Tuesday,
July 2, 2013
Metals
&
Mining
Spot
‐
based
valuation
–
Vol.
4
The names and trades below comprise our monthly M2M strategy:
Most favored stocks: Norilsk Nickel, TMK and Polymetal
Least favored stocks: Mechel, Polyus Gold and Uralkali
Pair trades:
o TMK vs Tenaris
o Polymetal vs Polyus
o Evraz vs Severstal
o Norilsk vs Uralkali
Base metals (Norilsk) is our top pick, Avoid steels
BCS M2M strategy: Spot‐based valuations used to create short‐term valuation calls. The BCS Mark‐to‐Market (M2M) strategy is geared to isolating equity value in an investment environment characterized by high volatility. To this end, we apply a sector valuation based on spot commodity prices and the exchange rate. To be more precise, our analysis takes into account the current market environment (e.g., commodities, exchange rates) to deliver a spot‐based valuation, which we use to decide our short‐term valuation calls in both pair trade and long‐only territory.
Most Favored/Trade ideas: Norilsk Nickel, TMK, Polymetal. There were no changes since
last month in either of our portfolios. In particular, our Most Favored stocks are still Norilsk Nickel (dividends were fully in line with guidance, confirming improving corporate governance), TMK (collapsed recently contrary to market and pipe peers, should benefit from high oil prices and declining steel prices) and Polymetal (a valuation call, never traded so low, a higher beta play on gold/silver price recovery).
Least Favored: Mechel, Polyus, Uralkali. Similarly, the same names remain among our
Least Favored: Mechel (coking coal prices under pressure, renewing record lows since 2008/09 crisis), Polyus Gold (outperformed the market heavily, looks overpriced on fundamentals) and Uralkali (lacking short‐term upside drivers, while the buyback appears set to end in 6 weeks).
Pair trades: TMK vs Tenaris, Polymetal vs Polyus, Evraz vs Severstal, Norilsk vs Uralkali. We added one pair trade – Norilsk vs Uralkali – to our latest portfolio of three, i.e., TMK vs Tenaris, Polymetal vs Polyus and Evraz vs Severstal. The TMK vs Tenaris trade: TMK underperformed its key peers dramatically, which we see as unjustified, fundamental risks are overvalued by the market.
The Polymetal vs Polyus trade: unjustified heavy underperformance of the former vs the latter should partially reverse. The Evraz vs Severstal trade: long steel prices should outperform flat steel, benefitting the trade. The Norilsk vs Uralkali trade: we are long in Norilsk and shorting Uralkali – nickel prices are seen
Most and least preferred stocks
Most preferred Least preferred
Norilsk Nickel Mechel TMK Polyus Polymetal Uralkali
Pair trade summary
Long Short TMK Tenaris Polymetal Polyus Evraz Severstal Norilsk Nickel Uralkali M2M valuation summary
12MF M2M
Company EV / EBITDA P/E
Norilsk 6.5 11.0 UC Rusal neg. neg. Severstal 7.0 22.1
NLMK 7.5 16.2
MMK 6.4 neg.
EVRAZ 5.5 neg.
Mechel neg. neg.
TMK 6.1 9.4 Uralkali 10.3 14.5 Phosagro 6.1 8.1 Acron 4.9 5.7 Polyus 10.0 18.7 Polymetal 6.2 14.4 Nordgold 3.9 20.1 Source: BCS estimates
Table
of
Contents
Most
favored
/
trading
ideas
...
3
Least
favored
...
3
Pair
trades
...
4
Mark
‐
to
‐
Market
summary
...
5
Key
inputs
for
M2M
EBITDA
estimate
...
6
M2M
EBITDA
v
BCS
and
Consensus
...
7
Sensitivity
to
input
changes
...
8
Debt
is
a
growing
major
concern
...
9
Most
favored
/
trading
ideas
Norilsk
Nickel
Dividends are coming, corporate governance improvement
The Buy call on Norilsk Nickel is the safest in our universe at this stage: Downside is limited by the valuation safety net (low multiples)
Profits highly unlikely to fall more: globally nickel price is below cash costs Norilsk’s M2M EV/EBITDA is 6.5x, a discount to historic averages; single‐digit P/E Stock to re‐rate as corporate governance set to improve
FY12 dividends are in line with guidance, should confirm governance improvement We see no risks to financial gearing, CapEx should be controlled
Finally, all shareholders are interested in a higher NN share price
TMK
Unjustified collapse, gap to global peers: attractive entry point
TMK should benefit from weakening steel prices, reducing cost pressures The stock is suffering from share overhang, that should ease
Thus, the stock’s recent decline offers a good buying opportunity M2M EV/EBITDA is 6.1x, below historical averages
Underperformance to global peers – Tenaris, Vallourec – is strong and unjustified
Polymetal
A valuation call, never traded this low
Polymetal shares have fallen 40% ytd, heavily underperforming peers
Risk #1 – operational, but valuations more than fully discount the worst case scenario Risk #2 – M&A, but Polymetal’s core shareholders will not accept merger at the
current market valuation, we believe
M2M EV/EBITDA is now 6.2x, below historical averages
Least
favored
Mechel
Coking coal prices under pressure, new capacity in long steel is a risk
Coking coal prices are under further pressure, renewing lows since 2008/09 crisis Risks for coking coal are high – China is almost self‐sufficient
High financial gearing is a concern, M2M net debt/EBITDA ratio is 38x On multiples the stock is expensive, with M2M EV/EBITDA is negative The only hope is a strong rebound in coking coal prices of c30%+ Highest beta play on China’s industrial cycle in Russia
Polyus
Outperformed the market, fundamentals look overpriced
Stock outperformed EM gold peers being flat ytd
Market overestimates the M&A premium, assuming Polymetal merger Operational issues remain, including Natalka project commissioning M2M EV/EBITDA is 10.0x, at a premium to key peer Polymetal
Uralkali
Pair
trades
Long
TMK,
Short
Tenaris
A great hedged play on TMK’s collapse
The recent Russian market correction presents strong bottom‐fishing opportunities: Underperformance to its global peers – Tenaris and Vallourec – is strong Historically TMK was highly correlated with global peers
Steel price declines should ensure limited financial risks for the stock The stock’s recent decline offers a good buying opportunity
M2M EV/EBITDA is 6.1x, somewhat below averages
Tenaris is a source of hedged funding, not a standalone short
Long
Polymetal,
Short
Polyus
Polymetal’s underperformance should partially reverse
Polymetal was among the worst‐performing stocks in the gold equity space ytd Polyus, on the other hand, was among the key outperformers in EM
Fundamentally, Polymetal has always traded at least in line with Polyus, sometimes at a 10% premium on EV/EBITDA – now there is a 38% discount
A merger with Polyus is unlikely to go through at current valuations The spread is unjustified; the trend should reverse once market recovers
Long
Evraz,
Short
Severstal
A bet on the ongoing rebar prices growth
Long steel prices (Evraz) are clearly much better positioned than flat steel (Severstal) Performance gap between stocks is only partially justified, fundamentally excessive Evraz’s M2M EV/EBITDA multiple was at par with Severstal’s, vs 21% discount now Construction season pick‐up may help long steel stocks (i.e. Evraz) in the short term Financial risks are not strong for Evraz, state should back the company
This is a higher risk trade though; competition risks for Evraz will increase in 2014
Long
Norilsk,
Short
Uralkali
Nickel prices to rebound, potash industry has risks to the downside
Current nickel prices are loss‐making for up to 40% of global producers We expect supply cuts in the very short term
Norilsk’s CapEx and OpEx are seen to be under control and we see no big threat to the dividend story
Negotiations with China on potash supplies are expected only for November due to high inventories, otherwise price may be reduced
Uralkali’s buyback set to end in 6 weeks and support will be gone from the stock
Mark
‐
to
‐
Market
summary
Below you can see the M2M summary valuation table for the M&M space in Russia.
Russian metals and mining equities mark‐to‐market valuation summary
Share price MCAP, $ mn EV, $ mn 12MF M2M
Company Crncy EV/EBITDA P/E Comment
Norilsk Nickel 13.6 $ 21 520 23 857 6.5 11.0 Trades at a mid‐cycle multiple, but we are in a trough – market inefficiency UC Rusal 3.0 HK$ 5 819 9 810 neg neg. M2M multiples discounts the best case scenario, an expensive option on Al Severstal 6.3 $ 5 166 9 512 7.0 22.1 Trading at a premium to peers – not fully justified
NLMK 12.5 $ 7 504 10 987 7.5 16.2 Premium to peers has recovered, no major triggers seen MMK 2.9 $ 2 519 5 711 6.4 neg. Lack of vertical integration partially offset by high financial gearing Evraz 103 GBp 2 395 9 185 5.5 neg. Cheapest stock in the sector thanks to construction season pick up Mechel 2.8 $ 1 303 10 684 neg neg. An expensive option on coking coal prices, which are at new lows since crisis TMK 11.0 $ 2 383 5 923 6.1 9.4 Gap to pipe peers is unjustified, benefits from weak steel and strong oil Uralkali 33.6 $ 19 708 21 307 10.3 14.5 Trades high and lacks short‐term drivers, buyback to end in less than 2M Phosagro 12.4 $ 4 631 5 250 6.1 8.1 Stock trades unfairly low, re‐rating expected as liquidity improved, potential MCSI inclusion Acron 3.9 $ 1 565 2 254 4.9 5.7 Fairly valued Polyus 493 GBp 9 278 8 697 10.0 18.7 Trades at an unfairly high premium to global peers Polymetal 199 GBp 2 908 3 098 6.2 14.4 At a discount to historic multiples, weak performance is still unjustified Nordgold 2.0 $ 755 1 175 3.9 20.1 The stock that is always cheap, lacking triggers Source: BCS estimates
Note that the discount to historical averages may be due to one of the following:
The market believes that the stock’s M2M EBITDA will deteriorate – usually due to expectations of lower commodity prices. Other reasons include expected growth in production costs or lower sales volumes.
The stock has fundamentally de‐rated on risks (i.e., corporate governance concerns, financial leverage risks, de‐rated growth outlook)
If none of these is true, then the stock is underpriced. The reverse logic applies for the explanation behind a potential premium to historic multiples.
Methodology
The M2M valuation assumes spot commodity prices in real terms as well as a spot exchange rate (in real terms as well), resulting in an implied spot‐based 12 Month Forward (12MF) profit estimate (EBITDA and net income) and, consecutively, EV/EBITDA and P/E multiples, which are then compared to historical averages for each stock. This approach gives a relatively short‐term analysis of the expected share price performance of the stocks covered in this report. We note that these recommendations may conflict with BCS’ official ratings, which are more long‐term.
Our methodology provides a relatively short‐term analysis of the expected share price performance of the stocks covered in this report
Key
inputs
for
M2M
EBITDA
estimate
The table below summarizes the inputs used in the current M2M strategy.
Key inputs summary (as of Monday’s close)
Ruble exchange rate 32.74 Nickel, $/ton 13 562 Copper, $/ton 6 638 Aluminium, $/ton 1 726 Platinum, $/oz 1 360 Palladium, $/oz 669 Gold, $/oz 1 287 Silver, $/oz 20 Steel (HRC dom/exp average), $/ton 496 Steel rebar (domestic), $/ton 554 Coking coal (Newcastle FOB), FCA, $/ton 130 Coking coal (Russia, mix), FCA, $/ton 105 Potash, China domestic, $/ton 424 DAP, Tampa FOB, $/ton 459 Urea, FOB Black Sea, $/ton 320 Source: Datastream
Track
record
The charts and tables below show the track record for our key portfolios. Note that our performance is based on the following:
Pricing is defined as a trading average in 30‐60 mins after the report release;
If the stock is not trading, we take the first 30 mins average at the opening;
If the number of stocks/pairs in a portfolio is less than 3, we assume the remaining being cash (i.e. with 2 trade ideas, cash is a third of the portfolio).Pair
trade
portfolio
Pair
trade
portfolio
summary
Long Short Launched Performance Share in portfolio
Active
TMK Tenaris 25‐Apr ‐5.5% 25%
Polymetal Polyus 2‐Apr ‐39.6% 25%
Evraz Severstal 7‐May 0.4% 25%
Norilsk Uralkali 20‐Jun 1.8% 25%
Pair trade portfolio return since April 2nd ‐12.4%
Source: BCS estimates
Most/Least
preferred
portfolios
Most/Least
preferred
portfolios
summary
Stock Open Return Share in portfolio
Most preferred Norilsk 2‐Apr ‐5.7% 25% TMK 2‐Apr ‐6.5% 25% Polymetal 2‐Apr ‐40.8% 25% Least preferred Polyus 2‐Apr ‐1.9% 33% Mechel 2‐Apr ‐40.0% 33% Uralkali 20‐Jun ‐0.4% 33%
Return since April 2nd:
Most preferred ‐15.0% Least preferred ‐17.9% RTS index ‐11.9% RTS M&M index ‐19.6% Source: BCS estimates ‐20% ‐15% ‐10% ‐5% 0% 5% 10% 15% 1 ‐ Apr 15 ‐ Apr 29 ‐ Apr 13 ‐ May 27 ‐ May 10 ‐ Jun 24 ‐ Jun ‐25% ‐20% ‐15% ‐10% ‐5% 0% 5% 10% 15%
1‐Apr 1‐May 1‐Jun 1‐Jul
Most Least RTS RTS M&M
M2M
BCS
EBITDA
changes
The table below summarizes the key changes to BCS EBITDA estimates for the stocks that we cover with a short justification.
Vol. 2 Vol. 3 Chng., Comment
Data as of 7‐May 4‐Jun %
Norilsk Nickel 4 226 3 660 (13%) Lower commodity prices
UC Rusal 546 neg. n/m Al prices slumped to loss‐making level Severstal 1 566 1 356 (13%) Steel slumped, ruble depreciation not enough NLMK 1 617 1 461 (10%) Steel slumped, ruble depreciation not enough MMK 1 007 896 (11%) Steel slumped, ruble depreciation not enough Evraz 1 677 1 664 (1%) Rebar prices still stronger vs HRC
Mechel 259 neg n/m Coking coal prices slumped to loss‐making level TMK 1 017 966 (5%) Slightly weaker market environment Uralkali 2 361 2 068 (12%) Weak 1Q13 force to revise optimistic estimates Phosagro 982 863 (12%) DAP price declined, ruble helped a bit Acron 378 462 22% Weaker N fertilizer prices Polyus 1 050 866 (18%) Weaker gold Polymetal 625 499 (20%) Weaker gold/silver Nordgold 394 303 (23%) Weaker gold Source: BCS estimates
M2M
EBITDA
v
BCS
and
Consensus
The chart below compares M2M EBITDA v the 12MF BCS and consensus forecasts. This is a good indication of potential dynamics of revisions to consensus estimates.
BCS/Consensus EBITDA upside/(downside) to M2M levels
*
not yet officially covered by BCS Source: BCS estimates
Comparison of M2M EBITDA v BCS and Consensus estimates
Company name
12MF Mark‐to‐
market EBITDA
BCS forecast Consensus forecast
2013E 2014E Implied 12MF 2013E 2014E Implied 12MF
Norilsk Nickel 3 660 5 602 5 902 5 752 4 627 5 062 4 844 UC Rusal neg. 1 024 1 244 1 134 1 019 1 204 1 111 Severstal 1 356 2 238 2 631 2 434 1 854 2 033 1 943 NLMK 1 461 1 843 2 041 1 942 1 811 2 050 1 930 ‐140% ‐120% ‐100% ‐80% ‐60% ‐40% ‐20% 0% MNOD Rusal SVST NLMK MMK EVR MTL URKA PHOR AKRN PLGL * POLY * NORD * vs. BCSe vs. Cons.
The table below shows the changes in consensus forecasts over the past month.
12MF Consensus EBITDA change over month
Source: BCS estimates
Sensitivity
to
input
changes
The analysis below shows the sensitivity of each company’s EBITDA and net income to commodity price changes (10% increase in all commodities). UC Rusal and Mechel are the most geared to commodity prices due to low profitability and integration into mining.
Sensitivity to a 10% increase in all commodity prices
M2M EBITDA M2M Net income
Source: BCS estimates * ‐n/m Source: BCS estimates We also show how sensitive Russian stocks are to ruble exchange rate changes (we consider a 10% appreciation). This sensitivity is highly important, given that the Russian currency is highly correlated to the oil prices and Russian stocks suffer from any ruble appreciation. Similarly, the most sensitive stocks here are UC Rusal and Mechel, also for the same reasons being low profitability and high mining exposure. Gold stocks, Norilsk and Uralkali are least levered to ruble exchange rates due to high margins.
Sensitivity
to
10%
ruble
appreciation
M2M EBITDA M2M Net income
Source: BCS estimates * ‐n/m Source: BCS estimates ‐3% ‐4% ‐6% ‐6% ‐5% ‐6% ‐5% ‐4% ‐4% ‐1% ‐7% ‐5% ‐8% ‐9% ‐8% ‐7% ‐6% ‐5% ‐4% ‐3% ‐2% ‐1% 0% MNOD Rusal SVST NLMK MMK EVR MTL URKA
PHOR AKRN PLGL POLY NORD
21% 155% 30% 35% 26% 23% 47% 17%29%26% 19%22%23% 0% 40% 80% 120% 160% 200% MNOD Rusal SVST EVR
MMK NLMK MTL URKA PHOR AKRN PLGL POLY NORD
28% 70% 43% 20% 36% 29% 24% 31% 46% 0% 20% 40% 60% 80% MNOD Rusal * SVST EVR * MMK * NLMK MTL *
URKA PHOR AKRN PLGL POLY NORD
‐7% ‐81% ‐19% ‐22% ‐16% ‐11% ‐28% ‐5% ‐17%‐16% ‐7%‐8% ‐5% ‐100% ‐80% ‐60% ‐40% ‐20%
0% MNOD Rusal SVST EVR MMK NLMK MTL URKA PHOR AKRN PLGL POLY NORD
‐9% ‐44% ‐22% ‐6% ‐22% ‐19% ‐8%‐11% ‐11% ‐50% ‐45% ‐40% ‐35% ‐30% ‐25% ‐20% ‐15% ‐10% ‐5% 0% MNOD Rusal * SVST EVR * MMK * NLMK MTL *
The chart on the left below illustrates the exact correlation between oil prices and the ruble exchange rate. This high correlation is a strong risk for many Russian miners, whose costs rise in USD terms on appreciation, but that growth is no longer compensated by higher commodity prices – see the chart on the right below showing the de‐coupling of oil from metals and mining commodities.
Ruble exchange rate vs oil price (real current terms) Oil vs CRB commodity price index – clear de‐coupling
Source: BCS estimates Source: BCS estimates
This de‐coupling is fully in line with our view, as we expected that consumption stories (i.e. oil) will outperform investment ones (i.e. steel, other metals) given the risks of global overinvestment. This is also the major reason why the Russian mining companies are showing deteriorating profitability over time (see chart below).
Debt
is
a
growing
major
concern
In this section, we provide some analysis of the Russian metals and mining space in terms of financial gearing. Below you can see a summary of Russian stocks’ net debt/EBITDA ratio based on mark‐to‐market estimates.
M2M
12MF
net
debt/EBITDA
ratio
y = 139,09x‐0,311 R² = 0,8408 25 30 35 40 45 50 30 50 70 90 110 130 US$ exchange rat e Brent oil price, $/bbl Historical Current 20 40 60 80 100 120 140 250 300 350 400 450 500 550 600 650
Jan‐09 Jan‐10 Jan‐11 Jan‐12 Jan‐13
CRB Index Brent oil price 0,5 9,4 2,8 4,2 3,5 2,0 38,0 3,5 0,7 0,6 4,0 ‐0,5 0,3 1,1 ‐5,0 0,0 5,0 10,0 15,0 20,0 25,0 30,0 35,0 40,0 MNOD Rusal *
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Head of Russian Product
Olga Sibiricheva
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