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07.11.2008 - MDM Comment: Market Color, Ruble, TMK, KOS, Banks, Svyazinvest, SEVCON

Nothing exciting going on in the Russian financial markets today. Equities and Eurobonds are almost flat vs yesterday; zero activity in local bonds, while the ruble is stable against the basket.
Below are our key news and comments for today:
1. Arkady Dvorkovich, the economic aide to the Russian president, has said that the ruble may weaken slightly through a gradual widening of the trading band for the basket if there is a current account deficit next year. That does not count as big news, in our view. We maintain our belief that the ruble will remain stable, at least in the short term. If the price of Urals crude oil goes down to $40 and stays there for a while, some ruble depreciation will be necessary. However, we are not sure oil prices will slide so far.
2. The Central Bank of Russia (CBR) has announced the list of banks with which it has signed, or will sign, agreements to partially guarantee compensation for potential losses arising from their activity in the inter-bank market. The regulator has already signed such agreements with Sberbank, Raiffeisenbank Russia and MDM Bank. In the pipeline are agreements with VTB, Gazprombank, Alfa Bank, Rosbank, Unicredit Russia and Russian Agricultural Bank. We understand that the key criteria for selecting the banks was a rating of Ba1/BB+ or above. We welcome the move, as it will increase the chances that smaller financial institutions will receive some of the liquidity provided by Ministry of Finance and the CBR.
3. TMK (Ba3/B+), Russia’s biggest pipemaker, released yesterday its 1H08 IFRS results, and we do not see them as particularly bright. EBITDA margin declined to 17% from 24% in 2007, while the “Debt/EBITDA annualized” ratio rose to 3.9X from 1.7X in 2007. Deterioration of profitability is due to a rise in steel prices in 1H08 as well as certain delays in the pipeline projects of Transneft (A2/BBB+) and Gazprom (A3/BBB+). The rise in leverage was the result of the untimely USD1.7 bn acquisition of IPSCO. In fact, 1H08 appears at first glance looking weaker then they should, since IPSCO’s balance sheet was fully consolidated, while P&L was not (the deal was closed mid-June).
In 2H08 we expect TMK to perform somewhat better on the back of a sharp decline in steel prices, as well as the consolidation of IPSCO’s cash flows. TMK sees Debt/EBITDA at 3X at 2008FYE and plans to lower the ratio to 2X in 2009. In our view, this target does not set the bar impossibly high, as the company announced a fivefold cut of 09 capex to as low as USD150 mn (not much for a company with USD6 bn in sales and EBITDA of USD1bn).
We doubt that TMK, being one of Russia’s ‘national champions’, will experience critical difficulties in refinancing its debts going forward. In the worst case scenario, the company will be acquired by either one of its major clients (Gazprom, Transneft) or one of the steel giants (Evraz, Severstal, MMK, NLMK). We believe that the TRUBRU 09 (YTM 72%) issue has been punished to harshly during the sell-off and represents good value.
4. Standard & Poor’s has downgraded Kazanorgsintez to CCC+/Negative from B-/Stable on a deterioration in profitability and liquidity concerns. We reported the company’s very disappointing results on October 22. S&P’s, like us, sees the storm clouds of another potential covenant violation looming on the horizon (the Debt/EBITDA ratio should not exceed 6X, according to the latest edition of the Eurobond terms and conditions; while as of mid-year it had exceeded 7X). Of course, it is close to impossible to renegotiate covenants when the bond is trading at below 50% price wise. We believe that Kazanorgsintez is unlikely to default on the bond, as support should ultimately come from either the Republic of Tatarstan (one of the owners) or Gazprom group (key supplier). That said, we don’t rule out more downward movement on the KZOSRU 11 issue before it has a chance of bouncing back.
5. Svyazinvest may merge all its telecom subsidiaries (including Southern Telecom, Sibirtelecom, Uralsvyazinform, VolgaTelecom, etc) into one entity, according an Interfax report in which the CEO of Svyazinvest was quoted. The article said that such proposal will be considered as part of the strategy discussions going forward. We recommend the lenders to Svyazinvest telecoms not to take any action. First, we doubt that the merger will be approved and implemented in the near future. According to the Russian law, a merger into a single legal entity automatically grants a put to all lenders. Exactly because of that many mergers are now on hold (particularly in the banking sector) until debt markets recover and bonds start trading at above par (although the law is planned to be amended). Second, a merger would not be credit-negative anyway, as Svyazinvest telecoms have very similar credit profiles.
6. Seventh Continent (NR) has announced that it received a RUB2.5 bn facility from VTB as part of the program of state banks’ financial support to key retailers. We see the news as credit-positive for lenders to the company. The SEVCON ruble issue is trading at a 62% yield to a put in June 2009. We see better value in retail bonds now: Kopeyka, another major retailer (discounter format should be preferable now vs. supermarket format of SEVCON), has a 3-month bond offered at a yield of 200% (recently was 500%). Kopeika is also likely to obtain refinancing from state banks.

07.11.2008 14:52
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