Metals and Mining

May go bust. Creditors will not mind. Minority shareholders should SELL.

In 1Q09, OJSC Enakievo ISW sold its 37.04% stake in JV Metalen LLC to Metinvest Holding LLC. The price is unknown; our estimate is USD 55-65 mln. Our interpretation: Metinvest Holding provided OJSC Enakievo ISW with liquidity, to be used in particular for the construction of Blast Furnace No. 3. Metinvest benefited from that deal by effectively increasing its share in the Enakievo ISW group, because OJSC Enakievo ISW will now have to issue 9.07 mln new shares in order to acquire all rights in Metalen (previously, we expected the issuance of 5.71 mln new shares). We also do not rule out additional share issuances aimed at financing BF No. 3’s construction.

On November 12, 2008, 272.57 mln of shares of Khartsyzk Pipes & Tubes (10.49%) changed hands. Most remarkably, the deal went through the PFTS exchange, the price being UAH 2.12 (USD 0.367) per share, for the deal’s total of USD 100.15 mln. We argue that the deal was not technical, and instead likely indicates that Metinvest needs cash, likely for an acquisition. The shares may now serve as the collateral. Should more HRTR deals go through, it may indicate a complete and permanent sellout, but only with additional support for such a possibility.

The corporate structure of the Enakievo ISW group requires a cleanup: the OJSC Enakievo ISW and Metalen LLC should merge. We speculate that the reorganization: (1) will take place by the year’s end, (2) will follow a particular scenario, and (3) will be positive for Enakievo ISW’s stock.

After an adventurous summer, the young Ukrainian business wizard is about to learn many useful lessons and to face his toughest opponent yet.

Depression on the steel market is confidently pushing its way upstream. The record-high USD 600-700 per mt domestic coke prices during Jul-Sep had been highly detrimental for domestic steelmakers. However, for more than a month, Ukrainian coke and coal prices have been falling. Last week, the price of coal imported from Russia has at last joined the downward dynamics. Notably, Ukrainian coke prices detached from world export levels and fell to levels close to domestic Russian and Chinese prices. This costs decrease is hugely positive for Ukrainian steelmakers. Meanwhile, even as coke fell to USD 332 per mt, coke makers continue to preserve some margins by depressing coal prices. Nevertheless, even though shares of coke makers are being traded at record-cheap levels on T12M multiples, the outlook is uncertain due to production volume decreases, which are expected to accelerate.

At the October 25 AGM, Azovstal’s shareholders will decide on dividends for 2002–2007 (maximum USD 0.264 per share, 124% yield). Azovstal has got some cash and, more importantly, the balls — the grinding ones, for supplies of which, together with other steel products, Azovstal can collect from its currently highly profitable ore-mining Metinvest Group partners. The wild card is Azovstal’s huge accounts receivable due from the Group’s traders (USD 0.211 per share, 100% yield), which are much less liquid assets under the current difficult conditions on the steel markets. Whether Metinvest has got the balls to actually declare dividends, and how much, remain open questions for ballsy investors to bet on.

On August 22, various sources reported that POSCO, a leading world steelmaker, is interested in several unnamed Ukrainian assets: an iron ore mine and, possibly, a steelmaker and even a shipyard. We think that Zaporizhstal, together with CJSC Zaporizhya Iron Ore Combine, may be the targets.

The profitability of coke makers depends on the balance between the prices of furnace coke (70-85% of sales, used in iron & steel production) and coking coal (75-90% of costs, most important grades are K and Zh). During the week of August 11-15, Ukrainian coking coal prices increased dramatically: K grade concentrate appreciated from USD 227 to USD 378 per mt (+67%), whereas Zh grade concentrate jumped from USD 199 to USD 346 per mt (+74%) (source: Metal Courier). We fully expected such an increase (see our July 15 Flash Note) in our valuations of Ukrainian coke makers. During the same week, coke appreciated 15% (from USD 612 to USD 702 per mt), adding to the 30-60% jump during the week of July 7-11. We reiterate our valuations of the three best companies in the sector, in which such a coal price increase had been accounted for. The risk of a coke price decrease following the recent correction in steel prices is also discussed.

On August 15, Azovstal, the leading Metinvest Group steelmaker, announced its intentions to invest USD 1 bln into ecological improvements. We focus on one of the items of this program that were announced, a stepwise retirement of three coke batteries. We have long suspected that Metinvest will shut down these coke batteries eventually, which would likely secure a substantial, about 1.1-1.2 mln tpa, increase in output for Avdiivka Coke, the main Metinvest coke maker. Today’s news confirms our suspicions and strengthens the case for BUYing Avdiivka Coke.