Ukrainian Fixed Income Strategy: Gathering dark clouds in summer

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Ukrainian Fixed Income Strategy: Gathering dark clouds in summer

  1. 1. Fixed Income Strategy July 1, 2009 Ukrainian Fixed Income Strategy: Gathering dark clouds in summer After spring rallying, Ukrainian òîãî, ÷òî öâåòîâàÿ ñèñòåìà PMS Process (CMYK) Ââèäó Eurobonds remain flat/slightly up. Despite EMBI spreads performance PMS 483C PMS 179C PMS 728C ÿâëÿåòñÿ áîëåå ýêîíîìè÷íîé, ïî ñðàâíåíèþ ñ PMS Solid, investors start considering EM to be overvalued, andëó÷øå êðàñêàìè âîñïðîèçâîäèòü êîðïîðàòèâíûå öâåòà the rally looks over, some ñèñòåìû PMS Process (CMYK). 4000 ideas have been left unnoticed. C:0 M:91 Y:100 K:60 C:10 M:90 Y:100 K:0 C:10 M:30 Y:42 K:0 EMBI Global R:122 G:31 B:16 R:213 G:53 B:27 R:230 G:188 B:151 3500 EMBI+ Ukraine 3000 It looks like the darkness is gathering in the summer: a large amount of 2500 sovereign and quasi-sovereign debt is to be redeemed, and natural gas 2000 should be pumped into underground storage bunkers. 1500 We believe, Ukraine will be able to repay its debt in 2009, and prefer short- 1000 term notes over long-term and high-quality issues over high-yield. 500 0 For those who feel bullish even though the rally is over, we recommend Sep-08 Nov-08 Jan-09 Mar-09 May-09 investing in our top picks. Among Ukrainian banks it is UKRSIB11 and Source: Cbonds PRBANK 12. Among other corporate sector issues, we recommend taking a look at NAFTO 09 and AZOVTL 11, while selling MHP 11. 7 best and 7 worst performing Eurobonds in terms of BID YTM change For those who prefer riskier, ‘junk’-grade bonds but offering high-yield opportunities, we've done a case study of Ukrainian distressed debt and ALFAUA 11 recommend VABANK 10 (43% of par) and XXIC 10 (20% of par), since returns FICBUA on these issues could become significant. 10 NAFTO 09 TOP trading ideas ALFAUA ASK ASK 09 Price YTM Comments EXIMUK 09 Low-leveraged company, core asset of strong ALFAUA Azovstal 11 79.00 25.50 Ukrainian business group SCM 10 Naftogaz 09 88.50 63.32 State support should be there UKRAIN E 09 The largest Ukrainian bank in terms of assets KIEV 11 Privatbank 12 65.00 27.87 Could count on support of strong Ukrainian Privat Group UKRSIB 11 UkrSibbank BNP Paribas subsidiary 93.00 13.20 PRBAN 08/11 Undervalued compared to other bank's issues K 12 Is priced at the level of banks which are in PIVDE 10 VAB Bank 10 43.00 132.80 default on their liabilities – but still paying coupon VABAN K 10 Both liquidation and restructuring scenarios FIUKR XXI Century 20.00 425.00* leave investors with good return 10 NADRA *estimated return, % of initial investment at current price (ROI) 10 Source: indicative Bloomberg quotes, Phoenix Capital -15,000 -5,000 5,000 15,000 25,000 35,000 Source: Bloomberg Recent Reports: Nadra bank: no light at the end of tunnel Kernel: Initiating coverage (BUY: FP=$15.56) MHP: Recommendation Update Ukrainian Steel Industry: Staying Alive Maria Maiboroda 1 mm@phoenix-capital.com.ua t. +380 44 254 62 75
  2. 2. Table of Contents The rally is over: some ideas left unnoticed............................................................................................................ 2 TOP investment ideas............................................................................................................................................... 4 Calendar of major upcoming events for 2009........................................................................................................ 5 The crisis is far from over: economic implications for Eurobond issuers........................................................... 6 Corporates: leaving 1Q2009 behind, what’s next?.................................................................................................. 10 Interpipe (INPIP): Cautious hold.......................................................................................................................... 10 Azovstal (AZOVTL): Undervalued corporate credit............................................................................................ 11 Kyivstar (OKST): An expensive safe haven........................................................................................................ 12 Naftogaz (NAFTO): A risky buy............................................................................................................................ 13 .... 14 MHP (MHPSA): Too much popularity................................................................................................................... “Junk” bonds case studies: is there any value?..................................................................................................... 15 First Ukrainian Interbational bank (FIUKR): Hold............................................................................................... 15 Finance and Credit Bank (FICBUA): Hold........................................................................................................... 16 Nadra bank (NADRA): Sell.................................................................................................................................... 17 Alfa Bank Ukraine (ALFAUA): Fair YTM of new notes at 60%........................................................................... 18 XXI Century (XXIC): Buy........................................................................................................................................ 19 Eurobond market data............................................................................................................................................... 20 Appendix 1: Summary of anticrisis measures in agriculture, metals and banks................................................. 22 Appendix 2: TOP ideas. Companies' financials....................................................................................................... 23
  3. 3. Fixed-Income Strategy Strategist’s comment: The rally is over, but some ideas have been left unnoticed PMS 483C PMS 179C PMS 728C Ââèäó òîãî, ÷òî öâåòîâàÿ ñèñòåìà PMS Process (CMYK) ÿâëÿåòñÿ áîëåå ýêîíîìè÷íîé, ïî ñðàâíåíèþ ñ PMS Solid, âîñïðîèçâîäèòü êîðïîðàòèâíûå öâåòà ëó÷øå êðàñêàìè C:0 M:91 Y:100 K:60 C:10 M:90 Y:100 K:0 C:10 M:30 Y:42 K:0 ñèñòåìû PMS Process (CMYK). Liquidity in global markets has gone up, as has sentiment towards Emerging Markets. R:122 G:31 B:16 R:213 G:53 B:27 R:230 G:188 B:151 Liquidity in global markets has gone Central banks and government efforts have helped restore optimism – but who knows up... for how long. We remain cautious about global inflationary pressure, which may follow the recent growth in monetary supply. And in the long-run, if inflationary scenarios come true, it would appear wise to look to equity rather than to fixed income instruments. ... pushing Ukrainian Eurobond After the spring rally, Ukrainian Eurobonds experienced only a slight correction prices higher. in mid-May and then remained flat to slightly up. The rally was supported by global optimism and driven by huge liquidity injections from developed world governments and their central banks, as well as improved sentiment towards Emerging Markets and IMF support to Ukraine. But the liquidity surplus in financial markets, as before, has unpredictable consequences, and nobody knows how long these consequences will last. It must be said, at least, that the Ukrainian market was heavily undervalued in early 2009 (see PHNC “Ukraine's Credit Ratings and Default. Does the Picture Really Look so Gloomy?” from Feb. 26, 2009) and helped correct this imbalance. As of now, we believe the rally is As of now, we believe the rally is over, with yields on the Ukrainian Eurobond market over already close to pre-crisis levels – and the crisis is far from over. The world economy remains in a downward trend, with the Ukrainian economy still in a critical period. There are some buyers of Ukrainian risk at current levels, but holders remain reluctant to sell, and bid-offer spreads are rather wide. Lately, investors have even begun considering the EM to be overvalued, and Ukraine is one country where such sentiment could prevail. The country continues to reel from political turmoil, as well as the Gazprom-Naftogaz payment problem and the ongoing banking crisis. We therefore believe that Ukrainian risk should be valued higher than before the crisis when comparing it to global EMs. Ukrainian spreads have reached a seven-month low, but this should imply only slightly more optimism than a fair evaluation of Ukrainian risk. EMBI Global vs. EMBI+ Ukraine 4000 EMBI Global 3500 3000 EMBI+ Ukraine 2500 2000 1500 1000 500 0 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Source: Cbonds The summer should remain more or The summer should remain more or less calm, without slides or rallies like those over less calm, but August-September autumn 2008 to spring 2009. But it looks like the picture is becoming gloomier in Ukraine will be an important stress test for over its fiscal stability and the banking system. The big boom could fall as early as the country August-September 2009, when a large amount of sovereign and quasi-sovereign debt (Eurobond issues of $1,250 mln) are to be redeemed, and a large amount of natural gas should be pumped into underground storage bunkers (approx. $3.5 bln in funding for this remains to be found). We believe Ukraine will be able to repay its Eurobond debt in 2009, but the coming months will be an important stress test for the country’s fiscal and economic stamina. After Ukraine 09 redemption, Ukraine 11 and Ukraine 12 Eurobonds prices could increase significantly. Overall, we prefer short-term notes Overall, regarding any investment strategy in the Ukrainian fixed income market, we over long-term and high-quality prefer short-term notes over long-term and high-quality issues over high-yield. From this issues over high yield. point of view, the Eurobonds of foreign-owned banks (UkrSibbank, Ukrsotsbank, Forum Bank), sovereign and quazi-sovereign issues look preferable. 3
  4. 4. Fixed-Income Strategy Top pics PMS 483C PMS 179C PMS 728C Ââèäó òîãî, ÷òî öâåòîâàÿ ñèñòåìà PMS Process (CMYK) ÿâëÿåòñÿ áîëåå ýêîíîìè÷íîé, ïî ñðàâíåíèþ ñ PMS Solid, âîñïðîèçâîäèòü êîðïîðàòèâíûå öâåòà ëó÷øå êðàñêàìè C:0 M:91 Y:100 K:60 C:10 M:90 Y:100 K:0 C:10 M:30 Y:42 K:0 ñèñòåìû PMS Process (CMYK). R:122 G:31 B:16 R:213 G:53 B:27 R:230 G:188 B:151 Our top pick among first-tier Ukrainian banks is UKRSIB11 (undervalued compared to other foreign bank issues) and PRBANK 12 (undervalued compared to PRBANK 16). Among other corporate sector issues, we recommend taking a look at NAFTO 09 and AZOVTL 11, while selling MHP 11. For those who prefer riskier, ‘junk’-grade bonds that offer high-yield opportunities, we recommend VABANK 10 (37.5% of par) and XXIC 10 (20% of par), since returns on these issues could become significant. (Please find respective companies' financials in Appendix 2). Summary of recommendations on corporate Eurobond issues Eurobond Recommendation Price, % of par YTM, % p.a. Maturity Comment Low-leverage Azovstal 11 BUY 79.00 25.50 28.02.11 Backed by strong parent, Metinvest Demand in metallurgy slowly recovering Over-leveraged company Interpipe 10 HOLD 69.00 49.24 02.08.10 Dramatic (over 75%) downturn in output No sources of funding, except shareholders support Low operational risks Kyivstar 12 HOLD 99.00 8.15 27.04.12 Extremely low leverage Support from foreign shareholders Strong operational results MHP 11 SELL 73.00* 26.06* 30.11.11 Very liquid Eurobond Overvalued comparative to other corporates Naftogaz 09 BUY 88.50 63.32 30.09.09 State support should be there Restructuring ahead XXI Century BUY 20.00** - - Liquidation scenario leaves investors with good return Restructuring terms are as well very favorable *BID price and YTM, for others ASK price and YTM used **indicative price Source: indicative Bloomberg quotes, Phoenix Capital Summary of recommendations on banking Eurobond issues Eurobond Recommendation Price, % of par YTM, % of par Maturity Comment BNP Paribas subsidiary (parent to increase its stake by further 8%) Should be priced with YTM below sovereign curve UkrSibbank 08/11 BUY 93.00 13.20 08.04.11 as at other foreign-owned banks The issue is priced below other issues of UkrSibbank The largest Ukrainian bank in terms of assets Could count on support of strong Ukrainian Privat Privatbank 12 BUY 65.00 27.87 06.02.12 Group Could count on state support in need The issue is undervalued compared to PRBANK 16 Ukrainian bank co-owned by Israeli Kardan Group and a Ukrainian citizen Is priced at the level of banks which are in default VAB Bank 10 BUY 43.00 132.80 14.06.10 on their liabilities – but still paying coupon Low leverage: Eurobond issue is the only foreign debt to be redeemed Restructuring or liquidation ahead The restructuring terms are unfavorable, with the Nadra 10 SELL 13.00* 415.17* - most optimistic recovery of 11,5% of par In case of liquidation recovery rate will be close to zero *BID price and YTM, for others ASK price and YTM used Source: indicative Bloomberg quotes, Phoenix Capital 4
  5. 5. Fixed-Income Strategy Major upcoming events for 2009 PMS 483C PMS 179C PMS 728C Ââèäó òîãî, ÷òî öâåòîâàÿ ñèñòåìà PMS Process (CMYK) ÿâëÿåòñÿ áîëåå ýêîíîìè÷íîé, ïî ñðàâíåíèþ ñ PMS Solid, âîñïðîèçâîäèòü êîðïîðàòèâíûå öâåòà ëó÷øå êðàñêàìè C:0 M:91 Y:100 K:60 C:10 M:90 Y:100 K:0 C:10 M:30 Y:42 K:0 ñèñòåìû PMS Process (CMYK). R:122 G:31 B:16 R:213 G:53 B:27 R:230 G:188 B:151 Major upcoming events that could determine market movements include the IMF’s decision on the third $3.8 bln tranche of the $16.5 bln loan to Ukraine which, according to Prime Minister Yulia Tymoshenko, could be given as soon as the end of July, depending on the outcome of the talks. The decision on the IMF’s 4th tranche, as well as EBRD participation and other funding from abroad, hold considerable importance for the public and banking sectors. Among other events we should note several debt restructuring proposals, which will be accepted or rejected this summer. Investors’ attitude towards borrowers and further developments (debt restructuring or bankruptcies) will determine prices on high-yield segment Eurobonds. Event July August September October November December Extremely Extremely Neutral to Overall environment and sentiment Neutral risky risky negative Positive Neutral Corporate debt FORUM 09 maturity, $100 mln 30.01.2009 ALFAUA debt restructuring proposal 22.12.2009 NADRA debt restructuring proposal FIUKR debt restructuring proposal XXI Century debt restructuring proposal 08.07.2009 Sovereign and quasi-sovereign debt UKRAINE 09 maturity, $500 mln 05.08.2009 EXIMUK 09 maturity, $250 mln 23.09.2009 NAFTO 09 maturity, $500 mln 30.09.2009 Major macro and industry events Monthly gas payments, $600-800 mln a month 07.07.2009 07.08.2009 07.09.2009 07.10.2009 07.11.2009 07.12.2009 Payments for gas stored underground, total of approx. $3.5 bln EBRD meeting on loans to Ukrainian entities IMF 3rd tranche decision IMF 4th tranche decision 15.11.2009 Six months to Presidential elections 17.07.2009 UEFA final approval on Euro 2012 in Ukraine 1Q2009 data on GDP publishing 01.07.2009 2Q2009 data on GDP publishing 01.10.2009 Seeding campaign Source: Phoenix Capital estimates 5
  6. 6. Fixed-Income Strategy The crisis is far from over: economic implications for Eurobond issuers PMS 483C PMS 179C PMS 728C Ââèäó òîãî, ÷òî öâåòîâàÿ ñèñòåìà PMS Process (CMYK) ÿâëÿåòñÿ áîëåå ýêîíîìè÷íîé, ïî ñðàâíåíèþ ñ PMS Solid, âîñïðîèçâîäèòü êîðïîðàòèâíûå öâåòà ëó÷øå êðàñêàìè C:0 M:91 Y:100 K:60 C:10 M:90 Y:100 K:0 C:10 M:30 Y:42 K:0 ñèñòåìû PMS Process (CMYK). R:122 G:31 B:16 R:213 G:53 B:27 R:230 G:188 B:151 We believe the crisis is far At present, the positive newsflow is coming from global markets and Ukraine’s co- from over despite the positive operation with IFIs, but we believe the crisis is far from over. Public finances in Ukraine newsflow are in poor shape, with a huge hidden budget deficit and the government all but begging for money to make monthly gas payments and pump gas into underground storage bunkers. Banks, meanwhile, continue to suffer from growing NPL level, funding outflows and undercapitalization. Many other companies are suffering from the global downturn in demand and falling commodity prices, and the government must somehow deal with this mess ahead of the 2010 Presidential elections. Below we will try to examine the implications of these major economic developments on the Eurobond market. The budget is in poor shape… The government has announced plans to collect UAH 239 bln in budget revenues in 2009 with expenditures of UAH 267 bln. Deficit and debt repayments are to be financed by borrowing UAH 88 bln. The budget, which is based on assumed GDP growth of 0.4%, is unrealistic in our opinion, though we still think the government’s current budget targets could be reached in 2009, but only through an increase in the money supply. The government’s anti-crisis measures, including support for agricultural producers, steel mills and banks, looks underfinanced but will still put additional pressure on the budget, especially with respect to bailing out troubled banks and other economic support programs now in play (please see Appendix 1 for details of Ukraine’s anti-crisis measures). … but a sovereign default is Sovereign debt repayments total $2.0 bln through the end of 2009. Even if we add $0.7 unlikely bln of quasi-sovereign debt repayments, the total remains insignificant compared to the $27 bln of current foreign reserves; The state budget includes UAH 125 bln to be redistributed through the Finance Ministry. This is much more than the UAH 67 bln from last year, and the Ministry can now redirect money flows from other spending to meet its foreign debt obligations; The current account deficit is insignificant, totaling $600 mln over January-April and seems set to continue to improve against a background of rapidly shrinking import. A positive C/A would allow the government to spend less of its foreign reserves on hryvnia interventions and instead make that money available for foreign debt repayments; The EBRD and the World Bank have recently agreed to provide Ukraine with new loans. Moreover, we expect that they will also prolong the country’s existing debts, and foreign banks with operations in Ukraine have announced plans to inject $2 bln-3 bln into their Ukrainian affiliates. All of these measures will match net capital outflows from Ukraine this year, which will in any case be much lower than foreign debt repayments of $12 bln in 2H2009; The IMF announced it will give an additional $7 bln loan to Ukraine by the end of 2009 ($2.8 bln was already given in May). These funds are allowed to be used to fund the budget deficit and help the government manage its external liabilities. 6
  7. 7. Fixed-Income Strategy The situation is much worse in Though the situation in the Ukrainian banking system has started to show positive the banking sector… signals, dark clouds are gathering on the horizon, as banks will face huge write-offs as PMS 483C PMS 179C PMS 728C Ââèäó òîãî, ÷òî öâåòîâàÿ ñèñòåìà PMS Process (CMYK) ÿâëÿåòñÿ áîëåå ýêîíîìè÷íîé, ïî ñðàâíåíèþ ñ PMS Solid, âîñïðîèçâîäèòü êîðïîðàòèâíûå öâåòà ëó÷øå êðàñêàìè ñèñòåìû PMS Process (CMYK). early as 3Q2009. The writing is already on the wall thanks to several banks (losses of C:0 M:91 Y:100 K:60 C:10 M:90 Y:100 K:0 C:10 M:30 Y:42 K:0 R:122 G:31 B:16 R:213 G:53 B:27 R:230 G:188 B:151 UAH 12 bln in 5M2009 were the result of UAH 28 bln in loan loss provisioning), so tough times lie ahead for domestic banks. According to our estimates, approximately 50% of problem loans could be restructured, whether by granting grace periods or delaying maturities, but this will put pressure on interest income. However, with the increased cost of borrowing, interest expenses will rise, but a more serious problem is the liquidity gap that typically appears between long-term, often restructured loan portfolios and short-term (up to three-month) funding bases created by current accounts and individual deposits. Money for the long-run (long-term deposits, syndicated loans, Eurobonds) remains a question mark for the future. We believe those banks receiving government help and those relying on funding from European parent banks or IFI funding will emerge the winners in the very end and could acquire larger market shares, as weaker banks lose clients and even go bankrupt. As such, we prefer to take an extremely conservative approach to banking risk; investment opportunities for conservative investors among banks should therefore include UKRSIB, USCBUZ, FORUM and EXIMUK (please see “PHNC Ukrainian Banking Eurobonds: Family Matters” from Mar. 26, 2009). At current levels, liquid foreign bank Eurobonds looks more or less adequately priced. Offers on FORUMZ 09, USCBUZ 10, EXIMUK 09 and 12 and UKRSIB 10 are too low to be interesting – slightely overvalued due to a lack of sellers – and spreads remain too wide to sell these bonds at BID levels. In the short-term, prices on UKRSIB 11 (with maturity in August) could rise on both the bid and offer sides. We believe it should be priced better than sovereign issues as other foreign bank debts are. … but the government’s bail- The recapitalization of troubled banks began on June 10, 2009, when the government out could help … injected UAH 9.6 bln of authorized capital into Ukrgazbank, Rodovid Bank and Kyiv Bank, in effect nationalizing them. Ukrgazbank received UAH 3.2 bln in exchange for GAINERS: the state receiving an 84.21% stake; Rodovid bank received UAH 2.81 bln in exchange NADRA FICBUA for a 99.97% stake; and Kyiv Bank was given UAH 3.56 bln for a 99.93% stake. With the injection, the IMF’s requirement to launch bank recapitalization has been met and we do not see any reason for the Ukrainian government to recapitalize any other banks. Delays in the recapitalization of Nadra Bank and Ukrprombank are therefore very likely we believe. In any case, the government will not repay these banks’ debts anytime soon but only after these are restructured. Finance and Credit Bank and Imexbank have put recapitalization negotiations on hold and probably will be denied government help. … as well as that of the EBRD Recent economic developments in Ukraine demand that we take a look at the EBRD’s and other IFIs activity in the country. The bank has recently announced that it intends to invest EUR 1 bln on different projects here, with half of this amount to be devoted to the banking GAINERS: sector. EBRD loans to banks are usually long-term (3-10 years) and subordinated so UKRSIB they can be added to the bank’s Tier 2 capital. The EBRD has already invested over USCBUZ $750 mln into Ukraine this year and plans to spend approx. $670 mln more. We expect EXIMUK FORUMZ EBRD targets to be Forum Bank, UkrSibbank, Megabank and ProCredit Bank, plus local infrastructure and agriculture projects. Help from the EBRD is very important for these banks’ capital and for the survival of the Ukrainian banking system in general. 7
  8. 8. Fixed-Income Strategy Global economic and We forecast a 9.9% y-o-y decline in Ukraine’s GDP for 2009, including a 15.4% y-o-y commodity price slumps have drop in industrial output. The downturn has caused numerous problems: a significant PMS 483C PMS 179C PMS 728C Ââèäó òîãî, ÷òî öâåòîâàÿ ñèñòåìà PMS Process (CMYK) ÿâëÿåòñÿ áîëåå ýêîíîìè÷íîé, ïî ñðàâíåíèþ ñ PMS Solid, âîñïðîèçâîäèòü êîðïîðàòèâíûå öâåòà ëó÷øå êðàñêàìè ñèñòåìû PMS Process (CMYK). drop in production in the metallurgy (AZOVTL) and pipe sectors (INPIP), a decline in gas C:0 M:91 Y:100 K:60 C:10 M:90 Y:100 K:0 C:10 M:30 Y:42 K:0 heavily affected Ukraine… R:122 G:31 B:16 R:213 G:53 B:27 R:230 G:188 B:151 consumption and slackening payment discipline (NAFTO), and a drop in households’ GAINERS: LOSERS: income which, in turn, has led to a severe crisis in the public finance and banking sectors NAFTO AZOVTL (sovereign, City of Kyiv, banks). At the same time, the oil prices decline in 2H2008 put INPIP NAFTO Naftogaz’s costs down. We still assume a global recovery to start in 4Q2009 and expect industrial production in Ukraine to hit rock bottom over 2Q-3Q2009. These forecasts are supported by positive signals that have started to come from industry and agriculture. … but metallurgy has shown Metallurgy production volumes and prices have started to slowly recover with new some signs of recovery orders from Southeast Asia and China. In May, the domestic steel industry saw output increase 9.3% m-o-m. The pipe sector is far from stable, with production volumes at 55% of pre-crisis levels. The first signs of recovery must wait for oil & gas demand to GAINERS: LOSERS: return and infrastructure projects to be launched. And if rising oil prices give us some AZOVTL INPIP reasons for optimism, state infrastructure projects and the communal service sectors NAFTO (major Interpipe consumers) are unlikely to enjoy a recovery in the foreseeable future. At the same time, currently rising oil prices (to $70 per barrel from $40 in the bottom) mean hard times for Naftogaz and for Ukraine’s state budget and current account, as imported gas price in 3Q2009 could decline to $240 per tcm from the current $270 per tcm but then rise to $250 per tcm in 4Q2009 (implying an oil price level of $65 per barrel). Hryvnia stability favors After the hryvnia depreciated in autumn-winter (the interbank rate changed from UAH domestic sellers and importers 4.60/US$ to a peak of UAH 9.50/US$), it strengthened and reached UAH 7.65/US$ as of June 18, 2009. A period of relative stability has lasted since March 2009, and GAINERS: LOSERS: a stable hryvnia favors domestic sellers and importers – which have obligations in NAFTO AZOVSTL foreign currency – as well as municipals and the state. By contrast, UAH appreciation MHP INTPIP BANKS has hit domestic exporters, whose goods have lost their competitiveness against the background of an overall decline in global demand. For 2009 we expect the hryvnia to be stable or even to slightly depreciate (target exchange rate – UAH 8.50/US$), with a slight depreciation also expected for early-2010. UAH/$ 8.80 Bid 8.60 Ask 8.40 8.20 8.00 7.80 7.60 7.40 7.20 7.00 2-Mar 16-Mar 30-Mar 13-Apr 27-Apr 11-May 25-May Source: Ukrdealing The political situation has The political outlook that was expected to bring changes in June, when the formation brought no changes to the of a broad coalition seemed possible, has instead only resulted in minor change. We market expect the president will be elected in January 2010 through a general election, with one of three candidates – former PM Viktor Yanukovych, current PM Yulia Tymoshenko and former Parliament Speaker Arseniy Yatsenyuk – likely to win the poll. No one political force will dominate the race and so the confrontation between the branches of power will remain. The political situation, at least until parliamentary elections in 2012, will be unlikely to differ from that seen in recent years. 8
  9. 9. Fixed-Income Strategy Summary of macro and operating environment implications PMS 483C PMS 179C PMS 728C Ââèäó òîãî, ÷òî öâåòîâàÿ ñèñòåìà PMS Process (CMYK) ÿâëÿåòñÿ áîëåå ýêîíîìè÷íîé, ïî ñðàâíåíèþ ñ PMS Solid, âîñïðîèçâîäèòü êîðïîðàòèâíûå öâåòà ëó÷øå êðàñêàìè C:0 M:91 Y:100 K:60 C:10 M:90 Y:100 K:0 C:10 M:30 Y:42 K:0 ñèñòåìû PMS Process (CMYK). R:122 G:31 B:16 R:213 G:53 B:27 R:230 G:188 B:151 Event/trend Impact Gainers (Losers) Government anti-crisis measures Banks + NADRA, FICBUA, EXIMUK Metallurgy + AZOVTL Oil & gas + NAFTO IFI help Banks + FORUM, UKRSIB, USCBUZ, EXIMUK Agriculture + Infrastructure + Commodity price slump Metallurgy - AZOVTL Pipes - INPIP Oil&gas + NAFTO Economic downturn NADRA, FICBUA, VAB, FIUKR, Banks - PIVDE, UKRSIB, USCBUZ, FORUMZ, EXIMUK, PRBANK, ALFAUA Metallurgy - AZOVTL Oil & gas - NAFTO Pipes - INPIP Municipal - KYIV CITY Hryvnia stability/appreciation NADRA, FICBUA, VAB, FIUKR, Banks + PIVDE, UKRSIB, USCBUZ, FORUMZ, EXIMUK, PRBANK, ALFAUA Domestic sellers, importers + MHP, OKST, NAFTO, KYIV CITY Exporters - AZOVTL, INPIP Source: Phoenix Capital 9
  10. 10. Fixed-Income Strategy Corporates: leaving 1Q2009 behind: what’s next? PMS 483C PMS 179C PMS 728C Ââèäó òîãî, ÷òî öâåòîâàÿ ñèñòåìà PMS Process (CMYK) ÿâëÿåòñÿ áîëåå ýêîíîìè÷íîé, ïî ñðàâíåíèþ ñ PMS Solid, âîñïðîèçâîäèòü êîðïîðàòèâíûå öâåòà ëó÷øå êðàñêàìè C:0 M:91 Y:100 K:60 C:10 M:90 Y:100 K:0 C:10 M:30 Y:42 K:0 ñèñòåìû PMS Process (CMYK). Interpipe: Cautious hold R:122 G:31 B:16 R:213 G:53 B:27 R:230 G:188 B:151 • The Interpipe Eurobond is being offered at 49% YTM, implying a 2,800 bps Interpipe 10 issue parameters spread over the sovereign curve. A substantial share of the issue was bought YTM, %* 49.24 back by an Interpipe affiliate company at a price below par, meaning the issue is Price, %* 69.00 no longer very liquid. Redemption Aug 2, 2010 • We believe a fair level exists at 2500-3000 bps, thus this Eurobond should be Amount, $mln 200 rated as a Hold, while holders should very carefully examine the situation in the Coupon, % p.a. 10.25 domestic pipe business. Frequency S/A *offer • Dramatic output decline over 2H2008-1H2009 and redundant leverage are bad Source: Bloomberg signs for investors. Interpipe 10 performance • Early signs of a revival in the pipe market could boost the Interpipe Eurobond, but if the situation continues into 2H2009, the company could wind up unable to 120 8000 redeem its debt without the help of its main shareholder, Ukrainian businessman 100 6000 Viktor Pinchuk. 4000 80 2000 Interpipe has suffered from a downturn in pipe demand (mainly the result of reduced 60 0 funding for infrastructure projects) maybe more than all other Ukrainian issuers. Its largest -2000 40 mill – Interpipe NTRP – has seen monthly production decline in September 2008 by -4000 20 -6000 76% from its peak to 11,000 tonnes in April. Other mills have performed the same or 0 -8000 even more poorly. Together with the heavy price correction, the drop in demand has hit Interpipe particularly hard, leading us to expect a significant deterioration in the company’s Jan-08 Jul-08 Jan-09 financials: profitability and debt ratios are likely to appear dramatically worse than 1H2008 BID YTM, % (lhs) results, and we do not exclude the possibility of net loss in 1H2009. Spread over sovereign curve, b.p. (rhs) Source: Bloomberg Interpipe’s future depends on pipe demand. If the current situation lasts through 2H2009, Interpipe financials, IFRS, $mln the company could suffer substantial losses, leaving only shareholders to redeem company 2007 1H2008 debts. Any early signs of revival will stem from increases in world crude oil prices and communal infrastructure investments reviving, as well as Interpipe changing its production Revenues 478 804 mix in favor of railcar wheels. EBITDA 154 278 Net income 47 180 The company performed a buy-back of its Eurobonds (the buyer was Millen Financial Ltd.) Assets 953 1,359 and a meeting of bondholders agreed changes to the covenants on Interpipe’s Eurobond Equity 419 781 issue in exchange for a 1.5pp coupon rate increase, to 10.25% p.a. The covenant on leverage ratio was increased from 3.5 to 4.5, and a $355 mln loan, secured by SACE, was Financial debt 427 436 added to the list of permitted indebtedness. We doubt the company will comply with this Debt/EBITDA 245% 127% leverage ratio when it releases its FY2009 financials (though for 2008FY IFRS financials Debt/ Equity 102% 56% the situation could be rescued by posting strong 1H2008 results together with today’s Source: Interpipe lower steel prices, Interpipe’s major input). As of Dec. 18, 2008, Interpipe had total debt of $970 mln, of which $465 mln was secured by company assets. Interpipe’s 1H2008 EBITDA totaled $170 mln (expected FY2008 EBITDA is $300 mln-350 mln), and is expected to decline dramatically in 2009. Given unsecured status of $200 mln in Eurobonds, Fitch assumes a 31-65% recovery of this debt in the event of default. The good news is that Interpipe’s main beneficiary, Viktor Pinchuk, is likely to support the company. He appears to have the cash to do this following the sale of Ukrsotsbank, Ukraine’s 4th-largest bank, to Italy’s UniCredit Group for $2 bln in 2007. Interpipe mills monthly tubes production, Average prices on seamless pipes, FOB, '000 tonnes Black and Azov sea 2500 60 50 2000 40 1500 30 1000 20 10 500 0 0 Jan-08 May-08 Sep-08 Jan-09 Jan-08 May-08 Sep-08 Jan-09 May-09 Interpipe NTRP Seamless pipes 168-325 mm Interpipe NIKO TUBE Interpipe NMPP Seamless pipes 57-159 mm Source: Metal-Courier Source: Metal-Courier 10
  11. 11. Fixed-Income Strategy Azovstal: Undervalued corporate credit PMS 483C PMS 179C PMS 728C Ââèäó òîãî, ÷òî öâåòîâàÿ ñèñòåìà PMS Process (CMYK) ÿâëÿåòñÿ áîëåå ýêîíîìè÷íîé, ïî ñðàâíåíèþ ñ PMS Solid, âîñïðîèçâîäèòü êîðïîðàòèâíûå öâåòà ëó÷øå êðàñêàìè C:0 M:91 Y:100 K:60 C:10 M:90 Y:100 K:0 C:10 M:30 Y:42 K:0 ñèñòåìû PMS Process (CMYK). R:122 G:31 B:16 R:213 G:53 B:27 R:230 G:188 B:151 • AZOVTL is still relatively cheap compared to local peers, particularly MHP. Azovstal 10 issue parameters AZOVTL 11 is on offer at 25.5% YTM, implying a 1,245 bps spread over the YTM, %* 25.50 sovereign curve. We believe a fair level should stand between 750-1,000 bps. Price, %* 79.00 Redemption Feb 28, 2011 • Despite the expected 30% decline in output in 2009, we expect Azovstal to be able to service its foreign debt. Amount, $mln 175 Coupon, % p.a. 9.13 • Parent Metinvest Group (controlled by the SCM holding) has a consolidated debt/ Frequency S/A EBITDA ratio below 1.0, and Azovstal itself has low levels of leverage. *offer Source: Bloomberg Azovstal’s operational activity was badly hit by the global downturn, the decline in metal prices, and its low volume of orders. However, strong growth in 1H2008 laid the groundwork AZOVTL11 performance for good operational results for FY2008. In 2009 the situation will likely be much tighter, as the company has announced plans to decrease crude steel production by 39% y-o-y. 120 10000 In any case, we believe this AZST forecast is too pessimistic given the current recovery 100 8000 underway on global steel markets. 80 6000 60 4000 We expect Azovstal to be able to service its foreign debt. Azovstal is currently operating at approx. 58% of its total steel production capacity, having produced 1.25 mln tonnes of 40 2000 crude over January-May (-41% y-o-y). Despite an announced 39% decline in crude steel 20 0 output in 2009 (to 3.36 mln tonnes) and a reduction in its rolled steel output of 41.4% y-o-y 0 -2000 (to 2.96 mln tonnes) brought about by major declines in steel prices, the company should Jan-08 Jul-08 Jan-09 be sustainable in the mid- and long-term. Azovstal’s greatest competitive advantage is its BID YTM, % (lhs) vertical integration, which provides for stable product demand from related European re- Spread over sovereign curve, b.p. (rhs) rolling mills, while also ensuring a stable and cheap supply of raw materials. Source: Bloomberg, Phoenix Capital estimates The company’s Debt/EBITDA ratio under UAS for 2008 was 0.31x, while its share of short- Azovstal financials, IFRS, $mln term debt is negligible at 0.9%. Azovstal’s EBITDA was $571 mln in FY2008. For 2009, we 2006 2007 assume a 30% drop in output and a 50% decline in selling prices for its products, meaning Revenues 2,467 3,294 EBITDA will be much lower, at $175 mln-200 mln, but still leaving its Debt/EBITDA ratio EBITDA 343 558 lower than 1.0x. Net income 139 349 Azovstal parent Metinvest Group maintains a strong financial position compared to other Assets 2,627 3,615 Ukrainian companies. Despite the weak demand for steel products in general, Metinvest Equity 1,825 2,670 has been able to generate positive results in the first few months of 2009 and also benefits Financial debt 343 235 from the substantial depreciation of the Ukrainian hryvnia and its self-sufficiency in raw materials, both of which give the company a significant cost advantage against other steel Debt/EBITDA 90% 28% mills focused on semi-finished products. Debt/ Equity 19% 9% Source: Azovstal Free cash flows generated by the holding have helped finance the first installment of Metinvest’s acquisition of U.S.-based United Coal Company. We cannot estimate the real level of leverage that Metinvest will have after the acquisition, as UCC is not a public company, but in general our filings about the group’s leverage are more positive than cautious. Metinvest’s short-term debt payable in 2009 (as of Dec. 31, 2008) is approx. $0.7 bln, which coincides with its cash and accounts held in various banks (mainly foreign). The group’s total debt was $2.5 bln as of Apr. 1, 2009, and is mainly long-term in nature. According to Moody’s, in 2008 Metinvest generated revenues of $13.3 bln and had operating profits of $4 bln. We believe its operational profit is sufficient for short-term debt redemption of the Metinvest Group (except for those of UCC, which are unknown) and will allow it to accumulate funds for further redemptions. AZST production structure Steel products prices, $/tonne, FOB, Black 0.6 1400 0.5 1200 0.4 1000 0.3 800 600 0.2 400 0.1 200 0 0 Jan-08 May-08 Sep-08 Jan-09 May-09 Jan-08 May-08 Sep-08 Jan-09 May-09 Crude steel Rolled steel Pig iron Billet Rebar Slab HRC Source: Metal -Courier Source: Metal-Courier 11
  12. 12. Fixed-Income Strategy Kyivstar: An expensive safe haven PMS 483C PMS 179C PMS 728C Ââèäó òîãî, ÷òî öâåòîâàÿ ñèñòåìà PMS Process (CMYK) ÿâëÿåòñÿ áîëåå ýêîíîìè÷íîé, ïî ñðàâíåíèþ ñ PMS Solid, âîñïðîèçâîäèòü êîðïîðàòèâíûå öâåòà ëó÷øå êðàñêàìè C:0 M:91 Y:100 K:60 C:10 M:90 Y:100 K:0 C:10 M:30 Y:42 K:0 ñèñòåìû PMS Process (CMYK). R:122 G:31 B:16 R:213 G:53 B:27 R:230 G:188 B:151 • Kyivstar Eurobonds seem to have been a safe haven during the crisis, as the Kyivstar 12 issue parameters telecom business is well insulated against the economic downturn. YTM, %* 8.15 Price, %* 99.00 • Low operational risk, a stable business model, extremely low leverage and the Redemption Apr 27, 2012 presence of foreign shareholders helps the company’s Eurobonds to trade close to par, with a negative spread over the sovereign curve even in Autumn 2008. Amount, $mln 172 Coupon, % p.a. 7.75 • YTM of the Kyivstar 12 Eurobond is 8.15%, which is not of interest for risk- Frequency S/A inclined investors, but may be suitable for conservative ones. *offer Kyivstar, being the low leveraged mobile telecommunications firm in Ukraine, has hardly Source: Bloomberg felt the global economic downturn. Its shareholders, Norway’s state-owned Telenor and Russian firm Altimo (Alfa Group) seem to have finally found common ground and have held OKST 12 performance several recent shareholders meetings in which the two sides have reached agreement on 30 2000 distribution of $1 bln in dividends from 2004-2005 and 2006-2007. 25 1000 20 0 Ukraine’s largest mobile phone services operator is overly liquid, having $1 bln in cash as of Jan. 1, 2009, and $730 mln as of Apr. 01, 2009, with total company liabilities of 15 -1000 $272 mln as of Apr. 1, 2009. Needless to say, the dividend payouts will not damage the 10 -2000 company’s liquidity profile. Though Kyivstar’s revenue and profits declined in USD-terms 5 -3000 due to the hryvnia depreciation ($130 mln of net profit in 1Q2009 vs. $217 mln in 1Q2008), 0 -4000 its efficiency remains very high, with an EBITDA margin of 58% and net margin of 36% based on 1Q2009 results. Jan-08 Jul-08 Jan-09 BID YTM, % (lhs) Spread over sovereign curve, b.p. (rhs) We believe Kyivstar is the best corporate credit in Ukraine, though its Eurobonds are Source: Bloomberg, Phoenix capital estimates very expensive compared to other Ukrainian issues, including sovereign Eurobonds, and attractive for conservative investors only. According to unaudited company financials Kyivstar financials, IFRS, $mln available on their website), Kyivstar has just $90 mln outstanding from its $175 mln Kyivstar 12 par value Eurobond. The rest is likely to be bought out by the company. 2007 2008 1Q2009 Revenue 2,148 2,465 360 EBITDA 1,251 1,458 211 Net profit 697 947 130 Total assets 3,024 2,267 1,916 Total equity 2,023 1,515 1,644 Financial debt 434 124 90 Financial debt/ EBITDA 35.0% 9.0% - Financial Debt/ Equity 21.0% 8.0% 5.0% Source:Kyivstar 12
  13. 13. Fixed-Income Strategy Naftogaz: A risky buy PMS 483C PMS 179C PMS 728C Ââèäó òîãî, ÷òî öâåòîâàÿ ñèñòåìà PMS Process (CMYK) ÿâëÿåòñÿ áîëåå ýêîíîìè÷íîé, ïî ñðàâíåíèþ ñ PMS Solid, âîñïðîèçâîäèòü êîðïîðàòèâíûå öâåòà ëó÷øå êðàñêàìè C:0 M:91 Y:100 K:60 C:10 M:90 Y:100 K:0 C:10 M:30 Y:42 K:0 ñèñòåìû PMS Process (CMYK). R:122 G:31 B:16 R:213 G:53 B:27 R:230 G:188 B:151 • We regard Naftogaz as a buying opportunity for risk-inclined investors. Naftogaz 09 issue parameters YTM, %* 63.32 • We believe it will trade at the sovereign level plus a risk premium of approximately Price, %* 88.50 750-1,250 bps given that the probability of state support is high. The NAFTO 09 Redemption Sep 30, 2009 spread over Ukraine 09 now stands at 3,450 bps, which seems unnaturally wide (and at the same time too tight for those who are bearish on NAFTO). Amount, $mln 500 Coupon, % p.a. 8.13 • The point of no return will be the maturity of the Ukraine 09 Eurobond on Aug. 5, Frequency S/A 2009, which is prior to the Naftogaz maturity on Sept. 30, 2009. After the sovereign *offer Eurobond maturity, the chances of a successful redemption of Naftogaz should Source: Bloomberg surge. Our understanding of Naftogaz risks takes into greater consideration the general fiscal and NAFTO 09 performance political environment in Ukraine and the government’s attempts to rescue the company 300 25000 rather than manage its own financials. The company’s standalone quality is poor, as it 250 20000 has to provide subsidized gas to local consumers at prices lower than is paid to Russia 200 15000 for imports. For 2009, imported gas prices were calculated with a formula widely used in 10000 150 Europe. For 1Q2009 the total was $360 per tcm and for 2Q2009 it was $270.5 per tcm, and 5000 for 3Q2009 we expect it to be $200 per tcm, then increasing to $220 per tcm in 4Q2009 100 0 due to oil priced rising. At the same time, gas prices for local consumers are fixed by the 50 -5000 National Energy Regulation Committee (NERC) at unsustainably low levels ($53-216 for 0 -10000 households and $253-266 for industrial consumers, excluding VAT and other fees). These Jan-08 Jul-08 Jan-09 payment levels, especially from the side of communal utilities, leave Naftogaz with huge BID YTM, % (lhs) accounts receivable, though since 2010 prices for industrial consumers will be established Spread over sovereign curve, b.p. (rhs) on quarterly basis. Source: Bloomberg, Phoenix capital estimates The Russia-Ukraine gas contract assumes very strict payment discipline and liquidity gaps have to be covered by borrowing. Naftogaz still needs money to pay for the gas it Naftogaz financials, IFRS, $mln consumes on a monthly basis (the bill is $600 mln-800 mln per month), and according to 2006 2007 UAS results for 2008, it has $2.5 bln of short-term debt to be repaid but with just $261 mln Revenues 5,460 6,025 of available cash. The company’s financial plan FY2009, approved with a $1.3 bln surplus, still assumes a $3.5 bln-4 bln funding deficit for pumping gas into underground storage EBITDA 335 1,145 containers. Net income -431 -13 Assets 20,685 21,513 We have not changed our opinion on the government’s willingness to support the company; Equity 11,028 11,298 avoiding default on Naftogaz debt will help the government in at least three areas: Financial debt 2,409 2,549 • Positive internal political ratings, as Naftogaz will be a favorite topic for speculation Debt/EBITDA 720% 223% ahead of the presidential elections; Debt/Equity 22% 23% • Securing an international reputation as a reliable gas transit partner, as well as Source: Naftogaz supporting a positive credit history to receive funding from the IMF, EU and other foreign lenders in future; and • National security considerations, as Naftogaz is of great strategic importance for the country. The steps taken by the government up to the present moment support our view: • Naftogaz has received UAH 18 bln in loans from state-owned Oshchadbank, which was funded by government injections into the bank’s statutory fund; • Naftogaz has redeemed its three-year $200 mln L+165 bp bilateral to Standard Bank with the help of loans from state-owned banks; and • The Ukrainian government has authorized an increase in Naftogaz’s share capital by UAH 18.6 bln, to UAH 24.16 bln. Naftogaz subsidiaries Ukrtransgaz and Ukrgazvydobuvannya will also see their statutory funds increased, though final approval will only be possible after final amendments are made to the 2009 state budget. 13

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