STRATEGY

December 2010

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CONTENTS 2011 – Cheer mind, open eyes 5 Right choice makes sense Russian Economy 6 Elections are coming Commodity markets 7 Start Your Engines! Fixed Income Market 11 Rates: Increase with no decrease Stock Market 13 Betting on growth and efficiency in 2011

Oil & Gas 17 Uncertainty with taxes remains Power Industry 31 Bet on quality 41 Metals & mining Further recovery in 2011 Telecoms 57 Growing beyond traditional mobile services to unlock more value Transport 75 Outpacing economic recovery Consumer and retail 85 Ready, Steady And Go Shopping! Banking sector 99 More loans – less risks Machinery 111 Citius, altius, fortius* Real Estate Sector 117 Footing get stronger, its time to build Infrastructure construction sector 127 World Cup 2018 – next impulse for development APPENDIX 133

2011 - Cheer mind, open eyes Right choice makes sense

STRATEGY 2011 5

2011 - Cheer mind, open eyes Right choice makes sense

Choose Profit in 1H11 over Risks in 2H11

We expect that in 1H11 markets will continue positive trend driven by excess liquidity and inflation risks. At the same time fundamental factor are not strong enough to support the current high price levels, European financial risks do exist and China may take further steps in strengthening its monetary policy that will put pressure on the stock and commodity markets.

Choose ideas vs. betting on market

We expect that 2011 will be characterized by a great number of corporate events to provide various investment opportunities. Interesting ideas will be observed in 3-tier equities, especially on primary market. It is time to get the reliable credit analysis. Besides, short-term (1.5 year) and floating rate bonds will be of high demand on the back of swap cost growth and expectations for key rates increase.

Choose Gold in a long-term and Oil in a short-term

Oil is expected to continue its positive trend backed by the speculative factors and we see price of Brent at $100 per barrel in 1H11, but this level does not seem sustainable. Average price of gold is forecasted at $1,500 per oz in 2011 as existing risks will increase demand for non-risky assets.

Choose Soya and Corn over Sugar and Wheat

Declining stocks of corn and soya and expanding consumption of these commodities from the part of China may lead to deficit on the market and price hike. Contrary, sugar currently is strongly overvalued and the market players are betting on correction in a close future. Situation on the wheat market is relatively stable.

Choose Efficiency and Growth over Uncertainty

Betting on external factors we recommend choosing undervalued stocks, which showed recovery of operating and financial results. Thus, some gas names, coal and non-ferrous metal companies will bring upside. Growing domestic demand, stable ruble and the state support increase attractiveness of domestic oriented players, which deliver strong growth potential. Here we mean retail, construction and banks. Government initiatives create uncertainty in some sectors that make them less promising, for example oil and power names.

Choose Retail, Banks, Gas, Constructions over Oil, Steel and Power

On the Russian stock market we recommend choosing retail companies, which deliver strong growth profile and allow to capitalize domestic drivers. We bet on Magint and X5. Banks will show stronger performance backed by loans growth and lower credit risks. Fundamental factors will drive price of Sberbank and Bank St-Petersburg, while M&A deals and sale of 10% stake will support VTB. Higher gas prices and tariff revision are not reflected yet in the share price of the gas companies, while Gazprom stocks still look cheap. The state support and recovery of real estate market determines substantial projects portfolio of construction companies (PIK, LSR Group, Mostotrest), that will also support some steel names. New state initiatives regarding taxation in the oil segment create uncertainties for the oil producers that makes these stocks less attractive despite strong oil prices. Doubts regarding tariff regulation in power segment allow choosing only those with set rules and high efficiency ratios (RusHydro). Steel companies look quite expensive at the current level, and in metal segment we prefer the cheapest ones with exposure to favorable metals prices (Mechel, NorNickel).

Russian Economy Elections are coming

6 STRATEGY 2011

Alexander Kovalev, PhD [email protected]

Russian Economy Elections are coming

Inertial motion. In 2011 we expect to see stronger divergence between Russian and the World economies. The World economy will continue confident recovering, irregularly though. Prices on commodity markets are likely to reach new post-crisis highs in 1H11. But positive influence of these factors on the Russian economy will be limited after they have been driving growth over the last 10 years. Lack of structural reforms in Russia, budget deficit and political instability will restrain economic growth. Thus, we would call scenario of Russian economic development as inertial motion. GDP is expected to increase by slow 4.3% despite strong external environment. Nevertheless, a certain number of macroindicators will look quite strong.

Investments and consumption to support growth. Investments are expected to show 8% growth especially in 1H11. But the main factors determining high growth rates of investments will be low base and postponing of investment projects. Consumption growth will also support economic recovery backed by higher income of households and higher credit activity. Retail sales are estimated to grow by 6.2-6.6% in real terms. Pensions’ growth and increase in salary paid from budget will also support consumption numbers. Despite positive trend on the oil market, deficit of the Russian budget stays at relatively high level, as coming president elections in 2012 determine realization of significant social programs.

Budget issues are getting more important. Thanks to higher oil price in 2010 than expected $65-70 per bbl budget deficit was below the forecasted numbers by Ministry of Finance. Beginning of 2011 is unlikely to change the situation as we will see boosting budget expenses largely compensated by high prices on commodity markets. But we think that risks of this play are significant. In 2011 no deficit budget is possible to reach at average Urals price around $90 bbl. Russian budget is strongly dependent on external conditions, and with the current structure of the Russian economy this trend is impossible to change, while structural reforms during the pre-election years are unlikely.

Ruble strengthening is possible, but not sustainable. Level of Russian sovereign debt is significantly lower comparing to South European countries, but high dependence of the budget income items on oil prices means substantial risks in case of changing environment on the external market. That makes ruble more vulnerable. Balance of payment may reduce strongly as a result of capital outflow. Thus, we do not expect ruble strengthening significantly above RUR29.9 even if oil prices stay at high level through 2011.

2010E 2011E 2010E 2011EUrals crude,$/bbl (avg) 76.5 78.0 78.4 90.0

GDP,% y-o-y 4.1% 3.6% 3.8% 4.3%

CPI,% Dec./Dec. 7.0% 7.5% 8.5% 8.4%

RUR/USD,year-end 28.9 28.6 30.4 29.9

OLD NEW

Macrooutlook

Commodity markets Start Your Engines!

STRATEGY 2011 7

Alexander Kovalev, PhD [email protected]


Bubble with the provisos. The inflationary growth on commodity markets will probably continue. Consumer prices are expected to accelerate not only in emerging economies but also in developed ones. These expectations will carry commodity prices higher in spite of relatively weak fundamentals. We don’t believe that rising global raw materials demand can present a base for sustainable commodity prices growth in 2011. Risk of double-dip recession remains high due to possible China cooling down, European debt problem and sluggish growth in US. It will hamper the impetuous growth. But in the beginning of the year the bubble will be at inflation study and it’s not good idea to withstand this movement.

China is in a tight corner. We believe that the main risk for world economy and commodity markets is a sharp China cooling down that could lead in the worst case to collapse of Chinese economic growth model. Dramatically growing consumer prices is a significant economic and social problem for Chinese government. Having stable currency rate and expectations of its appreciation in the future, China is an ideal target for carry traders. Concerns of capital inflow intension don’t permit the People Bank of China to increase interest rates noticeably. But the sharp Yuan appreciation that could end speculations on its appreciation is not on the agenda. Therefore inflation will accelerate further, rising costs and wages in a certain point will destroy Chinese export competitive advantage that the authorities protect by currency manipulations. Anyway, the actual Chinese model will disappear soon. If it takes place too soon the commodity markets become turbulent.

Risks are high but not too much. Taking the risks mentioned above into account, we presume that volatility on commodity markets will return to early 2010 levels after half-year of declining. The most vulnerable thereupon, in our opinion, are the base metals, in particular copper that reached all-time high in December. On oil market the trend will probably remain rising. But corrections will occur more often and will deeper than recent months. Among agricultural commodities the grain markets will be strong in the 1H2011, while sugar prices may fall dramatically.

Gold doesn’t tarnish. The fact that investment into gold allow to combine the hedge against inflation and safe heaven has become the generality a long time ago. But now this combination is the most actual ever. In spite of 30 percent price growth in 2010, gold will remain attractive for investors till interest rates are near zero and Central banks continue intervention to prevent national currencies appreciation. Besides, the potential risks for commodities that European debt problem or China tightening could carry are not so dangerous for gold.

Dollar and commodities decoupling. The further weakening of negative correlation between dynamics of commodities prices and US dollar rate will one of the characteristic features of 1H2011. Starting from early 2009 the dollar rate movement was an exact indicator of investor’s risk appetite. Dollar weakening was surely accompanied by commodities growing, while dollar appreciation meant commodities prices falling. European debt crisis escalation has broken this one-to-one correspondence. In 2011 periods of dollar and commodities movement in the same direction will occur more often. But while Fed rate is about zero, carry trade will continue. So the negative correlation between dollar and commodities isn’t completely destroyed yet.

Current

price

Target price

f or 2011Upside

Urals crude oil, $/bbl

93.65 95 1.44%

Gold, $/once

1385.35 1500 8.28%

Copper, $/tonne

9393 9240 -1.63%

Sugar, $/pound

33.13 22.5 -32.09%

Corn, $/bushel

6.09 6.2 1.81%

Wheat, $/bushel

7.835 7.7 -1.72%

Soy beans, $/bushel

13.2875 14.2 6.87%

*current price on 22.12.2010

Source: Bloomberg, TKB Capital estimates

Inflation pressure in China

-3

0

3

6

9

12

31.1

2.20

08

28.0

2.20

09

30.0

4.20

09

30.0

6.20

09

31.0

8.20

09

31.1

0.20

09

31.1

2.20

09

28.0

2.20

10

30.0

4.20

10

30.0

6.20

10

31.0

8.20

10

31.1

0.20

10

China CPI, %

China Food CPI, %

Source: Bloomberg

Stock markets volatility

10

21

32

43

54

25.1

2.20

09

22.0

1.20

1019

.02.

2010

19.0

3.20

1016

.04.

2010

14.0

5.20

10

11.0

6.20

1009

.07.

2010

06.0

8.20

1003

.09.

2010

01.1

0.20

1029

.10.

2010

26.1

1.20

10

VIX Index

RTS Volatility Index

Source: Bloomberg

Gold prices and USD dynamics correlation

800900

1,0001,1001,2001,3001,4001,500

27.0

2.20

09

27.0

6.20

09

27.1

0.20

09

27.0

2.20

10

27.0

6.20

10

27.1

0.20

10

74

78

82

86

90

Gold price $/tr. once (lhs)

Dollar index (rhs)

Source: Bloomberg


8 STRATEGY 2011

CRUDE OIL: $100 on the barrelhead!

Way to the top. The market had been waiting for crude oil demand recovery in the developed world for the whole 2010 to justify a sustainable growth, but it has never started. Never the less, plenty of cheap money and the concerns it might get even cheaper, create their own rules. They need no solid fundamentals to start a strong growth, especially if such a growth has a clear target. With respect to that, the mark of $100/bbl getting closer was the very time. Further movement directions will be put on the agenda only after this point is reached.

Inflation hedge. Inflation acceleration concerns do have reasonable background. Attempts of covering budget gaps by means of emissions have always in the history affected consumer prices. And while Ben Bernanke is trying to persuade both consumers and investors that should the prices rise up the Fed will be able to control it, nobody is buying this argument – neither the investors, nor - as it looks - Bernanke himself. The situation in the developing countries, where an avalanche capital inflow and currency manipulations have created and explosive mixture which is about to detonate, is even worse. Thus, raising demand for crude oil and other commodities as an inflation hedge looks quite reasonable. Still, reaching even $100/bbl is far ahead of the inflation rate, not mentioning any higher levels. Therefore, there should be other underlying factors.

Deficit ghost. World crude oil consumption has really risen noticeably after the crisis fall, as well as positive macroeconomic data, except for the EU, allow being rather optimistic for the upcoming 2011. As an example, the International Energy Agency has increased their estimates of the world oil demand in 2011 several times, before they finally announced their forecast of 88.8 bln bbl per day. This estimate is approximately 2 bln bbl per day higher than the consumption level in 2010. To meet this demand, OPEC will unavoidably have to pump more, diminishing spare capacity, which in turn could lead to potential supply shortage. Similar situation appeared in the market in 2007-2008, thus price increase conditions were created.

Speculative race. After Lehman Brothers collapse, the oil market was in stable contango, expectations of the world economy recovery were supporting the far end of the forward curve at a high level and these expectations came true. However, the continuation of this trend is questionable in spite of the mentioned experts’ point of view. By December of 2010, Brent crude oil forward curve became rather flat, and sometimes speculative inflow had been turning it into backwardation. The fact of speculative nature of the price rise is clearly proven by the statistics of the Commodity Futures Trading Commission (CFTC), showing the number of crude oil speculative long positions reached its all time high in the beginning of December.

Fundamentals remain weak. Speculators target is $100/bbl and it will probably be reached in 1H2011. But further on a rather deep correction might take place as speculators start to close their positions. From fundamental point of view, the market is not strong enough, the world crude oil consumption forecast, exceeding the pre-crisis level, seem too optimistic to us. Crude oil demand growth not only in Asia, but in the US and EU is a necessary condition for this to happen. One can not count on EU caught in debt crisis trap, and the US is not likely to show a better vs. 2010 fuel consumption dynamics until the unemployment level remains near the 10% mark. Therefore, inventories level is expected to remain at a high level, which doesn’t allow a sustainable price growth.

Investment demand as oil price growth driver

400

700

1,000

1,300

1,600

16.0

5.20

0026

.12.

2000

07.0

8.20

0119

.03.

2002

29.1

0.20

0210

.06.

2003

20.0

1.20

0431

.08.

2004

12.0

4.20

0522

.11.

2005

04.0

7.20

0613

.02.

2007

25.0

9.20

0706

.05.

2008

16.1

2.20

0828

.07.

2009

09.0

3.20

1019

.10.

2010

10

40

70

100

130

NYMEX Crude oil open interest,thou. contr. (lhs)

WTI Crude Oil price, $/bbl (rhs)

Source: CFTC, Bloomberg

Oil consumption in emerging and developed world

303438

42

4650

54

Jan-

07

May

-07

Sep

-07

Jan-

08

May

-08

Sep

-08

Jan-

09

May

-09

Sep

-09

Jan-

10

May

-10

Sep

-10

OECD Oil Consuption

Non-OECD Oil Consuption

Source: Energy Intelligence, Bloomberg

Speculators on oil market

405060708090

100

02.0

9.20

0802

.11.

2008

02.0

1.20

0902

.03.

2009

02.0

5.20

0902

.07.

2009

02.0

9.20

0902

.11.

2009

02.0

1.20

1002

.03.

2010

02.0

5.20

10

-30,00010,00050,00090,000130,000170,000210,000

WTI Crude Oil price, $/bbl (lhs)

Net speculativ e position (rhs)

Source: CFTC, Bloomberg

Oil stockpiles and demand in US

280300320340360380400

04.0

7.20

0804

.09.

2008

04.1

1.20

0804

.01.

2009

04.0

3.20

0904

.05.

2009

04.0

7.20

0904

.09.

2009

04.1

1.20

0904

.01.

2010

04.0

3.20

1004

.05.

2010

04.0

7.20

1004

.09.

2010

04.1

1.20

10

13.2013.6014.0014.4014.8015.2015.60

US Commercial crude oil inv entories,mn bblUS Crude oil implied demand, mnbbl/day

Source: DOE, Bloomberg


STRATEGY 2011 9

Copper not gold

Copper rush. Out of all industrial raw materials, base metals have shown the best performance. Copper prices have grown the most, showing more than 40% jump since June. The factors underlying this growth have very much in common with the ones pushed crude oil prices up. These are inflation concerns, Asian demand growth, inventories decline… In the case of copper, the latest two factors are even more pronounced than in the case of crude oil. The world copper consumption increased more than 5% in 2010 – significantly higher rate vs. crude oil and the most part of this growth was provided by China. Copper production can not match this rapid consumption growth, creating LME inventories decline by 37% vs. the February peak – thus, price growth fundamentals appear.

Supply constraints. Most of the market players consider the tendency for copper inventories reduce and prices growth will remain in 2011. And the arguments in favor of this point of view are much more solid than in favor of the consistent crude oil prices growth. It is expected that in copper market the growing demand can face supply shortage. At first, the quality of copper ore at the current mines is declining, and the investments into new mines are insufficient, which is making doubtful an ability to meet the growing prices with production growth. Moreover, union problems, like the one disturbing normal functioning of Collahuasi mine in Chile (the world leader of copper production) for more than a month, are likely to threaten metals supply in 2011.

Demand is growing... As supply problems escalate, the growing demand for metals in Asia looks frightening. The market is agreeing to expect the demand exceeding copper supply at the rate of approximately 350 thou tones in 2011, which is in line with the current LME copper inventories level – which means inventories will be able to cover less than one week of consumption in a year. Similar situation took place in 2007 at nickel market, leading to hyperbolic price growth. Concerns of the same scenario occurring at copper market have lead to hectic copper buying ,which in turn allowed the prices to reach all time high in December. But we consider the investors are wrong when extrapolating current copper consumption trends in China even to the nearest future, not mentioning any longer term perspectives.

…for a while. It should be noted that the high copper consumption level in China is partly determined by the realization of the governmental $585 bln program of infrastructure investments. A considerable amount of copper purchases under this program was made in Q2 2009, but there were some purchases in this year, too. Therefore, a certain part of the demand in China is artificial and reducing with time. This may be seen in the copper imports dynamics to China as well: it is significantly lower vs. the previous year and continuing to decline.

Chinese power is not unlimited. Many people underestimate the elasticity of copper demand in China, not mentioning the developed economies. China huge currency reserves do not necessarily mean the domestic consumers are ready to pay any price for it. Shanghai inventories, unlike ones in London, are increasing, and this growing intensified in autumn. This means copper demand at the prices close to record can not be stable even in China. Indirectly, demand decline in China is indicated by lower premium in copper tone price in Shanghai vs. London as it is falling since July. This trend has been set up quite clearly, and it is determined by the high prices. China monetary tightening can strike copper demand even more heavily provoking prices drop as much as 20-25%. Nevertheless copper price growth due to capital inflow is not over yet, still it may be risky to take part in it.

China – the main word copper growth driver

400450500550600650700750800

31.1

2.20

08

28.0

2.20

0930

.04.

2009

30.0

6.20

09

31.0

8.20

09

31.1

0.20

09

31.1

2.20

09

28.0

2.20

10

30.0

4.20

10

30.0

6.20

10

31.0

8.20

10

1000

1250

1500

1750

2000

China (lhs)

World (rhs)

Source: Bloomberg

LME base metals inventories

150225300375450525600

20.0

3.20

09

20.0

5.20

09

20.0

7.20

09

20.0

9.20

09

20.1

1.20

09

20.0

1.20

10

20.0

3.20

10

20.0

5.20

10

20.0

7.20

10

20.0

9.20

10

20.1

1.20

10

90105120135150165180

LME Cooper inv entories, thou. tons (lhs)

LME Nickel inv entories, thou. tons (rhs)

Source: LME, Bloomberg

China copper imports, thou. tons

100150200250300350400

01.1

2.20

08

01.0

2.20

09

01.0

4.20

09

01.0

6.20

09

01.0

8.20

09

01.1

0.20

09

01.1

2.20

09

01.0

2.20

10

01.0

4.20

10

01.0

6.20

10

01.0

8.20

10

01.1

0.20

10

Source: Bloomberg

China copper demand elasticity

6,6007,0007,4007,8008,2008,6009,0009,400

11.0

8.20

1021

.08.

2010

31.0

8.20

1010

.09.

2010

20.0

9.20

1030

.09.

2010

10.1

0.20

1020

.10.

2010

30.1

0.20

1009

.11.

2010

19.1

1.20

1029

.11.

2010

09.1

2.20

10

6%8%10%12%14%16%18%20%

LME Copper price, $/tonne (lhs)

Shanghai v s. London (rhs)

Source: Bloomberg


10 STRATEGY 2011

Hard grains

Wheat: concerns remain. The fact that sharp wheat prices growth in summer kept at a local level is not surprising. Several previous years allowed accumulating huge inventories, protecting from any weather fluctuations in a more or less secure way. Therefore, a correction of August highs is an absolutely natural thing. In a certain sense, the absence of any tight situation in the market had been provided by the fact Russian export ban has not been put into action by the major exporters although it was the main concern in the market. Nevertheless, there is a risk of situation getting worse in 2011. Winter wheat in the US was damaged by dry weather in autumn. La Nina phenomenon is damaging crops in Australia, Asia and South America.

Corn at rise. It should be noted that the world performance at the beginning of 2011 is much worse than a year ago. And if wheat stocks remain rather far from critically low level, other grains - and corn mainly - demonstrate reasons for concerns. With respect to that, any kind of yield problems, even less scalefull than in 2010, may lead to prices rally similar to the one happened in 2007-2008. In particular, the main concern now is that La Nina phenomenon can provoke draughts in Brazil and Argentina - a repeat of the 2005 draught, when approximately 15% of soybeans and corn was lost. Further inventories decline can face an intensified import activity of China as the latest is unable to cover its’ growing feed demand.

Soybeans hunger. The way China can influence agricultural commodities prices can be clearly seen by soybeans prices trend. It demonstrated the most stable performance during the crisis, and now it is closer to 2008 highs, as compared to wheat or corn prices. Strong Chinese demand is keeping inventories under heavy and growing pressure – both the US and the world ones. As the US Department of agriculture (USDA) showed in its December data, the US soybeans inventories are expected to decline to the critical 165 mln bushels. If due to draughts or diseases the Brazil crop is below 67.5 thou tones as it is forecasted now, soybeans market rally to all time high in April-May is almost unavoidable. Still, unlike grains, in long-term perspective soybeans prices can remain at a high level.

Sugar is at the edge. Sugar market has been in turbulence for more than a year. The 2008 and 2009 production fall in India and world inventories decline led to sugar shortages and prices jump to 29-year maximum in the beginning of 2010. While normalization was expected, the prices dropped more than twice as low, though no normalization occurred. Adverse weather in Asia - and mainly in Brazil - at the end of summer and in autumn raised doubts in the market regarding shortage disappearance. The prices not only returned to the ¢30/pound level but even exceeded it in the beginning of November. During the recent weeks speculations on India export ban lift are supporting the prices as the governmental decision on it is constantly postponing. With high probability, the ban lift will stop rally, and the prices are likely to fall as much as 30-35% by the mid of 2011.

Secure bet on sugar fall. Sugar prices are artificially high now, and this level is kept due to adverse weather only, limiting fast production increase. Strong backwardation of the sugar forward curve is clearly showing prices drop expectations. Nevertheless, simple futures sell might be dangerous as speculative growth has its internal logics. Under such conditions we believe the best solution is a bet on reduce of backwardation. This bet can be executed through calendar put-spread sell. An example may be as follows: May put-option buy simultaneously with July put-option with the same strike sell.

Wheat and corn Stock-to-use ratio

10%15%20%25%30%35%40%

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

Wheat Corn

Source: USDA

China soybeans and corn imports

0.001.002.003.004.005.006.00

01.0

1.20

07

01.1

0.20

07

01.0

7.20

08

01.0

4.20

09

01.0

1.20

10

01.1

0.20

10

0100200300400500600

China soy beans import, mn tons (lhs)

China corn import, thou tons (rhs)

Source: Bloomberg

Sugar prices in 2010, ¢/pound

10

15

2025

30

35

31.1

2.20

0920

.01.

2010

09.0

2.20

1001

.03.

2010

21.0

3.20

1010

.04.

2010

30.0

4.20

1020

.05.

2010

09.0

6.20

1029

.06.

2010

19.0

7.20

1008

.08.

2010

28.0

8.20

1017

.09.

2010

07.1

0.20

1027

.10.

2010

16.1

1.20

1006

.12.

2010

Source: Bloomberg

Sugar forward curve

22

24

26

28

30

32

34

Mar2011

May2011

Jul2011

Oct2011

Mar2011

Source: Bloomberg

Fixed Income Market Rates: Increase with no decrease

STRATEGY 2011 11

Dmitry Zak [email protected] Michael Zak [email protected]


The main risks of 2011 are the worldwide growth of key interests, confrontation of euro and dollar, where the preference in 1H2011 is given for the latter. In this context, there are only several investment vectors into financial markets: short-term fixed income securities to avoid market risk, dollar Eurobonds – the forex risk.

On domestic market we recommend primary market offerings. Get the reliable credit analysis and choose investments with higher yield! Third tier is on the way.

Euro is not an investment currency in 2011. The best target is dollar and commodities. We expect for several cards from the EU “deck of defaults” to be played in 2011. No doubt that EU collapse and euro immobilization is a kind of fantasy, though the parity is at fingertips.

LIQUIDITY: There is money, there was money…

… but with no effect. The bonds of high-quality issuers are completely sold out, the market consists of instruments affiliated with the state. Effective rates are in red, while the funds remained are placed on deposits in Fed and CBs again. Now, when we realize that free provision of financial resources within the context of economic crisis is not a lifelong strategy and can be withdrawn soon, they have to promptly earn. We are in anticipation of investments in risky and anti-inflationary assets.

FOREIGN MARKET: Leaving the safe haven

We suppose that the stories with spread compression of EM bond against Treasuries are not of topic yet and may be resulted by increased return of underlying asset rather than EM risks revaluation.

Growth and weighty primary offering of CDS coupled with inflation expectations in the US will offset Fed manipulations with the curve and permanently falling out “skeletons” from the European “closets”. Such expectations will determine the yield of Tbonds for 1H2011 on the level equal to the current one.

CURRENCY MARKET: Euro is at risk

UE currency is still at risk as in 2H2010. Poorly thought-out program on assistance to peripheral countries is making gap on the way to dollar parity – no clarity on its further implementation and whether the program will be applied at all. On this background, we bet on riskless US dollar used for carry trade, which is likely to take the lead in terms of investments in 2011 as well. As for ruble, commodities exported by Russia should play supportive for the currency strength, especially on the watch for key rates growth.

DOMESTIC MARKET: Gangway for the third tier!

Secondary market is not of interest any more as no wish to sell or buy. Only occasional corporate stories are capable to yield. We recommend to pay close attention to the primary market – the most important thing is an accurate credit analysis of issuers. The funds are still available and they will have to be invested – the third tier is likely to find use for the one third of liquidity available.

WHAT TO BUY? Bet on ideas!

We expect that 2011 will be characterized by a great number of corporate events to provide various investment opportunities. Keep an eye on our special reviews.

Short-dated (1,5 year) and floating rate bonds will be of high demand on the back of swap cost growth and expectation for key rates increase.

Indicator Actual 01.01.11

Forecast01.07.11

FED rate 0–0.25% 0.25%

ECB rate 1.0% 1.0%

BoE Rate 0.5% 0.5%

TED-spread (3m UST vs. 3m Libor) 15 bps. 10-20 б.п.

UST-7 Yield 3.00% 3.5%

Spread UST-7 vs. RUS-30 190 bps. 150 bps.

RUS-30 Yield 4.90% 5.00%

CBRF Rate 7.75% 8.00%

Overnight Rate 3–5% 3.5–5%

First Tier Yield 5.5-8.0% 6.0-8.0%

Second Tier Yield 7.0–10.0% 7.0–10.0%

Other Tiers Yield (1Y) 9.0–12.5% 9.0–12.0%

Sources: Reuters, TKB Capital estimates


12 STRATEGY 2011

WHAT TO BUY? As in 2H201, we do not recommend to invest though it was a rather conservative approach. However, it is ideas to be invested in. What kind? Traditional and conservative Short-dated and high-quality Where is the good of dealing with interest-bearing bonds pending the growth of rates? - Minimal credit risk, no market one: short-dated bonds are worth to be considered for repo. We prefer VTB Leasing 3/4, Moscow 45/54, bonds of RSHB, UniCredit bank, etc. However, we are not so pessimistic and suppose that 2011 (at least 1H11) will not demonstrate any drastic changes in long-term ruble interest rates. But we should keep in mind that the state, including quasi-public companies, will have to borrow on domestic market a lot (RUR1.7 bn for the Ministry of Finance and over RUR1 trn for quasi-public structures, especially for the ones with the need in heavy capex (utilities, infrastructure, etc.), giving no free hand to financial authorities in discount rate increase. Credit and arbitrage МТS vs Vympelcom The current spread between MTS and Vimpelcom is not equal to credit quality difference. We consider long position in MTS_8 vs. short position in Vympelcom invest_6/7 as a safe choice. Besides, uncovered long position in MTS_8/7 is an interesting idea in itself – investor is protected by put option at par (enforcement of investor right only through the court) in case of Comstar merger to MTS (reorganization by way of takeover), which is most likely to occur in 1H2011. St.-Petersburg vs Moscow We suppose that spread between bond yield curves “St.-Petersburg vs. Moscow” should be minimal or even mythic. Given stronger budget framework of St.-Petersburg, historically “neat” debt policy, lack of plans on fold increase in public borrowings in the coming years as opposed to Moscow, out target for SPB-25038 is 101.8% of the par value (7.45% YTM). Federal Grid Company vs RusHydro The current spread of 55 bps between locals of FGC_10 and ruble Eurobond of RusHydro_15 will come to naught soon that is exemplified by negative spread (-40 bps) between RSHB’s locals and ruble Eurobond of similar maturity. The main dogma is ruble bond appeal for a wide range of investors with no need to take risks of Russian infrastructure. Prospective Floaters We expect the growth of interest swaps, at least its short segment of curve due to pending increase in ruble rates. Coupon rates are tied up to the CB instruments or monetary market, and anticipation of their growth leads floating rate bonds to more interesting levels as compared to the fixed ones that will help to secure against turn in the market. Some of them will provide new arbitrage provisions in relation to its “fixed” analogues. Corporate Wimm-Bill-Dann Wimm-Bill-Dann bonds are still undervalued after acquisition of the issuer by the global food giant PepsiCo. The issuer rating is to be revised upon acquisition (“A+” rating for PepsiCo), i.e. the yield of WBD issue should not differ from the one of large private payers such as Lukoil. In addition, we do not rule out repurchase of bonds by the issuer on the back of lower cost of capital for PepsiCo. Outrunning VTB… The portfolio of any investor should include the bonds of the Bank of Moscow, TransCreditBank and HCF Bank. Transactions on purchase of assets should be completed within 2011. As a result the holders will get the asset of higher quality with a chance to exercise put option if the issuers are reorganized. Market Gangway for the third tier! Interesting ideas can be observed in 3-tier equities, especially on primary market. It’s time to get the reliable credit analysis. In our opinion, the new issues of UVZ, Kamaz as well as traded bonds of Citronix, Sollers, ChTPZ offer a goof yield in case of short duration.

Stock Market Betting on growth and efficiency in 2011

STRATEGY 2011 13

Maria Kalvarskaia [email protected]


Russian stock market – leading growth in 2010

22% growth in 2010 – outperforming competitors. 2010 was quite successful for the Russian stock market. RTS Index grew by 22% over the year beating most of its counterparts from developed and emerging markets. After reaching 1,676 on RTS Index in April the market went deep to 1,226 points on May 25. Uncertainty regarding further economic recovery, tightening of monetary policy in China, financial risks in Europe – all these factors led to profit taking in risky assets. At the beginning of 2H10 we revised our forecasts for the whole year from 1,900 to the range of 1,650-1,900 on the back of slower economic growth and existing risks on the market. As of December 22 RTS Index closed at 1,764 coming close to the mid of our forecasted range.

2H10 brought more optimism on the markets. 2H10 was more successful for the Russian stock market bringing it to the growth leaders over the year. Improving macroeconomic situation in Russia, better corporate operating and financial results attracted investors’ interest to the Russian market. Quantitative support from the US government boosted liquidity on the markets, while macro statistics in the US proved continuing economic recovery. China postponed interest rates growth despite higher inflation numbers that added optimism for investors. Commodity markets were posting growth backed by macro data, excessive liquidity and weather conditions that also supported demand for the shares. We consider that growth on the stock and commodity markets in 2H10 was mainly driven by monetary and speculative factors that means higher risks ahead, but upside potential still does exist.

Commodity markets in 2H10 – bears have gone. In 2H10 inflation risks together with excessive liquidity drove commodity markets up. If in 1H10 financial risks in Europe, weak signs of economic recovery and Chinese initiative to slow down growth rates in the country hold back prices on commodity markets, then in 2H10 the trends changed. Bad weather conditions determined deficit of soft goods in summer giving a start for price growth. Dollar lost its role of benchmark for the commodity markets, and in 2H10 we saw dollar strengthening on the back of growing risks in Europe together with increasing commodity prices. In order to secure money from inflation and find a safe haven in a risky environment, investor were buying gold, which looks more stable even in case of expanding financial risks in Europe and Chinese monetary policy strengthening. Industrial metals won back their losses over 1H10 and ending the year 20-50% above the levels at the beginning of 2010.

Consumer and retail – the best performer in 2010. Among Russian stocks consumer and retail segment was the best performer in 2010. RTS Consumer and Retail Index grew by 85% since the beginning of 2010. Growing domestics demand, strong financials, M&A deals and successful implementation of investment program determined high interest to the segment. Industrial companies took the second place in terms of growth over 2010 adding 55%. Auto and helicopter producers showed better performance on the back of recovery in demand on car market with the government support and substantial contract flows in helicopter industry. Metals&mining segment also showed strong performance above 40% playing out favorable pricing environment on commodity markets. The worst performer during 2010 was oil&gas sector, which ended the year in red. Investors played dividend stories in less liquid stocks, while the largest companies looked worse than the market. Prices growth in December helped to compensate negative dynamics.


World indices dynamic in 2010

-30% 0% 30% 60%

RTS

MICEX

Nikkei 225

Hang Seng

Seoul Composite

Shanghai Composite

SENSEX

FTSE 100

DAX

CAC 40

DJIA

S&P 500

NASDAQ

Bov espa

BUSE MERVAL

IBC

MSCI EM

22.12.2010 Max Min


Sector indices dynamic in 2010

-30% 0% 30% 60% 90%

RTS

O&G

Telecoms

M&M

Industrials

C&R

Utilities

Finance

22.12.2010 Max Min


14 STRATEGY 2011

2011 – External positive news and domestic recovery to support the stocks, but bear risks in mind

Strong commodity markets to support growth. External factors are likely to continue supporting the Russian stock market in 1H11. Excessive liquidity and inflation risks will boost commodities prices up and we expect to see oil at $100 per bbl, new high of non-ferrous metals and gold at $1,500 (see the section on commodity markets). Improving economic situation in the World will also determine upward trend on the markets, but fundamental factors are not strong enough to justify high prices, and we see risks of correction in 2H11. In this case we recommend betting on mining companies. Higher oil prices hardly influence financial performance of the Russia oil companies, thus we again prefer gas producers in oil&gas segment.

Growing domestic demand as important factor. Strengthening demand on domestic market backed by economic recovery and government support determined favorable conditions for those companies oriented on the Russian home growth. In 2011 we see domestic market as an important driver as well. Consumer and retail segment will keep its leading role betting on growing consumer demand and the governmental social program. Strong financial performance of retail companies allows delivering substantial growth rates that increases investors’ interest to the segment’s companies. State programs on infrastructure projects and higher demand for residential real estate determine better view on development, infrastructure and metal companies, as the construction segment was lagging the market in 2010 on the whole. Recovery of demand for loans with credit risks stabilization will determine faster development of the banking system. M&A deals and placements of the shares will raise interest to the companies.

Government initiatives – a ground for selective buys. In 2011 the state continues developing new taxation rules for oil&gas segment, which will mainly affect those companies with higher share of downstream. Special tax regime for greenfield projects will give advantages for particular players. In utilities sector decision on tariff regulation for grid companies and full liberalization of electricity market will set the trend in power segment. At the same time the government program aimed at expansion of domestic demand will support a number of segment oriented on the Russian home market.

External risks as the most important. As growth on the stock and commodity markets is not really supported by fundamental factors, higher prices pushed by excessive liquidity and inflation expectations may fall sharply in case of increasing risks. We think that risks may come from China if the country takes further steps to slow down economic growth. Taking profit by speculative players may also cause substantial decline on the market. Weaker growth rates of the Russian economy will also negatively affect financials forecasts and valuation of the companies, but we think that in case of positive external environment Russia will keep on growing.

RTS Index – more upside with higher risks. We estimate upside potential of the RTS Index for 2011 at 16-19% from the current level (1,764 as of December 22). Thus, we expect to see RTS index at 2,050-2,100 level. MICEX Index is estimated to reach 1,940-2,000 that means 15-18% potential. As we mentioned above positive external factors will drive the Russian stocks up with stronger upside in 1H11, and we recommend betting on undervalued mining companies playing out positive trends on commodity markets. Domestic factors look more sustainable and will drive the stocks through the year. After reaching new post-crisis highs in 2011 we expect to see correction, which may be used to increase stakes in less vulnerable segments. Companies with stronger growth profile, cheap on multiples relative to their peers and those providing interesting dividend play are to show better performance through the year.


STRATEGY 2011 15

Stock picking play Oil and gas – focus on gas companies and the oil stocks with strong growth profile. Our top picks: Gazprom (GAZP) – betting on regular tariff growth, the cheapest stock with P/E 2011E at 5, Novatek (NVTK) – an attractive strong growth story, Tatneft (TATN) – improvement on bottom-line with new refinery launching.

Power industry – efficient generation is expensive. Out top pick is hydro generation RusHydro (HYDR) to benefit the most from their competitive advantages in light of the electricity market liberalization and rising fuel prices. Bet on «distressed assets» in 2011 may live up, especially in the case of the more radical dynamics of electricity consumption caused by the acceleration of economic recovery or changes among strategic investors of the companies. In this connection we prefer OGK-1 (OGKA) and OGK-3 (OGKC). We like MRSK Holding (MRKH) in grid segment but note that risks are too high.

Metals and mining – steel demand and price growth, strong coking coal market in 2011, optimistic view on copper and nickel prices. Our top picks: Evraz Group (EVR LI) – key Russian long steel producer, lower debt burden, weak stock performance in 2010, Mechel (MTLR) – strong coking coal price, more coal from Elga deposit, MMK (MAGN) – key domestic steel manufacturer, high growth in value added products, Norilsk Nickel (GMKN) – robust copper and nickel prices, shareholder’s conflict as speculative driver, cheapest among global mining companies.

Transport – continue outperforming economic growth in 2011, buy on weakness. Top picks: Globaltrans (GLBT) diversified business with presence in the segments with intensive demand. TransContainer (TRCN) bet on economic growth and higher containerization level – new interesting name on the market. The stocks provide strong growth profile, but do not look cheap, so we recommend buying on weakness.

Telecoms, Media and IT Sector. In Telecoms – growing beyond traditional mobile services to unlock more value. MTS (MBT, MTSI) is our top pick for its large cash influx from Russian-largest mobile subscriber base and aggressive expansion into regional broadband market via Comstar. Solid fundamentals of Vimpelcom Ltd (VIP), but the stock under pressure from acquisition of assets in Africa and Asia. In 1H11 the market to put operating data of the united Rostelecom (RTKM) under close examination. Media – buying exposure on macro story. We like exposure of CTC Media (CTCM) to the fast growing market and advice making a bet on the sector through this stock. IT Sector – more names and niches to invest. IT sector in Russia is nurturing in sales and a number of trading names. We view Armada (ARMD) as the best choice on growth in the IT sector.

Consumer and retail – we expect generous government social payments in ahead of 2012 presidential elections to support consumers’ readiness to go shopping. Our top picks are Magnit (MGNT) and X5 Retail Group (FIVE) – record pace of store openings, M&As and gains on more operating efficiency, Pharmstandard (PHST) – coming triggers are flu season, budget tenders and strong financials disclosure and Veropharm (VRPH) – niche player with a solid pipeline of medicines.

Banking sector – better performance with growing demand for loans and credit quality stabilization. Our top picks: Sberbank (SBER) betting on strong operating results and growing financials with better credit quality. VTB (VTBR) – a play on corporate events with aggressive strategy and new investors. Bank St. Petersburg (STBK) to prove strong regional positions and high efficiency.

Machinery – strong vehicle sales recovery and companies’ financials improvements to support the segment. Our top picks – Sollers (SVAV). Expected IPO of Russian Helicopters in 1H11 will likely be the key event in the sector. Power Machines (SILM) is our bet on huge prospects for capacity installations in domestic utility sector.

Real estate sector – residential real estate construction rates to accelerate, demand remain high. LSR Group (LSRG) and PIK Group (PIKK) are capable to show one of the best rates of recovery in the sector due to growing demand for residential real estate. High readiness of AFI Development project portfolio will provide stable growth of its investment value.

Infrastructure construction sector – powerful growth of the sector next year. Mostotrest (MSTT) is successfully positioned for development of the state investments and is one of few companies capable to fulfill their orders with good quality and in a timely fashion.

Company Ticker TP 12M,$

Upside,%

Gazprom GAZP 8.5 33%

RusHy dro HY DR 0.0735 36%

Mechel MTLR 37 25%

NorNickel GMKN 270 22%

MTS MBT US 28.0 37%

Magnit MGNT 162.3 25%

Pharmstandard PHST LI 36.5 28%

Sberbank SBER 4.6 32%

U-UAZ UUAZ 2.9 38%

LSR Group LSRG 50 51%

TOP-10

16 STRATEGY 2011

Oil & Gas Uncertainty with taxes remains

STRATEGY 2011 17

Evgenia Dyshlyuk [email protected]


Strong performance of our top picks in 2H10. Looking back, practically all our top picks for 2H10 did very well. Bashneft’s preferred shares rose by roughly 55%. TNK-BP Holding’s ordinary and preferred shares were up by 30% and 44%, respectively. Gazprom’s stock added roughly 30% in value. As an exception, Tatneft’s preferred shares were up by moderate 7%.

The government approved some of the tax hikes. There is more clarity with taxes now: the state has approved increases of MET for crude oil and natural gas and excise taxes that should impose pressure on profitability of the Russian oil companies. While the first measure will have moderate impact on all producers, higher excise taxes should affect considerably the players with large refining exposure and strong focus on domestic market such as Bashneft and Gazprom neft.

Crude oil MET to grow at CAGR of 7% in the next five years. The government approved increases in the oil and gas MET. Now, we calculate that crude oil MET rate grow at CAGR of 7% in the next five years vs. CAGR of 3% for Urals price. Meanwhile, the increase in natural gas MET approved by the government is more gradual than we forecasted.

Excise tax for oil products to rise significantly. The government also approved increases in excise taxes that came out to be much higher than expected. In the next three years, the excise taxes for gasoline and lubricants will be raised, on average, at roughly 40% p.a. and for diesel – at 100% p.a. Assuming that the Russian oil companies will not make consumers pay this tax hike (perhaps at least before the 2012 elections), this tax change will affect primarily companies with strong focus on refining and domestic sales such as Bashneft and Gazprom neft.

Downgrading target prices for Rosneft, Lukoil and Gazprom neft. We calculate that positive impact of changes in our macroeconomic assumptions will not fully offset the negative impact of higher taxes and other factors. Based on the new macroeconomic and operating assumptions, we revised our financial models for the stocks and downgraded target prices for Rosneft, Lukoil and Gazprom neft.

Structural tax changes remain on the agenda in 2011. The government has been discussing possible structural changes of the oil taxation, shifting the burden from upstream to downstream, and is yet to finalize changes of the export duties for crude oil and oil products. The state should also develop special tax regime for greenfield projects in upstream as well as decide on other tax initiatives.

Top picks for 2011 – Gazprom, Novatek and Tatneft. Divergence of U.S. and European spot gas prices and widening of the NBP/Henry Hub differential suggest that pressure on the traditional oil-indexed formula in Gazprom’s long-term contracts should diminish. Domestically Gazprom will capitalize on regulated growth of gas tariffs. Gazprom remains one of the cheapest stocks, trading at 2011E P/E of 5.0.

Novatek remains a strong growth story. In spite of its double-digit financial multiples, we choose Novatek as a top pick due to its growth strategy. Novatek’s recent acquisitions in Yamal-Nenets autonomous region have substantial synergies with the company’s existing assets and boost its production upside. In a longer-term, Novatek’s growth should be driven by Yamal LNG project. The company’s strong shareholders base and management team should help with gas marketing.

Tatneft’s outlook will improve with the launch of the new refinery. The market forecasts Tatneft’s net income to grow by modest 11% y-o-y in 2011. In our view, this is a very conservative estimate, given that Urals price alone is forecasted to increase by 15% y-o-y next year. With the launch of the new refinery scheduled for 2011, Tatneft should deliver stronger bottom-line. Tatneft is also expected to pay attractive dividends for 2010.

YTD sector dynamic vs. RTS


-50% 0% 50% 100%

RTSTransnef tBashnef t

TNK-BP HoldingNov atek

SurgutNGGazprom

Alliance OilLukoil

Tatnef tRosnef t

Gazprom nef t

22.12.2010 Max Min

Source: RTS, TKB Capital estimates

70

85

100

115

130

Dec

09

Jan

10F

eb 1

0M

ar 1

0A

pr 1

0M

ay 1

0M

ay 1

0Ju

n 10

Jul 1

0A

ug 1

0S

ep 1

0O

ct 1

0O

ct 1

0N

ov 1

0D

ec 1

0

RTS Index RTS Oil&Gas


18 STRATEGY 2011

Strong performance of our top picks in 2H10. Due to uncertainty with oil and gas taxation we advised investors to focus on “safe” dividend plays in 2H10 – ordinary and preferred shares of TNK-BP Holding, preferred shares of Bashneft and Tatneft. We also included Gazprom as a top pick for 2H10: it was the cheapest stock then, trading at 2010E P/E of 4.1 and 60% of BV. Looking back, practically all our top picks did very well. Bashneft’s preferred shares rose by roughly 55% since July, while the company is yet to announce 2010 dividends. TNK-BP Holding’s ordinary and preferred shares were up by 30% and 44%, respectively. As expected, the firm declared generous interim dividends, offering double-digit yields. Most importantly, effective December 1, TNK-BP Holding’s shares have been admitted to trading on MICEX and main platform of RTS – a move that boosted liquidity of the stock. Gazprom’s shares added roughly 30% in value on the back of recovering gas prices in Europe. Finally, as an exception, Tatneft’s preferred shares were up by moderate 7%.

The government approved some of the tax hikes. There is more clarity with taxes now: recently the state approved increases of mineral extraction tax (MET) for crude oil and natural gas and excise taxes for oil products that should impose pressure on profitability of the Russian oil companies. While the first measure will have moderate impact on all the oil and gas producers, higher excise taxes should affect considerably the players with large refining exposure and strong focus on domestic market such as Bashneft and Gazprom neft. We calculate that the positive impact of changes in our macroeconomic assumptions (including a roughly 10% increase in forecasted Urals price in 2011-2015) will not fully offset the negative impact of higher taxes and other factors. Based on the new macroeconomic and operating assumptions, we revised our financial models for the stocks and downgraded target prices for Rosneft, Lukoil and Gazprom neft.

Downgrading target prices for Rosneft, Lukoil and Gazprom neft. We downgrade the target price for Rosneft (ROSN) from $8.5/share to $8.0/share and change the recommendation from BUY to HOLD. We downgrade the target price for Lukoil (LKOH) from $74/share to $71/share and maintain recommendation BUY. We upgrade the target price of TNK-BP Holding’s ordinary shares (TNBP) from $2.80/share to $2.95/share and change the recommendation from BUY to HOLD. We upgrade the target price for TNK-BP Holding’s preferred shares (TNBPP) from $2.52/share to $2.66/share and change the recommendation from BUY to HOLD. We downgrade the target price for Gazprom neft (SIBN) from $4.5/share to $4.0/share and maintain HOLD recommendation for the stock.

Figure 2. New target prices

Target price, $/share Recommendation Revenue, $ mn EBITDA, $ mn Net income, $ mn

Old New +/-

Upside, %

Old New 2010E 2011E 2012E 2010E 2011E 2012E 2010E 2011E 2012E

Rosneft 8.5 8.0 -5.9% 11% Buy Hold 62,850 77,200 76,165 19,259 20,186 17,394 10,511 11,456 9,252

Lukoil 74 71 -4.1% 24% Buy Buy 104,889 120,586 116,902 16,069 16,596 16,416 9,492 9,663 9,748

TNK-BP Holding – ordinary shares 2.80 2.95 5.4% 9% Buy Hold 40,276 46,823 46,027 10,052 11,146 9,797 6,300 6,965 5,784

TNK-BP Holding – preferred shares 2.52 2.66 5.6% 5% Buy Hold - - - - - - - - -

Gazprom neft 4.5 4.0 -11.1% -5% Hold Hold 32,928 38,334 37,600 6,502 7,442 7,492 3,544 4,320 4,260

Source: TKB Capital estimates

Uncertainty with taxes remains. The government has been considering structural changes of the oil taxation, shifting the burden from upstream to downstream and is yet to finalize changes of the export duties for crude oil and oil products. While, for now, the state may hold on to the base-case scenario, which envisages gradual equalization of export duties for oil products to the level of 60% of the crude oil export duty and is mild by impact, re-balancing of the tax burden will remain on the agenda in 2011. Further, the government is yet to develop special tax regime for greenfield projects in upstream, as well as decide on other tax initiatives. Thus, next year we expect performance of the Russian oil and gas stocks, particularly downstream-leveraged players (Bashneft and Gazprom neft), to be volatile on the news regarding possible tax changes.


STRATEGY 2011 19

Top picks for 2011 – Gazprom, Novatek and Tatneft. In 2011 we recommend investors to focus on shares of Gazprom, Novatek and Tatneft. Recovery of gas prices in Europe should continue to support Gazprom’s performance. The stock is still inexpensive, trading at 2011E P/E of 5.0 (consensus) and P/BV of 0.8. In spite of its double-digit financial multiples, we choose Novatek as a top pick due to its growth strategy. Novatek’s recent acquisitions of upstream assets (either at late stage of development, or are already producing) boost the company’s production potential. Further, both Gazprom and Novatek are well-positioned to capitalize on the tax breaks for Yamal, development of which the state considers a strategic priority. Tatneft’s operating and financial outlook will substantially improve with the launch of its new refining facility scheduled for 2011. According to the market consensus, Tatneft’s net income will grow by modest 11% y-o-y in 2011, while, in our view, the company should deliver stronger bottom-line. We also expect Tatneft to pay attractive dividends for 2010 (4% and 9% yields on ordinary and preferred shares, respectively).

Figure 3. Relative valuation EV/EBITDA P/E

Bloomberg ticker

Target price,

$/share

Upside, %

MCap, $ mn

EV, $ mn 2010E 2011E 2012E 2010E 2011E 2012E

P/ BV

Russian oil majors Rosneft ROSN RX 8.0 11% 69,303 83,330 4.3 4.1 4.8 6.6 6.0 7.5 1.3Lukoil LKOH RX 71 24% 44,867 56,700 3.5 3.4 3.5 4.7 4.6 4.6 0.8TNK-BP Holding TNBP RU 2.95 9% 41,590 43,380 4.3 3.9 4.4 6.6 6.0 7.2 2.0SurgutNG SNGS RX - - 39,944 26,942 3.7 3.8 4.0 8.6 9.0 9.6 1.0Gazprom neft SIBN RX 4.0 -5% 19,830 26,240 4.0 3.5 3.5 5.6 4.6 4.7 1.1Tatneft TATN RU - - 10,462 13,378 4.9 4.2 3.9 6.2 5.4 4.9 1.0Bashneft BANE RU - - 8,842 10,677 4.1 3.7 3.6 6.6 6.0 5.9 0.7Russian oil majors – weight. average 4.1 3.8 4.1 6.5 6.1 6.8 1.2International super majors ExxonMobil (US) XOM US - - 367,098 378,702 5.6 5.0 4.6 12.6 11.4 10.3 3.2RoyalDutchShell (Netherlands) RDSB LN - - 204,142 369,574 7.9 6.9 6.1 10.9 8.8 7.7 1.5Chevron (US) CVX US - - 180,958 181,238 4.0 3.6 3.3 9.8 9.2 8.3 2.0BP (UK) BP/ LN - - 136,243 250,679 7.0 5.7 5.4 6.4 6.5 6.2 1.3Total (France) FP FP - - 124,915 143,762 4.0 3.7 3.4 9.2 8.7 8.0 1.6ConocoPhillips (US) COP US - - 98,482 111,787 4.0 4.2 3.9 11.1 10.9 9.8 1.6International super majors – weight. average 5.9 5.2 4.8 10.6 9.6 8.7 2.1GEM oil majors Petrochina (China) 601857 CH - - 306,466 334,572 9.6 7.2 6.5 14.8 13.1 11.7 2.3Petrobras (Brazil) PETR3 BZ - - 209,445 251,489 8.7 6.8 6.1 11.4 10.3 9.7 2.2Sinopec (China) 386 HK - - 102,089 119,581 5.8 5.0 4.6 9.6 9.0 8.4 1.7CNOOC (China) 883 HK - - 105,662 86,959 11.4 6.2 5.5 13.8 12.4 11.7 4.1ONGC (India) ONGC IN - - 62,158 60,589 7.5 6.7 5.3 15.2 11.5 10.4 3.4GEM – weight. avr. 8.8 6.6 5.9 13.1 11.6 10.6 2.5Russian gas producers Gazprom GAZP RX - - 146,790 188,000 5.3 4.3 3.9 5.2 5.0 4.5 0.8Novatek NVTK RU - - 27,259 28,631 22.9 15.0 11.5 21.3 16.7 12.6 6.0Russian gas producers – weight. average 7.6 5.7 4.9 7.7 6.8 5.8 1.6International gas producers GDF Suez (France) GSZ FP - - 83,171 139,794 7.1 6.2 5.9 14.4 13.1 12.0 0.9BG Group (UK) BG/ LN - - 69,078 117,283 13.1 11.5 10.5 17.3 16.3 15.0 3.0Anadarko Petroleum (US) APC US - - 33,576 43,344 6.5 5.9 4.9 40.4 33.3 21.1 1.6Apache (US) APA US - - 43,102 49,634 5.6 4.4 3.9 13.1 10.3 8.8 2.7Devon Energy (US) DVN US - - 32,833 34,854 5.7 5.9 4.9 12.1 13.6 10.6 2.1Encana (Canada) ECA CN - - 21,236 27,097 4.9 5.9 5.0 19.8 44.1 25.2 1.3Chesapeake Energy (US) CHK US - - 16,616 30,517 6.1 5.7 5.2 8.3 8.7 8.6 1.3Murphy Oil (US) MUR US - - 14,279 14,211 5.2 4.4 3.8 17.2 13.0 10.8 1.9Pioneer Natural Resources (US) PXD US - - 10,160 12,735 9.2 7.9 6.2 36.1 30.1 18.4 2.8Ouicksilver Resources (US) KWK US - - 2,510 4,956 8.4 10.5 9.1 20.6 43.8 28.1 3.6International gas producers – weight. average 8.1 7.3 6.5 18.2 18.1 14.0 1.9Russian crude oil and product pipeline operators Transneft TRNFP RX - - 2,104 10,704 1.5 1.3 1.2 0.6 0.5 0.5 0.1U.S. crude oil and product pipeline operators Enterprise Products Partners EPD US - - 34,783 47,972 15.1 14.0 12.7 26.3 22.7 18.8 3.5Kinder Morgan Operating KMP US - - 21,571 34,134 11.8 10.2 9.5 49.2 35.8 28.5 3.2Plains Pipeline PAA US - - 8,789 14,496 13.6 12.5 11.6 22.6 20.3 18.4 2.1Magellan Midstream Pipelines MMP US - - 6,233 8,061 15.8 14.4 13.4 20.2 18.4 17.2 5.2Enbridge Energy EEP US - - 7,658 13,138 12.6 11.3 10.5 19.7 18.0 16.2 1.9Sunoco Pipeline SXL US - - 2,696 4,020 11.0 9.9 9.5 15.5 14.7 14.0 3.1U.S. oil and product pipeline operators – weight. average 13.7 12.4 11.4 30.5 24.9 20.8 3.2

Source: company data, Bloomberg, TKB Capital estimates


20 STRATEGY 2011

Changes in macroeconomic assumptions. We revised our macroeconomic assumptions (see Figure 4). As a result, the forecast of average Urals price increased on average by 9.5% in 2011-2015. We also estimate a weak ruble now. The Russian oil and gas producers stand to benefit from these macro changes. We also decreased market equity risk premium (used in calculating WACC) from 6.0% to 5.5%.

Figure 4: Changes in macroeconomic assumptions

2010E 2011E 2012E 2013E 2014E 2015EOld Average Urals price, $/bbl 76.0 78.0 85.0 83.0 80.0 84.5Average exchange rate, RUR/$ 30.0 28.2 28.0 29.5 31.2 29.9CPI, % 7.0% 7.5% 7.6% 7.1% 6.9% 6.6%New Average Urals price, $/bbl 78.1 90.0 87.0 89.0 91.0 92.0Average exchange rate, RUR/$ 30.4 29.9 31.3 30.8 30.3 30.0CPI, % 8.5% 8.4% 7.5% 7.1% 6.9% 5.4%Source: TKB Capital estimates

Crude oil MET to grow at CAGR of 7% in the next five years. Recently, the Russian government approved increases in the oil and gas mineral extraction tax (MET). The multiplier in the crude oil MET formula was raised by 6.4% to 446 in 2012 and by 5.4% to 470 in 2013. Taken into account higher forecast of Urals price, we calculate that crude oil MET rate will grow at CAGR of 7.0% in the next five years vs. CAGR of 3.3% for Urals price. Natural gas MET has been raised by 61% to RUR 237/mcm in 2011, by 5.9% to RUR 251/mcm in 2012, by 5.5% to RUR 265/mcm in 2013 and then is projected to grow in line with inflation. Meanwhile, we forecasted a much steeper increase of the gas MET. All factors considered, we calculate that MET payments of Rosneft, Lukoil, TNK-BP Holding and Gazprom neft will grow at 5%-11% p.a. in the next five years (see Figure 5).

Figure 5: Impact of higher crude oil and natural gas mineral extraction tax (MET)

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

Crude oil mineral extraction tax, $/bbl Old forecast 18.5 9.4 13.5 14.1 15.2 14.9 14.2 15.2 2.4% New forecast 18.5 9.4 13.5 16.5 16.8 18.2 18.7 18.9 7.0%Natural gas mineral extraction tax, $/mcm Old forecast 5.9 4.6 4.8 9.4 13.6 16.9 19.8 24.6 38.5% New forecast 5.9 4.6 4.8 7.9 8.0 8.6 10.9 13.3 22.4%Crude oil production* in Russia, mn t Rosneft 96.5 99.3 106.2 109.1 109.7 110.4 110.4 111.4 1.0% Lukoil 89.6 91.6 89.9 90.5 89.1 87.2 86.1 86.4 -0.8% TNK-BP Holding 69.4 71.0 73.7 74.5 74.3 74.2 75.8 78.5 1.3% Gazprom neft 30.8 29.9 30.1 29.8 29.3 28.5 27.7 27.0 -2.2%Gas production* in Russia, bcm Rosneft 11.5 11.9 11.5 11.4 11.2 11.2 11.2 11.2 -0.5% Lukoil 8.7 6.3 8.6 8.3 8.4 8.5 8.5 8.6 0.1% TNK-BP Holding 12.8 15.6 16.3 15.9 18.2 19.2 20.2 21.2 5.4% Gazprom neft 2.2 4.3 4.5 4.8 5.0 5.2 5.3 5.5 4.0%MET payments, $ bn Rosneft 12.8 6.5 9.1 12.1 13.5 14.7 14.7 15.3 11.0% Lukoil 12.3 5.3 8.1 10.8 10.7 11.3 11.4 11.7 7.7% TNK-BP Holding 9.6 4.8 6.9 8.6 8.7 9.2 9.4 10.5 8.8% Gazprom neft 4.2 2.2 3.0 3.6 3.6 3.8 3.9 3.8 4.8%

* By consolidated subsidiaries Source: company data, Konsultant Plus, TKB Capital estimates


STRATEGY 2011 21

Excise tax for oil products to rise significantly. The Russian government also approved increases in excise taxes for oil products that came out to be much higher than we expected. We forecasted the excise taxes to grow in line with inflation (2010E-2015E CAGR of 7.5%). Meanwhile, according to the new tax rates, in the next three years excise tax for gasoline and lubricants will grow, on average, at roughly 40% p.a. and for diesel – at 100% p.a. (see Figure 6). Assuming that the Russian oil companies will not make consumers pay this tax hike (perhaps at least before the 2012 presidential elections), this tax change should affect primarily oil companies with large refining operations and strong focus on domestic market, such as Bashneft and Gazprom neft. Large exposure to downstream makes them quite sensitive to any deterioration of refining profitability. We calculate that domestic excise tax payments of Rosneft, Lukoil, TNK-BP Holding and Gazprom neft will grow on average at CAGR of 35% in the next five years.

Figure 6: Impact of higher excise taxes for oil products

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

Old excise taxes for oil products, $/t Automotive gasoline Euro-4-5 146 114 131 152 165 167 170 189 7.5% Euro-3 126 99 114 132 143 145 147 163 7.5% Below Euro-3 107 84 96 112 121 123 124 138 7.5% Diesel 72 57 39 45 49 50 50 56 7.5% Straight-run gasoline 107 84 87 101 110 111 113 126 7.5% Lubricants 119 93 97 113 122 124 125 139 7.5%New excise taxes for oil products, $/t Automotive gasoline Euro-4-5 146 114 131 172 218 278 302 321 19.6% Euro-3 126 99 114 186 232 293 319 339 24.4% Below Euro-3 107 84 96 201 247 309 336 357 30.0% Diesel Euro-4-5 72 57 39 92 131 179 194 207 39.5% Euro-3 72 57 39 79 152 309 335 357 55.6% Below Euro-3 72 57 39 83 122 169 183 195 38.0% Straight-run gasoline 107 84 87 204 250 312 339 361 32.8% Lubricants 119 93 97 157 194 244 265 282 23.8%Domestic sales of oil products, mn t Rosneft 19.8 17.6 20.6 21.2 21.4 21.5 21.5 21.7 1.1% Lukoil 19.3 16.0 18.2 18.5 18.7 19.0 19.2 19.4 1.3% TNK-BP Holding 12.3 10.9 12.5 12.6 12.7 12.8 12.9 13.0 0.9% Gazprom neft 15.7 17.6 20.9 21.1 21.3 21.6 21.8 22.0 1.0%Russian excise tax payments, $ bn Rosneft 1.1 0.9 1.1 2.0 3.0 4.8 5.3 5.6 38.3% Lukoil 1.0 0.8 0.9 1.6 2.2 3.3 3.7 4.0 33.6% TNK-BP Holding 0.9 0.6 0.7 1.2 1.7 2.5 2.7 2.9 32.5% Gazprom neft 0.9 0.8 0.8 1.4 2.0 3.2 3.5 3.7 35.4%

Source: company data, Konsultant Plus, TKB Capital estimates

Downgrading recommendations for Rosneft, TNK-BP Holding and Gazprom neft. Based on the new macroeconomic and operating assumptions, we revised our financial models for the stocks (see Figure 2). As a result, we downgrade the 12-month DCF-based target price for Rosneft from $8.5/share to $8.0/share. The new target price implies 11% upside and we change the recommendation for Rosneft’s stock from BUY to HOLD. We downgrade the target price for Lukoil from $74/share to $71/share. The new target price implies 24% upside and we maintain recommendation BUY for Lukoil’s stock. We upgrade the target price of TNK-BP Holding’s ordinary shares from $2.80/share to $2.95/share that implies 9% upside and change the recommendation for the stock from BUY to HOLD. We upgrade the target price for TNK-BP Holding’s preferred shares from $2.52/share to $2.66/share that implies 5% upside and change the recommendation for the stock from BUY to HOLD. We downgrade the target price for Gazprom neft from $4.5/share to $4.0/share. The new target price implies 5% downside and we maintain HOLD recommendation for Gazprom neft’s stock.


22 STRATEGY 2011

Structural tax changes are still possible. The government has been considering major changes of the oil taxation, shifting the tax burden from upstream segment to downstream (see our research report “Oil & Gas – Shifting The Tax burden To Downstream” of November 15). In particular, the state has been discussing several scenarios of changing export duties for oil products. Under the base-case scenario, the government will gradually equalize export duties for light/middle (gasoline and diesel) and heavy distillates (fuel oil), setting them at around 60% of the crude oil export duty (see Figure 7). Another scenario envisages raising export duty for heavy distillates to the level of export duty for light/middle distillates (i.e. from roughly 40% to 70% of the crude oil export duty). Finally, there is also a very radical scenario: the government will significantly raise export duties for oil products, setting them at 85%-90% of the crude oil export duty, and provide subsidies to individual oil companies. Finally, to compensate for the tax hikes in downstream, the government also considered reducing crude oil export duty.

Figure 7. Possible changes in export duties for oil products

2008 2009 2010E 2011E 2012E 2013E 2014E 2015EUrals price, $/bbl 95 61 78 90 87 89 91 92Crude oil export duty, $/t 355 179 276 339 325 334 344 349

Export duties for oil products by scenario, $/t: Base-case (proposed by the Ministry of Economic Development) Light/middle distillates 252 133 198 227 208 201 206 209 as % of crude oil export duty 71% 74% 72% 67% 64% 60% 60% 60% Heavy distillates 136 72 107 159 172 201 206 209 as % of crude oil export duty 38% 40% 39% 47% 53% 60% 60% 60% Option 1. Increasing export duty for heavy distillates Light/middle distillates 252 133 198 244 233 240 247 251 as % of crude oil export duty 71% 74% 72% 72% 72% 72% 72% 72% Heavy distillates 136 72 107 244 233 240 247 251 as % of crude oil export duty 38% 40% 39% 72% 72% 72% 72% 72% Option 2. Increasing export duties for oil products to 85%-90%% of the crude oil export duty Light/middle distillates 252 133 198 305 292 301 309 314 as % of crude oil export duty 71% 74% 72% 90% 90% 90% 90% 90% Heavy distillates 136 72 107 305 292 301 309 314 as % of crude oil export duty 38% 40% 39% 90% 90% 90% 90% 90%

Source: Vedomosti, Bloomberg, InfoTEK, TKB Capital estimates

The base-case scenario is mild by impact. The base-case scenarios of changing export duties for oil products (proposed by the Ministry of Economic Development) is mild by impact (triggering up to 5% decrease of forecasted EBITDA of the oil companies) because higher export duty for heavy distillates will be somewhat offset by lower export duty for light/middle distillates. In this case, the tax changes will affect primarily oil companies operating refineries of simple complexity that export large volumes of heavy distillates (mainly fuel oil), i.e. all Russian oil majors except for Gazprom neft and Bashneft (both have superior product quality and focus on domestic market).

Re-balancing of the tax burden will remain on the agenda in 2011. While for now the state may hold on to the base-case scenario, re-balancing of the tax burden between upstream and downstream will remain on the agenda in 2011. If the most radical scenario (which envisages increasing export duties for oil products almost to the level of crude oil export duty) is implemented, it will considerably affect the Russian oil majors (all of which are vertically integrated). However, since most of the local producers are crude-long, the negative impact should be mitigated by reduction of the crude oil export duty. Thus, under the most radical scenario, changes of the export duties for crude oil and oil products will severely affect profitability of players with large downstream exposure such as Bashneft (2010E refining cover of 150%) and Gazprom neft (80%).

Other tax initiatives to be finalized. Further, next year the government should finalize other tax initiatives such as, for instance, special tax regime for upstream greenfield projects. Thus, in 2011 we expect performance of the Russian oil and gas stocks to be volatile on the news regarding possible tax changes.


STRATEGY 2011 23

Gazprom to capitalize on rising European and domestic gas prices

Top picks for 2011 – Gazprom, Novatek and Tatneft. For 2011, we recommend investors to focus on shares of Gazprom, Novatek and Tatneft. Weak gas prices in Europe, increased competition from LNG, and re-negotiations of the long-term contract terms adversely affected Gazprom’s performance this year. However, global energy studies indicate a number of trends suggesting that pressure on Gazprom should diminish:

Divergence of U.S. and European spot gas prices. National Balancing Point (NBP, UK spot gas price) tracked Henry Hub (U.S. spot gas price) closely in 2009 and early 2010 (see Figure 8) but this trend has changed since 2H10. NBP price has gone up due to stronger demand, lower supply availability and contract re-negotiations. Meanwhile, this dynamics did not affect North American spot gas prices, pressured by the developing surplus of unconventional gas production.

Figure 8. Spot gas prices in the U.S. and Europe, $/MMBtu

0.02.04.06.0

8.010.012.014.0

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep-

08

Nov

-08

Jan-

09

Mar

-09

May

-09

Jul-0

9

Sep-

09

Nov

-09

Jan-

10

Mar

-10

May

-10

Jul-1

0

Sep-

10

Nov

-10

Henry Hub NBP Gazprom's 2010E European export price

Source: Bloomberg, company data, TKB Capital estimates

Widening NBP/Henry Hub differential. According to CERA, there are signs of fundamental improvement in European demand for gas suggesting that NBP/Henry Hub differential will widen further going forward. CERA forecasted gas demand in Europe to rebound to 558 bcm in 2010, slightly below the 2008 level (561 bcm), and to 553 bcm (assuming normal weather) in 2011. For 2011, CERA projected average NBP price at $6.4/MMBtu and forecasted the NBP/Henry Hub differential to widen to over $2/MMBtu (see Figure 9). In December NBP price already went above $8/MMBtu, surpassing CERA estimate and Gazprom’s long-term contract price forecasted for 2010.

Figure 9. Forecast of spot gas prices, $/MMBtu

CERA forecast 2007 2008 2009 2010E 2010E 2011E Henry Hub 7.0 8.9 3.9 4.4 4.6 4.2 NBP 6.0 9.4 4.6 6.1 5.8 6.4 NBP/Henry Hub differential (1.0) 0.5 0.7 1.7 1.2 2.2 Gazprom’s European export price 7.5 11.4 8.0 7.8 7.8 7.5

Source: Bloomberg, CERA, company data, TKB Capital estimates

Disconnect between European and North American gas prices to continue. As the global gas market tightens, CERA expects continued disconnect between European and North American gas prices. Although there is some potential for North American liquefaction, CERA does not believe the NBP/Henry Hub differential will be large enough to incentivize LNG to Europe. CERA projects that the bulk of LNG to be absorbed by three LNG importing giants – Japan, Korea, and Taiwan – on the back of economic recovery in Asia. CERA has completed a number of studies of the North American shale gas potential and expects shale gas to remove the need for gas imports into North America almost completely. This factor has also caused CERA to reduce its long-term outlook for Henry Hub price.


24 STRATEGY 2011

Shale gas in Europe as major downside risk in long-term. According to CERA, the prospect for shale gas in Europe is a major downside risk. It is not expected to have the transformative effect on the European gas industry as it had in North America. Although the initial geological assessments suggest there are reserves in place, there are difficult technological and sociological challenges to overcome. However, if shale did take off in Europe, as it has in North America, this would be bearish for European gas prices.

Gazprom’s stock is still inexpensive, trading at 2011E P/E of 5.0. The trends described above suggest that pressure on the traditional oil-indexed formula in the long-term gas contracts should diminish, giving Gazprom more leverage in negotiations with the European customers. Domestically Gazprom will capitalize on regulated growth of gas prices (average gas tariff for industrial consumers is set to increase by 15% y-o-y in 2011). Gazprom remains one of the cheapest stocks in the oil and gas universe, trading at 2011E P/E of 5.0 (consensus) vs. an average of 6.1 for Russian oil companies and an average of 18.1 for international gas peers.

Novatek remains a strong growth story

Novatek’s recent acquisitions support the growth story. In spite of its double-digit financial multiples, we choose Novatek as a top pick due to its growth strategy. Novatek’s recent acquisitions in Yamal-Nenets autonomous region have substantial synergies with the company’s existing assets and boost its production upside (see Figure 10). Novatek acquired a 51% stake in Sibneftegas (49% held by Itera) that has 2P gas reserves of roughly 300 bcm and is forecasted to produce 10 bcm in 2010. Sibneftegas will not require significant investments: its fields are already connected to the UGSS pipeline system and there is infrastructure in place. Starting from 2011 Novatek will market its 50% share of Sibneftegas’ production. The other big transaction was acquisition of 51% stake in SeverEnergia by Yamal Development – a 50%-50% JV of Novatek and Gazprom neft – (49% held by ENI and Enel). SeverEnergia operates former YUKOS assets with combined ABC1+C2 reserves of 1.3 tcm. First production from these fields is expected in June 2011. Figure 10. Impact of acquisitions on Novatek's production and reserves

before after Novatek's transaction multiples, EV/boe, $

Novatek Sever-

Energia (aggregate)

Sibneftegas (aggregate) Novatek

Increase, %

Sever-Energia Sibneftegas

ABC1+C2 gas reserves, bcm 1,462 1,352 396 2,005 37% 0.4 0.9 ABC1+C2 oil reserves, mn t 124 722 8 312 152% 0.7 39.3

ABC1+C2 oil & gas reserves, mn boe 10,589 14,211 2,671 15,548 47% 0.2 0.9 1P gas reserves, bcm - - 290 - - - 1.3 1P oil reserves, mn t - - 2 - - - 165.8

1P oil & gas reserves, mn boe - - 1,928 - - - 1.3 2P gas reserves, bcm - - 344 - - - 1.1 2P oil reserves, mn t - - 4 - - - 87.2

2P oil & gas reserves, mn boe - - 2,297 - - - 1.1 Short-term gas production, bcm p.a. 42 3 10 48 13% 206 37 Long-term gas production, bcm p.a. 55 23 10 66 20% 24 37

Source: company data, media sources, TKB Capital estimates

Yamal LNG project as a long-term driver. In a longer-term, Novatek’s growth should be driven by Yamal LNG project, which envisages development of South-Tambeyskoye field holding C1+C2 gas reserves of 1.26 tcm and construction of an LNG plant. Novatek is close to finalizing the feasibility study and recently re-started the search of international partners for the project. The final investment decision is to be made in 2012. The project’s economics should be helped by tax breaks: Yamal LNG should be exempt from natural gas MET (first 250 bcm of LNG or 12 years of production, whichever comes soonest), gas condensate MET (first 12 mn tn of condensate or 12 years of production), and export duty for LNG and gas condensate. The state considers development of Yamal a strategic priority and may grant more licences to Novatek willing to build a strong foothold in this region.


STRATEGY 2011 25

Novatek’s strong shareholders’ base and management team should help with gas marketing. In our view, the market is not catching up with the fast pace of Novatek’s evolution and is yet to account for the drivers described above. In our view, the main risk behind the stock remains Novatek’s ability to contract its gas. Rising domestic gas tariffs may spur competition at the domestic gas market going forward. However, we believe that Novatek’s shareholders, which are well-connected in political and business circles, as well as strong management team, should help lure in more contracts.

Tatneft overlooked by the market

Tatneft is to launch its new refinery in 2011. Tatneft’s operating and financial outlook will substantially improve with the launch of its new refinery scheduled for 2011. Tatneft is currently trading at 2011E P/E of 5.4 and 2012E P/E of 4.9 (consensus) vs. an average of 6.1 for its peers. According to the market consensus, Tatneft’s net income will grow by modest 11% y-o-y to $1.925 bn in 2011. In our view, this is a conservative estimate, given that average Urals price alone is forecasted to increase by 15% y-o-y to $90//bbl. With the launch of the refinery, Tatneft should deliver stronger bottom-line. Another factor to consider is that Tatneft will retain relatively moderate refining cover (26%). This makes Tatneft less risky, should the radical scenario of increasing downstream taxes materialize.

Forecasting 9% dividend yield on Tatneft’s preferred shares. We also expect Tatneft to pay out attractive dividends for 2010, forecasting 4% and 9% yields on ordinary and preferred shares, respectively. With Tatarstan government as a major shareholder (controlling around 36%), Tatneft has been under pressure to deliver large dividends, consistently paying out 30% of the RAS net income as dividends (see Figure 11).

Figure 11. Tatneft's dividend history

2004 2005 2006 2007 2008 2009 2010E Dividend, RUB/share: Ordinary shares 0.9 1.0 4.6 5.7 4.4 6.6 6.2 Preferred shares 1.0 1.0 4.6 5.7 4.4 6.6 6.2 y-o-y growth, % 11% 360% 23% -22% 48% -5% Dividend payment, $ mn 73 82 394 514 413 480 477 GAAP net income, $ mn 813 998 1,096 1,692 338 1,711 1,701 GAAP payout ratio 9% 8% 36% 30% 122% 28% 28% Record date May 11 May 14 May 13 May 11 May 11 May 10

Current share price, $/share Ordinary shares 4.8 Preferred shares 2.3 Implied 2010 dividend yield, % Ordinary shares 4% Preferred shares 9%

Source: SPARK, company data


26 STRATEGY 2011

Rosneft

BALANCE SHEET$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ETOTAL CURRENT ASSETS 15,169 19,259 25,173 27,687 33,356 39,114 47,076PP&E, net 57,704 60,460 63,163 66,845 70,600 74,477 78,381Other non-current assets 10,359 9,686 9,686 9,686 9,686 9,686 9,686

Total NON-CURRENT ASSETS 68,063 70,146 72,849 76,531 80,286 84,163 88,067TOTAL ASSETS 83,232 89,405 98,022 104,219 113,642 123,277 135,143Short-term borrowings 7,838 4,624 4,551 4,211 4,040 3,885 4,041Other short-term liabilities 5,605 6,996 8,693 8,822 9,334 9,783 10,070

Total CURRENT LIABILITIES 13,443 11,620 13,245 13,033 13,374 13,668 14,111Long-term borrowings 15,669 14,855 14,855 10,883 9,315 7,973 8,824Other non-current liabilities 8,583 8,011 8,011 8,011 8,011 8,011 8,011

Total LONG-TERM LIABILITIES 24,252 22,866 22,866 18,894 17,326 15,984 16,835Minority interest 706 1,023 1,383 1,674 1,978 2,288 2,598Shareholders' equity 44,831 53,897 62,669 70,618 80,963 91,336 101,598

TOTAL EQUITY & LIABILITIES 83,232 89,405 100,162 104,219 113,642 123,277 135,143

INCOME STATEMENT$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ERevenue 46,826 62,850 77,200 76,165 79,138 81,417 81,828Cost of production 33,261 43,591 57,015 58,772 61,169 63,200 63,686

EBITDA 13,565 19,259 20,186 17,394 17,969 18,217 18,142Depreciation 4,437 5,508 5,540 5,578 5,726 5,795 5,734

EBIT 9,128 13,750 14,646 11,815 12,243 12,423 12,408Net interest income/(expenses) (89) (107) 5 7 126 175 216Net other income/(expenses) (520) 36 119 107 112 118 121

EBT 8,519 13,679 14,770 11,928 12,481 12,715 12,745Income tax (2,000) (2,851) (2,954) (2,386) (2,496) (2,543) (2,549)Minority (5) (317) (360) (291) (304) (310) (311)

Net income 6,514 10,511 11,456 9,252 9,681 9,862 9,885

INCOME STATEMENT$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ENet CF f rom operating activ ities 10,319 16,145 16,695 15,392 15,719 16,037 16,111Net CF f rom/(used in) inv estment activ ities (8,788) (10,604) (9,842) (7,429) (7,649) (7,840) (7,806)Net CF f rom/(used in) f inancing activ ities (877) (4,537) (3,163) (5,201) (2,794) (2,700) (327)

RATIOS% 2009 2010E 2011E 2012E 2013E 2014E 2015ERev enue growth -32% 34% 23% -1% 4% 3% 1%EBITDA margin 29% 31% 26% 23% 23% 22% 22%

Net margin 14% 17% 15% 12% 12% 12% 12%Net Debt/EBITDA 1.4 0.6 0.4 - - - -Source: company data, TKB Captial estimates

Note: Consensus

Common GDRTicker ROSN ROSN LIRecommendation Hold HoldPrice, $ 7.2 7.2Target price, $ 8.0 8.0Upside/downside, % 11% 11%

Bloomberg ROSN RX ROSN LIReuters ROSN.MM ROSNq.L

9,598EV, $ mn 83,351MC, $ mn 69,303MIN 12 mnth., $ 5.9MAX 12 mnth., $ 9.3

Common

1

US GAAP 2010E 2011E 2012ERev enue 62,850 77,200 76,165EBITDA 19,259 20,186 17,394Net income 10,511 11,456 9,252EPS, $ 1.10 1.19 0.96Rev . growth, % 34 23 -1EPS growth, % 61 9 -19EBITDA margin,% 31 26 23Net margin, % 17 15 12

2010E 2011E 2012EP/E 6.6 6.0 7.5EV/EBITDA 4.3 4.1 4.8

Rosnef tegaz 75.2%BP 1.2%Petronas 1.1%CNPC 0.1%Treasury shares 9.4%Other 13.1%

# of shares outstanding,mn

SUMMARY VALUATIONS

SUMMARY FINANCIALS, $ mn

Shares per GDR

Rosneft

SHARE DATA

SHAREHOLDER STRUCTURE

PRICE DYNAMICS

Source: MICEX, RTS. TKB Capital estimates

5.5

7.3

9.1

10.9

22.12.09 22.3.10 22.6.10 22.9.10 22.12.10

ROSN RTS


STRATEGY 2011 27

Lukoil

BALANCE SHEET$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ETOTAL CURRENT ASSETS 17,839 19,453 27,586 30,527 35,677 41,436 47,052

PP&E, net 52,228 54,250 56,960 59,648 62,422 64,682 67,099

Other non-current assets 8,952 8,823 8,823 8,823 8,823 8,823 8,823

Total NON-CURRENT ASSETS 61,180 63,073 65,783 68,471 71,245 73,505 75,922

TOTAL ASSETS 79,019 82,526 93,369 98,998 106,922 114,941 122,974

Short-term borrowings 2,058 1,918 2,472 1,661 1,640 1,630 1,628

Other short-term liabilities 7,636 10,312 11,654 11,458 11,671 11,820 11,946

Total CURRENT LIABILITIES 9,694 12,230 14,126 13,120 13,311 13,450 13,574

Long-term borrowings 9,265 8,006 8,588 6,806 6,700 6,651 6,642

Other non-current liabilities 3,681 8,678 8,678 8,678 8,678 8,678 8,678

Total LONG-TERM LIABILITIES 12,946 16,683 17,265 15,484 15,378 15,328 15,320

Minority interest 388 451 532 614 693 777 864

Shareholders' equity 55,991 53,162 61,446 69,780 77,540 85,386 93,216


INCOME STATEMENT$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ERevenue 81,083 104,888 120,604 116,921 119,708 121,876 123,719

Cost of production 66,987 88,819 103,998 100,495 104,023 105,719 107,272

EBITDA 14,096 16,070 16,606 16,426 15,685 16,156 16,446

Depreciation 4,318 4,200 4,353 4,497 4,644 4,773 4,855

EBIT 9,778 11,870 12,254 11,929 11,041 11,383 11,591

Net interest income/(expenses) (533) (507) (510) (152) 222 556 934

Net other income/(expenses) (182) 580 447 521 503 550 546

EBT 9,063 11,943 12,191 12,298 11,766 12,489 13,071

Income tax (1,994) (2,330) (2,438) (2,460) (2,353) (2,498) (2,614)

Minority (58) (122) (82) (82) (79) (84) (87)

Net income 7,011 9,492 9,671 9,756 9,334 9,908 10,370

INCOME STATEMENT$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ENet CF f rom operating activ ities 8,883 14,508 15,000 15,378 15,188 15,928 16,489

Net CF f rom/(used in) inv estment activ ities (8,923) (6,327) (7,020) (7,142) (7,375) (6,991) (7,229)

Net CF f rom/(used in) f inancing activ ities 87 (8,149) (1,493) (5,361) (3,056) (3,465) (3,887)

RATIOS% 2009 2010E 2011E 2012E 2013E 2014E 2015ERev enue growth -25% 29% 15% -3% 2% 2% 2%

EBITDA margin 17% 15% 14% 14% 13% 13% 13%

Net margin 9% 9% 8% 8% 8% 8% 8%

Net Debt/EBITDA 0.6 0.5 0.1 - - - -

Source: company data, TKB Captial estimates

Common GDRTicker LKOH LKOD LIRecommendation Buy BuyPrice, $ 57.4 57.4Target price, $ 71.0 71.0Upside/downside, % 24% 24%

Bloomberg LKOH RX LKOD LIReuters LKOH.MM LKOHy q.L

847EV, $ mn 54,238MC, $ mn 48,617MIN 12 mnth., $ 44.5MAX 12 mnth., $ 60.8

Common1

US GAAP 2010E 2011E 2012ERev enue 104,888 120,604 116,921EBITDA 16,070 16,606 16,426Net income 9,492 9,671 9,756EPS, $ 11.2 11.4 11.5Rev . growth, % 29 15 -3EPS growth, % 35 2 1EBITDA margin,% 15 14 14Net margin, % 9 8 8

2010E 2011E 2012EP/E 5.1 5.0 5.0EV/EBITDA 3.4 3.3 3.3

ConocoPhillips 3.0%Management 47.9%UniCredit 5.0%Treasury shares 7.6%Other 41.6%


SUMMARY VALUATIONS


Shares per GDR

Lukoil

SHARE DATA


PRICE DYNAMICS


40

55

70

85

22.12.09 22.3.10 22.6.10 22.9.10 22.12.10

LKOH RTS


28 STRATEGY 2011

ТНK-ВР


PP&E, net 16,893 18,272 21,650 24,539 27,245 29,011 30,759



TOTAL ASSETS 28,041 30,489 35,532 38,330 41,613 43,995 46,411

Short-term borrowings 634 604 702 690 723 759 799






Minority interest 729 807 807 807 807 807 807





EBITDA 8,127 10,051 11,150 9,800 9,489 10,074 9,835

Depreciation 1,855 1,908 2,002 2,226 2,389 2,502 2,523

EBIT 6,272 8,144 9,147 7,575 7,099 7,572 7,312

Net interest income/(expenses) 164 90 (30) (3) (15) (34) (67)

Net other income/(expenses) 121 (12) 8 6 6 6 6

EBT 6,557 8,222 9,126 7,578 7,091 7,544 7,252

Income tax (1,228) (1,621) (1,825) (1,516) (1,418) (1,509) (1,450)

Minority (154) (301) (333) (276) (258) (275) (264)

Net income 5,175 6,300 6,968 5,786 5,414 5,761 5,537



Net CF f rom/(used in) f inancing activ ities (5,058) (4,966) (2,388) (2,882) (2,271) (3,547) (3,295)


EBITDA margin 26% 25% 24% 21% 20% 20% 18%

Net margin 17% 16% 15% 13% 11% 11% 10%

Net Debt/EBITDA 0.2 0.2 0.1 0.1 0.2 0.2 0.2


Common Pref erredTicker TNBP TNBPPRecommendation Hold HoldPrice, $ 2.70 2.44Target price, $ 2.95 2.66Upside/downside, % 9% 9%

Bloomberg TNBP RX TNBPP RXReuters TNBPI.RTS

14,997 450EV, $ mn 42,573MC, $ mn 41,590MIN 12 mnth., $ 1.73MAX 12 mnth., $ 2.90

Common-

US GAAP 2010E 2011E 2012ERev enue 40,276 46,827 46,032EBITDA 10,051 11,150 9,800Net income 6,300 6,968 5,786EPS, $ 0.42 0.46 0.39Rev . growth, % 29 16 -2EPS growth, % 22 11 -17EBITDA margin,% 25 24 21Net margin, % 16 15 13

2010E 2011E 2012EP/E 6.6 6.0 7.2EV/EBITDA 4.2 3.8 4.3

Novy Investments Ltd (TNK-BP International Ltd) 95.0%Other 5.0%


SUMMARY VALUATIONS


Shares per GDR

ТНK-ВР

SHARE DATA



PRICE DYNAMICS


1.6

1.9

2.2

2.5

22.12.09 22.3.10 22.6.10 22.9.10 22.12.10

tnbp RTS

1.3

1.6

1.9

2.2

22.12.09 22.3.10 22.6.10 22.9.10 22.12.10

tnbpp RTS


STRATEGY 2011 29

Gazprom Neft


PP&E, net 14,265 15,768 17,386 18,794 20,468 22,244 24,058



TOTAL ASSETS 29,912 32,792 36,359 38,299 40,396 43,915 45,971

Short-term borrowings 2,148 1,252 2,342 2,362 1,076 2,491 995






Minority interest 2,506 1,977 1,977 1,977 1,977 1,977 1,977





EBITDA 4,904 6,502 7,442 7,492 7,820 7,969 8,071

Depreciation 1,475 1,671 1,722 1,862 1,986 2,110 2,231

EBIT 3,429 4,830 5,719 5,630 5,833 5,859 5,839

Net interest income/(expenses) (261) (305) (214) (201) (122) (33) 34

Net other income/(expenses) 729 123 157 155 160 161 161

EBT 3,897 4,648 5,662 5,584 5,871 5,988 6,033

Income tax (816) (933) (1,132) (1,117) (1,174) (1,198) (1,207)

Minority (68) (172) (210) (207) (217) (222) (224)

Net income 3,013 3,544 4,320 4,260 4,479 4,568 4,603



Net CF f rom/(used in) f inancing activ ities 185 (1,372) (469) (1,459) (2,568) (1,143) (2,614)


EBITDA margin 20% 20% 19% 20% 20% 20% 21%

Net margin 12% 11% 11% 11% 11% 12% 12%

Net Debt/EBITDA 1.1 0.5 0.4 0.1 - - -


Common GDRTicker SIBN GAZ LIRecommendation Hold HoldPrice, $ 4.2 21.0Target price, $ 4.0 20.0Upside/downside, % -5% -5%

Bloomberg SIBN RX GAZ LIReuters SIBN.RTS

4,718EV, $ mn 26,240MC, $ mn 19,830MIN 12 mnth., $ 3.55MAX 12 mnth., $ 5.86

Common5

US GAAP 2010E 2011E 2012ERev enue 32,928 38,334 37,600EBITDA 6,502 7,442 7,492Net income 3,544 4,320 4,260EPS, $ 0.75 0.92 0.90Rev . growth, % 36 16 -2EPS growth, % 18 22 -1EBITDA margin, % 20 19 20Net margin, % 11 11 11

2010E 2011E 2012EP/E 5.6 4.6 4.7EV/EBITDA 4.0 3.5 3.5

Gazprom 95.7%Other 4.3%

Shares per GDR

SUMMARY VALUATIONS


SHARE DATA



PRICE DYNAMICS

Source: MICEX, RTS, TKB Capital estimates

Gazprom Neft

3.2

4.4

5.6

6.8

22.12.09 22.3.10 22.6.10 22.9.10 22.12.10

SIBN RTS

30 STRATEGY 2011

Power Industry Bet on quality

STRATEGY 2011 31

Aleksey Serov [email protected]

Power Industry Bet on quality The electricity sector during 2010 has shown impressive growth. In fact two stories were played up: the efficiency in gencos in the run up to 100% liberalization of the wholesale electricity market and transition to RAB-regulation in grid sector. 2011 should be a pivotal year for both generation - 100% of market liberalization, and grid companies - the introduction of RAB-regulation and long-term tariff-indexation. In 2010 former shareholders of RAO UES resumed a subtotal of energy reform, because after the separation process the sector finally entered in a phase of consolidation, which will be the main story in the industry in 2011.

Sector reform is finishing. 2011 will be a year of full liberalization of the wholesale electricity market, launching a long-term capacity market power and transmission of grid companies to RAB-regulation and long-term tariffs-indexation, which in fact mark the end of the active part of the electricity reform. New regulation rules and market mechanisms qualitatively change the picture of the industry and will improve the financial performance of energy companies that generally increase their investment attractiveness.

Restoration of electricity consumption and rising energy prices. Most estimates on the annual growth of energy consumption in the country in the coming years are in the range from 2.2% to 3.5%, but even such modest by the standards of the pre-crisis figures could stably support the growth in electricity prices and, consequently, the financial performance of companies. In addition to the dynamics of electricity demand good support for prices will be provided by increase in domestic energy prices (gas and coal) on the background of the low level of commissioning capacities, so that we can expect a proportional increase in electricity prices and, accordingly, the company's revenues.

2011 – Year of selective purchases. Most of the positive, associated with the power industry sector transformation, has already priced in: the vanguard of cost effective and efficient companies were formed in generation, prospects and risks of grid companies have also become much clearer, so on the horizon of the year we can expect more moderate dynamics of stock price in power industry segment. Trend for consolidation became apparent in industry during 2010, which is accompanied by vertical and horizontal diversification and integration especially characteristic for state-owned companies. A series of events and transactions in 2011 could lead to formation of powerful energy conglomerates, but the creation of value for minority shareholders is an open question.

Probability of SPO’s and the growth of debt burden. In the process of investment program realization will be accompanied by a significant increase in the debt burden of generating and grid companies. This trend was observed throughout 2010 and, according to our estimates, will continue in 2011. In some cases large-scale additional share placement could occur that first of all may concern companies under state control.

State control in the sector will be determinative on the horizon the next few years via tariff-regulation and market mechanisms («price cap» policy), as well as through state-owned companies. First of all restrictions will affect the capacity tariff for generating companies and distribution tariff for grid companies, since their contribution to the cost of electricity for the end user is the most weighty, which could lead to deterioration of the financial performance of these companies.

Risks. Investment programs, primarily of the state-owned companies, could far exceed current estimates. Necessity of fund raising for investment programs realization means the absence of dividends and a greater likelihood of additional share placement in favor of the state or strategic investors, with the possible erosion of minority shares. In this regard, the risks of minority shareholders, especially large state-owned companies, can be assessed as high.

In the generating sector we recommend to bet on the purchase of RusHydro (HYDR) shares, as the most cost-effective generator in industry, conducting organic development, which will benefit from full liberalization of the market and be able to fully capitalize on rising energy prices.

In the segment of grid companies we bet on the purchase of common and preferred shares of MRSK Holding (MRKH), which minimize the risks of the individual regional discos and partly hedging the risks of investors in case of possible merger of assets and additional share placement of regional companies. We also like MRSK’s for all subsidiaries with already approved RAB-tariffs - MRSK of Center (MRKC), MRSK of Volga (MRKV), MRSK of Urals (MRKU) and MRSK of Center and Volga (MRKP).


-50% 0% 50% 100% 150%

RTS IndexFEES

HYDRIRAOIRGZLSNGMRKCMRKHMRKKMRKPMRKSMRKUMRKVMRKYMRKZOGKAOGKBOGKCOGKDOGKEOGKFTGKATGKB

MSNGTGKDTGKETGKFTGKGTGKITGKJTGKKKZBETGKMTGKN

22.12.2010 Max Min

Source: RTS, MICEX, TKB Capital estimates

RTS-Utilities vs RTS

0255075

100125150175200

Dec

09

Jan

10

Feb

10

Mar

10

Apr

10

May

10

Jun

10

Jul 1

0

Aug

10

Sep

10

Oct

10

Nov

10

RTS UtilitiesRTS Index

Grid Companies

Distribution Companies

(MRSK)

Federal Grid Company

(FGC)

Source: Companies data, TKB Capital estimates

Electricity Tariff Structure

Electricity Tariff

Retail Supply Companies

Generating Companies

4%

32%

64%

27% 5%


32 STRATEGY 2011

Generating Companies

Investors have been resigned to the fact that events in the power industry sector is fundamentally contrary to the nature of the RAO UES reform of in the context of full-fledged competition and market mechanisms. Basic principles have not once been violated. In fact, in the industry the process of creating a series of conglomerates could be observed, which are consolidating assets, but the effectiveness of which in future remains questionable.

The era of new energy «blue chips». Russian specifics of the consolidation process consist in creation of energy conglomerates on the base of state-owned companies. If the government confirms its commitment to creating a market environment and is a gradual privatization of state holdings, the creation of an efficient market is a matter of time. In the meantime, we can expect the appearance of power «chips» created by the principle of additivity.

State control in the generation sector will continue. Consolidation of state-owned companies against tariffs regulation will lead to the lack of competitiveness and marketability of industry in the near future.

Favorites and outsiders are understandable. In the context of 100% liberalization of wholesale electricity market the profitability of generating companies will depend on electricity prices in the wholesale market, which depend on the dynamics of consumption and energy resource price level (gas, coal). Under such conditions, the generators with high profitability are least likely to be influenced by wholesale prices. Profitability of the generating companies is largely determined by fuel efficiency (indicators: capacity utilization ratio, fuel rate) and competent management (tactics and strategy of working in the wholesale market). According to the results of 2010, some generators have demonstrated unexpectedly poor profitability. Especially this fact was evident in OGK segment.


Russian Gencos: сomparative valuation, 2011Е

OGK-4

Enel OGK-5TGK-1

TGK-2TGK-6 TGK-11

RusHy dro

OGK-1

OGK-2

OGK-3 OGK-6

Mosenergo

Quadra (TGK-4)TGK-5

Volga TGK-7 TGK-9

Fortum

Kuzbassenergo

Yenisei TGK-13

TGK-14

0

100

200

300

400

500

600

700

0 20 40 60 80 100 120

EBITDA 2011/Installed capacity , $/kW

EV

/Inst

alle

d ca

paci

ty,

$/kW

Efficient generation is expensive. At the moment, in terms of EV/Installed capacity ratio in the wholesale segment of the thermal generation, OGK-4 and OGK-5 are the leaders traded at $657/kW and $445/kW respectively, whereas the average value of this indicator for a segment of OGK is only $ 305/kW. For example, RusHydro is traded at $575/kW, TGK-1 - $512/kW. Such optimistic current investor estimates suggest not only the expected performance of companies, but also the clarity of their perspectives: the definition of the strategy, the predictability of financial results and corporate events. This moment explains the fact that the most expensive companies are companies with foreign capital and hydrogenerators. It is likely that in the course of clarifying the strategies of other companies attributed to outsiders segment, investor interest will gradually shift from the favorites to distressed assets, because they look much cheaper. Apparently, the main focus of the investment focus in 2011 will be concentrated there and be extremely selective.


Gencos' share dynamics YTD ($)

62.8%103.5%

17.8%91.1%

35.3%84.2%

26.6%30.2%

-2.9%49.9%49.9%

78.5%73.6%

51.5%28.8%

24.1%49.5%46.0%

19.9%

45.8%

-50% 0% 50% 100% 150%

RusHy droOGK-1OGK-2OGK-3OGK-4

Enel OGK-5OGK-6TGK-1TGK-2

MosenergoQuadra (TGK-4)

TGK-5TGK-6

Volga TGK-7TGK-9

FortumTGK-11

KuzbassenergoYenisei TGK-13

TGK-14


Russian Gencos:2010E financials

0

2,000

4,000

6,000

8,000

10,000

Rus

Hyd

ro

OG

K-4

TG

K-1

Mos

ener

go

Kuzb

asse

nerg

o

$ bn

0%10%20%30%

40%50%60%

Rev enue 2010EEBITDA 2010EEBITDA 2010E Margin


Russian Gencos:2013E financials

0

2,000

4,000

6,000

8,000

10,000

Rus

Hyd

ro

OG

K-4

TGK

-1

Mos

ener

go

Kuzb

asse

nerg

o

$ bn

0%10%20%30%40%50%60%

Rev enue 2013EEBITDA 2013EEBITDA 2013E Margin


STRATEGY 2011 33

Dilemma: either expensive and understandable, or cheap and uncertain. In our opinion, the bet on «distressed assets» in 2011 may check out, especially in the case of the more radical dynamics of electricity consumption caused by the acceleration of economic recovery or changes among strategic investors of the companies. There are a number of companies that look relatively cheap on EV/kW. These include the OGK-1, OGK-3, OGK-6 and most of the TGK. As a rule, in the moment these companies are characterized by low profitability, uncertainty of the development strategy or corporate events that involve significant risks of minority shareholders.

Hydrogeneration: bet on RusHydro. Companies with a predominance of hydrogenating capacities in the coming years will continue to capitalize the rising energy prices, but unlikely surprise investors by drastic increase in profitability and efficiency. Retail business and development of competent strategy of working in the wholesale market and retail segment could become one of the growth-points. We particularly point out the RusHydro shares, which will continue the organic growth through consolidation of hydrogeneration assets and development of retail business. We think that these shares are the least risky investment in the Russian generation segment.

Valuation risks. Placement of the Inter RAO second additional share issue, which will be paid-in by the assets with of the total cost of about $10 bn, merger of OGK-2 and OGK-6, consolidation of TGC-5, TGK-6 and TGK-9 (maybe TGK-7) and a number of other transactions may be key events next year in power industry. Valuation of assets in these transactions is proposed to be a long-term support for the sector stock price and at the same time give impetus to the growth of lagging securities, acting as a guide. However, the creation of value for minority shareholders in these companies is still questionable on the background of a significant increase in risk of reorganization. After valuation or share conversion ratios are announced, ideas will be priced in very quickly. The fundamental appeals of these companies are unlikely to worsen, but the impact of possible synergies in the value is difficult to assess.

M&A-activity redraw the map of the domestic energy industry. We continue to stick to the point of view according to which a large part of the numbered OGK and TGK in the coming years will cease to exist as separate organization as a result of market integration in the larger energy entities. The Russian energy sector will be characterized by a European scenario with the formation of energy conglomerates affiliated with the fuel suppliers or large consumers of electricity.

Effect of privatization will be insignificant. Several stakes in state-owned generating companies in the next 3 years could be privatized. The government has included 7.97% stake in RusHydro, 25.5% stake in TGK-5 and a number of less significant assets in the privatization plan. In our opinion, this fact does not have a significant impact on the sector quotations in connection with an insignificant size of packages. In addition, the state remains the majority shareholder in state-owned companies. Valuation for privatization purpose is also unlikely to be much different from the market price.

Generation debt burden will increase. Most of the generating companies in the coming years will face the necessity of raising funds for the investment program realization and, consequently, increase in debt burden. The significant number of companies has already announced plans to place bond issues. Placement of the additional share in the current environment will be used by companies as the last tool. In fact, the companies, which actively implement their investment programs and build effective capacities in the moment, are forming their own long-term competitive advantage.

Corporate risks and risks of SPO. In the generating companies the risks of the additional issue, in our opinion, significantly lower than in the grid companies, since most companies have attracted funds from the additional share placement. However, a number of companies in generating segment, primarily the state-owned (RusHydro, Inter RAO, Gazprom etc.) may continue to head for additional share placements to raise funds for investment needs or new acquisitions.

Curbing of tariffs hike and constraints policy. During the 2010 the question of natural monopolies tariff growth limitation was brought up several times. At present moment, the prevailing view is to limit growth in electricity tariffs at a level of 10-15% over the next three years. This fact promise serious constraints on capacity market («price cap»-policy) for generation companies and establishment of tariffs for a number of generators that have not been selected in capacity auction.


New capacity commissioning forecasts until 2015 under CDA, MW

0

500

1,000

1,500

2,000

2,500

3,000

3,500

OG

K-1

OG

K-2

OG

K-3

OG

K-4

Enel

OG

K-5

OG

K-6

TGK-

1TG

K-2

Mos

ener

goTG

K-4

TGK-

5TG

K-6

Volg

a TG

K-7

TGK-

9Fo

rtum

TGK-

11Ku

zbas

sene

rgo

(TG

K-12

)Ye

nise

i TG

K-13

TGK-

14


34 STRATEGY 2011

Sector thermal generation not looks so cheap on multiples. At present moment domestic companies are traded at EV/2011 EBITDA 5.6 on the average, implying a 30 percent discount to comparable DM peers. However, on P/E ratio domestic thermal generation sector looks overpriced.

RusHydro is our favorite. More aggressive strategy may be buying of «distressed assets», where the most interesting options are shares of OGK-1 and OGK-3. We are still impressed by the OGK-4: the company has the highest profitability among thermal OGK, the net cash position and largely implemented the investment program. After 2011 the company may start paying dividends. However, we believe that the company is trading already quite expensive and its quotations growth will be less.

Russian Gencos: Comparative valuationCompany Ticker Market Net Current Installed Mcap/ EV/inst.

Cap, debt*, EV, 2009 2010E 2011E 2010E 2011E capacity, Inst.capacity, capacity,

$ mn $m $m MW $/kW $/kW

RusHy dro HYDR 14,548 65 14,613 9.0 6.5 5.3 9.7 8.8 25,424 572 575

OGK-1 OGKA 1,742 52 1,794 10.0 7.3 5.4 20.1 13.7 9,861 177 182

OGK-2 OGKB 1,990 75 2,065 16.8 11.6 7.9 33.6 51.4 8,695 229 237

OGK-3 OGKC 2,670 -1,472 1,198 9.1 11.3 8.9 16.4 22.9 8,357 319 143

OGK-4 OGKD 6,354 -389 5,965 25.7 15.9 9.3 25.3 16.3 9,073 700 657

Enel OGK-5 OGKE 3,346 548 3,894 16.1 11.1 7.1 24.9 13.4 8,747 383 445

OGK-6 OGKF 1,447 13 1,460 8.5 11.0 6.8 neg. neg. 9,052 160 161

OGKs average 14.4 11.4 7.6 24.1 23.5 328 304

TGK-1 TGKA 2,622 612 3,234 13.9 8.6 5.3 14.7 8.7 6,315 415 512

TGK-2 TGKB 412 320 732 9.5 5.5 2.6 neg. neg. 2,577 160 284

Mosenergo MSNG 4,129 253 4,382 8.8 6.4 4.4 29.7 14.6 11,924 346 368

Quadra (TGK-4) TGKD 1,060 -13 1,047 5.9 5.4 4.3 17.4 25.2 3,420 310 306

TGK-5 TGKE 709 -103 606 13.5 10.4 7.9 19.3 22.7 2,453 289 247

TGK-6 TGKF 1,061 -305 756 8.4 7.6 7.7 13.6 13.5 3,123 340 242

Volga TGK-7 TGKG 2,309 3 2,312 11.5 8.7 7.1 21.6 18.4 6,880 336 336

TGK-9 TGKI 1,199 -61 1,138 6.2 5.9 4.4 12.6 11.8 3,284 365 347

Fortum TGKJ 1,366 -599 767 5.7 6.3 3.3 12.3 11.3 3,016 453 254

TGK-11 TGKK 361 97 458 5.8 5.7 4.1 10.0 7.5 2,026 178 226

Kuzbassenergo KZBE 909 -169 740 9.4 4.7 3.0 24.1 43.2 4,500 202 164

Yenisei TGK-13 TGKM 671 179 850 13.0 8.1 3.8 neg. 13.6 2,530 265 336

TGK-14 TGKN 186 -28 158 9.4 4.2 3.0 6.8 5.1 639 291 247

TGKs Average 9.3 6.7 4.7 16.5 16.3 304 298

Average 10.9 8.2 5.6 18.9 18.4 300

EM hydro generation average 7.0 6.4 6.0 12.5 10.9 1,254Premium (discount), % 29% 2% -11% -22% -19% -54%

DM hydro generation average 15.3 13.4 10.8 32.0 19.0 2,219Premium (discount), % -41% -51% -51% -70% -54% -74%

EM thermal generation average 6.0 6.3 6.7 9.2 9.5 1,077

Premium (discount), % 82% 30% -16% 105% 94% -72%

DM thermal generation average 9.4 8.9 8.3 16.6 15.8 1,118

Premium (discount), % 16% -8% -33% 14% 17% -73%


EV/EBITDA P/E


STRATEGY 2011 35

Grid Companies During 2010 the investment attractiveness of the sector was under pressure due to uncertainties in the RAB-regulation parameters, but despite this fact grid companies stocks showed considerable growth. It has became clear that the introduction of RAB-regulation does not guarantee the corresponding dynamics of tariffs as smoothing mechanism can be applied for the latter. In addition to a large number of branches long-term tariff-indexation will be introduced instead of RAB.

Ambitious plans under pressure. 2011 should be a year of large-scale transition to RAB-regulation of grid companies. New regulations rules will boost the investment attractiveness of the segment, which will be the consequence of attendant increasing in tariffs. However, in the coming years the state will likely actively use the mechanism of tariffs smoothing, including through the introduction of long-term tariff-indexation for a number of branches, guided by social factors, which significantly increases the risks of discos. In addition, the growth of the companies' operating profitability will be accompanied by increasing in investment programs, which will not be included in the initial parameters of the RAB-regulation.

RAB-overregulated. 2010 showed a lack of coherence in the actions of relevant government departments and grid companies directly for the introduction of new regulations in the segment. Philosophy of RAB-regulation suggests that the regulatory asset base, rates of return, duration of regulation period and the resulting tariffs are approved by the regulator at the beginning of regulatory period and revised only at the end. However, 2010 clearly demonstrated that domestic regulators have no systematic understanding of the end point in this process: all RAB-regulation parameters have changed, RAB-tariffs have been replaced by long-term indexation for a significant number of MRSK branches. Thus, the investment attractiveness of the MRSK has become a hostage of tariff decisions that are more likely will be reviewed annually. RAB-regulation methodology involves compensation decreased income for subsequent regulation periods, however, it is difficult to estimate the effect of smoothing mechanisms in the moment.

Investment program. Currently, the total program of MRSK Holding for the next 5 years is estimated at $ 35 bn. It is expected that total investment volume up to 2020 will amount to over RUR3 trillion, which in our opinion significantly increases the probability of increasing the share of the investment program not included into initial parameters of RAB-regulation.

Low liquidity. Most of the distribution grid sector shares are characterized by low liquidity, which makes investments so risky.

Debt burden and the additional share placement. According to our estimates, the majority of discos in the coming years will significantly increase the debt burden. This process can directly touch MRSK Holding with following translation of cash in the subsidiary. The companies with the most ambitious investment plans (Kubanenergo, MOESK, Lenenergo and etc.) could place additional share issues, which greatly increase the risk of minority shareholders in the context of stake dilution. Implementation of tariff-indexation in a number of subsidiaries also increases the likelihood of raising funds through additional share placement.

In the segment of grid companies, we like MRSK Holding shares, which have sufficient liquidity, are full-fledged alternative to buying a basket of regional MRSK’s securities; partly negate the risks of significant additional share placements in the latter and introduction of long-term indexing in a number of subsidiaries. More conservative investors could bet on the preference shares, since it will probably accrue dividends for 2010. In our opinion several regional MRSKs, for which RAB-tariff were approved for all subsidiaries, also have a certain appeal - IDC Center (MRKC), MRSC Volga (MRKV), IDC Urals (MRKU) and MRSK Center and Volga Region (MRKP). However, their investment attractiveness could be nullified by the efforts of regulators, ambitious capex as well as an annual reviewing of tariffs using smoothing mechanisms.



Grids' share dynamics YTD ($)

69.1%

58.4%

2.6%

62.5%

-1.7%

66.1%

20.1%

3.4%

34.6%

41.3%

32.5%

12.8%

-20% 0% 20% 40% 60% 80%

FGC

Holding MRSK

MOESK

Lenenergo

MRSK ofCenter

MRSK ofNorth-West

MRSK ofCenter&Volga

MRSK ofSiberia

MRSK ofSouth

MRSK ofN.Caucasus

MRSK ofVolga

MRSK ofUrals

Source: Company Data, TKB Capital estimates

MRSK's shares day average traded value ($mn)

0

1

2

3

4

5

6

7

Hol

ding

MR

SK

MR

SK o

f Cen

ter

MO

ESK

MR

SK o

f So

uth

MR

SK o

f N

orth

Cau

casu

s

Kuba

nene

rgo

MR

SK o

f Cen

ter&

Volg

a

MR

SK o

f Vo

lga

MR

SK o

f U

rals

MR

SK o

f Si

beria

MR

SK o

f N

orth

-Wes

t

Lene

nerg

o

Tom

sk d

istri

butio

n co

mpa

ny

$ mn


MRSК Holding Investment Program

(2008-2015)

0

50

100

150

200

250

2008

2009

2010

E

2011

E

2012

E

2013

E

2014

E

2015

E

RUR bn


36 STRATEGY 2011

Holding MRSK Investment programm (2010-2015)

2010 2011 2012 2013 2014 2015Total

2010-2015MRSK Center 10,688 22,951 25,270 35,466 37,237 36,103 167,716MRSK South 3,318 5,573 3,538 3,549 3,896 4,401 24,274MRSK North Caucasus 1,583 7,559 7,617 7,675 6,733 6,742 37,909MRSK Center and Volga 6,962 13,766 12,505 10,217 10,218 10,773 64,441MRSK North-West 2,307 4,892 9,032 10,513 10,859 10,521 48,124MRSK Siberia 4,122 6,325 11,765 16,426 25,012 28,690 92,339MRSK Urals 4,781 6,484 8,039 10,319 12,037 13,754 55,414MRSK Volga 4,173 7,258 8,788 9,985 11,439 9,107 50,749MOESK 22,111 28,807 32,512 35,131 32,119 31,819 182,499Lenenergo 12,387 25,198 25,103 22,945 22,782 17,972 126,387Kubanenergo 8,355 9,203 8,931 4,366 3,600 3,967 38,422Tyumenenergo 6,515 14,193 17,709 17,680 19,907 19,134 95,137Tomsk DisCo 429 759 870 707 707 707 4,178MRSK Holding 87,731 152,968 171,678 184,979 196,545 193,689 987,589Source: Company Data, TKB Capital estimates

EV/RAB - sector valuation. Currently, the average value of the EV/RAB ratio for MRSK, which are fully-switched to the RAB-regulation, is 0.51. We think this estimate is quite adequate, given the possibility of a significant depreciation of the holding’s assets and probability of applying the methodology of tariff smoothing.

On the financial multiples Russian discos look relatively cheap. The average EV/2011EBITDA ratio for discos is 2.56, the P/E2011 - 4.3, while for foreign peers these ratios are 4.57 and 11.1, respectively. MRSK Holding shares are traded at a premium (2.5%) to the sum of components of the holding companies. In our opinion, this fact is justified, given the liquidity of the Holding’s securities and lower risk compared with regional distribution companies.

Subsidiary name TickerStake

owned

Market value of

stake ($mn)

Сurrent MRSK Holding

Capitalization MRSK Center MRKC 50% 723MRSK North-West MRKZ 55% 361MRSK Urals MRKU 52% 362MRSK Siberia MRKS 53% 435MRSK Center and Volga MRKP 50% 375MRSK Volga MRKV 68% 388MRSK South MRKY 52% 128MRSK North Caucasus MRKK 58% 78Lenenergo LSNG 46% 350MOESK MSRS 51% 1 091Kubanenergo KUBE 49% 216Tomsk DC TORS 52% 37Tyumenenergo not listed 100% 833

5 611 5 7532.5%

0.1262 0.12940.0920 0.0943

Source: Company Data, TKB Capital estimates

SOTP Valuation (pref.) ,$

MRSK Holding SOTP valuation

Premium/(discount), %Price per share

SOTP Valuation (ord.) ,$


Degree of wear of the companies analogues and

target level

0%20%40%60%80%

MR

SK

Hol

ding

(Rus

sia)

Tra

nsel

ectr

ica

SA

(R

oman

ia)

Ele

tropa

ulo

(Bra

zil)

Nor

thea

stU

tiliti

es(U

SA

)

Degree of wear of the companiesanaloguesTarget lev el 48%


Grid companies: сomparative valuation (2011E)

MRKV

MRKC

MRKP

FEES

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

1.5 2.5 3.5 4.5

EV/EBITDA 2011

EV/R

AB


Current EV/RAB multiples for MRSKs

0.440.450.460.470.480.490.500.510.520.530.540.55

MR

SK o

fC

ente

r&Vo

lga

MR

SK

of

Volg

a

MR

SK o

fC

ente

r

MR

SK

of

Ura

ls

Tom

skdi

strib

utio

nco

mpa

ny


STRATEGY 2011 37

Comparative ValuationRussian Grid Sector 9 11 12 13 15 17 19Company Ticker Market Current EV/

Cap, EV, 2010E 2011E 2012E 2010E 2011E 2012E 2010E 2011E 2012E 2010E 2011E 2012E Output,

$m $m $/kW

FGC FEES 14,456 12,809 6.44 3.93 2.73 3.62 2.65 2.04 17.74 9.50 6.20 50% 60% 66% 27 0.64

MRSK of Center MRKC 1,792 2,118 3.47 2.43 2.71 0.83 0.63 0.59 5.80 3.81 5.37 28% 31% 26% 34 0.54

MRSK of Urals MRKV 523 592 1.87 1.43 1.13 0.31 0.25 0.21 3.87 2.62 1.90 19% 20% 21% 7 0.48MRSK of Center and Volga

MRKP 1,106 1,401 4.11 2.87 2.24 0.55 0.44 0.37 9.60 5.22 3.48 17% 19% 21% 23 0.52

MRSK of Volga MRKV 1,068 1,152 6.77 3.02 2.24 0.93 0.67 0.55 22.93 5.03 3.44 15% 24% 26% 18 0.48

MRSKs' Average 4.22 2.56 2.30 0.72 0.55 0.48 10.6 4.3 4.0 21% 25% 24% 24 0.51

International peers' average 4.78 4.57 4.36 0.84 0.79 0.72 11.7 11.1 10.1 121 1.08Premium (discount), % -12% -44% -47% -14% -31% -33% -10% -61% -60% -80% -53%


P/EEV/EBITDA P/S EBITDA marginEV/RAB

Following risks:

Rates of return for the old and new invested capital and in the second period of regulation, more precisely, their marketability will be the determining factor for investment attractiveness of the grid companies.

Ambiguity of terms or parameters of the heavy investment period. None of the grid company could not clarify the necessary (temporary) or adequate (quantitative) conditions for the end of heavy capex period, on which the company will stop and realize only maintenance investments. Subsequent RAB-regulation period in terms of required investment seems to be no less substantive than the transition one. Regular review of investment programs of grid companies upwards suggests this point. In case of rates of return on invested capital, investment growth poses no threat to shareholders as it will be accompanied by a significant tariffs hike. However, if we take into account that the grid companies accounts for about 35% in the structure of electricity cost for consumers, it is hardly possible, because the price of electricity can not grow indefinitely (economic growth can be forgotten). In addition, the electricity generators sale price will also increase because of rising energy prices, which makes this scenario even more unlikely. In such a situation, in our opinion, the scenario, where tariffs will be reviewed annually by the regulators and problem of raising funds to implement the grid company’s investment programs will be solved through additional share placement in favor of the state, is more feasible.


38 STRATEGY 2011

RusHydro Bet on efficiency

Company RusHydro showed high profitability during 2010, even amid falling own production of electricity. In our view, RusHydro will receive the greatest benefits from the liberalization of electricity market among Russian generating companies and is currently one of the most attractive long-term investments in the energy sector.

Low costs and quality of assets will allow RusHydro to capitalize rising energy prices. The growth of tariffs for gas and coal, coupled with the dynamics of consumption are critical parameters for the formation of electricity prices in the wholesale electricity market. Therefore, in conditions of low production costs RusHydro will capitalize on any increase in energy prices even at modest consumption growth dynamics that directly affect the financial performance and company profitability. RusHydro’s generation business EBITDA margin in 2009 totaled 44%. In coming years the profitability of generating business RusHydro on EBITDA, according to our estimates, will come close to 55% and exceed the same indicator of thermal generation companies. According to our estimates, in the next three years RusHydro EBITDA is proposed to be more than doubled.

Consolidation of hydroassets and restoration of the Sayano-Shushenskaya HPP. The acquisition of a blocking stake in Krasnoyarskaya HPP in 2010 and the possible consolidation of the 40% state-owned stake in Irkutskenergo during 2011 will enable the company to build lasting relationships between the hydro assets belonging to the RusHydro and retail supply companies that could significantly increase the margin of the company.

The company plans to commission a 4.8 GW of capacities by 2014, which include the generating capacity of Boguchanskaya HPP, Zagorskaya HPSPP-2 and Zaramagskie HPPs. In addition, Sayano-Shushenskaya HPP should be completely restored by 2014. The increase in installed capacity will have a direct impact on the growth of financial indicators. According to the management plans, in the coming years total production of RusHydro’s electric power stations will increase to 113 bn kWh from the current 80 bn kWh.

Underestimating by financial metrics. At the moment RusHydro shares are traded at 5.7 in terms of EV/EBITDA, implying a 45 percent discount to the shares of hydro companies in developed markets. In terms of EV/Installed capacity RusHydro papers are traded at $ 575/kW that is almost twice lower than that of companies in emerging markets.

Valuation based on DCF-model suggests a BUY recommendation. Our RusHydro financial model is based on new macroeconomic forecasts, estimates of price changes in the wholesale electricity market and the actual data on investment in the company. Our DCF-model with WACC equal to 13.1% and the terminal growth rate of 2% suggests the target level of $ 0.0735 per share that corresponds to a BUY recommendation with a 44-percent growth potential of quotes.

Risks. Firstly, the uncertainty of payment for new capacity; secondly, the possible growth of the investment program; thirdly, the additional issue in favor of the state or a new strategic investor; and finally, the risks of aggressive expansion of foreign markets and uncertainty about the prospects for asset swaps and options of payment.

RusHydroCommon GDR

Ticker HYDR HYDR LiRecommendation BUY BUYPrice, $ 0.051 5.10Target price, $ 0.0735 7.35Upside/downside, % 44% 44%

SHARE DATABloomberg HYDR RXReuters HYDR.MM

Common269,695

EV, $ mn 15,575MC, $ mn 14,548MIN 12 mnth., $ 0.0328MAX 12 mnth., $ 0.0629

Common100

SUMMARY FINANCIALS, $ mnIFRS 2010E 2011E 2012ERev enue 13,131 5,740 6,646EBITDA 2,233 2,742 3,190Net income 1,495 1,652 2,065EPS, $ 0.006 0.0061 0.0077Rev . growth, % 14.4 -56.3 15.8EPS growth, % 10.5 25.0EBITDA margin,% 17.0 47.8 48.0Net margin, % 11.4 28.8 31.1

2010Е 2011E 2012EP/E 9.7 8.8 7.0EV/EBITDA 7.0 5.7 4.9

Gov ernment of Russia 60.4%Free Float 39.6%

# of shares


Shares per GDR


PRICE DYNAMICS

SUMMARY VALUATIONS

0.025

0.040

0.055

0.070

22.12.09 22.3.10 22.6.10 22.9.10 22.12.10

HYDR RTS


STRATEGY 2011 39

RusHydro

BALANCE SHEET$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ETOTAL CURRENT ASSETS 2,691 3,819 2,590 3,994 5,193 6,091 6,633PP&E, net 11,734 15,344 16,427 16,329 17,044 17,708 18,259Other non-current assets 1,555 1,605 1,573 1,502 1,527 1,552 1,568Total NON-CURRENT ASSETS 13,290 16,949 18,000 17,832 18,571 19,260 19,826TOTAL ASSETS 15,981 20,768 20,590 21,826 23,764 25,351 26,460Short-term borrow ings 85 341 334 319 325 330 333Other short-term liabilities 746 2,572 1,106 1,233 1,471 1,697 1,845Total CURRENT LIABILITIES 831 2,913 1,441 1,553 1,796 2,027 2,179Long-term borrow ings 640 717 702 671 682 693 700Other non-current liabilities 1,173 1,210 1,186 1,133 1,152 1,171 1,182Total LONG-TERM LIABILITIES 374 375 376 377 378 379 380Minority interestShare and additional capital 9,315 10,260 10,057 9,607 9,763 9,924 10,023Retained earnings 4,351 6,008 7,537 9,181 10,696 11,866 12,708Total EQUITY 13,336 15,928 17,260 18,469 20,135 21,461 22,398TOTAL EQUITY & LIABILITIES 15,981 20,768 20,590 21,826 23,764 25,351 26,460

INCOME STATEMENT$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ERevenue 3,649 13,131 5,740 6,646 7,524 8,781 9,458Cost of production (2,401) (11,320) (3,531) (4,034) (4,224) (4,785) (5,172)EBITDA 1,621 2,233 2,742 3,190 3,880 4,609 4,912Depreciation 373 423 533 578 580 613 627EBIT 1,249 1,811 2,209 2,612 3,300 3,996 4,286Net interest income/(expenses) () 80 (122) (9) 108 187 233EBT 1,248 1,891 2,087 2,603 3,408 4,183 4,519Income tax (244) (378) (417) (521) (682) (837) (904)Net income 987 1,495 1,652 2,065 2,710 3,329 3,598

CASH FLOW STATEMENT$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ENet CF from operating activities 1,286 1,006 3,003 2,582 3,096 3,676 3,946Net CF from/(used in) investment activities (1,029) (3,647) (1,938) (1,248) (1,029) (1,000) (1,000)Net CF from/(used in) financing activities 741 1,079 (135) (117) (1,218) (2,111) (2,623)Net Debt (867) 1,028 77 (1,187) (2,020) (2,568) (2,881)

RATIOS% 2009 2010E 2011E 2012E 2013E 2014E 2015ERevenue grow th -16% 260% -56% 16% 13% 17% 8%EBITDA margin 44% 17% 48% 48% 52% 52% 52%Net margin 27% 11% 29% 31% 36% 38% 38%

Source: RusHydro, TKB Capital estimates

40 STRATEGY 2011

Metals & mining Further recovery in 2011

STRATEGY 2011 41

Evgeny Ryabkov [email protected]


We have a moderately optimistic view on the prospects of metals & mining sector in 2011. We expect further recovery in steel consumption on domestic market due to the growth of demand for long products that will serve as a driver for price advance. In addition, continuing increase in coking coal prices as a result of stable external market environment and high steelmakers’ demand will play supportive for the steel price. Mechel, Evraz Group and MMK are our top picks in ferrous metals sector.

We expect further growth in non-ferrous metals sector backed by strong demand from China and sound dollar liquidity. Demand for gold and subsequent price hikes will be influenced by investors’ striving to hedge the funding risks through investing in other financial instruments. Norilsk Nickel is our top pick in non-ferrous metal sector.

Steel

Focus on construction. According to our estimates, recovery of domestic consumption of rolled steel will continue in 1Q11. In particular, construction sector may demonstrate outstripping demand due to the low base in 2Q10.

Domestic market is in priority. Russian domestic market is characterized by a premium to export amounted to 15-16% in recent years. Among the Russian steelmakers, major loading share falls on Magnitogorsk Iron&Steel Works (about 65%).

Prices: main growth in 1Q11. We suppose that in 2011 the price dynamics for long products may outrun the other segments in light of more significant growth of consumption in construction sector.

Out favorites – Mechel, Evraz Group and ММК. We see three favorites in the sector. High prices on coking coal and development of Elga coal deposit are the key growth factors for Mechel’s stocks. Evraz Group takes leading positions on domestic long steel market and gradually amends the situation with debts. MMK has the strongest sectoral positions on domestic market.

Coal

We expect 15% increase in prices for coking coal in 2011. According to our forecasts, 2011 will be characterized by further advance in prices for coking coal backed by high consumption in steel sector and stable external market environment.

Market equilibrium. We expect the balance between demand and supply on domestic market of coking coal in 2011, but don’t rule out temporary supply difficulties in 1Q11.

Non-ferrous metals

Copper is pulling ahead. We expect the prices on non-ferrous metal to rise in 2011. According to our estimates, copper can become the growth leader supported by high demand from China.

Gold as the best cover. In 2011 the gold will continue its price rally, attracting investors as insurance against global economy deterioration and fall on stock markets.

Several possible IPOs in 2011

2011: several possible IPOs. We expect several public offerings in ferrous market sector (ChTPZ Group, SUEK, Metalloinvest and others). In addition, Severstal Gold is expected to place its stocks as well. According to our estimates, the total volume of IPOs in 2011 may reach about $5 bn that may heighten the interest of investors in the industry as a whole.


-50% 0% 50% 100% 150%

RTSCHMFMAGNNLMK

EVRMTL

TRMKRASPBLNGGMKN

PLZLPMTL

CHZN

22.12.2010 Max Min

758595

105115125135145155

Jan-

10Fe

b-10

Mar

-10

Apr-

10M

ay-1

0

Jun-

10Ju

l-10

Aug-

10Se

p-10

Oct

-10

Nov

-10

Dec

-10

RTSI Metals & mining


42 STRATEGY 2011

Steel We expect further steel price increase in 2011.

At the same time, in our point of view, the growth of the long products’ segment will be more dynamic vs. to the rest of market due to low base effect of 2010. Besides, price of coking coal will continue its upward movement driven by strong external market and high domestic demand. Our leaders in the sector are Mechel, Evraz Group and MMK.

2010-2012 price forecast for steel and raw materials, $/t New forecast

2010E 2011E %, y-o-y 2012E Current price

Hot-rolled coil (export) 608 668 10% 688 600 Rebar (export) 555 611 10% 629 575 Hot-rolled coil (domestic market) 687 735 7% 757 695 Rebar (domestic market) 632 733 16% 755 686 Coking coil concentrate 136 156 15% 161 150 Metal scrap 284 326 15% 336 323 Iron-ore concentrate 78 90 15% 92 83

Long products domestic market: demand and supply, Kt

0500

1,0001,5002,0002,500

01.0

7.08

01.0

8.08

01.0

9.08

01.1

0.08

01.1

1.08

01.1

2.08

01.0

1.09

01.0

2.09

01.0

3.09

01.0

4.09

01.0

5.09

01.0

6.09

01.0

7.09

01.0

8.09

01.0

9.09

01.1

0.09

01.1

1.09

01.1

2.09

01.0

1.10

01.0

2.10

01.0

3.10

01.0

4.10

01.0

5.10

01.0

6.10

01.0

7.10

01.0

8.10

01.0

9.10

Output Demand

Sources: TKB Capital estimates

Flat products domestic market: demand and supply, Kt

0500

1,0001,5002,0002,500

01.0

8.08

01.0

9.08

01.1

0.08

01.1

1.08

01.1

2.08

01.0

1.09

01.0

2.09

01.0

3.09

01.0

4.09

01.0

5.09

01.0

6.09

01.0

7.09

01.0

8.09

01.0

9.09

01.1

0.09

01.1

1.09

01.1

2.09

01.0

1.10

01.0

2.10

01.0

3.10

01.0

4.10

01.0

5.10

01.0

6.10

01.0

7.10

01.0

8.10

01.0

9.10

Output Demand

Sources: TKB Capital estimates

Construction sector: high potential

We expect increase in consumption of long products. In 2011 demand for long products may be characterized by significant growth and outrun the flat products segment. We believe that further construction recovery will serve as the key growth drivers. Within 2010 the demand level for long products was 1,5-2 times lower the pre-crisis level of 2008. At the same time the demand for flat products has almost completely been remedied. Pre-crisis share of construction sector in the whole long products’ consumption in Russia made up over 60%, though in 2010 the share reduced up to 50% implying considerable recovery potential.

Construction sector recovery. Recovery of housing construction is rather slow in Russia. According to our estimates, commissioning of residential real estate in 2010 increased by 4%. In 2011 it will gain 5% more. Demand for long products by construction companies is determined by the number of projects to be realized in the year coming.

Long products demand structure change on the

domestic market, %

52%51%49%62%

0%

50%

100%

2007 2008 2009 2010E

Engineering PipesConstruction TradersOther

Sources: Metal Expert, TKB Capital estimates

House building dynamics in 2007-2012E in Russia, mn m2

55

60

65

70

75

2007 2008 2009 2010E 2011E2012E-10%

0%

10%

20%

30%house building %

Sources: Rosstat , TKB Capital estimates


STRATEGY 2011 43

Flat products: stable figures

Slight expansion of demand. We expect that consumption of flat products will continue its expansion in 2011 due to high demand in pipe and automotive sectors sharing about 50% off the total consumption. In this context, we forecast 7% increase in flat products’ prices on domestic market in 2011 vs. 2010.

Pipe and automotive industry as a back-up. Pipe products market in Russia in 2009-2010 demonstrated stable growth mainly due to demand from O&G sector. The key factors of expanding consumption are new pipeline construction, repair and maintenance of current capacities. We believe that the factors will facilitate the stable demand for hot-rolled steel in pipe products sector in 2011 as well playing supportive for flat products’ prices. The situation in automotive sector is the same. It is our opinion that the Russian automotive production will demonstrate 25% growth up to 1,329 K units in 2011. Flat products produced by Russian companies (Severastal, MMK, NLMK) is primarily consumed by local automakers such as AutoVAZ, GAZ and KAMAZ. According to ACM Holding, in 2010 car production by Russian manufacturing plants increased by 50%, trucks – 35% against the level of 2009.

Pipes domestic market: demand and supply, Kt

0200

400600

8001000

01.0

7.08

01.0

8.08

01.0

9.08

01.1

0.08

01.1

1.08

01.1

2.08

01.0

1.09

01.0

2.09

01.0

3.09

01.0

4.09

01.0

5.09

01.0

6.09

01.0

7.09

01.0

8.09

01.0

9.09

01.1

0.09

01.1

1.09

01.1

2.09

01.0

1.10

01.0

2.10

01.0

3.10

01.0

4.10

01.0

5.10

01.0

6.10

01.0

7.10

01.0

8.10

01.0

9.10

output demand

Vehicle production dynamics in Russia in 2008-2016E

0500

1,0001,5002,0002,5003,000

2008

2009

2010

E

2011

E

2012

E

2013

E

2014

E

2015

E

2016

E

Motor cars Trucks Buses

Sources: Metal Expert, ASM Holding, TKB Capital estimates

A good premium for domestic market

Price premium at the level of 15-16%. Over the last years price premium for rolled products on the Russian market made up 15-16% to the export one. It is explained by the fact that domestic market is supplied with the products of higher value-added level than the export market as well as the level of transportation costs. We believe that the premium on domestic market in future will depend on demand expansion in real economy and increase in transportation costs. Among Russian steelmakers, major loading share falls on MMK (about 65%).

HRC: domestic and export prices, $/t

300400500600700800

01.0

1.20

0901

.02.

2009

01.0

3.20

0901

.04.

2009

01.0

5.20

0901

.06.

2009

01.0

7.20

0901

.08.

2009

01.0

9.20

0901

.10.

2009

01.1

1.20

0901

.12.

2009

01.0

1.20

1001

.02.

2010

01.0

3.20

1001

.04.

2010

01.0

5.20

1001

.06.

2010

01.0

7.20

1001

.08.

2010

01.0

9.20

1001

.10.

2010

01.1

1.20

10

-10%0%10%20%30%40%50%

premium domestic export

Rebars: domestic and export prices, $/t

300400500600700800

01.0

1.20

0901

.02.

2009

01.0

3.20

0901

.04.

2009

01.0

5.20

0901

.06.

2009

01.0

7.20

0901

.08.

2009

01.0

9.20

0901

.10.

2009

01.1

1.20

0901

.12.

2009

01.0

1.20

1001

.02.

2010

01.0

3.20

1001

.04.

2010

01.0

5.20

1001

.06.

2010

01.0

7.20

1001

.08.

2010

01.0

9.20

1001

.10.

2010

01.1

1.20

10

-20%-10%0%10%20%30%40%

premium domestic export

Sources: Metal Expert, Bloomberg, TKB Capital estimates


44 STRATEGY 2011

NLMK capitalization reached 2008 pick heights. Evraz Group and Mechel have the highest recovery potential. In 2010 Severstal and NLMK demonstrated the most dynamic growth in the sector. Indices showed 75% and 51% growth accordingly. At the same time NLMK’s GDR reached the level of 2008, while stock quotes on MICEX even exceeded it. In our opinion the fact as constraining factor for growth of NLMK’s shares in 2011. We suppose that the stocks of Evraz Group and Mechel have the highest potential to reach the highs of 2008 that may turn to be an extra growth driver.

Export traffic rates: potential rise in 2011

Cost of slabs transportation may grow by 66%. According to the data from FTS (Federal tariff service), the tariffs on ferrous metals and scrap transportation on import/export directions to and from ports as well as via Baltic countries and Finland may be increased in 2011. Thus, the duty tariff for pig iron transportation may increase by 30%, for pipes – by 30-66%, for rails – by 56%. Tariffs for other ferrous metal products are proposed to grow by 30-45%. Now the average transportation costs of steel manufacturers make up $40-60 per ton of slab.

Transportation costs may considerably grow.

At present the cost of transportation to port for steel manufacturers is equal to the cost of the inland one. According to companies’ data, in 2011 the tariffs on import/export transportation are set to grow by 8%, which should not have any significant impact on selling costs. In our opinion, transportation costs of the steelmakers will have a tendency of considerable growth in case of change in tariffs announced by FTS. We do not rule out such course of event.

Chine to remain the key driver

Chinese influence on global steel market will remain strong. In 2007 we saw the highest growth of GDP in China (14.2%), while in 2008 it reduced up to 9.6% alongside with the slowed down rate of steel output expansion up to 2% (see the Chart). The World Bank forecasts the growth of Chinese GDP in 2011 at the level of 10.1%. Despite the growth retardation, China continues its domination on the global steel and raw materials’ market. In 2010 steelmaking in the country is proposed to reach 630 mn t, i.e. 11% higher the level of 2009. However the degree of such influence may slightly decline within the next 2 years. The last months demonstrated the decrease in Chinese steel production due to the policy pursued by the government on closure of inefficient steel-making.

China gets rid of inefficient capacities. Currently the Chinese government takes a number of measures on liquidation of outdated ironworks. Besides, there is a moratorium on construction of new steel plants till the end of 2011. According to some reports, PRC intends to decommission about 25 mln t of outdated and inefficient steel capacities (4% of the current capacities by our estimates) to replace them with the new ones and improve the quality of steel products. In 2011 we expect the stabilization of steelmaking growth at the rate of 8-10%. We suppose that the level is good enough to sustain high prices on iron ore and coking coal.

Severstal, MMK and Mechel (ADR) quotes,

2008-2010

010203040506070

1.1.

08

21.3

.08

9.6.

08

28.8

.08

16.1

1.08

4.2.

0925

.4.0

9

14.7

.09

2.10

.09

21.1

2.09

11.3

.10

30.5

.10

18.8

.10

6.11

.10

ММК Sev erstal Mechel

NLMK and Evraz Group quotes, 2008-2010

020406080

100120

Jan-

08

Apr

-08

Jul-0

8

Oct

-08

Feb

-09

May

-09

Aug

-09

Dec

-09

Mar

-10

Jun-

10

Sep

-10

NLMK Ev raz Group

Sources: Bloomberg, TKB Capital estimates

Chinese econimics growth rates slow down

0

0.1

0.2

0.3

2004 2005 2006 2007 2008 2009 2010E

China GDP, %China steel output, mn t

Steel production in China

0102030405060

01.0

1.20

0901

.02.

2009

01.0

3.20

0901

.04.

2009

01.0

5.20

0901

.06.

2009

01.0

7.20

0901

.08.

2009

01.0

9.20

0901

.10.

2009

01.1

1.20

0901

.12.

2009

01.0

1.20

1001

.02.

2010

01.0

3.20

1001

.04.

2010

01.0

5.20

1001

.06.

2010

01.0

7.20

1001

.08.

2010

01.0

9.20

1001

.10.

2010

mn t

-10%-5%0%5%10%15%

production, mn t %

Sources: Bloomberg, WorldSteel, TKB Capital estimates


STRATEGY 2011 45

Comparison with peers by multiples

Steel makers EV/EBITDA P/E

2010E 2011E 2010E 2011E

NLMK 10.5 9.0 22.5 20.0

MMK 7.9 5.4 25.6 10.2

Severstal 7.6 6.1 73.9 11.0

Evraz Group 9.8 6.4 53.7 11.4

Mechel 8.6 5.9 14.8 10.4

Average 8.9 6.6 38.1 12.6

Developed markets

ArcelorMittal 9.3 7.4 16.5 13.8

Nippon Steel 7.1 6.5 12.0 9.9

JFE Holdings 6.3 6.0 11.0 9.6

US Steel 22.0 7.3 -22.0 20.2

Nucor 16.1 8.2 112.9 19.4

Voestalpine 6.7 6.0 13.4 10.4

Thyssen Krupp 5.5 4.5 15.7 10.2

Average 10.4 6.6 22.8 13.4

Emerging markets

Baoshan Iron&Steel 9.3 7.4 16.5 13.8

Angang Steel 7.1 6.5 12.0 9.9

Tata Steel 6.3 6.0 11.0 9.6

POSCO 22.0 7.3 -22.0 20.2

China Steel 16.1 8.2 112.9 19.4

Gerdau 6.7 6.0 13.4 10.4

Median 5.5 4.5 15.7 10.2

Sources: company data, TKB Capital estimates


46 STRATEGY 2011

Coal Further price growth in 1H11

In 2011 the cost of coking coal may grow by 15%. In 2010 the average annual price for coking coal concentrate advanced more than twice as compared to 2009 and made up $136/t. At the same time in 4Q10 price increased by 10% q-o-q. We consider it as a good support for further growth in 2011. We expect that in 2011 the average annual price on coking coal concentrate on domestic market will rise 15% per ton. Besides, domestic prices will be backed by strong external markets also expecting the price hikes due to continuing expansion of steel production in China, and South-East Asia. Global market players are reviewing the prices for coking coal supply in 1Q11. Thus, BMA (joint venture of BHP Billiton and Mitsubishi Alliance) agreed 8% price increase for hard coking coal in 1Q11. We do not rule out further growth of coal prices.

Zeroed import duties due to high domestic demand. In December, 2010 duties for coking coal import to Russia were zeroed, which is mostly explained by strong demand on domestic market. Previously the duty was implied at the rate of 5%. The volume of coking coal import to Russia is modest, so elimination of duties will not have any negative impact on the Russian steel makers. We suspect that in 2H11, when Raspadskaya may reach pre-emergency volumes of extraction, the balance between supply and demand on coking coal market will get into the equilibrium.

Coal companies EV/EBITDA P/E 2010E 2011E 2010E 2011E Raspadskaya 10.0 9.7 15.0 15.6 Belon 6.6 6.3 10.8 9.9 Average 8.6 6.3 14.8 10.4 Massey Energy 15.4 6.4 n/a 14.3 Gloucester coal 15.2 10.1 24.8 15.3 Whiteheaven Coal 19.0 10.5 34.7 17.3 Consol Energy 10.1 7.9 22.4 15.2 Yanzhou Coal Mining 11.0 9.2 16.3 14.2 Alpha Natural Resources 8.3 6.2 21.4 12.5 Average 13.1 8.5 21.9 14.8


Coking coal concentrate average price on the domestic

market in 2010, $/t

90110130150170

01.0

1.10

01.0

2.10

01.0

3.10

01.0

4.10

01.0

5.10

01.0

6.10

01.0

7.10

01.0

8.10

01.0

9.10

01.1

0.10

01.1

1.10

01.1

2.10


Coking coal concentrate average price forecast on the

domestic market, $/t

65

136156 161

0

50

100

150

200

2009 2010 2011E 2012E


Russian coking coal market structure, Mt

01234

Jan

10

Feb

10

Mar

10

Apr

10

May

10

Jun

10

Jul 1

0

Aug

10

Sep

10

concentrate outputpurchases in domestic marketexport



STRATEGY 2011 47

Mechel Coking coal as a key trigger

Mechel is one of our favorites in the Russian steel sector. We recommend to BUY its stocks with the target price of $37.0. In our point of view, Mechel’s key growth triggers are coking coal strong price, Elga coal deposit development and long products consumption increase in the Russian construction sector in 2011-2012.

Strong coking coal price – the base of Mechel attractiveness. Mechel’s mining segment, which produces coking coal concentrate, is the key company’s business. In 2010 mining segment share in Mechel’s EBITDA could to reach about 75%, in revenue – about 30%. Therefore, strong coking coal market situation is the positive trigger for Mechel. According to our estimates, in 2011 average domestic coking coal concentrate price should increase by 15% to $156/t in comparison with 2010.

Elga is the crucial project. Elga coal deposit development is the priority investment project for Mechel. Elga is the largest coalfield in Eurasia with 2.2 bn of coal reserves. Mechel have extracted the first coal on Elga in 2010 and output could to reach 27 Mt per year in the long-term outlook. According to Mechel estimates, in 2015 Elga coal output could amount 9 Mt, and the deposit will work with the full capacity in 2027. In our model we have used more blue output volumes considering a difficult nature conditions and probable troubles connected with development and corresponding correction of plans on output.

The second Russian long products manufacturer. Probable consumption growth in the Russian construction sector in 2011 could to have a positive impact on Mechel. The company appears the second Russian producer of the long steel products used in construction sector. According to our estimates, in 2010 Mechel’s share in the domestic long products output amounted to about 14%.

Mechel is an attractive bet on coking coal. We believe that Mechel’s stocks appears to be a good bet on the strong coking coal market situation. Mechel’s preference shares have a high dividend yield. According to our estimates, in 2010 it could amount to about 7%. Company’s EV/EBITDA’2011 and P/E’2011 look cheaper than peers that shows Mechel’s attractiveness. We recommend to BUY Mechel’s ADR with the target price of $37.0.

Mechel, ADRADR Common

Ticker MTL MTLRRecommendation BUY BUYPrice, $ 29.58 29.04Target price 12M, $ 37.00 37.00Upside/downside, % 25% 27%

SHARE DATABloomberg MTL US MTLR RXReuters MTL.N MTLR.MM

ADR Common# of ADR outstanding, mn 416 416EV, $ mn 17,217 16,994MC, $ mn 12,313 12,090MIN 12 mnth., $ 17.45 7.34MAX 12 mnth., $ 31.18 28.66

CommonShares per ADR 1

SUMMARY FINANCIALS, $ mnIFRS 2010E 2011E 2012ERev enue 9,621 11,014 11,973EBITDA 2,000 2,916 3,296Net income 835 1,189 1,346EPS, $ 2 2.86 3.23Rev . growth, % 67 14.48 8.7EPS growth, % 993 42.5 13.2EBITDA margin,% 21 26.5 27.5Net margin, % 9 10.8 11.2

SUMMARY VALUATIONS2010E 2011E 2012E

P/E 14.75 10.36 9.15EV/EBITDA 8.61 5.90 5.22

SHAREHOLDER STRUCTUREIgor Zy uzin 67.0%Free-f loat 33.0%

PRICE DYNAMICS

Source: NYSE, RTS. TKB Capital estimates

14

21

28

35

22.12.09 22.3.10 22.6.10 22.9.10 22.12.10

MTL RTS

Elga coal production forecast, mn т

0.21

2

5

7

9

1 1.53

5

7

0.2

0

2

4

6

8

10

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

MechelTKB Capital



48 STRATEGY 2011

Mechel BALANCE SHEET$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ETOTAL CURRENT ASSETS 2,483 3,273 3,744 5,760 7,299 7,741 9,162PP&E, net 4,461 5,378 6,540 6,508 6,557 6,602 6,641Other non-current assets 6,240 6,240 6,240 6,240 6,240 6,240 6,240Total NON-CURRENT ASSETS 10,700 11,618 12,780 12,748 12,797 12,841 12,881TOTAL ASSETS 13,183 14,890 16,523 18,507 20,096 20,582 22,043Short-term borrow ings 1,923 3,949 3,649 3,799 4,149 3,649 3,649Other short-term liabilities 1,097 1,298 1,399 1,472 1,552 1,634 1,663Total CURRENT LIABILITIES 3,020 5,248 5,049 5,271 5,702 5,284 5,312Long-term borrow ings 4,074 2,720 3,420 3,920 3,770 3,470 3,470Other non-current liabilities 1,758 1,758 1,758 1,758 1,758 1,758 1,758Total LONG-TERM LIABILITIES 5,832 4,478 5,178 5,678 5,528 5,228 5,228Minority interest 281 287 295 305 315 325 336Share and additional capital 1,008 1,008 1,008 1,008 1,008 1,008 1,008Retained earnings 3,189 4,017 5,141 6,393 7,691 8,885 10,307Total EQUITY 4,050 4,878 6,002 7,253 8,552 9,746 11,168TOTAL EQUITY & LIABILITIES 13,183 14,890 16,523 18,507 20,096 20,582 22,043

INCOME STATEMENT$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ERevenue 5,754 9,621 11,014 11,973 12,926 13,596 14,095Cost of production (3,961) (6,005) (6,485) (7,091) (7,761) (8,448) (8,687)EBITDA 673 2,000 2,916 3,296 3,387 3,188 3,449Depreciation (428) (482) (538) (654) (651) (656) (660)EBIT 594 1,627 2,419 2,679 2,784 2,574 2,842Net interest income/(expenses) (499) (584) (848) (926) (950) (854) (854)EBT 95 1,043 1,571 1,753 1,834 1,720 1,988Income tax (19) (209) (382) (407) (429) (415) (462)Net income 76 835 1,189 1,346 1,405 1,305 1,525

CASH FLOW STATEMENT$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ENet CF from operating activities 562 637 1,519 1,792 1,832 1,748 2,103Net CF from/(used in) investment activities (710) (1,400) (1,700) (622) (700) (700) (700)Net CF from/(used in) financing activities 375 666 334 556 94 (911) (103)Net Debt 5,583 6,352 6,599 5,523 4,498 3,561 2,260

RATIOS% 2009 2010E 2011E 2012E 2013E 2014E 2015ERevenue grow th -42% 67% 14% 9% 8% 5% 4%EBITDA margin 12% 21% 26% 28% 26% 23% 24%Net margin 1% 9% 11% 11% 11% 10% 11%Net Debt/EBITDA 8.3 3.2 2.3 1.7 1.3 1.1 0.7

Source: Mechel, TKB Capital estimates


STRATEGY 2011 49

Evraz Group Good potential in 2011

Evraz Group is our second favorite in the Russian steel sector. The company takes up a crucial position on the domestic long products market, which has a strong recovery potential. Also Evraz Group gradually improves its leverage situation. Evraz Group GDR quotes looked worsted in the sector in 2010: +22% at the end of December, when the sector average growth amounted 46%. We do not exclude that in 2011 we should see Evraz Group stocks robust growth. We recommend to BUY company’s GDR with the target price of $46.0.

The key long products manufacturer. Evraz Group is the Russian biggest producer of the long productsused in the construction sector. The company owns three large plants: Zapsib, NTMK and NKMK, which specialize on the output of the rolled products for building. According to our estimates, in 2010 Evraz Group’s share in the domestic long products output made up about 32%. We believe that in the light of expected recovery in the construction sector the key role of Group Evraz in this segment is the strong positive trigger for the company’s stocks.

NTMK reconstruction: +40% in steel output in 2015. Recently Evraz Group announced about completion of the BOF shop reconstruction on NTMK. As a result, shop’s annual capacity increased by 18% to 4.5 Mt. Further the company intends to construct a new BOF shop on NTMK. It will make possible to increase plant’s capacity by 40% to 6.0-6.5 Mt per year in 2015.

Leverage situation improves. For the present leverage is the key risk for Evraz Group’s stocks. As expected, Net debt/EBITDA at the end of 2010 should amount to 3.0 that is the high figure. However, recently the company has taken major efforts to decrease a short-term debt. Consequently, in 2011-2012 Group Evraz actually have no large loan’s payments. At the same time, in 2013-2015 total loans repayments will account about $6.5 bn. We believe that the company will continue to realize its strategy by short-term debt declining.

Evraz Group quotes could to indemnify the lag in 2011. Evraz Group’s stocks in 2010 have grown less than papers of other large Russian steelmaking companies. In particular, annual growth of the company’s GDR accounted for 22%, when the sector average growth made up 46%. We believe that company’s market capitalization growth potential could to realize in the case of strong long products market situation in 2011.

Evraz Group, GDRGDR

Ticker EVRRecommendation BUYPrice, $ 34.8Target price 12M, $ 46.0Upside/downside, % 32%

SHARE DATABloomberg EVR LIReuters HK1q.L

GDR# of GDR outstanding, mn 438EV, $ mn 23,059MC, $ mn 15,255MIN 12 mnth., $ 21.80MAX 12 mnth., $ 42.72

CommonShares per GDR 1/3

SUMMARY FINANCIALS, $ mnIFRS 2010E 2011E 2012ERev enue 13,231 15,896 17,973EBITDA 2,354 3,577 4,150Net income 284 1,340 1,699EPS, $ 0.65 3.06 3.88Rev . growth, % 35.4 20.1 13.1EPS growth, % -122.5 372.0 26.8EBITDA margin,% 17.8 22.5 23.1Net margin, % 2.1 8.4 9.5


P/E 53.72 11.38 8.98EV/EBITDA 9.79 6.45 5.56

SHAREHOLDER STRUCTURELanebrook Ltd 73.0%Igor Kolomoy sky 10.0%Free-f loat 17.0%

PRICE DYNAMICS

Source: LSE, RTS. TKB Capital estimates

20

28

36

44

22.12.09 22.3.10 22.6.10 22.9.10 22.12.10

EVR RTS


50 STRATEGY 2011

Evraz Group BALANCE SHEET$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ETOTAL CURRENT ASSETS 4,240 5,973 7,552 10,857 12,228 15,491 16,233PP&E, net 14,941 14,146 14,067 13,895 13,537 13,109 12,716Other non-current assets 4,230 4,230 4,230 4,230 4,230 4,230 4,230Total NON-CURRENT ASSETS 19,171 18,376 18,297 18,125 17,767 17,339 16,946TOTAL ASSETS 23,424 24,362 25,862 28,994 30,008 32,843 33,193Short-term borrow ings 1,992 3,622 3,622 4,867 3,622 4,572 3,622Other short-term liabilities 1,746 1,770 1,897 2,043 2,179 2,233 2,258Total CURRENT LIABILITIES 3,738 5,392 5,519 6,910 5,801 6,805 5,880Long-term borrow ings 5,931 4,924 4,924 4,924 5,179 5,179 4,229Other non-current liabilities 3,146 3,146 3,146 3,146 3,146 3,146 3,146Total LONG-TERM LIABILITIES 9,077 8,070 8,070 8,070 8,325 8,325 7,375Minority interest 324 331 364 406 451 495 548Share and additional capital 2,114 2,114 2,114 2,114 2,114 2,114 2,114Retained earnings 3,168 3,452 4,792 6,492 8,315 10,101 12,272Total EQUITY 10,284 10,568 11,908 13,608 15,431 17,217 19,388TOTAL EQUITY & LIABILITIES 23,424 24,362 25,862 28,994 30,008 32,843 33,193

INCOME STATEMENT$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ERevenue 9,772 13,231 15,896 17,973 19,387 19,962 20,564Cost of production (8,756) (10,333) (11,350) (12,566) (13,721) (14,181) (14,380)EBITDA 1,237 2,354 3,577 4,150 4,203 4,210 4,496Depreciation (901) (1,245) (1,179) (1,122) (1,070) (1,023) (979)EBIT 336 1,109 2,398 3,027 3,133 3,187 3,517Net interest income/(expenses) (637) (729) (729) (835) (751) (832) (670)EBT (1,600) 355 1,675 2,124 2,279 2,233 2,714Income tax (339) (71) (335) (425) (456) (447) (543)Net income (1,261) 284 1,340 1,699 1,823 1,786 2,171

CASH FLOW STATEMENT$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ENet CF from operating activities 1,700 1,065 1,488 1,789 2,058 2,039 2,573Net CF from/(used in) investment activities 183 (450) (1,100) (1,000) (800) (700) (700)Net CF from/(used in) financing activities (2,149) 1,339 729 2,080 (239) 1,782 (1,230)Net Debt 7,248 5,917 4,799 3,174 1,166 neg. neg.

RATIOS% 2009 2010E 2011E 2012E 2013E 2014E 2015ERevenue grow th -52% 35% 20% 13% 8% 3% 3%EBITDA margin 13% 18% 22% 23% 22% 21% 22%Net margin -13% 2% 8% 10% 10% 10% 11%Net Debt/EBITDA 5.9 2.5 1.3 0.8 0.3 neg. neg.

Source: Evraz Group, TKB Capital estimates


STRATEGY 2011 51

MMK Bet on the domestic steel market MMK takes up strongest position on the domestic steel market among Russian steelmaking companies. According to our estimates, in 2011 domestic market will recover more greatly than export markets. In addition, MMK should increase its high value added products output significantly due to Mill-2000 and Atakas projects implementation that could have a positive impact on the company’s profitability. We recommend to BUY MMK stocks with the target price of $1.32.

Strong domestic steel market position. MMK is a key supplier of the steel on the Russian market. In 2010 company’s share amounted to about 16%. Having said that, within next years domestic market should be more attractive for steelmakers than export due to price premium and demand growth. In 2010 MMK’s domestic shipments share in the sales structure made up about 57%.

Raw materials problem already is not so burning. Having bought the coal company Belon, MMK solved the own coking coal problem to a large degree. Further Belon should cover about 80% of MMK’s needs in coking coal. According company data, in short term outlook MMK’s iron ore assets should supply about 50% of company needs. MMK plans to reach this figure due to production growth on the company’s owns assets (Bakal, Sosnovsky mine). Besides, MMK launched new slag processing technology. This permits to produce annually about 1 Mt of iron ore in addition.

New projects = high value added products growth. At present MMK realizes several very important projects: Mill-2000 and Atakas. Mill-2000 should to go to full capacity in 2012 (installation work in Magnitogorsk at present). Mill-2000 will be producing 2 Mt of cold-rolled products. With its help MMK plans to drive out import flat products from the domestic market. Currently Russian auto industry needs in flat products amounts to about 2.5 Mt. Turkish project Atakas has already started production (galvanized and coated sheet). Atakas annual capacity makes up about 2.3 Mt of hot-rolled products and 2 Mt of flat products.

MMK’s new target price is $1.32. We believe that strong domestic market position, gradually solution of the raw materials problem and value added products growth are positive triggers for MMK. We recommend to BUY its stocks with the target price of $1.32. The company is trading by EV/EBITDA’2011 and P/E’2011 cheaper than peers.

MMKCommon GDR

Ticker MAGN MMK LIRecommendation BUY BUYPrice, $ 1.06 13.71Target price 12M, $ 1.32 17.16Upside/downside, % 25% 25%

SHARE DATABloomberg MAGN RXReuters MAGN.MM

Common# of shares outstanding,mn 11,174 -EV, $ mn 12,776 -MC, $ mn 11,812 -MIN 12 mnth., $ 0.68 -MAX 12 mnth., $ 1.12 -

CommonShares per GDR 13 -

SUMMARY FINANCIALS, $ mnIFRS 2010E 2011E 2012ERev enue 7,981 10,216 12,174EBITDA 1,617 2,344 2,814Net income 461 1,162 1,515EPS, $ 0.04 0.10 0.14Rev . growth, % 57.1 28.0 19.2EPS growth, % 110.3 152.3 30.4EBITDA margin,% 20.3 22.9 23.1Net margin, % 5.8 11.4 12.4


P/E 25.64 10.17 7.80EV/EBITDA 7.90 5.45 4.54

SHAREHOLDER STRUCTUREViktor Rashnikov 87.0%Free-f loat 13.0%

PRICE DYNAMICS


0.60

0.80

1.00

1.20

22.12.09 22.3.10 22.6.10 22.9.10 22.12.10

MAGN RTS

ММК: iron ore shipments structure, 2010E

ENRC70%

Own ore20%

Slag processing

10%



52 STRATEGY 2011

MMK BALANCE SHEET$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ETOTAL CURRENT ASSETS 2,430 3,535 4,592 5,017 6,745 9,097 11,594PP&E, net 11,276 11,724 12,143 12,533 12,898 13,038 13,169Other non-current assets 1,127 1,127 1,127 1,127 1,127 1,127 1,127Total NON-CURRENT ASSETS 12,403 12,851 13,270 13,660 14,025 14,165 14,296TOTAL ASSETS 14,833 16,387 17,861 18,677 20,770 23,262 25,890Short-term borrow ings 808 2,000 2,000 1,000 1,000 1,000 1,000Other short-term liabilities 969 1,424 1,729 2,019 2,250 2,570 2,655Total CURRENT LIABILITIES 1,777 3,424 3,729 3,019 3,250 3,570 3,655Long-term borrow ings 1,266 709 709 709 709 709 709Other non-current liabilities 1,465 1,465 1,465 1,465 1,465 1,465 1,465Total LONG-TERM LIABILITIES 2,731 2,174 2,174 2,174 2,174 2,174 2,174Minority interest 368 371 379 389 402 416 432Share and additional capital 1,830 1,830 1,830 1,830 1,830 1,830 1,830Retained earnings 10,424 10,885 12,046 13,562 15,411 17,568 19,876Total EQUITY 9,957 10,418 11,579 13,095 14,944 17,101 19,409TOTAL EQUITY & LIABILITIES 14,833 16,387 17,861 18,677 20,770 23,262 25,890

INCOME STATEMENT$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ERevenue 5,081 7,981 10,216 12,174 13,804 15,835 16,469Cost of production (3,940) (5,872) (7,167) (8,398) (9,380) (10,737) (11,098)EBITDA 996 1,617 2,344 2,814 3,251 3,654 3,719Depreciation (708) (752) (782) (810) (836) (860) (869)EBIT 333 690 1,563 2,004 2,415 2,794 2,975Net interest income/(expenses) (76) (118) (120) (123) (119) (115) (110)EBT 257 572 1,443 1,881 2,296 2,679 2,865Income tax (38) (114) (289) (376) (459) (536) (573)Net income 219 461 1,162 1,515 1,849 2,158 2,307

CASH FLOW STATEMENT$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ENet CF from operating activities 839 116 961 1,392 1,814 2,085 2,711Net CF from/(used in) investment activities (1,689) (1,200) (1,200) (1,200) (1,200) (1,000) (1,000)Net CF from/(used in) financing activities (40) 635 - (1,000) - - -Net Debt 1,909 2,395 2,034 1,239 26 neg. neg.

RATIOS% 2009 2010E 2011E 2012E 2013E 2014E 2015ERevenue grow th -52% 57% 28% 19% 13% 15% 4%EBITDA margin 20% 20% 23% 23% 24% 23% 23%Net margin 4% 6% 11% 12% 13% 14% 14%Net Debt/EBITDA 1.9 1.5 0.9 0.4 0.0 neg. neg.

Source: MMK, TKB Capital estimates


STRATEGY 2011 53

Non-ferrous metals Prices to keep on growing in 2011

Nickel and copper: a good balance between prices and stocks. In our opinion, the end of 2010 will demonstrate a favorable balance between the world prices and level of exchange warehouse stocks for nickel and copper. As it is clear from the chart, copper stocks reduced in 2010, which resulted in price soaring in 4Q10. Spread between nickel stocks and the metal price on LME narrowed considerably. We suppose that nickel prices will be backed by further increase in demand and dollar overhang.

Aluminum and zinc. We also expect further growth of prices for aluminum and zinc. Expansion of demand from aircraft industry will be the key trigger of aluminum price advance. At the same time, aluminum market is facing metal oversupply that is proposed to put pressure on prices at the start of 2011. According to our expectations, the cost of zinc in 2011 will be limited by a number of factors such as increase in production on the main fields as well as growing volume of zinc stocks.

Price forecast for ferrous and platinum-group metals 2010E 2011E 2012E 2013E Nickel , $/t 21 800 25 200 24 200 23 940 47% 16% -4% -1% Copper, $/t 7 500 9 240 8 900 8 820 43% 23% -4% -1% Aluminum, $/t 2 069 2 450 2 500 2 480 38% 18% 2% -1% Zinc, $/t 2 179 2 400 2 450 2 300 33% 10% 2% -6% Platinum, $/oz 1 600 1 750 1 750 1 650 33% 9% 0% -6% Palladium, $/oz 490 550 550 500 84% 12% 0% -9%

Norilsk Nickel is our favorite in the sector. Norilsk Nickel is one of our favorites in the sector. The company is a world leader on nickel and palladium production and has a considerable share on copper and platinum market. Norilsk Nickel is characterized by relatively low production costs and strong reserves with high grade of the valuable components. In our opinion, these factors and the growth of prices for metals make the company’s stocks as one of the most attractive in nonferrous industry. Besides, key shareholders conflict could to be an additional speculative trigger for the company.

Norilsk Nickel: peers’ comparison EV/EBITDA P/E 2010E 2011E 2010E 2011E Norilsk Nickel 5.6 5.0 8.1 7.2 BHP Billiton 6.8 6.1 11.8 10.4 VALE 7.7 5.5 11.0 7.5 RIO Tinto 6.3 5.3 10.4 8.5 Xstrata 7.7 5.9 13.1 9.6 Anglo American 7.1 5.7 13.1 9.5 Average 7.1 5.7 11.9 9.1 Freeport-McMoran 6.2 5.2 13.8 10.9 Antofagasta 8.6 5.2 20.9 12.6 KGHM 5.1 4.9 7.4 7.5 Southern Copper Corp 14.2 8.9 26.1 14.7 Jiangxi Copper 14.7 11.4 22.5 16.9 Average 9.7 7.1 18.2 12.5 Anglo Platinum 14.4 9.0 32.5 16.9 Impala Platinum 11.4 8.6 18.2 13.8 Northam 12.6 8.5 19.4 14.0 Aquarius Platinum 10.9 7.3 21.3 13.3 Average 12.3 8.3 22.8 14.5


Nickel: price vs stocks

0

10,000

20,000

30,000

40,000

Jan-

08M

ar-0

8M

ay-0

8Ju

l-08

Oct

-08

Dec

-08

Feb-

09M

ay-0

9Ju

l-09

Sep-

09D

ec-0

9Fe

b-10

Apr-

10Ju

n-10

Sep-

10N

ov-1

0

0

50,000

100,000

150,000

200,000price, $/t stocks, t

Sources: LME

Copper: price vs stocks

0

2,000

4,000

6,000

8,000

10,000

Jan-

08M

ar-0

8M

ay-0

8Ju

l-08

Oct

-08

Dec

-08

Feb-

09M

ay-0

9Ju

l-09

Sep-

09D

ec-0

9Fe

b-10

Apr-

10Ju

n-10

Sep-

10N

ov-1

0

0100,000200,000300,000400,000500,000600,000

price, $/t stocks, t

Sources: LME

Zinc: price vs stock

0500

1,0001,5002,0002,5003,000

Jan-

08Ap

r-08

Jul-0

8O

ct-0

8Fe

b-09

May

-09

Aug-

09D

ec-0

9M

ar-1

0Ju

n-10

Sep-

10

0

200,000

400,000

600,000

800,000price, $/t stocks, t

Sources: LME

Aluminium: price vs stock

0

1,000

2,000

3,000

4,000

Jan-

08M

ar-0

8Ju

n-08

Aug-

08N

ov-0

8Fe

b-09

Apr-

09Ju

l-09

Oct

-09

Dec

-09

Mar

-10

May

-10

Aug-

10N

ov-1

0

01,000,0002,000,0003,000,0004,000,0005,000,000

price, $/t stocks, t

Sources: LME


54 STRATEGY 2011

Gold Growth in 2011

Gold as the safest investment. We expect further increase in prices for gold in 2011. According to our estimates, annual average price is proposed to rise by 20% up to $1,500/oz as compared to 2010 when the cost of gold increased by 30% up to $1,250/oz vs. 2009. Gold remains attractive for investors as an insurance against global economy deterioration and, as a result, fall on stock markets. In 2011 prices for gold have all chances to continue growing in the context of low interest rates.

BUYING recommendation for gold mining companies upon quotes fall. Two Russian leading gold ore companies – Polyus Gold and Polymetal - demonstrate high EV/EBITDA and P/E multiples. Nevertheless, we recommend investors to use the “quotes fall” tactics to buy the stock of gold ore companies. In addition, we suppose that portfolio diversification can be achieved by adding the stocks of Petropavlovsk, Highland Gold and High River Gold. Gold ore companies’ multiples EV/EBITDA P/E

2010E 2011E 2010E 2011E

Polyus Gold 15.0 10.4 25.1 16.3

Polymetal 22.6 9.3 36.7 13.2

Petropavlovsk 12.2 7.0 23.4 11.4

Highland Gold 6.4 5.1 11.3 8.5

High River Gold 4.2 4.1 8.2 7.7

Average 12.1 7.2 20.9 11.4

Newmont 6.6 5.7 15.6 12.4

AngloGold 9.2 6.1 20.5 10.9

GoldFields 12.7 6.3 57.2 16.0

Barrick Gold 9.4 7.7 16.0 12.8

Harmony Gold 8.7 5.8 24.3 12.7

Kinross Gold 13.6 9.7 37.8 22.9

Goldcorp 16.3 11.8 28.6 22.5

Average 10.9 7.6 28.6 15.7

a

Gold price dynamics in 2008-2010

700

900

1,100

1,300

1,500

Jan-

08

Apr

-08

Jul-0

8

Oct

-08

Feb

-09

May

-09

Aug

-09

Dec

-09

Mar

-10

Jun-

10

Sep

-10

Source: Bloomberg


STRATEGY 2011 55

Norilsk Nickel Favorite in the non-ferrous sector

Norilsk Nickel is our favorite in the non-ferrous metals sector. The company has a low production costs, strong ore reserves with high grade of the valuable components. With the expectations of the copper and nickel prices growth it makes Norilsk Nickel stocks attractive. Besides, key shareholders conflict could to be an additional speculative trigger for the company. We recommend to BUY Norilsk Nickel stocks with the target price of $270.

Key global nickel and palladium producer. Norilsk Nickel is the biggest global producer of nickel and palladium. Company’s stake in global production of nickel amounts 22% and palladium – 38%. Also Norilsk Nickel is a large producer of copper and platinum.

Strong copper, nickel and PGM prices in 2011. We believe that non-ferrous metals prices will show a growth in 2011. According to our estimates, prices should continue to growth due to emerging countries economics recovery (basically China and India). In our point of view, copper could to demonstrate more strong dynamics, than the rest of metals thanks to Chinese consumption growth and US dollar liquidity increase.

Russian ore value is very high. Proven and probable reserves of the Russian division of Norilsk Nickel accounts for 473 Mt of nickel ore with content of 5.8 Mt of nickel, 8.7 Mt of copper and 80 Moz of platinum group metals (PGM). Metals value per tone of ore exceeded average peers’ figure by 84%.

Shareholder’s conflict: good speculative trigger. We believe that Norilsk Nickel key shareholder’s conflict could to be a speculative trigger for company’s stocks quotes in 2011. At present Interros and RUSAL are in a stage of consultations concerning value of 25% company stake. It should be noted, that Norilsk Nickel has already made the $12 bn ($252 per share) offer to RUSAL. Aluminum company has rejected the deal. We do not exclude that current offer is not the last and we could see the continuation of this story in 2011.

Norilsk Nickel looks cheaper than peers. According to our estimates, Norilsk Nickel stocks are significantly undervalued by market multipliers. Thus, the company is trading by P/E’2011 at the level of 7.2 (with 70% premium to peers) and by EV/EBITDA at the level of 5.0 (with 47% premium to peers).

NorNickelCommon GDR

Ticker GMKN MNOD LIRecommendation BUY BUYPrice, $ 220.7 23.4Target price 12M, $ 270.0 27.0Upside/downside, % 22% 15%

SHARE DATABloomberg GMKN RXReuters GMKN.MM

Common GDR# of shares outstanding,mn 191 191EV, $ mn 44 040 46 611MC, $ mn 42 074 44 645MIN 12 mnth., $ 135.9 14.0MAX 12 mnth., $ 220.9 23.9

CommonShares per GDR 0.10 -

SUMMARY FINANCIALS, $ mnIFRS 2010E 2011E 2012ERev enue 14 327 15 502 15 157EBITDA 7 847 8 827 8 289Net income 5 203 5 834 5 192EPS, $ 27.29 30.60 27.24Rev . growth, % 41.1 8.2 -2.2EPS growth, % 96.3 12.1 -11.0EBITDA margin,% 54.8 56.9 54.7Net margin, % 36.3 37.6 34.3


P/E 8.09 7.21 8.10EV/EBITDA 5.61 4.99 5.31

SHAREHOLDER STRUCTUREInterros 25.0%Rusal 25.0%Traf igura 8.0%Free-f loat 42.0%

PRICE DYNAMICS


110

150

190

230

22.12.09 22.3.10 22.6.10 22.9.10 22.12.10

GMKN RTS


56 STRATEGY 2011

Norilsk Nickel

BALANCE SHEET$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ETOTAL CURRENT ASSETS 8,376 13,433 18,729 24,587 30,685 35,160 38,691PP&E, net 11,017 12,115 14,128 14,981 15,568 15,909 16,124Other non-current assets 3,335 3,335 3,335 3,335 3,335 3,335 3,335Total NON-CURRENT ASSETS 14,352 15,450 17,463 18,316 18,903 19,244 19,459TOTAL ASSETS 22,760 28,915 36,223 42,935 49,620 54,435 58,183Short-term borrow ings 2,972 2,972 2,972 2,972 2,972 3,022 2,972Other short-term liabilities 1,140 1,092 1,067 1,087 1,103 1,121 1,149Total CURRENT LIABILITIES 4,112 4,064 4,039 4,059 4,075 4,143 4,121Long-term borrow ings 2,345 3,345 4,845 6,345 8,345 8,845 9,295Other non-current liabilities 1,548 1,548 1,548 1,548 1,548 1,548 1,548Total LONG-TERM LIABILITIES 3,893 4,893 6,393 7,893 9,893 10,393 10,843Minority interest 1,080 1,080 1,080 1,080 1,080 1,080 1,080Share and additional capital 1,398 1,398 1,398 1,398 1,398 1,398 1,398Retained earnings 15,600 20,803 26,637 31,828 36,496 40,744 44,064Total EQUITY 14,755 19,958 25,792 30,983 35,651 39,899 43,219TOTAL EQUITY & LIABILITIES 22,760 28,915 36,223 42,935 49,620 54,435 58,183

INCOME STATEMENT$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ERevenue 10,155 14,327 15,502 15,157 14,890 14,646 13,749Cost of production (5,014) (4,378) (4,037) (4,303) (4,525) (4,764) (5,128)EBITDA 4,414 7,847 8,827 8,289 7,840 7,399 6,293Depreciation (638) (902) (988) (1,147) (1,213) (1,259) (1,285)EBIT 3,776 6,946 7,839 7,142 6,627 6,140 5,009Net interest income/(expenses) (186) (442) (547) (652) (792) (831) (859)EBT 3,487 6,504 7,292 6,490 5,835 5,310 4,150Income tax (836) (1,301) (1,458) (1,298) (1,167) (1,062) (830)Net income 2,651 5,203 5,834 5,192 4,668 4,248 3,320

CASH FLOW STATEMENT$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ENet CF from operating activities 3,010 5,908 6,818 6,286 5,836 5,453 4,574Net CF from/(used in) investment activities (967) (2,000) (3,000) (2,000) (1,800) (1,600) (1,500)Net CF from/(used in) financing activities (1,123) 1,000 1,500 1,500 2,000 550 400Net Debt 1,685 998 neg. neg. neg. neg. neg.

RATIOS% 2009 2010E 2011E 2012E 2013E 2014E 2015ERevenue grow th -27% 41% 8% -2% -2% -2% -6%EBITDA margin 43% 55% 57% 55% 53% 51% 46%Net margin 26% 36% 38% 34% 31% 29% 24%Net Debt/EBITDA 0.4 0.1 neg. neg. neg. neg. neg.

Source: Norilsk Nickel, TKB Capital estimates

Telecoms Growing beyond traditional mobile services

to unlock more value

STRATEGY 2011 57

Kirill Bakhtin [email protected]

Telecoms Growing beyond traditional mobile services to unlock more value

Russian telecoms offer an appealing investment case permanently expanding horizons of their activity. At this point the Big-Three operators have turned into integrated operators and established operations in the CIS. Starting from purely mobile domestic facilities, MTS and VimpelCom Ltd are moving forward to promising broadband and pay-TV markets. Strong balance sheets, high margins from mobile operations along with a defined dividend policy make MTS and VimpelCom Ltd strong amid international peers. Rise in domestic spending in 1H11 and low competition in pricing are supportive for traditional mobile services. Rostelecom needs much time to operationally unite wire-line business of inter-regional telecoms (IRs), it has not voiced a clear strategy on mobile business. We favour MTS as the safe bet in the sector and remain a 12-month target price of $28/ADR and $14/locals.

ENVIRONMENT

Wave of consolidation in 1H11. Corporate procedures on a merger MTS ad Comstar-UTS, combining IRs into Rostelecom and a purchase of Weather Investments by Vimpelcom Ltd are essential for reshaping the industry’s landscape and lead to lock-up periods in trading of some stocks in the first half of 2011.

No acceleration in mobile pricing competition. In the Russian oligopoly market operators are very reluctant to cut APPM what is good to margins.

Mobile data traffic to serve as a major catalyst. VAS ARPU in Russia is forecast to add 34% y-o-y in 2011 led by a boost in data traffic.

Bet on domestic spending. Mobile ARPU is set to pick up a growth of residential spending and be bolstered by increased corporate budgets for 2011.

REGULATORY IMPACT

Ministry backs technology neutrality and refarming. The office calls for changes in frequency spectrum regulation hinting at launch of LTE networks in the mid-term.

Hikes on fixed-line local services allowed. Wire-line incumbents have received the right to raise local fees on 8.8% on average in 2011. The tariff cap rate is in line with our macroeconomic forecast of CPI.

Roaming fees in Russia and the CIS reduced, no cuts for 2011. Forced by FAS, the Big-Three voluntary reduced tariffs on roaming calls – slightly negative for sales and margins.

PROS

New additions in the CIS are not over. The CIS countries are still underpenetrated, that opens up an opportunity for further advance.

High FCF from established markets. Mobile markets of Russia and Ukraine generate high cash flows to back modernization and enter new markets.

Attractive valuation in the sector. Both MTS and VimpelCom Ltd are trading with discounts on multiples to emerging market peers.

CONS

Fixed-line BB ARPU under pressure with rising competition. Presence of tens players in the market drastically impacts dynamics of monthly payments.

Large capex wanted to keep pace with peers in VAS market. For the Big-Three, we estimate a 2011 capex-to-sales of around 20% needed for infrastructure update.

Source: Bloomberg

Sector dynamics vs. RTS in 2010

-50% 0% 50% 100%

RTS

MBT

MTSI

CMST

VIP

RTKM

RTKMP

SSA

22.12.2010 Max Min

Source: Bloomberg

60708090

100110120130140

Jan-

10

Feb

-10

Mar

-10

Apr

-10

May

-10

Jun-

10

Jul-1

0

Aug

-10

Sep

-10

Oct

-10

Nov

-10

Dec

-10

RTSI Telecoms


On the verge of rapid growth3G modems and 3G phone users

in Russia, mn

0

10

2030

40

50

60

2009 2010E 2011E 2012E 2013E

3G modems, mn

Activ e 3G phone users, mn

Source: ITU, TKB Capital estimates

CIS markets underpenetratedMobile penetration globally in 2009, %

020406080

100120140160

Tur

kmen

ista

n

Taj

ikis

tan

Uzb

ekis

tan

Kyr

gyzs

tan

Geo

rgia

EM

Kaz

akhs

tan

Arm

enia

Ukr

aine

DM

Rus

sia


58 STRATEGY 2011

ENVIRONMENT

Wave of consolidation in 1H11. For the first half of the year 2011 Russian telecoms operators have scheduled a number of corporate actions which markedly change the industry’s landscape. Some companies aim to enlarge business activity through combining mobile and fixed-line business, seek new geography of their operations, while other are forced to unite operations in order to secure market share and margins. Generally in the telecoms business, small players, which lack national coverage, backbone networks and do not provide a full range of facilities face tough competition from the Big-Three and Rostelecom. The list of transaction includes the following: (1) MTS is proceeding with a complete merger of Comstar-UTS to become a universal provider and extract synergy effects. On December 23, 2010 the extraordinary meetings of shareholders of both companies approved the deal but that was anticipated given a 73.3% stake (not taking into account treasuries) accumulated by MTS in Comstar on the record date; (2) VimpelCom Ltd is set to acquire Weather Investments owning a controlling stake in Orascom Telecoms (operates in Africa and Asia) and 100% in Italy’s Wind Telecomunikazioni. Also, the company is participating into a tender on a purchase of controlling stake in Telekom Srbija. The results of the tender will be announced in 1H11; (3) the state has finally started reorganization of Svyazinvest on the base of Rostelecom. The first round of the process is to be completed in February-March 2011 with assembling IRs into Rostelecom.

Lock-up periods inevitable. There will be a lock-up periods in trading shares of Comstar and IRs in 1H11. In the case of Comstar GDR, a stop in trading will occur in the beginning of April and the newly issued locals of MTS will start trading in late April – early May. A lock-up period in IRs from 14 to 44 days is inevitable for IRs shareholders.

No acceleration in mobile pricing competition. So far the Russian telecoms operators did not make sizeable cuts in mobile tariffs. The competitive environment in pricing is rather loose opposite to the rivalry for mobile subscribers. This gives a confidence that APPM will remain intact from drastic deterioration in the mid-term. For 9M10 APPM of the Big-Three was down only 4% y-o-y. All conflicts lied in the field of attracting new subscribers. For advertising and marketing, the Big-Three raised its costs by 14% y-o-y in 9M10. The supportive evidence is that Tele2 Russia which goes on with attraction of customers, but avoids an APPM slump and improves OIBDA margin.

2010E 2011E 2012E 2013ETraff ic per user, MB/mo 20 31 48 73

Y-o-y, % 54 57 50 33Price, RUR/MB 5.9 5.0 4.2 3.6

Y-o-y, % (15) (15) (15) (15)Incremental ARPU, RUR/mo 181 241 308 348

Y-o-y, % 31 34 28 13Source: TKB Capital estimates

Increasing data volumes back rise of 3G ARPU3G mobile ARPU

Mobile data traffic to serve as a major catalyst. We would like to mark out the data traffic market as the most promising driver for revenues growth. VAS ARPU in Russia is forecast to add 34% y-o-y in 2010 led by a boost in data traffic. The base of active 3G handsets in Russia is anticipated to rise 53% y-o-y in 2011. Mobile devices able to work within 3G networks dominate among newly purchased phones and yet account for 21% of the total number. The 3G USB modems market is on the making, too. We estimate users of USB modems at 10.8 mn in 2011, up 52% y-o-y and total mobile data revenues up 74% y-o-y next year.

Bet on domestic spending. Macroeconomic picture looks quite prosperous for an increase in GDP and real income. Mobile ARPU from traditional services is set to advance further (in Russia we see a 2% y-o-y advance in ruble terms for MTS in 2011 and same 2% for Vimpelcom Ltd). The increase should come on the back of improvement MOU (4% y-o-y to 233 min/month for MTS and 3% to 225 min/month for VimpelCom Ltd). More potential will be uncovered in regions where many mobile users spend below $3 per month.



STRATEGY 2011 59

REGULATORY IMPACT

Ministry backs technology neutrality and refarming. During the interview on December, 9, 2010 Igor Schegolev, head of the Ministry of Telecommunications and Mass Media, voiced revolutionary statements for the Russian mobile industry. The ministry supports technology neutrality and promises adopting refarming of the frequency spectrum. Key initiatives are the following: (1) operators may invest in conversion of 790 to 860 MHz waveband and receive the access to distribution of frequency afterwards. The Ministry of Defense does not oppose the initiative, and key operators have acceded to the terms. In the Big-Three estimates, $1.6-5.0 bn is required for the conversion, that is obtainable for large operators; (2) the range of 2.5-2.7 GHz may be used after refarming what enables to combine few ranges of frequency spectrum. Both 790-860 MHz and 2.5-2.7 GHz are occupied by LTE networks in Europe. Operators have fine-turned equipment for these wavebands; (3) the Ministry does not object technology neutrality. Potentially, the Big-Three operators may replace equipment and roll-out LTE services on their current 900/1800 MHz frequencies.

Hikes on fixed-line local services allowed. Wire-line incumbents have received the right from the Federal Tariff Service (FTS) to raise local fees on 8.8% on average in 2011. The tariff cap rate is in line with our macroeconomic forecast of CPI (8.4%) what is very positive for financials of fixed-line providers. Local services dominate in the structure of MGTS and inter-regional telecoms’ revenues; therefore the raised tariffs on locals will add 3% to the total sales. The cap pricing system was implemented in February 2007 on the rationale of low price per minute of local calls in comparison to Central and Eastern Europe. Nevertheless, quarterly figures of IRs demonstrate that without hikes on local fees segment’s revenues would slightly decline.

Roaming fees in Russia and the CIS reduced, no cuts for 2011. In fall 2010 the Russian Federal Antimonopoly Service (FAS) forced the Big-Three to voluntarily reduce tariffs on roaming in the CIS since October 2010 and within Russia from December 2010. Operators, in our view, will lose no more than 1.5% of sales since 2011 and bear a very slight deterioration in margin (FAS estimated a 60% OIBDA margin from roaming services). Growing usage of roaming will offset the dramatic drop in roaming prices. The authorities were comfortable with the reductions the Big-Three made and promised to charge as low as practicable 1% of last-year revenues from the service, just about $9 mn from the Big-Three in total. Therefore, threat of further cuts in price in 2011 seems immaterial. FAS intends to make mobile operators introduce per-second tariffs on roaming calls in 2011. If the changes come into effect, we estimate a minor 0.5% deterioration of MTS total sales since transparent roaming fees will make mobile users more relaxed when consuming the service, so the rise in roaming usage will abate reduction in price.

PROS

New additions in the CIS are not over. The CIS countries (not taking into account Ukraine) are still underpenetrated, that opens up an opportunity for further advance. As of the end of 2009 mobile penetration in the majority counties stood below 80% versus 98% in the emerging markets. MTS and VimpelCom Ltd hold leading positions there. We estimate that in 2011 MTS and VimpelCom Ltd will get in the CIS 21% and 28% the total mobile revenues, accordingly. For 2011 we project a 7% y-o-y increase of mobile subscribers in the CIS accompanied by 10% y-o-y growth in dollar revenues.

Rosy margins compared to international peers. Our forecast of 2011 total OIBDA margins for MTS and VimpelCom Ltd is 43.6% (down 0.8 ppt) and 46.6% (down 0.9 ppt), respectively. Somewhat the lower margin for MTS is explained by non-profitable retail business. On the global basis, operators in the developed markets posted a 41% OIBDA margin in 2009. In case of Rostelecom, we see a 2011E OIBDA margin at 38% what is decent for the provider of mostly fixed-line facilities. A strict policy on cash costs at IRs in 2010 confirms this point.

MTS VimpelCom LtdRussia 78.6 72.0CIS 21.4 27.7SEA 0.3Source: TKB Capital estimates

VimpelCom Ltd has more operations abroad

Mobile revenues breakdown in 2011, %

Source: companies data, TKB Capital estimates

Sound OIBDA marginsTotal OIBDA margin, %

0

10

2030

40

50

60

2009 2010E 2011E 2012E 2013E

MTS VimpelCom Ltd Rostelecom


60 STRATEGY 2011

High FCF from established markets. Mobile markets of Russia and Ukraine generate high cash flows to provide modernization and enter new markets. MTS makes 82% of its total FCF in Russia, and 11% in Ukraine. This trend will prevail in the future despite raised capex for 3G services and fixed-line infrastructure update.

Attractive valuation in the sector. Both MTS and VimpelCom Ltd are trading with discounts on multiples to emerging market peers. 2011E EV/EBITDA of MTS is 4.3, 18% its emerging market peers. MTS’ 2011E P/E of 10.3 is also 18% below company’s peers median. VimpelCom Ltd’ P/E multiples are 14% off than MTS’ arising from uncertainty regarding the acquisition of Weather Investments. Rostelecom is valued broadly on par with its international analogues at this time.

Determined dividend policy. Russian telecoms are largely dividend distributing companies. The track record of dividend payments lasts several years and was not interrupted by the economic crisis (not a VimpelCom Ltd’ case). Since 2005 MTS is committed to pay out at least 50% of net income implying a dividend yield of 4.9% in 2011 for ADRs and 6.3% for locals. VimpelCom Ltd introduced payment of 50% of free cash flow from Russian and Ukrainian operations. That will result into a 3.7% yield next year. The new management of Rostelecom has indicated on the dividend payout ratio of 20% for commons (up from 15% in IRs).

CONS

Fixed-line BB ARPU under pressure with rising competition. Presence of tens players in the market drastically impacts monthly payments. In regions Comstar recorded a 10% y-o-y decline in residential ARPU in 3Q10. Consequently, we believe this dynamics will persist and ARPU will go down 5% y-o-y for the full 2011. However, new additions (penetration of broadband is to go up impressive 11 ppt y-o-y to 38%) enhance sales from broadband fixed.

Large capex wanted to keep pace with peers in VAS market. For the Big-Three, we estimate a capex-to-sales of around 20% needed for infrastructure update. The amount of investment program is unavoidable for needs of 3G services expansion in regions and modernization of last-mile access to the end consumers. This investment program is permissible for Russian telecoms operators which Capex/OCF ratio is above 0.6.

Limited potential in pay-TV services. High penetration of pay-TV facilities (already above 50%) and introduction of digital multiplexes by the state dwarf further increase in customer base. Upside potential in revenues growth is bounded by a narrow base of new customers as well as ARPU deterioration. For 2011-12 a number of new subscribers will come high (11% y-o-y to 35 mn). For 2013-15 an average growth rate is forecast at more moderate 2% y-o-y ending 2015 with 38 mn pay-TV subscribers. Overall, segment’s revenues are to rise 7% y-o-y in 2011-12 and stay flat in 2013-14.

Stiff value asked for telecoms targets. Current prices of telecoms assets considerably exceed valuation of bidders what reduces a return on investments. For instance, In July 2010 MTS acquired Multiregion at 2009 EV/EBITDA of around 13 (including a minority stake). Shareholders of Akado (provides services in saturated market in Moscow) demand Rostelecom to pay 2009 EV/EBITDA of 10-12 for the asset. Baring Vostok agreed on 2009 EV/EBITDA valuation of 16 for ER-Telecom which demonstrates the highest rates of growth in the Internet subscriber base.

Source: company data, TKB Capital estimates

Cash generating machineOCF, Capex and FCF at MTS, $ bn

0

1

23

4

5

6

2009 2010E 2011E 2012E 2013E

OCF Capex FCF

Source: ComNews Research, TKB Capital estimates

Growth to slow only after 2012Pay-TV customer base and

penetration in Russia

0

10

20

30

40

2008

2009

2010

E

2011

E

2012

E

2013

E

30

40

50

60

70

Users, mn (LHS)

Penetration, % (RHS)



STRATEGY 2011 61

MCAP EV

$ mn $ mn 2009 2010E 2011E 2012E 2009 2010E 2011E 2012E 2009 2010E 2011E 2012E

MTS Russia 20,398 24,386 20.4 11.7 10.3 9.5 5.5 4.8 4.3 4.0 2.5 2.1 1.9 1.8

VimpelCom Ltd Russia 19,459 23,485 17.4 11.4 8.9 8.5 5.5 4.7 4.2 4.0 2.7 2.2 2.0 1.8

Rostelecom Russia 14,718 18,437 18.0 14.3 14.4 11.4 5.7 5.6 5.3 5.3 2.1 1.9 2.0 1.9

Median 18.0 11.7 10.3 9.5 5.5 4.8 4.3 4.0 2.5 2.1 2.0 1.8

Premium (discount) to EM peers 6% -16% -18% -19% -16% -11% -18% -20% 9% 1% -1% 0%

Premium (discount) to DM peers 31% 3% -11% -12% -3% -14% -20% -24% 28% 8% 3% 2%

China Unicom China 34,895 44,474 24.9 51.1 31.2 21.4 5.1 4.9 4.4 3.9 2.0 1.8 1.6 1.5

America Mov il Mexico 114,271 131,142 20.0 15.6 13.8 12.9 11.2 7.1 6.5 6.2 4.5 2.9 2.7 2.6

Orascom Telecom Egy pt 3,893 7,984 11.7 6.3 8.9 7.2 3.4 4.2 4.0 3.8 1.6 1.8 1.7 1.6

Philippine LD Philippine 10,800 12,350 12.9 11.5 11.3 11.0 6.4 6.3 6.2 6.2 4.0 3.7 3.6 3.5

Telkommunnikacija polska Poland 7,287 8,667 17.6 17.5 16.7 15.3 4.2 4.9 4.5 4.6 1.6 1.7 1.7 1.7

Carso global telecom Mexico 17,972 31,940 15.1 - - - 5.7 5.4 5.3 - 2.1 1.9 1.8 -

Chunghwa telecom Taiwan 24,239 22,164 18.3 15.4 15.4 15.2 8.0 7.3 7.3 7.3 4.0 3.4 3.4 3.4

Singapore Telecom Singapore 37,217 41,059 15.5 13.2 12.6 11.7 13.3 10.4 9.2 8.7 4.0 3.4 3.0 2.9

Magy ar Telekom Hungary 2,560 4,139 6.6 9.5 10.2 9.6 3.3 3.8 4.0 4.0 1.3 1.4 1.5 1.4

Turkcell Turkey 14,751 13,356 13.3 12.5 11.6 10.6 7.0 6.9 6.3 5.7 2.3 2.3 2.2 2.0

Mobinil Egy pt 2,805 3,721 7.6 10.8 11.3 9.9 4.0 4.8 4.6 4.3 1.9 2.0 1.9 1.8

MTN South Af rica 36,477 37,238 20.7 13.9 11.5 10.1 6.7 5.2 4.7 4.3 2.8 2.2 2.0 1.8

Telekom Malay sia Malay sia 4,050 4,813 22.2 20.4 21.6 20.3 5.6 5.1 5.0 4.8 2.0 1.7 1.7 1.6

Adv anced inf o serv ice Thailand 8,570 8,984 17.2 12.8 12.3 11.5 6.7 5.4 5.3 5.2 3.0 2.5 2.4 2.4Bharti Airtel India 29,109 29,318 16.9 14.4 19.4 15.3 8.7 8.1 6.6 5.4 3.6 3.3 2.3 1.9Viv o Participacoes S.A. Brazil 17,042 18,489 39.2 20.8 15.9 13.3 7.0 5.6 5.3 5.0 2.2 1.8 1.7 1.6

Median 17.1 13.9 12.6 11.7 6.5 5.4 5.3 5.0 2.3 2.1 2.0 1.8

Deutsche Telekom Germany 55,307 125,826 112.4 12.6 12.5 11.9 4.5 4.9 5.0 5.0 1.4 1.5 1.6 1.6

France Telecom France 55,578 101,284 13.3 8.3 9.0 9.0 4.8 4.9 4.9 5.0 1.6 1.7 1.7 1.7

Tele2 Sweden 9,143 9,490 15.4 10.5 11.5 10.3 7.9 6.2 5.9 5.3 1.8 1.6 1.6 1.5

Verizon US 99,446 193,348 27.2 15.9 15.6 14.1 5.4 5.6 5.4 5.2 1.8 1.8 1.8 1.8

Portugal Telecom Portugal 11,479 12,822 12.0 23.8 13.9 12.3 3.9 5.5 4.8 4.4 1.4 2.1 1.8 1.7

Belgacom Belgium 11,317 13,709 9.0 11.0 11.1 11.2 4.8 4.9 5.4 5.4 1.7 1.6 1.6 1.6

OTE US 4,095 11,238 7.3 10.2 9.2 8.1 3.6 4.4 4.6 4.5 1.3 1.5 1.6 1.6

Swisscom Switzerland 22,678 32,267 12.7 11.7 11.2 11.1 8.0 6.7 6.6 6.6 2.9 2.6 2.6 2.6

Telecom Italia Italia 23,746 75,538 10.8 7.9 7.7 7.3 4.9 5.1 4.9 4.9 2.0 2.1 2.1 2.0

Telef onica Spain 104,251 191,303 9.6 8.7 9.1 8.8 6.1 5.9 6.1 5.9 2.4 2.4 2.3 2.2

Telenor Norway 26,249 31,378 19.0 13.1 12.0 10.3 5.8 6.6 6.1 5.6 2.0 2.0 1.9 1.8

AT&T US 172,158 238,177 13.7 11.1 11.5 10.8 5.8 5.6 5.3 5.1 1.9 1.9 1.9 1.9

Qwest communications US 13,384 24,396 20.2 28.2 18.7 18.2 5.7 5.6 5.7 5.7 2.0 2.1 2.1 2.2

Telus Canada 14,573 20,519 16.6 14.1 12.6 11.5 6.3 5.7 5.5 5.3 2.4 2.1 2.1 2.0

Teliasonera Sweden 35,359 43,786 14.3 11.4 11.0 10.5 9.4 8.0 7.9 7.7 3.0 2.8 2.8 2.7

Median 13.7 11.4 11.5 10.8 5.7 5.6 5.4 5.3 1.9 2.0 1.9 1.8

Russia

Emerging market peers

Russian telecoms comparative valuation


P/E EV/EBITDA EV/SCompany Country

Developed market peers


62 STRATEGY 2011

MTS / Comstar-UTS Safe investment case in telecoms

MTS is our top pick in the sector for a large cash influx from the Russian-largest mobile subscriber base and constant search for additional value creation. The company holds 32% of the total customers in Russia and is successful competing in regional markets with MegaFon and Tele2 Russia. It is one of three companies which received frequency spectrum for 3G services and rolled up sterling networks. Our optimism arises around the stock from company’s superior growth prospects in the mobile market and continuing expansion into the broadband market. A merger with Comstar in 1H11 on the operating level makes possible to promote all-round telecoms facilities and save on equipment procurement and SG&A expenses. The stock is undervalued on multiples and gives a 65% upside potential from its current market level to our target price of $14 per local share. The target price is $28 for ADRs. Comstar is our preferred way to enter the capital of MTS. At the expense of lock-up period in April, buying Comstar GDRs and converting them into MTS locals unlocks 8% value versus a direct purchase of MTS locals.

PROS

Mobile 3G data traffic is a key catalyst. For MTS’ active users of 3G phones we see a three-fold increase between 2010 and 2013 to 100 MB per month. In 2013, 3G mobile Internet sales will top $1.2 bn and constitute 12% of the total mobile revenues in Russia.

MTS VAS share to rise from 19% to 31% in 2010-13. The share of VAS (data traffic, content and texting) in ARPU, in our estimates, will demonstrate a riot growth on the back of proliferation of active users of 3G phones and USB devices. Mostly thanks to data traffic, VAS share is forecast to add in 2011 3 ppt y-o-y to 22% and reach 31% by the end-2013.

Attracting broadband clients in small towns. We anticipate MTS in 2011-13 to post a 140% rise to 2.9 mn in fixed-line broadband subscribers (along with Comstar) and a 185% growth to 3.7 mn in USB modems. In revenue terms, segment’s sales will double and account for $0.8 bn.

New addition in the CIS markets. Mobile penetration in the CIS countries, apart from Ukraine, is still low and provides a large room for organic growth. Penetration stays in the range from 41% to 86% there versus 98% in EM countries. A significant market share of MTS (from 45% in Uzbekistan to 85% in Turkmenistan) will secure the realization of this potential.

Stable dividend distribution. Under a conservative dividend payout ratio of 50% in 2010-13 shareholders may receive a 4.9% dividend yield on average for ADRs and 6.3% for locals.

CONS

Corporate actions in MTS under influence by parent AFK Sistema. The board of directors of MTS agreed to acquire Sistema Telecom from AFK Sistema for $379 mn implying a payback period of more than 10 years. In 2011 AFK Sistema intends to sell 28% ordinary (23% of the total) shares in MGTS to MTS. The price guideline stays unknown, but we assume a premium to $330 mn value paid by Sistema.

Threat of higher capex. MegaFon’s outperformance in the mobile data traffic market was promoted by a large investment program in the last couple of years. MTS may try to surpass the competitor scaling up capex. Adoption of a clear mechanism of conversion of 790-860 MHz waveband for LTE will force MTS to adjust investment upwards, too

MTS is prescribed to halt operations in Turkmenistan. The Ministry of Communications of Turkmenistan has ordered to suspend licenses for one month since December, 21 2010. Under the worst case scenario (MTS will loss business in Turkmenistan), we estimate a 2% loss of fair equity value.

MTSCommon ADR

Ticker MTSI MBTRecommendation BUY BUYPrice, $ 8.48 20.47Target price, $ 14.0 28.0Upside/downside, % 65% 37%

SHARE DATABloomberg MTSI RX MBT USReuters MTSI.MM MBT.N

# of ADR outstanding, mn 997EV, $ mn 24,386MC, $ mn 20,398MIN 12 mnth., $ 9.42 17.84MAX 12 mnth., $ 6.91 23.33

Shares per ADR 2

SUMMARY FINANCIALS, $ mnUS GAAP 2010E 2011E 2012ERev enue 11,447 12,923 13,928EBITDA 5,078 5,636 6,030Net income 1,749 1,987 2,157EPS, $ 1.75 1.99 2.16Rev . growth, % 16.1 12.9 7.8EPS growth, % 75.2 13.6 8.6EBITDA margin,% 44.4 43.6 43.3Net margin, % 15.3 15.4 15.5


P/E 11.7 10.3 9.5EV/EBITDA 4.8 4.3 4.0PRICE DYNAMICS


17

20

23

26

22.12.09 22.3.10 22.6.10 22.9.10 22.12.10

MBT RTS



STRATEGY 2011 63

MTS / Comstar-UTS

BALANCE SHEET$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ETOTAL CURRENT ASSETS 4,390 4,464 4,297 4,566 5,355 6,649 8,235PP&E, net 7,749 7,754 8,330 8,007 8,156 7,972 7,564Other non-current assets 3,611 2,868 3,074 3,069 3,268 3,452 3,610TOTAL NON-CURRENT ASSETS 11,359 10,623 11,404 11,077 11,425 11,424 11,174TOTAL ASSETS 15,749 15,086 15,702 15,642 16,779 18,073 19,409Short-term borrow ings 2,022 2,407 2,270 1,949 1,820 1,748 1,706Other short-term liabilities 2,256 2,238 2,283 2,189 2,233 2,278 2,308TOTAL CURRENT LIABILITIES 4,279 4,645 4,553 4,139 4,053 4,026 4,015Long-term borrow ings 6,327 4,620 4,116 3,633 3,528 3,496 3,481Other non-current liabilities 711 702 714 682 693 704 711TOTAL LONG-TERM LIABILITIES 7,037 5,322 4,830 4,315 4,221 4,200 4,193TOTAL EQUITY 4,433 5,120 6,318 7,189 8,506 9,847 11,201TOTAL EQUITY & LIABILITIES 15,749 15,086 15,702 15,642 16,779 18,073 19,409

INCOME STATEMENT$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ERevenue 9,857 11,447 12,923 13,928 14,671 15,642 16,496Cash costs (5,388) (6,369) (7,288) (7,897) (8,384) (9,025) (9,591)EBITDA 4,469 5,078 5,636 6,030 6,287 6,617 6,904D&A (1,844) (1,926) (2,243) (2,459) (2,621) (2,847) (3,002)EBIT 2,539 3,152 3,392 3,571 3,667 3,770 3,902Net interest income/(expenses) (468) (647) (554) (490) (447) (433) (427)EBT 1,482 2,506 2,838 3,081 3,219 3,337 3,476Income tax (504) (556) (624) (678) (708) (734) (765)Net income 998 1,749 1,987 2,157 2,254 2,336 2,433

$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ENet CF from operating activities 3,596 3,630 4,181 4,567 4,825 5,132 5,382Net CF from investing activities (2,385) (1,324) (2,843) (2,646) (2,788) (2,659) (2,639)Net CF from financing activities 148 (2,235) (1,635) (1,507) (1,385) (1,335) (1,292)Net Debt 5,621 4,260 3,872 2,776 1,838 530 (1,032)

RATIOS% 2009 2010E 2011E 2012E 2013E 2014E 2015ERevenue grow th (17) 16 13 8 5 7 5EBITDA margin 45.3 44.4 43.6 43.3 42.9 42.3 41.9Net margin 10.1 15.3 15.4 15.5 15.4 14.9 14.7Net Debt/EBITDA 1.3 0.8 0.7 0.5 0.3 0.1 neg


CASH FLOW STATEMENT


64 STRATEGY 2011

VimpelCom Ltd Risks priced in, good fundamentals to hardly fulfill themselves in 1H11

VimpelCom Ltd offers greater exposure to the growing telecoms markets in the CIS than MTS or MegaFon. VimpelCom Ltd is strongly committed to turn into a global telecom operator for fair and is moving forward with acquisition of Weather Investments which owns operations in Italy, Asia, and Africa, becoming the fifth largest mobile operator in the world by number of customers. Russia and a majority of countries in the CIS are pure cash generators for the company. VimpelCom Ltd has all means to bring to the end net outflow of customers in Russia and keep pace with MegaFon in mobile Internet segment. VimpelCom LTd’s 18% discount on 2011E P/E to MTS’s multiples reflects M&A risks arising from nationalization of Djezzy, Algeria’s mobile asset, and insistent willingness to acquire mobile assets abroad (e.g. Telekom Srbija). Meanwhile company’s fundamentals are strong and downside risks look limited. If VimpelCom Ltd rejects to acquire Weather Investments, we see a 12-month target price of $22/share. In the case of nationalization of Djezzy, the target price depends on the price paid for the asset, valuation varies from $2.5 bn to $7.8 bn. Should the Algerian state start nationalization of Djezzy, market price of VImpelCom Ltd will barely recover in 1H11 being under pressure of new corporate conflict between Altimo and Telenor.

PROS

Strong cash flows from the major market. Voice pricing in Russia remains stable and we expect VimpelCom Ltd to record an average 46% OIBDA margin in 2011-13.

Early stage of development of mobile broadband services. Mobile penetration of USB modems (12%) and active 3G mobile (6%) in Russia remains low. We expect mobile broadband revenues to account for 20% of VimpelCom Ltd’s total sales in Russia by 2012.

Leadership in most of markets abroad. Currently VimpelCom Ltd is the number one or two mobile player in the majority of CIS markets. Mobile operators in Africa and Asia acquired by VimpelCom Ltd from Weather Investments also hold large market shares in terms of subscribers.

Defined dividend policy gives 3.7% dividend yield in 2011. Distribution of 50% FCF from Russia and Ukraine implies a 3.7% dividend yield next year, however DpS will be reduced by 20% if the purchase of Weather Investments occurs.

CONS

Target Weather Investments valued at stiff 7.7 EV/LTM EBITDA. The target is valued at high EV/LTM EBITDA of 7.7, 50% above EV/LTM EBITDA at VimpelCom Ltd and 13% above EV/LTM EBITDA on the merger with Kyivstar).

Net debt/LTM EBITDA to grow to 2.5 from 0.8. Following the merger, VimpelCom Ltd’ net debt will rise from $4.0 bn to $24 bn. The company expects to generate only $1.5-3.0 bn as redemption capacity implying a payback period more than 10 years.

Necessity to raise capex to 3G services. MegaFon has consistently been the most aggressive player for some time in investing in 3G coverage expansion in attempts to raise market share. To match with MegaFon, Vimpelcom Ltd will be tempted to increase its investing program.

VimpelCom LtdADR

Ticker VIPRecommendation URPrice, $ 14.94Target price, $ -Upside/downside, % -

SHARE DATABloomberg VIP USReuters VIP.N

# of shares outstanding, mn 1,302EV, $ mn 23,485MC, $ mn 19,459MIN 12 mnth., $ 13.96MAX 12 mnth., $ 19.01

SUMMARY FINANCIALS, $ mnUS GAAP 2010E 2011E 2012ERev enue 10,520 12,039 12,780EBITDA 4,996 5,611 5,923Net income 1,704 2,179 2,288EPS, $ 1.31 1.67 1.76Rev . growth, % 20.9 14.4 6.2EPS growth, % 52.2 27.9 5.0EBITDA margin,% 47.5 46.6 46.3Net margin, % 16.2 18.1 17.9


P/E 11.4 8.9 8.5EV/EBITDA 4.7 4.2 4.0

PRICE DYNAMICS


50

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100

125

150

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VIP RTS



STRATEGY 2011 65

VimpelCom Ltd BALANCE SHEET$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ETOTAL CURRENT ASSETS 2,967 3,115 3,728 4,717 6,238 8,373 10,885PP&E, net 5,562 8,252 9,317 9,704 10,075 10,207 10,176Other non-current assets 6,204 7,643 8,149 8,076 7,979 7,867 7,753Total NON-CURRENT ASSETS 11,766 15,895 17,466 17,780 18,054 18,074 17,929TOTAL ASSETS 14,733 19,010 21,194 22,497 24,292 26,447 28,814Short-term borrow ings 1,813 1,794 1,542 1,178 881 655 486Other short-term liabilities 1,601 1,785 1,909 1,897 1,878 1,859 1,842Total CURRENT LIABILITIES 3,414 3,578 3,451 3,075 2,759 2,514 2,328Long-term borrow ings 5,540 5,579 4,460 3,311 2,450 1,813 1,343Other non-current liabilities 761 1,200 1,263 1,234 1,200 1,167 1,135Total LONG-TERM LIABILITIES 6,301 6,779 5,722 4,545 3,649 2,980 2,479Total EQUITY 5,018 8,653 12,021 14,877 17,884 20,952 24,008TOTAL EQUITY & LIABILITIES 14,733 19,010 21,194 22,497 24,292 26,447 28,814

INCOME STATEMENT$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ERevenue 8,703 10,520 12,039 12,780 13,383 14,131 14,739Cash costs (4,430) (5,524) (6,428) (6,857) (7,241) (7,730) (8,134)EBITDA 4,273 4,996 5,611 5,923 6,142 6,401 6,605D&A (1,694) (2,181) (2,477) (2,667) (2,681) (2,708) (2,779)EBIT 2,539 2,849 3,342 3,363 3,359 3,409 3,445Net interest income/(expenses) (547) (664) (548) (430) (322) (238) (176)EBT 1,551 2,185 2,794 2,933 3,037 3,171 3,269Income tax (435) (481) (615) (645) (668) (698) (719)Net income 1,120 1,704 2,179 2,288 2,369 2,473 2,550

$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ENet CF from operating activities 3,513 4,475 5,263 5,791 6,111 6,269 6,410Net CF from investing activities (1,433) (2,737) (3,196) (3,392) (3,454) (3,227) (3,131)Net CF from financing activities (1,545) (1,893) (1,701) (1,389) (1,055) (783) (580)Net Debt 5,906 4,482 4,094 2,998 2,060 752 (810)

RATIOS% 2009 2010E 2011E 2012E 2013E 2014E 2015ERevenue grow th (14) 21 14 6 5 6 4EBITDA margin 49.1 47.5 46.6 46.3 45.9 45.3 44.8Net margin 12.9 16.2 18.1 17.9 17.7 17.5 17.3Net Debt/EBITDA 1.4 0.9 0.7 0.5 0.3 0.1 neg


CASH FLOW STATEMENT


66 STRATEGY 2011

Rostelecom Examining the operational strength

The first stage of Svyazinvest restructuring is set to be completed in March-April, 2011 with the consolidation of inter-regional telecoms around Rostelecom. Following the settlement of transactions, the market will put operations of the united provider under close examination. Decline in the volume of fixed-line voice services (mostly in ILD and DLD calls) along with the absence of nation-wide coverage of mobile network is negative point for investors. We are neutral regarding Rostelecom ordinary shares which are valued at par with its international peers. A cheap entry ticket to the united Rostelecom through shares of IRs still exists. However, a single digit potential remains at the cost of a halt in trading (from 14 to 44 days). Potential value-destructive purchases of assets are not good for the market’s perception. We expect narrowing spreads between Rostelecom prefs and ordinary shares and reiterate our BUY recommendation of Rostelecom prefs with a target price of $3.3/share.

PROS

High potential for broadband additions in towns with population under 100,000. Rostelecom has a vast potential to expand in small towns avoiding tough competition with the altnets in spite of competing with alternative providers (altnets) like Comstar-UTS. For 2011 we project a 40% y-o-y growth in a number of total broadband customers to 21 mn. As of the end of 9M10, the new Rostelecom had 40-90% market share in the regional markets with 6 mn subscribers in total (43% share of Russian wire-line broadband market).

Hikes on local service essential for Rostelecom. While fixed voice remains the dominant revenue source for Russian fixed line incumbents, the cap price on local calls allowed by the Russian Tariff Service are very favourable for the company. For 2011 the tariff was raised by 8.8% on average and should result in a 3% increase of the total sales.

Inclusion of the ordinary shares into MSCI Index. We believe that the inclusion of the ordinary shares of the united Rostelecom into MSCI Index in summer 2011 will spark liquidity in the trading.

CONS

Low liquidity may remain for three months after restructuring. It is not clear yet whether Rostelecom will make several issues (16 for all IRs) or only one. Right after the beginning of trading in the new Rostelecom, trading volumes may remain low, since large investors will stay unable to accumulate large stakes within one issue of shares. Over three months different share issues are trading separately on MICEX post their listing.

Broadband ARPU deterioration. We expect broadband ARPU of $5/month in 2013 among mass market subscribers, three times lower than current monthly payments in IRs. This is due to the fierce competition in the internet broadband market in large cities.

May be forced to acquire a stake from ADI. Rostelecom has agreed to purchase 10% of its shares from VEB granting the state bank the option to sell these shares between mid-2013 and mid-2014 at a price of RUR230/share (57% above the current price) plus 7.7% interest accrued from July 2010. 30% of pre-merger Rostelecom is owned by the Agency for Deposit Insurance. If Rostelecom agrees to buy back this stake for the same price, it will cost $1.5 bn out of the company.

RostelecomCommon Pref erred

Ticker RTKM RTKMPRecommendation HOLD BUYPrice, $ 4.78 2.67Target price, $ 4.1 3.3Upside/downside, % -14% 23%

SHARE DATABloomberg RTKM RX RTKMP RXReuters RTKM.MM RTKMP.MM

Common Pref erred# of shares outstanding, mn 2,943 243EV, $ mn 18,437MC, $ mn 14,718MIN 12 mnth., $ 3.02 2.03MAX 12 mnth., $ 5.36 3.44

SUMMARY FINANCIALS, $ mnIFRS 2010E 2011E 2012ERev enue 9,591 9,198 9,545EBITDA 3,297 3,473 3,504Net income 1,029 1,020 1,287EPS, $ 0.35 0.35 0.44Rev . growth, % 8.3 -4.1 3.8EPS growth, % 26.0 -0.8 26.2EBITDA margin,% 34.4 37.8 36.7Net margin, % 10.7 11.1 13.5


P/E 14.3 14.4 11.4EV/EBITDA 5.6 5.3 5.3

PRICE DYNAMICS


2

5

8

11

22.12.09 22.3.10 22.6.10 22.9.10 22.12.10

RTKM RTS

Source: ACM-Consulting, TKB Capital estimates

Rostelecom occupies 40% of the marketFixed-line broadband subscriber base,

%, end of 9M10

11.7

8.9

42.8

36.7

MTS VimpelCom Ltd

United Rostelecom Other



STRATEGY 2011 67

KEY FINANCIAL INDICATORS$ mn 2009* 2010E* 2011E 2012E 2013ERevenue 8,855 9,591 9,198 9,545 10,722Cash costs (5,630) (6,293) (5,725) (6,041) (6,862)EBITDA 3,225 3,297 3,473 3,504 3,860Net income 816 1,029 1,020 1,287 1,394

RATIOS% 2009* 2010E* 2011E 2012E 2013ERevenue grow th 7 8 (4) 4 12EBITDA margin 36.4 34.4 37.8 36.7 36.0Net margin 9.2 10.7 11.1 13.5 13.0* calculated on the sum-of-the-parts base, the new Rostelecom face a double account problem

Source: Bloomberg, TKB Capital estimates Reorganization to be done by May 2011Time frame of inter-regional telecoms and Rostelecom restructuring

Source: Rostelecom

Mar-11

Apr-11

Feb-11

Sep-10

Mar-11

May -10

Mar-10

Jun-10

Feb-11

Jul-10

Sep-09

Apr-10

Jul-10

Jan-10

Sep-09

Aug-09

License reissue

Corporateprocedures

Debt restructuring

Buyout of minorities

Issue of newRostelecom shares

Corporate approvals

Preparatory period

Valuation

Aug-10 Jan-11

Oct-10 Feb-11

Current time


68 STRATEGY 2011

AFK Sistema Portfolio of seasoned and long-range assets

AFK Sistema shares offer exposure to a number of growing sectors in the Russian economy, including both domestic- and export-oriented. Since acquiring its oil assets, Sistema has become more diversified, with two strong sources of cash (telecoms and oil) to finance its development. AFK Sistema is set to benefit from improvements in domestic consumption as it has a presence in the consumer, banking and hi-tech sectors. Based on Sistema SOTP valuation which incorporates only Sistema’s trading assets, we see a 23% corporate holding discount (generally established discount for the holding is 25%). There is no difference when choosing between Sistema’s GDRs and local shares as current spread between GDRs and locals is in line with last 12-month average (29%).

PROS

Telecoms and Oil & Energy units generate stable cashflow. AFK Sistema receives dividends from well-developed and profitable business of MTS and Bashneft. A dividend payout ratio at MTS is set at not least 50%, but for 2010 the ratio was raised to 100%.

No purchases of telecoms in Europe. The management is repeatedly reassuring that the company does not consider transactions similar VimpelCom Ltd’ entry to Europe, Asia and Africa.

Bashneft gains more weight in Sistema’s total value. Sistema has streamlined BashTEK’s operations, creating an efficient vertically-integrated oil business, and won licence to develop Trebs and Titiov oil fields, the last deposit of this size in Russia left. The investment program may account for $5.5 - 6 bn.

Consumer segment has good growth potential. Sistema’s consumer units businesses have strong market positions and are set to benefit from Russian economic growth in the long term.

CONS

Dividend absence. Sistema’s management is not ready to raise question on dividend policy until seeing several years of stable net income. For 2009 Sistema paid out just a nominal sum of dividends.

SSTL’s prospects are not convincing. We are cautious regarding Sistema’s Indian mobile venture, given the high level of competition on the Indian mobiles market. SSTL may reach positive OIBDA in 2013, positive net income in 2014 and has to invest $2.5-2.7 bn by 2018.

Sitronics’s borrowings do not decline. Sistema’s hi-tech business is struggling to repay its debt from operating cashflows and will likely depend on support from Sistema. Therefore Sistema mulls a merger of Sitronics and RTI Systems in order to reduce net debt/OIBDA ratio.

Assets MCAP, $ mn % attr. to Sistema

MCAP attr. to Sistema, $ mn

MTS 20,398 53 10,811Bashneft 8,842 73 6,455Sitronics 153 64 98Total 17,364Corporate net debt, $ mn 1,900Equity value, $ mn 15,464

GDRs outstanding, mn 482.5

Current price, $/GDR 24.8Market capitalization, $ mn 11,971

Corporate holding discount, % 23


Sistema SOTP Valuation based on trading assets

AFK SistemaCommon GDR

Ticker AFKC SSARecommendation UR URPrice, $ 0.87 24.81Target price, $ - -Upside/downside, % - -

SHARE DATABloomberg AFKC RX SSA LIReuters AFKC.MM SSAq.L

GDR# of GDR outstanding, mn 483EV, $ mn 26,003MC, $ mn 11,971MIN 12 mnth., $ 0.78 21.00MAX 12 mnth., $ 1.12 30.99

Shares per GDR 20

SUMMARY FINANCIALS, $ mnUS GAAP 2010E 2011E 2012ERev enue 28,528 29,834 32,398EBITDA 7,702 8,229 9,060Net income 1,165 1,475 1,821EPS, $ 2.41 3.06 3.77Rev . growth, % 52.2 4.6 8.6EPS growth, % -29.1 26.7 23.4EBITDA margin,% 27.0 27.6 28.0Net margin, % 4.1 4.9 5.6


P/E 10.3 8.1 6.6EV/EBITDA 3.4 3.2 2.9

PRICE DYNAMICS


11

18

25

32

22.12.09 22.3.10 22.6.10 22.9.10 22.12.10

AFKS RTS

Source: company data

Telecommunication sales dominateRevenues breakdown by segment in 3Q10, %

49

36

105

Telecommunications Oil and Energy

Consumer Other



STRATEGY 2011 69

Media Buying exposure on macro story

Macroeconomic situation is propitious to continuing growth in the media sector. Real income and retail prices growth, consumer confidence incite advertising demand. Total Russian advertising market is to grow 14% y-o-y in 2011 (the economy is set to advance 13% y-o-y in nominal price), with the highest growth rate in Internet (30% y-o-y) and TV (17% y-o-y) segments. Growth of Internet advertising is forecast at impressive 20% on average in 2012-15. TV is a very attractive bet on the economy in the mid-term. Cost of delivery is low on the global basis expanding margins for media companies. Going forward, legislatures approved payroll tax benefits for 2011-14 giving privilege to mass media business. We like CTC Media’s exposure to the fast growing market and advice making a bet on the sector buying this stock.

ENVIRONMENT

Pricing environment in TV improving since mid-2010. Companies raised demand on TV advertising already in late spring of 2010 outpacing the outlook of selling houses and booked all advertising time on some channels till the end of the year. CTC Media’s prices for 4Q10 were up 20% y-o-y, RBC announced a 10% increase in advertising prices for Internet starting from 1 January 2011.

Reshaping of sales house landscape very likely ran smoothly. The legislation adopted in 2009 limits contracts with media sale houses’ power to 35% share of TV market. For Moscow operations CTC Media has established an own in-house agency which signed a 5-year contract to cooperate with Video International (VI).

Digital multiplexes include CTC Media’s channels. All CTC Media’s channels are recommended for inclusion in the second multiplex meaning no threat CTC Media will be off-line on the federal level since 2016.

IPOs of UTV and ProfMedia are slated on 2011. UTV and ProfMedia may attract funds for development in 2011, expanding the list of names for investment in the sector.

PROS

Bright perspectives of Internet segment. Internet advertising is gaining momentum from a very low base, since many advertisers see it as a cost-effective way to reach out to a premium base. The forecast from VI assumes above 20% y-o-y rise of Internet sales for 2011-13 backed by an increase in Internet penetration to 56% (now it stands at 40%).

Bail out of RBC brings new name for investors. Process of financial debt restructuring process and legal reorganization of RBC is coming to the end. Apart from TV and press, the company offers entry to the most promising contextual advertising.

Financial strength of CTC Media. We favor CTC Media the most in the Russian media universe. The company enjoys the debt free position, maintains margin of above 35% and is raising dividend payout ratio.

CONS

Good fundamentals of CTC Media might have priced in. Given a solid year-to-date performance of CTC Media’ stock (64%) and multiples matched to international peers, a room for further appreciation of the stock is not large.

Increasing competition in well-established TV market. Audience shares of the largest Russian channels remain stable, so it seems complicated to outperform the market as the majority of players may easily allow more spending on programming.

Source: Bloomberg


-50% 0% 50% 100%

RTS

CTCM

RBCI

MAIL

22.12.2010 Max Min

Source: Video International, TKB Capital estimates

Set to expand 16% in 2011Russian advertising market, RUR bn

204232

270316

364413 464

0

100

200

300

400

500

2009

2010

E

2011

E

2012

E

2013

E

2014

E

2015

E

Source: Video International, TKB Capital estimates

TV to occupy more than 50% of the market

Russian advertising market breakdown by segments

0%20%40%60%80%

100%

2010

E

2011

E

2012

E

2013

E

2014

E

2015

E

TV Radio Press

Outdoor Internet Other

Source: ConsultantPlus, Interfax

Tax benefits for mass mediato be in place till 2015

Payroll tax rate in Russia, %

0

10

20

30

40

2010 2011 2012 2013 2014 2015

General Mass media


70 STRATEGY 2011

MCAP EV

$ mn $ mn 2009 2010E 2011E 2012E 2009 2010E 2011E 2012E 2009 2010E 2011E 2012E

CTC Media Russia 3,525 3,378 35.1 24.6 18.4 14.2 9.2 15.4 11.5 9.1 6.7 5.7 4.5 3.7

Mail.Ru Russia 7,204 7,034 42.7 90.4 47.2 33.0 434.5 66.7 36.0 25.8 47.4 22.9 16.4 12.7

RBC Russia 202 396 - - 141.6 13.0 - - 16.4 8.9 4.1 3.2 2.3 1.8

Median 38.9 57.5 47.2 14.2 221.9 41.0 16.4 9.1 6.7 5.7 4.5 3.7

Premium (discount) to EM peers 124% 317% 171% -4% 2527% 462% 82% 8% 130% 134% 100% 78%

Premium (discount) to DM peers 60% 258% 256% 23% 1882% 354% 118% 33% 262% 227% 166% 127%

TV Azteca Mexico 2,072 2,546 19.9 17.1 16.5 14.8 8.3 7.4 7.1 6.6 3.4 3.0 2.9 2.7

Central European Media CEE 1,297 2,413 - - - 75.7 7.5 22.7 13.6 10.3 3.4 3.3 3.0 2.7

TVN Poland 1,914 2,685 14.1 37.3 18.9 13.8 12.1 12.3 9.8 8.4 3.9 3.2 2.9 2.6

Naspers South Af rica 23,205 24,632 35.1 35.9 23.7 18.5 35.6 27.2 20.8 17.5 8.0 6.5 5.1 4.6

Kagiso Media South Af rica 329 327 17.4 13.6 11.2 10.2 8.6 6.7 6.1 5.7 3.4 2.6 2.3 2.2

Balaju Telef ilms India 59 58 563.6 20.8 73.0 17.1 14.2 58.6 205.5 14.4 0.8 1.4 1.3 1.1

Workpoint Thailand 79 71 37.0 13.8 11.2 8.7 15.0 7.2 6.2 5.2 2.4 1.7 1.5 1.4

TV Today Network India 87 73 11.9 7.6 17.4 11.9 7.5 5.0 8.1 5.7 1.3 1.2 1.1 1.0

ZEE News India 73 109 7.5 7.1 28.4 17.0 5.4 5.2 14.1 10.5 1.0 0.9 1.8 1.6

GMA Network Philippines 533 513 9.0 7.1 7.7 - 5.6 4.3 4.0 - 2.3 2.3 2.2 2.0

Median 17.4 13.8 17.4 14.8 8.4 7.3 9.0 8.4 2.9 2.5 2.2 2.1

Canal+ France 844 634 15.1 14.5 14.3 13.9 4.3 5.2 5.0 4.9 0.3 0.2 0.2 0.2

TF1 France 3,782 3,804 23.7 20.1 15.1 13.0 12.7 9.9 7.5 6.7 1.2 1.1 1.1 1.0

CBS US 13,340 18,805 58.9 17.9 14.2 11.8 10.3 7.9 7.3 6.6 1.4 1.3 1.3 1.3

ITV UK 4,349 5,333 30.5 13.3 11.8 10.2 14.2 8.2 7.5 6.9 1.8 1.7 1.6 1.6

Time Warner US 35,797 48,350 14.5 13.7 12.3 11.2 8.2 7.7 7.2 6.8 1.9 1.8 1.7 1.7

Antena 3 Spain 2,065 2,161 24.4 14.6 12.3 11.0 19.1 10.3 8.8 7.8 2.4 2.1 1.9 1.9

Mediaset Italy 7,028 9,045 18.5 13.8 11.5 10.2 3.6 4.6 4.2 3.9 1.7 1.6 1.5 1.4

Gestev ision Spain 3,813 3,925 56.4 18.3 11.6 9.9 9.7 13.5 9.0 7.5 4.5 3.4 2.6 2.4

RTL Luxemburg 15,422 15,589 53.9 18.0 15.8 15.0 12.1 10.0 9.3 8.9 2.1 2.2 2.1 2.0

MTG Sweden 4,414 4,914 - 17.5 14.2 12.1 19.9 13.4 11.4 10.0 2.6 2.2 2.2 2.0

Median 24.4 16.0 13.3 11.5 11.2 9.0 7.5 6.8 1.8 1.8 1.7 1.6

Russia

Emerging market peers

Russian media sector comparative valuation



Developed market peers



STRATEGY 2011 71

IT Sector More names and niches to invest

IT sector in Russia is nurturing in sales and a number of public names. With the support from the government, IT industry is gaining grounds supplying government agencies and corporates with programming solutions. Advance in PC and Internet penetration is advantageous for spending on all core segments – hardware, software and IT solutions. Two latter segments bring high margin and have been put under the scope by companies and the market. The light regime on payroll tax extended for these niches create positive momentum towards the sector. Today public names in the industry offer entry points into Russian vendors of software for the government and business needs, e-mail agents, instant messengers and social networks. Amid IT names, we pick out Armada for its debt-free position, ambitious strategy and a good record of sales and margins during the crisis.

ENVIRONMENT

More demand from private and government sectors. Private consumption on hardware and software solution is enormous source for sector’s formation. There are only 40 active users of Internet per 100 people in Russia versus 65 per 100 citizens in Central and Eastern Europe. Also, the state takes 35% of the total IT spending in Russia and is moving forward with programs aimed to develop IT industry.

Corporate budgets increase, but still stand below pre-crisis level. Feeling more certainty about the future, corporate clients are revising the spending on IT facilities upwards. At this point they gradually unfreeze projects postponed in 2008, but remain cautions when launching new massive initiatives.

Government support extended to 2020. The budget of the new state program “Information society” in 2011-13 is fixed 40% above spending in 2010. Since 2014 the program of financing per year will be enlarged by 3 times to RUR10 bn ($330 mn). The light payroll tax of 14% was set intact until 2017 (for Russian companies tax rate is 26% in 2011 and 34% since 2011).

Round of IPOs is planned for 2011. More interest towards the sector should come in 1H11 when popular search engines Rambler (owned by ProfMedia) and Yandex.

PROS

Highest growth rates in IT services and software segments. These segments are to demonstrate the most impressive performance thanks to gaining weight of adjusted- to-client-needs applications.

Profitability did not suffer greatly during the breakdown. Examples of Armada and IBS Group show that margin did not erode in the crisis on the back of wise control over costs.

Healthy balance sheets. Best performing names are continuing to remain debt-free (Armada) or reduce borrowings (IBS Group).

CONS

Low liquidity. Market capitalization of public companies is relatively small resulting in wide spreads and difficulties to assembly large stakes.

Fragmented market, high competition. Top-50 IT companies in Russia occupy 57% of the total market what is low compared to international peers and leads to completion on price.

Low transparency, delayed releases of reports. Companies are improving quality of their financial reports and operating results, however many of them are issued with a delay or do not include key data (e.g. margins and debt).

Source: Bloomberg


-100% 0% 100% 200% 300%

RTS

ARMD

IBSG

SITR

22.12.2010 Max Min

Source: ITU, TKB Capital estimates

Russia to close gap in Internet usage Internet users in 2009, % of total

population

0 50 100

ArgentinaUkraine

BrazilRussiaPoland

Chezh Rep.US

Germany Finland

Source: PMR, TKB Capital estimates

On the recovery trackRussian IT market, $ bn

12.315.0

20.418.7

13.1 14.116.9

0

5

10

15

20

25

2005

2006

2007

2008

2009

2010

E

2011

E

Source: ConsultantPlus, TKB Capital estimates

Payroll rate sizeably decreasedRussian IT Companies' Payroll Taxes,

RUR ths

0

30

60

90

120

150

100 200 300 400 500 600 700 800 9001000

Annual salary

Pay roll tax

20092010 w/t changes2011 w/t changes2011-17 with changes


72 STRATEGY 2011

MCAP EV

$ mn $ mn 2009 2010E 2011E 2012E 2009 2010E 2011E 2012E 2009 2010E 2011E 2012E

Armada Russia 152 118 - 20.3 12.5 9.4 62.1 8.0 5.6 3.9 1.2 1.2 0.7 0.5

IBS Group Russia 631 681 - - 32.0 18.8 26.0 - 13.1 9.8 1.0 1.3 1.1 0.9

Sitronics Russia 153 829 - - - 27.9 - 8.7 6.7 5.3 0.8 0.8 0.7 0.6

Median - 20.3 22.3 18.8 44.0 8.3 6.7 5.3 1.0 1.2 0.7 0.6

Premium (discount) to peers - 30% 76% 93% 387% 0% -3% -8% -10% 27% 4% -9%

Sy gnity Poland 61 72 - - 28.4 10.2 - 8.5 6.9 5.7 0.4 0.4 0.3 0.3

LDK China 1,373 3,140 - 6.4 6.2 6.3 - 6.8 6.1 5.7 2.9 1.4 1.1 1.0

First Deriv ativ es UK 114 140 20.9 20.0 18.2 12.1 12.3 13.1 11.5 8.5 4.5 4.3 2.5 2.2

E-Credible South Korea 72 59 25.6 18.5 12.7 10.7 16.1 - - - 6.4 4.6 3.6 3.0

Data Respons Norway 87 90 - 62.5 12.9 9.6 - 26.1 8.2 6.5 0.8 0.8 0.6 0.6

Positiv o Brazil 496 577 8.2 7.9 7.6 6.6 6.8 5.8 5.3 4.9 0.5 0.4 0.4 0.4

Endace LTD New Zeland 83 82 30.4 32.6 39.9 30.4 11.7 17.1 13.6 11.5 2.7 2.6 2.3 2.0

TIVIT Brazil 995 1,066 28.7 15.9 12.6 - 11.5 8.3 7.0 - 2.3 - - -

Patsy stems UK 73 59 13.8 143.7 129.1 98.1 7.6 - - 65.2 1.7 1.7 1.6 1.4

Connecta AB Sweden 124 120 20.3 15.4 11.5 9.8 13.6 10.1 7.8 6.6 1.3 1.1 0.9 0.8

BOUVET ASA Norway 99 92 14.6 13.5 10.6 9.0 9.0 8.2 6.6 5.7 1.0 0.8 0.7 0.7

Osiatis Belgium 110 115 10.0 8.8 8.3 8.0 5.7 5.0 4.5 4.2 0.4 0.4 0.3 0.3

Aubay Belgium 90 90 16.2 10.6 8.5 7.6 6.8 5.1 4.1 3.8 0.4 0.4 0.4 0.3

Agrex Japan 105 67 30.4 - 43.7 17.5 3.8 - - - 0.2 - 0.2 0.2

Median 20.3 15.6 12.6 9.8 9.0 8.3 6.9 5.7 1.1 0.9 0.7 0.7

Russia

International peers

Russian IT sector comparative valuation





STRATEGY 2011 73

Armada Aimed to grow above the market

We view Armada as the best choice on growth in the IT sector. Armada operates only in the domestic market and is presented in all major IT segments. Armada has a solid track of revenues growth and effectively introduced cost-reduction measures in fall 2008 followed by 6 ppt y-o-y improvement in 2009 OIBDA margin to 12%. The management issued solid guidance on the top line and margins for 2010-11, which seems feasible. Armada does not reject plans on making purchases that allows sales to outpace the total market. The stock is traded with a significant 19% discount to international peers in terms of 2011E EV/EBITDA.

PROS

Major orders come from state-controlled entities. Up to 75% of the total revenues come from contracts with Russian government agencies and state corporations serving reliable source of cash inflow.

Organic development of IT services and software… After purchases of assets in 2007, Armada owns a production chain including hardware, software and IT services branches. Currently the company relies broadly on high-margin IT services and software production.

…And reasonable M&A strategy. Armada strategy stipulates acquiring 25% stakes in IT companies in various sub-segments (in order to avoid internal competition) with the option to expand to controlling stakes.

Sound guidance on the full 2010 and 2011. The Armada’s management expects the company’s top line to add 25-28% for the full 2010 and EBITDA margin to stand in 10-12%. Armada targets a 25-30% y-o-y improvement on the top line in 2011, considerably ahead the market growth rate. On the EBITDA level, for 2011 Armada views a 12-14% margin, up 2 ppt y-o-y.

Stable financial position. Armada has no debt, as it did not use loans to buy software and IT services companies in 2007, using instead $30 mln raised during the IPO. Also, the company may direct 3.6% treasury stock on acquisitions.

Cheap on multiples. Despite the fact that the stock appreciated 93% year-to-date, upside potential is not vanished. 2011E EV/EBITDA of 5.6 and 2011E P/E of 12.5 are 19% and 3% below international peers, respectively.

CONS

Strong competition in domestic market. As more IT companies enter the market, the competition for new clients among corporate clients is becoming stronger, which may reduce Armada’s margins.

High-beta IT sector comes with significant risks. If the Russian stock market performs drops, the IT sector’s trading stocks deliver a more drastic slump.

KEY FINANCIAL INDICATORS$ mn 2009 2010E 2011E 2012E 2013ERevenue 103 132 161 218 270Cash costs (91) (117) (140) (188) (232)EBITDA 12 15 21 30 38Net income - 7 12 16 20

RATIOS% 2009 2010E 2011E 2012E 2013ERevenue grow th (41) 28 22 35 24EBITDA margin 12.0 11.2 13.0 13.8 14.0Net margin 5.7 7.5 7.4 7.6


ArmadaCommon

Ticker ARMDRecommendation URPrice, $ 12.64Target price, $ -Upside/downside, % -

SHARE DATABloomberg ARMD RXReuters ARMD.MM

# of shares outstanding, mn 12EV, $ mn 118MC, $ mn 152MIN 12 mnth., $ 6.49MAX 12 mnth., $ 12.64

SUMMARY FINANCIALS, $ mnIFRS 2010E 2011E 2012ERev enue 132 161 218EBITDA 15 21 30Net income 7 12 16EPS, $ 0.62 1.01 1.35Rev . growth, % 28.1 21.9 35.3EPS growth, % - 61.9 33.3EBITDA margin,% 11.2 13.0 13.8Net margin, % 5.7 7.5 7.4


P/E 20.3 12.5 9.4EV/EBITDA 8.0 5.6 3.9

PRICE DYNAMICS


50

100

150

200

22.12.09 22.3.10 22.6.10 22.9.10 22.12.10

ARMD RTS

Source: company data

Free float is above 50%Armada shareholders structure, %

56.5

8.7

3.6

10.4

10.4

10.4

Free f loat Kuzov kin Treasuries

Belik Morgulchik Kaplun

74 STRATEGY 2011

Transport Outpacing economic recovery

STRATEGY 2011 75

Maria Kalvarskaia [email protected] Tatiana Zadorozhnaya [email protected]


Transportation segment recovery outperformed economic growth in 2010 with 7.5% expansion in freight turnover and 3% in transportation volumes. The core growth drivers were metal and coal segments as well as container transportation. Construction sector was lagging the others and is expected to boost volumes in 2011. Improving macroeconomic conditions determine growing demand for passenger transportation services that is reflected in higher volumes of passenger turnover and better financial performance. In 2011 we expect gross transportation volumes (without pipes) to expand by 3-4% with 6-7% in rail freight. 2010 was also important for Russian transportation companies on the stock market. Traded shares reached their pre-crisis levels, while TransContainer entered the market driving up interest to the segment. We keep our positive view on the transportation companies in 2011, but recommend using the market weakness to enter the stocks of Aeroflot (AFLT), Globaltrans (GLTR) and TransContainer (TRCN).

Growth in transportation segment beat forecast. Freight turnover grew by 7.5% over 11M10 with 9.4% expansion in rail segment. Improving economic conditions helped to increase volumes.

Recovery will continue in 2011, but at slower pace. We expect 6-7% growth of rail transportation volumes with the highest growth in construction and container segments.

Tariff to grow by 8% in 2011, methodology to change in coming years. According to FTS rail transportation tariff is set to grow by 8% in 2011. RZhD is developing new methodology of tariff calculation based on return on invested capital, which may lead to higher growth rates in coming years.

Container segment to post strong growth rates. In 2010 container transportation segment is expected to expand by 19-20% thanks to economic recovery and consumption growth. In 2011 container business will continue upward trend beating the average growth in transportation segment.

Privatization plan – more players coming to the market. In 2010 RZhD successfully sold 35% of TransContainer on the market through IPO. In 2011 RZhD will continue privatization program. More private players will increase competition on the market and create new investment opportunities.

Air passenger transportation – a good year with upside potential. In 2010 air passenger traffic grew by 30% exceeding pre-crisis level and outperforming the world market. Better economic conditions will provide further expansion of the segment.

Transportation stocks – buy on weakness. Among the traded transportation companies we prefer shares of Aeroflot (AFLT), Globaltrans (GLTR) and TransContainer (TRCN). Further economy growth will improve operational and financial company’s results, but current prices close to pre-crisis level, therefore we see the growth potential as limited. We recommend using the market weakness to enter the stocks.

Source: Bloomberg, MICEX, RTS

YTD sector dynamic vs. RTS in 2010

-50% 0% 50% 100%

RTS

GLTR

AFLT

TMAT

NCSP

FESH

PRIM

22.12.2010 Max Min

Source: TKB Capital calculation, Bloomberg, MICEX, RTS

60%70%80%90%

100%110%120%130%140%

Dec

-09

Jan-

10F

eb-1

0M

ar-1

0Ap

r-10

May

-10

Jun-

10Ju

l-10

Aug

-10

Sep

-10

Oct

-10

Nov

-10

Transport RTS


76 STRATEGY 2011

Freight transportation

Growth of transportation volumes in 2010 will beat forecasts. Over 11M10 the total Russian turnover volume of freight transportation grew 7.5% y-o-y to 4.322 bn t-km (vs. 4.021 bn t-km in 11M09). Air transport demonstrated the most robust growth (35% y-o-y). However its share in the total transportation is traditionally just marginal and amounts to less than 1%. The growth rate of motor and rail cargo turnover matched over the period and reached 9.4%, while motor cargo load decreased by 1.8% against growth by 9.2% in rail transportation. This means that the volume of motor transportation decreased with expansion of transportation distance. Our previous freight turnover forecast was at 6%, but thanks to faster recovery of private consumption 11M10 results already exceeded this level. We do not expect significant changes in the freight turnover in December and see full year growth close to 7-8% in 2010. We believe that further economic recovery will be driving up total freight cargo and the volumes may reach pre-crisis levels already in 2011.

Source: Rosstat

Russian freight turnover structure by type of transport over 11M10, %

42.3%

4.1%

2.2%

1.2%

50%

0.1%

Pipeline Railway Road Marine Riv erine Air

Source: Federal State Statistical Service

Freight turnover, bn t-km

250

300

350

400

450

500

Jan

Feb

Mar

Apr

May Ju

n

Jul

Aug

Sep

Oct

Nov

Dec

2008 2009 2010

Railway transportation Rail freight transportation kept its leading position reflecting economic recovery. Railway transportation outperformed the industry in whole and demonstrated strongest growth rate over 11M10 (except air transportation). At the same time after very strong results in 1H10, the growth rate of Russian rail transportation slowed down in 2H10 due to higher base in 2H09. Thus rail cargo load increased by 9.4% over 11M10 (12.2% over 6M10) to 1,105 mn t (vs.1,013 mn t in 11M09), while total cargo load increase by just 1.2%. The strongest growth in year terms was shown by container transportation, metals and mining segment as well as construction sector. In spite of impressive growth rates in 2010, total railway cargo transportation, except container, oil, coking coal and fertilizers, still did not reach pre-crisis levels. However we expect to see full recovery of cargo transportation volume already in 2011, while development will change cargo mix. Due to high growth rate of cargo transportation, recently Russian Railways for the third time increased its forecasts for the full year from 7.4% to 8.7% growth (at the beginning of the year RZhD expected 3.7%), which corresponds to our expectation.

Source:Federal State Stat is tical Serv ice, TKB Capital

The m ain characte r is tics of fre ight transportation in Russ ia in 2010

0

200

400

600

800

Jan Feb Mar Apr May Jun Jul Aug Sep Oct

-5%

0%

5%

10%

15%

20%

Freight turnov er, bl t-km Cargo load, mn tFreight turnov er growth rate y -o-y , % Index of industrial production y -o-y , %Cargo load growth rate y -o-y , %


STRATEGY 2011 77

Growth will continue in 2011, but at lower rate. Impressive growth of rail cargo transportation in 2010 was mainly attributed to low base in 2009 and we expect growth rates in railway freight transportation in Russia to slowdown in 2011. However we believe that economic growth in 2011 (according to our forecasts GDP will rise by 4.3%) will provide further recovery of transportation industry. Moreover, due to export-oriented structure of railway cargo traffic coupled with more rapid rebound of some industries freight transportation will outperform industrial production and the economy as a whole. We expect to see increase in the volume of Russian railway cargo load by 6-7% y-o-y in 2011. In our view the main triggers of growth will be segments of the construction materials (thanks to restoration of new construction volumes), metals and mining, and container transportation.

Source:RZhD, TKB Capital

Volume and growrh rate of cargo load on the Russian railway in 2010

0.0

5.0

10.0

15.0

20.0

25.0

30.0

Jan Feb Mar Apr May June Jul Aug Sep Oct Nov

0%

5%

10%

15%

20%

Coal, mn t Oil and oil products, mn tConstruction materials, mn t Iron ore, mn tRail cargo load growth rate y -o-y , %

Tariffs set to grow by 8% in 2011. In 2010 tariffs were set 9.4% up y-o-y, while in 1H10 prices on cargo transportation increased by 10-15% backed by demand recovery. The government set the growth rate of tariffs for rail transportation at 8% in 2011. However FTS continued adjusting tariffs that may lead to stronger growth rates in ferrous metals segment (FTS provided information about tariff growth at 30-65% for some export/import directions). But in general transportation prices for metal companies will change in line with tariff growth set at 8%. These adjustments will allow to redirect export flows from ports to inland border posts to optimize routing and reduce capacities overutilization in ports. We see slightly positive effect for transportation companies working in these segments (for Globaltrans for example) and neutral to marginally negative effect for metal companies.

Railway tariff regulation in Russia – to change soon? In November, 2010 FTS approved new methodology of RZhD tariff calculation based on return on invested capital. With new tariffs the company is planning to earn money both for operating activities and for implementation of its long-term investment program. RZhD considers to start using this methodology beginning from 2012. Tariff increase for 2012-2013 will be considered in 2011. However, according to RZhD calculations based on this method, tariff’s growth rates in 2012 and 2013 should reach 23% and 7.6% respectively. Otherwise Russian Railways expect to get additional subsidies from the state to finance their investment program. For now we do not consider the announced numbers as a guide for the future tariff growth. In 2011 prices for rail transportation will grow in line with RZhD tariff with higher rates in some segments.

More players on the stock market will joint TransContainer and Globaltrans. Russian transportation industry shows impressive growth rates outperforming the world numbers in many segments. That boosted investors’ interest to the Russian transport industry. Successful placement of TransContainer in 2010 gave a start for privatization process of RZhD railway subsidiaries and proved again interest to the segment. Further privatization of RZhD assets will provide more opportunities on the market. Thus railway monopoly plans to sell 10-15% Freight One through IPO until the end of 3Q11, but final selling option is still not determined and total share’s placement (include private to a strategic investor) may amount to 75% (minus one share) during 2011-2012. Moreover, company is thinking about TransContainer’s SPO and IPO of Freight Two in two years.


78 STRATEGY 2011

Russian railway container transportation Railway container transportation takes a leading position in inland traffic. Container transportation market in Russia includes railway, marine and road traffic. Maritime transport holds a leading position in import and export transportation flows. However, despite its low cost, the trip time of marine transportation is much longer than via railway and road routes, additional costs arise as the cargo should be delivered to/from port. At the same time, due to the structure of the Russian economy and geographically spread industrials centers, railway dominates in total container transportation. Moreover, railway transportation is the only cargo transportation mode in some regions of Russia, for example, east of the Urals.

Source: RZhD information center

The volume of container transportation in Russia by month in 2007-2010, mn TEUs

17% 18% 12% 15% 15% 16%

-29% -27%-19% -19% -22% -21%

-27%-23% -24% -22%

-12% -15%

0

50

100

150

200

250

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

2010/2009 (rhs) 2009/2008 (rhs) 2010 (lhs)

2009(lhs) 2008(lhs) 2007(lhs)

Before the crisis the Russian container market outperformed the global trend. Due to significant growth in Russian import and export flows (as a result Russian economic development), before the crisis the Russian container market outperformed the global trend and grew from 1.0 mn TEUs in 2001 to 2.5 mn TEUs in 2008 (including loaded and empty-run trips). However during the crisis, due to high share of import flows in total container transportation (30% in 2008) dropped by 57% y-o-y to 207,000 in 2009 (478,000 TEUs in 2008), Russian railway container traffic declined by 21% in 2009, while marine container transportation dropped by 38%.

Growth container transshipment in Russiain 2004-2010E, mn TEUs

Sources: Association of Russian Ports (ASOP), RBC report, A.T. Kearney analysis

1.4

1.9

2.42.7

3.4

2.1

2.7

1.5 1.7 1.82.1

2.5

1.92.2

0

0.5

1

1.5

2

2.5

3

3.5

4

2004 2005 2006 2007 2008 2009 2010E-50%-40%

-30%-20%-10%0%

10%20%30%40%

Port's handling, mn TEUs (lhs) Rail shipping, mn TEUs (lhs)

Port's handling growth rate, % (rhs) Rail shipping growth rate, % (rhs)


STRATEGY 2011 79

Higher import volumes and favorable pricing to provide stable growth. As a result of high dependence the container transportation on the economic situation, this segment started to recover only at the end of 1H2010 backed by global and domestic economic revival. Thus, thanks to the rebound in the economy and increasing domestic consumption, the volume of Russian rail container transportation in 2010 will increase by 19-20% y-o-y and reach 2.3 mn TEUs (loaded and empty run). We think that thanks to growth of import flows (13% in 2011 according to expectations of the ministry of economic development), higher level of containerization, as well as development of sea port and rail infrastructure we will see further increase in the volume of rail container transportation in 2011, but growth rate will slowdown and amount 9-11%. Pre-crisis level of container transportation is likely to be reached in 2013. Container transportation remains favorable for class 3 cargo as it is cheaper to transport them in container rather than in box-cars. In 2011 tariffs for container transportation will grow by 5% vs. 8% for railway services that also increase efficiency of container services.

The growth of rail container transportation by type of directions, 000 TEUs loaded containers

Sources: RZhD database, A.T. Kearney analysis, A.T. Kearney rail forecast model

546 567 594 498 620 660 705 756 814 872229 350 478

207347 383 422 455 489 526

317344

413

413

418 447 477 508541

574

96125

118

91

126 132141

149163

176

1,1881,386

1,603

1,2091,511 1,622 1,745

1,8682,007

2,148

2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E 2015E

Domestic Import Export Transit CAGR(2009-2015)

12%

17%

6%

10%

+16% -25%

+10%

The growth of the Russian container market will outperform overall global market. Container transportation sector is strongly dependent on the global and domestic economic environment, therefore growth rates of transportation volumes will hinge on the economy’s rebound. As a result of global economic recovery (up by 4.3% in 2010E vs. 0.5% decline in 2009), container cargoes started demonstrating positive performance already in 1H10. Owing to more robust growth of developing economies (BRIC GDP growth is estimated at 5-7% over next 10 years vs. 2-3% for developed countries), expansion of transportation volumes on EM is likely to outperform growth rates on DM. At the same time, due to higher expected growth rates of real GDP at 4.4% CAGR in 2010-2013 (based on our estimates) with high growth rate of real consumer spending per capita, we think Russia is the most attractive for investments among the BRIC countries.

Sources: RZhD database, A.T. Kearney analysis, A.T. Kearney rail forecast model

Russian rail container transportation grow th in 2006-2015, '000 TEUs

654 734 848 716 797 855 920 986 1,058 1,133

1,1881,387

1,6021,209

1,512 1,622 1,7441,868 2,006

2,1481,8422,121

2,450

1,9252,309

2,4772,664

2,8543,064

3,281

2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E 2015E

Empty Loaded

+15% -21%+9%


80 STRATEGY 2011

Air passenger transportation Air passenger transportation outperformed Russian transport market. Russian passenger turnover over 10M10 increased by 3.9% and reached 356 bn p-km, however growth was mainly due to increase of air transportation, according to the Rosstat. Air passenger turnover over 10M10 increased by 30% y-o-y against the decline of passenger traffic by motor and railway transport by 1.2% and 10% respectively. In spite of the higher prices for air transportation, the growth rate of air transportation volume significantly exceeds other segments, thus its share in total passenger traffic in Russia since 2007 increased from 25% to 34% in 2010. Further economic recovery, higher real disposable income growth coupled with increasing availability of air transportation (thanks to appearance of low cost airlines) will drive growth of air transportation share in the structure of passenger traffic. We believe that Russian passenger market will keep positive trend in November-December and passenger transportation in Russia will increase by 4% over 2010.

Russian air traffic growth exceeded global peers. After the deep 9.4% y-o-y decline in 2009 and due to low prices for transportation in 2010, the passenger turnover of air transportation increased almost by 30% y-o-y to 125 bn p-km, while passenger transportation grew by 27.4% y-o-y to 43.7 mn passengers. In spite of this impressive growth mainly connected with low 2009 base, total volume of air transportation exceeded pre-crisis 2008 year by 16%. At the same time almost half of the growth was due to increased traffic five key airlines. Traditionally growth rates of Russia air transportation outperformed the world market in 2010, which increased by 11-13%. Thanks to the good operating results over 10M10 Rosaviation changed its forecast for air traffic growth from 24% to 30% for the year, which means that year 2010 will be the best for Russian aviation industry in modern country’s history since 1991. Moreover, according to recent 2010 IATA’s forecast global market will rise by 8.9% y-o-y. Thus growth rates of Russian air passenger traffic still will outperform world market.

We see big potential for growth in Russia's domestic air travel market. As a result of strong traffic growth in 2010 and expected increase in transportation prices, we anticipate slowdown in air passenger traffic in 2011. We expect that Russian air transportation will outperform world market and increase by 15% backed by growth of real disposable income coupled with the improvement of economic conditions as a whole. This is confirmed by the expectations of Rosaviation, which announced growth rate of air passenger traffic near 10-12% for 2011. Moreover, we believe that further increase in the economically active population, which use air services (currently only 5% of Russia's population), together with growing share of low-cost carriers in total Russian air transportation market (currently less than 4%) will take new opportunities for the development of Russian passenger aviation market.

Source: Mintrans

Russian airline passenger turnover growth rate in 2010

0

5,000

10,000

15,000

20,000

Jan Feb Mach Apr May June July Aug Sept Oct

0%

10%

20%

30%

40%

50%

Passenger turnov er 2010, mn p-kmPassenger turnov er 2009, mn p-kmAir passenger turnov er growth rate, y -o-y %

Source: Mintrans

Russian airline passenger transportation grow th rate in

0

2,000

4,000

6,000

8,000

Jan Feb Mach Apr May June July Aug Sept Oct

Passenger transportation 2010, mn persPassenger transportation 2009, mn persGrowth rate, y -o-y %

Transportation stocks Undervalued bet on recovery. Transportation segment suffered strong during the crisis, but recovery was fast following economic revival. Next year is expected to bring substantial growth in air transportation, where we prefer Aeroflot (AFLT), which financials beat pre-crisis level on EBITDA and bottom-line, while market capitalization is 30% below those numbers (we have no official recommendation and TP for the stocks). Globaltrans (GLTR) is traded close to its pre-crisis level and this fairly reflects financials recovery. We positively estimate the company’s prospects, but see upside potential for the stocks as limited, thus recommend buying the shares during the market weakness (12M TP $20.3). TransContainer (TRCN) is a relatively new name on the stock market, representing fast growing segment that increase attractiveness of TransContainer’s shares. We will initiate coverage of the company shortly after the winter holidays.

Source: Rosstat

Air passenger turnover, bn p-km

4

9

13

18

Jan

Feb

Mar

Apr

May Jun

Jul

Aug

Sep

Oct

Nov Dec

2008 20092010 2007

Source: Rosstat

Russian passenger turnover structure by type of transport,

bn p-km

420.8403.2446.3432

0

200

400

600

800

2007 2008 2009 2010

Railway Road Air

Source: Rosstat

Russian air passenger market structure by players, %

20%

12%

8.4%7.8%4%

48%

Aerof lot TRANSAEROSibir UtairOrenAir Other


STRATEGY 2011 81

Globaltrans Stable growth – buy on weakness

As we wrote in our strategy for 2H10 transportation segment was thought to be a hot topic backed by economic growth and more names entering the market. Globaltrans shares continued their positive dynamics and added 42% during the last 6 months. We still consider the company’s stocks to be an interesting idea for 2011 as demand for transportation services remains solid, but upside potential for 2011 is limited. We recommend using market weakness to increase stake in the company as rail transportation segment will continue growing and corporate events in the segment will boost interest to the traded shares. We do not exclude Globaltrans participation in M&A deals, while optimization of routs will support financial performance of the company. Our 12 TP of Globaltrans shares is $20.3.

The largest private player with diversified operations. The company’s business is well balanced and diversified with metal segment as well as oil&gas providing 82% share of revenue. Globaltrans owns 21,626 gondola cars and 19,598 oil tank cars. Demand on transportation in gondola cars is stably high that determines attractive pricing on the market and reduces costs related to empty runs. In 1H10 according to the company’s numbers 45% of freight rail turnover came from metallurgical segment, 33% from oil segment. Construction sector is still lagging in volumes recovery, and 2011 is expected to bring more activity in this segment that will increase transportation volumes.

2H10 financial performance will support stock price. Over 1H10 Globaltrans posted revenue growth at 28% y-o-y to $407.5 mn with EBITDA margin recovery to 44%. 2H10 is expected to be at least as successful as 1H10, while profitability will be even higher with lower costs of empty runs beard by the company. Globaltrans is planning to publish 2010 full year financials in the end of March – beginning of April, which together with details on the company’s development in 2011 will support the stocks.

Revenue to grow at CAGR of 11% in 2011-2015. We expect net adjusted revenue to grow at CAGR of 11% thanks to transportation price increase, optimization of the cargo mix and routing. Average price per trip will increase by 16% during the period in dollar terms, while number of trips per year will go up by 46%. Empty run costs will decline comparing to 2009 driven by dispatch optimization, high demand for transportation services and economic recovery.

M&A deals and new placement on the market to be strong drivers. Globaltrans is active in M&A deals aiming at expansion of its fleet and transportation routs. The company is constantly watching the market and we expect to see more deals in the coming future. In 2011-2012 Freight Two is planned to be privatized and Globaltrans is considered as one of potential strategic buyers.

Buy on weakness. In 2010 Globaltrans GDRs grew by 82% and now they are traded with EV/EBITDA 2011E 7.0. Globaltrans GDRs are valued with a 26% discount to their EM peers and with a 7% discount to DM peers. In 2010 EBITDA margin is estimated 42.8% and we expect it at healthy 44-45% in 2011-2014. We positively view prospects of the company, but estimate upside potential from the current levels as limited. We recommend using weakness on the market to buy the stocks.

GlobaltransGDR

Ticker GLTRRecommendation BUYPrice, $ 18.0Target price 12M, $ 20.3Upside, % 13%

SHARE DATABloomberg GLTR LIReuters GLTRq.L

GDR# of shares outstanding,mn 158EV, $ mn 3,135MC, $ mn 2,846MIN 12 months, $ 9.35MAX 12 months, $ 18.47

CommonShares per GDR 1

SUMMARY FINANCIALS, $ mnIFRS 2010E 2011E 2012ENet rev enue 823 999 1,122Adj.EBITDA 352 447 513Net income 205 275 320EPS, $ 1.30 1.74 2.02Rev . growth, % 20.3 21.4 12.3EPS growth, % 70.7 34.1 16.3Adj.EBITDAmargin,%

42.8 44.7 45.7

Net margin, % 24.9 27.5 28.5


P/E 13.9 10.4 8.9EV/EBITDA 8.9 7.0 6.1

SHAREHOLDER STRUCTURETIHL 50.10%EIL 14.45%Free-f loat 35.45%

PRICE DYNAMICS

Source: LSE, TKB Capital estimates

6

11

16

21

22.12.09 22.3.10 22.6.10 22.9.10 22.12.10

GLTR RTS


82 STRATEGY 2011

Globaltrans

BALANCE SHEET$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ETOTAL CURRENT ASSETS 300 326 371 565 757 953 1,151PP&E, net 905 1,042 1,237 1,298 1,354 1,417 1,486Other non-current assets 56 59 72 58 63 67 70Total NON-CURRENT ASSETS 965 1,104 1,311 1,359 1,420 1,486 1,559TOTAL ASSETS 1,265 1,430 1,682 1,924 2,177 2,439 2,710Short-term borrow ings 153 154 128 161 165 130 130Trade and other payables 64 92 107 119 129 140 152Other short-term liabilities 1 2 2 2 3 3 3Total CURRENT LIABILITIES 218 247 237 282 297 273 285Long-term borrow ings 296 273 324 274 219 203 154Other non-current liabilities 39 34 27 18 20 22 23Total NON-CURRENT LIABILITIES 335 307 351 292 239 225 177Minority interest 101 142 197 261 334 409 486Share and additional capital 278 278 278 278 278 278 278Retained earnings 332 455 619 811 1,030 1,254 1,485Total EQUITY 610 733 897 1,089 1,308 1,532 1,763TOTAL EQUITY & LIABILITIES 1,265 1,430 1,682 1,924 2,177 2,439 2,710

INCOME STATEMENT$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ENet revenue 684 823 999 1,122 1,228 1,297 1,366Cost of production (396) (467) (546) (605) (660) (716) (776)EBITDA 281 352 447 513 565 579 589Adjusted EBITDA 285 352 447 513 565 579 589DD&A (53) (62) (69) (82) (86) (89) (93)EBIT 228 290 378 431 480 490 496Net interest income/(expenses) (79) (35) (35) (32) (24) (22) (15)EBT 150 256 343 399 457 468 481Income tax (30) (51) (69) (80) (91) (94) (96)Net income 120 205 275 320 365 375 385

CASH FLOW STATEMENT$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ENet CF from operating activities 271 309 338 453 475 481 486Net CF from/(used in) investment activities (167) (202) (266) (144) (142) (153) (163)Net CF from/(used in) financing activities (81) (143) (116) (176) (221) (193) (194)Net Debt 289 305 374 225 61 (125) (303)

RATIOS% 2009 2010E 2011E 2012E 2013E 2014E 2015ENet adjusted revenue grow th -12% 20% 21% 12% 9% 6% 5%Adj. EBITDA margin (to net revenue) 42% 43% 45% 46% 46% 45% 43%Net margin (to net revenue) 18% 25% 27% 28% 30% 29% 28%Net Debt/Adj. EBITDA 1.0 0.9 0.8 0.4 neg. neg. neg.

Source: Globaltrans, TKB Capital estimates


STRATEGY 2011 83

TransContainer Appealing infrastructure play

TransContainer is the largest intermodal container operator in Russia, providing transportation services and integrated logistic solutions for its customers. The recovery in domestic consumption, increase in containerization levels and expansion of transit traffic from Asia to Europe will determine the growth in the Russian container transportation market, where TransContainer plays the leading role. The company’s unique asset base allows it to provide high-value, end-to-end logistic services and maximize operational efficiency. We have positive view on TransContainer and plan to initiate the coverage in the offing.

Container market growth will outperform global economic trends. Due to the rapid market recovery (GDP will increase in 2011 by 4.3%) and the rebound in private consumption, Russian container transportation will outperform the global one, posting a 2011 growth rate of 9-11%. Economic growth and low level of containerization in Russia will help to expand volumes that makes container business attractive for investors.

Favorable pricing will support development of the segment. Container transportation is efficient for cargo class 3 as tariffs for containers are close to cargo class 2. Moreover, in 2011 FTS set tariff growth for rail container transportation at 5% vs. 8% for rail-based shipping. This confirms the state strategy to develop container business and increase competitiveness of container services. This change in tariffs will attract additional container cargo and increase containerization level.

Leading position on the market and unique asset base. The Company is the largest operator of railway container transportation with a 52% stake on the market, which has strong growth potential. We estimate container transportation to grow by 53% in the next 5 years. The Company’s extensive asset base permits its leading role in a market with high entry barriers and allows it to provide high-value, end-to-end integrated logistic solutions to its customers. As of 30 June 2010, the company owned 25,463 flatcars, 58,394 ISO containers and 47 terminals (46 in Russia and one in Slovakia), and a substantial fleet of trucks.

Integrated services and spread geographic presence as the strengths. TransContainer is the leading provider of high value integrated logistic solutions, which include end-to-end intermodal container transportation, handling and freight forwarding services. We estimate integrated services to provide up to 53% of the revenue by 2014. TransContainer has strong domestic and international presence based on 47 container terminals, 148 services centers and sales offices, international subsidiaries and joint ventures with international partners. TransContainer serves more than 20,000 regular customers with the top 10, generating 23.3% of revenue.

Economic recovery and sophisticated management to support efficiency. Growth of demand for container transportation will result in fewer empty runs and higher efficiency ratios. Route expansion, containerization of new cargo types, optimization of the freight transportation and pricing will improve company’s financial performance. We estimate 2010 financial results to be close to pre-crisis level on top-line with lagging recovery of efficiency ratios. 9M10 operating results support our forecasts for 2010 financials, which are to be published by April 20, 2011.

Cheaper than peers, but with strong growth profile. Since IPO TransContainer shares grew by 17% to $9.35. Currently TransContainer’s GDRs are traded at EV/EBITDA ratio at 6.3 2011E, which means 33% discount to the EM peers. Further economic recovery, expanding demand for transportation services and better pricing environment attracting flows to container business will determine the company’s growth in the future, while new placements on the market may increase interest to the stocks. We are planning to start covering TransContainer shares shortly after the winter holidays.

TransContainerCommon GDR

Ticker TRCN TRCN LIRecommendation NR NRPrice, $ 94.4 9.4Target price 12M, $ NA NAUpside, % NA NA

SHARE DATABloomberg TRCN RX TRCN LIReuters TRCN.MM TRCNq.L

Common GDR# of shares outstanding,mn 13.9 138.9EV, $ mn 1,451 1,439MC, $ mn 1312 1,299MIN, $ 78.57 7.49MAX, $ 99.95 10.00

Common GDRSwap ratio 0.1 10

SUMMARY FINANCIALS, $ mnIFRS 2010E 2011E 2012ENet rev enue 531 661 791Adj.EBITDA 165 228 314Net income 44 88 137EPS, $ 0.32 0.63 0.98Rev . growth, % 27.1 24.5 19.8EPS growth, % 139.7 97.2 56.0Adj.EBITDA margin,%

31.2 34.5 39.7

Net margin, % 8.4 13.3 17.3


P/E 29.2 14.8 9.5EV/EBITDA 8.7 6.3 4.6

SHAREHOLDER STRUCTURERZhD 50%+1EBRD 9.25%NSPF BLAGOSOSTOYANIE 5.20%Other 35.55%

PRICE DYNAMICS

Source: LSE, TKB Capital estimates

7.1

8.1

9.1

10.1

9.11.10 23.11.10 7.12.10 21.12.10

TRCN LI RTS

84 STRATEGY 2011

Consumer and retail Ready, Steady And Go Shopping!

STRATEGY 2011 85

Natasha Кolupaeva [email protected]

Consumer and retail Ready, Steady And Go Shopping! We reiterate our POSITIVE view on consumer and retail sector in 2011, which we believe will continue to outperform the broad market indices. Consumer & retail offers both defensive (like pharma and food staples) and aggressive (like retail) exposure to the Russian economy growth, which is expected to go forward at a steady gait. We expect consumer power to be supported by further post-crisis recovery in oil prices, which will enable generous government social payments on the eve of the presidential elections in 2012. Moreover, consumer & retail segment is expected to gain on Sochi 2014 Winter Olympic Games and 2018 FIFA World Cup, which assume hefty investments into regional infrastructure and increase in the regional employment. At the same time, tightening of market regulation, which came into play in 2010, seems to remain one of the major risks in coming years. Our BUY TOP picks for 2011 are food retailers - Magnit and X5 Retail Group and pharma producers – Pharmstandard and Veropharm.

Consumer demand is on the uptrend

Ready to go shopping. Looking forward in 2011, we expect consumer demand to continue strengthening thanks to real disposable income growth, lower unemployment rate, relatively stable inflation and gradual consumer credit growth. We also expect consumer power to be supported by further post-crisis recovery in oil prices, which will enable generous government social payments in ahead of the presidential elections in 2012.

New macro assumptions imply more optimism. Our updated macro forecasts assume 2011 real disposable income growth of 4.7%, which should improve consumer purchasing power going forward. At the same time, we expect ruble to remain relatively strong at RUR29.5/$ and RUR28.5/$ (average) for 2011 and 2012, respectively, which would support companies’ US-dollar based top line growth.

In expectation of strong financial performance… In 1H11 we expect the main sector growth driver to be the disclosure of seasonally strong 4Q10 financials, which should significantly contribute to full-year figures. Besides, early next year companies are expected to elaborate on their expansion ambitions.

…and corporate events. 2H10 appeared to be event-intensive: retailer O`KEY successfully placed its shares on LSE, PepsiCo announced the acquisition of 66% stake in Wimm-Bill-Dann and retailer Kopeyka was acquired by X5 Retail Group. All these confirm the high attractiveness of Russian consumer & retail sector and we believe that a series of new IPOs, SPOs and M&As will be launched in coming years, heating investors’ interest toward the sector.

Fundamentally attractive

DCF valuation implies attractive upsides. The key investment theme in the sector remains the affluent long-term growth prospects for the Russian companies, which look more attractive than developed market peers and even the majority of emerging market analogues (particularly based on PEG ratio). We continue to highlight food retailers and pharma producers - for 2011 we recommend to BUY Magnit, X5 Retail Group, Pharmstandard and Veropharm.

Don’t disregard the risks

Macro conditions, regulation and change in taxation. The key risks in the sector are well-known - weaker than forecasted macro conditions and ongoing tightening of regulation. Moreover, since 2011 companies will face the change in the taxation – a step-up increase in insurance contributions (from 26% to 34%) and cancellation of the uniform tax on imputed income (which was applied by pharma retail).

Sector performance in 2010

-100% 0% 100% 200%

APTKPRTKGRAZ

SCOРТС

OKEYFIVE

PKBAPHSTVRPHPKBAKLNAMGNT

SYNDIXYGCHMVIDWBD

ROST

22.12.2010 Max Min

Source: RTS, LSE, TKB Capital estimates


80

130

180

Dec Jan

Feb Mar

Apr

May Jun

Jul

Aug

Sep Oct

Nov

RTS IndexConsumer & Retail

Russia’s retail sales dynamics

0

200

400

600

800

2000

2002

2004

2006

2008

2010

E

2012

E

2014

E

20%

25%

30%

35%

40%

45%

Non-FoodFoodas % of GDP, rhs

$ bn

CAGR 12%

CAGR 27%

Source: Federal Statistics Service, TKB Capital estimates

-10%

0%

10%

20%

янв

09ма

р 09

май

09ию

л 09

сен

09ноя

09янв

10ма

р 10

май

10ию

л 10

сен

10ноя

10

-15%-10%-5%0%5%10%

Real wage, % y -o-yDisposable income, % y -o-y realRetail trade, % y -o-y real

Source: Federal Statistics Service


86 STRATEGY 2011

Consumer demand is on the uptrend

Consumer demand is on the uptrend. As we expected, in 2010 consumer demand has been on the uptrend geared by the real disposable income growth (by 4.3% y-o-y for 11M10) supported by the increased pensions, which account for about 15% of gross personal income and were forecasted to rise by 38% this year (in real terms). At the same time, 11M10 real wages growth appeared to be slightly moderate at 4.5% y-o-y, which, on the other hand, means that companies are successful in optimizing personnel costs. As a result, we see the recovery of retail sales growth, which totaled 5% y-o-y in 11M10. Looking forward in 2011, we expect consumer demand to continue strengthening on further income growth due to lower unemployment rate (almost 7% in November vs. more than 9% in January) along with stable inflation and gradual consumer credit growth. Going forward, we expect consumer power to be supported by further post-crisis recovery in oil prices, which are expected to enable the government to increase social payments before the upcoming presidential elections in 2012. Moreover, consumer & retail segment is expected to gain on Sochi 2014 Winter Olympic Games and 2018 FIFA World Cup, which assume hefty investments into regional infrastructure and increase in the regional employment.

On the long way to DM…

0

10

20

30

40

0 1 2 3 4 5Spending on food per capita, $`000

Tota

l spe

ndin

g pe

r cap

ita, $

`000

Russia`08

Russia`15E

Russia`20E

NorwayUSA

Switzerland

Denmark

France

SingaporeJapan

India PolandBrazil

Source: USDA, TKB Capital estimates

4.1%

-15%

-5%

5%

15%

25%

Jan

08

Mar

08

May

08

Jul 0

8

Sep

08

Nov

08

Jan

09

Mar

09

May

09

Jul 0

9

Sep

09

Nov

09

Jan

10

Mar

10

May

10

Jul 1

0

Sep

10

Nov

10

Food Non-Food

Retail sales dynamics, % y-o-y

10M10, % y-o-y:food 5.5%non-food 3.4%


New macro assumptions imply more optimism. Our updated macro forecasts assume 2011 real disposable income growth of 4.7% y-o-y on the expected recovery in real wages and indexation of pensions, which should improve the consumer purchasing power. At the same time, we expect ruble to remain relatively strong at RUR29.5/$ and RUR28.5/$ (average) for 2011 and 2012, respectively, which would support companies’ US-dollar based top line growth. Looking forward, we see the economy to grow quite moderately at 4-5% y-o-y in real terms in 2011-2020, which however looks sufficient to reach Top 5 world economies by 2020 (taking into account Euromonitor projections) after China, the USA, India and Japan (in PPP terms) from the current 9th place. All in all, we now see more evidence for our optimism regarding the sector growth prospects.

Key macro parametrs2000-08 2009 2010E 2011-15E

Real GDP grow th, % CAGR 6.9% -7.9% 4.1% 3.8%CPI, % (avg) 13.7% 8.9% 8.5% 7.3%Real w ages, % 14.7% -2.8% 4.5% 3.4%Real disposable income grow th, % CAGR 10.7% 2.3% 7.5% 3.4%Retail trade, % CAGR 11.9% -5.5% 4.6% 4.7%Retail trade as % to GDP (avg) 33.3% 37.2% 36.1% 40.0%Unemployment rate, % (avg) 7.8% 8.4% 7.0% 7.0%Source: Federal Statistics Service, TKB Capital estimates In expectation of strong financial performance… In 1H11 we expect the main sector growth driver to be the disclosure of seasonally strong 4Q10 results, which should significantly contribute to full-year figures. Besides, the market is now reloading more optimistic scenario in sector valuation, which is justified by the ongoing consumption recovery in food and non-food segments as well as companies’ bullish investment programs. For instance, Magnit’s capex in 2011E will total $1.5 bn, X5 has guided the market of almost $1.3bn investments in 2011 development plans and Cherkizovo reinstate its plans for almost 50% increase in poultry & pork production volumes by 2012. All these imply that companies’ are ready to deliver the expected solid performance on both top line and bottom line, focusing also on the improvement of operating efficiency.

Consumer confidence index and retail sales dynamics

-60

-40

-20

0

3Q99

3Q00

3Q01

3Q02

3Q03

3Q04

3Q05

3Q06

3Q07

3Q08

3Q09

3Q10

-20%

-10%

0%

10%

20%

Consumer conf idence indexReal retail sales growth, % y -o-y


-10%

-5%

0%

5%

10%

2008 2009 2010E 2011E 2012E 2013E

Real GDP growth, y -o-yReal disposable income, y -o-y

Source: MEDT, TKB Capital estimates


STRATEGY 2011 87

…and corporate events. We saw that 2H10 appeared to be event-intensive. In early November hypermarket chain O`KEY successfully raised $420 mn via IPO on LSE (at 14 EV/EBITDA`10F). In early December, PepsiCo announced the acquisition of 66% stake in Wimm-Bill-Dann for $3.8 bn (implies EV/EBITDA`10F at 16.1), intending to consolidate 100% of the company thereafter. Also in early December, Kopeyka was acquired by X5 Retail Group for $1.65 bn (including debt, which implies EV/EBITDA`10F at 12). At the same time, American retail giant, Wal-Mart, decided to go away from Russia and close its Moscow office, which was quite expectable as the retailer has lost its chance to buy cheap in crisis, while the Russian retail companies have started to trade with the premium to EM recently. However, Wal-Mart said it will keep a close eye on the possible entry points to the Russian market in coming years, which implies the company is likely to wait until the Russian market goes through the consolidation process and come back with a multi-billion offer for the key player, just as Pepsi did for Wimm-Bill-Dann. All these confirm still high attractiveness of the Russian consumer & retail sector and we believe that a series of new IPOs, SPOs and M&As will be launched in coming years.

Fundamentally attractive

DCF valuation implies attractive upsides. The key investment theme in the sector remains the affluent long-term growth prospects for the Russian companies, which look more attractive than DM and even the majority of EM (particularly based on PEG ratio). The grounds for such growth are still low level of per capita consumption of main goods vs. European levels in line with upbeat expectations of steady growth in disposable income per capita toward European benchmarks in the long run (to above $15,000 by 2020 from $5,300 in 2009). We continue to highlight food retailers and pharma producers - for 2011 we recommend to BUY Magnit, X5 Retail Group, Pharmstandard and Veropharm.

Don’t disregard the risks

Macro conditions, market regulation and change in taxation. The key risks in the sector are well-known. The consumer power recovery trend may be undermined by weaker than forecasted macroeconomic conditions. At the same time, we see the regulation tightening, which came into play in 2010 (for instance, in food retail, pharma, brewing, alcoholic beverages, etc…), may spread to other segments as well (in particular, we expect further considerable increase of the excise tax on alcohol). However we believe the market will make all necessary adjustments in the long-run. There are additional points of concern – in respect of the change of taxation, which are as follows:

We would remind you that since 2011 the simplified system of taxation, which implies uniform tax on imputed income, is expected to be gradually ceased to exist. Instead of this, tax payers, which now apply the simplified system of taxation (in particular, pharma retailers) and have more than 100 employees, will have to switch to the common tax system and thus to pay 10% or 18% VAT, 2% property tax, 20% income tax and others. Thus, individual entrepreneurs and organizations will face an increase in the tax burden since 2011, which may hurt their profitability. Among the public companies, the simplified system of taxation is implemented by Proteks’ retail business and Pharmacy Chain 36.6. Thus they will be impacted by this change, which is expected to lead to 1.3-1.5 p.p. deterioration of their EBITDA margin in 2011. We expect consumer & retail companies to pass-through the increased tax costs onto consumers, though we also expect them to focus on the operating efficiency improvement.

At the same time, there is another change in taxation. We would also remind you a step-up increase in the direct insurance contributions (which replaced the unified social tax since 2010), which will amount to 34% since 2011 vs. 26% in 2010 (for tax payers under the common tax system) and vs. 14% in 2010 (for tax payers under the simplified system of taxation). This implies an increase in the companies’ SG&A costs, which is expected to cost up to 0.5 p.p. EBITDA margin. As in the previous case, we expect companies to pass-through the increased tax costs onto consumers and also believe they will aim to enhance the efficiency of the work force.

100%

90%

100%

110%

120%

2008

2009

2010

E

2011

E

2012

E

2013

E

Retail trade recov ery (in real terms)

real

gro

wth

, %

y-o

-y

2008 Lev el = 100%


Modern format penetration

in food retail, %

70%

53%

35%

0%

20%

40%

60%

80%

100%

Den

mar

kF

ranc

eN

ethe

rland

sSw

eden

Rus

sia`

20E

Bel

gium

Port

ugal

Cze

chH

unga

ryR

ussi

a`15

EP

olan

dR

ussi

a`09

Rom

ania

Phi

lippi

nes

Indo

nesi

aIn

dia

Source: Eurostat, Minpromtorg, TKB Capital estimate

Market share of Top5 players, %

82% 1%11%15%68%0%

40%

80%

Mob

ileph

ones

Con

sum

erel

ectr

onic

s

Pha

rma

reta

il

Food

ret

ail

Clo

thin

gs



88 STRATEGY 2011

Food retail in 2011 Growing companies and growing stocks Recovery in food is apparent; non-food is catching up. As we expected, in 2010 food retail sales have continued to demonstrate a sizable recovery, while non-food segment is still catching up. Retail sales statistics for 11M10 showed 4.4% y-o-y growth with 5.5% y-o-y growth in food and 3.4% y-o-y growth in non-food. We attribute it to the fact that real disposable income growth in 2010 was mainly due to increase in pensions. These have supported food retail companies’ sales (discounters and hypermarkets), as pensioners and other low-budget consumers, who focus on staples goods consumption (in particular, food and drugs), are the target audience of discounters and to some extent of hypermarkets. We see food retail companies to remain our favorites for 2011 as we expect further sizable increase in social payments by the government ahead of the presidential elections in 2012.

Discounters and hypermarkets continue to win traffic. In 2010 we saw that food discounters and hypermarkets continued to outperform the market in LFL sales growth and we expect them to remain on the front line through 2011. As earlier, we consider supermarkets and non-food segment to be a longer term bets on consumption recovery. We also see non-food retailers expressing optimism and ambitious expansion plans (in particular, in such segments as apparel, consumer electronics, cosmetics, sporting goods, etc. and even luxury goods).

Store openings and efficiency gains drive value. We see that in 2011 most retail companies plan to speed up their store openings, while focusing on the effective cost control. For instance, Magnit’s capex ambitions for 2011E amount to $1.5 bn, while X5 guided the market of a considerable step-up in 2011 development plans (the market is still waiting for the company’s capex disclosure). At the same time, Dixy said it will open 150 stores next year, spending up to $100 mn, and try to restrain its SG&A costs growth by targeting the decrease of inventories shrinkage. We believe that next year disclosure of seasonally strong 4Q10 will significantly contribute to the companies’ solid full-year financials, while next year trading updates should reflect the realization of companies’ ambitious top line growth targets.

Food retail: market shares of key players, %2010E 2015E 2020E

X5 Retail Group 4% 9% 14%Magnit 3% 8% 14%Auchan 3% 4% 6%Metro Cash & Carry 2% 2% 3%O`Key 1% 2% 4%Dixy 1% 2% 2%Lenta 1% 2% 3%Seventh Continent 1% 1% 1%Share of top 5 players 12% 25% 39%Source: TKB Capital estimates New market rule is regulation. Since 2010, food retailers have been adjusting their operations to comply with the Trade Law, which created new reality for food retailers and suppliers. We would remind you that from 1 August food retailers are obliged to set supplier bonuses (which suppliers pay to retailers) at not more than 10% with no any bonuses allowed for socially important goods (the list of products includes chicken, milk, rye bread, wheat bread, wheat rolls and buns) and comply with maximum payment period for food products (10, 45 and 90 days), depending on their shelf life. The government now has the right to introduce price caps for socially important food for not more than 90 days in the case of more than 30% price increase during one month. At the same time, the most thrilling clause of the Trade Law regarding food retailers’ market share regulation has come into effect since 1 July, 2010. Now food retailers are prohibited from new store openings or acquisition of stores if its retail sales exceed 25% of the total retail turnover of a particular urban district (or municipal region, in particular, Moscow and St. Petersburg). However, we saw that the market share regulation didn’t hurt X5 Retail Group ambitions to acquire Kopeyka in mid-December, though it was obliged to sell or close around 27 of about 700 Kopeyka’s stores, which seemed to be in violation of the market shares limitations. All in all, we see that the Trade Law market share restrictions had no material implications on the food retailers’ ambitious investment programs, which were even step-up to all-time record levels. We estimated that Russian food retail market is able to more than double its selling space by 2020, which assume about 15 mn of modern format retail space to be added before achieving the market saturation level close to that of developed countries.

Russia food stores roll-out prospects

0

5,000

10,000

15,000

20,000

25,000

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

0

50

100

150

200`1000 sq msq m per 1000 inhabitants

Source: Minpromtorg, TKB Capital estimate

Employees per `000 sq m of selling space

0

20

40

60

80

100

120

2006 2007 2008 2009

Dixy

Magnit

Wal-Mart

LentaSev enth Continent

X5 Retail Group


Revenue per employee, $

Wal-Mart

X5 Retail Group

Magnit Dixy

Lenta

0

50000

100000

150000

200000

2006 2007 2008 2009

Sev enth Continent



STRATEGY 2011 89

We keep our BUY Top PICKS for Magnit and X5 Retail Group. Russian food retailers are now trading with 2011E EV/EBITDA at 6-15 on average vs. EM peers median at 11. We believe Russian retailers deserve such a premium due to the expected rapid growth of consumer spending, which should be translated into companies EBITDA and bottom line growth (EBITDA GAGR`11-13F at close to 30%) outpacing EM peers. We keep our BUY recommendation for both Magnit (12M target price at $162.3 per share and $32.5 per GDR) and X5 Retail Group (12M target price at $56 per GDR)

Relative valuation

P/E EV/EBITDA EV/S Company

2009 2010E 2011E 2009 2010E 2011E 2009 2010E 2011EPEG

Russian peers

X 5 Retail Group (GDR) 70.0 40.4 30.5 17.8 14.0 10.6 1.5 1.1 0.7 0.9

Magnit (GDR) 46.8 37.5 34.7 26.0 19.4 14.4 2.4 1.6 1.1 1.3

Magnit 42.0 33.6 31.1 23.3 17.4 12.9 2.2 1.5 1.0 0.6

O`KEY (GDR) n/a 41.0 25.9 n/a 18.1 13.8 n/a 1.6 1.2 1.0

Seventh Continent 16.2 12.9 9.2 6.6 6.9 5.8 0.6 0.5 0.4 0.6

Dixy Group neg 66.0 42.7 15.7 12.0 9.5 0.8 0.6 0.5 1.4

Median 44.4 39.0 30.8 17.8 15.7 11.8 1.5 1.3 0.9 1.0

Average 43.8 38.6 29.0 17.9 14.6 11.2 1.5 1.1 0.8 1.0

Developed markets peers

Median 14.4 16.2 13.3 7.2 7.0 6.3 0.4 0.4 0.4 1.3

Average 18.8 15.9 13.5 7.9 7.5 6.7 0.5 0.5 0.4 1.4

Emerging markets peers

Median 36.5 26.4 21.4 20.5 13.8 10.5 1.3 1.2 0.9 1.7

Average 33.8 25.6 21.8 21.4 15.2 12.6 1.3 1.1 0.9 1.6

Source: Bloomberg, TKB Capital estimate

0

5

10

15

0%

10%

20%

30%

40%

50%

DM EM Russia

EV/E

BITD

A 20

10E

Net

inco

me

CAG

R`1

1-15

F

Relative valuation

CAGR, %



90 STRATEGY 2011

Pharma producers in 2011 Growth under the government support

Russian pharma market growth is secured by the government. We see the that foreign producers keep their interest to establish local production in Russia and thus bet on the Russian pharma market growth prospects, which remains 2nd largest in terms of long-term growth rates after China. The matter is the new government strategy for the long-term development of the Russian pharmacy industry targeting a considerable increase in the domestic drugs production, which should reach up to 50% of the market by 2020 (in value terms) vs. current share of less than 25%. Moreover, the government aims to stimulate domestic R&D and production of original drugs and substances in Russia, modernize production capacities to GMP standard, support import substitution in budget tenders and promote export. We maintain our positive view on domestic leaders - Pharmstandard and Veropharm, and consider them to be able to benefit from the projected Russian pharma market growth and government call for import substitution due to their high quality production capacities and a successful track record of launching new drugs production. Besides, both companies have expressed their ambitions to continue to strengthen their leading positions via both organic growth and M&As.

New market regulation turmoil seems to calm down. We would remind you that this year pharma market faced turmoil from the implementation of the new regulation. It was held in respect of the maximum allowed producer prices and markups by pharma wholesalers and retailers on VED (vital and essential) drugs (since April 1) and new packaging rules (since September 1). Pharma companies appeared to be vulnerable to such changes, taking into account that the share of VED drugs accounts for about 30% of the total market. However, by the end of the year, all market participants seem to complete the adjustment of their operations to fully comply with the new regulation. Pharma producers expectedly suffered least of all vs. pharma distributors and retailers (Protek is trading at 40% below its price on IPO, held in April 2010, as the company 1H10 EBITDA margin plunged by almost 2 times to 2.9% vs. 6.4% in FY10, which reflected the negative implications of the regulation changes on the company business). We expect that pharma producers will remain steady in 2011, demonstrating healthy growth.

More growth triggers are coming. We expect Pharmstandard and Veropharm to demonstrate solid FY10 financials. Moreover, we believe both companies will remain successful in achieving their optimistic top line growth guidance for 2011, which should trigger further companies’ stocks growth. Besides, we consider Pharmstandard GDRs may be included to MSCI Russia Index, from which they was excluded in 2010 due to the deteriorated trading activity. We keep our BUY rating for both Pharmstandard and Veropharm. Our 12M target price for Pharmstandard is at $36.5 per GDR and $146 per local share. Our 12M target price for Veropharm shares is at $62, which implies more than 30% of upside potential.

Relative valuation P/E EV/EBITDA EV/S

Company 2009 2010E 2011E 2009 2010E 2011E 2009 2010E 2011E

PEG

Russian peers Pharmstandard (GDR) 19.9 18.4 16.1 14.3 13.0 11.3 5.5 4.7 4.3 1.4 Pharmstandard 17.5 16.2 14.1 12.6 11.3 9.9 4.8 4.1 3.8 1.3 Veropharm 13.7 11.6 9.6 11.4 8.7 7.5 3.6 2.7 2.4 0.7 Median 17.5 16.2 14.1 12.6 11.3 9.9 4.8 4.1 3.8 1.3 Average 17.1 15.4 13.2 12.8 11.0 9.6 4.7 3.9 3.5 1.1 Developed markets peers Median 16.3 11.4 8.8 7.0 6.6 6.5 3.0 2.6 2.6 2.1 Average 15.6 10.5 8.2 8.1 6.8 6.4 2.8 2.6 2.5 1.8 Emerging markets peers Median 17.2 15.8 13.4 14.1 11.8 11.0 2.6 2.4 2.2 1.9 Average 27.4 20.9 15.8 16.3 14.3 12.3 3.7 3.5 3.0 1.5


Pharmacies, consumption, $ per capita

0

200

400

600

800

1,000

US

A

Fra

nce

Can

ada

Japa

n

Ger

man

y

Spa

in

GB

Ital

y

Rus

sia

Source: Company data

Russian pharmacy market

Foreign supplies

77%

Domestic production

23%


Russian producers breakdown (23% of the market)

Others52%

Pharmstandart 15%

Veropharm 7%Pharmcentr 6%

Biosintez 3%Soteks 6%

Schtada 11%


0

5

10

15

0%

5%

10%

15%

20%

DM EM Russia

EV/E

BITD

A 20

10E

Net

inco

me

CAG

R`1

1-15

F

Relative valuation

CAGR, %



STRATEGY 2011 91

Magnit Record stores roll-out with focus on efficiency

We believe Magnit will remain highly attractive in 2011 despite the impressive performance in 2010. The main growth drivers for the stock in 2011 will be strong financial numbers from discounters and hypermarkets and continued aggressive store openings. The Trade Law restriction on food retailers’ market shares, which came into effect recently, seems to have no material impact on the companies’ expansion ambitions. This was confirmed by the recent acquisition of Kopeyka by X5 Retail Group as well as Magnit’s next year investment program of $1.5bn. We keep our BUY recommendation for Magnit stocks with 12M target price of $162.3 per local share and $32.5 per GDR.

More growth triggers are ahead. We should note that the fourth quarter sales are seasonally the strongest for retailers, which is explained by New Year holidays (4Q sales may contribute 28-30% of the full-year revenue). We also see that the two months of 4Q10 appeared to be very strong for Magnit, which justify our expectations of very strong full-year results, which may come ahead of the market expectations. We would remind you that during the recent conference-call the company said that it had nearly stopped all price investments that, in our view, implies 4Q10 gross margin to be stronger than in 3Q10 enabling the company to deliver its previously guided 8.2% EBITDA margin.

New stores to fuel growth. We see growth triggers for the company value in 2011 to be strong full-year financial results and continued aggressive store openings. We would remind you that Magnit has recently updated its guidance for 2011 capex to be at $1.5 bn, which should be spent on up to 800 convenience stores openings and 55-60 hypermarkets. Thus, Magnit continues an aggressive growth strategy with a focus on increased efficiency through optimizing business processes and further logistics development. At the same time, Magnit plans to retain Net Debt/EBITDA ratio at less than 1.5.

Government regulation and macro risks. Investors should take into account the risk of weaker than forecasted macro conditions (in particular, real wages growth and unemployment rate), which may adversely affect the consumer power. Besides, the Trade Law clause on retailers’ market share regulation within the particular urban districts, which came into effect on 1 July, 2010, may limit food retailers’ expansion ambitions in the long run. However, we regard Magnit’s store opening plans as quite safe and consistent with the Trade Law.

BUY with still attractive upside. We maintain our BUY recommendation for the company with a 12-month target price for Magnit local shares at $162.3 per share ($32.5 per GDR), based on DCF-model (WACC of 10.8%, terminal growth of 3%). Magnit trades with almost a 20-36% premium (for local shares and GDRs, respectively) to its EM peers on 2011E EV/EBITDA, which we see is justified by the expected company’s financials growth in the medium term (EBITDA CAGR`11-13E of almost 35%).

MagnitCommon GDR

Ticker MGNT MGNT LIRecommendation BUY BUYPrice, $ 129.9 29.0Target price, $ 162.3 32.5Upside/downside, % 25% 12%

SHARE DATABloomberg MGNT RXReuters MGNT.MM

Common# of shares outstanding,mn 89.0EV, $ mn 11,598MC, $ mn 11,557MIN 12 mnth., $ 64.2MAX 12 mnth., $ 135.0


SUMMARY FINANCIALS, $ mnIFRS 2010E 2011E 2012ERev enue 7,993 11,461 14,680EBITDA 666 900 1,175Net income 344 371 445EPS, $ 3.86 4.17 5.00Rev . growth, % 49.3 43.4 28.1EPS growth, % 24.9 8.0 19.7EBITDA margin, % 8.3 7.9 8.0Net margin, % 4.3 3.2 3.0


P/E 33.6 31.1 26.0EV/EBITDA 17.4 12.9 9.9

SHAREHOLDER STRUCTURESergey Galitskiy , CEO 41%Management & BoD 4%Other 56%

PRICE DYNAMICS


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MGNT RTS


92 STRATEGY 2011

Magnit BALANCE SHEETIFRS, $ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ECASH 378 444 476 563 816 1,133 1,408ACCOUNTS RECEIVABLE 2 2 3 4 5 6INVENTORIES 415 492 709 912 1,187 1,502 1,822OTHER CURRENT ASSETS 68 292 280 252 201 254 307TOTAL CURRENT ASSETS 862 1,230 1,467 1,730 2,208 2,894 3,544PPE 1,638 2,948 4,257 5,216 6,206 7,233 8,286INTANGIBLE ASSETS 4 14 21 22 22 19 13OTHER NON-CURRENT ASSETS 25 () () ()TOTAL NON-CURRENT ASSETS 1,667 2,962 4,278 5,238 6,227 7,252 8,299TOTAL ASSETS 2,529 4,191 5,745 6,969 8,435 10,146 11,843ST BORROWINGS 267 939 1,530 1,885 2,194 2,386 2,417OTHER CURRENT LIABILITIES 658 852 1,226 1,575 2,056 2,746 3,475TOTAL CURRENT LIABILITIES 924 1,791 2,755 3,460 4,250 5,132 5,892LT BORROWINGS 152 519 837 1,029 1,196 1,300 1,316OTHER NON-CURRENT LIABILITIES 27 29 31 38 57 82 105TOTAL NON-CURRENT LIABILITIES 180 548 869 1,067 1,253 1,381 1,421MINORITY INTEREST - - - - - - -SHARE AND APIC 1,008 1,008 1,008 1,008 1,008 1,008 1,008OTHER EQUITY ITEMS (179) - - - - - -RETAINED EARNINGS 596 845 1,113 1,434 1,924 2,625 3,523TOTAL EQUITY 1,425 1,853 2,121 2,442 2,932 3,632 4,531TOTAL LIABILITIES AND EQUITY 2,529 4,191 5,745 6,969 8,435 10,146 11,843

PROFIT & LOSS STATEMENTIFRS, $ mn 2009 2010E 2011E 2012E 2013E 2014E 2015EREVENUES 5,354 7,993 11,461 14,680 19,090 24,153 29,273OPERATING EXPENSES LESS DD&A (4,857) (7,327) (10,561) (13,505) (17,473) (22,025) (26,668)EBITDA 497 666 900 1,175 1,617 2,128 2,605DD&A 103 131 233 341 432 531 640EBIT 394 535 667 834 1,185 1,597 1,965INTEREST INCOME 2 - - - - - -INTEREST EXPENSES (54) (94) (191) (264) (315) (354) (371)MINORITY INTEREST - - - - - - -OTHER NON-OPERATING INCOME (EXPENSES) 12 - - - - - -EXTRAORDINARY INCOME (LOSS) - - - - - - -PRE-TAX PROFIT 355 441 476 570 870 1,243 1,594TOTAL INCOME TAX EXPENSE (80) (97) (105) (125) (191) (273) (351)NET INCOME 275 344 371 445 678 969 1,243

CASH FLOW STATEMENTIFRS, $ mn 2009 2010E 2011E 2012E 2013E 2014E 2015EOperating CF 376 576 723 897 1,265 1,678 2,062CF from investments (448) (1,451) (1,548) (1,301) (1,421) (1,556) (1,687)CF from financing activities 339 941 858 491 409 194 (99)Net Debt 41 1,013 1,891 2,351 2,574 2,553 2,324

RATIOS% 2009 2010E 2011E 2012E 2013E 2014E 2015ERevenue grow th 0.1% 49.3% 43.4% 28.1% 30.0% 26.5% 21.2%EBITDA margin 9.3% 8.3% 7.9% 8.0% 8.5% 8.8% 8.9%Net margin 5.1% 4.3% 3.2% 3.0% 3.6% 4.0% 4.2%Net Debt/EBITDA 0.1 1.5 2.1 2.0 1.6 1.2 0.9


STRATEGY 2011 93

X5 Retail Group Betting on the synergy of Kopeyka’s integration

Our new 12M target price for X5 Retail Group, which accounts for the recently acquired discounter chain of Kopeka and company’s new 2011 capex plans, is at $56 per GDR. We thus keep our BUY recommendation for the stocks. Solid financials, a step up increase in next year investment program as well as potential new M&A deals will trigger the company’s growth in 2011. We see, that the Trade Law restriction on food retailers’ market shares, which came into effect recently, has no material impact on the companies’ store opening plans. X5’s acquisition of Kopeyka confirms it as well as Magnit and X5 next year record investment programs of about $1.5bn and $1.3bn respectively.

Betting on the synergy from Kopeyka’s acquisition. We would remind you that X5 Retail Group recent acquisition of sixth largest food retailer in Russia, Kopeyka, was priced at about $1.65bn (R51.5bn), including debt (in assumption of not more than R16.5bn or $527mn net debt. This implied EV/EBITDA`10F multiple to be at 11.6 (vs. X5’s EV/EBITDA`10F of 15), which seems to be a reasonable price paid for up to 700 soft discounters (roughly 300`000 sq m of total space) operating at about 90% centralization level vs. X5’s 67% (thanks to 7 distribution centers of about 87`000 sq m and well developed logistics). Acquisition of Kopeyka enables X5 Retail Group to expand its stores count by 40%, adding 25% to selling space, which will result in 19% revenue growth and 15% growth on EBITDA level. X5 Retail Group considers to complete the full integration of Kopeyka by 2013. X5 will raise an additional $1bn credit by Sberbank (5-years, nominated in rubles), which will result in Net Debt/EBITDA`11F at 2.7 (vs. 2.3 reported as on the end-September) and will remain consistent with all company’s current credit facility covenants. Going forward, X5 also plans to refinance Kopeyka’s debt on more attractive terms and gain on synergy resulted from the integration (expected to be maximized by 2015). In particular, X5’s targets to lift up sales per sq. m – at the moment Kopeyka demonstrates roughly $7500 revenue per sq m vs. X5’s $13`200.

Coming growth triggers: FY10 financial disclosure and management forecasts. We expect that coming 4Q10 and FY10 financials disclosure along with the management guidance of $1.3bn capex in 2011, to be spend on up to 500 new discounters, 20-25 supermarkets, 5-10 hypermarkets and up to 10 Pyaterochka Maxi openings, confirm the company attractive valuation as a bet on further company success in Russian food retail market consolidation. We believe that X5 will continue to play an active role in market consolidation through M&As.

Government regulation and macro risks. The overall consumer & retail sector risk is weaker than forecasted macro conditions (in particular real wages growth and unemployment), which may negatively affect the consumer power. Besides, food retail in Russia is now exposed to certain government regulation risks. We would like to remind you that the Trade Law clause on retailers’ market share regulation within the particular urban districts, which came into effect since July 1, may limit food retailers’ expansion ambitions in the long run. However, we regard X5’s store opening plans as quite safe and consistent with the Trade Law.

Attractive upside on impressive growth prospects. Our new company DCF-based 12M target price (WACC of 10.8%, terminal growth of 3%) is $56 per GDR, which now accounts for the recent acquisition of discounter chain Kopeyka and a considerable step up in 2011 capex plans. X5 now trades with almost 5% premium to its EM peers EV/EBITDA`11E multiple. However, we see this to be justified by the forecasted EBITDA CAGR for 2011-2013 to be at almost 30%.

X5 RETAIL GROUPGDR

Ticker FIVERecommendation BUYPrice, $ 42.7Target price, $ 56.0Upside/downside, % 31%

SHARE DATABloomberg FIVE LIReuters PJPq.L

GDR# of GDR outstanding, mn 271.6EV, $ mn 13,121MC, $ mn 11,583MIN 12 mnth., $ 64.2MAX 12 mnth., $ 135.0


SUMMARY FINANCIALS, $ mnIFRS 2010E 2011E 2012ERev enue 11,709 17,791 20,228EBITDA 935 1,235 1,438Net income 286 380 448EPS, $ 1.05 1.40 1.65Rev . growth, % 34.3 51.9 13.7EPS growth, % 73.2 32.7 17.8EBITDA margin,% 8.0 6.9 7.1Net margin, % 2.4 2.1 2.2


P/E 40.4 30.5 25.9EV/EBITDA 14.0 10.6 9.1

SHAREHOLDER STRUCTUREAlf a Group 48%Founders of Py aterochka 23%Management 2%Other 27%

PRICE DYNAMICS

Source: LSE, RTS, TKB Capital estimates

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FIVE RTS


94 STRATEGY 2011

X5 Retail Group

BALANCE SHEETIFRS, $ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ECASH 412 434 374 237 569 1,218 2,204ACCOUNTS RECEIVABLE 310 289 439 499 615 717 824INVENTORIES 613 634 966 1,099 1,357 1,583 1,820OTHER CURRENT ASSETS 210 363 548 624 769 899 1,049TOTAL CURRENT ASSETS 1,544 1,720 2,327 2,459 3,309 4,417 5,898PPE 2,995 4,321 5,634 5,618 5,539 5,474 5,399INTANGIBLE ASSETS 496 542 563 531 495 461 426OTHER NON-CURRENT ASSETS 1,144 1,168 1,216 1,244 1,287 1,339 1,397TOTAL NON-CURRENT ASSETS 4,636 6,031 7,413 7,393 7,321 7,274 7,223TOTAL ASSETS 6,180 7,750 9,740 9,852 10,631 11,691 13,121ST BORROWINGS 1,659 890 908 718 503 353 247OTHER CURRENT LIABILITIES 2,221 2,488 4,038 4,337 5,058 5,635 6,226TOTAL CURRENT LIABILITIES 3,880 3,379 4,946 5,055 5,561 5,987 6,474LT BORROWINGS 292 2,077 2,119 1,674 1,173 823 577OTHER NON-CURRENT LIABILITIES 236 236 236 236 236 236 236TOTAL NON-CURRENT LIABILITIES 527 2,313 2,355 1,910 1,409 1,058 813MINORITY INTEREST - - - - - - -SHARE AND APIC 2,143 2,143 2,143 2,143 2,143 2,143 2,143OTHER EQUITY ITEMS (570) (570) (570) (570) (570) (570) (570)RETAINED EARNINGS 199 486 866 1,314 2,088 3,072 4,261TOTAL EQUITY 1,772 2,059 2,439 2,887 3,661 4,646 5,835TOTAL LIABILITIES AND EQUITY 6,180 7,750 9,740 9,852 10,631 11,691 13,121

PROFIT & LOSS STATEMENTIFRS, $ mn 2009 2010E 2011E 2012E 2013E 2014E 2015EREVENUES 8,717 11,709 17,791 20,228 24,940 29,088 33,436OPERATING EXPENSES LESS DD&A (7,981) (10,775) (16,557) (18,790) (23,021) (26,862) (30,894)EBITDA 736 935 1,235 1,438 1,919 2,227 2,542DD&A 268 297 410 532 566 598 632EBIT 468 637 825 906 1,353 1,629 1,909INTEREST INCOME - - - - - - -INTEREST EXPENSES (154) (197) (240) (217) (163) (114) (80)MINORITY INTEREST 4 - - - - - -OTHER NON-OPERATING INCOME (EXPENSES) 50 - - - - - -EXTRAORDINARY INCOME (LOSS) - - - - - - -PRE-TAX PROFIT 264 441 585 689 1,190 1,515 1,829TOTAL INCOME TAX EXPENSE (99) (154) (205) (241) (417) (530) (640)NET INCOME 165 286 380 448 774 985 1,189

CASH FLOW STATEMENTIFRS, $ mn 2009 2010E 2011E 2012E 2013E 2014E 2015EOperating CF 734 696 1,286 1,114 1,639 1,798 2,017CF from investments (434) (1,684) (1,406) (616) (591) (647) (680)CF from financing activities (194) 1,011 60 (635) (716) (501) (351)Net Debt 1,539 2,534 2,654 2,155 1,107 (43) (1,380)

RATIOS% 2009 2010E 2011E 2012E 2013E 2014E 2015ERevenue grow th 4% 34% 52% 14% 23% 17% 15%EBITDA margin 8% 8% 7% 7% 8% 8% 8%Net margin 2% 2% 2% 2% 3% 3% 4%Net Debt/EBITDA 2.1 2.7 2.1 1.5 0.6 (0.0) (0.5)


STRATEGY 2011 95

Pharmstandard Healthy financials and solid growth

We believe Pharmstandard will demonstrate strong performance in 2011. We also expect the company GDRs to be included back into MSCI Russia Index after the exclusion in 2010. The company remains a wise bet on the Russian pharma market growth, fueled by the government call for import substitution. Demonstrating its high financial stability, Pharmstandard maintains its ability to generate positive cash flows for shareholders and finance development via organic growth and M&As. We keep our BUY recommendation for its local shares and GDRs.

Coming triggers - flu season, budget tenders and financials disclosure. We expect Pharmstandard to perform strong in 4Q10 thanks to its significant share of anti-flu drugs and vitamins (for instance, sales of Arbidol, Codelac and Complivit account for up to 20% of the company’s total sales and more than 30% of own pharma products sales). Moreover, the company expects to win budget tenders, which will promote 2011 sales growth. Besides, with sufficient liquidity, the company is able to continue M&As in the next few years. Acquiring successful brands could become an additional catalyst for its financials. We believe Pharmstandard is a wise bet on Russian pharma market growth, fueled by the government call for import substitution, which implies good opportunities for domestic producers to replace imported drugs in government purchases and increase their market shares.

Government regulation and macro risks. We see downside risks to our valuation model in the case of worsening macro conditions in 2011, which may undermine consumer purchasing power, though medicines consumption is less sensitive to changes in prices. Besides, we see the tightening of government regulation to be another point of concern. In particular, the limitation of direct promotion of new drugs to physicians may hamper the launch of new drugs on the market.

Undervalued exposure to the Russian pharma market. Our target price for the company is $146 per share ($36.5 per GDR) based on DCF-model (WACC of 11.2%, terminal growth of 3%), which justifies our BUY recommendation on the stock. The company shares are now traded with about 5-10% discount to its EM peers on the basis of 2011E EV/EBITDA (for GDRs and local shares respectively), which doesn’t reflect the expected company financials’ growth in the medium-term.

PharmstandardCommon GDR

Ticker PHST PHST LIRecommendation BUY BUYPrice, $ 100.1 28.5Target price, $ 146.0 36.5Upside/downside, % 46% 28%

SHARE DATABloomberg PHST LIReuters PHSTq.L

GDR# of GDR outstanding, mn 151.2EV, $ mn 3,681MC, $ mn 3,784MIN 12 mnth., $ 16.8MAX 12 mnth., $ 29.5

GDRShares per GDR 1/4

SUMMARY FINANCIALS, $ mnIFRS 2010E 2011E 2012ERev enue 889 969 1,045EBITDA 324 372 406Net income 234 268 293EPS, $ 1.5 1.8 1.9Rev . growth, % 17.1 9.0 7.8EPS growth, % 8.3 14.7 9.1EBITDA margin,% 36.5 38.4 38.9Net margin, % 26.3 27.7 28.0


P/E 16.2 14.1 12.9EV/EBITDA 11.3 9.9 9.1

SHAREHOLDER STRUCTUREAugement Inv estments Limited 54.3%GDRs 27.6%Local shares 18.1%

PRICE DYNAMICS

Source: LSE, RTS. TKB Capital estimates

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PHST RTS


96 STRATEGY 2011

Pharmstandard

BALANCE SHEETIFRS, $ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ECASH 130 253 438 693 970 1,297 1,680ACCOUNTS RECEIVABLE 307 356 387 418 477 545 616INVENTORIES 91 110 114 123 139 158 177OTHER CURRENT ASSETS 13 22 24 25 29 33 37TOTAL CURRENT ASSETS 541 741 963 1,259 1,616 2,032 2,509PPE 122 151 181 184 185 185 184INTANGIBLE ASSETS 204 216 229 231 233 236 238OTHER NON-CURRENT ASSETS - - - - - - -TOTAL NON-CURRENT ASSETS 326 367 410 415 418 420 422TOTAL ASSETS 867 1,108 1,374 1,673 2,034 2,453 2,931ST BORROWINGS 13 6 3 2 1OTHER CURRENT LIABILITIES 161 198 262 331 432 549 677TOTAL CURRENT LIABILITIES 174 205 266 333 433 549 677LT BORROWINGS 13 6 3 2 1OTHER NON-CURRENT LIABILITIES 29 62 71 77 90 104 119TOTAL NON-CURRENT LIABILITIES 42 69 74 79 91 104 119MINORITY INTEREST 14 14 14 14 14 14 14SHARE AND APIC 1 1 1 1 1 1 1OTHER EQUITY ITEMS () ()RETAINED EARNINGS 636 820 1,019 1,247 1,495 1,785 2,120TOTAL EQUITY 638 821 1,020 1,248 1,497 1,786 2,122TOTAL LIABILITIES AND EQUITY 867 1,108 1,374 1,673 2,034 2,453 2,931

PROFIT & LOSS STATEMENTIFRS, $ mn 2009 2010E 2011E 2012E 2013E 2014E 2015EREVENUES 759 889 969 1,045 1,194 1,362 1,540OPERATING EXPENSES LESS DD&A (466) (565) (596) (638) (724) (821) (922)EBITDA 293 324 372 406 469 541 617DD&A 24 28 33 36 39 42 45EBIT 270 297 339 370 430 499 572INTEREST INCOME 4 - - - - - -INTEREST EXPENSES (5) (1) (1) () () () ()MINORITY INTEREST 1 1 1 1 1 1 1OTHER NON-OPERATING INCOME (EXPENSES) 3 (3) (3) (4) (4) (5) (6)EXTRAORDINARY INCOME (LOSS) - - - - - - -PRE-TAX PROFIT 272 292 335 366 426 494 566TOTAL INCOME TAX EXPENSE (57) (58) (67) (73) (85) (99) (113)NET INCOME 216 234 268 293 340 395 453

CASH FLOW STATEMENTIFRS, $ mn 2009 2010E 2011E 2012E 2013E 2014E 2015EOperating CF 193 207 269 301 324 375 433CF from investments 28 (71) (78) (43) (45) (47) (50)CF from financing activities (53) (13) (6) (3) (2) (1) ()Net Debt (104) (240) (432) (690) (969) (1,296) (1,679)

RATIOS% 2009 2010E 2011E 2012E 2013E 2014E 2015ERevenue grow th 32% 17% 9% 8% 14% 14% 13%EBITDA margin 39% 36% 38% 39% 39% 40% 40%Net margin 28% 26% 28% 28% 29% 29% 29%Net Debt/EBITDA neg. neg. neg. neg. neg. neg. neg.


STRATEGY 2011 97

Veropharm Niche player with a solid pipeline of medicines

We recommend investors to BUY Veropharm, which is a clear bet on the Russian pharma market growth and a proxy of government call for import substitution. In 1H11 the value growth drivers will be expected recovery in 4Q10 financials, which should revive investors’ interest towards the stock.

Strong financials with a favorable growth outlook. Though the company’s 3Q10 financials came considerably below our and market forecasts, affected by the regulation change on the market, we see Veropharm’s 9M10 financial results are consistent with our full-year revenue growth forecast of 22% y-o-y and the company’s management guidance, taking into account that coming 4Q10 is seasonally strong for pharma producers. Thus, the expected recovery in 4Q10 financials should revive investors’ interest towards the stock in 1H11. Veropharm has previously guided the market with 70% gross margin in FY10 (vs. our current forecast of 68%) and EBITDA margin of up to 35% (vs. our forecast of 32%). We remain confident with our full-year projections and even see some upside risks to our company valuation model.

Government regulation and macro risks. The overall sector risk is weaker than expected macro conditions in 2011, which may lead to worsening of consumer power, though consumer demand on medicines looks the most resistant to price changes. Another point of concern is increasing government regulation in the sector. However, we believe Veropharm is able to demonstrate healthy growth of its financials in 2011.

Attractive valuation with more than 30% upside potential. We keep our BUY recommendation for the stock with 12M target price at $53.5, derived from our DCF-model (WACC of 12.7%, terminal growth of 3%). Veropharm relative valuation in comparison with its EM peers implies almost 30% discount on the basis of 2011E EV/EBITDA.

.

VeropharmCommon

Ticker VRPHRecommendation BUYPrice, $ 47.9Target price, $ 62.0Upside/downside, % 30%

SHARE DATABloomberg VFRM RXReuters VFRM.MM

Common# of shares outstanding,mn 10.0EV, $ mn 501MC, $ mn 479MIN 12 mnth., $ 27.4MAX 12 mnth., $ 48.4

CommonShares per GDR -

SUMMARY FINANCIALS, $ mnIFRS 2010E 2011E 2012ERev enue 183 211 227EBITDA 57 66 72Net income 41 50 54EPS, $ 4.1 5.0 5.4Rev . growth, % 32.0 15.5 7.4EPS growth, % 18.2 21.4 8.3EBITDA margin,% 31.3 31.4 31.8Net margin, % 22.6 23.7 23.9


P/E 11.6 9.6 8.8EV/EBITDA 8.7 7.5 6.9

PRICE DYNAMICS


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VRPH RTS


98 STRATEGY 2011

Veropharm

BALANCE SHEETIFRS, $ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ECASH 10 8 17 54 79 113 151ACCOUNTS RECEIVABLE 138 175 191 205 233 265 297INVENTORIES 35 31 36 39 44 50 57OTHER CURRENT ASSETS - - - - - - -TOTAL CURRENT ASSETS 183 215 244 298 357 427 506PPE 26 32 38 42 46 50 52INTANGIBLE ASSETS 11 12 13 13 14 14 14OTHER NON-CURRENT ASSETS - - - - - - -TOTAL NON-CURRENT ASSETS 38 44 50 56 60 64 67TOTAL ASSETS 221 259 294 353 417 491 573ST BORROWINGS 29 24 7 8 7 6 3OTHER CURRENT LIABILITIES 19 21 33 38 51 64 79TOTAL CURRENT LIABILITIES 49 45 39 46 57 70 83LT BORROWINGS 3 10 10 12 10 9 5OTHER NON-CURRENT LIABILITIES 2 2 2 2 2 2 2TOTAL NON-CURRENT LIABILITIES 6 13 12 14 12 11 7MINORITY INTEREST - - - - - - -SHARE AND APICOTHER EQUITY ITEMS () () () ()RETAINED EARNINGS 166 201 242 293 347 410 482TOTAL EQUITY 167 202 243 293 347 410 483TOTAL LIABILITIES AND EQUITY 221 259 294 353 417 491 573

PROFIT & LOSS STATEMENTIFRS, $ mn 2009 2010E 2011E 2012E 2013E 2014E 2015EREVENUES 139 183 211 227 258 293 329OPERATING EXPENSES LESS DD&A (95) (126) (145) (155) (175) (198) (222)EBITDA 44 57 66 72 83 95 107DD&A 4 5 6 6 7 8 8EBIT 40 52 61 66 76 87 99INTEREST INCOME - - - - - - -INTEREST EXPENSES (2) (4) (2) (2) (2) (2) (1)MINORITY INTEREST - - - - - - -OTHER NON-OPERATING INCOME (EXPENSES) - - - - - - -EXTRAORDINARY INCOME (LOSS) (1) - - - - - -PRE-TAX PROFIT 37 49 59 64 74 85 98TOTAL INCOME TAX EXPENSE (2) (7) (9) (10) (11) (13) (15)NET INCOME 35 41 50 54 63 73 83

CASH FLOW STATEMENTIFRS, $ mn 2009 2010E 2011E 2012E 2013E 2014E 2015EOperating CF (1) 17 39 46 41 47 57CF from investments (7) (12) (12) (12) (12) (12) (12)CF from financing activities 7 2 (18) 3 (3) (2) (6)Net Debt 22 26 (1) (34) (63) (98) (143)

RATIOS% 2009 2010E 2011E 2012E 2013E 2014E 2015ERevenue grow th -20% 32% 15% 7% 14% 13% 12%EBITDA margin 32% 31% 31% 32% 32% 32% 33%Net margin 25% 23% 24% 24% 24% 25% 25%Net Debt/EBITDA 0.5 0.5 neg. neg. neg. neg. neg.

Banking sector More loans – less risks

STRATEGY 2011 99

Maria Kalvarskaia [email protected] Nadezhda Krupennikova [email protected]


2011 is expected to bring important news and events in the Russian banking sector. Further development of financial segment together with corporate deals will boost interest to the banking stocks. At the same time forecasts provided by the banks look quite conservative – loans growth will continue with no acceleration, margins recovery may become visible in 2H11, profits will grow supported by improving credit quality, but positive effect of provisions recovery will be limited. Partial privatization of the state stakes in VTB and Sberbank as well as possible placement of other banks and M&A deals in the segment will determine activity in the banking shares on the market. We keep positive view on the banks’ stocks with Sberbank and Bank St-Petersburg as our top picks for 2011, while corporate events may boost interest to VTB stocks.

Higher demand for loans with economic recovery. In 2011 we expect total loans portfolio of the Russian banks to grow by 18.7% backed by higher demand for loans from retail and corporate segments. Total assets of the Russian banks to add 15%.

Assets to be reshaped in favor of loans. We expect the banks to reduce share of liquid assets on their balances, which accounted to 20% in 2H10, being replaced by expanding loans portfolio.

Stabilization and possible growth of interest rates in 2011 may support margins. Declining rates put pressure on margins in 2010, while in 2011 liabilities revaluation and possible interest rates growth will lead to margins stabilization.

Loans quality will stabilize, but effect of provisions release will be limited. Stabilization of loan portfolio quality will lead to normalization of provisions, but release of reserves will have limited effect on the bottom-line taking into account loans growth and write off of NPLs.

Deals in the sector will increase activity on banking stocks. In 2011 the state is planning to sell part of its stakes in VTB and Sberbank, some other placement are possible as well that will boost interest to the stocks. M&A deals will also increase demand for the shares.

Upside potential of the banks’ stocks is 12-38%, positive prospects for 2011. Lower risks in the segment, economic recovery and better financial performance will drive up market capitalization of the banks.

Sberbank (SBER) and Bank St-Petersburg (STBK) as fundamental ideas, play corporate events in VTB (VTBR). We consider Sberbank and Bank St-Petersburg as our top picks for 2011. Despite strong stocks’ performance through 2010 solid financial forecasts determine positive view on the shares. Sberbank is trading close to its historical highs, while NI exceeded maximum level and there are grounds for substantial improvement in 2011. We recommend BUY Sberbank OS with TP 12 mo $4.6 and PS with TP 12 m $3.53. Bank St-Petersburg (BSPB) market cap exceeds pre-crisis level by the volume of preferred shares, while the bank delivers strong financial results proving its stable position in the region and efficiency of its business-model. TP 12 m for STBK OS is $6.8, for PS $7.5. VTB is lagging its main competitor Sberbank in terms of profitability that implies HOLD recommendation with 12 m TP at $0.0036 ($7.2 for GDR), while corporate events (privatization of 10% state stake and possible M&A) may increase speculative interest to the bank shares. Bank Vozrozhdenie (VZRZ) recovers slowly after the downturn and it will take longer time to reach pre-crisis level on bottom-line. We recommend HOLВ Bank Vozrozhdenie shares with TP 12 m $48.4 and see upside risks for our valuation in case of better performance and favorable market conditions.



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RTS IndexFinances


100 STRATEGY 2011

2010 – new market conditions revealed the strongest players. In 2010 Russian financial market was characterized by declining interest rates, limited demand for new loans and still relatively high credit risks. Lower interest rates put pressure on interest margins and operating results of the banks, as reprising of liabilities was slower, while high share of cash in the assets structure reduced interest income. Favorable conditions on the fixed-income market attracted borrowers, while banks sometimes failed to offer the same cheap financing. Most of the players followed conservative policy in terms of provisioning taking into account existing risks on the market, but in 2H2010 lower provisions on the back of loans portfolio quality stabilization helped to improve financial performance of the bank.

Market growth in 2010 in line with our expectations. According to the published CBR 10M10 data and forecasts for the last two months in 2010 total assets of the bank grew by 12%, loans expanded by 12.5% mainly thanks to demand from corporate segment. Clients funds increased by 16%, and in this case retail deposits boosted the total numbers. These numbers correspond to our expectations for 2010, which looked rather conservative at the beginning of the year. Fixed income market was a strong competitor for the borrowings from the banks in 1H2010, while expansion of demand for loans in 2H2010 was limited. Banks are coming on the end of 2010 with strong liquidity position (cash and cash equivalents plus securities amount to 23% of the assets). Thus, Russian banks have substantial ground to expand loans portfolios in the coming years, while growth rates will be determined by economic recovery and interest rate environment.

Macro view on the sector

Higher demand for loans in 2011 with economic recovery. In 2011 we expect total loans portfolio of the Russian banks to grow by 18.7% backed by higher demand for loans from retail and corporate segments. We expect GDP growth in 2011 at 4.3% that will help to increase corporate loan book by 20%. Under the current low interest rate environment and sufficient liquidity of the Russian banks we would expect significant demand from the largest corporate clients in order to reduce share of wholesale funding from the international markets. But if financial institutions face growing interest rates already in 1H2011 that will limit demand for financial resources on domestic markets. Another factor of growing demand for loans will be postponed needs in financing from the smaller corporate clients, while this segment provides strong growth potential in the future. Demand for retail loans will grow faster than for corporate with higher rate of consumption and more stable economic prospects. Total assets of the Russian banks are expected to add 15% next year, while share of loans will grow from 68% in 2010 to 70% in 2011.

Assets to be reshaped in favor of loans. We expect the banks to reduce share of liquid assets on their balances, which accounted to 20% in 2H10, being replaced by expanding loans portfolio. At the same time with growing competition in the segment those players with cheaper financing are gaining market share that reduces financial performance of the weaker ones. Thus, during the crisis 2009 banks created substantial liquidity cushion, which have not been transferred into loans yet despite better market conditions. The state banks have the strongest position on the market as they are ready to take higher risks with sufficient funding base. The smaller banks are looking for strategic investors or develop in their market segment. Among the smaller banks we consider regional financial institutions to have greater opportunity comparing to ones operating in the Moscow region. By the end of 2011 we expect reduction of liquid assets including securities portfolio to 15-17%, but mainly thanks to the largest banks.

Stabilization and possible growth of interest rates in 2011 may support margins. Declining rates put pressure on margins in 2010. Average rate for non-financial organizations set by the banks (excluding Sberbank) declined during the year to the absolute low level of 8.9%, while average retail deposits rate was 7.0% in November which is also the absolute low level for retail deposits. However in 2011 liabilities revaluation and possible interest rates growth will lead to margins stabilization. On liabilities side it take several quarters to see positive effect of reprising on financial results, and in a higher degree this concerns those banks, which funding comes mainly from retail deposits. On the assets side there is downside potential for interest rates in retail segment, but possible decline is now limited taking into account the current market level. The largest banks see interest rates reduction by 50-150 bpp next year for retail loans, while in corporate segment yields are close to their minimum reasonable level. In 2011 we may see further interest margins contraction by 20-30 bpp under the current market conditions. At the same time growing inflation in Russia may lead to interest rates growth already in 2011 that will support margins especially for those with cheaper financing.

P/E vs. P/BV RUS vs. EM


4

8

12

16

0.5 1.0 1.5 2.0 2.5 3.0

P/BV

P/E

VZRZSBER

Average RUS

STBK

VTBR

Russian banks' assets and currency exchange rate

Source: CBR, TKB Capital estimates

27000280002900030000310003200033000

1.1.

101.

2.10

1.3.

101.

4.10

1.5.

101.

6.10

1.7.

101.

8.10

1.9.

101.

10.1

01.

11.1

0

2828.52929.53030.53131.5

Total banks assets (RUR mn)RUR/$ EOP (rhs)

BN RUR 2010E 2011E 2012E

Total Assets 32962 37906 43592

Equity Capital 4293 4937 5777

Loans 22336 26512 30587

Retail Loans 4110 4850 5820

Corporate Loans 14047 16856 19385

Clients Funds 19872 23449 27318

Retail Clients Funds 9356 11228 13136

Corporate Deposits 5740 6601 7592

Growth rates 2010E 2011E 2012E

Total Assets 12.0% 15.0% 15.0%

Equity Capital 14.0% 15.0% 17.0%

Loans 12.5% 18.7% 15.4%

Retail Loans 15.0% 18.0% 20.0%

Corporate Loans 12.0% 20.0% 15.0%

Clients Funds 16.0% 18.0% 16.5%

Retail Clients Funds 25.0% 20.0% 17.0%

Corporate Deposits 5.0% 15.0% 15.0%



STRATEGY 2011 101

Loans quality will stabilize, but effect of provisions release will be limited. Stabilization of loan portfolio quality will lead to normalization of provisions, but release of reserves will have limited effect on the bottom-line taking into account loans growth and write off of NPLs. In 2010 the share of overdue loans in total loan portfolio was flat at 6.2%, while in absolute terms overdue loans grew by 10%. At the same time provisions increased from 10.3% to 10.5% at the end 2010. Expansion of loan portfolio helped to reduce a share of overdue loans, while the most of banks have been reporting moderate increase in overdues through the whole year. In 2011 we expect stabilization of the volume of overdue loans that together with loan portfolio growth will lead to reduction of share of overdues in the total loans. We also expect to see write-offs of bad loans in 2011 that will have negative effect on opportunity to release provisions.

Conservative forecasts on bottom line. Pressure on interest margins and limited effect of provisions release determine conservative forecasts on the bottom-line for the whole banking system. The largest banks are expected to increase their NI by 25-30% y-o-y in 2011 backed by improving quality of loan portfolio, while consolidated results look weaker. According to CBR NI of Russian banks will be flat in 2011 (for 2010 NI is estimated at RUR500 bn), while we expect to see net income growth at 20% backed by better performance of the largest players. Provision release will continue through 2012-2013 that postponing positive effect on the banks’ income.

CBR regulation – tightening requirements to capital. CBR will increase requirements to the minimum capital of the banks to RUR180 mn in 2012 vs. current RUR90 mn. By the end of 2010 the number of banks in Russia reduced to 1023 from 1058 in 2009, and with increasing requirements to the capital the number of banks will continue to decline (if the banks don’t increase their capital) since 456 banks had capital below the minimum level at the end of 2010 (in accordance with 2012 requirements). M&A deals also lead to reduction of the number of financial institutions, but here banks from the top 50 with developed client base and expanded network of offices become acquisition target more often.

Corporate events to watch

Shares to be sold to strategic investors or on the market. In 2011 the state is planning to sell part of its stakes in VTB and Sberbank. 10% of VTB are expected to be privatized in 1Q2011, and we believe that details of the deal will boost interest to the bank’s shares. For now a sale to a strategic investors looks more probable. The government is planning to sell another 10-15% stake in VTB in 2012-2013. The state is also planning to privatize 7.6% of Sberbank keeping control in the largest bank. The time of the deal is still to be set, while in this case market placement is more likely. Some other placements (Rosselhozbank, Uralsib, Nomos-bank) are possible as well that will boost interest to the stocks. The volume of VTB and Sberbank stakes to be sold in 2011 are estimated at $11 bn that is 26% of the current total free float of the liquid banks’ shares.

More M&A deals to strengthen position on the market. The process of consolidation in the Russian banking system continues. In 2010 VTB was the most active newsmaker on M&A deals in the segment. Thus, the bank announced acquisition of controlling stake in TransCreditBank and raised its interest to majority stake in Bank of Moscow. VTB also acquired 20% in Rosbank from Open Investments, but the bank considered this deal as investment and is planning to look for a strategic investor. In 2011 we may see a sale of a stake in Uralsib, which is searching for a strategic investor or to place stocks on the market. With growing competition from the largest banks and in low interest rate environment smaller banks look weaker that pursued them being more active in M&A deals and searching for strategic investor or a merger with another player to strengthen their positions.

Interest Rates CBR


0

10

20

30

40

50

Jul 08 Feb 09 Aug 09 Mar 10

Ov ernight2 - 7 day s8 - 30 day s31 - 90 day sRef inancing

Average rates of the Russian banks excluding Sberbank (in RUR)


0.0%

4.0%

8.0%

12.0%

16.0%

Aug

-09

Oct

-09

Dec

-09

Feb-

10

Apr

-10

Jun-

10

Aug

-10

Oct

-10

Loans to corporate clients

Retail deposits (not counting f orcurrent accounts)

Operating costs to assets and income, 2011E

Source: banks' data, TKB Capital estimates

0% 25% 50% 75%

Sberbank

VTB

BankVozrozhdenie

Bank St-Petersburg

Cost-to-income, % 2011Е

Cost-to-assets, % 2011E


102 STRATEGY 2011

Banks’ stocks in focus again

Upside potential of the banks’ stocks is 12-38%, positive prospects for 2011. Lower risks in the segment, economic recovery and better financial performance will drive up market capitalization of the banks. Russian financial system still has considerable growth potential in the future that will attract long-term investment in the segment. In 2011 we expect further recovery after the downturn that will be reflected in higher growth rate of loan portfolio, stabilization of operating results, lower costs of risk and higher net income. Our choice of the stocks to invest in is based on the banks’ ability to generate profit under the changing market conditions and the stocks’ performance during the period. Russian banks are traded with 11% discount to EM peers on P/BV 2011E. Corporate events and new placement on the market will increase interest to the Russian banks’ stocks through 2011.

Sberbank (SBER) and Bank St-Petersburg (BSPB) as fundamental ideas. We consider Sberbank and Bank St-Petersburg as our top picks for 2011. Despite strong stocks’ performance through 2010 solid financial forecasts determine positive view on the shares. Sberbank is trading close to its historical highs, while NI exceeded maximum level and there are grounds for substantial improvement in 2011. We recommend to BUY Sberbank OS with TP 12 mo $4.6 and PS with TP 12 m $3.53. Bank St-Petersburg (STBK) market cap exceeds pre-crisis level by the volume of preferred shares, while the bank delivers strong financial results proving its stable position in the region and efficiency of its business-model. TP 12 m for STBK OS is $6.8, for PS $7.5.

Play corporate events in VTB (VTBR), HODL Bank Vozrozhdenie (VZRZ). VTB is lagging its main competitor Sberbank in terms of profitability that implies HOLD recommendation with 12 m TP at $0.0036 (7$7.2 for GDR), while corporate events (privatization of 10% state stake and possible M&A) may increase speculative interest to the bank shares. Currently VTB shares are traded with 19% discount to its main peer Sberbank on P/BV 2011E, but with premium of 24% on P/E 2011E ratio. Bank Vozrozhdenie (VZRZ) recovers slowly after the downturn and it will take longer time to reach pre-crisis level on bottom-line. We recommend to HOLD Bank Vozrozhdenie shares with TP 12 m $48.4 and see upside risks for our valuation in case of better performance and favorable market conditions. Currently VZRZ shares are the cheapest in the universe with P/BV 2011E 1.58, but P/E 2011E ratio at 10.5 does not look attractive.

Loans to corporate clients

Source: CBR, TKB Capital

0

3,000

6,000

9,000

12,000

15,000

Jan

Feb Mar

Apr

May Jun

Jul

Aug

Sep Oct

Nov

RUR bn 30 largest banks Other banks

Retail loans

Source: CBR, TKB Capital

0

1,000

2,000

3,000

4,000

5,000

Jan

Feb Mar

Apr

May Jun

Jul

Aug

Sep Oct

Nov

RUR bn30 largest banks Other banks

Overdue Loans

Source: CBR data, TKB Capital estimates

0

5000

10000

15000

Jan

07Ja

n 08

Jul 0

8S

ep 0

8Ja

n 09

Jul 0

9O

ct 0

9Ja

n 10

Feb

10

Mar

10

Apr

10

May

Jun

10Ju

l 10

Aug

10

Sep

10

Oct

10

Nov

0.0%

2.0%

4.0%

6.0%

8.0%

Corporate Loans, RUR bnRetail Loans, RUR bnCorporate NPLs shareRetail NPLs share

NPL Provisions


1600

2000

2400

1-Ja

n

1-Fe

b

1-M

ar

1-A

pr1-

May

1-Ju

n

1-Ju

l1-

Aug

1-Se

p

1-O

ct

1-N

ov

0%2%4%6%8%10%12%

Prov isions, RUR mn

Prov ision, % of total loans (rhs)

NPLs, % of loans (rhs)

CAR of the Russian banks


0%4%

8%12%

16%20%

24%

1.1.

10

2.1.

10

3.1.

10

4.1.

10

5.1.

10

6.1.

107.

1.10

8.1.

10

9.1.

10

10.1

.10

11.1

.10

Assets/GDP

Source: CBR, WB, TKB Capital estimates

0% 50% 100% 150% 200%

IsraelSouth Af rica

Czech RepublicChile

HungaryKazakhstan

TurkeyBrazil

RussiaPoland

ArgentinaColombia

Mexico


STRATEGY 2011 103

Sberbank Successfully going the distance We revised our 12 months target price for Sberbank ordinary shares from $3.5 to $4.6 and for preferred shares from $2.9 to $3.53 with BUY recommendation for both stocks. Financial performance of the bank in 2010 was better than expected and the next year opens even stronger opportunities. The bank has done a lot in terms of modernization of its business, launching new services, improving efficiency and strengthening its competitive positions. Interest margins and demand for loans were the main concerns in 2010, and together with lower costs of risks will determine financial performance of the bank through 2011. DR program and sale of the state 7.6% stake will boost demand for the stocks. We consider Sberbank shares as our top pick in the Russian banking universe with upside potential at 32% for OS and 38% for PS.

Loan portfolio growth – believe in bullish case, bearing in mind a bearish one. Sberbank CEO German Gref shared its view in the bank’s loans growth at 13-15% in corporate segment and at 20-23% in retail segment, which was characterized by the management as the bullish case with more conservative forecasts from Sberbank CFO Anton Karamzin (9-10% and 15-18% correspondingly). We estimate growth Sberbank’s gross loan portfolio at 17% in 2011 with stronger numbers in retail segment. The bank develops new credit products for retail clients, improving sales and risk management system. In corporate segment Sberbank is working with all types of businesses from micro to large corporates. In regional aspect the bank is planning to expand its share in the key cities (Moscow and St-Petersburg), where the bank has 15% and 19% correspondingly vs. 31% across Russia.

Strong liquidity position to finance loan growth. As of November 1, loan portfolio constituted for 67% of the total bank’s assets, while securities together with cash and cash equivalents amounted to 22%. We expect that the bank will use part of these funds to finance loan portfolio expansion. In 2007-2008 loans were 75-80% of the total assets. In 2010 Sberbank continued attracting money on fixed-income market and in 2010 raised money on international market, but clients’ funds remain the main source of funding for the bank representing 87% of the total liabilities.

Margins stabilization with liabilities reprising and slight growth rates next year. In 2010 net interest margins reduced to 6.6% (according to our estimate) vs. 7.3% in 2009 under the pressure of declining rates and faster reprising of assets vs. liabilities. In 4Q10-1Q11 the bank expects further slight decline in margins and stabilization at that level. CBR is likely to increase refinancing rate in 1H11, but that will hardly affect interest rates on the market. We estimate NIM at 6.1% in 2011.

Lower costs of risk to support bottom line, but net release of provisions already in 2011 is unlikely. In 2011 the bank will continue reducing provisions on the back of credit quality stabilization, but expansion of loan portfolio and still existing risks will not allow to post net release of provisions. We estimate loan loss provisions in 2011 at RUR11 bn vs. RUR183 bn in 2010, while total reserves will reduce to 8% of the gross loans vs. 10% in 2010. Cost control program helps the bank to keep cost-to-income ratio at a relatively low level (42% in 2010). We expect net income in 2011 at RUR243.6 bn that will increase ROAE over the period to 22%.

Market drivers, corporate events and strong performance to boost interest to the stocks. In 2010 Sberbank ordinary shares grew by 20%, preferred stocks surged by 11% playing out strong performance of the bank and positive market trend as Sberbank ords became the most traded stocks on the Russian market. We believe that launching of DR program and privatization of the state 7.6% stake in the banks will further increase interest to the shares, while strong fundamental ratios and recovery of financial markets will also support demand for the shares. Our 12 months TP for Sberbank ords is $4.6 and $3.53 for prefs. Current stock prices give estimate of P/BV 2011E at 2.13, which means premium of 18% to emerging market banks, but bank’s strong position on the market justifies this premium. Sberbank is our top pick for 2011 among Russian banking shares.

SberbankCommon Pref erred

Ticker SBER SBERPRecommendation BUY BUYPrice, $ 3.48 2.55Target price, $ 4.60 3.53Upside/downside potential 32% 38%

SHARE DATABloomberg SBER RUReuters SBER.RTS

Common Pref erred# of shares outstanding,mn 21,588 1,001MC, $ mn 77,679 -MIN 12 mnth, $ 2.08 1.64MAX 12 mnth, $ 3.50 2.55

SUMMARY FINANCIALS, RUR mn2010E 2011E 2012E

Interest incomes 775,341 817,483 922,656Net Interest incomes 465,358 482,559 526,348Net Income 144,682 243,639 299,349Equity 923,909 1,091,365 1,330,414EPS, RUR 6.70 11.29 13.87Interest income growth, %

-5 5 13

EPS growth, % 493 68 23ROAE 16% 22% 23%


P/BV 2.6 2.1 1.8P/E 16.3 9.5 8.1

Loans/Deposits 86% 91% 97%P/B trailing 2.6

58%Others 42%

SHAREHOLDER STRUCTURECentral Bank of Russia



PRICE DYNAMICS

1.8

2.5

3.2

3.9

22.12.09 22.3.10 22.6.10 22.9.10 22.12.10

SBER RTS

1.0

1.6

2.2

2.8

22.12.09 22.3.10 22.6.10 22.9.10 22.12.10

SBERP RTS


104 STRATEGY 2011

Sberbank

BALANCERUR mn 2009 2010E 2011E 2012E 2013E 2014E 2015ELoans and advances to customers 4,864,031 5,388,742 6,423,752 7,800,564 9,211,990 10,641,005 11,971,366Securities 1,061,436 1,484,483 1,376,154 1,343,046 1,316,423 1,296,631 2,011,479Due from other banks 10,219 12,774 15,329 18,394 22,073 26,488 30,461Other 1,169,380 1,213,776 1,418,509 1,456,801 1,554,952 1,593,967 1,171,756TOTAL ASSETS 7,105,066 8,099,775 9,233,744 10,618,805 12,105,438 13,558,091 15,185,062Customer accounts and deposits 5,438,871 6,243,004 7,083,870 8,080,901 9,125,058 10,099,543 11,170,920Issued securities 124,599 129,166 162,848 185,768 209,771 232,173 256,803Due to other banks 53,947 157,869 162,848 157,903 157,329 174,130 192,602Other liabilities 709,547 645,828 732,814 863,820 996,414 1,102,824 1,219,813TOTAL LIABILITIES 6,326,130 7,175,866 8,142,379 9,288,392 10,488,573 11,608,670 12,840,138Share capital 87,742 87,742 87,742 87,742 87,742 87,742 87,742Share premium 232,493 232,493 232,493 232,493 232,493 232,493 232,493Revaluation Reserves 54,942 82,540 55,540 55,540 55,540 55,540 55,540Retained Earnings 403,934 521,134 715,590 954,639 1,241,090 1,573,645 1,969,148TOTAL EQUITY 778,162 923,909 1,091,365 1,330,414 1,616,865 1,949,420 2,344,923TOTAL EQUITY & LIABILITIES 7,105,066 8,099,775 9,233,744 10,618,805 12,105,438 13,558,091 15,185,062

ASSET QUALITYRUR mn 2009 2010E 2011E 2012E 2013E 2014E 2015ENPLs 462,727 612,144 570,843 505,799 390,572 333,793 247,701NPL Reserves 579,814 732,702 711,784 629,416 552,311 485,420 413,680NPLs/Gross Loans 8.5% 10.0% 8.0% 6.0% 4.0% 3.0% 2.0%Reserves/NPLs 1.3 1.2 1.2 1.2 1.4 1.5 1.7

PROFIT & LOSS STATEMENTRUR mn 2009 2010E 2011E 2012E 2013E 2014E 2015EInterest income 814,962 775,341 817,483 922,656 1,069,126 1,221,127 1,397,985Interest expenses 312,245 309,983 334,925 396,308 452,458 506,336 559,497Net interest income 502,717 465,358 482,559 526,348 616,667 714,791 838,488Provision for loan impairment (388,932) (183,495) (11,201) 43,365 40,256 45,609 53,783Net income from security operations 36,463 25,000 5,000 5,000 5,000 5,000 5,000Net comission fee 101,089 120,970 128,322 150,874 174,202 197,035 219,852Other net income 7,804 16,786 1,594 (5,061) 12,431 13,132 10,000Administrative and other operating expenses (229,277) (263,767) (301,726) (346,339) (397,941) (449,427) (499,289)Profit before tax 29,864 180,853 304,549 374,186 450,616 526,140 627,834Income tax (5,468) (36,171) (60,910) (74,837) (90,123) (105,228) (125,567)Net profit 24,396 144,682 243,639 299,349 360,493 420,912 502,267

RATIOS% 2009 2010E 2011E 2012E 2013E 2014E 2015ENet interest income grow th 33% -7% 4% 9% 17% 16% 17%Net comission fee grow th 17% 20% 6% 18% 15% 13% 12%Net interest margin 7% 7% 6% 6% 6% 6% 6%Cost/income ratio 35% 42% 49% 51% 49% 48% 47%ROE 3% 16% 22% 23% 22% 22% 21%Loan/Assets 68% 67% 70% 73% 76% 78% 79%Deposits/Liabilities 86% 87% 87% 87% 87% 87% 87%Loans/Deposits 89% 86% 91% 97% 101% 105% 107%Equity/Assets 11% 11% 12% 13% 13% 14% 15%


STRATEGY 2011 105

VTB Play on corporate events

We keep our HOLD recommendation for VTB shares with a TP of $0.0036 per stock ($7.2 per GDR). Decreasing pressure on interest margins along with accelerating loan portfolio growth and lower provisions should support the bottom line. However estimated ROAE at 15% for 2011 makes the bank fundamentally less attractive compared to its major peer Sberbank. At the same time planned privatization of government stake in the bank as well as possible acquisition of Bank of Moscow may boost the demand for the stock in the first half of 2011.

Loan portfolio growth is expected to accelerate next year. Management of the bank expects corporate loan portfolio to grow by 15% in 2011, while retail segment will expand even stronger by approximately 20%. We view the targeted growth rates as achievable due to expected increase in demand from both – corporate and retail clients boosted by further economic recovery and current low yield environment.

NIM to stabilize next year. Bank’s NIM showed relatively stable dynamics over 3 quarters of 2010. VTB management expects NIM over 2010 at the level above 5%. We do not exclude slight decline in corporate yields during the first quarter of next year with further possible recovery backed by growing inflation in Russia and increase in refinancing rate by CBR. At the same time according to the management words, the yields on the main bank’s retail products have already reached almost their bottom, and further possible decline is limited by 50-150 bpp next year. Thus we expect for relatively flat NIM for VTB next year at 4.8-5.0%.

Declining provisions and growth in commission income to support bottom-line. The share of overdue loans in total loan portfolio decreased by 70 bp over 9M10. We forecast further improvement of loan portfolio quality in 2011 with NPLs share around 8% and provisions at 8-8.5%. Stabilization of the loan portfolio quality will determine lower provisions, but the bank is not planning considerable release of provisions in 2011. At the same time, net fees and commission income that grew over 9M10 by 21% y-o-y will continue to support the bottom-line in 2011 on the back of increase in credit card segment along with growth in commissions from small business.

Targeted return to be achieved in later years. We expect net income in 2011 at RUR89 bn. That corresponds to ROAE of 15% which is low band of targeted 15-20% in the coming years. We believe that VTB has all chances to achieve the higher goals in later years in terms of profitability, but now the stock looks less attractive comparing to Sberbank's shares due to lower ROE.

Privatization and possible acquisition of Bank of Moscow as the core drivers. According to Andrey Kostin (CEO) recent announcement in press, privatization of 10% government stake in the bank may take place in January-February 2011, and the stake will be acquired by several investors headed by American TPG fund. Mr. Kostin also mentioned that the high demand for the bank’s shares may force the government to hold additional placement during 2011. Another corporate driver for VTB stocks is possible acquisition of Bank of Moscow in the first half of 2011. VTB is interested in acquisition of controlling stake or even 100% of the bank. According to the press acquisition of Bank of Moscow does not look transparent, but with these assets VTB will get leading position in Moscow region and strengthen its business structure. Thus, privatization of 10% government stake as well as possible acquisition of Bank of Moscow may drive up the share price in the first half of the next year. Now VTB is traded at 1.72 its peers on P/BV vs. 1.8 on average), while on P/E ratio the stock is valued at 11.8 by the market comparing to the average of 11.2. We keep a HOLD recommendation on the bank’s shares

VTBCommon GDR

Ticker VTBR VTBR LIRecommendation HOLD HOLDPrice, $ 0.0034 6.69Target price, $ 0.0036 7.20Upside/downside, % 7% 8%

SHARE DATABloomberg VTBR RUReuters VTBR.MM

Common GDR# of shares outstanding, bn 10,461MC, $ mn 35,566MIN 12 mnth, $ 0.00210MAX 12 mnth, $ 0.00350

Shares per GDR 2000

SUMMARY FINANCIALS, RUR mn2010Е 2011E 2012E

Interest incomes 345,598 385,433 421,098Net Interest 174,070 186,468 202,121Net Income 56,699 89,359 108,385Equity 547,818 612,304 699,049EPS, RUR 0.0054 0.0085 0.0104Interest income growth, %

8 12 9

EPS growth, % - 58 21 ROAE 11% 15% 17%

SUMMARY VALUATIONS2010Е 2011E 2012E

P/BV 2.0 1.7 1.6P/E 18.9 11.8 10.2


85.50%14.50%

SHAREHOLDER STRUCTUREState property autorityOthers


PRICE DYNAMICS

0.0016

0.0023

0.0030

0.0037

22.12.09 22.3.10 22.6.10 22.9.10 22.12.10

VTBR RTS


106 STRATEGY 2011

VTB

BALANCE SHEETRUR mn 2009 2010E 2011E 2012E 2013E 2014E 2015ELoans and advances to customers 2,309,900 2,642,031 3,141,990 3,658,020 4,215,413 4,788,837 5,318,691Securities 400,700 426,205 476,247 520,673 558,675 547,260 542,451Due from other banks 345,600 276,480 276,480 276,480 276,480 276,480 276,480Other 554,600 536,894 491,503 413,530 402,380 494,725 641,483TOTAL ASSETS 3,610,800 3,881,610 4,386,219 4,868,703 5,452,948 6,107,302 6,779,105Customer accounts and deposits 1,568,800 1,744,065 2,027,362 2,364,344 2,744,143 3,170,488 3,666,013Issued securities 485,700 496,252 528,886 557,290 562,800 571,980 349,700Due to other banks 287,000 301,350 316,418 332,238 348,850 366,293 384,607Other liabilities 764,477 786,425 896,351 910,189 986,443 1,038,270 1,258,847TOTAL LIABILITIES 3,105,977 3,328,092 3,769,016 4,164,062 4,642,236 5,147,031 5,659,168Share capital 113,064 113,064 113,064 113,064 113,064 113,064 113,064Share premium 358,500 358,500 358,500 358,500 358,500 358,500 358,500Treasury stocks (441) (441) (441) (441) (441) (441) (441)Non-realized gains 3,400 3,400 3,400 3,400 3,400 3,400 3,400Revaluation Reserves 25,000 25,200 18,200 18,200 18,200 18,200 18,201Retained Earnings 2,700 48,095 119,581 206,326 313,153 462,770 622,195TOTAL EQUITY 502,223 547,818 612,304 699,049 805,876 955,493 1,114,919Minority share 2,600 5,700 4,898 5,592 4,835 4,777 5,017TOTAL EQUITY & LIABILITIES 3,610,800 3,881,610 4,386,219 4,868,703 5,452,948 6,107,302 6,779,105

ASSET QUALITYRUR mn 2009 2010E 2011E 2012E 2013E 2014E 2015ENPLs 249,390 292,652 273,922 275,634 269,334 226,241 221,213NPL Reserves 234,900 284,489 282,038 279,612 273,488 238,732 211,635NPLs/Gross Loans 9.8% 10.0% 8.0% 7.0% 6.0% 4.5% 4.0%Reserves/NPLs 0.9 1.0 1.0 1.0 1.0 1.1 1.0

PROFIT & LOSS STATEMENTRUR mn 2009 2010E 2011E 2012E 2013E 2014E 2015EInterest income 373,700 345,598 385,433 421,098 467,274 521,892 574,287Interest expenses (221,500) (171,529) (198,965) (218,977) (237,633) (252,283) (273,784)Net interest income 152,200 174,070 186,468 202,121 229,640 269,609 300,504Provision for loan impairment (154,700) (51,899) (13,401) (13,284) (12,166) 22,110 17,519Net income from security operations (39,900) 7,000 4,000 15,000 14,000 14,500 14,500Net comission fee 21,000 21,930 28,431 33,123 41,757 47,756 53,908Other net income 33,300 3,275 3,165 4,464 11,264 11,648 10,001Administrative and other operating expenses (80,200) (83,502) (96,964) (105,942) (117,627) (131,879) (147,347)Profit before tax (68,300) 70,874 111,699 135,482 166,868 233,743 249,085Income tax 8,700 (14,175) (22,340) (27,096) (33,374) (46,749) (49,817)Net profit (59,600) 56,699 89,359 108,385 133,495 186,995 199,268

RATIOS% 2009 2010E 2011E 2012E 2013E 2014E 2015ENet interest income grow th 23% 14% 7% 8% 14% 17% 11%Net comission fee grow th 9% 4% 30% 17% 26% 14% 13%Net interest margin 5% 5% 5% 5% 5% 5% 5%Cost/income ratio 42% 44% 44% 43% 41% 0% 37%ROAE neg 11% 15% 17% 18% 21% 19%Loan/Assets 64% 68% 72% 75% 77% 78% 78%Deposits/Liabilities 51% 52% 54% 57% 59% 62% 65%Loans/Deposits 147% 151% 155% 155% 154% 151% 145%Equity/Assets 14% 14% 14% 14% 15% 16% 16%


STRATEGY 2011 107

Bank St. Petersburg Upside potential is still not played out Solid position on the market of St.-Petersburg, concentrated branch network and high operating efficiency helped the bank to show strong financial performance in 2010. Further improvement of quality of loan portfolio will lead reduce cost of risk for the bank that along with stabilization of NIM should support net income figures in 2011. We keep our positive view on the bank ordinary and preferred shares. Bank St-Petersburg (STBK) market cap exceeds pre-crisis level by the volume of preferred shares, while the bank delivers strong financial results proving its stable position in the region and efficiency of its business-model. TP 12 m for Bank St.-Petersburg OS is $6.8, for PS $7.5.

Expansion of loan portfolio is limited. Loan portfolio is expected to grow by 15% in 2011. In 2010 loan portfolio is expected to expand by 15% (posted 12.9% over 9M10). According to the recent data the share of retail loans was 7.2% while management of the bank guided it above 10% by the end of 2011 that should support the interest income figures next year on the back of higher yields in retail segment of the business.

NIM estimated at 5.6% next year. NIM compressed by 30 bpp in 3Q10 to 5.1% posting 5.2% over 9M10. Management of the bank does not provide any guidance on NIM level in 2011, but shared its preliminary expectations that NIM will remain at least flat next year. Meanwhile, we estimate NIM at 5.6% in 2011 vs. estimated 5.4% in 2010.

Despite improvement of loan portfolio quality bank will continue provisioning next year. Bank reported decrease in the share of overdue loans in the total loan portfolio by 160 bpp in 3Q10 compared to January 1, 2010. We expect further decline in NPLs next year on the back of restructuring as well as repayment of overdue loans. As a result according to the management expectations loan loss provisions should substantially decrease next year bringing cost of risk down by around 200 bp in 2011 vs. 340 bp in 2010E. However management of the bank does not expect for release of provisions next year.

Keeping the lowest cost-to-income ratio in the sector. Operating expense over 9M10 surged by 22% y-o-y giving cost-to-income ratio at 28.2% over 9M10 vs. 25.3% in the same period of the last year. We expect for further increase in cost-to-income ratio in 2011 up to 31% due to increasing staff costs. However, this is still the lowest ratio among its market peers, which is one of the core competitive advantages of the bank.

Growth potential is still not played out. Bank’s shares showed strong growth during the year. Ordinary shares of the bank grew by 100% from the beginning of the year while preferred surged by 94% for the same period. However the ordinary shares are still traded at a discount to Sberbank (based on 2011 P/BV of 1.96 vs. 2.13). The estimated target price for Bank St Petersburg’s ordinary shares is $6.8 for the next 12-months which assumes 22% upside from the current levels, while upside risk for bank's preferred shares is estimated at 28% with fair value of $7.5.

Bank St. PetersburgCommon Pref erred

Ticker STBK STBKPRecommendation BUY BUYPrice, $ 5.60 5.86Target price, $ 6.80 7.50Upside/downside, % 22% 28%

SHARE DATABloomberg SRBK RUReuters STBK.MM

Common Pref erred# of shares outstanding, mn 282 74MC, $ mn 2,012 -MIN 12 mnth, $ 2.52 3.02MAX 12 mnth, $ 5.67 5.92


Interest incomes 24,092 27,240 30,094Net Interest incomes

11,992 13,196 14,693

Net Income 2,986 4,836 7,061Equity 27,515 31,635 37,990EPS, RUR 10.58 17.14 25.02Interest income growth, %

-6 13 10

EPS growth, % 366 62 46ROAE 11% 16% 20%


P/BV 2.3 1.9 1.6P/E 21.2 12.0 7.5


Sav ely ev A.V. 29.91%29.48%

Others 40.61%


Other managers


PRICE DYNAMICS

2.2

3.2

4.2

5.2

22.12.09 22.3.10 22.6.10 22.9.10 22.12.10

STBK RTS


108 STRATEGY 2011

Bank St. Petersburg

BALANCE SHEETRUR mn 2009 2010E 2011E 2012E 2013E 2014E 2015ELoans and advances to customers 158,200 179,118 206,216 235,948 269,578 306,316 348,071Securities 29,717 27,427 27,844 26,441 25,623 23,855 23,218Due from other banks 5,867 1,173 1,291 1,420 1,420 1,278 1,150Other 41,822 39,667 44,195 49,283 54,042 54,281 59,578TOTAL ASSETS 235,606 247,386 279,547 313,092 350,663 385,729 432,017Customer accounts and deposits 175,990 171,653 195,914 221,315 246,510 273,238 303,040Issued securities 5,151 6,695 7,029 7,380 7,749 8,136 9,762Due to other banks 16,002 18,689 18,593 16,506 15,152 13,091 14,408Other liabilities 13,179 22,835 26,376 29,901 33,638 32,803 33,000TOTAL LIABILITIES 210,322 219,871 247,911 275,102 303,049 327,267 360,210Share capital 3,630 3,630 3,630 3,630 3,630 3,630 3,630Share premium 15,744 15,744 15,744 15,744 15,744 15,744 15,744Revaluation Reserves 1,966 2,064 2,168 2,276 1,600 1,400 1,401Retained Earnings 3,912 6,077 10,094 16,340 26,640 37,688 51,032TOTAL EQUITY 25,252 27,515 31,635 37,990 47,614 58,462 71,807TOTAL EQUITY & LIABILITIES 235,574 247,386 279,547 313,092 350,663 385,729 432,017

INCOME STATEMENTRUR mn 2009 2010E 2011E 2012E 2013E 2014E 2015ENPLs 12,884 12,021 12,673 13,036 13,186 13,175 12,960NPL Reserves 15,910 21,238 24,193 24,768 23,442 23,056 22,217NPLs/Gross Loans 7.4% 6.0% 5.5% 5.0% 4.5% 4.0% 3.5%Reserves/NPLs 1.2 1.8 1.9 1.9 1.8 1.8 1.7

CASH FLOW STATEMENTRUR mn 2009 2010E 2011E 2012E 2013E 2014E 2015EInterest income 25,597 24,092 27,240 30,094 33,459 37,105 41,370Interest expenses (15,177) (12,100) (14,044) (15,401) (16,945) (18,329) (19,951)Net interest income 10,420 11,992 13,196 14,693 16,514 18,776 21,418Provision for loan impairment (10,512) (6,330) (4,107) (2,400) 447 (273) 98Net income from security operations 1,714 400 250 300 300 300 300Net comission fee 1,490 1,486 1,786 2,079 2,356 2,718 3,132Other net income 1,422 550 270 295 395 395 447Administrative and other operating expenses (3,773) (4,365) (5,350) (6,141) (7,143) (8,113) (8,724)Profit before tax 761 3,733 6,045 8,826 12,870 13,803 16,671Income tax (120) (747) (1,209) (1,765) (2,574) (2,761) (3,334)Net profit 641 2,986 4,836 7,061 10,296 11,043 13,337

RATIOS% 2009 2010E 2011E 2012E 2013E 2014E 2015ENet interest income grow th 10% 15% 10% 11% 12% 14% 14%Net comission fee grow th 108% 100% 120% 116% 113% 115% 115%Net interest margin 5% 5% 5% 5% 5% 6% 6%Cost/income ratio 25% 30% 35% 35% 37% 37% 34%ROAE 3% 11% 16% 20% 24% 21% 20%Loan/Assets 67% 72% 74% 75% 77% 79% 81%Deposits/Liabilities 84% 78% 79% 80% 81% 83% 84%Loans/Deposits 90% 104% 105% 107% 109% 112% 115%Equity/Assets 11% 11% 11% 12% 14% 15% 17%


STRATEGY 2011 109

Bank Vozrozhdenie Cheap stocks with limited upside for now Moderate growth of bank Vozrozhdenie loan portfolio along with the weakest interest margins and high operating costs put pressure on bottom-line in 2010 and may negatively affect financial performance the next year. Business-model of the bank with expensive retail funding and spread network of branches on highly competitive market performed badly under the crisis conditions, and the bank needs more time to recover its numbers. We see a limited upside for the name in 2011, which will be realized only in case of faster credit market recovery. We recommend HOLD Bank Vozrozhdenie shares with TP 12 m $48.4 and see upside risks for our valuation in case of better performance and favorable market conditions.

Moderate growth of loan portfolio. Recently management of the bank guided 15-20% growth in total loan portfolio in 2011 with 30% growth in retail loans. However, we are more conservative in our forecasts and expects for 14% growth of loan portfolio next year. In 2010 loan portfolio growth is expected at 15%.

Loan portfolio quality stabilizes slower than expected In 3Q10 bank declared increase in share of overdue loans to 10.98% from 10.55% in 2Q10 due to impairment of large loan to one of the bank’s corporate clients. Total volume of loans overdue by 360+ days surged by 37% q-o-q. The share of loans overdue by more than 360 days increased from 4.6% in 2Q10 to 6.1% in 3Q10. Total volume of overdue loans grew by 7% to RUR11.6 bn. We expect NPLs to decline to 10% in 2011 while provisions will decrease to 9.0%.

High margins are in the past. Slow growth of loan portfolio and lower interest income resulted in net interest income decline and NIM contraction to 3.3% in 3Q10. Management of the bank expects to post NIM at around 5% next year. However we estimate NIM of 4.4% in 2011 due to increasing competition on the market mainly from the side of the largest sector players.

Net income is under pressure of high OPEX. Lower core income and relatively high operating costs due to existing business model continue reducing efficiency of the bank. Cost-to-income ratio in 3Q10 was 69.4% vs. 48.7% in 2009. We expect cost-to-income at 65-67% in 2011 that will also put pressure on bottom line.

Limited upside under the current market conditions. Now the shares of bank Vozrozhdenie are traded with 2011 P/BV of 1.58 vs. 2.13 for Sberbank, which was earlier a kind of benchmark for Vozrozhdenie taking into account their business models with large branch network and a significant share of retail funding. Stronger competition and existing credit risks limit upside of the shares and we recommend to HOLD them. We stay cautious in terms of relatively high operating costs and low margins showed by the bank, but we see upside risks for our valuation if the market conditions are getting more favorable for the bank.

Bank VozrozhdenieCommon Pref erred

Ticker VZRZ VZRZPRecommendation HOLD HOLDPrice, $ 43.36 14.32Target price, $ 48.40 16.90Upside/downside potential 12% 18%

SHARE DATABloomberg VZRZ RUReuters VZRZ.RTS

Common Pref erred# of shares outstanding, mn 24 1MC, $ mn 1,048 -MIN 12 mnth, $ 26.46 9.74MAX 12 mnth, $ 48.25 19.40


Interest incomes 13,654 15,428 17,621Net Interest 5,728 7,373 8,911Net Income 593 2,996 4,845Equity 16,846 19,828 24,673EPS, RUR 24.96 126.15 203.99Interest income growth, %

-14 7 14

EPS growth, % -51 405 62ROAE 4% 16% 22%


P/BV 1.9 1.6 1.3P/E 53.8 10.5 6.8


Orlov D.L. 30.70%18.65%

9.37%41.28%Others

Marganiy a O.L.JPM International Consumer


PRICE DYNAMICS


24

34

44

54

22.12.09 22.3.10 22.6.10 22.9.10 22.12.10

VZRZ RTS


110 STRATEGY 2011

Bank Vozrozhdenie BALANCE SHEETRUR mn 2009 2010E 2011E 2012E 2013E 2014E 2015ELoans and advances to customers 85,205 97,486 112,873 132,388 154,555 179,449 207,451Securities 11,068 12,175 13,392 14,732 16,205 17,825 19,608Due from other banks 6,363 7,317 8,196 9,179 10,280 11,514 12,896Other 42,967 41,729 40,117 42,720 45,842 52,126 52,269TOTAL ASSETS 145,603 158,707 174,578 199,019 226,882 260,914 292,223Customer accounts and deposits 113,129 130,098 144,409 163,182 184,396 212,055 243,864Issued securities 6,364 3,612 3,951 5,598 6,751 7,913 8,082Due to other banks 4,368 1,747 1,660 1,577 1,498 1,423 1,352Other liabilities 5,456 6,403 4,730 3,989 4,002 2,840 -4,748TOTAL LIABILITIES 129,317 141,861 154,750 174,346 196,647 224,231 248,549Share capital 250 250 250 250 250 250 250Share premium 7,306 7,306 7,306 7,306 7,306 7,306 7,306Revaluation Reserves 70 52 52 52 52 52 53Retained Earnings 8,660 9,238 12,220 17,065 22,626 29,075 36,065TOTAL EQUITY 16,286 16,846 19,828 24,673 30,234 36,683 43,674TOTAL EQUITY & LIABILITIES 145,603 158,707 174,578 199,019 226,882 260,914 292,223

INCOME STATEMENTRUR mn 2009 2010E 2011E 2012E 2013E 2014E 2015ENPLs 9,370 12,517 12,408 11,415 9,846 9,435 10,851NPL Reserves 9,439 11,355 11,205 10,302 9,539 9,259 9,563NPLs/Gross Loans 9.9% 11.5% 10.0% 8.0% 6.0% 5.0% 5.0%Reserves/NPLs 1.0 0.9 0.9 0.9 1.0 1.0 0.9

CASH FLOW STATEMENTRUR mn 2009 2010E 2011E 2012E 2013E 2014E 2015EInterest income 16,954 13,654 15,428 17,621 19,987 22,750 26,108Interest expenses (8,628) (7,926) (8,055) (8,710) (9,543) (10,485) (11,962)Net interest income 8,326 5,728 7,373 8,911 10,445 12,266 14,146Provision for loan impairment (4,752) (2,425) (433) 503 456 103 (507)Net income from security operations 204 20 50 50 50 50 51Net comission fee 3,729 4,006 4,279 5,164 5,826 6,914 7,942Other net income 737 543 710 760 760 760 761Administrative and other operating expenses (6,325) (7,131) (8,234) (9,332) (10,585) (12,033) (13,656)Profit before tax 1,919 741 3,745 6,056 6,952 8,060 8,738Income tax (702) (148) (749) (1,211) (1,390) (1,612) (1,748)Net profit 1,217 593 2,996 4,845 5,562 6,448 6,990

RATIOS% 2009 2010E 2011E 2012E 2013E 2014E 2015ENet interest income grow th -2% -31% 29% 21% 17% 17% 15%Net comission fee grow th -10% 7% 7% 21% 13% 19% 15%Net interest margin 6% 4% 4% 5% 5% 5% 6%Cost/income ratio 49% 69% 66% 63% 62% 60% 60%ROAE 8% 4% 16% 22% 20% 19% 17%Loan/Assets 59% 61% 65% 67% 68% 69% 71%Deposits/Liabilities 87% 92% 93% 94% 94% 95% 98%Loans/Deposits 75% 75% 78% 81% 84% 85% 85%Equity/Assets 11% 11% 11% 12% 13% 14% 15%

Machinery Citius, altius, fortius*

STRATEGY 2011 111

Artem Lavrischev [email protected]


Russian machinery sector provides investors a lot of opportunities to make money. However, we believe that a selective choice should be used. Thus, we prefer auto and helicopter producers on the back of strong vehicle sales recovery in domestic auto segment and Russian Helicopters’ IPO prospects respectively. We are also positive on power equipment producers due to expected capacity installations in domestic utility sector. On the contrary, nuclear fuel fabricators are likely to face lack of export orders’ flow from Asia, which will significantly limit their upside potential.

Auto industry – a premium for the growth

Domestic auto market continues to fill the gap. We expect cars and LCVs sales in Russia to increase by 20% y-o-y to 2.3 mn vehicles in 2011 on the back of the state support via extension of cash-for-clunkers program and consumer power strengthening. Russian truck producers will also gain from construction market recovery and infrastructure projects’ realization.

Foreign partners may get an expensive ticket for control. Renault-Nissan and Daimler may boost their stakes in AVTOVAZ and KAMAZ respectively up to control, which will be a good support for the latter’s stocks taking into account that the major shareholder – Russian Technologies – estimates fair value of these companies with a 30-50% premium to the market quotes.

Sollers – more value ahead. We believe Sollers to outperform other Russian auto producers in 2011 due to strong auto sales dynamics and sharp recovery in profitability. The company trades with EV/EBITDA’11E of 7.4, which implies a discount of 10% and 15% to domestic and foreign peers respectively.

Helicopter producers – waiting for the holding company’s IPO

Russian Helicopters’ IPO could bring new value for the companies. Oboronprom intends to hold an IPO of Russian Helicopters by the end of 1H11. We estimate the holding company’s market capitalization at $1.8-2.0 bn, which implies EV/S’11E of 1.4 – practically in line with emerging market peers.

Ulan-Ude Aviation Plant is mostly undervalued among helicopter producers. We consider Ulan-Ude Aviation Plant’ shares could be the cheapest ticket into the holding company on the back of its fundamentals. The company’s EV/EBITDA’11E of 3.3 is also attractive in compare with other helicopter producers. However, swap ratios into the Russian Helicopters may bring disappointing news.

Power machinery – “cherry-picking” is on track

It’s time to realize capacity installations in domestic utility sector. 2011 is expected to be a starting point to capacity installations in Russian utility sector, which envisage investments over $50 bn for new power units of 31 GW by 2017. We believe that it is a key long-term driver for power equipment producers.

Power Machines is our bet on the industry’s growth. According to our estimates, Power Machines will benefit the biggest part of domestic utilities’ orders flow. We believe that the company’s solid prospects should be reflected in its financials and lead to a decrease of 40% discount to foreign peers on the base of its EV/EBITDA’11E of 5.8.

Nuclear fuel enrichment vs. fabrication and lack of Asian orders. We expect TVEL Holding will shift its priority from nuclear fuel fabrication to enrichment. Meanwhile Rosatom’s negotiations with China and India suggest that fuel fabrication for their NPPs will not to be realized in Russia. We believe that these factors bring negative sense to Mashinostroitelny Zavod and Novosibirsk Chemical Concentrates Plant and significantly limit their upside potential.

* – Latin for “Faster, higher, stronger”.


-100% 0% 100% 200%

RTSAVAZ

GAZASVAVKMAZKHELUUAZRTVLSILM

KRKOIZHZ

MASZ

NZHKPGHORKKESATR

UFMO

22.12.10 Max Min


80

100

120

140

160

Dec

09

Jan

10F

eb 1

0M

ar 1

0A

pr 1

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ay 1

0M

ay 1

0Ju

n 10

Jul 1

0A

ug 1

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ec 1

0

RTS Index RTS Industrials


112 STRATEGY 2011

Auto producers – a premium for the growth

Domestic auto market continues filling the gap. We believe that 2011 could be a breaking point for the Russian auto market. The key point is that the state plans to close cash-for-clunkers program next year, which was a key driver for the market during 2010. Thus, cars and LCVs sales in Russia increased by 28% y-o-y to 1.7 mn vehicles in 11M10, while scrappage program’s share, according to our estimates, amounted to 15%. Next year our government plans to provide at least 100,000 scrappage certificates (a decrease of 75% y-o-y), however the budget could be extended to avoid the European experience when the auto market dropped significantly after the state closed cash-for-clunkers program. We also note that almost 100,000 vehicles purchased with scrappage certificates in 2010, will be delivered to customers only in 2011, which will have an additional impact on auto sales statistics next year. Taking into account the state support and strengthening consumer confidence, we expect cars and LCVs sales in Russia to increase by 20% y-o-y to 2.3 mn vehicles in 2011. At the same time domestic truck market could also show positive performance on the back of construction and infrastructure projects’ realization, including preparations to Sochi Olympic Games-2014.

Costs increase will likely boost vehicle prices. Russian auto producers could face appreciable growth of operating expenses in 2011. Domestic steel makers plan to increase cold rolled steel prices by 25-30%, which share in auto producers’ COGS amounted to 20-40%. As a result it will lead either to the growth of vehicle end-price by 3-5% or auto makers’ margin decline. We regard Sollers’ profitability is relatively less influenced by possible steel prices boost vs. other Russian auto producers due to practically 40% of the company’s auto sales provided by assembled vehicles.

Foreign partners may get an expensive ticket for control. AVTOVAZ and KAMAZ are national champions in Russian auto industry with production capacities of 1 mn cars and 100,000 trucks per year respectively. Both these companies are controlled by the state corporation – Russian Technologies. Renault owns 25% share in AVTOVAZ, while Daimler has 15% in KAMAZ (including EBRD share of 4%). This year foreign partners approved their intention to reach control in Russian auto producers, which seems quite reasonable on the back of expected cooperation in technologies and vehicle output. Thus, Nissan may purchase 10% of AVTOVAZ’s common shares already in 1H11, which will lead to increase of Renault-Nissan’s stake to 35%. The next possible step suggests further boost of French-Japanese alliance’s share in Russian auto maker to 55% – Renault and Nissan will own 35% and 20% respectively. The same scenario will likely happen with Daimler’s share in KAMAZ, which is expected to exceed 50% threshold by 2016. It is clear that the main question is price and we believe that the answer is behind Russian Technologies’ position. The state corporation estimates key domestic auto producers with a premium of 30-50% to their market quotes. Thus, Russian Technologies calculations of AVTOVAZ’s and KAMAZ’s fair value imply their market capitalization of at least $2.9 bn and $2.5 bn respectively.

Sollers – more value ahead. According to our estimates, Sollers should increase its auto sales by 25% y-o-y in 2011. Thereby, the company’s annual sales will exceed 100,000 vehicles and turn back to precrisis level, which will also lead to solid improvements in Sollers’ financials. Thus, the company’s management expects to achieve revenue of $2.1 bn next year (28% increase y-o-y), which will be just 15% less the level of 2008, when auto producer reached its historical high. We note that Sollers engine segment recovers slowly as GAZ canceled huge part of orders during the crisis year. However, vehicle sales growth together with major efforts taken by the management to reduce costs will have a significant impact on the company’s margins recovery. In particular, Sollers expects to double its EBITDA to $200 mn in 2011, which implies Net Debt/EBITDA’11E ratio of 3. We consider Sollers the most undervalued auto producer in Russia on the back of strong fundamental story. The company trades with EV/EBITDA’11E of 7.4, which implies a discount of 10% and 15% to domestic and foreign peers respectively. We also believe that long-term prospects of establishing Sollers-Fiat joint venture, which total production capacities are expected to exceed 300,000 vehicles per year, are not priced in.

Russian automarket volume, units

Source: AEB, TKB Capital estimates

50,000100,000150,000200,000250,000300,000350,000

Jan

Feb Mar

Apr

May Jun

Jul

Aug

Sep Oct

Nov Dec

2008 2009 2010

Source: Minpromtorg, TKB Capital estimates

Scrappage certificatesdelivery dynamics

0

50,000

100,000

150,000

200,000

8.3.

1024

.3.1

08.

4.10

28.4

.10

12.5

.10

3.6.

1017

.6.1

01.

7.10

29.7

.10

1.9.

108.

10.1

08.

12.1

022

.12.

10

0

800

1,600

2,400

3,200

Scrappage certif icates (rest)

Daily certif icates deliv ery

AVTOVAZ car sales, units


50,000100,000150,000200,000250,000300,000

Jan

2008

Apr 2

008

July

200

8O

ct 2

008

Jan

2009

Apr 2

009

July

200

9O

ct 2

009

Jan

2010

Apr 2

010

Jul 2

010

Oct

201

0

15,00030,00045,00060,00075,00090,000

Whole automarket (lhs)

AVTOVAZ (rhs)

Sollers car and LCV sales, units


50,000100,000150,000200,000250,000300,000

Jan

2008

Apr

2008

July

200

8O

ct 2

008

Jan

2009

Apr

2009

July

200

9O

ct 2

009

Jan

2010

Apr

2010

Jul 2

010

Oct

201

02,5004,5006,5008,50010,50012,500


Sollers (rhs)

GAZ Group car and LCV sales, units


50,000100,000150,000200,000250,000300,000

Jan

2008

Apr

2008

July

200

8O

ct 2

008

Jan

2009

Apr

2009

July

200

9O

ct 2

009

Jan

2010

Apr

2010

Jul 2

010

Oct

201

0

2,5005,0007,50010,00012,50015,000


GAZ Group (rhs)


STRATEGY 2011 113

Helicopter producers – waiting for the holding company’s IPO

Russian Helicopters’ IPO could bring new value for the companies. In the meantime, domestic helicopter industry is not transparent enough to the investment community. We expect that coming IPO of Russian Helicopters will force the company to provide more information about its contracts and disclose financials under IFRS vs. RAS, which should increase the overall transparency of the sector. Oboronprom’s subsidiary will consolidate assets in R&D, production, maintenance, modernization and service of Mi and Ka helicopters – totally at least 13 companies, which overall 2011 revenue may reach $2.0-2.1 bn. According to our estimates, Russian Helicopters’ market capitalization could amount to $1.8-2.0 bn, which implies EV/S’11E of 1.4 – practically in line with emerging market peers. In this case we consider that Russian Helicopters should place 25-30% shares to raise Oboronprom’s targeted sum of $500 mn.

Ulan-Ude Aviation Plant is mostly undervalued among helicopter producers. Russian producers traditionally have strong position on helicopter markets of China, India and Latin America. According to published 9M10 RAS financials, the consolidated export revenue of Ulan-Ude Aviation Plant, Kazan Helicopters and Rostvertol amounted to $630 mn or 59% of their total sales for the same period. We also note that these companies generate above 70% and 90% of Russian Helicopters’ consolidated revenue and net income respectively. Rosoboronexport, which provide export orders for U-UAZ, KVZ and Rostvertol, is likely to complete their backlog for 2012–2013 in the run-up to IPO of the holding company. According to our estimates, Ulan-Ude Aviation Plant’ shares are the cheapest ticket into Russian Helicopters on the back of its high profitability and zero borrowings. Furthermore, we believe that U-UAZ is the most undervalued company among domestic helicopter producers, which EV/EBITDA’11E amounted to 3.3. However we note that it could be announced unattractive swap ratios into the Russian Helicopters, which we believe is a key risk for U-UAZ.

Power machinery – “cherry-picking” is on track

It’s time to realize capacity installations in domestic utility sector. 2011 is expected to be a starting point to capacity installations in Russia after the crisis. Key domestic utility players will sign capacity delivery agreements, which give them a free hand to place orders for power equipment to execute their investment programs. We note that Minenergo general scheme envisages investments over $50 bn for new power units of 31 GW by 2017. We believe that execution of investment programs in utility sector is a key long-term driver for domestic power equipment producers.

Power Machines is our bet on the industry’s growth. According to our estimates, Power Machines, which is generally specialized in production of turbines and generators, will benefit the most from domestic utilities’ orders flow. Thus, the company’s current backlog already amounted to $4 bn, while its net cash position equals $170 mn. Huge industry prospects forced Power Machines to build new production capacities in Kolpino. The state provides the company its support in this project including co-financing and subsidized loans. In this case we do not see any significant risks to Power Machines’ ability to generate solid cash flow to its shareholders. According to Bloomberg consensus estimates the company trades with EV/EBITDA’11E of 5.8, which implies a 40% discount to foreign peers.

Nuclear fuel enrichment vs. fabrication and lack of Asian orders. Atomenergoprom’s subsidiary – TVEL Holding – plans to rebuild nuclear fuel cycle in Russia according to the world practice. It means that the company’s focus will be shifted from fuel fabrication to enrichment. Meanwhile Rosatom’s negotiations with its key Asian partners – China and India – will likely force TVEL to establish fuel fabrication capacities in their territories (in a form of joint ventures) in order to supply fuel to existing and future NPPs in these countries. We believe that mentioned factors have negative sense to Mashinostroitelny Zavod and Novosibirsk Chemical Concentrates Plant and significantly limit their upside potential. However, both companies trade at a 50% discount to foreign peers on a base of EV/EBITDA’11E.


Enterprise Value breakdown, $ mn

161

489

561

234

197

-78

-200 0 200 400 600 800

RTVL

KHEL

UUAZ

Mkt Cap Net Debt

P/E EV/EBITDA EV/S5.1 3.3 0.895.4 4.8 0.984.5 5.9 0.71

5.0 4.7 0.86

-65% -45% -28%

P/E EV/EBITDA EV/S

14.3 8.5 1.20


Premium/(discount)

Rostv ertol

Foreign peers av erage

Russian companies av erage

Ulan-Ude Av iaplantKazan Helicopters

Key financial multiples of companies for 2011

Source: Rosstat, APBE, TKB Capital estimates

Electricity output in Russia (KWh bn)

0

300

600

900

1,200

1,500

1,800

2005

2007

2009

2011

E20

13E

2015

E20

17E

2019

E20

21E

2023

E

2025

E20

27E

2029

E

Heat Nuclear Hy dro

25%20%

16%


114 STRATEGY 2011

Ulan-Ude Aviation Plant (U-UAZ) The best company in the sector We believe that Russian Helicopters’ IPO will have positive impact on the whole sector. Publication of IFRS statements and supplementary info about the holding’s backlog is expected to increase the industry’s transparency. According to our estimates, U-UAZ is mostly undervalued by the market among domestic helicopter producers on the back of the company’s strong financials and attractive comparative valuation. U-UAZ trades with EV/EBITDA’11E of 3.3, which implies a discount of 40% and 60% to domestic and foreign market peers respectively. We should note that unattractive swap ratios announcement is a key risk for the company. We recommend to BUY U-UAZ’ shares with a 12-months target price of $2.9 per share and upside potential of 38%.

Valuation of the holding as a new benchmark for the industry. We believe that expected IPO of Russian Helicopters – a 100% subsidiary of Oboronprom – will increase the overall transparency of the sector. It means that the holding company is to disclose IFRS financials vs. RAS statements. Furthermore, we expect that IPO will force Russian Helicopters to announce major part of its backlog. We remind that Oboronprom’s subsidiary will acquire assets in R&D, production, maintenance, modernization and service of Mi and Ka helicopters i.e. at least 13 companies in total. According to our estimates, Russian Helicopters’ consolidated revenue may reach $2.0–2.1 bn in 2011. Oboronprom has already announced that the state corporation plans to raise $500 mn through Russian Helicopters’ IPO. We expect the holding will place 25-30% shares, which implies its market cap of $1.7–2.0 bn. Thereby, Russian Helicopters’ EV/S’11E could amount 1.3–1.4, which is practically in line with emerging market peers. We note that currently domestic helicopter producers trade with EV/S’11E of 0.9 on average, which implies a discount to the holding company of above 30%.

We prefer U-UAZ as the most undervalued company in the sector. According to our estimates, Ulan-Ude Aviation Plant’s shares may become the best entrance into Russian Helicopters. There are several reasons to choose this company. First of all, U-UAZ is the most efficient helicopter producer in Russia – its EBITDA margin and Net margin for 9M10 amounted to 27% and 23%, while average levels for domestic peers equal 21% and 13% respectively. Secondly, U-UAZ is the only company among Russian helicopter producers with zero borrowings – its net cash position totaled $78 mn (by the end of September, 2010). We expect the company to keep its leading position in terms of margins and financial stability in the nearest future. In addition, U-UAZ trades with EV/EBITDA’11E of 3.3, which implies a discount to domestic and foreign market peers of 40% and 60% respectively.

Unattractive swap ratios into the holding is a key risk. Russia traditionally has strong position on helicopter markets in China, India and Latin America. According to the published 9M10 RAS statements, the consolidated export revenue of three Russian producers amounted to $630 mn or 59% of their total sales. Rosoboronexport, which manages orders’ flow distribution for Mi-171 (Mi-8) helicopters between U-UAZ and Kazan Helicopters, will likely complete both their backlog for 2012–2013 in the run-up to IPO of Russian Helicopters. That’s why we believe that the key risk for U-UAZ is an announcement of unattractive swap ratios into the Russian Helicopters.

12-months target price of $2.9 per share, upside potential – 38%. According to our estimates, U-UAZ is the most undervalued helicopter producer in Russia on the back of its relatively high profitability and cheap multiples. We also believe that the company’s shares will be the best entrance into Russian Helicopters, which IPO will increase transparency of the whole sector. Healthy financials together with the backlog completion will make positive sense to U-UAZ prospects. We recommend BUY the company’s shares with a 12-months target price of $2.9 and upside potential of 38%.

Ulan-Ude Avia PlantCommon Pref erred

Ticker UUAZ -Recommendation BUY -Last price, $ 2.10 -Target price 12M, $ 2.90 -Upside/downside, % 38% -

SHARE DATABloomberg UUAZ RUReuters UUAZ.RTS

Common Pref erred# of shares outstanding,mn 267 -EV, $ mn 483MC, $ mn 561MIN 12 mnth., $ 1.09MAX 12 mnth., $ 2.29

SUMMARY FINANCIALS, $ mnRAS 2010E 2011E 2012ERev enue 503 542 583EBITDA 145 147 150Net income 109 110 112EPS, $ 0.41 0.41 0.42Rev . growth, % 29.3 7.7 7.6EPS growth, % 36.8 0.9 2.1EBITDA margin,% 28.8 27.1 25.8Net margin, % 21.6 20.2 19.2


P/E 5.2 5.1 5.0EV/EBITDA 3.3 3.3 3.2

SHAREHOLDER STRUCTUREOboronprom 55.1%AVIGAZ-FINANS 20.0%ZAO "Lider" (Gazf ond) 6.2%Others 18.7%

PRICE DYNAMICS


0.70

1.30

1.90

2.50

22.12.09 22.3.10 22.6.10 22.9.10 22.12.10

UUAZ RTS


STRATEGY 2011 115

Ulan-Ude Aviation Plant BALANCE SHEET$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ETOTAL CURRENT ASSETS 381 497 499 507 484 481 485PP&E, net 27 33 35 37 40 43 46Other non-current assets 25 35 37 40 44 47 51Total NON-CURRENT ASSETS 52 67 72 78 84 90 96TOTAL ASSETS 433 564 571 585 568 571 582Short-term borrow ings 13 - - - - - -Other short-term liabilities 222 263 161 63 (61) (165) (264)Total CURRENT LIABILITIES 235 263 161 63 (61) (165) (264)Long-term borrow ings - - - - - - -Other non-current liabilities 6 - - - - - -Total LONG-TERM LIABILITIES 6 - - - - - -Minority interest - - - - - - -Share and additional capital 18 19 19 20 18 18 18Retained earnings 173 281 391 503 611 719 828Total EQUITY 192 301 410 523 629 737 846TOTAL EQUITY & LIABILITIES 433 564 571 585 568 571 582

INCOME STATEMENT$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ERevenue 389 503 542 583 627 674 719Cost of production (274) (342) (377) (414) (448) (485) (521)EBITDA 111 145 147 150 146 147 149Depreciation 3 4 4 5 5 5 6EBIT 108 141 143 146 141 142 144Net interest income/(expenses) (1) - - - - - -EBT 104 136 137 140 135 135 137Income tax (25) (27) (27) (28) (27) (27) (27)Net income 79 109 110 112 108 108 109

CASH FLOW STATEMENT$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ENet CF from operating activities 94 123 125 128 124 125 127Net CF from/(used in) investment activities (19) (27) (25) (27) (27) (29) (31)Net CF from/(used in) financing activities (4) (67) (66) (56) (69) (22) (25)Net Debt (83) (107) (118) (129) (140) (151) (161)

RATIOS% 2009 2010E 2011E 2012E 2013E 2014E 2015ERevenue grow th 27% 29% 8% 8% 8% 8% 7%EBITDA margin 29% 29% 27% 26% 23% 22% 21%Net margin 20% 22% 20% 19% 17% 16% 15%Net Debt/EBITDA neg. neg. neg. neg. neg. neg. neg.

Source: U-UAZ, TKB Capital estimates

116 STRATEGY 2011

Real Estate Sector Footing get stronger, its time to build

STRATEGY 2011 117

Anatoly Vysotsky [email protected]


Next year we expect acceleration of revenue growth rates both for residential and commercial real estate companies. The increase in volumes of construction residential will provide companies’ short-term liquidity. Decrease in volumes of commercial real estate construction will lead rental rates and investments value for constructed project to growth. Our top-picks in the sector for 2011 – LSR Group, PIK Group and AFI Development.

Residential real estate is in priority

Volumes of residential construction are restored. We expect the growth of residential construction by 5% in 2011. In our opinion, state investments into development, perfection of construction conditions and infrastructure on the sites are among effective steps of sector stimulation.

Inflation will overtake the residential prices. We expect 3.6% growth of the average price per sq m of the residential real estate in Moscow for 2011 with 8.4% ruble inflation. We expect correction of the average price per sq m in 1H11 by 3-5% with the subsequent restoration by 7-9% in 2H11.

Mortgage development will support the sales. We expect confident growth of the mortgage market for next year. Signs of market restoration are obvious. Credit rates have reached pre-crisis level, banks became more loyal to borrowers, prices for residential are stable.

Commissioning of commercial real estate to decrease

Vacancy rates will continue to decrease. Under the low construction volumes of commercial real estate projects and stabilization of demand, we expect continuing decrease in vacancy rate by 3-7% next year depending on quality and location of facility.

Financial risks remain

Debt loading remains stably high. In modern conditions the companies should actively increase construction volumes; therefore financial load of the sector in 2011 will remain stably high. Our expectation for Net debt-to-EBITDA average for the sector in 2011 is 3.5.

Our top-picks

LSR Group. We believe that LSR Group is capable to show one of the best rates of recovery in the sector due to growing demand for residential real estate and investments into infrastructure construction. We recommend to buy LSR Group with the target price of $12.5/GDR and 50$/share.

PIK Group. The strategy is primarily focused on affordable residential housing segment on Moscow Metropolitan market. Availability of mortgage programs with banks is proposed to support demand for residential real estate constructed by the company. We recommend to buy PIK Group and our target price is 7.3$/share.

AFI Development. Commissioning AFIMOLL City - one of Europe’s largest retail projects in recent years – should double the rental revenue of the company. Residential sales will provide financial stability and lower financial risks. We recommend to buy AFI Development and our target price is 1.8$/share.


Sources: Bloomberg, RTS, TKB Capital estimates


-60% 0% 60%

RTS Index

PIK Group

LSR Group

AFI Dev .

MirLand

Sistema-Hals

OPIN

RGI Int.

Rav en Russia

22.12.2010 Max Min

-20%-10%

0%10%

20%30%40%

Jan-

10

Feb

-10

Mar

-10

Apr-

10

May

-10

Jun-

10Ju

l-10

Aug-

10

Sep-

10O

ct-1

0

Nov

-10

Dec

-10

RTS IndexReal Estate Sector


118 STRATEGY 2011

Moderately positive estimation of real estate market development prospects we adhered in strategy for 2010, has completely justified. Residential sales grew against the moderate growth of price; the building companies together with banks reduced mortgage rates and improved credit conditions. As for commercial real estate, despite the growth of business and consumer activity, high level of vacant areas has limited the growth of rent rates and led to expected reduction of new construction. In 2011 we forecast more active recovery both in residential and commercial real estate. The companies will continue to increase residential construction, ensuring short-term financial liquidity for them, while reduction of commercial construction to accelerate the rental growth and raise investment value of existing projects.

Residential real estate is in priority

Recovery in volumes of residential construction. According to our forecasts, growth of residential construction in 2011 will reach 5%. Fundamental deficiency of residential will come to the fore again. The minimum of residential area to be provided per person is 22 sq m in Russia - less the Chinese level by 5 sq m and twice less the average European indicator. At the average, in Europe the volume of residential construction makes up 1 sq m per person per annum, in Russia – 0.4 sq m. High deficit of residential real estate has limited the decline in prices for the real estate during the crisis. Continuation of housing construction stagnation will increase the gap between demand and supply leading to the next price soaring under conditions of economic recovery. Realizing the extent of the problem, the state actively promotes housing construction development. Among effective measures on increase in rates of construction, we see the state initiatives on removal of administrative barriers for the building companies, more simplified procedure of land allocation, drawing of the project documentation, municipal and road infrastructure for construction sites. The state plans to spend RUR620 bn in 2011-2015 to achieve these goals.

Inflation will overtake the prices for residential. We expect 3.6% growth of the average price per sq m for residential real estate in Moscow in 2011 when the ruble inflation is 8.4%. From the beginning of 2010 the average price of residential square meter in Moscow has grown by 17% in rubles and by 13% in USD. The possible reasons are recovery of national economy and, as consequence, growth of consumer confidence as well as entry of the so-called "postponed" demand into the market. We expect further recovery of national economy next year and the growth of demand for real estate as a result. Nevertheless, judging by dynamics of the average price per sq m in 2H10, "the postponed" demand is close to an exhaustion, the reasons for fast renewal of pre-crisis price levels are not observed. Therefore, we predict correction of the average price per square meter in 1H11 by 3-5% with the subsequent growth by 7-9% following the results of 2H11.

Mortgage development will support the sales. We expect the stable growth of the mortgage market for the next year. The state support of mortgage lending development brings positive results. According to the Central Bank of Russia, from the beginning of 2010 till October the rate on a mortgage decreased by 1.2 ppt to 12.8% and the minimum level of an initial payment reduced to 10% against 20-30% the year before. The volume of credits granted for acquisition of residential made up RUR301 bn, exceeding the last year indicator by 143%. No doubt that the volumes are still significantly below the pre-crisis level (during the first 10 months of 2008 the volume of credits for residential purchase made up RUR615 bn). However, the market recovery factors are obvious. Credit rates have reached the pre-crisis level, banks became more loyal to borrowers and the prices for residential are stable. All in all, the given factors are capable to become powerful triggers for the growth of the mortgage market. Therefore, we do not exclude that the volumes of the granted mortgage loans in 2011 will recover to 2008 levels.


Price dynamics of our top-picks and RTS Index

-30%-20%-10%

0%10%20%30%40%50%

Jan-10 Apr-10 Jul-10 Oct-10

RTS PIKLSR AFID

Sources: Rosstat, TKB Capital estimates

Russia has a long way to go to EU countries’ levels

Volume of residential construction per capita, sqm

0.45 0.42 0.44 0.46

1.00

0.2

0.4

0.7

0.9

1.1

2008 2009 2010E 2011E av eragein

Europe


Average price per sq m of residential real estate in Moscow

2011FY price dynamic to close on positive side

80

120

160

200

2008 2009 2010E1H11E2H11E-20%

0%

20%

40%

Price per sq m, th rub

price growth

Sources: Central bank of Russia, TKB Capital estimates

Mortgage continue to growMortgage credits issued, bn rub

100

200

300

400

500

600

700

2008 2009 2010E 2011E


STRATEGY 2011 119

Volumes of commercial real estate commissioning to decrease

Vacancy rates will continue decreasing. Under the low construction volumes of commercial real estate projects and stabilization of demand, next year we expect further decrease in vacancy rate by 3-7% depending on the quality and location of facilities. Construction decline and tenants’ activity has led to decrease of vacancy level in commercial real estate by 3-5%. The best demand is observed in retail real estate where rental rates growth has made 5% - 10% from the start of the year depending on quality of facilities. Vacancy level has fallen below 10%. Besides, demand for quality spaces with a good location in the center of Moscow has already exceeded the supply, rental rates have reached the pre-crisis level. Lease contracts for the areas are concluded at construction stage again.

Financial risks remain

Debt load remains stably high. Recovery of demand for real estate in 2010 had a positive influence on financial situation of construction companies; banks willingly restructured debts and reduced crediting rates. Nevertheless, debt burden of the companies is far from the comfortable level that, in our opinion, keeps financial risks in the sector. To maintain and increase the market share today, the companies should actively increase construction volumes, therefore financial risks of the sector in 2011 will remain stably high. Despite our forecast of increase in operational profit and corresponding decrease in Net Debt-to-EBITDA up to 3.5 at the average in the sector, comfortable level of a debt burden in construction sector, in our opinion, should not exceed 2.0 EBITDA.

Our favorites – LSR Group, PIK Group and AFI Development

We prefer LSR Group and PIK Group in residential construction sector. LSR Group has good prospects of business growth on Moscow market and availability of own facilities to produce almost any type of building materials is proposed to provide competitive advantage and high profitability on St.-Petersburg and Leningrad region markets. PIK Group conducts business in the most highly profitable region of Russia – Moscow. The region has the greatest demand for residential and showed the best rates of recovery in 2010. Large land bank and own construction facilities will provide high rates of revenue increase next year. We pick out AFI Development in commercial real estate. Strong cash positions, high share of ready projects and successful distribution of projects by development stages, in our opinion, will play supportive for the growth of company’s investment appeal. o. Commissioning of AFIMALL in Moscow-city will double the rental income and help to reach the break-even point next year.

Office real estate

4

8

12

16

2008 2009 2010E 2011E

5%

15%

25%

New construction, mn sq mOf f ices (class А + B + С), mn sq m

Vacancy lev el


Commercial real estate

1

3

5

2008 2009 2010E 2011E

0%

5%

10%

15%

New construction, mn sq mRetail, mn sq mVacancy lev el


Debt load of the real estate sector

6.6x

3.5x2.8x

0.0x

2.0x

4.0x

6.0x

8.0x

2010E 2011E 2012E

NetDebt to EBITDA



120 STRATEGY 2011

LSR Group A diversified leader of St.-Petersburg real estate market comes to Moscow

LSR Group possesses competitive advantage in the real estate sector due to flexible and effective business model, comfortable debt level and prospective projects portfolio focused on expansion of construction volumes in the Moscow region. In 2010 the company launched new cement plant, opened the representation, initiated a number of large perspective projects in the Moscow region, modernized and expanded capacities, continued negotiations with banks to improve credit terms for the buyers of residential real estate. We believe that LSR Group is capable to show one of the best recovery rates in the sector backed by growing demand for residential real estate and investments into infrastructure construction sector. We recommend to BUY LSR Group with the target price of $12.5/GDR and 50$/share.

Expansion to Moscow will be accelerated. LSR Group has thoroughly prepared to enter the Moscow real estate market. In 2010 the portfolio of projects in the Moscow region grew 7 -fold up to 890,000 sq m that makes about 18% of all the company’s projects at development stage. Construction is planned to complete till 2015. Company upgrades capacities of its concrete products’ facilities in Moscow by 40%. This will enable the company to increase its output to 240,000 sq m of housing per year. Besides, the own concrete facilities with a capacity of 3,000 cubic m per day will be involved in construction process. To cut administrative expenses and construction time, the company bets on low-height panel housing construction in Moscow Region. We believe that this fact should also play supportive for increase in short-term liquidity and raise of company’s financial stability. Business expansion in the Moscow region will have a positive impact on profitability of the company: the capital market is the most profitable for construction companies.

Infrastructural projects will cater for materials’ demand. Despite active expansion to the Moscow region, St.-Petersburg and Leningrad region are still the basic market for LSR Group. The company takes leading positions practically in all segments of construction market where it operates. Launch of cement plant with capacity of 2 mn tons per year has completed the building materials production chain and provided the company with an additional source of income. By our calculations, in 2011 the cement plant share in revenue will make 4% and increase up to 7% by 2012. Additional demand for cement will be provided by infrastructure construction sector which, in our opinion, will continue its development in the coming years. Flexibility of business model allows the company to shift products in a segment of infrastructure construction which were previously supplied only for housing construction. By our forecasts, the share of building materials’ segment will make 36% of 2011 total revenue against 26% in 2009 and 31% in 2010.

Debt loading will be reduced. LSR Group remains the unique construction company which did not experience difficulties with repayment and refinancing of debt even during financial crisis. Following the results of 1H10 the net debt made up $1,033 mn. We expect decrease in Net debt-to-EBITDA in 2011 to 1.7 against 2.3 in 2010 and 2.6 in 2009.

Attractive by multiplies. Valuation based on multiplies indicates good upside potential. LSR Group trades at an average 2011-2012E EV/EBITDA of 9.1 and 7.4 accordingly, that implies average 22% discount to its foreign peers.

Fundamental value is above the market. We recommend to buy LSR Group - the market leader of construction sector. Based on our DCF-model, 12-month’s target price of LSR Group is $12.5 per GDR and $50 per share.

LSR GROUPCommon GDR

Ticker LSRG LSRG LIRecommendation BUY BUYPrice, $ 33.2 9.2Target price 12M, $ 50.0 12.5Upside/downside potential 51% 37%

SHARE DATABloomberg LSRG LI

GDR# of GDRs outstanding, mn 515.2EV, $mn 5,540MC, $ mn 4,714MIN 12 mnth., $ 6.8MAX 12 mnth., $ 10.9

CommonGDR per 1 share 5

SUMMARY FINANCIALS, $ mn2010E 2011E 2012E

Rev enue 1,751 2,161 2,669EBITDA 484 607 752Net income 199 306 418EPS ($) 0.4 0.6 0.8Rev . growth (%) 8.9 23 24EBITDA margin (% 27.6 28.1 28.2Net Margin (%) 11.4 14.2 15.6


P/E 23.7 15.4 11.3EV/EBITDA 11.5 9.1 7.4

SHAREHOLDER STRUCTUREStreetlink Limited 53%A. Molchanov 9%Management 11%Free Float 27%

PRICE DYNAMICS


6

8

10

12

22.12.09 22.3.10 22.6.10 22.9.10 22.12.10

LSRG RTS


STRATEGY 2011 121

LSR GROUP

BALANCE SHEET$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ETOTAL CURRENT ASSETS 2,240 2,897 3,351 4,254 5,014 5,786 6,784PP&E, net 1,053 1,124 1,121 1,082 1,070 1,056 1,042Other non-current assets 354 356 390 420 442 457 475Total NON-CURRENT ASSETS 1,407 1,480 1,510 1,502 1,512 1,514 1,517TOTAL ASSETS 3,647 4,377 4,861 5,757 6,526 7,300 8,301Short-term borrow ings 500 500 500 500 500 500 500Other short-term liabilities 972 1,116 1,402 1,930 2,234 2,471 2,825Total CURRENT LIABILITIES 1,471 1,616 1,902 2,430 2,733 2,971 3,324Long-term borrow ings 808 808 700 650 600 550 550Other non-current liabilities 58 58 58 58 58 58 58Total LONG-TERM LIABILITIES 866 866 758 708 658 608 608Minority interest 12 12 12 12 12 12 12Share and additional capital 1,039 1,424 1,424 1,424 1,424 1,424 1,424Retained earnings 259 458 765 1,182 1,698 2,284 2,932Total EQUITY 1,298 1,882 2,189 2,607 3,122 3,709 4,357TOTAL EQUITY & LIABILITIES 3,647 4,377 4,861 5,757 6,526 7,300 8,301

INCOME STATEMENT$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ERevenue 1,608 1,751 2,161 2,669 3,025 3,277 3,660Cost of production (1,018) (1,092) (1,382) (1,725) (1,953) (2,113) (2,364)EBITDA 462 484 607 752 872 955 1,038Depreciation 76 83 92 100 100 98 102EBIT 331 400 514 652 772 857 935Net interest income/(expenses) (144) (144) (120) (114) (108) (102) (101)EBT 187 257 394 538 664 755 834Income tax (42) (57) (88) (120) (148) (168) (186)Net income 145 199 306 418 516 586 648

CASH FLOW STATEMENT$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ENet CF from operating activities 109 (86) 199 759 516 602 671Net CF from/(used in) investment activities (182) (184) (114) (82) (102) (95) (98)Net CF from/(used in) financing activities 63 385 (108) (50) (50) (50) -Net Debt 1,212 1,096 1,012 334 (80) (587) (1,160)

RATIOS% 2009 2010E 2011E 2012E 2013E 2014E 2015ERevenue grow th -20% 9% 23% 24% 13% 8% 12%EBITDA margin 29% 28% 28% 28% 29% 29% 28%Net margin 9% 11% 14% 16% 17% 18% 18%Net Debt/EBITDA 2.6 2.3 1.7 0.4 отр. отр. отр.

Source: LSR Group, TKB Capital estimates


122 STRATEGY 2011

PIK Group Demand for residential to support revenue, moderate risks remain

Advantage of PIK Group over other developers is in a portfolio of projects in Moscow and Moscow Region – region with the best demand and high prices for residential real estate. The state initiatives on removal of administrative barriers at construction and confidently growing demand, in our opinion, will provide fast profit recovery and high level of profitability of the company. The strategy primarily focused on construction of affordable residential housing segment on Moscow Metropolitan market with a good location and developed social infrastructure will ensure the growth of financial liquidity and lower financial risks. Mortgage programs with banks to support demand for the residential real estate constructed by the company. We recommend to BUY PIK Group and our target price is 7.3$/share.

Residential sales raise liquidity. Favorable changes are observed on the Moscow real estate market. The results of 2010 prove the stable growing demand. In this context PIK Group, as one of leaders of the Moscow residential real estate market, confidently increases volumes of construction and demonstrates the growth of sales. By our forecasts, own capacities of the company will help PIK group to construct 1,100 th sq m of residential real estate in 2011 that exceeds our forecasts by 13% for 2010 and by 24% above the actual volumes for 2009. Proceeding from PIK Group results as regards residential real estate sales for 9М10 (growth by 131%), we expect further recovery of cash flows next year. Among positive factors increasing pace of sales in 2011, we expect the growth of mortgage transactions’ share by 15-17% in total sales (9% in 3Q10). Expected slight advance in prices for residential real estate (within 5-7%) is also capable to maintain a great demand against economic recovery.

Financial risks remain. Debt load of the company following the results of 1H10 is $1,352 mn, Net debt-to-EBITDA is 8.3. Despite restructuring of the major part of debts with direct support of the Sberbank undertaken a part of PIK Group debt service obligations, there are concerns on uncertainty with overdue credit to Nomos-bank, which makes up 19% of credit portfolio. To decrease its debt load, we believe that in 2011 PIK group may hold SPO already approved by the board of directors in the middle of 2010. At the same time we do not exclude that the main creditor – Sberbank, may enter the shareholding structure of the company that, in our opinion, is a preferable variant for future financial stability of PIK Group.

Multiple based upside remains. Valuation based on multiplies shows the upside potential. PIK Group is traded at an average 2011-2012E EV/EBITDA of 11.9 and 7.5 accordingly, that implies average 12% discount to its foreign peers.

Fundamental prospects depend on a company transparency. We recommend to buy PIK Group which, in our opinion, is capable to quickly restore financial flows by demand recovery for real estate in Moscow. However, we recommend consider the risks attributed to weak transparency and high debt load of the company that may negatively affect its investment appeal. Based on our DCF-model, 12-month’s target price of PIK Group is $7.3 per share.

PIK GROUPGDR

Ticker PIK LIRecommendation BUYPrice, $ 4.3Target price 12M, $ 7.3Upside/downside potential 69%

SHARE DATABloomberg PIK LI

# of shares outstanding,mn 493.3EV, $mn 3,478MC, $ mn 2,126MIN 12 mnth., $ 3.0MAX 12 mnth., $ 5.8

GDR per 1 share 1


Rev enue 1,293 1,900 2,525EBITDA 96 293 465Net income -122 64 208EPS ($) -0.2 0.1 0.4Rev . growth (%) -0.2 47 33EBITDA Margin (% 7.4 15.4 18.4Net Margin (%) neg. 3.4 8.3


EV/EBITDA neg. 33.1 10.2EV/S 36.1 11.9 7.5

SHAREHOLDER STRUCTURENaf ta Moskv a 38%Y.Zhy kov 13%K.Pisarev 11%Free Float 39%

PRICE DYNAMICS


3

4

5

6

22.12.09 22.3.10 22.6.10 22.9.10 22.12.10

PIKK RTS


STRATEGY 2011 123

PIK GROUP

BALANCE SHEET$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ETOTAL CURRENT ASSETS 2,601 3,076 4,002 5,152 5,484 6,180 7,874PP&E, net 344 339 320 315 280 262 268Other non-current assets 880 868 877 887 815 792 850Total NON-CURRENT ASSETS 1,224 1,208 1,197 1,201 1,096 1,054 1,118TOTAL ASSETS 3,824 4,284 5,199 6,353 6,580 7,234 8,993Short-term borrow ings 1,058 1,108 1,189 1,184 1,040 963 933Other short-term liabilities 2,162 2,634 3,400 4,363 4,588 5,091 6,414Total CURRENT LIABILITIES 3,220 3,742 4,589 5,547 5,629 6,054 7,347Long-term borrow ings 208 252 254 240 188 135 111Other non-current liabilities 208 218 220 223 205 199 213Total LONG-TERM LIABILITIES 416 470 475 462 392 334 325Minority interest 18 19 19 20 18 18 19Share and additional capital 741 776 784 792 729 708 760Retained earnings (572) (723) (667) (468) (188) 122 543Total EQUITY 188 72 136 343 559 847 1,322TOTAL EQUITY & LIABILITIES 3,824 4,284 5,199 6,353 6,580 7,234 8,993

INCOME STATEMENT$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ERevenue 1,296 1,293 1,900 2,525 2,884 3,289 3,853Cost of production (1,059) (1,095) (1,471) (1,886) (2,162) (2,473) (2,907)EBITDA 126 96 293 465 536 615 725Depreciation 27 28 36 47 53 61 72EBIT 99 68 256 419 482 554 653Net interest income/(expenses) (283) (227) (176) (158) (148) (124) (110)EBT (372) (159) 80 260 334 430 543Income tax (27) 37 (16) (52) (67) (86) (109)Net income (362) (122) 64 208 267 344 434

CASH FLOW STATEMENT$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ENet CF from operating activities (174) (125) 5 199 254 347 452Net CF from/(used in) investment activities (24) 58 (13) (38) (43) (49) (58)Net CF from/(used in) financing activities (5) 34 71 (36) (89) (107) (143)Net Debt 1,153 1,275 1,296 1,151 866 578 247

RATIOS% 2009 2010E 2011E 2012E 2013E 2014E 2015ERevenue grow th -4% 0% 47% 33% 14% 14% 17%EBITDA margin 10% 7% 15% 18% 19% 19% 19%Net margin neg. neg. 3% 8% 9% 10% 11%Net Debt/EBITDA 9.1 13.2 4.4 2.5 1.6 0.9 0.3

Source: PIKGroup, TKB Capital estimates


124 STRATEGY 2011

AFI Development At an organic growth stage

AFI Development is one of the largest developers of Moscow real estate market. Company’s project portfolio includes commercial and residential properties located in attractive areas of the city. According to market tendencies, in 2010 the company changed development strategy and increased the presence in residential real estate. Cash inflow from residential sales, by our estimates, is proposed to begin as early as 2011. In our opinion, break-even point is a primary growth driver of AFI Development investment appeal next year. Commissioning of AFIMOLL City - one of the European largest retail projects in recent years, will double the rental revenue of the company, residential sales to provide financial stability and lower financial risks. We recommend to BUY AFI Development and our target price is 1.8$/share.

From net loss to net profit. In 2010 AFI Development actively developed the projects with a high stage of completion. As a result, the company completed the construction of the large trade centre “AFIMOLL City” with a total area of 180,000 sq m (share in project portfolio by net area – 28%) placed in the centre of Moscow-city. We estimate $78 mn rental revenue from the project next year that will make 56% of all the rental payments and 44% of the total company’s revenue. Thus, commissioning of AFIMALL City will cover operational and administrative expenses and play supportive for the company to reach the break-even point as early as 1H11. Net profit will provide financial stability and raise investors’ confidence. Besides, we expect further growth of business and consumer activity in the capital that will reduce the supply against reduction of construction volumes. We forecast the vacancy rate for AFI Development’s projects at 86% on the average next year.

Strong cash positions as a development guarantee. Following the results of 9М10 the volume of cash on company’s balance made up $110 mn. Investment activity of AFI Development in 2010 amplified considerably. So, the volume of investments into project development reached $101 mn for 9М10, which is over 110% growth y-o-y. Next year AFI Development will focus on completion of Tverskaya Zastava retail centre (implemented under control of the Moscow government), business centre on Paveletskaya Embankment and mixed-use complex on Ozerkovskaya Embankment. According to our calculations, the volume of investments to complete these projects in 2011-2012 can make up about $180 mn. We forecast increase in the cash flow, generating area size by 175% y-o-y to 320,000 sq m in 2011, the rental revenue to reach $140 mn (197% y-o-y). Thus, we believe that the company will not face the financial difficulties in course of projects’ realization.

Debt structure quite comfortable. According to last financials of the company, total debt of the company has made $420 mn, where 91% comes to long-term debts. Debt-to-net asset value (NAV) makes 0.2 and, in our opinion, is quite comfortable for the developer.

Perspective growth of value. We recommend to buy AFI Development and bet on fast recovery of project portfolio investment value. Based on our DCF-model and NAV valuation, 12-month’s target price of AFI Development is $1.8 per share.

AFI DEVELOPMENT

Ticker AFID LIRecommendation BUYPrice, $ 1.1Target price 12M, $ 1.8Upside/downside potential 59%

SHARE DATABloomberg AFID LI

# of shares outstanding,mn 1047.7EV, $mn 1,493MC, $ mn 1,184MIN 12 mnth., $ 0.7MAX 12 mnth., $ 1.3


Rev enue 81.1 178.7 401.1EBITDA 29.5 110.0 191.6Net income -17.9 27.7 78.7EPS ($) neg. 0.0 0.1EBITDA Margin (% 36% 62% 48%Net Margin (%) neg. 16% 20%


EV/EBITDA neg. 42.7 15.0EV/S 50.7 13.6 7.8

SHAREHOLDER STRUCTUREAf rica Israel 54%A. Haldey 10%Bond holders 18%Free Float 18%

PRICE DYNAMICS

Source: Bloomberg, RTS, TKB Capital estimates

0.7

0.9

1.1

1.3

22.12.09 22.3.10 22.6.10 22.9.10 22.12.10

AFID RTS


STRATEGY 2011 125

AFI Development BALANCE SHEET$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ETOTAL CURRENT ASSETS 741 593 674 801 809 859 944PP&E, net 103 100 90 79 61 45 28Other non-current assets 1,504 1,728 1,883 1,991 2,066 2,066 2,066Total NON-CURRENT ASSETS 1,606 1,827 1,974 2,070 2,128 2,111 2,095TOTAL ASSETS 2,348 2,420 2,647 2,871 2,937 2,970 3,039Short-term borrow ings 94 114 114 108 103 98 93Other short-term liabilities 181 181 181 181 181 181 181Total CURRENT LIABILITIES 275 295 295 290 284 279 274Long-term borrow ings 322 392 592 742 642 442 242Other non-current liabilities 45 45 45 45 45 45 45Total LONG-TERM LIABILITIES 367 437 637 787 687 487 287Minority interest 3 3 3 3 3 3 3Share and additional capital 1,622 1,622 1,622 1,622 1,622 1,622 1,622Retained earnings 81 63 91 170 341 579 853Total EQUITY 1,703 1,685 1,712 1,791 1,963 2,201 2,475TOTAL EQUITY & LIABILITIES 2,348 2,420 2,647 2,871 2,937 2,970 3,039

INCOME STATEMENT$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ERevenue 63 81 179 401 673 776 808Cost of production (38) (55) (78) (221) (386) (427) (435)EBITDA 26 29 110 192 303 366 390Depreciation 1 3 9 12 17 17 16EBIT 49 26 101 180 286 349 374Net interest income/(expenses) (4) (49) (66) (81) (71) (51) (31)EBT 45 (22) 35 98 215 297 343Income tax (47) 4 (7) (20) (43) (59) (69)Net income (3) (18) 28 79 172 238 274

CASH FLOW STATEMENT$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ENet CF from operating activities (15) 61 (5) 63 262 308 313Net CF from/(used in) investment activities (82) (224) (156) (108) (75) - -Net CF from/(used in) financing activities 77 38 131 61 (179) (258) (238)Net Debt 205 420 650 779 665 410 131

RATIOS% 2009 2010E 2011E 2012E 2013E 2014E 2015ERevenue grow th -44% 29% 120% 124% 68% 15% 4%EBITDA margin 41% 36% 62% 48% 45% 47% 48%Net margin neg. neg. 16% 20% 26% 31% 34%Net Debt/EBITDA 7.9 14.3 5.9 4.1 2.2 1.1 0.3

Source: AFI Development, TKB Capital estimates

126 STRATEGY 2011

Infrastructure construction sector World Cup 2018 – next impulse for development

STRATEGY 2011 127

Anatoly Vysotsky [email protected]


We expect powerful growth of the sector next year. Ministry of transport of the Russian Federation plans to provide about $60 bn next year and $390 bn for 2011-2015 for construction and modernization of transport infrastructure. We consider the APEC-2012 summit and the 2014 Olympics games among strategically important projects for Russia in mid-terms period. Another strong impulse for the infrastructure sector development is a victory of Russia for the right to host World Cup 2018, expenses of which are preliminary estimated at $50 bn.

Plenty Room for Growth

Infrastructure projects are of top priority. Construction and reconstruction of transport infrastructure were announced as one of the top national policy priorities. Volume of investments into sector planned by the Transportation Ministry for the next five years is about RUR12 bn ($390 bn).

Powerful growth drivers: APEC-2012 summit, The 2014 Olympics, World Cup 2018. Infrastructure construction in Sochi for the Olympic Games 2014 ($16 bn), preparation to APEC-2012 summit ($9 bn) and World Cup 2018 ($50 bn) are powerful drivers for development of Russia’s infrastructure.

Moscow to receive $4.6 bn for the next 3 years. Moscow transportation infrastructure is underdeveloped. According to the Moscow Department of Road Bridge and Engineering Construction, RUB140 bn ($ 4.6 bn) is earmarked for road construction in 2011/2013.

Small number of large players. The companies with more than a 3% market share have made up only 15.9% of the entire market in 2009. Consequently, the responsibility for carrying out the orders issued by the government for high-quality and efficient transportation infrastructure development falls onto well-established and well-capitalized companies.

Main risk - financial

Limited sources of financing. Almost all Russian transportation infrastructure construction projects are undertaken at the initiative and expense of the government. Only one third of investments into the industry over the past three years were private.

Bureaucratization of business processes. The federal target program on Russian transport infrastructure development is poorly suited to changes in external conditions during project completion and anticipates delays already at the initial establishment stage.

Our favorite

Mostotrest. In our opinion, Mostotrest is successfully positioned for development of the state investments and is one of few companies capable to fulfill their orders with good quality and in a timely fashion.



-80% 10% 100%

RTS Index

Mostotrest

Bamtonnelstroy

Khanty -Mansiy skdorstroy

Mostootry ad-19

Mostostroy -11

Dalmostostroy

22.12.10 Max Min

Sources: Bloomberg, RTS, TKB Capital estimates

-10%0%

10%20%30%40%50%60%

Jan-

10F

eb-1

0M

ar-1

0A

pr-1

0M

ay-1

0Ju

n-10

Jul-1

0A

ug-1

0S

ep-1

0O

ct-1

0N

ov-1

0D

ec-1

0

RTS IndexInf rastructure sector


128 STRATEGY 2011

Plenty Room for Growth

Priority of infrastructural projects for the state. Construction and reconstruction of transport infrastructure were announced as one of the top national policy priorities. The transportation infrastructure modernisation programs provides for impressive growth of investments as compared with previous years. According to the plans of the Ministry of Transportation, infrastructure development investments over the next five years are proposed to reach about RUR12 bn ($390 bn). To implement the plans in addition to development of public-private partnership projects, the Russian government is going to establish the Federal Road Fund that, in our estimates, can cover up to 65% of all the planned investments into road infrastructure in 2011. The overall size of the Road Fund is estimated to reach RUB 378 bn, RUB 348 bn and RUB 408 bn in 2011, 2012 and 2013 respectively.

Powerful growth drivers: APEC-2012 summit, The 2014 Olympics, World Cup 2018. Sochi’s infrastructure preparations for the 2014 Winter Olympics will be a good growth driver for companies with order books in Krasnoyarsk Territory. Olympic projects are to be commissioned in 2012, with full completion of infrastructure construction by the end of 2013. Expenditures on preparation for the 2014 Olympics and development of Sochi infrastructure will come to RUR500 bn ($16 bn). The largest project under the Far East development program is the Asia-Pacific Economic Cooperation forum that will take place in 2012 in Vladivostok. Nearly RUR270 bn ($9 bn) will be spent on construction and reconstruction of infrastructure. Russia victory for the right to host World Cup 2018 has become a strong impulse for development of the infrastructure sector. New football stadiums, roads and railways will be constructed. Tourism in the country will be developing with renewed vigor, the number of projects on construction of hotels will increase as well. Preliminary expenses on preparation to World Cup 2018 are estimated in $50 bn.

Moscow to receive $4.6 bn for the next 3 years. If we consider the Moscow Region separately, where up to 60% of all Russian cargo moves, we will see a catastrophic situation here: over the last 15 years the number of cars increased more than 10-fold, while the total motorway length (completely overloaded) increased by 60%. The average traffic speed in Moscow and the Moscow Region is lower almost twice than in Western Europe, the transportation cost is higher by 30%-40%. Traffic jams in Moscow and the Moscow Region take about RUB 400 bn ($ 12.6 bn) from the Moscow budget annually. According to the Moscow Department of Road, Bridge and Engineering Construction, RUB 140 billion (US$ 4.6 billion) is earmarked for road construction in 2011/2013. The bulk of funds in 2011 will be spent on the Bolshaya Leningradka project, Fourth Ring Road, Veshnyaki-Liubertsy motorway, second Dmitrovskoye Motorway road and Zvenigorodsky Prospect. In addition, Moscow will continue realization of such major projects as the Moscow-St. Petersburg high-speed motorway and construction of the second Kutuzovsky Prospect roadway near the Moscow City business centre.

Small number of large players. The Russian transportation infrastructure market is largely represented by numerous specialized companies with less than 3% market share, which are focused on the projects that do not require major technological resources. The companies with more than a 1% market share largely consist of regional players established to implement reasonably complex projects with limited technological requirements. Infrastructure construction market leaders with more than 3% market share took 15.9% of the entire market in 2009. The complexity of entry into infrastructure construction market, high capital equipment costs for production-scale equipment and, that is most important, the lack of qualified personnel in the industry serve as a great obstacle for new serious competitors to enter the market. Consequently, the responsibility for carrying out the orders issued by the government for high-quality and efficient transportation infrastructure development falls onto well-established and well-capitalized companies, which are also capable of increasing investments to scale up capacity.

Source: Federal target program "Development of the Transportation System of Russia (2010-2015)"

Infrastructure construction sector investments, RUR bn

2,8082,6692,452

2,1881,873

0

500

1,000

1,500

2,000

2,500

3,000

2011E 2012E 2013E 2014E 2015E

Sources: Department of road and bridges construction of Moscow

Investments into road construction of Moscow, RUR bn

0

40

80

2011E 2012E 2013E

Source: PMR

Infrastructure constructors in Russia, by amount of works in 2009

Sector is highly fragmented, the share of top-players less than 16%

16%

17%

67%

Market leaders, share > 3%Mid-size players, share > 1%Small players, share < 1%


STRATEGY 2011 129

Main risk - financial

Limited sources of financing. Almost all Russian transportation infrastructure construction projects are undertaken at the initiative and expense of the government. Only one third of investments into the industry over the past three years were private. In our opinion, the inflow of private investment is closely tied to governmental support. Deterioration in the country’s economic situation will result in reduced governmental investment, triggering the withdrawal of private companies from the new projects and, as a result, the growth of incomplete construction. If we look at implementation of transportation infrastructure modernization program in 2005/2009, we can say that, besides general cost reduction under the program by 26% up to RUB 631 bn ($20 bn), the consequences of the financial squeeze and economic recession slashed private investment as a percentage of total actual costs.

Bureaucratization of business processes. The federal target program of Russian transport infrastructure development is poorly suited to changes in external conditions that occur during project completion and anticipates delays already at the initial establishment stage. Consequently, construction companies may have difficulties with the timely fulfillment of contractual obligations and bear additional expenses that are impossible to calculate. The investment projects under the Russian Federal Transportation System Program (2010–2015) do not take into account the time required for designating, final allocation and purchasing the land plots, rezoning them for transportation, state registration of the corresponding rights and ownership formalization, including termination of rights and relocation of the owners of houses and other real estate subject to appropriation for governmental needs. All of these efforts are time-consuming and may take many years.

Our favorite – Mostotrest

Undeniable leader of the sector. Mostotrest is one of few companies capable to fulfill their orders with good quality and in a timely fashion. It is noteworthy that one of Mostotrest’s principal competitive advantages is its high mobility that enables to quickly switch to the most important projects. As a result of a series of strategic purchases in 2010, Mostotrest expanded its options and acquired the ability to act as the general contractor for all infrastructure market segments by strengthening its foothold in bridge and motorway construction and expanding its presence in the railway, airport and port construction segments.

Source: FTP "Development of the Transportation System of Russia 2005-2009", TKB Capital estimates

Private investments are strongly sensitive to risks

Volumes of private investments into sector, RUR bn

211249 272 294

343

231

320

201242 244

0

90

180

270

360

450

2005 2006 2007 2008 200975%

80%

85%

90%

95%

100%

Priv ate inv estments (plan)

Priv ate inv estments (f act)

% completion


130 STRATEGY 2011

Mostotrest Well positioned for assimilation of state investments

Among the construction companies capable to accrue maximum benefit from growing investments into infrastructure, we allocate diversified leader of infrastructure construction sector – Mostotrest. Extensive experience, unique technologies, high performance and efficiency coupled with a large order portfolio of strategic significance for Russia will, in our opinion, enable Mostotrest to become the leader and gain investment appeal.

Impressive $8.4 bn backlog. As the number one infrastructure construction company in Russia in terms of work performed by own forces in 2009, Mostotrest holds a regionally diversified backlog of RUB 260 bn ($8.4 bn), including RUB 181 bn ($5.8 bn) directly and RUB 79 bn ($2.5 bn) - via the companies acquired in 2010. The backlog is largely represented by projects, the funding of which is the top government priority.

Strong positions in the sector. The technologies and mobility allow Mostotrest to perform comprehensive work on projects of any degree of complexity. Having made a number of major acquisitions in 2010, Mostotrest gained the competence to act as general contractor in virtually all segments of infrastructural construction and expanded its presence in Siberia and the Far East. The general contractor’s role enables the company to fully monitor all processes in the projects completed.

Stable customer base. Mostotrest’s projects are largely carried out pursuant to governmental orders and account for 79% of the backlog, which is equal to RUB 218 bn ($7 bn). The company’s key customers are the Federal Road Agency, the Russian Ministry for Economic Development, the Moscow government as well as various regional and municipal authorities. The major advantage of governmental orders is stable work and guaranteed payment, which directly affects construction time and profitability.

A strong management team. Five out of eight key senior managers have been working in the construction industry for more than 10 years. Mostotrest’s team has an impressive track record in all lines of the company’s business. Mostotrest has also established strong relationships with regional and federal authorities, which simplifies implementation of many projects. Competent and experienced managers are, in our opinion, the Company’s most important competitive advantage.

Stable financing options. The impeccable credit record and few schedule disruptions in construction contract performance have enabled Mostotrest to develop stable partnerships with Russia’s largest banks – Sberbank, VTB and Gazprombank. In our opinion, this enables the company, when necessary, to obtain short-term loans in order to mitigate the impact of irregular customer payments and maintain construction volume leadership in the cities of presence.

Fundamentally strong company. In our opinion, Mostotrest possesses all data for organic growth and development of incoming investments in sector. Financial stability, technologies, unique experience and qualified personnel are a guarantee of successful company development in long-term period.

We have no recommendation for Mostotrest’s stocks, however we plan to issue full report and start to cover the company in the nearest future.

Mostotrest Ticker MSTTRecommendation NRPrice, $ 7.9Target price 12M, $ NRUpside/downside potential NR

SHARE DATABloomberg MSTT RU

# of shares outstanding,mn 248.2EV, $ mn 2,244MC, $ mn 1,949MIN 12 mnth., $ 3.3MAX 12 mnth., $ 8.0


Rev enue 1,193 1,469 1,715EBITDA 203 254 295Net income 92 125 163EPS ($) 0.4 0.5 0.7Rev . growth (%) -9.5 23.1 16.8EBITDA Margin (% 17.0 17.3 17.2Net Margin (%) 7.7 8.5 9.5


P/E 21.1 15.6 11.9EV/EBITDA 11.1 8.8 7.6

SHAREHOLDER STRUCTUREMarc O’Polo Inv estments Ltd. 38.9%Non-State Pension Fund Blagosostoy anie 26.5%Other shareholders 34.6%

PRICE DYNAMICS


2.5

4.5

6.5

8.5

22.12.09 22.3.10 22.6.10 22.9.10 22.12.10

MSTT RTS


STRATEGY 2011 131

Mostotrest

BALANCE SHEET$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ETOTAL CURRENT ASSETS 454 733 794 852 946 1,046 1,283PP&E, net 311 330 339 357 345 341 361Other non-current assets 58 182 184 187 172 167 179Total NON-CURRENT ASSETS 370 512 523 543 517 508 541TOTAL ASSETS 824 1,246 1,317 1,396 1,463 1,554 1,824Short-term borrow ings 199 173 103 52 48 33 24Other short-term liabilities 289 279 325 381 407 429 489Total CURRENT LIABILITIES 487 452 428 433 455 461 514Long-term borrow ings 9 131 132 89 74 64 62Other non-current liabilities 22 50 52 49 51 40 40Total LONG-TERM LIABILITIES 31 181 184 137 124 105 102Share and additional capital 8 235 237 240 220 214 230Retained earnings 298 378 468 586 664 774 978Total EQUITY 306 613 704 825 884 988 1,208TOTAL EQUITY & LIABILITIES 824 1,246 1,317 1,396 1,463 1,554 1,824

INCOME STATEMENT$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ERevenue 1,020 1,193 1,469 1,715 1,918 1,974 2,192Cost of production (762) (892) (1,093) (1,274) (1,423) (1,472) (1,640)EBITDA 180 203 254 295 329 344 388Depreciation 45 44 60 63 68 83 103EBIT 135 159 194 232 261 261 284Net interest income/(expenses) (26) (36) (27) (14) (13) (10) (9)EBT 109 123 166 217 248 251 276Income tax (27) (31) (42) (54) (62) (63) (69)Net income 84 92 125 163 186 188 207

CASH FLOW STATEMENT$ mn 2009 2010E 2011E 2012E 2013E 2014E 2015ENet CF from operating activities 157 158 208 234 266 270 313Net CF from/(used in) investment activities (37) (166) (66) (77) (86) (89) (99)Net CF from/(used in) financing activities (131) 21 (138) (161) (77) (88) (88)Net Debt 47 (104) (181) (276) (361) (463) (643)

RATIOS% 2009 2010E 2011E 2012E 2013E 2014E 2015ERevenue grow th -16% 17% 23% 17% 12% 3% 11%EBITDA margin 18% 17% 17% 17% 17% 17% 18%Net margin 8% 8% 8% 10% 10% 10% 9%Net Debt/EBITDA 0.3 neg. neg. neg. neg. neg. neg.

Source: Company data, TKB Capital estimates

132 STRATEGY 2011

APPENDIX

STRATEGY 2011 133

RECOMMENDATIONS

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2010E 2011E 2012E 2010E 2011E 2012EGAZP ** Gazprom 6.41 8.50 BUY 33% 146,858 177,884 5.2 5.0 4.5 4.0 3.7 3.4 1.4 0.8 0.6ROSN ** Rosneft 7.22 8.5 HOLD 18% 69,294 84,396 6.5 9.3 8.4 4.3 5.6 5.2 1.3 1.4 1.0LKOH ** LUKOIL 57.4 74.0 BUY 29% 48,564 54,421 6.0 7.4 5.8 3.7 4.5 3.9 0.5 0.9 0.5SNGS * Surgutneftegas 1.01 UR UR UR 39,896 26,895 8.6 9.0 9.5 3.7 3.8 4.0 1.2 1.0 negSNGSP * Surgutneftegas, Pref 0.51 UR UR URSIBN ** Gazprom Neft 4.20 4.50 HOLD 7% 19,810 24,243 6.6 6.7 6.5 4.8 4.3 4.1 0.8 1.1 0.8tnbp ** TNK-BP Holding 2.70 2.80 HOLD 4% 41,590 42,573 8.0 6.8 7.2 5.2 4.4 4.6 1.0 2.0 0.1tnbpp ** TNK-BP Holding, Pref 2.44 2.50 HOLD 2%TATN * Tatneft 4.85 UR UR UR 10,665 12,709 6.4 5.8 5.2 4.8 4.1 3.8 0.8 1.1 0.7TATNP * Tatneft, Pref 2.71 UR URBANE * Bashneft 44.75 UR UR UR 8,842 10,461 6.6 6.0 5.9 4.0 3.6 3.5 0.8 n/a 0.6BANEP * Bashneft, Pref 35.45 UR UR URNVTK * NOVATEK 10.28 UR UR UR 31,184 31,884 24.4 19.1 14.4 16.7 12.8 10.2 6.4 6.9 0.3

Metals & MiningTicker Company P/BV

2010E 2011E 2012E 2010E 2011E 2012EGMKN NorNickel 220.7 270.0 BUY 22% 42,074 44,040 8.1 7.2 8.1 5.6 5.0 5.3 2.8 1.9 0.2CHMF Severstal 16.79 20.00 HOLD 19% 16,917 21,369 73.9 11.0 10.4 7.6 6.1 5.7 1.2 2.2 1.3NLMK NLMK 4.48 4.15 HOLD -7% 26,865 28,069 22.5 20.0 14.8 10.5 9.0 7.2 2.5 3.4 0.4MAGN MMK 1.06 1.32 BUY 25% 11,812 12,776 25.6 10.2 7.8 7.9 5.4 4.5 1.3 1.3 0.4MTL Mechel, ADR 29.58 37.00 BUY 25% 12,313 17,217 14.8 10.4 9.2 8.6 5.9 5.2 1.6 3.9 1.7EVR Evraz Group, GDR 34.84 46.00 BUY 32% 15,255 23,059 53.7 11.4 9.0 9.8 6.4 5.6 1.5 1.5 2.2PLZL * Polyus Gold 62.88 UR UR UR 11,986 12,013 24.8 17.1 18.8 15.3 11.2 11.2 5.4 3.8 0.0PMTL * Polymetal 18.56 UR UR UR 5,845 6,264 32.6 12.5 13.2 19.9 8.8 9.2 4.8 6.4 0.6TRMK * TMK 5.14 UR UR UR 4,487 7,995 23.3 11.0 7.8 9.2 7.3 5.7 1.3 3.0 3.2RASP Raspadskaya 6.83 9.00 BUY 32% 5,333 5,636 15.0 15.6 7.5 10.0 9.7 5.5 5.9 4.2 0.5BLNG Belon 0.84 1.29 BUY 54% 962 1,278 10.8 9.9 11.2 6.6 6.3 6.5 1.5 2.0 1.6unkl Yuzhuralnickel 250.0 472.0 BUY 89% 150 111 9.9 6.4 3.6 3.6 2.7 1.7 0.3 n/a negAMEZ Ashinskiy Steel Works 0.570 0.579 HOLD 2% 284 357 6.5 11.5 9.7 4.0 5.3 4.6 1.0 0.8 1.1VSMZ Vyksa Steel Works 1410 1740 BUY 23% 2,422 2,492 5.7 4.1 3.9 3.7 2.9 2.9 0.8 n/a 0.5CHZN Chelyabinsk Zinc Plant 4.43 4.64 HOLD 5% 240 226 6.8 5.1 7.6 3.1 2.6 3.3 0.4 0.8 neg

UtilitiesTicker Company P/BV

2010E 2011E 2012E 2010E 2011E 2012EFEES Federal Grid Company 0.0117 0.0124 HOLD 6% 14,456 11,750 18.4 9.5 6.2 6.2 3.6 2.6 2.1 0.5 negHYDR RusHydro 0.054 0.0735 BUY 36% 14,548 15,575 9.7 8.8 7.0 7.0 5.7 4.9 2.7 0.9 0.4IRAO * INTER RAO UES 0.0016 UR UR UR 3,568 4,309 26.3 17.7 13.6 10.4 7.8 6.7 1.3 1.9 1.3OGKA * OGK-1 0.039 UR UR UR 1,742 1,787 18.7 9.9 8.4 7.7 5.1 4.2 0.8 1.5 0.1OGKB * OGK-2 0.061 UR UR UR 1,990 2,257 25.4 14.0 10.5 12.8 7.1 5.7 1.1 1.6 0.8OGKC * OGK-3 0.056 UR UR UR 2,670 967 57.6 28.4 17.2 16.1 7.4 3.5 0.7 0.8 negOGKD OGK-4 0.101 0.118 HOLD 17% 6,354 5,789 25.3 16.3 12.6 15.5 9.0 6.8 2.5 2.3 negOGKE * Enel OGK-5 0.095 UR UR UR 3,346 3,926 25.8 11.8 9.3 11.7 6.9 6.1 1.9 1.6 1.0OGKF * OGK-6 0.045 UR UR UR 1,447 1,573 34.5 30.8 16.8 11.1 7.6 5.5 0.9 0.8 0.6TGKA * TGC-1 0.00068 UR UR UR 2,622 3,104 15.8 7.2 5.9 8.4 4.6 3.9 1.5 1.2 0.7TGKB * TGC-2 0.00028 UR UR UR 413 746 neg 47.4 43.9 6.4 5.4 2.0 0.7 0.6 2.4TGKBP * TGC-2, Pref 0.00029 UR UR URMSNG * Mosenergo 0.104 UR UR UR 4,129 4,678 27.8 13.6 11.2 7.8 5.6 4.8 0.9 0.7 0.7TGKD * TGC-4 0.00054 UR UR UR 1,049 1,019 12.0 9.2 15.1 5.2 4.0 3.6 0.7 1.1 negTGKDP * TGC-4, Pref 0.00028 UR UR URTGKE * TGC-5 0.00058 UR UR UR 709 747 18.5 10.7 177.2 7.0 5.3 9.7 0.9 0.8 0.3TGKF * TGC-6 0.00057 UR UR UR 1,061 1,325 11.0 8.3 16.0 7.4 6.4 11.6 1.2 n/a 1.3TGKG * Volga TGC (TGC-7) 0.077 UR UR UR 2,309 2,231 14.8 11.4 11.5 7.0 6.1 5.7 0.9 1.4 negTGKI * TGC-9 0.00015 UR UR UR 1,199 1,578 8.6 6.5 97.8 6.1 5.1 6.1 0.7 0.7 1.2TGKJ * Fortum, TGC-10 1.55 UR UR UR 1,366 (132) 12.3 11.3 neg neg. neg. neg. neg. 0.5 negTGKK TGC-11 0.00070 0.00113 BUY 61% 361 464 9.8 7.7 8.6 5.1 4.6 4.6 0.7 0.9 1.0KZBE * Kusbassenergo 0.0129 UR UR UR 909 999 10.4 22.8 28.8 4.2 5.2 4.0 0.9 0.9 0.5TGKM * Yenisei TGC (TGC-13) 0.0042 UR UR UR 671 725 neg 13.6 8.9 5.3 3.2 2.6 0.9 1.1 0.2TGKN * TGC-14 0.00014 UR UR UR 186 123 6.8 5.1 4.4 3.3 2.3 2.2 0.5 0.7 negMRKH * Holding MRSK 0.183 UR UR UR 7,725 11,782 11.7 8.7 5.7 3.6 3.0 2.3 0.6 0.7 1.0MRKHP * Holding MRSK, Pref 0.111 UR UR URLSNG * Lenenergo 0.84 UR UR UR 889 1,346 11.3 10.1 8.4 4.8 4.0 3.3 1.2 0.6 1.4LSNGP * Lenenergo, Pref 1.17 UR UR URMRKC * IDGC of Centre 0.042 UR UR UR 1,792 2,224 11.5 6.2 5.2 5.5 3.6 3.1 1.0 1.9 0.7MRKK * IDGC of Northern Caucasus 5.86 UR UR UR 173 207 12.9 15.2 5.5 3.6 3.0 2.1 0.5 0.4 0.5MRKP * IDGC of Center and Volga Region 0.0098 UR UR UR 1,106 1,449 26.7 6.5 4.4 6.2 3.6 2.7 0.7 0.8 0.8MRKS * IDGC of Siberia 0.0096 UR UR UR 857 1,075 neg 10.0 5.8 7.6 4.1 3.0 0.6 1.0 0.8MRKU * IDGC of of Urals 0.0111 UR UR UR 967 1,118 9.2 6.6 4.6 4.0 3.5 2.8 0.5 1.0 0.5MRKV * IDGC of Volga 0.0060 UR UR UR 1,068 1,255 21.9 10.1 6.2 6.6 4.7 3.6 0.9 1.5 0.7MRKY * IDGC of South 0.0060 UR UR UR 301 693 30.0 5.0 4.3 4.7 3.2 2.9 0.8 0.4 1.8MRKZ * IDGC of North-West 0.0074 UR UR UR 711 851 45.3 11.8 6.4 6.9 4.6 3.4 0.7 1.0 0.8MSRS * MOESK 0.055 UR UR UR 2,686 4,201 5.8 7.5 5.2 3.7 4.1 3.3 1.2 0.9 1.5KUBE * Kubanenergo 5.9394 UR UR UR 459 663 589.1 10.3 7.1 9.4 6.0 4.5 0.9 1.6 1.8TORS * Tomsk distribution company 0.021 UR UR UR 89 81 6.4 3.6 2.6 3.1 1.9 1.5 0.3 1.0 negTORSP * Tomsk distribution company, Pref 0.016 UR UR UR

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EV/S'2011E

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EV/EBITDA

APPENDIX

134 STRATEGY 2011

RECOMMENDATIONS TransportTicker Company P/BV

2010E 2011E 2012E 2010E 2011E 2012EGLTR ** Globaltrans 18.00 20.30 HOLD 13% 2,846 3,135 13.9 10.4 8.9 8.9 7.0 6.1 3.1 4.7 0.6AFLT * Aeroflot 2.61 UR UR UR 2,903 4,493 16.0 11.9 9.6 7.4 6.3 4.5 0.9 2.9 2.2UTAR * Utair Aviation 0.53 UR UR UR 307 1,160 61.2 8.7 3.6 6.2 5.3 4.0 0.8 1.4 3.9NCSP * NCSP, GDR 9.99 UR UR UR 2,565 2,861 10.0 9.3 7.4 6.8 5.9 4.9 3.7 3.1 0.6

FESH * FESCO 0.54 UR UR UR 1,590 2,304 11.5 39.6 21.0 16.9 13.2 10.1 2.5 1.2 4.1TRCN LI * TransContainer, GDR 9.35 UR UR UR 1,299 1,439 29.2 14.8 9.5 8.7 6.3 4.6 2.2 2.1 0.6

TelecomsTicker Company P/BV

2010E 2011E 2012E 2010E 2011E 2012EMBT US MTS, ADR 20.47 28.00 BUY 37% 20,398 24,386 11.7 10.3 9.5 4.8 4.3 4.0 2.1 4.0 0.7MTSS MTS, Common 8.48 14.00 BUY 65% 20,398 24,386 11.7 10.3 9.5 4.8 4.3 4.0 2.1 4.0 0.7VIP US VimpelCom Ltd, ADR 14.94 UR UR UR 19,459 23,485 11.4 8.9 8.5 4.7 4.2 4.0 2.0 2.3 0.7CMST LI * Comstar, GDR 6.49 11.55 BUY 78% 2,712 2,195 11.8 9.4 7.8 3.2 3.1 2.8 1.2 1.4 negSSA LI * Sistema, GDR 24.81 UR UR UR 11,971 26,003 10.3 8.1 10.6 3.4 3.2 2.9 0.9 0.8 2.0AFKS * Sistema, Common 0.87 UR UR UR 11,971 26,003 10.3 8.1 6.6 3.4 3.2 2.9 0.9 0.8 2.0CTCM US* CTC Media 22.52 UR UR UR 3,510 3,454 24.5 18.3 14.1 15.7 11.8 9.3 4.6 5.3 negRBCI * RBC Information Systems 1.44 UR UR UR 202 396 neg 141.6 11.6 33.2 16.4 6.5 2.3 -1.1 8.0SITR LI * SITRONICS, GDR 0.80 UR UR UR 153 526 neg neg 27.9 5.5 4.3 3.3 0.4 0.2 3.0IBSG GR * IBS Group, GDR 25.32 UR UR UR 581 608 29.5 17.3 12.6 11.7 8.7 7.5 0.8 3.3 0.4ARMD * ARMADA 12.63 UR UR UR 152 135 20.2 12.5 9.4 9.1 6.4 4.5 0.8 5.7 negURSI Uralsvyazinform 0.0472 0.05 HOLD 0% 1,808 2,221 11.1 8.7 13.6 3.8 3.6 8.5 1.5 1.9 0.7URSIP Uralsvyazinform, Pref 0.0363 0.036 HOLD -1%NNSI VolgaTelecom 4.59 4.60 HOLD 0% 1,432 1,711 8.7 7.4 - 3.5 3.3 - 1.4 1.4 0.5NNSIP VolgaTelecom, Pref 3.69 3.60 HOLD -3%ENCO Sibirtelekom 0.0878 0.087 HOLD -1% 1,320 1,922 9.7 8.4 - 3.7 3.5 - 1.4 1.9 1.1ENCOP Sibirtelekom, Pref 0.0679 0.068 HOLD 0%KUBN UTK 0.2089 0.21 HOLD 1% 784 1,393 10.1 7.4 - 4.4 4.2 - 1.8 2.2 1.8KUBNP UTK, Pref 0.1704 0.17 HOLD 0%SPTL N.W. Telecom 0.990 1.00 HOLD 1% 1,068 1,620 10.3 9.3 - 4.0 3.9 - 1.7 1.0 1.3SPTLP N.W. Telecom, Pref 0.781 0.78 HOLD 0%ESMO CenterTelecom 1.046 1.050 HOLD 0% 2,095 2,646 9.3 8.3 - 4.7 4.4 - 1.9 2.4 0.9ESMOP CenterTelecom, Pref 0.846 0.830 HOLD -2%ESPK Far East Telecom 4.32 4.30 HOLD -1% 519 717 5.9 6.0 - 3.2 3.2 - 1.2 1.4 0.9ESPKP Far East Telecom, Pref 3.40 3.40 HOLD 0%RTKM Rostelecom 4.77 4.10 HOLD -14% 14,718 18,437 14.3 14.4 11.4 5.6 5.3 5.3 2.0 7.2 1.1RTKMP Rostelecom, Pref 2.67 3.30 BUY 23%

Consumer & RetailTicker Company P/BV

2010E 2011E 2012E 2010E 2011E 2012EFIVE X5 Retail Group 42.7 56.0 BUY 31% 11,583 13,121 40.4 30.5 25.9 14.0 10.6 9.1 0.7 6.5 1.2MGNT LI ** Magnit, GDR 29.0 32.5 BUY 12% 12,879 12,920 37.5 34.7 29.0 19.4 14.4 11.0 1.1 9.0 0.0MGNT ** Magnit, Common 129.9 162.3 BUY 25% 11,557 11,598 33.6 31.1 26.0 17.4 12.9 9.9 1.0 8.1 0.0DIXY ** Dixy Group 13.2 14.6 HOLD 10% 1,139 1,397 66.1 42.8 33.9 12.0 9.6 8.3 0.5 6.0 1.8SCON Seventh Continent 8.1 9.6 HOLD 19% 605 852 12.8 9.1 7.4 6.9 5.8 5.2 0.4 1.1 1.7MVID * M.video 8.7 UR UR UR 1,568 1,354 29.6 21.0 15.5 10.2 7.6 6.0 0.4 5.4 negAPTK * Pharmacy Chain 36.6 3.6 UR UR UR 341 566 neg neg 10.7 8.3 6.8 5.2 0.7 2.3 2.7WBD US Wimm-Bill-Dann, ADR 32.8 33.0 HOLD 1% 5,766 6,016 52.1 41.9 31.7 16.0 13.9 12.1 1.9 8.2 0.6WBDF Wimm-Bill-Dann, Common 121.1 132.0 HOLD 9% 5,328 5,578 48.2 38.7 29.3 14.8 12.9 11.2 1.8 7.6 0.6PKBA * Baltika Breweries 48.2 UR UR UR 7,819 7,767 10.9 10.6 11.6 7.2 6.8 6.4 2.4 3.7 negPKBAP * Baltika Breweries, Pref 41.5 UR UR URPHST LI cc Pharmstandard, GDR 28.5 36.5 BUY 28% 4,308 4,205 18.4 16.1 14.7 13.0 11.3 10.4 4.3 6.8 negPHST Pharmstandard, Common 100.1 146.0 BUY 46% 3,784 3,681 16.2 14.1 12.9 11.3 9.9 9.1 3.8 5.9 negVRPH ** Veropharm 47.9 62.0 BUY 30% 479 501 11.6 9.6 8.8 8.7 7.5 6.9 2.4 2.9 0.3PRTK * Protek 2.07 UR UR UR 971 1,042 20.7 10.9 7.6 10.3 7.0 5.1 0.3 2.3 0.5KLNA * Kalina 29.0 UR UR UR 283 390 11.7 10.2 8.5 6.9 6.9 5.8 0.7 2.3 1.9MHPC LI * MHP 17.3 UR UR UR 1,871 2,362 10.3 8.6 7.1 7.9 6.6 5.6 2.2 3.8 1.4CHE LI * Cherkizovo Group, GDR 19.2 UR UR UR 1,240 1,686 10.0 8.5 6.9 8.3 7.0 5.8 1.2 2.3 1.9

BanksTicker Company

2010E 2011E 2012E 2010E 2011E 2012ESBER Sberbank 3.48 4.60 BUY 32% 77,589 16.3 9.5 8.1 2.56 2.13 1.83SBERP Sberbank, Pref 2.55 3.53 BUY 38%VTBR VTB Bank 0.0034 0.0036 HOLD 7% 35,210 18.9 11.8 10.2 1.96 1.72 1.58MMBM * Bank of Moscow 31.54 UR UR UR 5,678 14.8 8.6 6.7 1.43 1.20 1.05VZRZ Vozrozhdenie Bank, Common 43.36 48.4 HOLD 12% 1,048 53.8 10.5 6.8 1.90 1.58 1.33VZRZP Vozrozhdenie Bank, Pref 14.32 16.9 HOLD 18%STBK Bank Saint-Petersburg, Common 5.60 6.80 BUY 22% 2,079 21.2 12.0 7.5 2.30 1.94 1.63STBKPA Bank Saint-Petersburg, Pref 5.86 7.50 BUY 28%

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N.Debt/EBITDA'11

P/E

APPENDIX

STRATEGY 2011 135

RECOMMENDATIONS

MachineryTicker Company P/BV

2010E 2011E 2012E 2010E 2011E 2012EAVAZ * AvtoVaz 1.22 UR UR UR 1,883 4,240 neg neg 26.5 30.4 12.4 6.4 0.8 4.8 6.9AVAZP * AvtoVaz, Pref 0.40 UR UR URGAZA * GAZ 35.90 UR UR UR 690 1,591 neg neg n/a 13.9 4.7 n/a 0.4 0.8 2.7GAZAP * GAZ, Pref 17.00 UR UR URSVAV * Sollers 21.73 UR UR UR 745 1,517 neg 23.9 6.8 13.9 7.4 4.7 0.7 2.2 3.8KMAZ * KAMAZ 2.36 UR UR UR 1,666 2,248 neg 29.7 8.8 16.3 9.1 5.4 0.7 1.6 2.4SILM * Power machines 0.30 UR UR UR 2,614 2,361 13.0 10.3 9.6 7.2 5.8 5.4 1.1 6.1 negMASZ ** Mashinostroitelny Zavod 275 320 HOLD 16% 383 346 6.1 6.2 6.2 2.6 2.6 2.5 0.8 0.6 negNZHK ** NCCP 7.2 8.0 HOLD 11% 199 177 10.7 9.5 8.9 3.4 3.1 3.0 1.0 0.5 negNZHKP * NCCP, Pref 3.0 UR UR URKHEL ** Kazan Helicopters 3.18 3.75 HOLD 18% 489 687 5.5 5.4 5.4 5.1 4.8 4.6 1.0 2.2 1.4uuaz ** Ulan-Ude Avia Plant 2.10 2.90 BUY 38% 561 483 5.2 5.1 5.0 3.3 3.3 3.2 0.9 2.1 negrtvl ** Rostvertol 0.070 0.078 HOLD 11% 161 395 5.6 4.5 4.0 7.2 5.9 5.2 0.7 0.9 3.5

Real Estate & InfrastructureTicker Company P/BV

2010E 2011E 2012E 2010E 2011E 2012ELSRG ** LSR Group, Common 33.2 50.0 BUY 51% 3,420 4,246 16.7 13.0 9.7 9.0 7.9 6.5 2.0 2.6 1.5LSRG LI ** LSR Group, GDR 9.2 12.5 BUY 37% 4,714 5,540 23.0 18.0 13.4 11.7 10.3 8.4 2.6 3.6 1.5PIK LI ** Pik Group, GDR 4.3 7.3 BUY 69% 2,126 3,452 neg 58.9 86.0 15.8 13.5 11.3 2.3 3.8 5.2AFID ** AFI Development, GDR 1.13 1.80 BUY 59% 1,187 1,392 neg 83.4 18.1 41.2 16.6 8.3 8.6 0.7 2.5MLD MirLand Development, GDR 4.44 5.00 HOLD 13% 460 674 179.0 12.6 6.4 33.0 10.6 6.6 5.8 1.4 3.4

** - Target price for 12 months. For other companies target price calculated at the end of 2010

EV/S'2011E

Current price, $

* - multilpes for companies Under Review based on Bloomberg consensus estimates

Source: RTS, MICEX, Bloomberg, TKB Capital estimates

EV/EBITDA EV/S'2011E

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APPENDIX

136 STRATEGY 2011

RUSSIAN ADRS & GDRS ON WESTERN EXCHANGES

22.12.2010 31.12.2009

BloombergCode

Issuer Stock Exchange

Sharesper

ADR/GDR

Price perADR/GDR,

$

Price perADR/GDR,

$

Change,%

YTDhigh

YTDlow

OGZD LI Gazprom LSE 4 25.72 25.50 0.86% 26.64 18.06

ROSN LI Rosneft LSE 1 7.22 8.60 -16.10% 9.30 5.92

LKOD LI LUKOIL LSE 1 57.30 57.30 0.00% 60.80 44.70

SGGD LI Surgutneftegas, Common LSE 10 10.04 8.90 12.81% 10.44 7.76

ATAD LI Tatneft, Common LSE 6 32.35 29.14 11.02% 34.80 22.66

GAZ LI Gazprom Neft LSE 5 20.98 27.40 -23.43% 29.40 16.95

NVTK LI NOVATEK LSE 10 116.90 66.00 77.12% 116.90 63.40

AOIL SS Alliance Oil OMXS 1 15.49 14.31 8.30% 17.28 10.96

EDCL LI Eurasia Drilling LSE 1 31.00 16.04 93.22% 31.80 13.02

INTE LI Integra LSE 0.05 3.70 3.00 23.33% 3.70 2.15

O2C GR CAT Oil XETRA 1 9.65 10.07 -4.14% 11.87 8.24

VGAS LN Volga Gas LSE 1 1.22 3.39 -63.96% 4.59 1.20

SSA LI Sistema LSE 20 24.81 21.00 18.14% 30.99 21.00

MBT US Mobile TeleSystems NYSE 2 20.47 19.56 4.67% 23.55 17.84

VIP US VimpelCom NYSE 0.05 14.94 n/a n/a 19.01 13.96

CMST LI Comstar-UTS LSE 1 6.49 5.50 18.00% 7.01 5.45

IBSG GR IBS Group XETRA 1 25.32 9.82 157.82% 25.56 9.20

CTCM US CTC Media NASDAQ 1 22.52 14.72 52.97% 24.76 12.64

MAIL LI Mail.ru LSE 1 36.70 27.70 32.49% 42.95 27.70

SITR LI SITRONICS LSE 50 0.80 1.55 -48.39% 1.55 0.70

VTBR LI VTB Bank LSE 2000 31.50 26.50 18.87% 35.68 20.00

VZY GR Vozrozhdenie Bank, Common XETRA 0.75 6.69 4.72 41.74% 7.10 4.20

FIVE LI X5 Retail Group LSE 0.25 42.65 31.90 33.70% 44.80 29.35

MGNT LI Magnit LSE 0.20 28.95 15.85 82.65% 30.59 14.35

OKEY LI O'Key Group LSE 1 14.90 11.00 35.45% 14.90 10.45

PHST LI Pharmstandard LSE 0.25 28.50 20.49 39.09% 29.50 16.75

WBD US Wimm-Bill-Dann Foods NYSE 0.25 32.76 23.83 37.47% 32.76 17.62

CHE LI Cherkizovo Group LSE 2/3 19.20 10.50 82.86% 22.50 10.50

URKA LI Uralkali LSE 5 34.81 21.00 65.76% 35.86 15.00

RUSAL FP RUSAL Euronext 20 29.64 24.92 18.94% 29.64 17.43

MNOD LI Norilsk Nickel LSE 0.1 23.42 14.35 63.21% 23.88 14.00

SVST LI Severstal LSE 1 16.80 9.50 76.84% 16.80 9.20

NLMK LI NLMK LSE 10 44.88 30.70 46.19% 45.60 25.04

MMK LI MMK LSE 13 13.71 11.30 21.33% 14.40 8.90

MTL US Mechel, Common NYSE 1 29.58 18.82 57.17% 31.18 17.45

EVR LI Evraz Group LSE 1/3 34.84 28.25 23.33% 42.72 21.80

PLZL LI Polyus Gold LSE 0.5 35.50 27.75 27.93% 38.50 22.75

PMTL LI Polymetal LSE 1 18.27 9.17 99.24% 20.10 8.90

HGM LN Highland Gold LSE 1 2.69 1.46 83.80% 3.14 1.34

HRG CN High River Gold TSX 1 1.20 0.55 119.16% 1.47 0.59

TMKS LI TMK LSE 4 20.80 17.93 16.01% 23.50 14.60

CHZN LI Chelyabinsk Zinc Plant LSE 1 4.30 3.35 28.36% 5.11 3.05

LSRG LI LSR Group LSE 0.2 9.15 9.10 0.55% 10.90 6.75

PIK LI PIK Group LSE 1 4.31 4.15 3.86% 5.81 3.02

AFID LI AFI Development LSE 1 1.13 0.95 19.26% 1.26 0.70

MLD LN MirLand Development LSE 1 4.44 2.58 71.93% 4.47 2.70

HALS LI Sistema Hals LSE 0.05 1.59 1.45 9.66% 2.17 0.90

RUS LN Raven Russia LSE 1 0.94 0.73 29.56% 1.01 0.55RGI LN RGI International LSE 1 2.55 1.58 61.39% 2.55 1.23GLTR LI Globaltrans LSE 1 18.00 9.90 81.82% 18.47 10.20NCSP LI NCSP LSE 75 9.99 11.51 -13.21% 15.20 8.70TRCN LI TransContainer LSE 0.1 9.35 7.75 20.65% 10.00 7.49

Source: Bloomberg

APPENDIX

STRATEGY 2011 137

WORLD EQUITY INDICES

Index Country 30.06.2010 31.12.2009 Change,%

1H10high

1H10low

Asia

Nikkei 225 Japan 9,382.64 10,546.44 -11.04% 11,339.30 9,382.64

Hang Seng Hong Kong 20,128.99 21,872.50 -7.97% 22,416.67 18,985.50

Straits Times Singapore 2,835.51 2,897.62 -2.14% 3,019.74 2,650.61

Seoul Composite South Korea 1,698.29 1,682.77 0.92% 1,752.20 1,552.79

Shanghai Composite China 2,398.37 3,277.14 -26.82% 3,282.18 2,398.37

Taiwan Weighted Taiwan 7,329.37 8,188.11 -10.49% 8,356.89 7,071.67

SENSEX India 17,700.90 17,464.81 1.35% 17,970.02 15,790.93

Europe

FTSE 100 Great Britain 4,916.87 5,412.88 -9.16% 5,825.01 4,914.22

DAX Germany 5,965.52 5,957.43 0.14% 6,332.10 5,434.34

CAC 40 France 3,442.89 3,936.33 -12.54% 4,065.65 3,331.29

Budapest SE Index Hungary 21,050.43 21,227.01 -0.83% 25,322.96 20,224.74

PX50 Czech Republic 1,103.90 1,117.30 -1.20% 1,314.60 1,092.80

WIG 20 TR Poland 2,271.03 2,388.72 -4.93% 2,604.76 2,173.25

ISE 100 Turkey 54,839.46 52,825.02 3.81% 59,330.34 48,739.43

RTS Russia 1,339.35 1,444.61 -7.29% 1,676.27 1,226.57

MICEX Russia 1,309.31 1,370.01 -4.43% 1,530.93 1,197.39

Africa

FTSE/JSE Top 40 South Africa 23,294.83 24,996.97 -6.81% 26,547.87 23,093.24

Egypt CMA GENL Egypt 561.07 573.44 -2.16% 695.44 545.94

AmericaDJIA USA 9,774.02 10,428.05 -6.27% 11,205.03 9,774.02S&P 500 USA 1,030.71 1,115.10 -7.57% 1,217.28 1,030.71

NASDAQ USA 2,109.24 2,269.15 -7.05% 2,530.15 2,109.24

Bovespa Brazil 60,935.90 68,588.41 -11.16% 71,784.78 58,192.08

BUSE MERVAL Argentina 2,185.01 2,320.73 -5.85% 2,487.76 2,061.07

IBC Venezuela 65,158.40 55,075.68 18.31% 65,264.84 54,368.95

Emerging markets indexes

MSCI BRIC 300.20 332.29 -9.66% 347.68 277.12

FTSE Russia IOB Index 769.59 879.03 -12.45% 984.11 705.18

MSCI Russia 707.47 795.32 -11.05% 909.21 656.44 Source: Bloomberg

APPENDIX

138 STRATEGY 2011

COMMODITY MARKETS

Bloomberg code Commodity 22.12.2010 31.12.2009 Change,%

YTFhigh

YTDlow

Spot-market

EUCRBRDT Brent 93.47 77.20 21.08% 93.47 69.60

EUCRURMD Urals 90.97 76.73 18.56% 91.03 67.31

USCRWTIC WTI 89.83 79.36 13.19% 89.83 65.96

GOLDLNPM Gold 1,387.00 1,087.50 27.54% 1,421.00 1,058.00

SLVRLN Silver 29.35 16.99 72.75% 30.50 15.14

PLAT Platinum 1,724.25 1,465.50 17.66% 1,784.00 1,445.85

PALL Palladium 751.75 407.80 84.34% 768.50 394.00

LMAHDY Aluminium 2,452.75 2,197.00 11.64% 2,452.75 1,834.75

LMCADY Copper 9,403.00 7,342.00 28.07% 9,405.00 6,067.75

LMNIDY Nickel 23,991.00 18,452.00 30.02% 27,227.00 16,976.00

LMZSDY Zinc 2,319.00 2,529.00 -8.30% 2,686.25 1,596.50

MBSTCIHR Steel HRC (FOB Black Sea) 635.00 507.50 25.12% 715.00 507.50

MBSTUSHR Steel HRC (USA) 515.00 505.00 1.98% 645.00 505.00

LMSNDY Tin 26,881.00 16,869.00 59.35% 27,370.00 15,139.00

LMPBDY Lead 2,443.50 2,402.00 1.73% 2,652.75 1,529.00

Futures

CO1 Brent 93.65 77.93 20.17% 93.65 69.55

CL1 WTI 90.48 79.36 14.01% 90.48 68.01

HO1 Heating Oil 252.85 211.88 19.34% 252.85 187.17

PG1 Gasoline 242.45 205.29 18.10% 243.51 184.94

NG1 Natural Gas 4.15 5.57 -25.48% 6.01 3.29

GC1 Gold 1,386.80 1,096.20 26.51% 1,415.30 1,052.20

SI1 Silver 29.37 16.82 74.57% 29.76 14.83

PL1 Platinum 1,730.90 1,460.00 18.55% 1,809.60 1,452.30

PA1 Palladium 754.25 408.85 84.48% 768.85 396.10

LY1 Aluminium 2,294.00 1,934.50 18.58% 2,304.00 1,777.50

LP1 Copper 9,393.00 7,351.50 27.77% 9,401.00 6,069.50

LN1 Nickel 24,019.00 18,467.00 30.06% 27,245.00 16,984.00

LX1 Zinc 2,321.00 2,534.75 -8.43% 2,691.25 1,598.00

LT1 Tin 26,900.00 16,893.00 59.24% 27,367.00 15,145.00

LL1 Lead 2,450.00 2,409.00 1.70% 2,657.75 1,529.75

API21MON Steam Coal 125.85 83.25 51.17% 125.85 70.50

CCKPTAIY Index Coking Coal 1,760.00 1,700.00 3.53% 1,830.00 1,580.00

MBFOFO01 Index Iron Ore 174.00 111.50 56.05% 189.50 124.00

SB1 Sugar 33.13 26.95 22.93% 33.13 13.67

CC1 Cocoa 2,970.00 3,289.00 -9.70% 3,461.00 2,562.00

KC1 Coffee 230.20 135.95 69.33% 233.85 127.70

C 1 Corn 609.00 414.50 46.92% 609.00 325.00

W 1 Wheat 783.50 541.50 44.69% 785.75 428.00S 1 Soybean 1,328.75 1,039.75 27.80% 1,330.25 908.00CT1 Cotton 154.12 75.60 103.86% 159.12 66.62

Source: Bloomberg

APPENDIX

STRATEGY 2011 139

MONEY MARKET FOREX

Bloomberg code Currency 22.12.2010 31.12.2009 Change,%

YTDhigh

YTDlow

RUB Curncy Dollar USD (rubles per $1) 30.69 30.04 2.18% 31.80 28.93

RREU Curncy Euro (rubles per 1 euro) 40.16 43.07 -6.76% 43.41 37.58

RUBBASK Curncy Basket $0.55/0.45€ (rubles) 34.95 35.96 -2.81% 36.44 33.46

EUR Curncy Euro ($ per 1 euro) 1.309 1.433 -8.68% 1.451 1.195

GBP Curncy British Pound Sterling ($ per 1 pound) 1.537 1.615 -4.81% 1.638 1.432

JPY Curncy Japanese Yen (yen per $1) 83.58 93.14 -10.26% 94.72 80.49

CHF Curncy Swiss Franc (francs per $1) 0.952 1.035 -8.00% 1.162 0.952

CNY Curncy Chinese Yuan (yuan per $1) 6.648 6.827 -2.62% 6.835 6.625

BRL Curncy Brazilian Real (reals per $1) 1.696 1.742 -2.64% 1.895 1.657

MXN Curncy Mexican Peso (pesos per $1) 12.31 13.08 -5.86% 13.21 12.15

TRY Curncy Turkish Lira (liras per $1) 1.553 1.493 3.98% 1.604 1.396

INR Curncy Indian Rupee (rupee per $1) 45.00 46.53 -3.28% 47.71 44.10

KRW Curncy S.Korean Won (won per $1) 1,151.9 1,158.1 -0.53% 1,262.9 1,103.3

Interest rates

Bloomberg code Indicator 22.12.2010 31.12.2009 Change,p.p.

YTDhigh

YTDlow

BP00O/N Index LIBOR Overnight 0.24 0.17 0.07 0.32 0.17

BP0001M Index LIBOR 1Month 0.26 0.23 0.03 0.35 0.23

BP0003M Index LIBOR 3Months 0.30 0.25 0.05 0.54 0.25

EUR001M Index EURIBOR 1Month 0.81 0.45 0.36 0.85 0.40

EUR003M Index EURIBOR 3Months 1.02 0.70 0.32 1.05 0.63

MOSKON Index MosPrime Overnight 2.89 4.45 -1.56 5.95 2.50

MOSK1W Index MosPrime 1Week 3.22 4.60 -1.38 5.45 2.88

MOSK2W Index MosPrime 2Weeks 3.41 4.95 -1.54 5.50 3.02

MOSKP1 Index MosPrime 1Month 3.75 6.32 -2.57 6.32 3.23

MOSKP3 Index MosPrime 3Months 4.01 7.05 -3.04 7.05 3.73

NDF RUR

Bloomberg code Maturity 22.12.2010 31.12.2009 Change,p.p.

YTDhigh

YTDlow

RRNI1M Curncy 1 Month 3.38 5.74 -2.36 7.72 0.41

RRNI3M Curncy 3 Months 3.41 7.52 -4.11 7.57 2.00

RRNI6M Curncy 6 Months 3.91 6.05 -2.14 6.08 2.92

RRNI12M Curncy 1 Year 4.70 6.46 -1.76 6.46 4.00

Bloomberg code Bond 22.12.2010 31.12.2009 Change,p.p.

YTDhigh

YTDlow

GT2 Govt UST 2Y 0.63 1.14 -0.51 1.17 0.33

GT5 Govt UST 5Y 2.01 2.68 -0.68 2.74 1.03

GT10 Govt UST 10Y 3.35 3.84 -0.49 3.99 2.39

GT30 Govt UST 30Y 4.45 4.64 -0.20 4.84 3.51

EC228830 Corp RUS 30Y 4.86 5.38 -0.53 5.84 3.91

Spread RF30/US10 1.51 1.54 -0.03

Government Bonds

Source: Bloomberg

CONTENTS

Research Department Equity Research + 7 (495) 981 3430

Fixed Income Research + 7 (495) 981 3430

Maria Kalvarskaia Head of Equity Research Banking [email protected]

Dmitry Zak [email protected]

Alexander Kovalev, PhD Commodity markets [email protected]

Evgenia Dyshlyuk Oil & Gas [email protected]

Michael Zak [email protected]

Alexey Serov Utilities Sector [email protected]

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Fixed Income Markets

Moscow + 7 (495) 981 3430 Moscow + 7 (495) 981 3430 Dmitry Romanov [email protected]

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Artem Ananyan [email protected]

Dmitry Zak [email protected]

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This document is provided to you for informational purposes only and does not constitute an offer to buy, sell or subscribe to investment products described herein. The sources used for this report are believed to be reliable, but TKB Capital makes no representation as to their accuracy or completeness. The views, advice and recommendations contained within represent the analyst’s view as of the publication date. Such views may change without notice and may contradict previously expressed views and recommendations. TKB Capital is under no obligation to bring such previously held views to the attention of the reader.

This report is intended for market professionals and institutional investors capable of assessing the risks associated with the securities mentioned herein. TKB Capital shall not be held liable for any losses or other damages which may occur as a result of using this information or investment decisions made on the basis of opinions and recommendations contained in this report. Some Russian equities experience volatility which increases their investment risk, as their value may fall causing losses if the investment is realized. Many Russian equities are illiquid, and some investments are not readily or quickly realizable in good markets, and in times of market duress they may be impossible to realize. Many Russian equities do not trade on a daily basis and thus do not have a daily price quote, giving rise to questions concerning their true value. TKB Capital can give no representation as to the absolute volatility or liquidity of any Russian equity, nor can it give any representation as to the true value of an illiquid security. The value of all ruble-denominated Russian equities is also dependent on currency fluctuations in addition to equity market conditions. Investors should conduct their own investigation and research into a given investment and make their own assessment as to the risks involved with a particular investment in Russian equities.

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