Metals and Mining

On July 30, Bagliy Coke launched its brand new coke battery No. 7-bis (490 thsd tpa). As a result of the launch, the output is expected to increase by 30% in 2008 (to 900 thsd mt), and further by 37% in 2009, reaching the long-term level of 1.23 mln tpa (source: Metal Courier). Source material supplies and sales should be secured through affiliation with the powerful Evraz Group, as well as due to the high domestic demand for coke. The launch increases capacity by 50%, and distinguishes the relatively small company as having the largest upside potential among the entire Ukrainian coke maker sector, which is very exciting right now.

It has just become clear that Enakievo ISW and Metalen LLC will indeed merge, and that this will happen soon. We take investors beyond overcoming these risks through the question of HOW the merger will happen. We emphasize that the minority shareholders of Enakievo ISW will be diluted 1.54 times in order to finance the acquisition of Metalen, according to the usual practice in Ukraine (Azovstal in 2006 is the most relevant example). The dilution is not a risk but a certainty, which has, for some time, been fully accounted for in our valuation of the company.

On July 11, 2008, coke prices in both Ukraine and Russia jumped 30-60%. Coal prices have much room to grow, and certainly will use some of it. This news is clearly negative for steelmakers and positive for coal mines. Our focus here is coke producers, which depend on a balance between coke and coal prices. In our view, both the profits and profitability of Ukrainian coke makers will increase even further in 2H08.

Yasynivka Coke has been rebuilt over 10 years under the Energo Group ownership. The company is now well positioned to process concentrate supplies secured by Energo affiliation on its modern facilities. We expect the company to discontinue leasing two coke batteries and selling coking charge mix, increasing the more profitable sales of coke to 2 mln mt from the current 0.4–0.5 mln mt. Due to expected 74% increase in coke price in 2008, we project an EBITDA margin of 15.8%, up 2.2 pp YoY. In 1Q08, EBITDA margin reportedly reached 17.6% (up 5.9 pp YoY) on top of 66% increase in net sales. Coke production has become a profitable business, is expected to remain such, and Yasynivka Coke is one of the best companies in the sector.

The June 06 AGM of Zaporizhstal detailed modernization plans and introduced corporate governance changes consistent with both more transparent functioning and takeover preparations. Both would be highly positive.

On April 10, Zaporizhstal signed a contract with Siemens VAI for construction of a USD 1.7 bln, 5.5 mln mt oxygen converter, continuous casting complex. Until recently, it was not clear how the company would finance this CapEx program, especially in light of persisting transfer pricing. But on May 12, it was announced that Citigroup was syndicating a USD 250 mln, LIBOR+2.5% credit for Zaporizhstal. We believe that both implementation of the CapEx program and an eventual abolition of transfer pricing have just become real. By 2012, Zaporizhstal will become much younger, modern an ISW, and will continue to be a ripe takeover target all along. For years, the company has been an outsider in both modernization and corporate governance. Now, Zaporizhstal is on a brink of huge changes not many have believed in. Largest value usually is found in such situations.

Income = Volumes * Prices * Margins. All three right hand side terms are favorable for Avdiivka Coke: in 2008, we forecast a volume increase of 35%, price hike of 74%, and strong margins.

On June 06, Metinvest Holding will likely hold its annual press conference. We expect good news to be presented, and markets to react. There is a only a week left for buying promising Metinvest Group members before their likely appreciation after the press conference.

On May 30, a Metinvest Holding official announced that the Group will supply 600 thsd mt of skelp and pipes for Central Asia – China natural gas pipeline. We affirm positive Azovstal expectations and consider possibilities regarding future of Khartsyzsk Tube Works.

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.