Investing in Ukraine: changing rules of the game

Abstract

Over at least the next six months, we are going to see extremely low and economically unjustified valuations. The local Ukrainian stock market will lack the fuel for sustainable appreciation, if any, as funds unload their portfolios and some close altogether. By our estimates, the outflow from EM equity funds over November-December will reach USD 10 bln, increasing the total tally for the year to USD 50 bln.

In this report we introduce recommendations for Ukrainian equities from our coverage universe. We set upsides assuming crossing the full spread and expected local currency depreciation of 15-20% next year - Upside Effective. Beta, Liquidity, Leverage, Upside Effective - we see these as keys to trading in the current BLUE market.

Table of Contents

TABLE OF CONTENTS

Part 1. Changing rules of the game
Seize volatile market opportunities
Ukrainian assets are trading at levels unjustified by purely economic reasons.
Corporate profitability reached a new record high in 1H08
Yields on Ukrainian fixed income instruments have overshot the earnings yields of Ukrainian stocks by a wide margin
Our basis for screening stocks in coming months is to shun credit risks, and tend toward more liquid names.
Stocks vs. Bonds
Equities

Fixed income
Fixed income ideas
1) Sovereign Eurobonds
Ukrainian government
2) Corporate Eurobonds with high credit quality and strong parent support
Equity ideas
Sector-wise
High dividend yield
Low P/Net Cash
Discount to intrinsic P/E
Corporate solvency
Warning list
Early bond redemptions and maturities

Ukrainian equities key valuation metrics
Ukrainian equities key valuation metrics (continued)
Ukrainian equities key valuation metrics (continued)
Corporate profitability at historic high
1H08 results of the PFTS' top-150 companies:
Where will profitability be in 2H08 and 2009?

APPENDIX
Estimation of market CoE
Stock performance
Sector multiples

Part 2. BLUE market guidelines

Little chance for market to lift in coming months
Trading on volatility
Taking liquidity into account gives discriminative power
B.L.U.E. mode
Long-term recommendations
Models recalibrated
Next year earnings estimates halved for our coverage universe
BLUE(1) picks

BUY list
SELL list
Ukrainian equities: recommendations (continued)
Forecast revision summary by sector
Key fundamental forecast revisions by company
Key fundamental forecast revisions by company (continued)

CHARTS
Stock indices relative performance
Most oversold stocks YTD
Spread: equities earnings yield over government bond yield
Outstanding sovereign Eurobonds
Ukraine' s sovereign yield curve
Cost of default protection, bps
For those who see reasons to play on the steel rebound, our recommendation is exposure to metals & mining through SCM/Metinvest-related stocks: Azovstal, Avdiyivka Coke, and Enakievo Steel - among the few relatively liquid companies with little leverage. Metinvest-controlled producers, backed by the strongest integrated steel group in Ukraine, will stay in business the latest among Ukrainian sector players if global market conditions worsen under the polar negative scenario. At the same time, these stocks could react sharply to improving market fundamentals.
Capital investment by financing sources, January - June 2008
In 1H08, corporate profitability made another historic high

TABLES
Our picks
Key market data
Key economic data
Upside based on franchise value model
Franchise value model (Approach 1)
Franchise value model (Approach 2)
Leverage and interest coverage by industry, as of 1H08
Key credit metrics by company
Local bonds with maturities and put options coming due in the next 12 months
Ukrainian equities key valuation metrics
Results by sector
Stock performance
Sector multiples
Ukrainian equities: recommendations
Earnings revisions
Revenue forecast revisions
Key fundamental forecast revisions by company