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Sokrat Research: In the eye of the storm: Ukraine’s economy amidst global crisis
From mid-2007 till now, it has been a difficult period for the global economy. Despite not being fully integrated into the global economic system, the Ukrainian economy
has felt the influence of the economic crisis. In this report we analyze the performance of the Ukrainian economy in 2008 so far and give our forecast for the macroeconomic performance towards the end of 2008 and onwards.
Executive summary
• The Ukrainian real sector grew at impressive rates in 2000-2007. While we anticipate that the global financial crisis and the anti-inflationary war will somewhat slow down the GDP, real GDP growth will nevertheless stay between 5 and 6.5% for the next five years. The machinery, trade and transportation sectors will continue to be the main driving forces of the real sector’s growth. The performance of the chemical and metallurgical sectors will depend heavily on global markets, while Ukrainian agriculture may get a boost if the Parliament lifts the land trade moratorium.
• As we anticipate world steel prices to decline and imported natural gas prices to rise, we forecast the worsening of an already high trade balance deficit, driving a slight UAH devaluation in 2009.
• Despite record inflation in late-2007 to early 2008, we see clear signals of price stabilization, driven by the economy’s cool-down and the government’s anti-inflationary policies. While we anticipate inflation to stay double-digit until 2010, we view the recent summer deflation as the beginning of a CPI growth rate slowdown.
• While Ukraine observed the collapse of the Parliament’s coalition in September 2008, we anticipate the consolidation of major political forces as we witness a very effective current lawmaking process in the Parliament, coordinated by recent foes – the Bloc of Yuliya Tymoshenko and Party of Regions. While we see some possibility of the President dissolving Parliament, we do not consider the odds of this happening to be very high.
Slavutych approved additional share issue results: POSITIVE
On September 23, 2008 at their AGM, Slavutych [SLAV UZ, BUY] shareholders approved the results of an additional share issue. The company increased its statutory fund by USD 358 mln (+72.2%) to USD 175.7 mln. The additional share issue was held in two stages and lasted from December 20, 2007 to August 30, 2008.
The company plans to spend the proceeds in order to lift its monthly production capacity by 45% to the level of 0.795 mln hl at its Zaporizhzhya and Kyiv breweries.
Our view:
We believe that the market has adjusted to the new price level and we do not expect any negative impact on SLAV’s liquidity from this emission. In our DCF model, we have already taken into account an additional injection of USD 358 mln from the emission. We reiterate our BUY recommendation at a target price of USD 0.93.
Pharmaceutical imports increased 34.5% in August: NEUTRAL
In August 2008, Ukraine’s imports of pharmaceutical increased by 34.% YoY. In value terms, it increased by USD 50.618 mln to reach USD 197.364 mln. Considering the period Jan-Aug 2008, however, the level of pharmaceutical imports rose by 45.6%, up to USD 1.519 bln.
Our view:
According to results from the period Jan-Aug 2008, we expect that the pharmaceutical market value in 2008 will be even higher than our earlier USD 2.7 bln forecast.
On the other hand, the competition faced by local producers has become even higher due to the high level of 2008 imports. According to our estimates, we expect that the share of local producers on the local market could decrease by 0.5-1%.
ZPST: current problems + grand plans = sellout: MIXED
Zaporizhstal [ZPST UZ, Strong BUY] decreased crude steel output to 250-270 thsd mt in September, according to Metal Courier; this is about 35-40% below the average 8M08 level of 417 thsd mt per month. Metal Courier attributed the decrease to the ongoing correction on steel markets, both domestic and worldwide.
In a separate development, a September 26 press-release by Siemens VAI described details of the company’s recently signed several-hundred-million-euro contract with Zaporizhstal for construction of a 4.7 mln tpa converter-concaster shop. The project plans foresee installing two 250 mt oxygen converters, two twin-station ladle furnaces, a vacuum vessel, and two slab concasters, as well as auxiliary systems. The launch of the first line is planned for late 2010. Upon completion, the outdated, inefficient open-hearth steel smelting, ingot casting facilities will be retired.
Zaporizhstal is the fifth-largest Ukrainian steelmaker (4.46 mln metric tons of steel in 2007, 4.37 mln metric tons expected for 2008). The company is not vertically integrated. Zaporizhstal shares have been traded on PFTS since May 20, after almost two years of being delisted due to a rough 3.13x minority dilution. The Midland Group owns a significant stake in Zaporizhstal - 47.70% according to our recent tally.
Our view:
The short-term problems due to weak steel markets are clearly NEGATIVE, as the profits will be depressed in the immediate future. This will exacerbate the poor situation with profitability at Zaporizhstal, which transfers substantial profits to affiliated trading houses. The cash flows will be depleted further due to payout of the declared 100% dividends for 2007 (about USD 110 mln).
The situation with cash inflows contrasts dramatically with the company’s grand spending plans. According to our analysis, the company does not have enough money to finance the implementation of its CapEx program, which is expected to cost USD 1.7-2.0 bln. We estimate that even if Zaporizhstal abolishes transfer pricing and the situation on steel markets is reasonably good, the company will need about USD 500-800 mln of credit at some point. Considering the ongoing financial crisis, the attraction of such debt may prove very difficult.
We believe that the solution to this paradox is a sellout, planned by the current owners, possibly to POSCO of South Korea. A sellout will be highly POSITIVE: it will eliminate substantial corporate governance risks, secure completion of the CapEx program, and eliminate transfer pricing. Even the sales and production volumes, which have recently been heavily depressed due to the steel market correction, may be boosted due to the more substantial realization powers of the group Zaporizhstal will join (although it is not known which group it will be, it cannot be weaker than the standalone Zaporizhstal).
Therefore, we suggest the investors look beyond the short-term problems experienced under the current owners and consider the bright prospects a few years ahead: a modernized, clean, secure Zaporizhstal operating under new ownership.
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