As a result of the Metinvest/Smart merger, Metinvest has prepared a bridgehead for further organic growth and acquisitions. Metinvest's resource base now theoretically allows it to almost triple crude steel production. We expect further consolidation in the sector.
Ukrainian rolled steel production grew 7.4% yoy in 8M07 with integrated long steel producers related to Metinvest, Arcelor Mittal and Privat contributing the most. Due to their large-scale capacity development programs and competitive advantages in raw materials, we think these groups will benefit from the forecasted global and local increases in steel demand.
The aggregate reported top line of traded Ukrainian steel makers in 1H07 shot up to USD 7.5 bln, driven by steel price growth and slashing transfer pricing in 1H07. In 2008, we forecast sales growth to decrease for flat and long steel producers on the back of production and steel prices.
Most domestic producers are able to withstand a ~50% increase in gas prices expected in 2008, but those that use almost 40% of gas in their open heath furnaces are at a disadvantage, namely Zaporizhstal, MMK Illicha and Alchevsk Iron & Steel. As opposed to integrated producers, these companies lack the raw materials base and have mostly limited their investment programs at improving efficiency, not increasing capacity. Moreover, we see a risk that non-integrated producers might postpone planned CapEx.
Local steel producers are undertaking the transformation to non-gas technologies (PCI), which require K grade quality coal with low sulphur content. In view of the lack of seaports for deliveries from abroad and a deficit on the CIS market, Chervonoarmiyska-Zakhidna, producer of 62% of total Ukrainian output, is poised to experience robust demand.
At the AGM last week, management disclosed new production plans by 2012, which are 20% higher than our previous forecasts. Though we remain more conservative in light of probable delays in increasing production, we revise upward our production forecasts, now estimating 8.5 mln mt in 2008 vs. 7.5 previously.
In our discussion with management after the AGM, they disclosed plans for an IFRS audit and evaluation of reserves by the end of 2008. Our general impression is that they are heading toward an IPO, which would be a catalyst for the stock's price. Look for improved reporting standards as a result of IPO preparations and a strong external impetus - the return of Yulia Tymoshenko as prime minister; her new government is likely to take a tough stance on tax evaders.
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