3.5 4.2 3.7 3.8

4.8 3.5 4.4 4.0 3.5 3.9 3.6 4.1

6.6 4.7 6.6 8.6 5.6 6.2 6.6 6.5

6.0 4.6 6.0 9.0 4.6 5.4 6.0 6.1

7.5 4.6 7.2 9.6 4.7 4.9 5.9 6.8

1.3 0.8 2.0 1.0 1.1 1.0 0.7 1.2

-

367,098 204,142 180,958 136,243 124,915 98,482

378,702 369,574 181,238 250,679 143,762 111,787

5.6 7.9 4.0 7.0 4.0 4.0 5.9

5.0 6.9 3.6 5.7 3.7 4.2 5.2

4.6 6.1 3.3 5.4 3.4 3.9 4.8

12.6 10.9 9.8 6.4 9.2 11.1 10.6

11.4 8.8 9.2 6.5 8.7 10.9 9.6

10.3 7.7 8.3 6.2 8.0 9.8 8.7

3.2 1.5 2.0 1.3 1.6 1.6 2.1

-

306,466 209,445 102,089 105,662 62,158

334,572 251,489 119,581 86,959 60,589

9.6 8.7 5.8 11.4 7.5 8.8

7.2 6.8 5.0 6.2 6.7 6.6

6.5 6.1 4.6 5.5 5.3 5.9

14.8 11.4 9.6 13.8 15.2 13.1

13.1 10.3 9.0 12.4 11.5 11.6

11.7 9.7 8.4 11.7 10.4 10.6

2.3 2.2 1.7 4.1 3.4 2.5

-

146,790 27,259

188,000 28,631

5.3 22.9 7.6

4.3 15.0 5.7

3.9 11.5 4.9

5.2 21.3 7.7

5.0 16.7 6.8

4.5 0.8 12.6 6.0 5.8 1.6

-

83,171 69,078 33,576 43,102 32,833 21,236 16,616 14,279 10,160 2,510

139,794 117,283 43,344 49,634 34,854 27,097 30,517 14,211 12,735 4,956

7.1 13.1 6.5 5.6 5.7 4.9 6.1 5.2 9.2 8.4 8.1

6.2 11.5 5.9 4.4 5.9 5.9 5.7 4.4 7.9 10.5 7.3

5.9 10.5 4.9 3.9 4.9 5.0 5.2 3.8 6.2 9.1 6.5

14.4 17.3 40.4 13.1 12.1 19.8 8.3 17.2 36.1 20.6 18.2

13.1 16.3 33.3 10.3 13.6 44.1 8.7 13.0 30.1 43.8 18.1

12.0 15.0 21.1 8.8 10.6 25.2 8.6 10.8 18.4 28.1 14.0

-

2,104

10,704

1.5

1.3

1.2

0.6

0.5

-

34,783 21,571 8,789 6,233 7,658 2,696

47,972 34,134 14,496 8,061 13,138 4,020

15.1 11.8 13.6 15.8 12.6 11.0 13.7

14.0 10.2 12.5 14.4 11.3 9.9 12.4

12.7 9.5 11.6 13.4 10.5 9.5 11.4

26.3 49.2 22.6 20.2 19.7 15.5 30.5

22.7 35.8 20.3 18.4 18.0 14.7 24.9

0.9 3.0 1.6 2.7 2.1 1.3 1.3 1.9 2.8 3.6 1.9

0.5 0.1 18.8 28.5 18.4 17.2 16.2 14.0 20.8

3.5 3.2 2.1 5.2 1.9 3.1 3.2

STRATEGY 2011

19

Source: company data, Bloomberg, TKB Capital estimates


Oil & Gas Uncertainty with taxes remains

Changes in macroeconomic assumptions. We revised our macroeconomic assumptions (see Figure 4). As a result, the forecast of average Urals price increased on average by 9.5% in 2011-2015. We also estimate a weak ruble now. The Russian oil and gas producers stand to benefit from these macro changes. We also decreased market equity risk premium (used in calculating WACC) from 6.0% to 5.5%. Figure 4: Changes in macroeconomic assumptions 2010E

2011E

2012E

2013E

2014E

2015E

Average Urals price, $/bbl

76.0

78.0

85.0

83.0

80.0

84.5

Average exchange rate, RUR/$

30.0

28.2

28.0

29.5

31.2

29.9

7.0%

7.5%

7.6%

7.1%

6.9%

6.6%

Average Urals price, $/bbl

78.1

90.0

87.0

89.0

91.0

92.0

Average exchange rate, RUR/$

30.4

29.9

31.3

30.8

30.3

30.0

8.5%

8.4%

7.5%

7.1%

6.9%

5.4%

Old

CPI, %

New

CPI, % Source: TKB Capital estimates

Crude oil MET to grow at CAGR of 7% in the next five years. Recently, the Russian government approved increases in the oil and gas mineral extraction tax (MET). The multiplier in the crude oil MET formula was raised by 6.4% to 446 in 2012 and by 5.4% to 470 in 2013. Taken into account higher forecast of Urals price, we calculate that crude oil MET rate will grow at CAGR of 7.0% in the next five years vs. CAGR of 3.3% for Urals price. Natural gas MET has been raised by 61% to RUR 237/mcm in 2011, by 5.9% to RUR 251/mcm in 2012, by 5.5% to RUR 265/mcm in 2013 and then is projected to grow in line with inflation. Meanwhile, we forecasted a much steeper increase of the gas MET. All factors considered, we calculate that MET payments of Rosneft, Lukoil, TNK-BP Holding and Gazprom neft will grow at 5%-11% p.a. in the next five years (see Figure 5). Figure 5: Impact of higher crude oil and natural gas mineral extraction tax (MET) 2008

2009 2010E 2011E 2012E 2013E 2014E 2015E

CAGR 2010-2015E

Crude oil mineral extraction tax, $/bbl Old forecast

18.5

9.4

13.5

14.1

15.2

14.9

14.2

15.2

2.4%

New forecast

18.5

9.4

13.5

16.5

16.8

18.2

18.7

18.9

7.0%

Natural gas mineral extraction tax, $/mcm Old forecast

5.9

4.6

4.8

9.4

13.6

16.9

19.8

24.6

38.5%

New forecast

5.9

4.6

4.8

7.9

8.0

8.6

10.9

13.3

22.4%

Crude oil production* in Russia, mn t Rosneft

96.5

99.3

106.2

109.1

109.7

110.4

110.4

111.4

1.0%

Lukoil

89.6

91.6

89.9

90.5

89.1

87.2

86.1

86.4

-0.8%

TNK-BP Holding

69.4

71.0

73.7

74.5

74.3

74.2

75.8

78.5

1.3%

Gazprom neft

30.8

29.9

30.1

29.8

29.3

28.5

27.7

27.0

-2.2%

11.5

11.9

11.5

11.4

11.2

11.2

11.2

11.2

-0.5%

8.7

6.3

8.6

8.3

8.4

8.5

8.5

8.6

0.1%

12.8

15.6

16.3

15.9

18.2

19.2

20.2

21.2

5.4%

2.2

4.3

4.5

4.8

5.0

5.2

5.3

5.5

4.0%

Gas production* in Russia, bcm Rosneft Lukoil TNK-BP Holding Gazprom neft

MET payments, $ bn Rosneft

12.8

6.5

9.1

12.1

13.5

14.7

14.7

15.3

11.0%

Lukoil

12.3

5.3

8.1

10.8

10.7

11.3

11.4

11.7

7.7%

TNK-BP Holding

9.6

4.8

6.9

8.6

8.7

9.2

9.4

10.5

8.8%

Gazprom neft

4.2

2.2

3.0

3.6

3.6

3.8

3.9

3.8

4.8%

* By consolidated subsidiaries Source: company data, Konsultant Plus, TKB Capital estimates

20

STRATEGY 2011


Oil & Gas Uncertainty with taxes remains

Excise tax for oil products to rise significantly. The Russian government also approved increases in excise taxes for oil products that came out to be much higher than we expected. We forecasted the excise taxes to grow in line with inflation (2010E-2015E CAGR of 7.5%). Meanwhile, according to the new tax rates, in the next three years excise tax for gasoline and lubricants will grow, on average, at roughly 40% p.a. and for diesel – at 100% p.a. (see Figure 6). Assuming that the Russian oil companies will not make consumers pay this tax hike (perhaps at least before the 2012 presidential elections), this tax change should affect primarily oil companies with large refining operations and strong focus on domestic market, such as Bashneft and Gazprom neft. Large exposure to downstream makes them quite sensitive to any deterioration of refining profitability. We calculate that domestic excise tax payments of Rosneft, Lukoil, TNK-BP Holding and Gazprom neft will grow on average at CAGR of 35% in the next five years. Figure 6: Impact of higher excise taxes for oil products 2008

2009 2010E 2011E 2012E 2013E 2014E 2015E

Old excise taxes for oil products, $/t Automotive gasoline Euro-4-5 146 114 Euro-3 126 99 Below Euro-3 107 84 Diesel 72 57 Straight-run gasoline 107 84 Lubricants 119 93 New excise taxes for oil products, $/t Automotive gasoline Euro-4-5 146 114 Euro-3 126 99 Below Euro-3 107 84 Diesel Euro-4-5 72 57 Euro-3 72 57 Below Euro-3 72 57 Straight-run gasoline 107 84 Lubricants 119 93 Domestic sales of oil products, mn t Rosneft 19.8 17.6 Lukoil 19.3 16.0 TNK-BP Holding 12.3 10.9 Gazprom neft 15.7 17.6 Russian excise tax payments, $ bn Rosneft 1.1 0.9 Lukoil 1.0 0.8 TNK-BP Holding 0.9 0.6 Gazprom neft 0.9 0.8

CAGR 2010-2015E

131 114 96 39 87 97

152 132 112 45 101 113

165 143 121 49 110 122

167 145 123 50 111 124

170 147 124 50 113 125

189 163 138 56 126 139

7.5% 7.5% 7.5% 7.5% 7.5% 7.5%

131 114 96

172 186 201

218 232 247

278 293 309

302 319 336

321 339 357

19.6% 24.4% 30.0%

39 39 39 87 97

92 79 83 204 157

131 152 122 250 194

179 309 169 312 244

194 335 183 339 265

207 357 195 361 282

39.5% 55.6% 38.0% 32.8% 23.8%

20.6 18.2 12.5 20.9

21.2 18.5 12.6 21.1

21.4 18.7 12.7 21.3

21.5 19.0 12.8 21.6

21.5 19.2 12.9 21.8

21.7 19.4 13.0 22.0

1.1% 1.3% 0.9% 1.0%

1.1 0.9 0.7 0.8

2.0 1.6 1.2 1.4

3.0 2.2 1.7 2.0

4.8 3.3 2.5 3.2

5.3 3.7 2.7 3.5

5.6 4.0 2.9 3.7

38.3% 33.6% 32.5% 35.4%

Source: company data, Konsultant Plus, TKB Capital estimates

Downgrading recommendations for Rosneft, TNK-BP Holding and Gazprom neft. Based on the new macroeconomic and operating assumptions, we revised our financial models for the stocks (see Figure 2). As a result, we downgrade the 12-month DCF-based target price for Rosneft from $8.5/share to $8.0/share. The new target price implies 11% upside and we change the recommendation for Rosneft’s stock from BUY to HOLD. We downgrade the target price for Lukoil from $74/share to $71/share. The new target price implies 24% upside and we maintain recommendation BUY for Lukoil’s stock. We upgrade the target price of TNK-BP Holding’s ordinary shares from $2.80/share to $2.95/share that implies 9% upside and change the recommendation for the stock from BUY to HOLD. We upgrade the target price for TNK-BP Holding’s preferred shares from $2.52/share to $2.66/share that implies 5% upside and change the recommendation for the stock from BUY to HOLD. We downgrade the target price for Gazprom neft from $4.5/share to $4.0/share. The new target price implies 5% downside and we maintain HOLD recommendation for Gazprom neft’s stock.

STRATEGY 2011

21


Oil & Gas Uncertainty with taxes remains

Structural tax changes are still possible. The government has been considering major changes of the oil taxation, shifting the tax burden from upstream segment to downstream (see our research report “Oil & Gas – Shifting The Tax burden To Downstream” of November 15). In particular, the state has been discussing several scenarios of changing export duties for oil products. Under the base-case scenario, the government will gradually equalize export duties for light/middle (gasoline and diesel) and heavy distillates (fuel oil), setting them at around 60% of the crude oil export duty (see Figure 7). Another scenario envisages raising export duty for heavy distillates to the level of export duty for light/middle distillates (i.e. from roughly 40% to 70% of the crude oil export duty). Finally, there is also a very radical scenario: the government will significantly raise export duties for oil products, setting them at 85%-90% of the crude oil export duty, and provide subsidies to individual oil companies. Finally, to compensate for the tax hikes in downstream, the government also considered reducing crude oil export duty. Figure 7. Possible changes in export duties for oil products 2008 Urals price, $/bbl Crude oil export duty, $/t

2009

2010E

2011E 2012E 2013E 2014E 2015E

95

61

78

90

87

89

91

92

355

179

276

339

325

334

344

349

Export duties for oil products by scenario, $/t: Base-case (proposed by the Ministry of Economic Development) Light/middle distillates as % of crude oil export duty Heavy distillates as % of crude oil export duty

252

133

198

227

208

201

206

209

71%

74%

72%

67%

64%

60%

60%

60%

136

72

107

159

172

201

206

209

38%

40%

39%

47%

53%

60%

60%

60%

Option 1. Increasing export duty for heavy distillates Light/middle distillates as % of crude oil export duty Heavy distillates as % of crude oil export duty

252

133

198

244

233

240

247

251

71%

74%

72%

72%

72%

72%

72%

72%

136

72

107

244

233

240

247

251

38%

40%

39%

72%

72%

72%

72%

72%

Option 2. Increasing export duties for oil products to 85%-90%% of the crude oil export duty Light/middle distillates as % of crude oil export duty Heavy distillates as % of crude oil export duty

252

133

198

305

292

301

309

314

71%

74%

72%

90%

90%

90%

90%

90%

136

72

107

305

292

301

309

314

38%

40%

39%

90%

90%

90%

90%

90%

Source: Vedomosti, Bloomberg, InfoTEK, TKB Capital estimates

The base-case scenario is mild by impact. The base-case scenarios of changing export duties for oil products (proposed by the Ministry of Economic Development) is mild by impact (triggering up to 5% decrease of forecasted EBITDA of the oil companies) because higher export duty for heavy distillates will be somewhat offset by lower export duty for light/middle distillates. In this case, the tax changes will affect primarily oil companies operating refineries of simple complexity that export large volumes of heavy distillates (mainly fuel oil), i.e. all Russian oil majors except for Gazprom neft and Bashneft (both have superior product quality and focus on domestic market). Re-balancing of the tax burden will remain on the agenda in 2011. While for now the state may hold on to the base-case scenario, re-balancing of the tax burden between upstream and downstream will remain on the agenda in 2011. If the most radical scenario (which envisages increasing export duties for oil products almost to the level of crude oil export duty) is implemented, it will considerably affect the Russian oil majors (all of which are vertically integrated). However, since most of the local producers are crude-long, the negative impact should be mitigated by reduction of the crude oil export duty. Thus, under the most radical scenario, changes of the export duties for crude oil and oil products will severely affect profitability of players with large downstream exposure such as Bashneft (2010E refining cover of 150%) and Gazprom neft (80%). Other tax initiatives to be finalized. Further, next year the government should finalize other tax initiatives such as, for instance, special tax regime for upstream greenfield projects. Thus, in 2011 we expect performance of the Russian oil and gas stocks to be volatile on the news regarding possible tax changes.

22

STRATEGY 2011


Oil & Gas Uncertainty with taxes remains

Gazprom to capitalize on rising European and domestic gas prices Top picks for 2011 – Gazprom, Novatek and Tatneft. For 2011, we recommend investors to focus on shares of Gazprom, Novatek and Tatneft. Weak gas prices in Europe, increased competition from LNG, and re-negotiations of the long-term contract terms adversely affected Gazprom’s performance this year. However, global energy studies indicate a number of trends suggesting that pressure on Gazprom should diminish:

ƒ Divergence of U.S. and European spot gas prices. National Balancing Point (NBP, UK spot gas price) tracked Henry Hub (U.S. spot gas price) closely in 2009 and early 2010 (see Figure 8) but this trend has changed since 2H10. NBP price has gone up due to stronger demand, lower supply availability and contract renegotiations. Meanwhile, this dynamics did not affect North American spot gas prices, pressured by the developing surplus of unconventional gas production. Figure 8. Spot gas prices in the U.S. and Europe, $/MMBtu

14.0

Henry Hub

12.0

NBP

10.0

Gazprom's 2010E European export price

8.0 6.0 4.0 2.0 Nov-10

Sep-10

Jul-10

May-10

Mar-10

Jan-10

Nov-09

Sep-09

Jul-09

May-09

Mar-09

Jan-09

Nov-08

Sep-08

Jul-08

Mar-08

May-08

Jan-08

0.0

Source: Bloomberg, company data, TKB Capital estimates

ƒ Widening NBP/Henry Hub differential. According to CERA, there are signs of fundamental improvement in European demand for gas suggesting that NBP/Henry Hub differential will widen further going forward. CERA forecasted gas demand in Europe to rebound to 558 bcm in 2010, slightly below the 2008 level (561 bcm), and to 553 bcm (assuming normal weather) in 2011. For 2011, CERA projected average NBP price at $6.4/MMBtu and forecasted the NBP/Henry Hub differential to widen to over $2/MMBtu (see Figure 9). In December NBP price already went above $8/MMBtu, surpassing CERA estimate and Gazprom’s long-term contract price forecasted for 2010. Figure 9. Forecast of spot gas prices, $/MMBtu CERA forecast 2007

2008

2009

2010E

2010E

2011E

Henry Hub

7.0

8.9

3.9

4.4

4.6

4.2

NBP

6.0

9.4

4.6

6.1

5.8

6.4

(1.0)

0.5

0.7

1.7

1.2

2.2

7.5

11.4

8.0

7.8

7.8

7.5

NBP/Henry Hub differential Gazprom’s European export price

Source: Bloomberg, CERA, company data, TKB Capital estimates

ƒ Disconnect between European and North American gas prices to continue. As the global gas market tightens, CERA expects continued disconnect between European and North American gas prices. Although there is some potential for North American liquefaction, CERA does not believe the NBP/Henry Hub differential will be large enough to incentivize LNG to Europe. CERA projects that the bulk of LNG to be absorbed by three LNG importing giants – Japan, Korea, and Taiwan – on the back of economic recovery in Asia. CERA has completed a number of studies of the North American shale gas potential and expects shale gas to remove the need for gas imports into North America almost completely. This factor has also caused CERA to reduce its long-term outlook for Henry Hub price.

STRATEGY 2011

23


Oil & Gas Uncertainty with taxes remains

ƒ Shale gas in Europe as major downside risk in long-term. According to CERA, the prospect for shale gas in Europe is a major downside risk. It is not expected to have the transformative effect on the European gas industry as it had in North America. Although the initial geological assessments suggest there are reserves in place, there are difficult technological and sociological challenges to overcome. However, if shale did take off in Europe, as it has in North America, this would be bearish for European gas prices. Gazprom’s stock is still inexpensive, trading at 2011E P/E of 5.0. The trends described above suggest that pressure on the traditional oil-indexed formula in the long-term gas contracts should diminish, giving Gazprom more leverage in negotiations with the European customers. Domestically Gazprom will capitalize on regulated growth of gas prices (average gas tariff for industrial consumers is set to increase by 15% y-o-y in 2011). Gazprom remains one of the cheapest stocks in the oil and gas universe, trading at 2011E P/E of 5.0 (consensus) vs. an average of 6.1 for Russian oil companies and an average of 18.1 for international gas peers.

Novatek remains a strong growth story Novatek’s recent acquisitions support the growth story. In spite of its double-digit financial multiples, we choose Novatek as a top pick due to its growth strategy. Novatek’s recent acquisitions in Yamal-Nenets autonomous region have substantial synergies with the company’s existing assets and boost its production upside (see Figure 10). Novatek acquired a 51% stake in Sibneftegas (49% held by Itera) that has 2P gas reserves of roughly 300 bcm and is forecasted to produce 10 bcm in 2010. Sibneftegas will not require significant investments: its fields are already connected to the UGSS pipeline system and there is infrastructure in place. Starting from 2011 Novatek will market its 50% share of Sibneftegas’ production. The other big transaction was acquisition of 51% stake in SeverEnergia by Yamal Development – a 50%-50% JV of Novatek and Gazprom neft –  (49% held by ENI and Enel). SeverEnergia operates former YUKOS assets with combined ABC1+C2 reserves of 1.3 tcm. First production from these fields is expected in June 2011.   Figure 10. Impact of acquisitions on Novatek's production and reserves

before

ABC1+C2 gas reserves, bcm ABC1+C2 oil reserves, mn t

after

Increase, %

Novatek

SeverEnergia (aggregate)

Sibneftegas (aggregate)

Novatek

1,462

1,352

396

2,005

37%

Novatek's transaction multiples, EV/boe, $ SeverEnergia

Sibneftegas

0.4

0.9

124

722

8

312

152%

0.7

39.3

10,589

14,211

2,671

15,548

47%

0.2

0.9

1P gas reserves, bcm

-

-

290

-

-

-

1.3

1P oil reserves, mn t

-

-

2

-

-

-

165.8

1P oil & gas reserves, mn boe

-

-

1,928

-

-

-

1.3

2P gas reserves, bcm

-

-

344

-

-

-

1.1

2P oil reserves, mn t

-

-

4

-

-

-

87.2

ABC1+C2 oil & gas reserves, mn boe

2P oil & gas reserves, mn boe

-

-

2,297

-

-

-

1.1

Short-term gas production, bcm p.a.

42

3

10

48

13%

206

37

Long-term gas production, bcm p.a.

55

23

10

66

20%

24

37

Source: company data, media sources, TKB Capital estimates

Yamal LNG project as a long-term driver. In a longer-term, Novatek’s growth should be driven by Yamal LNG project, which envisages development of South-Tambeyskoye field holding C1+C2 gas reserves of 1.26 tcm and construction of an LNG plant. Novatek is close to finalizing the feasibility study and recently re-started the search of international partners for the project. The final investment decision is to be made in 2012. The project’s economics should be helped by tax breaks: Yamal LNG should be exempt from natural gas MET (first 250 bcm of LNG or 12 years of production, whichever comes soonest), gas condensate MET (first 12 mn tn of condensate or 12 years of production), and export duty for LNG and gas condensate. The state considers development of Yamal a strategic priority and may grant more licences to Novatek willing to build a strong foothold in this region.

24

STRATEGY 2011


Oil & Gas Uncertainty with taxes remains

Novatek’s strong shareholders’ base and management team should help with gas marketing. In our view, the market is not catching up with the fast pace of Novatek’s evolution and is yet to account for the drivers described above. In our view, the main risk behind the stock remains Novatek’s ability to contract its gas. Rising domestic gas tariffs may spur competition at the domestic gas market going forward. However, we believe that Novatek’s shareholders, which are well-connected in political and business circles, as well as strong management team, should help lure in more contracts.

Tatneft overlooked by the market Tatneft is to launch its new refinery in 2011. Tatneft’s operating and financial outlook will substantially improve with the launch of its new refinery scheduled for 2011. Tatneft is currently trading at 2011E P/E of 5.4 and 2012E P/E of 4.9 (consensus) vs. an average of 6.1 for its peers. According to the market consensus, Tatneft’s net income will grow by modest 11% y-o-y to $1.925 bn in 2011. In our view, this is a conservative estimate, given that average Urals price alone is forecasted to increase by 15% y-o-y to $90//bbl. With the launch of the refinery, Tatneft should deliver stronger bottom-line. Another factor to consider is that Tatneft will retain relatively moderate refining cover (26%). This makes Tatneft less risky, should the radical scenario of increasing downstream taxes materialize. Forecasting 9% dividend yield on Tatneft’s preferred shares. We also expect Tatneft to pay out attractive dividends for 2010, forecasting 4% and 9% yields on ordinary and preferred shares, respectively. With Tatarstan government as a major shareholder (controlling around 36%), Tatneft has been under pressure to deliver large dividends, consistently paying out 30% of the RAS net income as dividends (see Figure 11). Figure 11. Tatneft's dividend history 2004

2005

2006

2007

2008

2009

2010E

Dividend, RUB/share: Ordinary shares

0.9

1.0

4.6

5.7

4.4

6.6

6.2

Preferred shares

1.0

1.0

4.6

5.7

4.4

6.6

6.2

11%

360%

23%

-22%

48%

-5%

Dividend payment, $ mn

y-o-y growth, % 73

82

394

514

413

480

477

GAAP net income, $ mn

813

998

1,096

1,692

338

1,711

1,701

9%

8%

36%

30%

122%

28%

28%

May 11

May 14

May 13

May 11

May 11

May 10

GAAP payout ratio Record date

Current share price, $/share Ordinary shares

4.8

Preferred shares

2.3

Implied 2010 dividend yield, % Ordinary shares

4%

Preferred shares

9%

Source: SPARK, company data

STRATEGY 2011

25


Oil & Gas Uncertainty with taxes remains

Rosneft BALANCE SHEET $ mn

2009

2010E

2011E

2012E

2013E

2014E

2015E

15,169

19,259

25,173

27,687

33,356

39,114

47,076

PP&E, net

57,704

60,460

63,163

66,845

70,600

74,477

78,381

Other non-current assets

10,359

9,686

9,686

9,686

9,686

9,686

9,686

Total NON-CURRENT ASSETS

68,063

70,146

72,849

76,531

80,286

84,163

88,067

TOTAL ASSETS

135,143

TOTAL CURRENT ASSETS

83,232

89,405

98,022

104,219

113,642

123,277

Short-term borrowings

7,838

4,624

4,551

4,211

4,040

3,885

4,041

Other short-term liabilities

5,605

6,996

8,693

8,822

9,334

9,783

10,070

Total CURRENT LIABILITIES

13,443

11,620

13,245

13,033

13,374

13,668

14,111

Long-term borrowings

15,669

14,855

14,855

10,883

9,315

7,973

8,824

8,583

8,011

8,011

8,011

8,011

8,011

8,011

Other non-current liabilities Total LONG-TERM LIABILITIES

24,252

22,866

22,866

18,894

17,326

15,984

706

1,023

1,383

1,674

1,978

2,288

2,598

Shareholders' equity

44,831

53,897

62,669

70,618

80,963

91,336

101,598

TOTAL EQUITY & LIABILITIES

83,232

89,405

100,162

104,219

113,642

123,277

135,143

2009

2010E

2011E

2012E

2013E

2014E

2015E

Revenue

46,826

62,850

77,200

76,165

79,138

81,417

81,828

Cost of production

33,261

43,591

57,015

58,772

61,169

63,200

63,686

EBITDA

13,565

19,259

20,186

17,394

17,969

18,217

18,142

Depreciation

4,437

5,508

5,540

5,578

5,726

5,795

5,734

EBIT

9,128

13,750

14,646

11,815

12,243

12,423

12,408 216

Minority interest

16,835

INCOME STATEMENT $ mn

Net interest income/(expenses)

(89)

(107)

5

7

126

175

(520)

36

119

107

112

118

121

EBT

8,519

13,679

14,770

11,928

12,481

12,715

12,745

(2,000)

(2,851)

(2,954)

(2,386)

(2,496)

(2,543)

(2,549)

(5)

(317)

(360)

(291)

(304)

(310)

(311)

6,514

10,511

11,456

9,252

9,681

9,862

9,885

Minority Net income

INCOME STATEMENT $ mn

2009

2010E

Net CF f rom operating activ ities

10,319

16,145

16,695

15,392

15,719

16,037

16,111

Net CF f rom/(used in) inv estment activ ities

(8,788) (10,604)

(9,842)

(7,429)

(7,649)

(7,840)

(7,806)

Net CF f rom/(used in) f inancing activ ities

2011E

2012E

2013E

2014E

2015E

(877)

(4,537)

(3,163)

(5,201)

(2,794)

(2,700)

(327)

%

2009

2010E

2011E

2012E

2013E

2014E

2015E

Rev enue growth

-32%

34%

23%

-1%

4%

3%

1%

EBITDA margin

29%

31%

26%

23%

23%

22%

22%

Net margin

14%

17%

15%

12%

12%

12%

12%

Net Debt/EBITDA

1.4

0.6

0.4

-

-

-

-

RATIOS

Source: company data, TKB Captial estimates

Note: Consensus

Ticker Recommendation Price, $ Target price, $ Upside/downside, % SHARE DATA Bloomberg Reuters

Common ROSN Hold 7.2 8.0 11%

GDR ROSN LI Hold 7.2 8.0 11%

ROSN RX ROSN.MM

ROSN LI ROSNq.L

# of shares outstanding,mn

9,598

EV, $ mn MC, $ mn MIN 12 mnth., $ MAX 12 mnth., $

83,351 69,303 5.9 9.3 Common

Shares per GDR

1

SUMMARY FINANCIALS, $ mn

Net other income/(expenses) Income tax

Rosneft

US GAAP Rev enue EBITDA Net income EPS, $ Rev . growth, % EPS growth, % EBITDA margin,% Net margin, %

2010E 62,850 19,259 10,511 1.10 34 61 31 17

2011E 77,200 20,186 11,456 1.19 23 9 26 15

2012E 76,165 17,394 9,252 0.96 -1 -19 23 12

SUMMARY VALUATIONS 2010E P/E 6.6 EV/EBITDA 4.3

2011E 6.0 4.1

2012E 7.5 4.8

SHAREHOLDER STRUCTURE Rosnef tegaz BP Petronas CNPC Treasury shares Other

75.2% 1.2% 1.1% 0.1% 9.4% 13.1%

PRICE DYNAMICS 10.9

ROSN

RTS

9.1 7.3 5.5 22.12.09

22.3.10

22.6.10

22.9.10 22.12.10

Source: MICEX, RTS. TKB Capital estimates

26

STRATEGY 2011


Oil & Gas Uncertainty with taxes remains

Lukoil BALANCE SHEET $ mn

2009

2010E

2011E

2012E

2013E

2014E

2015E

TOTAL CURRENT ASSETS

17,839

19,453

27,586

30,527

35,677

41,436

47,052

PP&E, net

52,228

54,250

56,960

59,648

62,422

64,682

67,099

8,952

8,823

8,823

8,823

8,823

8,823

8,823

Total NON-CURRENT ASSETS

61,180

63,073

65,783

68,471

71,245

73,505

75,922

TOTAL ASSETS

79,019

82,526

93,369

98,998

106,922

114,941

122,974

Short-term borrowings

2,058

1,918

2,472

1,661

1,640

1,630

1,628

Other short-term liabilities

7,636

10,312

11,654

11,458

11,671

11,820

11,946

Total CURRENT LIABILITIES

9,694

12,230

14,126

13,120

13,311

13,450

13,574

Long-term borrowings

9,265

8,006

8,588

6,806

6,700

6,651

6,642

Other non-current liabilities

3,681

8,678

8,678

8,678

8,678

8,678

8,678

12,946

16,683

17,265

15,484

15,378

15,328

15,320

388

451

532

614

693

777

864

Shareholders' equity

55,991

53,162

61,446

69,780

77,540

85,386

93,216

TOTAL EQUITY & LIABILITIES

79,019

82,526

93,369

98,998

106,922

114,941

122,974

Other non-current assets

Total LONG-TERM LIABILITIES Minority interest

INCOME STATEMENT $ mn

2009

2010E

2011E

2012E

2013E

2014E

2015E

Revenue

81,083

104,888

120,604

116,921

119,708

121,876

123,719

Cost of production

66,987

88,819

103,998

100,495

104,023

105,719

107,272

EBITDA

16,446

14,096

16,070

16,606

16,426

15,685

16,156

Depreciation

4,318

4,200

4,353

4,497

4,644

4,773

4,855

EBIT

9,778

11,870

12,254

11,929

11,041

11,383

11,591

Net interest income/(expenses)

(533)

(507)

(510)

(152)

222

556

934

Net other income/(expenses)

(182)

580

447

521

503

550

546

EBT Income tax Minority Net income

9,063

11,943

12,191

12,298

11,766

12,489

13,071

(1,994)

(2,330)

(2,438)

(2,460)

(2,353)

(2,498)

(2,614)

(58)

(122)

(82)

(82)

(79)

(84)

(87)

7,011

9,492

9,671

9,756

9,334

9,908

10,370

INCOME STATEMENT $ mn Net CF f rom operating activ ities Net CF f rom/(used in) inv estment activ ities Net CF f rom/(used in) f inancing activ ities

2009

2010E

2011E

2012E

2013E

2014E

2015E

8,883

14,508

15,000

15,378

15,188

15,928

16,489

(8,923)

(6,327)

(7,020)

(7,142)

(7,375)

(6,991)

(7,229)

87

(8,149)

(1,493)

(5,361)

(3,056)

(3,465)

(3,887)

Lukoil Common LKOH Buy 57.4 71.0 24%

Ticker Recommendation Price, $ Target price, $ Upside/downside, % SHARE DATA Bloomberg Reuters

LKOH RX LKOD LI LKOH.MM LKOHy q.L

# of shares outstanding,mn EV, $ mn MC, $ mn MIN 12 mnth., $ MAX 12 mnth., $

847 54,238 48,617 44.5 60.8 Common 1

Shares per GDR

SUMMARY FINANCIALS, $ mn US GAAP 2010E 2011E Rev enue 104,888 120,604 EBITDA 16,070 16,606 Net income 9,492 9,671 EPS, $ 11.2 11.4 Rev . growth, % 29 15 EPS growth, % 35 2 EBITDA margin,% 15 14 Net margin, % 9 8 SUMMARY VALUATIONS 2010E P/E 5.1 EV/EBITDA 3.4

2011E 5.0 3.3

SHAREHOLDER STRUCTURE ConocoPhillips Management UniCredit Treasury shares Other PRICE DYNAMICS 85

LKOH

GDR LKOD LI Buy 57.4 71.0 24%

2012E 116,921 16,426 9,756 11.5 -3 1 14 8

2012E 5.0 3.3

3.0% 47.9% 5.0% 7.6% 41.6%

RTS

70 55

RATIOS

40

%

2009

2010E

2011E

2012E

2013E

2014E

2015E

Rev enue growth

-25%

29%

15%

-3%

2%

2%

2%

EBITDA margin

17%

15%

14%

14%

13%

13%

13%

9%

9%

8%

8%

8%

8%

8%

-

-

-

-

Net margin Net Debt/EBITDA

0.6

0.5

0.1

22.12.09

22.3.10

22.6.10

22.9.10

22.12.10

Source: MICEX, RTS. TKB Capital estimates

Source: company data, TKB Captial estimates

STRATEGY 2011

27


Oil & Gas Uncertainty with taxes remains

ТНK-ВР BALANCE SHEET $ mn

2009

2010E

2011E

2012E

2013E

2014E

2015E

9,194

10,263

11,928

11,837

12,414

13,030

13,698

16,893

18,272

21,650

24,539

27,245

29,011

30,759

1,954

1,954

1,954

1,954

1,954

1,954

1,954

Total NON-CURRENT ASSETS

18,847

20,226

23,604

26,493

29,199

30,965

32,713

TOTAL ASSETS

28,041

30,489

35,532

38,330

41,613

43,995

46,411

634

604

702

690

723

759

799

4,148

5,361

5,900

5,824

6,012

6,211

6,427

TOTAL CURRENT ASSETS PP&E, net Other non-current assets

Short-term borrowings Other short-term liabilities Total CURRENT LIABILITIES

4,782

5,965

6,602

6,515

6,735

6,970

7,226

Long-term borrowings

1,591

1,556

1,013

1,226

1,516

2,016

2,516

Other non-current liabilities

1,505

1,573

1,573

1,573

1,573

1,573

1,573

Total LONG-TERM LIABILITIES

3,096

3,129

2,586

2,799

3,089

3,589

4,089

729

807

807

807

807

807

807

Shareholders' equity

19,434

20,587

25,537

28,210

30,982

32,628

34,289

TOTAL EQUITY & LIABILITIES

28,041

30,489

35,532

38,330

41,613

43,995

46,411

Minority interest

INCOME STATEMENT $ mn

2009

2010E

2011E

2012E

2013E

2014E

2015E

Revenue

31,172

40,276

46,827

46,032

48,194

50,616

53,245

Cost of production

23,045

30,224

35,677

36,231

38,705

40,541

43,410

EBITDA

8,127

10,051

11,150

9,800

9,489

10,074

9,835

Depreciation

1,855

1,908

2,002

2,226

2,389

2,502

2,523

EBIT

6,272

8,144

9,147

7,575

7,099

7,572

7,312

Net interest income/(expenses)

164

90

(30)

(3)

(15)

(34)

(67)

Net other income/(expenses)

121

(12)

8

6

6

6

6

EBT Income tax

6,557

8,222

9,126

7,578

7,091

7,544

7,252

(1,228)

(1,621)

(1,825)

(1,516)

(1,418)

(1,509)

(1,450)

Minority

(154)

(301)

(333)

(276)

(258)

(275)

(264)

Net income

5,175

6,300

6,968

5,786

5,414

5,761

5,537

ТНK-ВР Common TNBP Hold 2.70 2.95 9%

Ticker Recommendation Price, $ Target price, $ Upside/downside, % SHARE DATA Bloomberg Reuters

Pref erred TNBPP Hold 2.44 2.66 9%

TNBP RX TNBPP RX TNBPI.RTS 14,997 42,573 41,590 1.73 2.90 Common -

# of shares outstanding,mn EV, $ mn MC, $ mn MIN 12 mnth., $ MAX 12 mnth., $ Shares per GDR

450

SUMMARY FINANCIALS, $ mn US GAAP 2010E Rev enue 40,276 EBITDA 10,051 Net income 6,300 EPS, $ 0.42 Rev . growth, % 29 EPS growth, % 22 EBITDA margin,% 25 Net margin, % 16

2011E 46,827 11,150 6,968 0.46 16 11 24 15

2012E 46,032 9,800 5,786 0.39 -2 -17 21 13

SUMMARY VALUATIONS 2010E P/E 6.6 EV/EBITDA 4.2

2011E 6.0 3.8

2012E 7.2 4.3

SHAREHOLDER STRUCTURE Novy Investments Ltd (TNK-BP International Ltd) Other

95.0% 5.0%

PRICE DYNAMICS

INCOME STATEMENT $ mn

2.5

2009

2010E

2011E

2012E

2013E

2014E

2015E

7,631

8,817

8,267

8,424

7,699

8,151

7,905

Net CF f rom/(used in) inv estment activ ities

(3,180)

(3,635)

(5,780)

(5,415)

(5,395)

(4,568)

(4,571)

Net CF f rom/(used in) f inancing activ ities

(5,058)

(4,966)

(2,388)

(2,882)

(2,271)

(3,547)

(3,295)

Net CF f rom operating activ ities

tnbp

RTS

2.2 1.9 1.6 22.12.09

22.3.10

22.6.10

22.9.10

22.12.10

RATIOS %

2009

2010E

2011E

2012E

2013E

2014E

2015E

Rev enue growth

-31%

29%

16%

-2%

5%

5%

5%

EBITDA margin

26%

25%

24%

21%

20%

20%

18%

Net margin

17%

16%

15%

13%

11%

11%

10%

Net Debt/EBITDA

0.2

0.2

0.1

0.1

0.2

0.2

0.2

Source: company data, TKB Captial estimates

Source: RTS, TKB Capital estimates

2.2

tnbpp

RTS

1.9 1.6 1.3 22.12.09

22.3.10

22.6.10

22.9.10

Source: RTS, TKB Capital estimates

28

STRATEGY 2011

22.12.10


Oil & Gas Uncertainty with taxes remains

Gazprom Neft BALANCE SHEET $ mn

2009

2010E

2011E

2012E

2013E

2014E

2015E

6,802

9,006

10,954

11,487

11,910

13,653

13,895

14,265

15,768

17,386

18,794

20,468

22,244

24,058

8,845

8,018

8,018

8,018

8,018

8,018

8,018

Total NON-CURRENT ASSETS

23,110

23,786

25,404

26,812

28,486

30,262

32,076

TOTAL ASSETS

29,912

32,792

36,359

38,299

40,396

43,915

45,971

Short-term borrowings

2,148

1,252

2,342

2,362

1,076

2,491

995

Other short-term liabilities

3,544

3,498

3,866

3,810

3,925

3,944

3,933

TOTAL CURRENT ASSETS PP&E, net Other non-current assets

Total CURRENT LIABILITIES

5,692

4,750

6,208

6,172

5,001

6,435

4,928

Long-term borrowings

4,162

4,287

3,622

3,067

2,802

1,327

1,346

Other non-current liabilities

1,401

1,447

1,447

1,447

1,447

1,447

1,447

Total LONG-TERM LIABILITIES

5,563

5,734

5,069

4,514

4,249

2,774

2,793

Minority interest

2,506

1,977

1,977

1,977

1,977

1,977

1,977

Shareholders' equity

16,151

20,331

23,104

25,636

29,168

32,728

36,272

TOTAL EQUITY & LIABILITIES

29,912

32,792

36,359

38,299

40,396

43,915

45,971

INCOME STATEMENT $ mn

2009

2010E

2011E

2012E

2013E

2014E

2015E

Revenue

24,166

32,928

38,334

37,600

39,214

39,496

39,333

Cost of production

19,262

26,427

30,893

30,108

31,395

31,527

31,262 8,071

EBITDA

4,904

6,502

7,442

7,492

7,820

7,969

Depreciation

1,475

1,671

1,722

1,862

1,986

2,110

2,231

EBIT

3,429

4,830

5,719

5,630

5,833

5,859

5,839

Net interest income/(expenses)

(261)

(305)

(214)

(201)

(122)

(33)

34

729

123

157

155

160

161

161

EBT

3,897

4,648

5,662

5,584

5,871

5,988

6,033

Income tax

(816)

(933)

(1,132)

(1,117)

(1,174)

(1,198)

(1,207)

(68)

(172)

(210)

(207)

(217)

(222)

(224)

3,013

3,544

4,320

4,260

4,479

4,568

4,603

Net other income/(expenses)

Minority Net income

Gazprom Neft Common SIBN Hold 4.2 4.0 -5%

GDR GAZ LI Hold 21.0 20.0 -5%

SIBN RX SIBN.RTS

GAZ LI

Ticker Recommendation Price, $ Target price, $ Upside/downside, % SHARE DATA Bloomberg Reuters

4,718 26,240 19,830 3.55 5.86 Common 5

# of shares outstanding,mn EV, $ mn MC, $ mn MIN 12 mnth., $ MAX 12 mnth., $ Shares per GDR

SUMMARY FINANCIALS, $ mn US GAAP 2010E Rev enue 32,928 EBITDA 6,502 Net income 3,544 EPS, $ 0.75 Rev . growth, % 36 EPS growth, % 18 EBITDA margin, % 20 Net margin, % 11

2011E 38,334 7,442 4,320 0.92 16 22 19 11

2012E 37,600 7,492 4,260 0.90 -2 -1 20 11

SUMMARY VALUATIONS 2010E P/E 5.6 EV/EBITDA 4.0

2011E 4.6 3.5

2012E 4.7 3.5

SHAREHOLDER STRUCTURE Gazprom Other

95.7% 4.3%

PRICE DYNAMICS

INCOME STATEMENT $ mn Net CF f rom operating activ ities Net CF f rom/(used in) inv estment activ ities Net CF f rom/(used in) f inancing activ ities

6.8

2009

2010E

2011E

2012E

2013E

2014E

2015E

3,474

5,770

5,635

6,239

6,384

6,715

6,911

(4,879)

(3,215)

(4,196)

(3,438)

(3,647)

(3,872)

(4,030)

185

(1,372)

(469)

(1,459)

(2,568)

(1,143)

(2,614)

SIBN

RTS

5.6 4.4 3.2 22.12.09

22.3.10

22.6.10

22.9.10

22.12.10

RATIOS %

2009

2010E

2011E

2012E

2013E

2014E

Rev enue growth

-29%

36%

16%

-2%

4%

1%

2015E 0%

EBITDA margin

20%

20%

19%

20%

20%

20%

21%

Net margin

12%

11%

11%

11%

11%

12%

12%

Net Debt/EBITDA

1.1

0.5

0.4

0.1

-

-

-

Source: MICEX, RTS, TKB Capital estimates

Source: company data, TKB Captial estimates

STRATEGY 2011

29


30

STRATEGY 2011


Power Industry Bet on quality Aleksey Serov

YTD sector dynam ic vs. RTS 22.12.2010

Max

Min

FEES HY DR

The electricity sector during 2010 has shown impressive growth. In fact two stories were played up: the efficiency in gencos in the run up to 100% liberalization of the wholesale electricity market and transition to RAB-regulation in grid sector. 2011 should be a pivotal year for both generation - 100% of market liberalization, and grid companies - the introduction of RAB-regulation and long-term tariff-indexation. In 2010 former shareholders of RAO UES resumed a subtotal of energy reform, because after the separation process the sector finally entered in a phase of consolidation, which will be the main story in the industry in 2011.

IRAO IRGZ LSNG MRKC MRKH MRKK MRKP MRKS MRKU

Sector reform is finishing. 2011 will be a year of full liberalization of the wholesale electricity market, launching a long-term capacity market power and transmission of grid companies to RAB-regulation and long-term tariffs-indexation, which in fact mark the end of the active part of the electricity reform. New regulation rules and market mechanisms qualitatively change the picture of the industry and will improve the financial performance of energy companies that generally increase their investment attractiveness.

MRKV MRKY MRKZ OGKA OGKB OGKC OGKD

Restoration of electricity consumption and rising energy prices. Most estimates on the annual growth of energy consumption in the country in the coming years are in the range from 2.2% to 3.5%, but even such modest by the standards of the pre-crisis figures could stably support the growth in electricity prices and, consequently, the financial performance of companies. In addition to the dynamics of electricity demand good support for prices will be provided by increase in domestic energy prices (gas and coal) on the background of the low level of commissioning capacities, so that we can expect a proportional increase in electricity prices and, accordingly, the company's revenues.

OGKE OGKF TGKA TGKB MSNG TGKD TGKE TGKF TGKG TGKI TGKJ TGKK KZBE TGKM TGKN -50%

0%

50%

100% 150%

RTS-Utilities vs RTS RTS Utilities

200 175 150 125 100 75 50 25 0

Oct 10

Nov 10

Sep 10

Jul 10

Aug 10

Jun 10

Apr 10

May 10

Mar 10

Jan 10

Feb 10

Source: RTS, MICEX, TKB Capital estimates

Electricity Tariff Structure Electricity Tariff

4%

64%

Retail Supply Companies

27%

32% Grid Companies

2011 – Year of selective purchases. Most of the positive, associated with the power industry sector transformation, has already priced in: the vanguard of cost effective and efficient companies were formed in generation, prospects and risks of grid companies have also become much clearer, so on the horizon of the year we can expect more moderate dynamics of stock price in power industry segment. Trend for consolidation became apparent in industry during 2010, which is accompanied by vertical and horizontal diversification and integration especially characteristic for state-owned companies. A series of events and transactions in 2011 could lead to formation of powerful energy conglomerates, but the creation of value for minority shareholders is an open question. Probability of SPO’s and the growth of debt burden. In the process of investment program realization will be accompanied by a significant increase in the debt burden of generating and grid companies. This trend was observed throughout 2010 and, according to our estimates, will continue in 2011. In some cases large-scale additional share placement could occur that first of all may concern companies under state control.

RTS Index

Dec 09

Power Industry Bet on quality

RTS Index

Distribution Companies (MRSK)

a.serov@tkbc.ru

Generating Companies

5% Federal Grid Company (FGC)

Source: Companies data, TKB Capital estimates

State control in the sector will be determinative on the horizon the next few years via tariff-regulation and market mechanisms («price cap» policy), as well as through state-owned companies. First of all restrictions will affect the capacity tariff for generating companies and distribution tariff for grid companies, since their contribution to the cost of electricity for the end user is the most weighty, which could lead to deterioration of the financial performance of these companies. Risks. Investment programs, primarily of the state-owned companies, could far exceed current estimates. Necessity of fund raising for investment programs realization means the absence of dividends and a greater likelihood of additional share placement in favor of the state or strategic investors, with the possible erosion of minority shares. In this regard, the risks of minority shareholders, especially large state-owned companies, can be assessed as high. In the generating sector we recommend to bet on the purchase of RusHydro (HYDR) shares, as the most cost-effective generator in industry, conducting organic development, which will benefit from full liberalization of the market and be able to fully capitalize on rising energy prices. In the segment of grid companies we bet on the purchase of common and preferred shares of MRSK Holding (MRKH), which minimize the risks of the individual regional discos and partly hedging the risks of investors in case of possible merger of assets and additional share placement of regional companies. We also like MRSK’s for all subsidiaries with already approved RAB-tariffs - MRSK of Center (MRKC), MRSK of Volga (MRKV), MRSK of Urals (MRKU) and MRSK of Center and Volga (MRKP).

STRATEGY 2011

31


Power Industry Bet on quality

Generating Companies Gencos' share dynam ics YTD ($)

Investors have been resigned to the fact that events in the power industry sector is fundamentally contrary to the nature of the RAO UES reform of in the context of fullfledged competition and market mechanisms. Basic principles have not once been violated. In fact, in the industry the process of creating a series of conglomerates could be observed, which are consolidating assets, but the effectiveness of which in future remains questionable. The era of new energy «blue chips». Russian specifics of the consolidation process consist in creation of energy conglomerates on the base of state-owned companies. If the government confirms its commitment to creating a market environment and is a gradual privatization of state holdings, the creation of an efficient market is a matter of time. In the meantime, we can expect the appearance of power «chips» created by the principle of additivity. State control in the generation sector will continue. Consolidation of state-owned companies against tariffs regulation will lead to the lack of competitiveness and marketability of industry in the near future. Favorites and outsiders are understandable. In the context of 100% liberalization of wholesale electricity market the profitability of generating companies will depend on electricity prices in the wholesale market, which depend on the dynamics of consumption and energy resource price level (gas, coal). Under such conditions, the generators with high profitability are least likely to be influenced by wholesale prices. Profitability of the generating companies is largely determined by fuel efficiency (indicators: capacity utilization ratio, fuel rate) and competent management (tactics and strategy of working in the wholesale market). According to the results of 2010, some generators have demonstrated unexpectedly poor profitability. Especially this fact was evident in OGK segment. Russian Gencos: сom parative valuation, 2011Е

TGK-14 Y enisei TGK-13 Kuzbassenergo TGK-11 Fortum TGK-9 Volga TGK-7 TGK-6 TGK-5 Quadra (TGK-4) Mosenergo -2.9% TGK-2 TGK-1 OGK-6 Enel OGK-5 OGK-4 OGK-3 OGK-2 OGK-1 RusHy dro -50%

19.9% 46.0% 49.5% 24.1% 28.8% 51.5% 73.6% 78.5% 49.9% 49.9% 30.2% 26.6% 84.2% 35.3% 91.1% 17.8% 103.5% 62.8% 45.8%

0%

50%

100% 150%

Source: RTS, MICEX, TKB Capital estimates

Russian Gencos:2010E financials Rev enue 2010E EBITDA 2010E EBITDA 2010E Margin

$ bn 10,000

60%

8,000

50%

6,000

40% 30%

OGK-4

600

20%

2,000

RusHy dro

10% 0%

300 TGK-5

200

OGK-2 TGK-6

Enel OGK-5 TGK-9

Quadra (TGK-4) TGK-11

OGK-1

100

OGK-3

OGK-6

Mosenergo Y enisei TGK-13 TGK-2 Fortum TGK-14

Kuzbassenergo

Volga TGK-7

Mosenergo

400

TGK-1

TGK-1

500

OGK-4

0 RusHydro

EV/Installed capacity, $/kW

4,000 700

Source: Companies data, TKB Capital estimates

Kuzbassenergo

0 0

20

40

60

80

100

120

EBITDA 2011/Installed capacity , $/kW

Russian Gencos:2013E financials Rev enue 2013E EBITDA 2013E EBITDA 2013E Margin

Source: RTS, MICEX, TKB Capital estimates

$ bn 10,000

32

STRATEGY 2011

60% 50% 40% 30% 20% 10% 0%

8,000 6,000 4,000 2,000 Kuzbassenergo

Mosenergo

TGK-1

OGK-4

0 RusHydro

Efficient generation is expensive. At the moment, in terms of EV/Installed capacity ratio in the wholesale segment of the thermal generation, OGK-4 and OGK-5 are the leaders traded at $657/kW and $445/kW respectively, whereas the average value of this indicator for a segment of OGK is only $ 305/kW. For example, RusHydro is traded at $575/kW, TGK-1 - $512/kW. Such optimistic current investor estimates suggest not only the expected performance of companies, but also the clarity of their perspectives: the definition of the strategy, the predictability of financial results and corporate events. This moment explains the fact that the most expensive companies are companies with foreign capital and hydrogenerators. It is likely that in the course of clarifying the strategies of other companies attributed to outsiders segment, investor interest will gradually shift from the favorites to distressed assets, because they look much cheaper. Apparently, the main focus of the investment focus in 2011 will be concentrated there and be extremely selective.

Source: Companies data, TKB Capital estimates


Power Industry Bet on quality

New capacity com m issioning forecasts until 2015 under CDA, MW 3,500 3,000 2,500 2,000 1,500 1,000

0

OGK-1 OGK-2 OGK-3 OGK-4 Enel OGK-5 OGK-6 TGK-1 TGK-2 Mosenergo TGK-4 TGK-5 TGK-6 Volga TGK-7 TGK-9 Fortum TGK-11 Kuzbassenergo (TGK-12) Yenisei TGK-13 TGK-14

500

Source: Companies data, TKB Capital estimates

Dilemma: either expensive and understandable, or cheap and uncertain. In our opinion, the bet on «distressed assets» in 2011 may check out, especially in the case of the more radical dynamics of electricity consumption caused by the acceleration of economic recovery or changes among strategic investors of the companies. There are a number of companies that look relatively cheap on EV/kW. These include the OGK-1, OGK-3, OGK-6 and most of the TGK. As a rule, in the moment these companies are characterized by low profitability, uncertainty of the development strategy or corporate events that involve significant risks of minority shareholders. Hydrogeneration: bet on RusHydro. Companies with a predominance of hydrogenating capacities in the coming years will continue to capitalize the rising energy prices, but unlikely surprise investors by drastic increase in profitability and efficiency. Retail business and development of competent strategy of working in the wholesale market and retail segment could become one of the growth-points. We particularly point out the RusHydro shares, which will continue the organic growth through consolidation of hydrogeneration assets and development of retail business. We think that these shares are the least risky investment in the Russian generation segment. Valuation risks. Placement of the Inter RAO second additional share issue, which will be paid-in by the assets with of the total cost of about $10 bn, merger of OGK-2 and OGK-6, consolidation of TGC-5, TGK-6 and TGK-9 (maybe TGK-7) and a number of other transactions may be key events next year in power industry. Valuation of assets in these transactions is proposed to be a long-term support for the sector stock price and at the same time give impetus to the growth of lagging securities, acting as a guide. However, the creation of value for minority shareholders in these companies is still questionable on the background of a significant increase in risk of reorganization. After valuation or share conversion ratios are announced, ideas will be priced in very quickly. The fundamental appeals of these companies are unlikely to worsen, but the impact of possible synergies in the value is difficult to assess. M&A-activity redraw the map of the domestic energy industry. We continue to stick to the point of view according to which a large part of the numbered OGK and TGK in the coming years will cease to exist as separate organization as a result of market integration in the larger energy entities. The Russian energy sector will be characterized by a European scenario with the formation of energy conglomerates affiliated with the fuel suppliers or large consumers of electricity. Effect of privatization will be insignificant. Several stakes in state-owned generating companies in the next 3 years could be privatized. The government has included 7.97% stake in RusHydro, 25.5% stake in TGK-5 and a number of less significant assets in the privatization plan. In our opinion, this fact does not have a significant impact on the sector quotations in connection with an insignificant size of packages. In addition, the state remains the majority shareholder in state-owned companies. Valuation for privatization purpose is also unlikely to be much different from the market price. Generation debt burden will increase. Most of the generating companies in the coming years will face the necessity of raising funds for the investment program realization and, consequently, increase in debt burden. The significant number of companies has already announced plans to place bond issues. Placement of the additional share in the current environment will be used by companies as the last tool. In fact, the companies, which actively implement their investment programs and build effective capacities in the moment, are forming their own long-term competitive advantage. Corporate risks and risks of SPO. In the generating companies the risks of the additional issue, in our opinion, significantly lower than in the grid companies, since most companies have attracted funds from the additional share placement. However, a number of companies in generating segment, primarily the state-owned (RusHydro, Inter RAO, Gazprom etc.) may continue to head for additional share placements to raise funds for investment needs or new acquisitions. Curbing of tariffs hike and constraints policy. During the 2010 the question of natural monopolies tariff growth limitation was brought up several times. At present moment, the prevailing view is to limit growth in electricity tariffs at a level of 10-15% over the next three years. This fact promise serious constraints on capacity market («price cap»-policy) for generation companies and establishment of tariffs for a number of generators that have not been selected in capacity auction. STRATEGY 2011

33


Power Industry Bet on quality

Sector thermal generation not looks so cheap on multiples. At present moment domestic companies are traded at EV/2011 EBITDA 5.6 on the average, implying a 30 percent discount to comparable DM peers. However, on P/E ratio domestic thermal generation sector looks overpriced. RusHydro is our favorite. More aggressive strategy may be buying of ÂŤdistressed assetsÂť, where the most interesting options are shares of OGK-1 and OGK-3. We are still impressed by the OGK-4: the company has the highest profitability among thermal OGK, the net cash position and largely implemented the investment program. After 2011 the company may start paying dividends. However, we believe that the company is trading already quite expensive and its quotations growth will be less. Russian Gencos: Com parative valuation Company

Ticker

Market

Net

Current

Cap,

debt*,

EV,

$ mn

$m

EV/EBITDA

P/E

Installed

Mcap/

EV/inst.

2009

2010E

2011E

2010E

2011E

capacity,

Inst.capacity,

capacity,

MW

$/kW

$/kW

6.5

5.3

9.7

8.8

25,424

572

575

$m

RusHy dro

HY DR

14,548

65

14,613

9.0

OGK-1

OGKA

1,742

52

1,794

10.0

7.3

5.4

20.1

13.7

9,861

177

182

OGK-2

OGKB

1,990

75

2,065

16.8

11.6

7.9

33.6

51.4

8,695

229

237 143

OGK-3

OGKC

2,670

-1,472

1,198

9.1

11.3

8.9

16.4

22.9

8,357

319

OGK-4

OGKD

6,354

-389

5,965

25.7

15.9

9.3

25.3

16.3

9,073

700

657

Enel OGK-5

OGKE

3,346

548

3,894

16.1

11.1

7.1

24.9

13.4

8,747

383

445

OGK-6

OGKF

1,447

13

1,460

9,052

OGKs average

8.5

11.0

6.8

neg.

neg.

14.4

11.4

7.6

24.1

23.5

160

161

328

304

TGK-1

TGKA

2,622

612

3,234

13.9

8.6

5.3

14.7

8.7

6,315

415

512

TGK-2

TGKB

412

320

732

9.5

5.5

2.6

neg.

neg.

2,577

160

284

Mosenergo

MSNG

4,129

253

4,382

8.8

6.4

4.4

29.7

14.6

11,924

346

368

Quadra (TGK-4)

TGKD

1,060

-13

1,047

5.9

5.4

4.3

17.4

25.2

3,420

310

306

TGK-5

TGKE

709

-103

606

13.5

10.4

7.9

19.3

22.7

2,453

289

247

TGK-6

TGKF

1,061

-305

756

8.4

7.6

7.7

13.6

13.5

3,123

340

242

Volga TGK-7

TGKG

2,309

3

2,312

11.5

8.7

7.1

21.6

18.4

6,880

336

336

TGK-9

TGKI

1,199

-61

1,138

6.2

5.9

4.4

12.6

11.8

3,284

365

347

Fortum

TGKJ

1,366

-599

767

5.7

6.3

3.3

12.3

11.3

3,016

453

254 226

TGK-11

TGKK

361

97

458

5.8

5.7

4.1

10.0

7.5

2,026

178

Kuzbassenergo

KZBE

909

-169

740

9.4

4.7

3.0

24.1

43.2

4,500

202

164

Y enisei TGK-13

TGKM

671

179

850

13.0

8.1

3.8

neg.

13.6

2,530

265

336

TGK-14

TGKN

186

-28

158

9.4

4.2

3.0

6.8

5.1

639

9.3

6.7

4.7

16.5

16.3

10.9

8.2

5.6

18.9

18.4

300 1,254

TGKs Average Average EM hydro generation average

291

247

304

298

7.0

6.4

6.0

12.5

10.9

Premium (discount), %

29%

2%

-11%

-22%

-19%

-54%

DM hydro generation average

15.3

13.4

10.8

32.0

19.0

2,219

-41%

-51%

-51%

-70%

-54%

-74% 1,077

Premium (discount), % EM thermal generation average Premium (discount), % DM thermal generation average Premium (discount), % Source: RTS, MICEX, TKB Capital estimates

34

STRATEGY 2011

6.0

6.3

6.7

9.2

9.5

82%

30%

-16%

105%

94%

-72%

9.4

8.9

8.3

16.6

15.8

1,118

16%

-8%

-33%

14%

17%

-73%


Power Industry Bet on quality

Grid Companies

Grids' share dynam ics YTD ($) MRSK of Urals MRSK of Volga MRSK of N.Caucasus MRSK of South MRSK of Siberia MRSK of Center&Volga MRSK of North-West MRSK of Center

32.5%

During 2010 the investment attractiveness of the sector was under pressure due to uncertainties in the RAB-regulation parameters, but despite this fact grid companies stocks showed considerable growth. It has became clear that the introduction of RAB-regulation does not guarantee the corresponding dynamics of tariffs as smoothing mechanism can be applied for the latter. In addition to a large number of branches long-term tariff-indexation will be introduced instead of RAB.

41.3% 34.6% 3.4% 20.1% 66.1% -1.7% 62.5%

Lenenergo

2.6% 58.4%

MOESK Source: RTS, MICEX, TKB Capital estimates Holding MRSK

69.1%

FGC

12.8% -20%

0% 20% 40% 60% 80%

Source: RTS, MICEX, TKB Capital estimates

$ mn

MRSK's shares day average traded value ($m n)

7 6 5 4 3

Lenenergo

Tomsk distribution company

MRSK of Urals

MRSK of Siberia

MRSK of Volga

Kubanenergo

MRSK of Center&Volga

MRSK of North Caucasus

MOESK

MRSK of South

Holding MRSK

MRSK of Center

MRSK of North-West

1

Low liquidity. Most of the distribution grid sector shares are characterized by low liquidity, which makes investments so risky. Debt burden and the additional share placement. According to our estimates, the majority of discos in the coming years will significantly increase the debt burden. This process can directly touch MRSK Holding with following translation of cash in the subsidiary. The companies with the most ambitious investment plans (Kubanenergo, MOESK, Lenenergo and etc.) could place additional share issues, which greatly increase the risk of minority shareholders in the context of stake dilution. Implementation of tariff-indexation in a number of subsidiaries also increases the likelihood of raising funds through additional share placement.

Source: Company Data, TKB Capital estimates

MRSĐš Holding Investm ent Program (2008-2015)

RUR bn 250 200 150 100 50

2015E

2014E

2013E

2012E

2011E

2010E

2009

0 2008

RAB-overregulated. 2010 showed a lack of coherence in the actions of relevant government departments and grid companies directly for the introduction of new regulations in the segment. Philosophy of RAB-regulation suggests that the regulatory asset base, rates of return, duration of regulation period and the resulting tariffs are approved by the regulator at the beginning of regulatory period and revised only at the end. However, 2010 clearly demonstrated that domestic regulators have no systematic understanding of the end point in this process: all RAB-regulation parameters have changed, RAB-tariffs have been replaced by long-term indexation for a significant number of MRSK branches. Thus, the investment attractiveness of the MRSK has become a hostage of tariff decisions that are more likely will be reviewed annually. RAB-regulation methodology involves compensation decreased income for subsequent regulation periods, however, it is difficult to estimate the effect of smoothing mechanisms in the moment. Investment program. Currently, the total program of MRSK Holding for the next 5 years is estimated at $ 35 bn. It is expected that total investment volume up to 2020 will amount to over RUR3 trillion, which in our opinion significantly increases the probability of increasing the share of the investment program not included into initial parameters of RAB-regulation.

2 0

Ambitious plans under pressure. 2011 should be a year of large-scale transition to RABregulation of grid companies. New regulations rules will boost the investment attractiveness of the segment, which will be the consequence of attendant increasing in tariffs. However, in the coming years the state will likely actively use the mechanism of tariffs smoothing, including through the introduction of long-term tariff-indexation for a number of branches, guided by social factors, which significantly increases the risks of discos. In addition, the growth of the companies' operating profitability will be accompanied by increasing in investment programs, which will not be included in the initial parameters of the RABregulation.

In the segment of grid companies, we like MRSK Holding shares, which have sufficient liquidity, are full-fledged alternative to buying a basket of regional MRSK’s securities; partly negate the risks of significant additional share placements in the latter and introduction of long-term indexing in a number of subsidiaries. More conservative investors could bet on the preference shares, since it will probably accrue dividends for 2010. In our opinion several regional MRSKs, for which RAB-tariff were approved for all subsidiaries, also have a certain appeal - IDC Center (MRKC), MRSC Volga (MRKV), IDC Urals (MRKU) and MRSK Center and Volga Region (MRKP). However, their investment attractiveness could be nullified by the efforts of regulators, ambitious capex as well as an annual reviewing of tariffs using smoothing mechanisms.

Source: Companies data, TKB Capital estimates

STRATEGY 2011

35


Power Industry Bet on quality

Holding MRSK Investment programm (2010-2015) Total 2010-2015

Degree of w ear of the com panies analogues and target level

2010

2011

2012

2013

2014

2015

MRSK Center

10,688

22,951

25,270

35,466

37,237

36,103

167,716

MRSK South

3,318

5,573

3,538

3,549

3,896

4,401

24,274

MRSK North Caucasus

1,583

7,559

7,617

7,675

6,733

6,742

37,909

MRSK Center and Volga

6,962

13,766

12,505

10,217

10,218

10,773

64,441

80%

MRSK North-West

2,307

4,892

9,032

10,513

10,859

10,521

48,124

MRSK Siberia

4,122

6,325

11,765

16,426

25,012

28,690

92,339

60% 40%

MRSK Urals

4,781

6,484

8,039

10,319

12,037

13,754

55,414

9,985

11,439

9,107

50,749

32,512

35,131

32,119

31,819

182,499

Lenenergo

12,387

25,198

25,103

22,945

22,782

17,972

126,387

Kubanenergo

8,355

9,203

8,931

4,366

3,600

3,967

38,422

Tyumenenergo

6,515

14,193

17,709

17,680

19,907

19,134

95,137

429

759

870

707

707

707

4,178

87,731 152,968 171,678 184,979 196,545 193,689

987,589

Tomsk DisCo MRSK Holding

Northeast Utilities (USA)

8,788

28,807

Eletropaulo (Brazil)

7,258

22,111

Transelectrica SA (Romania)

4,173

MOESK

20% 0% MRSK Holding (Russia)

MRSK Volga

Degree of wear of the companies analogues Target lev el 48%

Source: Companies data, TKB Capital estimates

Grid com panies: сom parative valuation (2011E)

Source: Company Data, TKB Capital estimates

0.70

On the financial multiples Russian discos look relatively cheap. The average EV/2011EBITDA ratio for discos is 2.56, the P/E2011 - 4.3, while for foreign peers these ratios are 4.57 and 11.1, respectively. MRSK Holding shares are traded at a premium (2.5%) to the sum of components of the holding companies. In our opinion, this fact is justified, given the liquidity of the Holding’s securities and lower risk compared with regional distribution companies.

FEES

MRKC

0.60 EV/RAB

EV/RAB - sector valuation. Currently, the average value of the EV/RAB ratio for MRSK, which are fully-switched to the RAB-regulation, is 0.51. We think this estimate is quite adequate, given the possibility of a significant depreciation of the holding’s assets and probability of applying the methodology of tariff smoothing.

0.50

MRKV MRKP

0.40 0.30 0.20 0.10 0.00 1.5

2.5

3.5

4.5

EV/EBITDA 2011 Source: RTS, MICEX, TKB Capital estimates

MRSK Holding SOTP valuation

50%

723

MRKZ

55%

361

MRSK Urals

MRKU

52%

362

MRSK Siberia

MRKS

53%

435

MRSK Center and Volga

MRKP

50%

375

MRSK Volga

MRKV

68%

388

MRSK South

MRKY

52%

128

MRSK North Caucasus

MRKK

58%

78

Lenenergo

LSNG

46%

350

MOESK

MSRS

51%

1 091

Kubanenergo

KUBE

49%

216

Tomsk DC

TORS

52%

37

Tyumenenergo

not listed

100%

833 5 611

Premium/(discount), %

0.55 0.54 0.53 0.52 0.51 0.50 0.49 0.48 0.47 0.46 0.45 0.44

5 753

2.5% Price per share

SOTP Valuation (ord.) ,$

0.1262

0.1294

SOTP Valuation (pref.) ,$

0.0920

0.0943

Source: Company Data, TKB Capital estimates

36

STRATEGY 2011

Tomsk distribution company

MRKC

MRSK North-West

Current EV/RAB m ultiples for MRSKs

MRSK of Urals

MRSK Center

Сurrent MRSK Holding Capitalization

MRSK of Center

Market value of stake ($m n)

MRSK of Volga

Stake ow ned

MRSK of Center&Volga

Ticker

Subsidiary nam e

Source: Companies data, TKB Capital estimates


Power Industry Bet on quality

Com parative Valuation Russian Grid Sector Company

Ticker

9

11

Market

Current

Cap,

12

13

15

EV/EBITDA

17 P/S

P/E

EBITDA margin

EV, 2010E 2011E 2012E 2010E 2011E 2012E 2010E 2011E 2012E 2010E 2011E 2012E

$m

$m

FEES

14,456

12,809

MRSK of Center

MRKC

1,792

2,118

3.47

2.43

2.71

0.83

0.63

0.59

5.80

3.81

5.37

28%

MRSK of Urals

MRKV

523

592

1.87

1.43

1.13

0.31

0.25

0.21

3.87

2.62

1.90

19%

MRSK of Center and Volga

MRKP

1,106

1,401

4.11

2.87

2.24

0.55

0.44

0.37

9.60

5.22

3.48

17%

19%

MRSK of Volga

MRKV

1,068

1,152

FGC

MRSKs' Average

International peers' average Premium (discount), %

EV/ Output,

19 EV/ RAB

$/kW 6.44

3.93

2.73

3.62

2.65

2.04

17.74

9.50

6.20

50%

60%

66%

27

0.64

31%

26%

34

0.54

20%

21%

7

0.48

21%

23

0.52

6.77

3.02

2.24

0.93

0.67

0.55

22.93

5.03

3.44

15%

24%

26%

18

0.48

4.22

2.56

2.30

0.72

0.55

0.48

10.6

4.3

4.0

21%

25%

24%

24

0.51

4.78

4.57

4.36

0.84

0.79

0.72

11.7

11.1

10.1

121

1.08

-12%

-44%

-47%

-14%

-31%

-33%

-10%

-61%

-60%

-80%

-53%

Source: Companies data, TKB Capital estimates

Following risks:

ƒ Rates of return for the old and new invested capital and in the second period of regulation, more precisely, their marketability will be the determining factor for investment attractiveness of the grid companies.

ƒ Ambiguity of terms or parameters of the heavy investment period. None of the grid company could not clarify the necessary (temporary) or adequate (quantitative) conditions for the end of heavy capex period, on which the company will stop and realize only maintenance investments. Subsequent RAB-regulation period in terms of required investment seems to be no less substantive than the transition one. Regular review of investment programs of grid companies upwards suggests this point. In case of rates of return on invested capital, investment growth poses no threat to shareholders as it will be accompanied by a significant tariffs hike. However, if we take into account that the grid companies accounts for about 35% in the structure of electricity cost for consumers, it is hardly possible, because the price of electricity can not grow indefinitely (economic growth can be forgotten). In addition, the electricity generators sale price will also increase because of rising energy prices, which makes this scenario even more unlikely. In such a situation, in our opinion, the scenario, where tariffs will be reviewed annually by the regulators and problem of raising funds to implement the grid company’s investment programs will be solved through additional share placement in favor of the state, is more feasible.

STRATEGY 2011

37


Power Industry Bet on quality

RusHydro Bet on efficiency RusHydro

Company RusHydro showed high profitability during 2010, even amid falling own production of electricity. In our view, RusHydro will receive the greatest benefits from the liberalization of electricity market among Russian generating companies and is currently one of the most attractive long-term investments in the energy sector. Low costs and quality of assets will allow RusHydro to capitalize rising energy prices. The growth of tariffs for gas and coal, coupled with the dynamics of consumption are critical parameters for the formation of electricity prices in the wholesale electricity market. Therefore, in conditions of low production costs RusHydro will capitalize on any increase in energy prices even at modest consumption growth dynamics that directly affect the financial performance and company profitability. RusHydro’s generation business EBITDA margin in 2009 totaled 44%. In coming years the profitability of generating business RusHydro on EBITDA, according to our estimates, will come close to 55% and exceed the same indicator of thermal generation companies. According to our estimates, in the next three years RusHydro EBITDA is proposed to be more than doubled. Consolidation of hydroassets and restoration of the Sayano-Shushenskaya HPP. The acquisition of a blocking stake in Krasnoyarskaya HPP in 2010 and the possible consolidation of the 40% state-owned stake in Irkutskenergo during 2011 will enable the company to build lasting relationships between the hydro assets belonging to the RusHydro and retail supply companies that could significantly increase the margin of the company. The company plans to commission a 4.8 GW of capacities by 2014, which include the generating capacity of Boguchanskaya HPP, Zagorskaya HPSPP-2 and Zaramagskie HPPs. In addition, Sayano-Shushenskaya HPP should be completely restored by 2014. The increase in installed capacity will have a direct impact on the growth of financial indicators. According to the management plans, in the coming years total production of RusHydro’s electric power stations will increase to 113 bn kWh from the current 80 bn kWh. Underestimating by financial metrics. At the moment RusHydro shares are traded at 5.7 in terms of EV/EBITDA, implying a 45 percent discount to the shares of hydro companies in developed markets. In terms of EV/Installed capacity RusHydro papers are traded at $ 575/kW that is almost twice lower than that of companies in emerging markets.

SHARE DATA Bloomberg Reuters

GDR HYDR Li BUY 5.10 7.35 44%

HY DR RX HY DR.MM Common 269,695 15,575 14,548 0.0328 0.0629 Common 100

# of shares EV, $ mn MC, $ mn MIN 12 mnth., $ MAX 12 mnth., $ Shares per GDR

SUMMARY FINANCIALS, $ mn IFRS 2010E 2011E Rev enue 13,131 5,740 EBITDA 2,233 2,742 Net income 1,495 1,652 EPS, $ 0.006 0.0061 Rev . growth, % 14.4 -56.3 EPS growth, % 10.5 EBITDA margin,% 17.0 47.8 Net margin, % 11.4 28.8

2012E 6,646 3,190 2,065 0.0077 15.8 25.0 48.0 31.1

SUMMARY VALUATIONS 2010Е P/E 9.7 EV/EBITDA 7.0

2012E 7.0 4.9

2011E 8.8 5.7

SHAREHOLDER STRUCTURE Gov ernment of Russia Free Float

60.4% 39.6%

PRICE DYNAMICS 0.070

Valuation based on DCF-model suggests a BUY recommendation. Our RusHydro financial model is based on new macroeconomic forecasts, estimates of price changes in the wholesale electricity market and the actual data on investment in the company. Our DCF-model with WACC equal to 13.1% and the terminal growth rate of 2% suggests the target level of $ 0.0735 per share that corresponds to a BUY recommendation with a 44percent growth potential of quotes.

Common HYDR BUY 0.051 0.0735 44%

Ticker Recommendation Price, $ Target price, $ Upside/downside, %

HY DR

RTS

0.055 0.040 0.025 22.12.09 22.3.10

22.6.10

22.9.10 22.12.10

Source: MICEX, RTS. TKB Capital estimates

Risks. Firstly, the uncertainty of payment for new capacity; secondly, the possible growth of the investment program; thirdly, the additional issue in favor of the state or a new strategic investor; and finally, the risks of aggressive expansion of foreign markets and uncertainty about the prospects for asset swaps and options of payment.

38

STRATEGY 2011


Power Industry Bet on quality

RusHydro BALANCE SHEET $ mn

2009

2010E

2011E

2012E

2013E

2014E

TOTAL CURRENT ASSETS

2,691

3,819

2,590

3,994

5,193

6,091

6,633

11,734

15,344

16,427

16,329

17,044

17,708

18,259

PP&E, net Other non-current assets

2015E

1,555

1,605

1,573

1,502

1,527

1,552

1,568

Total NON-CURRENT ASSETS

13,290

16,949

18,000

17,832

18,571

19,260

19,826

TOTAL ASSETS

15,981

20,768

20,590

21,826

23,764

25,351

26,460

85

341

334

319

325

330

333

Other short-term liabilities

746

2,572

1,106

1,233

1,471

1,697

1,845

Total CURRENT LIABILITIES

831

2,913

1,441

1,553

1,796

2,027

2,179

Long-term borrow ings

640

717

702

671

682

693

700

1,173

1,210

1,186

1,133

1,152

1,171

1,182

374

375

376

377

378

379

380

Share and additional capital

9,315

10,260

10,057

9,607

9,763

9,924

10,023

Retained earnings

4,351

6,008

7,537

9,181

10,696

11,866

12,708

Total EQUITY

13,336

15,928

17,260

18,469

20,135

21,461

22,398

TOTAL EQUITY & LIABILITIES

15,981

20,768

20,590

21,826

23,764

25,351

26,460

2015E

Short-term borrow ings

Other non-current liabilities Total LONG-TERM LIABILITIES Minority interest

INCOME STATEMENT $ mn

2009

2010E

2011E

2012E

2013E

2014E

Revenue

3,649

13,131

5,740

6,646

7,524

8,781

9,458

(2,401)

(11,320)

(3,531)

(4,034)

(4,224)

(4,785)

(5,172)

1,621

2,233

2,742

3,190

3,880

4,609

4,912

373

423

533

578

580

613

627

1,249

1,811

2,209

2,612

3,300

3,996

4,286

Cost of production EBITDA Depreciation EBIT Net interest income/(expenses)

()

80

(122)

(9)

108

187

233

EBT

1,248

1,891

2,087

2,603

3,408

4,183

4,519

Income tax

(244)

(378)

(417)

(521)

(682)

(837)

(904)

987

1,495

1,652

2,065

2,710

3,329

3,598

$ mn

2009

2010E

2011E

2012E

2013E

2014E

2015E

Net CF from operating activities

1,286

1,006

3,003

2,582

3,096

3,676

3,946

(1,029)

(3,647)

(1,938)

(1,248)

(1,029)

(1,000)

(1,000)

Net incom e CASH FLOW STATEMENT

Net CF from /(used in) investm ent activities

741

1,079

(135)

(117)

(1,218)

(2,111)

(2,623)

(867)

1,028

77

(1,187)

(2,020)

(2,568)

(2,881)

%

2009

2010E

2011E

2012E

2013E

2014E

2015E

Revenue grow th

-16%

260%

-56%

16%

13%

17%

8%

EBITDA margin

44%

17%

48%

48%

52%

52%

52%

Net margin

27%

11%

29%

31%

36%

38%

38%

Net CF from /(used in) financing activities Net Debt RATIOS

Source: RusHydro, TKB Capital estimates

STRATEGY 2011

39


40

STRATEGY 2011


Metals & mining Further recovery in 2011 Evgeny Ryabkov e.ryabkov@tkbc.ru

Metals & mining Further recovery in 2011 YTD sector dynamic vs. RTS 22.12.2010

Max

Min

RTS CHMF MAGN NLMK EVR MTL TRMK RASP BLNG GMKN PLZL PMTL CHZN

We have a moderately optimistic view on the prospects of metals & mining sector in 2011. We expect further recovery in steel consumption on domestic market due to the growth of demand for long products that will serve as a driver for price advance. In addition, continuing increase in coking coal prices as a result of stable external market environment and high steelmakers’ demand will play supportive for the steel price. Mechel, Evraz Group and MMK are our top picks in ferrous metals sector. We expect further growth in non-ferrous metals sector backed by strong demand from China and sound dollar liquidity. Demand for gold and subsequent price hikes will be influenced by investors’ striving to hedge the funding risks through investing in other financial instruments. Norilsk Nickel is our top pick in nonferrous metal sector.

-50%

0%

RTSI

50%

100%

150%

Metals & mining

155 145 135 125 115 105 95 85 75

Steel Focus on construction. According to our estimates, recovery of domestic consumption of rolled steel will continue in 1Q11. In particular, construction sector may demonstrate outstripping demand due to the low base in 2Q10. Domestic market is in priority. Russian domestic market is characterized by a premium to export amounted to 15-16% in recent years. Among the Russian steelmakers, major loading share falls on Magnitogorsk Iron&Steel Works (about 65%).

Dec-10

Oct-10

Nov-10

Sep-10

Aug-10

Jun-10 Jul-10

Apr-10 May-10

Jan-10

Feb-10 Mar-10

Prices: main growth in 1Q11. We suppose that in 2011 the price dynamics for long products may outrun the other segments in light of more significant growth of consumption in construction sector. Out favorites – Mechel, Evraz Group and ММК. We see three favorites in the sector. High prices on coking coal and development of Elga coal deposit are the key growth factors for Mechel’s stocks. Evraz Group takes leading positions on domestic long steel market and gradually amends the situation with debts. MMK has the strongest sectoral positions on domestic market.

Coal We expect 15% increase in prices for coking coal in 2011. According to our forecasts, 2011 will be characterized by further advance in prices for coking coal backed by high consumption in steel sector and stable external market environment. Market equilibrium. We expect the balance between demand and supply on domestic market of coking coal in 2011, but don’t rule out temporary supply difficulties in 1Q11.

Non-ferrous metals Copper is pulling ahead. We expect the prices on non-ferrous metal to rise in 2011. According to our estimates, copper can become the growth leader supported by high demand from China. Gold as the best cover. In 2011 the gold will continue its price rally, attracting investors as insurance against global economy deterioration and fall on stock markets.

Several possible IPOs in 2011 2011: several possible IPOs. We expect several public offerings in ferrous market sector (ChTPZ Group, SUEK, Metalloinvest and others). In addition, Severstal Gold is expected to place its stocks as well. According to our estimates, the total volume of IPOs in 2011 may reach about $5 bn that may heighten the interest of investors in the industry as a whole.

STRATEGY 2011

41


Metals & mining Further recovery in 2011

Steel We expect further steel price increase in 2011. At the same time, in our point of view, the growth of the long products’ segment will be more dynamic vs. to the rest of market due to low base effect of 2010. Besides, price of coking coal will continue its upward movement driven by strong external market and high domestic demand. Our leaders in the sector are Mechel, Evraz Group and MMK.

2010-2012 price forecast for steel and raw materials, $/t New forecast 2010E

2011E

%, y-o-y

2012E

Hot-rolled coil (export)

608

668

10%

688

Current price 600

Rebar (export)

555

611

10%

629

575

Hot-rolled coil (domestic market)

687

735

7%

757

695

Rebar (domestic market)

632

733

16%

755

686

Coking coil concentrate

136

156

15%

161

150

Metal scrap

284

326

15%

336

323

78

90

15%

92

83

Iron-ore concentrate

Long products dom estic m arket: dem and and supply, Kt 2,000

Output

Demand

1,500 1,000 500 01.07.08 01.08.08 01.09.08 01.10.08 01.11.08 01.12.08 01.01.09 01.02.09 01.03.09 01.04.09 01.05.09 01.06.09 01.07.09 01.08.09 01.09.09 01.10.09 01.11.09 01.12.09 01.01.10 01.02.10 01.03.10 01.04.10 01.05.10 01.06.10 01.07.10 01.08.10 01.09.10

0

Sources: TKB Capital estimates

2,500 2,000

Output

Demand

Engineering Construction Other

1,500 1,000

100%

500 0

50% 01.08.08 01.09.08 01.10.08 01.11.08 01.12.08 01.01.09 01.02.09 01.03.09 01.04.09 01.05.09 01.06.09 01.07.09 01.08.09 01.09.09 01.10.09 01.11.09 01.12.09 01.01.10 01.02.10 01.03.10 01.04.10 01.05.10 01.06.10 01.07.10 01.08.10 01.09.10

2,500

Long products dem and structure change on the dom estic m arket, %

Flat products dom estic m arket: dem and and supply, Kt

Sources: TKB Capital estimates

Pipes Traders

62%

49%

51%

52%

2007

2008

2009

2010E

0%

Sources: Metal Expert, TKB Capital estimates

Construction sector: high potential We expect increase in consumption of long products. In 2011 demand for long products may be characterized by significant growth and outrun the flat products segment. We believe that further construction recovery will serve as the key growth drivers. Within 2010 the demand level for long products was 1,5-2 times lower the pre-crisis level of 2008. At the same time the demand for flat products has almost completely been remedied. Pre-crisis share of construction sector in the whole long products’ consumption in Russia made up over 60%, though in 2010 the share reduced up to 50% implying considerable recovery potential. Construction sector recovery. Recovery of housing construction is rather slow in Russia. According to our estimates, commissioning of residential real estate in 2010 increased by 4%. In 2011 it will gain 5% more. Demand for long products by construction companies is determined by the number of projects to be realized in the year coming.

42

STRATEGY 2011

House building dynam ics in 2007-2012E in Russia, m n m 2 75

house building

%

30%

70

20%

65

10%

60

0%

55

-10% 2007 2008 2009 2010E 2011E 2012E

Sources: Rosstat , TKB Capital estimates


Metals & mining Further recovery in 2011

Flat products: stable figures Slight expansion of demand. We expect that consumption of flat products will continue its expansion in 2011 due to high demand in pipe and automotive sectors sharing about 50% off the total consumption. In this context, we forecast 7% increase in flat products’ prices on domestic market in 2011 vs. 2010. Pipe and automotive industry as a back-up. Pipe products market in Russia in 2009-2010 demonstrated stable growth mainly due to demand from O&G sector. The key factors of expanding consumption are new pipeline construction, repair and maintenance of current capacities. We believe that the factors will facilitate the stable demand for hot-rolled steel in pipe products sector in 2011 as well playing supportive for flat products’ prices. The situation in automotive sector is the same. It is our opinion that the Russian automotive production will demonstrate 25% growth up to 1,329 K units in 2011. Flat products produced by Russian companies (Severastal, MMK, NLMK) is primarily consumed by local automakers such as AutoVAZ, GAZ and KAMAZ. According to ACM Holding, in 2010 car production by Russian manufacturing plants increased by 50%, trucks – 35% against the level of 2009.

2008

01.07.08 01.08.08 01.09.08 01.10.08 01.11.08 01.12.08 01.01.09 01.02.09 01.03.09 01.04.09 01.05.09 01.06.09 01.07.09 01.08.09 01.09.09 01.10.09 01.11.09 01.12.09 01.01.10 01.02.10 01.03.10 01.04.10 01.05.10 01.06.10 01.07.10 01.08.10 01.09.10

0

2016E

200

2015E

400

Buses

2014E

600

Trucks

2013E

Motor cars

3,000 2,500 2,000 1,500 1,000 500 0

2012E

demand

2011E

output

800

2010E

1000

Vehicle production dynam ics in Russia in 2008-2016E

2009

Pipes dom estic m arket: dem and and supply, Kt

Sources: Metal Expert, ASM Holding, TKB Capital estimates

A good premium for domestic market Price premium at the level of 15-16%. Over the last years price premium for rolled products on the Russian market made up 15-16% to the export one. It is explained by the fact that domestic market is supplied with the products of higher value-added level than the export market as well as the level of transportation costs. We believe that the premium on domestic market in future will depend on demand expansion in real economy and increase in transportation costs. Among Russian steelmakers, major loading share falls on MMK (about 65%).

HRC: dom estic and export prices, $/t 700 600 500 400

domestic

export 50% 40% 30% 20% 10% 0% -10%

01.01.2009 01.02.2009 01.03.2009 01.04.2009 01.05.2009 01.06.2009 01.07.2009 01.08.2009 01.09.2009 01.10.2009 01.11.2009 01.12.2009 01.01.2010 01.02.2010 01.03.2010 01.04.2010 01.05.2010 01.06.2010 01.07.2010 01.08.2010 01.09.2010 01.10.2010 01.11.2010

300

premium

premium 800 700 600 500 400 300

domestic

export 40% 30% 20% 10% 0% -10% -20%

01.01.2009 01.02.2009 01.03.2009 01.04.2009 01.05.2009 01.06.2009 01.07.2009 01.08.2009 01.09.2009 01.10.2009 01.11.2009 01.12.2009 01.01.2010 01.02.2010 01.03.2010 01.04.2010 01.05.2010 01.06.2010 01.07.2010 01.08.2010 01.09.2010 01.10.2010 01.11.2010

800

Rebars: dom estic and export prices, $/t

Sources: Metal Expert, Bloomberg, TKB Capital estimates

STRATEGY 2011

43


Metals & mining Further recovery in 2011

NLMK capitalization reached 2008 pick heights.

6.11.10

18.8.10

30.5.10

11.3.10

2.10.09

Mechel

21.12.09

14.7.09

4.2.09

16.11.08

9.6.08

Sep-10

Jun-10

Mar-10

Dec-09

Ev raz Group

May-09

Feb-09

Oct-08

Jul-08

Apr-08

Jan-08

NLMK

Aug-09

120 100 80 60 40 20 0

Sources: Bloomberg, TKB Capital estimates

Chinese econim ics grow th rates slow dow n China GDP, % China steel output, mn t

0.3

Chine to remain the key driver

Sev erstal

NLMK and Evraz Group quotes, 2008-2010

Transportation costs may considerably grow. At present the cost of transportation to port for steel manufacturers is equal to the cost of the inland one. According to companies’ data, in 2011 the tariffs on import/export transportation are set to grow by 8%, which should not have any significant impact on selling costs. In our opinion, transportation costs of the steelmakers will have a tendency of considerable growth in case of change in tariffs announced by FTS. We do not rule out such course of event.

28.8.08

1.1.08

ММК

25.4.09

70 60 50 40 30 20 10 0

Export traffic rates: potential rise in 2011 Cost of slabs transportation may grow by 66%. According to the data from FTS (Federal tariff service), the tariffs on ferrous metals and scrap transportation on import/export directions to and from ports as well as via Baltic countries and Finland may be increased in 2011. Thus, the duty tariff for pig iron transportation may increase by 30%, for pipes – by 3066%, for rails – by 56%. Tariffs for other ferrous metal products are proposed to grow by 3045%. Now the average transportation costs of steel manufacturers make up $40-60 per ton of slab.

Severstal, MMK and Mechel (ADR) quotes, 2008-2010

21.3.08

Evraz Group and Mechel have the highest recovery potential. In 2010 Severstal and NLMK demonstrated the most dynamic growth in the sector. Indices showed 75% and 51% growth accordingly. At the same time NLMK’s GDR reached the level of 2008, while stock quotes on MICEX even exceeded it. In our opinion the fact as constraining factor for growth of NLMK’s shares in 2011. We suppose that the stocks of Evraz Group and Mechel have the highest potential to reach the highs of 2008 that may turn to be an extra growth driver.

0.2 0.1

China gets rid of inefficient capacities. Currently the Chinese government takes a number of measures on liquidation of outdated ironworks. Besides, there is a moratorium on construction of new steel plants till the end of 2011. According to some reports, PRC intends to decommission about 25 mln t of outdated and inefficient steel capacities (4% of the current capacities by our estimates) to replace them with the new ones and improve the quality of steel products. In 2011 we expect the stabilization of steelmaking growth at the rate of 8-10%. We suppose that the level is good enough to sustain high prices on iron ore and coking coal.

44

STRATEGY 2011

0 2004 2005 2006 2007 2008 2009 2010E

mn t 60 50 40 30 20 10 0

Steel production in China production, mn t

%

15% 10% 5% 0% -5% -10%

01.01.2009 01.02.2009 01.03.2009 01.04.2009 01.05.2009 01.06.2009 01.07.2009 01.08.2009 01.09.2009 01.10.2009 01.11.2009 01.12.2009 01.01.2010 01.02.2010 01.03.2010 01.04.2010 01.05.2010 01.06.2010 01.07.2010 01.08.2010 01.09.2010 01.10.2010

Chinese influence on global steel market will remain strong. In 2007 we saw the highest growth of GDP in China (14.2%), while in 2008 it reduced up to 9.6% alongside with the slowed down rate of steel output expansion up to 2% (see the Chart). The World Bank forecasts the growth of Chinese GDP in 2011 at the level of 10.1%. Despite the growth retardation, China continues its domination on the global steel and raw materials’ market. In 2010 steelmaking in the country is proposed to reach 630 mn t, i.e. 11% higher the level of 2009. However the degree of such influence may slightly decline within the next 2 years. The last months demonstrated the decrease in Chinese steel production due to the policy pursued by the government on closure of inefficient steel-making.

Sources: Bloomberg, WorldSteel, TKB Capital estimates


Metals & mining Further recovery in 2011

Comparison with peers by multiples Steel makers EV/EBITDA 2010E

P/E 2011E

2010E

2011E

NLMK

10.5

9.0

22.5

20.0

MMK

7.9

5.4

25.6

10.2

Severstal

7.6

6.1

73.9

11.0

Evraz Group

9.8

6.4

53.7

11.4

Mechel

8.6

5.9

14.8

10.4

Average

8.9

6.6

38.1

12.6

Developed markets ArcelorMittal

9.3

7.4

16.5

13.8

Nippon Steel

7.1

6.5

12.0

9.9

JFE Holdings

6.3

6.0

11.0

9.6

US Steel

22.0

7.3

-22.0

20.2

Nucor

16.1

8.2

112.9

19.4

Voestalpine

6.7

6.0

13.4

10.4

Thyssen Krupp

5.5

4.5

15.7

10.2

10.4

6.6

22.8

13.4

Average

Emerging markets Baoshan Iron&Steel

9.3

7.4

16.5

13.8

Angang Steel

7.1

6.5

12.0

9.9

Tata Steel

6.3

6.0

11.0

9.6

POSCO

22.0

7.3

-22.0

20.2

China Steel

16.1

8.2

112.9

19.4

Gerdau

6.7

6.0

13.4

10.4

Median

5.5

4.5

15.7

10.2

Sources: company data, TKB Capital estimates

STRATEGY 2011

45


Metals & mining Further recovery in 2011

Coal Further price growth in 1H11

Zeroed import duties due to high domestic demand. In December, 2010 duties for coking coal import to Russia were zeroed, which is mostly explained by strong demand on domestic market. Previously the duty was implied at the rate of 5%. The volume of coking coal import to Russia is modest, so elimination of duties will not have any negative impact on the Russian steel makers. We suspect that in 2H11, when Raspadskaya may reach pre-emergency volumes of extraction, the balance between supply and demand on coking coal market will get into the equilibrium.

01.12.10

01.11.10

01.10.10

01.09.10

01.08.10

01.07.10

01.06.10

01.05.10

01.04.10

01.03.10

01.02.10

170 150 130 110 90

Coking coal concentrate average price on the dom estic m arket in 2010, $/t

01.01.10

In 2011 the cost of coking coal may grow by 15%. In 2010 the average annual price for coking coal concentrate advanced more than twice as compared to 2009 and made up $136/t. At the same time in 4Q10 price increased by 10% q-o-q. We consider it as a good support for further growth in 2011. We expect that in 2011 the average annual price on coking coal concentrate on domestic market will rise 15% per ton. Besides, domestic prices will be backed by strong external markets also expecting the price hikes due to continuing expansion of steel production in China, and South-East Asia. Global market players are reviewing the prices for coking coal supply in 1Q11. Thus, BMA (joint venture of BHP Billiton and Mitsubishi Alliance) agreed 8% price increase for hard coking coal in 1Q11. We do not rule out further growth of coal prices.

Sources: Metal Expert, TKB Capital estimates

Coking coal concentrate average price forecast on the dom estic m arket, $/t 200

136

150

156

161

2011E

2012E

65

100 50 0

2009

Coal companies

Sources: company data, TKB Capital estimates

46

STRATEGY 2011

Sources: Metal Expert, TKB Capital estimates

Sep 10

Aug 10

4 3 2 1 0

Jul 10

concentrate output purchases in domestic market export

Jun 10

14.3 15.3 17.3 15.2 14.2 12.5 14.8

May 10

n/a 24.8 34.7 22.4 16.3 21.4 21.9

Russian coking coal m arket structure, Mt

Apr 10

6.4 10.1 10.5 7.9 9.2 6.2 8.5

2011E 15.6 9.9 10.4

Mar 10

15.4 15.2 19.0 10.1 11.0 8.3 13.1

2010E 15.0 10.8 14.8

Feb 10

Massey Energy Gloucester coal Whiteheaven Coal Consol Energy Yanzhou Coal Mining Alpha Natural Resources Average

Sources: Metal Expert, TKB Capital estimates

P/E

Jan 10

Raspadskaya Belon Average

EV/EBITDA 2010E 2011E 10.0 9.7 6.6 6.3 8.6 6.3

2010


Metals & mining Further recovery in 2011

Mechel Coking coal as a key trigger Mechel, ADR ADR MTL BUY 29.58 37.00 25%

Ticker Recommendation Price, $ Target price 12M, $ Upside/downside, % SHARE DATA Bloomberg Reuters # of ADR outstanding, mn EV, $ mn MC, $ mn MIN 12 mnth., $ MAX 12 mnth., $ Shares per ADR

Common MTLR BUY 29.04 37.00 27%

MTL US MTL.N ADR 416 17,217 12,313 17.45 31.18 Common 1

MTLR RX MTLR.MM Common 416 16,994 12,090 7.34 28.66

SUMMARY FINANCIALS, $ mn IFRS 2010E 2011E Rev enue 9,621 11,014 EBITDA 2,000 2,916 Net income 835 1,189 EPS, $ 2 2.86 Rev . growth, % 67 14.48 EPS growth, % 993 42.5 EBITDA margin,% 21 26.5 Net margin, % 9 10.8

2012E 11,973 3,296 1,346 3.23 8.7 13.2 27.5 11.2

SUMMARY VALUATIONS 2010E P/E 14.75 EV/EBITDA 8.61

2012E 9.15 5.22

2011E 10.36 5.90

SHAREHOLDER STRUCTURE Igor Zy uzin Free-f loat

67.0% 33.0%

Mechel is one of our favorites in the Russian steel sector. We recommend to BUY its stocks with the target price of $37.0. In our point of view, Mechel’s key growth triggers are coking coal strong price, Elga coal deposit development and long products consumption increase in the Russian construction sector in 2011-2012. Strong coking coal price – the base of Mechel attractiveness. Mechel’s mining segment, which produces coking coal concentrate, is the key company’s business. In 2010 mining segment share in Mechel’s EBITDA could to reach about 75%, in revenue – about 30%. Therefore, strong coking coal market situation is the positive trigger for Mechel. According to our estimates, in 2011 average domestic coking coal concentrate price should increase by 15% to $156/t in comparison with 2010. Elga is the crucial project. Elga coal deposit development is the priority investment project for Mechel. Elga is the largest coalfield in Eurasia with 2.2 bn of coal reserves. Mechel have extracted the first coal on Elga in 2010 and output could to reach 27 Mt per year in the longterm outlook. According to Mechel estimates, in 2015 Elga coal output could amount 9 Mt, and the deposit will work with the full capacity in 2027. In our model we have used more blue output volumes considering a difficult nature conditions and probable troubles connected with development and corresponding correction of plans on output. The second Russian long products manufacturer. Probable consumption growth in the Russian construction sector in 2011 could to have a positive impact on Mechel. The company appears the second Russian producer of the long steel products used in construction sector. According to our estimates, in 2010 Mechel’s share in the domestic long products output amounted to about 14%. Mechel is an attractive bet on coking coal. We believe that Mechel’s stocks appears to be a good bet on the strong coking coal market situation. Mechel’s preference shares have a high dividend yield. According to our estimates, in 2010 it could amount to about 7%. Company’s EV/EBITDA’2011 and P/E’2011 look cheaper than peers that shows Mechel’s attractiveness. We recommend to BUY Mechel’s ADR with the target price of $37.0.

PRICE DYNAMICS MTL

35

RTS

28 21 14 22.12.09

22.3.10

22.6.10

22.9.10

22.12.10

Source: NYSE, RTS. TKB Capital estimates

Elga coal production forecast, mn т 10

Mechel

8

TKB Capital 5

6 4 2

7

0.2 0.2

1 1

21.5

9 7

5 3

0 2010E 2011E 2012E 2013E 2014E 2015E

Sources: company data, TKB Capital estimates

STRATEGY 2011

47


Metals & mining Further recovery in 2011

Mechel BALANCE SHEET $ mn

2009

2010E

2011E

2012E

2013E

2014E

2015E

TOTAL CURRENT ASSETS

2,483

3,273

3,744

5,760

7,299

7,741

9,162

PP&E, net

4,461

5,378

6,540

6,508

6,557

6,602

6,641

Other non-current assets

6,240

6,240

6,240

6,240

6,240

6,240

6,240

Total NON-CURRENT ASSETS

10,700

11,618

12,780

12,748

12,797

12,841

12,881

TOTAL ASSETS

22,043

13,183

14,890

16,523

18,507

20,096

20,582

Short-term borrow ings

1,923

3,949

3,649

3,799

4,149

3,649

3,649

Other short-term liabilities

1,097

1,298

1,399

1,472

1,552

1,634

1,663

Total CURRENT LIABILITIES

3,020

5,248

5,049

5,271

5,702

5,284

5,312

Long-term borrow ings

4,074

2,720

3,420

3,920

3,770

3,470

3,470

Other non-current liabilities

1,758

1,758

1,758

1,758

1,758

1,758

1,758

Total LONG-TERM LIABILITIES

5,832

4,478

5,178

5,678

5,528

5,228

5,228

281

287

295

305

315

325

336

Minority interest Share and additional capital

1,008

1,008

1,008

1,008

1,008

1,008

1,008

Retained earnings

3,189

4,017

5,141

6,393

7,691

8,885

10,307

4,050

4,878

6,002

7,253

8,552

9,746

11,168

13,183

14,890

16,523

18,507

20,096

20,582

22,043

$ mn

2009

2010E

2011E

2012E

2013E

2014E

2015E

Revenue

5,754

9,621

11,014

11,973

12,926

13,596

14,095

(3,961)

(6,005)

(6,485)

(7,091)

(7,761)

(8,448)

(8,687)

673

2,000

2,916

3,296

3,387

3,188

3,449

Total EQUITY TOTAL EQUITY & LIABILITIES INCOME STATEMENT

Cost of production EBITDA Depreciation EBIT Net interest income/(expenses) EBT Income tax Net incom e

(428)

(482)

(538)

(654)

(651)

(656)

(660)

594

1,627

2,419

2,679

2,784

2,574

2,842

(499)

(584)

(848)

(926)

(950)

(854)

(854)

95

1,043

1,571

1,753

1,834

1,720

1,988

(19)

(209)

(382)

(407)

(429)

(415)

(462)

76

835

1,189

1,346

1,405

1,305

1,525

2009

2010E

2011E

2012E

2013E

2014E

2015E

562

637

1,519

1,792

1,832

1,748

2,103

(710)

(1,400)

(1,700)

(622)

(700)

(700)

(700)

CASH FLOW STATEMENT $ mn Net CF from operating activities Net CF from /(used in) investm ent activities

375

666

334

556

94

(911)

(103)

5,583

6,352

6,599

5,523

4,498

3,561

2,260

%

2009

2010E

2011E

2012E

2013E

2014E

2015E

Revenue grow th

-42%

67%

14%

9%

8%

5%

4%

12%

21%

26%

28%

26%

23%

24%

Net CF from /(used in) financing activities Net Debt RATIOS

EBITDA margin Net margin

1%

9%

11%

11%

11%

10%

11%

Net Debt/EBITDA

8.3

3.2

2.3

1.7

1.3

1.1

0.7

Source: Mechel, TKB Capital estimates

48

STRATEGY 2011


Metals & mining Further recovery in 2011

Evraz Group Good potential in 2011 Evraz Group, GDR

Evraz Group is our second favorite in the Russian steel sector. The company takes up a crucial position on the domestic long products market, which has a strong recovery potential. Also Evraz Group gradually improves its leverage situation. Evraz Group GDR quotes looked worsted in the sector in 2010: +22% at the end of December, when the sector average growth amounted 46%. We do not exclude that in 2011 we should see Evraz Group stocks robust growth. We recommend to BUY company’s GDR with the target price of $46.0.

GDR EVR BUY 34.8 46.0 32%

Ticker Recommendation Price, $ Target price 12M, $ Upside/downside, % SHARE DATA Bloomberg Reuters # of GDR outstanding, mn EV, $ mn MC, $ mn MIN 12 mnth., $ MAX 12 mnth., $ Shares per GDR

EVR LI HK1q.L GDR 438 23,059 15,255 21.80 42.72 Common 1/3

The key long products manufacturer. Evraz Group is the Russian biggest producer of the long productsused in the construction sector. The company owns three large plants: Zapsib, NTMK and NKMK, which specialize on the output of the rolled products for building. According to our estimates, in 2010 Evraz Group’s share in the domestic long products output made up about 32%. We believe that in the light of expected recovery in the construction sector the key role of Group Evraz in this segment is the strong positive trigger for the company’s stocks.

SUMMARY FINANCIALS, $ mn IFRS 2010E 2011E Rev enue 13,231 15,896 EBITDA 2,354 3,577 Net income 284 1,340 EPS, $ 0.65 3.06 Rev . growth, % 35.4 20.1 EPS growth, % -122.5 372.0 EBITDA margin,% 17.8 22.5 Net margin, % 2.1 8.4

2012E 17,973 4,150 1,699 3.88 13.1 26.8 23.1 9.5

SUMMARY VALUATIONS 2010E P/E 53.72 EV/EBITDA 9.79

2012E 8.98 5.56

2011E 11.38 6.45

SHAREHOLDER STRUCTURE Lanebrook Ltd Igor Kolomoy sky Free-f loat

73.0% 10.0% 17.0%

PRICE DYNAMICS 44

EVR

NTMK reconstruction: +40% in steel output in 2015. Recently Evraz Group announced about completion of the BOF shop reconstruction on NTMK. As a result, shop’s annual capacity increased by 18% to 4.5 Mt. Further the company intends to construct a new BOF shop on NTMK. It will make possible to increase plant’s capacity by 40% to 6.0-6.5 Mt per year in 2015. Leverage situation improves. For the present leverage is the key risk for Evraz Group’s stocks. As expected, Net debt/EBITDA at the end of 2010 should amount to 3.0 that is the high figure. However, recently the company has taken major efforts to decrease a short-term debt. Consequently, in 2011-2012 Group Evraz actually have no large loan’s payments. At the same time, in 2013-2015 total loans repayments will account about $6.5 bn. We believe that the company will continue to realize its strategy by short-term debt declining. Evraz Group quotes could to indemnify the lag in 2011. Evraz Group’s stocks in 2010 have grown less than papers of other large Russian steelmaking companies. In particular, annual growth of the company’s GDR accounted for 22%, when the sector average growth made up 46%. We believe that company’s market capitalization growth potential could to realize in the case of strong long products market situation in 2011.

RTS

36 28 20 22.12.09

22.3.10

22.6.10

22.9.10

22.12.10

Source: LSE, RTS. TKB Capital estimates

STRATEGY 2011

49


Metals & mining Further recovery in 2011

Evraz Group BALANCE SHEET $ mn

2009

2010E

2011E

2012E

2013E

2014E

2015E

TOTAL CURRENT ASSETS

4,240

5,973

7,552

10,857

12,228

15,491

16,233

14,941

14,146

14,067

13,895

13,537

13,109

12,716

4,230

4,230

4,230

4,230

4,230

4,230

4,230

Total NON-CURRENT ASSETS

19,171

18,376

18,297

18,125

17,767

17,339

16,946

TOTAL ASSETS

33,193

PP&E, net Other non-current assets

23,424

24,362

25,862

28,994

30,008

32,843

Short-term borrow ings

1,992

3,622

3,622

4,867

3,622

4,572

3,622

Other short-term liabilities

1,746

1,770

1,897

2,043

2,179

2,233

2,258

Total CURRENT LIABILITIES

3,738

5,392

5,519

6,910

5,801

6,805

5,880

Long-term borrow ings

5,931

4,924

4,924

4,924

5,179

5,179

4,229

Other non-current liabilities

3,146

3,146

3,146

3,146

3,146

3,146

3,146

Total LONG-TERM LIABILITIES

9,077

8,070

8,070

8,070

8,325

8,325

7,375

324

331

364

406

451

495

548

2,114

2,114

2,114

2,114

2,114

2,114

2,114

Minority interest Share and additional capital Retained earnings

3,168

3,452

4,792

6,492

8,315

10,101

12,272

Total EQUITY

10,284

10,568

11,908

13,608

15,431

17,217

19,388

TOTAL EQUITY & LIABILITIES

23,424

24,362

25,862

28,994

30,008

32,843

33,193

INCOME STATEMENT $ mn

2009

2010E

2011E

2012E

2013E

2014E

2015E

Revenue

9,772

13,231

15,896

17,973

19,387

19,962

20,564

Cost of production

(8,756)

(10,333)

(11,350)

(12,566)

(13,721)

(14,181)

(14,380)

EBITDA

1,237

2,354

3,577

4,150

4,203

4,210

4,496

Depreciation

(901)

(1,245)

(1,179)

(1,122)

(1,070)

(1,023)

(979)

336

1,109

2,398

3,027

3,133

3,187

3,517

EBIT Net interest income/(expenses)

(637)

(729)

(729)

(835)

(751)

(832)

(670)

(1,600)

355

1,675

2,124

2,279

2,233

2,714

(339)

(71)

(335)

(425)

(456)

(447)

(543)

(1,261)

284

1,340

1,699

1,823

1,786

2,171

$ mn

2009

2010E

2011E

2012E

2013E

2014E

2015E

Net CF from operating activities

1,700

1,065

1,488

1,789

2,058

2,039

2,573

183

(450)

(1,100)

(1,000)

(800)

(700)

(700)

(2,149)

1,339

729

2,080

(239)

1,782

(1,230)

7,248

5,917

4,799

3,174

1,166

neg.

neg.

%

2009

2010E

2011E

2012E

2013E

2014E

2015E

Revenue grow th

-52%

35%

20%

13%

8%

3%

3%

13%

18%

22%

23%

22%

21%

22%

2%

8%

10%

10%

10%

11%

2.5

1.3

0.8

0.3

neg.

neg.

EBT Income tax Net incom e CASH FLOW STATEMENT

Net CF from /(used in) investm ent activities Net CF from /(used in) financing activities Net Debt RATIOS

EBITDA margin Net margin Net Debt/EBITDA Source: Evraz Group, TKB Capital estimates

50

STRATEGY 2011

-13% 5.9


Metals & mining Further recovery in 2011

MMK Bet on the domestic steel market MMK Common MAGN BUY 1.06 1.32 25%

Ticker Recommendation Price, $ Target price 12M, $ Upside/downside, %

GDR MMK LI BUY 13.71 17.16 25%

SHARE DATA Bloomberg Reuters

MAGN RX MAGN.MM Common 11,174 # of shares outstanding,mn EV, $ mn 12,776 MC, $ mn 11,812 MIN 12 mnth., $ 0.68 MAX 12 mnth., $ 1.12 Common Shares per GDR 13

-

SUMMARY FINANCIALS, $ mn IFRS 2010E 2011E Rev enue 7,981 10,216 EBITDA 1,617 2,344 Net income 461 1,162 EPS, $ 0.04 0.10 Rev . growth, % 57.1 28.0 EPS growth, % 110.3 152.3 EBITDA margin,% 20.3 22.9 Net margin, % 5.8 11.4

2012E 12,174 2,814 1,515 0.14 19.2 30.4 23.1 12.4

SUMMARY VALUATIONS 2010E P/E 25.64 EV/EBITDA 7.90

2012E 7.80 4.54

2011E 10.17 5.45

SHAREHOLDER STRUCTURE Viktor Rashnikov Free-f loat

-

87.0% 13.0%

PRICE DYNAMICS MAGN

1.20

MMK takes up strongest position on the domestic steel market among Russian steelmaking companies. According to our estimates, in 2011 domestic market will recover more greatly than export markets. In addition, MMK should increase its high value added products output significantly due to Mill-2000 and Atakas projects implementation that could have a positive impact on the company’s profitability. We recommend to BUY MMK stocks with the target price of $1.32. Strong domestic steel market position. MMK is a key supplier of the steel on the Russian market. In 2010 company’s share amounted to about 16%. Having said that, within next years domestic market should be more attractive for steelmakers than export due to price premium and demand growth. In 2010 MMK’s domestic shipments share in the sales structure made up about 57%. Raw materials problem already is not so burning. Having bought the coal company Belon, MMK solved the own coking coal problem to a large degree. Further Belon should cover about 80% of MMK’s needs in coking coal. According company data, in short term outlook MMK’s iron ore assets should supply about 50% of company needs. MMK plans to reach this figure due to production growth on the company’s owns assets (Bakal, Sosnovsky mine). Besides, MMK launched new slag processing technology. This permits to produce annually about 1 Mt of iron ore in addition. New projects = high value added products growth. At present MMK realizes several very important projects: Mill-2000 and Atakas. Mill-2000 should to go to full capacity in 2012 (installation work in Magnitogorsk at present). Mill-2000 will be producing 2 Mt of cold-rolled products. With its help MMK plans to drive out import flat products from the domestic market. Currently Russian auto industry needs in flat products amounts to about 2.5 Mt. Turkish project Atakas has already started production (galvanized and coated sheet). Atakas annual capacity makes up about 2.3 Mt of hot-rolled products and 2 Mt of flat products. MMK’s new target price is $1.32. We believe that strong domestic market position, gradually solution of the raw materials problem and value added products growth are positive triggers for MMK. We recommend to BUY its stocks with the target price of $1.32. The company is trading by EV/EBITDA’2011 and P/E’2011 cheaper than peers.

RTS

1.00 0.80 0.60 22.12.09

22.3.10

22.6.10

22.9.10 22.12.10

Source: MICEX, RTS. TKB Capital estimates

ММК: iron ore shipm ents structure, 2010E Slag processing 10%

Own ore 20%

ENRC 70%

Sources: company data, TKB Capital estimates

STRATEGY 2011

51


Metals & mining Further recovery in 2011

MMK BALANCE SHEET $ mn

2009

2010E

2011E

2012E

2013E

2014E

2015E

TOTAL CURRENT ASSETS

2,430

3,535

4,592

5,017

6,745

9,097

11,594

11,276

11,724

12,143

12,533

12,898

13,038

13,169

PP&E, net Other non-current assets

1,127

1,127

1,127

1,127

1,127

1,127

1,127

Total NON-CURRENT ASSETS

12,403

12,851

13,270

13,660

14,025

14,165

14,296

TOTAL ASSETS

25,890

14,833

16,387

17,861

18,677

20,770

23,262

Short-term borrow ings

808

2,000

2,000

1,000

1,000

1,000

1,000

Other short-term liabilities

969

1,424

1,729

2,019

2,250

2,570

2,655

Total CURRENT LIABILITIES

1,777

3,424

3,729

3,019

3,250

3,570

3,655

Long-term borrow ings

1,266

709

709

709

709

709

709

Other non-current liabilities

1,465

1,465

1,465

1,465

1,465

1,465

1,465

Total LONG-TERM LIABILITIES

2,731

2,174

2,174

2,174

2,174

2,174

2,174

368

371

379

389

402

416

432

Minority interest Share and additional capital Retained earnings

1,830

1,830

1,830

1,830

1,830

1,830

1,830

10,424

10,885

12,046

13,562

15,411

17,568

19,876

9,957

10,418

11,579

13,095

14,944

17,101

19,409

14,833

16,387

17,861

18,677

20,770

23,262

25,890

$ mn

2009

2010E

2011E

2012E

2013E

2014E

2015E

Revenue

5,081

7,981

10,216

12,174

13,804

15,835

16,469

(3,940)

(5,872)

(7,167)

(8,398)

(9,380)

(10,737)

(11,098)

996

1,617

2,344

2,814

3,251

3,654

3,719

Total EQUITY TOTAL EQUITY & LIABILITIES INCOME STATEMENT

Cost of production EBITDA Depreciation

(708)

(752)

(782)

(810)

(836)

(860)

(869)

EBIT

333

690

1,563

2,004

2,415

2,794

2,975

Net interest income/(expenses)

(76)

(118)

(120)

(123)

(119)

(115)

(110)

EBT

257

572

1,443

1,881

2,296

2,679

2,865

Income tax

(38)

(114)

(289)

(376)

(459)

(536)

(573)

Net incom e

219

461

1,162

1,515

1,849

2,158

2,307

2009

2010E

2011E

2012E

2013E

2014E

2015E

839

116

961

1,392

1,814

2,085

2,711

(1,689)

(1,200)

(1,200)

(1,200)

(1,200)

(1,000)

(1,000)

CASH FLOW STATEMENT $ mn Net CF from operating activities Net CF from /(used in) investm ent activities

(40)

635

-

(1,000)

-

-

-

1,909

2,395

2,034

1,239

26

neg.

neg.

%

2009

2010E

2011E

2012E

2013E

2014E

2015E

Revenue grow th

-52%

57%

28%

19%

13%

15%

4%

20%

20%

23%

23%

24%

23%

23%

Net CF from /(used in) financing activities Net Debt RATIOS

EBITDA margin Net margin

4%

6%

11%

12%

13%

14%

14%

Net Debt/EBITDA

1.9

1.5

0.9

0.4

0.0

neg.

neg.

Source: MMK, TKB Capital estimates

52

STRATEGY 2011


Metals & mining Further recovery in 2011

Non-ferrous metals Prices to keep on growing in 2011 Nickel: price vs stocks price, $/t

40,000

stocks, t

200,000 150,000

20,000

100,000

10,000

50,000

0

Jan-08 Mar-08 May-08 Jul-08 Oct-08 Dec-08 Feb-09 May-09 Jul-09 Sep-09 Dec-09 Feb-10 Apr-10 Jun-10 Sep-10 Nov-10

30,000

0

Sources: LME

Copper: price vs stocks price, $/t

stocks, t 600,000 500,000

10,000 8,000 6,000 4,000 0

Jan-08 Mar-08 May-08 Jul-08 Oct-08 Dec-08 Feb-09 May-09 Jul-09 Sep-09 Dec-09 Feb-10 Apr-10 Jun-10 Sep-10 Nov-10

2,000

Nickel and copper: a good balance between prices and stocks. In our opinion, the end of 2010 will demonstrate a favorable balance between the world prices and level of exchange warehouse stocks for nickel and copper. As it is clear from the chart, copper stocks reduced in 2010, which resulted in price soaring in 4Q10. Spread between nickel stocks and the metal price on LME narrowed considerably. We suppose that nickel prices will be backed by further increase in demand and dollar overhang. Aluminum and zinc. We also expect further growth of prices for aluminum and zinc. Expansion of demand from aircraft industry will be the key trigger of aluminum price advance. At the same time, aluminum market is facing metal oversupply that is proposed to put pressure on prices at the start of 2011. According to our expectations, the cost of zinc in 2011 will be limited by a number of factors such as increase in production on the main fields as well as growing volume of zinc stocks. Price forecast for ferrous and platinum-group metals

400,000 300,000 200,000

Nickel , $/t

100,000 0

Copper, $/t Aluminum, $/t

Sources: LME

Zinc, $/t

Zinc: price vs stock Platinum, $/oz price, $/t 3,000 2,500 2,000 1,500 1,000 500 0

stocks, t 800,000

400,000

Jun-10 Sep-10

0 Aug-09 Dec-09 Mar-10

Oct-08 Feb-09 May-09

Jan-08 Apr-08 Jul-08

200,000

Sources: LME

Alum inium : price vs stock price, $/t

5,000,000

3,000

4,000,000 3,000,000

2,000

2,000,000

1,000 Jan-08 Mar-08 Jun-08 Aug-08 Nov-08 Feb-09 Apr-09 Jul-09 Oct-09 Dec-09 Mar-10 May-10 Aug-10 Nov-10

1,000,000

Sources: LME

0

2011E 25 200 16% 9 240 23% 2 450 18% 2 400 10% 1 750 9% 550 12%

2012E 24 200 -4% 8 900 -4% 2 500 2% 2 450 2% 1 750 0% 550 0%

2013E 23 940 -1% 8 820 -1% 2 480 -1% 2 300 -6% 1 650 -6% 500 -9%

Norilsk Nickel is our favorite in the sector. Norilsk Nickel is one of our favorites in the sector. The company is a world leader on nickel and palladium production and has a considerable share on copper and platinum market. Norilsk Nickel is characterized by relatively low production costs and strong reserves with high grade of the valuable components. In our opinion, these factors and the growth of prices for metals make the company’s stocks as one of the most attractive in nonferrous industry. Besides, key shareholders conflict could to be an additional speculative trigger for the company. Norilsk Nickel: peers’ comparison

stocks, t

4,000

0

Palladium, $/oz

600,000

2010E 21 800 47% 7 500 43% 2 069 38% 2 179 33% 1 600 33% 490 84%

Norilsk Nickel

EV/EBITDA 2010E 2011E 5.6 5.0

P/E 2010E 8.1

2011E 7.2

BHP Billiton VALE RIO Tinto Xstrata Anglo American Average

6.8 7.7 6.3 7.7 7.1 7.1

6.1 5.5 5.3 5.9 5.7 5.7

11.8 11.0 10.4 13.1 13.1 11.9

10.4 7.5 8.5 9.6 9.5 9.1

Freeport-McMoran Antofagasta KGHM Southern Copper Corp Jiangxi Copper Average

6.2 8.6 5.1 14.2 14.7 9.7

5.2 5.2 4.9 8.9 11.4 7.1

13.8 20.9 7.4 26.1 22.5 18.2

10.9 12.6 7.5 14.7 16.9 12.5

Anglo Platinum Impala Platinum Northam Aquarius Platinum Average

14.4 11.4 12.6 10.9 12.3

9.0 8.6 8.5 7.3 8.3

32.5 18.2 19.4 21.3 22.8

16.9 13.8 14.0 13.3 14.5

Sources: company data, TKB Capital estimates

STRATEGY 2011

53


Metals & mining Further recovery in 2011

Gold Growth in 2011 Gold as the safest investment. We expect further increase in prices for gold in 2011. According to our estimates, annual average price is proposed to rise by 20% up to $1,500/oz as compared to 2010 when the cost of gold increased by 30% up to $1,250/oz vs. 2009. Gold remains attractive for investors as an insurance against global economy deterioration and, as a result, fall on stock markets. In 2011 prices for gold have all chances to continue growing in the context of low interest rates. BUYING recommendation for gold mining companies upon quotes fall. Two Russian leading gold ore companies – Polyus Gold and Polymetal - demonstrate high EV/EBITDA and P/E multiples. Nevertheless, we recommend investors to use the “quotes fall” tactics to buy the stock of gold ore companies. In addition, we suppose that portfolio diversification can be achieved by adding the stocks of Petropavlovsk, Highland Gold and High River Gold.

2011E

2010E

2011E

15.0

10.4

25.1

16.3

22.6

9.3

36.7

13.2

Petropavlovsk

12.2

7.0

23.4

11.4

Highland Gold

6.4

5.1

11.3

8.5

High River Gold

4.2

4.1

8.2

7.7

Average

12.1

7.2

20.9

11.4

Newmont

6.6

5.7

15.6

12.4

AngloGold

9.2

6.1

20.5

10.9

GoldFields

12.7

6.3

57.2

16.0

Barrick Gold

9.4

7.7

16.0

12.8

Harmony Gold

8.7

5.8

24.3

12.7

Kinross Gold

13.6

9.7

37.8

22.9

Goldcorp

16.3

11.8

28.6

22.5

Average

10.9

7.6

28.6

15.7

STRATEGY 2011

1,100 900

Source: Bloomberg

Jun-10

Sep-10

Mar-10

Aug-09

Dec-09

Feb-09

May-09

Jul-08

Oct-08

Apr-08

P/E

2010E

Polymetal

54

1,300

Jan-08

EV/EBITDA

a

1,500

700

Gold ore companies’ multiples

Polyus Gold

Gold price dynam ics in 2008-2010


Metals & mining Further recovery in 2011

Norilsk Nickel Favorite in the non-ferrous sector NorNickel Common GMKN BUY 220.7 270.0 22%

Ticker Recommendation Price, $ Target price 12M, $ Upside/downside, %

GDR MNOD LI BUY 23.4 27.0 15%

SHARE DATA Bloomberg Reuters

GMKN RX GMKN.MM Common 191 # of shares outstanding,mn EV, $ mn 44 040 MC, $ mn 42 074 MIN 12 mnth., $ 135.9 MAX 12 mnth., $ 220.9 Common Shares per GDR 0.10

GDR 191 46 611 44 645 14.0 23.9 -

SUMMARY FINANCIALS, $ mn IFRS 2010E 2011E Rev enue 14 327 15 502 EBITDA 7 847 8 827 Net income 5 203 5 834 EPS, $ 27.29 30.60 Rev . growth, % 41.1 8.2 EPS growth, % 96.3 12.1 EBITDA margin,% 54.8 56.9 Net margin, % 36.3 37.6

2012E 15 157 8 289 5 192 27.24 -2.2 -11.0 54.7 34.3

SUMMARY VALUATIONS 2010E P/E 8.09 EV/EBITDA 5.61

2012E 8.10 5.31

2011E 7.21 4.99

SHAREHOLDER STRUCTURE Interros Rusal Traf igura Free-f loat

25.0% 25.0% 8.0% 42.0%

Norilsk Nickel is our favorite in the non-ferrous metals sector. The company has a low production costs, strong ore reserves with high grade of the valuable components. With the expectations of the copper and nickel prices growth it makes Norilsk Nickel stocks attractive. Besides, key shareholders conflict could to be an additional speculative trigger for the company. We recommend to BUY Norilsk Nickel stocks with the target price of $270. Key global nickel and palladium producer. Norilsk Nickel is the biggest global producer of nickel and palladium. Company’s stake in global production of nickel amounts 22% and palladium – 38%. Also Norilsk Nickel is a large producer of copper and platinum. Strong copper, nickel and PGM prices in 2011. We believe that non-ferrous metals prices will show a growth in 2011. According to our estimates, prices should continue to growth due to emerging countries economics recovery (basically China and India). In our point of view, copper could to demonstrate more strong dynamics, than the rest of metals thanks to Chinese consumption growth and US dollar liquidity increase. Russian ore value is very high. Proven and probable reserves of the Russian division of Norilsk Nickel accounts for 473 Mt of nickel ore with content of 5.8 Mt of nickel, 8.7 Mt of copper and 80 Moz of platinum group metals (PGM). Metals value per tone of ore exceeded average peers’ figure by 84%. Shareholder’s conflict: good speculative trigger. We believe that Norilsk Nickel key shareholder’s conflict could to be a speculative trigger for company’s stocks quotes in 2011. At present Interros and RUSAL are in a stage of consultations concerning value of 25% company stake. It should be noted, that Norilsk Nickel has already made the $12 bn ($252 per share) offer to RUSAL. Aluminum company has rejected the deal. We do not exclude that current offer is not the last and we could see the continuation of this story in 2011. Norilsk Nickel looks cheaper than peers. According to our estimates, Norilsk Nickel stocks are significantly undervalued by market multipliers. Thus, the company is trading by P/E’2011 at the level of 7.2 (with 70% premium to peers) and by EV/EBITDA at the level of 5.0 (with 47% premium to peers).

PRICE DYNAMICS 230

GMKN

RTS

190 150 110 22.12.09

22.3.10

22.6.10

22.9.10

22.12.10

Source: MICEX, RTS. TKB Capital estimates

STRATEGY 2011

55


Metals & mining Further recovery in 2011

Norilsk Nickel BALANCE SHEET $ mn

2009

2010E

2011E

2012E

2013E

2014E

2015E

TOTAL CURRENT ASSETS

8,376

13,433

18,729

24,587

30,685

35,160

38,691

11,017

12,115

14,128

14,981

15,568

15,909

16,124

3,335

3,335

3,335

3,335

3,335

3,335

3,335

Total NON-CURRENT ASSETS

14,352

15,450

17,463

18,316

18,903

19,244

19,459

TOTAL ASSETS

58,183

PP&E, net Other non-current assets

22,760

28,915

36,223

42,935

49,620

54,435

Short-term borrow ings

2,972

2,972

2,972

2,972

2,972

3,022

2,972

Other short-term liabilities

1,140

1,092

1,067

1,087

1,103

1,121

1,149

Total CURRENT LIABILITIES

4,112

4,064

4,039

4,059

4,075

4,143

4,121

Long-term borrow ings

2,345

3,345

4,845

6,345

8,345

8,845

9,295

Other non-current liabilities

1,548

1,548

1,548

1,548

1,548

1,548

1,548

Total LONG-TERM LIABILITIES

3,893

4,893

6,393

7,893

9,893

10,393

10,843

Minority interest

1,080

1,080

1,080

1,080

1,080

1,080

1,080

Share and additional capital

1,398

1,398

1,398

1,398

1,398

1,398

1,398

Retained earnings

15,600

20,803

26,637

31,828

36,496

40,744

44,064

Total EQUITY

14,755

19,958

25,792

30,983

35,651

39,899

43,219

TOTAL EQUITY & LIABILITIES

22,760

28,915

36,223

42,935

49,620

54,435

58,183

INCOME STATEMENT $ mn

2009

2010E

2011E

2012E

2013E

2014E

2015E

Revenue

10,155

14,327

15,502

15,157

14,890

14,646

13,749

Cost of production

(5,128)

(5,014)

(4,378)

(4,037)

(4,303)

(4,525)

(4,764)

EBITDA

4,414

7,847

8,827

8,289

7,840

7,399

6,293

Depreciation

(638)

(902)

(988)

(1,147)

(1,213)

(1,259)

(1,285)

EBIT

3,776

6,946

7,839

7,142

6,627

6,140

5,009

Net interest income/(expenses)

(186)

(442)

(547)

(652)

(792)

(831)

(859)

EBT

3,487

6,504

7,292

6,490

5,835

5,310

4,150

Income tax

(836)

(1,301)

(1,458)

(1,298)

(1,167)

(1,062)

(830)

Net incom e

2,651

5,203

5,834

5,192

4,668

4,248

3,320

$ mn

2009

2010E

2011E

2012E

2013E

2014E

2015E

Net CF from operating activities

3,010

5,908

6,818

6,286

5,836

5,453

4,574

Net CF from /(used in) investm ent activities

(967)

(2,000)

(3,000)

(2,000)

(1,800)

(1,600)

(1,500)

(1,123)

1,000

1,500

1,500

2,000

550

400

1,685

998

neg.

neg.

neg.

neg.

neg.

%

2009

2010E

2011E

2012E

2013E

2014E

2015E

Revenue grow th

-27%

41%

8%

-2%

-2%

-2%

-6%

EBITDA margin

43%

55%

57%

55%

53%

51%

46%

Net margin

26%

36%

38%

34%

31%

29%

24%

0.4

0.1

neg.

neg.

neg.

neg.

neg.

CASH FLOW STATEMENT

Net CF from /(used in) financing activities Net Debt RATIOS

Net Debt/EBITDA Source: Norilsk Nickel, TKB Capital estimates

56

STRATEGY 2011


Telecoms Growing beyond traditional mobile services to unlock more value Kirill Bakhtin

k.bakhtin@tkbc.ru

Telecoms Growing beyond traditional mobile services to unlock more value Russian telecoms offer an appealing investment case permanently expanding horizons of their activity. At this point the Big-Three operators have turned into integrated operators and established operations in the CIS. Starting from purely mobile domestic facilities, MTS and VimpelCom Ltd are moving forward to promising broadband and pay-TV markets. Strong balance sheets, high margins from mobile operations along with a defined dividend policy make MTS and VimpelCom Ltd strong amid international peers. Rise in domestic spending in 1H11 and low competition in pricing are supportive for traditional mobile services. Rostelecom needs much time to operationally unite wire-line business of inter-regional telecoms (IRs), it has not voiced a clear strategy on mobile business. We favour MTS as the safe bet in the sector and remain a 12-month target price of $28/ADR and $14/locals.

Sector dynam ics vs. RTS in 2010 22.12.2010

Max

Min

RTS MBT MTSI CMST VIP RTKM RTKMP

ENVIRONMENT

SSA -50%

0%

50%

Wave of consolidation in 1H11. Corporate procedures on a merger MTS ad ComstarUTS, combining IRs into Rostelecom and a purchase of Weather Investments by Vimpelcom Ltd are essential for reshaping the industry’s landscape and lead to lock-up periods in trading of some stocks in the first half of 2011.

100%

Source: Bloomberg

RTSI

140 130 120 110 100 90 80 70 60

Telecoms

No acceleration in mobile pricing competition. In the Russian oligopoly market operators are very reluctant to cut APPM what is good to margins.

Dec-10

Oct-10

Nov-10

Sep-10

Jul-10

Aug-10

Jun-10

Apr-10

May-10

Mar-10

Jan-10

Feb-10

Mobile data traffic to serve as a major catalyst. VAS ARPU in Russia is forecast to add 34% y-o-y in 2011 led by a boost in data traffic.

Source: Bloomberg

On the verge of rapid grow th 3G m odem s and 3G phone users in Russia, m n

REGULATORY IMPACT Ministry backs technology neutrality and refarming. The office calls for changes in frequency spectrum regulation hinting at launch of LTE networks in the mid-term. Hikes on fixed-line local services allowed. Wire-line incumbents have received the right to raise local fees on 8.8% on average in 2011. The tariff cap rate is in line with our macroeconomic forecast of CPI.

3G modems, mn Activ e 3G phone users, mn

60

Bet on domestic spending. Mobile ARPU is set to pick up a growth of residential spending and be bolstered by increased corporate budgets for 2011.

50 40

Roaming fees in Russia and the CIS reduced, no cuts for 2011. Forced by FAS, the BigThree voluntary reduced tariffs on roaming calls – slightly negative for sales and margins.

30 20 10 0 2009

2010E

2011E

2012E

2013E

Source: TKB Capital estimates

CIS m arkets underpenetrated Mobile penetration globally in 2009, % 160 140 120 100 80 60 40 20 0

PROS New additions in the CIS are not over. The CIS countries are still underpenetrated, that opens up an opportunity for further advance. High FCF from established markets. Mobile markets of Russia and Ukraine generate high cash flows to back modernization and enter new markets.

Source: ITU, TKB Capital estimates

DM

Russia

Ukraine

Armenia

Kazakhstan

EM

Georgia

Kyrgyzstan

Uzbekistan

Tajikistan

Turkmenistan

Attractive valuation in the sector. Both MTS and VimpelCom Ltd are trading with discounts on multiples to emerging market peers.

CONS Fixed-line BB ARPU under pressure with rising competition. Presence of tens players in the market drastically impacts dynamics of monthly payments. Large capex wanted to keep pace with peers in VAS market. For the Big-Three, we estimate a 2011 capex-to-sales of around 20% needed for infrastructure update.

STRATEGY 2011

57


Telecoms Growing beyond traditional mobile services to unlock more value

ENVIRONMENT Wave of consolidation in 1H11. For the first half of the year 2011 Russian telecoms operators have scheduled a number of corporate actions which markedly change the industry’s landscape. Some companies aim to enlarge business activity through combining mobile and fixed-line business, seek new geography of their operations, while other are forced to unite operations in order to secure market share and margins. Generally in the telecoms business, small players, which lack national coverage, backbone networks and do not provide a full range of facilities face tough competition from the Big-Three and Rostelecom. The list of transaction includes the following: (1) MTS is proceeding with a complete merger of Comstar-UTS to become a universal provider and extract synergy effects. On December 23, 2010 the extraordinary meetings of shareholders of both companies approved the deal but that was anticipated given a 73.3% stake (not taking into account treasuries) accumulated by MTS in Comstar on the record date; (2) VimpelCom Ltd is set to acquire Weather Investments owning a controlling stake in Orascom Telecoms (operates in Africa and Asia) and 100% in Italy’s Wind Telecomunikazioni. Also, the company is participating into a tender on a purchase of controlling stake in Telekom Srbija. The results of the tender will be announced in 1H11; (3) the state has finally started reorganization of Svyazinvest on the base of Rostelecom. The first round of the process is to be completed in February-March 2011 with assembling IRs into Rostelecom. Lock-up periods inevitable. There will be a lock-up periods in trading shares of Comstar and IRs in 1H11. In the case of Comstar GDR, a stop in trading will occur in the beginning of April and the newly issued locals of MTS will start trading in late April – early May. A lock-up period in IRs from 14 to 44 days is inevitable for IRs shareholders. No acceleration in mobile pricing competition. So far the Russian telecoms operators did not make sizeable cuts in mobile tariffs. The competitive environment in pricing is rather loose opposite to the rivalry for mobile subscribers. This gives a confidence that APPM will remain intact from drastic deterioration in the mid-term. For 9M10 APPM of the Big-Three was down only 4% y-o-y. All conflicts lied in the field of attracting new subscribers. For advertising and marketing, the Big-Three raised its costs by 14% y-o-y in 9M10. The supportive evidence is that Tele2 Russia which goes on with attraction of customers, but avoids an APPM slump and improves OIBDA margin. Increasing data volum es back rise of 3G ARPU 3G m obile ARPU Traffic per user, MB/mo Y-o-y, %

2010E

2011E

2012E

20

31

48

54

57

50

2013E 73 33

Price, RUR/MB

5.9

5.0

4.2

3.6

Y-o-y, %

(15)

(15)

(15)

(15)

181

241

308

348

31

34

28

13

Incremental ARPU, RUR/mo Y-o-y, % Source: TKB Capital estimates

Mobile data traffic to serve as a major catalyst. We would like to mark out the data traffic market as the most promising driver for revenues growth. VAS ARPU in Russia is forecast to add 34% y-o-y in 2010 led by a boost in data traffic. The base of active 3G handsets in Russia is anticipated to rise 53% y-o-y in 2011. Mobile devices able to work within 3G networks dominate among newly purchased phones and yet account for 21% of the total number. The 3G USB modems market is on the making, too. We estimate users of USB modems at 10.8 mn in 2011, up 52% y-o-y and total mobile data revenues up 74% y-o-y next year. Bet on domestic spending. Macroeconomic picture looks quite prosperous for an increase in GDP and real income. Mobile ARPU from traditional services is set to advance further (in Russia we see a 2% y-o-y advance in ruble terms for MTS in 2011 and same 2% for Vimpelcom Ltd). The increase should come on the back of improvement MOU (4% y-o-y to 233 min/month for MTS and 3% to 225 min/month for VimpelCom Ltd). More potential will be uncovered in regions where many mobile users spend below $3 per month.

58

STRATEGY 2011


Telecoms Growing beyond traditional mobile services to unlock more value

REGULATORY IMPACT Ministry backs technology neutrality and refarming. During the interview on December, 9, 2010 Igor Schegolev, head of the Ministry of Telecommunications and Mass Media, voiced revolutionary statements for the Russian mobile industry. The ministry supports technology neutrality and promises adopting refarming of the frequency spectrum. Key initiatives are the following: (1) operators may invest in conversion of 790 to 860 MHz waveband and receive the access to distribution of frequency afterwards. The Ministry of Defense does not oppose the initiative, and key operators have acceded to the terms. In the Big-Three estimates, $1.6-5.0 bn is required for the conversion, that is obtainable for large operators; (2) the range of 2.5-2.7 GHz may be used after refarming what enables to combine few ranges of frequency spectrum. Both 790-860 MHz and 2.5-2.7 GHz are occupied by LTE networks in Europe. Operators have fine-turned equipment for these wavebands; (3) the Ministry does not object technology neutrality. Potentially, the BigThree operators may replace equipment and roll-out LTE services on their current 900/1800 MHz frequencies. Hikes on fixed-line local services allowed. Wire-line incumbents have received the right from the Federal Tariff Service (FTS) to raise local fees on 8.8% on average in 2011. The tariff cap rate is in line with our macroeconomic forecast of CPI (8.4%) what is very positive for financials of fixed-line providers. Local services dominate in the structure of MGTS and inter-regional telecoms’ revenues; therefore the raised tariffs on locals will add 3% to the total sales. The cap pricing system was implemented in February 2007 on the rationale of low price per minute of local calls in comparison to Central and Eastern Europe. Nevertheless, quarterly figures of IRs demonstrate that without hikes on local fees segment’s revenues would slightly decline. Roaming fees in Russia and the CIS reduced, no cuts for 2011. In fall 2010 the Russian Federal Antimonopoly Service (FAS) forced the Big-Three to voluntarily reduce tariffs on roaming in the CIS since October 2010 and within Russia from December 2010. Operators, in our view, will lose no more than 1.5% of sales since 2011 and bear a very slight deterioration in margin (FAS estimated a 60% OIBDA margin from roaming services). Growing usage of roaming will offset the dramatic drop in roaming prices. The authorities were comfortable with the reductions the Big-Three made and promised to charge as low as practicable 1% of last-year revenues from the service, just about $9 mn from the Big-Three in total. Therefore, threat of further cuts in price in 2011 seems immaterial. FAS intends to make mobile operators introduce per-second tariffs on roaming calls in 2011. If the changes come into effect, we estimate a minor 0.5% deterioration of MTS total sales since transparent roaming fees will make mobile users more relaxed when consuming the service, so the rise in roaming usage will abate reduction in price.

Vim pelCom Ltd has m ore operations abroad Mobile revenues breakdow n in 2011, % MTS

Vim pelCom Ltd

Russia

78.6

72.0

CIS

21.4

27.7

SEA

0.3

Source: TKB Capital estimates

Sound OIBDA m argins Total OIBDA m argin, % MTS

VimpelCom Ltd

Rostelecom

PROS New additions in the CIS are not over. The CIS countries (not taking into account Ukraine) are still underpenetrated, that opens up an opportunity for further advance. As of the end of 2009 mobile penetration in the majority counties stood below 80% versus 98% in the emerging markets. MTS and VimpelCom Ltd hold leading positions there. We estimate that in 2011 MTS and VimpelCom Ltd will get in the CIS 21% and 28% the total mobile revenues, accordingly. For 2011 we project a 7% y-o-y increase of mobile subscribers in the CIS accompanied by 10% y-o-y growth in dollar revenues.

60 50 40 30 20 10 0 2009

2010E

2011E

2012E

2013E

Rosy margins compared to international peers. Our forecast of 2011 total OIBDA margins for MTS and VimpelCom Ltd is 43.6% (down 0.8 ppt) and 46.6% (down 0.9 ppt), respectively. Somewhat the lower margin for MTS is explained by non-profitable retail business. On the global basis, operators in the developed markets posted a 41% OIBDA margin in 2009. In case of Rostelecom, we see a 2011E OIBDA margin at 38% what is decent for the provider of mostly fixed-line facilities. A strict policy on cash costs at IRs in 2010 confirms this point.

Source: companies data, TKB Capital estimates

STRATEGY 2011

59


Telecoms Growing beyond traditional mobile services to unlock more value

High FCF from established markets. Mobile markets of Russia and Ukraine generate high cash flows to provide modernization and enter new markets. MTS makes 82% of its total FCF in Russia, and 11% in Ukraine. This trend will prevail in the future despite raised capex for 3G services and fixed-line infrastructure update. Attractive valuation in the sector. Both MTS and VimpelCom Ltd are trading with discounts on multiples to emerging market peers. 2011E EV/EBITDA of MTS is 4.3, 18% its emerging market peers. MTS’ 2011E P/E of 10.3 is also 18% below company’s peers median. VimpelCom Ltd’ P/E multiples are 14% off than MTS’ arising from uncertainty regarding the acquisition of Weather Investments. Rostelecom is valued broadly on par with its international analogues at this time.

Cash generating m achine OCF, Capex and FCF at MTS, $ bn OCF

Capex

FCF

6 5 4

Determined dividend policy. Russian telecoms are largely dividend distributing companies. The track record of dividend payments lasts several years and was not interrupted by the economic crisis (not a VimpelCom Ltd’ case). Since 2005 MTS is committed to pay out at least 50% of net income implying a dividend yield of 4.9% in 2011 for ADRs and 6.3% for locals. VimpelCom Ltd introduced payment of 50% of free cash flow from Russian and Ukrainian operations. That will result into a 3.7% yield next year. The new management of Rostelecom has indicated on the dividend payout ratio of 20% for commons (up from 15% in IRs).

3 2 1 0 2009

2010E

2011E

2012E

2013E

Source: company data, TKB Capital estimates

CONS Fixed-line BB ARPU under pressure with rising competition. Presence of tens players in the market drastically impacts monthly payments. In regions Comstar recorded a 10% y-o-y decline in residential ARPU in 3Q10. Consequently, we believe this dynamics will persist and ARPU will go down 5% y-o-y for the full 2011. However, new additions (penetration of broadband is to go up impressive 11 ppt y-o-y to 38%) enhance sales from broadband fixed.

Stiff value asked for telecoms targets. Current prices of telecoms assets considerably exceed valuation of bidders what reduces a return on investments. For instance, In July 2010 MTS acquired Multiregion at 2009 EV/EBITDA of around 13 (including a minority stake). Shareholders of Akado (provides services in saturated market in Moscow) demand Rostelecom to pay 2009 EV/EBITDA of 10-12 for the asset. Baring Vostok agreed on 2009 EV/EBITDA valuation of 16 for ER-Telecom which demonstrates the highest rates of growth in the Internet subscriber base.

60

STRATEGY 2011

Penetration, % (RHS)

40

70

40

0

30 2013E

10 2012E

50

2011E

60

20

2010E

30

2009

Limited potential in pay-TV services. High penetration of pay-TV facilities (already above 50%) and introduction of digital multiplexes by the state dwarf further increase in customer base. Upside potential in revenues growth is bounded by a narrow base of new customers as well as ARPU deterioration. For 2011-12 a number of new subscribers will come high (11% y-o-y to 35 mn). For 2013-15 an average growth rate is forecast at more moderate 2% y-o-y ending 2015 with 38 mn pay-TV subscribers. Overall, segment’s revenues are to rise 7% y-o-y in 2011-12 and stay flat in 2013-14.

Users, mn (LHS)

2008

Large capex wanted to keep pace with peers in VAS market. For the Big-Three, we estimate a capex-to-sales of around 20% needed for infrastructure update. The amount of investment program is unavoidable for needs of 3G services expansion in regions and modernization of last-mile access to the end consumers. This investment program is permissible for Russian telecoms operators which Capex/OCF ratio is above 0.6.

Grow th to slow only after 2012 Pay-TV custom er base and penetration in Russia

Source: ComNews Research, TKB Capital estimates


Telecoms Growing beyond traditional mobile services to unlock more value

Russian telecoms comparative valuation Company

Country

MCAP

EV

$ mn

$ mn

P/E

EV/EBITDA

2009 2010E 2011E 2012E

EV/S

2009 2010E 2011E 2012E

2009 2010E 2011E 2012E

Russia MTS

Russia

20,398

24,386

20.4

11.7

10.3

9.5

5.5

4.8

4.3

4.0

2.5

2.1

1.9

1.8

VimpelCom Ltd

Russia

19,459

23,485

17.4

11.4

8.9

8.5

5.5

4.7

4.2

4.0

2.7

2.2

2.0

1.8

Rostelecom

Russia

14,718

18,437

18.0

14.3

14.4

11.4

5.7

5.6

5.3

5.3

2.1

1.9

2.0

1.9

18.0

11.7

10.3

9.5

5.5

4.8

4.3

4.0

2.5

2.1

2.0

1.8

Premium (discount) to EM peers

6%

-16%

-18%

-19%

-16%

-11%

-18%

-20%

9%

1%

-1%

0%

Premium (discount) to DM peers

31%

3%

-11%

-12%

-3%

-14%

-20%

-24%

28%

8%

3%

2%

Median

Em erging m arket peers China Unicom

China

America Mov il

Mexico

Orascom Telecom

Egy pt

Philippine LD

Philippine

34,895

44,474

24.9

51.1

31.2

21.4

5.1

4.9

4.4

3.9

2.0

1.8

1.6

1.5

114,271

131,142

20.0

15.6

13.8

12.9

11.2

7.1

6.5

6.2

4.5

2.9

2.7

2.6

3,893

7,984

11.7

6.3

8.9

7.2

3.4

4.2

4.0

3.8

1.6

1.8

1.7

1.6

10,800

12,350

12.9

11.5

11.3

11.0

6.4

6.3

6.2

6.2

4.0

3.7

3.6

3.5 1.7

Telkommunnikacija polska

Poland

7,287

8,667

17.6

17.5

16.7

15.3

4.2

4.9

4.5

4.6

1.6

1.7

1.7

Carso global telecom

Mexico

17,972

31,940

15.1

-

-

-

5.7

5.4

5.3

-

2.1

1.9

1.8

-

Chunghwa telecom

Taiwan

24,239

22,164

18.3

15.4

15.4

15.2

8.0

7.3

7.3

7.3

4.0

3.4

3.4

3.4

Singapore Telecom

Singapore

37,217

41,059

15.5

13.2

12.6

11.7

13.3

10.4

9.2

8.7

4.0

3.4

3.0

2.9

Magy ar Telekom

Hungary

2,560

4,139

6.6

9.5

10.2

9.6

3.3

3.8

4.0

4.0

1.3

1.4

1.5

1.4

Turkcell

Turkey

14,751

13,356

13.3

12.5

11.6

10.6

7.0

6.9

6.3

5.7

2.3

2.3

2.2

2.0

Mobinil

Egy pt

2,805

3,721

7.6

10.8

11.3

9.9

4.0

4.8

4.6

4.3

1.9

2.0

1.9

1.8

MTN

South Af rica

36,477

37,238

20.7

13.9

11.5

10.1

6.7

5.2

4.7

4.3

2.8

2.2

2.0

1.8

Telekom Malay sia

Malay sia

4,050

4,813

22.2

20.4

21.6

20.3

5.6

5.1

5.0

4.8

2.0

1.7

1.7

1.6

Adv anced inf o serv ice

Thailand

8,570

8,984

17.2

12.8

12.3

11.5

6.7

5.4

5.3

5.2

3.0

2.5

2.4

2.4

Bharti Airtel

India

29,109

29,318

16.9

14.4

19.4

15.3

8.7

8.1

6.6

5.4

3.6

3.3

2.3

1.9

Viv o Participacoes S.A.

Brazil

17,042

18,489

39.2

20.8

15.9

13.3

7.0

5.6

5.3

5.0

2.2

1.8

1.7

1.6

17.1

13.9

12.6

11.7

6.5

5.4

5.3

5.0

2.3

2.1

2.0

1.8

12.6

12.5

11.9

4.5

4.9

5.0

5.0

1.4

1.5

1.6

1.6 1.7

Median

Developed m arket peers Deutsche Telekom

Germany

55,307

125,826 112.4

France Telecom

France

55,578

101,284

13.3

8.3

9.0

9.0

4.8

4.9

4.9

5.0

1.6

1.7

1.7

Tele2

Sweden

9,143

9,490

15.4

10.5

11.5

10.3

7.9

6.2

5.9

5.3

1.8

1.6

1.6

1.5

Verizon

US

99,446

193,348

27.2

15.9

15.6

14.1

5.4

5.6

5.4

5.2

1.8

1.8

1.8

1.8

Portugal Telecom

Portugal

11,479

12,822

12.0

23.8

13.9

12.3

3.9

5.5

4.8

4.4

1.4

2.1

1.8

1.7

Belgacom

Belgium

11,317

13,709

9.0

11.0

11.1

11.2

4.8

4.9

5.4

5.4

1.7

1.6

1.6

1.6

OTE

US

4,095

11,238

7.3

10.2

9.2

8.1

3.6

4.4

4.6

4.5

1.3

1.5

1.6

1.6

Swisscom

Switzerland

22,678

32,267

12.7

11.7

11.2

11.1

8.0

6.7

6.6

6.6

2.9

2.6

2.6

2.6

Telecom Italia

Italia

23,746

75,538

10.8

7.9

7.7

7.3

4.9

5.1

4.9

4.9

2.0

2.1

2.1

2.0

Telef onica

Spain

104,251

191,303

9.6

8.7

9.1

8.8

6.1

5.9

6.1

5.9

2.4

2.4

2.3

2.2

Telenor

Norway

26,249

31,378

19.0

13.1

12.0

10.3

5.8

6.6

6.1

5.6

2.0

2.0

1.9

1.8

AT&T

US

172,158

238,177

13.7

11.1

11.5

10.8

5.8

5.6

5.3

5.1

1.9

1.9

1.9

1.9 2.2

Qwest communications

US

13,384

24,396

20.2

28.2

18.7

18.2

5.7

5.6

5.7

5.7

2.0

2.1

2.1

Telus

Canada

14,573

20,519

16.6

14.1

12.6

11.5

6.3

5.7

5.5

5.3

2.4

2.1

2.1

2.0

Teliasonera

Sweden

35,359

43,786

14.3

11.4

11.0

10.5

9.4

8.0

7.9

7.7

3.0

2.8

2.8

2.7

13.7

11.4

11.5

10.8

5.7

5.6

5.4

5.3

1.9

2.0

1.9

1.8

Median

Source: Bloomberg, TKB Capital estimates

STRATEGY 2011

61


Telecoms Growing beyond traditional mobile services to unlock more value

MTS / Comstar-UTS Safe investment case in telecoms MTS is our top pick in the sector for a large cash influx from the Russian-largest mobile subscriber base and constant search for additional value creation. The company holds 32% of the total customers in Russia and is successful competing in regional markets with MegaFon and Tele2 Russia. It is one of three companies which received frequency spectrum for 3G services and rolled up sterling networks. Our optimism arises around the stock from company’s superior growth prospects in the mobile market and continuing expansion into the broadband market. A merger with Comstar in 1H11 on the operating level makes possible to promote all-round telecoms facilities and save on equipment procurement and SG&A expenses. The stock is undervalued on multiples and gives a 65% upside potential from its current market level to our target price of $14 per local share. The target price is $28 for ADRs. Comstar is our preferred way to enter the capital of MTS. At the expense of lock-up period in April, buying Comstar GDRs and converting them into MTS locals unlocks 8% value versus a direct purchase of MTS locals.

MTS Ticker Recommendation Price, $ Target price, $ Upside/downside, %

Common MTSI BUY 8.48 14.0 65%

ADR MBT BUY 20.47 28.0 37%

SHARE DATA Bloomberg Reuters

MTSI RX MTSI.MM

MBT US MBT.N

9.42 6.91

997 24,386 20,398 17.84 23.33

# of ADR outstanding, mn EV, $ mn MC, $ mn MIN 12 mnth., $ MAX 12 mnth., $ Shares per ADR

2

PROS Mobile 3G data traffic is a key catalyst. For MTS’ active users of 3G phones we see a three-fold increase between 2010 and 2013 to 100 MB per month. In 2013, 3G mobile Internet sales will top $1.2 bn and constitute 12% of the total mobile revenues in Russia. MTS VAS share to rise from 19% to 31% in 2010-13. The share of VAS (data traffic, content and texting) in ARPU, in our estimates, will demonstrate a riot growth on the back of proliferation of active users of 3G phones and USB devices. Mostly thanks to data traffic, VAS share is forecast to add in 2011 3 ppt y-o-y to 22% and reach 31% by the end2013. Attracting broadband clients in small towns. We anticipate MTS in 2011-13 to post a 140% rise to 2.9 mn in fixed-line broadband subscribers (along with Comstar) and a 185% growth to 3.7 mn in USB modems. In revenue terms, segment’s sales will double and account for $0.8 bn.

SUMMARY FINANCIALS, $ mn US GAAP 2010E 2011E Rev enue 11,447 12,923 EBITDA 5,078 5,636 Net income 1,749 1,987 EPS, $ 1.75 1.99 Rev . growth, % 16.1 12.9 EPS growth, % 75.2 13.6 EBITDA margin,% 44.4 43.6 Net margin, % 15.3 15.4 SUMMARY VALUATIONS 2010E P/E 11.7 EV/EBITDA 4.8 PRICE DYNAMICS 26

MBT

2011E 10.3 4.3

2012E 13,928 6,030 2,157 2.16 7.8 8.6 43.3 15.5

2012E 9.5 4.0

RTS

23

New addition in the CIS markets. Mobile penetration in the CIS countries, apart from Ukraine, is still low and provides a large room for organic growth. Penetration stays in the range from 41% to 86% there versus 98% in EM countries. A significant market share of MTS (from 45% in Uzbekistan to 85% in Turkmenistan) will secure the realization of this potential. Stable dividend distribution. Under a conservative dividend payout ratio of 50% in 201013 shareholders may receive a 4.9% dividend yield on average for ADRs and 6.3% for locals. CONS Corporate actions in MTS under influence by parent AFK Sistema. The board of directors of MTS agreed to acquire Sistema Telecom from AFK Sistema for $379 mn implying a payback period of more than 10 years. In 2011 AFK Sistema intends to sell 28% ordinary (23% of the total) shares in MGTS to MTS. The price guideline stays unknown, but we assume a premium to $330 mn value paid by Sistema. Threat of higher capex. MegaFon’s outperformance in the mobile data traffic market was promoted by a large investment program in the last couple of years. MTS may try to surpass the competitor scaling up capex. Adoption of a clear mechanism of conversion of 790-860 MHz waveband for LTE will force MTS to adjust investment upwards, too MTS is prescribed to halt operations in Turkmenistan. The Ministry of Communications of Turkmenistan has ordered to suspend licenses for one month since December, 21 2010. Under the worst case scenario (MTS will loss business in Turkmenistan), we estimate a 2% loss of fair equity value.

62

STRATEGY 2011

20 17 22.12.09

22.3.10

22.6.10

22.9.10

Source: Bloomberg, TKB Capital estimates

22.12.10


Telecoms Growing beyond traditional mobile services to unlock more value

MTS / Comstar-UTS BALANCE SHEET $ mn

2009

2010E

2011E

2012E

2013E

2014E

2015E

TOTAL CURRENT ASSETS

4,390

4,464

4,297

4,566

5,355

6,649

8,235

PP&E, net

7,749

7,754

8,330

8,007

8,156

7,972

7,564

Other non-current assets

3,611

2,868

3,074

3,069

3,268

3,452

3,610

TOTAL NON-CURRENT ASSETS

11,359

10,623

11,404

11,077

11,425

11,424

11,174

TOTAL ASSETS

15,749

15,086

15,702

15,642

16,779

18,073

19,409

Short-term borrow ings

2,022

2,407

2,270

1,949

1,820

1,748

1,706

Other short-term liabilities

2,256

2,238

2,283

2,189

2,233

2,278

2,308

TOTAL CURRENT LIABILITIES

4,279

4,645

4,553

4,139

4,053

4,026

4,015

Long-term borrow ings

6,327

4,620

4,116

3,633

3,528

3,496

3,481

Other non-current liabilities TOTAL LONG-TERM LIABILITIES TOTAL EQUITY TOTAL EQUITY & LIABILITIES

711

702

714

682

693

704

711

7,037

5,322

4,830

4,315

4,221

4,200

4,193

4,433

5,120

6,318

7,189

8,506

9,847

11,201

15,749

15,086

15,702

15,642

16,779

18,073

19,409

INCOME STATEMENT $ mn

2009

2010E

2011E

2012E

2013E

2014E

2015E

Revenue

9,857

11,447

12,923

13,928

14,671

15,642

16,496

(5,388)

(6,369)

(7,288)

(7,897)

(8,384)

(9,025)

(9,591)

4,469

5,078

5,636

6,030

6,287

6,617

6,904

D&A

(1,844)

(1,926)

(2,243)

(2,459)

(2,621)

(2,847)

(3,002)

EBIT

2,539

3,152

3,392

3,571

3,667

3,770

3,902

Net interest income/(expenses)

(468)

(647)

(554)

(490)

(447)

(433)

(427)

EBT

1,482

2,506

2,838

3,081

3,219

3,337

3,476

Income tax

(504)

(556)

(624)

(678)

(708)

(734)

(765)

998

1,749

1,987

2,157

2,254

2,336

2,433

2009

2010E

2011E

2012E

2013E

2014E

2015E

Cash costs EBITDA

Net incom e CASH FLOW STATEMENT $ mn Net CF from operating activities

3,596

3,630

4,181

4,567

4,825

5,132

5,382

Net CF from investing activities

(2,385)

(1,324)

(2,843)

(2,646)

(2,788)

(2,659)

(2,639)

Net CF from financing activities Net Debt

148

(2,235)

(1,635)

(1,507)

(1,385)

(1,335)

(1,292)

5,621

4,260

3,872

2,776

1,838

530

(1,032)

2015E

RATIOS %

2009

2010E

2011E

2012E

2013E

2014E

Revenue grow th

(17)

16

13

8

5

7

5

EBITDA margin

45.3

44.4

43.6

43.3

42.9

42.3

41.9

Net margin

10.1

15.3

15.4

15.5

15.4

14.9

14.7

1.3

0.8

0.7

0.5

0.3

0.1

neg

Net Debt/EBITDA Source: company data, TKB Capital estimates

STRATEGY 2011

63


Telecoms Growing beyond traditional mobile services to unlock more value

VimpelCom Ltd Risks priced in, good fundamentals to hardly fulfill themselves in 1H11 VimpelCom Ltd offers greater exposure to the growing telecoms markets in the CIS than MTS or MegaFon. VimpelCom Ltd is strongly committed to turn into a global telecom operator for fair and is moving forward with acquisition of Weather Investments which owns operations in Italy, Asia, and Africa, becoming the fifth largest mobile operator in the world by number of customers. Russia and a majority of countries in the CIS are pure cash generators for the company. VimpelCom Ltd has all means to bring to the end net outflow of customers in Russia and keep pace with MegaFon in mobile Internet segment. VimpelCom LTd’s 18% discount on 2011E P/E to MTS’s multiples reflects M&A risks arising from nationalization of Djezzy, Algeria’s mobile asset, and insistent willingness to acquire mobile assets abroad (e.g. Telekom Srbija). Meanwhile company’s fundamentals are strong and downside risks look limited. If VimpelCom Ltd rejects to acquire Weather Investments, we see a 12-month target price of $22/share. In the case of nationalization of Djezzy, the target price depends on the price paid for the asset, valuation varies from $2.5 bn to $7.8 bn. Should the Algerian state start nationalization of Djezzy, market price of VImpelCom Ltd will barely recover in 1H11 being under pressure of new corporate conflict between Altimo and Telenor. PROS Strong cash flows from the major market. Voice pricing in Russia remains stable and we expect VimpelCom Ltd to record an average 46% OIBDA margin in 2011-13. Early stage of development of mobile broadband services. Mobile penetration of USB modems (12%) and active 3G mobile (6%) in Russia remains low. We expect mobile broadband revenues to account for 20% of VimpelCom Ltd’s total sales in Russia by 2012. Leadership in most of markets abroad. Currently VimpelCom Ltd is the number one or two mobile player in the majority of CIS markets. Mobile operators in Africa and Asia acquired by VimpelCom Ltd from Weather Investments also hold large market shares in terms of subscribers. Defined dividend policy gives 3.7% dividend yield in 2011. Distribution of 50% FCF from Russia and Ukraine implies a 3.7% dividend yield next year, however DpS will be reduced by 20% if the purchase of Weather Investments occurs. CONS Target Weather Investments valued at stiff 7.7 EV/LTM EBITDA. The target is valued at high EV/LTM EBITDA of 7.7, 50% above EV/LTM EBITDA at VimpelCom Ltd and 13% above EV/LTM EBITDA on the merger with Kyivstar). Net debt/LTM EBITDA to grow to 2.5 from 0.8. Following the merger, VimpelCom Ltd’ net debt will rise from $4.0 bn to $24 bn. The company expects to generate only $1.5-3.0 bn as redemption capacity implying a payback period more than 10 years. Necessity to raise capex to 3G services. MegaFon has consistently been the most aggressive player for some time in investing in 3G coverage expansion in attempts to raise market share. To match with MegaFon, Vimpelcom Ltd will be tempted to increase its investing program.

64

STRATEGY 2011

VimpelCom Ltd ADR VIP UR 14.94 -

Ticker Recommendation Price, $ Target price, $ Upside/downside, % SHARE DATA Bloomberg Reuters

VIP US VIP.N

# of shares outstanding, mn EV, $ mn MC, $ mn MIN 12 mnth., $ MAX 12 mnth., $

1,302 23,485 19,459 13.96 19.01

SUMMARY FINANCIALS, $ mn US GAAP 2010E 2011E Rev enue 10,520 12,039 EBITDA 4,996 5,611 Net income 1,704 2,179 EPS, $ 1.31 1.67 Rev . growth, % 20.9 14.4 EPS growth, % 52.2 27.9 EBITDA margin,% 47.5 46.6 Net margin, % 16.2 18.1

2012E 12,780 5,923 2,288 1.76 6.2 5.0 46.3 17.9

SUMMARY VALUATIONS 2010E P/E 11.4 EV/EBITDA 4.7

2012E 8.5 4.0

2011E 8.9 4.2

PRICE DYNAMICS 150

VIP

RTS

125 100 75 50 22.12.09 22.3.10

22.6.10

22.9.10 22.12.10

Source: Bloomberg, TKB Capital estimates


Telecoms Growing beyond traditional mobile services to unlock more value

VimpelCom Ltd BALANCE SHEET $ mn

2009

2010E

2011E

2012E

TOTAL CURRENT ASSETS

2,967

3,115

3,728

4,717

6,238

8,373

10,885

PP&E, net

5,562

8,252

9,317

9,704

10,075

10,207

10,176

Other non-current assets

2013E

2014E

2015E

6,204

7,643

8,149

8,076

7,979

7,867

7,753

Total NON-CURRENT ASSETS

11,766

15,895

17,466

17,780

18,054

18,074

17,929

TOTAL ASSETS

14,733

19,010

21,194

22,497

24,292

26,447

28,814

Short-term borrow ings

1,813

1,794

1,542

1,178

881

655

486

Other short-term liabilities

1,601

1,785

1,909

1,897

1,878

1,859

1,842

Total CURRENT LIABILITIES

3,414

3,578

3,451

3,075

2,759

2,514

2,328

Long-term borrow ings

5,540

5,579

4,460

3,311

2,450

1,813

1,343

761

1,200

1,263

1,234

1,200

1,167

1,135

6,301

6,779

5,722

4,545

3,649

2,980

2,479

Other non-current liabilities Total LONG-TERM LIABILITIES Total EQUITY TOTAL EQUITY & LIABILITIES

5,018

8,653

12,021

14,877

17,884

20,952

24,008

14,733

19,010

21,194

22,497

24,292

26,447

28,814

2009

2010E

2011E

2012E

2013E

2014E

2015E

INCOME STATEMENT $ mn Revenue Cash costs

8,703

10,520

12,039

12,780

13,383

14,131

14,739

(4,430)

(5,524)

(6,428)

(6,857)

(7,241)

(7,730)

(8,134)

4,273

4,996

5,611

5,923

6,142

6,401

6,605

D&A

(1,694)

(2,181)

(2,477)

(2,667)

(2,681)

(2,708)

(2,779)

EBIT

2,539

2,849

3,342

3,363

3,359

3,409

3,445

EBITDA

Net interest income/(expenses)

(547)

(664)

(548)

(430)

(322)

(238)

(176)

EBT

1,551

2,185

2,794

2,933

3,037

3,171

3,269

Income tax

(435)

(481)

(615)

(645)

(668)

(698)

(719)

Net incom e

1,120

1,704

2,179

2,288

2,369

2,473

2,550

$ mn

2009

2010E

2011E

2012E

2013E

2014E

2015E

Net CF from operating activities

3,513

4,475

5,263

5,791

6,111

6,269

6,410

Net CF from investing activities

(1,433)

(2,737)

(3,196)

(3,392)

(3,454)

(3,227)

(3,131)

Net CF from financing activities

(1,545)

(1,893)

(1,701)

(1,389)

(1,055)

(783)

(580)

5,906

4,482

4,094

2,998

2,060

752

(810)

2009

2010E

2011E

2012E

2013E

2014E

2015E

CASH FLOW STATEMENT

Net Debt RATIOS % Revenue grow th

(14)

21

14

EBITDA margin

49.1

47.5

46.6

46.3

45.9

45.3

44.8

Net margin

12.9

16.2

18.1

17.9

17.7

17.5

17.3

1.4

0.9

0.7

0.5

0.3

0.1

neg

Net Debt/EBITDA

6

5

6

4

Source: company data, TKB Capital estimates

STRATEGY 2011

65


Telecoms Growing beyond traditional mobile services to unlock more value

Rostelecom Examining the operational strength Rostelecom

The first stage of Svyazinvest restructuring is set to be completed in March-April, 2011 with the consolidation of inter-regional telecoms around Rostelecom. Following the settlement of transactions, the market will put operations of the united provider under close examination. Decline in the volume of fixed-line voice services (mostly in ILD and DLD calls) along with the absence of nation-wide coverage of mobile network is negative point for investors. We are neutral regarding Rostelecom ordinary shares which are valued at par with its international peers. A cheap entry ticket to the united Rostelecom through shares of IRs still exists. However, a single digit potential remains at the cost of a halt in trading (from 14 to 44 days). Potential valuedestructive purchases of assets are not good for the market’s perception. We expect narrowing spreads between Rostelecom prefs and ordinary shares and reiterate our BUY recommendation of Rostelecom prefs with a target price of $3.3/share.

Common RTKM HOLD 4.78 4.1 -14%

Ticker Recommendation Price, $ Target price, $ Upside/downside, %

Pref erred RTKMP BUY 2.67 3.3 23%

SHARE DATA Bloomberg Reuters

RTKM RX RTKMP RX RTKM.MM RTKMP.MM Common Pref erred # of shares outstanding, mn 2,943 243 EV, $ mn 18,437 MC, $ mn 14,718 MIN 12 mnth., $ 3.02 2.03 MAX 12 mnth., $ 5.36 3.44

PROS High potential for broadband additions in towns with population under 100,000. Rostelecom has a vast potential to expand in small towns avoiding tough competition with the altnets in spite of competing with alternative providers (altnets) like Comstar-UTS. For 2011 we project a 40% y-o-y growth in a number of total broadband customers to 21 mn. As of the end of 9M10, the new Rostelecom had 40-90% market share in the regional markets with 6 mn subscribers in total (43% share of Russian wire-line broadband market). Hikes on local service essential for Rostelecom. While fixed voice remains the dominant revenue source for Russian fixed line incumbents, the cap price on local calls allowed by the Russian Tariff Service are very favourable for the company. For 2011 the tariff was raised by 8.8% on average and should result in a 3% increase of the total sales. Inclusion of the ordinary shares into MSCI Index. We believe that the inclusion of the ordinary shares of the united Rostelecom into MSCI Index in summer 2011 will spark liquidity in the trading.

SUMMARY FINANCIALS, $ mn IFRS 2010E Rev enue 9,591 EBITDA 3,297 Net income 1,029 EPS, $ 0.35 Rev . growth, % 8.3 EPS growth, % 26.0 EBITDA margin,% 34.4 Net margin, % 10.7

2011E 9,198 3,473 1,020 0.35 -4.1 -0.8 37.8 11.1

2012E 9,545 3,504 1,287 0.44 3.8 26.2 36.7 13.5

SUMMARY VALUATIONS 2010E P/E 14.3 EV/EBITDA 5.6

2011E 14.4 5.3

2012E 11.4 5.3

PRICE DYNAMICS RTKM

11

RTS

8

CONS 5

Low liquidity may remain for three months after restructuring. It is not clear yet whether Rostelecom will make several issues (16 for all IRs) or only one. Right after the beginning of trading in the new Rostelecom, trading volumes may remain low, since large investors will stay unable to accumulate large stakes within one issue of shares. Over three months different share issues are trading separately on MICEX post their listing. Broadband ARPU deterioration. We expect broadband ARPU of $5/month in 2013 among mass market subscribers, three times lower than current monthly payments in IRs. This is due to the fierce competition in the internet broadband market in large cities. May be forced to acquire a stake from ADI. Rostelecom has agreed to purchase 10% of its shares from VEB granting the state bank the option to sell these shares between mid2013 and mid-2014 at a price of RUR230/share (57% above the current price) plus 7.7% interest accrued from July 2010. 30% of pre-merger Rostelecom is owned by the Agency for Deposit Insurance. If Rostelecom agrees to buy back this stake for the same price, it will cost $1.5 bn out of the company.

2 22.12.09

22.3.10

22.6.10

22.9.10

22.12.10

Source: Bloomberg, TKB Capital estimates

Rostelecom occupies 40% of the m arket Fixed-line broadband subscriber base, %, end of 9M10 MTS

VimpelCom Ltd

United Rostelecom

Other 11.7

36.7

8.9

42.8 Source: ACM-Consulting, TKB Capital estimates

66

STRATEGY 2011


Telecoms Growing beyond traditional mobile services to unlock more value

KEY FINANCIAL INDICATORS $ mn

2009*

2010E*

2011E

2012E

2013E

Revenue

8,855

9,591

9,198

9,545

10,722

(5,630)

(6,293)

(5,725)

(6,041)

(6,862)

3,225

3,297

3,473

3,504

3,860

816

1,029

1,020

1,287

1,394

2009*

2010E*

2011E

2012E

2013E

7

8

(4)

4

12

36.4

34.4

37.8

36.7

36.0

9.2

10.7

11.1

13.5

13.0

Cash costs EBITDA Net incom e RATIOS % Revenue grow th EBITDA margin Net margin

* calculated on the sum-of-the-parts base, the new Rostelecom face a double account problem Source: Bloomberg, TKB Capital estimates

Reorganization to be done by May 2011 Tim e fram e of inter-regional telecom s and Rostelecom restructuring

Valuation Aug-09

Preparatory period

Mar-10

Sep-09

May -10

Jan-10

Corporate approvals

Jun-10

Issue of new Rostelecom shares

Jul-10

Corporate procedures

License reissue

Oct-10 Feb-11

Apr-10

Buyout of minorities

Debt restructuring

Current time

Mar-11

Sep-10

Sep-09

Aug-10

Jan-11

Jul-10

Feb-11

Apr-11

Feb-11

Mar-11

Source: Rostelecom

STRATEGY 2011

67


Telecoms Growing beyond traditional mobile services to unlock more value

AFK Sistema Portfolio of seasoned and long-range assets AFK Sistema

AFK Sistema shares offer exposure to a number of growing sectors in the Russian economy, including both domestic- and export-oriented. Since acquiring its oil assets, Sistema has become more diversified, with two strong sources of cash (telecoms and oil) to finance its development. AFK Sistema is set to benefit from improvements in domestic consumption as it has a presence in the consumer, banking and hi-tech sectors. Based on Sistema SOTP valuation which incorporates only Sistema’s trading assets, we see a 23% corporate holding discount (generally established discount for the holding is 25%). There is no difference when choosing between Sistema’s GDRs and local shares as current spread between GDRs and locals is in line with last 12-month average (29%). PROS Telecoms and Oil & Energy units generate stable cashflow. AFK Sistema receives dividends from well-developed and profitable business of MTS and Bashneft. A dividend payout ratio at MTS is set at not least 50%, but for 2010 the ratio was raised to 100%. No purchases of telecoms in Europe. The management is repeatedly reassuring that the company does not consider transactions similar VimpelCom Ltd’ entry to Europe, Asia and Africa. Bashneft gains more weight in Sistema’s total value. Sistema has streamlined BashTEK’s operations, creating an efficient vertically-integrated oil business, and won licence to develop Trebs and Titiov oil fields, the last deposit of this size in Russia left. The investment program may account for $5.5 - 6 bn. Consumer segment has good growth potential. Sistema’s consumer units businesses have strong market positions and are set to benefit from Russian economic growth in the long term.

Ticker Recommendation Price, $ Target price, $ Upside/downside, % SHARE DATA Bloomberg Reuters

Common AFKC UR 0.87 -

GDR SSA UR 24.81 -

AFKC RX AFKC.MM

SSA LI SSAq.L GDR 483 26,003 11,971 21.00 30.99

# of GDR outstanding, mn EV, $ mn MC, $ mn MIN 12 mnth., $ MAX 12 mnth., $

0.78 1.12

Shares per GDR

20

SUMMARY FINANCIALS, $ mn US GAAP 2010E 2011E Rev enue 28,528 29,834 EBITDA 7,702 8,229 Net income 1,165 1,475 EPS, $ 2.41 3.06 Rev . growth, % 52.2 4.6 EPS growth, % -29.1 26.7 EBITDA margin,% 27.0 27.6 Net margin, % 4.1 4.9

2012E 32,398 9,060 1,821 3.77 8.6 23.4 28.0 5.6

SUMMARY VALUATIONS 2010E P/E 10.3 EV/EBITDA 3.4

2012E 6.6 2.9

2011E 8.1 3.2

CONS Dividend absence. Sistema’s management is not ready to raise question on dividend policy until seeing several years of stable net income. For 2009 Sistema paid out just a nominal sum of dividends. SSTL’s prospects are not convincing. We are cautious regarding Sistema’s Indian mobile venture, given the high level of competition on the Indian mobiles market. SSTL may reach positive OIBDA in 2013, positive net income in 2014 and has to invest $2.5-2.7 bn by 2018. Sitronics’s borrowings do not decline. Sistema’s hi-tech business is struggling to repay its debt from operating cashflows and will likely depend on support from Sistema. Therefore Sistema mulls a merger of Sitronics and RTI Systems in order to reduce net debt/OIBDA ratio.

MTS Bashneft Sitronics Total Corporate net debt, $ mn Equity value, $ m n GDRs outstanding, mn Current price, $/GDR Market capitalization, $ mn Corporate holding discount, % Source: Bloomberg, TKB Capital estimates

68

STRATEGY 2011

MCAP, $ m n 20,398 8,842 153

AFKS

32

RTS

25 18 11 22.12.09

22.3.10

22.6.10

24.8 11,971 23

22.12.10

Source: Bloomberg, TKB Capital estimates

Telecom m unication sales dom inate

% attr. to Sistem a 53 73 64

MCAP attr. to Sistem a, $ m n 10,811 6,455 98 17,364

Telecommunications

Oil and Energy

Consumer

Other 10

5

1,900 15,464 482.5

22.9.10

Revenues breakdow n by segm ent in 3Q10, %

Sistem a SOTP Valuation based on trading assets Assets

PRICE DYNAMICS

49 36

Source: company data


Telecoms Growing beyond traditional mobile services to unlock more value

Sector dynam ics vs. RTS in 2010 22.12.2010

Max

Min

RTS

CTCM

RBCI

MAIL

-50%

0%

50%

100%

Set to expand 16% in 2011 Russian advertising m arket, RUR bn 500 400 204

232

316 270

364

413

464

200 100

2015E

2014E

2013E

2012E

2011E

2010E

0 2009

Buying exposure on macro story Macroeconomic situation is propitious to continuing growth in the media sector. Real income and retail prices growth, consumer confidence incite advertising demand. Total Russian advertising market is to grow 14% y-o-y in 2011 (the economy is set to advance 13% y-o-y in nominal price), with the highest growth rate in Internet (30% y-o-y) and TV (17% y-o-y) segments. Growth of Internet advertising is forecast at impressive 20% on average in 2012-15. TV is a very attractive bet on the economy in the mid-term. Cost of delivery is low on the global basis expanding margins for media companies. Going forward, legislatures approved payroll tax benefits for 2011-14 giving privilege to mass media business. We like CTC Media’s exposure to the fast growing market and advice making a bet on the sector buying this stock. ENVIRONMENT

Source: Bloomberg

300

Media

Source: Video International, TKB Capital estimates

TV to occupy m ore than 50% of the m arket

Radio

Press

Outdoor

Internet

Other

Reshaping of sales house landscape very likely ran smoothly. The legislation adopted in 2009 limits contracts with media sale houses’ power to 35% share of TV market. For Moscow operations CTC Media has established an own in-house agency which signed a 5-year contract to cooperate with Video International (VI). Digital multiplexes include CTC Media’s channels. All CTC Media’s channels are recommended for inclusion in the second multiplex meaning no threat CTC Media will be off-line on the federal level since 2016. IPOs of UTV and ProfMedia are slated on 2011. UTV and ProfMedia may attract funds for development in 2011, expanding the list of names for investment in the sector.

Russian advertising m arket breakdow n by segm ents TV

Pricing environment in TV improving since mid-2010. Companies raised demand on TV advertising already in late spring of 2010 outpacing the outlook of selling houses and booked all advertising time on some channels till the end of the year. CTC Media’s prices for 4Q10 were up 20% y-o-y, RBC announced a 10% increase in advertising prices for Internet starting from 1 January 2011.

PROS

100% 80% 60%

Bright perspectives of Internet segment. Internet advertising is gaining momentum from a very low base, since many advertisers see it as a cost-effective way to reach out to a premium base. The forecast from VI assumes above 20% y-o-y rise of Internet sales for 2011-13 backed by an increase in Internet penetration to 56% (now it stands at 40%). 2015E

2014E

2013E

2012E

2011E

2010E

40% 20% 0%

Source: Video International, TKB Capital estimates

Tax benefits for m ass m edia to be in place till 2015 Payroll tax rate in Russia, % General

Mass media

Bail out of RBC brings new name for investors. Process of financial debt restructuring process and legal reorganization of RBC is coming to the end. Apart from TV and press, the company offers entry to the most promising contextual advertising. Financial strength of CTC Media. We favor CTC Media the most in the Russian media universe. The company enjoys the debt free position, maintains margin of above 35% and is raising dividend payout ratio. CONS

40

Good fundamentals of CTC Media might have priced in. Given a solid year-to-date performance of CTC Media’ stock (64%) and multiples matched to international peers, a room for further appreciation of the stock is not large.

30 20 10 0 2010

2011

2012

2013

2014

2015

Increasing competition in well-established TV market. Audience shares of the largest Russian channels remain stable, so it seems complicated to outperform the market as the majority of players may easily allow more spending on programming.

Source: ConsultantPlus, Interfax

STRATEGY 2011

69


Telecoms Growing beyond traditional mobile services to unlock more value

Russian media sector comparative valuation Company

Country

P/E

EV/EBITDA

MCAP

EV

$ mn

$ mn

2009

2010E

2011E

2012E

2009

2010E

2011E

EV/S 2012E

2009

2010E

2011E

2012E

Russia CTC Media

Russia

3,525

3,378

35.1

24.6

18.4

14.2

9.2

15.4

11.5

9.1

6.7

5.7

4.5

3.7

Mail.Ru

Russia

7,204

7,034

42.7

90.4

47.2

33.0

434.5

66.7

36.0

25.8

47.4

22.9

16.4

12.7

RBC

Russia

202

396

1.8

Median Premium (discount) to EM peers Premium (discount) to DM peers

-

-

141.6

13.0

-

-

16.4

8.9

4.1

3.2

2.3

38.9

57.5

47.2

14.2

221.9

41.0

16.4

9.1

6.7

5.7

4.5

3.7

124%

317%

171%

-4% 2527%

462%

82%

8%

130%

134%

100%

78%

60%

258%

256%

23% 1882%

354%

118%

33%

262%

227%

166%

127%

Em erging m arket peers TV Azteca

Mexico

2,072

2,546

19.9

17.1

16.5

14.8

8.3

7.4

7.1

6.6

3.4

3.0

2.9

2.7

Central European Media

CEE

1,297

2,413

-

-

-

75.7

7.5

22.7

13.6

10.3

3.4

3.3

3.0

2.7

TVN

Poland

1,914

2,685

14.1

37.3

18.9

13.8

12.1

12.3

9.8

8.4

3.9

3.2

2.9

2.6

Naspers

South Af rica

23,205

24,632

35.1

35.9

23.7

18.5

35.6

27.2

20.8

17.5

8.0

6.5

5.1

4.6

Kagiso Media

South Af rica

329

327

17.4

13.6

11.2

10.2

8.6

6.7

6.1

5.7

3.4

2.6

2.3

2.2

Balaju Telef ilms

India

59

58

563.6

20.8

73.0

17.1

14.2

58.6

205.5

14.4

0.8

1.4

1.3

1.1

Workpoint

Thailand

79

71

37.0

13.8

11.2

8.7

15.0

7.2

6.2

5.2

2.4

1.7

1.5

1.4

TV Today Network

India

87

73

11.9

7.6

17.4

11.9

7.5

5.0

8.1

5.7

1.3

1.2

1.1

1.0

ZEE News

India

73

109

7.5

7.1

28.4

17.0

5.4

5.2

14.1

10.5

1.0

0.9

1.8

1.6

GMA Network

Philippines

533

513

Median

9.0

7.1

7.7

-

5.6

4.3

4.0

-

2.3

2.3

2.2

2.0

17.4

13.8

17.4

14.8

8.4

7.3

9.0

8.4

2.9

2.5

2.2

2.1

15.1

14.5

14.3

13.9

4.3

5.2

5.0

4.9

0.3

0.2

0.2

0.2

Developed m arket peers Canal+

France

TF1

France

CBS

US

844

634

3,782

3,804

23.7

20.1

15.1

13.0

12.7

9.9

7.5

6.7

1.2

1.1

1.1

1.0

13,340

18,805

58.9

17.9

14.2

11.8

10.3

7.9

7.3

6.6

1.4

1.3

1.3

1.3

ITV

UK

4,349

5,333

30.5

13.3

11.8

10.2

14.2

8.2

7.5

6.9

1.8

1.7

1.6

1.6

Time Warner

US

35,797

48,350

14.5

13.7

12.3

11.2

8.2

7.7

7.2

6.8

1.9

1.8

1.7

1.7 1.9

Antena 3

Spain

2,065

2,161

24.4

14.6

12.3

11.0

19.1

10.3

8.8

7.8

2.4

2.1

1.9

Mediaset

Italy

7,028

9,045

18.5

13.8

11.5

10.2

3.6

4.6

4.2

3.9

1.7

1.6

1.5

1.4

Gestev ision

Spain

3,813

3,925

56.4

18.3

11.6

9.9

9.7

13.5

9.0

7.5

4.5

3.4

2.6

2.4

RTL

Luxemburg

15,422

15,589

53.9

18.0

15.8

15.0

12.1

10.0

9.3

8.9

2.1

2.2

2.1

2.0

MTG

Sweden

4,414

4,914

-

17.5

14.2

12.1

19.9

13.4

11.4

10.0

2.6

2.2

2.2

2.0

24.4

16.0

13.3

11.5

11.2

9.0

7.5

6.8

1.8

1.8

1.7

1.6

Median

Source: Bloomberg, TKB Capital estimates

70

STRATEGY 2011


Telecoms Growing beyond traditional mobile services to unlock more value

Sector dynam ics vs. RTS in 2010 22.12.2010

Max

Min

RTS

ARMD

IBSG

SITR

-100%

0%

100%

200%

300%

IT Sector More names and niches to invest IT sector in Russia is nurturing in sales and a number of public names. With the support from the government, IT industry is gaining grounds supplying government agencies and corporates with programming solutions. Advance in PC and Internet penetration is advantageous for spending on all core segments – hardware, software and IT solutions. Two latter segments bring high margin and have been put under the scope by companies and the market. The light regime on payroll tax extended for these niches create positive momentum towards the sector. Today public names in the industry offer entry points into Russian vendors of software for the government and business needs, e-mail agents, instant messengers and social networks. Amid IT names, we pick out Armada for its debt-free position, ambitious strategy and a good record of sales and margins during the crisis. ENVIRONMENT

Source: Bloomberg

Russia to close gap in Internet usage Internet users in 2009, % of total population Finland Germany US Chezh Rep. Poland

Corporate budgets increase, but still stand below pre-crisis level. Feeling more certainty about the future, corporate clients are revising the spending on IT facilities upwards. At this point they gradually unfreeze projects postponed in 2008, but remain cautions when launching new massive initiatives.

Russia Brazil Ukraine Argentina 0

50

100

Source: ITU, TKB Capital estimates

On the recovery track Russian IT m arket, $ bn 25

20.4

20 12.3

15

More demand from private and government sectors. Private consumption on hardware and software solution is enormous source for sector’s formation. There are only 40 active users of Internet per 100 people in Russia versus 65 per 100 citizens in Central and Eastern Europe. Also, the state takes 35% of the total IT spending in Russia and is moving forward with programs aimed to develop IT industry.

18.7

15.0

16.9 13.1 14.1

Government support extended to 2020. The budget of the new state program “Information society” in 2011-13 is fixed 40% above spending in 2010. Since 2014 the program of financing per year will be enlarged by 3 times to RUR10 bn ($330 mn). The light payroll tax of 14% was set intact until 2017 (for Russian companies tax rate is 26% in 2011 and 34% since 2011). Round of IPOs is planned for 2011. More interest towards the sector should come in 1H11 when popular search engines Rambler (owned by ProfMedia) and Yandex.

10

PROS

5

2011E

2010E

2009

2008

2007

2006

2005

0

Highest growth rates in IT services and software segments. These segments are to demonstrate the most impressive performance thanks to gaining weight of adjusted- toclient-needs applications.

Source: PMR, TKB Capital estimates

Payroll rate sizeably decreased Russian IT Com panies' Payroll Taxes, RUR ths Pay roll tax

2009 2010 w/t changes 2011 w/t changes 2011-17 with changes

150 120

Profitability did not suffer greatly during the breakdown. Examples of Armada and IBS Group show that margin did not erode in the crisis on the back of wise control over costs. Healthy balance sheets. Best performing names are continuing to remain debt-free (Armada) or reduce borrowings (IBS Group). CONS Low liquidity. Market capitalization of public companies is relatively small resulting in wide spreads and difficulties to assembly large stakes.

90 60 30 0 100 200 300 400 500 600 700 800 9001000 Annual salary

Source: ConsultantPlus, TKB Capital estimates

Fragmented market, high competition. Top-50 IT companies in Russia occupy 57% of the total market what is low compared to international peers and leads to completion on price. Low transparency, delayed releases of reports. Companies are improving quality of their financial reports and operating results, however many of them are issued with a delay or do not include key data (e.g. margins and debt).

STRATEGY 2011

71


Telecoms Growing beyond traditional mobile services to unlock more value

Russian IT sector comparative valuation Company

Country

P/E

MCAP

EV

$ mn

$ mn

EV/EBITDA

2009 2010E 2011E 2012E

EV/S

2009 2010E 2011E 2012E

2009 2010E 2011E 2012E

Russia Armada

Russia

152

118

-

20.3

12.5

9.4

62.1

8.0

5.6

3.9

1.2

1.2

0.7

IBS Group

Russia

631

681

-

-

32.0

18.8

26.0

-

13.1

9.8

1.0

1.3

1.1

0.5 0.9

Sitronics

Russia

153

829

-

-

-

27.9

-

8.7

6.7

5.3

0.8

0.8

0.7

0.6

Median

-

20.3

22.3

18.8

44.0

8.3

6.7

5.3

1.0

1.2

0.7

0.6

Premium (discount) to peers

-

30%

76%

93%

387%

0%

-3%

-8%

-10%

27%

4%

-9%

International peers Sy gnity

Poland

LDK

China

First Deriv ativ es

UK

61

72

-

-

28.4

10.2

-

8.5

6.9

5.7

0.4

0.4

0.3

0.3

1,373

3,140

-

6.4

6.2

6.3

-

6.8

6.1

5.7

2.9

1.4

1.1

1.0

114

140

20.9

20.0

18.2

12.1

12.3

13.1

11.5

8.5

4.5

4.3

2.5

2.2 3.0

E-Credible

South Korea

72

59

25.6

18.5

12.7

10.7

16.1

-

-

-

6.4

4.6

3.6

Data Respons

Norway

87

90

-

62.5

12.9

9.6

-

26.1

8.2

6.5

0.8

0.8

0.6

0.6

Positiv o

Brazil

496

577

8.2

7.9

7.6

6.6

6.8

5.8

5.3

4.9

0.5

0.4

0.4

0.4

Endace LTD

New Zeland

2.0

TIVIT

Brazil

Patsy stems

UK

Connecta AB BOUVET ASA

83

82

30.4

32.6

39.9

30.4

11.7

17.1

13.6

11.5

2.7

2.6

2.3

995

1,066

28.7

15.9

12.6

-

11.5

8.3

7.0

-

2.3

-

-

-

73

59

13.8

143.7

129.1

98.1

7.6

-

-

65.2

1.7

1.7

1.6

1.4

Sweden

124

120

20.3

15.4

11.5

9.8

13.6

10.1

7.8

6.6

1.3

1.1

0.9

0.8

Norway

99

92

14.6

13.5

10.6

9.0

9.0

8.2

6.6

5.7

1.0

0.8

0.7

0.7

Osiatis

Belgium

110

115

10.0

8.8

8.3

8.0

5.7

5.0

4.5

4.2

0.4

0.4

0.3

0.3

Aubay

Belgium

90

90

16.2

10.6

8.5

7.6

6.8

5.1

4.1

3.8

0.4

0.4

0.4

0.3

Agrex

Japan

105

67

30.4

-

43.7

17.5

3.8

-

-

-

0.2

-

0.2

0.2

20.3

15.6

12.6

9.8

9.0

8.3

6.9

5.7

1.1

0.9

0.7

0.7

Median

Source: Bloomberg, TKB Capital estimates

72

STRATEGY 2011


Telecoms Growing beyond traditional mobile services to unlock more value

Armada Aimed to grow above the market Armada Common ARMD UR 12.64 -

Ticker Recommendation Price, $ Target price, $ Upside/downside, % SHARE DATA Bloomberg Reuters

We view Armada as the best choice on growth in the IT sector. Armada operates only in the domestic market and is presented in all major IT segments. Armada has a solid track of revenues growth and effectively introduced cost-reduction measures in fall 2008 followed by 6 ppt y-o-y improvement in 2009 OIBDA margin to 12%. The management issued solid guidance on the top line and margins for 2010-11, which seems feasible. Armada does not reject plans on making purchases that allows sales to outpace the total market. The stock is traded with a significant 19% discount to international peers in terms of 2011E EV/EBITDA.

ARMD RX ARMD.MM 12 118 152 6.49 12.64

# of shares outstanding, mn EV, $ mn MC, $ mn MIN 12 mnth., $ MAX 12 mnth., $

PROS Major orders come from state-controlled entities. Up to 75% of the total revenues come from contracts with Russian government agencies and state corporations serving reliable source of cash inflow.

SUMMARY FINANCIALS, $ mn IFRS 2010E Rev enue 132 EBITDA 15 Net income 7 EPS, $ 0.62 Rev . growth, % 28.1 EPS growth, % EBITDA margin,% 11.2 Net margin, % 5.7

2011E 161 21 12 1.01 21.9 61.9 13.0 7.5

2012E 218 30 16 1.35 35.3 33.3 13.8 7.4

SUMMARY VALUATIONS 2010E P/E 20.3 EV/EBITDA 8.0

2011E 12.5 5.6

2012E 9.4 3.9

Organic development of IT services and software… After purchases of assets in 2007, Armada owns a production chain including hardware, software and IT services branches. Currently the company relies broadly on high-margin IT services and software production. …And reasonable M&A strategy. Armada strategy stipulates acquiring 25% stakes in IT companies in various sub-segments (in order to avoid internal competition) with the option to expand to controlling stakes. Sound guidance on the full 2010 and 2011. The Armada’s management expects the company’s top line to add 25-28% for the full 2010 and EBITDA margin to stand in 1012%. Armada targets a 25-30% y-o-y improvement on the top line in 2011, considerably ahead the market growth rate. On the EBITDA level, for 2011 Armada views a 12-14% margin, up 2 ppt y-o-y.

PRICE DYNAMICS ARMD

200

Stable financial position. Armada has no debt, as it did not use loans to buy software and IT services companies in 2007, using instead $30 mln raised during the IPO. Also, the company may direct 3.6% treasury stock on acquisitions.

RTS

150 100 50 22.12.09

22.3.10

22.6.10

22.9.10

22.12.10

Source: Bloomberg, TKB Capital estimates

Free float is above 50% Arm ada shareholders structure, % Free f loat

Kuzov kin

Treasuries

Belik

Morgulchik

Kaplun

10.4

56.5

3.6 8.7

Source: company data

CONS Strong competition in domestic market. As more IT companies enter the market, the competition for new clients among corporate clients is becoming stronger, which may reduce Armada’s margins. High-beta IT sector comes with significant risks. If the Russian stock market performs drops, the IT sector’s trading stocks deliver a more drastic slump.

10.4

10.4

Cheap on multiples. Despite the fact that the stock appreciated 93% year-to-date, upside potential is not vanished. 2011E EV/EBITDA of 5.6 and 2011E P/E of 12.5 are 19% and 3% below international peers, respectively.

KEY FINANCIAL INDICATORS $ mn Revenue Cash costs EBITDA Net incom e RATIOS % Revenue grow th EBITDA margin Net margin

2009 103 (91) 12 -

2010E 132 (117) 15 7

2011E 161 (140) 21 12

2012E 218 (188) 30 16

2013E 270 (232) 38 20

2009 (41) 12.0

2010E 28 11.2 5.7

2011E 22 13.0 7.5

2012E 35 13.8 7.4

2013E 24 14.0 7.6

Source: Bloomberg, TKB Capital estimates

STRATEGY 2011

73


74

STRATEGY 2011


Transport Outpacing economic recovery Maria Kalvarskaia m.kalvarskaia@tkbc.ru Tatiana Zadorozhnaya t.zadorozhnaya@tkbc.ru

Transport Outpacing economic recovery YTD sector dynamic vs. RTS in 2010 22.12.2010

Max

Min

50%

100%

RTS GLTR AFLT TMAT NCSP FESH PRIM -50%

0%

Source: Bloomberg, MICEX, RTS

140% 130% 120% 110% 100% 90% 80% 70% 60%

Transport

RTS

Transportation segment recovery outperformed economic growth in 2010 with 7.5% expansion in freight turnover and 3% in transportation volumes. The core growth drivers were metal and coal segments as well as container transportation. Construction sector was lagging the others and is expected to boost volumes in 2011. Improving macroeconomic conditions determine growing demand for passenger transportation services that is reflected in higher volumes of passenger turnover and better financial performance. In 2011 we expect gross transportation volumes (without pipes) to expand by 3-4% with 6-7% in rail freight. 2010 was also important for Russian transportation companies on the stock market. Traded shares reached their pre-crisis levels, while TransContainer entered the market driving up interest to the segment. We keep our positive view on the transportation companies in 2011, but recommend using the market weakness to enter the stocks of Aeroflot (AFLT), Globaltrans (GLTR) and TransContainer (TRCN). Growth in transportation segment beat forecast. Freight turnover grew by 7.5% over 11M10 with 9.4% expansion in rail segment. Improving economic conditions helped to increase volumes. Recovery will continue in 2011, but at slower pace. We expect 6-7% growth of rail transportation volumes with the highest growth in construction and container segments.

Aug-10 Sep-10 Oct-10 Nov-10

May-10 Jun-10 Jul-10

Jan-10 Feb-10 Mar-10 Apr-10

Dec-09

Tariff to grow by 8% in 2011, methodology to change in coming years. According to FTS rail transportation tariff is set to grow by 8% in 2011. RZhD is developing new methodology of tariff calculation based on return on invested capital, which may lead to higher growth rates in coming years.

Source: TKB Capital calculation, Bloomberg, MICEX, RTS

Container segment to post strong growth rates. In 2010 container transportation segment is expected to expand by 19-20% thanks to economic recovery and consumption growth. In 2011 container business will continue upward trend beating the average growth in transportation segment. Privatization plan – more players coming to the market. In 2010 RZhD successfully sold 35% of TransContainer on the market through IPO. In 2011 RZhD will continue privatization program. More private players will increase competition on the market and create new investment opportunities. Air passenger transportation – a good year with upside potential. In 2010 air passenger traffic grew by 30% exceeding pre-crisis level and outperforming the world market. Better economic conditions will provide further expansion of the segment. Transportation stocks – buy on weakness. Among the traded transportation companies we prefer shares of Aeroflot (AFLT), Globaltrans (GLTR) and TransContainer (TRCN). Further economy growth will improve operational and financial company’s results, but current prices close to pre-crisis level, therefore we see the growth potential as limited. We recommend using the market weakness to enter the stocks.

STRATEGY 2011

75


Transport Outpacing economic recovery

Freight transportation Growth of transportation volumes in 2010 will beat forecasts. Over 11M10 the total Russian turnover volume of freight transportation grew 7.5% y-o-y to 4.322 bn t-km (vs. 4.021 bn t-km in 11M09). Air transport demonstrated the most robust growth (35% y-o-y). However its share in the total transportation is traditionally just marginal and amounts to less than 1%. The growth rate of motor and rail cargo turnover matched over the period and reached 9.4%, while motor cargo load decreased by 1.8% against growth by 9.2% in rail transportation. This means that the volume of motor transportation decreased with expansion of transportation distance. Our previous freight turnover forecast was at 6%, but thanks to faster recovery of private consumption 11M10 results already exceeded this level. We do not expect significant changes in the freight turnover in December and see full year growth close to 7-8% in 2010. We believe that further economic recovery will be driving up total freight cargo and the volumes may reach pre-crisis levels already in 2011. Russian freight turnover structure by type of transport over 11M10, %

Freight turnover, bn t-km 2008

500 Road

Marine

Riv erine

450 2.2%

400 1.2%

350

0.1%

300

4.1%

Rail freight transportation kept its leading position reflecting economic recovery. Railway transportation outperformed the industry in whole and demonstrated strongest growth rate over 11M10 (except air transportation). At the same time after very strong results in 1H10, the growth rate of Russian rail transportation slowed down in 2H10 due to higher base in 2H09. Thus rail cargo load increased by 9.4% over 11M10 (12.2% over 6M10) to 1,105 mn t (vs.1,013 mn t in 11M09), while total cargo load increase by just 1.2%. The strongest growth in year terms was shown by container transportation, metals and mining segment as well as construction sector. In spite of impressive growth rates in 2010, total railway cargo transportation, except container, oil, coking coal and fertilizers, still did not reach pre-crisis levels. However we expect to see full recovery of cargo transportation volume already in 2011, while development will change cargo mix. Due to high growth rate of cargo transportation, recently Russian Railways for the third time increased its forecasts for the full year from 7.4% to 8.7% growth (at the beginning of the year RZhD expected 3.7%), which corresponds to our expectation. The m ain char acte r is tics of fr e ight tr ans por tation in Rus s ia in 2010 F reight turnov er, bl t-km

C argo load, m n t

F reight turnov er growth rate y -o-y , % C argo load growth rate y -o-y , %

Index of industrial produc tion y -o-y , %

800

20%

600

15% 10%

400

5%

200

0% -5%

0 F eb

Mar

Apr

May

Sourc e:Federal State Statis tic al Serv ic e, TKB Capital

STRATEGY 2011

J un

J ul

Aug

Sep

Oc t

Dec

Nov

Oct

Sep

Aug

Jul

Source: Federal State Statistical Service

Railway transportation

76

Jun

Jan

Source: Rosstat

May

250

50%

Apr

42.3%

J an

2010

Air

Mar

Railway

Feb

Pipeline

2009


Transport Outpacing economic recovery

Growth will continue in 2011, but at lower rate. Impressive growth of rail cargo transportation in 2010 was mainly attributed to low base in 2009 and we expect growth rates in railway freight transportation in Russia to slowdown in 2011. However we believe that economic growth in 2011 (according to our forecasts GDP will rise by 4.3%) will provide further recovery of transportation industry. Moreover, due to export-oriented structure of railway cargo traffic coupled with more rapid rebound of some industries freight transportation will outperform industrial production and the economy as a whole. We expect to see increase in the volume of Russian railway cargo load by 6-7% y-o-y in 2011. In our view the main triggers of growth will be segments of the construction materials (thanks to restoration of new construction volumes), metals and mining, and container transportation.

Volum e and grow rh rate of cargo load on the Russian railw ay in 2010 Coal, mn t Construction materials, mn t Rail cargo load growth rate y -o-y , %

Oil and oil products, mn t Iron ore, mn t 20%

30.0 25.0

15%

20.0 15.0

10%

10.0

5%

5.0 0.0

0% Jan

Feb

Mar

Apr

May

June

Jul

Aug

Sep

Oct

Nov

Source:RZhD, TKB Capital

Tariffs set to grow by 8% in 2011. In 2010 tariffs were set 9.4% up y-o-y, while in 1H10 prices on cargo transportation increased by 10-15% backed by demand recovery. The government set the growth rate of tariffs for rail transportation at 8% in 2011. However FTS continued adjusting tariffs that may lead to stronger growth rates in ferrous metals segment (FTS provided information about tariff growth at 30-65% for some export/import directions). But in general transportation prices for metal companies will change in line with tariff growth set at 8%. These adjustments will allow to redirect export flows from ports to inland border posts to optimize routing and reduce capacities overutilization in ports. We see slightly positive effect for transportation companies working in these segments (for Globaltrans for example) and neutral to marginally negative effect for metal companies. Railway tariff regulation in Russia – to change soon? In November, 2010 FTS approved new methodology of RZhD tariff calculation based on return on invested capital. With new tariffs the company is planning to earn money both for operating activities and for implementation of its long-term investment program. RZhD considers to start using this methodology beginning from 2012. Tariff increase for 2012-2013 will be considered in 2011. However, according to RZhD calculations based on this method, tariff’s growth rates in 2012 and 2013 should reach 23% and 7.6% respectively. Otherwise Russian Railways expect to get additional subsidies from the state to finance their investment program. For now we do not consider the announced numbers as a guide for the future tariff growth. In 2011 prices for rail transportation will grow in line with RZhD tariff with higher rates in some segments. More players on the stock market will joint TransContainer and Globaltrans. Russian transportation industry shows impressive growth rates outperforming the world numbers in many segments. That boosted investors’ interest to the Russian transport industry. Successful placement of TransContainer in 2010 gave a start for privatization process of RZhD railway subsidiaries and proved again interest to the segment. Further privatization of RZhD assets will provide more opportunities on the market. Thus railway monopoly plans to sell 10-15% Freight One through IPO until the end of 3Q11, but final selling option is still not determined and total share’s placement (include private to a strategic investor) may amount to 75% (minus one share) during 2011-2012. Moreover, company is thinking about TransContainer’s SPO and IPO of Freight Two in two years.

STRATEGY 2011

77


Transport Outpacing economic recovery

Russian railway container transportation Railway container transportation takes a leading position in inland traffic. Container transportation market in Russia includes railway, marine and road traffic. Maritime transport holds a leading position in import and export transportation flows. However, despite its low cost, the trip time of marine transportation is much longer than via railway and road routes, additional costs arise as the cargo should be delivered to/from port. At the same time, due to the structure of the Russian economy and geographically spread industrials centers, railway dominates in total container transportation. Moreover, railway transportation is the only cargo transportation mode in some regions of Russia, for example, east of the Urals. The volum e of container transportation in Russia by m onth in 2007-2010, m n TEUs 2010/2009 (rhs)

2009/2008 (rhs)

2010 (lhs)

2009(lhs)

2008(lhs)

2007(lhs)

250

60% 50%

200

40% 30%

150

20% 18%

17% 100 50

12%

15%

-19%

-19%

15%

10%

16% -12%

-22%

-27%

-29%

-21%

-23%

-27%

-24%

0% -15%

-22%

-10% -20% -30% -40%

0 Jan

Feb

Mar

Apr

May

Jun

Jul

Aug

Sep

Oct

Nov

Dec

Source: RZhD information center

Before the crisis the Russian container market outperformed the global trend. Due to significant growth in Russian import and export flows (as a result Russian economic development), before the crisis the Russian container market outperformed the global trend and grew from 1.0 mn TEUs in 2001 to 2.5 mn TEUs in 2008 (including loaded and empty-run trips). However during the crisis, due to high share of import flows in total container transportation (30% in 2008) dropped by 57% y-o-y to 207,000 in 2009 (478,000 TEUs in 2008), Russian railway container traffic declined by 21% in 2009, while marine container transportation dropped by 38%. Grow th container transshipm ent in Russia in 2004-2010E, m n TEUs Port's handling, mn TEUs (lhs)

Rail shipping, mn TEUs (lhs)

Port's handling growth rate, % (rhs)

Rail shipping growth rate, % (rhs) 40%

4 3.4

3.5 3

2.4

2.5

1.9

2 1.5

2.7

1.4

1.5

1.7

1.8

30% 2.5

2.1

20%

2.7 2.1

1.9

2.2

10% 0% -10% -20%

1

-30%

0.5

-40%

0

-50% 2004

2005

2006

2007

2008

Sources: Association of Russian Ports (ASOP), RBC report, A.T. Kearney analysis

78

STRATEGY 2011

2009

2010E


Transport Outpacing economic recovery

Higher import volumes and favorable pricing to provide stable growth. As a result of high dependence the container transportation on the economic situation, this segment started to recover only at the end of 1H2010 backed by global and domestic economic revival. Thus, thanks to the rebound in the economy and increasing domestic consumption, the volume of Russian rail container transportation in 2010 will increase by 19-20% y-o-y and reach 2.3 mn TEUs (loaded and empty run). We think that thanks to growth of import flows (13% in 2011 according to expectations of the ministry of economic development), higher level of containerization, as well as development of sea port and rail infrastructure we will see further increase in the volume of rail container transportation in 2011, but growth rate will slowdown and amount 9-11%. Pre-crisis level of container transportation is likely to be reached in 2013. Container transportation remains favorable for class 3 cargo as it is cheaper to transport them in container rather than in box-cars. In 2011 tariffs for container transportation will grow by 5% vs. 8% for railway services that also increase efficiency of container services. The grow th of rail container transportation by type of directions, 000 TEUs loaded containers Domestic

Import

Export

Transit

+10% +16%

-25% 1,603

1,188 96 317 229

1,386

118

125

413

344 478

350

1,511 1,209

126

91

418

413

1,622

1,745

1,868

541

508

477

447

163

149

141

132

2,007

455

347

422

489

383

207

2,148 176

CAGR (2009-2015)

12%

574

6%

526

17%

546

567

594

620

660

705

756

814

872

498

2006

2007

2008

2009

2010E

2011E

2012E

2013E

2014E

2015E

10%

Sources: RZhD database, A.T. Kearney analysis, A.T. Kearney rail forecast model

The growth of the Russian container market will outperform overall global market. Container transportation sector is strongly dependent on the global and domestic economic environment, therefore growth rates of transportation volumes will hinge on the economy’s rebound. As a result of global economic recovery (up by 4.3% in 2010E vs. 0.5% decline in 2009), container cargoes started demonstrating positive performance already in 1H10. Owing to more robust growth of developing economies (BRIC GDP growth is estimated at 5-7% over next 10 years vs. 2-3% for developed countries), expansion of transportation volumes on EM is likely to outperform growth rates on DM. At the same time, due to higher expected growth rates of real GDP at 4.4% CAGR in 2010-2013 (based on our estimates) with high growth rate of real consumer spending per capita, we think Russia is the most attractive for investments among the BRIC countries. Russian rail container transportation grow th in 2006-2015, '000 TEUs Empty

Loaded

+9% +15%

2,450

2,121

1,188

2,309

2,477

2,664

1,925

1,842 1,387

-21%

2,854

1,602 1,209

1,512

1,622

1,744

1,868

3,064

2,006

3,281

2,148

654

734

848

716

797

855

920

986

1,058

1,133

2006

2007

2008

2009

2010E

2011E

2012E

2013E

2014E

2015E

Sources: RZhD database, A.T. Kearney analysis, A.T. Kearney rail forecast model

STRATEGY 2011

79


Transport Outpacing economic recovery

Air passenger transportation

Air passenger turnover, bn p-km

Russian air traffic growth exceeded global peers. After the deep 9.4% y-o-y decline in 2009 and due to low prices for transportation in 2010, the passenger turnover of air transportation increased almost by 30% y-o-y to 125 bn p-km, while passenger transportation grew by 27.4% y-o-y to 43.7 mn passengers. In spite of this impressive growth mainly connected with low 2009 base, total volume of air transportation exceeded pre-crisis 2008 year by 16%. At the same time almost half of the growth was due to increased traffic five key airlines. Traditionally growth rates of Russia air transportation outperformed the world market in 2010, which increased by 11-13%. Thanks to the good operating results over 10M10 Rosaviation changed its forecast for air traffic growth from 24% to 30% for the year, which means that year 2010 will be the best for Russian aviation industry in modern country’s history since 1991. Moreover, according to recent 2010 IATA’s forecast global market will rise by 8.9% y-o-y. Thus growth rates of Russian air passenger traffic still will outperform world market. We see big potential for growth in Russia's domestic air travel market. As a result of strong traffic growth in 2010 and expected increase in transportation prices, we anticipate slowdown in air passenger traffic in 2011. We expect that Russian air transportation will outperform world market and increase by 15% backed by growth of real disposable income coupled with the improvement of economic conditions as a whole. This is confirmed by the expectations of Rosaviation, which announced growth rate of air passenger traffic near 10-12% for 2011. Moreover, we believe that further increase in the economically active population, which use air services (currently only 5% of Russia's population), together with growing share of low-cost carriers in total Russian air transportation market (currently less than 4%) will take new opportunities for the development of Russian passenger aviation market.

Russian airline passenger turnover growth rate in 2010

15,000

40% 30% 20% 10% 0% Jan

Feb Mach Apr

Source: Mintrans

May

June July

Aug

Sept

Oct

Dec

Oct

Nov

Sep

Jul

Aug

Jun

Apr

May

Mar

Jan

Source: Rosstat

Russian passenger turnover structure by type of transport, bn p-km 800 600

Railway

Road

Air

432

446.3

403.2

420.8

2007

2008

2009

2010

400 200 0

Source: Rosstat

Russian air passenger m arket structure by players, % Aerof lot Sibir OrenAir

TRANSAERO Utair Other 20%

48%

12% 8.4% 4%

7.8%

Source: Rosstat

6,000 4,000 2,000 0 Jan

Feb

Source: Mintrans

Undervalued bet on recovery. Transportation segment suffered strong during the crisis, but recovery was fast following economic revival. Next year is expected to bring substantial growth in air transportation, where we prefer Aeroflot (AFLT), which financials beat pre-crisis level on EBITDA and bottom-line, while market capitalization is 30% below those numbers (we have no official recommendation and TP for the stocks). Globaltrans (GLTR) is traded close to its pre-crisis level and this fairly reflects financials recovery. We positively estimate the company’s prospects, but see upside potential for the stocks as limited, thus recommend buying the shares during the market weakness (12M TP $20.3). TransContainer (TRCN) is a relatively new name on the stock market, representing fast growing segment that increase attractiveness of TransContainer’s shares. We will initiate coverage of the company shortly after the winter holidays.

STRATEGY 2011

4

8,000

Transportation stocks

80

9

Passenger transportation 2009, mn pers Growth rate, y -o-y %

50%

0

13

Passenger transportation 2010, mn pers

20,000

5,000

2009 2007

Russian airline passenger transportation grow th rate in

Passenger turnov er 2010, mn p-km Passenger turnov er 2009, mn p-km Air passenger turnov er growth rate, y -o-y %

10,000

2008 2010

18

Feb

Air passenger transportation outperformed Russian transport market. Russian passenger turnover over 10M10 increased by 3.9% and reached 356 bn p-km, however growth was mainly due to increase of air transportation, according to the Rosstat. Air passenger turnover over 10M10 increased by 30% y-o-y against the decline of passenger traffic by motor and railway transport by 1.2% and 10% respectively. In spite of the higher prices for air transportation, the growth rate of air transportation volume significantly exceeds other segments, thus its share in total passenger traffic in Russia since 2007 increased from 25% to 34% in 2010. Further economic recovery, higher real disposable income growth coupled with increasing availability of air transportation (thanks to appearance of low cost airlines) will drive growth of air transportation share in the structure of passenger traffic. We believe that Russian passenger market will keep positive trend in November-December and passenger transportation in Russia will increase by 4% over 2010.

Mach

Apr

May

June

July

Aug

Sept

Oct


Transport Outpacing economic recovery

Globaltrans Stable growth – buy on weakness Globaltrans GDR GLTR BUY 18.0 20.3 13%

Ticker Recommendation Price, $ Target price 12M, $ Upside, % SHARE DATA Bloomberg Reuters

GLTR LI GLTRq.L GDR 158 3,135 2,846 9.35 18.47 Common 1

# of shares outstanding,mn EV, $ mn MC, $ mn MIN 12 months, $ MAX 12 months, $ Shares per GDR SUMMARY FINANCIALS, $ mn IFRS 2010E 2011E Net rev enue 823 999 Adj.EBITDA 352 447 Net income 205 275 EPS, $ 1.30 1.74 Rev . growth, % 20.3 21.4 EPS growth, % 70.7 34.1 Adj.EBITDA 42.8 44.7 margin,% Net margin, % 24.9 27.5 SUMMARY VALUATIONS 2010E P/E 13.9 EV/EBITDA 8.9

2012E 1,122 513 320 2.02 12.3 16.3 45.7 28.5

2011E 10.4 7.0

2012E 8.9 6.1

SHAREHOLDER STRUCTURE TIHL EIL Free-f loat

50.10% 14.45% 35.45%

PRICE DYNAMICS GLTR

21

RTS

16 11 6 22.12.09

22.3.10

22.6.10

22.9.10

Source: LSE, TKB Capital estimates

22.12.10

As we wrote in our strategy for 2H10 transportation segment was thought to be a hot topic backed by economic growth and more names entering the market. Globaltrans shares continued their positive dynamics and added 42% during the last 6 months. We still consider the company’s stocks to be an interesting idea for 2011 as demand for transportation services remains solid, but upside potential for 2011 is limited. We recommend using market weakness to increase stake in the company as rail transportation segment will continue growing and corporate events in the segment will boost interest to the traded shares. We do not exclude Globaltrans participation in M&A deals, while optimization of routs will support financial performance of the company. Our 12 TP of Globaltrans shares is $20.3. The largest private player with diversified operations. The company’s business is well balanced and diversified with metal segment as well as oil&gas providing 82% share of revenue. Globaltrans owns 21,626 gondola cars and 19,598 oil tank cars. Demand on transportation in gondola cars is stably high that determines attractive pricing on the market and reduces costs related to empty runs. In 1H10 according to the company’s numbers 45% of freight rail turnover came from metallurgical segment, 33% from oil segment. Construction sector is still lagging in volumes recovery, and 2011 is expected to bring more activity in this segment that will increase transportation volumes. 2H10 financial performance will support stock price. Over 1H10 Globaltrans posted revenue growth at 28% y-o-y to $407.5 mn with EBITDA margin recovery to 44%. 2H10 is expected to be at least as successful as 1H10, while profitability will be even higher with lower costs of empty runs beard by the company. Globaltrans is planning to publish 2010 full year financials in the end of March – beginning of April, which together with details on the company’s development in 2011 will support the stocks. Revenue to grow at CAGR of 11% in 2011-2015. We expect net adjusted revenue to grow at CAGR of 11% thanks to transportation price increase, optimization of the cargo mix and routing. Average price per trip will increase by 16% during the period in dollar terms, while number of trips per year will go up by 46%. Empty run costs will decline comparing to 2009 driven by dispatch optimization, high demand for transportation services and economic recovery. M&A deals and new placement on the market to be strong drivers. Globaltrans is active in M&A deals aiming at expansion of its fleet and transportation routs. The company is constantly watching the market and we expect to see more deals in the coming future. In 2011-2012 Freight Two is planned to be privatized and Globaltrans is considered as one of potential strategic buyers. Buy on weakness. In 2010 Globaltrans GDRs grew by 82% and now they are traded with EV/EBITDA 2011E 7.0. Globaltrans GDRs are valued with a 26% discount to their EM peers and with a 7% discount to DM peers. In 2010 EBITDA margin is estimated 42.8% and we expect it at healthy 44-45% in 2011-2014. We positively view prospects of the company, but estimate upside potential from the current levels as limited. We recommend using weakness on the market to buy the stocks.

STRATEGY 2011

81


Transport Outpacing economic recovery

Globaltrans BALANCE SHEET $ mn

2009

2010E

2011E

2012E

2013E

2014E

2015E

TOTAL CURRENT ASSETS

300

326

371

565

757

953

1,151

PP&E, net

905

1,042

1,237

1,298

1,354

1,417

1,486

56

59

72

58

63

67

70

965

1,104

1,311

1,359

1,420

1,486

1,559

1,265

1,430

1,682

1,924

2,177

2,439

2,710

153

154

128

161

165

130

130

64

92

107

119

129

140

152

Other non-current assets Total NON-CURRENT ASSETS TOTAL ASSETS Short-term borrow ings Trade and other payables Other short-term liabilities

1

2

2

2

3

3

3

Total CURRENT LIABILITIES

218

247

237

282

297

273

285

Long-term borrow ings

296

273

324

274

219

203

154

39

34

27

18

20

22

23

335

307

351

292

239

225

177

Other non-current liabilities Total NON-CURRENT LIABILITIES Minority interest

101

142

197

261

334

409

486

Share and additional capital

278

278

278

278

278

278

278

Retained earnings

332

455

619

811

1,030

1,254

1,485

Total EQUITY

610

733

897

1,089

1,308

1,532

1,763

1,265

1,430

1,682

1,924

2,177

2,439

2,710

2009

2010E

2011E

2012E

2013E

2014E

2015E

684

823

999

1,122

1,228

1,297

1,366

(396)

(467)

(546)

(605)

(660)

(716)

(776)

EBITDA

281

352

447

513

565

579

589

Adjusted EBITDA

285

352

447

513

565

579

589

DD&A

(53)

(62)

(69)

(82)

(86)

(89)

(93)

EBIT

228

290

378

431

480

490

496

Net interest income/(expenses)

(79)

(35)

(35)

(32)

(24)

(22)

(15)

TOTAL EQUITY & LIABILITIES INCOME STATEMENT $ mn Net revenue Cost of production

EBT

150

256

343

399

457

468

481

Income tax

(30)

(51)

(69)

(80)

(91)

(94)

(96)

Net incom e

120

205

275

320

365

375

385

2009

2010E

2011E

2012E

2013E

2014E

2015E

271

309

338

453

475

481

486

(167)

(202)

(266)

(144)

(142)

(153)

(163)

Net CF from /(used in) financing activities

(81)

(143)

(116)

(176)

(221)

(193)

(194)

Net Debt

289

305

374

225

61

(125)

(303)

%

2009

2010E

2011E

2012E

2013E

2014E

2015E

Net adjusted revenue grow th

-12%

20%

21%

12%

9%

6%

5%

Adj. EBITDA margin (to net revenue)

42%

43%

45%

46%

46%

45%

43%

Net margin (to net revenue)

18%

25%

27%

28%

30%

29%

28%

Net Debt/Adj. EBITDA

1.0

0.9

0.8

0.4

neg.

neg.

neg.

CASH FLOW STATEMENT $ mn Net CF from operating activities Net CF from /(used in) investm ent activities

RATIOS

Source: Globaltrans, TKB Capital estimates

82

STRATEGY 2011


Transport Outpacing economic recovery

TransContainer Appealing infrastructure play TransContainer Common TRCN NR 94.4 NA NA

GDR TRCN LI NR 9.4 NA NA

TRCN RX TRCN.MM Common # of shares outstanding,mn 13.9 EV, $ mn 1,451 MC, $ mn 1312 MIN, $ 78.57 MAX, $ 99.95 Common Swap ratio 0.1

TRCN LI TRCNq.L GDR 138.9 1,439 1,299 7.49 10.00 GDR 10

Ticker Recommendation Price, $ Target price 12M, $ Upside, % SHARE DATA Bloomberg Reuters

SUMMARY FINANCIALS, $ mn IFRS 2010E 2011E Net rev enue 531 661 Adj.EBITDA 165 228 Net income 44 88 EPS, $ 0.32 0.63 Rev . growth, % 27.1 24.5 EPS growth, % 139.7 97.2 Adj.EBITDA margin,%

2012E 791 314 137 0.98 19.8 56.0

31.2

34.5

39.7

8.4

13.3

17.3

SUMMARY VALUATIONS 2010E P/E 29.2 EV/EBITDA 8.7

2011E 14.8 6.3

2012E 9.5 4.6

Net margin, %

SHAREHOLDER STRUCTURE RZhD EBRD NSPF BLAGOSOSTOY ANIE Other

50%+1 9.25% 5.20% 35.55%

PRICE DYNAMICS 10.1

TRCN LI

RTS

9.1 8.1 7.1 9.11.10

23.11.10

7.12.10

Source: LSE, TKB Capital estimates

21.12.10

TransContainer is the largest intermodal container operator in Russia, providing transportation services and integrated logistic solutions for its customers. The recovery in domestic consumption, increase in containerization levels and expansion of transit traffic from Asia to Europe will determine the growth in the Russian container transportation market, where TransContainer plays the leading role. The company’s unique asset base allows it to provide high-value, end-to-end logistic services and maximize operational efficiency. We have positive view on TransContainer and plan to initiate the coverage in the offing. Container market growth will outperform global economic trends. Due to the rapid market recovery (GDP will increase in 2011 by 4.3%) and the rebound in private consumption, Russian container transportation will outperform the global one, posting a 2011 growth rate of 9-11%. Economic growth and low level of containerization in Russia will help to expand volumes that makes container business attractive for investors. Favorable pricing will support development of the segment. Container transportation is efficient for cargo class 3 as tariffs for containers are close to cargo class 2. Moreover, in 2011 FTS set tariff growth for rail container transportation at 5% vs. 8% for rail-based shipping. This confirms the state strategy to develop container business and increase competitiveness of container services. This change in tariffs will attract additional container cargo and increase containerization level. Leading position on the market and unique asset base. The Company is the largest operator of railway container transportation with a 52% stake on the market, which has strong growth potential. We estimate container transportation to grow by 53% in the next 5 years. The Company’s extensive asset base permits its leading role in a market with high entry barriers and allows it to provide high-value, end-to-end integrated logistic solutions to its customers. As of 30 June 2010, the company owned 25,463 flatcars, 58,394 ISO containers and 47 terminals (46 in Russia and one in Slovakia), and a substantial fleet of trucks. Integrated services and spread geographic presence as the strengths. TransContainer is the leading provider of high value integrated logistic solutions, which include end-to-end intermodal container transportation, handling and freight forwarding services. We estimate integrated services to provide up to 53% of the revenue by 2014. TransContainer has strong domestic and international presence based on 47 container terminals, 148 services centers and sales offices, international subsidiaries and joint ventures with international partners. TransContainer serves more than 20,000 regular customers with the top 10, generating 23.3% of revenue. Economic recovery and sophisticated management to support efficiency. Growth of demand for container transportation will result in fewer empty runs and higher efficiency ratios. Route expansion, containerization of new cargo types, optimization of the freight transportation and pricing will improve company’s financial performance. We estimate 2010 financial results to be close to pre-crisis level on top-line with lagging recovery of efficiency ratios. 9M10 operating results support our forecasts for 2010 financials, which are to be published by April 20, 2011. Cheaper than peers, but with strong growth profile. Since IPO TransContainer shares grew by 17% to $9.35. Currently TransContainer’s GDRs are traded at EV/EBITDA ratio at 6.3 2011E, which means 33% discount to the EM peers. Further economic recovery, expanding demand for transportation services and better pricing environment attracting flows to container business will determine the company’s growth in the future, while new placements on the market may increase interest to the stocks. We are planning to start covering TransContainer shares shortly after the winter holidays.

STRATEGY 2011

83


84

STRATEGY 2011


Consumer and retail Ready, Steady And Go Shopping! Natasha Кolupaeva n.kolupaeva@tkbc.ru

Consumer and retail Ready, Steady And Go Shopping! Sector performance in 2010 22.12.2010

Max

Min

APTK PRTK GRAZ SCO РТС OKEY FIVE PKBA PHST VRPH PKBA KLNA MGNT SY N DIXY GCH MVID WBD ROST -100%

0%

100%

200%

Consumer demand is on the uptrend

Source: RTS, LSE, TKB Capital estimates

Ready to go shopping. Looking forward in 2011, we expect consumer demand to continue strengthening thanks to real disposable income growth, lower unemployment rate, relatively stable inflation and gradual consumer credit growth. We also expect consumer power to be supported by further post-crisis recovery in oil prices, which will enable generous government social payments in ahead of the presidential elections in 2012.

RTS Index Consumer & Retail 180

130

Oct

Nov

Sep

Jul

Aug

Jun

Apr

May

Mar

Jan

Feb

Dec

80

Source: RTS, TKB Capital estimates

Russia’s retail sales dynamics Non-Food Food as % of GDP, rhs

$ bn

45% 800

40%

600

30%

CAGR 27%

25%

2014E

2012E

2008

2010E

2006

2004

2002

20% 2000

0

Source: Federal Statistics Service, TKB Capital estimates

20% 10% 0%

Real wage, % y -o-y Disposable income, % y -o-y real Retail trade, % y -o-y real 10% 5% 0% -5% -10% -15% янв 09 мар 09 май 09 июл 09 сен 09 ноя 09 янв 10 мар 10 май 10 июл 10 сен 10 ноя 10

-10%

New macro assumptions imply more optimism. Our updated macro forecasts assume 2011 real disposable income growth of 4.7%, which should improve consumer purchasing power going forward. At the same time, we expect ruble to remain relatively strong at RUR29.5/$ and RUR28.5/$ (average) for 2011 and 2012, respectively, which would support companies’ USdollar based top line growth. In expectation of strong financial performance… In 1H11 we expect the main sector growth driver to be the disclosure of seasonally strong 4Q10 financials, which should significantly contribute to full-year figures. Besides, early next year companies are expected to elaborate on their expansion ambitions.

CAGR 12% 35%

400 200

We reiterate our POSITIVE view on consumer and retail sector in 2011, which we believe will continue to outperform the broad market indices. Consumer & retail offers both defensive (like pharma and food staples) and aggressive (like retail) exposure to the Russian economy growth, which is expected to go forward at a steady gait. We expect consumer power to be supported by further post-crisis recovery in oil prices, which will enable generous government social payments on the eve of the presidential elections in 2012. Moreover, consumer & retail segment is expected to gain on Sochi 2014 Winter Olympic Games and 2018 FIFA World Cup, which assume hefty investments into regional infrastructure and increase in the regional employment. At the same time, tightening of market regulation, which came into play in 2010, seems to remain one of the major risks in coming years. Our BUY TOP picks for 2011 are food retailers - Magnit and X5 Retail Group and pharma producers – Pharmstandard and Veropharm.

Source: Federal Statistics Service

…and corporate events. 2H10 appeared to be event-intensive: retailer O`KEY successfully placed its shares on LSE, PepsiCo announced the acquisition of 66% stake in Wimm-BillDann and retailer Kopeyka was acquired by X5 Retail Group. All these confirm the high attractiveness of Russian consumer & retail sector and we believe that a series of new IPOs, SPOs and M&As will be launched in coming years, heating investors’ interest toward the sector. Fundamentally attractive DCF valuation implies attractive upsides. The key investment theme in the sector remains the affluent long-term growth prospects for the Russian companies, which look more attractive than developed market peers and even the majority of emerging market analogues (particularly based on PEG ratio). We continue to highlight food retailers and pharma producers - for 2011 we recommend to BUY Magnit, X5 Retail Group, Pharmstandard and Veropharm. Don’t disregard the risks Macro conditions, regulation and change in taxation. The key risks in the sector are well-known - weaker than forecasted macro conditions and ongoing tightening of regulation. Moreover, since 2011 companies will face the change in the taxation – a step-up increase in insurance contributions (from 26% to 34%) and cancellation of the uniform tax on imputed income (which was applied by pharma retail).

STRATEGY 2011

85


Consumer and retail Ready, Steady And Go Shopping!

Consumer demand is on the uptrend Consumer demand is on the uptrend. As we expected, in 2010 consumer demand has been on the uptrend geared by the real disposable income growth (by 4.3% y-o-y for 11M10) supported by the increased pensions, which account for about 15% of gross personal income and were forecasted to rise by 38% this year (in real terms). At the same time, 11M10 real wages growth appeared to be slightly moderate at 4.5% y-o-y, which, on the other hand, means that companies are successful in optimizing personnel costs. As a result, we see the recovery of retail sales growth, which totaled 5% y-o-y in 11M10. Looking forward in 2011, we expect consumer demand to continue strengthening on further income growth due to lower unemployment rate (almost 7% in November vs. more than 9% in January) along with stable inflation and gradual consumer credit growth. Going forward, we expect consumer power to be supported by further post-crisis recovery in oil prices, which are expected to enable the government to increase social payments before the upcoming presidential elections in 2012. Moreover, consumer & retail segment is expected to gain on Sochi 2014 Winter Olympic Games and 2018 FIFA World Cup, which assume hefty investments into regional infrastructure and increase in the regional employment. Retail sales dynam ics, % y-o-y

On the long way to DM… 25%

Food

Switzerland USA

Denmark

30

Norway

Non-Food

10M10, % y-o-y: food 5.5% non-food 3.4%

15%

France

20

4.1%

5%

Japan Singapore Russia`20E Brazil

Nov 10

Jul 10

Sep 10

Mar 10

May 10

Jan 10

Nov 09

Jul 09

Sep 09

Mar 09

Source: Federal Statistics Service

Source: Federal Statistics Service, TKB Capital estimates

-40

-10% -20% 3Q10

-60 3Q08 3Q09

2011-15E 3.8% 7.3% 3.4% 3.4% 4.7% 40.0% 7.0%

0%

3Q07

2010E 4.1% 8.5% 4.5% 7.5% 4.6% 36.1% 7.0%

10% -20

3Q06

2009 -7.9% 8.9% -2.8% 2.3% -5.5% 37.2% 8.4%

0

3Q04 3Q05

2000-08 6.9% 13.7% 14.7% 10.7% 11.9% 33.3% 7.8%

Consumer conf idence index Real retail sales growth, % y -o-y 20%

3Q03

Key macro parametrs

Consumer confidence index and retail sales dynamics

3Q02

New macro assumptions imply more optimism. Our updated macro forecasts assume 2011 real disposable income growth of 4.7% y-o-y on the expected recovery in real wages and indexation of pensions, which should improve the consumer purchasing power. At the same time, we expect ruble to remain relatively strong at RUR29.5/$ and RUR28.5/$ (average) for 2011 and 2012, respectively, which would support companies’ US-dollar based top line growth. Looking forward, we see the economy to grow quite moderately at 4-5% y-o-y in real terms in 2011-2020, which however looks sufficient to reach Top 5 world economies by 2020 (taking into account Euromonitor projections) after China, the USA, India and Japan (in PPP terms) from the th current 9 place. All in all, we now see more evidence for our optimism regarding the sector growth prospects.

3Q01

Source: USDA, TKB Capital estimates

Real GDP grow th, % CAGR CPI, % (avg) Real w ages, % Real disposable income grow th, % CAGR Retail trade, % CAGR Retail trade as % to GDP (avg) Unemployment rate, % (avg)

May 09

5

Jan 09

4

3Q99 3Q00

3

Nov 08

2

Spending on food per capita, $`000

Jul 08

1

-15% Sep 08

0 0

Russia`15E

Poland Russia`08

Mar 08

India

-5%

May 08

10

Jan 08

Total spending per capita, $`000

40

Source: Federal Statistics Service

Real GDP growth, y -o-y Real disposable income, y -o-y 10% 5% 0% 2008 2009 2010E 2011E 2012E 2013E

In expectation of strong financial performance… In 1H11 we expect the main sector growth driver to be the disclosure of seasonally strong 4Q10 results, which should significantly contribute to full-year figures. Besides, the market is now reloading more optimistic scenario in sector valuation, which is justified by the ongoing consumption recovery in food and nonfood segments as well as companies’ bullish investment programs. For instance, Magnit’s capex in 2011E will total $1.5 bn, X5 has guided the market of almost $1.3bn investments in 2011 development plans and Cherkizovo reinstate its plans for almost 50% increase in poultry & pork production volumes by 2012. All these imply that companies’ are ready to deliver the expected solid performance on both top line and bottom line, focusing also on the improvement of operating efficiency.

86

STRATEGY 2011

-5% -10%

Source: MEDT, TKB Capital estimates


Consumer and retail Ready, Steady And Go Shopping!

Retail trade recov ery (in real terms)

120% 110% 100%

100%

2013E

2012E

2011E

2010E

2009

90% 2008

real growth, % y-o-y

2008 Lev el = 100%

Source: TKB Capital estimates Modern format penetration in food retail, % 100%

…and corporate events. We saw that 2H10 appeared to be event-intensive. In early November hypermarket chain O`KEY successfully raised $420 mn via IPO on LSE (at 14 EV/EBITDA`10F). In early December, PepsiCo announced the acquisition of 66% stake in Wimm-Bill-Dann for $3.8 bn (implies EV/EBITDA`10F at 16.1), intending to consolidate 100% of the company thereafter. Also in early December, Kopeyka was acquired by X5 Retail Group for $1.65 bn (including debt, which implies EV/EBITDA`10F at 12). At the same time, American retail giant, Wal-Mart, decided to go away from Russia and close its Moscow office, which was quite expectable as the retailer has lost its chance to buy cheap in crisis, while the Russian retail companies have started to trade with the premium to EM recently. However, Wal-Mart said it will keep a close eye on the possible entry points to the Russian market in coming years, which implies the company is likely to wait until the Russian market goes through the consolidation process and come back with a multi-billion offer for the key player, just as Pepsi did for Wimm-Bill-Dann. All these confirm still high attractiveness of the Russian consumer & retail sector and we believe that a series of new IPOs, SPOs and M&As will be launched in coming years.

Fundamentally attractive

80% 60%

Denmark France Netherlands Sweden Russia`20E Belgium Portugal Czech Hungary Russia`15E Poland Russia`09 Romania Philippines Indonesia India

0%

35%

70%

20%

53%

40%

Source: Eurostat, Minpromtorg, TKB Capital estimate

Don’t disregard the risks

Market share of Top5 players, %

80%

40%

Source: TKB Capital estimates

11%

1% Clothings

Consumer electronics

Mobile phones

15%

Food retail

68%

Pharma retail

82% 0%

DCF valuation implies attractive upsides. The key investment theme in the sector remains the affluent long-term growth prospects for the Russian companies, which look more attractive than DM and even the majority of EM (particularly based on PEG ratio). The grounds for such growth are still low level of per capita consumption of main goods vs. European levels in line with upbeat expectations of steady growth in disposable income per capita toward European benchmarks in the long run (to above $15,000 by 2020 from $5,300 in 2009). We continue to highlight food retailers and pharma producers - for 2011 we recommend to BUY Magnit, X5 Retail Group, Pharmstandard and Veropharm.

Macro conditions, market regulation and change in taxation. The key risks in the sector are well-known. The consumer power recovery trend may be undermined by weaker than forecasted macroeconomic conditions. At the same time, we see the regulation tightening, which came into play in 2010 (for instance, in food retail, pharma, brewing, alcoholic beverages, etc…), may spread to other segments as well (in particular, we expect further considerable increase of the excise tax on alcohol). However we believe the market will make all necessary adjustments in the long-run. There are additional points of concern – in respect of the change of taxation, which are as follows:

ƒ We would remind you that since 2011 the simplified system of taxation, which implies uniform tax on imputed income, is expected to be gradually ceased to exist. Instead of this, tax payers, which now apply the simplified system of taxation (in particular, pharma retailers) and have more than 100 employees, will have to switch to the common tax system and thus to pay 10% or 18% VAT, 2% property tax, 20% income tax and others. Thus, individual entrepreneurs and organizations will face an increase in the tax burden since 2011, which may hurt their profitability. Among the public companies, the simplified system of taxation is implemented by Proteks’ retail business and Pharmacy Chain 36.6. Thus they will be impacted by this change, which is expected to lead to 1.3-1.5 p.p. deterioration of their EBITDA margin in 2011. We expect consumer & retail companies to pass-through the increased tax costs onto consumers, though we also expect them to focus on the operating efficiency improvement.

ƒ At the same time, there is another change in taxation. We would also remind you a step-up increase in the direct insurance contributions (which replaced the unified social tax since 2010), which will amount to 34% since 2011 vs. 26% in 2010 (for tax payers under the common tax system) and vs. 14% in 2010 (for tax payers under the simplified system of taxation). This implies an increase in the companies’ SG&A costs, which is expected to cost up to 0.5 p.p. EBITDA margin. As in the previous case, we expect companies to pass-through the increased tax costs onto consumers and also believe they will aim to enhance the efficiency of the work force.

STRATEGY 2011

87


Consumer and retail Ready, Steady And Go Shopping!

Food retail in 2011 Growing companies and growing stocks

Russia food stores roll-out prospects

Recovery in food is apparent; non-food is catching up. As we expected, in 2010 food retail sales have continued to demonstrate a sizable recovery, while non-food segment is still catching up. Retail sales statistics for 11M10 showed 4.4% y-o-y growth with 5.5% y-o-y growth in food and 3.4% y-o-y growth in non-food. We attribute it to the fact that real disposable income growth in 2010 was mainly due to increase in pensions. These have supported food retail companies’ sales (discounters and hypermarkets), as pensioners and other low-budget consumers, who focus on staples goods consumption (in particular, food and drugs), are the target audience of discounters and to some extent of hypermarkets. We see food retail companies to remain our favorites for 2011 as we expect further sizable increase in social payments by the government ahead of the presidential elections in 2012.

25,000

Discounters and hypermarkets continue to win traffic. In 2010 we saw that food discounters and hypermarkets continued to outperform the market in LFL sales growth and we expect them to remain on the front line through 2011. As earlier, we consider supermarkets and non-food segment to be a longer term bets on consumption recovery. We also see non-food retailers expressing optimism and ambitious expansion plans (in particular, in such segments as apparel, consumer electronics, cosmetics, sporting goods, etc. and even luxury goods). Store openings and efficiency gains drive value. We see that in 2011 most retail companies plan to speed up their store openings, while focusing on the effective cost control. For instance, Magnit’s capex ambitions for 2011E amount to $1.5 bn, while X5 guided the market of a considerable step-up in 2011 development plans (the market is still waiting for the company’s capex disclosure). At the same time, Dixy said it will open 150 stores next year, spending up to $100 mn, and try to restrain its SG&A costs growth by targeting the decrease of inventories shrinkage. We believe that next year disclosure of seasonally strong 4Q10 will significantly contribute to the companies’ solid full-year financials, while next year trading updates should reflect the realization of companies’ ambitious top line growth targets.

Food retail: market shares of key players, % X5 Retail Group Magnit Auchan Metro Cash & Carry O`Key Dixy Lenta Seventh Continent Share of top 5 players

2015E 9% 8% 4% 2% 2% 2% 2% 1% 25%

2020E 14% 14% 6% 3% 4% 2% 3% 1% 39%

Source: TKB Capital estimates

New market rule is regulation. Since 2010, food retailers have been adjusting their operations to comply with the Trade Law, which created new reality for food retailers and suppliers. We would remind you that from 1 August food retailers are obliged to set supplier bonuses (which suppliers pay to retailers) at not more than 10% with no any bonuses allowed for socially important goods (the list of products includes chicken, milk, rye bread, wheat bread, wheat rolls and buns) and comply with maximum payment period for food products (10, 45 and 90 days), depending on their shelf life. The government now has the right to introduce price caps for socially important food for not more than 90 days in the case of more than 30% price increase during one month. At the same time, the most thrilling clause of the Trade Law regarding food retailers’ market share regulation has come into effect since 1 July, 2010. Now food retailers are prohibited from new store openings or acquisition of stores if its retail sales exceed 25% of the total retail turnover of a particular urban district (or municipal region, in particular, Moscow and St. Petersburg). However, we saw that the market share regulation didn’t hurt X5 Retail Group ambitions to acquire Kopeyka in mid-December, though it was obliged to sell or close around 27 of about 700 Kopeyka’s stores, which seemed to be in violation of the market shares limitations. All in all, we see that the Trade Law market share restrictions had no material implications on the food retailers’ ambitious investment programs, which were even step-up to all-time record levels. We estimated that Russian food retail market is able to more than double its selling space by 2020, which assume about 15 mn of modern format retail space to be added before achieving the market saturation level close to that of developed countries.

88

STRATEGY 2011

200

20,000

150

15,000

100

10,000

50

5,000

0 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

0

Source: Minpromtorg, TKB Capital estimate

Employees per `000 sq m of selling space 120 100

Dixy Magnit

X5 Retail Group

80 60 40

Sev enth Continent

Lenta

20 0

Wal-Mart 2006

2007

2008

2009

Source: TKB Capital estimates

Revenue per employee, $ WalMart

200000 150000

2010E 4% 3% 3% 2% 1% 1% 1% 1% 12%

`1000 sq m sq m per 1000 inhabitants

Lenta X5 Retail Group

Sev enth Continent

100000

Dixy

Magnit 50000 0 2006

2007

2008

Source: TKB Capital estimates

2009


Consumer and retail Ready, Steady And Go Shopping!

50% CAGR, %

40% 10

30% 20%

5

10% 0

0% DM

EM

Russia

Net income CAGR`11-15F

EV/EBITDA 2010E

Relative valuation 15

We keep our BUY Top PICKS for Magnit and X5 Retail Group. Russian food retailers are now trading with 2011E EV/EBITDA at 6-15 on average vs. EM peers median at 11. We believe Russian retailers deserve such a premium due to the expected rapid growth of consumer spending, which should be translated into companies EBITDA and bottom line growth (EBITDA GAGR`11-13F at close to 30%) outpacing EM peers. We keep our BUY recommendation for both Magnit (12M target price at $162.3 per share and $32.5 per GDR) and X5 Retail Group (12M target price at $56 per GDR)

Relative valuation P/E

Source: Bloomberg, TKB Capital estimate

EV/EBITDA

EV/S

Company 2009 2010E 2011E

2009 2010E 2011E

2009 2010E 2011E

70.0

17.8

1.5

PEG

Russian peers X 5 Retail Group (GDR)

40.4

30.5

14.0

10.6

1.1

0.7

0.9

Magnit (GDR)

46.8

37.5

34.7

26.0

19.4

14.4

2.4

1.6

1.1

1.3

Magnit

42.0

33.6

31.1

23.3

17.4

12.9

2.2

1.5

1.0

0.6

O`KEY (GDR)

n/a

41.0

25.9

n/a

18.1

13.8

n/a

1.6

1.2

1.0

Seventh Continent

16.2

12.9

9.2

6.6

6.9

5.8

0.6

0.5

0.4

0.6

Dixy Group

neg

66.0

42.7

15.7

12.0

9.5

0.8

0.6

0.5

1.4

Median

44.4

39.0

30.8

17.8

15.7

11.8

1.5

1.3

0.9

1.0

Average

43.8

38.6

29.0

17.9

14.6

11.2

1.5

1.1

0.8

1.0

Median

14.4

16.2

13.3

7.2

7.0

6.3

0.4

0.4

0.4

1.3

Average

18.8

15.9

13.5

7.9

7.5

6.7

0.5

0.5

0.4

1.4

Median

36.5

26.4

21.4

20.5

13.8

10.5

1.3

1.2

0.9

1.7

Average

33.8

25.6

21.8

21.4

15.2

12.6

1.3

1.1

0.9

1.6

Developed markets peers

Emerging markets peers

Source: Bloomberg, TKB Capital estimate

STRATEGY 2011

89


Consumer and retail Ready, Steady And Go Shopping!

Pharma producers in 2011 Growth under the government support

New market regulation turmoil seems to calm down. We would remind you that this year pharma market faced turmoil from the implementation of the new regulation. It was held in respect of the maximum allowed producer prices and markups by pharma wholesalers and retailers on VED (vital and essential) drugs (since April 1) and new packaging rules (since September 1). Pharma companies appeared to be vulnerable to such changes, taking into account that the share of VED drugs accounts for about 30% of the total market. However, by the end of the year, all market participants seem to complete the adjustment of their operations to fully comply with the new regulation. Pharma producers expectedly suffered least of all vs. pharma distributors and retailers (Protek is trading at 40% below its price on IPO, held in April 2010, as the company 1H10 EBITDA margin plunged by almost 2 times to 2.9% vs. 6.4% in FY10, which reflected the negative implications of the regulation changes on the company business). We expect that pharma producers will remain steady in 2011, demonstrating healthy growth. More growth triggers are coming. We expect Pharmstandard and Veropharm to demonstrate solid FY10 financials. Moreover, we believe both companies will remain successful in achieving their optimistic top line growth guidance for 2011, which should trigger further companies’ stocks growth. Besides, we consider Pharmstandard GDRs may be included to MSCI Russia Index, from which they was excluded in 2010 due to the deteriorated trading activity. We keep our BUY rating for both Pharmstandard and Veropharm. Our 12M target price for Pharmstandard is at $36.5 per GDR and $146 per local share. Our 12M target price for Veropharm shares is at $62, which implies more than 30% of upside potential.

1,000

Pharm acies, consum ption, $ per capita

800 600 400 200 Russia

GB

Italy

Spain

Germany

Japan

Source: Company data

Russian pharm acy m arket Domestic production 23%

Foreign supplies 77%

Source: Company data

Russian producers breakdow n (23% of the m arket) Pharmstandart 15%

Others 52%

Schtada 11%

Veropharm 7% Pharmcentr 6% Soteks 6% Biosintez 3%

Relative valuation Company

Canada

France

0 USA

Russian pharma market growth is secured by the government. We see the that foreign producers keep their interest to establish local production in Russia and thus bet on the nd Russian pharma market growth prospects, which remains 2 largest in terms of long-term growth rates after China. The matter is the new government strategy for the long-term development of the Russian pharmacy industry targeting a considerable increase in the domestic drugs production, which should reach up to 50% of the market by 2020 (in value terms) vs. current share of less than 25%. Moreover, the government aims to stimulate domestic R&D and production of original drugs and substances in Russia, modernize production capacities to GMP standard, support import substitution in budget tenders and promote export. We maintain our positive view on domestic leaders - Pharmstandard and Veropharm, and consider them to be able to benefit from the projected Russian pharma market growth and government call for import substitution due to their high quality production capacities and a successful track record of launching new drugs production. Besides, both companies have expressed their ambitions to continue to strengthen their leading positions via both organic growth and M&As.

P/E

EV/EBITDA

EV/S

PEG

2009 2010E 2011E

2009 2010E 2011E

2009 2010E 2011E

Pharmstandard (GDR)

19.9

18.4

16.1

14.3

13.0

11.3

5.5

4.7

4.3

1.4

Pharmstandard

17.5

16.2

14.1

12.6

11.3

9.9

4.8

4.1

3.8

1.3

Veropharm

13.7

11.6

9.6

11.4

8.7

7.5

3.6

2.7

2.4

0.7

Median

17.5

16.2

14.1

12.6

11.3

9.9

4.8

4.1

3.8

1.3

Average

17.1

15.4

13.2

12.8

11.0

9.6

4.7

3.9

3.5

1.1

Source: Company data

Russian peers

16.3

11.4

8.8

7.0

6.6

6.5

3.0

2.6

2.6

2.1

Average

15.6

10.5

8.2

8.1

6.8

6.4

2.8

2.6

2.5

1.8

20% CAGR, %

15%

10

10% 5

5%

0

Emerging markets peers Median

17.2

15.8

13.4

14.1

11.8

11.0

2.6

2.4

2.2

1.9

Average

27.4

20.9

15.8

16.3

14.3

12.3

3.7

3.5

3.0

1.5

Source: Bloomberg, TKB Capital estimates

90

STRATEGY 2011

0% DM

EM

Russia

Source: Bloomberg, TKB Capital estimate

Net income CAGR`11-15F

Median

EV/EBITDA 2010E

Developed markets peers

Relative valuation 15


Consumer and retail Ready, Steady And Go Shopping!

Magnit Record stores roll-out with focus on efficiency Magnit Common MGNT BUY 129.9 162.3 25%

Ticker Recommendation Price, $ Target price, $ Upside/downside, % SHARE DATA Bloomberg Reuters

GDR MGNT LI BUY 29.0 32.5 12%

MGNT RX MGNT.MM Common 89.0 11,598 11,557 64.2 135.0 Common 1/5

# of shares outstanding,mn EV, $ mn MC, $ mn MIN 12 mnth., $ MAX 12 mnth., $ Shares per GDR SUMMARY FINANCIALS, $ mn IFRS 2010E 2011E Rev enue 7,993 11,461 EBITDA 666 900 Net income 344 371 EPS, $ 3.86 4.17 Rev . growth, % 49.3 43.4 EPS growth, % 24.9 8.0 8.3 7.9 EBITDA margin, % Net margin, % 4.3 3.2

2012E 14,680 1,175 445 5.00 28.1 19.7 8.0 3.0

SUMMARY VALUATIONS 2010E P/E 33.6 EV/EBITDA 17.4

2012E 26.0 9.9

2011E 31.1 12.9

SHAREHOLDER STRUCTURE Sergey Galitskiy , CEO Management & BoD Other

41% 4% 56%

We believe Magnit will remain highly attractive in 2011 despite the impressive performance in 2010. The main growth drivers for the stock in 2011 will be strong financial numbers from discounters and hypermarkets and continued aggressive store openings. The Trade Law restriction on food retailers’ market shares, which came into effect recently, seems to have no material impact on the companies’ expansion ambitions. This was confirmed by the recent acquisition of Kopeyka by X5 Retail Group as well as Magnit’s next year investment program of $1.5bn. We keep our BUY recommendation for Magnit stocks with 12M target price of $162.3 per local share and $32.5 per GDR. More growth triggers are ahead. We should note that the fourth quarter sales are seasonally the strongest for retailers, which is explained by New Year holidays (4Q sales may contribute 28-30% of the full-year revenue). We also see that the two months of 4Q10 appeared to be very strong for Magnit, which justify our expectations of very strong full-year results, which may come ahead of the market expectations. We would remind you that during the recent conference-call the company said that it had nearly stopped all price investments that, in our view, implies 4Q10 gross margin to be stronger than in 3Q10 enabling the company to deliver its previously guided 8.2% EBITDA margin. New stores to fuel growth. We see growth triggers for the company value in 2011 to be strong full-year financial results and continued aggressive store openings. We would remind you that Magnit has recently updated its guidance for 2011 capex to be at $1.5 bn, which should be spent on up to 800 convenience stores openings and 55-60 hypermarkets. Thus, Magnit continues an aggressive growth strategy with a focus on increased efficiency through optimizing business processes and further logistics development. At the same time, Magnit plans to retain Net Debt/EBITDA ratio at less than 1.5. Government regulation and macro risks. Investors should take into account the risk of weaker than forecasted macro conditions (in particular, real wages growth and unemployment rate), which may adversely affect the consumer power. Besides, the Trade Law clause on retailers’ market share regulation within the particular urban districts, which came into effect on 1 July, 2010, may limit food retailers’ expansion ambitions in the long run. However, we regard Magnit’s store opening plans as quite safe and consistent with the Trade Law.

PRICE DYNAMICS 140

MGNT

BUY with still attractive upside. We maintain our BUY recommendation for the company with a 12-month target price for Magnit local shares at $162.3 per share ($32.5 per GDR), based on DCF-model (WACC of 10.8%, terminal growth of 3%). Magnit trades with almost a 20-36% premium (for local shares and GDRs, respectively) to its EM peers on 2011E EV/EBITDA, which we see is justified by the expected company’s financials growth in the medium term (EBITDA CAGR`11-13E of almost 35%).

RTS

110 80 50 22.12.09

22.3.10

22.6.10

22.9.10

22.12.10

Source: MICEX, RTS. TKB Capital estimates

STRATEGY 2011

91


Consumer and retail Ready, Steady And Go Shopping!

Magnit BALANCE SHEET IFRS, $ m n CASH

2009

2010E

2011E

2012E

2013E

2014E

2015E

378

444

476

563

816

1,133

1,408

2

2

3

4

5

6

492

709

912

1,187

1,502

1,822

ACCOUNTS RECEIVABLE INVENTORIES

415

OTHER CURRENT ASSETS

68

292

280

252

201

254

307

TOTAL CURRENT ASSETS

862

1,230

1,467

1,730

2,208

2,894

3,544

1,638

2,948

4,257

5,216

6,206

7,233

8,286

4

14

21

22

22

19

13

()

()

()

PPE INTANGIBLE ASSETS OTHER NON-CURRENT ASSETS TOTAL NON-CURRENT ASSETS TOTAL ASSETS

25 1,667

2,962

4,278

5,238

6,227

7,252

8,299 11,843

2,529

4,191

5,745

6,969

8,435

10,146

ST BORROWINGS

267

939

1,530

1,885

2,194

2,386

2,417

OTHER CURRENT LIABILITIES

658

852

1,226

1,575

2,056

2,746

3,475

TOTAL CURRENT LIABILITIES

924

1,791

2,755

3,460

4,250

5,132

5,892

LT BORROWINGS

152

519

837

1,029

1,196

1,300

1,316

27

29

31

38

57

82

105

180

548

869

1,067

1,253

1,381

1,421

OTHER NON-CURRENT LIABILITIES TOTAL NON-CURRENT LIABILITIES MINORITY INTEREST

-

-

-

-

-

-

-

SHARE AND APIC

1,008

1,008

1,008

1,008

1,008

1,008

1,008

OTHER EQUITY ITEMS

(179)

-

-

-

-

-

-

RETAINED EARNINGS

596

845

1,113

1,434

1,924

2,625

3,523

1,425 2,529

1,853 4,191

2,121 5,745

2,442 6,969

2,932 8,435

3,632 10,146

4,531 11,843

2009

2010E

2011E

2012E

2013E

2014E

2015E

TOTAL EQUITY TOTAL LIABILITIES AND EQUITY PROFIT & LOSS STATEMENT IFRS, $ m n REVENUES OPERATING EXPENSES LESS DD&A

5,354

7,993

11,461

14,680

19,090

24,153

29,273

(4,857)

(7,327)

(10,561)

(13,505)

(17,473)

(22,025)

(26,668) 2,605

EBITDA

497

666

900

1,175

1,617

2,128

DD&A

103

131

233

341

432

531

640

EBIT

394

535

667

834

1,185

1,597

1,965

INTEREST INCOME INTEREST EXPENSES MINORITY INTEREST OTHER NON-OPERATING INCOME (EXPENSES) EXTRAORDINARY INCOME (LOSS)

2

-

-

-

-

-

-

(54)

(94)

(191)

(264)

(315)

(354)

(371)

-

-

-

-

-

-

-

12

-

-

-

-

-

-

-

-

-

-

-

-

-

PRE-TAX PROFIT

355

441

476

570

870

1,243

1,594

TOTAL INCOME TAX EXPENSE NET INCOME

(80) 275

(97) 344

(105) 371

(125) 445

(191) 678

(273) 969

(351) 1,243

2009

2010E

2011E

2012E

2013E

2014E

2015E

376

576

723

897

1,265

1,678

2,062

(448) 339

(1,451) 941

(1,548) 858

(1,301) 491

(1,421) 409

(1,556) 194

(1,687) (99)

41

1,013

1,891

2,351

2,574

2,553

2,324

CASH FLOW STATEMENT IFRS, $ m n Operating CF CF from investm ents CF from financing activities Net Debt RATIOS %

2009

2010E

2011E

2012E

2013E

2014E

2015E

Revenue grow th

0.1%

49.3%

43.4%

28.1%

30.0%

26.5%

21.2%

EBITDA margin

9.3%

8.3%

7.9%

8.0%

8.5%

8.8%

8.9%

Net margin

5.1%

4.3%

3.2%

3.0%

3.6%

4.0%

4.2%

0.1

1.5

2.1

2.0

1.6

1.2

0.9

Net Debt/EBITDA

92

STRATEGY 2011


Consumer and retail Ready, Steady And Go Shopping!

X5 Retail Group Betting on the synergy of Kopeyka’s integration X5 RETAIL GROUP

Our new 12M target price for X5 Retail Group, which accounts for the recently acquired discounter chain of Kopeka and company’s new 2011 capex plans, is at $56 per GDR. We thus keep our BUY recommendation for the stocks. Solid financials, a step up increase in next year investment program as well as potential new M&A deals will trigger the company’s growth in 2011. We see, that the Trade Law restriction on food retailers’ market shares, which came into effect recently, has no material impact on the companies’ store opening plans. X5’s acquisition of Kopeyka confirms it as well as Magnit and X5 next year record investment programs of about $1.5bn and $1.3bn respectively.

GDR FIVE BUY 42.7 56.0 31%

Ticker Recommendation Price, $ Target price, $ Upside/downside, % SHARE DATA Bloomberg Reuters # of GDR outstanding, mn EV, $ mn MC, $ mn MIN 12 mnth., $ MAX 12 mnth., $ Shares per GDR

FIVE LI PJPq.L GDR 271.6 13,121 11,583 64.2 135.0 Common 1/4

SUMMARY FINANCIALS, $ mn IFRS 2010E 2011E Rev enue 11,709 17,791 EBITDA 935 1,235 Net income 286 380 EPS, $ 1.05 1.40 Rev . growth, % 34.3 51.9 EPS growth, % 73.2 32.7 EBITDA margin,% 8.0 6.9 Net margin, % 2.4 2.1

2012E 20,228 1,438 448 1.65 13.7 17.8 7.1 2.2

SUMMARY VALUATIONS 2010E P/E 40.4 EV/EBITDA 14.0

2012E 25.9 9.1

2011E 30.5 10.6

SHAREHOLDER STRUCTURE Alf a Group Founders of Py aterochka Management Other

48% 23% 2% 27%

Betting on the synergy from Kopeyka’s acquisition. We would remind you that X5 Retail Group recent acquisition of sixth largest food retailer in Russia, Kopeyka, was priced at about $1.65bn (R51.5bn), including debt (in assumption of not more than R16.5bn or $527mn net debt. This implied EV/EBITDA`10F multiple to be at 11.6 (vs. X5’s EV/EBITDA`10F of 15), which seems to be a reasonable price paid for up to 700 soft discounters (roughly 300`000 sq m of total space) operating at about 90% centralization level vs. X5’s 67% (thanks to 7 distribution centers of about 87`000 sq m and well developed logistics). Acquisition of Kopeyka enables X5 Retail Group to expand its stores count by 40%, adding 25% to selling space, which will result in 19% revenue growth and 15% growth on EBITDA level. X5 Retail Group considers to complete the full integration of Kopeyka by 2013. X5 will raise an additional $1bn credit by Sberbank (5-years, nominated in rubles), which will result in Net Debt/EBITDA`11F at 2.7 (vs. 2.3 reported as on the endSeptember) and will remain consistent with all company’s current credit facility covenants. Going forward, X5 also plans to refinance Kopeyka’s debt on more attractive terms and gain on synergy resulted from the integration (expected to be maximized by 2015). In particular, X5’s targets to lift up sales per sq. m – at the moment Kopeyka demonstrates roughly $7500 revenue per sq m vs. X5’s $13`200. Coming growth triggers: FY10 financial disclosure and management forecasts. We expect that coming 4Q10 and FY10 financials disclosure along with the management guidance of $1.3bn capex in 2011, to be spend on up to 500 new discounters, 20-25 supermarkets, 5-10 hypermarkets and up to 10 Pyaterochka Maxi openings, confirm the company attractive valuation as a bet on further company success in Russian food retail market consolidation. We believe that X5 will continue to play an active role in market consolidation through M&As.

PRICE DYNAMICS 47

FIVE

RTS

40 33 26 22.12.09

22.3.10

22.6.10

22.9.10

Source: LSE, RTS, TKB Capital estimates

22.12.10

Government regulation and macro risks. The overall consumer & retail sector risk is weaker than forecasted macro conditions (in particular real wages growth and unemployment), which may negatively affect the consumer power. Besides, food retail in Russia is now exposed to certain government regulation risks. We would like to remind you that the Trade Law clause on retailers’ market share regulation within the particular urban districts, which came into effect since July 1, may limit food retailers’ expansion ambitions in the long run. However, we regard X5’s store opening plans as quite safe and consistent with the Trade Law. Attractive upside on impressive growth prospects. Our new company DCF-based 12M target price (WACC of 10.8%, terminal growth of 3%) is $56 per GDR, which now accounts for the recent acquisition of discounter chain Kopeyka and a considerable step up in 2011 capex plans. X5 now trades with almost 5% premium to its EM peers EV/EBITDA`11E multiple. However, we see this to be justified by the forecasted EBITDA CAGR for 20112013 to be at almost 30%.

STRATEGY 2011

93


Consumer and retail Ready, Steady And Go Shopping!

X5 Retail Group BALANCE SHEET IFRS, $ m n

2009

2010E

2011E

2012E

2013E

2014E

2015E

CASH

412

434

374

237

569

1,218

2,204

ACCOUNTS RECEIVABLE

310

289

439

499

615

717

824

INVENTORIES

613

634

966

1,099

1,357

1,583

1,820

OTHER CURRENT ASSETS

210

363

548

624

769

899

1,049

TOTAL CURRENT ASSETS

1,544

1,720

2,327

2,459

3,309

4,417

5,898

PPE

2,995

4,321

5,634

5,618

5,539

5,474

5,399

496

542

563

531

495

461

426

OTHER NON-CURRENT ASSETS

1,144

1,168

1,216

1,244

1,287

1,339

1,397

TOTAL NON-CURRENT ASSETS TOTAL ASSETS

4,636

6,031

7,413

7,393

7,321

7,274

7,223

6,180

7,750

9,740

9,852

10,631

11,691

13,121

INTANGIBLE ASSETS

ST BORROWINGS

1,659

890

908

718

503

353

247

OTHER CURRENT LIABILITIES

2,221

2,488

4,038

4,337

5,058

5,635

6,226

TOTAL CURRENT LIABILITIES

6,474

3,880

3,379

4,946

5,055

5,561

5,987

LT BORROWINGS

292

2,077

2,119

1,674

1,173

823

577

OTHER NON-CURRENT LIABILITIES TOTAL NON-CURRENT LIABILITIES

236

236

236

236

236

236

236

527

2,313

2,355

1,910

1,409

1,058

813

-

-

-

-

-

-

-

SHARE AND APIC

2,143

2,143

2,143

2,143

2,143

2,143

2,143

OTHER EQUITY ITEMS

(570)

(570)

(570)

(570)

(570)

(570)

(570)

RETAINED EARNINGS

199

486

866

1,314

2,088

3,072

4,261

1,772 6,180

2,059 7,750

2,439 9,740

2,887 9,852

3,661 10,631

4,646 11,691

5,835 13,121

MINORITY INTEREST

TOTAL EQUITY TOTAL LIABILITIES AND EQUITY PROFIT & LOSS STATEMENT IFRS, $ m n

2009

2010E

2011E

2012E

2013E

2014E

2015E

REVENUES

8,717

11,709

17,791

20,228

24,940

29,088

33,436

OPERATING EXPENSES LESS DD&A

(7,981)

(10,775)

(16,557)

(18,790)

(23,021)

(26,862)

(30,894)

EBITDA

736

935

1,235

1,438

1,919

2,227

2,542

DD&A

268

297

410

532

566

598

632

EBIT

468

637

825

906

1,353

1,629

1,909

-

-

-

-

-

-

-

(154)

(197)

(240)

(217)

(163)

(114)

(80)

INTEREST INCOME INTEREST EXPENSES MINORITY INTEREST OTHER NON-OPERATING INCOME (EXPENSES) EXTRAORDINARY INCOME (LOSS)

4

-

-

-

-

-

-

50

-

-

-

-

-

-

-

-

-

-

-

-

-

PRE-TAX PROFIT

264

441

585

689

1,190

1,515

1,829

TOTAL INCOME TAX EXPENSE NET INCOME

(99) 165

(154) 286

(205) 380

(241) 448

(417) 774

(530) 985

(640) 1,189

2009

2010E

2011E

2012E

2013E

2014E

2015E

CASH FLOW STATEMENT IFRS, $ m n Operating CF CF from investm ents

734

696

1,286

1,114

1,639

1,798

2,017

CF from financing activities

(434) (194)

(1,684) 1,011

(1,406) 60

(616) (635)

(591) (716)

(647) (501)

(680) (351)

Net Debt

1,539

2,534

2,654

2,155

1,107

(43)

(1,380)

RATIOS %

2009

2010E

2011E

2012E

2013E

2014E

2015E

Revenue grow th

4%

34%

52%

14%

23%

17%

15%

EBITDA margin

8%

8%

7%

7%

8%

8%

8%

Net margin

2%

2%

2%

2%

3%

3%

4%

Net Debt/EBITDA

2.1

(0.0)

(0.5)

94

STRATEGY 2011

2.7

2.1

1.5

0.6


Consumer and retail Ready, Steady And Go Shopping!

Pharmstandard Healthy financials and solid growth Pharmstandard Common PHST BUY 100.1 146.0 46%

Ticker Recommendation Price, $ Target price, $ Upside/downside, % SHARE DATA Bloomberg Reuters

GDR PHST LI BUY 28.5 36.5 28%

PHST LI PHSTq.L GDR 151.2 3,681 3,784 16.8 29.5 GDR 1/4

# of GDR outstanding, mn EV, $ mn MC, $ mn MIN 12 mnth., $ MAX 12 mnth., $ Shares per GDR SUMMARY FINANCIALS, $ mn IFRS 2010E 2011E Rev enue 889 969 EBITDA 324 372 Net income 234 268 EPS, $ 1.5 1.8 Rev . growth, % 17.1 9.0 EPS growth, % 8.3 14.7 EBITDA margin,% 36.5 38.4 Net margin, % 26.3 27.7

2012E 1,045 406 293 1.9 7.8 9.1 38.9 28.0

SUMMARY VALUATIONS 2010E P/E 16.2 EV/EBITDA 11.3

2012E 12.9 9.1

2011E 14.1 9.9

SHAREHOLDER STRUCTURE Augement Inv estments Limited GDRs Local shares

54.3% 27.6% 18.1%

We believe Pharmstandard will demonstrate strong performance in 2011. We also expect the company GDRs to be included back into MSCI Russia Index after the exclusion in 2010. The company remains a wise bet on the Russian pharma market growth, fueled by the government call for import substitution. Demonstrating its high financial stability, Pharmstandard maintains its ability to generate positive cash flows for shareholders and finance development via organic growth and M&As. We keep our BUY recommendation for its local shares and GDRs. Coming triggers - flu season, budget tenders and financials disclosure. We expect Pharmstandard to perform strong in 4Q10 thanks to its significant share of anti-flu drugs and vitamins (for instance, sales of Arbidol, Codelac and Complivit account for up to 20% of the company’s total sales and more than 30% of own pharma products sales). Moreover, the company expects to win budget tenders, which will promote 2011 sales growth. Besides, with sufficient liquidity, the company is able to continue M&As in the next few years. Acquiring successful brands could become an additional catalyst for its financials. We believe Pharmstandard is a wise bet on Russian pharma market growth, fueled by the government call for import substitution, which implies good opportunities for domestic producers to replace imported drugs in government purchases and increase their market shares. Government regulation and macro risks. We see downside risks to our valuation model in the case of worsening macro conditions in 2011, which may undermine consumer purchasing power, though medicines consumption is less sensitive to changes in prices. Besides, we see the tightening of government regulation to be another point of concern. In particular, the limitation of direct promotion of new drugs to physicians may hamper the launch of new drugs on the market. Undervalued exposure to the Russian pharma market. Our target price for the company is $146 per share ($36.5 per GDR) based on DCF-model (WACC of 11.2%, terminal growth of 3%), which justifies our BUY recommendation on the stock. The company shares are now traded with about 5-10% discount to its EM peers on the basis of 2011E EV/EBITDA (for GDRs and local shares respectively), which doesn’t reflect the expected company financials’ growth in the medium-term.

PRICE DYNAMICS 32

PHST

RTS

26 20 14 22.12.09

22.3.10

22.6.10

22.9.10

22.12.10

Source: LSE, RTS. TKB Capital estimates

STRATEGY 2011

95


Consumer and retail Ready, Steady And Go Shopping!

Pharmstandard BALANCE SHEET IFRS, $ m n CASH ACCOUNTS RECEIVABLE INVENTORIES OTHER CURRENT ASSETS TOTAL CURRENT ASSETS PPE INTANGIBLE ASSETS OTHER NON-CURRENT ASSETS TOTAL NON-CURRENT ASSETS TOTAL ASSETS ST BORROWINGS OTHER CURRENT LIABILITIES TOTAL CURRENT LIABILITIES LT BORROWINGS OTHER NON-CURRENT LIABILITIES TOTAL NON-CURRENT LIABILITIES MINORITY INTEREST SHARE AND APIC OTHER EQUITY ITEMS RETAINED EARNINGS TOTAL EQUITY TOTAL LIABILITIES AND EQUITY

2009 130 307 91 13 541 122 204 326 867 13 161 174 13 29 42 14 1 () 636 638 867

2010E 253 356 110 22 741 151 216 367 1,108 6 198 205 6 62 69 14 1

2011E 438 387 114 24 963 181 229 410 1,374 3 262 266 3 71 74 14 1

2012E 693 418 123 25 1,259 184 231 415 1,673 2 331 333 2 77 79 14 1

2013E 970 477 139 29 1,616 185 233 418 2,034 1 432 433 1 90 91 14 1

2014E 1,297 545 158 33 2,032 185 236 420 2,453

2015E 1,680 616 177 37 2,509 184 238 422 2,931

549 549

677 677

104 104 14 1

820 821 1,108

1,019 1,020 1,374

1,247 1,248 1,673

1,495 1,497 2,034

1,785 1,786 2,453

119 119 14 1 () 2,120 2,122 2,931

2009 759 (466) 293 24 270 4 (5) 1 3 272 (57) 216

2010E 889 (565) 324 28 297 (1) 1 (3) 292 (58) 234

2011E 969 (596) 372 33 339 (1) 1 (3) 335 (67) 268

2012E 1,045 (638) 406 36 370 () 1 (4) 366 (73) 293

2013E 1,194 (724) 469 39 430 () 1 (4) 426 (85) 340

2014E 1,362 (821) 541 42 499 () 1 (5) 494 (99) 395

2015E 1,540 (922) 617 45 572 () 1 (6) 566 (113) 453

2009 193 28 (53) (104)

2010E 207 (71) (13) (240)

2011E 269 (78) (6) (432)

2012E 301 (43) (3) (690)

2013E 324 (45) (2) (969)

2014E 375 (47) (1) (1,296)

2015E 433 (50) () (1,679)

2009 32% 39% 28% neg.

2010E 17% 36% 26% neg.

2011E 9% 38% 28% neg.

2012E 8% 39% 28% neg.

2013E 14% 39% 29% neg.

2014E 14% 40% 29% neg.

2015E 13% 40% 29% neg.

PROFIT & LOSS STATEMENT IFRS, $ m n REVENUES OPERATING EXPENSES LESS DD&A EBITDA DD&A EBIT INTEREST INCOME INTEREST EXPENSES MINORITY INTEREST OTHER NON-OPERATING INCOME (EXPENSES) EXTRAORDINARY INCOME (LOSS) PRE-TAX PROFIT TOTAL INCOME TAX EXPENSE NET INCOME CASH FLOW STATEMENT IFRS, $ m n Operating CF CF from investm ents CF from financing activities Net Debt RATIOS % Revenue grow th EBITDA margin Net margin Net Debt/EBITDA

96

STRATEGY 2011


Consumer and retail Ready, Steady And Go Shopping!

Veropharm Niche player with a solid pipeline of medicines Veropharm

We recommend investors to BUY Veropharm, which is a clear bet on the Russian pharma market growth and a proxy of government call for import substitution. In 1H11 the value growth drivers will be expected recovery in 4Q10 financials, which should revive investors’ interest towards the stock.

Common VRPH BUY 47.9 62.0 30%

Ticker Recommendation Price, $ Target price, $ Upside/downside, %

Strong financials with a favorable growth outlook. Though the company’s 3Q10 financials came considerably below our and market forecasts, affected by the regulation change on the market, we see Veropharm’s 9M10 financial results are consistent with our full-year revenue growth forecast of 22% y-o-y and the company’s management guidance, taking into account that coming 4Q10 is seasonally strong for pharma producers. Thus, the expected recovery in 4Q10 financials should revive investors’ interest towards the stock in 1H11. Veropharm has previously guided the market with 70% gross margin in FY10 (vs. our current forecast of 68%) and EBITDA margin of up to 35% (vs. our forecast of 32%). We remain confident with our full-year projections and even see some upside risks to our company valuation model.

SHARE DATA Bloomberg Reuters

VFRM RX VFRM.MM Common 10.0 # of shares outstanding,mn EV, $ mn 501 MC, $ mn 479 MIN 12 mnth., $ 27.4 MAX 12 mnth., $ 48.4 Common Shares per GDR SUMMARY FINANCIALS, $ mn IFRS 2010E 2011E Rev enue 183 211 EBITDA 57 66 Net income 41 50 EPS, $ 4.1 5.0 Rev . growth, % 32.0 15.5 EPS growth, % 18.2 21.4 EBITDA margin,% 31.3 31.4 Net margin, % 22.6 23.7

2012E 227 72 54 5.4 7.4 8.3 31.8 23.9

SUMMARY VALUATIONS 2010E P/E 11.6 EV/EBITDA 8.7

2012E 8.8 6.9

2011E 9.6 7.5

PRICE DYNAMICS 51

VRPH

Government regulation and macro risks. The overall sector risk is weaker than expected macro conditions in 2011, which may lead to worsening of consumer power, though consumer demand on medicines looks the most resistant to price changes. Another point of concern is increasing government regulation in the sector. However, we believe Veropharm is able to demonstrate healthy growth of its financials in 2011. Attractive valuation with more than 30% upside potential. We keep our BUY recommendation for the stock with 12M target price at $53.5, derived from our DCF-model (WACC of 12.7%, terminal growth of 3%). Veropharm relative valuation in comparison with its EM peers implies almost 30% discount on the basis of 2011E EV/EBITDA.

. RTS

42 33 24 22.12.09

22.3.10

22.6.10

22.9.10

22.12.10

Source: MICEX, RTS, TKB Capital estimates

STRATEGY 2011

97


Consumer and retail Ready, Steady And Go Shopping!

Veropharm BALANCE SHEET IFRS, $ m n CASH ACCOUNTS RECEIVABLE INVENTORIES OTHER CURRENT ASSETS TOTAL CURRENT ASSETS PPE INTANGIBLE ASSETS OTHER NON-CURRENT ASSETS TOTAL NON-CURRENT ASSETS TOTAL ASSETS ST BORROWINGS OTHER CURRENT LIABILITIES TOTAL CURRENT LIABILITIES LT BORROWINGS OTHER NON-CURRENT LIABILITIES TOTAL NON-CURRENT LIABILITIES MINORITY INTEREST SHARE AND APIC OTHER EQUITY ITEMS RETAINED EARNINGS TOTAL EQUITY TOTAL LIABILITIES AND EQUITY PROFIT & LOSS STATEMENT IFRS, $ m n REVENUES OPERATING EXPENSES LESS DD&A EBITDA DD&A EBIT INTEREST INCOME INTEREST EXPENSES MINORITY INTEREST OTHER NON-OPERATING INCOME (EXPENSES) EXTRAORDINARY INCOME (LOSS) PRE-TAX PROFIT TOTAL INCOME TAX EXPENSE NET INCOME CASH FLOW STATEMENT IFRS, $ m n Operating CF CF from investm ents CF from financing activities Net Debt RATIOS % Revenue grow th EBITDA margin Net margin Net Debt/EBITDA

98

STRATEGY 2011

2009

2010E

2011E

2012E

2013E

2014E

2015E

10 138 35 183 26 11 38 221 29 19 49 3 2 6 -

8 175 31 215 32 12 44 259 24 21 45 10 2 13 -

17 191 36 244 38 13 50 294 7 33 39 10 2 12 -

54 205 39 298 42 13 56 353 8 38 46 12 2 14 -

79 233 44 357 46 14 60 417 7 51 57 10 2 12 -

113 265 50 427 50 14 64 491 6 64 70 9 2 11 -

151 297 57 506 52 14 67 573 3 79 83 5 2 7 -

166 167 221

201 202 259

242 243 294

() 293 293 353

() 347 347 417

() 410 410 491

() 482 483 573

2009

2010E

2011E

2012E

2013E

2014E

2015E

139 (95) 44 4 40 (2) (1) 37 (2) 35

183 (126) 57 5 52 (4) 49 (7) 41

211 (145) 66 6 61 (2) 59 (9) 50

227 (155) 72 6 66 (2) 64 (10) 54

258 (175) 83 7 76 (2) 74 (11) 63

293 (198) 95 8 87 (2) 85 (13) 73

329 (222) 107 8 99 (1) 98 (15) 83

2009

2010E

2011E

2012E

2013E

2014E

2015E

(1) (7) 7 22

17 (12) 2 26

39 (12) (18) (1)

46 (12) 3 (34)

41 (12) (3) (63)

47 (12) (2) (98)

57 (12) (6) (143)

2009 -20% 32% 25% 0.5

2010E 32% 31% 23% 0.5

2011E 15% 31% 24% neg.

2012E 7% 32% 24% neg.

2013E 14% 32% 24% neg.

2014E 13% 32% 25% neg.

2015E 12% 33% 25% neg.


Banking sector More loans – less risks Maria Kalvarskaia m.kalvarskaia@tkbc.ru Nadezhda Krupennikova n.krupennikova@tkbc.ru

Banking sector More loans – less risks YTD sector dynamic vs. RTS 22.12.10

Max

Min

RTS SBER SBERP VTBR VZRZ VZRZP STBK STBKPA MMBM ROSB -40%

0%

40%

80%

120%

2011 is expected to bring important news and events in the Russian banking sector. Further development of financial segment together with corporate deals will boost interest to the banking stocks. At the same time forecasts provided by the banks look quite conservative – loans growth will continue with no acceleration, margins recovery may become visible in 2H11, profits will grow supported by improving credit quality, but positive effect of provisions recovery will be limited. Partial privatization of the state stakes in VTB and Sberbank as well as possible placement of other banks and M&A deals in the segment will determine activity in the banking shares on the market. We keep positive view on the banks’ stocks with Sberbank and Bank StPetersburg as our top picks for 2011, while corporate events may boost interest to VTB stocks. Higher demand for loans with economic recovery. In 2011 we expect total loans portfolio of the Russian banks to grow by 18.7% backed by higher demand for loans from retail and corporate segments. Total assets of the Russian banks to add 15%.

Source: RTS, MICEX, TKB Capital estimates

Assets to be reshaped in favor of loans. We expect the banks to reduce share of liquid assets on their balances, which accounted to 20% in 2H10, being replaced by expanding loans portfolio. RTS Index Finances

130

Stabilization and possible growth of interest rates in 2011 may support margins. Declining rates put pressure on margins in 2010, while in 2011 liabilities revaluation and possible interest rates growth will lead to margins stabilization.

120 110 100 90 80

Source: RTS, TKB Capital estimates

Oct 10

Nov 10

Sep 10

Jul 10

Aug 10

Jun 10

Apr 10

May 10

Mar 10

Jan 10

Feb 10

Dec 09

70

Loans quality will stabilize, but effect of provisions release will be limited. Stabilization of loan portfolio quality will lead to normalization of provisions, but release of reserves will have limited effect on the bottom-line taking into account loans growth and write off of NPLs. Deals in the sector will increase activity on banking stocks. In 2011 the state is planning to sell part of its stakes in VTB and Sberbank, some other placement are possible as well that will boost interest to the stocks. M&A deals will also increase demand for the shares. Upside potential of the banks’ stocks is 12-38%, positive prospects for 2011. Lower risks in the segment, economic recovery and better financial performance will drive up market capitalization of the banks. Sberbank (SBER) and Bank St-Petersburg (STBK) as fundamental ideas, play corporate events in VTB (VTBR). We consider Sberbank and Bank St-Petersburg as our top picks for 2011. Despite strong stocks’ performance through 2010 solid financial forecasts determine positive view on the shares. Sberbank is trading close to its historical highs, while NI exceeded maximum level and there are grounds for substantial improvement in 2011. We recommend BUY Sberbank OS with TP 12 mo $4.6 and PS with TP 12 m $3.53. Bank StPetersburg (BSPB) market cap exceeds pre-crisis level by the volume of preferred shares, while the bank delivers strong financial results proving its stable position in the region and efficiency of its business-model. TP 12 m for STBK OS is $6.8, for PS $7.5. VTB is lagging its main competitor Sberbank in terms of profitability that implies HOLD recommendation with 12 m TP at $0.0036 ($7.2 for GDR), while corporate events (privatization of 10% state stake and possible M&A) may increase speculative interest to the bank shares. Bank Vozrozhdenie (VZRZ) recovers slowly after the downturn and it will take longer time to reach pre-crisis level on bottom-line. We recommend HOLВ Bank Vozrozhdenie shares with TP 12 m $48.4 and see upside risks for our valuation in case of better performance and favorable market conditions.

STRATEGY 2011

99


Banking sector More loans – less risks

2010 – new market conditions revealed the strongest players. In 2010 Russian financial market was characterized by declining interest rates, limited demand for new loans and still relatively high credit risks. Lower interest rates put pressure on interest margins and operating results of the banks, as reprising of liabilities was slower, while high share of cash in the assets structure reduced interest income. Favorable conditions on the fixed-income market attracted borrowers, while banks sometimes failed to offer the same cheap financing. Most of the players followed conservative policy in terms of provisioning taking into account existing risks on the market, but in 2H2010 lower provisions on the back of loans portfolio quality stabilization helped to improve financial performance of the bank.

P/E vs. P/BV RUS vs. EM 16 P/E STBK

12

VTBR Average RUS

VZRZ

8

SBER

4 0.5

1.0

1.5

2.0

2.5

3.0

P/BV

Macro view on the sector Higher demand for loans in 2011 with economic recovery. In 2011 we expect total loans portfolio of the Russian banks to grow by 18.7% backed by higher demand for loans from retail and corporate segments. We expect GDP growth in 2011 at 4.3% that will help to increase corporate loan book by 20%. Under the current low interest rate environment and sufficient liquidity of the Russian banks we would expect significant demand from the largest corporate clients in order to reduce share of wholesale funding from the international markets. But if financial institutions face growing interest rates already in 1H2011 that will limit demand for financial resources on domestic markets. Another factor of growing demand for loans will be postponed needs in financing from the smaller corporate clients, while this segment provides strong growth potential in the future. Demand for retail loans will grow faster than for corporate with higher rate of consumption and more stable economic prospects. Total assets of the Russian banks are expected to add 15% next year, while share of loans will grow from 68% in 2010 to 70% in 2011. Assets to be reshaped in favor of loans. We expect the banks to reduce share of liquid assets on their balances, which accounted to 20% in 2H10, being replaced by expanding loans portfolio. At the same time with growing competition in the segment those players with cheaper financing are gaining market share that reduces financial performance of the weaker ones. Thus, during the crisis 2009 banks created substantial liquidity cushion, which have not been transferred into loans yet despite better market conditions. The state banks have the strongest position on the market as they are ready to take higher risks with sufficient funding base. The smaller banks are looking for strategic investors or develop in their market segment. Among the smaller banks we consider regional financial institutions to have greater opportunity comparing to ones operating in the Moscow region. By the end of 2011 we expect reduction of liquid assets including securities portfolio to 15-17%, but mainly thanks to the largest banks. Stabilization and possible growth of interest rates in 2011 may support margins. Declining rates put pressure on margins in 2010. Average rate for non-financial organizations set by the banks (excluding Sberbank) declined during the year to the absolute low level of 8.9%, while average retail deposits rate was 7.0% in November which is also the absolute low level for retail deposits. However in 2011 liabilities revaluation and possible interest rates growth will lead to margins stabilization. On liabilities side it take several quarters to see positive effect of reprising on financial results, and in a higher degree this concerns those banks, which funding comes mainly from retail deposits. On the assets side there is downside potential for interest rates in retail segment, but possible decline is now limited taking into account the current market level. The largest banks see interest rates reduction by 50-150 bpp next year for retail loans, while in corporate segment yields are close to their minimum reasonable level. In 2011 we may see further interest margins contraction by 20-30 bpp under the current market conditions. At the same time growing inflation in Russia may lead to interest rates growth already in 2011 that will support margins especially for those with cheaper financing.

100

STRATEGY 2011

Source: Bloomberg, TKB Capital estimates

Russian banks' assets and currency exchange rate Total banks assets (RUR mn) RUR/$ EOP (rhs) 33000 32000 31000

31.5 31 30.5 30 29.5 29 28.5 28

30000 29000 28000 27000 1.1.10 1.2.10 1.3.10 1.4.10 1.5.10 1.6.10 1.7.10 1.8.10 1.9.10 1.10.10 1.11.10

Market growth in 2010 in line with our expectations. According to the published CBR 10M10 data and forecasts for the last two months in 2010 total assets of the bank grew by 12%, loans expanded by 12.5% mainly thanks to demand from corporate segment. Clients funds increased by 16%, and in this case retail deposits boosted the total numbers. These numbers correspond to our expectations for 2010, which looked rather conservative at the beginning of the year. Fixed income market was a strong competitor for the borrowings from the banks in 1H2010, while expansion of demand for loans in 2H2010 was limited. Banks are coming on the end of 2010 with strong liquidity position (cash and cash equivalents plus securities amount to 23% of the assets). Thus, Russian banks have substantial ground to expand loans portfolios in the coming years, while growth rates will be determined by economic recovery and interest rate environment.

Source: CBR, TKB Capital estimates

BN RUR

2010E

2011E

2012E

Total Assets

32962

37906

43592

4293

4937

5777

22336

26512

30587

Equity Capital Loans Retail Loans

4110

4850

5820

Corporate Loans

14047

16856

19385

Clients Funds

19872

23449

27318

Retail Clients Funds

9356

11228

13136

Corporate Deposits

5740

6601

7592

Growth rates

2010E

2011E

2012E

Total Assets

12.0%

15.0%

15.0%

Equity Capital

14.0%

15.0%

17.0%

Loans

12.5%

18.7%

15.4%

Retail Loans

15.0%

18.0%

20.0%

Corporate Loans

12.0%

20.0%

15.0%

Clients Funds

16.0%

18.0%

16.5%

Retail Clients Funds

25.0%

20.0%

17.0%

Corporate Deposits

5.0%

15.0%

15.0%

Source: CBR, TKB Capital estimates


Banking sector More loans – less risks

Loans quality will stabilize, but effect of provisions release will be limited. Stabilization of loan portfolio quality will lead to normalization of provisions, but release of reserves will have limited effect on the bottom-line taking into account loans growth and write off of NPLs. In 2010 the share of overdue loans in total loan portfolio was flat at 6.2%, while in absolute terms overdue loans grew by 10%. At the same time provisions increased from 10.3% to 10.5% at the end 2010. Expansion of loan portfolio helped to reduce a share of overdue loans, while the most of banks have been reporting moderate increase in overdues through the whole year. In 2011 we expect stabilization of the volume of overdue loans that together with loan portfolio growth will lead to reduction of share of overdues in the total loans. We also expect to see write-offs of bad loans in 2011 that will have negative effect on opportunity to release provisions.

Interest Rates CBR Ov ernight 2 - 7 day s 8 - 30 day s 31 - 90 day s Ref inancing

50 40 30 20 10 0 Jul 08

Feb 09

Aug 09

Mar 10

Source: CBR, TKB Capital estimates

Average rates of the Russian banks excluding Sberbank (in RUR) Loans to corporate clients Retail deposits (not counting f or current accounts)

16.0% 12.0% 8.0% 4.0%

Oct-10

Aug-10

Jun-10

Apr-10

Feb-10

Dec-09

Oct-09

Aug-09

0.0%

Conservative forecasts on bottom line. Pressure on interest margins and limited effect of provisions release determine conservative forecasts on the bottom-line for the whole banking system. The largest banks are expected to increase their NI by 25-30% y-o-y in 2011 backed by improving quality of loan portfolio, while consolidated results look weaker. According to CBR NI of Russian banks will be flat in 2011 (for 2010 NI is estimated at RUR500 bn), while we expect to see net income growth at 20% backed by better performance of the largest players. Provision release will continue through 2012-2013 that postponing positive effect on the banks’ income. CBR regulation – tightening requirements to capital. CBR will increase requirements to the minimum capital of the banks to RUR180 mn in 2012 vs. current RUR90 mn. By the end of 2010 the number of banks in Russia reduced to 1023 from 1058 in 2009, and with increasing requirements to the capital the number of banks will continue to decline (if the banks don’t increase their capital) since 456 banks had capital below the minimum level at the end of 2010 (in accordance with 2012 requirements). M&A deals also lead to reduction of the number of financial institutions, but here banks from the top 50 with developed client base and expanded network of offices become acquisition target more often.

Source: CBR, TKB Capital estimates

Operating costs to assets and incom e, 2011E Cost-to-income, % 2011Е

Shares to be sold to strategic investors or on the market. In 2011 the state is planning to sell part of its stakes in VTB and Sberbank. 10% of VTB are expected to be privatized in 1Q2011, and we believe that details of the deal will boost interest to the bank’s shares. For now a sale to a strategic investors looks more probable. The government is planning to sell another 10-15% stake in VTB in 2012-2013. The state is also planning to privatize 7.6% of Sberbank keeping control in the largest bank. The time of the deal is still to be set, while in this case market placement is more likely. Some other placements (Rosselhozbank, Uralsib, Nomos-bank) are possible as well that will boost interest to the stocks. The volume of VTB and Sberbank stakes to be sold in 2011 are estimated at $11 bn that is 26% of the current total free float of the liquid banks’ shares.

Cost-to-assets, % 2011E Bank StPetersburg Bank Vozrozhdenie VTB Sberbank 0%

25%

50%

Corporate events to watch

75%

Source: banks' data, TKB Capital estimates

More M&A deals to strengthen position on the market. The process of consolidation in the Russian banking system continues. In 2010 VTB was the most active newsmaker on M&A deals in the segment. Thus, the bank announced acquisition of controlling stake in TransCreditBank and raised its interest to majority stake in Bank of Moscow. VTB also acquired 20% in Rosbank from Open Investments, but the bank considered this deal as investment and is planning to look for a strategic investor. In 2011 we may see a sale of a stake in Uralsib, which is searching for a strategic investor or to place stocks on the market. With growing competition from the largest banks and in low interest rate environment smaller banks look weaker that pursued them being more active in M&A deals and searching for strategic investor or a merger with another player to strengthen their positions.

STRATEGY 2011

101


Banking sector More loans – less risks

Banks’ stocks in focus again

Sberbank (SBER) and Bank St-Petersburg (BSPB) as fundamental ideas. We consider Sberbank and Bank St-Petersburg as our top picks for 2011. Despite strong stocks’ performance through 2010 solid financial forecasts determine positive view on the shares. Sberbank is trading close to its historical highs, while NI exceeded maximum level and there are grounds for substantial improvement in 2011. We recommend to BUY Sberbank OS with TP 12 mo $4.6 and PS with TP 12 m $3.53. Bank St-Petersburg (STBK) market cap exceeds pre-crisis level by the volume of preferred shares, while the bank delivers strong financial results proving its stable position in the region and efficiency of its business-model. TP 12 m for STBK OS is $6.8, for PS $7.5. Play corporate events in VTB (VTBR), HODL Bank Vozrozhdenie (VZRZ). VTB is lagging its main competitor Sberbank in terms of profitability that implies HOLD recommendation with 12 m TP at $0.0036 (7$7.2 for GDR), while corporate events (privatization of 10% state stake and possible M&A) may increase speculative interest to the bank shares. Currently VTB shares are traded with 19% discount to its main peer Sberbank on P/BV 2011E, but with premium of 24% on P/E 2011E ratio. Bank Vozrozhdenie (VZRZ) recovers slowly after the downturn and it will take longer time to reach pre-crisis level on bottom-line. We recommend to HOLD Bank Vozrozhdenie shares with TP 12 m $48.4 and see upside risks for our valuation in case of better performance and favorable market conditions. Currently VZRZ shares are the cheapest in the universe with P/BV 2011E 1.58, but P/E 2011E ratio at 10.5 does not look attractive.

Source: CBR, TKB Capital

Oct

Jul

Aug

NPL Provisions

Corporate Loans, RUR bn Retail Loans, RUR bn Corporate NPLs share Retail NPLs share

Prov isions, RUR mn Prov ision, % of total loans (rhs) NPLs, % of loans (rhs) 8.0%

2400

12% 10%

6.0%

10000

4.0% 5000

8% 6% 4%

2000

2.0%

Source: CBR data, TKB Capital estimates

STRATEGY 2011

2% 0%

Source: CBR, TKB Capital estimates

1-Oct

1-Nov

1-Sep

1-Jul

1-Aug

1-Jun

1-May

1-Apr

1-Mar

1-Jan

1600 1-Feb

0.0% Jan 07 Jan 08 Jul 08 Sep 08 Jan 09 Jul 09 Oct 09 Jan 10 Feb 10 Mar 10 Apr 10 May Jun 10 Jul 10 Aug 10 Sep 10 Oct 10 Nov

0

102

Other banks

Source: CBR, TKB Capital

Overdue Loans

15000

Jun

30 largest banks

Apr

Jan

Oct

Nov

Sep

0 Jul

1,000

0 Aug

3,000

Jun

2,000

Apr

3,000

6,000

May

9,000

Mar

4,000

Jan

12,000

Feb

5,000

Nov

RUR bn

May

Other banks

Mar

30 largest banks

15,000

Feb

RUR bn

Retail loans

Sep

Loans to corporate clients

CAR of the Russian banks 24% 20% 16% 12% 8% 4% 11.1.10

9.1.10

10.1.10

8.1.10

7.1.10

6.1.10

5.1.10

4.1.10

3.1.10

2.1.10

0% 1.1.10

Upside potential of the banks’ stocks is 12-38%, positive prospects for 2011. Lower risks in the segment, economic recovery and better financial performance will drive up market capitalization of the banks. Russian financial system still has considerable growth potential in the future that will attract long-term investment in the segment. In 2011 we expect further recovery after the downturn that will be reflected in higher growth rate of loan portfolio, stabilization of operating results, lower costs of risk and higher net income. Our choice of the stocks to invest in is based on the banks’ ability to generate profit under the changing market conditions and the stocks’ performance during the period. Russian banks are traded with 11% discount to EM peers on P/BV 2011E. Corporate events and new placement on the market will increase interest to the Russian banks’ stocks through 2011.

Source: CBR, TKB Capital estimates

Assets/GDP Mexico Colombia Argentina Poland Russia Brazil Turkey Kazakhstan Hungary Chile Czech Republic South Af rica Israel 0%

50% 100% 150% 200%

Source: CBR, WB, TKB Capital estimates


Banking sector More loans – less risks

Sberbank Successfully going the distance Sberbank Common SBER BUY 3.48 4.60 32%

Pref erred SBERP BUY 2.55 3.53 38%

SBER RU SBER.RTS Common 21,588 77,679 2.08 3.50

Pref erred 1,001 1.64 2.55

Ticker Recommendation Price, $ Target price, $ Upside/downside potential SHARE DATA Bloomberg Reuters # of shares outstanding,mn MC, $ mn MIN 12 mnth, $ MAX 12 mnth, $

SUMMARY FINANCIALS, RUR mn 2010E 2011E Interest incomes 775,341 817,483 Net Interest incomes 465,358 482,559 Net Income 144,682 243,639 Equity 923,909 1,091,365 EPS, RUR 6.70 11.29 Interest income -5 5 growth, % EPS growth, % 493 68 ROAE 16% 22% SUMMARY VALUATIONS 2010E P/BV 2.6 P/E 16.3 Loans/Deposits P/B trailing

86% 2.6

2012E 922,656 526,348 299,349 1,330,414 13.87 13 23 23%

2011E 2.1 9.5

2012E 1.8 8.1

91%

97%

SHAREHOLDER STRUCTURE Central Bank of Russia

58%

Others

42%

PRICE DYNAMICS 3.9

SBER

RTS

3.2 2.5 1.8 22.12.09

22.3.10

22.6.10

22.9.10

22.12.10

Source: Bloomberg, TKB Capital estimates

2.8

SBERP

RTS

2.2 1.6 1.0 22.12.09

22.3.10

22.6.10

22.9.10

Source: Bloomberg, TKB Capital estimates

22.12.10

We revised our 12 months target price for Sberbank ordinary shares from $3.5 to $4.6 and for preferred shares from $2.9 to $3.53 with BUY recommendation for both stocks. Financial performance of the bank in 2010 was better than expected and the next year opens even stronger opportunities. The bank has done a lot in terms of modernization of its business, launching new services, improving efficiency and strengthening its competitive positions. Interest margins and demand for loans were the main concerns in 2010, and together with lower costs of risks will determine financial performance of the bank through 2011. DR program and sale of the state 7.6% stake will boost demand for the stocks. We consider Sberbank shares as our top pick in the Russian banking universe with upside potential at 32% for OS and 38% for PS. Loan portfolio growth – believe in bullish case, bearing in mind a bearish one. Sberbank CEO German Gref shared its view in the bank’s loans growth at 13-15% in corporate segment and at 20-23% in retail segment, which was characterized by the management as the bullish case with more conservative forecasts from Sberbank CFO Anton Karamzin (9-10% and 1518% correspondingly). We estimate growth Sberbank’s gross loan portfolio at 17% in 2011 with stronger numbers in retail segment. The bank develops new credit products for retail clients, improving sales and risk management system. In corporate segment Sberbank is working with all types of businesses from micro to large corporates. In regional aspect the bank is planning to expand its share in the key cities (Moscow and St-Petersburg), where the bank has 15% and 19% correspondingly vs. 31% across Russia. Strong liquidity position to finance loan growth. As of November 1, loan portfolio constituted for 67% of the total bank’s assets, while securities together with cash and cash equivalents amounted to 22%. We expect that the bank will use part of these funds to finance loan portfolio expansion. In 2007-2008 loans were 75-80% of the total assets. In 2010 Sberbank continued attracting money on fixed-income market and in 2010 raised money on international market, but clients’ funds remain the main source of funding for the bank representing 87% of the total liabilities. Margins stabilization with liabilities reprising and slight growth rates next year. In 2010 net interest margins reduced to 6.6% (according to our estimate) vs. 7.3% in 2009 under the pressure of declining rates and faster reprising of assets vs. liabilities. In 4Q10-1Q11 the bank expects further slight decline in margins and stabilization at that level. CBR is likely to increase refinancing rate in 1H11, but that will hardly affect interest rates on the market. We estimate NIM at 6.1% in 2011. Lower costs of risk to support bottom line, but net release of provisions already in 2011 is unlikely. In 2011 the bank will continue reducing provisions on the back of credit quality stabilization, but expansion of loan portfolio and still existing risks will not allow to post net release of provisions. We estimate loan loss provisions in 2011 at RUR11 bn vs. RUR183 bn in 2010, while total reserves will reduce to 8% of the gross loans vs. 10% in 2010. Cost control program helps the bank to keep cost-to-income ratio at a relatively low level (42% in 2010). We expect net income in 2011 at RUR243.6 bn that will increase ROAE over the period to 22%. Market drivers, corporate events and strong performance to boost interest to the stocks. In 2010 Sberbank ordinary shares grew by 20%, preferred stocks surged by 11% playing out strong performance of the bank and positive market trend as Sberbank ords became the most traded stocks on the Russian market. We believe that launching of DR program and privatization of the state 7.6% stake in the banks will further increase interest to the shares, while strong fundamental ratios and recovery of financial markets will also support demand for the shares. Our 12 months TP for Sberbank ords is $4.6 and $3.53 for prefs. Current stock prices give estimate of P/BV 2011E at 2.13, which means premium of 18% to emerging market banks, but bank’s strong position on the market justifies this premium. Sberbank is our top pick for 2011 among Russian banking shares.

STRATEGY 2011

103


Banking sector More loans – less risks

Sberbank BALANCE RUR m n

2009

2010E

2011E

2012E

Loans and advances to customers

4,864,031

5,388,742

6,423,752

7,800,564

9,211,990 10,641,005 11,971,366

Securities

1,061,436

1,484,483

1,376,154

1,343,046

1,316,423

1,296,631

10,219

12,774

15,329

18,394

22,073

26,488

30,461

Other

1,169,380

1,213,776

1,418,509

1,456,801

1,554,952

1,593,967

1,171,756

TOTAL ASSETS

7,105,066

8,099,775

9,233,744 10,618,805 12,105,438 13,558,091 15,185,062

Customer accounts and deposits

5,438,871

6,243,004

7,083,870

8,080,901

124,599

129,166

162,848

185,768

209,771

232,173

256,803

53,947

157,869

162,848

157,903

157,329

174,130

192,602

863,820

996,414

1,102,824

1,219,813

Due from other banks

Issued securities Due to other banks Other liabilities TOTAL LIABILITIES Share capital

709,547

645,828

732,814

6,326,130

7,175,866

8,142,379

2013E

2014E

2015E 2,011,479

9,125,058 10,099,543 11,170,920

9,288,392 10,488,573 11,608,670 12,840,138

87,742

87,742

87,742

87,742

87,742

87,742

87,742

232,493

232,493

232,493

232,493

232,493

232,493

232,493

54,942

82,540

55,540

55,540

55,540

55,540

55,540

Retained Earnings

403,934

521,134

715,590

954,639

1,241,090

1,573,645

1,969,148

TOTAL EQUITY

778,162

923,909

1,091,365

1,330,414

1,616,865

1,949,420

2,344,923

7,105,066

8,099,775

Share premium Revaluation Reserves

TOTAL EQUITY & LIABILITIES

9,233,744 10,618,805 12,105,438 13,558,091 15,185,062

ASSET QUALITY RUR m n

2009

2010E

2011E

2012E

2013E

2014E

2015E

NPLs

462,727

612,144

570,843

505,799

390,572

333,793

247,701

NPL Reserves

579,814

732,702

711,784

629,416

552,311

485,420

413,680

8.5%

10.0%

8.0%

6.0%

4.0%

3.0%

2.0%

1.3

1.2

1.2

1.2

1.4

1.5

1.7

NPLs/Gross Loans Reserves/NPLs PROFIT & LOSS STATEMENT RUR m n

2009

2010E

2011E

2012E

2013E

2014E

2015E

Interest income

814,962

775,341

817,483

922,656

1,069,126

1,221,127

1,397,985

Interest expenses

312,245

309,983

334,925

396,308

452,458

506,336

559,497

Net interest incom e

502,717

465,358

482,559

526,348

616,667

714,791

838,488

(388,932)

(183,495)

(11,201)

43,365

40,256

45,609

53,783

Provision for loan impairment Net income from security operations Net comission fee Other net income Administrative and other operating expenses

36,463

25,000

5,000

5,000

5,000

5,000

5,000

101,089

120,970

128,322

150,874

174,202

197,035

219,852

7,804

16,786

1,594

(5,061)

12,431

13,132

10,000

(229,277)

(263,767)

(301,726)

(346,339)

(397,941)

(449,427)

(499,289)

Profit before tax

29,864

180,853

304,549

374,186

450,616

526,140

627,834

Income tax

(5,468)

(36,171)

(60,910)

(74,837)

(90,123)

(105,228)

(125,567)

Net profit

24,396

144,682

243,639

299,349

360,493

420,912

502,267

%

2009

2010E

2011E

2012E

2013E

2014E

2015E

Net interest income grow th

33%

-7%

4%

9%

17%

16%

17%

Net comission fee grow th

17%

20%

6%

18%

15%

13%

12%

RATIOS

Net interest margin Cost/income ratio ROE Loan/Assets

7%

7%

6%

6%

6%

6%

6%

35%

42%

49%

51%

49%

48%

47%

3%

16%

22%

23%

22%

22%

21%

68%

67%

70%

73%

76%

78%

79%

Deposits/Liabilities

86%

87%

87%

87%

87%

87%

87%

Loans/Deposits

89%

86%

91%

97%

101%

105%

107%

Equity/Assets

11%

11%

12%

13%

13%

14%

15%

104

STRATEGY 2011


Banking sector More loans – less risks

VTB Play on corporate events VTB Ticker Recommendation Price, $ Target price, $ Upside/downside, % SHARE DATA Bloomberg Reuters # of shares outstanding, bn MC, $ mn MIN 12 mnth, $ MAX 12 mnth, $ Shares per GDR

Common VTBR

GDR VTBR LI

HOLD

HOLD

0.0034 0.0036 7%

6.69 7.20 8%

VTBR RU VTBR.MM Common 10,461 35,566 0.00210 0.00350

SUMMARY VALUATIONS 2010Е P/BV 2.0 P/E 18.9 151% 2.0

2012E 421,098 202,121 108,385 699,049 0.0104 9 21 17%

2011E 1.7 11.8

2012E 1.6 10.2

155%

155%

SHAREHOLDER STRUCTURE State property autority 85.50% Others 14.50%

PRICE DYNAMICS 0.0037

VTBR

Loan portfolio growth is expected to accelerate next year. Management of the bank expects corporate loan portfolio to grow by 15% in 2011, while retail segment will expand even stronger by approximately 20%. We view the targeted growth rates as achievable due to expected increase in demand from both – corporate and retail clients boosted by further economic recovery and current low yield environment.

2000

SUMMARY FINANCIALS, RUR mn 2010Е 2011E Interest incomes 345,598 385,433 Net Interest 174,070 186,468 Net Income 56,699 89,359 Equity 547,818 612,304 EPS, RUR 0.0054 0.0085 Interest income 8 12 growth, % EPS growth, % 58 ROAE 11% 15%

Loans/Deposits P/B trailing

GDR

We keep our HOLD recommendation for VTB shares with a TP of $0.0036 per stock ($7.2 per GDR). Decreasing pressure on interest margins along with accelerating loan portfolio growth and lower provisions should support the bottom line. However estimated ROAE at 15% for 2011 makes the bank fundamentally less attractive compared to its major peer Sberbank. At the same time planned privatization of government stake in the bank as well as possible acquisition of Bank of Moscow may boost the demand for the stock in the first half of 2011.

RTS

NIM to stabilize next year. Bank’s NIM showed relatively stable dynamics over 3 quarters of 2010. VTB management expects NIM over 2010 at the level above 5%. We do not exclude slight decline in corporate yields during the first quarter of next year with further possible recovery backed by growing inflation in Russia and increase in refinancing rate by CBR. At the same time according to the management words, the yields on the main bank’s retail products have already reached almost their bottom, and further possible decline is limited by 50-150 bpp next year. Thus we expect for relatively flat NIM for VTB next year at 4.8-5.0%. Declining provisions and growth in commission income to support bottom-line. The share of overdue loans in total loan portfolio decreased by 70 bp over 9M10. We forecast further improvement of loan portfolio quality in 2011 with NPLs share around 8% and provisions at 8-8.5%. Stabilization of the loan portfolio quality will determine lower provisions, but the bank is not planning considerable release of provisions in 2011. At the same time, net fees and commission income that grew over 9M10 by 21% y-o-y will continue to support the bottom-line in 2011 on the back of increase in credit card segment along with growth in commissions from small business. Targeted return to be achieved in later years. We expect net income in 2011 RUR89 bn. That corresponds to ROAE of 15% which is low band of targeted 15-20% the coming years. We believe that VTB has all chances to achieve the higher goals later years in terms of profitability, but now the stock looks less attractive comparing Sberbank's shares due to lower ROE.

at in in to

0.0030 0.0023 0.0016 22.12.09 22.3.10 22.6.10 22.9.10 22.12.10 Source: Bloomberg, TKB Capital estimates

Privatization and possible acquisition of Bank of Moscow as the core drivers. According to Andrey Kostin (CEO) recent announcement in press, privatization of 10% government stake in the bank may take place in January-February 2011, and the stake will be acquired by several investors headed by American TPG fund. Mr. Kostin also mentioned that the high demand for the bank’s shares may force the government to hold additional placement during 2011. Another corporate driver for VTB stocks is possible acquisition of Bank of Moscow in the first half of 2011. VTB is interested in acquisition of controlling stake or even 100% of the bank. According to the press acquisition of Bank of Moscow does not look transparent, but with these assets VTB will get leading position in Moscow region and strengthen its business structure. Thus, privatization of 10% government stake as well as possible acquisition of Bank of Moscow may drive up the share price in the first half of the next year. Now VTB is traded at 1.72 its peers on P/BV vs. 1.8 on average), while on P/E ratio the stock is valued at 11.8 by the market comparing to the average of 11.2. We keep a HOLD recommendation on the bank’s shares

STRATEGY 2011

105


Banking sector More loans – less risks

VTB BALANCE SHEET RUR m n

2009

2010E

2011E

2012E

2013E

2014E

2015E

2,309,900

2,642,031

3,141,990

3,658,020

4,215,413

4,788,837

5,318,691

Securities

400,700

426,205

476,247

520,673

558,675

547,260

542,451

Due from other banks

345,600

276,480

276,480

276,480

276,480

276,480

276,480

Other

554,600

536,894

491,503

413,530

402,380

494,725

641,483

TOTAL ASSETS

3,610,800

3,881,610

4,386,219

4,868,703

5,452,948

6,107,302

6,779,105

Customer accounts and deposits

1,568,800

1,744,065

2,027,362

2,364,344

2,744,143

3,170,488

3,666,013

485,700

496,252

528,886

557,290

562,800

571,980

349,700

Loans and advances to customers

Issued securities Due to other banks

287,000

301,350

316,418

332,238

348,850

366,293

384,607

Other liabilities

764,477

786,425

896,351

910,189

986,443

1,038,270

1,258,847

TOTAL LIABILITIES

3,105,977

3,328,092

3,769,016

4,164,062

4,642,236

5,147,031

5,659,168

Share capital

113,064

113,064

113,064

113,064

113,064

113,064

113,064

Share premium

358,500

358,500

358,500

358,500

358,500

358,500

358,500

Treasury stocks

(441)

(441)

(441)

(441)

(441)

(441)

(441)

Non-realized gains

3,400

3,400

3,400

3,400

3,400

3,400

3,400

25,000

25,200

18,200

18,200

18,200

18,200

18,201

2,700

48,095

119,581

206,326

313,153

462,770

622,195

502,223

547,818

612,304

699,049

805,876

955,493

1,114,919

Revaluation Reserves Retained Earnings TOTAL EQUITY Minority share TOTAL EQUITY & LIABILITIES

2,600

5,700

4,898

5,592

4,835

4,777

5,017

3,610,800

3,881,610

4,386,219

4,868,703

5,452,948

6,107,302

6,779,105

ASSET QUALITY RUR m n

2009

2010E

2011E

2012E

2013E

2014E

2015E

NPLs

249,390

292,652

273,922

275,634

269,334

226,241

221,213

NPL Reserves

234,900

284,489

282,038

279,612

273,488

238,732

211,635

9.8%

10.0%

8.0%

7.0%

6.0%

4.5%

4.0%

0.9

1.0

1.0

1.0

1.0

1.1

1.0

NPLs/Gross Loans Reserves/NPLs PROFIT & LOSS STATEMENT RUR m n Interest income Interest expenses Net interest income Provision for loan impairment Net income from security operations Net comission fee Other net income

2009

2010E

2011E

2012E

2013E

2014E

2015E

373,700

345,598

385,433

421,098

467,274

521,892

574,287

(221,500)

(171,529)

(198,965)

(218,977)

(237,633)

(252,283)

(273,784)

152,200

174,070

186,468

202,121

229,640

269,609

300,504

(154,700)

(51,899)

(13,401)

(13,284)

(12,166)

22,110

17,519

(39,900)

7,000

4,000

15,000

14,000

14,500

14,500

21,000

21,930

28,431

33,123

41,757

47,756

53,908

33,300

3,275

3,165

4,464

11,264

11,648

10,001

Administrative and other operating expenses

(80,200)

(83,502)

(96,964)

(105,942)

(117,627)

(131,879)

(147,347)

Profit before tax

(68,300)

70,874

111,699

135,482

166,868

233,743

249,085

Income tax

8,700

(14,175)

(22,340)

(27,096)

(33,374)

(46,749)

(49,817)

Net profit

(59,600)

56,699

89,359

108,385

133,495

186,995

199,268

%

2009

2010E

2011E

2012E

2013E

2014E

2015E

Net interest income grow th

23%

14%

7%

8%

14%

17%

11%

Net comission fee grow th

9%

4%

30%

17%

26%

14%

13%

Net interest margin

5%

5%

5%

5%

5%

5%

5%

42%

44%

44%

43%

41%

0%

37%

RATIOS

Cost/income ratio ROAE Loan/Assets Deposits/Liabilities Loans/Deposits Equity/Assets

106

STRATEGY 2011

neg

11%

15%

17%

18%

21%

19%

64%

68%

72%

75%

77%

78%

78%

51%

52%

54%

57%

59%

62%

65%

147%

151%

155%

155%

154%

151%

145%

14%

14%

14%

14%

15%

16%

16%


Banking sector More loans – less risks

Bank St. Petersburg Upside potential is still not played out Bank St. Petersburg Common STBK

Ticker Recommendation Price, $ Target price, $ Upside/downside, %

Pref erred STBKP

BUY

BUY

5.60 6.80 22%

5.86 7.50 28%

SRBK RU STBK.MM Common # of shares outstanding, mn 282 MC, $ mn 2,012 MIN 12 mnth, $ 2.52 MAX 12 mnth, $ 5.67

Pref erred 74 3.02 5.92

SHARE DATA Bloomberg Reuters

SUMMARY FINANCIALS, RUR 2010E Interest incomes 24,092 Net Interest 11,992 incomes Net Income 2,986 Equity 27,515 EPS, RUR 10.58 Interest income -6 growth, % EPS growth, % 366 ROAE 11%

mn 2011E 27,240

2012E 30,094

13,196

14,693

4,836 31,635 17.14

7,061 37,990 25.02

13

10

62 16%

46 20%

2011E 1.9 12.0

2012E 1.6 7.5

105%

107%

SUMMARY VALUATIONS 2010E P/BV 2.3 P/E 21.2 Loans/Deposits P/B trailing

104% 2.3

SHAREHOLDER STRUCTURE Sav ely ev A.V. 29.91% Other managers 29.48% Others 40.61% PRICE DYNAMICS 5.2

STBK

RTS

Solid position on the market of St.-Petersburg, concentrated branch network and high operating efficiency helped the bank to show strong financial performance in 2010. Further improvement of quality of loan portfolio will lead reduce cost of risk for the bank that along with stabilization of NIM should support net income figures in 2011. We keep our positive view on the bank ordinary and preferred shares. Bank St-Petersburg (STBK) market cap exceeds pre-crisis level by the volume of preferred shares, while the bank delivers strong financial results proving its stable position in the region and efficiency of its business-model. TP 12 m for Bank St.Petersburg OS is $6.8, for PS $7.5. Expansion of loan portfolio is limited. Loan portfolio is expected to grow by 15% in 2011. In 2010 loan portfolio is expected to expand by 15% (posted 12.9% over 9M10). According to the recent data the share of retail loans was 7.2% while management of the bank guided it above 10% by the end of 2011 that should support the interest income figures next year on the back of higher yields in retail segment of the business. NIM estimated at 5.6% next year. NIM compressed by 30 bpp in 3Q10 to 5.1% posting 5.2% over 9M10. Management of the bank does not provide any guidance on NIM level in 2011, but shared its preliminary expectations that NIM will remain at least flat next year. Meanwhile, we estimate NIM at 5.6% in 2011 vs. estimated 5.4% in 2010. Despite improvement of loan portfolio quality bank will continue provisioning next year. Bank reported decrease in the share of overdue loans in the total loan portfolio by 160 bpp in 3Q10 compared to January 1, 2010. We expect further decline in NPLs next year on the back of restructuring as well as repayment of overdue loans. As a result according to the management expectations loan loss provisions should substantially decrease next year bringing cost of risk down by around 200 bp in 2011 vs. 340 bp in 2010E. However management of the bank does not expect for release of provisions next year. Keeping the lowest cost-to-income ratio in the sector. Operating expense over 9M10 surged by 22% y-o-y giving cost-to-income ratio at 28.2% over 9M10 vs. 25.3% in the same period of the last year. We expect for further increase in cost-to-income ratio in 2011 up to 31% due to increasing staff costs. However, this is still the lowest ratio among its market peers, which is one of the core competitive advantages of the bank.

4.2 3.2 2.2 22.12.09 22.3.10

22.6.10

22.9.10 22.12.10

Source: Bloomberg, TKB Capital estimates

Growth potential is still not played out. Bank’s shares showed strong growth during the year. Ordinary shares of the bank grew by 100% from the beginning of the year while preferred surged by 94% for the same period. However the ordinary shares are still traded at a discount to Sberbank (based on 2011 P/BV of 1.96 vs. 2.13). The estimated target price for Bank St Petersburg’s ordinary shares is $6.8 for the next 12-months which assumes 22% upside from the current levels, while upside risk for bank's preferred shares is estimated at 28% with fair value of $7.5.

STRATEGY 2011

107


Banking sector More loans – less risks

Bank St. Petersburg BALANCE SHEET RUR m n Loans and advances to customers Securities Due from other banks Other

2009

2010E

2011E

2012E

2013E

2014E

2015E

158,200

179,118

206,216

235,948

269,578

306,316

348,071

29,717

27,427

27,844

26,441

25,623

23,855

23,218

5,867

1,173

1,291

1,420

1,420

1,278

1,150

41,822

39,667

44,195

49,283

54,042

54,281

59,578

TOTAL ASSETS

235,606

247,386

279,547

313,092

350,663

385,729

432,017

Customer accounts and deposits

175,990

171,653

195,914

221,315

246,510

273,238

303,040

5,151

6,695

7,029

7,380

7,749

8,136

9,762

Issued securities Due to other banks

16,002

18,689

18,593

16,506

15,152

13,091

14,408

Other liabilities

13,179

22,835

26,376

29,901

33,638

32,803

33,000

210,322

219,871

247,911

275,102

303,049

327,267

360,210

3,630

3,630

3,630

3,630

3,630

3,630

3,630

15,744

15,744

15,744

15,744

15,744

15,744

15,744

Revaluation Reserves

1,966

2,064

2,168

2,276

1,600

1,400

1,401

Retained Earnings

3,912

6,077

10,094

16,340

26,640

37,688

51,032

TOTAL LIABILITIES Share capital Share premium

TOTAL EQUITY TOTAL EQUITY & LIABILITIES

25,252

27,515

31,635

37,990

47,614

58,462

71,807

235,574

247,386

279,547

313,092

350,663

385,729

432,017

INCOME STATEMENT RUR m n

2009

2010E

2011E

2012E

2013E

2014E

2015E

NPLs

12,884

12,021

12,673

13,036

13,186

13,175

12,960

NPL Reserves

15,910

21,238

24,193

24,768

23,442

23,056

22,217

7.4%

6.0%

5.5%

5.0%

4.5%

4.0%

3.5%

1.2

1.8

1.9

1.9

1.8

1.8

1.7

NPLs/Gross Loans Reserves/NPLs CASH FLOW STATEMENT RUR m n Interest income Interest expenses Net interest income

2009

2010E

2011E

2012E

2013E

2014E

2015E

25,597

24,092

27,240

30,094

33,459

37,105

41,370

(15,177)

(12,100)

(14,044)

(15,401)

(16,945)

(18,329)

(19,951) 21,418

10,420

11,992

13,196

14,693

16,514

18,776

(10,512)

(6,330)

(4,107)

(2,400)

447

(273)

98

Net income from security operations

1,714

400

250

300

300

300

300

Net comission fee

1,490

1,486

1,786

2,079

2,356

2,718

3,132

Other net income

1,422

550

270

295

395

395

447

(3,773)

(4,365)

(5,350)

(6,141)

(7,143)

(8,113)

(8,724)

Provision for loan impairment

Administrative and other operating expenses Profit before tax

761

3,733

6,045

8,826

12,870

13,803

16,671

Income tax

(120)

(747)

(1,209)

(1,765)

(2,574)

(2,761)

(3,334)

Net profit

641

2,986

4,836

7,061

10,296

11,043

13,337

%

2009

2010E

2011E

2012E

2013E

2014E

2015E

Net interest income grow th

10%

15%

10%

11%

12%

14%

14%

108%

100%

120%

116%

113%

115%

115%

RATIOS

Net comission fee grow th Net interest margin Cost/income ratio ROAE

5%

5%

5%

5%

5%

6%

6%

25%

30%

35%

35%

37%

37%

34%

3%

11%

16%

20%

24%

21%

20%

Loan/Assets

67%

72%

74%

75%

77%

79%

81%

Deposits/Liabilities

84%

78%

79%

80%

81%

83%

84%

Loans/Deposits

90%

104%

105%

107%

109%

112%

115%

Equity/Assets

11%

11%

11%

12%

14%

15%

17%

108

STRATEGY 2011


Banking sector More loans – less risks

Bank Vozrozhdenie Cheap stocks with limited upside for now Bank Vozrozhdenie Common VZRZ

Ticker Recommendation Price, $ Target price, $ Upside/downside potential

Pref erred VZRZP

HOLD

HOLD

43.36 48.40 12%

14.32 16.90 18%

VZRZ RU VZRZ.RTS Common # of shares outstanding, mn 24 MC, $ mn 1,048 MIN 12 mnth, $ 26.46 MAX 12 mnth, $ 48.25

Pref erred 1 9.74 19.40

SHARE DATA Bloomberg Reuters

SUMMARY FINANCIALS, RUR mn 2010E 2011E Interest incomes 13,654 15,428 Net Interest 5,728 7,373 Net Income 593 2,996 Equity 16,846 19,828 EPS, RUR 24.96 126.15 Interest income -14 7 growth, % EPS growth, % -51 405 ROAE 4% 16% SUMMARY VALUATIONS 2010E P/BV 1.9 P/E 53.8 Loans/Deposits P/B trailing

75% 1.9

2012E 17,621 8,911 4,845 24,673 203.99 14 62 22%

2011E 1.6 10.5

2012E 1.3 6.8

78%

81%

SHAREHOLDER STRUCTURE Orlov D.L. 30.70% Marganiy a O.L. 18.65% JPM International Consumer 9.37% Others 41.28% PRICE DYNAMICS 54

VZRZ

RTS

44 34 24 22.12.09

22.3.10

22.6.10

22.9.10 22.12.10

Moderate growth of bank Vozrozhdenie loan portfolio along with the weakest interest margins and high operating costs put pressure on bottom-line in 2010 and may negatively affect financial performance the next year. Business-model of the bank with expensive retail funding and spread network of branches on highly competitive market performed badly under the crisis conditions, and the bank needs more time to recover its numbers. We see a limited upside for the name in 2011, which will be realized only in case of faster credit market recovery. We recommend HOLD Bank Vozrozhdenie shares with TP 12 m $48.4 and see upside risks for our valuation in case of better performance and favorable market conditions. Moderate growth of loan portfolio. Recently management of the bank guided 15-20% growth in total loan portfolio in 2011 with 30% growth in retail loans. However, we are more conservative in our forecasts and expects for 14% growth of loan portfolio next year. In 2010 loan portfolio growth is expected at 15%. Loan portfolio quality stabilizes slower than expected In 3Q10 bank declared increase in share of overdue loans to 10.98% from 10.55% in 2Q10 due to impairment of large loan to one of the bank’s corporate clients. Total volume of loans overdue by 360+ days surged by 37% q-o-q. The share of loans overdue by more than 360 days increased from 4.6% in 2Q10 to 6.1% in 3Q10. Total volume of overdue loans grew by 7% to RUR11.6 bn. We expect NPLs to decline to 10% in 2011 while provisions will decrease to 9.0%. High margins are in the past. Slow growth of loan portfolio and lower interest income resulted in net interest income decline and NIM contraction to 3.3% in 3Q10. Management of the bank expects to post NIM at around 5% next year. However we estimate NIM of 4.4% in 2011 due to increasing competition on the market mainly from the side of the largest sector players. Net income is under pressure of high OPEX. Lower core income and relatively high operating costs due to existing business model continue reducing efficiency of the bank. Cost-to-income ratio in 3Q10 was 69.4% vs. 48.7% in 2009. We expect cost-to-income at 65-67% in 2011 that will also put pressure on bottom line. Limited upside under the current market conditions. Now the shares of bank Vozrozhdenie are traded with 2011 P/BV of 1.58 vs. 2.13 for Sberbank, which was earlier a kind of benchmark for Vozrozhdenie taking into account their business models with large branch network and a significant share of retail funding. Stronger competition and existing credit risks limit upside of the shares and we recommend to HOLD them. We stay cautious in terms of relatively high operating costs and low margins showed by the bank, but we see upside risks for our valuation if the market conditions are getting more favorable for the bank.

Source: Bloomberg, TKB Capital estimates

STRATEGY 2011

109


Banking sector More loans – less risks

Bank Vozrozhdenie BALANCE SHEET RUR m n

2009

2010E

2011E

2012E

2013E

2014E

2015E

Loans and advances to customers

85,205

97,486

112,873

132,388

154,555

179,449

207,451

Securities

11,068

12,175

13,392

14,732

16,205

17,825

19,608

6,363

7,317

8,196

9,179

10,280

11,514

12,896

42,967

41,729

40,117

42,720

45,842

52,126

52,269

Due from other banks Other TOTAL ASSETS

145,603

158,707

174,578

199,019

226,882

260,914

292,223

Customer accounts and deposits

113,129

130,098

144,409

163,182

184,396

212,055

243,864

Issued securities

6,364

3,612

3,951

5,598

6,751

7,913

8,082

Due to other banks

4,368

1,747

1,660

1,577

1,498

1,423

1,352

Other liabilities TOTAL LIABILITIES Share capital Share premium Revaluation Reserves Retained Earnings TOTAL EQUITY TOTAL EQUITY & LIABILITIES

5,456

6,403

4,730

3,989

4,002

2,840

-4,748

129,317

141,861

154,750

174,346

196,647

224,231

248,549

250

250

250

250

250

250

250

7,306

7,306

7,306

7,306

7,306

7,306

7,306

70

52

52

52

52

52

53

8,660

9,238

12,220

17,065

22,626

29,075

36,065

16,286

16,846

19,828

24,673

30,234

36,683

43,674

145,603

158,707

174,578

199,019

226,882

260,914

292,223

INCOME STATEMENT RUR m n

2009

2010E

2011E

2012E

2013E

2014E

2015E

NPLs

9,370

12,517

12,408

11,415

9,846

9,435

10,851

NPL Reserves

9,439

11,355

11,205

10,302

9,539

9,259

9,563

NPLs/Gross Loans

9.9%

11.5%

10.0%

8.0%

6.0%

5.0%

5.0%

1.0

0.9

0.9

0.9

1.0

1.0

0.9

Reserves/NPLs CASH FLOW STATEMENT RUR m n

2009

2010E

2011E

2012E

2013E

2014E

2015E

Interest income

16,954

13,654

15,428

17,621

19,987

22,750

26,108

Interest expenses

(8,628)

(7,926)

(8,055)

(8,710)

(9,543)

(10,485)

(11,962)

8,326

5,728

7,373

8,911

10,445

12,266

14,146

(4,752)

(2,425)

(433)

503

456

103

(507)

204

20

50

50

50

50

51

3,729

4,006

4,279

5,164

5,826

6,914

7,942

Net interest income Provision for loan impairment Net income from security operations Net comission fee Other net income Administrative and other operating expenses

737

543

710

760

760

760

761

(6,325)

(7,131)

(8,234)

(9,332)

(10,585)

(12,033)

(13,656)

Profit before tax

1,919

741

3,745

6,056

6,952

8,060

8,738

Income tax

(702)

(148)

(749)

(1,211)

(1,390)

(1,612)

(1,748)

Net profit

1,217

593

2,996

4,845

5,562

6,448

6,990

RATIOS %

2009

2010E

2011E

2012E

2013E

2014E

2015E

Net interest income grow th

-2%

-31%

29%

21%

17%

17%

15%

Net comission fee grow th

-10%

7%

7%

21%

13%

19%

15%

6%

4%

4%

5%

5%

5%

6%

49%

69%

66%

63%

62%

60%

60%

Net interest margin Cost/income ratio ROAE

8%

4%

16%

22%

20%

19%

17%

Loan/Assets

59%

61%

65%

67%

68%

69%

71%

Deposits/Liabilities

87%

92%

93%

94%

94%

95%

98%

Loans/Deposits

75%

75%

78%

81%

84%

85%

85%

Equity/Assets

11%

11%

11%

12%

13%

14%

15%

110

STRATEGY 2011


Machinery Citius, altius, fortius* Artem Lavrischev

a.lavrischev@tkbc.ru

Machinery Citius, altius, fortius* YTD sector dynam ic vs. RTS 22.12.10

Max

Min

RTS AVAZ GAZA SVAV KMAZ

Russian machinery sector provides investors a lot of opportunities to make money. However, we believe that a selective choice should be used. Thus, we prefer auto and helicopter producers on the back of strong vehicle sales recovery in domestic auto segment and Russian Helicopters’ IPO prospects respectively. We are also positive on power equipment producers due to expected capacity installations in domestic utility sector. On the contrary, nuclear fuel fabricators are likely to face lack of export orders’ flow from Asia, which will significantly limit their upside potential.

KHEL UUAZ

Auto industry – a premium for the growth

RTVL

Domestic auto market continues to fill the gap. We expect cars and LCVs sales in Russia to increase by 20% y-o-y to 2.3 mn vehicles in 2011 on the back of the state support via extension of cash-for-clunkers program and consumer power strengthening. Russian truck producers will also gain from construction market recovery and infrastructure projects’ realization.

SILM KRKO IZHZ MASZ NZHK PGHO RKKE SATR UFMO -100%

160

0%

RTS Index

100%

200%

RTS Industrials

Foreign partners may get an expensive ticket for control. Renault-Nissan and Daimler may boost their stakes in AVTOVAZ and KAMAZ respectively up to control, which will be a good support for the latter’s stocks taking into account that the major shareholder – Russian Technologies – estimates fair value of these companies with a 30-50% premium to the market quotes. Sollers – more value ahead. We believe Sollers to outperform other Russian auto producers in 2011 due to strong auto sales dynamics and sharp recovery in profitability. The company trades with EV/EBITDA’11E of 7.4, which implies a discount of 10% and 15% to domestic and foreign peers respectively.

140

Helicopter producers – waiting for the holding company’s IPO

120 100

Dec 09 Jan 10 Feb 10 Mar 10 Apr 10 May 10 May 10 Jun 10 Jul 10 Aug 10 Sep 10 Oct 10 Oct 10 Nov 10 Dec 10

80

Source: RTS, TKB Capital estimates

Russian Helicopters’ IPO could bring new value for the companies. Oboronprom intends to hold an IPO of Russian Helicopters by the end of 1H11. We estimate the holding company’s market capitalization at $1.8-2.0 bn, which implies EV/S’11E of 1.4 – practically in line with emerging market peers. Ulan-Ude Aviation Plant is mostly undervalued among helicopter producers. We consider Ulan-Ude Aviation Plant’ shares could be the cheapest ticket into the holding company on the back of its fundamentals. The company’s EV/EBITDA’11E of 3.3 is also attractive in compare with other helicopter producers. However, swap ratios into the Russian Helicopters may bring disappointing news. Power machinery – “cherry-picking” is on track It’s time to realize capacity installations in domestic utility sector. 2011 is expected to be a starting point to capacity installations in Russian utility sector, which envisage investments over $50 bn for new power units of 31 GW by 2017. We believe that it is a key long-term driver for power equipment producers. Power Machines is our bet on the industry’s growth. According to our estimates, Power Machines will benefit the biggest part of domestic utilities’ orders flow. We believe that the company’s solid prospects should be reflected in its financials and lead to a decrease of 40% discount to foreign peers on the base of its EV/EBITDA’11E of 5.8. Nuclear fuel enrichment vs. fabrication and lack of Asian orders. We expect TVEL Holding will shift its priority from nuclear fuel fabrication to enrichment. Meanwhile Rosatom’s negotiations with China and India suggest that fuel fabrication for their NPPs will not to be realized in Russia. We believe that these factors bring negative sense to Mashinostroitelny Zavod and Novosibirsk Chemical Concentrates Plant and significantly limit their upside potential.

* – Latin for “Faster, higher, stronger”.

STRATEGY 2011

111


Machinery Citius, altius, fortius*

Auto producers – a premium for the growth Russian autom arket volum e, units

Costs increase will likely boost vehicle prices. Russian auto producers could face appreciable growth of operating expenses in 2011. Domestic steel makers plan to increase cold rolled steel prices by 25-30%, which share in auto producers’ COGS amounted to 20-40%. As a result it will lead either to the growth of vehicle end-price by 3-5% or auto makers’ margin decline. We regard Sollers’ profitability is relatively less influenced by possible steel prices boost vs. other Russian auto producers due to practically 40% of the company’s auto sales provided by assembled vehicles.

2008

2009

2010

Dec

Oct

Nov

Sep

Jul

Aug

Jun

Apr

May

Mar

Jan

Feb

350,000 300,000 250,000 200,000 150,000 100,000 50,000

Source: AEB, TKB Capital estimates

Scrappage certificates delivery dynam ics Scrappage certif icates (rest) Daily certif icates deliv ery 200,000

3,200

150,000

2,400

100,000

1,600

50,000

800

0

0 8.3.10 24.3.10 8.4.10 28.4.10 12.5.10 3.6.10 17.6.10 1.7.10 29.7.10 1.9.10 8.10.10 8.12.10 22.12.10

Domestic auto market continues filling the gap. We believe that 2011 could be a breaking point for the Russian auto market. The key point is that the state plans to close cash-forclunkers program next year, which was a key driver for the market during 2010. Thus, cars and LCVs sales in Russia increased by 28% y-o-y to 1.7 mn vehicles in 11M10, while scrappage program’s share, according to our estimates, amounted to 15%. Next year our government plans to provide at least 100,000 scrappage certificates (a decrease of 75% y-o-y), however the budget could be extended to avoid the European experience when the auto market dropped significantly after the state closed cash-for-clunkers program. We also note that almost 100,000 vehicles purchased with scrappage certificates in 2010, will be delivered to customers only in 2011, which will have an additional impact on auto sales statistics next year. Taking into account the state support and strengthening consumer confidence, we expect cars and LCVs sales in Russia to increase by 20% y-o-y to 2.3 mn vehicles in 2011. At the same time domestic truck market could also show positive performance on the back of construction and infrastructure projects’ realization, including preparations to Sochi Olympic Games-2014.

Source: Minpromtorg, TKB Capital estimates

AVTOVAZ car sales, units

Source: AEB, TKB Capital estimates

Sollers car and LCV sales, units Whole automarket (lhs) 300,000 250,000 200,000 150,000 100,000 50,000

Sollers (rhs)

STRATEGY 2011

12,500 10,500 8,500 6,500 4,500 2,500

Source: AEB, TKB Capital estimates

GAZ Group car and LCV sales, units Whole automarket (lhs) 300,000 250,000 200,000 150,000 100,000 50,000

GAZ Group (rhs)

Source: AEB, TKB Capital estimates

112

90,000 75,000 60,000 45,000 30,000 15,000

Jan 2008 Apr 2008 July 2008 Oct 2008 Jan 2009 Apr 2009 July 2009 Oct 2009 Jan 2010 Apr 2010 Jul 2010 Oct 2010

AVTOVAZ (rhs)

Jan 2008 Apr 2008 July 2008 Oct 2008 Jan 2009 Apr 2009 July 2009 Oct 2009 Jan 2010 Apr 2010 Jul 2010 Oct 2010

Sollers – more value ahead. According to our estimates, Sollers should increase its auto sales by 25% y-o-y in 2011. Thereby, the company’s annual sales will exceed 100,000 vehicles and turn back to precrisis level, which will also lead to solid improvements in Sollers’ financials. Thus, the company’s management expects to achieve revenue of $2.1 bn next year (28% increase y-o-y), which will be just 15% less the level of 2008, when auto producer reached its historical high. We note that Sollers engine segment recovers slowly as GAZ canceled huge part of orders during the crisis year. However, vehicle sales growth together with major efforts taken by the management to reduce costs will have a significant impact on the company’s margins recovery. In particular, Sollers expects to double its EBITDA to $200 mn in 2011, which implies Net Debt/EBITDA’11E ratio of 3. We consider Sollers the most undervalued auto producer in Russia on the back of strong fundamental story. The company trades with EV/EBITDA’11E of 7.4, which implies a discount of 10% and 15% to domestic and foreign peers respectively. We also believe that long-term prospects of establishing Sollers-Fiat joint venture, which total production capacities are expected to exceed 300,000 vehicles per year, are not priced in.

Whole automarket (lhs) 300,000 250,000 200,000 150,000 100,000 50,000

Jan 2008 Apr 2008 July 2008 Oct 2008 Jan 2009 Apr 2009 July 2009 Oct 2009 Jan 2010 Apr 2010 Jul 2010 Oct 2010

Foreign partners may get an expensive ticket for control. AVTOVAZ and KAMAZ are national champions in Russian auto industry with production capacities of 1 mn cars and 100,000 trucks per year respectively. Both these companies are controlled by the state corporation – Russian Technologies. Renault owns 25% share in AVTOVAZ, while Daimler has 15% in KAMAZ (including EBRD share of 4%). This year foreign partners approved their intention to reach control in Russian auto producers, which seems quite reasonable on the back of expected cooperation in technologies and vehicle output. Thus, Nissan may purchase 10% of AVTOVAZ’s common shares already in 1H11, which will lead to increase of RenaultNissan’s stake to 35%. The next possible step suggests further boost of French-Japanese alliance’s share in Russian auto maker to 55% – Renault and Nissan will own 35% and 20% respectively. The same scenario will likely happen with Daimler’s share in KAMAZ, which is expected to exceed 50% threshold by 2016. It is clear that the main question is price and we believe that the answer is behind Russian Technologies’ position. The state corporation estimates key domestic auto producers with a premium of 30-50% to their market quotes. Thus, Russian Technologies calculations of AVTOVAZ’s and KAMAZ’s fair value imply their market capitalization of at least $2.9 bn and $2.5 bn respectively.

15,000 12,500 10,000 7,500 5,000 2,500


Machinery Citius, altius, fortius*

Helicopter producers – waiting for the holding company’s IPO

Enterprise Value breakdow n, $ mn Mkt Cap

UUAZ

-78

Net Debt

561

KHEL

489

RTVL

161

-200

0

197

234

200

400

600

800

Source: TKB Capital estimates

Key financial m ultiples of com panies for 2011 Ulan-Ude Av iaplant

P/E 5.1

EV/EBITDA EV/S 3.3 0.89

Kazan Helicopters

5.4

4.8

0.98

Rostv ertol

4.5

5.9

0.71

Russian companies av erage

5.0

4.7

0.86

Premium/(discount)

-65%

-45%

-28%

P/E

EV/EBITDA EV/S

14.3

Foreign peers av erage

8.5

1.20

Source: Bloomberg, TKB Capital estimates

Electricity output in Russia (KWh bn) 1,800

Heat

1,500

Nuclear

Hy dro

1,200

25%

900

20% 16%

600 300

2029E

2027E

2025E

2023E

2021E

2019E

2017E

2015E

2013E

2009

2011E

2007

2005

0

Source: Rosstat, APBE, TKB Capital estimates

Russian Helicopters’ IPO could bring new value for the companies. In the meantime, domestic helicopter industry is not transparent enough to the investment community. We expect that coming IPO of Russian Helicopters will force the company to provide more information about its contracts and disclose financials under IFRS vs. RAS, which should increase the overall transparency of the sector. Oboronprom’s subsidiary will consolidate assets in R&D, production, maintenance, modernization and service of Mi and Ka helicopters – totally at least 13 companies, which overall 2011 revenue may reach $2.0-2.1 bn. According to our estimates, Russian Helicopters’ market capitalization could amount to $1.8-2.0 bn, which implies EV/S’11E of 1.4 – practically in line with emerging market peers. In this case we consider that Russian Helicopters should place 25-30% shares to raise Oboronprom’s targeted sum of $500 mn. Ulan-Ude Aviation Plant is mostly undervalued among helicopter producers. Russian producers traditionally have strong position on helicopter markets of China, India and Latin America. According to published 9M10 RAS financials, the consolidated export revenue of Ulan-Ude Aviation Plant, Kazan Helicopters and Rostvertol amounted to $630 mn or 59% of their total sales for the same period. We also note that these companies generate above 70% and 90% of Russian Helicopters’ consolidated revenue and net income respectively. Rosoboronexport, which provide export orders for U-UAZ, KVZ and Rostvertol, is likely to complete their backlog for 2012–2013 in the run-up to IPO of the holding company. According to our estimates, Ulan-Ude Aviation Plant’ shares are the cheapest ticket into Russian Helicopters on the back of its high profitability and zero borrowings. Furthermore, we believe that U-UAZ is the most undervalued company among domestic helicopter producers, which EV/EBITDA’11E amounted to 3.3. However we note that it could be announced unattractive swap ratios into the Russian Helicopters, which we believe is a key risk for UUAZ.

Power machinery – “cherry-picking” is on track It’s time to realize capacity installations in domestic utility sector. 2011 is expected to be a starting point to capacity installations in Russia after the crisis. Key domestic utility players will sign capacity delivery agreements, which give them a free hand to place orders for power equipment to execute their investment programs. We note that Minenergo general scheme envisages investments over $50 bn for new power units of 31 GW by 2017. We believe that execution of investment programs in utility sector is a key long-term driver for domestic power equipment producers. Power Machines is our bet on the industry’s growth. According to our estimates, Power Machines, which is generally specialized in production of turbines and generators, will benefit the most from domestic utilities’ orders flow. Thus, the company’s current backlog already amounted to $4 bn, while its net cash position equals $170 mn. Huge industry prospects forced Power Machines to build new production capacities in Kolpino. The state provides the company its support in this project including co-financing and subsidized loans. In this case we do not see any significant risks to Power Machines’ ability to generate solid cash flow to its shareholders. According to Bloomberg consensus estimates the company trades with EV/EBITDA’11E of 5.8, which implies a 40% discount to foreign peers. Nuclear fuel enrichment vs. fabrication and lack of Asian orders. Atomenergoprom’s subsidiary – TVEL Holding – plans to rebuild nuclear fuel cycle in Russia according to the world practice. It means that the company’s focus will be shifted from fuel fabrication to enrichment. Meanwhile Rosatom’s negotiations with its key Asian partners – China and India – will likely force TVEL to establish fuel fabrication capacities in their territories (in a form of joint ventures) in order to supply fuel to existing and future NPPs in these countries. We believe that mentioned factors have negative sense to Mashinostroitelny Zavod and Novosibirsk Chemical Concentrates Plant and significantly limit their upside potential. However, both companies trade at a 50% discount to foreign peers on a base of EV/EBITDA’11E.

STRATEGY 2011

113


Machinery Citius, altius, fortius*

Ulan-Ude Aviation Plant (U-UAZ) The best company in the sector Ulan-Ude Avia Plant

We believe that Russian Helicopters’ IPO will have positive impact on the whole sector. Publication of IFRS statements and supplementary info about the holding’s backlog is expected to increase the industry’s transparency. According to our estimates, U-UAZ is mostly undervalued by the market among domestic helicopter producers on the back of the company’s strong financials and attractive comparative valuation. U-UAZ trades with EV/EBITDA’11E of 3.3, which implies a discount of 40% and 60% to domestic and foreign market peers respectively. We should note that unattractive swap ratios announcement is a key risk for the company. We recommend to BUY U-UAZ’ shares with a 12-months target price of $2.9 per share and upside potential of 38%. Valuation of the holding as a new benchmark for the industry. We believe that expected IPO of Russian Helicopters – a 100% subsidiary of Oboronprom – will increase the overall transparency of the sector. It means that the holding company is to disclose IFRS financials vs. RAS statements. Furthermore, we expect that IPO will force Russian Helicopters to announce major part of its backlog. We remind that Oboronprom’s subsidiary will acquire assets in R&D, production, maintenance, modernization and service of Mi and Ka helicopters i.e. at least 13 companies in total. According to our estimates, Russian Helicopters’ consolidated revenue may reach $2.0–2.1 bn in 2011. Oboronprom has already announced that the state corporation plans to raise $500 mn through Russian Helicopters’ IPO. We expect the holding will place 25-30% shares, which implies its market cap of $1.7–2.0 bn. Thereby, Russian Helicopters’ EV/S’11E could amount 1.3–1.4, which is practically in line with emerging market peers. We note that currently domestic helicopter producers trade with EV/S’11E of 0.9 on average, which implies a discount to the holding company of above 30%. We prefer U-UAZ as the most undervalued company in the sector. According to our estimates, Ulan-Ude Aviation Plant’s shares may become the best entrance into Russian Helicopters. There are several reasons to choose this company. First of all, U-UAZ is the most efficient helicopter producer in Russia – its EBITDA margin and Net margin for 9M10 amounted to 27% and 23%, while average levels for domestic peers equal 21% and 13% respectively. Secondly, U-UAZ is the only company among Russian helicopter producers with zero borrowings – its net cash position totaled $78 mn (by the end of September, 2010). We expect the company to keep its leading position in terms of margins and financial stability in the nearest future. In addition, U-UAZ trades with EV/EBITDA’11E of 3.3, which implies a discount to domestic and foreign market peers of 40% and 60% respectively. Unattractive swap ratios into the holding is a key risk. Russia traditionally has strong position on helicopter markets in China, India and Latin America. According to the published 9M10 RAS statements, the consolidated export revenue of three Russian producers amounted to $630 mn or 59% of their total sales. Rosoboronexport, which manages orders’ flow distribution for Mi-171 (Mi-8) helicopters between U-UAZ and Kazan Helicopters, will likely complete both their backlog for 2012–2013 in the run-up to IPO of Russian Helicopters. That’s why we believe that the key risk for U-UAZ is an announcement of unattractive swap ratios into the Russian Helicopters. 12-months target price of $2.9 per share, upside potential – 38%. According to our estimates, U-UAZ is the most undervalued helicopter producer in Russia on the back of its relatively high profitability and cheap multiples. We also believe that the company’s shares will be the best entrance into Russian Helicopters, which IPO will increase transparency of the whole sector. Healthy financials together with the backlog completion will make positive sense to U-UAZ prospects. We recommend BUY the company’s shares with a 12-months target price of $2.9 and upside potential of 38%.

114

STRATEGY 2011

Common UUAZ BUY 2.10 2.90 38%

Ticker Recommendation Last price, $ Target price 12M, $ Upside/downside, %

Pref erred -

SHARE DATA Bloomberg Reuters

UUAZ RU UUAZ.RTS Common # of shares outstanding,mn 267 EV, $ mn 483 MC, $ mn 561 MIN 12 mnth., $ 1.09 MAX 12 mnth., $ 2.29

Pref erred -

SUMMARY FINANCIALS, $ mn RAS 2010E 2011E Rev enue 503 542 EBITDA 145 147 Net income 109 110 EPS, $ 0.41 0.41 Rev . growth, % 29.3 7.7 EPS growth, % 36.8 0.9 EBITDA margin,% 28.8 27.1 Net margin, % 21.6 20.2

2012E 583 150 112 0.42 7.6 2.1 25.8 19.2

SUMMARY VALUATIONS 2010E P/E 5.2 EV/EBITDA 3.3

2012E 5.0 3.2

2011E 5.1 3.3

SHAREHOLDER STRUCTURE Oboronprom AVIGAZ-FINANS ZAO "Lider" (Gazf ond) Others

55.1% 20.0% 6.2% 18.7%

PRICE DYNAMICS UUAZ

2.50

RTS

1.90 1.30 0.70 22.12.09

22.3.10

22.6.10

22.9.10 22.12.10

Source: MICEX, RTS, TKB Capital estimates


Machinery Citius, altius, fortius*

Ulan-Ude Aviation Plant BALANCE SHEET $ mn

2009

2010E

2011E

2012E

2013E

2014E

2015E

381

497

499

507

484

481

485

PP&E, net

27

33

35

37

40

43

46

Other non-current assets

25

35

37

40

44

47

51

TOTAL CURRENT ASSETS

Total NON-CURRENT ASSETS TOTAL ASSETS Short-term borrow ings

52

67

72

78

84

90

96

433

564

571

585

568

571

582

13

-

-

-

-

-

-

Other short-term liabilities

222

263

161

63

(61)

(165)

(264)

Total CURRENT LIABILITIES

235

263

161

63

(61)

(165)

(264)

Long-term borrow ings

-

-

-

-

-

-

-

Other non-current liabilities

6

-

-

-

-

-

-

Total LONG-TERM LIABILITIES

6

-

-

-

-

-

-

Minority interest

-

-

-

-

-

-

-

18

19

19

20

18

18

18

Retained earnings

173

281

391

503

611

719

828

Total EQUITY

192

301

410

523

629

737

846

TOTAL EQUITY & LIABILITIES

433

564

571

585

568

571

582

2009

2010E

2011E

2012E

2013E

2014E

2015E

389

503

542

583

627

674

719

(274)

(342)

(377)

(414)

(448)

(485)

(521)

111

145

147

150

146

147

149

3

4

4

5

5

5

6

108

141

143

146

141

142

144

Share and additional capital

INCOME STATEMENT $ mn Revenue Cost of production EBITDA Depreciation EBIT Net interest income/(expenses)

(1)

-

-

-

-

-

-

EBT

104

136

137

140

135

135

137

Income tax

(25)

(27)

(27)

(28)

(27)

(27)

(27)

79

109

110

112

108

108

109

2009

2010E

2011E

2012E

2013E

2014E

2015E

94

123

125

128

124

125

127

(19)

(27)

(25)

(27)

(27)

(29)

(31)

Net incom e CASH FLOW STATEMENT $ mn Net CF from operating activities Net CF from /(used in) investm ent activities

(4)

(67)

(66)

(56)

(69)

(22)

(25)

(83)

(107)

(118)

(129)

(140)

(151)

(161)

%

2009

2010E

2011E

2012E

2013E

2014E

2015E

Revenue grow th

27%

29%

8%

8%

8%

8%

7%

EBITDA margin

29%

29%

27%

26%

23%

22%

21%

Net margin

20%

22%

20%

19%

17%

16%

15%

Net Debt/EBITDA

neg.

neg.

neg.

neg.

neg.

neg.

neg.

Net CF from /(used in) financing activities Net Debt RATIOS

Source: U-UAZ, TKB Capital estimates

STRATEGY 2011

115


116

STRATEGY 2011


Real Estate Sector Footing get stronger, its time to build Anatoly Vysotsky a.vysotsky@tkbc.ru

Real Estate Sector Footing get stronger, its time to build YTD sector dynamic vs. RTS 22.12.2010

Max

Min

RTS Index PIK Group LSR Group

Next year we expect acceleration of revenue growth rates both for residential and commercial real estate companies. The increase in volumes of construction residential will provide companies’ short-term liquidity. Decrease in volumes of commercial real estate construction will lead rental rates and investments value for constructed project to growth. Our top-picks in the sector for 2011 – LSR Group, PIK Group and AFI Development.

AFI Dev . MirLand

Residential real estate is in priority

Sistema-Hals

Volumes of residential construction are restored. We expect the growth of residential construction by 5% in 2011. In our opinion, state investments into development, perfection of construction conditions and infrastructure on the sites are among effective steps of sector stimulation.

OPIN RGI Int. Rav en Russia -60%

0%

60%

Inflation will overtake the residential prices. We expect 3.6% growth of the average price per sq m of the residential real estate in Moscow for 2011 with 8.4% ruble inflation. We expect correction of the average price per sq m in 1H11 by 3-5% with the subsequent restoration by 7-9% in 2H11.

Sources: Bloomberg, TKB Capital estimates

Mortgage development will support the sales. We expect confident growth of the mortgage market for next year. Signs of market restoration are obvious. Credit rates have reached pre-crisis level, banks became more loyal to borrowers, prices for residential are stable.

RTS Index Real Estate Sector

40% 30% 20% 10% 0% -10%

Commissioning of commercial real estate to decrease Dec-10

Oct-10

Nov-10

Sep-10

Jul-10

Aug-10

Jun-10

Apr-10

May-10

Mar-10

Jan-10

Feb-10

-20%

Sources: Bloomberg, RTS, TKB Capital estimates

Vacancy rates will continue to decrease. Under the low construction volumes of commercial real estate projects and stabilization of demand, we expect continuing decrease in vacancy rate by 3-7% next year depending on quality and location of facility.

Financial risks remain Debt loading remains stably high. In modern conditions the companies should actively increase construction volumes; therefore financial load of the sector in 2011 will remain stably high. Our expectation for Net debt-to-EBITDA average for the sector in 2011 is 3.5.

Our top-picks LSR Group. We believe that LSR Group is capable to show one of the best rates of recovery in the sector due to growing demand for residential real estate and investments into infrastructure construction. We recommend to buy LSR Group with the target price of $12.5/GDR and 50$/share. PIK Group. The strategy is primarily focused on affordable residential housing segment on Moscow Metropolitan market. Availability of mortgage programs with banks is proposed to support demand for residential real estate constructed by the company. We recommend to buy PIK Group and our target price is 7.3$/share. AFI Development. Commissioning AFIMOLL City - one of Europe’s largest retail projects in recent years – should double the rental revenue of the company. Residential sales will provide financial stability and lower financial risks. We recommend to buy AFI Development and our target price is 1.8$/share.

STRATEGY 2011

117


Real Estate Sector Footing get stronger, its time to build

Moderately positive estimation of real estate market development prospects we adhered in strategy for 2010, has completely justified. Residential sales grew against the moderate growth of price; the building companies together with banks reduced mortgage rates and improved credit conditions. As for commercial real estate, despite the growth of business and consumer activity, high level of vacant areas has limited the growth of rent rates and led to expected reduction of new construction. In 2011 we forecast more active recovery both in residential and commercial real estate. The companies will continue to increase residential construction, ensuring short-term financial liquidity for them, while reduction of commercial construction to accelerate the rental growth and raise investment value of existing projects.

Price dynam ics of our top-picks and RTS Index RTS LSR

50% 40%

PIK AFID

30% 20% 10% 0% -10% -20% -30% Jan-10

Residential real estate is in priority

Apr-10

Jul-10

Oct-10

Sources: Bloomberg, TKB Capital estimates

Recovery in volumes of residential construction. According to our forecasts, growth of residential construction in 2011 will reach 5%. Fundamental deficiency of residential will come to the fore again. The minimum of residential area to be provided per person is 22 sq m in Russia - less the Chinese level by 5 sq m and twice less the average European indicator. At the average, in Europe the volume of residential construction makes up 1 sq m per person per annum, in Russia – 0.4 sq m. High deficit of residential real estate has limited the decline in prices for the real estate during the crisis. Continuation of housing construction stagnation will increase the gap between demand and supply leading to the next price soaring under conditions of economic recovery. Realizing the extent of the problem, the state actively promotes housing construction development. Among effective measures on increase in rates of construction, we see the state initiatives on removal of administrative barriers for the building companies, more simplified procedure of land allocation, drawing of the project documentation, municipal and road infrastructure for construction sites. The state plans to spend RUR620 bn in 2011-2015 to achieve these goals. Inflation will overtake the prices for residential. We expect 3.6% growth of the average price per sq m for residential real estate in Moscow in 2011 when the ruble inflation is 8.4%. From the beginning of 2010 the average price of residential square meter in Moscow has grown by 17% in rubles and by 13% in USD. The possible reasons are recovery of national economy and, as consequence, growth of consumer confidence as well as entry of the socalled "postponed" demand into the market. We expect further recovery of national economy next year and the growth of demand for real estate as a result. Nevertheless, judging by dynamics of the average price per sq m in 2H10, "the postponed" demand is close to an exhaustion, the reasons for fast renewal of pre-crisis price levels are not observed. Therefore, we predict correction of the average price per square meter in 1H11 by 3-5% with the subsequent growth by 7-9% following the results of 2H11. Mortgage development will support the sales. We expect the stable growth of the mortgage market for the next year. The state support of mortgage lending development brings positive results. According to the Central Bank of Russia, from the beginning of 2010 till October the rate on a mortgage decreased by 1.2 ppt to 12.8% and the minimum level of an initial payment reduced to 10% against 20-30% the year before. The volume of credits granted for acquisition of residential made up RUR301 bn, exceeding the last year indicator by 143%. No doubt that the volumes are still significantly below the pre-crisis level (during the first 10 months of 2008 the volume of credits for residential purchase made up RUR615 bn). However, the market recovery factors are obvious. Credit rates have reached the precrisis level, banks became more loyal to borrowers and the prices for residential are stable. All in all, the given factors are capable to become powerful triggers for the growth of the mortgage market. Therefore, we do not exclude that the volumes of the granted mortgage loans in 2011 will recover to 2008 levels.

Russia has a long way to go to EU countries’ levels Volume of residential construction per capita, sqm 1.1

1.00

0.9 0.7

0.46

0.45

0.42

0.44

2008

2009

2010E

0.4 0.2 2011E av erage in Europe

Sources: Rosstat, TKB Capital estimates

2011FY price dynam ic to close on positive side Average price per sq m of residential real estate in Moscow Price per sq m, th rub price growth

200

40%

160

20%

120

0%

80

-20% 2008 2009 2010E 1H11E2H11E

Sources: Bloomberg, TKB Capital estimates

Mortgage continue to grow Mortgage credits issued, bn rub 700 600 500 400 300 200 100 2008

2009

2010E

Sources: Central bank of Russia, TKB Capital estimates

118

STRATEGY 2011

2011E


Real Estate Sector Footing get stronger, its time to build

Volumes of commercial real estate commissioning to decrease

Office real estate New construction, mn sq m Of f ices (class А + B + С), mn sq m Vacancy lev el 16

25%

12 15% 8 4

5% 2008

2009

2010E

Vacancy rates will continue decreasing. Under the low construction volumes of commercial real estate projects and stabilization of demand, next year we expect further decrease in vacancy rate by 3-7% depending on the quality and location of facilities. Construction decline and tenants’ activity has led to decrease of vacancy level in commercial real estate by 3-5%. The best demand is observed in retail real estate where rental rates growth has made 5% - 10% from the start of the year depending on quality of facilities. Vacancy level has fallen below 10%. Besides, demand for quality spaces with a good location in the center of Moscow has already exceeded the supply, rental rates have reached the pre-crisis level. Lease contracts for the areas are concluded at construction stage again.

2011E

Source: TKB Capital estimates

Commercial real estate

Financial risks remain

New construction, mn sq m

Debt load remains stably high. Recovery of demand for real estate in 2010 had a positive influence on financial situation of construction companies; banks willingly restructured debts and reduced crediting rates. Nevertheless, debt burden of the companies is far from the comfortable level that, in our opinion, keeps financial risks in the sector. To maintain and increase the market share today, the companies should actively increase construction volumes, therefore financial risks of the sector in 2011 will remain stably high. Despite our forecast of increase in operational profit and corresponding decrease in Net Debt-to-EBITDA up to 3.5 at the average in the sector, comfortable level of a debt burden in construction sector, in our opinion, should not exceed 2.0 EBITDA.

Retail, mn sq m Vacancy lev el 5

15% 10%

3 5% 1

0% 2008

2009

2010E

2011E

Source: TKB Capital estimates

Our favorites – LSR Group, PIK Group andAFI Development

Debt load of the real estate sector 8.0x

6.6x

NetDebt to EBITDA

6.0x 3.5x

4.0x

2.8x

2.0x 0.0x 2010E

2011E

2012E

Source: Bloomberg, TKB Capital estimates

We prefer LSR Group and PIK Group in residential construction sector. LSR Group has good prospects of business growth on Moscow market and availability of own facilities to produce almost any type of building materials is proposed to provide competitive advantage and high profitability on St.-Petersburg and Leningrad region markets. PIK Group conducts business in the most highly profitable region of Russia – Moscow. The region has the greatest demand for residential and showed the best rates of recovery in 2010. Large land bank and own construction facilities will provide high rates of revenue increase next year. We pick out AFI Development in commercial real estate. Strong cash positions, high share of ready projects and successful distribution of projects by development stages, in our opinion, will play supportive for the growth of company’s investment appeal. o. Commissioning of AFIMALL in Moscow-city will double the rental income and help to reach the break-even point next year.

STRATEGY 2011

119


Real Estate Sector Footing get stronger, its time to build

LSR Group A diversified leader of St.-Petersburg real estate market comes to Moscow LSR Group possesses competitive advantage in the real estate sector due to flexible and effective business model, comfortable debt level and prospective projects portfolio focused on expansion of construction volumes in the Moscow region. In 2010 the company launched new cement plant, opened the representation, initiated a number of large perspective projects in the Moscow region, modernized and expanded capacities, continued negotiations with banks to improve credit terms for the buyers of residential real estate. We believe that LSR Group is capable to show one of the best recovery rates in the sector backed by growing demand for residential real estate and investments into infrastructure construction sector. We recommend to BUY LSR Group with the target price of $12.5/GDR and 50$/share. Expansion to Moscow will be accelerated. LSR Group has thoroughly prepared to enter the Moscow real estate market. In 2010 the portfolio of projects in the Moscow region grew 7 -fold up to 890,000 sq m that makes about 18% of all the company’s projects at development stage. Construction is planned to complete till 2015. Company upgrades capacities of its concrete products’ facilities in Moscow by 40%. This will enable the company to increase its output to 240,000 sq m of housing per year. Besides, the own concrete facilities with a capacity of 3,000 cubic m per day will be involved in construction process. To cut administrative expenses and construction time, the company bets on lowheight panel housing construction in Moscow Region. We believe that this fact should also play supportive for increase in short-term liquidity and raise of company’s financial stability. Business expansion in the Moscow region will have a positive impact on profitability of the company: the capital market is the most profitable for construction companies. Infrastructural projects will cater for materials’ demand. Despite active expansion to the Moscow region, St.-Petersburg and Leningrad region are still the basic market for LSR Group. The company takes leading positions practically in all segments of construction market where it operates. Launch of cement plant with capacity of 2 mn tons per year has completed the building materials production chain and provided the company with an additional source of income. By our calculations, in 2011 the cement plant share in revenue will make 4% and increase up to 7% by 2012. Additional demand for cement will be provided by infrastructure construction sector which, in our opinion, will continue its development in the coming years. Flexibility of business model allows the company to shift products in a segment of infrastructure construction which were previously supplied only for housing construction. By our forecasts, the share of building materials’ segment will make 36% of 2011 total revenue against 26% in 2009 and 31% in 2010.

LSR GROUP Ticker Recommendation Price, $ Target price 12M, $ Upside/downside potential

Common LSRG

GDR LSRG LI

BUY

BUY

33.2 50.0 51%

9.2 12.5 37%

SHARE DATA Bloomberg

LSRG LI GDR 515.2 5,540 4,714 6.8 10.9 Common 5

# of GDRs outstanding, mn EV, $mn MC, $ mn MIN 12 mnth., $ MAX 12 mnth., $ GDR per 1 share SUMMARY FINANCIALS, $ mn 2010E Rev enue 1,751 EBITDA 484 Net income 199 EPS ($) 0.4 Rev . growth (%) 8.9 EBITDA margin (% 27.6 Net Margin (%) 11.4

2011E 2,161 607 306 0.6 23 28.1 14.2

2012E 2,669 752 418 0.8 24 28.2 15.6

SUMMARY VALUATIONS 2010E P/E 23.7 EV/EBITDA 11.5

2011E 15.4 9.1

2012E 11.3 7.4

SHAREHOLDER STRUCTURE Streetlink Limited A. Molchanov Management Free Float

53% 9% 11% 27%

PRICE DYNAMICS 12

LSRG

RTS

10

Debt loading will be reduced. LSR Group remains the unique construction company which did not experience difficulties with repayment and refinancing of debt even during financial crisis. Following the results of 1H10 the net debt made up $1,033 mn. We expect decrease in Net debt-to-EBITDA in 2011 to 1.7 against 2.3 in 2010 and 2.6 in 2009.

8 6 22.12.09

22.3.10

22.6.10

22.9.10

Source: Bloomberg, TKB Capital estimates

Attractive by multiplies. Valuation based on multiplies indicates good upside potential. LSR Group trades at an average 2011-2012E EV/EBITDA of 9.1 and 7.4 accordingly, that implies average 22% discount to its foreign peers. Fundamental value is above the market. We recommend to buy LSR Group - the market leader of construction sector. Based on our DCF-model, 12-month’s target price of LSR Group is $12.5 per GDR and $50 per share.

120

STRATEGY 2011

22.12.10


Real Estate Sector Footing get stronger, its time to build

LSR GROUP BALANCE SHEET $ mn

2009

2010E

2011E

2012E

2013E

2014E

2015E

TOTAL CURRENT ASSETS

2,240

2,897

3,351

4,254

5,014

5,786

6,784

PP&E, net

1,053

1,124

1,121

1,082

1,070

1,056

1,042

Other non-current assets

354

356

390

420

442

457

475

Total NON-CURRENT ASSETS

1,407

1,480

1,510

1,502

1,512

1,514

1,517

TOTAL ASSETS

8,301

3,647

4,377

4,861

5,757

6,526

7,300

Short-term borrow ings

500

500

500

500

500

500

500

Other short-term liabilities

972

1,116

1,402

1,930

2,234

2,471

2,825

1,471

1,616

1,902

2,430

2,733

2,971

3,324

808

808

700

650

600

550

550

58

58

58

58

58

58

58

866

866

758

708

658

608

608

12

12

12

12

12

12

12

1,039

1,424

1,424

1,424

1,424

1,424

1,424

259

458

765

1,182

1,698

2,284

2,932

Total EQUITY

1,298

1,882

2,189

2,607

3,122

3,709

4,357

TOTAL EQUITY & LIABILITIES

3,647

4,377

4,861

5,757

6,526

7,300

8,301

$ mn

2009

2010E

2011E

2012E

2013E

2014E

2015E

Revenue

1,608

1,751

2,161

2,669

3,025

3,277

3,660

(1,018)

(1,092)

(1,382)

(1,725)

(1,953)

(2,113)

(2,364)

462

484

607

752

872

955

1,038

Total CURRENT LIABILITIES Long-term borrow ings Other non-current liabilities Total LONG-TERM LIABILITIES Minority interest Share and additional capital Retained earnings

INCOME STATEMENT

Cost of production EBITDA Depreciation EBIT Net interest income/(expenses)

76

83

92

100

100

98

102

331

400

514

652

772

857

935 (101)

(144)

(144)

(120)

(114)

(108)

(102)

EBT

187

257

394

538

664

755

834

Income tax

(42)

(57)

(88)

(120)

(148)

(168)

(186)

Net incom e

145

199

306

418

516

586

648

2009

2010E

2011E

2012E

2013E

2014E

2015E

109

(86)

199

759

516

602

671

(182)

(184)

(114)

(82)

(102)

(95)

(98)

CASH FLOW STATEMENT $ mn Net CF from operating activities Net CF from /(used in) investm ent activities

63

385

(108)

(50)

(50)

(50)

-

1,212

1,096

1,012

334

(80)

(587)

(1,160)

%

2009

2010E

2011E

2012E

2013E

2014E

2015E

Revenue grow th

-20%

9%

23%

24%

13%

8%

12%

29%

28%

28%

28%

29%

29%

28%

Net margin

9%

11%

14%

16%

17%

18%

18%

Net Debt/EBITDA

2.6

2.3

1.7

0.4

отр.

отр.

отр.

Net CF from /(used in) financing activities Net Debt RATIOS

EBITDA margin

Source: LSR Group, TKB Capital estimates

STRATEGY 2011

121


Real Estate Sector Footing get stronger, its time to build

PIK Group Demand for residential to support revenue, moderate risks remain Advantage of PIK Group over other developers is in a portfolio of projects in Moscow and Moscow Region – region with the best demand and high prices for residential real estate. The state initiatives on removal of administrative barriers at construction and confidently growing demand, in our opinion, will provide fast profit recovery and high level of profitability of the company. The strategy primarily focused on construction of affordable residential housing segment on Moscow Metropolitan market with a good location and developed social infrastructure will ensure the growth of financial liquidity and lower financial risks. Mortgage programs with banks to support demand for the residential real estate constructed by the company. We recommend to BUY PIK Group and our target price is 7.3$/share. Residential sales raise liquidity. Favorable changes are observed on the Moscow real estate market. The results of 2010 prove the stable growing demand. In this context PIK Group, as one of leaders of the Moscow residential real estate market, confidently increases volumes of construction and demonstrates the growth of sales. By our forecasts, own capacities of the company will help PIK group to construct 1,100 th sq m of residential real estate in 2011 that exceeds our forecasts by 13% for 2010 and by 24% above the actual volumes for 2009. Proceeding from PIK Group results as regards residential real estate sales for 9М10 (growth by 131%), we expect further recovery of cash flows next year. Among positive factors increasing pace of sales in 2011, we expect the growth of mortgage transactions’ share by 15-17% in total sales (9% in 3Q10). Expected slight advance in prices for residential real estate (within 5-7%) is also capable to maintain a great demand against economic recovery.

PIK GROUP GDR PIK LI

Ticker Recommendation Price, $ Target price 12M, $ Upside/downside potential

BUY

4.3 7.3 69%

SHARE DATA Bloomberg

PIK LI

# of shares outstanding,mn EV, $mn MC, $ mn MIN 12 mnth., $ MAX 12 mnth., $

493.3 3,478 2,126 3.0 5.8

GDR per 1 share

1

SUMMARY FINANCIALS, $ mn 2010E Rev enue 1,293 EBITDA 96 Net income -122 EPS ($) -0.2 Rev . growth (%) -0.2 EBITDA Margin (% 7.4 Net Margin (%) neg.

2011E 1,900 293 64 0.1 47 15.4 3.4

2012E 2,525 465 208 0.4 33 18.4 8.3

Financial risks remain. Debt load of the company following the results of 1H10 is $1,352 mn, Net debt-to-EBITDA is 8.3. Despite restructuring of the major part of debts with direct support of the Sberbank undertaken a part of PIK Group debt service obligations, there are concerns on uncertainty with overdue credit to Nomos-bank, which makes up 19% of credit portfolio. To decrease its debt load, we believe that in 2011 PIK group may hold SPO already approved by the board of directors in the middle of 2010. At the same time we do not exclude that the main creditor – Sberbank, may enter the shareholding structure of the company that, in our opinion, is a preferable variant for future financial stability of PIK Group.

SUMMARY VALUATIONS 2010E EV/EBITDA neg. EV/S 36.1

2011E 33.1 11.9

2012E 10.2 7.5

Multiple based upside remains. Valuation based on multiplies shows the upside potential. PIK Group is traded at an average 2011-2012E EV/EBITDA of 11.9 and 7.5 accordingly, that implies average 12% discount to its foreign peers.

PRICE DYNAMICS

SHAREHOLDER STRUCTURE Naf ta Moskv a Y .Zhy kov K.Pisarev Free Float

6

PIKK

38% 13% 11% 39%

RTS

5

Fundamental prospects depend on a company transparency. We recommend to buy PIK Group which, in our opinion, is capable to quickly restore financial flows by demand recovery for real estate in Moscow. However, we recommend consider the risks attributed to weak transparency and high debt load of the company that may negatively affect its investment appeal. Based on our DCF-model, 12-month’s target price of PIK Group is $7.3 per share.

122

STRATEGY 2011

4 3 22.12.09

22.3.10

22.6.10

22.9.10

Source: Bloomberg, TKB Capital estimates

22.12.10


Real Estate Sector Footing get stronger, its time to build

PIK GROUP BALANCE SHEET $ mn

2009

2010E

2011E

2012E

2013E

2014E

2015E

TOTAL CURRENT ASSETS

2,601

3,076

4,002

5,152

5,484

6,180

7,874

344

339

320

315

280

262

268

PP&E, net Other non-current assets Total NON-CURRENT ASSETS

880

868

877

887

815

792

850

1,224

1,208

1,197

1,201

1,096

1,054

1,118 8,993

TOTAL ASSETS

3,824

4,284

5,199

6,353

6,580

7,234

Short-term borrow ings

1,058

1,108

1,189

1,184

1,040

963

933

Other short-term liabilities

2,162

2,634

3,400

4,363

4,588

5,091

6,414

Total CURRENT LIABILITIES

7,347

3,220

3,742

4,589

5,547

5,629

6,054

Long-term borrow ings

208

252

254

240

188

135

111

Other non-current liabilities

208

218

220

223

205

199

213

Total LONG-TERM LIABILITIES

416

470

475

462

392

334

325

18

19

19

20

18

18

19 760

Minority interest Share and additional capital

741

776

784

792

729

708

(572)

(723)

(667)

(468)

(188)

122

543

188

72

136

343

559

847

1,322

3,824

4,284

5,199

6,353

6,580

7,234

8,993

$ mn

2009

2010E

2011E

2012E

2013E

2014E

2015E

Revenue

1,296

1,293

1,900

2,525

2,884

3,289

3,853

(1,059)

(1,095)

(1,471)

(1,886)

(2,162)

(2,473)

(2,907)

126

96

293

465

536

615

725

Depreciation

27

28

36

47

53

61

72

EBIT

99

68

256

419

482

554

653

Net interest income/(expenses)

(283)

(227)

(176)

(158)

(148)

(124)

(110)

EBT

(372)

(159)

80

260

334

430

543

(27)

37

(16)

(52)

(67)

(86)

(109)

(362)

(122)

64

208

267

344

434

$ mn

2009

2010E

2011E

2012E

2013E

2014E

2015E

Net CF from operating activities

(174)

(125)

5

199

254

347

452

(24)

58

(13)

(38)

(43)

(49)

(58)

Retained earnings Total EQUITY TOTAL EQUITY & LIABILITIES INCOME STATEMENT

Cost of production EBITDA

Income tax Net incom e CASH FLOW STATEMENT

Net CF from /(used in) investm ent activities Net CF from /(used in) financing activities Net Debt

(5)

34

71

(36)

(89)

(107)

(143)

1,153

1,275

1,296

1,151

866

578

247

RATIOS %

2009

2010E

2011E

2012E

2013E

2014E

2015E

Revenue grow th

-4%

0%

47%

33%

14%

14%

17%

EBITDA margin

10%

7%

15%

18%

19%

19%

19%

Net margin

neg.

neg.

3%

8%

9%

10%

11%

Net Debt/EBITDA

9.1

4.4

2.5

1.6

0.9

0.3

13.2

Source: PIKGroup, TKB Capital estimates

STRATEGY 2011

123


Real Estate Sector Footing get stronger, its time to build

AFI Development At an organic growth stage AFI Development is one of the largest developers of Moscow real estate market. Company’s project portfolio includes commercial and residential properties located in attractive areas of the city. According to market tendencies, in 2010 the company changed development strategy and increased the presence in residential real estate. Cash inflow from residential sales, by our estimates, is proposed to begin as early as 2011. In our opinion, break-even point is a primary growth driver of AFI Development investment appeal next year. Commissioning of AFIMOLL City - one of the European largest retail projects in recent years, will double the rental revenue of the company, residential sales to provide financial stability and lower financial risks. We recommend to BUY AFI Development and our target price is 1.8$/share. From net loss to net profit. In 2010 AFI Development actively developed the projects with a high stage of completion. As a result, the company completed the construction of the large trade centre “AFIMOLL City” with a total area of 180,000 sq m (share in project portfolio by net area – 28%) placed in the centre of Moscow-city. We estimate $78 mn rental revenue from the project next year that will make 56% of all the rental payments and 44% of the total company’s revenue. Thus, commissioning of AFIMALL City will cover operational and administrative expenses and play supportive for the company to reach the break-even point as early as 1H11. Net profit will provide financial stability and raise investors’ confidence. Besides, we expect further growth of business and consumer activity in the capital that will reduce the supply against reduction of construction volumes. We forecast the vacancy rate for AFI Development’s projects at 86% on the average next year. Strong cash positions as a development guarantee. Following the results of 9М10 the volume of cash on company’s balance made up $110 mn. Investment activity of AFI Development in 2010 amplified considerably. So, the volume of investments into project development reached $101 mn for 9М10, which is over 110% growth y-o-y. Next year AFI Development will focus on completion of Tverskaya Zastava retail centre (implemented under control of the Moscow government), business centre on Paveletskaya Embankment and mixed-use complex on Ozerkovskaya Embankment. According to our calculations, the volume of investments to complete these projects in 2011-2012 can make up about $180 mn. We forecast increase in the cash flow, generating area size by 175% y-o-y to 320,000 sq m in 2011, the rental revenue to reach $140 mn (197% y-o-y). Thus, we believe that the company will not face the financial difficulties in course of projects’ realization. Debt structure quite comfortable. According to last financials of the company, total debt of the company has made $420 mn, where 91% comes to long-term debts. Debt-to-net asset value (NAV) makes 0.2 and, in our opinion, is quite comfortable for the developer. Perspective growth of value. We recommend to buy AFI Development and bet on fast recovery of project portfolio investment value. Based on our DCF-model and NAV valuation, 12-month’s target price of AFI Development is $1.8 per share.

124

STRATEGY 2011

AFI DEVELOPMENT Ticker Recommendation Price, $ Target price 12M, $ Upside/downside potential

AFID LI BUY

1.1 1.8 59%

SHARE DATA Bloomberg

AFID LI

# of shares outstanding,mn EV, $mn MC, $ mn MIN 12 mnth., $ MAX 12 mnth., $

1047.7 1,493 1,184 0.7 1.3

SUMMARY FINANCIALS, $ mn 2010E Rev enue 81.1 EBITDA 29.5 Net income -17.9 EPS ($) neg. EBITDA Margin (% 36% Net Margin (%) neg.

2011E 178.7 110.0 27.7 0.0 62% 16%

2012E 401.1 191.6 78.7 0.1 48% 20%

SUMMARY VALUATIONS 2010E EV/EBITDA neg. EV/S 50.7

2011E 42.7 13.6

2012E 15.0 7.8

SHAREHOLDER STRUCTURE Af rica Israel A. Haldey Bond holders Free Float

54% 10% 18% 18%

PRICE DYNAMICS 1.3

AFID

RTS

1.1 0.9 0.7 22.12.09

22.3.10

22.6.10

22.9.10 22.12.10

Source: Bloomberg, RTS, TKB Capital estimates


Real Estate Sector Footing get stronger, its time to build

AFI Development BALANCE SHEET $ mn

2009

2010E

2011E

2012E

2013E

2014E

2015E

TOTAL CURRENT ASSETS

741

593

674

801

809

859

944

PP&E, net

103

100

90

79

61

45

28

Other non-current assets

1,504

1,728

1,883

1,991

2,066

2,066

2,066

Total NON-CURRENT ASSETS

1,606

1,827

1,974

2,070

2,128

2,111

2,095

TOTAL ASSETS

2,348

2,420

2,647

2,871

2,937

2,970

3,039

94

114

114

108

103

98

93

181

181

181

181

181

181

181

Short-term borrow ings Other short-term liabilities Total CURRENT LIABILITIES

275

295

295

290

284

279

274

Long-term borrow ings

322

392

592

742

642

442

242

Other non-current liabilities Total LONG-TERM LIABILITIES Minority interest Share and additional capital Retained earnings

45

45

45

45

45

45

45

367

437

637

787

687

487

287

3

3

3

3

3

3

3

1,622

1,622

1,622

1,622

1,622

1,622

1,622

81

63

91

170

341

579

853

Total EQUITY

1,703

1,685

1,712

1,791

1,963

2,201

2,475

TOTAL EQUITY & LIABILITIES

2,348

2,420

2,647

2,871

2,937

2,970

3,039

2009

2010E

2011E

2012E

2013E

2014E

2015E

63

81

179

401

673

776

808

(38)

(55)

(78)

(221)

(386)

(427)

(435)

26

29

110

192

303

366

390

1

3

9

12

17

17

16

EBIT

49

26

101

180

286

349

374

Net interest income/(expenses)

(4)

(49)

(66)

(81)

(71)

(51)

(31)

EBT

45

(22)

35

98

215

297

343

(47)

4

(7)

(20)

(43)

(59)

(69)

(3)

(18)

28

79

172

238

274

INCOME STATEMENT $ mn Revenue Cost of production EBITDA Depreciation

Income tax Net incom e CASH FLOW STATEMENT $ mn

2009

2010E

2011E

2012E

2013E

2014E

2015E

Net CF from operating activities

(15)

61

(5)

63

262

308

313

Net CF from /(used in) investm ent activities

(82)

(224)

(156)

(108)

(75)

-

-

77

38

131

61

(179)

(258)

(238)

205

420

650

779

665

410

131

%

2009

2010E

2011E

2012E

2013E

2014E

2015E

Revenue grow th

-44%

29%

120%

124%

68%

15%

4%

EBITDA margin

41%

36%

62%

48%

45%

47%

48%

Net margin

neg.

neg.

16%

20%

26%

31%

34%

Net Debt/EBITDA

7.9

5.9

4.1

2.2

1.1

0.3

Net CF from /(used in) financing activities Net Debt RATIOS

14.3

Source: AFI Development, TKB Capital estimates

STRATEGY 2011

125


126

STRATEGY 2011


Infrastructure construction sector World Cup 2018 – next impulse for development Anatoly Vysotsky a.vysotsky@tkbc.ru

Infrastructure construction sector World Cup 2018 – next impulse for development YTD sector dynamic vs. RTS 22.12.10

Max

Min

RTS Index Mostotrest Bamtonnelstroy

We expect powerful growth of the sector next year. Ministry of transport of the Russian Federation plans to provide about $60 bn next year and $390 bn for 20112015 for construction and modernization of transport infrastructure. We consider the APEC-2012 summit and the 2014 Olympics games among strategically important projects for Russia in mid-terms period. Another strong impulse for the infrastructure sector development is a victory of Russia for the right to host World Cup 2018, expenses of which are preliminary estimated at $50 bn.

Khanty Mansiy skdorstroy Mostootry ad-19

Plenty Room for Growth

Mostostroy -11

Infrastructure projects are of top priority. Construction and reconstruction of transport infrastructure were announced as one of the top national policy priorities. Volume of investments into sector planned by the Transportation Ministry for the next five years is about RUR12 bn ($390 bn).

Dalmostostroy -80%

10%

100%

Powerful growth drivers: APEC-2012 summit, The 2014 Olympics, World Cup 2018. Infrastructure construction in Sochi for the Olympic Games 2014 ($16 bn), preparation to APEC-2012 summit ($9 bn) and World Cup 2018 ($50 bn) are powerful drivers for development of Russia’s infrastructure.

Sources: Bloomberg, TKB Capital estimates

RTS Index Inf rastructure sector

60% 50% 40% 30% 20% 10% 0% -10%

Dec-10

Oct-10

Nov-10

Sep-10

Jul-10

Aug-10

Jun-10

Apr-10

May-10

Mar-10

Jan-10

Feb-10

Moscow to receive $4.6 bn for the next 3 years. Moscow transportation infrastructure is underdeveloped. According to the Moscow Department of Road Bridge and Engineering Construction, RUB140 bn ($ 4.6 bn) is earmarked for road construction in 2011/2013. Small number of large players. The companies with more than a 3% market share have made up only 15.9% of the entire market in 2009. Consequently, the responsibility for carrying out the orders issued by the government for high-quality and efficient transportation infrastructure development falls onto well-established and well-capitalized companies.

Sources: Bloomberg, RTS, TKB Capital estimates

Main risk - financial Limited sources of financing. Almost all Russian transportation infrastructure construction projects are undertaken at the initiative and expense of the government. Only one third of investments into the industry over the past three years were private. Bureaucratization of business processes. The federal target program on Russian transport infrastructure development is poorly suited to changes in external conditions during project completion and anticipates delays already at the initial establishment stage.

Our favorite Mostotrest. In our opinion, Mostotrest is successfully positioned for development of the state investments and is one of few companies capable to fulfill their orders with good quality and in a timely fashion.

STRATEGY 2011

127


Infrastructure construction sector World Cup 2018 – next impulse for development

Plenty Room for Growth Priority of infrastructural projects for the state. Construction and reconstruction of transport infrastructure were announced as one of the top national policy priorities. The transportation infrastructure modernisation programs provides for impressive growth of investments as compared with previous years. According to the plans of the Ministry of Transportation, infrastructure development investments over the next five years are proposed to reach about RUR12 bn ($390 bn). To implement the plans in addition to development of public-private partnership projects, the Russian government is going to establish the Federal Road Fund that, in our estimates, can cover up to 65% of all the planned investments into road infrastructure in 2011. The overall size of the Road Fund is estimated to reach RUB 378 bn, RUB 348 bn and RUB 408 bn in 2011, 2012 and 2013 respectively.

Infrastructure construction sector investments, RUR bn 3,000 2,500

1,500

2,808

2,669 2,452

2,000

2,188 1,873

1,000 500 0

Powerful growth drivers: APEC-2012 summit, The 2014 Olympics, World Cup 2018. Sochi’s infrastructure preparations for the 2014 Winter Olympics will be a good growth driver for companies with order books in Krasnoyarsk Territory. Olympic projects are to be commissioned in 2012, with full completion of infrastructure construction by the end of 2013. Expenditures on preparation for the 2014 Olympics and development of Sochi infrastructure will come to RUR500 bn ($16 bn). The largest project under the Far East development program is the Asia-Pacific Economic Cooperation forum that will take place in 2012 in Vladivostok. Nearly RUR270 bn ($9 bn) will be spent on construction and reconstruction of infrastructure. Russia victory for the right to host World Cup 2018 has become a strong impulse for development of the infrastructure sector. New football stadiums, roads and railways will be constructed. Tourism in the country will be developing with renewed vigor, the number of projects on construction of hotels will increase as well. Preliminary expenses on preparation to World Cup 2018 are estimated in $50 bn. Moscow to receive $4.6 bn for the next 3 years. If we consider the Moscow Region separately, where up to 60% of all Russian cargo moves, we will see a catastrophic situation here: over the last 15 years the number of cars increased more than 10-fold, while the total motorway length (completely overloaded) increased by 60%. The average traffic speed in Moscow and the Moscow Region is lower almost twice than in Western Europe, the transportation cost is higher by 30%-40%. Traffic jams in Moscow and the Moscow Region take about RUB 400 bn ($ 12.6 bn) from the Moscow budget annually. According to the Moscow Department of Road, Bridge and Engineering Construction, RUB 140 billion (US$ 4.6 billion) is earmarked for road construction in 2011/2013. The bulk of funds in 2011 will be spent on the Bolshaya Leningradka project, Fourth Ring Road, Veshnyaki-Liubertsy motorway, second Dmitrovskoye Motorway road and Zvenigorodsky Prospect. In addition, Moscow will continue realization of such major projects as the Moscow-St. Petersburg high-speed motorway and construction of the second Kutuzovsky Prospect roadway near the Moscow City business centre.

2011E 2012E 2013E 2014E 2015E Source: Federal target program "Development of the Transportation System of Russia (2010-2015)"

Investments into road construction of Moscow, RUR bn 80

40

0 2011E

2012E

2013E

Sources: Department of road and bridges construction of Moscow

Sector is highly fragmented, the share of top-players less than 16% Infrastructure constructors in Russia, by amount of works in 2009 Market leaders, share > 3%

Small number of large players. The Russian transportation infrastructure market is largely represented by numerous specialized companies with less than 3% market share, which are focused on the projects that do not require major technological resources. The companies with more than a 1% market share largely consist of regional players established to implement reasonably complex projects with limited technological requirements. Infrastructure construction market leaders with more than 3% market share took 15.9% of the entire market in 2009. The complexity of entry into infrastructure construction market, high capital equipment costs for production-scale equipment and, that is most important, the lack of qualified personnel in the industry serve as a great obstacle for new serious competitors to enter the market. Consequently, the responsibility for carrying out the orders issued by the government for high-quality and efficient transportation infrastructure development falls onto well-established and well-capitalized companies, which are also capable of increasing investments to scale up capacity.

128

STRATEGY 2011

Mid-size players, share > 1% Small players, share < 1%

16%

17% 67%

Source: PMR


Infrastructure construction sector World Cup 2018 – next impulse for development

Private investments are strongly sensitive to risks Volumes of private investments into sector, RUR bn Priv ate inv estments (plan) Priv ate inv estments (f act) % completion 100%

450 343

360 270 180

211 201

249 242

272 244

320

294

95% 90%

231

85% 80%

90

75%

0 2005 2006 2007 2008 2009

Source: FTP "Development of the Transportation System of Russia 2005-2009", TKB Capital estimates

Main risk - financial Limited sources of financing. Almost all Russian transportation infrastructure construction projects are undertaken at the initiative and expense of the government. Only one third of investments into the industry over the past three years were private. In our opinion, the inflow of private investment is closely tied to governmental support. Deterioration in the country’s economic situation will result in reduced governmental investment, triggering the withdrawal of private companies from the new projects and, as a result, the growth of incomplete construction. If we look at implementation of transportation infrastructure modernization program in 2005/2009, we can say that, besides general cost reduction under the program by 26% up to RUB 631 bn ($20 bn), the consequences of the financial squeeze and economic recession slashed private investment as a percentage of total actual costs. Bureaucratization of business processes. The federal target program of Russian transport infrastructure development is poorly suited to changes in external conditions that occur during project completion and anticipates delays already at the initial establishment stage. Consequently, construction companies may have difficulties with the timely fulfillment of contractual obligations and bear additional expenses that are impossible to calculate. The investment projects under the Russian Federal Transportation System Program (2010–2015) do not take into account the time required for designating, final allocation and purchasing the land plots, rezoning them for transportation, state registration of the corresponding rights and ownership formalization, including termination of rights and relocation of the owners of houses and other real estate subject to appropriation for governmental needs. All of these efforts are time-consuming and may take many years.

Our favorite – Mostotrest Undeniable leader of the sector. Mostotrest is one of few companies capable to fulfill their orders with good quality and in a timely fashion. It is noteworthy that one of Mostotrest’s principal competitive advantages is its high mobility that enables to quickly switch to the most important projects. As a result of a series of strategic purchases in 2010, Mostotrest expanded its options and acquired the ability to act as the general contractor for all infrastructure market segments by strengthening its foothold in bridge and motorway construction and expanding its presence in the railway, airport and port construction segments.

STRATEGY 2011

129


Infrastructure construction sector World Cup 2018 – next impulse for development

Mostotrest Well positioned for assimilation of state investments Among the construction companies capable to accrue maximum benefit from growing investments into infrastructure, we allocate diversified leader of infrastructure construction sector – Mostotrest. Extensive experience, unique technologies, high performance and efficiency coupled with a large order portfolio of strategic significance for Russia will, in our opinion, enable Mostotrest to become the leader and gain investment appeal.

Mostotrest Ticker Recommendation Price, $ Target price 12M, $ Upside/downside potential

MSTT NR 7.9 NR NR

SHARE DATA Bloomberg

MSTT RU

Impressive $8.4 bn backlog. As the number one infrastructure construction company in Russia in terms of work performed by own forces in 2009, Mostotrest holds a regionally diversified backlog of RUB 260 bn ($8.4 bn), including RUB 181 bn ($5.8 bn) directly and RUB 79 bn ($2.5 bn) - via the companies acquired in 2010. The backlog is largely represented by projects, the funding of which is the top government priority.

# of shares outstanding,mn EV, $ mn MC, $ mn MIN 12 mnth., $ MAX 12 mnth., $

Strong positions in the sector. The technologies and mobility allow Mostotrest to perform comprehensive work on projects of any degree of complexity. Having made a number of major acquisitions in 2010, Mostotrest gained the competence to act as general contractor in virtually all segments of infrastructural construction and expanded its presence in Siberia and the Far East. The general contractor’s role enables the company to fully monitor all processes in the projects completed.

SUMMARY FINANCIALS, $ mn 2010E Rev enue 1,193 EBITDA 203 Net income 92 EPS ($) 0.4 Rev . growth (%) -9.5 17.0 EBITDA Margin (% Net Margin (%) 7.7

2011E 1,469 254 125 0.5 23.1 17.3 8.5

2012E 1,715 295 163 0.7 16.8 17.2 9.5

SUMMARY VALUATIONS 2010E P/E 21.1 EV/EBITDA 11.1

2011E 15.6 8.8

2012E 11.9 7.6

SHAREHOLDER STRUCTURE Marc O’Polo Inv estments Ltd. Non-State Pension Fund Blagosostoy anie Other shareholders

38.9% 26.5% 34.6%

Stable customer base. Mostotrest’s projects are largely carried out pursuant to governmental orders and account for 79% of the backlog, which is equal to RUB 218 bn ($7 bn). The company’s key customers are the Federal Road Agency, the Russian Ministry for Economic Development, the Moscow government as well as various regional and municipal authorities. The major advantage of governmental orders is stable work and guaranteed payment, which directly affects construction time and profitability. A strong management team. Five out of eight key senior managers have been working in the construction industry for more than 10 years. Mostotrest’s team has an impressive track record in all lines of the company’s business. Mostotrest has also established strong relationships with regional and federal authorities, which simplifies implementation of many projects. Competent and experienced managers are, in our opinion, the Company’s most important competitive advantage.

248.2 2,244 1,949 3.3 8.0

PRICE DYNAMICS 8.5

MSTT

RTS

6.5 4.5

Stable financing options. The impeccable credit record and few schedule disruptions in construction contract performance have enabled Mostotrest to develop stable partnerships with Russia’s largest banks – Sberbank, VTB and Gazprombank. In our opinion, this enables the company, when necessary, to obtain short-term loans in order to mitigate the impact of irregular customer payments and maintain construction volume leadership in the cities of presence. Fundamentally strong company. In our opinion, Mostotrest possesses all data for organic growth and development of incoming investments in sector. Financial stability, technologies, unique experience and qualified personnel are a guarantee of successful company development in long-term period.

We have no recommendation for Mostotrest’s stocks, however we plan to issue full report and start to cover the company in the nearest future.

130

STRATEGY 2011

2.5 22.12.09

22.3.10

22.6.10

22.9.10

Source: RTS, TKB Capital estimates

22.12.10


Infrastructure construction sector World Cup 2018 â&#x20AC;&#x201C; next impulse for development

Mostotrest BALANCE SHEET $ mn

2009

2010E

2011E

2012E

2013E

2014E

2015E

TOTAL CURRENT ASSETS

454

733

794

852

946

1,046

1,283

PP&E, net

311

330

339

357

345

341

361 179

Other non-current assets

58

182

184

187

172

167

Total NON-CURRENT ASSETS

370

512

523

543

517

508

541

TOTAL ASSETS

824

1,246

1,317

1,396

1,463

1,554

1,824

Short-term borrow ings

199

173

103

52

48

33

24

Other short-term liabilities

289

279

325

381

407

429

489

Total CURRENT LIABILITIES

487

452

428

433

455

461

514

9

131

132

89

74

64

62

Other non-current liabilities

22

50

52

49

51

40

40

Total LONG-TERM LIABILITIES

31

181

184

137

124

105

102

8

235

237

240

220

214

230

Retained earnings

298

378

468

586

664

774

978

Total EQUITY

306

613

704

825

884

988

1,208

TOTAL EQUITY & LIABILITIES

824

1,246

1,317

1,396

1,463

1,554

1,824

$ mn

2009

2010E

2011E

2012E

2013E

2014E

2015E

Revenue

1,020

1,193

1,469

1,715

1,918

1,974

2,192

Cost of production

(762)

(892)

(1,093)

(1,274)

(1,423)

(1,472)

(1,640)

180

203

254

295

329

344

388

45

44

60

63

68

83

103 284

Long-term borrow ings

Share and additional capital

INCOME STATEMENT

EBITDA Depreciation EBIT

135

159

194

232

261

261

Net interest income/(expenses)

(26)

(36)

(27)

(14)

(13)

(10)

(9)

EBT

109

123

166

217

248

251

276

Income tax

(27)

(31)

(42)

(54)

(62)

(63)

(69)

84

92

125

163

186

188

207

2015E

Net incom e CASH FLOW STATEMENT $ mn

2009

2010E

2011E

2012E

2013E

2014E

Net CF from operating activities

157

158

208

234

266

270

313

Net CF from /(used in) investm ent activities

(37)

(166)

(66)

(77)

(86)

(89)

(99)

(131)

21

(138)

(161)

(77)

(88)

(88)

47

(104)

(181)

(276)

(361)

(463)

(643)

%

2009

2010E

2011E

2012E

2013E

2014E

2015E

Revenue grow th

-16%

17%

23%

17%

12%

3%

11%

18%

17%

17%

17%

17%

17%

18%

Net margin

8%

8%

8%

10%

10%

10%

9%

Net Debt/EBITDA

0.3

neg.

neg.

neg.

neg.

neg.

neg.

Net CF from /(used in) financing activities Net Debt RATIOS

EBITDA margin

Source: Company data, TKB Capital estimates

STRATEGY 2011

131


132

STRATEGY 2011


APPENDIX

RECOMMENDATIONS Oil & Gas Ticker

Company

Current price, TP, $

$

Recom.*

Upside, %

GAZP

**

Gazprom

6.41

8.50

ROSN

**

Rosneft

7.22

8.5

LKOH

**

LUKOIL

57.4

74.0

BUY

SNGS

*

Surgutneftegas

1.01

UR

UR

Mkt Cap,

EV,

$ mn

$ mn

P/E 2010E

2011E

EV/EBITDA 2012E

2010E

2011E

EV/S' 2012E

N.Debt/

P/BV

2011E

EBITDA'11

BUY

33%

146,858

177,884

5.2

5.0

4.5

4.0

3.7

3.4

1.4

0.8

0.6

HOLD

18%

69,294

84,396

6.5

9.3

8.4

4.3

5.6

5.2

1.3

1.4

1.0

29%

48,564

54,421

6.0

7.4

5.8

3.7

4.5

3.9

0.5

0.9

0.5

UR

39,896

26,895

8.6

9.0

9.5

3.7

3.8

4.0

1.2

1.0

neg

SNGSP

*

Surgutneftegas, Pref

0.51

UR

UR

UR

SIBN

**

Gazprom Neft

4.20

4.50

HOLD

7%

19,810

24,243

6.6

6.7

6.5

4.8

4.3

4.1

0.8

1.1

0.8

tnbp

**

T NK-BP Holding

2.70

2.80

HOLD

4%

41,590

42,573

8.0

6.8

7.2

5.2

4.4

4.6

1.0

2.0

0.1

tnbpp

**

T NK-BP Holding, Pref

2.44

2.50

HOLD

2% UR

10,665

12,709

6.4

5.8

5.2

4.8

4.1

3.8

0.8

1.1

0.7

8,842

10,461

6.6

6.0

5.9

4.0

3.6

3.5

0.8

n/a

0.6

31,184

31,884

24.4

19.1

14.4

16.7

12.8

10.2

6.4

6.9

0.3

EV/S'

P/BV

2010E

2011E

2012E

2010E

2012E

2011E

T AT N

*

T atneft

4.85

UR

UR

T AT NP

*

T atneft, Pref

2.71

UR

UR

BANE

*

Bashneft

44.75

UR

UR

UR

BANEP

*

Bashneft, Pref

35.45

UR

UR

UR

NVT K

*

NOVAT EK

10.28

UR

UR

UR

Metals & Mining Ticker

Company

Current price, TP, $

$

Recom.*

Upside, %

Mkt Cap,

EV,

$ mn

$ mn

P/E

EV/EBITDA 2011E

N.Debt/ EBITDA'11

GMKN

NorNickel

220.7

270.0

BUY

22%

42,074

44,040

8.1

7.2

8.1

5.6

5.0

5.3

2.8

1.9

0.2

CHMF

Severstal

16.79

20.00

HOLD

19%

16,917

21,369

73.9

11.0

10.4

7.6

6.1

5.7

1.2

2.2

1.3

NLMK

NLMK

4.48

4.15

HOLD

-7%

26,865

28,069

22.5

20.0

14.8

10.5

9.0

7.2

2.5

3.4

0.4

MAGN

MMK

1.06

1.32

BUY

25%

11,812

12,776

25.6

10.2

7.8

7.9

5.4

4.5

1.3

1.3

0.4

MT L

Mechel, ADR

29.58

37.00

BUY

25%

12,313

17,217

14.8

10.4

9.2

8.6

5.9

5.2

1.6

3.9

1.7

EVR

Evraz Group, GDR

34.84

46.00

BUY

32%

15,255

23,059

53.7

11.4

9.0

9.8

6.4

5.6

1.5

1.5

2.2

*

Polyus Gold

62.88

UR

UR

11,986

12,013

24.8

17.1

18.8

15.3

11.2

11.2

5.4

3.8

0.0

PMT L

*

Polymetal

18.56

UR

UR

UR

5,845

6,264

32.6

12.5

13.2

19.9

8.8

9.2

4.8

6.4

0.6

T RMK

*

T MK

5.14

UR

UR

UR

4,487

7,995

23.3

11.0

7.8

9.2

7.3

5.7

1.3

3.0

3.2

RASP

Raspadskaya

6.83

9.00

BUY

32%

5,333

5,636

15.0

15.6

7.5

10.0

9.7

5.5

5.9

4.2

0.5

BLNG

Belon

0.84

1.29

BUY

54%

962

1,278

10.8

9.9

11.2

6.6

6.3

6.5

1.5

2.0

1.6

unkl

Yuzhuralnickel

250.0

472.0

BUY

89%

150

111

9.9

6.4

3.6

3.6

2.7

1.7

0.3

n/a

neg

AMEZ

Ashinskiy Steel Works

0.570

0.579

HOLD

1.1

VSMZ

Vyksa Steel Works

1410

1740

BUY

CHZN

Chelyabinsk Zinc Plant

4.43

4.64

HOLD

PLZL

UR

2% 23% 5%

284

357

6.5

11.5

9.7

4.0

5.3

4.6

1.0

0.8

2,422

2,492

5.7

4.1

3.9

3.7

2.9

2.9

0.8

n/a

0.5

240

226

6.8

5.1

7.6

3.1

2.6

3.3

0.4

0.8

neg

EV/S'

P/BV

Utilities Ticker

Company

Current price, TP, $

$

Recom.

Federal Grid Company

0.0117

0.0124

HOLD

HYDR

RusHydro

0.054

0.0735

BUY

EV/EBITDA

N.Debt/

EV,

$ mn

$ mn

2010E

2011E

2012E

2010E

2011E

2012E

2011E

6%

14,456

11,750

18.4

9.5

6.2

6.2

3.6

2.6

2.1

0.5

neg

36%

14,548

15,575

9.7

8.8

7.0

7.0

5.7

4.9

2.7

0.9

0.4

%

FEES

P/E

Mkt Cap,

Upside,

EBITDA'11

IRAO

*

INT ER RAO UES

0.0016

UR

UR

UR

3,568

4,309

26.3

17.7

13.6

10.4

7.8

6.7

1.3

1.9

1.3

OGKA

*

OGK-1

0.039

UR

UR

UR

1,742

1,787

18.7

9.9

8.4

7.7

5.1

4.2

0.8

1.5

0.1

OGKB

*

OGK-2

0.061

UR

UR

UR

1,990

2,257

25.4

14.0

10.5

12.8

7.1

5.7

1.1

1.6

0.8

OGKC

*

OGK-3

0.056

UR

UR

UR

2,670

967

57.6

28.4

17.2

16.1

7.4

3.5

0.7

0.8

neg neg

OGKD

OGK-4

0.101

0.118

17%

6,354

5,789

25.3

16.3

12.6

15.5

9.0

6.8

2.5

2.3

OGKE

*

Enel OGK-5

0.095

UR

UR

UR

3,346

3,926

25.8

11.8

9.3

11.7

6.9

6.1

1.9

1.6

1.0

OGKF

*

OGK-6

0.045

UR

UR

UR

1,447

1,573

34.5

30.8

16.8

11.1

7.6

5.5

0.9

0.8

0.6

T GKA

*

T GC-1

0.00068

UR

UR

UR

2,622

3,104

15.8

7.2

5.9

8.4

4.6

3.9

1.5

1.2

0.7

T GKB

*

T GC-2

0.00028

UR

UR

UR

413

746

neg

47.4

43.9

6.4

5.4

2.0

0.7

0.6

2.4

T GKBP

*

T GC-2, Pref

0.00029

UR

UR

UR

MSNG

*

Mosenergo

0.104

UR

UR

UR

4,129

4,678

27.8

13.6

11.2

7.8

5.6

4.8

0.9

0.7

0.7

T GKD

*

T GC-4

0.00054

UR

UR

UR

1,049

1,019

12.0

9.2

15.1

5.2

4.0

3.6

0.7

1.1

neg

T GKDP

*

T GC-4, Pref

0.00028

UR

UR

UR

T GKE

*

T GC-5

0.00058

UR

UR

UR

709

747

18.5

10.7

177.2

7.0

5.3

9.7

0.9

0.8

0.3

T GKF

*

T GC-6

0.00057

UR

UR

UR

1,061

1,325

11.0

8.3

16.0

7.4

6.4

11.6

1.2

n/a

1.3

T GKG

*

Volga T GC (T GC-7)

0.077

UR

UR

UR

2,309

2,231

14.8

11.4

11.5

7.0

6.1

5.7

0.9

1.4

neg

T GKI

*

T GC-9

0.00015

UR

UR

UR

1,199

1,578

8.6

6.5

97.8

6.1

5.1

6.1

0.7

0.7

1.2

T GKJ

*

Fortum, T GC-10

1.55

UR

UR

UR

1,366

(132)

12.3

11.3

neg

neg.

neg.

neg.

neg.

0.5

neg

T GC-11

0.00070

0.00113

*

Kusbassenergo

0.0129

UR

T GKK KZBE

HOLD

BUY UR

61%

361

464

9.8

7.7

8.6

5.1

4.6

4.6

0.7

0.9

1.0

UR

909

999

10.4

22.8

28.8

4.2

5.2

4.0

0.9

0.9

0.5

T GKM

*

Yenisei T GC (T GC-13)

0.0042

UR

UR

UR

671

725

neg

13.6

8.9

5.3

3.2

2.6

0.9

1.1

0.2

T GKN

*

T GC-14

0.00014

UR

UR

UR

186

123

6.8

5.1

4.4

3.3

2.3

2.2

0.5

0.7

neg

7,725

11,782

11.7

8.7

5.7

3.6

3.0

2.3

0.6

0.7

1.0

889

1,346

11.3

10.1

8.4

4.8

4.0

3.3

1.2

0.6

1.4 0.7

MRKH

*

Holding MRSK

0.183

UR

UR

UR

MRKHP

*

Holding MRSK, Pref

0.111

UR

UR

UR

LSNG

*

Lenenergo

0.84

UR

UR

UR

LSNGP

*

Lenenergo, Pref

1.17

UR

UR

UR

MRKC

*

IDGC of Centre

0.042

UR

UR

UR

1,792

2,224

11.5

6.2

5.2

5.5

3.6

3.1

1.0

1.9

MRKK

*

IDGC of Northern Caucasus

5.86

UR

UR

UR

173

207

12.9

15.2

5.5

3.6

3.0

2.1

0.5

0.4

0.5

MRKP

*

IDGC of Center and Volga Region

0.0098

UR

UR

UR

1,106

1,449

26.7

6.5

4.4

6.2

3.6

2.7

0.7

0.8

0.8

MRKS

*

IDGC of Siberia

0.0096

UR

UR

UR

857

1,075

neg

10.0

5.8

7.6

4.1

3.0

0.6

1.0

0.8

MRKU

*

IDGC of of Urals

0.0111

UR

UR

UR

967

1,118

9.2

6.6

4.6

4.0

3.5

2.8

0.5

1.0

0.5 0.7

MRKV

*

IDGC of Volga

0.0060

UR

UR

UR

1,068

1,255

21.9

10.1

6.2

6.6

4.7

3.6

0.9

1.5

MRKY

*

IDGC of South

0.0060

UR

UR

UR

301

693

30.0

5.0

4.3

4.7

3.2

2.9

0.8

0.4

1.8

MRKZ

*

IDGC of North-West

0.0074

UR

UR

UR

711

851

45.3

11.8

6.4

6.9

4.6

3.4

0.7

1.0

0.8

MSRS

*

MOESK

0.055

UR

UR

UR

2,686

4,201

5.8

7.5

5.2

3.7

4.1

3.3

1.2

0.9

1.5

KUBE

*

Kubanenergo

5.9394

UR

UR

UR

459

663

589.1

10.3

7.1

9.4

6.0

4.5

0.9

1.6

1.8

89

81

6.4

3.6

2.6

3.1

1.9

1.5

0.3

1.0

neg

T ORS

*

T omsk distribution company

0.021

UR

UR

UR

T ORSP

*

T omsk distribution company, Pref

0.016

UR

UR

UR

STRATEGY 2011

133


APPENDIX

RECOMMENDATIONS Transport Ticker

Company

Current price, TP, $

$

Recom.*

Upside, %

EV,

$ mn

$ mn

2010E

2011E

P/E 2012E

2010E

EV/EBITDA 2011E

2012E

2011E

EV/S'

P/BV

N.Debt/ EBITDA'11

GLT R

**

Globaltrans

18.00

20.30

13%

2,846

3,135

13.9

10.4

8.9

8.9

7.0

6.1

3.1

4.7

AFLT

*

Aeroflot

2.61

UR

UR

UR

2,903

4,493

16.0

11.9

9.6

7.4

6.3

4.5

0.9

2.9

2.2

UT AR

*

Utair Aviation

0.53

UR

UR

UR

307

1,160

61.2

8.7

3.6

6.2

5.3

4.0

0.8

1.4

3.9

NCSP

*

NCSP, GDR

9.99

UR

UR

UR

2,565

2,861

10.0

9.3

7.4

6.8

5.9

4.9

3.7

3.1

0.6

FESH

*

FESCO

0.54

UR

UR

UR

1,590

2,304

11.5

39.6

21.0

16.9

13.2

10.1

2.5

1.2

4.1

T ransContainer, GDR

9.35

UR

UR

UR

1,299

1,439

29.2

14.8

9.5

8.7

6.3

4.6

2.2

2.1

0.6

EV/S'

P/BV

2010E

2011E

2012E

2010E

2012E

2011E

T RCN LI *

HOLD

Mkt Cap,

0.6

Telecoms Ticker

Company

Current price, TP, $

$

Recom.*

Upside, %

Mkt Cap,

EV,

$ mn

$ mn

EV/EBITDA

P/E

2011E

N.Debt/ EBITDA'11

MBT US

MT S, ADR

20.47

28.00

BUY

37%

20,398

24,386

11.7

10.3

9.5

4.8

4.3

4.0

2.1

4.0

0.7

MT SS

MT S, Common

8.48

14.00

BUY

65%

20,398

24,386

11.7

10.3

9.5

4.8

4.3

4.0

2.1

4.0

0.7

UR BUY

UR

19,459

23,485

11.4

8.9

8.5

4.7

4.2

4.0

2.0

2.3

0.7

78%

2,712

2,195

11.8

9.4

7.8

3.2

3.1

2.8

1.2

1.4

neg

VIP US

VimpelCom Ltd, ADR

14.94

UR

CMST LI *

Comstar, GDR

6.49

11.55

SSA LI

*

Sistema, GDR

24.81

UR

UR

UR

11,971

26,003

10.3

8.1

10.6

3.4

3.2

2.9

0.9

0.8

2.0

AFKS

*

Sistema, Common

0.87

UR

UR

UR

11,971

26,003

10.3

8.1

6.6

3.4

3.2

2.9

0.9

0.8

2.0 neg

CT CM US*

CT C Media

22.52

UR

UR

UR

3,510

3,454

24.5

18.3

14.1

15.7

11.8

9.3

4.6

5.3

RBCI

*

RBC Information Systems

1.44

UR

UR

UR

202

396

neg

141.6

11.6

33.2

16.4

6.5

2.3

-1.1

8.0

SIT R LI

*

SIT RONICS, GDR

0.80

UR

UR

UR

153

526

neg

neg

27.9

5.5

4.3

3.3

0.4

0.2

3.0

IBSG GR *

IBS Group, GDR

ARMD

25.32

UR

UR

UR

608

29.5

17.3

12.6

11.7

8.7

7.5

0.8

3.3

0.4

ARMADA

12.63

UR

UR

UR

152

135

20.2

12.5

9.4

9.1

6.4

4.5

0.8

5.7

neg

URSI

Uralsvyazinform

0.0472

0.05

HOLD

0%

1,808

2,221

11.1

8.7

13.6

3.8

3.6

8.5

1.5

1.9

0.7

URSIP

Uralsvyazinform, Pref

0.0363

0.036

HOLD

-1% 1,432

1,711

8.7

7.4

-

3.5

3.3

-

1.4

1.4

0.5

1,320

1,922

9.7

8.4

-

3.7

3.5

-

1.4

1.9

1.1

784

1,393

10.1

7.4

-

4.4

4.2

-

1.8

2.2

1.8

1,068

1,620

10.3

9.3

-

4.0

3.9

-

1.7

1.0

1.3

2,095

2,646

9.3

8.3

-

4.7

4.4

-

1.9

2.4

0.9

519

717

5.9

6.0

-

3.2

3.2

-

1.2

1.4

0.9

14,718

18,437

14.3

14.4

11.4

5.6

5.3

5.3

2.0

7.2

1.1

EV/S'

P/BV

2010E

2011E

2012E

2010E

2012E

2011E

*

NNSI

VolgaT elecom

4.59

4.60

HOLD

0%

NNSIP

VolgaT elecom, Pref

3.69

3.60

HOLD

-3%

ENCO

Sibirtelekom

0.0878

0.087

HOLD

-1%

ENCOP

Sibirtelekom, Pref

0.0679

0.068

HOLD

0%

KUBN

UT K

0.2089

0.21

HOLD

1%

KUBNP

UT K, Pref

0.1704

0.17

HOLD

0%

SPT L

N.W. T elecom

0.990

1.00

HOLD

1%

SPT LP

N.W. T elecom, Pref

0.781

0.78

HOLD

0%

ESMO

CenterT elecom

1.046

1.050

HOLD

0%

ESMOP

CenterT elecom, Pref

0.846

0.830

HOLD

-2%

ESPK

Far East T elecom

4.32

4.30

HOLD

-1%

ESPKP

Far East T elecom, Pref

3.40

3.40

HOLD

0%

RT KM

Rostelecom

4.77

4.10

HOLD

-14%

RT KMP

Rostelecom, Pref

2.67

3.30

BUY

23%

581

Consumer & Retail Ticker

Company

Current price, TP, $

$

Recom.*

Upside, %

Mkt Cap,

EV,

$ mn

$ mn

P/E

EV/EBITDA 2011E

N.Debt/ EBITDA'11

FIVE

X5 Retail Group

42.7

56.0

BUY

31%

11,583

13,121

40.4

30.5

25.9

14.0

10.6

9.1

0.7

6.5

1.2

MGNT LI **

Magnit, GDR

29.0

32.5

BUY

12%

12,879

12,920

37.5

34.7

29.0

19.4

14.4

11.0

1.1

9.0

0.0

MGNT

**

Magnit, Common

129.9

162.3

BUY

25%

11,557

11,598

33.6

31.1

26.0

17.4

12.9

9.9

1.0

8.1

0.0

DIXY

**

Dixy Group

13.2

14.6

HOLD

10%

1,139

1,397

66.1

42.8

33.9

12.0

9.6

8.3

0.5

6.0

1.8

Seventh Continent

8.1

9.6

HOLD

19%

605

852

12.8

9.1

7.4

6.9

5.8

5.2

0.4

1.1

1.7

UR

UR

1,568

1,354

29.6

21.0

15.5

10.2

7.6

6.0

0.4

5.4

neg 2.7

SCON MVID

*

M.video

8.7

UR

APT K

*

Pharmacy Chain 36.6

3.6

UR

UR

UR

341

566

neg

neg

10.7

8.3

6.8

5.2

0.7

2.3

WBD US

Wimm-Bill-Dann, ADR

32.8

33.0

HOLD

1%

5,766

6,016

52.1

41.9

31.7

16.0

13.9

12.1

1.9

8.2

0.6

WBDF

Wimm-Bill-Dann, Common

121.1

132.0

HOLD

9%

5,328

5,578

48.2

38.7

29.3

14.8

12.9

11.2

1.8

7.6

0.6

7,819

7,767

10.9

10.6

11.6

7.2

6.8

6.4

2.4

3.7

neg

PKBA

*

Baltika Breweries

48.2

UR

UR

UR

PKBAP

*

Baltika Breweries, Pref

41.5

UR

UR

UR

PHST LI cc Pharmstandard, GDR

28.5

36.5

BUY

28%

4,308

4,205

18.4

16.1

14.7

13.0

11.3

10.4

4.3

6.8

neg

PHST

Pharmstandard, Common

100.1

146.0

BUY

46%

3,784

3,681

16.2

14.1

12.9

11.3

9.9

9.1

3.8

5.9

neg

30%

479

501

11.6

9.6

8.8

8.7

7.5

6.9

2.4

2.9

0.3

971

1,042

20.7

10.9

7.6

10.3

7.0

5.1

0.3

2.3

0.5

VRPH

**

Veropharm

47.9

62.0

BUY

PRT K

*

Protek

2.07

UR

UR

UR

KLNA

*

Kalina

29.0

UR

UR

UR

283

390

11.7

10.2

8.5

6.9

6.9

5.8

0.7

2.3

1.9

MHPC LI *

MHP

17.3

UR

UR

UR

1,871

2,362

10.3

8.6

7.1

7.9

6.6

5.6

2.2

3.8

1.4

CHE LI

Cherkizovo Group, GDR

19.2

UR

UR

UR

1,240

1,686

10.0

8.5

6.9

8.3

7.0

5.8

1.2

2.3

1.9

Company

Current price, TP,

$ mn

2010E

2011E

2012E

2010E

2011E

2012E

77,589

16.3

9.5

8.1

2.56

2.13

1.83

*

Banks Ticker

$

$

Recom.*

Upside, %

SBER

Sberbank

3.48

4.60

BUY

32%

SBERP

Sberbank, Pref

2.55

3.53

BUY

38%

VT BR MMBM

*

VT B Bank

0.0034

0.0036

Bank of Moscow

31.54

UR

P/E

P/BV

HOLD

7%

35,210

18.9

11.8

10.2

1.96

1.72

1.58

UR

UR

5,678

14.8

8.6

6.7

1.43

1.20

1.05

1,048

53.8

10.5

6.8

1.90

1.58

1.33

2,079

21.2

12.0

7.5

2.30

1.94

1.63

VZRZ

Vozrozhdenie Bank, Common

43.36

48.4

HOLD

12%

VZRZP

Vozrozhdenie Bank, Pref

14.32

16.9

HOLD

18%

ST BK

Bank Saint-Petersburg, Common

5.60

6.80

BUY

22%

ST BKPA

Bank Saint-Petersburg, Pref

5.86

7.50

BUY

28%

134 STRATEGY 2011

Mkt Cap,


APPENDIX

RECOMMENDATIONS Machinery Ticker

Company

Current price, TP, $

Recom.*

$

Upside, %

AVAZ

*

AvtoVaz

1.22

UR

UR

UR

AVAZP

*

AvtoVaz, Pref

0.40

UR

UR

UR

Mkt Cap,

EV,

$ mn

$ mn

2010E

2011E

P/E 2012E

2010E

EV/EBITDA 2011E

2012E

2011E

1,883

4,240

neg

neg

26.5

30.4

12.4

6.4

0.8

4.8

6.9

690

1,591

neg

neg

n/a

13.9

4.7

n/a

0.4

0.8

2.7 3.8

EV/S'

N.Debt/

P/BV

EBITDA'11

GAZA

*

GAZ

35.90

UR

UR

UR

GAZAP

*

GAZ, Pref

17.00

UR

UR

UR

SVAV

*

Sollers

21.73

UR

UR

UR

745

1,517

neg

23.9

6.8

13.9

7.4

4.7

0.7

2.2

KMAZ

*

KAMAZ

2.36

UR

UR

UR

1,666

2,248

neg

29.7

8.8

16.3

9.1

5.4

0.7

1.6

2.4

SILM

*

Power machines

0.30

UR

UR

UR

2,614

2,361

13.0

10.3

9.6

7.2

5.8

5.4

1.1

6.1

neg

MASZ

**

Mashinostroitelny Zavod

275

320

HOLD

16%

383

346

6.1

6.2

6.2

2.6

2.6

2.5

0.8

0.6

neg

NZHK

**

NCCP

7.2

8.0

HOLD

11%

199

177

10.7

9.5

8.9

3.4

3.1

3.0

1.0

0.5

neg

NZHKP

*

NCCP, Pref

3.0

UR

UR

KHEL

**

Kazan Helicopters

3.18

3.75

HOLD

18%

489

687

5.5

5.4

5.4

5.1

4.8

4.6

1.0

2.2

1.4

uuaz

**

Ulan-Ude Avia Plant

2.10

2.90

BUY

38%

561

483

5.2

5.1

5.0

3.3

3.3

3.2

0.9

2.1

neg

rtvl

**

Rostvertol

0.070

0.078

HOLD

11%

161

395

5.6

4.5

4.0

7.2

5.9

5.2

0.7

0.9

3.5

EV/S'

P/BV

2012E

2010E

2011E

2012E

2011E

UR

Real Estate & Infrastructure Ticker LSRG

Company

$

$

Recom.*

Upside, %

Mkt Cap,

EV,

$ mn

$ mn

2010E

2011E

P/E

EV/EBITDA

N.Debt/ EBITDA'11

LSR Group, Common

33.2

50.0

BUY

51%

3,420

4,246

16.7

13.0

9.7

9.0

7.9

6.5

2.0

2.6

1.5

LSRG LI **

LSR Group, GDR

9.2

12.5

BUY

37%

4,714

5,540

23.0

18.0

13.4

11.7

10.3

8.4

2.6

3.6

1.5

PIK LI

**

Pik Group, GDR

4.3

7.3

BUY

69%

2,126

3,452

neg

58.9

86.0

15.8

13.5

11.3

2.3

3.8

5.2

AFID

**

AFI Development, GDR

1.13

1.80

BUY

59%

1,187

1,392

neg

83.4

18.1

41.2

16.6

8.3

8.6

0.7

2.5

MirLand Development, GDR

4.44

5.00

HOLD

13%

460

674

179.0

12.6

6.4

33.0

10.6

6.6

5.8

1.4

3.4

MLD

**

Current price, TP,

* - multilpes for companies Under Review based on Bloomberg consensus estimates ** - Target price for 12 months. For other companies target price calculated at the end of 2010 Source: RTS, MICEX, Bloomberg, TKB Capital estimates

STRATEGY 2011

135


APPENDIX

RUSSIAN ADRS & GDRS ON WESTERN EXCHANGES 22.12.2010 31.12.2009 Bloomberg Code

Issuer

Stock Exchange

Shares Price per Price per per ADR/GDR, ADR/GDR, ADR/GDR $ $

Change, %

YTD high

YTD low 18.06

OGZD LI

Gazprom

LSE

4

25.72

25.50

0.86%

26.64

ROSN LI

Rosneft

LSE

1

7.22

8.60

-16.10%

9.30

5.92

LKOD LI

LUKOIL

LSE

1

57.30

57.30

0.00%

60.80

44.70

SGGD LI

Surgutneftegas, Common

LSE

10

10.04

8.90

12.81%

10.44

7.76

ATAD LI

Tatneft, Common

LSE

6

32.35

29.14

11.02%

34.80

22.66

GAZ LI

Gazprom Neft

LSE

5

20.98

27.40

-23.43%

29.40

16.95

NVTK LI

NOVATEK

LSE

10

116.90

66.00

77.12%

116.90

63.40

AOIL SS

Alliance Oil

OMXS

1

15.49

14.31

8.30%

17.28

10.96

EDCL LI

Eurasia Drilling

LSE

1

31.00

16.04

93.22%

31.80

13.02

INTE LI

Integra

LSE

0.05

3.70

3.00

23.33%

3.70

2.15

O2C GR

CAT Oil

XETRA

1

9.65

10.07

-4.14%

11.87

8.24

VGAS LN

Volga Gas

LSE

1

1.22

3.39

-63.96%

4.59

1.20

SSA LI

Sistema

LSE

20

24.81

21.00

18.14%

30.99

21.00

MBT US

Mobile TeleSystems

NYSE

2

20.47

19.56

4.67%

23.55

17.84

VIP US

VimpelCom

NYSE

0.05

14.94

n/a

n/a

19.01

13.96

CMST LI

Comstar-UTS

LSE

1

6.49

5.50

18.00%

7.01

5.45

IBSG GR

IBS Group

XETRA

1

25.32

9.82

157.82%

25.56

9.20

CTCM US

CTC Media

NASDAQ

1

22.52

14.72

52.97%

24.76

12.64

MAIL LI

Mail.ru

LSE

1

36.70

27.70

32.49%

42.95

27.70

SITR LI

SITRONICS

LSE

50

0.80

1.55

-48.39%

1.55

0.70

VTBR LI

VTB Bank

LSE

2000

31.50

26.50

18.87%

35.68

20.00

VZY GR

Vozrozhdenie Bank, Common

XETRA

0.75

6.69

4.72

41.74%

7.10

4.20

FIVE LI

X5 Retail Group

LSE

0.25

42.65

31.90

33.70%

44.80

29.35

MGNT LI

Magnit

LSE

0.20

28.95

15.85

82.65%

30.59

14.35

OKEY LI

O'Key Group

LSE

1

14.90

11.00

35.45%

14.90

10.45

PHST LI

Pharmstandard

LSE

0.25

28.50

20.49

39.09%

29.50

16.75

WBD US

Wimm-Bill-Dann Foods

NYSE

0.25

32.76

23.83

37.47%

32.76

17.62

CHE LI

Cherkizovo Group

LSE

2/3

19.20

10.50

82.86%

22.50

10.50

URKA LI

Uralkali

LSE

5

34.81

21.00

65.76%

35.86

15.00

RUSAL FP

RUSAL

Euronext

20

29.64

24.92

18.94%

29.64

17.43

MNOD LI

Norilsk Nickel

LSE

0.1

23.42

14.35

63.21%

23.88

14.00

SVST LI

Severstal

LSE

1

16.80

9.50

76.84%

16.80

9.20

NLMK LI

NLMK

LSE

10

44.88

30.70

46.19%

45.60

25.04

MMK LI

MMK

LSE

13

13.71

11.30

21.33%

14.40

8.90

MTL US

Mechel, Common

NYSE

1

29.58

18.82

57.17%

31.18

17.45

EVR LI

Evraz Group

LSE

1/3

34.84

28.25

23.33%

42.72

21.80

PLZL LI

Polyus Gold

LSE

0.5

35.50

27.75

27.93%

38.50

22.75

PMTL LI

Polymetal

LSE

1

18.27

9.17

99.24%

20.10

8.90

HGM LN

Highland Gold

LSE

1

2.69

1.46

83.80%

3.14

1.34

HRG CN

High River Gold

TSX

1

1.20

0.55

119.16%

1.47

0.59

TMKS LI

TMK

LSE

4

20.80

17.93

16.01%

23.50

14.60

CHZN LI

Chelyabinsk Zinc Plant

LSE

1

4.30

3.35

28.36%

5.11

3.05

LSRG LI

LSR Group

LSE

0.2

9.15

9.10

0.55%

10.90

6.75

PIK LI

PIK Group

LSE

1

4.31

4.15

3.86%

5.81

3.02

AFID LI

AFI Development

LSE

1

1.13

0.95

19.26%

1.26

0.70

MLD LN

MirLand Development

LSE

1

4.44

2.58

71.93%

4.47

2.70

HALS LI

Sistema Hals

LSE

0.05

1.59

1.45

9.66%

2.17

0.90

RUS LN

Raven Russia

LSE

1

0.94

0.73

29.56%

1.01

0.55

RGI LN GLTR LI

RGI International Globaltrans

LSE LSE

1 1

2.55 18.00

1.58 9.90

61.39% 81.82%

2.55 18.47

1.23 10.20

NCSP LI TRCN LI

NCSP TransContainer

LSE LSE

75 0.1

9.99 9.35

11.51 7.75

-13.21% 20.65%

15.20 10.00

8.70 7.49

Source: Bloomberg

136 STRATEGY 2011


APPENDIX

WORLD EQUITY INDICES Index

Country

30.06.2010

31.12.2009

Change, %

1H10 high

1H10 low

9,382.64

10,546.44

-11.04%

11,339.30

9,382.64

20,128.99

21,872.50

-7.97%

22,416.67

18,985.50

Asia Nikkei 225

Japan

Hang Seng

Hong Kong

Straits Times

Singapore

2,835.51

2,897.62

-2.14%

3,019.74

2,650.61

Seoul Composite

South Korea

1,698.29

1,682.77

0.92%

1,752.20

1,552.79

Shanghai Composite

China

2,398.37

3,277.14

-26.82%

3,282.18

2,398.37

Taiwan Weighted

Taiwan

7,329.37

8,188.11

-10.49%

8,356.89

7,071.67

SENSEX

India

17,700.90

17,464.81

1.35%

17,970.02

15,790.93

Europe FTSE 100

Great Britain

4,916.87

5,412.88

-9.16%

5,825.01

4,914.22

DAX

Germany

5,965.52

5,957.43

0.14%

6,332.10

5,434.34

CAC 40

France

Budapest SE Index

Hungary

3,442.89

3,936.33

-12.54%

4,065.65

3,331.29

21,050.43

21,227.01

-0.83%

25,322.96

20,224.74 1,092.80

PX50

Czech Republic

1,103.90

1,117.30

-1.20%

1,314.60

WIG 20 TR

Poland

2,271.03

2,388.72

-4.93%

2,604.76

2,173.25

ISE 100

Turkey

54,839.46

52,825.02

3.81%

59,330.34

48,739.43

RTS

Russia

1,339.35

1,444.61

-7.29%

1,676.27

1,226.57

MICEX

Russia

1,309.31

1,370.01

-4.43%

1,530.93

1,197.39

23,294.83

24,996.97

-6.81%

26,547.87

23,093.24

561.07

573.44

-2.16%

695.44

545.94

Africa FTSE/JSE Top 40

South Africa

Egypt CMA GENL

Egypt

America DJIA

USA

9,774.02

10,428.05

-6.27%

11,205.03

9,774.02

S&P 500

USA

1,030.71

1,115.10

-7.57%

1,217.28

1,030.71

NASDAQ

USA

2,109.24

2,269.15

-7.05%

2,530.15

2,109.24

Bovespa

Brazil

60,935.90

68,588.41

-11.16%

71,784.78

58,192.08

BUSE MERVAL

Argentina

2,185.01

2,320.73

-5.85%

2,487.76

2,061.07

IBC

Venezuela

65,158.40

55,075.68

18.31%

65,264.84

54,368.95

Emerging markets indexes MSCI BRIC

300.20

332.29

-9.66%

347.68

277.12

FTSE Russia IOB Index

769.59

879.03

-12.45%

984.11

705.18

MSCI Russia

707.47

795.32

-11.05%

909.21

656.44

Source: Bloomberg

STRATEGY 2011

137


APPENDIX

COMMODITY MARKETS Bloomberg code

Commodity

22.12.2010

31.12.2009

Change, %

YTF high

YTD low

Spot-market EUCRBRDT

Brent

93.47

77.20

21.08%

93.47

69.60

EUCRURMD

Urals

90.97

76.73

18.56%

91.03

67.31

USCRWTIC

WTI

89.83

79.36

13.19%

89.83

65.96

GOLDLNPM

Gold

1,387.00

1,087.50

27.54%

1,421.00

1,058.00

SLVRLN

Silver

PLAT

Platinum

29.35

16.99

72.75%

30.50

15.14

1,724.25

1,465.50

17.66%

1,784.00

1,445.85

PALL

Palladium

751.75

407.80

84.34%

768.50

394.00

LMAHDY

Aluminium

2,452.75

2,197.00

11.64%

2,452.75

1,834.75

LMCADY

Copper

9,403.00

7,342.00

28.07%

9,405.00

6,067.75

LMNIDY

Nickel

23,991.00

18,452.00

30.02%

27,227.00

16,976.00

LMZSDY

Zinc

2,319.00

2,529.00

-8.30%

2,686.25

1,596.50

MBSTCIHR

Steel HRC (FOB Black Sea)

635.00

507.50

25.12%

715.00

507.50

MBSTUSHR

Steel HRC (USA)

515.00

505.00

1.98%

645.00

505.00

LMSNDY

Tin

26,881.00

16,869.00

59.35%

27,370.00

15,139.00

LMPBDY

Lead

2,443.50

2,402.00

1.73%

2,652.75

1,529.00

CO1

Brent

93.65

77.93

20.17%

93.65

69.55

CL1

WTI

90.48

79.36

14.01%

90.48

68.01

HO1

Heating Oil

252.85

211.88

19.34%

252.85

187.17

PG1

Gasoline

242.45

205.29

18.10%

243.51

184.94

NG1

Natural Gas

4.15

5.57

-25.48%

6.01

3.29

GC1

Gold

1,386.80

1,096.20

26.51%

1,415.30

1,052.20

SI1

Silver

PL1

Platinum

Futures

29.37

16.82

74.57%

29.76

14.83

1,730.90

1,460.00

18.55%

1,809.60

1,452.30

PA1

Palladium

754.25

408.85

84.48%

768.85

396.10

LY1

Aluminium

2,294.00

1,934.50

18.58%

2,304.00

1,777.50

LP1

Copper

9,393.00

7,351.50

27.77%

9,401.00

6,069.50

LN1

Nickel

24,019.00

18,467.00

30.06%

27,245.00

16,984.00

LX1

Zinc

2,321.00

2,534.75

-8.43%

2,691.25

1,598.00

LT1

Tin

26,900.00

16,893.00

59.24%

27,367.00

15,145.00

2,450.00

2,409.00

1.70%

2,657.75

1,529.75

125.85

83.25

51.17%

125.85

70.50

1,760.00

1,700.00

3.53%

1,830.00

1,580.00 124.00

LL1

Lead

API21MON

Steam Coal

CCKPTAIY Index

Coking Coal

MBFOFO01 Index

Iron Ore

174.00

111.50

56.05%

189.50

SB1

Sugar

33.13

26.95

22.93%

33.13

13.67

CC1

Cocoa

2,970.00

3,289.00

-9.70%

3,461.00

2,562.00

KC1

Coffee

230.20

135.95

69.33%

233.85

127.70

C1

Corn

609.00

414.50

46.92%

609.00

325.00

W1

Wheat

783.50

541.50

44.69%

785.75

428.00

S1 CT1

Soybean Cotton

1,328.75 154.12

1,039.75 75.60

27.80% 103.86%

1,330.25 159.12

908.00 66.62

Source: Bloomberg

138 STRATEGY 2011


APPENDIX

MONEY MARKET FOREX Bloomberg code

Currency

22.12.2010

31.12.2009

RUB Curncy RREU Curncy

Change, %

YTD high

YTD low

Dollar USD (rubles per $1)

30.69

30.04

2.18%

31.80

28.93

Euro (rubles per 1 euro)

40.16

43.07

-6.76%

43.41

37.58

RUBBASK Curncy

Basket $0.55/0.45â&#x201A;Ź (rubles)

34.95

35.96

-2.81%

36.44

33.46

EUR Curncy

Euro ($ per 1 euro)

1.309

1.433

-8.68%

1.451

1.195

GBP Curncy

British Pound Sterling ($ per 1 pound)

1.537

1.615

-4.81%

1.638

1.432

JPY Curncy

Japanese Yen (yen per $1)

83.58

93.14

-10.26%

94.72

80.49

CHF Curncy

Swiss Franc (francs per $1)

0.952

1.035

-8.00%

1.162

0.952

CNY Curncy

Chinese Yuan (yuan per $1)

6.648

6.827

-2.62%

6.835

6.625

BRL Curncy

Brazilian Real (reals per $1)

1.696

1.742

-2.64%

1.895

1.657

MXN Curncy

Mexican Peso (pesos per $1)

12.31

13.08

-5.86%

13.21

12.15

TRY Curncy

Turkish Lira (liras per $1)

1.553

1.493

3.98%

1.604

1.396

INR Curncy

Indian Rupee (rupee per $1)

45.00

46.53

-3.28%

47.71

44.10

KRW Curncy

S.Korean Won (won per $1)

1,151.9

1,158.1

-0.53%

1,262.9

1,103.3

22.12.2010

31.12.2009

Change, p.p.

YTD high

YTD low

Interest rates Bloomberg code

Indicator

BP00O/N Index

LIBOR Overnight

0.24

0.17

0.07

0.32

0.17

BP0001M Index

LIBOR 1Month

0.26

0.23

0.03

0.35

0.23

BP0003M Index

LIBOR 3Months

0.30

0.25

0.05

0.54

0.25

EUR001M Index

EURIBOR 1Month

0.81

0.45

0.36

0.85

0.40

EUR003M Index

EURIBOR 3Months

1.02

0.70

0.32

1.05

0.63

MOSKON Index

MosPrime Overnight

2.89

4.45

-1.56

5.95

2.50

MOSK1W Index

MosPrime 1Week

3.22

4.60

-1.38

5.45

2.88

MOSK2W Index

MosPrime 2Weeks

3.41

4.95

-1.54

5.50

3.02

MOSKP1 Index

MosPrime 1Month

3.75

6.32

-2.57

6.32

3.23

MOSKP3 Index

MosPrime 3Months

4.01

7.05

-3.04

7.05

3.73

22.12.2010

31.12.2009

Change, p.p.

YTD high

YTD low

NDF RUR Bloomberg code

Maturity

RRNI1M Curncy

1 Month

3.38

5.74

-2.36

7.72

0.41

RRNI3M Curncy

3 Months

3.41

7.52

-4.11

7.57

2.00

RRNI6M Curncy

6 Months

3.91

6.05

-2.14

6.08

2.92

RRNI12M Curncy

1 Year

4.70

6.46

-1.76

6.46

4.00

22.12.2010

31.12.2009

Change, p.p.

YTD high

YTD low

Government Bonds Bloomberg code

Bond

GT2 Govt

UST 2Y

0.63

1.14

-0.51

1.17

0.33

GT5 Govt

UST 5Y

2.01

2.68

-0.68

2.74

1.03

GT10 Govt

UST 10Y

3.35

3.84

-0.49

3.99

2.39

GT30 Govt

UST 30Y

4.45

4.64

-0.20

4.84

3.51

RUS 30Y

4.86

5.38

-0.53

5.84

3.91

Spread RF30/US10

1.51

1.54

-0.03

EC228830 Corp

Source: Bloomberg

STRATEGY 2011

139


CONTENTS Research Department Equity Research + 7 (495) 981 3430

Fixed Income Research + 7 (495) 981 3430

Maria Kalvarskaia Head of Equity Research Banking m.kalvarskaia@tkbc.ru

Dmitry Zak d.zak@tkbc.ru

Alexander Kovalev, PhD Commodity markets aa.kovalev@tkbc.ru

Evgenia Dyshlyuk Oil & Gas e.dyshlyuk@tkbc.ru

Michael Zak m.zak@tkbc.ru

Alexey Serov Utilities Sector a.serov@tkbc.ru

Evgeny Ryabkov Metals & Mining e.ryabkov@tkbc.ru

Vladimir Kosyakov v.kosyakov@tkbc.ru

Kirill Bakhtin Telecommunications k.bakhtin@tkbc.ru

Natasha Кolupaeva Consumer & Retail n.kolupaeva@tkbc.ru

Marina Kosikhina Designer m.kosikhina@tkbc.ru

Artem Lavrischev Machinery, Database Management, Dividends a.lavrischev@tkbc.ru

Anatoly Vysotsky Real Estate, Infrastructure a.vysotsky@tkbc.ru

Tatiana Zadorozhnaya Transport t.zadorozhnaya@tkbc.ru

Nadezhda Krupennikova Banking n.krupennikova@tkbc.ru

Êèðèëë Áà

Structured Product, Equity & Derivative Department Moscow

+ 7 (495) 981 3430

Fixed Income Markets Moscow

+ 7 (495) 981 3430

Dmitry Romanov d.romanov@tkbc.ru

Vladimir Kurov v.kurov@tkbc.ru

Evgenia Starchenko e.starchenko@tkbc.ru

Pavel Shlyk p.shlyk@tkbc.ru

Artem Ananyan a.ananyan@tkbc.ru

Dmitry Zak d.zak@tkbc.ru

Vadim Guglenko v.googlenko@tkbc.ru

Denis Piskunov d.piskunov@tkbc.ru

Michael Zak m.zak@tkbc.ru

Danil Olimov d.olimov@tkbc.ru

7, bld 3, Znamenka Street, Moscow 119019 Tel. +7 (495) 981 3430 Fax +7 (495) 783 3170 www.tkbc.ru This document is provided to you for informational purposes only and does not constitute an offer to buy, sell or subscribe to investment products described herein. The sources used for this report are believed to be reliable, but TKB Capital makes no representation as to their accuracy or completeness. The views, advice and recommendations contained within represent the analyst’s view as of the publication date. Such views may change without notice and may contradict previously expressed views and recommendations. TKB Capital is under no obligation to bring such previously held views to the attention of the reader. This report is intended for market professionals and institutional investors capable of assessing the risks associated with the securities mentioned herein. TKB Capital shall not be held liable for any losses or other damages which may occur as a result of using this information or investment decisions made on the basis of opinions and recommendations contained in this report. Some Russian equities experience volatility which increases their investment risk, as their value may fall causing losses if the investment is realized. Many Russian equities are illiquid, and some investments are not readily or quickly realizable in good markets, and in times of market duress they may be impossible to realize. Many Russian equities do not trade on a daily basis and thus do not have a daily price quote, giving rise to questions concerning their true value. TKB Capital can give no representation as to the absolute volatility or liquidity of any Russian equity, nor can it give any representation as to the true value of an illiquid security. The value of all ruble-denominated Russian equities is also dependent on currency fluctuations in addition to equity market conditions. Investors should conduct their own investigation and research into a given investment and make their own assessment as to the risks involved with a particular investment in Russian equities. TKB Capital may trade for its own account based on any short-term or long-term recommendations or trade ideas. It may also trade in recommended securities in a manner that is contrary to any trade idea or recommendation. This report may not be reproduced, distributed or published without the written agreement of TKB Capital.


STRATEGY  

STRATEGY RUSSIAN CAPITAL MARKETS 2011

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