-
8/7/2019 Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15
1/62
DinnurGalikhanov:+74957776677(ext.2677)
Forprofessionalinvestors only.Thisdocumenthasnotbeenpreparedinaccordancewithlegal
requirementsdesignedtopromotetheindependenceofinvestmentresearch. Pleaserefertoimportant
disclosuresandanalystcertificationattheendofthisdocument
UralsBaseMetalProducersLookingforHiddenValue:Withthisreportweinitiate
coverageofthreeRussianbasemetalproducersthatusuallyslipundertheradarof
mainstreamemergingmarketsinvestors:GaiskyGOK,UchalinskyGOKand
UralelectromedthreesubsidiariesoftheUralsMiningandMetallurgicalCompany
(UMMC).Thecompaniesprovideexposuretogrowinginfrastructureinvestmentin
Russiaandtotheeconomicrecoverythatweexpect,bothdomesticallyandglobally.
Russiancoppersharpriseinexportslimitsproductiondownside:DespiteRussias
apparentcopperconsumptionfallingbyover50%YoYin2009,Russiancopperoutput
dippedonly4%,primarilyduetoadoublingofexports.Russiancopper,whilehigh
purity,isnotcurrentlyLondonMetalsExchange(LME)certifiedwhichmeansthatthe
companiescansellthemetalinexportmarketsatadiscount,undercuttingtheir
competitorswithoutattractingthewrathoftheregulators.WeexpectRussiancopper
exportstoremainstrong,supportedfurtherbyrestockingintheEUandUSaswellas
continuedstrongdemandfromChina.
Russianzincprovingresistanttoexternalfactors:TheRussianzincindustryhas
shownstrongresistancetoexternaleconomicinfluences.Productionwasdownjust
1%YoYin2009,at262kt;netexportswere27%lowerYoY,whichledtoa6%YoY
increaseinapparentconsumptionto222kt.Whileweadmitthatthefullincrease
cannotbeattributedtorealdemand,webelievethatRussianzincconsumptionis
relativelystablevscertainothermetals,drivenbyastrongrecoveryinthesteel
industrythemainconsumerofzincinRussia.Moreover,weexpectRussianzinc
consumptiontoseefurtherexpansionasaresultofitsexposuretothegrowing
constructionsector.
Weseeglobaleconomictrendsassupportiveforcommodities,althoughprice
volatilityissettocontinue:Theenvironmentforcommoditiesislikelytoremain
volatileascompetingmarketforcescontinuetoinfluenceinvestorsentiment.
Nevertheless,whilewedonotexpectcommoditiestorepeattheirstellar2009
performancethisyear,thereshouldbeenoughdownsideprotection.Weanticipatea
numberofmarkettriggersthatwebelieveshouldbecommoditypricesupportive.
Whiledollarstrengtheningcontinuestocauseshorttermvolatility,keymarketsfor
commoditiestheEUandUSarestartingtoshowsomesignsofasustained
economicrecovery,thoughdemandforcommoditiesinthoseregionscouldbelimited
torestockingatthistime.Moreover,liquiditytighteninginChinaisyettohaveany
noticeableeffect,whilestrengtheningChineseexportsshouldsustainstrongdemand
forawiderangeofcommodities.
InitiatingwithaBUYbasedonupsidepotentialandexposuretotherecovery:The
companiesunderourcoveragemaybelessvisiblecontrastedwithNorilskNickelor
Rusal,butnevertheless,theyplayasubstantialroleinthesector:UELMisoneofthe
largestcopperrefineriesintheworld;GGOKisRussiassecondlargestcopper
producer,whileUGOKisthelargestsupplierofzinctotheRussianmarket.Webelieve
thecompaniesoffersubstantialpotentialupside(rangingfromaround40%toover
100%),whichwouldjustifytakingonthehigherrisksassociatedwithinvestinginthese
lesserknown,lesstransparentandlessliquidstocks.
MARKETINGMATERIAL
METALSANDMINING
15April2010
RUSSIAN COPPER AND ZINC PRODUCERSTreasures of the Urals
Note:Pricesasof13:00on12 Apr2010throughoutthereport(unlessotherwisestated)
Coverage MktCap $1,042mn
Fair MktCap $1,796mn
Potential upside 72%
12MStock,MetalsandIndexperformance
0% 100% 200% 300%
UGOK
Gold
Silver
LME3MZinc
LME3MCopper
FTSE350 Mining
RTS
UELM
GGOK
RTS2
Source:Bloomberg
Company FV($/share) Upsidepotential
GaiskyGOK 671 124%
UchalinskyGOK 20.60 42%
Uralelectromed 118 96%
YtDStock,MetalsandIndexperformance
20% 0% 20% 40% 60%
LME3MZinc
UGOK
Gold
LME3MCopper
Silver
FTSE350 Mining
RTS
GGOK
RTS2
UELM
Source:Bloomberg
-
8/7/2019 Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15
2/62
2
Contents
InvestmentCase...................................................................................................3CompanyFactCards.............................................................................................7SettingMetalPricesInLineWithConsensus.......................................................8HighlightingtheRisks...........................................................................................9RussianCopper:CountingOnEconomicRecoveryandExportStrength ..........11
CopperIndustryOverview .......................................................................... ............. 11RussianCopperProducersExportsSavetheDay.................................................. 12
RussianZinc:ResistingtheElements .................................................................17ZincIndustryOverview....................................... ...................................................... 17
GlobalFactors:SupportiveForCommoditiesButConduciveToVolatility........22AStrongerUSDollarStillaFactororJustaDistractor?........................................ 22LiquiditytighteninginChinaisyettohaveanynoticeableimpact.......................... 23RealDemandorJustStockpilingandSpeculation?.................................................. 23
CompaniesSection
GGOK:CopperWhopper.28
UGOK:StrengthinZinc;GrowingExposuretoCopper.37
UELM:BreakingAwayFromOldMisconceptions47
AppendixIUMMCCopperProductionFlows .................................................57AppendixIIRussian2020StrategyfortheMetalsIndustry............................58AppendixIIIUELMProductFlow.....................................................................60
-
8/7/2019 Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15
3/62
3
Investment Case
Withthisreportweinitiatecoverageofthreecopperandzincproducingsubsidiaries
oftheUralsMiningandMetallurgicalCompanyUMMCtwominingcompanies,
GaiskyGOK(GGOK)andUchalinskyGOK(UGOK),andthecopperrefinery
Uralelectromed(UELM).WeassignBUYratingstoallthreeaswebelievethatthe
companiesoffersubstantialupsidepotentialandcouldbeexposedtotheresumption
ofinfrastructureinvestmentinRussiaandagradualrecoveryinkeyglobalmarkets.
Moreover,webelievethattherecentcommoditypricerallyhasnotbeenfully
reflectedinthestocksshareprices.
Figure1:Fairvalueandratingsummary
Company TickerFairvalueper
share($)
Currentshare
price($)
Upside
potentialRating
GaiskyGOK GGOKRU 671 300 124% BUY
UchalinskyGOK UGOKRU 20.60 14.50 42% BUY
Uralelectromed UELMRU 118 60 96% BUY
Source:Bloomberg,Atonestimates
Valuationsstilllagglobalpeers
WebaseourcompanyvaluationsonaweightedaverageofourDCFcalculation,6xour
forecast2010P/Eand4xourforecast2010EV/EBITDA,ina50:25:25ratio.
ToarriveatourvaluationmultiplesweassessedtrailingP/EandEV/EBITDAmultiples
forpeersfrombothdeveloped(DM)andemergingmarkets(EM).Thehistoryofthe
majorityofRussianlistedstocksdoesnotgobackfarenoughtoanalysetheir
behaviourduringthepreviouseconomiccrises,butwebelievethatananalysisoftheir
pricingtrendspriortoandfollowingtherecentcrisisgivesanindicationofthe
potentialforpriceappreciation.Therefore,webasedourpeergroupanalysisontwo
distinctperiods:precrisis(200607)andtroughtorecoveryperiod(200809).
Lookingattheprecrisisvaluationmultiplesforthepeergroup,wecanseethatDM
companiesweretradingatP/Emultiplesofaround1015x,attimesrisingto20x.On
anEV/EBITDAbasis,thesamecompaniesweretradingatapproximately56x,with
somecopperproducerstouchingEV/EBITDAratiosashighas8x.Inemergingmarkets,
metalproducershavehistoricallytradedatP/Esof810xandEV/EBITDAmultiplesof
25x,althoughsomeChinesecompanies(e.g.XinjiangXinxin,TonglingNonferrous)
havetradedashighas1415x(P/E)and510x(EV/EBITDA)atprecrisispeaks.
DuringtheprecrisisperiodRussiancopperproducerstradedatP/Esofbetween4x
and8x,andEV/EBITDAsof24x.Inroughtermstheselevelsputthemata50%
discounttotheirDMpeersanda40%discounttotheirEMpeersonaP/Ebasis.In
termsoftheEV/EBITDAmultiple,Russiancompaniestradedata50%discounttotheir
DM,anda25%discounttotheirEMcomparables.
AsillustratedinFigure2,globalpeersarecurrentlytradingat2010P/Esofaround13
14xindevelopedmarketsand1819xinemergingmarkets(basedonBloomberg
estimates).
-
8/7/2019 Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15
4/62
4
Figure2:Globalcomparisons
2010E 2011E
P/E P/S EV/S EV/EBITDA P/E P/S EV/S EV/EBITDA
(x) (x) (x) (x) (x) (x) (x) (x)
Russianpeers(mean) 2.8 0.6 1.0 2.4 2.5 0.6 0.9 2.2
Russianpeers(median) 2.8 0.5 1.1 2.4 2.4 0.4 1.0 2.2
Developedmarkets(mean) 13.6 2.3 2.5 7.7 13.3 1.9 2.1 6.3
Developedmarkets(median) 13.4 2.1 2.5 7.1 10.6 1.9 2.2 5.8
Emergingmarkets(mean) 18.7 2.7 2.7 11.0 14.6 2.3 2.4 8.6
Emergingmarkets(median) 19.0 2.4 2.3 10.8 12.7 2.1 1.9 7.8
AverageDMDiscount 80% 74% 59% 67% 79% 73% 58% 64%
AverageEMDiscount 85% 78% 59% 78% 82% 77% 56% 73%
Source:Bloomberg
OnanEV/EBITDAbasis(consensus2010estimates),DMpeersaretradingatmultiples
of78x,whiletheratiosfortheirEMpeersstandat1011x.AssumingthatbothDM
andEMratiosreverttotheirhistoricalnorms,webelievethatthethreestocksunder
ourcoveragecouldbevaluedataround48x2010P/Eand35x2010EV/EBITDA.We
thereforeusemidpointmultiplesof6xforecast2010P/Eand4xforecast2010
EV/EBITDAasthebasisforourvaluation.
Whileamultiplesbasedmethodallowsustocomparethestocksshareprice
performanceinrelationtotheirglobalpeers,avaluationbasedonDCFgivesabetter
reflectionofthecompaniesmediumtermgrowthpotential.Therefore,weassigna
greaterweightingtoourDCFforecastwhencalculatingthecompaniesfairvalues.Our
DCFmodelsincorporateaterminalgrowthrateof1%andWACCassumptionsranging
from11.5%to12.6%dependingoneachstocksassumeddebtcostandgearinglevels.
InFigure3belowweprovideasummaryofthevaluationrangesforourcovered
stocks:
Figure3:Valuationrangesforthestocks
2010EP/E 2010EEV/EBITDA
Currentshare
price($/share)Fairvalue
($/share) DCF
4x 6x 8x 3x 4x 5x
GaiskyGOK 300 671 563 560 840 1120 452 717 982
UchalinskyGOK 14.50 20.60 16.32 17.09 25.63 34.18 17.69 24.13 30.56
Uralelectromed 60 118 100 87 131 174 93 139 186
Source:Atonestimates
-
8/7/2019 Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15
5/62
5
InFigures47belowwesummarisekeyvaluationratios,performanceinformation,and
productionandfinancialdataforthethreestocksunderourcoverage.
Figure4:Keyvaluationratios
GaiskyGOK UchalinskyGOK Uralelectromed
Keyvaluationmetrics
Commonsharesinissue(mn) 0.6 38.1 5.1
MktCap($mn)185
552
304
Netdebt($mn) 212 61 238
EV($mn) 397 614 542
BV($mn) 233 514 370
P/Eratios(x)
2008 22.0 9.0 7.4
2009E 5.3 5.3 12.3
2010E 2.1 3.4 2.8
2011E 1.9 3.2 2.4
EV/Sratios(x)
2008 1.2 1.2 0.8
2009E 1.4 1.5 0.9
2010E 1.1 1.1 0.7
2011E 1.0 1.0 0.6
EV/EBITDAratios(x)
2008 5.3 4.8 4.5
2009E 4.4 3.8 6.4
2010E 2.4 2.5 2.3
2011E 2.2 2.4 2.0
P/Bratio2009E(x) 0.8 1.1 0.8
Source:Bloomberg,Atonestimates
Figure5:Recentstockperformance
GaiskyGOK UchalinskyGOK Uralelectromed
1M 9% 7% 10%
3M 16% 5% 38%
6M
25%
38%
50%
YtD 16% 5% 38%
1Y 216% 21% 106%
52weekhigh($) 300 15.50 60
52weeklow($) 95 8.00 21
Dailyt/o($) 24,683 42,952 19,500
Freefloat(%) 15.4% 11.5% 18.4%
Freefloat($mn) 28 64 56
Source:Bloomberg,Atonestimates
Figure6:Keyproductionfigures
GaiskyGOK UchalinskyGOK Uralelectromed
Copperinconcentrate(kt)
2008 75 91
2009E 78 96
2010E 79 96
2011E 85 98
Zincinconcentrate(kt)
2008 6 116
2009E 6 109
2010E 6 104
2011E 6 99
Refinedcopper(kt)
2008 348
2009E 330
2010E 350
2011E
361
Source:Companydata,Atonestimates
-
8/7/2019 Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15
6/62
6
Figure7:Keyfinancialfigures($mn) GaiskyGOK UchalinskyGOK Uralelectromed
Revenue($mn)
2008 325 497 685
2009E 282 422 583
2010E 369 544 772
2011E 412 585 837
EBITDA($mn)
2008 75 127 122
2009E 91 160 84
2010E 164 245 236
2011E 183 258 269
Netincome($mn)
2008 8 61 41
2009E 35 105 25
2010E 87 163 111
2011E 97 171 128
EBITDAmargin(%)
2008 23% 26% 18%
2009E 32% 38% 14%
2010E 44% 45% 31%
2011E 44% 44% 32%
Netmargin(%)
2008 3% 12% 6%
2009E 13% 25% 4%
2010E 23% 30% 14%
2011E 23% 29% 15%
Source:Bloomberg,Atonestimates
-
8/7/2019 Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15
7/62
7
Company Fact Cards
GaiskyGOK(GGOKRU)Copperconcentrateproductiongrowthstory
Overview
SecondlargestcopperconcentrateproducerinRussia,operatingoneofthelargest
copperdepositsinthecountryGai.Producescopperandzincconcentrates,gold,
andsilver.Copperconcentrateaccountsforapproximately70%ofrevenuesandgolda
further17%(2009E)
Bullpoints
Oneofthemostundervaluedstocksamongcopperproducers,byourestimates(124%potentialupsidetothecurrentshareprice).
Companyexpectsoreprocessingcapacitytoincrease33%,to8mntpa,byYE13. Sharepricelagsfarbehindtheongoingcopperpricerally.Bearpoints
MajorityownershipbyUMMCresultsinlowtransparency;minorityshareholderrightsmaypotentiallybeatrisk(Freefloatof15.4%);Lowstockliquidity
ReportsunderRussianAccountingStandards(RAS)maybelessreliablethanIFRS
UchalinskyGOK(UGOKRU)Largezincconcentrateproducer;strongbalancesheet
Overview
Thelargestzincconcentrateproducerandthirdlargestcopperconcentrateproducer
inRussia.Zincconcentrateaccountsforaround21%ofsales,copperconcentrate57%,
gold12%,andsilver6%(2009E).
BullPoints
Thecompanyplanstoincreaseoreprocessingcapacity20%byYE12,to6.5mntpa. DownsideprotectionprovidedbyzincdemandthecompanyremainsRussias
singlelargestsupplierofzincconcentrate
Growingcopperconcentrateoutputincreasesexposuretohigherpricedcopper Lowdebtlevel,strongbalancesheetBearPoints
Reductioninzincconcentrateoutputby26%by2015duetofallingoregrades UMMCsmajorityownershipleadstolowertransparency;potentialrisktominority
shareholdersduetolowfreefloat(11.5%);lowliquidity
FinancialsunderRASnotasreliableasunderIFRS
Uralelectromed (UELMRU)Russiaslargestcopperrefinerywithgrowingcapacity
Overview
ThelargestsinglecopperrefineryinRussiaandamongthetop20largestintheworld.
Capableofproducingupto380ktpaofrefinedcopperandcopperproducts.Good
DeliverystatusfromLBMAforgoldandsilver,intheprocessofreceivingLME
certificationforitscoppercathodeoutput.
BullPoints
Tollingschemeremainsmisunderstood,despiteUELMstollingfeesbeingreasonablyhigh($250300/tonne)vsglobalbenchmarks(2009RCof$165/tonne).
UELMplanstoincreaserefiningcapacity32%byYE12,to500ktpa. Lagsbehindglobalpeers,offering96%potentialupsidetothecurrentshareprice.BearPoints
TollingschemeusageinRussiastillhasnegativeconnotationsandisthusfearedbythemarket;thismaycausenegativesentimentamonginvestors.
Possibledelaytorefineryexpansionduetofinancialcrisis. UMMCscontrolmayleadtolowtransparencyandpotentialriskstominority
shareholders(freefloat:18.4%).RASbasedaccountingislessreliablethanIFRS.
GGOKlargecopperconcentrateproducer
GGOK'sshareofRussiancopperin
concentrateproduction(2009E)
Norilsk
69%
Other
Co's
3%
UMMC
other17%
GGOK
11%
Source:Reuters,InfoGeo,ResearchCentreMineral
UGOKlargestzincconcentrateproducer
UGOK'sshareofRussianzincin
concentrateproduction(2009E)
UGOK
70%
Other
Co's
26%
UMMC
other
4%
Source:Reuters,Companydata
UELMRussiaslargestcopperrefinery
UMMC's share ofRussianrefined
copperproduction(2009E)
Norilsk
45%
Others
1%RMK16%
UMMC
38%
Source:Companydata,Reuters
-
8/7/2019 Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15
8/62
8
Setting Metal Prices In Line With Consensus
OurmodelsrelyonpriceassumptionsthatarebasedonthecurrentBloomberg
consensus.Thisisbasedonpriceforecastsfromatleast15analysts,whichwebelieve
givesareasonablereflectionofthecurrentmarketsentiment.
ThesummaryofcurrentconsensuspriceforecastsisgiveninFigure8.
Figure8:Metalpriceassumptionssetinlinewithconsensus
2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E
LME3MCopper($/t) 3,507 6,679 7,103 6,886 5,199 6,875 7,358 7,743 6,668 6,500
LME3MZinc($/t) 1,393 3,248 3,249 1,901 1,689 2,307 2,513 2,423 2,232 2,200
SpotGold($/oz) 445 605 697 872 974 1,150 1,187 1,035 989 950
SpotSilver($/oz) 7.32 11.59 13.39 14.97 14.70 18.00 19.00 16.45 15.40 15.00
Source:Bloombergconsensus(asof12Mar2009),Atonestimates
Basemetalsreturntoprecrisislevelsin2010andcontinueaiminghigher
Themarketcurrentlyexpectspricesforthemajorityofbasemetalstorecovertotheir
precrisisaveragesin2010andtocontinuerisingthrough201112onthebackof
improved
economic
conditions
and
growing
demand
(Figures
9,
10).
Figure9:Copperpriceassumptions Figure10:Zincpriceassumptions
1840
1599
1578 1
789
2790
350
7
6679 7
103
6886
5199
6668
6500
774
3
735
8
687
5
0
1000
2000
3000
4000
5000
6000
7000
8000
9000
10000
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010E
2011E
2012E
2013E
LT
$/t
1137
905
797 84
4 106
4 139
3
3248
3249
1901
1689
2232
22002
423
2513
230
7
0
500
1000
1500
2000
2500
3000
3500
4000
4500
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010E
2011E
2012E
2013E
LT
$/t
Source:Bloombergconsensus,Atonestimates
Goldandsilverstillusedasinflationhedgesandsafehavens
Theexpectationinthemarketisforgoldtotradeataround$1,1501,190/ozin2010
11,whilesilverisexpectedtoreach$1819/ozthroughthatperiod(Figures11,12).
Figure11:Goldpriceassumptions Figure12:Silverpriceassumptions
279
271 31
1 364 4
10 445
605
697
872
974 989
95010
35
118
7
115
0
0
200
400
600
800
1000
1200
1400
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010E
2011E
2012E
2013E
LT
$/oz
4.95
4.38 4.
61 4.89
6.68
7.32
11.59 13
.39 14
.97
14.70
15.40
15.0016
.451
9.00
18.00
0.00
5.00
10.00
15.00
20.00
25.00
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010E
2011E
2012E
2013E
LT
$/oz
Source:Bloombergconsensus,Atonestimates
-
8/7/2019 Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15
9/62
9
Highlighting the Risks
Wehaveapositiveoutlookonthecompaniescoveredbythisreportandbelievethat
someoftherisksusuallymentionedinconnectionwithRussianstocksmaybe
outdatedorbasedonerroneousconcepts.However,westillneedtodrawinvestors
attentiontotherisksthatmaystillberelevantforthestocksunderourcoverage.
Low
free
float:
This
is
often
quoted
as
the
main
risk
associated
with
investing
in
Russianstocks.Theaversiontoholdingminoritysharesincompanieswithlowfree
floatmaystemfromthecolourfulhistoryofRussianbusinessrivalriesfromthe
relativelyrecentpast.AtthetimesomeRussiancompanieswereknowntoactwith
completedisregardforminorityshareholders,usinghostileanddilutiveshareissuesas
instrumentsofgainingcontrol.
ThesedayslowfreefloatisstillacommonfeatureofRussianstocks,includingwell
knownnames,listedoninternationalstockexchanges.Rusal,thelatestentranttothe
equitymarkets,hasafreefloatofjustunder11%,whilethefivelargestlistedRussian
steelmakershavefreefloatsrangingbetween13%and28%.NorilskNickelhasthe
largestfreefloatamongtheRussianmetalsandminingnames,atjustunder40%.
Thefreefloatsofthecompaniesunderourcoverage(GGOK,15.4%,UGOK,11.5%,
UELM,18.4%)haveremainedstablesinceatleast2006,accordingtocompanyfilings.
WithUMMCbusyinvestingingrowingandmodernisingthebusiness,preferringto
financetheprocessthroughdebt,ratherthanturningtoshareholders,weseetherisk
ofactionsthatabusetherightsofminorityshareholderaslowatthemoment.
Nevertheless,theriskshouldnotbediscountedcompletely.
OneofthesituationswhereweseethisriskarisingisinpreparationforapossibleIPO,
whichhasbeenmentionedoncountlessoccasions,butinourviewremainsunlikelyin
theshortterm.Theholdingcompany,UMMC,maywishtoconsolidateitscontrolover
thesubsidiariesprioritsentryintotheequitymarket.Itcouldtrytopurchasethe
subsidiariessharesintheopenmarketor,morelikely,makeatenderofferin
exchangeforcashorequityintheholdingcompany.Thereisariskthatsuchanoffer
couldbemadebasedonvaluationsthatdiscountthetruevalueofthesubsidiaries.
Shouldthissituationmaterialise,theshareholderswouldhavetoassessthemeritsof
sellingtheirsharesatadiscountvsthelikelygainfromtheparentcompanyspotential
IPO.
Lowliquidity:Asaresultofalimitedfreefloatandlowcapitalisation,theliquidityof
thestockscoveredinthisreportremainsquitelow,withdailytradingvolumesinthe
pastthreemonthsaveragingaslowas$19,500anduptoaround$43,000,depending
onthecompany.Investorshavetotakethisriskintoaccountwhenmakinginvestment
decisionsregardingthestocks:itmaynotalwaysbepossibleobtainaccurate
indicationsofthestockstradingprice,marketcapitalisationortransactioncosts.It
mayalsobedifficulttoadjustpositionsinthestockswithintimeframesdesiredby
investors.
Inadequatecorporategovernancestandards:Russiancompaniescorporate
governancestandardsareawellresearchedtopicanditisbroadlyunderstoodthat
theystillhavealongwaytogo,withthecurrentprogressslowandarduous.The
recentacquisitionofacontrollingshareinChelyabinskZincPlantbyUMMCand
RussianCopperCompany(RMK)onceagainraisedconcernsoverapotentialworsening
ofcorporategovernanceatChelyabinskZinctheinternationallylistedcompany.
Whilewecannotdiscountthepossibilityofthathappening,wemayalsoseethisasan
opportunityforUMMCtouseitsexperiencemanagingalarge,publiclylistedcompany
togainabetterappreciationofinternationalcorporategovernancerequirementsand
standardspriortoitsownpotentialentryintotheequitymarket.
-
8/7/2019 Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15
10/62
1
0
Withrespecttothecompaniescoveredinthisreport,weareencouragedthatAndrey
Kozitsyn,GeneralDirectorofUMMC,isanactivememberoftheRussianNational
CouncilonCorporateGovernance(NCCG),anonprofitorganisation,whichunitestop
managersfromlistedRussiancompanies,investmentprofessionalsandfederal
governmentrepresentatives.ThecouncilischairedbyVladimirPotanin,majority
shareholderinNorilskNickel.Itactsasanadvisorybodyaimingtoimprovelegislation
andintroducemodernstandardsofcorporategovernancetoRussiancompanies.
Lowtransparencyandinadequatereportingstandards:Russianaccountingstandards
(RAS)areoftenviewedasinadequateincomparisonwithIFRSorUSGAAP.Whilewe
donotnecessarilysharethisviewcompletely,weagreethatRussianaccounting
reportsoftenleavemuchtobedesiredintermsofqualityofreportingandthe
disclosureofkeyfinancialandoperationalfacts.Reportingtoshareholdersisoften
kepttotheminimumspecifiedbythecurrentlegislation.
AccordingtonumerouscommentsmadebyUMMCsmanagementinthepast,the
holdingcompanyhasbeenreportingitsfinancialsunderIFRSsince2003(althoughthe
reportswereaimedatcreditinstitutionsandarecurrentlynotavailablepublicly).
However,theholdingssubsidiariesarestillreportingunderRAS.
OurexperiencewiththeUMMCsubsidiarieshasgenerallybeenpositive,bothinterms
offinancialreporting(makingallowancesforcertainshortcomingsoftheRussian
financialreportingstandards)andintermsofdirectcontactwiththecompanies.The
companiesweregenerallyopenwithrespecttodiscussingthemainaspectsoftheir
businesses:operationalfactors,productflows,revenueandcostdrivers,capital
budgets,workplans,etc.However,whenanalysingtheareasofthebusiness,which
wereconsideredcommerciallysensitivebythecompanies,wehadtorelyonourown
judgementwhenmakingconclusions.
Politicalrisks:TherecenthistoryofRussianlistedcompanieshasnumerousexamples
ofthenegativeconsequencesacommentbyagovernmentofficialorachangein
political
priorities
may
have
on
an
enterprise.
While
no
Russian
listed
companies
may
beconsideredimmunetotherisk,thoselistedasstrategicenterprisesbythe
Russiangovernment,ofwhichUMMCisone,couldbebetterinsulated.
Financialrisks:UMMCsubsidiarieshavesubstantialinvestmentprogrammesaimedat
modernisingtheirbusinessesandincreasingoperatingcapacity.Attheonsetofthe
crisistheparentcompanyriskedbreachingcovenantsonsomeofitsloans.However,
bycuttingcostsanddeferringsomeofitscapitalprojects,thecompanymanagedto
stabiliseitsfinancialposition.Itrefinanceditsdebtobligations,whichcurrentlystand
ataround$3bnintotalforthegroup,accordingtotheUMMCmanagements
commentsinthemedia.Thecompanycurrentlyreliesonsupportfromgovernment
ownedbanks,however,thereisnoguaranteethatsuchrelationshipswillcontinueor
willbesupportedbythegovernmentinthefuture.
-
8/7/2019 Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15
11/62
1
1
Russian Copper: Counting On Economic Recovery and Export Strength
Russiawasrankedamongthetop10globalcopperproducersandconsumersin2008
anditssubstantialreservebasehassubsequentlyallowedittoplayanimportant
roleintheinternationalcoppertrade.TheRussiangovernmentexpectstheindustry
toremainexportorientedintheshorttomediumterm,andforecaststhecountrys
apparentconsumptiontoreturntoprecrisislevelsonlybyaround2015.
CopperIndustryOverview
Copperisoneofthemostwidelyusedoftheindustrialmetals,findingitswayintoa
multitudeofdifferentapplications.AscanbeseenfromFigure13,electrical(e.g.
cables,wires)andconstructionapplications(e.gtubes,buildingparts,fittings)account
foraround70%ofglobalcopperconsumption.
Figure13:Worldcopperconsumptiontrends
Worldrefinedcopperconsumption
byenduse (2008)Industrial
machinery
9%
Construction
28%
Transportation
12% Consumer
products
9%
Electrical
42%
Worldcopperconsumption
byregion(2008)
USA
11%Europe
26%
Restof
Asia
21%
Japan
7%
Africa
2%
China
26%
Australia
1%
Restof
America
6%
Source:CRU
ChinaconsumesoveraquarteroftheworldscopperoutputwithAsiaasawhole
accountingforaround55%ofglobalcopperconsumption.Consumptionofthemetal
inEuropeandtheUSisnonethelessalsoquitesubstantial.
Globalcopperreservesarerelativelyabundant.TheUSGeologicalSurveyputsthe
worldstotalprovedreservesataround540mnt(whichaloneshouldbesufficientfor
around35yearsofproductionatcurrentoutputlevels).Chile,theUSandPeru
accountedforaroundhalfofglobalcopperproductionin2008,whileRussiawasin
sixthplace,witharound750ktofmineoutput(Figure14).
Figure14:Topminedcopperproducers(rankedby2008output) Mineproduction(kt) Reserves(kt)
Country 2005 2006 2007 2008 2009E
Chile 5,320 5,360 5,560 5,330 160,000
US
1,140
1,200
1,170
1,310
35,000
Peru 1,010 1,049 1,190 1,270 63,000
China 755 890 946 950 30,000
Australia 927 859 870 886 24,000
Russia 700 725 740 750 20,000
Indonesia 1,070 816 797 651 31,000
Canada 567 607 589 607 8,000
Zambia 436 476 520 546 19,000
Poland 523 512 452 430 26,000
Kazakhstan 402 457 407 420 18,000
Mexico 429 338 347 247 38,000
Othercountries 1,720 1,835 1,840 2,030 70,000
Worldtotal(rounded) 15,000 15,100 15,400 15,700 540,000
Source:
US
Geological
Survey,
Mineral
Commodity
Summaries,
Jan
2010
-
8/7/2019 Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15
12/62
1
2
Thecoppermanufacturingcyclecanbesubdividedintothreeroughstages:
1.Miningandcopperconcentrateproduction
2.Smeltingandrefining(attimesseparatedintotwostages)
3.Semifinishedandfinishedproductfabrication
Aswithallbasemetals,themaindriverbehindmineandconcentratingoperations
locationsistheavailabilityofsufficientmetalcontentintheore/soiltomakecopper
extractioneconomic.Smeltingandrefiningfacilities,ontheotherhand,relyonthe
availabilityoffuelandelectricityandarethereforelocatedintheareasinwhichthese
energysourcesareavailablecheaplyandinabundance.Finally,fabricationplantstend
tobelocatedincloseproximitytotheultimateconsumers.
Dependingonarangeofoperationalandeconomicfactors(e.g.theavailabilityof
economicallyexploitablemetaldeposits,theirlocation,transportinfrastructure,
availabilityofpower,etc.)countriesand/orcompaniesmayhavesignificantpresence
inallthreestagesorspecialiseinaparticularone.
Chile,forinstance,theworldslargestcopperproducer,producedanequivalentof
5.3mntofthemetalinminedproductionin2008.However,only3.1mntofthiswas
refinedinthecountry,withtherestbeingexported,primarilytoAsia.Finally,only
0.1mntofrefinedmetalwasconsumedinthemanufactureofcopperbasedproducts
(Figure15).
Figure15:Coppermining,refiningandconsumptiontrends(2008,kt) Minedproduction Refinedproduction Refinedusage
Chile 5,328 3,058 103
UnitedStates 1,335 1,282 2,020
Peru 1,268 464 55
China 951 3,791 5,198
Russia 705 862 650
Source:ICSG
Chinesemines,incontrast,producedtheequivalentofjustunder1mntofcopperin
2008.Itishowevertheworldsbiggestcopperrefinerandconsumer,usingcopper
concentrateimportedfromelsewheretoproducearound3.8mntofrefinedcopper.
Thecountryconsumescloseto5.2mntofrefinedcopper,withthebalancecoveredby
importsofrefinedproduct,andinternalandexternalcopperscrapsupplies.
RussianCopperProducersExportsSavetheDay
TheRussiancopperindustryisreasonablybalancedbetweenthethreemanufacturing
stages,althoughexposuretoeachmanufacturingstagediffersbyproducer,aswe
discussbelow.
ThecurrentcircumstancesoftheRussiancopperindustry,notdissimilartoother
metalsoperationsinRussia,aredominatedbytheirSovietlegacywithsomeofthe
largestmetalsdepositslocatedintheSovietrepublics,whicharenowindependent
states.Asaresult,afterthedemiseoftheSovietUnion,manyRussianbasemetal
producersfoundthattheirmainoronlysuppliersofrawmaterialswerenow
independentcompaniesandrelationshipshadtoberebuiltandbasedonanentirely
different,freemarketorientedapproach.Aluminiumandzincproducerswerethe
hardesthitwiththecopperindustrylessaffectedgiventhatRussiasowncopper
reservebaseissufficientlylargetosatisfythelocalindustrysrequirements.
-
8/7/2019 Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15
13/62
1
3
InthisreportwefocusonUMMCcompaniesoperatinginthetwomainstagesofthe
coppermanufacturingprocess(seeAppendixIfortheoutlineofUMMCsexposure
todifferentstagesofcopperproduction):
Miningandconcentrateproduction(GGOK,UGOK),and Refining(UELM)
Themarketishighlyconcentratedatbothstages,withonlythreecompanies,Norilsk
Nickel,UMMCandRussianCopperCompany(RMK),controllingalmosttheentire
market.ThesituationmaychangeinthenearfuturewhenthelargeUdokancopper
depositinEastSiberia,whichiscurrentlybeingdevelopedbyMetalloinvestandstate
ownedRostechnologii(RussianTechnologies),commencesproduction.
Themarketisslightlylessconcentratedatthefabricationstage,althoughallthree
companieshavebeenactivelyconsolidatingassetsinthisspaceandnowhaveavery
sizeablefootprintinthisportionofthemarket.
Miningandcopperconcentrateproduction
Russianofficialstatisticsdonotdisclosecopperconcentrateoutputbreakdownby
enterprise,citingcommercialconfidentiality.Consequentlywehavereliedpartlyon
companydata,butlargelyonavarietyofotherstatisticalsources(bothinternational
theReutersBaseMetalsDatabaseandtheInternationalCopperStudyGroup(ICSG)
andRussian:statisticaldatamaintainedbyInfoGeoandtheresearchbureauMineral)
toarriveatwhatwebelieveisareasonablyaccurateestimateofthemajorproducers
concentrateoutput.
NorilskNickeldominatestheRussianmarketintermsofcopperconcentrateoutput
(justshyof70%,onourestimates).Thisisnotsurprisinggiventhatthecompany
controlssomeofRussiaslargestdeposits,wherecopperisproducedasabyproduct
ofnickelmanufacturing.UMMCisthesecondlargestproducer,supplyingaround29
30%ofthecountryscopperconcentrate.TherestissuppliedbyRMKandsomeother
smallerenterprises(Figure16).
Figure16:LargedepositsmakeNorilsktheleadingcopperconcentrateproducer
ShareofABC1reservesoflargest
Russianproducingdeposits(2007)
Oktyabrskoe
(Norilsk)
50%
Gai
(UMMC)
15%Talnakhskoe
(Norilsk)
25%
Yubileynoe
(UMMC)
5%
Volkovskoe
(UMMC)
5%
UMMCsubsidiaries as %ofRussian
copperconc.production (2009E)
Norilsk68%
Other
Co's
3%
GGOK
11% UGOK
7%
UMMC
other
11%
Source:Source:Reuters,InfoGeo,ResearchCentreMineral,Atonestimates
-
8/7/2019 Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15
14/62
1
4
InFigure17weprovideanestimatedbreakdownofcopperconcentrateproductionby
Russiasmainproducers.
Figure17:Russiancopperconcentrateproductionbycompany(kt) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
NorilskNickel 425 453 455 465 485 495 505 505 505 505
UMMC 136 149 158 179 187 187 195 205 209 206
of
which:
GaiskiyGOK 59 66 69 72 75 73 74 75 75 78UchalinskyGOK 28 34 35 46 48 48 50 51 55 50SafyanovskayaMed(partofUELM) 28 26 29 30 32 32 32 32 32 32OtherUMMCassets 21 23 25 31 32 34 40 46 46 46
RMKtotal 10 11 13 14 14 14 14 14 14 14
Others 10 15 15 11 10 10 10 10 10 10
Grosstotal 581 628 641 669 696 707 725 734 738 736
Source:Reuters,Companydata,InfoGeo
Refinedcopperproduction
Withrespecttoprocessingcopperconcentrateintorefinedcopper,thebalanceof
control
shifts
significantly
away
from
Norilsk
Nickel,
which
produces
around
45%
of
Russiasrefinedcopper,onourestimates.TheremainderisprocessedbyUMMC
(around38%)andRMK(around16%)andseveralothersmallcompanies(Figure18).
Figure18:Refinedcopperproducers Figure19:Theworldstop20copperrefineriesbycapacity,2009(ktpa)
UMMC's shareofRussianrefined
copperproduction(2009E)
Norilsk
45%
Others
1%RMK
16%
UMMC
38%
900
500
490
470
450
450
415
400
400
400
395
390
380
380
380
360
350
350
345
330
330
0
200
400
600
800
1000
Guixi
Birla
Chuquicamata
CodelcoNorte
Toyo/Niihama
Amarillo
ElPaso
LasVentanas
Jinchuan
Morenci
Hamburg
PyshmaUELM
CCRMontreal
Escondida
Sterlite
IioRefinery
Yunnan
Jinlong
Olen
Onsan
Norilsk
Source:Companydata,Reuters,Atonestimates Source:ICSG
UMMCownsoneofthelargestcopperrefineriesintheworldbyinstalledcapacity
Uralelectromed(UELM)intheRussiantownofPyshma(Figure19).ICSGestimates
UELMscapacityat390ktpa,althoughwebelievethatthisfigurecouldincluderefined
copperproducedbyUMMCsothersmallersubsidiaries.UMMCitselfreportedUELMs
nameplateannualcapacityat300kt,butconfirmedthattheplantiscurrentlyableto
producearound350380ktofrefinedcopperperyear,withanincreaseinitscapacity
to500ktplannedbyYE12.
-
8/7/2019 Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15
15/62
1
5
InFigure20wegiveasummaryofrefinedcopperoutputbythemainRussian
enterprises.
Figure20:Russianrefinedcopperproductionbycompany(kt) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
NorilskNickel 413 475 454 467 447 452 425 423 419 402
UMMC 315 330 333 296 345 355 357 381 351 333
RMK
Total
76
80
66
86
121
137
170
175
144
139
Others 5 6 6 6 6 6 6 6 6 6
GrossTotal 803 891 859 856 919 950 957 985 920 880
Source:Reuters,Companydata,InfoGeo
Relianceonexportsremainssignificant
ModernRussiaisanetexporterofrefinedcopper.Weanalysedrecenttrendsin
Russiancopperproductionandtrade,basedondataprovidedbytheRussian
governmentsrecentlyadoptedStrategyontheDevelopmentoftheRussianMetallurgicalIndustryto2020(MetalsStrategy2020)andthelatestofficialstatistics.
Thecountryscopperimportsareinsignificant,whileitsexportsaveragedaround
350ktperyear,orroughlyaround3540%ofitstotalrefinedcopperoutputbetween
2003and2008.However,astheconsumptionofrefinedcopperbymanufacturersof
copperbasedproductswithinthecountryincreased,theshareofexportsgradually
decreased,fallingto28%oftotaloutput(270kt)in2006.
Nevertheless,exportsreliancewasonceagainconfirmedin2009,whennetexportsof
refinedcoppermorethandoubled,risingfrom290ktin2008to590kt.Thiswaslargely
asaresultoffallingdemandwithinRussia.
Relianceoncopperisexpectedtoremainsignificant:theRussianMetalsStrategy
2020assumesthreemodesofdevelopmentforthesector:passive(orinert);resource
oriented;andinnovative(seeAppendixIIforadetaileddescription).Dependingonthe
approach,thestateexpectsproductionofrefinedcoppertoremainataround850900ktin201011,risingtoaround9501050ktby2015(Figure21).
Figure21:Russianrefinedcopperproductionandconsumption(kt)
284
715650
591664684623
515
372310
430
750
900
520390
600
400
200
0
200
400
600
800
1000
1200
2003
2004
2005
2006
2007
2008
2009
2010E
2011E
2015E
2020E
Production (inert) Production(innovative)Netimport(inert) Netimport(innovative)Apparentcons(inert) Apparentcons(innovative)
Source:Russian2020MetalsStrategy,InfoGeo,Atonestimates
AscanbeseenfromFigure21,internalconsumptionofrefinedcopperisnotexpected
toreturntoprecrisislevelsuntilsometimebetween2011and2015.Asaresult,
MetalsStrategy2020forecastsexportstobeintheregionof450550ktin201011.
-
8/7/2019 Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15
16/62
1
6
WhiletheimportanceofChinaasanexportdestinationforRussianproducersis
graduallyincreasing,EuropeandtheMiddleEastremainitsmainmarkets.Inthis
regard,thecurrentgradualimprovementincopperdemandbeingseeninthe
EuropeanmarketsonthebackofrestockingshouldplayintotheRussianproducers
handsandprovidefurthersupportfortheirexports.
Moreover,bothNorilskNickelandUELMhavealreadyappliedtolisttheircopper
cathodesasbrandsfordeliveryattheLME,withtestsofUELMscopperforbranding
alreadyproceeding.ThemoveshouldallowRussiancopperproducerstoboosttheir
profitsasLMEbrandingwouldallowthemtoselltheircopperatLMEquotedprices,
whilenonLMEregisteredmaterialissoldatadiscount.Whilewebelievesellingata
discountwasanadvantageduringthetimeofthecrisis,allowingthelowerpriced
Russianmaterialtogainlargermarketshare,inafullyfledgedrecovery,differentiation
basedonquality,ratherthanprice,wouldbemorebeneficial,inourview.
WenotethatUELMsgoldandsilverarealreadyincludedontheGoodDeliverylist
oftheLondonBullionMarketAssociation(LBMA).
-
8/7/2019 Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15
17/62
1
7
Russian Zinc: Resisting the Elements
Russiascontributiontoworldzincoutputisrelativelymodestbyglobalstandards
despiteitsreservebasebeingamongthelargestintheworld.Thecountrysindustry
waslittleaffectedbytheeconomiccrisismainlythankstothestrongperformanceof
galvanisedsteelmanufacturers.WebelievetheRussianzincindustrywilllikelyfocus
onsupplyingthecountrysinternalneeds,withdemandgrowthbeingboostedbythe
construction
sector,
in
particular.
ZincIndustryOverview
Zincispredominantlyusedasacoatingforsteelandironinordertoprotectthese
metalsagainstcorrosion(galvanising).Thisisgraduallyreplacingmoretraditional
methodssuchascolourpolymercoatingandpainting.Zincisalsowidelyusedinalloys
suchasbrassandinavarietyofchemicalapplications.Globally,aroundhalfofzinc
productionisusedingalvanising,andover30%isutilisedinalloys(Figure22).
Figure22:GlobalandRussianprimaryzincusage
Globalzincusagebyfirstuse
(2007)
Other
11%
Galvanising
47%Alloys
33%
Chemicals
9%
Russianzincusagebyfirstuse
(2008)
Other
6%
Galvanising
62%
Alloys
18%
Chemicals
14%
Source:GlobalLME,Russia ChelyabinskZinc
InRussiagalvanisingisbyfarthelargestapplicationforzinc,accountingforover60%,
withalloyandchemicalproductionconsuminganother32%.
Intermsofglobalminedzincproduction,Russiaplaysarelativelymodestrole,with
thetopproducersbeingChina,PeruandAustralia(togetherproducingaround44%of
theworldsoutputofzinc(Figure23).
Figure23:Topminedzincproducers(rankedby2008output) Mineproduction(kt) Reserves(kt)
Country 2005 2006 2007 2008 2009E
China 2,547 2,844 3,048 3,186 33,000
Peru 1,202 1,202 1,444 1,603 19,000
Australia
1,329
1,338
1,498
1,479
21,000
Canada 667 638 630 716 8,000
US 748 727 803 779 14,000
India 472 503 558 616 10,000
Kazakhstan 364 410 446 459 17,000
Mexico 476 469 452 442 14,000
Ireland 445 426 401 398 2,000
Othercountries 1,896 1,890 1,849 2,024 62,000
ofwhichRussia 156 163 171 171 40,000Worldtotal(rounded) 10,146 10,447 11,129 11,702 540,000
Source:ILZSG,USGeologicalSurvey,MineralCommoditySummaries,Jan2010
Nevertheless,Russianzincreservesareamongthelargestintheworld.Theestimates
ofthesereservesdifferbysource(weuseABC1reservesquotedinRussiansources);however,itranksamongthetopthree.
-
8/7/2019 Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15
18/62
1
8
Ironicallythen,Russiaisatpresentessentiallyshortofzincconcentrate. Thisis
anotherlegacyoftheSoviettimes.FollowingthebreakupoftheSovietUnion,around
80%ofthereservebaseandaround50%oftheconcentrateprocessingcapacitywas
lost(themajorityofzincminingandconcentratingcapacitywasbasedinKazakhstan,
withsomeinUzbekistan).Asaresult,thecurrentRussianzincconcentrateoutputcan
coveronlyaround70%oftheinternalzincrefiningcapacity.InFigure24we
summariseRussianzincconcentrateoutputbyenterprise.
Figure24:Russianzincconcentrateproductionbycompany(ktofcontainedmetal) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
UMMC 96 102 115 123 124 124 129 124 122 115
ofwhich:
GaiskiyGOK 12 10 13 12 12 9 8 8 6 6UchalinskyGOK 84 92 102 111 112 115 121 117 116 109
RMKTotal 11 12 12 10 12 12 18 28 30 23
Dalpolimetal 20 18 23 22 19 19 16 19 19 15
Grosstotal 127 132 150 156 155 156 163 171 171 153
Source:Reuters,Companydata,InfoGeo
UMMCandRMKremainthemainsupplierstotheRussianmarket,withUMMC
producingaroundthreequartersofthecurrentRussianzincconcentrateoutput
(Figure25).
Figure25:UchalinskyGOKremainsthemainzincconcentratesupplierinRussia
UGOK'sshareofRussianzincin
concentrateproduction(2009E)
UGOK
70%
Other
Co's
26%
UMMC
other
4%
Source:Reuters,Companydata
DalpolimetalslocationintheFarEastofRussiamakesthetransportationofzinc
concentratetosmeltersinthewesternpartsofthecountryuneconomic.Therefore,its
zincconcentrateoutputisexported.Russianzincrefinerieshavetorelyonimports
fromKazakhstan,UzbekistanandnonCIScountriestosatisfytheirproduction
requirements.
Russianzincconcentrateproductioncouldincreasebyover100%byYE13whenthe
Ozernoedepositisexpectedtocomeonstream,withforecastcapacityofaround250
300ktofzincequivalentinconcentrateatpeakproduction,accordingtooperator,East
SiberianMetalsCorporation(MBC).OzernoecouldbefollowedbyHolodninskoe
deposit(alsooperatedbyMBC)shortlyafterthat.About50%oftheoutputfromthose
depositscouldbeexported.Thesedevelopmentsalongwithsomesmallerfields,as
wellascapacityincreasesatexistingfacilities,shouldensurethatRussianrefinedzinc
productionbecomesalmostfullyselfsufficientinzincconcentrateby2020,as
envisagedbytheRussianMetalsStrategy2020.
Intermsofrefinedzincproduction,theRussianmarketisevenmoreconcentrated
thanforcopper.DuringSoviettimesRussiahadthreerefineries.Oneofthem,Belovo
Metallurgicalplanthasbeenidleforaconsiderablelengthoftimeandnoplansto
-
8/7/2019 Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15
19/62
1
9
revivetheplanthavebeenannounced.AsaresulttheRussianmarketissuppliedby
tworefineries:ChelyabinskZincandElektrotsinkinVladikavkaz,controlledbyUMMC
(Figure26).
Figure26:OnlytwocompaniesproduceallofRussiasrefinedzinc
BreakdownofRussian
refinedzincproduction(2009E)
Chelyabinsk
Zinc
55% Elektrotsink
45%
Source:Reuters,CompanyData
ThemarkethasbecomeevenmoreconcentratedafterUMMCandRussianCopper
Company(RMK)completedthepurchaseofa58%holdinginChelyabinskZinc.Asa
resultUMMChasbecomepracticallyamonopolyinrefinedzincproductioninRussia.
Figure27belowgivesabreakdownofRussianrefinedzincoutputbyplant.
Figure27:Russianrefinedzincproductionbycompany(kt) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
ChelyabinskZinc 146 156 166 177 152 116 148 165 166 120
Elektrotsink 81 81 88 75 81 90 88 88 98 90
Grosstotal 227 237 254 252 233 206 236 253 264 210
Source:Reuters,Companydata,InfoGeo
Refinedzincusagesteelmakersinthelead
Intermsofzincrefiningandrefinedzincconsumption,theworldslargeststeel
producingcountriesare,unsurprisingly,inthelead(Figure28).
Figure28:Majorrefinedzincconsumingcountries(2008)
Refinedzincproduction Refinedzincusage
China 3,913 4,015
US 286 1,003
Japan 616 485
Germany 292 564
SouthKorea 739 504
Russia 262 222
Source:
ILZSG,
Metals
Strategy
2020
Thesituationisnotsurprisinggiventhatthemajorityofglobalzincproductionisused
inprotectingzincandironagainstcorrosion,asdiscussedabove.
Intermsoffinalapplication(i.e.areasoffinaluseforzincbasedorzinccovered
products)about32%ofglobalrefinedzincoutputisusedintheproductionofvehicles,
machineryandengineering,witharound45%ofzincusedinconstruction.The
remaindergoestovariousconsumergoodsandelectricalequipment(Figure29).
-
8/7/2019 Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15
20/62
2
0
Figure29:Russianzincuseinconstructionandotherareasisstilllow
Globalzincusagebyend use
(2003)
Construction
45%
Transport,
general
engineering32%
Consumer,
electrical
23%
Russianzincusagebyend use
(2007)
Other
10%
Transport,
machinery,
engineering
70%
Construction
20%
Source:InternationalZincAssociation,Russian2020MetalsStrategy
InRussia,theultimateusesofzincandzincproductsdifferconsiderablyfromglobal
trends,withthemajorityendingupinvehicleandmachinerymanufacturingand
generalengineering.Onlyabout20%ofrefinedzincisaccountedforbyconstruction
relatedapplications.
Exposuretomachineryandvehicleproductionwasoneofthereasonsthat,we
believe,allowedRussianzincconsumptiontoremainreasonablyrobustduringthe
economiccrisis.AscanbeseenfromFigure30,followingadifficult4Q082Q09,
productionofHotDipGalvanised(HDG)sheetbyRussiansteelmakershasrecovered
strongly,evenapproachingprecrisislevelsin3Q09.Thedipin4Q09wasmainly
seasonal,inourview,andtherecentsteelproductionfigures(JanFeb2010)remain
quitestrong.
Figure30:RussianHDGtradedynamics
450
623 618
527481
584
358
260
599
501
788
329
200
0
200
400
600
800
1
Q07
2
Q07
3
Q07
4
Q07
1
Q08
2
Q08
3
Q08
4
Q08
1
Q09
2
Q09
3
Q09
4
Q09
'000tonnes
Production Export Import Apparentconsumption
Source:MetalCourier
Statesupportoftheautosector,aswellasincreasedinfrastructurespending,werethe
maindriversbehindtherevivalofdemandforgalvanisedsteel,inouropinion.In
addition,Russiansteelproducersmanagedtoincreasetheirexportsales,primarilyto
theCIScountries.
Asaresult,theapparentconsumptionofzincinRussiawasmarginallyupduring2009,
increasingbyjustover6%YoY,toaround220kt(Figure31)
-
8/7/2019 Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15
21/62
2
1
Figure31:Russianzincproductionandconsumptiontrends
246219
83115
174195 206 209
267322
222
217 267
410
300
100
0
100
200
300
400
500
2003
2004
2005
2006
2007
2008
2009
2010E
2011E
2015E
2020E
Production(inert) Production(innovative)Netimport(inert) Netimport(innovative)Apparentcons(inert) Apparentcons(innovative)
Source:Russian2020MetalsStrategy,InfoGeo,Atonestimates
Weexpecthigherinfrastructurespendingtobethemaindriverbehindrefinedzinc
consumptiongrowthinRussiaintheshorttomediumterm.Anumberof
infrastructureprojectsareeitherunderconstructionoralreadyapprovedtheSochi
Olympics,the2012APECsummit,tonamejustafew,togetherwithawholehostof
federalroadandbridgeconstructionprojects(seeourSpecialSituationsteamsreport
BridgeoverTroubledWater,23Mar,foradetailedreviewofthemainRussiantransportationinfrastructureprojects).Theseschemeswillcallforincreasedamounts
ofzinc,givenitsprimaryfunctionasaprotectorofsteelusedinconstruction.
AccordingtoUMMC,Russiahasover40enterprisesprovidinggalvanisingservices
(includingtherecentlycommissionedplantatUELM).Anumberofsteelgalvanising
facilitiesarecurrentlybeingbuiltaroundRussiatoenablewideruseofsteel
galvanisingforconstructionpurposes.
TheRussianMetalsStrategy2020envisagesthattheshareofconstructionintotalzincconsumptionwillrisefromthecurrent20%toaround33%by2020.Asaresult,
Russianrefinedzincconsumptionisforecasttoincreasefromaround200ktpa(2010)
tobetween260300ktby2015and300400ktby2020(Figure31).
-
8/7/2019 Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15
22/62
-
8/7/2019 Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15
23/62
2
3
LesspublicisedistheChinesecurrencysroleTheChineserenminbi(RMB)remains
closelypeggedtothedollar,virtuallyreplicatingtheUScurrencysmovesagainstother
currencies(includingtheeuro,forinstance).Therefore,webelievethatChinese
demandforcommoditiesshouldnotbeaffectedtoanygreatextentbyfuturedollar
appreciation.Onthecontrary,anyweaknessincommoditypricesonthebackofa
strongerdollarcouldonceagainbeusedbytheChineseasanopportunitytorestock.
RoubleappreciationismoreconcerningfortheRussianproducers.Whatismore
seriousforRussianbasemetalproducersisnotthestrengthofthedollarvstheeuro,
butrathertheongoingstrengtheningoftheroubleagainstbothcurrenciesontheback
ofstableoilprices.Astrongerroublemeansthatwhentranslatingcompanyfinancials
intoUSdollarsforvaluationpurposes,weendupwithconsiderablyhigherdollar
denominatedcosts,squeezingtheprofitmarginsonwhichwerelyforourassessment
ofthecompanysinvestmentappeal.
LiquiditytighteninginChinaisyettohaveanynoticeableimpact
TherecentjumpintheChineseCPIratehasreignitedfearsofliquiditytighteningby
thecountrysgovernment,whichmayresultinacontractionindemandfor
commodities.Theseworriesareoverrated,inourview.
TheChinesegovernmenthasalreadyputinplaceanumberofmeasurestoreduce
banklendingandlimitexcessliquidity:thepaceofYoYgrowthinbanklendingslowed
fromaround34%to30%throughout4Q09.Andwhilewearecertainthatthe
governmentwillcontinuethisagenda,wetendtoagreewithmarketcommentators
whoexpecttheChineseauthoritiestofavourgradualcoolingoverabruptanddrastic
cuts.Indeed,asweseefromthereportsoninternationalnewswires,thegovernment
appearstobeaimingforanapproximately10%annualgrowthrate,whichwouldbea
majorbullishfactorforcommodities.Moreover,judgingbytherecentofficialstatistics
oncommodityimportsintoChina,liquiditytighteningmeasureshaveyettohaveany
noticeableimpactonthecountryscommoditiesappetite.
Figures33and34,illustratetherecenttrendsintwoofChinasmaincommodity
imports,copperandironore,oftenusedasproxiesfordemandforthesematerialsin
theglobalmarket.Chineseunwroughtcopperandcopperproductsimportsrose42%
MoMinMarch,to456kt(justbelowthealltimehighof477ktreachedinJune2009).
IronoreimportsalsoincreasedinMarch,rising20%MoM,tojustover59mnt.
RealDemandorJustStockpilingandSpeculation?
The
unprecedented
growth
in
Chinese
commodity
imports
throughout
2009
and
the
lackoftransparencywithregardstotherealstateofthecountryseconomyand
Figure33:ChineseMarchcopperimportsrise42%MoM Figure34:whileironoreimportsgoup20%MoM
200
100
0
100
200
300400
500
Jan08
Mar08
May08
Jul08
Sep08
Nov08
Jan09
Mar09
May09
Jul09
Sep09
Nov09
Jan10
Mar10
40%
20%
0%
20%
40%
60%80%
100%
China copperimports CopperimportgrowthMoM(%)
TightscrapmarketpushesMarchimportof
copperand copperproducts up42% MoM
20
30
40
50
60
70
80
90
Jun08
Jul08
Aug08
Sep08
Oct08
Nov08
Dec08
Jan09
Feb09
Mar09
Apr09
May09
Jun09
Jul09
Aug09
Sep09
Oct09
Nov09
Dec09
Jan10
Feb10
Mar10
mntonnes
Chinaironoreimports Ironorestocksat Chineseports
despite the holidaysand iron
oreimportsrising6%and 20%
MoM,respectively, inFebMarch
Ironorestocksat Chinese portsincreasedonly
marginallyinFebruaryMarch2010...
Source:Bloomberg Source:Bloomberg
-
8/7/2019 Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15
24/62
2
4
manufacturinghaveledmanytobelievethattheincreaseinimportswasdueto
stockpilingandspeculationratherthananindicationofgrowingrealdemandfor
commodities.OneofthemajorconcernsamonginvestorsisthatChineseproducers
hadstockpiledsufficientrawmaterialinventoriestolastforseveralmonthswithout
theneedforreplenishment.
Wewouldagreethattheincreaseincommodityimportsin1H09wasdrivenprimarily
bythedesiretoreplenishrawmaterialinventorieswhilepriceswerelow.However,
importshavesubsequentlynormalisedand,whileaspeculativeelementmaystillbein
play,ourviewisthatthecurrentcommodityimportlevelsgiveamoreaccurate
reflectionofrealdemandinthecountry.Thereisplentyofstatisticalandanecdotal
evidenceinthemarkettosupportthis.
ReturningtoFigure34,itisinterestingtonotethatdespitetheshortmonthof
February(furthershortenedbytheChineseNewYearholidays)ironorestocksat
Chineseportsincreasedonlymarginallyduringthemonth.Stocksstoodat69.6mntat
theendofFebruary,upjust2%fromtheendofJanuary,whileironoreimportsinto
Chinaincreased6%MoMinFebruary.This,webelieve,wouldimplythatstock
drawdownbysteelmakersremainedstronginFebruary,suggestingthatatleastapart
oftheironoreimportswentstraightintosteelproduction,ratherthansimplybeingaccumulated.ThepaceofdrawdownbecameevenmoreapparentinMarch,withiron
oreimportsincreasing20%MoM,whileportstocksincreasedtoaround71.5mnt,
whichisgrowthoflessthan3%.
Moreover,accordingtoMarceloAwad,CEOofAntofagasta,oneofthemajorcopper
producers,speakingattheReutersMiningSummitrecently,thecompanyssales
representativestoChinahavereportedthatthefabricatingplants,whichareamong
themainconsumersofrefinedcopper,wererunningclosetocapacity.Assuch,the
companybelievesthatcurrentimportdemandisverymuchreal.
Chineseinternalproductionlevelscannotbeusedasanindependentindicationof
demand
unless
there
is
evidence
that
the
output
is
generating
revenue
instead
of
simplybeingaddedtoinventory.Inthisregard,webelievethatChineseexportsmay
beoneofthemaindrivingforcesbehindthecountrysmanufacturingefforts.In
FebruaryandMarchthesehavecontinuedtheirsurge,postingincreasesof46%and
24%YoY,respectively.Thefigureswerequiteobviouslydrivenbythelowbasefactor
(thevalueofexportsinFeb2009cameinataround$65bn;inMar2009itwasjust
over$90bn).WehavethereforelookedattheabsolutelevelinsteadofsimpleYoY
comparisons.AscanbeseenfromFigure35,despitetheseasonalslowdowninJanFeb
2010,exportsin1Q10wereactuallyslightlybetterthanin2008,theyearofrecord
exportsfromChina($105bnin1Q10vs$102bnin1Q08).
Figure35:Yetanotheryearofrecordexportsinthemaking? Figure36:Although,notallexportsaresurgingyet
40
302010
0
102030405060
70
Jan08
Mar08
May08
Jul08
Sep08
Nov08
Jan09
Mar09
May09
Jul09
Sep09
Nov09
Jan10
Mar10
%
80
6040200
20406080100120
140
$bn
ValueofChinese exports ChineseexportYoYchange%
2009average exportvalue
Chinese exportssustainedtheir
positivegrowthmomentuminMarch
Chinese exportvaluesinJan Mar'10are similarto
levelsofJan Marof2008,the yearofrecordexports
2000
1000
0
1000
2000
3000
4000
5000
6000
7000
8000
Jan08
Mar08
May08
Jul08
Sep08
Nov08
Jan09
Mar09
May09
Jul09
Sep09
Nov09
Jan10
'000t
Steelproductimport Steelproductexport Netexport
Theperiodofbeingnet importer
ofsteelwas shortlived...
althoughChinese steelexports
are yettorecovertopastpeaks
Source:Bloomberg Source:Bloomberg
-
8/7/2019 Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15
25/62
2
5
GiventhestateoftheeconomiesofChinasmaintradingpartners,wewouldnotgoas
farassuggestingthatChinaisonthevergeofrepeatingitsstellar2008export
performance.AsFigure36shows,notallindustrialexportsaredoingwell.The
anaemicsteelexportlevelcouldbeexplainedbythelackofrealdemandforsteelin
theregionalmarketsthathavenotexperiencedthesameamountofstimulusdriven
growthasChina.Moreover,Chineseexportsofcertaintypesofsteelwererestrained
byrestrictivequotasimposedbytheUSandEU.Finally,growinginfrastructure
spendinginChinaonthebackofstimulusspendingcouldalsohavedivertedalarge
partofthesteeloutputtowardsinternalprojects.Thispicturecouldchangeinthe
comingmonths,oncetherestoftheworldenterstherestockingphase.
Restockingwhenwilltherestoftheworldfollowsuit?
WhileChinahasbeeninrestockingmodeforoverayear,thesamecannotbesaidfor
othermajoreconomies.Theresultsoftheeconomiccrisishavebeensosevereandthe
recoverysoslowincomingthatthemanufacturingindustriesintheUSandEurope
havespentalmosttwoyearsindestockingmode(i.e.runningdownthebuildupof
excessstockratherthanmanufacturingnewproducts).IndustrialproductionintheUS
andEUhadfallenbyasmuchas13%and20%YoY,respectivelybythemiddleof2009
andhasjuststartedtomoveintopositivegrowthterritory,helpedtoalargeextentby
thelowbasefactor(Figure37).
Figure37:Industrialproductioninkeyeconomies(YoYchange%) Figure38:GDPgrowthinkeyeconomies(YoYchange%)
25%
20%
15%
10%
5%
0%
5%
10%
15%
20%
25%
Jan06
Apr06
Jul06
Oct06
Jan07
Apr07
Jul07
Oct07
Jan08
Apr08
Jul08
Oct08
Jan09
Apr09
Jul09
Oct09
Jan10
%chgyoy
China China5Yaverage US Eurozone
Afterthesurgeof'09,Chinese IPgrowth
rateis backtoits 5Yaveragelevels...
whilebothUSand Europeare starting
toshowsomesignsofrecovery
10%
5%
0%
5%
10%
15%
20%
1Q03
4Q03
3Q04
2Q05
1Q06
4Q06
3Q07
2Q08
1Q09
4Q09
%chgyoy
China US Eurozone
ChinaGDPgrowthrate
continuestogainmomentum...
whileUSand EUappear
tohavestabilised
Source:Bloomberg Source:Bloomberg
AndthisindustrialproductionrecoveryintheUSandEUisgraduallybeingreflectedin
theratesofeconomicgrowth.AlthoughquarterlyGDPgrowthratesinthedeveloped
worldstillremaininnegativeterritory,theyaretrendingup,raisinghopesofpositive
growthin2010(Figure38).
Weexpectthattheearlystagesofthatgrowthwillbedrivenbyrestocking,ratherthan
therecoveryofrealdemand,asthemanufacturingsectorwillhavetorebuildheavily
depletedinventories.Wehavealreadyseensomeevidenceofrestockinginsteelandit
appearsthattheprocessisabouttocommenceinthebasemetalsmarket.
Figure39illustratesthedrawdownofLMEcopperinventoriesduring2009ontheback
ofChinesebuying.Theprocesstookplaceintwostages:initialpurchasesatthe
beginningoftheyearwerefollowedbyamuchstrongerdrawdowninAprMay2009,
thetraditionalseasonforcoppermarketrestocking.Asaresult,LMEcopper
inventoriesdipped53%fromthepeakofaround550ktattheendofFeb2009tothe
lowofaround257ktinmidJuly2009.
-
8/7/2019 Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15
26/62
2
6
Figure39:Copperrestockingin2Q10couldindicatethetruestateofdemand
0
100
200
300
400
500
600
01Jan08
01Mar08
01May08
01Jul08
01Sep08
01Nov08
01Jan09
01Mar09
01May09
01Jul09
01Sep09
01Nov09
01Jan10
01Mar10
0%
5%
10%
15%
20%
25%
30%
LMEstock('000tonne s) Ca nce ll edwarrantsas %ofLMEstock
Judgingbythe numberofcancelledwarrants,
copperstockat LMEis expectedtogodown...
...but2Qwithdrawals
are keytoasustained
stockreduction
Source:Bloomberg
Thisprocessmayberepeatedthisyear,albeitatalessdramaticpaceduetoreduced
purchasesbyChina.Thenumberofcancelledwarrants,themainindicatorofthesize
ofthecopperinventorywaitingtoleavetheLMEwarehouses,hasrisenthrough1Q10
andstoodatjustover5%ofthetotalstockinmidMarch.AsaresulttheLMEcopper
inventoryhasfallen8%fromthe555ktpeakattheendofFeb2010toaround511ktat
thetimeofwriting.
ThekeydifferencebetweentheMar2009andMar2010figuresisthegeographical
spreadofthecancelledwarrants(LMEhaswarehousesaroundtheworldtoeasethe
deliveryofphysicalmetaltocustomers).In2009,around55%ofcancelledwarrants
werefordeliveriesfromwarehousesinAsia,withtherestbeinginEurope.TheUS
warehousessawvirtuallynoactivityatthetime.Thistime,however,around32%of
thecancelledwarrantsrelatetodeliveriesfromtheUSwarehouses,45%fromEuropeandjust23%fromAsia.Thiscouldindicatethatsomeinterestincopperisreemerging
intheUSandEurope.Indeed,coppermanufacturershavereportedanincreasein
ordersfromthoseeconomies.
Whileitistooearlytointerprettheabovepictureasanindicationofdemand
resurgenceintheUSandEU,wecouldinterpretitasasignthatrestockingby
manufacturersinthosemarketsisalreadyunderway.AswemoveintotheAprilMay
restockingperiodforkeycopperconsumers,wewillwatchthedrawdownofLME
copperinventoriescloselyasanindicationofthesupplydemandbalanceinthe
marketandthepaceofrestockinginthekeyglobaleconomies.
-
8/7/2019 Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15
27/62
2
7
Companies
-
8/7/2019 Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15
28/62
2
8
WeinitiatecoverageofGaiskyGOK(GGOK)withaBUYratingandafairvalue
estimateof$671/share,representing124%upsidepotential.Thecompanylooks
undervaluedbothintermsofourDCFvaluationandacomparisonwithdeveloped
andemergingmarketpeers.Moreover,therecoveryinbasemetalpriceshasyetto
bereflectedinthestocksperformance.
Figure1:GGOK:Russiassecondlargestcopperconcentrateproducer
GGOK'sshareofRussiancopperin
concentrateproduction (2009E)
Norilsk
69%
Other
Co's
3%
UMMC
other
17%
GGOK
11%
ShareofABC1reservesoflargest
Russianproducingdeposits(2007)
Oktyabrskoe
(Norilsk)
50%
Gai
(UMMC)
15%Talnakhskoe
(Norilsk)
25%
Yubileynoe
(UMMC)
5%
Volkovskoe
(UMMC)
5%
Source:Reuters,InfoGeo,ResearchBureauMineral,Companydata,Atonestimates
Organicgrowthexpectedthroughcapacityexpansion.GGOKsinvestmentprogrammeisaimedatincreasingthethroughputcapacityofitsenrichmentplantby
33%(from6mtpato8mtpa)byend2013,whichwillboostcopperandzincoutput.
Thecompanyexpectsa42%increaseincopperconcentrateproductionbyend2013.
Copperconcentrateandgoldoutputmakeuparound86%ofthecompanystotal
sales.Withtheexpansionoftheenrichmentplantcapacity,thecompanybelievesits
copperconcentrateproductionshouldjumpbyupto42%byend2013.GGOKhasalso
indicatedthatitsgoldandsilveroutputwouldremainflatgoingforward.
Mostbasemetalpricesexpectedtorecovertoprecrisislevelsin2010.The
Bloombergconsensusestimatesthatweuseinourcalculationshowthemarket
expectscopperpricestoreturntoprecrisislevelsin2010,implyinganaverageprice
of$6,875/t,up32%YoY,($7,265/tin1Q10),beforehittinganewaveragehighof
around$7,358/tin2011.Zincisexpectedtorise37%YoYin2010,toaround$2,307/t
($2,306in1Q10),beforetradingatanaverageof$2,513/tin2011.
Ourvaluationsuggeststhestockhasupsidepotentialof124%.BothourDCFmodel
andcomparativeanalysissuggestthatthemarkethassignificantlyundervaluedGGOK:
thecompanytradesata66%discounton2010EEV/EBITDAtodevelopedmarket
competitorsanda77%discounttoemergingmarketcompetitors,whileourDCF
valuationof$565/sharesuggests88%upsidepotentialtothecurrentshareprice.In
addition,whilemostmetalspriceshavealmostrecoveredtoprecrisislevels,GGOK
stilltradesathalfitsprecrisispeak,whichisnotjustified,inourview.
GAISKY GOKCopper Whopper
BUY
Fair value $671
Potential upside 124%
Bloombergcode GGOKRU
Reuterscode GGOKI.RTS
Price(ordinary,$) 300.0
Price(preferred,$) n/a
Potentialupside(%) 124%
Potentialupside,prefs(%) n/a
ADRratio(x) n/a
Sharedata
No.ofordinaryshares(mn) 0.6
No.ofpreferredshares(mn) n/a
Dailyturnover($mn) 0.02
Freefloat(%) 15.4%
Marketcapitalisation($mn) 185
Majorshareholders
UGMK 84.6%
FINANCIALS($mn) 2009E 2010E 2011E
Revenue 282 369 412
Grossprofit 97 172 192
EBITDA 91 164 183
Netincome 35 87 97
EPS(USD) 57 140 157
Grossdebt 232 283 298
Equity 233 320 416
Assets 510 644 760
VALUATION
P/E(x) 5.3 2.1 1.9
EV/EBITDA(x) 4.4 2.4 2.2
Earningsgrowth(%) 319% 145% 12%
P/B(x) 0.8 0.6 0.4
RoA(%) 6.9% 13.4% 12.7%
RoE(%) 15.1% 27.1% 23.2%
PERFORMANCE
1M(%) 9%
3M(%) 16%
12M(%) 216%
52weekhigh($) 300.00
52
week
low
($)
95.00
-
8/7/2019 Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15
29/62
2
9
Companybackground
GGOKisthesecondlargestcopperconcentrateproducerinRussia,afterNorilskNickel.
Copperconcentrateandgoldbarsareitsmainproducts,whichweexpectcontributed
upto86%ofsalesin2009.Weforecast2009copperinconcentrateproductionof78kt
(+4%YoY)andgoldoutputof1.6tonnes(4%YoY).GGOKsellsitsconcentrateto
majorityownerUMMCanditsgoldbarstoGazprombank.Concentratetransactions
areata4849%discounttoLMEcopperandzincprices.
GGOKoperatesthreepolymetallicdeposits,withtotalorereservesofmorethan
300mnt,andalimestonemine(Figure2).Atthecurrentenrichmentplantcapacityof
6mntpa,theassetslifespaniscalculatedtobearound50years(disregardingany
followupexploration).
Figure2:Reserves
Deposit MineralOrereserves,
mnt
Annualmining
capacity,ktpa
Lifespan,
years
Gaiskoye Cu,Zn,Au,Ag 300 5,000 50
Kamenskoye Au,Ag 1 300 1
Osennee
Cu,
Zn,
Au,
Ag
7
500
2
SeveroIrklinskoye Limestone
Source:Companydata
GGOKownsfourotherdepositsinvariousstagesofdevelopment,butweexpectsthis
supplementaryresourcebasetosubstituteretireddepositstoallowthecompanyto
maintainproductionatcurrentlevelsratherthanboostitsproductionvolumes.
Ownershipanddividends
UralsMiningandMetallurgicalCompany(UMMC)isthemajorityownerofGGOK.Total
freefloatamountstoaround15%,allowingthedailyvolumetradedtoaveragearound
$25,000overthepastthreemonths.
Figure3:Ownershipstructure
UMMC,
84.6%
Free
float,
15.4%
Source:Companydata
Alowfreefloatandthepresenceofasinglemajorshareholderareoftencitedasrisks
forminorityshareholdersinRussia.Moreover,inGGOKscasethelowtransparencyof
theparentcompanymayposeahighercorporategovernancerisk.Inthepastsome
Russiancompanieshavelaunchedhostileanddilutiveshareissuesandengagedin
otheractivitiesthathavefloutedthewishesandrightsoftheirminorityshareholders.
Onthepositiveside,GGOKsfreefloathasremainedstablesince2006.Moreover,the
companycurrentlyfinancesitsexpansionprogrammebyincreasingborrowings,not
ThetotallifespanofGGOKassetsis
around50years,disregardingfollowup
exploration
Freefloatis15%,or$26mnbasedonits
currentmarketcap
-
8/7/2019 Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15
30/62
3
0
throughissuingequity.Henceweconsidertheriskofnewshareissuesandfreefloat
dilutiontobelow.
GGOKhasnotpaidanydividendssince1993,whenitwasincorporatedintoanopen
jointstockcompany(OJSC).Withthecurrentinvestmentprogrammeinfullswing,we
wouldnotexpectanydividendpaymentsinthenearfuture.
ProductiongrowththroughcapacityexpansionGGOKproducescopperandzincconcentrates,goldandsilver.Through200508
copperconcentrateoutputremainedrelativelyflatataround75ktpa.Changesin
productionofothermetalswerealsoinsignificant.Copperconcentrateproduction
shouldaccountforaround93%ofthecompanysoutputandaround70%ofsales.
Althoughtheshareofpreciousmetalstototalproductionisminor,itaccountsfor
around22%ofsales(Figure4).
Figure4:Salesvolumesandrevenuebreakdownbyproduct
Sales volume breakdown(2009E)
Copper
93.4%
Silver
0.03%
Gold
0.002%
Zinc
6.6%
Revenuebreakdown (2009E)
Other
7%
Zinc
2%
Gold
17%
Silver5%
Copper
69%
Source:Companydata,Atonestimates
Recently,
the
company
reported
that
in
2009
its
output
of
copper
in
concentrate
grew
4%YoY,to78kt,althoughgoldoutputfell4%YoYto1.6tonnes.
ThecurrentcapacityofGGOKsenrichmentplantisaround6mntpaoforeprocessing.
Bytheendof2013thecompanyplanstoincreaseitscapacityby33%to8mntpa.This
shouldresultinefficiencyimprovements,leadingtoanincreaseincopperandzinc
production.Thecompanyexpectstheexpansionoftheenrichmentplanttoboost
copperinconcentrateproductionto111kt(up42%)andzincto7.7kt(up39%)
respectivelybyYE13,althoughwehavemodelledamoregradualincreaseinoutput
(Figure5).Thecompanyhasalsoindicatedthatitsgoldoutputwouldremainrelatively
flatgoingforward.
Figure
5:
Production
schedule
75 75 78 7985 90
97 1041118 6 6
6
6
78
7
6
50
60
70
80
90
100
110
120
130
2007
2008
2009E
2010E
2011E
2012E
2013E
2014E
2015E
Copper,kt Zi nk,Kt
Source:Companydata,Atonestimates
Copperoutputforecasttoincreaseby
upto42%,to111ktby2013
Copperandgoldremainkeyproducts,
generating86%ofrevenue,withzinc
andsilvercontributinganother7%
-
8/7/2019 Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15
31/62
3
1
Financialsproductiongrowthandmetalpricesarethemajordrivers
GGOKshowedaconsiderableimprovementinfinancialsthrough200308,mainlyon
thebackofmetalpriceincreases.Inparticular,revenuegrewataCAGRof44%,from
$88mnin2003to$260mnin2006,whenEBITDAandnetincomemarginsreached
peaksof43%and26%,respectively.However,marginsweresubsequentlycurbedbya
considerableincreaseinCoGSandSG&Aexpenses,pushingthe2008EBITDAmargin
down23%andthenetmarginto3%,althoughwebelievethatpartofthatreduction
wasduetothesharpfallincopperpricesin2H08(Figure6).
Figure6:Breakdownofkeyfinancials
0%
20%
40%
60%
80%
100%
2006
2007
2008
2009E
2010E
Netincome Incometa xOtherexpense(net) Interestexpense,(net)SG&A CoGS
Source:Companydata,Atonestimates
Our2009forecastisbasedonGGOKs3Q09RASfinancialresultsandrecentlyreleased
productionvolumes.Whileweexpecta13%YoYreductioninrevenueto$282mnon
thebackoflowercopperandzincpricesin1H09,weforecastmarginstoimproveon
thebackofeffectivecostcontrol.Thecompanymanagedtobringdownits9M09CoGS
byaround29%vs9M08.
Wedonotexpectthecostreductiontobefullysustainablegoingforward,and
thereforeforecastGGOKsCoGStogrowataCAGRof12%in201012vsa9%CAGRin
revenuesduringthatperiod.However,wedoanticipatethatthelowercostbasewill
haveapositiveimpactonmargins,assummarisedinFigure7below.
Figure7:Keyfinancialfigures($mn)
2005 2006 2007 2008 2009E 2010E
Sales 148 260 302 325 282 369
EBITDA 37 111 104 75 91 164
EBITDAmargin 25% 43% 34% 23% 32% 44%
Netincome 17 67 53 8 35 87
Netmargin 12% 26% 18% 3% 13% 23%
Source:Companydata,Atonestimates
Weforecastrevenuegrowthof31%YoYfor2010,to$369mn,drivenbyhighermetal
pricesandanincreaseincopperoutput,whichweexpecttorise2%YoYtoabout79kt.
WeexpectthistogenerateanincreaseinEBITDAof79%YoYto$164m,withnet
incomeclimbing145%YoYto$87mn,demonstratingthefirmsoperationalleverage.
-
8/7/2019 Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15
32/62
3
2
Debtloadismanageable
GGOKsdebtpositionremainsmanageable,inourview.Bytheendof2009weexpect
grossdebtofaround$232mn,withlongtermdebtaccountingformorethan90%of
thetotal.Thisimpliesagrossdebt/EBITDAratioof2.5x,downfrom3.2xattheendof
2008(Figure8).
Figure
8:
Debt
load
0
100
200
300
400
2005
2006
2007
2008
2009E
2010E
2011E
2012E
2013E
2014E
2015E
0.0
1.0
2.0
3.0
4.0
Gross debt(LHS $mn) EBITDA(LHS $mn)
Gross debt/EBITDA(RHS)
Source:Companydata,Atonestimates
Duetotheongoingexpansionprogrammeweexpectthedebtloadtoremainstablein
thenearfuture.Nevertheless,weconsiderthecurrentlevelofdebttobemanageable
aswebelievethatinternallygeneratedcashflowsshouldbemorethansufficientto
servicefuturerepaymentcommitments.Moreover,GGOKshouldbeabletorelyon
theongoingsupportofitsparentcompany,UMMC,forwhichitisthekeyproducing
asset.
Valuation
WebaseourvaluationonaweightedaverageofourfiveyearDCFcalculation,withacombinationof6x2010forecastP/Eand4x2010forecastEV/EBITDAmultiples,taken
inproportion50:25:25,respectively.OurDCFmodelassumesaterminalgrowthrateof
1%andaWACCof11.9%.Thisresultsinafairvalueestimateof$671perordinary
share,implying124%upsidepotential(Figure9).WethereforeratethestockaBUY.
Figure9:Elementsoffairvaluecalculation($/share)
717671
840
563
300
0
200
400
600
800
1000
Current
share
price
DCF
P/E
EV/EBITDA
Fairvalue
Source:Bloomberg,Atonestimates
Withinthisvaluation,webelieveourDCFcalculationallowsustoincorporatenotjust
thecurrentfinancialpositionofthecompanybutalsoitsvisiblefuturedevelopment
opportunities.WesummariseourDCFapproachinFigure10below.
Grossdebt/EBITDAratioisaround2.5x
-
8/7/2019 Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15
33/62
3
3
Figure10:GGOK DCFmodel($mn,unlessotherwisestated)
2010E 2011E 2012E 2013E 2014E 2015E
NOPLAT 114 128 127 78 59 63
Amortisation 28 31 33 31 32 34
Capex 100 83 67 31 32 34
ChangeinWC 6 10 11 3 8 5
FCFF
36
66
83
81
51
58
WACC(%) 11.9%
DiscountedFCFs 270
Terminalvalue 290
Netdebt,2009E 212
Fairequityvalue 348
Numberofshares(mn) 0.6
Fairvalue($/share) 563
Source:Atonestimates
OurDCFvaluationincorporatesGGOKsgrowthplans,andresultsinafairvalue
estimateof$563pershare.Inourdownsidescenario,wealsoconsideredascenario
whereproductionvolumesremainflat,withthecompanysimplyseekingtomaintain
marginsattheirfiveyearhistoricalaverage.ThiswouldresultinaDCFof$455/share,
whichrepresents52%upsidetothecurrentshareprice.
WehavealsolookedatthesensitivityofourfairvaluecalculationtovariousWACCand
terminalgrowthrateassumptions,assummarisedinFigure11below.
Figure11:FairvaluesensitivitytoWACCandterminalgrowthrateassumptions Terminalgrowthrate
WACC 0.0% 0.5% 1.0% 1.5% 2.0%
9.9% 730 747 765 786 809
10.9% 686 699 713 729 747
11.9% 649 659 671 683 697
12.9% 618 626 635 645 656
13.9% 591 598 605 614 622
Source:Atonestimates
OurcomparativeanalysisgivesanideaofGGOKsupsidepotentialinlightofthe
currentmarketenvironmentandgeneralinvestorattitudetowardsthesector.We
havecomparedGGOKwithRussianpeersandcopperproducersfrombothdeveloped
markets(DM)andemergingmarkets(EM).
AsshowninFigure12below,thecompanyissignificantlyundervaluedvsDMandEM
peersonboth2010Eand2011Emultiples.Inparticular,GGOKtradesat84%and89%
discountstoDMandEMpeers,respectively,basedonitsforecast2010EP/Emultiples
(Figure12).
Figure12:GGOKcomparisonwithpeers(medianvaluationratios)
2010 2011
P/E(x) P/S(x) EV/S(x) EV/EBITDA(x) P/E(x) P/S(x) EV/S(x) EV/EBITDA(x)
Russianpeers 2.8 0.5 1.1 2.4 2.4 0.4 1.0 2.2
Developedmarkets 13.4 2.1 2.5 7.1 10.6 1.9 2.2 5.8
Premium/(Discount) 79% 76% 57% 66% 78% 76% 57% 62%
Emergingmarkets 19.0 2.4 2.3 10.8 12.7 2.1 1.9 7.8
Premium/(Discount) 85% 79% 53% 77% 81% 79% 49% 72%
GaiskyGOK 2.1 0.5 1.1 2.4 1.9 0.4 1.0 2.2
DMPremium/(Discount) 84% 76% 57% 66% 82% 76% 57% 62%
EMPremium/(Discount) 89% 79% 53% 77% 85% 79% 49% 72%
Source:Bloomberg,Atonestimates
-
8/7/2019 Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15
34/62
3
4
Basedonourforecast2010EEV/EBITDAmultiples,GGOKtradesata66%discountto
DMcompaniesanda77%discounttoEMones.
WebasedourvaluationofGGOKon6x2010forecastP/Eand4x2010forecast
EV/EBITDA,resultinginvaluationsof$840/shareand$717/share,respectively.
AsummaryofourfairvaluessensitivitytovariousP/EandEV/EBITDAmultiplesis
giveninFigure13.
Figure13:FairvaluesensitivitytoP/EandEV/EBITDAmultipleassumptions P/E
EV/EBITDA 4.0 5.0 6.0 7.0 8.0
2.0 468 503 538 573 608
3.0 535 570 605 640 675
4.0 601 636 671 706 741
5.0 667 702 737 772 807
6.0 733 768 803 838 873
Source:Atonestimates
A
final
thought:
GGOKs
shares
still
lag
the
recovery
in
metal
prices
WehavelookedattheperformanceofGGOKsstockvsthecopperpricerecovery
sincethebeginningof2009.Figure14belowrevealstwodistinctperiodsintheprice
performancesofcopperandGGOKsshareprice.WhileintheprecrisisperiodGGOKs
sharestrackedchangesinthecopperprice,theyhavefailedtodososincethestartof
therecovery.
Figure14:PerformanceofGGOKsharesvscopperprice
0
2000
4000
6000
8000
10000
Jan07
Apr07
Jul07
Oct07
Jan08
Apr08
Jul08
Oct08
Jan09
Apr09
Jul09
Oct09
Jan10
Apr10
0
200
400
600
800
1000
Copper,$/t(lhs) GGOK,$/share(rhs)
Source:Bloomberg
Wenotethatwhilethecopperpriceisapproachingitsprecrisishighsandhasalmost
returnedto$8,000/trecently,GGOKssharesaretradingatlessthanhalftheirearlier
levels.Thisdivergenceisnotjustifiedinourview,andhenceweseethepotentialforanupwardcorrectionintheshareprice.
-
8/7/2019 Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15
35/62
3
5
KeyFinancials
Figure15:Incomestatement(RAS,$mn)
2008 2009E 2010E 2011E 2012E 2013E 2014E 2015E
Sales 325 282 369 412 439 410 423 446
CoGS 245 185 197 220 245 277 312 329
Grossprofit 80 97 172 192 194 132 111 117
SG&A 34 28 36 40 43 40 41 44
Operatingprofit 46 70 136 152 151 92 69 73
EBITDA 75 91 164 183 185 124 101 107
Interestexpense,(net) 7 27 20 23 23 14 10 11
Otherincome 12 32 29 33 35 33 34 36
Otherexpense 39 33 37 41 44 41 42 45
EBT 12 42 108 121 120 70 51 53
Incometax 1 7 22 24 24 14 10 11
Netincome 8 35 87 97 96 56 40 43
Margins(%)
Gross 25% 35% 47% 47% 44% 32% 26% 26%
Operating 14% 25% 37% 37% 34% 23% 16% 16%
EBITDA 23% 32% 44% 44% 42% 30% 24% 24%
Net 3% 13% 23% 23% 22% 14% 10% 10%
Source:Companydata,Atonestimates
Figure16:Balancesheet(RAS,$mn)
2008 2009E 2010E 2011E 2012E 2013E 2014E 2015E
PP&E 126 123 146 164 174 174 174 174
Constructioninprogress 282 263 313 347 370 370 370 370
Totalnoncurrentassets 408 387 460 512 545 545 545 545
Inventories 35 45 40 42 44 49 56 59
Accountsreceivable 22 41 45 56 66 62 64 67
Other 27 17 19 20 21 21 23 23
Cash 3 20 80 129 177 116 121 157
Totalcurrentassets 88 122 185 248 308 249 262 306
Totalassets 496 510 644 760 853 794 808 851
Totalequity 199 233 320 416 512 569 609 652
Longtermloans 219 215 252 265 262 153 128 130
Deferredtaxliabilities 9 9 9 9 9 9 9 9
Totallongtermliabilities 227 224 261 274 271 162 137 139
Shorttermloans 20 17 31 33 33 21 19 14
Accountspayable 49 36 32 36 37 42 43 45
Totalshorttermliabilities 70 52 64 69 70 63 61 60
Totalliabilities 297 277 325 343 341 225 199 199
Totalliabilities&equity 496 510 644 760 853 794 808 851
Source:Companydata,Atonestimates
-
8/7/2019 Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15
36/62
-
8/7/2019 Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15
37/62
3
7
WeinitiatecoverageofUchalinskyGOK(UGOK)withaBUYratingandafairvalue
estimateof$20.60/share,representing42%upsidepotential.AlthoughourDCF
modelshowsonlymodestupside(duetofallingzincoutput)thestockstilllooks
undervaluedcomparedtoitspeers.DespitethelowerupsidecomparedtoGGOKor
UELM,thestockoffersastrongbalancesheet,withlowerdebtcomparedtoits
peers.
Figure1:UGOKRussiaslargestzincconcentrateproducer
UGOK'sshareofRussianzincin
concentrateproduction(2009E)
UGOK
70%
Other
Co's
26%
UMMC
other
4%
UGOK'sshareofRussiancopperin
concentrateproduction (2009E)
Norilsk
69%
UGOK
7%UMMC
other
21%
Other
Co's
3%
Source:Reuters,Companydata,Atonestimates
Companyplanstoincreaseplantcapacityby20%in2012.Copperandzinc
concentratesalesaccountforaround77%ofUGOKsrevenues.Weestimatethat
UGOK(includingitsSibaysubsidiary)produced96kt ofcopperconcentrate(up5%
YoY)and109ktofzincinconcentrate(down6%YoY)in2009.Thecompanyintendsto
increaseitsenrichmentplantcapacityby20%,from5.4mntpato6.5mntpaby2012,
boostingitscopperconcentrateproductionby8%.
Zincconcentrateproductiontofall.Wehaveincorporatedcompanyguidanceonzinc
concentrateoutputinourmodel,assuminga26%reductioninproductioninthenext
fiveyears,from109ktcurrentlyto81ktin2015.Asaresult,weexpectzincssharein
revenuegenerationtodecreasefromthecurrent21%to17%in2015.
Mostbasemetalpricesexpectedtorecover