Research

Recently PFTS saw a worst ever performance with –10% fall this week while global equity markets performed fairly better. In our view the reason for that was the artificially created lack of liquidity on the local money market as the interbank overnight rates skyrocketed to 40%. The prices at which the stocks are traded at the moment seemed unreasonably cheap to us as we see the recovery starting in May. We recommend using the momentum for acquiring Ukrainian stocks.

We revise our April 04 recommendations due to substantial decrease in stock prices. We correlate the drop of the Ukrainian stock market with a local, temporary, artificial liquidity crisis. Those with cash have several opportunities to buy cheap.

Farmak is one of the top three pharmaceutical producers in terms of output volumes in Ukraine with a strong position on the domestic market. Its well-recognized brand portfolio consists of 140 products. Stable revenue growth (+21.2% YOY and +38.9% YOY in 2006 and 2007, respectively). In 2008, the EBRD gave it a CapEx of USD 24.2 mln. Ownership is concentrated in one hand. We recommend BUYing Farmak, with an upside of 80.3% and are setting a fair target price of USD 85.7 based on several factors that, in our opinion, will drive FARM’s market price up.

The stock of Donetskgirmash [DGRM UZ] has long remained a rather promising pick in the market due to its noticeably lower than the industry’s average EV/Sales and P/Sales ratios. However, for the last two years the negative profitability has been inevitably reported by the company at the year-end: USD 3.5 mln net loss in 2006 was followed by the USD 7.2 mln net loss in 2007.

Ukraine is in the WTO, at last. Thursday, Ukraine’s parliament approved protocol on Ukraine’s accession to the WTO. This was the final step needed for the country to access the organization, after Ukrainian President Viktor Yushchenko and WTO Director- General Pascal Lamy signed the accession protocol on Feb. 5, 2008 in Geneva. Ukraine has been trying to enter the WTO for 15 years and this final outcome is a strategic gain. We expect gradual improvements in the quality and volume of Ukrainian exports in the forthcoming years.

Azovzagalmash [AZGM], a leading producer of carriages within the Azovmash holding, showed an impressive performance in 2007, having increased its net sales 52% YoY. AZGM produced 6,045 freight carriages during the year and while total carriage-building products constituted 87% of the company’s output. The company plans to increase its production in 2008 by another 24% YoY, which is a higher number than the one expected for MZVM’s 2008 production growth rate. We believe AZGM is going to remain a leading carriage building asset for Azovmash, which should be capable of fulfilling the holding’s strategic plans of preserving and extending its share in the Russian market.

Mariupol Heavy Machinery [MZVM], a member of the Azovmash holding, specializes in producing boxcars, gondola cars, tank cars, open rail cars and hoppers, as well as miscellaneous heavy machinery equipment. In 2007, the company went through the restructuring of its product mix, determined to take advantage of the growing demand for carriage-building products in Russia. The percentage of the carriage building-products put out by MZVM in 2007 grew 1.6x YoY, with, 84% of MZVM’s total output going to export in 2007, with Russia as the company’s major customer. In 2007, 60% of the total product mix constituted newly developed products, such as automobile carriers, new models of crane equipment, special-purpose cars, etc. Nevertheless, the 2007 net sales growth dynamics were disappointing, with slightly more than 3.4% YoY growth reported by the company.

We introduce an equation for Ukrainian Iron & Steel Works: Minority Value = Corporate Governance * Asset Quality * Investors’ Analysis Crucially, the larger Metallurgy and Mining Groups (MMGs) are just emerging in Ukraine, and the strategies of their owners (Corporate Governance) affect the stock prices (the apparent Minority Value) of the member companies (ISWs). Investors must understand the factors and patterns at play (Investors’ Analysis). In particular, it is beneficial to understand the intentions of an MMG owner and to react mindfully to Corporate Governance trends and moves that substantially distort Asset Quality, creating dangerous illusions. We suggest the investors play a long-term game and look for the underpriced, high quality assets that can still be found in the sector. Despite the development problems and tricks of Ukrainian MMGs, recognizing only them and overlooking genuinely underpriced stocks would be just another illusion.

The privatization process in the electricity sector, insisted on by the current government, has revealed the existing corporate conflicts among leading Ukrainian business groups. These conflicts were mainly to blame for the failed AGMs at Centrenergo, Dniproenergo, Krymenergo, Volynoblenergo, etc. On March 28, 2008, Kyivenergo [KIEN UZ] failed to hold an AGM for the same reason.We believe these conflicts will have no substantial influence on the current operational activity of the companies and therefore reiterate our BUY recommendation for Kyivenergo, with a target price currently under review.

The Ukrainian electricity industry is going through the process of modernization and reform. Planned privatization of electricity companies and the ongoing industry reform, coupled with possible export liberalization, opens new perspectives for the companies in the sector. Once the current “cost plus” tariff calculation method is changed to a more economically sound RAB-based method, we expect the sector to be revaluated, creating new investment opportunities.