Research

The corporate conflict at Ukrnafta led to unreasonable compression of investors’ expectations. An ignition may be close in time.

As compared to our previous report on Druzhkivka Machinery [DRMZ UZ], dated Dec. 20, 2007, this present update strives to incorporate a broader set of the company’s peers for comparative valuation and a more accurate and extended DCF model. Druzhkivka Machinery, a leading producer of mining equipment in the CIS, is steadily picking up the pace in its sales volumes, and boasts a strong improvement in its financials. Our previous target price for DRMZ was USD 1.97, with DRMZ then being traded at USD 0.99 per share. DRMZ is now traded at 1.22 USD per share and is maintaining a stable upward trend in line with our expectations. Our recalculated target price is set at USD 1.82 per share, which still leaves a 49% upside for DRMZ’s stock. We reiterate our BUY recommendation for DRMZ.

Right after the March 06 AGM, Daniel Valk, Dniprospetsstal’s CEO, announced that a USD 200 mln program will be implemented by the company within 2 years, likely prior to the expected 2009–2010 IPO at a Western exchange. The company is adding the final ingredients in order to become truly stainless, securing long-lasting success for its shareholders. We update our view of the stock accordingly.

Motor Sich [MSICH], the sole Ukrainian manufacturer of engines for helicopters and jet airplanes, has demonstrated an impressive improvement of its financials by posting a 6.2% YoY net income increase, according to preliminary 2007 financials. In terms of its production potential, the company is also in quite good shape. However, one of the risks today remains the vague perspective of the Russian market, on which Motor Sich has a long history of supplying its helicopter engines. Motor Sich’s stock displayed spectacular growth in 2007, with the market positively reacting to the company’s improving financials and the latest achievements in engine building developments, and while its profitability potential is still not depleted, investors tend to slightly overreact to any news related to the company’s Russian markets.

Khersonoblenergo [HOEN] is one of Ukrainian electricity distribution companies where privatization is already completed. Almost 95% of the company is owned by Czech energy company – VS Energy, affiliated to Russian businessman Alexander Babakov. As the company already shows better than average operational indicators, it is currently aimed at improving its financial transparency via restructuring its long term debt and bad debt write offs. Based on the replacement cost valuation method we value HOEN at USD 6.23 per share and recommend BUYing with current upside of 125%.

One of the best companies in terms of corporate governance, Concern Galnaftogaz may be able to deliver value to shareholders using a long and windy road of self-sustained development and expansion. However, ample opportunities for corporate maneuvers may present much speedier and certain ways of deliverance.

Chernivtsioblenergo, is one of the few oblenergos left with high rate of electricity losses in the grids. However, the company is successfully reducing these losses through replacement of old electricity meters and increasing modernization investments: from 34% of electricity losses in 2005 to 22% in 2007. With household consumers share strongly dominating the clientele base of the company we view the company as a better play against large industrial based oblenergos.

Indeed, 2007 was a year of challenges for the Ukrainian economy. Not even appreciating energy resources, the global financial crisis and domestic political instability could inhibit the development of the country. And we expect this growth saga to continue in 2008.

Enakievo Iron & Steel Works has been modernizing and expanding since 2000, and is poised to continue to progress until 2012. Until now, the company has utilized its conjoined sibling, Metalen LLC, which once enjoyed certain tax breaks, as a modernization vehicle. Now, Metinvest Holding LLC, the governing company of the Metinvest Group, is taking over modernization matters, and Metalen LLC will likely be acquired by ENMZ. The acquisition will likely be financed by an ENMZ share issue, which will dilute minorities’ shares. Furthermore, the financial benefits of the acquisition have been almost exhausted by the recent concentration of profits at Enakievo ISW and by investors’ excitement about the company’s stock. To avoid a correction in your expectations, price in now the likely impending stock dilution and the remaining financial benefits of Metalen acquisition. Even though ENMZ’s long-term prospects are bright, the coming 2008 will be a year of transition, possibly a turbulent one, for the company’s stock.

Oil prices rises, mixed with moderate expectations of fuel sales increases, both vindicate an upward revision of Ukrnafta’s prospects.