russian steel remain cautious as costs take centre stage

8/3/2019 RUSSIAN STEEL Remain Cautious as Costs Take Centre Stage

1/38

DINNURGALIKHANOV+7(495)2130338

[email protected]

ILYAMAKAROV+7(495)7779090ext.2644

[email protected]

Note:Pricesasofclose15Feb2011throughoutthereport.Localsharedataisforinformationonlyandwas

calculatedusingeachcompanyscommonshare/GDRratioandprevailing USD/RUBexchangerate

Forprofessionalinvestorsonly.Thisdocumenthasnotbeenpreparedinaccordancewithlegal

requirementsdesignedtopromotetheindependenceofinvestmentresearch. Pleaserefertoimportant

disclosuresandanalystcertificationattheendofthis document

WeraiseourtargetpricesforRussiansteelmakersEvraz,MMK,SeverstalandNLMKto

reflectstrengthening

steel

prices.

However,

we

advocate

aselective

approach

to

stock

pickingin2011astheindustrycontinuestofaceanumberofchallengeswhichwe

believearenotyetreflectedinmarketforecasts.

Figure1:Russiansteelheadingforanotherrollercoasterridein2011?

80

100

120

140

160

180

200

Oct09

Nov09

Dec09

Feb10

Mar10

May10

Jun10

Aug10

Sep10

Nov10

Dec10

Feb11

Rus s i ansteelmakersharepriceindexRus s i ansteel priceindex

Willwesee the boombustpatternof2010repeatingitselfin 2011?

The2010correctionma yhavebeenlinkedtoEUdebtworries

Source:Bloomberg,MetalExpert

Coststakecentrestagein2011.Webelievecostpressureswillriseaslabour,energy

andotherexpensesaddtorawmaterialpricehikes.Wedoubtthecurrenteconomic

environmentwouldallowforcoststobefullypassedontocustomers,sosteelmakers

mayhavetoabsorbsomeoftheburden,tothedetrimentoftheirmargins.

Assteelpricessoftenmarginsmaybedepressedfurther.Januarysawasharpincrease

insteelprices,bothdomesticallyandinexportmarkets.Webelievethatpartofthe

increasewasduetorestockingandmaynotbesustainable.Therearealsosignsthatend

customersmaynotbereadytoacceptsubstantiallyhighersteelpriceswhenfacedwith

uncertaintyintheirownmarkets.Lackofrealdemandmayleadtoasteelprice

correctionin2011,depressingsteelmakersmarginsfurther.

Wemayseefurthervolatilityinsteelnamesasmarketexpectationsadjust.Current

marketforecastsforRussiansteelmakers2011financialsassumemarginimprovement

vs2010.Thismaybethecaseassteelpricesstrengthenovertheyear.However,ascost

pressuresbecomemoreapparent,wemayseeexpectationsreducedleadingto

downgradesinfairvaluecalculationsforsteelstocks.

WACCadjustedtoreflectlowercostofequity,forecastingperiodextendedto2016.As

aresultofa50bptsreductioninourcountryspecificequityriskpremiumourbasecost

ofequityhasbeencutto11.7%.CompanyspecificWACCshavebeenadjustedfurtherto

reflecttheirliquidity,debtloadandcurrentcostofdebt.

RemainbullishonRussiansteel,butfocusonnameswithshorttermvaluetriggers.

WeexpectRussiansteelperformancetobecloselycorrelatedwithsteelpricesand

companiesabilitytoprotecttheirmargins.Werecommendfocusingonnameswith

shorttermvaluetriggersasweexpectthemtooutperformtheirpeers.Severstal

(reiterateBUY)mayseeanimprovedperformanceintheUS,whileNLMK(upgradeto

BUY)couldbenefitfromacquiringtheremainingDufercoJVstake.MMKs(reiterate

BUY)performancecouldbedrivenbyagrowingshareofHVAproductsinitssalesmix.

Evraz(downgradetoHOLD)maynotseethefullbenefitofincreasedconstruction

activityinRussiauntil2012.

EQUITYRESEARCH

METALS&MINING

17February2011

RUSSIAN STEELMAKERSRemain Cautious as Costs Take Centre Stage

3Mstock,indexandsteelperformance

0 % 10% 2 0% 30% 40 %

MMKGDR

BBGIron/SteelCo

Index

Baosteel

NLMKGDR

RTSIndex

ArcelorMittal

SBBHRCTracker

SBBRebarTracker

EvrazGDR

SeverstalGDR

Mechel ADR

Source:Bloomberga

Company

Target

price

($/share)

Potential

upside

(%)

Rating

(old)

Rating

(new)

EvrazGroup 42.30 10.7% BUY HOLD

MMK 16.20 17.2% BUY BUY

NLMK 49.40 13.6% HOLD BUY

Severstal 22.10 24.9% BUY BUY

YtDstock,indexandsteelperformance

10% 0% 10% 20%

NLMKGDR

MMKGDR

BBGIron/SteelCo

Index

ArcelorMittal

SeverstalGDR

RTSIndex

EvrazGDR

MechelADR

BaosteelSBB

Rebar

Tracker

SBBHRCTracker

Source:Bloomberga

Sector target value $84.3bn

Potential upside 16%


2/38

2

Contents

InvestmentCase...........................................................................................3CostsStarttoTakeCentreStage.................................................................................3WedonotyetSeeCostPressuresReflectedin2011MarketForecasts.................... 5

RussianSteel

Valuations

Premiums

to

Global

Peers

Still

Justified................10

SummaryDataforSteelStocksunderCoverage ...........................................12PriceForecastsUpgradedduetoStrongGainsinRecentMonths................15

CompanyPages..........................................................................................19EVRAZGROUP ............................................................................................21

ForecastChangesandValuation............................................................................... 21

FinancialAccounts..................................................................................................... 22

MAGNITOGORSKIRONANDSTEEL...............................................................24ForecastChangesandValuation............................................................................... 25


NOVOLIPETSKSTEEL ...................................................................................28ForecastChangesandValuation............................................................................... 29


SEVERSTAL .................................................................................................32USBusinessmayHoldtheKeyto2010MarginExpansion....................................... 33

ForecastChangesandValuation............................................................................... 34



3/38

3

Investment Case

Russiansteelstockshaveenjoyedastrongrunfollowingthecorrectionofmid2010.The

gainshavebeensupportedbyagradualrecoveryindemandandpricesandencouraging

Russianeconomicdata.However,weareincreasinglywaryofgrowingcostpressures

andthefragilestateofrealdemandwhichcouldmakeitdifficultforsteelmakersto

protecttheirmarginsin2011,letalonerecordgrowthatthelevelsachievedin2010.

AshighlightedinourJan2011issueofStratonomics,weremainfundamentallybullish

ontheRussiansteelsectorduetotheeconomicrecovery,appreciatingsteelpricesand

steelmakershighdegreeofverticalintegration.However,weareconcernedthatrecent

steelpriceincreases,drivenbycostinflationandseasonalrestocking,areunsustainable

inthemediumtermduetothelackofsupportfromrealdemand.Atthesametime,raw

materialcostpressures,exacerbatedbyrisingenergyandlabourcosts,continueto

depressmargins.

Russiassteelmakerscurrentsharepricesmaynotfullyreflectthechallengesthe

industryisstillfacing.Russiansteelstockshaveperformedstronglysincethe

publicationofourreportRoundupYourFlats,ShortWaitforLongs(25Oct2010),gaininganaverageof35%beforeacorrectionattheendofJanuary.Whiletheoverall

gainsinsharepriceswerebroadlyinlinewithourexpectations(apartfromNLMKwhich,

despiteourHOLDrating,gainedaround45%,reachingapeakof$51.30/GDRon4Jan),

thepaceofsharepriceappreciationhassurpassedourexpectations.

Althoughsomeofthesharepricemovementcouldbeexplainedbytherapidgainsin

steelpricesattheendof2010andthebeginningof2011,aswellasencouragingdata

onRussiaseconomicdevelopment,wethinkthisexuberancemaybeunfoundedgiven

thattheindustrystillfacesanumberoftoughchallenges.

CostsStarttoTakeCentreStage

Rapidrawmaterialcostrisescamebackintofocusin2H10

Thefirst

half

of

2010

was

a

period

of

continued

improvement

in

margins

for

Russian

steelmakersasgrowingproductionvolumesandstrengtheningsteelpricesoffsetrising

rawmaterialcosts.Steelmakerswerealsoquitesuccessfulinkeepingnonrawmaterial

costsundertightcontrol,ascanbeseenfromFigures2and3,whichdepictcompanies

withahighdegreeofverticalintegrationEvrazandSeverstal.

Figure2:EvrazCashcostsandEBITDAmarginprogression Figure3:Severstal*CashcostsandEBITDAmarginprogression

37.1% 34.7% 38.2%

16.7%15.6%

16.6%

36.2%34.6% 27.1%

10.1% 15.0% 18.1%

0%

20%

40%

60%

80%

100%

1H09 2H09 1H10

Material Cos ts Energy+Labour

Cash SG&Aa nd othe r EBITDA

36.0% 36.5% 35.2% 42.4%

18.6% 19.2%

16.9%

14.0%

24.1% 18.5%19.1%

19.0%

21.3% 25.8% 28.9% 24.6%

0%

20%

40%

60%

80%

100%

2009 1Q10 2Q10 3Q10


CashSG&Aan dother EBITDA

*Note:abovefiguresareforRussianSteelandSeverstalResources

Source:Companydata,Atonestimates

Meanwhile,Figures4and5showthemarginprogressionfortwocompanieswitha

lowerdegreeofverticalintegrationMMKandNLMK.


4/38

4

Figure4:MMKCashcostsandEBITDAmarginprogression Figure5:NLMKCashcostsandEBITDAmarginprogression

43.9% 43.7% 47.6% 51.4%

15.6% 17.3% 13.7%14.3%

15.3% 17.0% 17.6%15.4%

25.3% 22.0% 21.1% 18.9%

0%

20%

40%

60%

80%

100%

2009 1Q10 2Q10 3Q10


Cash SG&Aa nd othe r EBITDA

27.4% 34.5% 33.7%35.1%

16.7%20.3% 16.1% 15.9%

26.8%22.4%

14.2% 17.9%

29.1% 22.7% 35.9% 31.1%

0%

20%

40%

60%

80%

100%

4Q09 1Q10 2Q10 3Q10


CashSG&Aan dother EBITDA


Inthesecondhalfof2010severalfactorstookaturnfortheworseforsteelcompanies,

notjustinRussia,butglobally:

Demandforsteelfaltered,leadingtosharppricecorrections Steel

companies

were

forced

to

cut

output

to

bring

it

in

line

with

demand

Pressurefromrawmaterialcostscontinuedtoincrease

ThecombinationofthesefactorsledtomargindeteriorationforallRussiansteelmakers

in3Q10,ascanbeseeninFigures25.

WhileRussiansteelmakershavenotyetpublishedtheir4Q10financials,guidance

providedbycompaniesduringrecentannouncementsofoperatingresultshintsata

furthermargindeclineinthelastquarterof2010.

Forinstance,Evrazs4Q10operatingresultshighlightedacontinuousincreaseinraw

materialprices,exacerbatedbyrisinglabourandenergycosts.Consequently,despite

strongerthan

expected

output

and

price

realisations

during

the

quarter,

its

4Q10

EBITDAguidanceremainedunchangedfromtheprevioustradingupdate.NLMKhasalso

indicatedthatits4Q10EBITDAmarginshouldbearound25%,significantlydownfrom

the30%achievedin3Q10,partlyduetosteelpriceweaknessattheendoftheyear,but

mainlyasaresultofgrowingcosts,inourview.

Costinflationspreadstononrawmaterialcostsin2011

While2H10costincreasesweredrivenprimarilybyrawmaterials,in2011,weestimate

thatpricesforlabour,transportation,utilitiesandenergywillaccountforagrowing

portionofcashcosts.

AccordingtodatafromRussiasMinistryofEconomicDevelopment(MED),thecountrys

electricitytariffs

for

industrial

users

are

estimated

to

have

risen

by

18%

YoY

in

2010,

with1316%increasesexpectedin2011.Theincreaseinwholesalenaturalgaspricesin

2010wasevengreater,currentlyestimatedat26.7%YoY,while2011willlikelysee

pricesrisinganother15%andthisisjustfortheregulatedmarket.Finally,rail

transportationtariffsgained9.4%in2010andareexpectedtorise8%in2011(see

Figure6).


5/38

5

Figure6:Tariffsonnaturalmonopolies(%increaseYoY)

2008 2009 2010E 2011E 2012E

Electricity:regulatedandunregulatedtariffsforallusers(excluding generalpublic) 22.4%* 20.0% 18.0% 1316% 1113%

Naturalgas:regulatedpricesforallusers(excludinggeneralpublic) 25.0% 15.9% 26.7% 15.0% 15.0%

Railfreighttransportation(annualaverages) 16.3% 12.4% 12.4% 8.0% 7.4%

*includesgeneralpublic

Source:RussianMinistryofEconomicDevelopment

Inaddition,weanticipatesteelmakerslabourcostsrisingatleastinlinewithdomestic

inflation.AccordingtopreliminaryMEDestimates,inflationtotalled8.8%in2010andis

expectedtoreach78%in2011.However,giventhatRussiansteelcompanieskept

labourcostsundertightcontrolduringthecrisis,theactualincreasescouldbeeven

higher,inourview.

Forexample,accordingtotheRussianindustryjournalMetalSupplyandSales(Metallosnabzhenie iSbyt),ZapSiboneofEvrazssteelproductionunitsinRussiarecentlyheldanemployeeconferencewhereacollectiveagreementfor201112was

finalised.Itwasagreedthataveragesalarieswouldincreaseby7%from1Mar2011and

byanother7%from1Oct2011anincreaseofover14%fortheyear.Weexpectother

Russiansteelmakerstoagreetosimilarlabourcostincreasesfor2011.

Roublestrengthmayaddtocostpressures

AshighlightedinourrecentreportTimetoStartAppreciatingtheRouble(21Dec2010),theRussiancurrencyisstronglycorrelatedtotheoilprice.Basedonourmodels,an

averageoilpriceof$79/bblfor2011(AtonOilandGasteamestimate)wouldimplythe

rouble/$exchangeratestrengtheningtoRUB29/$byYE11,averagingaroundRUB30/$

fortheyear.Withoilnowtradingataround$100/bbl,ourforecastisbeginningtolook

conservative.

SincemostRussiansteelcompanycostsareroubledenominated,localcurrency

appreciationinflatescosts,althoughthisissomewhatoffsetbyastrengthenedrevenue

line.

ThedomesticcurrencystrengthenedtoRUB29.42/$in1Q10andthenweakenedto

RUB31.24/$in2Q,whichwebelievewaslikelyoneofthefactorsthatallowedRussian

steelmakerstodemonstratestrongerfinancialperformancevs1Q10.Thecurrencythen

appreciatedtoaroundRUB30.60/$in3Q4Q10,exacerbatingcostpressures.

WeDoNotYetSeeCostPressuresReflectedin2011MarketForecasts

Ascoststakecentrestagein2011,weseelittlereflectionofthemincurrentBloomberg

consensusforecastsfortheyear.Wehaveanalysedchangesto201011consensus

forecastsbetweenJuly2010,whentheoutlookforthesteelmarketandpriceswasstill

positive,andFeb2011,whenthefirstsignsof2H10margindeteriorationbecamevisible

andthe

risk

of

further

deterioration

in

2011

became

clear.

AscanbeseeninFigure7,BloombergconsensusEBITDAmarginforecastsfor2010saw

someminoradjustmentsastheyearprogressed.However,expectationsfor2011

marginssawlittledownwardrevisionbetweenJuly2010andFeb2011.Infact,in

Severstalscasetheforecastfor2011actuallyimproved(althoughthiscouldbe

explainedbyexpectationsofmarginimprovementsinthecompanysUSbusiness,which

maybejustifiedgiventhecurrentstrongrecoveryintheUSsteelmarket).


6/38

6

Figure7:EBITDAmarginforecastprogression(July10Feb11) Figure8:EPSforecastprogression(July10Feb11)

23.3

%

16.2%

20.2

%

19

.1%

18

.5%

17.

1%

32.0

%

32.1

%

29.1

%

29.2

%

22.1

%

22.5

%

20.0

%

2

0.9

%

20.3

%

22.5

%

15%

20%25%

30%

35%

40%

Jul'10

Feb'11

Jul'10

Feb'11

Jul'10

Feb'11

Jul'10

Feb'11

Jul'10

Feb'11

Jul'10

Feb'11

Jul'10

Feb'11

Jul'10

Feb'11

2010 2011 2010 2011 2010 2011 2010 2011

Evrazf'ca st MMKf'ca st NL MKf'ca st SVSTf'cast

Mostconsensus2011EBITDAmarginforecastshavehardly

changeddespitesharpdeteriorationofmarginsin 2H10

1.4

8

0

.03

3.2

5

2.6

8

1.7

9

1.6

5

0.6

7

0.9

8

3.5

3

3.3

5

2.1

6

2.3

52.9

1

3.0

3

1.0

11.8

6

0.5

0.5

1.5

2.5

3.5

Jul'10

Feb'11

Jul'10

Feb'11

Jul'10

Feb'11

Jul'10

Feb'11

Jul'10

Feb'11

Jul'10

Feb'11

Jul'10

Feb'11

Jul'10

Feb'11

2010 2011 2010 2011 2010 2011 2010 2011

EvrazEPSf'cast MMKEPSf'cast NLMKEPSf'cast SVSTEPSf'cast

Consensus 2011EPSforecastssaw little revisioninthe lastsix months

Source:Bloomberg consensus

WeseeasimilarpictureinconsensusEPSforecastsfor201011:while2010EPS

estimateshavebeenreviseddownwardconsiderably(exceptforNLMK),themarkets

2011EPSexpectationshaveremainedbroadlyunchangedandinsomecases(NLMK,

Severstal)have

actually

improved

(see

Figure

8).

Webelievethelackofdownwardrevisionto2011forecastsfromJuly2010toFeb2011

canbeexplainedbythefollowingfactors:

Anexpectationofhighersteeloutputvolumesin2011whichwouldtranslateintoimprovedtoplineperformance

Anassumptionthatsteelmakerswouldbeabletoprotectorevenimprovetheirmarginsbypassingmost,ifnotall,cashcostincreasesontotheircustomers

throughhighersteelprices

Thecombinationofthesetwofactorswouldintheoryhaveallowedsteelmakersto

protecttheir

margins

while

improving

bottom

line.

Lackofrealdemandmayhampersteelmakersfrompassingcostsontocustomers

Whilethetwofactorsnotedabovetoplineimprovementsandsuccessinpassingcosts

ontocustomerscouldinfactmaterialisein2011,webelieveswiftresultsareunlikely

andnoteseveralriskfactorsthatmaydelaythefullpositiveeffectfrombeingfeltin

2012.

Firstly,steelpriceappreciationattheendof2010andthebeginning2011shouldnotbe

confusedwithasustainedpricerecovery,whichisverymuchdependantonarecovery

inrealdemandforsteel.Rather,webelievethisisagaintheresultofrestocking,which

mayhavebeencausedbyexpectationsofhighersteelpricesin1Q2Q10drivenbyrising

rawmaterial

costs.

This

is

perhaps

similar

to

the

steel

price

rally

seen

at

the

beginning

of

2010.

Secondly,forpriceincreasestobesustainable,realdemandneedstorecovertolevels

sufficienttoabsorbtheincreasedvolumeofsteelsuppliedtothemarket.AstheRussian

economycontinuestorecover,soshouldrealdemand.Atthemomentthesignsare

encouraging:ascanbeseenfromFigure9,bothindustrialproductionandfixed

investmentarefirmlyinpositivegrowthterritory.However,growthrateshavestabilised

atlevelsthatarestillbelowthepeaksreachedatthebeginningof2008.


7/38

7

Figure9:FixedinvestmentandIPgrowthinpositiveterritory Figure10:RussianGDPtogrowbyaround6%in201112

30%

20%

10%

0%

10%

20%

30%

Ja n08 Jul08 Jan09 Jul09 Jan10 Jul10

Industrialproduction Fixedinvestment

Industrialproductionand fixed

investmentgrowthrateshave

stabilisedat stronglevels

7.1%6.4%

7.4%8.1%

5.6%

7.9%

4.0%

5.9% 5.50%

10%

8%

6%

4%

2%

0%

2%

4%

6%

8%

10%

2 00 4 2 00 5 2 00 6 2 00 7 2 00 8 2 00 9 2 01 0E 2 01 1E 2 01 2E

Source:Rosstat Source:Rosstat,Atonestimates

Moreover,theAtonStrategyandEconomicsteamforecastthattherateofeconomic

growthin2011willnotexceed6%.Althoughthiswouldbeanimprovementon2010,it

isstillfarbelowtheratesachievedbyRussiaintherunupto2008(Figure10).Inthis

macroeconomicsetting

we

doubt

that

real

demand

for

steel

could

return

to

2007

08

levelsthisyear.

Infact,thecurrentdisputebetweenRussiansteelcompaniesandautomakers

demonstratesthatnotallsteelconsumersarereadytoabsorbpriceincreaseswhen

uncertaintyontheirownmarketsisstillhigh.Thissuggests,inourview,thatitcouldbe

difficultforsteelmakerstopassonthefullextentofcostinflationtotheircustomers.

Automakersarenottheonlycustomerswhoarefeelingtheeffectofrisingsteelprices.

Russiantubemakers,workinginmuchbettermarketconditions a$100/bbloilworld

arealsofeelingtheheat.TMKandChTPZrecentlyapproachedRussiasFederal

AntimonopolyService(FAS)askingthemtoinvestigatesharppriceincreasesbytheir

mainsuppliers,

MMK

and

Severstal.

Weshouldalsonotdiscountthegovernmentsdesiretokeepdomesticmarketpricesin

checkascontaininginflationcomesintofocusduringtherunuptoparliamentary

electionsin2011andpresidentialpollsin2012.Inthissituation,webelievethe

governmentcouldintroducemeasuresaimedatcontrollingdomesticpriceincreases.

Thegovernment hasalreadybroachedtheideaofexporttariffsonrolledsteelandiron

oreasonepotentialmeasure.Wethinkthisapproachcouldleadtoashortterm

oversupplyofsteelonthedomesticmarketandaneventualcurtailmentofproduction

byRussiansteelmakers.

Finally,highersteelpricescouldenticesteelmakerstoincreaseoutput,whichinthe

absenceof

strong

real

demand

could

lead

to

oversupply.

This

would

put

additional

downwardpressureonsteelprices,likelyleadingtoasharpcorrectionsimilartowhat

wasseenin2010.However,thistimearound,wethinkstrongerexportmarketscould

helpoffsetsomeofthepotentialweaknessathome.Nevertheless,thiscouldalsobe

shortlivedasindustrynewswires(MetalBulletin,SteelBusinessBriefing)arealreadyreportingsofteningsteelpricesinseveralkeyexportmarkets.Inanycase,theexport

offeringsofRussiansteelmakersarelimitedprimarilytolowvalueaddedproducts.

Mostofthesefactors,inoneformoranother,wereinplayin2010,whenprices

increasedinthefirstthreetofourmonthsoftheyearoverexpectationsofhigherraw

materialcosts,leadingtopanicrestocking.Thiswasfollowedbyasharpprice

correctionduringthesummermonthsandonlyaslightrecoveryinsteelpricescloserto

the

end

of

the

year.


8/38

8

Steelsharescouldseearepeatof2010pricevolatility

GivenhowcloselycorrelatedRussiansteelstocksaretosteelprices,wecouldseea

repeatofthe2010correctionin2011,inourview.Figures11and12showthatRussian

steelcompanysharepricesmovedinanticipationofchangesinsteelprices,gaining

throughthelatterpartof2009andthebeginningof2010andthenreversingdirection

evenbeforethefullextentofthesteelpricecorrectionwasapparent.

Figure11:

MMK

and

NLMK

share

performance

vs

flat

steel

prices

Figure

12:

Evraz

share

performance

vs

long

steel

prices

80

100

120

140

160

180

Oct09

Nov09

Dec09

Feb10

Mar10

Apr10

Jun10

Jul10

Sep10

Oct10

Nov10

Jan11

MMKstockprice i ndex

NLMKstockpriceindex

F l atsteel

price

index

80

100

120

140

160

180

Oct09

Nov09

Dec09

Feb10

Mar10

Apr10

Jun10

Jul10

Sep10

Oct10

Nov10

Jan11

Evrazstockpriceindex

Longsteel

price

index

Source:Bloomberg

Althoughreportsfromsteelcompaniessuggestthatstrongrisesinsteelpricesshouldbe

expectedin1Q11,sharepricesstartedtocorrectwhensteelpricessoftenedafter

supportfromtherestockingdrivebegantodiminish.Giventhatasteelpricecorrection

couldbecomearealityasearlyas1Q11,wewouldnotruleoutthepossibilityoffurther

volatilityinRussiansteelstocksinthecomingquarters.

Notallisdoomandgloom

Whilesteelandcommoditypricesshouldcontinuetobethemaindriverofshareprice

performance

for

Russian

steelmakers,

we

believe

that

shares

with

additional

value

catalystsshouldoutperformtheirpeersin2011.Belowaresomeofthedriversthatmay

supportRussiansteelsharesin2011:

Severstal:

ArecoveryintheUSsteelmarketleadingtoupsidesurprises.WethinkSeverstalUScouldrepeatitspositive2Q10performanceonthebackofstrongerUSprices

andgrowingcapacityutilisation.AswingtopositiveEBITDAin2Q10cameona15%

QoQincreaseinsalesvolumesandan8%QoQincreaseinaveragerealisedprices.

NordgoldIPOmaysoonbebackonthecards.AlthoughthemarketsreceptionoftheIPOwaslukewarm,webelievethatavaluationintherangeof$3.54bnisstill

realisticandcouldoffer1015%upsidepotentialtothecurrentshareprice.

MMK:

RisingshareofHVAgoodscouldhelpoffsetcostpressures.ThecompanysMill5000isnowoperatingatfullcapacity(1.5mntpa)withitsorderbookfullatleastto

theendof1H11.

NLMK:

AcquisitionoftheremainingstakeinJVwithDuferco.NLMKisshortofinhouserollingcapacityandusestheJVasanoutletforitsexcessslabproduction.The

acquisitionwouldallowittorecordhighersalesmarginswithinthegroup.


9/38

9

Evraz:

RecoveryinconstructionactivityinRussiaandUkraine.Evrazcouldbeastocktowatchin2011giventheexpectedrecoveryinRussiasconstructionindustry.

However,weviewexpectationsofanystrongsharepricehikesaspremature,given

thatthefullextentofincreasedconstructionactivitywouldprobablynotbefelt

untilwellinto2012.Werecommendwaitinguntilearly2Q11toreassessthe

progressof

Russias

construction

industry

before

increasing

positions

in

the

stock.


10/38

1

0

Russian Steel Valuations Premiums to Global Peers Still Justified

Despiterisingcostpressuresandtheresultingdeteriorationofmargins,webelieve

thatRussiansteelmakersvaluationpremiumstointernationalpeersarejustified.

Whileincreasingcostpressuresareaworldwidephenomenon,Russiancompanies

verticalintegrationgivesthemanimportantedgeoverglobalpeers,actingasa

cushionandlimitingthenegativeimpactofhighercostsonmargins.

Ourvaluationmethodusesacombinedmultiplesbasedapproach(P/EandEV/EBITDA)

andDCF.Thetwomultipleseachaccountfor25%oftheweightedaveragevaluation,

withtheDCFvaluationprovidingtheremaining50%.Themultiplesvaluationallowsus

toaccountforacompanysshorttomediumtermfinancialperformanceanddebtload,

whiletheDCFcalculationaimstoreflectthegrowthpotentialofeachstockandhence

hasahigherweightinginourvaluations.

Oneminoradjustmentfromourpreviouscalculationsisachangetothebasecostof

equityduetotherecentrevisionofourcountryspecificriskpremium,whichwas

reducedfrom3.7%to3.2%.Asaresult,thebasecostofequitydeclinedfrom12.2%to

11.7%.TheWACCforeachindividualcompanyalsotakesintoaccountitsliquidityand

debtposition.

Russiansteelspremiumtoglobalpeersisstilljustified,inourview

Figures13and14arebasedonBloombergconsensusforecastsofthe2011EBITDA

marginsofRussiancompaniesandaselectionofinternationalpeersinbothdeveloped

andemergingmarketsatthetimeofourpreviousupdateon25Oct2010(Figure13)

andnow(Figure14).ThechartsshowthatthemarketstillexpectsRussiansteelmakers

tooutperformtheirpeersin2011.TheaverageEBITDAmarginforecastforfiveRussian

steelmajorsin2011isapproximately25%vstheemergingmarketaverageof16%and

thedevelopedmarketaverageof11%(seeFigure14).

Figure13:Consensus2011EEBITDAmargins(25Octupdate) Figure14:Consensus2011EEBITDAmargins(currentupdate)

26.9%

21.1% 20.9%19.4%

16.3%

12.7%

32.2%

0%

5%

10%

15%

20%

25%

30%

35%

NLMK

Mechel

MMK

Evraz

Severstal

Avg.

Int.

Emerging

Markets

Avg.

Int.

Developed

Markets

25.9%2 2. 3% 2 2.4 %

20.7%

16.4%

10.0%

31.9%

0%

5%

10%

15%

20%

25%

30%

35%

NLMK

Mechel

MMK

Evraz

Severstal

Avg.

Int.

Emerging

Markets

Avg.

Int.

Developed

Markets

Source:Bloomberg

Evenifweassumethe2011estimatesforRussiansteelmakersareoverlyoptimisticand

theywilleventuallybereviseddownward,wethinktherewillstillbeenoughofalead

overinternationalpeerstojustifythepremiumsatwhichRussiansteelmakerscurrently

trade.

OurapproachtovaluingRussiansteelsreflectsourexpectationsofsustained

profitabilityleadershipoverinternationalpeers

Globalsteelmakersarecurrentlytradingat2011P/Esrangingfrom9xto16xfor

emergingmarketpeersand1218xforsteelmakersindevelopedmarkets.Therangefor

EV/EBITDAis511xforemergingmarketsand58xfordevelopedmarkets(foramore

detailedbreakdown,seeFigure15).


11/38

1

1

Figure15:Comparativemultiplesofpeersbasedonestimatesfor201112E

CountryMktCap

($mn)EV/EBITDA P/E

EBITDA

margin(%)

Netmargin

(%)

2011E 2012E 2011E 2012E 2011E 2011E

Developedmarkets

ArcelorMittal Luxembourg 57,986 7.1 5.8 13.1 9.2 12% 5%

ThyssenKrupp Germany 21,132 4.5 3.6 15.7 9.9 8% 2%

Voestalpine

Austria

7,555

6.9

6.1

12.0

9.6

14%

4%

NucorCorp USA 15,262 8.0 6.1 18.9 13.0 11% 4%

USSteel USA 8,949 6.5 5.2 15.9 11.0 8% 3%

AKSteel USA 1,815 5.3 4.1 17.5 11.1 6% 2%

NipponSteel Japan 24,877 6.8 6.3 17.3 12.9 12% 3%

JFEHoldings Japan 20,070 6.6 6.0 17.6 11.9 14% 3%

BluescopeSteel Australia 4,145 8.5 5.6 53.7 14.6 6% 1%

Median,DMpeers 6.8 5.8 17.3 11.1 11% 3%

Emergingmarkets

POSCO SouthKorea 37,468 5.3 4.9 9.4 8.7 21% 12%

HyundaiSteel SouthKorea 10,410 7.3 6.9 9.6 8.8 16% 9%

ChinaSteelCorp Taiwan 15,460 11.1 9.9 13.3 10.9 17% 13%

BaoshanIron&Steel China 19,082 4.8 4.3 8.7 7.5 16% 6%

WuhanIron&Steel

China

5,389

5.8

5.2

12.9

9.6

14%

3%

MaanshanIron&Steel China 4,330 5.1 4.7 13.1 11.9 12% 3%

AngangSteel China 9,108 6.4 5.7 13.5 10.4 14% 4%

TataSteel India 12,993 6.7 6.1 9.2 8.1 14% 6%

Gerdau Brazil 19,242 6.6 5.3 11.5 9.3 18% 8%

Usiminas Brazil 14,300 8.8 6.3 17.4 11.9 20% 9%

Median,EMpeers 6.5 5.5 12.2 9.4 16% 7%

Russia

EvrazGroup Russia 16,731 7.2 5.9 16.7 10.6 22% 7%

MagnitogorskSteel Russia 11,879 7.4 5.4 14.6 8.9 21% 8%

Mechel Russia 13,154 6.2 5.5 8.6 8.4 26% 13%

NovolipetskSteel Russia 26,071 8.5 6.2 13.4 9.5 30% 18%

Severstal Russia 17,836 6.4 5.4 11.1 8.8 19% 9%

Median,Russian

peers

7.2

5.5

13.4

8.9

22%

9%

Russiansteelproducerspremium/discounttointernationalpeers:

EvrazGroup 8% 5% 13% 4%

MagnitogorskSteel 11% 5% 1% 14%

Mechel 7% 2% 42% 18%

NovolipetskSteel 27% 10% 9% 8%

Severstal 4% 4% 25% 14%

Source:Bloomberg,Atonestimates

WestillbelievethatRussiansteelmakersshouldbevaluedatapremiumtointernational

peers,giventheirsuperiorfinancialperformancetodateandmarketandour

expectationsthattheywillsustainthisleadershipintheshorttomediumterm.

Nevertheless,weremainconservativeandusemultiplesof14xP/Eand7xEV/EBITDAin

ourcalculations

(except

for

NLMK,

which

we

value

using

a

P/E

of

16x

and

an

EV/EBITDA

of8xtoreflectitsprofitabilityleadership,mediumtermgrowthprospectsandthe

uniquemixofhighvalueproductsinitssalesportfolio).

However,wearemoreconservativethantheconsensusinour2011forecasts

AsFigure22demonstrates,wearemoreconservativethantheBloombergconsensusin

our2011forecastsforRussiansteelmakers.Thisisintendedtoreflectthepressures

steelcompaniescouldfacethisyear.However,wealsobelievethatasmarketsrecover

in2012,steelcompaniesshouldbewellplacedtotakeadvantageofrisingdemandand

prices.

Therefore,wehaveusedtheaverageofour201112EEBITDAandnetincomeforecasts

asthe

basis

for

our

multiples

valuations.


12/38

1

2

Summary Data for Steel Stocks under Coverage

ThissectionprovidessummaryinformationforstocksunderAtoncoverage.

InFigure16wesummarisethechangestoourtargetpricesandratings.

Figure16:

Rating

summary

Company Ticker

Target

price

(old)

Target

price

(new)

Target

price

change

Current

price

Upside

potential

Rating

(old)

Rating

(new)

($/share) ($/share) (%) ($/share) (%)

EvrazGroup(GDR) EVRLI 35.33 42.30 19.7% 38.21 10.7% BUY HOLD

MMK(GDR) MMKLI 15.33 16.20 5.7% 13.82 17.2% BUY BUY

MMK(Local) MAGNRM 1.18 1.25 6.0% 1.07 16.6% BUY BUY

NLMK(GDR) NLMKLI 35.55 49.40 39.0% 43.50 13.6% HOLD BUY

NLMK(Local) NLKMRM 3.56 4.94 39.0% 4.35 13.5% HOLD BUY

Severstal(GDR)

SVST

LI

18.57

22.10

19.0%

17.70

24.9%

BUY

BUY

Severstal(Local) CHMFRM 18.57 22.10 19.0% 17.62 25.4% BUY BUY


Figure17reflectsthechangesinourtargetpricesifwealteranyofthekeyvaluation

criteriaforthestocksundercoverage.

Figure17:Valuationrangesforthestocks

Company

Current

share

price

Target

priceDCFWACCRate

201112E

averageP/E

201112E

averageEV/EBITDA

($/share) ($/share)Base

+1%

Base

WACC

Base

1%

12x 14x 16x 6x 7x 8x

EvrazGroup(GDR) 38.21 42.30 35.15 42.83 53.36 35.30 41.18 47.07 33.77 42.27 50.77

MMK(GDR) 13.82 16.20 13.00 15.44 18.69 15.11 17.63 20.15 13.26 16.12 18.99

NLMK(GDR) 43.50 49.40 50.73 59.24 70.92 32.84 38.32 43.79 26.01 30.70 35.38

Severstal(GDR) 17.70 22.10 17.86 20.69 24.32 21.62 25.22 28.83 18.13 21.91 25.70


Thefollowingtablesprovidesomeusefulperformanceandfinancialdataforthestocks.

Figure18:Stockperformancedata

EvrazGroup MMK NLMK Severstal

1M 3.2% 11.0% 7.6% 7.0%

3M 27.4% 8.0% 15.8% 27.0%

YtD

6.5%5.0%

8.8%

5.0%

1Y 15.1% 8.1% 42.2% 42.9%

52weekhigh($) 42.72 16.23 51.00 19.78

52weeklow($) 21.80 8.90 25.04 9.35

Combineddailyt/o($mn) 47.1 8.2 19.9 46.9

Freefloat(%) 17.4% 13.4% 12.9% 17.6%

Freefloat($mn) 2,911 1,592 3,363 3,139

Source:Companydata,Bloomberg,Atonestimates


13/38

1

3

Figure19:Keyvaluationdata

EvrazGroup MMK NLMK Severstal

Valuationsummary:

Targetprice($/GDR) 42.30 16.20 49.40 22.10

Currentprice($/GDR) 38.21 13.82 43.50 17.70

Potentialupside/downside(%) 10.7% 17.2% 13.6% 24.9%

Rating(GDR) HOLD BUY BUY BUY

Target

price

local

($/share)

n/a

1.25

4.94

22.10

Currentprice local($/share) n/a 1.07 4.35 17.62

Potentialupside/downside(%) n/a 16.6% 13.5% 25.4%

Rating(local) n/a BUY BUY BUY

Keyvaluationmetrics:

Commonsharesinissue(mn) 146 11,174 5,993 1,008

CommonshareGDRequivalent(mn) 438 860 599 1,008

Marketcap($mn) 16,731 11,879 26,071 17,836

Netdebt($mn) 7,219 2,928 1,148 4,331

EV($mn) 24,269 15,228 27,333 22,448

BV($mn) 10,312 10,128 9,556 7,718

Keyvaluationratios:

P/Eratios(x)

2009 n/a 51.1 97.7 n/a

2010E n/a 49.5 17.4 n/a

2011E 16.7 14.6 10.4 11.1

2012E 10.6 8.9 9.2 8.8

EV/EBITDAratios(x)

2009 19.6 14.9 15.8 26.5

2010E 10.2 10.6 9.2 8.0

2011E 7.2 7.4 6.9 6.4

2012E 5.9 5.4 6.0 5.4

P/BVratio(x) 1.6 1.2 2.7 2.0

Source:Companydata,Bloomberg,Atonestimates

Figure20:Keyfinancials

EvrazGroup

MMK

NLMK

Severstal

Revenue($mn)

2009 9,772 5,081 6,140 13,054

2010E 12,382 7,597 8,382 15,021

2011E 15,365 10,038 10,905 18,767

2012E 16,835 12,091 13,524 20,823

AdjustedEBITDA($mn)

2009 1,237 1,023 1,370 846

2010E 2,368 1,437 2,384 2,804

2011E 3,361 2,059 3,233 3,508

2012E 4,081 2,837 4,397 4,121

EBITDAmargin(%)

2009 12.7% 20.1% 22.3% 6.5%

2010E

19.1%

18.9%

28.4%

18.7%

2011E 21.9% 20.5% 29.6% 18.7%

2012E 24.2% 23.5% 32.5% 19.8%

Netincome($mn)

2009 1,251 232 215 1,037

2010E 54 240 1,332 87

2011E 1,002 812 1,949 1,603

2012E 1,574 1,342 2,753 2,029

Netmargin(%)

2009 12.8% 4.6% 3.5% 7.9%

2010E 0.4% 3.2% 15.9% 0.6%

2011E 6.5% 8.1% 17.9% 8.5%

2012E 9.4% 11.1% 20.4% 9.7%

Source:

Company

data,

Aton

estimates


14/38

1

4

Figure21summariseschangesmadetoourkeyestimates(EBITDAandnetincome)

sinceourpreviousupdate.

Figure21:AtonestimatesoldvsnewEBITDA Netincome

Company 2010E 2011E 2012E3Y

average2010E 2011E 2012E

3Y

average

EvrazGroup:

Newestimate($mn) 2,368 3,361 4,081 54 1,002 1,574

Oldestimate($mn) 2,373 3,431 4,040 112 826 1,297

Changevsold(%) 0.2% 2.0% 1.0% 0.4% n/a 21.3% 21.4% 21.3%

MMK:

Newestimate($mn) 1,437 2,059 2,837 240 812 1,342

Oldestimate($mn) 1,535 2,423 2,737 270 872 1,058

Changevsold(%) 6.3% 15.0% 3.7% 5.9% 11.2% 6.8% 26.8% 2.9%

NLMK:

Newestimate($mn) 2,384 3,233 4,397 1,332 1,949 2,753

Oldestimate($mn) 2,424 3,263 3,700 1,208 2,011 2,293

Changevsold(%) 1.6% 0.9% 18.8% 5.4% 10.3% 3.1% 20.1% 9.1%

SVST*:

Newestimate

($mn)

2,804

3,508

3,508

87

1,603

2,029

Oldestimates($mn) 3,315 3,961 4,155 9 1,598 1,802

Changevsold(%) 15.4% 11.4% 15.6% 14.2% n/a 0.3% 12.6% 6.4%

*PreviousSeverstalforecastsincludedLucchini

Source:Atonestimates

Finally,Figure22comparesourestimatesforsteelstockswiththecurrentBloomberg

consensusview.Wearemoreconservativethanconsensusinour2011forecasts.

Meanwhile,ourexpectationsfor2012areeitherinlinewithoraheadofconsensus,as

webelievethebenefitofincreaseddemandandhighersteelpriceswillnotbefullyfelt

in2011,butshouldbepushedbackto2012.

Figure

22:

Aton

estimates

vs

Bloomberg

consensus

EBITDA Netincome

Company 2010E 2011E 2012E3Y

average2010E 2011E 2012E

3Y

Average

EvrazGroup:

Atonestimates($mn) 2,368 3,361 4,081 54 1,002 1,574

Bloombergconsensus($mn) 2,384 3,553 4,068 103 1,208 1,442

Atonvsconsensus(%) 0.7% 5.4% 0.3% 1.9% n/a 17.1% 9.2% 3.9%

MMK:

Atonestimates($mn) 1,437 2,059 2,837 240 812 1,342


Atonvsconsensus(%) 7.7% 14.7% 1.4% 7.0% 36.8% 22.4% 1.3% 20.2%

NLMK:

Aton

estimates

($mn)

2,384

3,233

4,397

1,332

1,949

2,753

Bloombergconsensus($mn) 2,400 3,370 3,959 1,311 2,047 2,373


SVST:






15/38

1

5

Price Forecasts Upgraded Due to Strong Recent Gains

Wehaveupgradedourpriceforecastsforsteelandrawmaterialpricestoreflectthe

stronggainsrecordedinrecentmonths.Exportpricesforflatsteelhaveseenasolid

recoveryandnowtradeataslightpremiumtodomesticsteel.Longsteelpriceshave

alsotrendedhigheronagradualrecoveryinconstructionactivity.Inrawmaterials,

cokingcoalpricessawamajorappreciationduetothedeficitthatfollowedthe

Raspadskaya

mine

accident

in

2010.

Highrawmaterialprices,inparticularforcokingcoalandsteelscrap,willlikelycontinue

toputpressureonRussiansteelproducersmargins,asitwillbedifficultforthemto

passonthefullextentofcostincreasestocustomerswhilethedemandpictureremains

uncertain.

HRCprices:weexpectasofteningin2H11

HRCpricesexperiencedexceptionalgainsatthebeginningof2011,whichweexpectto

continueintheseasonallystronger2Q11:weestimateaveragepriceswillrangefrom

$700/tto$800/tinthefirsthalfoftheyear.However,weexpectpricestosoftenin

2H11,withafullyearaverageof$740/tforthedomesticmarketand$760/tforexports

(seeFigure

23).

Figure23:HRCpricesstrongin1H11,softeningin2H11($/t) Figure24:CISHRCuparound13%vsourpreviousforecast($/t)

200

300

400

500

600

700

800

1Q09

2Q09

3Q09

4Q09

1Q10

2Q10

3Q10

4Q10

1Q11E

2Q11E

3Q11E

4Q11E

HRC CIS producerpri ce HRC CIS exportprice

Weassumeprice

softeningin 2H11,similar

to2H10correction

Exportpricesstarttrading

at apremiumtodomestic

516

642588 604

695

781742 731

601631

663 666 650

400

500

600

700

800

900

1Q10

2Q10

3Q10

4Q10

1Q11E

2Q11E

3Q11E

4Q11E

HR C CIS producerprice NEW

HR C CIS producerprice OLD

Source(Figures32and33):MetalExpert,Bloomberg,Atonestimates

OurnewdomesticHRCpriceestimatesfor2011areanaverageof13%higherthanour

previousforecast(seeFigure24).

Rebar:strongrecoveryatend2010andstartof2011

Rebarpricesenjoyedastrongerrecoverythanweexpectedin4Q10,averagingaround

$590/tvs$550/tinourOctoberforecast.Wehaverevisedourestimatestotakeinto

accountthepricestrengthseeninJanuaryandFebruary.Onceagain,weexpect3Q

4Q11tobeseasonallyweak,bringingtheaveragepricefor2011toaround$700730/t,

withdomesticpricesexpectedtoreachapremiumtoexport(seeFigure25).


16/38

1

6

Figure25:Rebarstrongerrecoveryin4Q10vsforecast($/t) Figure26:Rebarpriceestimateup20%vsearlierforecast($/t)

200

300

400

500

600

700

800

1Q09

2Q09

3Q09

4Q09

1Q10

2Q10

3Q10

4Q10

1Q11E

2Q11E

3Q11E

4Q11E

Rebar CIS producerpri ce Re ba r CIS exportprice

Domesticprices improveas

constructionactivitypicks up

Weassumeprice

softeningin2H11,similar

to2H10correction

474

618

579589

663

762 751 732

550577

621 605 599

400

500

600

700

800

900

1Q10

2Q10

3Q10

4Q10

1Q11E

2Q11E

3Q11E

4Q11E

Rebar CIS producerprice NEW

Rebar CIS producerprice OLD

Sources:MetalExpert,Bloomberg,Atonestimates

Ournewpriceassumptionsforrebarare2021%higherthanourOctoberestimates(see

Figure26).

Flatsteelmaintainsanarrowingpremiumoverlongproducts

Longsteelpriceshaveundergoneastrongrecovery,narrowingthediscounttoflatsteel

toaround3%in4Q10.AlthoughweexpectHRCtocontinuetradingatapremiumto

rebargoingforward,wethinkthepremiumwillbelower:around5%in2011vs10%in

ourpreviousforecast(Figure27).

Figure27:Longssteeldiscounttoflatexpectedtonarrow($/t)

500

600

700

800

900

1Q

09

2Q

09

3Q

09

4Q

09

1Q

10

2Q

10

3Q

10

4Q

10E

1Q

11E

2Q

11E

3Q

11E

4Q

11E

CIS DomesticFlatSteel Basket

CIS DomesticLongSteelBasket

Flatsteel is still

expectedtotradeat

apremiumtolong...

butthe discountis expectedtonarrow

as constructionactivitypicksup

Source:MetalExpert,Bloomberg,Atonestimates

Pressurefromhighrawmaterialpricessettorolloverinto2011

Weexpecthighrawmaterialpricestocontinuepressuringsteelmakersmargins.This

shouldbe

especially

pronounced

in

coking

coal

in

2011

(due

to

the

Raspadskaya

accidentlastyearandastructuralshortageofhighquality,locallyproducedcoking

coal).Amajorincreaseinscrappricescanbeexpectedfrom2012onthebackof

insufficientscrapgenerationandaddeddemandfromnewelectricarcfurnace(EAF)

capacity.

Wethinktheincreaseinironorepriceswillbelesspronouncedvscokingcoalsince

Russiaisnotcurrentlyexperiencinganyshortageofthismaterial(seeFigure28).


17/38

1

7

Figure28:StrongincreaseincokingcoalpriceduetoRussiandeficit($/t)

51 49 58

92103 125 124

134158 166 168 164

33 32 3648

6288 81 82 92 94

95 94

0

50

100

150

200

250

1Q09

2Q09

3Q09

4Q09

1Q10

2Q10

3Q10

4Q10

1Q11E

2Q11E

3Q11E

4Q11E

Cokingcoal (Russia domesticGZh type)Iron ore concentrate(Russiadomestic)

Shortageofdomesticoutput

supportscokingcoalprices

Source:MetalExpert,Bloomberg,Atonestimates

Raspadskayarecentlyannouncedan11%increasein1Q11pricesforcokingcoal.

However,weexpectthisupwardmomentumtoslowfrom2Q11,asRaspadskayastarts

torecovertheoutputlostfollowinglastyearsaccident.Weexpect1Q113Q11pricesto

averagearound

$160

165,

softening

in

4Q11

(see

Figure

29).

We

estimate

an

average

2011cokingcoalpriceofaround$165/t,35%higherthanin2010.

Figure29:Cokingcoalpricessupportedbycontinueddeficit($/t) Figure30:Ironorepricestrengtheningonhigherdemand($/t)

103

125 124134

158166 168 164

151153157

146135

75

100

125

150

175

200

1Q10

2Q10

3Q10

4Q10

1Q11E

2Q11E

3Q11E

4Q11E

Cokingcoal (Russia domesticGZh type) NEW

Cokingcoal (Russia domesticGZh type) OLD

62

8881 82

92 94 95 94

82 80 8486 85

50

75

100

125

1Q10

2Q10

3Q10

4Q10

1Q11E

2Q11E

3Q11E

4Q11E

Iron ore concentrate (Russiadomestic)NEWIron ore concentrate (Russiadomestic)OLD

Sources(Figures29and30):MetalExpert,Bloomberg,Atonestimates

Weexpectironoreconcentratepricestoincreasemodestlyovertheyear,averaging

$95/t,up20%YoY(seeFigure30).

Forsteelscrap,weforecastapriceincreaseofapproximately15%YoYin2011toaround

$270/t.Thisis16%higherthanourearlierforecast,mainlyduetoincreasedlongsteel

pricesandthereforeelevateddemandforscrap.

Ourpriceassumptionsforthemainsteelproductsandrawmaterialsaresummarisedin

Figures3132.


18/38

1

8

Figure31:AtonrawmaterialandsteelpriceassumptionsFeb2011($/metrictonne)Annualprices Quarterlyprices

2010 2011E 2012E 2013E 2014E 2015E 3Q10 4Q10 1Q11E 2Q11E 3Q11E 4Q11E

Rawmaterialprices,FCA,exVAT:

Ironoreconcentrate old 79 83 88 85 80 76 84 83 80 84 85 84

new 79 95 101 101 97 92 84 84 93 96 96 96

%

chg

0.5%

14.6%

15.7%

18.8%

21.0%

21.5%

2.0%

16.2%

14.9%

13.7%

13.7%

Cokingcoalconcentrate(GZhtype) old 122 152 157 156 152 150 124 135 146 157 153 151

new 122 164 181 179 174 168 124 134 158 166 168 164

%chg 0.2% 8.1% 15.1% 15.2% 14.5% 12.2% 0.8% 8.1% 5.6% 9.9% 8.8%

Steelscrap old 230 231 257 272 272 272 211 207 218 234 237 234

new 233 268 314 345 349 347 211 221 249 267 281 274

%chg 1.5% 16.0% 22.1% 26.9% 28.5% 27.5% 6.5% 14.1% 14.1% 18.7% 16.9%

Domesticprices,exworks,exVAT:

HRC old 589 653 667 655 639 630 598 601 631 663 666 650

new 587 737 825 803 778 757 588 604 695 781 742 731

%chg 0.3% 13.0% 23.6% 22.6% 21.7% 20.3% 0.4% 10.0% 17.9% 11.4% 12.6%

Rebar old 555 601 632 633 618 607 579 550 577 621 605 599

new 565 727 844 838 812 790 579 589 663 762 751 732

%chg 1.8% 21.0% 33.6% 32.4% 31.2% 30.2% 7.1% 14.8% 22.8% 24.0% 22.2%

Exportprices,FOB,exVAT:

Slab old 532 561 574 563 549 541 514 517 543 570 573 558

new 533 669 755 731 708 689 514 521 599 674 708 697

%chg 0.2% 19.4% 31.6% 29.8% 28.8% 27.3% 0.8% 10.4% 18.3% 23.6% 24.8%

Billet old 517 548 576 578 564 554 528 502 527 567 552 547

new 532 687 817 823 797 776 528 564 635 698 716 698

%chg 3.0% 25.2% 41.7% 42.4% 41.2% 40.1% 12.4% 20.4% 23.2% 29.6% 27.6%

HRC old 595 626 640 628 613 604 574 577 605 636 639 623

new 605 764 866 843 816 795 574 618 710 799 779 767

%chg 1.7% 22.1% 35.2% 34.2% 33.2% 31.6% 7.1% 17.3% 25.7% 21.9% 23.2%

Rebar old 548 583 613 614 600 589 562 534 560 602 587 581

new 563 702 811 805 780 759 562 592 651 732 721 703

%chg 2.6% 20.4% 32.3% 31.1% 29.9% 28.9% 10.9% 16.2% 21.6% 22.8% 21.0%

Source:MetalExpert,Atonestimates

Figure32:Rawmaterialandsteelpriceassumptions(Feb2010)periodonperiodprogression(%)

YoYchangeinprices QoQchangeinprices

2010

2011E

2012E

2013E

2014E

2015E

3Q10

4Q10

1Q11E

2Q11E

3Q11E

4Q11E

Rawmaterialprices,FCA,exVAT:

Ironoreconcentrate 83% 20% 6% 1% 4% 5% 4% 0% 10% 4% 1% 1%

Cokingcoalconcentrate(GZhtype) 95% 35% 10% 1% 3% 3% 1% 8% 18% 5% 1% 3%

Steelscrap 39% 15% 17% 10% 1% 1% 15% 5% 13% 8% 5% 3%

Domesticprices,exworks,exVAT:

HRC 35% 26% 12% 3% 3% 3% 8% 3% 15% 13% 5% 2%

Rebar 34% 29% 16% 1% 3% 3% 6% 2% 13% 15% 2% 3%

Exportprices,FOB,exVAT:

Slab 43% 26% 13% 3% 3% 3% 14% 1% 15% 13% 5% 2%

Billet 35% 29% 19% 1% 3% 3% 1% 7% 13% 10% 2% 3%

HRC 33% 26% 13% 3% 3% 3% 12% 8% 15% 13% 3% 2%

Rebar 28% 25% 16% 1% 3% 3% 3% 5% 10% 13% 2% 2%

Source:

Metal

Expert,

Aton

estimates


19/38

1

9

Companies


20/38

2

0

WeincreaseourtargetpriceforEvrazto$42.30/GDR(up20%from$35.33/GDR

previously)onstrongersteelpricesandencouragingsignsfromtheRussian

constructionsector.However,wedowngradeourratingtoHOLDaswethinkthe

shareshave

run

slightly

ahead

of

fundamentals:

while

arecovery

in

construction

seemstobeunderway,weneedmoreevidencetobesureitissustainable.

Figure33:Evrazssteelsalescontinuetoberelativelyflat(000tonnes)

0

1,000

2,000

3,000

4,000

5,000

1Q0

9

2Q0

9

3Q0

9

4Q0

9

1Q1

0

2Q1

0

3Q1

0

4Q1

0

Semi finished p ro du cts Con s truc ti o nproductsRailwayproducts Fl atrolledproductsTubularproducts Othe rsteel products

Steelsales volumesremained

relativelyflatoverlastsixquarters

Source:CompanyData

Operatingresultsfor2010broadlyinlinewithexpectations.Outputin4Q10recovered

acrossmostproductgroupsafterplannedmaintenancein3Q10.Asaresult,2010crude

steelproductionincreased6.6%YoYto16.3mnt.Rolledproductsalesgained3%YoYto

14.7mnt.Encouragingly,salesofconstructionsteelcontinuedtoshowpositiveQoQ

dynamics,whichwehopereflectsagradualrecoveryintheRussianconstruction

industry.Inmining,Evrazproduced19.4mntofironoreproducts(up9%YoY)andmined

7.5mntof

coking

coal

(down

27%

YoY

due

to

operational

issues).

ButconservativeEBITDAguidanceconfirmsourcostconcerns.Despiteencouraging

operatingdata,Evrazmaintainedits4Q10EBITDAguidanceataround$595mn(inline

with3Q10)highlightinggrowingcostpressuresfromrawmaterials,energyandwages

thateffectivelycancelledoutgainsinoutputandprices.

Verticalintegrationshouldprovidesomemarginprotection.Evrazenjoysahighdegree

ofintegrationinironore(closeto90%in2010)andcokingcoal,whereselfsufficiencyis

expectedtoincreasefrom85%currentlytoover100%onceoutputfromRaspadskaya

recovers.EvrazsinternationalfootprintallowsittotakeselfsufficiencybeyondRussia

byexportingsemifinishedsteeltounitsintheUSandtheEU.

Russianstatisticsareencouragingbutsustainabilityisuncertain.Russiapostedfixed

investmentgrowthof6%YoYin2010,whileproductionofcement,bricksandplywood

roseanaverageof15%YoY.However,weneedtoseesustainedgrowthinthese

productsoveralongerperiod(probablyto2Q11)tobeconfidentthattheyreflectareal

recoveryinconstructionandnotjustseasonalrestockingpatterns.

DowngradetoHOLDdespiteincreasedtargetpriceof$42.30/GDR.Aftergainingover

34%sinceourinitiationtoahighof$42.00/GDRinJan2011,Evrazhelditsground

duringtherecentcorrectionandisnowtradingat$38.21/GDR.Althoughweraisedour

TPto$42.30/GDRonstrongersteelpricesandsignsofarecoveryinRussian

construction,thisoffersonly11%upsidepotential,sowedowngradethestocktoHOLD.

We

need

to

see

a

sustained

recovery

in

domestic

construction

before

we

can

believe

the

stockcouldofferanygreaterupside.

EVRAZ GROUPHold on a Little Bit Longer

HOLD

Target price $42.30


Bloombergcode EVRLI

Reuterscode

HK1q.L

Price(ordinaryGDR,$) 38.21

Price(pref,$) n/a

Upsidepotential 10.7%

Ordinary:GDRratio 1:3

Sharedata

No.ofordinaryshares(mn) 146

No.ofordinaryGDRs(mn) 438

No.ofprefshares(mn) n/a

3Maveragedailyt/o($mn) 47

Freefloat(%) 17.4%

Marketcapitalisation($mn) 16,731

Enterprisevalue

($mn)

24,269

Majorshareholders

LanebrookLimited 72.39%

FINANCIALS($mn) 2009 10E 11E

Revenue 9,772 12,382 15,365

EBITDA 1,237 2,368 3,361

EBIT (1,047) 514 1,795

Netincome (1,251) (54) 1,002

EPS (9.30) (0.37) 6.87

VALUATION

P/E(x) (13.4) (307.0) 16.7

P/CF(x) 15.8 25.5 13.3

EV/EBITDA(x) 19.6 10.2 7.2

EV/Sales(x) 2.5 2.0 1.6

P/BV(x) 1.6 1.6 1.4

RoCE(%) 6.9% 0.3% 5.6%

RoE(%) 12.2% 0.5% 8.4%

PERFORMANCE

1month(%) 3.2%

3month(%) 27.4%

12month(%) 15.1%

52weekhigh($) 42.72

52weeklow($) 21.80



21/38

2

1

Forecast Changes and Valuation

Figure34:EvrazAtonestimates,newvsoldEBITDA Netincome

YearendDecember: 2010E 2011E 2012E3Yaverage

2010E 2011E 2012E3Yaverage

Newestimates($mn) 2,368 3,361 4,081 54 1,002 1,574

Oldestimates($mn) 2,373 3,431 4,040 112 826 1,297

Changevsold(%) 0.2% 2.0% 1.0% 0.4% n/a 21.3% 21.4% 21.3%


Figure35:EvrazAtonestimatesvsconsensusEBITDA Netincome

YearendDecember: 2010E 2011E 2012E3Yaverage






Figure36:EvrazValuationbreakdown

DCFcalculation

($mn):

2011E

2012E

2013E

2014E

2015E

2016E

EBIT 1,795 2,472 2,409 1,838 1,409 1,198

Lesstaxation (449) (618) (602) (460) (352) (299)

Taxadj.EBIT 1,346 1,854 1,807 1,379 1,057 898

Depreciation 1,566 1,609 1,635 1,635 1,635 1,635

Lesscapex (1,100) (1,250) (1,000) (750) (750) (750)

Changeinworkingcapital (556) (435) (222) (10) 20 37

Freecashflow 1,256 1,778 2,220 2,254 1,963 1,820

Terminal value 28,679

NPVoffreecashflow 1,056 1,573 1,796 1,668 1,328 1,126

NPVofterminalvalue 17,746

Discountedcashflowvaluation: ($mn) (%) WACCcalculation: %

NPVof

free

cash

flow

8,547

32.5%

Risk

free

rate

4.50%

NPVofterminalvalue 17,746 67.5% Standardequityriskpremium 4.00%

Enterprisevalue 26,293 100.0% Countryspecificequitypremium 3.20%

Plus:otherassets Liquidityriskpremium 0.00%

Less:minorities 319 Othercompanyspecificriskpremiums 1.00%

Less:netdebt 7,219 Totalcostofequity 12.70%

Equityvalue 18,755 Currentcostofdebt 7.00%

Less:preferredstockvalue Effectivecorporatetaxrate 25.00%

Commonequityvalue 18,755 Costofdebtaftertax 5.25%

No.ordinaryshares(mn) 146 Targetgearing(debt/equity) 45.00%

Valuepercommonshare 128.50 WACC 9.35%

CommonsharestoGDRratio 0.3

ValueperGDR 42.83 Terminalgrowthrate 3.00%

Multiplesbasedvaluation:

Ratios: Multiple Value($mn) $/GDR

14 xEarnings 18,034 41.18

7 xEBITDA 18,509 42.27

Weightedaveragevaluation:

Valuation Weightings Netvaluation

$/GDR % $/GDR

DCF 42.83 50% 21.42

P/E 41.18 25% 10.30

EV/EBITDA 42.27 25% 10.57

Valuepershare($/GDR) 100% 42.28

Potentialupside(%) 10.7%

Source:Aton

estimates


22/38

2

2

Financial Accounts

Figure37:EvrazIFRSnetincomestatement($mn)2008 2009 2010E 2011E 2012E 2013E 2014E 2015E

Revenue 20,380 9,772 12,382 15,365 16,835 17,156 16,685 16,303

Costofrevenueandotheroperatingcosts(exDD&A) (13,944) (8,399) (9,964) (11,954) (12,704) (13,061) (13,162) (13,208)

Unallocatedexpenses (221) (136) (50) (50) (50) (50) (50) (50)

EBITDA 6,215 1,237 2,368 3,361 4,081 4,045 3,473 3,044

EBITDAmargin 30.5% 12.7% 19.1% 21.9% 24.2% 23.6% 20.8% 18.7%

DD&A (1,195) (1,632) (1,735) (1,566) (1,609) (1,635) (1,635) (1,635)

Otherincome/(expenses) (1,388) (652) (119)

EBIT 3,632 (1,047) 514 1,795 2,472 2,409 1,838 1,409

Netfinancialexpenses (598) (637) (602) (463) (365) (276) (180) (83)

Otherpretaxincome/(expenses) 17 84 45 45 45 45 45 45

Profitbeforetax 3,051 (1,600) (43) 1,377 2,153 2,178 1,703 1,371

Incometaxexpenses (1,192) 339 (13) (344) (538) (545) (426) (343)

Profitaftertax 1,859 (1,261) (56) 1,033 1,615 1,634 1,277 1,028

Minorityinterests 62 (10) (2) 31 40 41 32 26

Profitattributabletoequityholdersofthecompany 1,797 (1,251) (54) 1,002 1,574 1,593 1,246 1,002

Netmargin 8.8% 12.8% 0.4% 6.5% 9.4% 9.3% 7.5% 6.1%

Earningspershare:

BasicEPSperordinaryshare 14.6 (9.3) (0.4) 6.9 10.8 10.9 8.5 6.9

No.ofordinaryshares 123 134 146 146 146 146 146 146

No.ofGDRs(1GDR=1/3ordinaryshare) 370 403 438 438 438 438 438 438


Figure38:EvrazIFRSbalancesheet($mn)2008 2009 2010E 2011E 2012E 2013E 2014E 2015E

Cashandcashequivalents 930 675 406 503 1,110 1,995 2,884 3,544

Inventories 2,416 1,886 2,186 2,457 2,776 2,784 2,863 2,885

Receivables 2,349 1,559 2,013 2,415 2,632 2,724 2,689 2,649

Other

current

assets

589

120

76

76

76

76

76

76

Totalcurrentassets 6,284 4,240 4,681 5,451 6,594 7,579 8,511 9,154

Property,plantandequipment 9,012 14,941 14,156 13,689 13,331 12,695 11,810 10,924

Intangibleassets 1,108 1,098 1,016 1,016 1,016 1,016 1,016 1,016

Goodwill 2,167 2,211 2,165 2,165 2,165 2,165 2,165 2,165

Othernoncurrentassets 873 921 1,025 1,025 1,025 1,025 1,025 1,025

Totalnoncurrentassets 13,160 19,171 18,362 17,895 17,537 16,901 16,016 15,130

Assetsclassifiedforsale 7 13 113

Totalassets 19,451 23,424 23,156 23,346 24,131 24,481 24,527 24,284

Payables 2,538 1,694 1,884 2,000 2,101 1,980 2,012 2,015

Shorttermloansandleaseliabilities 3,937 2,009 1,758 1,658 1,508 1,358 1,208 1,058

Provisions 63 35 38 38 38 38 38 38

Totalcurrentliabilities 6,538 3,738 3,680 3,696 3,647 3,376 3,258 3,111

Longtermloans 6,064 5,931 5,431 4,281 3,431 2,581 1,731 881

Otherlongtermliabilities 1,932 3,146 3,129 3,129 3,129 3,129 3,129 3,129

Liabilitiesassociatedwithassetsclassifiedforsales 1 48

Totalnoncurrentliabilities 7,996 9,078 8,608 7,410 6,560 5,710 4,860 4,010

Shareholders'equity 4,672 10,284 10,548 11,920 13,604 15,075 16,089 16,844

Minorityinterests 245 324 320 320 320 320 320 320

Totalequity 4,917 10,608 10,868 12,240 13,924 15,395 16,409 17,164

Totalequityandliabilities 19,451 23,424 23,156 23,346 24,131 24,481 24,527 24,284



23/38

2

3

Figure39:EvrazIFRScashflowstatement($mn)

2008 2009 2010E 2011E 2012E 2013E 2014E 2015E

Netincome 1,859 (1,261) (56) 1,033 1,615 1,634 1,277 1,028

Adjustments:

Depreciation,depletionandamortisation 1,195 1,632 1,735 1,566 1,609 1,635 1,635 1,635

Othernoncashadjustments 1,672 675 200 418 320 231 135 38

Operatingprofitbeforechangesinworkingcapital 4,726 1,046 1,879 3,017 3,543 3,500 3,048 2,702

Changesinworkingcapital (163) 654 (516) (556) (435) (222) (10) 20

Netcashprovidedbyoperatingactivities 4,563 1,700 1,364 2,461 3,108 3,278 3,037 2,722

Cashflowfrominvestingactivities:

Purchasesofproperty,plantandequipment (1,103) (441) (950) (1,100) (1,250) (1,000) (750) (750)

Otherinvestingactivities (2,633) 624 12

Netcashusedforinvestingactivities (3,736) 183 (938) (1,100) (1,250) (1,000) (750) (750)

Cashflowfromfinancingactivities:

Proceeds fromissuanceofsharecapital,netoftransactioncosts (1) 310

Proceeds frombankloansandpromissorynotes 5,657 3,427 1,750 750 250 250 250 250

Repaymentofbankloansandpromissorynotes,includinginterest (3,949) (4,987) (2,500) (2,000) (1,250) (1,250) (1,250) (1,250)

Dividendspaidbytheparententitytoitsshareholders (1,276) (90) (14) (250) (394) (398) (311)

Otherfinancingactivities (558) (809) 110

Netcashprovidedbyfinancingactivities (127) (2,149) (640) (1,264) (1,250) (1,394) (1,398) (1,311)

Effectsofexchangeratechangesoncashandcashequivalents (97) 11 (55)

Cashandcashequivalentsatbeginningoftheperiod 327 930 675 406 503 1,110 1,995 2,884

Netincreaseincashandcashequivalents 603 (255) (269) 97 607 885 889 661

Cashofdisposalgroupsclassifiedasheldforsale (21)

Cashandcashequivalentsattheendoftheperiod 930 675 406 503 1,110 1,995 2,884 3,544



24/38

2

4

WeincreaseourtargetpriceforMMKto$16.20/GDR(up6%from$15.33/GDR)to

accountforstrongersteelpricesanditsgrowingexposuretoHighValueAdded(HVA)

products,whichshouldmitigatesomeoftherisingpressurefromcosts.Ournew

targetprice

offers

17%

upside

potential

from

the

current

level,

allowing

us

to

reiterate

ourBUYratingonMMK.

Figure40:Domesticmarketremainsthefocusforhighvalueaddedproductsales

77%

10%

8%5%

Regional s a l e s structure (3Q10)

Domesticmarket

Middle

East

Asia&

Fa rEast Other

12%

37%

21%13%

12%

5%

Domestics a l e s bysector(3Q10)

Pipe

production

Spotsales

Russia &CISMachine

building

Construction

Auto

industryOther

Source:Companydata

Financialsfor3Q10highlightgrowingcostpressures.MMKs3Q10IFRSresultsclearly

reflectthecostpressuresitfacesasoneofRussiasleastintegratedsteelmakers:EBITDA

wasdown11%QoQto$388mnduetohighercosts,withEBITDAmarginslippingto

18.9%from21.1%in2Q10(seeFigure41).

Figure41:MMK3Q10IFRSresultssummary($mn)

3Q10

actual

2Q10

actual

QoQ

change

3Q10

Atonest.

3Q09

actualvs

Atonest.

3Q10

Interfax

consensus

3Q09

actualvs

consensus

EBITDA 388 437 11.2% 404 4.0% 381 1.8%

EBITDAmargin 18.9% 21.1% 19.7% 18.8%

Netincome 43 53 18.9% 78 44.9% 85 49.4%

Source:Companydata,Interfax,Atonestimates

Operatingresultsbelowexpectationsin4Q10,promptingrevisiontoFY10forecast.

MMKs4Q10productionnumberscameinbelowourexpectationswithQoQreductions

acrossmoststeelproductgroups;rolledproductoutputwasdown6%QoQto2.7mn

tonnes.ThenotableexceptionwasHVAproduction,whichaccountedfor42%of4Q10

shipments(upfrom38%in3Q10).AsaresultwerevisedourFY10netincomeforecast

down11%from$270mnto$240mn.

HVAproductsandverticalintegrationshouldhelpinprotectingmargins.The

companysMill5000,whichaccountsforalargeshareofHVAproductiongrowth,isnow

operatingatitsfullcapacityof1.5mntpaofthickplate.Togetherwithgrowingself

sufficiencyincokingcoal,thisshouldmitigatesomeofthecostpressuresexpectedin

2011.Onthedownside,theprofitabilityofitsAtakasJVremainsuncertain.Weestimate

MMKcouldeasilyadd3mnt(27%)ofsteelproductionfromexistingfacilitiesifmarket

conditionsimprove,quicklytranslatingintobetterfinancialperformance.

Targetpriceuppedto$16.20/GDR;BUYratingreiterated.Ournewtargetpriceimplies

17%upsidepotentialfromcurrentlevels,supportingourBUYratingonthestock.Future

reviewswill

depend

on

MMKs

ability

to

manage

its

cost

exposure

and

protect

margins

fromfurtherdeterioration.

MAGNITOGORSK IRON AND STEELGrowing HVA Output Offsets Cost Pressures

BUY

Target price $16.20


Bloombergcode MMKLI

Reuterscode

MAGNq.L

Price(ordinaryGDR,$) 13.82

Price(pref,$) n/a



Sharedata

No.ofordinaryshares(mn) 11,174


No.ofprefshares(mn) n/a

3Maveragedailyt/o($mn) 8

Freefloat(%) 13.4%


Enterprisevalue

($mn)

15,228

Majorshareholders

MinthaHoldingLimited 45.62%

FulnekEnterprisesLimited 41.01%


Revenue 5,081 7,597 10,038

EBITDA 1,023 1,437 2,059

EBIT 288 643 1,219

Netincome 232 240 812

EPS 0.02 0.02 0.07

VALUATION

P/E(x)

51.1

49.5

14.6

P/CF(x) 15.2 11.1 153.8

EV/EBITDA(x) 14.9 10.6 7.4

EV/Sales(x) 3.0 2.0 1.5

P/BV(x) 1.2 1.2 1.1

RoCE(%) 1.9% 1.8% 5.7%

RoE(%) 2.3% 2.4% 7.7%

PERFORMANCE

1month(%) 11.0%

3month(%) 8.0%

12month(%) 8.1%

52weekhigh($) 16.23

52week

low

($)

8.90



25/38

2

5


Figure42:MMKAtonestimates,newvsoldEBITDA Netincome

YearendDecember 2010E 2011E 2012E3Yaverage


Newestimates($mn) 1,437 2,059 2,837 240 812 1,342

Oldestimates($mn) 1,535 2,423 2,737 270 872 1,058

Changevsold(%) 6.3% 15.0% 3.7% 5.9% 11.2% 6.8% 26.8% 2.9%


Figure43:MMKAtonestimatesvsconsensusEBITDA Netincome



Atonestimates($mn) 1,437 2,059 2,837 240 812 1,342




Figure44:MMKValuationbreakdown

DCFcalculation

($mn):

2011E

2012E

2013E

2014E

2015E

2016E

EBIT 1,219 1,907 1,644 1,328 1,121 1,009

Lesstaxation (274) (429) (370) (299) (252) (227)

Taxadj.EBIT 945 1,478 1,274 1,029 869 782

Depreciation 840 930 969 1,019 1,037 1,063

Lesscapex (1,000) (950) (850) (650) (500) (500)

Changeinworkingcapital (707) (386) (96) (27) 31 49

Freecashflow 77 1,072 1,297 1,372 1,437 1,393


NPVoffreecashflow 65 940 1,034 993 945 833



NPVof

free

cash

flow

4,810

28.9%

Risk

free

rate

4.50%









No.ordinaryshares(mn) 11,174 Targetgearing(debt/equity) 30.00%


Commonshares:GDRratio 13




14 xEarnings 15,076 17.63

7 xEBITDA 13,786 16.12



$/GDR % $/GDR

DCF 15.44 50% 7.72

P/E 17.63 25% 4.41

EV/EBITDA 16.12 25% 4.03



Source:Aton

estimates


26/38

2

6

Financial Accounts

Figure45:MMKIFRSnetincomestatement($mn)2008 2009 2010E 2011E 2012E 2013E 2014E 2015E

Grossrevenue 10,550 5,081 7,597 10,038 12,091 12,330 12,327 12,107

Costofgoodssold (6,890) (3,205) (4,944) (6,322) (7,259) (7,682) (7,945) (7,951)

Selling,distributionandadministrativeexpenses (1,163) (802) (1,064) (1,556) (1,874) (1,911) (1,911) (1,877)

Otheroperatingexpenses/(income) (378) (51) (152) (100) (121) (123) (123) (121)

EBITDA(reported) 2,204 1,285 1,566 2,059 2,837 2,613 2,348 2,158

EBITDA(adjusted) 2,119 1,023 1,437 2,059 2,837 2,613 2,348 2,158

EBITDA(adjusted)margin 20.1% 20.1% 18.9% 20.5% 23.5% 21.2% 19.0% 17.8%

EBIT 1,174 288 643 1,219 1,907 1,644 1,328 1,121

Netforeignexchangegain/(loss) 16 9 (40)

Othernonoperatingincome/(loss) 1 180 10

Netinterestexpense (18) (76) (136) (160) (158) (128) (87) (40)

Otherincome/(expenses),net (67) (144) (168)

Incomebeforetaxandminorityinterest 1,106 257 310 1,059 1,749 1,516 1,241 1,081

Incometax (25) (38) (68) (238) (394) (341) (279) (243)

Incomebeforeminorityinterest 1,081 219 242 821 1,356 1,175 962 838

Minorityinterest (6) 13 (2) (8) (14) (12) (10) (8)

Netincome 1,075 232 240 812 1,342 1,163 952 830

Netmargin 10.2% 4.6% 3.2% 8.1% 11.1% 9.4% 7.7% 6.9%

Earningspershare:

BasicEPSperordinaryshare 0.10 0.02 0.02 0.07 0.12 0.10 0.09 0.07

No.ofordinarysharesoutstanding 11,160 11,099 11,116 11,116 11,116 11,116 11,116 11,116

No.ofGDRs(1GDR=13ordinaryshares) 858 854 855 855 855 855 855 855


Figure46:MMKIFRSbalancesheet($mn)2008 2009 2010E 2011E 2012E 2013E 2014E 2015E

Cashandcashequivalents 1,106 165 248 246 490 958 1,557 2,270

Otherinvestments 138 221 202 202 202 202 202 202

Accounts

receivables

980

941

1,249

1,650

1,817

1,773

1,773

1,741

Inventories 996 856 1,084 1,299 1,388 1,421 1,469 1,470

Othercurrentassets 408 247 203 182 165 168 174 174

Totalcurrentassets 3,628 2,430 2,986 3,579 4,062 4,523 5,176 5,858

Plant,propertyandequipment 9,751 11,276 12,218 12,378 12,398 12,279 11,910 11,373

Intangibleassets 36 37 34 34 34 34 34 34

Goodwill 45 309 299 299 299 299 299 299

Investmentsinaffiliates 228 22 25 25 25 25 25 25

Otherinvestments 358 627 562 562 562 562 562 562

Othernoncurrentassets 151 132 154 154 154 154 154 154

Totalnoncurrentassets 10,569 12,403 13,292 13,452 13,472 13,352 12,983 12,446

Totalassets 14,197 14,833 16,277 17,031 17,534 17,875 18,159 18,305

Shorttermloansandleaseliabilities 1,295 828 972 1,022 922 822 722 622

Accountsandnotespayable 1,321 928 1,151 1,039 892 789 816 817

Othercurrentliabilities 24 21 23 23 23 23 23 23

Totalcurrentliabilities 2,640 1,777 2,146 2,084 1,837 1,634 1,561 1,462

Longtermdebtandcapitalleases 431 1,290 2,378 2,578 2,328 2,078 1,828 1,578

Othernoncurrentliabilities 1,274 1,441 1,403 1,403 1,403 1,403 1,403 1,403

Totalnoncurrentliabilities 1,705 2,731 3,781 3,981 3,731 3,481 3,231 2,981

Totalliabilities 4,345 4,508 5,927 6,065 5,568 5,115 4,792 4,443

Minorityinterests 189 368 405 405 405 405 405 405

Totalshareholders'equity 9,664 9,957 9,945 10,560 11,560 12,355 12,962 13,457

Totalliabilitiesandshareholders'equity 14,198 14,833 16,277 17,031 17,534 17,875 18,159 18,305



27/38

2

7

Figure47:MMKIFRScashflowstatement($mn)2008 2009 2010E 2011E 2012E 2013E 2014E 2015E

Operatingactivities:

Netincome 1,075 232 240 812 1,342 1,163 952 830

Adjustmentsfornoncashitems:

Depreciationandamortisation 945 735 794 840 930 969 1,019 1,037

Income

tax

25

38

68

238

394

341

279

243

Netfinancecost 18 76 136 160 158 128 87 40

Otheradjustmentsfornoncashitems 715 (115) 224 30 31 8 4 8

Operatingprofitbeforechangesinworkingcapital 2,778 966 1,461 2,080 2,854 2,609 2,342 2,158

Changesinworkingcapital (269) (127) (245) (707) (386) (96) (27) 31

Cashgeneratedfromoperations 2,509 839 1,216 1,373 2,468 2,513 2,315 2,189

Interestpaid (104) (109) (110) (165) (172) (170) (152) (135)

Incometaxrefund/(paid) (480) 135 (70) (217) (376) (345) (285) (243)

Netcashgeneratedbyoperatingactivities 1,925 865 1,036 991 1,920 1,999 1,877 1,810

Investingactivities:

Acquisitionofproperty,plantandequipment (2,112) (1,613) (2,118) (1,000) (950) (850) (650) (500)

Otherinvestingactivities 1,133 (76) 10

Netcashusedforinvestingactivities (979) (1,689) (2,108) (1,000) (950) (850) (650) (500)

Financing

activities:

Proceeds fromborrowings 3,974 2,935 2,500 500

Repaymentofborrowings (3,562) (2,974) (1,250) (250) (350) (350) (350) (350)

Dividendspaid (314) (16) (48) (203) (336) (291) (238) (207)

Otherfinancingactivities (36) 15 3 (40) (40) (40) (40) (40)

Netcashprovidedbyfinancingactivities 62 (40) 1,205 7 (726) (681) (628) (597)

Effectsofexchangeratechangesincashandcashequivalents (158) (77) (50)

Cashandcashequivalentsatbeginningoftheperiod 256 1,106 165 248 246 490 958 1,557

Netincreaseincashandcashequivalents 850 (941) 83 (2) 244 468 599 713

Cashandcashequivalentsattheendoftheperiod 1,106 165 248 246 490 958 1,557 2,270



28/38

2

8

WeupgradeourratingonNLMKfromHOLDtoBUYwitha12MTPof$49.40/GDR,

implying14%upsidepotential.Whileupsidemaybelimitedcomparedtoothersteel

stocks,NLMKsassetquality,healthybalancesheetandstrongprofitabilitymakeita

soundpotential

addition

to

any

steel

company

portfolio,

in

our

view.

Figure48:Salesandrevenuearefinelybalancedovermajormarkets

Other

11%Middle

East

15%

USA

17%

Russia

35%

Europe22%

Regional s a l e s structure (3Q10)

Other

12%Middle

East

14%

USA

13%

Russia

40%

Europe

21%

Regional revenue structure(3Q10)

Source:CompanyData

HVAproductsunderpinprofitabilityleadership.AlthoughHVAproducts(e.g.pre

painted,transformeranddynamosteels)accountforonly30%ofNLMKssalesvolumes,

thepremiummarginstheseproductscommandunderpinitsprofitabilityleadershipover

peers,evenintimesofrisingcosts.Increasedlongsteeloutputshouldprovide

additionalupsideonceRussianconstructionactivityrecovers,inourview.

Outlookfor4Q10highlightschallengingcostenvironment.NLMKreportedastrongset

of3Q10results,outperformingbothourandconsensusestimatesbyasubstantial

margin,recordingEBITDAof$695mnandnetincomeof$516mn(seeFigure49).

Figure49:NLMK3Q10USGAAPresultssummary($mn)

3Q10

actual

2Q10

actual

QoQ

change

3Q10

Atonest.

3Q09

actualvs

Atonest.

3Q10

Interfax

consensus

3Q09

actualvs

consensus

EBITDA 695 750 7% 612 14% 646 8%

EBITDAmargin 30.5% 34.8% 29.1% 30.2%

Netincome 516 466 11% 309 67% 409 26%

Source:Companydata,Interfax,Atonestimates

However,thecompanysoutlookfor4Q10highlightsthecostpressuresthebusinessis

facing:EBITDA

margin

is

expected

at

around

25%

vs

31%

in

3Q10.

BuyingremainingstakeinDufercoJVcouldbeakeyvaluecatalyst.NLMK's

internationalexpansionhasfocusedonacquiringsteelrerollingassetstocompensate

forashortageofrollingcapacity.TheJVwithDuferco(SteelInvest&FinanceS.A.)aimed

togiveNLMKanoutletforitsexpandingslabproduction.Buyingtheremaining50%in

theJVcouldbecomeapowerfulvaluedriversupportinghighermarginsviasalesto

internationalmarkets(providedthepriceisrightandNLMKcanreturnthefacilitiesto

profitability).

TPraisedto$49.40/share,upgradetoBUY.Thestockhascorrectedaround15%from

itsJanuarypeakof$51.30/GDR.WhileournewTPimpliesjust14%upsidefromcurrent

levels,wehaveupgradedourratingtoBUYonNLMKsassetquality,strongbalance

sheetand

profitability

leadership

vs

global

peers,

which

should

keep

the

stock

among

thetoppicksforanysteelfocusedportfolio,inourview.

NOVOLIPETSK STEELProfitability Leader Despite Margin Pressures

BUY

Target price $49.40


Bloombergcode NLMKLI

Reuterscode

NLMKq.L

Price(ordinary,$) 43.50

Price(pref,$) n/a



Sharedata

No.ofordinaryshares(mn) 5,993


No.ofprefshares(mn) n/a3Maveragedailyt/o($mn) 19

Freefloat(%) 12.9%


Enterprisevalue

($mn)

27,333

Majorshareholders

FletcherGroupHoldings 85.5%


Revenue 6,140 8,382 10,905

EBITDA 1,370 2,384 3,233

EBIT 892 1,882 2,673

Netincome 215 1,332 1,949

EPS 0.04 0.22 0.33

VALUATION

P/E(x) 121.2 19.6 13.4

P/CF(x) 101.5 100.1 76.5

EV/EBITDA(x) 20.0 11.5 8.5

EV/Sales(x) 4.5 3.3 2.5

P/BV(x) 3.0 2.7 2.3

RoCE(%) 1.9% 10.7% 14.3%

RoE(%) 2.5% 13.7% 17.5%

PERFORMANCE

1month(%) 7.6%

3month(%) 15.8%

12month(%) 42.2%

52weekhigh($) 51.00

52weeklow($) 25.04



29/38

2

9


Figure50:NLMKAtonestimates,newvsoldEBITDA Netincome



Newestimates($mn) 2,384 3,233 4,397 1,332 1,949 2,753

Oldestimates($mn) 2,424 3,263 3,700 1,208 2,011 2,293

Changevsold(%) 1.6% 0.9% 18.8% 5.4% 10.3% 3.1% 20.1% 9.1%


Figure51:NLMKAtonestimatesvsconsensusEBITDA Netincome



Atonestimates($mn) 2,384 3,233 4,397 1,332 1,949 2,753




Figure52:NLMKValuationbreakdown

DCFcalculation

($mn):

2011E

2012E

2013E

2014E

2015E

2016E

EBIT 2,673 3,756 3,923 3,953 3,748 3,635

Lesstaxation (601) (845) (883) (889) (843) (818)

Taxadj.EBIT 2,071 2,911 3,040 3,063 2,905 2,818

Depreciation 560 640 696 710 709 709

Lesscapex (1,800) (1,500) (900) (700) (700) (700)

Changeinworkingcapital (491) (478) (266) (71) (39) (39)

Freecashflow 341 1,574 2,570 3,002 2,875 2,788


NPVoffreecashflow 290 1,391 2,077 2,219 1,943 1,723



NPVof

free

cash

flow

9,643

26.2%

Risk

free

rate

4.5%









No.ordinaryshares(mn) 5,993 Targetgearing(debt/equity) 30.0%


Commonshares:GDRratio 10




16 xEarnings 26,246 43.79

8 xEBITDA 21,206 35.38



$/GDR % $/GDR

DCF 59.2 50% 29.62

P/E 43.8 25% 10.95

EV/EBITDA 35.4 25% 8.85



Source:Aton

estimates


30/38

3

0

Financial Accounts

Figure53:NLMKUSGAAPP&Lstatement($mn)2009 2010E 2011E 2012E 2013E 2014E 2015E

Totalrevenue 6,140 8,382 10,905 13,524 14,839 15,184 15,298

COGS (4,150) (5,399) (7,033) (8,280) (9,284) (9,561) (9,867)

Grossprofit 1,990 2,982 3,872 5,244 5,555 5,623 5,431

SG&A (1,054) (1,097) (1,200) (1,488) (1,632) (1,670) (1,683)

Otheroperatingincome/(expense) (44) (3)

Operatingincome(EBIT) 892 1,882 2,673 3,756 3,923 3,953 3,748

EBITDA 1,370 2,384 3,233 4,397 4,619 4,662 4,457

DD&A (478) (503) (560) (640) (696) (710) (709)

Netinterestincome/(expense) (111) (54) (78) (90) (65) (6) 70

Associates

FX(loss)/gain (78) (54)

Others(recurring) (108) (13)

Pretaxprofit 595 1,761 2,595 3,666 3,858 3,947 3,818

Tax (182) (423) (584) (825) (868) (888) (859)

Equityinnetlosses/(earnings)ofassociates (315) (29) (43) (60) (63) (65) (63)

Netincome(preexceptionals) 98 1,310 1,969 2,781 2,927 2,994 2,896

Minorityinterest 117 22 (20) (28) (29) (30) (29)

Netincome(postexceptionals) 215 1,332 1,949 2,753 2,898 2,964 2,868

EPS($/GDR) 0.36 2.22 3.25 4.59 4.83 4.95 4.78

DividendperGDR($) 0.07 0.31 0.98 1.38 1.45 1.48 1.44

NumberofGDRs(mn) 599 599 599 599 599 599 599


Figure54:NLMKUSGAAPbalancesheet($mn)2009 2010E 2011E 2012E 2013E 2014E 2015E

Cash&shortterminvestments 1,699 1,268 722 540 2,027 3,971 5,978

Accountsreceivable 913 1,247 1,622 2,011 2,207 2,258 2,275

Inventory 1,134 1,475 1,922 2,263 2,537 2,613 2,696

Other

current

assets

131

131

131

131

131

131

131

Totalcurrentassets 3,877 4,121 4,396 4,944 6,902 8,972 11,080

PP&E 7,316 8,613 9,853 10,713 10,917 10,907 10,898

Intangibleassets 760 760 760 760 760 760 760

Investments 468 468 468 468 468 468 468

Otherlongtermassets 81 122 122 122 122 122 122

Totalnoncurrentassets 8,625 9,963 11,204 12,063 12,267 12,257 12,248

Totalassets 12,502 14,084 15,599 17,007 19,168 21,230 23,328

Accountspayable 841 1,094 1,425 1,678 1,882 1,938 2,000

Shorttermdebt 557 600 600 600 600 600 600

Othercurrentliabilities 19 19 19 19 19 19 19

Totalcurrentliabilities 1,417 1,714 2,045 2,298 2,501 2,557 2,619

Longtermdebt 1,939 2,100 1,900 1,100 1,000 900 900

Deferredtaxliabilities 396 396 396 396 396 396 396

Othernoncurrentliabilities 140 140 140 140 140 140 140

Totallongtermliabilities 2,475 2,636 2,436 1,636 1,536 1,436 1,436

Totalliabilities 3,892 4,350 4,481 3,934 4,037 3,994 4,056

Minorityinterests (108) (108) (108) (108) (108) (108) (108)

Totalshareholdersequity 8,610 9,734 11,118 13,073 15,131 17,236 19,272

Totalliabilitiesandequity 12,502 14,084 15,599 17,007 19,168 21,229 23,328



31/38

3

1

Figure55:NLMKUSGAAPcashflow($mn)

2009 2010E 2011E 2012E 2013E 2014E 2015E

Netincome 98 1,310 1,969 2,781 2,927 2,994 2,896

DD&Aaddback 478 503 560 640 696 710 709

(Increase)/Decreaseinworkingcapital 859 (422) (491) (478) (266) (71) (39)

Otheroperatingcashflowitems (41)

Cashflowfromoperations 1,394 1,391 2,038 2,944 3,357 3,633 3,567

Capital

expenditure

(1,121)

(1,800)

(1,800)

(1,500)

(900)

(700)

(700)

Acquisitions

Otherinvestingcashflow (651)

Cashflowfrominvesting (1,771) (1,800) (1,800) (1,500) (900) (700) (700)

Dividendspaid (2) (185) (585) (826) (869) (889) (860)

Share(repurchase)/issue

Increase/(decrease)interestbearingliabilities (533) 164 (200) (800) (100) (100)

Cashflowfromfinancing (535) (21) (785) (1,626) (969) (989) (860)

Cashandcashequivalentsatbeginningofyear 2,159 1,247 817 270 88 1,575 3,519

Netincrease/(decrease)incashandcashequivalents (912) (431) (547) (182) 1,487 1,944 2,007

Cashandcashequivalentsatendofyear 1,247 817 270 88 1,575 3,519 5,526



32/38

3

2

WeupgradeourtargetpriceforSeverstalto$22.10/GDRandreiterateourBUYrating

ontheshares.PostponementofthecompanysgoldbusinessIP

russian steel remain cautious as costs take centre stage

Documents