russian steel remain cautious as costs take centre stage
TRANSCRIPT
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8/3/2019 RUSSIAN STEEL Remain Cautious as Costs Take Centre Stage
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DINNURGALIKHANOV+7(495)2130338
ILYAMAKAROV+7(495)7779090ext.2644
Note:Pricesasofclose15Feb2011throughoutthereport.Localsharedataisforinformationonlyandwas
calculatedusingeachcompanyscommonshare/GDRratioandprevailing USD/RUBexchangerate
Forprofessionalinvestorsonly.Thisdocumenthasnotbeenpreparedinaccordancewithlegal
requirementsdesignedtopromotetheindependenceofinvestmentresearch. Pleaserefertoimportant
disclosuresandanalystcertificationattheendofthis document
WeraiseourtargetpricesforRussiansteelmakersEvraz,MMK,SeverstalandNLMKto
reflectstrengthening
steel
prices.
However,
we
advocate
aselective
approach
to
stock
pickingin2011astheindustrycontinuestofaceanumberofchallengeswhichwe
believearenotyetreflectedinmarketforecasts.
Figure1:Russiansteelheadingforanotherrollercoasterridein2011?
80
100
120
140
160
180
200
Oct09
Nov09
Dec09
Feb10
Mar10
May10
Jun10
Aug10
Sep10
Nov10
Dec10
Feb11
Rus s i ansteelmakersharepriceindexRus s i ansteel priceindex
Willwesee the boombustpatternof2010repeatingitselfin 2011?
The2010correctionma yhavebeenlinkedtoEUdebtworries
Source:Bloomberg,MetalExpert
Coststakecentrestagein2011.Webelievecostpressureswillriseaslabour,energy
andotherexpensesaddtorawmaterialpricehikes.Wedoubtthecurrenteconomic
environmentwouldallowforcoststobefullypassedontocustomers,sosteelmakers
mayhavetoabsorbsomeoftheburden,tothedetrimentoftheirmargins.
Assteelpricessoftenmarginsmaybedepressedfurther.Januarysawasharpincrease
insteelprices,bothdomesticallyandinexportmarkets.Webelievethatpartofthe
increasewasduetorestockingandmaynotbesustainable.Therearealsosignsthatend
customersmaynotbereadytoacceptsubstantiallyhighersteelpriceswhenfacedwith
uncertaintyintheirownmarkets.Lackofrealdemandmayleadtoasteelprice
correctionin2011,depressingsteelmakersmarginsfurther.
Wemayseefurthervolatilityinsteelnamesasmarketexpectationsadjust.Current
marketforecastsforRussiansteelmakers2011financialsassumemarginimprovement
vs2010.Thismaybethecaseassteelpricesstrengthenovertheyear.However,ascost
pressuresbecomemoreapparent,wemayseeexpectationsreducedleadingto
downgradesinfairvaluecalculationsforsteelstocks.
WACCadjustedtoreflectlowercostofequity,forecastingperiodextendedto2016.As
aresultofa50bptsreductioninourcountryspecificequityriskpremiumourbasecost
ofequityhasbeencutto11.7%.CompanyspecificWACCshavebeenadjustedfurtherto
reflecttheirliquidity,debtloadandcurrentcostofdebt.
RemainbullishonRussiansteel,butfocusonnameswithshorttermvaluetriggers.
WeexpectRussiansteelperformancetobecloselycorrelatedwithsteelpricesand
companiesabilitytoprotecttheirmargins.Werecommendfocusingonnameswith
shorttermvaluetriggersasweexpectthemtooutperformtheirpeers.Severstal
(reiterateBUY)mayseeanimprovedperformanceintheUS,whileNLMK(upgradeto
BUY)couldbenefitfromacquiringtheremainingDufercoJVstake.MMKs(reiterate
BUY)performancecouldbedrivenbyagrowingshareofHVAproductsinitssalesmix.
Evraz(downgradetoHOLD)maynotseethefullbenefitofincreasedconstruction
activityinRussiauntil2012.
EQUITYRESEARCH
METALS&MINING
17February2011
RUSSIAN STEELMAKERSRemain Cautious as Costs Take Centre Stage
3Mstock,indexandsteelperformance
0 % 10% 2 0% 30% 40 %
MMKGDR
BBGIron/SteelCo
Index
Baosteel
NLMKGDR
RTSIndex
ArcelorMittal
SBBHRCTracker
SBBRebarTracker
EvrazGDR
SeverstalGDR
Mechel ADR
Source:Bloomberga
Company
Target
price
($/share)
Potential
upside
(%)
Rating
(old)
Rating
(new)
EvrazGroup 42.30 10.7% BUY HOLD
MMK 16.20 17.2% BUY BUY
NLMK 49.40 13.6% HOLD BUY
Severstal 22.10 24.9% BUY BUY
YtDstock,indexandsteelperformance
10% 0% 10% 20%
NLMKGDR
MMKGDR
BBGIron/SteelCo
Index
ArcelorMittal
SeverstalGDR
RTSIndex
EvrazGDR
MechelADR
BaosteelSBB
Rebar
Tracker
SBBHRCTracker
Source:Bloomberga
Sector target value $84.3bn
Potential upside 16%
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2
Contents
InvestmentCase...........................................................................................3CostsStarttoTakeCentreStage.................................................................................3WedonotyetSeeCostPressuresReflectedin2011MarketForecasts.................... 5
RussianSteel
Valuations
Premiums
to
Global
Peers
Still
Justified................10
SummaryDataforSteelStocksunderCoverage ...........................................12PriceForecastsUpgradedduetoStrongGainsinRecentMonths................15
CompanyPages..........................................................................................19EVRAZGROUP ............................................................................................21
ForecastChangesandValuation............................................................................... 21
FinancialAccounts..................................................................................................... 22
MAGNITOGORSKIRONANDSTEEL...............................................................24ForecastChangesandValuation............................................................................... 25
FinancialAccounts..................................................................................................... 26
NOVOLIPETSKSTEEL ...................................................................................28ForecastChangesandValuation............................................................................... 29
FinancialAccounts..................................................................................................... 30
SEVERSTAL .................................................................................................32USBusinessmayHoldtheKeyto2010MarginExpansion....................................... 33
ForecastChangesandValuation............................................................................... 34
FinancialAccounts..................................................................................................... 35
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3
Investment Case
Russiansteelstockshaveenjoyedastrongrunfollowingthecorrectionofmid2010.The
gainshavebeensupportedbyagradualrecoveryindemandandpricesandencouraging
Russianeconomicdata.However,weareincreasinglywaryofgrowingcostpressures
andthefragilestateofrealdemandwhichcouldmakeitdifficultforsteelmakersto
protecttheirmarginsin2011,letalonerecordgrowthatthelevelsachievedin2010.
AshighlightedinourJan2011issueofStratonomics,weremainfundamentallybullish
ontheRussiansteelsectorduetotheeconomicrecovery,appreciatingsteelpricesand
steelmakershighdegreeofverticalintegration.However,weareconcernedthatrecent
steelpriceincreases,drivenbycostinflationandseasonalrestocking,areunsustainable
inthemediumtermduetothelackofsupportfromrealdemand.Atthesametime,raw
materialcostpressures,exacerbatedbyrisingenergyandlabourcosts,continueto
depressmargins.
Russiassteelmakerscurrentsharepricesmaynotfullyreflectthechallengesthe
industryisstillfacing.Russiansteelstockshaveperformedstronglysincethe
publicationofourreportRoundupYourFlats,ShortWaitforLongs(25Oct2010),gaininganaverageof35%beforeacorrectionattheendofJanuary.Whiletheoverall
gainsinsharepriceswerebroadlyinlinewithourexpectations(apartfromNLMKwhich,
despiteourHOLDrating,gainedaround45%,reachingapeakof$51.30/GDRon4Jan),
thepaceofsharepriceappreciationhassurpassedourexpectations.
Althoughsomeofthesharepricemovementcouldbeexplainedbytherapidgainsin
steelpricesattheendof2010andthebeginningof2011,aswellasencouragingdata
onRussiaseconomicdevelopment,wethinkthisexuberancemaybeunfoundedgiven
thattheindustrystillfacesanumberoftoughchallenges.
CostsStarttoTakeCentreStage
Rapidrawmaterialcostrisescamebackintofocusin2H10
Thefirst
half
of
2010
was
a
period
of
continued
improvement
in
margins
for
Russian
steelmakersasgrowingproductionvolumesandstrengtheningsteelpricesoffsetrising
rawmaterialcosts.Steelmakerswerealsoquitesuccessfulinkeepingnonrawmaterial
costsundertightcontrol,ascanbeseenfromFigures2and3,whichdepictcompanies
withahighdegreeofverticalintegrationEvrazandSeverstal.
Figure2:EvrazCashcostsandEBITDAmarginprogression Figure3:Severstal*CashcostsandEBITDAmarginprogression
37.1% 34.7% 38.2%
16.7%15.6%
16.6%
36.2%34.6% 27.1%
10.1% 15.0% 18.1%
0%
20%
40%
60%
80%
100%
1H09 2H09 1H10
Material Cos ts Energy+Labour
Cash SG&Aa nd othe r EBITDA
36.0% 36.5% 35.2% 42.4%
18.6% 19.2%
16.9%
14.0%
24.1% 18.5%19.1%
19.0%
21.3% 25.8% 28.9% 24.6%
0%
20%
40%
60%
80%
100%
2009 1Q10 2Q10 3Q10
Material Cos ts Energy+Labour
CashSG&Aan dother EBITDA
*Note:abovefiguresareforRussianSteelandSeverstalResources
Source:Companydata,Atonestimates
Meanwhile,Figures4and5showthemarginprogressionfortwocompanieswitha
lowerdegreeofverticalintegrationMMKandNLMK.
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4
Figure4:MMKCashcostsandEBITDAmarginprogression Figure5:NLMKCashcostsandEBITDAmarginprogression
43.9% 43.7% 47.6% 51.4%
15.6% 17.3% 13.7%14.3%
15.3% 17.0% 17.6%15.4%
25.3% 22.0% 21.1% 18.9%
0%
20%
40%
60%
80%
100%
2009 1Q10 2Q10 3Q10
Material Cos ts Energy+Labour
Cash SG&Aa nd othe r EBITDA
27.4% 34.5% 33.7%35.1%
16.7%20.3% 16.1% 15.9%
26.8%22.4%
14.2% 17.9%
29.1% 22.7% 35.9% 31.1%
0%
20%
40%
60%
80%
100%
4Q09 1Q10 2Q10 3Q10
Material Cos ts Energy+Labour
CashSG&Aan dother EBITDA
Source:Companydata,Atonestimates
Inthesecondhalfof2010severalfactorstookaturnfortheworseforsteelcompanies,
notjustinRussia,butglobally:
Demandforsteelfaltered,leadingtosharppricecorrections Steel
companies
were
forced
to
cut
output
to
bring
it
in
line
with
demand
Pressurefromrawmaterialcostscontinuedtoincrease
ThecombinationofthesefactorsledtomargindeteriorationforallRussiansteelmakers
in3Q10,ascanbeseeninFigures25.
WhileRussiansteelmakershavenotyetpublishedtheir4Q10financials,guidance
providedbycompaniesduringrecentannouncementsofoperatingresultshintsata
furthermargindeclineinthelastquarterof2010.
Forinstance,Evrazs4Q10operatingresultshighlightedacontinuousincreaseinraw
materialprices,exacerbatedbyrisinglabourandenergycosts.Consequently,despite
strongerthan
expected
output
and
price
realisations
during
the
quarter,
its
4Q10
EBITDAguidanceremainedunchangedfromtheprevioustradingupdate.NLMKhasalso
indicatedthatits4Q10EBITDAmarginshouldbearound25%,significantlydownfrom
the30%achievedin3Q10,partlyduetosteelpriceweaknessattheendoftheyear,but
mainlyasaresultofgrowingcosts,inourview.
Costinflationspreadstononrawmaterialcostsin2011
While2H10costincreasesweredrivenprimarilybyrawmaterials,in2011,weestimate
thatpricesforlabour,transportation,utilitiesandenergywillaccountforagrowing
portionofcashcosts.
AccordingtodatafromRussiasMinistryofEconomicDevelopment(MED),thecountrys
electricitytariffs
for
industrial
users
are
estimated
to
have
risen
by
18%
YoY
in
2010,
with1316%increasesexpectedin2011.Theincreaseinwholesalenaturalgaspricesin
2010wasevengreater,currentlyestimatedat26.7%YoY,while2011willlikelysee
pricesrisinganother15%andthisisjustfortheregulatedmarket.Finally,rail
transportationtariffsgained9.4%in2010andareexpectedtorise8%in2011(see
Figure6).
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5
Figure6:Tariffsonnaturalmonopolies(%increaseYoY)
2008 2009 2010E 2011E 2012E
Electricity:regulatedandunregulatedtariffsforallusers(excluding generalpublic) 22.4%* 20.0% 18.0% 1316% 1113%
Naturalgas:regulatedpricesforallusers(excludinggeneralpublic) 25.0% 15.9% 26.7% 15.0% 15.0%
Railfreighttransportation(annualaverages) 16.3% 12.4% 12.4% 8.0% 7.4%
*includesgeneralpublic
Source:RussianMinistryofEconomicDevelopment
Inaddition,weanticipatesteelmakerslabourcostsrisingatleastinlinewithdomestic
inflation.AccordingtopreliminaryMEDestimates,inflationtotalled8.8%in2010andis
expectedtoreach78%in2011.However,giventhatRussiansteelcompanieskept
labourcostsundertightcontrolduringthecrisis,theactualincreasescouldbeeven
higher,inourview.
Forexample,accordingtotheRussianindustryjournalMetalSupplyandSales(Metallosnabzhenie iSbyt),ZapSiboneofEvrazssteelproductionunitsinRussiarecentlyheldanemployeeconferencewhereacollectiveagreementfor201112was
finalised.Itwasagreedthataveragesalarieswouldincreaseby7%from1Mar2011and
byanother7%from1Oct2011anincreaseofover14%fortheyear.Weexpectother
Russiansteelmakerstoagreetosimilarlabourcostincreasesfor2011.
Roublestrengthmayaddtocostpressures
AshighlightedinourrecentreportTimetoStartAppreciatingtheRouble(21Dec2010),theRussiancurrencyisstronglycorrelatedtotheoilprice.Basedonourmodels,an
averageoilpriceof$79/bblfor2011(AtonOilandGasteamestimate)wouldimplythe
rouble/$exchangeratestrengtheningtoRUB29/$byYE11,averagingaroundRUB30/$
fortheyear.Withoilnowtradingataround$100/bbl,ourforecastisbeginningtolook
conservative.
SincemostRussiansteelcompanycostsareroubledenominated,localcurrency
appreciationinflatescosts,althoughthisissomewhatoffsetbyastrengthenedrevenue
line.
ThedomesticcurrencystrengthenedtoRUB29.42/$in1Q10andthenweakenedto
RUB31.24/$in2Q,whichwebelievewaslikelyoneofthefactorsthatallowedRussian
steelmakerstodemonstratestrongerfinancialperformancevs1Q10.Thecurrencythen
appreciatedtoaroundRUB30.60/$in3Q4Q10,exacerbatingcostpressures.
WeDoNotYetSeeCostPressuresReflectedin2011MarketForecasts
Ascoststakecentrestagein2011,weseelittlereflectionofthemincurrentBloomberg
consensusforecastsfortheyear.Wehaveanalysedchangesto201011consensus
forecastsbetweenJuly2010,whentheoutlookforthesteelmarketandpriceswasstill
positive,andFeb2011,whenthefirstsignsof2H10margindeteriorationbecamevisible
andthe
risk
of
further
deterioration
in
2011
became
clear.
AscanbeseeninFigure7,BloombergconsensusEBITDAmarginforecastsfor2010saw
someminoradjustmentsastheyearprogressed.However,expectationsfor2011
marginssawlittledownwardrevisionbetweenJuly2010andFeb2011.Infact,in
Severstalscasetheforecastfor2011actuallyimproved(althoughthiscouldbe
explainedbyexpectationsofmarginimprovementsinthecompanysUSbusiness,which
maybejustifiedgiventhecurrentstrongrecoveryintheUSsteelmarket).
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6
Figure7:EBITDAmarginforecastprogression(July10Feb11) Figure8:EPSforecastprogression(July10Feb11)
23.3
%
16.2%
20.2
%
19
.1%
18
.5%
17.
1%
32.0
%
32.1
%
29.1
%
29.2
%
22.1
%
22.5
%
20.0
%
2
0.9
%
20.3
%
22.5
%
15%
20%25%
30%
35%
40%
Jul'10
Feb'11
Jul'10
Feb'11
Jul'10
Feb'11
Jul'10
Feb'11
Jul'10
Feb'11
Jul'10
Feb'11
Jul'10
Feb'11
Jul'10
Feb'11
2010 2011 2010 2011 2010 2011 2010 2011
Evrazf'ca st MMKf'ca st NL MKf'ca st SVSTf'cast
Mostconsensus2011EBITDAmarginforecastshavehardly
changeddespitesharpdeteriorationofmarginsin 2H10
1.4
8
0
.03
3.2
5
2.6
8
1.7
9
1.6
5
0.6
7
0.9
8
3.5
3
3.3
5
2.1
6
2.3
52.9
1
3.0
3
1.0
11.8
6
0.5
0.5
1.5
2.5
3.5
Jul'10
Feb'11
Jul'10
Feb'11
Jul'10
Feb'11
Jul'10
Feb'11
Jul'10
Feb'11
Jul'10
Feb'11
Jul'10
Feb'11
Jul'10
Feb'11
2010 2011 2010 2011 2010 2011 2010 2011
EvrazEPSf'cast MMKEPSf'cast NLMKEPSf'cast SVSTEPSf'cast
Consensus 2011EPSforecastssaw little revisioninthe lastsix months
Source:Bloomberg consensus
WeseeasimilarpictureinconsensusEPSforecastsfor201011:while2010EPS
estimateshavebeenreviseddownwardconsiderably(exceptforNLMK),themarkets
2011EPSexpectationshaveremainedbroadlyunchangedandinsomecases(NLMK,
Severstal)have
actually
improved
(see
Figure
8).
Webelievethelackofdownwardrevisionto2011forecastsfromJuly2010toFeb2011
canbeexplainedbythefollowingfactors:
Anexpectationofhighersteeloutputvolumesin2011whichwouldtranslateintoimprovedtoplineperformance
Anassumptionthatsteelmakerswouldbeabletoprotectorevenimprovetheirmarginsbypassingmost,ifnotall,cashcostincreasesontotheircustomers
throughhighersteelprices
Thecombinationofthesetwofactorswouldintheoryhaveallowedsteelmakersto
protecttheir
margins
while
improving
bottom
line.
Lackofrealdemandmayhampersteelmakersfrompassingcostsontocustomers
Whilethetwofactorsnotedabovetoplineimprovementsandsuccessinpassingcosts
ontocustomerscouldinfactmaterialisein2011,webelieveswiftresultsareunlikely
andnoteseveralriskfactorsthatmaydelaythefullpositiveeffectfrombeingfeltin
2012.
Firstly,steelpriceappreciationattheendof2010andthebeginning2011shouldnotbe
confusedwithasustainedpricerecovery,whichisverymuchdependantonarecovery
inrealdemandforsteel.Rather,webelievethisisagaintheresultofrestocking,which
mayhavebeencausedbyexpectationsofhighersteelpricesin1Q2Q10drivenbyrising
rawmaterial
costs.
This
is
perhaps
similar
to
the
steel
price
rally
seen
at
the
beginning
of
2010.
Secondly,forpriceincreasestobesustainable,realdemandneedstorecovertolevels
sufficienttoabsorbtheincreasedvolumeofsteelsuppliedtothemarket.AstheRussian
economycontinuestorecover,soshouldrealdemand.Atthemomentthesignsare
encouraging:ascanbeseenfromFigure9,bothindustrialproductionandfixed
investmentarefirmlyinpositivegrowthterritory.However,growthrateshavestabilised
atlevelsthatarestillbelowthepeaksreachedatthebeginningof2008.
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Figure9:FixedinvestmentandIPgrowthinpositiveterritory Figure10:RussianGDPtogrowbyaround6%in201112
30%
20%
10%
0%
10%
20%
30%
Ja n08 Jul08 Jan09 Jul09 Jan10 Jul10
Industrialproduction Fixedinvestment
Industrialproductionand fixed
investmentgrowthrateshave
stabilisedat stronglevels
7.1%6.4%
7.4%8.1%
5.6%
7.9%
4.0%
5.9% 5.50%
10%
8%
6%
4%
2%
0%
2%
4%
6%
8%
10%
2 00 4 2 00 5 2 00 6 2 00 7 2 00 8 2 00 9 2 01 0E 2 01 1E 2 01 2E
Source:Rosstat Source:Rosstat,Atonestimates
Moreover,theAtonStrategyandEconomicsteamforecastthattherateofeconomic
growthin2011willnotexceed6%.Althoughthiswouldbeanimprovementon2010,it
isstillfarbelowtheratesachievedbyRussiaintherunupto2008(Figure10).Inthis
macroeconomicsetting
we
doubt
that
real
demand
for
steel
could
return
to
2007
08
levelsthisyear.
Infact,thecurrentdisputebetweenRussiansteelcompaniesandautomakers
demonstratesthatnotallsteelconsumersarereadytoabsorbpriceincreaseswhen
uncertaintyontheirownmarketsisstillhigh.Thissuggests,inourview,thatitcouldbe
difficultforsteelmakerstopassonthefullextentofcostinflationtotheircustomers.
Automakersarenottheonlycustomerswhoarefeelingtheeffectofrisingsteelprices.
Russiantubemakers,workinginmuchbettermarketconditions a$100/bbloilworld
arealsofeelingtheheat.TMKandChTPZrecentlyapproachedRussiasFederal
AntimonopolyService(FAS)askingthemtoinvestigatesharppriceincreasesbytheir
mainsuppliers,
MMK
and
Severstal.
Weshouldalsonotdiscountthegovernmentsdesiretokeepdomesticmarketpricesin
checkascontaininginflationcomesintofocusduringtherunuptoparliamentary
electionsin2011andpresidentialpollsin2012.Inthissituation,webelievethe
governmentcouldintroducemeasuresaimedatcontrollingdomesticpriceincreases.
Thegovernment hasalreadybroachedtheideaofexporttariffsonrolledsteelandiron
oreasonepotentialmeasure.Wethinkthisapproachcouldleadtoashortterm
oversupplyofsteelonthedomesticmarketandaneventualcurtailmentofproduction
byRussiansteelmakers.
Finally,highersteelpricescouldenticesteelmakerstoincreaseoutput,whichinthe
absenceof
strong
real
demand
could
lead
to
oversupply.
This
would
put
additional
downwardpressureonsteelprices,likelyleadingtoasharpcorrectionsimilartowhat
wasseenin2010.However,thistimearound,wethinkstrongerexportmarketscould
helpoffsetsomeofthepotentialweaknessathome.Nevertheless,thiscouldalsobe
shortlivedasindustrynewswires(MetalBulletin,SteelBusinessBriefing)arealreadyreportingsofteningsteelpricesinseveralkeyexportmarkets.Inanycase,theexport
offeringsofRussiansteelmakersarelimitedprimarilytolowvalueaddedproducts.
Mostofthesefactors,inoneformoranother,wereinplayin2010,whenprices
increasedinthefirstthreetofourmonthsoftheyearoverexpectationsofhigherraw
materialcosts,leadingtopanicrestocking.Thiswasfollowedbyasharpprice
correctionduringthesummermonthsandonlyaslightrecoveryinsteelpricescloserto
the
end
of
the
year.
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8
Steelsharescouldseearepeatof2010pricevolatility
GivenhowcloselycorrelatedRussiansteelstocksaretosteelprices,wecouldseea
repeatofthe2010correctionin2011,inourview.Figures11and12showthatRussian
steelcompanysharepricesmovedinanticipationofchangesinsteelprices,gaining
throughthelatterpartof2009andthebeginningof2010andthenreversingdirection
evenbeforethefullextentofthesteelpricecorrectionwasapparent.
Figure11:
MMK
and
NLMK
share
performance
vs
flat
steel
prices
Figure
12:
Evraz
share
performance
vs
long
steel
prices
80
100
120
140
160
180
Oct09
Nov09
Dec09
Feb10
Mar10
Apr10
Jun10
Jul10
Sep10
Oct10
Nov10
Jan11
MMKstockprice i ndex
NLMKstockpriceindex
F l atsteel
price
index
80
100
120
140
160
180
Oct09
Nov09
Dec09
Feb10
Mar10
Apr10
Jun10
Jul10
Sep10
Oct10
Nov10
Jan11
Evrazstockpriceindex
Longsteel
price
index
Source:Bloomberg
Althoughreportsfromsteelcompaniessuggestthatstrongrisesinsteelpricesshouldbe
expectedin1Q11,sharepricesstartedtocorrectwhensteelpricessoftenedafter
supportfromtherestockingdrivebegantodiminish.Giventhatasteelpricecorrection
couldbecomearealityasearlyas1Q11,wewouldnotruleoutthepossibilityoffurther
volatilityinRussiansteelstocksinthecomingquarters.
Notallisdoomandgloom
Whilesteelandcommoditypricesshouldcontinuetobethemaindriverofshareprice
performance
for
Russian
steelmakers,
we
believe
that
shares
with
additional
value
catalystsshouldoutperformtheirpeersin2011.Belowaresomeofthedriversthatmay
supportRussiansteelsharesin2011:
Severstal:
ArecoveryintheUSsteelmarketleadingtoupsidesurprises.WethinkSeverstalUScouldrepeatitspositive2Q10performanceonthebackofstrongerUSprices
andgrowingcapacityutilisation.AswingtopositiveEBITDAin2Q10cameona15%
QoQincreaseinsalesvolumesandan8%QoQincreaseinaveragerealisedprices.
NordgoldIPOmaysoonbebackonthecards.AlthoughthemarketsreceptionoftheIPOwaslukewarm,webelievethatavaluationintherangeof$3.54bnisstill
realisticandcouldoffer1015%upsidepotentialtothecurrentshareprice.
MMK:
RisingshareofHVAgoodscouldhelpoffsetcostpressures.ThecompanysMill5000isnowoperatingatfullcapacity(1.5mntpa)withitsorderbookfullatleastto
theendof1H11.
NLMK:
AcquisitionoftheremainingstakeinJVwithDuferco.NLMKisshortofinhouserollingcapacityandusestheJVasanoutletforitsexcessslabproduction.The
acquisitionwouldallowittorecordhighersalesmarginswithinthegroup.
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9
Evraz:
RecoveryinconstructionactivityinRussiaandUkraine.Evrazcouldbeastocktowatchin2011giventheexpectedrecoveryinRussiasconstructionindustry.
However,weviewexpectationsofanystrongsharepricehikesaspremature,given
thatthefullextentofincreasedconstructionactivitywouldprobablynotbefelt
untilwellinto2012.Werecommendwaitinguntilearly2Q11toreassessthe
progressof
Russias
construction
industry
before
increasing
positions
in
the
stock.
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0
Russian Steel Valuations Premiums to Global Peers Still Justified
Despiterisingcostpressuresandtheresultingdeteriorationofmargins,webelieve
thatRussiansteelmakersvaluationpremiumstointernationalpeersarejustified.
Whileincreasingcostpressuresareaworldwidephenomenon,Russiancompanies
verticalintegrationgivesthemanimportantedgeoverglobalpeers,actingasa
cushionandlimitingthenegativeimpactofhighercostsonmargins.
Ourvaluationmethodusesacombinedmultiplesbasedapproach(P/EandEV/EBITDA)
andDCF.Thetwomultipleseachaccountfor25%oftheweightedaveragevaluation,
withtheDCFvaluationprovidingtheremaining50%.Themultiplesvaluationallowsus
toaccountforacompanysshorttomediumtermfinancialperformanceanddebtload,
whiletheDCFcalculationaimstoreflectthegrowthpotentialofeachstockandhence
hasahigherweightinginourvaluations.
Oneminoradjustmentfromourpreviouscalculationsisachangetothebasecostof
equityduetotherecentrevisionofourcountryspecificriskpremium,whichwas
reducedfrom3.7%to3.2%.Asaresult,thebasecostofequitydeclinedfrom12.2%to
11.7%.TheWACCforeachindividualcompanyalsotakesintoaccountitsliquidityand
debtposition.
Russiansteelspremiumtoglobalpeersisstilljustified,inourview
Figures13and14arebasedonBloombergconsensusforecastsofthe2011EBITDA
marginsofRussiancompaniesandaselectionofinternationalpeersinbothdeveloped
andemergingmarketsatthetimeofourpreviousupdateon25Oct2010(Figure13)
andnow(Figure14).ThechartsshowthatthemarketstillexpectsRussiansteelmakers
tooutperformtheirpeersin2011.TheaverageEBITDAmarginforecastforfiveRussian
steelmajorsin2011isapproximately25%vstheemergingmarketaverageof16%and
thedevelopedmarketaverageof11%(seeFigure14).
Figure13:Consensus2011EEBITDAmargins(25Octupdate) Figure14:Consensus2011EEBITDAmargins(currentupdate)
26.9%
21.1% 20.9%19.4%
16.3%
12.7%
32.2%
0%
5%
10%
15%
20%
25%
30%
35%
NLMK
Mechel
MMK
Evraz
Severstal
Avg.
Int.
Emerging
Markets
Avg.
Int.
Developed
Markets
25.9%2 2. 3% 2 2.4 %
20.7%
16.4%
10.0%
31.9%
0%
5%
10%
15%
20%
25%
30%
35%
NLMK
Mechel
MMK
Evraz
Severstal
Avg.
Int.
Emerging
Markets
Avg.
Int.
Developed
Markets
Source:Bloomberg
Evenifweassumethe2011estimatesforRussiansteelmakersareoverlyoptimisticand
theywilleventuallybereviseddownward,wethinktherewillstillbeenoughofalead
overinternationalpeerstojustifythepremiumsatwhichRussiansteelmakerscurrently
trade.
OurapproachtovaluingRussiansteelsreflectsourexpectationsofsustained
profitabilityleadershipoverinternationalpeers
Globalsteelmakersarecurrentlytradingat2011P/Esrangingfrom9xto16xfor
emergingmarketpeersand1218xforsteelmakersindevelopedmarkets.Therangefor
EV/EBITDAis511xforemergingmarketsand58xfordevelopedmarkets(foramore
detailedbreakdown,seeFigure15).
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Figure15:Comparativemultiplesofpeersbasedonestimatesfor201112E
CountryMktCap
($mn)EV/EBITDA P/E
EBITDA
margin(%)
Netmargin
(%)
2011E 2012E 2011E 2012E 2011E 2011E
Developedmarkets
ArcelorMittal Luxembourg 57,986 7.1 5.8 13.1 9.2 12% 5%
ThyssenKrupp Germany 21,132 4.5 3.6 15.7 9.9 8% 2%
Voestalpine
Austria
7,555
6.9
6.1
12.0
9.6
14%
4%
NucorCorp USA 15,262 8.0 6.1 18.9 13.0 11% 4%
USSteel USA 8,949 6.5 5.2 15.9 11.0 8% 3%
AKSteel USA 1,815 5.3 4.1 17.5 11.1 6% 2%
NipponSteel Japan 24,877 6.8 6.3 17.3 12.9 12% 3%
JFEHoldings Japan 20,070 6.6 6.0 17.6 11.9 14% 3%
BluescopeSteel Australia 4,145 8.5 5.6 53.7 14.6 6% 1%
Median,DMpeers 6.8 5.8 17.3 11.1 11% 3%
Emergingmarkets
POSCO SouthKorea 37,468 5.3 4.9 9.4 8.7 21% 12%
HyundaiSteel SouthKorea 10,410 7.3 6.9 9.6 8.8 16% 9%
ChinaSteelCorp Taiwan 15,460 11.1 9.9 13.3 10.9 17% 13%
BaoshanIron&Steel China 19,082 4.8 4.3 8.7 7.5 16% 6%
WuhanIron&Steel
China
5,389
5.8
5.2
12.9
9.6
14%
3%
MaanshanIron&Steel China 4,330 5.1 4.7 13.1 11.9 12% 3%
AngangSteel China 9,108 6.4 5.7 13.5 10.4 14% 4%
TataSteel India 12,993 6.7 6.1 9.2 8.1 14% 6%
Gerdau Brazil 19,242 6.6 5.3 11.5 9.3 18% 8%
Usiminas Brazil 14,300 8.8 6.3 17.4 11.9 20% 9%
Median,EMpeers 6.5 5.5 12.2 9.4 16% 7%
Russia
EvrazGroup Russia 16,731 7.2 5.9 16.7 10.6 22% 7%
MagnitogorskSteel Russia 11,879 7.4 5.4 14.6 8.9 21% 8%
Mechel Russia 13,154 6.2 5.5 8.6 8.4 26% 13%
NovolipetskSteel Russia 26,071 8.5 6.2 13.4 9.5 30% 18%
Severstal Russia 17,836 6.4 5.4 11.1 8.8 19% 9%
Median,Russian
peers
7.2
5.5
13.4
8.9
22%
9%
Russiansteelproducerspremium/discounttointernationalpeers:
EvrazGroup 8% 5% 13% 4%
MagnitogorskSteel 11% 5% 1% 14%
Mechel 7% 2% 42% 18%
NovolipetskSteel 27% 10% 9% 8%
Severstal 4% 4% 25% 14%
Source:Bloomberg,Atonestimates
WestillbelievethatRussiansteelmakersshouldbevaluedatapremiumtointernational
peers,giventheirsuperiorfinancialperformancetodateandmarketandour
expectationsthattheywillsustainthisleadershipintheshorttomediumterm.
Nevertheless,weremainconservativeandusemultiplesof14xP/Eand7xEV/EBITDAin
ourcalculations
(except
for
NLMK,
which
we
value
using
a
P/E
of
16x
and
an
EV/EBITDA
of8xtoreflectitsprofitabilityleadership,mediumtermgrowthprospectsandthe
uniquemixofhighvalueproductsinitssalesportfolio).
However,wearemoreconservativethantheconsensusinour2011forecasts
AsFigure22demonstrates,wearemoreconservativethantheBloombergconsensusin
our2011forecastsforRussiansteelmakers.Thisisintendedtoreflectthepressures
steelcompaniescouldfacethisyear.However,wealsobelievethatasmarketsrecover
in2012,steelcompaniesshouldbewellplacedtotakeadvantageofrisingdemandand
prices.
Therefore,wehaveusedtheaverageofour201112EEBITDAandnetincomeforecasts
asthe
basis
for
our
multiples
valuations.
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Summary Data for Steel Stocks under Coverage
ThissectionprovidessummaryinformationforstocksunderAtoncoverage.
InFigure16wesummarisethechangestoourtargetpricesandratings.
Figure16:
Rating
summary
Company Ticker
Target
price
(old)
Target
price
(new)
Target
price
change
Current
price
Upside
potential
Rating
(old)
Rating
(new)
($/share) ($/share) (%) ($/share) (%)
EvrazGroup(GDR) EVRLI 35.33 42.30 19.7% 38.21 10.7% BUY HOLD
MMK(GDR) MMKLI 15.33 16.20 5.7% 13.82 17.2% BUY BUY
MMK(Local) MAGNRM 1.18 1.25 6.0% 1.07 16.6% BUY BUY
NLMK(GDR) NLMKLI 35.55 49.40 39.0% 43.50 13.6% HOLD BUY
NLMK(Local) NLKMRM 3.56 4.94 39.0% 4.35 13.5% HOLD BUY
Severstal(GDR)
SVST
LI
18.57
22.10
19.0%
17.70
24.9%
BUY
BUY
Severstal(Local) CHMFRM 18.57 22.10 19.0% 17.62 25.4% BUY BUY
Source:Bloomberg,Atonestimates
Figure17reflectsthechangesinourtargetpricesifwealteranyofthekeyvaluation
criteriaforthestocksundercoverage.
Figure17:Valuationrangesforthestocks
Company
Current
share
price
Target
priceDCFWACCRate
201112E
averageP/E
201112E
averageEV/EBITDA
($/share) ($/share)Base
+1%
Base
WACC
Base
1%
12x 14x 16x 6x 7x 8x
EvrazGroup(GDR) 38.21 42.30 35.15 42.83 53.36 35.30 41.18 47.07 33.77 42.27 50.77
MMK(GDR) 13.82 16.20 13.00 15.44 18.69 15.11 17.63 20.15 13.26 16.12 18.99
NLMK(GDR) 43.50 49.40 50.73 59.24 70.92 32.84 38.32 43.79 26.01 30.70 35.38
Severstal(GDR) 17.70 22.10 17.86 20.69 24.32 21.62 25.22 28.83 18.13 21.91 25.70
Source:Bloomberg,Atonestimates
Thefollowingtablesprovidesomeusefulperformanceandfinancialdataforthestocks.
Figure18:Stockperformancedata
EvrazGroup MMK NLMK Severstal
1M 3.2% 11.0% 7.6% 7.0%
3M 27.4% 8.0% 15.8% 27.0%
YtD
6.5%5.0%
8.8%
5.0%
1Y 15.1% 8.1% 42.2% 42.9%
52weekhigh($) 42.72 16.23 51.00 19.78
52weeklow($) 21.80 8.90 25.04 9.35
Combineddailyt/o($mn) 47.1 8.2 19.9 46.9
Freefloat(%) 17.4% 13.4% 12.9% 17.6%
Freefloat($mn) 2,911 1,592 3,363 3,139
Source:Companydata,Bloomberg,Atonestimates
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Figure19:Keyvaluationdata
EvrazGroup MMK NLMK Severstal
Valuationsummary:
Targetprice($/GDR) 42.30 16.20 49.40 22.10
Currentprice($/GDR) 38.21 13.82 43.50 17.70
Potentialupside/downside(%) 10.7% 17.2% 13.6% 24.9%
Rating(GDR) HOLD BUY BUY BUY
Target
price
local
($/share)
n/a
1.25
4.94
22.10
Currentprice local($/share) n/a 1.07 4.35 17.62
Potentialupside/downside(%) n/a 16.6% 13.5% 25.4%
Rating(local) n/a BUY BUY BUY
Keyvaluationmetrics:
Commonsharesinissue(mn) 146 11,174 5,993 1,008
CommonshareGDRequivalent(mn) 438 860 599 1,008
Marketcap($mn) 16,731 11,879 26,071 17,836
Netdebt($mn) 7,219 2,928 1,148 4,331
EV($mn) 24,269 15,228 27,333 22,448
BV($mn) 10,312 10,128 9,556 7,718
Keyvaluationratios:
P/Eratios(x)
2009 n/a 51.1 97.7 n/a
2010E n/a 49.5 17.4 n/a
2011E 16.7 14.6 10.4 11.1
2012E 10.6 8.9 9.2 8.8
EV/EBITDAratios(x)
2009 19.6 14.9 15.8 26.5
2010E 10.2 10.6 9.2 8.0
2011E 7.2 7.4 6.9 6.4
2012E 5.9 5.4 6.0 5.4
P/BVratio(x) 1.6 1.2 2.7 2.0
Source:Companydata,Bloomberg,Atonestimates
Figure20:Keyfinancials
EvrazGroup
MMK
NLMK
Severstal
Revenue($mn)
2009 9,772 5,081 6,140 13,054
2010E 12,382 7,597 8,382 15,021
2011E 15,365 10,038 10,905 18,767
2012E 16,835 12,091 13,524 20,823
AdjustedEBITDA($mn)
2009 1,237 1,023 1,370 846
2010E 2,368 1,437 2,384 2,804
2011E 3,361 2,059 3,233 3,508
2012E 4,081 2,837 4,397 4,121
EBITDAmargin(%)
2009 12.7% 20.1% 22.3% 6.5%
2010E
19.1%
18.9%
28.4%
18.7%
2011E 21.9% 20.5% 29.6% 18.7%
2012E 24.2% 23.5% 32.5% 19.8%
Netincome($mn)
2009 1,251 232 215 1,037
2010E 54 240 1,332 87
2011E 1,002 812 1,949 1,603
2012E 1,574 1,342 2,753 2,029
Netmargin(%)
2009 12.8% 4.6% 3.5% 7.9%
2010E 0.4% 3.2% 15.9% 0.6%
2011E 6.5% 8.1% 17.9% 8.5%
2012E 9.4% 11.1% 20.4% 9.7%
Source:
Company
data,
Aton
estimates
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Figure21summariseschangesmadetoourkeyestimates(EBITDAandnetincome)
sinceourpreviousupdate.
Figure21:AtonestimatesoldvsnewEBITDA Netincome
Company 2010E 2011E 2012E3Y
average2010E 2011E 2012E
3Y
average
EvrazGroup:
Newestimate($mn) 2,368 3,361 4,081 54 1,002 1,574
Oldestimate($mn) 2,373 3,431 4,040 112 826 1,297
Changevsold(%) 0.2% 2.0% 1.0% 0.4% n/a 21.3% 21.4% 21.3%
MMK:
Newestimate($mn) 1,437 2,059 2,837 240 812 1,342
Oldestimate($mn) 1,535 2,423 2,737 270 872 1,058
Changevsold(%) 6.3% 15.0% 3.7% 5.9% 11.2% 6.8% 26.8% 2.9%
NLMK:
Newestimate($mn) 2,384 3,233 4,397 1,332 1,949 2,753
Oldestimate($mn) 2,424 3,263 3,700 1,208 2,011 2,293
Changevsold(%) 1.6% 0.9% 18.8% 5.4% 10.3% 3.1% 20.1% 9.1%
SVST*:
Newestimate
($mn)
2,804
3,508
3,508
87
1,603
2,029
Oldestimates($mn) 3,315 3,961 4,155 9 1,598 1,802
Changevsold(%) 15.4% 11.4% 15.6% 14.2% n/a 0.3% 12.6% 6.4%
*PreviousSeverstalforecastsincludedLucchini
Source:Atonestimates
Finally,Figure22comparesourestimatesforsteelstockswiththecurrentBloomberg
consensusview.Wearemoreconservativethanconsensusinour2011forecasts.
Meanwhile,ourexpectationsfor2012areeitherinlinewithoraheadofconsensus,as
webelievethebenefitofincreaseddemandandhighersteelpriceswillnotbefullyfelt
in2011,butshouldbepushedbackto2012.
Figure
22:
Aton
estimates
vs
Bloomberg
consensus
EBITDA Netincome
Company 2010E 2011E 2012E3Y
average2010E 2011E 2012E
3Y
Average
EvrazGroup:
Atonestimates($mn) 2,368 3,361 4,081 54 1,002 1,574
Bloombergconsensus($mn) 2,384 3,553 4,068 103 1,208 1,442
Atonvsconsensus(%) 0.7% 5.4% 0.3% 1.9% n/a 17.1% 9.2% 3.9%
MMK:
Atonestimates($mn) 1,437 2,059 2,837 240 812 1,342
Bloombergconsensus($mn) 1,557 2,414 2,799 380 1,047 1,360
Atonvsconsensus(%) 7.7% 14.7% 1.4% 7.0% 36.8% 22.4% 1.3% 20.2%
NLMK:
Aton
estimates
($mn)
2,384
3,233
4,397
1,332
1,949
2,753
Bloombergconsensus($mn) 2,400 3,370 3,959 1,311 2,047 2,373
Atonvsconsensus(%) 0.7% 4.1% 11.1% 2.1% 1.6% 4.8% 16.1% 4.3%
SVST:
Atonestimates($mn) 2,804 3,508 3,508 87 1,603 2,029
Bloombergconsensus($mn) 2,930 3,831 4,016 1,002 1,818 1,970
Atonvsconsensus(%) 4.3% 8.4% 12.6% 8.5% n/a 11.8% 3.0% 4.4%
Source:Bloomberg,Atonestimates
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Price Forecasts Upgraded Due to Strong Recent Gains
Wehaveupgradedourpriceforecastsforsteelandrawmaterialpricestoreflectthe
stronggainsrecordedinrecentmonths.Exportpricesforflatsteelhaveseenasolid
recoveryandnowtradeataslightpremiumtodomesticsteel.Longsteelpriceshave
alsotrendedhigheronagradualrecoveryinconstructionactivity.Inrawmaterials,
cokingcoalpricessawamajorappreciationduetothedeficitthatfollowedthe
Raspadskaya
mine
accident
in
2010.
Highrawmaterialprices,inparticularforcokingcoalandsteelscrap,willlikelycontinue
toputpressureonRussiansteelproducersmargins,asitwillbedifficultforthemto
passonthefullextentofcostincreasestocustomerswhilethedemandpictureremains
uncertain.
HRCprices:weexpectasofteningin2H11
HRCpricesexperiencedexceptionalgainsatthebeginningof2011,whichweexpectto
continueintheseasonallystronger2Q11:weestimateaveragepriceswillrangefrom
$700/tto$800/tinthefirsthalfoftheyear.However,weexpectpricestosoftenin
2H11,withafullyearaverageof$740/tforthedomesticmarketand$760/tforexports
(seeFigure
23).
Figure23:HRCpricesstrongin1H11,softeningin2H11($/t) Figure24:CISHRCuparound13%vsourpreviousforecast($/t)
200
300
400
500
600
700
800
1Q09
2Q09
3Q09
4Q09
1Q10
2Q10
3Q10
4Q10
1Q11E
2Q11E
3Q11E
4Q11E
HRC CIS producerpri ce HRC CIS exportprice
Weassumeprice
softeningin 2H11,similar
to2H10correction
Exportpricesstarttrading
at apremiumtodomestic
516
642588 604
695
781742 731
601631
663 666 650
400
500
600
700
800
900
1Q10
2Q10
3Q10
4Q10
1Q11E
2Q11E
3Q11E
4Q11E
HR C CIS producerprice NEW
HR C CIS producerprice OLD
Source(Figures32and33):MetalExpert,Bloomberg,Atonestimates
OurnewdomesticHRCpriceestimatesfor2011areanaverageof13%higherthanour
previousforecast(seeFigure24).
Rebar:strongrecoveryatend2010andstartof2011
Rebarpricesenjoyedastrongerrecoverythanweexpectedin4Q10,averagingaround
$590/tvs$550/tinourOctoberforecast.Wehaverevisedourestimatestotakeinto
accountthepricestrengthseeninJanuaryandFebruary.Onceagain,weexpect3Q
4Q11tobeseasonallyweak,bringingtheaveragepricefor2011toaround$700730/t,
withdomesticpricesexpectedtoreachapremiumtoexport(seeFigure25).
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Figure25:Rebarstrongerrecoveryin4Q10vsforecast($/t) Figure26:Rebarpriceestimateup20%vsearlierforecast($/t)
200
300
400
500
600
700
800
1Q09
2Q09
3Q09
4Q09
1Q10
2Q10
3Q10
4Q10
1Q11E
2Q11E
3Q11E
4Q11E
Rebar CIS producerpri ce Re ba r CIS exportprice
Domesticprices improveas
constructionactivitypicks up
Weassumeprice
softeningin2H11,similar
to2H10correction
474
618
579589
663
762 751 732
550577
621 605 599
400
500
600
700
800
900
1Q10
2Q10
3Q10
4Q10
1Q11E
2Q11E
3Q11E
4Q11E
Rebar CIS producerprice NEW
Rebar CIS producerprice OLD
Sources:MetalExpert,Bloomberg,Atonestimates
Ournewpriceassumptionsforrebarare2021%higherthanourOctoberestimates(see
Figure26).
Flatsteelmaintainsanarrowingpremiumoverlongproducts
Longsteelpriceshaveundergoneastrongrecovery,narrowingthediscounttoflatsteel
toaround3%in4Q10.AlthoughweexpectHRCtocontinuetradingatapremiumto
rebargoingforward,wethinkthepremiumwillbelower:around5%in2011vs10%in
ourpreviousforecast(Figure27).
Figure27:Longssteeldiscounttoflatexpectedtonarrow($/t)
500
600
700
800
900
1Q
09
2Q
09
3Q
09
4Q
09
1Q
10
2Q
10
3Q
10
4Q
10E
1Q
11E
2Q
11E
3Q
11E
4Q
11E
CIS DomesticFlatSteel Basket
CIS DomesticLongSteelBasket
Flatsteel is still
expectedtotradeat
apremiumtolong...
butthe discountis expectedtonarrow
as constructionactivitypicksup
Source:MetalExpert,Bloomberg,Atonestimates
Pressurefromhighrawmaterialpricessettorolloverinto2011
Weexpecthighrawmaterialpricestocontinuepressuringsteelmakersmargins.This
shouldbe
especially
pronounced
in
coking
coal
in
2011
(due
to
the
Raspadskaya
accidentlastyearandastructuralshortageofhighquality,locallyproducedcoking
coal).Amajorincreaseinscrappricescanbeexpectedfrom2012onthebackof
insufficientscrapgenerationandaddeddemandfromnewelectricarcfurnace(EAF)
capacity.
Wethinktheincreaseinironorepriceswillbelesspronouncedvscokingcoalsince
Russiaisnotcurrentlyexperiencinganyshortageofthismaterial(seeFigure28).
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7
Figure28:StrongincreaseincokingcoalpriceduetoRussiandeficit($/t)
51 49 58
92103 125 124
134158 166 168 164
33 32 3648
6288 81 82 92 94
95 94
0
50
100
150
200
250
1Q09
2Q09
3Q09
4Q09
1Q10
2Q10
3Q10
4Q10
1Q11E
2Q11E
3Q11E
4Q11E
Cokingcoal (Russia domesticGZh type)Iron ore concentrate(Russiadomestic)
Shortageofdomesticoutput
supportscokingcoalprices
Source:MetalExpert,Bloomberg,Atonestimates
Raspadskayarecentlyannouncedan11%increasein1Q11pricesforcokingcoal.
However,weexpectthisupwardmomentumtoslowfrom2Q11,asRaspadskayastarts
torecovertheoutputlostfollowinglastyearsaccident.Weexpect1Q113Q11pricesto
averagearound
$160
165,
softening
in
4Q11
(see
Figure
29).
We
estimate
an
average
2011cokingcoalpriceofaround$165/t,35%higherthanin2010.
Figure29:Cokingcoalpricessupportedbycontinueddeficit($/t) Figure30:Ironorepricestrengtheningonhigherdemand($/t)
103
125 124134
158166 168 164
151153157
146135
75
100
125
150
175
200
1Q10
2Q10
3Q10
4Q10
1Q11E
2Q11E
3Q11E
4Q11E
Cokingcoal (Russia domesticGZh type) NEW
Cokingcoal (Russia domesticGZh type) OLD
62
8881 82
92 94 95 94
82 80 8486 85
50
75
100
125
1Q10
2Q10
3Q10
4Q10
1Q11E
2Q11E
3Q11E
4Q11E
Iron ore concentrate (Russiadomestic)NEWIron ore concentrate (Russiadomestic)OLD
Sources(Figures29and30):MetalExpert,Bloomberg,Atonestimates
Weexpectironoreconcentratepricestoincreasemodestlyovertheyear,averaging
$95/t,up20%YoY(seeFigure30).
Forsteelscrap,weforecastapriceincreaseofapproximately15%YoYin2011toaround
$270/t.Thisis16%higherthanourearlierforecast,mainlyduetoincreasedlongsteel
pricesandthereforeelevateddemandforscrap.
Ourpriceassumptionsforthemainsteelproductsandrawmaterialsaresummarisedin
Figures3132.
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Figure31:AtonrawmaterialandsteelpriceassumptionsFeb2011($/metrictonne)Annualprices Quarterlyprices
2010 2011E 2012E 2013E 2014E 2015E 3Q10 4Q10 1Q11E 2Q11E 3Q11E 4Q11E
Rawmaterialprices,FCA,exVAT:
Ironoreconcentrate old 79 83 88 85 80 76 84 83 80 84 85 84
new 79 95 101 101 97 92 84 84 93 96 96 96
%
chg
0.5%
14.6%
15.7%
18.8%
21.0%
21.5%
2.0%
16.2%
14.9%
13.7%
13.7%
Cokingcoalconcentrate(GZhtype) old 122 152 157 156 152 150 124 135 146 157 153 151
new 122 164 181 179 174 168 124 134 158 166 168 164
%chg 0.2% 8.1% 15.1% 15.2% 14.5% 12.2% 0.8% 8.1% 5.6% 9.9% 8.8%
Steelscrap old 230 231 257 272 272 272 211 207 218 234 237 234
new 233 268 314 345 349 347 211 221 249 267 281 274
%chg 1.5% 16.0% 22.1% 26.9% 28.5% 27.5% 6.5% 14.1% 14.1% 18.7% 16.9%
Domesticprices,exworks,exVAT:
HRC old 589 653 667 655 639 630 598 601 631 663 666 650
new 587 737 825 803 778 757 588 604 695 781 742 731
%chg 0.3% 13.0% 23.6% 22.6% 21.7% 20.3% 0.4% 10.0% 17.9% 11.4% 12.6%
Rebar old 555 601 632 633 618 607 579 550 577 621 605 599
new 565 727 844 838 812 790 579 589 663 762 751 732
%chg 1.8% 21.0% 33.6% 32.4% 31.2% 30.2% 7.1% 14.8% 22.8% 24.0% 22.2%
Exportprices,FOB,exVAT:
Slab old 532 561 574 563 549 541 514 517 543 570 573 558
new 533 669 755 731 708 689 514 521 599 674 708 697
%chg 0.2% 19.4% 31.6% 29.8% 28.8% 27.3% 0.8% 10.4% 18.3% 23.6% 24.8%
Billet old 517 548 576 578 564 554 528 502 527 567 552 547
new 532 687 817 823 797 776 528 564 635 698 716 698
%chg 3.0% 25.2% 41.7% 42.4% 41.2% 40.1% 12.4% 20.4% 23.2% 29.6% 27.6%
HRC old 595 626 640 628 613 604 574 577 605 636 639 623
new 605 764 866 843 816 795 574 618 710 799 779 767
%chg 1.7% 22.1% 35.2% 34.2% 33.2% 31.6% 7.1% 17.3% 25.7% 21.9% 23.2%
Rebar old 548 583 613 614 600 589 562 534 560 602 587 581
new 563 702 811 805 780 759 562 592 651 732 721 703
%chg 2.6% 20.4% 32.3% 31.1% 29.9% 28.9% 10.9% 16.2% 21.6% 22.8% 21.0%
Source:MetalExpert,Atonestimates
Figure32:Rawmaterialandsteelpriceassumptions(Feb2010)periodonperiodprogression(%)
YoYchangeinprices QoQchangeinprices
2010
2011E
2012E
2013E
2014E
2015E
3Q10
4Q10
1Q11E
2Q11E
3Q11E
4Q11E
Rawmaterialprices,FCA,exVAT:
Ironoreconcentrate 83% 20% 6% 1% 4% 5% 4% 0% 10% 4% 1% 1%
Cokingcoalconcentrate(GZhtype) 95% 35% 10% 1% 3% 3% 1% 8% 18% 5% 1% 3%
Steelscrap 39% 15% 17% 10% 1% 1% 15% 5% 13% 8% 5% 3%
Domesticprices,exworks,exVAT:
HRC 35% 26% 12% 3% 3% 3% 8% 3% 15% 13% 5% 2%
Rebar 34% 29% 16% 1% 3% 3% 6% 2% 13% 15% 2% 3%
Exportprices,FOB,exVAT:
Slab 43% 26% 13% 3% 3% 3% 14% 1% 15% 13% 5% 2%
Billet 35% 29% 19% 1% 3% 3% 1% 7% 13% 10% 2% 3%
HRC 33% 26% 13% 3% 3% 3% 12% 8% 15% 13% 3% 2%
Rebar 28% 25% 16% 1% 3% 3% 3% 5% 10% 13% 2% 2%
Source:
Metal
Expert,
Aton
estimates
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9
Companies
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2
0
WeincreaseourtargetpriceforEvrazto$42.30/GDR(up20%from$35.33/GDR
previously)onstrongersteelpricesandencouragingsignsfromtheRussian
constructionsector.However,wedowngradeourratingtoHOLDaswethinkthe
shareshave
run
slightly
ahead
of
fundamentals:
while
arecovery
in
construction
seemstobeunderway,weneedmoreevidencetobesureitissustainable.
Figure33:Evrazssteelsalescontinuetoberelativelyflat(000tonnes)
0
1,000
2,000
3,000
4,000
5,000
1Q0
9
2Q0
9
3Q0
9
4Q0
9
1Q1
0
2Q1
0
3Q1
0
4Q1
0
Semi finished p ro du cts Con s truc ti o nproductsRailwayproducts Fl atrolledproductsTubularproducts Othe rsteel products
Steelsales volumesremained
relativelyflatoverlastsixquarters
Source:CompanyData
Operatingresultsfor2010broadlyinlinewithexpectations.Outputin4Q10recovered
acrossmostproductgroupsafterplannedmaintenancein3Q10.Asaresult,2010crude
steelproductionincreased6.6%YoYto16.3mnt.Rolledproductsalesgained3%YoYto
14.7mnt.Encouragingly,salesofconstructionsteelcontinuedtoshowpositiveQoQ
dynamics,whichwehopereflectsagradualrecoveryintheRussianconstruction
industry.Inmining,Evrazproduced19.4mntofironoreproducts(up9%YoY)andmined
7.5mntof
coking
coal
(down
27%
YoY
due
to
operational
issues).
ButconservativeEBITDAguidanceconfirmsourcostconcerns.Despiteencouraging
operatingdata,Evrazmaintainedits4Q10EBITDAguidanceataround$595mn(inline
with3Q10)highlightinggrowingcostpressuresfromrawmaterials,energyandwages
thateffectivelycancelledoutgainsinoutputandprices.
Verticalintegrationshouldprovidesomemarginprotection.Evrazenjoysahighdegree
ofintegrationinironore(closeto90%in2010)andcokingcoal,whereselfsufficiencyis
expectedtoincreasefrom85%currentlytoover100%onceoutputfromRaspadskaya
recovers.EvrazsinternationalfootprintallowsittotakeselfsufficiencybeyondRussia
byexportingsemifinishedsteeltounitsintheUSandtheEU.
Russianstatisticsareencouragingbutsustainabilityisuncertain.Russiapostedfixed
investmentgrowthof6%YoYin2010,whileproductionofcement,bricksandplywood
roseanaverageof15%YoY.However,weneedtoseesustainedgrowthinthese
productsoveralongerperiod(probablyto2Q11)tobeconfidentthattheyreflectareal
recoveryinconstructionandnotjustseasonalrestockingpatterns.
DowngradetoHOLDdespiteincreasedtargetpriceof$42.30/GDR.Aftergainingover
34%sinceourinitiationtoahighof$42.00/GDRinJan2011,Evrazhelditsground
duringtherecentcorrectionandisnowtradingat$38.21/GDR.Althoughweraisedour
TPto$42.30/GDRonstrongersteelpricesandsignsofarecoveryinRussian
construction,thisoffersonly11%upsidepotential,sowedowngradethestocktoHOLD.
We
need
to
see
a
sustained
recovery
in
domestic
construction
before
we
can
believe
the
stockcouldofferanygreaterupside.
EVRAZ GROUPHold on a Little Bit Longer
HOLD
Target price $42.30
Potential upside 11%
Bloombergcode EVRLI
Reuterscode
HK1q.L
Price(ordinaryGDR,$) 38.21
Price(pref,$) n/a
Upsidepotential 10.7%
Ordinary:GDRratio 1:3
Sharedata
No.ofordinaryshares(mn) 146
No.ofordinaryGDRs(mn) 438
No.ofprefshares(mn) n/a
3Maveragedailyt/o($mn) 47
Freefloat(%) 17.4%
Marketcapitalisation($mn) 16,731
Enterprisevalue
($mn)
24,269
Majorshareholders
LanebrookLimited 72.39%
FINANCIALS($mn) 2009 10E 11E
Revenue 9,772 12,382 15,365
EBITDA 1,237 2,368 3,361
EBIT (1,047) 514 1,795
Netincome (1,251) (54) 1,002
EPS (9.30) (0.37) 6.87
VALUATION
P/E(x) (13.4) (307.0) 16.7
P/CF(x) 15.8 25.5 13.3
EV/EBITDA(x) 19.6 10.2 7.2
EV/Sales(x) 2.5 2.0 1.6
P/BV(x) 1.6 1.6 1.4
RoCE(%) 6.9% 0.3% 5.6%
RoE(%) 12.2% 0.5% 8.4%
PERFORMANCE
1month(%) 3.2%
3month(%) 27.4%
12month(%) 15.1%
52weekhigh($) 42.72
52weeklow($) 21.80
Source:Bloomberg,Atonestimates
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1
Forecast Changes and Valuation
Figure34:EvrazAtonestimates,newvsoldEBITDA Netincome
YearendDecember: 2010E 2011E 2012E3Yaverage
2010E 2011E 2012E3Yaverage
Newestimates($mn) 2,368 3,361 4,081 54 1,002 1,574
Oldestimates($mn) 2,373 3,431 4,040 112 826 1,297
Changevsold(%) 0.2% 2.0% 1.0% 0.4% n/a 21.3% 21.4% 21.3%
Source:Atonestimates
Figure35:EvrazAtonestimatesvsconsensusEBITDA Netincome
YearendDecember: 2010E 2011E 2012E3Yaverage
2010E 2011E 2012E3Yaverage
Atonestimates($mn) 2,368 3,361 4,081 54 1,002 1,574
Bloombergconsensus($mn) 2,384 3,553 4,068 103 1,208 1,442
Atonvsconsensus(%) 0.7% 5.4% 0.3% 1.9% n/a 17.1% 9.2% 3.9%
Source:Bloomberg,Atonestimates
Figure36:EvrazValuationbreakdown
DCFcalculation
($mn):
2011E
2012E
2013E
2014E
2015E
2016E
EBIT 1,795 2,472 2,409 1,838 1,409 1,198
Lesstaxation (449) (618) (602) (460) (352) (299)
Taxadj.EBIT 1,346 1,854 1,807 1,379 1,057 898
Depreciation 1,566 1,609 1,635 1,635 1,635 1,635
Lesscapex (1,100) (1,250) (1,000) (750) (750) (750)
Changeinworkingcapital (556) (435) (222) (10) 20 37
Freecashflow 1,256 1,778 2,220 2,254 1,963 1,820
Terminal value 28,679
NPVoffreecashflow 1,056 1,573 1,796 1,668 1,328 1,126
NPVofterminalvalue 17,746
Discountedcashflowvaluation: ($mn) (%) WACCcalculation: %
NPVof
free
cash
flow
8,547
32.5%
Risk
free
rate
4.50%
NPVofterminalvalue 17,746 67.5% Standardequityriskpremium 4.00%
Enterprisevalue 26,293 100.0% Countryspecificequitypremium 3.20%
Plus:otherassets Liquidityriskpremium 0.00%
Less:minorities 319 Othercompanyspecificriskpremiums 1.00%
Less:netdebt 7,219 Totalcostofequity 12.70%
Equityvalue 18,755 Currentcostofdebt 7.00%
Less:preferredstockvalue Effectivecorporatetaxrate 25.00%
Commonequityvalue 18,755 Costofdebtaftertax 5.25%
No.ordinaryshares(mn) 146 Targetgearing(debt/equity) 45.00%
Valuepercommonshare 128.50 WACC 9.35%
CommonsharestoGDRratio 0.3
ValueperGDR 42.83 Terminalgrowthrate 3.00%
Multiplesbasedvaluation:
Ratios: Multiple Value($mn) $/GDR
14 xEarnings 18,034 41.18
7 xEBITDA 18,509 42.27
Weightedaveragevaluation:
Valuation Weightings Netvaluation
$/GDR % $/GDR
DCF 42.83 50% 21.42
P/E 41.18 25% 10.30
EV/EBITDA 42.27 25% 10.57
Valuepershare($/GDR) 100% 42.28
Potentialupside(%) 10.7%
Source:Aton
estimates
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2
Financial Accounts
Figure37:EvrazIFRSnetincomestatement($mn)2008 2009 2010E 2011E 2012E 2013E 2014E 2015E
Revenue 20,380 9,772 12,382 15,365 16,835 17,156 16,685 16,303
Costofrevenueandotheroperatingcosts(exDD&A) (13,944) (8,399) (9,964) (11,954) (12,704) (13,061) (13,162) (13,208)
Unallocatedexpenses (221) (136) (50) (50) (50) (50) (50) (50)
EBITDA 6,215 1,237 2,368 3,361 4,081 4,045 3,473 3,044
EBITDAmargin 30.5% 12.7% 19.1% 21.9% 24.2% 23.6% 20.8% 18.7%
DD&A (1,195) (1,632) (1,735) (1,566) (1,609) (1,635) (1,635) (1,635)
Otherincome/(expenses) (1,388) (652) (119)
EBIT 3,632 (1,047) 514 1,795 2,472 2,409 1,838 1,409
Netfinancialexpenses (598) (637) (602) (463) (365) (276) (180) (83)
Otherpretaxincome/(expenses) 17 84 45 45 45 45 45 45
Profitbeforetax 3,051 (1,600) (43) 1,377 2,153 2,178 1,703 1,371
Incometaxexpenses (1,192) 339 (13) (344) (538) (545) (426) (343)
Profitaftertax 1,859 (1,261) (56) 1,033 1,615 1,634 1,277 1,028
Minorityinterests 62 (10) (2) 31 40 41 32 26
Profitattributabletoequityholdersofthecompany 1,797 (1,251) (54) 1,002 1,574 1,593 1,246 1,002
Netmargin 8.8% 12.8% 0.4% 6.5% 9.4% 9.3% 7.5% 6.1%
Earningspershare:
BasicEPSperordinaryshare 14.6 (9.3) (0.4) 6.9 10.8 10.9 8.5 6.9
No.ofordinaryshares 123 134 146 146 146 146 146 146
No.ofGDRs(1GDR=1/3ordinaryshare) 370 403 438 438 438 438 438 438
Source:Companydata,Atonestimates
Figure38:EvrazIFRSbalancesheet($mn)2008 2009 2010E 2011E 2012E 2013E 2014E 2015E
Cashandcashequivalents 930 675 406 503 1,110 1,995 2,884 3,544
Inventories 2,416 1,886 2,186 2,457 2,776 2,784 2,863 2,885
Receivables 2,349 1,559 2,013 2,415 2,632 2,724 2,689 2,649
Other
current
assets
589
120
76
76
76
76
76
76
Totalcurrentassets 6,284 4,240 4,681 5,451 6,594 7,579 8,511 9,154
Property,plantandequipment 9,012 14,941 14,156 13,689 13,331 12,695 11,810 10,924
Intangibleassets 1,108 1,098 1,016 1,016 1,016 1,016 1,016 1,016
Goodwill 2,167 2,211 2,165 2,165 2,165 2,165 2,165 2,165
Othernoncurrentassets 873 921 1,025 1,025 1,025 1,025 1,025 1,025
Totalnoncurrentassets 13,160 19,171 18,362 17,895 17,537 16,901 16,016 15,130
Assetsclassifiedforsale 7 13 113
Totalassets 19,451 23,424 23,156 23,346 24,131 24,481 24,527 24,284
Payables 2,538 1,694 1,884 2,000 2,101 1,980 2,012 2,015
Shorttermloansandleaseliabilities 3,937 2,009 1,758 1,658 1,508 1,358 1,208 1,058
Provisions 63 35 38 38 38 38 38 38
Totalcurrentliabilities 6,538 3,738 3,680 3,696 3,647 3,376 3,258 3,111
Longtermloans 6,064 5,931 5,431 4,281 3,431 2,581 1,731 881
Otherlongtermliabilities 1,932 3,146 3,129 3,129 3,129 3,129 3,129 3,129
Liabilitiesassociatedwithassetsclassifiedforsales 1 48
Totalnoncurrentliabilities 7,996 9,078 8,608 7,410 6,560 5,710 4,860 4,010
Shareholders'equity 4,672 10,284 10,548 11,920 13,604 15,075 16,089 16,844
Minorityinterests 245 324 320 320 320 320 320 320
Totalequity 4,917 10,608 10,868 12,240 13,924 15,395 16,409 17,164
Totalequityandliabilities 19,451 23,424 23,156 23,346 24,131 24,481 24,527 24,284
Source:Companydata,Atonestimates
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3
Figure39:EvrazIFRScashflowstatement($mn)
2008 2009 2010E 2011E 2012E 2013E 2014E 2015E
Netincome 1,859 (1,261) (56) 1,033 1,615 1,634 1,277 1,028
Adjustments:
Depreciation,depletionandamortisation 1,195 1,632 1,735 1,566 1,609 1,635 1,635 1,635
Othernoncashadjustments 1,672 675 200 418 320 231 135 38
Operatingprofitbeforechangesinworkingcapital 4,726 1,046 1,879 3,017 3,543 3,500 3,048 2,702
Changesinworkingcapital (163) 654 (516) (556) (435) (222) (10) 20
Netcashprovidedbyoperatingactivities 4,563 1,700 1,364 2,461 3,108 3,278 3,037 2,722
Cashflowfrominvestingactivities:
Purchasesofproperty,plantandequipment (1,103) (441) (950) (1,100) (1,250) (1,000) (750) (750)
Otherinvestingactivities (2,633) 624 12
Netcashusedforinvestingactivities (3,736) 183 (938) (1,100) (1,250) (1,000) (750) (750)
Cashflowfromfinancingactivities:
Proceeds fromissuanceofsharecapital,netoftransactioncosts (1) 310
Proceeds frombankloansandpromissorynotes 5,657 3,427 1,750 750 250 250 250 250
Repaymentofbankloansandpromissorynotes,includinginterest (3,949) (4,987) (2,500) (2,000) (1,250) (1,250) (1,250) (1,250)
Dividendspaidbytheparententitytoitsshareholders (1,276) (90) (14) (250) (394) (398) (311)
Otherfinancingactivities (558) (809) 110
Netcashprovidedbyfinancingactivities (127) (2,149) (640) (1,264) (1,250) (1,394) (1,398) (1,311)
Effectsofexchangeratechangesoncashandcashequivalents (97) 11 (55)
Cashandcashequivalentsatbeginningoftheperiod 327 930 675 406 503 1,110 1,995 2,884
Netincreaseincashandcashequivalents 603 (255) (269) 97 607 885 889 661
Cashofdisposalgroupsclassifiedasheldforsale (21)
Cashandcashequivalentsattheendoftheperiod 930 675 406 503 1,110 1,995 2,884 3,544
Source:Companydata,Atonestimates
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4
WeincreaseourtargetpriceforMMKto$16.20/GDR(up6%from$15.33/GDR)to
accountforstrongersteelpricesanditsgrowingexposuretoHighValueAdded(HVA)
products,whichshouldmitigatesomeoftherisingpressurefromcosts.Ournew
targetprice
offers
17%
upside
potential
from
the
current
level,
allowing
us
to
reiterate
ourBUYratingonMMK.
Figure40:Domesticmarketremainsthefocusforhighvalueaddedproductsales
77%
10%
8%5%
Regional s a l e s structure (3Q10)
Domesticmarket
Middle
East
Asia&
Fa rEast Other
12%
37%
21%13%
12%
5%
Domestics a l e s bysector(3Q10)
Pipe
production
Spotsales
Russia &CISMachine
building
Construction
Auto
industryOther
Source:Companydata
Financialsfor3Q10highlightgrowingcostpressures.MMKs3Q10IFRSresultsclearly
reflectthecostpressuresitfacesasoneofRussiasleastintegratedsteelmakers:EBITDA
wasdown11%QoQto$388mnduetohighercosts,withEBITDAmarginslippingto
18.9%from21.1%in2Q10(seeFigure41).
Figure41:MMK3Q10IFRSresultssummary($mn)
3Q10
actual
2Q10
actual
QoQ
change
3Q10
Atonest.
3Q09
actualvs
Atonest.
3Q10
Interfax
consensus
3Q09
actualvs
consensus
EBITDA 388 437 11.2% 404 4.0% 381 1.8%
EBITDAmargin 18.9% 21.1% 19.7% 18.8%
Netincome 43 53 18.9% 78 44.9% 85 49.4%
Source:Companydata,Interfax,Atonestimates
Operatingresultsbelowexpectationsin4Q10,promptingrevisiontoFY10forecast.
MMKs4Q10productionnumberscameinbelowourexpectationswithQoQreductions
acrossmoststeelproductgroups;rolledproductoutputwasdown6%QoQto2.7mn
tonnes.ThenotableexceptionwasHVAproduction,whichaccountedfor42%of4Q10
shipments(upfrom38%in3Q10).AsaresultwerevisedourFY10netincomeforecast
down11%from$270mnto$240mn.
HVAproductsandverticalintegrationshouldhelpinprotectingmargins.The
companysMill5000,whichaccountsforalargeshareofHVAproductiongrowth,isnow
operatingatitsfullcapacityof1.5mntpaofthickplate.Togetherwithgrowingself
sufficiencyincokingcoal,thisshouldmitigatesomeofthecostpressuresexpectedin
2011.Onthedownside,theprofitabilityofitsAtakasJVremainsuncertain.Weestimate
MMKcouldeasilyadd3mnt(27%)ofsteelproductionfromexistingfacilitiesifmarket
conditionsimprove,quicklytranslatingintobetterfinancialperformance.
Targetpriceuppedto$16.20/GDR;BUYratingreiterated.Ournewtargetpriceimplies
17%upsidepotentialfromcurrentlevels,supportingourBUYratingonthestock.Future
reviewswill
depend
on
MMKs
ability
to
manage
its
cost
exposure
and
protect
margins
fromfurtherdeterioration.
MAGNITOGORSK IRON AND STEELGrowing HVA Output Offsets Cost Pressures
BUY
Target price $16.20
Potential upside 17%
Bloombergcode MMKLI
Reuterscode
MAGNq.L
Price(ordinaryGDR,$) 13.82
Price(pref,$) n/a
Upsidepotential 17.2%
Ordinary:GDRratio 13:1
Sharedata
No.ofordinaryshares(mn) 11,174
No.ofordinaryGDRs(mn) 860
No.ofprefshares(mn) n/a
3Maveragedailyt/o($mn) 8
Freefloat(%) 13.4%
Marketcapitalisation($mn) 11,879
Enterprisevalue
($mn)
15,228
Majorshareholders
MinthaHoldingLimited 45.62%
FulnekEnterprisesLimited 41.01%
FINANCIALS($mn) 2009 10E 11E
Revenue 5,081 7,597 10,038
EBITDA 1,023 1,437 2,059
EBIT 288 643 1,219
Netincome 232 240 812
EPS 0.02 0.02 0.07
VALUATION
P/E(x)
51.1
49.5
14.6
P/CF(x) 15.2 11.1 153.8
EV/EBITDA(x) 14.9 10.6 7.4
EV/Sales(x) 3.0 2.0 1.5
P/BV(x) 1.2 1.2 1.1
RoCE(%) 1.9% 1.8% 5.7%
RoE(%) 2.3% 2.4% 7.7%
PERFORMANCE
1month(%) 11.0%
3month(%) 8.0%
12month(%) 8.1%
52weekhigh($) 16.23
52week
low
($)
8.90
Source:Bloomberg,Atonestimates
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5
Forecast Changes and Valuation
Figure42:MMKAtonestimates,newvsoldEBITDA Netincome
YearendDecember 2010E 2011E 2012E3Yaverage
2010E 2011E 2012E3Yaverage
Newestimates($mn) 1,437 2,059 2,837 240 812 1,342
Oldestimates($mn) 1,535 2,423 2,737 270 872 1,058
Changevsold(%) 6.3% 15.0% 3.7% 5.9% 11.2% 6.8% 26.8% 2.9%
Source:Atonestimates
Figure43:MMKAtonestimatesvsconsensusEBITDA Netincome
YearendDecember 2010E 2011E 2012E3Yaverage
2010E 2011E 2012E3Yaverage
Atonestimates($mn) 1,437 2,059 2,837 240 812 1,342
Bloombergconsensus($mn) 1,557 2,414 2,799 380 1,047 1,360
Atonvsconsensus(%) 7.7% 14.7% 1.4% 7.0% 36.8% 22.4% 1.3% 20.2%
Source:Bloomberg,Atonestimates
Figure44:MMKValuationbreakdown
DCFcalculation
($mn):
2011E
2012E
2013E
2014E
2015E
2016E
EBIT 1,219 1,907 1,644 1,328 1,121 1,009
Lesstaxation (274) (429) (370) (299) (252) (227)
Taxadj.EBIT 945 1,478 1,274 1,029 869 782
Depreciation 840 930 969 1,019 1,037 1,063
Lesscapex (1,000) (950) (850) (650) (500) (500)
Changeinworkingcapital (707) (386) (96) (27) 31 49
Freecashflow 77 1,072 1,297 1,372 1,437 1,393
Terminal value 19,758
NPVoffreecashflow 65 940 1,034 993 945 833
NPVofterminalvalue 11,811
Discountedcashflowvaluation: ($mn) (%) WACCcalculation: %
NPVof
free
cash
flow
4,810
28.9%
Risk
free
rate
4.50%
NPVofterminalvalue 11,811 71.1% Standardequityriskpremium 4.00%
Enterprisevalue 16,621 100.0% Countryspecificequitypremium 3.20%
Plus:otherassets Liquidityriskpremium 1.00%
Less:minorities 421 Othercompanyspecificriskpremiums 0.00%
Less:netdebt 2,928 Totalcostofequity 12.70%
Equityvalue 13,272 Currentcostofdebt 5.00%
Less:preferredstockvalue Effectivecorporatetaxrate 22.50%
Commonequityvalue 13,272 Costofdebtaftertax 3.88%
No.ordinaryshares(mn) 11,174 Targetgearing(debt/equity) 30.00%
Valuepercommonshare 1.19 WACC 10.05%
Commonshares:GDRratio 13
ValueperGDR 15.44 Terminalgrowthrate 3.0%
Multiplesbasedvaluation:
Ratios: Multiple Value($mn) $/GDR
14 xEarnings 15,076 17.63
7 xEBITDA 13,786 16.12
Weightedaveragevaluation:
Valuation Weightings Netvaluation
$/GDR % $/GDR
DCF 15.44 50% 7.72
P/E 17.63 25% 4.41
EV/EBITDA 16.12 25% 4.03
Valuepershare($/GDR) 100% 16.16
Potentialupside(%) 17.2%
Source:Aton
estimates
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Financial Accounts
Figure45:MMKIFRSnetincomestatement($mn)2008 2009 2010E 2011E 2012E 2013E 2014E 2015E
Grossrevenue 10,550 5,081 7,597 10,038 12,091 12,330 12,327 12,107
Costofgoodssold (6,890) (3,205) (4,944) (6,322) (7,259) (7,682) (7,945) (7,951)
Selling,distributionandadministrativeexpenses (1,163) (802) (1,064) (1,556) (1,874) (1,911) (1,911) (1,877)
Otheroperatingexpenses/(income) (378) (51) (152) (100) (121) (123) (123) (121)
EBITDA(reported) 2,204 1,285 1,566 2,059 2,837 2,613 2,348 2,158
EBITDA(adjusted) 2,119 1,023 1,437 2,059 2,837 2,613 2,348 2,158
EBITDA(adjusted)margin 20.1% 20.1% 18.9% 20.5% 23.5% 21.2% 19.0% 17.8%
EBIT 1,174 288 643 1,219 1,907 1,644 1,328 1,121
Netforeignexchangegain/(loss) 16 9 (40)
Othernonoperatingincome/(loss) 1 180 10
Netinterestexpense (18) (76) (136) (160) (158) (128) (87) (40)
Otherincome/(expenses),net (67) (144) (168)
Incomebeforetaxandminorityinterest 1,106 257 310 1,059 1,749 1,516 1,241 1,081
Incometax (25) (38) (68) (238) (394) (341) (279) (243)
Incomebeforeminorityinterest 1,081 219 242 821 1,356 1,175 962 838
Minorityinterest (6) 13 (2) (8) (14) (12) (10) (8)
Netincome 1,075 232 240 812 1,342 1,163 952 830
Netmargin 10.2% 4.6% 3.2% 8.1% 11.1% 9.4% 7.7% 6.9%
Earningspershare:
BasicEPSperordinaryshare 0.10 0.02 0.02 0.07 0.12 0.10 0.09 0.07
No.ofordinarysharesoutstanding 11,160 11,099 11,116 11,116 11,116 11,116 11,116 11,116
No.ofGDRs(1GDR=13ordinaryshares) 858 854 855 855 855 855 855 855
Source:Companydata,Atonestimates
Figure46:MMKIFRSbalancesheet($mn)2008 2009 2010E 2011E 2012E 2013E 2014E 2015E
Cashandcashequivalents 1,106 165 248 246 490 958 1,557 2,270
Otherinvestments 138 221 202 202 202 202 202 202
Accounts
receivables
980
941
1,249
1,650
1,817
1,773
1,773
1,741
Inventories 996 856 1,084 1,299 1,388 1,421 1,469 1,470
Othercurrentassets 408 247 203 182 165 168 174 174
Totalcurrentassets 3,628 2,430 2,986 3,579 4,062 4,523 5,176 5,858
Plant,propertyandequipment 9,751 11,276 12,218 12,378 12,398 12,279 11,910 11,373
Intangibleassets 36 37 34 34 34 34 34 34
Goodwill 45 309 299 299 299 299 299 299
Investmentsinaffiliates 228 22 25 25 25 25 25 25
Otherinvestments 358 627 562 562 562 562 562 562
Othernoncurrentassets 151 132 154 154 154 154 154 154
Totalnoncurrentassets 10,569 12,403 13,292 13,452 13,472 13,352 12,983 12,446
Totalassets 14,197 14,833 16,277 17,031 17,534 17,875 18,159 18,305
Shorttermloansandleaseliabilities 1,295 828 972 1,022 922 822 722 622
Accountsandnotespayable 1,321 928 1,151 1,039 892 789 816 817
Othercurrentliabilities 24 21 23 23 23 23 23 23
Totalcurrentliabilities 2,640 1,777 2,146 2,084 1,837 1,634 1,561 1,462
Longtermdebtandcapitalleases 431 1,290 2,378 2,578 2,328 2,078 1,828 1,578
Othernoncurrentliabilities 1,274 1,441 1,403 1,403 1,403 1,403 1,403 1,403
Totalnoncurrentliabilities 1,705 2,731 3,781 3,981 3,731 3,481 3,231 2,981
Totalliabilities 4,345 4,508 5,927 6,065 5,568 5,115 4,792 4,443
Minorityinterests 189 368 405 405 405 405 405 405
Totalshareholders'equity 9,664 9,957 9,945 10,560 11,560 12,355 12,962 13,457
Totalliabilitiesandshareholders'equity 14,198 14,833 16,277 17,031 17,534 17,875 18,159 18,305
Source:Companydata,Atonestimates
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Figure47:MMKIFRScashflowstatement($mn)2008 2009 2010E 2011E 2012E 2013E 2014E 2015E
Operatingactivities:
Netincome 1,075 232 240 812 1,342 1,163 952 830
Adjustmentsfornoncashitems:
Depreciationandamortisation 945 735 794 840 930 969 1,019 1,037
Income
tax
25
38
68
238
394
341
279
243
Netfinancecost 18 76 136 160 158 128 87 40
Otheradjustmentsfornoncashitems 715 (115) 224 30 31 8 4 8
Operatingprofitbeforechangesinworkingcapital 2,778 966 1,461 2,080 2,854 2,609 2,342 2,158
Changesinworkingcapital (269) (127) (245) (707) (386) (96) (27) 31
Cashgeneratedfromoperations 2,509 839 1,216 1,373 2,468 2,513 2,315 2,189
Interestpaid (104) (109) (110) (165) (172) (170) (152) (135)
Incometaxrefund/(paid) (480) 135 (70) (217) (376) (345) (285) (243)
Netcashgeneratedbyoperatingactivities 1,925 865 1,036 991 1,920 1,999 1,877 1,810
Investingactivities:
Acquisitionofproperty,plantandequipment (2,112) (1,613) (2,118) (1,000) (950) (850) (650) (500)
Otherinvestingactivities 1,133 (76) 10
Netcashusedforinvestingactivities (979) (1,689) (2,108) (1,000) (950) (850) (650) (500)
Financing
activities:
Proceeds fromborrowings 3,974 2,935 2,500 500
Repaymentofborrowings (3,562) (2,974) (1,250) (250) (350) (350) (350) (350)
Dividendspaid (314) (16) (48) (203) (336) (291) (238) (207)
Otherfinancingactivities (36) 15 3 (40) (40) (40) (40) (40)
Netcashprovidedbyfinancingactivities 62 (40) 1,205 7 (726) (681) (628) (597)
Effectsofexchangeratechangesincashandcashequivalents (158) (77) (50)
Cashandcashequivalentsatbeginningoftheperiod 256 1,106 165 248 246 490 958 1,557
Netincreaseincashandcashequivalents 850 (941) 83 (2) 244 468 599 713
Cashandcashequivalentsattheendoftheperiod 1,106 165 248 246 490 958 1,557 2,270
Source:Companydata,Atonestimates
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WeupgradeourratingonNLMKfromHOLDtoBUYwitha12MTPof$49.40/GDR,
implying14%upsidepotential.Whileupsidemaybelimitedcomparedtoothersteel
stocks,NLMKsassetquality,healthybalancesheetandstrongprofitabilitymakeita
soundpotential
addition
to
any
steel
company
portfolio,
in
our
view.
Figure48:Salesandrevenuearefinelybalancedovermajormarkets
Other
11%Middle
East
15%
USA
17%
Russia
35%
Europe22%
Regional s a l e s structure (3Q10)
Other
12%Middle
East
14%
USA
13%
Russia
40%
Europe
21%
Regional revenue structure(3Q10)
Source:CompanyData
HVAproductsunderpinprofitabilityleadership.AlthoughHVAproducts(e.g.pre
painted,transformeranddynamosteels)accountforonly30%ofNLMKssalesvolumes,
thepremiummarginstheseproductscommandunderpinitsprofitabilityleadershipover
peers,evenintimesofrisingcosts.Increasedlongsteeloutputshouldprovide
additionalupsideonceRussianconstructionactivityrecovers,inourview.
Outlookfor4Q10highlightschallengingcostenvironment.NLMKreportedastrongset
of3Q10results,outperformingbothourandconsensusestimatesbyasubstantial
margin,recordingEBITDAof$695mnandnetincomeof$516mn(seeFigure49).
Figure49:NLMK3Q10USGAAPresultssummary($mn)
3Q10
actual
2Q10
actual
QoQ
change
3Q10
Atonest.
3Q09
actualvs
Atonest.
3Q10
Interfax
consensus
3Q09
actualvs
consensus
EBITDA 695 750 7% 612 14% 646 8%
EBITDAmargin 30.5% 34.8% 29.1% 30.2%
Netincome 516 466 11% 309 67% 409 26%
Source:Companydata,Interfax,Atonestimates
However,thecompanysoutlookfor4Q10highlightsthecostpressuresthebusinessis
facing:EBITDA
margin
is
expected
at
around
25%
vs
31%
in
3Q10.
BuyingremainingstakeinDufercoJVcouldbeakeyvaluecatalyst.NLMK's
internationalexpansionhasfocusedonacquiringsteelrerollingassetstocompensate
forashortageofrollingcapacity.TheJVwithDuferco(SteelInvest&FinanceS.A.)aimed
togiveNLMKanoutletforitsexpandingslabproduction.Buyingtheremaining50%in
theJVcouldbecomeapowerfulvaluedriversupportinghighermarginsviasalesto
internationalmarkets(providedthepriceisrightandNLMKcanreturnthefacilitiesto
profitability).
TPraisedto$49.40/share,upgradetoBUY.Thestockhascorrectedaround15%from
itsJanuarypeakof$51.30/GDR.WhileournewTPimpliesjust14%upsidefromcurrent
levels,wehaveupgradedourratingtoBUYonNLMKsassetquality,strongbalance
sheetand
profitability
leadership
vs
global
peers,
which
should
keep
the
stock
among
thetoppicksforanysteelfocusedportfolio,inourview.
NOVOLIPETSK STEELProfitability Leader Despite Margin Pressures
BUY
Target price $49.40
Potential upside 14%
Bloombergcode NLMKLI
Reuterscode
NLMKq.L
Price(ordinary,$) 43.50
Price(pref,$) n/a
Upsidepotential 13.6%
Ordinary:GDRratio 10:1
Sharedata
No.ofordinaryshares(mn) 5,993
No.ofordinaryGDRs(mn) 599
No.ofprefshares(mn) n/a3Maveragedailyt/o($mn) 19
Freefloat(%) 12.9%
Marketcapitalisation($mn) 26,071
Enterprisevalue
($mn)
27,333
Majorshareholders
FletcherGroupHoldings 85.5%
FINANCIALS($mn) 2009 10E 11E
Revenue 6,140 8,382 10,905
EBITDA 1,370 2,384 3,233
EBIT 892 1,882 2,673
Netincome 215 1,332 1,949
EPS 0.04 0.22 0.33
VALUATION
P/E(x) 121.2 19.6 13.4
P/CF(x) 101.5 100.1 76.5
EV/EBITDA(x) 20.0 11.5 8.5
EV/Sales(x) 4.5 3.3 2.5
P/BV(x) 3.0 2.7 2.3
RoCE(%) 1.9% 10.7% 14.3%
RoE(%) 2.5% 13.7% 17.5%
PERFORMANCE
1month(%) 7.6%
3month(%) 15.8%
12month(%) 42.2%
52weekhigh($) 51.00
52weeklow($) 25.04
Source:Bloomberg,Atonestimates
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Forecast Changes and Valuation
Figure50:NLMKAtonestimates,newvsoldEBITDA Netincome
YearendDecember 2010E 2011E 2012E3Yaverage
2010E 2011E 2012E3Yaverage
Newestimates($mn) 2,384 3,233 4,397 1,332 1,949 2,753
Oldestimates($mn) 2,424 3,263 3,700 1,208 2,011 2,293
Changevsold(%) 1.6% 0.9% 18.8% 5.4% 10.3% 3.1% 20.1% 9.1%
Source:Atonestimates
Figure51:NLMKAtonestimatesvsconsensusEBITDA Netincome
YearendDecember 2010E 2011E 2012E3Yaverage
2010E 2011E 2012E3Yaverage
Atonestimates($mn) 2,384 3,233 4,397 1,332 1,949 2,753
Bloombergconsensus($mn) 2,400 3,370 3,959 1,311 2,047 2,373
Atonvsconsensus(%) 0.7% 4.1% 11.1% 2.1% 1.6% 4.8% 16.1% 4.3%
Source:Bloomberg,Atonestimates
Figure52:NLMKValuationbreakdown
DCFcalculation
($mn):
2011E
2012E
2013E
2014E
2015E
2016E
EBIT 2,673 3,756 3,923 3,953 3,748 3,635
Lesstaxation (601) (845) (883) (889) (843) (818)
Taxadj.EBIT 2,071 2,911 3,040 3,063 2,905 2,818
Depreciation 560 640 696 710 709 709
Lesscapex (1,800) (1,500) (900) (700) (700) (700)
Changeinworkingcapital (491) (478) (266) (71) (39) (39)
Freecashflow 341 1,574 2,570 3,002 2,875 2,788
Terminal value 43,887
NPVoffreecashflow 290 1,391 2,077 2,219 1,943 1,723
NPVofterminalvalue 27,123
Discountedcashflowvaluation: ($mn) (%) WACCcalculation: %
NPVof
free
cash
flow
9,643
26.2%
Risk
free
rate
4.5%
NPVofterminalvalue 27,123 73.8% Standardequityriskpremium 4.0%
Enterprisevalue 36,766 100.0% Countryspecificequitypremium 3.2%
Plus:otherassets Liquidityriskpremium 0.0%
Less:minorities 115 Othercompanyspecificriskpremiums 0.0%
Less:netdebt 1,148 Totalcostofequity 11.7%
Equityvalue 35,504 Currentcostofdebt 5.0%
Less:preferredstockvalue Effectivecorporatetaxrate 22.5%
Commonequityvalue 35,504 Costofdebtaftertax 3.9%
No.ordinaryshares(mn) 5,993 Targetgearing(debt/equity) 30.0%
Valuepercommonshare 5.92 WACC 9.4%
Commonshares:GDRratio 10
ValueperGDR 59.24 Terminalgrowthrate 3.0%
Multiplesbasedvaluation:
Ratios: Multiple Value($mn) $/GDR
16 xEarnings 26,246 43.79
8 xEBITDA 21,206 35.38
Weightedaveragevaluation:
Valuation Weightings Netvaluation
$/GDR % $/GDR
DCF 59.2 50% 29.62
P/E 43.8 25% 10.95
EV/EBITDA 35.4 25% 8.85
Valuepershare($/GDR) 100% 49.41
Potentialupside(%) 13.6%
Source:Aton
estimates
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Financial Accounts
Figure53:NLMKUSGAAPP&Lstatement($mn)2009 2010E 2011E 2012E 2013E 2014E 2015E
Totalrevenue 6,140 8,382 10,905 13,524 14,839 15,184 15,298
COGS (4,150) (5,399) (7,033) (8,280) (9,284) (9,561) (9,867)
Grossprofit 1,990 2,982 3,872 5,244 5,555 5,623 5,431
SG&A (1,054) (1,097) (1,200) (1,488) (1,632) (1,670) (1,683)
Otheroperatingincome/(expense) (44) (3)
Operatingincome(EBIT) 892 1,882 2,673 3,756 3,923 3,953 3,748
EBITDA 1,370 2,384 3,233 4,397 4,619 4,662 4,457
DD&A (478) (503) (560) (640) (696) (710) (709)
Netinterestincome/(expense) (111) (54) (78) (90) (65) (6) 70
Associates
FX(loss)/gain (78) (54)
Others(recurring) (108) (13)
Pretaxprofit 595 1,761 2,595 3,666 3,858 3,947 3,818
Tax (182) (423) (584) (825) (868) (888) (859)
Equityinnetlosses/(earnings)ofassociates (315) (29) (43) (60) (63) (65) (63)
Netincome(preexceptionals) 98 1,310 1,969 2,781 2,927 2,994 2,896
Minorityinterest 117 22 (20) (28) (29) (30) (29)
Netincome(postexceptionals) 215 1,332 1,949 2,753 2,898 2,964 2,868
EPS($/GDR) 0.36 2.22 3.25 4.59 4.83 4.95 4.78
DividendperGDR($) 0.07 0.31 0.98 1.38 1.45 1.48 1.44
NumberofGDRs(mn) 599 599 599 599 599 599 599
Source:Companydata,Atonestimates
Figure54:NLMKUSGAAPbalancesheet($mn)2009 2010E 2011E 2012E 2013E 2014E 2015E
Cash&shortterminvestments 1,699 1,268 722 540 2,027 3,971 5,978
Accountsreceivable 913 1,247 1,622 2,011 2,207 2,258 2,275
Inventory 1,134 1,475 1,922 2,263 2,537 2,613 2,696
Other
current
assets
131
131
131
131
131
131
131
Totalcurrentassets 3,877 4,121 4,396 4,944 6,902 8,972 11,080
PP&E 7,316 8,613 9,853 10,713 10,917 10,907 10,898
Intangibleassets 760 760 760 760 760 760 760
Investments 468 468 468 468 468 468 468
Otherlongtermassets 81 122 122 122 122 122 122
Totalnoncurrentassets 8,625 9,963 11,204 12,063 12,267 12,257 12,248
Totalassets 12,502 14,084 15,599 17,007 19,168 21,230 23,328
Accountspayable 841 1,094 1,425 1,678 1,882 1,938 2,000
Shorttermdebt 557 600 600 600 600 600 600
Othercurrentliabilities 19 19 19 19 19 19 19
Totalcurrentliabilities 1,417 1,714 2,045 2,298 2,501 2,557 2,619
Longtermdebt 1,939 2,100 1,900 1,100 1,000 900 900
Deferredtaxliabilities 396 396 396 396 396 396 396
Othernoncurrentliabilities 140 140 140 140 140 140 140
Totallongtermliabilities 2,475 2,636 2,436 1,636 1,536 1,436 1,436
Totalliabilities 3,892 4,350 4,481 3,934 4,037 3,994 4,056
Minorityinterests (108) (108) (108) (108) (108) (108) (108)
Totalshareholdersequity 8,610 9,734 11,118 13,073 15,131 17,236 19,272
Totalliabilitiesandequity 12,502 14,084 15,599 17,007 19,168 21,229 23,328
Source:Companydata,Atonestimates
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Figure55:NLMKUSGAAPcashflow($mn)
2009 2010E 2011E 2012E 2013E 2014E 2015E
Netincome 98 1,310 1,969 2,781 2,927 2,994 2,896
DD&Aaddback 478 503 560 640 696 710 709
(Increase)/Decreaseinworkingcapital 859 (422) (491) (478) (266) (71) (39)
Otheroperatingcashflowitems (41)
Cashflowfromoperations 1,394 1,391 2,038 2,944 3,357 3,633 3,567
Capital
expenditure
(1,121)
(1,800)
(1,800)
(1,500)
(900)
(700)
(700)
Acquisitions
Otherinvestingcashflow (651)
Cashflowfrominvesting (1,771) (1,800) (1,800) (1,500) (900) (700) (700)
Dividendspaid (2) (185) (585) (826) (869) (889) (860)
Share(repurchase)/issue
Increase/(decrease)interestbearingliabilities (533) 164 (200) (800) (100) (100)
Cashflowfromfinancing (535) (21) (785) (1,626) (969) (989) (860)
Cashandcashequivalentsatbeginningofyear 2,159 1,247 817 270 88 1,575 3,519
Netincrease/(decrease)incashandcashequivalents (912) (431) (547) (182) 1,487 1,944 2,007
Cashandcashequivalentsatendofyear 1,247 817 270 88 1,575 3,519 5,526
Source:Companydata,Atonestimates
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WeupgradeourtargetpriceforSeverstalto$22.10/GDRandreiterateourBUYrating
ontheshares.PostponementofthecompanysgoldbusinessIP