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VTB Capital All prices are as of 02.10.09
VTB Capital and/or VTB Group do and seek to do business with companies covered in their research reports. Thus, investors should be aware that the firms may have a conflict of interest that could affect the objectivity of this report.
Investors should consider this report as only a single factor in making their investment decision.
RUSSIA Chemicals
Elena Sakhnova, CFA +7 495 663 46 53 [email protected] Vladimir Bespalov +7 495 663 46 51 [email protected] Georgy Tarakanov +7 495 663 46 69 [email protected]
5 October 2009
Uralkali Company Visit: Notes
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Moscow meetings
We would like to thank Uralkali for an excellent organization of their part of the trip. We have barely slept, but it was worth it. And we are sure that everybody who participated will agree.
Meeting with Dmitry Rybolovlev, Uralkali’s major shareholder
Thursday, 1 October, 5pm Moscow time. Although there are still a lot of people in the hall of the President Hotel in central Moscow, it is not as overcrowded as it has been over the past busy three days of VTB Capital's Investment Forum. While investors are running to their last meetings, there is a new and positive surprise awaiting them. Dmitry Rybolovlev, a non-public owner of Uralkali, who rarely meets with the investment community, shows up at the hotel to start his meeting with investors. It lasted for more than an hour. His most interesting comments are below:
On flooding reinvestigation. The RUB 5bn to construct the railway has not been paid yet, but everything is ready and once the government gives the green light, they will transfer the amount. Potential additional expenses: TGK 9, foregone mineral extraction tax for USD 20mn (but the company would dispute any decision by the tax authorities to charge this amount). Our comment: Neither the TGK’s nor tax authorities’ claim would be significant for the company.
On China: The contracts are expected to be signed this year. Our comment: This is in line with our expectations.
On the price-over-volume strategy: Rybolovlev said the company would stick to this strategy, but within reasonable bounds: if there is demand we shall deliver, rather than artificially increasing the price. Our comment: We believe that Uralkali might go for volumes rather than for price in China. This supports our view that China might be signed quite soon. We think that a 10% discount to India (implying a price of around USD 360/tonne FOB) might be justified, but we do not expect the price in China to go below USD 350.
On a potential merger with a larger mining company: If it were to bring additional value, such a merger could not be ruled out, but at the moment the opportunities are quite limited.
On the loan taken from Uralkali: “When I promised during the IPO that I would not take loans from the company any more, I did not expect my wife to divorce me.”
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Meeting with Denis Manturov, Deputy Minister for Industry and Trade
Three hours later. The hall is now empty, the conference is over, but one conference room is still crowded. Investors are waiting for Deputy Minister of Industry and Trade Denis Manturov, the government decision-maker in the fertilizer industry. His Mercedes, with all-powerful AMR plates, approaches the entrance and soon we start our meeting. At the beginning there is tension among the investors, but Manturov starts the discussion in a friendly manner. In five minutes everyone is relaxed, laughing and enjoying themselves. It is not a Q&A session, but rather a business seminar with professionals exchanging opinions. We have even held a mini vote on one of the points being debated.
Below is a short summary of the topics discussed.
The Russian government would support foreign investments in the fertilizer industry. Potash and phosphate are not strategic resources. Our comment: This statement is definitely positive, but we have yet to see any precedents. Moreover, this appears to be a logical answer during a crisis.
The government will stick to its policy of ensuring low domestic prices on potash and phosphates, at least until the end of the current crisis. Our comment: We see this development as negative, but such an approach towards the suppliers of raw materials was totally expected.
As long as there are low domestic prices for potash and phosphates, export duties will not be introduced. Our comment: This statement is clearly positive, because the damage from low domestic prices is much lower than from export duties.
The government will help implement new capital intensive projects by developing infrastructure and providing guarantees (if the producer provides adequate collateral). Our comment: We believe this is positive for the industry.
The discussion was so interesting that we hardly noticed how 1.5 hours had passed. Now, though, we needed to rush as the buses to the airport were waiting for us. Although it was nearly 10pm, the centre of Moscow was still full of cars. But the traffic jams were not that awful, while the staff at Sheremetyevo’s domestic terminal proved surprisingly quick. So, our private jet took off at around the midnight and headed to east.
Two hours later we landed in Perm, which is two hours ahead of Moscow, and in less than half an hour our comfortable bus started the three-hour trip to Berezniki, the city where Uralkali’s facilities are located. The road is narrow and might look dangerous, but nobody really cared: almost everyone fell asleep.
At 6am, as we were driving to the hotel, we could see a surprising number of people in Berezniki: bus stops were crowded, people moving along the streets. But all we could think of as we arrived was to take a shower and a nap.
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Tour to mine-4 and refining factory
Friday, 2 October, Berezniki, 9 am local time. Looking at the people in our group, you would never say that they had slept less than three hours after three days of a tough conference schedule: everyone is excited putting on the special uniforms, rubber boots and helmets. Equipped with respirators, the visitors are laughing at each other and eager to see the mine. The thrilling descent in an open lift takes several minutes, after which we found ourselves in an underground corridor six metres wide and three metres high. It is dark and you need to keep your lights on all the time. The network of corridors stretches several hundred kilometres and a special vehicle is driving us towards the place where the potash is currently being extracted. That is being done by an efficient Marietta machine which has an extraction capacity 30% greater than that of Russian mining machines.
Figure 1: Talking to Marietta driver – one of Uralkali’s shareholders
Figure 2: Potash moving shaft car
Source: Company Source: Company
The potash mine has its own beauty: lit by our lights, the salt is shining and you feel as though you are in a fairy tale. Having learned about the extraction process in detail, and been impressed by the large underground warehouse of ore, and having breathed the healthful air laden with salt particles, we are going to see the production facilities.
Another positive surprise is waiting for us here: the company has significantly upgraded and renovated its production facilities since we last visited back in 2006. With memories of the gloomy picture so familiar to those who knew post-Soviet enterprises, we entered well lit and clean premises. It is worth noting that both at the mine and at the factory we saw only a small number of people, who were all busy at their own jobs, which highlights the well-organised production process.
The company continues to work on upgrading its production facilities. Once the new production line has been launched (and it is almost complete) and the subsequent renovation of the line which is currently in operation, Uralkali’s production capacity will reach 7mn tonnes, while all control systems will be modernised and fully automated.
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Just finished: gas power plant and new warehouses
After a quick refreshment of red caviar and fruit, we depart to see the recently built power generating unit and new 50,000-tonne warehouses.
The new glittering power unit is another recent achievement, based on the most up-to-date European technology. It is capable of covering 25% of the company’s needs, expanding it will likely double this number, reducing Uralkali’s dependence on Russia’s aging power infrastructure and ensuring cost savings. According to the facility’s management, before the company had its own production unit, resuming work at the production facilities following a power cut might take up to a day.
The new warehouses were built during the uneasy 1Q09, when global potash demand subsided. The facility that we entered had a huge hill of pink potash of some 8,000 tonnes, waiting for delivery to India and luring everyone to conquer its top.
Figure 3: Flooded mine (railway on the horizon)
Figure 4: VTB Capital’s fertilizer research team visiting Uralkali’s facility (from left to right Georgy Tarakanov, Elena Sakhnova and Vladimir Bespalov)
Source: Company Source: Company
Flooded mine
Our next stop was even more exciting: a visit to the crater of the flooded mine. We see a large pond with a crumbling building on its bank and some rusted iron sticking out of the water. If Hollywood decides to shoot a movie about the end of civilisation, it would be hard to find a better setting.
We are standing on the dam which prevents the salt waters of the flooded mine from pouring into the jewel of Perm region: the Kama River. On the opposite side, we can see a railway with a train carrying Silvinit’s potash. The railway is just 70 metres from the crater, but the latter is no longer dangerous: the mine is totally flooded and crater is not expanding any more, while the water level has even started to subside. That is also true for the 16 houses, whose inhabitants were relocated to new flats: seven of them were destroyed to avoid any potential collapse just after the flooding, while the other nine are still standing and only the dark windows show that they are not inhabited. The head of Uralkali’s production facilities, located near the crater, is optimistic. He is confident that production will continue and the flooding is no longer an issue.
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Talk with the CEO in private jet
The Uralkali people that we met during the trip were extremely welcoming and open to any questions. Whatever tricky questions they were asked, they did their best to provide us with exhaustive information in a clear and understandable way, without resorting to such tricks as referring to commercial or industrial secrets.
Although it was interesting to look around, especially given the charming nature, beautiful weather and the shining sun, we had to rush to a restaurant, where Uralkali CEO Vlad Baumgertner was already waiting for us. Later on, he joined us on the plane to share his views on the development of the industry and the company.
The major points of our discussions during lunch and on the plane are summarised below.
Current utilisation stands at around 60%, with full-year utilisation to be close to 50%, which is in line with our model. If large mining companies (BHP, Vale) join the industry, it would be a positive development as consolidation of the industry would continue.
Baumgertner believes that any new capacity launch in the potash industry will see a delay. We tend to agree with him because the companies that are currently building large capacities (Eurochem, BHP) do not have the experience in this industry, implying high risks.
China pricing is not that important: unlocking demand is more important. Our analysis shows that the sensitivity of our model is much higher to the 2011 price in China than to the 2009 price. In any case, we think the China price will not go below USD 350, which would imply only slight adjustment of spot prices.
After a three-hour trip by bus and a two-hour flight by plane and we are back in the capital of Russia at 9pm, Moscow time. We are tired and sleepy, but nobody regrets a single minute of the trip. We feel the natural regret of saying good-bye to each other, but are doing so in order to meet again in the future. We shall definitely return to the Perm region to visit Silvinit and other fertilizer and non-fertilizer companies in the region.
We would be glad to see you with us next time!
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Disclosures
VTB Capital — Equity rating definitions
BUY: Fair value exceeds the market price by 20% or more (as of the publishing date)
HOLD: Fair value is no less than the market price but does not exceed it by more than 20% (as of the publishing date)
SELL: Fair value is below the market price (as of the publishing date)
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VTB Capital Research team
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