Machinery

The Zaporizhya-based Motor Sich [MSICH UZ, BUY] company – the largest producer of aviation jets and gas-turbine units in the CIS – now faces two key risks, which are lack of money amongst buyers and its exports to Russia, according to recent news by Umgk.info news portal.

MSICH’s production dropped 25% in 4Q2008. While some products were made according to order place, now MSICH is experiencing problems in that some of these clients no longer have the means to pay for them, with such products now stored in the warehouse. This past week, the company announced that it will be moving to a three-day work week, while still trying to avoid mass layoffs.

Regarding exports to Russia, Ukraine’s potential NATO membership could cause problems with respect to fulfilling Russian orders, despite MSICH’s capability to completely fill orders for Russian helicopters. MSICH exported 450 helicopter engines to Russia in 2007 and had planned for 600 in 2008. However, Umgk.info confirms that Motor Sich may be cut off from further Russian orders, while Russia instead enters into contracts with manufacturers from other NATO countries and simultaneously aims for its own serial production of helicopter engines.

Our view: This news is unquestionably NEGATIVE for Motor Sich. It seems MSICH’s problems regarding payments for contract fulfilled has resulted less from cancelled orders and more from delays in funds transferred from abroad for contracts, due to the tighter control on money transfers imposed European and U.S.banks. Currently, according to Vyacheslav Bohuslaev, the monthly debt on contracts is about USD 60 mln, but thus sum is constantly changing, due to delays of up to two months in the receipt of contract payments. We suppose that the debt owing on contracts is mostly from clients in Russia and Ukraine, which are experiencing problems with liquidity.

Indeed, Sokrat has previously identified too heavy a reliance on the Russian market as a great risk for the company. The Russian Government has announced plans to produce 15% of the world’s helicopters by 2015, for which about 500 engines a year will have to be produced. Despite skepticism on the part of many experts, if this ambitious plan is realized in full or even in part in the next seven years, this means the inevitable abandonment of Ukrainian products.

In the meantime, in spite of Russia’s otherwise-stated opposition to dealing with Ukraine should it gain NATO member status, Russia continues to award contracts to companies from other NATO member-countries: Ka-226 helicopters are fitted with Rolls-Royce engines, Ka-226T machines are fitted with Arrius engines from the French company Turbomeca. As well, the Mi-38 should have received engines from Pratt & Whitney Canada, but that contract fell through.

According to Russian estimates, the current procurement of helicopter engines from Ukraine is worth USD 50-80 mln per year. Specifically with respect to the Mi-2 helicopter, for which MSICH provides high-quality engines, Russia’s fleet has more than 400 that have reached their service life, in addition to those tailored to the Yak-58, Be-103, Yak-152, and Su-49.

Justifiably so, the company’s strategy is increasingly directed at diversifying sales markets, which has allowed the company to boost its number of orders from Asian countries, which have suffered less from the international crisis, as demonstrated by recent contracts with Iranian, French, Chinese, Libyan and Indian clients (see details in previous Sokrat news). We think that new contracts will be positive steps in diversifying the company’s client portfolio, which will allow the company to decrease its dependence on the Russian market.

According our estimates, MSICH’s revenue in 2008 will be USD 392.3 mln, with an EBITDA margin of 16% and net margin of 8%. We reiterate our BUY recommendation, with USD 182.9 as a fair value per share. For our 27-page November 2008 report “Motor Sich: Facts Support Strong Prospects” please contact the Head of International Sales, Constantine Lisnychyy at +38 050 310 0819, lisnychyy@sokrat.kiev.ua.

The Bogdan Corporation has announced that it is, so far, not ruling out the possibility that the company may have to lay off 2,000 of the 10,000 personnel presently employed at its enterprises over the period of January-March 2009. This statement was made by the corporation’s Press Secretary Serhii Krasulia, who explained that it is being forced to cut production because the authorities (including the prime minister and the president) are doing nothing during the current financial and economic crisis and this may force the corporation to reduce the number of its employees.

Krasulia stressed that, until recently, the corporation had hoped it could avoid laying off significant numbers of people and, instead, resort to limiting operations to a single shift. However, the current situation means that the company now faces the real possibility of having to dismiss workers at the outset of 2009. The official noted that layoffs may be temporary if the economic crisis is overcome and auto manufacturing begins to grow, enabling the corporation to return staff levels to current levels. He also said that productivity at the corporation’s enterprises has risen significantly in the midst of this current crisis and on the eve of this possible layoff.

The Bogdan Corporation forecasts the volume of the Ukrainian new cars market will fall by 310,000-330,000 units (or from 50.82-52.38%) to 300,000 units in 2009 compared with its forecasted volume for 2008.

The Bogdan Corporation is the parent company of the Bogdan Automobile Plant [LUAZ UZ, BUY] and is the auto division of Ukraine's Ukrprominvest group. Apart from the Bogdan Corporation also includes 19 other companies, among which are OJSC Cherkasy Bus and Hyundai Motors Ukraine.

Our view: This news is, certainly NEGATIVE for the Bogdan Corporation. Indeed, this week’s introduction by Parliament of a law temporarily introducing additional duties of 13% on all imports, excluding critical imports (adopted on December 23), may provide a security blanket for the Bogdan Corporation, allowing it to lay off a smaller number of people. However, the adoption of this law by Parliament is not the end of the road for this legislation, as it still requires President Yuschenko to sign it into law. This may be problematic or result in a delay in its approval, in a best case scenario, since the President has already spoken out publicly in opposition to this legislation for reasons unrelated to the automobile manufacturing industry.

We also hold a positive view with respect to local motor vehicle producers (e.g. LUAZ and UkrAvto). An increase in import duties on foreign cars, together with the virtual end of retail loans programs focusing on the car segment, will be a supporting factor for local vehicle manufacturers, as the bill would spur demand for domestically-produced goods and thus support domestic producers. This may be the right step to make on the part of the government as we anticipate an overall curb of Ukrainians’ purchasing power that will trigger a downturn in consumer demand. The bill would effectively counteract the negative impact of a purchasing power drop and will support Ukrainian producers.

The Bogdan Corporation has called again on the Ukrainian authorities to take urgent measures to support the national automobile industry, warning that government failure to assist will force the company to lay off significant numbers of its employees. However, we think that Bogdan must focus on the development of its sales strategy, customer stimulation programs, and loyalty improvement.

For an in-depth analysis of the Bogdan Automobile Plant, see our October 13 flash note “Bogdan Automobile Plant – Consolidation on the Final Lap” and our report “Bogdan Automobile Plant – Ready to Shoot Forward” of August 2008. For more information please contact the Head of International Sales, Constantine Lisnychyy, +38 050 310 0819, lisnychyy@sokrat.kiev.ua

The Zaporizhya-based Motor Sich [MSICH UZ, BUY] company – the largest producer of aviation jets and gas-turbine units in the CIS – has announced its intention to deliver helicopter engines worth USD 12-13 mln to Canada. This announcement was made by Vyacheslav Bohuslaev, the Chairman of MSICH’s Board of Directors in an interview with the “Delo” newspaper.

Motor Sich reported a net profit of UAH 236.190 mln in 2007, while its net revenues increased by 52.04% (or UAH 146.066 mln) to UAH 426.743 mln compared to 2006.

A 9.7% stake in Motor Sich, which is an open joint-stock company, belongs to Bartens Alliance Ltd, (USA), 5.7% to the Kyiv-based Finance and Credit Bank, and 61% belongs to management and employees, including a 15% stake owned by Vyacheslav Bohuslayev, the Chairman of Motor Sich’s Board of Directors. About 24% is a free float.

Our view: This news is definitely POSITIVE for Motor Sich, whose activity with Canada is a logical extension of previous contracts for supplying clients there with various engine parts. MSICH’S order book for 2009 has grown considerably and signed agreements will allow the company to retain positive sales growth in 2009, with revenues from the supply of aircraft engines and helicopter engines estimated to be at least USD 450 mln. The growth rate for some engines in 2009 is expected to rise as much as 60%.

The company’s strategy is now increasingly directed at diversifying sales markets, which has allowed the company to boost its number of orders from Asian countries, which have suffered less from the international crisis, as demonstrated by recent contracts with Iranian, French, Chinese, Libyan and Indian clients (see details in previous Sokrat news). We think that new contracts will be positive steps in diversifying the company’s client portfolio, which will allow the company to decrease its dependence on the Russian market.

This week it was also revealed that MSICH is experiencing difficulties receiving funds transferred from abroad for contracts, due to the tighter control on money transfers imposed European and U.S. banks. Currently, according to Vyacheslav Bohuslaev, the monthly debt on contracts is about USD 60 mln, but thus sum is constantly changing, due to delays of up to two months in the receipt of contract payments.

According our estimates, MSICH’s revenue in 2008 will be USD 392.3 mln, with an EBITDA margin of 16% and net margin of 8%. We reiterate our BUY recommendation, with USD 182.9 as a fair value per share. For our 27-page November 2008 report “Motor Sich: Facts Support Strong Prospects” please contact the Head of International Sales, Constantine Lisnychyy at +38 050 310 0819, lisnychyy@sokrat.kiev.ua.

Sumy Frunze Machine Building [SMASH UZ, N/R], one of largest European producers of equipment for the oil, gas, and chemical industries, has announced that it expects to increase its production by 40% YoY in 2008, which would put the total at roughly UAH 1.92 bln in value terms. For the same period, the company anticipates that its sales will grow by 51% YoY, from USD 281.4 mln in 2007 to reach USD 425.4 mln in 2008.

As Sumy Frunze’s Director General Igor Ivanov stated in a press release, these results may primarily be attributed to the introduction of modern management techniques, the use of advanced technologies and improvement in its planning process. An additional contributing factor to this growth is the market for gas-compressor units.

The company exports about 95% of their products, with clients mainly located in Russia and Central Asia. Among its largest customers are the Russian companies ‘Gazprom’ and ‘Surgutneftegaz’ and Turkmen companies ‘Turkmenneft’ and ‘Turkmengaz’. Russia’s Purgaz company, for whom SMASH delivered gas pumping units and equipment to the Gubkinskoe gas condensate deposit, has also recently appeared on the scene.

The company was founded in 1896 and specializes in the production of gas pumping units and complete compressor stations for different purposes, centrifugal, vacuum, chemical pumps, centrifuges and equipment for chemical, gas and petroleum industries. It is part of the Energy Standard Group (Kyiv) owned by Ukrainian businessman Kostiantyn Grigorishin, along with a number of other large machine manufacturing enterprises.

Our view: This news is POSITIVE for Sumy Frunze Machine Building. Indeed, the company has been successfully filling its order book, which confirms its high quality and competitiveness.

At present, about 40% of the equipment for Gazprom’s gas pumping capacities is produced by SMASH. Their continued strong cooperation will provide for the growth of Sumy Frunze sales in the background of Gazprom’s large projects, such as the building of the ‘North Strand’, ‘South Strand’, Caspian gas pipeline and ‘Yamal-Europe-2’ pipeline.

It appears that SMASH supplied Gazprom with an estimated USD 95 mln in products in 2008, including equipment for the reconstruction of a compressor station at the Yamburg field. This dollar figure excludes the value of several large orders that have yet to be fulfilled, among which are the supply of gas pumping devices to the Griazovetskaya compressor station and the Zapolyarnaya linear compressor station at the Zapolyarnaya oil-gas-condensate deposit, equipment for the reconstruction of existing units at the Urengoy oil-gas-condensate field.

The fact that SMASH is also not completely reliant on Russian clients is a good sign, as Central Asian deposits of oil and gas continue to be explored and developed. SMASH is strengthening its position in this region, and especially in Turkmenistan, which will drive its orders in the near future. There may also be additional prospects for contracts with the Government of Bulgaria with respect to equipment for implementing various international energy projects and local gas transmission stations. SMASH is also pursuing deals with Ukrainian clients, which include the ‘Ukrtranshaz’ company (a subsidiary of Naftohaz Ukrainy) for gas-pumping units at the recently-commissioned Bobrovytska compressor station (Chernihiv Region).

Due to the current world economic slowdown and the dramatically dropping oil price, we expect that the machinery sector, which provides equipment for the oil & gas sector, will defiantly decrease. Most of the largest oil companies have recently announced cuts to their investment programs for 2009-2010. We think it will be a straight negatively impact on all oil & gas equipment producers, including SMASH. The influence of decreasing demand on volumes and price levels can put negative pressure on anticipated SMASH revenue figures in 2009.

According to preliminary data, it appears that Zaporizhtransformator [ZATR UZ, N/R] – the world's largest manufacturer of transformer equipment – will achieve a 2008 sales level of about USD 700 mln, which is 70% higher than the 2007 level of USD 412 mln.

The company’s press service noted that production in 2008 a total capacity of more than 45 GVA, while it was only 37 GVA in 2007.

In 2007, the company had a net profit of USD 429.712 bln (more than 3.7 times greater than that achieved in 2006) and a net income from product sales of USD 2.081 trln (more than doubled that of 2006).

The OJSC Zaporizhtransformator produces power transformers, power units, and systems for monitoring and controlling electricity grids. It exports to 83 countries around the world. Since 2001, ZATR has been a member of the Energy Standard Group, which includes a particularly large number of machine manufacturing enterprises and is headed by businessman Konstantin Grigorishin.

Our view: This news is unquestionably POSITIVE for Zaporizhtransformator. According to company management, ZART plans to increase production up to 50 GVA in 2009. We look very optimistically at new ZATR contracts in the coming year, based on agreements that have already been signed and its created portfolio of USD 327.5 mln in 2009.

All major customers of ZATR are energy companies which require the replacement of a significant volume of equipment, including transformers. According to our estimates, the average depreciation level of the equipment installed at electricity companies is equal to 50-60%, with an average age of 20-25 years. Based on these numbers, we believe that new orders for ZATR will also follow in 2009-2011.

Also, in our view, the company has a strong position abroad and especially on the CIS market, where ZATR’s market share was around 60% in 2007 and will remain at the 50-60% level in 2009. In addition to that, we think that Zaporizhtransformator can increase its presence in Latin America, Western Europe and Asia. Based on a good diversification of its client base, the company is decreasing its dependence on particular markets. We also believe that ZATR’s current investment programs, which amount to about USD 60 mln, will positively effect the company in terms of an increase in efficiency and reduction in the cost of production.