Deutsche Bank
Russia-2011: Narrowing the EM gap
March 2011
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covered in its research reports. Thus, investors should be aware that the firm 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. DISCLOSURES AND ANALYST CERTIFICATIONS ARE
LOCATED IN APPENDIX 1. MICA(P) 007/05/2010
I. Global factors: economy and equities
Deutsche Bank
1
Sovereign debt problems in the medium term
Debt ratios projected to rise in many advanced economies
Source: Deutsche Bank Global Markets Research
The US and many other advanced economies appear to be on unsustainable fiscal
trajectories, with projected increases in debt-to-GDP ratios over the next 30 years driven by
a combination of unfavorable initial conditions (debt and deficit levels), prospective
substantial increases in age-related spending growth, and unfavorable interest rate-to-GDP
differentials. Even with a freeze in age-related spending as a share of GDP, the debt ratios
in many countries, including the US, would rise under current policies.
Deutsche Bank
2
US Equity Outlook: buy on growth
 Our
RTS Index 2011 year-end targets envisaged by 2011 S&P500 Index targets
Beta \S&P500 2011 target
1420 (consensus) 1550 (consensus)
1 (no beta, pure performance catch-up)
2079
2270
1.2 (current)
2109
2337
1.4 (LT average)
2138
2405
2011 RTS Index target of
2300@2011 is in line with our S&P 500
end-2011 target and the current beta of
1.2x vs the US equity market
Q4 earnings have follow ed t he recent pat t ern of solid
The cont ribut ion from sales beat s has increased
beat s and are on t rack t o reach DB forecast of $22.9
subst ant ially
23
If companies yet to report
maintain current beat trend
S&P 500 Quarterly
Operating EPS ($)
23
S&P 500: M argins and Sales Surprise (% )
M argin
Sales
11%
19
9%
9%
18
18
17
17
7%
7%
16
16
5%
5%
15
15
3%
3%
14
14
1%
1%
13
13
-1%
-1%
12
12
Q2 09
Q3 09
Q4 09
Q1 10
Q2 10
Q3 10
Q4 10
Q1 11
Source: Bloomberg Finance LP, Deutsche Bank
15%
Q4 10
11%
19
Q3 10
20
Q2 10
20
Q1 10
13%
Surprise
Q4 09
13%
Consensus EPS
Q3 09
21
21
Q2 09
15%
Q1 09
22
22
Source: Bloomberg Finance LP, Deutsche Bank
 Our US equity strategists expect S&P500 at 1,550 (16.4x P/E) by the end-2011,
+20% upside from current levels
 Sales increasingly the driver of strong earnings growth
Deutsche Bank
3
Economy and oil
 A 20% increase in oil prices should still leave US economic expansion in place
with growth rates above consensus
 US equities are negatively correlated with oil prices. While oil prices go up and
S&P goes down, Russia’s potential from rising oil price gains is limited
 Once MENA risks subside, oil prices will go down, S&P will go up – in such
cases Russia comes under selling pressure given its susceptibility to the oil
price factor, but the rising global markets provide a cushion and limit Russia’s
declines notably.
 OPEC is ready to to compensate any oil supply shortages from Lybia and
Algeria, while Gazprom is already compensating Italy its lost gas supplies from
Lybia
OPEC spare capacit y scenarios
Libya crude oil production
6.0
Dependence on gas from M ENA, % of 2010 demand)
Algeria crude oil production
60%
Other
5.0
50%
4.0
40%
Egypt
30%
Qatar
Million Bbl/Day
Libya
3.0
Algeria
20%
2.0
10%
1.0
0%
Spain
0.0
1994
1996
1998
Source: US DOE/EIA, Deutsche Bank
2000
2002
2004
2006
2008
Italy
UK
2010
Source: Enagas, Snam Rete, Tullett Prebon LNG
Deutsche Bank
4
Inflation in EM Asia and interest rates
 There is a strong concern that the inflation in EM Asia (China in particular), will
lead the monetary authorities to raise rates, which will put pressure on
commodities and, eventually, Russian equities
 However, inflation in the EM Asia is largely driven by (global) food prices, while
core inflation is not a major concern. Monetary policy will not be effective in
combating food prices
 History suggests we should not expect much of a policy response at all to
higher inflation
Headline, food and non-food inflat ion in Asia
20
18
16
14
12
10
8
6
4
2
0
-2
% yoy
Int erest rat e response t o 1% increase in inflat ion
0.8
Headline
Food
Nonfood
%
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0.0
2004
2005
2006
2007
2008
2009
2010
Sources: CEIC and Deutsche Bank CIB Research. CPI indexes are used for China, Hong Kong, Indonesia,
M alaysia, the Philippines, Singapore, South Korea, Sri Lanka Taiw an, Thailand, and Vietnam. WPI index is
used for India.
TH
ID
SK
IN
TW
MY
CH
PH
Sources: CEIC and Deutsche Bank CIB Research
Deutsche Bank
5
II. Global factors: commodities and FX
Deutsche Bank
6
Oil vs the dollar
90
100
88
90
86
80
84
82
70
80
60
78
76
50
74
40
72
70
2009
30
2010
2011
US Dollar Index (LHS)
WTI oil price, $/bbl (RHS)
Source: Bloomberg Finance LP, Deutsche Bank Global Markets Research
 Historically, oil prices are strongly correlated with USD. A devaluation of USD is
associated with stronger nominal oil prices, and vice versa.
 However, throughout the 2010 wave of USD appreciation the oil price decoupled and
remained relatively stable
Deutsche Bank
7
Euro: signs of life most recently
1.7
1.6
1.5
1.4
1.3
1.2
1.1
2007
2008
2009
2010
2011
Euro rate
Source: Bloomberg Finance LP, Deutsche Bank Global Markets Research
 With the exacerbation of sovereign debt risks in Europe, EUR dropped below 1.2…
 … however it peaked above 1.4 in late 2010, which was followed by a slide down to
1.3 due to new concerns of sovereign debt risks in Europe
 DB forecasts EUR rate at 1.3 at end-2011
Deutsche Bank
8
III. Russia‘s economy
Deutsche Bank
9
GDP growth: coming out of crisis
5.0
3.1
5.2
2.7
10.0
3.8
4.4
4.4
6.2
7.5
7.9
6.1
7.6
7.2
8.0
7.3
6.2
5.6
6.0
6.0
7.8
7.3
8.1
8.2
8.9
8.1
8.6
8.2
9.2
9.1
7.7
6.4
15.0
-10.0
-15.0
1Q02
2Q02
3Q02
4Q02
1Q03
2Q03
3Q03
4Q03
1Q04
2Q04
3Q04
4Q04
1Q05
2Q05
3Q05
4Q05
1Q06
2Q06
3Q06
4Q06
1Q07
2Q07
3Q07
4Q07
1Q08
2Q08
3Q08
4Q08
1Q09
-9.3
2Q09 -11.0
3Q09
-8.6
4Q09
1Q10
2Q10
3Q10
-5.0
-2.9
-1.1
0.0
Source: Rosstat, Deutsche Bank Global Markets Research
■ Russia posted one of the largest GDP declines during crisis and economy is increasingly
recovering since 2Q09
■ By 2Q10 Russia has formally exited from crisis, posting 2 quarters of growth slightly slowing
down in Q3. The most recent estimates made by Rosstat suggest a 4% real GDP growth in
2010, which is in line with our projections and implies a 4.9% real growth in Q4 2010
■ We project GDP growth at 5.4% in 2011 and 5.5% in 2012
Deutsche Bank
10
Economic indicators: recovery driven by consumption
35%
25%
15%
5%
-5%
-15%
-25%
2007
IP, YoY, real, %
Construction, YoY, real, %
2008
2009
Retail sales, YoY, real, %
Agriculture, YoY, %
2010
2011
Fixed investment, YoY, real, %
Source: Rosstat, Deutsche Bank Global Markets Research
 By the beginning of 2010 all key economic indicators returned into YoY positive zone
 By the end of 2010 the recovery shifted from consumption to investment, but we
continue to see consumption as a major driver of economic growth
 Agriculture contributed largely to the 3Q 2010 slowdown
Deutsche Bank
11
Deutsche Bank
A consumer driven recovery
 Lower inflation
 Rouble appreciation, particularly versus the Euro
 A saving reservoir preserved in the course of the gradual devaluation
 Rapid decline in unemployment
 Budget spending prioritizes the social sphere and hence household consumption
 Interaction of political and economic cycle to continue to favor current outlays
 Cash-for-clunkers program extended
 Lower interest rates and a recovery in consumer lending
 Regulated tariff increases for households contained
 The return of the migrants from the near abroad
Deutsche Bank
12
Unemployment and hidden unemployment
2
10
9
8
7
6
5
4
3
2
1
0
1
Part-time, (employer's initiative) % employed (LHS)
Nov-10
Sep-10
Jul-10
May-10
Mar-10
Jan-10
Nov-09
Sep-09
Jul-09
May-09
Mar-09
Jan-09
3q2008
1q2008
3q2007
1q2007
3q2006
1q2006
3q2005
1q2005
0
Admin leave (employer's initiative), % employed (LHS)
Unemployment rate, % (RHS)
Source: Rosstat, Deutsche Bank Global Markets Research
Unemployment dropped notably throughout 2010 bottoming at 6.7% in
October
Most recently, it started a seasonal rise reaching 7.6% in January
Unemployment statistics in Russia does not take into account the actual
amount of idle workforce – those working part-time or on admin leave
 During the crisis the share of part-time workers and those on admin leave
peaked to 1.5% and 0.8% of employed, respectively
Deutsche Bank
13
Russian exports and imports growth, % YoY
80
60
40
20
0
-20
-40
-60
Jan-07
Jul-07
Jan-08
Jul-08
Jan-09
Jul-09
Russia's import, YoY, %
Jan-10
Jul-10
Jan-11
Russia's export, YoY, %
Source: Rosstat, Ministry of economy, Deutsche Bank Global Markets Research
 Both exports and imports have recovered as well, with growth in imports outpacing
the growth in exports starting from 2H 2010
Deutsche Bank
14
Current account vs budget deficit, % GDP, 2009
25
20
Current Account, % of GDP
15
y = 0.7733x + 5.5718
R² = 0.2862
10
5
Russia
0
-15
-10
-5
0
5
10
15
-5
-10
-15
Budget Deficit % of GDP
Source: IMF
Deutsche Bank
15
Deutsche Bank
S&P ratings vs CDS spreads, bp, 2009
S&P ratings
AAA
BBB+
Russia
CCC
0
100
200
300
400
500
600
700
800
900
CDS 5Y Spreads
Source: Standard & Poor’s, Bloomberg Finance LP, Deutsche Bank Global Markets Research
Deutsche Bank
16
External debt, USD bn
4Q2004
1Q2005
2Q2005
3Q2005
4Q2005
1Q2006
2Q2006
3Q2006
4Q2006
1Q2007
2Q2007
3Q2007
4Q2007
1Q2008
2Q2008
3Q2008
4Q2008
1Q2009
2Q2009
3Q2009
4Q2009
1Q2010
2Q2010
3Q2010
4Q2010
600
500
400
300
200
100
0
State, USD bn
Banks, USD bn
Other sectors, USD bn
Source: CBR, Deutsche Bank Global Markets Research
 Corporate external debt remains a risk factor for Russia…
 … with state debt starting to rise as well on the back of the fiscal deficits
Deutsche Bank
17
Debt repayment schedule, USD bn
External debt repayment schedule (face value + interest), USDbn
30
25
20
15
10
5
State authorities, USD bn
Banks, USD bn
3q12
2q12
1q12
4q11
Sep-11
Aug-11
Jul-11
Jun-11
May-11
Apr-11
Mar-11
Feb-11
Jan-11
Dec-10
Nov-10
Oct-10
0
Other sectors, USD bn
Source: CBR, Deutsche Bank Global Markets Research
Deutsche Bank
18
Non-oil budget deficit at nearly 15% of GDP in 2009
12%
7%
2%
-3%
-8%
2004
2005
Non-oil deficit, %GDP
2006
2004-2009 average non-oil deficit, %GDP
2007
2008
Budget deficit, %GDP
2009
2010
2004-2009 average deficit, %GDP
Source: Economic Expert Group, Deutsche Bank Global Markets Research
Deutsche Bank
19
Government assets for sale
M cap, USD
bn (or Amount t o
mult iplesbe sold,
Type of asset Government Amount t o
based
USD bn,
Company Name
(public/ non-public)
st ake, % be sold, %
valuat ion)
est imat e
Rosneft
public
75.2
24.2
63.0
15.2
Transneft
public
78.1
27.1
6.5
1.8
Sberbank
public
60.3
9.3
62.0
5.8
VTB
public
85.5
24.5
28.0
6.9
Rushydro
public
60.4
9.4
14.0
1.3
FSK
public
79.1
28.1
14.0
3.9
NTM P
public
20.0
20.0
3.0
0.6
Sovkomflot
non-public
100.025% -1 share
2.3
0.6
AIZHK (National M ortgage Agency)
non-public
100.0
49.0
2.5
1.2
Rosselkhozbank
non-public
100.0
49.0
4.5
2.2
RZHD
non-public
100.025% -1 share
52.3
13.1
TOTAL PUBLIC, USD bn
35.5
TOTAL NON-PUBLIC, USD bn
17.0
TOTAL, USD bn
52.5
Source: Vedomosti, Bloomberg, Deutsche Bank
Source:
Vedomosti, Bloomberg Finance LP, Deutsche Bank Global Markets Research
 Government plans to step up privatization in the coming 3-5 years
 Government plans to extract up to USD50bn from the sale of assets
 Proceeds are expected to be used for financing the budget deficit
Deutsche Bank
20
Reserve Fund and National-Well-Being Fund
250
200
150
At the peak the size of
the two oil funds
amounted to USD220bn
100
Currently funds were
50
reduced to around
USD120 bn
0
Aug-06 Feb-07 Aug-07 Feb-08 Aug-08 Feb-09 Aug-09 Feb-10 Aug-10 Feb-11
St abilisat ion Fund, $ bn
Reserve Fund, $ bn
Nat ional Well-Being Fund, $ bn
Source: Ministry of Finance of the Russian Federation, Deutsche Bank Global Markets Research
 Finance Minister Alexei Kudrin recently stated that Russia will pursue a policy of
preserving the Reserve fund
 At the start of 2010 the government planned to finance the budget deficit by means
of the Reserve fund reducing it to about USD10bn over the year, but due to more
favourable conditions than initially projected, the Fund ended 2010 at about
USD25bn (USD15bn was spent to finance the budget deficit in December)
Deutsche Bank
21
Pro-cyclical fiscal policy
GDP growth and Russian budget, % GDP
25%
20%
v
+3% GDP
15%
10%
5%
0%
-5%
-10%
1998
1999
Budget deficit, %GDP
2000
2001
2002
Budget expenditure, %GDP
2003
2004
Real GDP growth, %
2005
2006
2007
2008
2009
Average budget expenditure for the period, % GDP
Source: Economic Expert Group, Deutsche Bank Global Markets Research
Deutsche Bank
22
The new electoral cycle starts in 2011
Parliamentary elections
22%
17%
12%
7%
2%
-3%
-8%
1998
1999
2000
2001
2002
2003
2004
2005
Budget deficit, %GDP
Budget expenditure, %GDP
2006
2007
2008
Budget revenue, %GDP
2009
2010
Source: Economic Expert Group, Deutsche Bank Global Markets Research
Deutsche Bank
23
Expenditures on key international infrastructure projects,
RUR bn
2011
№
2012
Project
ed
% to
prev.
year
73,0
106,1
52,1
201,5
93,3
106,1
52,7
72,3
2,1
4,0
0,0
0,0
70,5
0,0
0,0
0,0
0,0
2010
Projecte
d
305,2
278,9
91,4
203,6
Sochi Olympic Games 2014
217,8
216,0
99,2
Preparation for APEC summit
72,5
52,4
14,9
10,5
Total
2013
% to
prev. year
Projecte
d
% to
prev. year
including:
1
.
2
.
3
.
Preparatio for 2013 Universiade in
Kazan
Source: Russian Authorities, Deutsche Bank Global Markets Research
 Sochi 2014 is the key project for Russia in the medium term
 Another infrastructural “hot spot” is the Far East (one of the most depressed regions
in Russia currently)
Deutsche Bank
24
CBR reserves recovered by USD100bn already
15
600
10
550
5
0
500
-5
450
-10
-15
400
-20
-25
350
Jul-07
Jan-08
Jul-08
Jan-09
CBR reserves inflow, USD bn (LHS)
Jul-09
Jan-10
Jul-10
Jan-11
CBR Reserves, USD bn (RHS)
Source: CBR, Deutsche Bank Global Markets Research
 CBR reserves recovered by more than USD110bn since the bottom of the crisis
peaking above USD500bn…
 …Due to recent euro weakness the reserves dynamics was not strong in the second
half of 2010, but we expect them to continue their recovery
Deutsche Bank
25
Foreign direct investment into Russia
25.0
22 22
19
20.0
15.0
9
10.0
5.0
5
5
0
0.0
-5.0
8
8 8
5
17
11
10
18
13
9
4
12
11
9 9
6
8
7
1
-5
1Q04
2Q04
3Q04
4Q04
1Q05
2Q05
3Q05
4Q05
1Q06
2Q06
3Q06
4Q06
1Q07
2Q07
3Q07
4Q07
1Q08
2Q08
3Q08
4Q08
1Q09
2Q09
3Q09
4Q09
1Q10
2Q10
3Q10
-10.0
FDI, $bln
Source: CBR, Deutsche Bank Global Markets Research
Deutsche Bank
26
Net capital inflows, $ bn vs RTS Index
100
3,000
54
50
0
8 2
-4 -6 -7
21
8
-5
21
12 14 14
-5 -6
-50
2,500
40
-7
3
-24 -19
9
2,000
3
-15
-35 -34
-4
-23
-100
1,500
1,000
500
-130
0
1Q04
2Q04
3Q04
4Q04
1Q05
2Q05
3Q05
4Q05
1Q06
2Q06
3Q06
4Q06
1Q07
2Q07
3Q07
4Q07
1Q08
2Q08
3Q08
4Q08
1Q09
2Q09
3Q09
4Q09
1Q10
2Q10
3Q10
4Q10
-150
Net capital inflows, $bn (LHS)
RTS Index (RHS)
Source: Bloomberg Finance L. P., CBR, Deutsche Bank Global Markets Research
 Q4 2010 showed an unexpected amount of capital flight from Russia (an outflow of
almost USD23bn
 The outflow came despite favourable oil prices (USD83.5/bbl on average for Brent)
and did not stop the RTS Index from gaining 17% over the quarter
Deutsche Bank
27
Inflation in Russia is a monetary phenomenon
16
70
14
60
50
12
40
10
30
8
20
6
10
4
0
2
-10
0
-20
May-06
Nov-06
May-07
Nov-07
May-08
Nov-08
May-09
Nov-09
May-10
Nov-10
May-11
Nov-11
Rouble depreciation vs dual currency basket, YoY, % (RHS)
CPI inflation, YoY, % (LHS)
Core inflation, YoY, % (LHS)
M2 money supply growth, YoY, %, lagged by 15 months (RHS)
Source: CBR, Rosstat, Deutsche Bank Global Markets Research
Deutsche Bank
28
Liquidity and interest rates
1,400
25%
1,200
20%
1,000
15%
800
600
10%
400
5%
200
0
0%
Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11
Deposits in CBR*, USD bn (lhs)
Correspondent accounts*, USD bn (lhs)
Refinancing rate, % (rhs)
MIACR**, % (rhs)
* - 100 day MA, ** - 10 day MA
Source: CBR, Deutsche Bank Global Markets Research
 Low Interbank interest rates are coming on the back of excess liquidity in the system
 Starting from the first quarter of 2009 they declined towards the current value of 2-3%
 Most recently the CBR raised credit and deposit rates effective from 28 February
Deutsche Bank
29
Inflation vs refinancing rate: bottoming out
16
14
12
10
8
6
4
2
0
2004
2005
CPI Inflation, %
2006
2007
Refinancing rate, %
2008
2009
Repo rate, %
2010
2011
Tom-next deposit rate, %
Source: CBR, Rosstat, Deutsche Bank Global Markets Research
 After 13.3% in 2008, Russian inflation dropped to 5.5% YoY as of July 2010
 Since 1Q09 CBR reduced the refinancing rate from 13% to 7.75%
 Inflation started to recover reaching 9.6% YoY by the end of January 2011….
 Most recently the CBR raised refinancing rate by 25 bp to 8%, and deposit rate by
50bp to 3%
Deutsche Bank
30
Loans growth, pp
120
100
80
60
40
20
0
-20
2005
2006
2007
2008
2009
Bank loans to corporates growth, YoY, %
Bank loans to households growth, YoY, %
11M
2010
Source: CBR, Deutsche Bank Global Markets Research
 Before the crisis, lending to both corporates and households was steadily expanding
 During the crisis lending to households contracted while the corporate sector was
flat
Deutsche Bank
31
Capacity utilization rates are recovering
Capacity Utilization, quarterly data (seasonally adjusted), pp
75
75
70
70
65
65
60
60
55
55
50
50
45
45
40
40
1993
1995 19961997
1993 1994
1997
Capacity utilization,
utilization, pppp
Capacity
1999 2000
20012001 2003
2005 20052007
2009 2010
1998
2003 2004
2007 2008
year moving
moving average,
pp pp
Average 2001-2009,
pp pp
11year
average,
Average
2001-2009,
Source: Gaidar Institute for Economic Policy (former Institute for Economy in Transition), Deutsche Bank Global Markets Research
 Capacity utilization is currently below its pre-crisis level albeit breaking through the
moving average as well as the 9-year average on the upside
Deutsche Bank
32
Basket/Rouble exchange rate and Urals price, USD/bbl
41
110
40
100
39
90
38
80
37
70
36
60
35
34
50
33
2009
40
2010
Rouble/basket rate (LHS)
2011
Urals oil price, $/bbl (RHS)
Source: CBR, Deutsche Bank Global Markets Research
 The recent strength in oil prices suggests further rouble appreciation
 One of the factors of the rouble weakness, which is now gone, was the weak euro
 We forecast USD/rouble rate at 28.0 at end-2010 and 27.8 at end-2011 (31.8 and
30.9 for the basket)
Deutsche Bank
33
Politics: Margin of support for Putin, Medvedev remains stable
Put in and M edvedev approval rat ings, %
9090
8585
8080
7575
%7070
6565
6060
5555
5050
2007
2007
20082008
Percentage
%%
PercentageofofPutin
Putinsupporters,
supporters,
2009 2009
2010
2010
2011
2011
Percentage
of Medvedev
supporters,
Percentage
of Medvedev
supporters,
%%
Source: Levada Center, Deutsche Bank
 According to the recent polls the popularity ratings of Putin and Medvedev remain
around 70%
 The gap between leaders this year approached its all-time low of 1pp in October but
broadened in the most recent polls
Deutsche Bank
34
Politics: elections to support the equity market
130
120
110
100
90
80
70
60
50
40
-181
30
6M before elections
July 1996 elections
Presidential elections date
March 2000 elections
March 2004 elections
6M after elections
March 2008 elections
*all series rebased to 100 as of respective elections date
Source: Bloomberg Finance LP, Deutsche Bank Global Markets Research
 It is common for the Russian equity market, as well as the US equity market, to
reveal strong trends before the presidential elections
 Given that 2012 elections are scheduled to take place in 1Q, we expect this factor to
be one of the driver for the equities already in 2H11
Deutsche Bank
35
Politics: stronger rouble coming from the electoral cycle
Source: Bloomberg Finance LP, Deutsche Bank Global Markets Research
 Two previous electoral cycles were characterized by rouble’s appreciation vs the US
dollar
 We expect the 2011-2012 electoral cycle to be one of the positive factors for the
rouble
Deutsche Bank
36
Russia’s diarchy in the making
Medvedev as President:
 Liberal credentials, no ties with the hardliners
 Loyalty to Putin
 Looks to forging ties with Europe
Putin as Russia’s Prime Minister:
 The most popular Prime Minister in Russia’s history
 Has a keen interest in the pursuit of the Asian model
 Looks at Asia as a promising venue for expanding energy
supplies/cooperation
 Considers Asia as a counterbalance to Europe/West
Deutsche Bank
37
Number of bureaucrats
130
120
110
100
90
80
70
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
Number of bureaucrats per 10000 citizens
Source: Rosstat, Deutsche Bank Global Markets Research
 Number of bureaucrats was rising at a pace of 4.5% per year throughout 20002009…
 … and stays now at all-time-high levels
Deutsche Bank
38
Doing Business in Russia
Ease of…
Doing business
Starting a business
Dealing with
construction permits
Registering property
Getting credit
Protecting investors
Paying taxes
Trading across borders
Enforcing contracts
Closing a business
Doing business 2011
rank
123
108
Doing business 2010
rank
116
104
182
182
51
89
93
105
162
18
103
45
87
92
103
162
18
93
Change in rank
-7
-4
-6
-2
-1
-2
-10
Source: World Bank, IFC, Deutsche Bank Global Markets Research
 The World bank and IFC made joint project on evaluating easiness of doing business in
Russia
 In 2011 vs 2010 doing business became more difficult with the major deterioration in
registering property and closing a business
 Survey comprises 183 countries
Deutsche Bank
39
Best and worst regions to do business in Russia
 Variations across cities show potential to learn from the existing local best
practices
Indicator
Best practice
Difficult
Moscow (9 procedures)
Voronezh (14 procedures)
Days to start a business
Rostov-on-Don (22 days)
Petrozavodsk (37 days)
Cost to start a business
Kazan (3,000 rubles)
Moscow (6,200 rubles)
Rostov-on-Don (22 procedures)
Moscow (54 procedures)
Days to deal with construction permits
Rostov-on-Don (194 days)
Voronezh (1,207 days)
Cost to deal with construction permits
Petrozavodsk (270.3% GNI)
Moscow (2,612.8% GNI)
Procedures to register property
Kazan, Voronezh, Rostov-onDon (5 procedures)
Petrozavodsk (7 procedures)
Days to register property
Tomsk (47 days)
St. Petersburg (117 days)
Cost to register property
Kazan (16,706 rubles)
Rostov-on-Don (40,360 rubles)
Time to export
Kazan (24 days)
Moscow (36 days)
Time to import
Voronezh (23 days)
Moscow (36 days)
Cost to export
Petrozavodsk
(1,050 USD per container)
Moscow
(2,150 USD per container)
Cost to import
Petrozavodsk
(933USD per container)
Moscow
(2,150 USD per container)
Procedures to start a business
Procedures to deal with construction permits
Source: World Bank, IFC, Deutsche Bank Global Markets Research
Deutsche Bank
40
IV. Russia‘s market: current issues
Deutsche Bank
41
Russian market vs other assets YTD performance
25
18
20
14
15
10
9 10 9 9
5
8
7
5 5 6
4 4
3
3
2
0
-1
-5
-5 -3
-5
-10
-4
-10
-15
-15
Copper 3M
Aluminium 3M
LMEX Index
Nickel
Silver
Gold
WTI oil
Brent oil
USD/EUR
RUB/basket
RUB/USD
Istanbul C.
Sensex
Shanghai C.
Bovespa
MSCI EM
DS STOXX 600
S&P500
DJIA
MSCI Russia
MICEX-10
MICEX
RTS
-20
Source: Bloomberg Finance LP, Deutsche Bank Global Markets Research
 Russian equities outperformed the international equity markets, Brent and Nickel
showed the best performance in 2011
Deutsche Bank
42
Russian market 2011 sectoral performance
20%
 Oil & gas was the best
17%
15%
sector YTD in Russia
13%
10%
10%
 Consumer goods &
10%
9%
were flat after an
impressive 83% gain in
2010
6%
4%
5%
1%
0%
0%
0%
 Electric utilities show
-1%
SMALL CAP
MID CAP
LARGE CAP
ELECTRIC
UTILITIES
CG & RETAIL
METALS &
MINING
FINANCIALS
RTS INDEX
TELECOMS
INDUSTRIALS
OIL & GAS
-5%
marginally negative
returns despite the
upside potential seen in
the names
Source: Bloomberg Finance LP, Deutsche Bank Global Markets Research
Key sector drivers:
 Oil & gas, metals & mining: Strong commodity prices
 Consumer goods & retail: Rising consumer confidence
 Industrials, metals & mining: Economic recovery in manufacturing and construction
 Electric utilities: Power market liberalization
 Telecoms: Strong growth in regional telecoms ahead of Svyazinvest restructuring
Deutsche Bank
43
Russian exporters: relative performance to market
200
180
160
140
120
100
80
60
40
20
0
Jan-07
Jul-07
RTS Index
Jan-08
Jul-08
Jan-09
Jul-09
RTS Oil & Gas Index
Jan-10
Jul-10
Jan-11
Jul-11
RTS Metals & Mining Index
Source: Bloomberg Finance LP, Deutsche Bank Global Markets Research
 Oil & gas has been underperforming the RTS Index for two consecutive years
 At the same time, the second major exporting sector (metals & mining) has been
outperforming the RTS Index during this period
Deutsche Bank
44
Large caps catching up
190%
 MICEX Index Large
Cap / Small Cap ratio is
revealing 1.5+ year
downward trend…
170%
150%
 … which continued
130%
following 3-months of
recovery of large caps
vs small caps in Q2
2010
110%
90%
70%
Jan-08
 The recent stock
Jul-08
Jan-09
Jul-09
Jan-10
Jul-10
MICEX Large Cap / MICEX Small Cap ratio
Jan-11
Jul-11
market rally narrowed
the gap, but did not
close it
Source: Bloomberg Finance LP, Deutsche Bank Global Markets Research
Drivers for a catch-up play in blue chips in 2011:
 30-35pp gap in the large-small cap performance
 Continuing flow of funds into Russia
Deutsche Bank
45
Russia’s 2011 performance vs EM countries
20
9
8
6
5
5
1
0
-5
-10
-21
-15
0
-1
-2
-3
-3
-4
-5
-5
-6
-6
-6
-6
-7
-7
-8
-9
-12
-12
-12
-13
-15
10
14
15
-20
Hungary
RUSSIA
Czech Republic
Morocco
WORLD
Sri Lanka
Poland
Malaysia
Brazil
Mexico
Korea
China
EM
Thailand
Indonesia
Taiwan
Jordan
Colombia
Israel
Pakistan
S. Africa
Argentina
Turkey
Peru
Philippines
Chile
India
Egypt
-25
Source: Bloomberg Finance LP, Deutsche Bank Global Markets Research
 After catching up with the the EM in late 2010, Russia is the top-2 performing market
in 2011.
 We see further scope for Russia’s catch-up vs EM given longer-term past
underperformance
Deutsche Bank
46
Russia’s performance relative to MSCI EM
CURRENT
100%
90%
80%
Jan-10
Apr-10
Jul-10
Oct-10
Jan-11
Apr-11
Jul-11
MSCI Russia / MSCI EM ratio
Source: Bloomberg Finance LP, Deutsche Bank Global Markets Research
 Until the end of April Russia’s market was outperforming EM by 5-7pp on a YTD
horizon
 May-June sell-off pushed Russia back to 4pp YTD underperformance vs EM with a
return to tie in the end of July followed by Russia lagging EM by 7pp
 Due to the year-end rally, Russia managed to catch up with EM by the end of 2010
 In 2011 Russia performs stronger that the EM mainly due to high oil prices
Deutsche Bank
47
RTS Index drivers
100%
-80%
S&P500
-70%
80%
-60%
-50%
60%
-40%
40%
-30%
-20%
Oil prices
20%
Rouble
(inverted, RHS)
Euro rate
-10%
0%
0%
10%
-20%
2006
20%
2007
2008
Correlation of RTS vs Urals oil price
Correlation of RTS vs Euro rate
2009
2010
2011
Correlation of RTS vs S&P500
Correlation of RTS vs Rb/basket
Source: Bloomberg Finance LP, Deutsche Bank Global Markets Research
 The correlation of the RTS Index vs global factors stays around its historical highs:
 76% vs S&P500, proving US market being the key driver for the Russia’s equities
 72% vs oil prices – up from 61% on average in 2010
 63% vs the rouble rate
 Another important factor, the euro rate, is becoming less important (40% correlation)
for the Russian equities
Deutsche Bank
48
Seasonality in RTS Index
10
8
6
5.7
4
3.4
5.7 5.8
2
0
7.9
5.1
8.3
7.3 6.6
2.6
1.6
3.4
1.3
5.2
4.7
2.3
-0.3
0.2
-1.3-1.1
0.8
6.9
1.2 1.3
-2.4
-4.3
-2
-4
-6
Jan
Feb
Mar
Apr
Average monthly return for the RTS Index, %
May
Jun
Jul
Aug
Median monthly return for the RTS Index, %
Sep
Oct
Nov
Dec
2011 monthly return, % (RHS)
Source: Bloomberg Finance LP, Deutsche Bank Global Markets Research
 March-April are among the seasonally strongest months for the Russian equity market
 The RTS Index showed strong returns in January despite its seasonally weak nature on
the basis of strong oil prices and the QE2 effect
 February, a seasonally stronger month, showed weaker returns due to the Chinese
monetary tightening and the global contraction in risk-appetite
Deutsche Bank
49
V. Russia‘s equities and valuation
Deutsche Bank
50
The discount of Russia’s P/E to EM
Russia’s P/ E vs EM P/ E discount , %
10%
10%
0%
0%
+1 ST. DEV.
-10%
-10%
+1
+1ST.
ST.DEV.
DEV.
-20%
-20%
A
A
AVERAGE DISCOUNT:
26%
Average:
Average:33%
33%
-30%
-30%
-40%
-40%
-1 ST. DEV.
-50%
-50%
-1-1ST.
ST.DEV.
DEV.
-60%
-60%
-70%
-70%
-80%
-80%
2003
2003
2004
2004
2004
2005
2005
2005
2006
2006
2006
2007
2007
2007
2008
2008
2008
2009
2009
2009
2010
2010
2010
2011
2011
2011
SCI Russia
12-m
trailing
P/E
SCI
trailing
P/E discount
discount
M SCIMMSCI
Russia
12-m
trailing
M
SCIEM
EM12-m
12-m
trailing
P/E discount
Russia
12-m
trailingP/E
P/E/ /M
MSCI
EM
12-m
P/E
Source:
Bloomberg,
Deutsche
Bank
Source:
Bloomberg
Finance
LP, Deutsche Bank Global Markets Research
 Russia historically trades with a 33% long-term average discount to EM
 In most cases the discount fluctuates within 1S.D. from the LT average
 Currently the discount is below average - this creates room for Russia to further
outperform EM
Deutsche Bank
51
2011-2012E EPS growth, %
Relative valuation of Russia vs other countries
50%
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
South Africa
United Arab
Russia without Emirates
EMEA
Gazprom
Russia
BRIC
Hungary
Korea
6
7
8
9
Poland Argentina Indonesia
Mexico
GEM LATAM India
Brazil
Thailand
Israel
Colombia
ASIA
US
PanamaChina
Malaysia
Taiwan
Turkey EUROPE
JAPAN
Philippines
Czech Republic
10
11
12M forward P/E, x
12
13
14
15
Source: Bloomberg Finance LP, Deutsche Bank Global Markets Research
 On a 12M forward-looking P/E basis Russia is one of the cheapest markets in the EM
space - trades at 6.9x (8.1x without Gazprom), while EM at 10.3 and BRIC at 9.9x
 Russia’s 2011E-2012E eps growth rate (23%; 25% without Gazprom) is larger than the
GEM average (21%)
Deutsche Bank
52
Valuation dichotomy between sectors
35
350
30
300
25
250
20
200
15
150
10
100
5
50
0
Jan-07
Jul-07
Jan-08
Jul-08
Jan-09
Jul-09
Jan-10
Jul-10
Jan-11
Consumer goods & Retail valuation premium over Oil & Gas, % (RHS)
Oil & Gas 12M forward P/E (LHS)
Consumer goods & Retail 12M forward P/E (LHS)
0
Jul-11
Source: Bloomberg Finance LP, Deutsche Bank Global Markets Research
 Recovery was not the same for different sectors
 Retail trades around pre-crisis multiples
 Oil & gas names, especially Gazprom, are trading well below
 The recent strong performance of energy names vs consumer stocks narrowed the valuation
premium of the latter, but there is still scope for outperformance for oil & gas vs retail
Deutsche Bank
53
2011E-2012E EPS growth, %
Relative valuation of Russian sectors vs GEM
50%
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
Materials
Fin Materials
Cons Disc
Utilities
Cons Stap
Indus
Indus Fin Health IT
Cons Disc
Energy TelecomsUtilities
Energy
Telecoms
4
6
GEM
8
Russia
10
Health
Cons Stap
12
14
16
12M forward P/E, x
18
20
22
24
Source: Bloomberg Finance LP, Deutsche Bank Global Markets Research
 While Russian Energy is undervalued, that cannot be said about consumer stocks
Deutsche Bank
54
RTS Index end-2011 Target of 2,300
2,300 RTS Target
2,300
c
2,100
1,900
1,700
1,500
1,300
1,100
Jan-10
Apr-10
Jul-10
Oct-10
Jan-11
Apr-11
Jul-11
Oct-11
Jan-12
RTS Index
Source: Bloomberg Finance LP, Deutsche Bank Global Markets Research
 For the end of this year our new RTS target is 2,300
 The closing rally of 2010 as well as the opening rally of 2011 support our projections
Deutsche Bank
55
MSCI Index rebalancing
M edian perform ance of st ocks follow ing t he M SCI Russia Index rebalancing
30%
20%
10%
0%
-10%
-20%
-30%
Previous Previous 2 days
week
day
after
1 week 2 weeks 3 weeks 4 weeks 6 weeks
Inclusion into MSCI Russia
Exclusion from MSCI Russia
 The MSCI Russia Index currently has 29 constituents
Source: Bloomberg Finance L.P., Deutsche Bank
 Buying the stocks to be included into MSCI Russia (and selling those to be excluded)
before the official announcement might lead to significant returns
 Another trading strategy is to sell (buy) the stocks mistakenly taken by the market as
inclusion (exclusion) targets
 Therefore, it is important to be able to predict the changes MSCI is going to make
 Trading opportunities still exist after the announcement, because index funds will be
rebalanced only after the changes take effect (typically 2-3 weeks later)
 In May, we might see Rusal and Holding MRSK included and OGK-4 excluded from
the MSCI Russia Index
Deutsche Bank
56
Russia’s dividend plays (1/2)
 Dividend yield gap between Russia
and EM is narrowing, but still
substantial (30%)
 Dividend factor will be one of the key
market drivers in the next several
months and may feature safer plays
amidst the increased volatility in global
markets
 Q1 is the best time to invest in
dividend stocks – seasonal patterns
suggest the biggest outperformance vs
the market in Q1
15
14
13
13
United Arab Em irates
Panam a
Korea
Russia
22
19
EM EA
Poland
Chile
Israel
India
23
GEM
22
ASIA
Turkey
25
25
Hungary
M exico
27
26
Indonesia
28
27
Brazil
LATAM
30
30
Peru
Argentina
31
30
China
South Africa
35
31
Lebanon
38
36
Egypt
Colom bia
41
40
M alaysia
Philippines
42
42
Thailand
Saudi Arabia
43
Source: Bloomberg Finance L. P., Deutsche Bank
Czech Republic
Korea
Panam a
India
M exico
Russia
United Arab Em irates
Indonesia
Argentina
GEM
ASIA
Chile
Turkey
EM EA
LATAM
Brazil
Colom bia
Peru
South Africa
China
M alaysia
Hungary
Philippines
Poland
Saudi Arabia
Taiw an
Thailand
0
Israel
0
Egypt
10
Lebanon
1
Czech Republic
55
20
Taiw an
1.4
1.3
1.7
1.6
1.8
2
1.7
2.1
30
1.9
2.3
2.2
2.3
2.3
2.4
2.4
2.7
2.5
2.9
2.8
2.9
2.9
3.1
3
2.9
3.2
40
3.2
3.7
3.7
4
50
4.0
5
4.5
60
4.7
6
53
70
6.3
7
Dividend payout rat io, Russia vs EM , %
66
Dividend yield, Russia vs EM , %
Source: Bloomberg Finance L. P., Deutsche Bank
Average quarterly performance of dividend-paying stocks, %, quarterly, relative to the RTS Index
6%
5%
4.8%
4.2%
4%
3.9%
3.1%
3%
2.5%
2.1%
2%
2.4%
1.5%
1%
0%
1Q
2Q
3Q
4Q
Average high-dividend basket quarterly outperform ance vs RTS Index, %
M edian high-dividend basket quarterly outperform ance vs RTS Index, %
Source: Bloomberg Finance L.P., Deutsche Bank
Deutsche Bank
57
Russia’s dividend plays (2/2)
Russia’s pref/ ords discount
Performance of high-dividend basket vs RTS Index
70%
350%
60%
300%
50%
250%
40%
30%
200%
20%
150%
10%
0%
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
100%
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Pref/ord discount for Russia, %
High-dividend stocks Index / RTS Index relative performance
Source: Bloomberg Finance L. P., Deutsche Bank
Source: Bloomberg Finance L. P., Deutsche Bank
Basket of st ocks based on 6 crit eria
Stock
High
Large
name
dividend
cap
story
attractive
+
+
+
+
+
+
+
+
+
+
+
+
+
+
+
+
+
+
+
+
Sberbank
Rusal
Evraz
Gazprom
LUKOil
MMK
MTS
Norilsk Nickel
Surgutneftegaz
Tatneft
TNK-BP
+
+
+
+
+
+
+
X5
Bashneft
Gazprom Neft
Kazmunai Gas
+
+
+
+
+
+
+
Growth Fundamentally
High
+
+
+
+
+
+
+
+
+
+
+
+
+
+
+
+
+
+
+
Number of
liquidity pref shares "+" shares
+
+
Has
+
+
+
5
4
4
4
4
4
4
4
4
4
4
4
3
3
3
 Other features pointing on good
investment opportunities:
fundamental upside, liquidity,
presence of pref shares, large
cap status and growth
 Basket: Sberbank Rusal, Evraz,
Gazprom, LUKoil, MMK, MTS,
Norilsk Nickel, Surgutneftegaz,
Tatneft, TNK-BP, X5, Bashneft,
Gazpromneft, Kazmunai Gas
Source: Deutsche Bank
Deutsche Bank
58
Key drivers of our year-end target
 Our positive view on Russian equities is reinforced by the following factors:
 (i) Weak relative performance: While performing in line in 2010 and stronger than
EM in 2011 so far, the Russian equity market still underperforms EM on longer
horizons, given heavier losses during the crisis
 (ii) Cheap valuation: Russia trades at a 7.4x 12M forward P/E, which is one of the
cheapest in the EM space. At the same time, Russia offers a 2010-11E EPS CAGR
of 43%, which is the largest in EM;
 (iii) Strong performance of global markets: Our US strategists believe in strong
2011 performance of the US market, which would be driven by both economic and
corporate recovery. Deutsche Bank’s S&P 500 2011 year-end target of 1,550 offers
20% upside potential – fully in line with our 2011 RTS target of 2,300 given the
current beta of 1.2x
 (iv) Further mitigation of risks regarding the situation in Europe, and recovery
of the European currency;
 (v) Russia enters the 2011-2012 electoral cycle, which will support the rouble
and the equity market
 We recommend focusing on blue chip names, which have been substantially
underperforming second-tier names for more than 2 years.
 In terms of sectors, we highlight oil & gas and financials – the weakest performers of
2010 which, in our opinion, have scope for catch-up with the market
Deutsche Bank
59
Drivers at the macro level:
 Fiscal spending to boost consumption
 High oil prices: Deutsche Bank projects USD97/bbl for Brent in 2011 and USD98/bbl
in 2012 with oil recently peaking above USD100/bbl
 Rouble appreciation
 Greater capital inflows/ investor interest, FDI
 Recovery in construction
 WTO accession
 Sovereign issuance and credit rating upgrades
 Monetary policy targeting positive real interest rates
 Lending growth
 Increase in dividend payouts
 Privatization, M&A and IPOs picking up
 Administrative reforms
 The return of the Russian investor base
 Increased use of RDRs by Russian corporates
Deutsche Bank
60
Risks:
 Unstable tax regime (unified social tax, export duties on oil products)
 Domestic political risks
 Greater pressure from domestic opposition generating hardline pressures that
may harm investment climate
 Potential terrorist risks in the Caucasus
 Significant changes in the Kremlin (Putin deciding to step down)
 Political elite becoming too “defensive” with the onset of a new electoral cycle
 Risks for the global economy
 Further mounting of the European sovereign debt crisis
 Negative effects for capital inflows into Russia, given strong investment
and trade links with EU
 High corporate debt burden
 Excessive fiscal spending renders Russia more sensitive to oil price fluctuations
 Corporate governance still a problem: corporate conflicts in Norilsk Nickel, treatment
of minorities in MTS/Comstar deal
 Further increase in inflation
Deutsche Bank
61
Assumptions of our RTS Target
Russia’s risk-free rat e and cost of equit y
30
30
25
25
pp
pp
20
20
15
15
10
10
5
5
0
0
2002
2002
2003
2003
2004
2005
2006
2007
2008
2009
2004
2005
2006
2007
2008
2009
2010
2011
Risk-free rate (US Treasuries), pp
Country Risk Premium, pp
Risk-free rate (US Equity
Treasuries),
pp
Country
Risk
Premium,
pp
Equity Risk Premium, pp
Risk Premium, pp
ROE, %
Source:
Bloomberg,
Deutsche
BankLP,
Source:
Bloomberg
Finance
Deutsche Bank Global Markets Research
 We target the RFR for Russian equities at 5.5%,ERP at 6% and CoE at 11.5%
 A 1pp move in ROE leads to around a 200-300 points change in our RTS target
Deutsche Bank
62
VI. Top picks
Deutsche Bank
63
Top picks by sectors
 Oil & gas: gas – Gazprom; oil – Rosneft, LUKoil
 Metals & Mining: Norilsk Nickel and Polymetal
 Real Estate: PIK, LSR
 Banks: Sberbank
 Telecoms: MTS
 Consumer goods & Retail: Pharmstandard, X5 Retail Group, Dixy
Stock
Re c.
Price
TP
U pside ,
M cap
U S$
U S$
%
U S$ m n
10F
11F
P/E
12F
13F
P/CF
10F 11F 12F
EV/EBITD A
13F
10F 11F
Fre e Float %
12F
13F
P/B
D iv Yld %
10F
10F
Gazprom
Buy
7.17
9.50
32
164,594
5.1
3.9
3.8
3.9
3.6
4.0
3.2
3.3
4.4
3.3
3.2
3.0
38.4
0.8
2.0
Rosneft
Buy
9.46
11.40
21
99,425
6.5
8.1
10.5
10.0
4.5
6.2
6.6
6.2
4.1
4.7
5.5
5.1
8.5
1.7
1.9
LUKOIL
Buy
68.86
95.00
38
53,803
5.7
4.1
4.7
4.7
3.8
3.5
3.4
3.4
3.4
2.4
2.4
2.4
50.0
0.9
3.2
Norilsk Nickel
Buy
,227
,300
32
39,738
7.6
5.7
4.6
5.8
6.9
5.5
4.2
4.4
5.2
3.7
2.6
2.8
35.0
2.5
3.3
Polymetal
Buy
18.95
22.50
19
6,849
27.5
9.9
6.1
7
17.1 7.0
3.8
3.7
25.0
6.0
0.0
MTS ADR
Buy
18.51
24.00
30
18,480
11.4
12.3
10.0
9
4.9
4.5
4.3
46.7
4.6
5.7
PIK
Buy
4.46
7.50
68
2,200
neg
neg
neg
LSR
Buy
9.54
12.80
34
4,911
31.6
15.1
Pharmastandard, GDR
Buy
27.62
32.10
16
4,175
15.3
X5 Retail Group Ltd
Dixy
Buy
Buy
39.18
14.50
51.80
15.90
32
10
10,639
1,247
Buy
3.35
5.30
58
74,609
5.0
6
4.6
4.1
4.0
nm
neg neg
2.4
3.4
15.0 nm
nm
29.2
26.0
3.7
0.0
7.7
5.2
24.6 12.8 8.4
8.0
14.0 9.6
5.6
3.8
26.8
2.7
0.0
12.6
10.4
9
16.6 14.0 11.4
9.9
10.9 8.8
6.8
5.4
46.8
4.7
0.0
35.4
49.6
22.1
17.6
16.0
11.9
8.1
14.4 7.5
9.2 6.2
3.3
15.7 11.5
9.7 7.9
8.2
5.8
4.7
30.3
11.0
5.1
5.8
0.0
0.0
10F
11F
12F
13F
10F 11F 12F
13F
2.4
1.9
1.5
1.2
19.4 27.9 27.8
28.5
P/B
Sberbank
25.3 11.0 6.1
6.0
4.2
4.9
ROE , %
Source: Deutsche Bank Global Markets Research estimates
Deutsche Bank
64
Oil – Rosneft and LUKoil
Emerging m arket s oil majors 12-mont h forw ard P/ E, x
20.0
20.0
16.0
16.0
12.0
12.0
8.0
8.0
4.0
4.0
0.0
0.0
2007
2007
2008
2008
Rosneft
Rosneft
LUKoil
LUKoil
2009 2009
TNK-BP
TNK-BPHolding
Holding
2010
Surgutneftegaz
Surgutneftegaz
2010
Petrobras
Petrobras
2011
2011
Sasol
Sasol
Source: Bloomberg Finance LP, Deutsche Bank estimates
 Rosneft offers a good combination of attractive valuation and production growth
 Rosneft underperformed LUKoil by 15pp in 2010, outperformed by 7pp in 2011
 LUKoil, in turn, stayed flat in 2011 while the RTS Index added 23% (added 25% while RTS
gained 11% in 2011)
 LUKoil is trading at extremely cheap valuations –4x 2011 P/E
 DB is above consensus for 2011E earnings given our high oil price projection of USD101/bbl
Deutsche Bank
65
Taxation – current issues and newsflow
Export duties and mineral extraction taxes account for 65-70% of costs
The average marginal tax rate for Russian VICs is ~75%:
~90% in the crude exports segment
~55% in the refined product exports segment
~45% in the sales of domestic refined products segment
Tax concessions:
■ Differentiation of the mineral extraction tax: tax discounts of up to 70% for fields with more
than 80% depletion (in effect from 1 January 2007)
■ Tax holidays of 10-15 years or until cumulative production reaches 25m tonnes for new fields
in Eastern Siberia (in effect from 1 January 2009)
■ Export duty holidays for oil exports from East Siberia fields; we incorporate holidays for 1H10
only, reduced export duty from 2H10E
Single export duty for heavy and light products at 60% level in 2013:
■ LUKoil is one of the main potential beneficiaries
■ Smaller effect on Rosneft as it is behind in refinery upgrades
Introduction of Excess Profit Tax (EPT)/supplementary tax:
■
■
■
First proposal by end of 1Q11
Likely to be applied to new projects
Likely to come into effect in 2012-13
Deutsche Bank
66
Taxation – recent proposals
upstream vs. downstream
■ The government may shift the tax burden from the upstream to downstream, making upstream
projects more attractive. Today, taxes in the downstream are smaller than those in the upstream.
■ The maximum rate of crude oil export duty may fall from 65% to 60%. This would positively
impact net-backs in crude oil exports and domestic crude oil sales.
■ Simultaneously, export duties on refined products may increase to 66% of crude oil export duties
from the currently approved 60% level.
■ We assume Russian oil companies would find more upstream projects value-accretive and make
a bigger number of positive FIDs as a result of the tax changes.
■ The bigger upstream tax base is to compensate for the potential losses in the Russian budget
that may be incurred as a result of the reduction in the crude oil export duty rate.
For the new fields, the Russian government's consultants have proposed a supplementary tax
rather than a windfall tax. The proposed rate is 27%.
■ In the UK, a supplementary tax represents a 10% hike in the basic corporation tax. Thus, where
UK CT is 30%, the tax increased to 40% in the 1990s and to 50% in 2006.
■ Offsetting this are more generous capital allowances, and there are exemptions and incentives to
drill and develop.
■ Along the same lines, in Russia, a 27% hike in the basic CT of 20% would equal 47%. At
USD70/bbl it is now 65%, at USD80/bbl 68% and at USD90/bbl 70%.
■ We are unable to assess the impact on the Russian oil sector as the scale of capital allowances,
exemptions and incentives is unclear.
Deutsche Bank
67
Natural Gas - Gazprom
Gazprom 12-mont h forw ard P/ E, x
15.0
15.0
Beginning
of the
Beginning of
the spot
spot
gas
gas price
price collapse
collapse
12.5
12.5
10.0
10.0
7.5
7.5
Europeans start
start to
Europeans
ask for
for concessions
concessions
Average
Average P/E
P/E== 7.5x
7.5x
5.0
5.0
2.5
2.5
0.0
0.0
2006
2007
2008
2008
2009
2009
2010
2010
2011
2011
Source: Bloomberg Finance LP, Deutsche Bank estimates
 Gazprom trades at 4.1x 12M forward P/E – one of the cheapest stocks in the
Russian equity space and much lower than its LT average P/E of 7.5x
 Gazprom underperformed the market notably – by 19pp in 2010
Deutsche Bank
68
Near-term gas sector issues
■ Production: slow production recovery this year as European demand continues to stagnate, the
market is oversupplied.
■ European supplies: European customers have largely accepted Gazprom’s take-or-pay terms
but they have been modified as a result of recent price and volume concessions.
■ Gas market liberalisation: the government plans full-scale liberalisation on the basis of
European export net-back parity in 2014.
■ Taxes: Finance Ministry proposed an increase in the mineral extraction tax (MET) for gas
companies which is in effect from 1 January 2011.
Gas deal with China:
■ A gas deal with China is more likely today than at any time in the recent past:
■ Chinese government forecasts that gas demand will increase at 12% p.a. in the next decade
■ China cannot ignore the vast energy resources just next door
■ Geographical diversification should allow Gazprom to reduce its exposure to Europe
■ Gazprom expects a final deal with China to close in the middle of 2011
■ We forecast first deliveries of Russian gas to China in 2017-18E
■ We estimate that a successful project would involve the development of Kovykta field
■ Future gas exports to China could add USD0.65-0.80/share to our current Gazprom valuation
Deutsche Bank
69
Summary: domestic gas market liberalisation
Pre-liberalisation environment
■ European gas prices peaked at nearly USD500/mcm in 4Q08, and should decline to our midcycle price (real) of USD330-340/mcm
■ We apply a 15% discount to the European contracted gas price level to reflect expanding spot
market sales and a spot price discount to the oil-linked price
■ European customers will continue to subsidise Gazprom’s domestic customers and
investment programme in the next several years
■ Gazprom’s focus on the exports market will enable independent gas producers to rapidly build
Russian domestic market share
Post-liberalisation environment
■
■
■
■
Equal net-backs for domestic (excluding households) and export deliveries
No difference to gas producers where they sell their gas
Domestic customers provide a fairer chunk of cash flow to Gazprom
Independent gas producers start to benefit from market share build-up
Deutsche Bank
70
Base Metals – Norilsk Nickel
 Deutsche Bank is bullish on metal
prices – both base and PGM
350
700
 Historically, Norilsk closely follows 300
600
it’s commodity basket (R2 at 80%)
 Main drivers – Copper and
Palladium
 Attractive valuation – Norilsk is trading
at a discount to peers
 An increasing share of PGM
250
500
200
400
150
300
100
200
50
100
0
revenues would boost Norilsk’s fair
value – PGM companies generally
trade on higher valuations than
diversified miners
0
2003
2004
2005
2006
2007
2008
2009
2010
2011
Norilsk Nickel, USD - LHS
Com m odity index (50% nickel, 25% copper, 12.5% platinum , 12.5% palladium ) - RHS
Source: Bloomberg Finance LP, Deutsche Bank Global Markets Research
P/E
EV/EBITDA
Diversifieds
2010
2011
2012
2010
2011
2012
Norilsk Nickel
Average Diversified Large Caps
7.8
11.8
6.0
7.6
4.8
6.1
5.2
7.0
3.7
4.7
2.6
3.5
Average Copper
Average Platinum
17.1
30.5
8.9
17.6
7.1
11.1
8.3
14.1
4.4
9.2
3.4
6.2
2010-2012 2010-2012 EBITDA
EPS growth
growth
52.9%
8.5%
102.9%
38.9%
54.2%
72.3%
47.1%
54.6%
Source: Deutsche Bank Global Markets Research estimates
Deutsche Bank
71
3/12/2016
2010 DB Blue template
Precious Metals – Polymetal
 Deutsche Bank is bullish on gold and
silver as well as copper
 We project the prices to peak in
2012
 Attractive valuation – Polymetal is
trading at a discount to peers on
2012E earnings
1,600
1,400
1,200
1,000
800
600
400
200
-
 At the same time, the growth
2009 2010F 2011F 2012F 2013F 2014F 2015F 2016F
profile looks strong
Polym etal gold equivalent production, koz
Source: Deutsche Bank Global Markets Research
P/ E
EV/ EBITDA
Gold & Silver companies
2010
2011
2012
2010
2011
2012
2010-2012
EPS grow th
2010-2012
EBITDA grow th
POLYMETAL
Average Russia
Average EM
Average DM
25.0
25.3
23.2
17.9
9.0
12.0
8.8
12.8
5.5
7.8
6.6
8.6
15.6
15.0
14.6
10.8
6.3
7.8
6.8
6.4
3.4
4.8
5.4
4.3
114%
83%
52%
48%
91%
67%
48%
60%
Source: Deutsche Bank Global Markets Research estimates
Deutsche Bank
72
3/12/2016
2010 DB Blue template
Real Estate – PIK and LSR
Continue to be positive on the sector
 Signs of pick up in physical real estate market
 Stocks trade ex-’solvency risk’, declining risk premiums priced-in; however,
 Valuation upside remains on further re-valuation of land banks; P/NAV discounts still
meaningful. Prefer residential, quality retail as least oversupplied segments and
construction materials as exposure to recovery in construction
PIK
LSR
 A play on demand recovery for mass market residential

A play on demand recovery for mass market residential
property and construction materials that we expect to
lead the recovery; exposure to state contracts
(USD700m+)

Construction materials: poor performance in 1Q10,
stabilization in 2Q10-3Q10, expect recovery in 4Q10

2010-2012 3-yr CAGR of 27% in sales and 60% in
EBITDA on increased capacity utilization

Land bank - mostly residential developments represents future upside; regional diversification with a
flurry of new contracts in Moscow and region

SPO in April adds financial stability and provides
acquisition currency
property; best leverage to recovery in consumer demand for
cheap housing
 Restructuring is nearly complete
 Additional financing from Sberbank now available
(RUR12.75bn)
 New projects have commenced: over 3.0m sqm of projects
are open for pre-sales
 Triggers: restructuring of Nomos Bank debt and deleveraging through SPO, leading to lower financial costs,
discount rates and higher asset valuation
Deutsche Bank
73
Banks - Sberbank
 Credit growth has returned with a strong dynamics in recent months…
 Credit costs in 2011/12 will depend on growth, write-offs and write-back potential
 Sberbank has the strongest coverage and cash flows and hence the potential for lowest credit costs
VTB trades at the same 1.5x norm 2012E P/B despite:
 Structurally lower ROE due to wholesale funding and focus on low-margin loans
 Lower quality earnings due to high dependence on IB and trading gains
 Inferior asset quality
Why does VTB trade on the same P/B and what is going to change it?
 Only DR that offers exposure to Russian banks - DR listing of SBER planned for 1H11
 Higher beta due to IB and upside in non-core assets - IB acquisition by Sberbank (1H11)
 Acquisition and re-leveraging potential Disappointing earnings momentum in the upturn
Deutsche Bank
page 74
74
Sberbank’s beta vs the RTS Index now bigger than
Gazprom’s and Rosneft’s
1.3
1.2
1.1
1
0.9
0.8
Jan-08
Jul-08
Jan-09
SBERBANK
Jul-09
GAZPROM
Jan-10
Jul-10
Jan-11
ROSNEFT
* - 2-year window, weekly data
Source: Bloomberg Finance LP, Deutsche Bank Global Markets Research
■ While previously oil & gas names, such as Gazprom and Rosneft were high-beta
liquid plays on Russia…
■ … now Sberbank seems to take their place in this role
Deutsche Bank
page 75
75
Sberbank also caught up with Gazprom in terms of
trading volumes (mn dollars, annual)
350000
300000
250000
200000
150000
100000
50000
0
2007
SBERBANK
2008
GAZPROM
2009
2010
ROSNEFT
Source: Bloomberg Finance LP, Deutsche Bank Global Markets Research
■ In 2007-2008, Gazprom was an unchallenged leader in terms of trading volumes
(we look at combined volumes at Russian exchanges + international listings)
■ … now Sberbank has almost caught up with Gazprom, and heavily outperforms
Rosneft
Deutsche Bank
page 76
76
Recent trends in Russian mobiles
 The big picture
50
 Mobile revenues closely track household
40
30
consumption
20
10
 Healthy non-voice growth driven by
3Q
10
2Q
10
1Q
10
4Q
09
3Q
09
2Q
09
1Q
09
4Q
08
3Q
08
Total traffic grow th y-o-y
Nom inal GDP growth y-o-y
avg M OU grow th y-o-y
Grow th of nom inal household consum ption y-o-y
Total m obile revenue grow th
 Voice recovering on macro
 Headlines on roaming only confirm that
2Q
08
1Q
08
modem and smartphone sales, rollout of
3G networks, content
0
-10
Source: Deutsche Bank, Rosstat, Company data
regulation remains softer than elsewhere
 Expected appreciation of the Rouble
 Revenue CAGR of about 12% - notably
higher than EM peers’
 7-19% valuation discount to peers (on
2011-12F EV/EBITDA and PER) despite
better fundamentals
50%
40%
30%
20%
10%
0%
-10%
3Q
08
E
4Q
08
E
1Q
09
E
2Q
09
E
3Q
09
E
4Q
09
E
1Q
10
E
2Q
10
E
3Q
10
E
 MTS drivers:
Voice
Non-voice
Source: Deutsche Bank, Company data
Deutsche Bank
77
3/12/2016 12:29:46 PM
2010 DB Blue template
Pharmaceuticals – Pharmstandard - a leading
domestic pharmaceutical company
PHST is the second largest player with a 4% market share and an undisputed leader in the
domestic market with 18.4% of the market positioned to benefit from domestic growth
We expect the company to increase its market share through acquisitions of smaller players
We expect pharma market to grow by 6-10% in the next three years
Improvement in the macro environment: rising GDP, rising incomes and rising social spending
Increase in government spending on the Russian Health System
Introduction of the medication insurance program
Increase in average per capita consumption for medications
page 78
Deutsche Bank
page 78
78
CG& Retail - X5 to gain from recovery
DCF-derived TP is USD51.8 per GDR – 10% upside potential for the stock. Buy
We expect X5 to open:
■ 300 new stores in 2010
■ 335 discounters in 2011-12 - the most popular format
■ 25 supermarkets and 10 hypermarkets pa in 2011-12
We estimate:
■ Selling space to increase by 18% yoy in 2011 and by 19% in 2012
■ LFL sales growth is 10% for 2011 and 12% for 2012
Capex increase following aggressive rollout:
■ Capex in 2011- USD913m, 2012-USD1.206m
■ Net Debt/EBITDA level – 1.5x in 2011, 1.4x in 2012 (without M&A)
Successful M&A experience - Acquisition of Kopeyka - Value accretive
Deutsche Bank
page 79
79
CG & Retail - Dixy proves the importance of logistics
in this business
DCF-derived TP is USD 15.9 per share – 26% upside potential to the
current price of 12.4
Dixy trying to catch up pace with market leaders-we expect DIXY to
open:
140 new stores in 2011, 174 pa in 2011-12
We estimate:
■ The selling space to increase by 21% yoy in 2011-12
■ Sales to increase by 30% in 2011 and by 32% in 2012
■ Capex to increase to USD110m in 2011 and USD184m in 2012
■ NET Debt/EBITDA is below 2x- acceptable level
Dixy’s goal is to decrease shrinkage level to 1.7-1.8% of sales in 2010
– positive for EBITDA margin in 4Q10
Deutsche Bank
page 80
80
Statements of risk for following the recommendations (1/4)
Dixy (DIXY.RTS, TP USD 15.90, price 12.80, rating: Buy) Issues: Dixy is a smaller and, in our view, more risky company than X5 and Magnit. However, we believe 1Q10 showed that the
company is turning around its operating performance thanks to the improvements to its logistics operations executed in 2009. Our DCF derived target price implies substantial upside
potential to Dixy's current share price therefore we recommend Buy. Evaluation: In our DCF valuation we use the following assumptions: We use terminal growth of 3% as we believe
Dixy will not outpace its market growth. To derive the cost of equity, we use a risk-free rate of 6% and an equity premium of 6%
for all the companies under coverage. We use beta of 1.1 for Dixy due to to its lower liquidity. We use a debt/equity ratio of 30% for a company such as Dixy which is quite leveraged.
Risks:The main industry risks include, but are not limited to, declining consumer confidence, increasing unemployment and potential entry into the market of international players. Among
the company-specific risks, we highlight the management execution risk.
Gazprom (GAZP.RTS, TP USD 8.40, price 6.58, rating: Buy) Issues: We rate Gazprom, the world's largest gas company, Buy, reflecting the considerable upside potential implied by our
target price. Gazprom's major operating challenge to date has been how to replace declining production. The company has announced plans to make a substantial increase in its capital
expenditures, the majority of which would be spent on developing remote production areas on the Yamal peninsula. Furthermore, the discussion about increasing gas sector taxes seems
to have lost momentum, and we do not think there will be any negative newsflow hanging over the market. In addition, Gazprom looks set to benefit fully from the upcoming liberalisation
of the gas market. Evaluation: Our 12-month target price is derived on the basis of DCF valuation. We use APT-based discounted cash flow valuation because we believe it provides a
superior tool for estimating company-specific risks compared with the CAPM model. It also enables us to account for a much wider range of fundamental factors than comparable
multiples valuation, which often fails to account for differences in capex plans, capital structure and growth rates. The key assumptions of our DCF model are an RWACC of 14.3%
(RROE of 15.5%, including a standard equity risk premium of 7.5% [3.0% is idiosyncratic, which accounts for a high risk of volatility in cashflow due to changes in prices and tax rates in
the Russian gas sector], a liquidity risk premium of 0.0%, and a corporate governance risk premium of 2.0%) and a long-term nominal growth rate of 2% - a function of the expected
increases in the prices of gas, crude oil and refined products, inflation and the availability of proved, probable, and possible reserves in the company's portfolio beyond our forecast
horizon (2010-2020E). Risks: The key downside risks for Gazprom are: lower-than-expected energy prices, a deeper-than-expected negative impact of the economic downturn on natural
gas demand, the cancellation of the proposed full-scale liberalisation of the domestic gas market and the government's decision to raise taxes more than is currently reflected in our
discount rate for Gazprom. An additional downside risk is that the major infrastructure or development projects are not being implemented as planned or delayed indefinitely owing to
political, environmental, technological or other reasons.
LUKOIL (LKOH.RTS, TP USD 82.00, price 64.50, rating: Buy) Issues: LUKoil is Russia's second-largest oil company in terms of reserves and production. We believe that owing to its
recent heavy investment in greenfield operations, the company will be able to maintain growth rates above the Russian average. On the financial front, a healthy balance between
upstream and downstream segments makes LUKoil one of the most profitable oil companies in Russia. LUKoil also enjoys the most comprehensive international exposure of all Russian
oil companies, which brings its status closer to that of international peers. LUKoil stands out as one of the most likely of the oil companies to benefit from the expansion of the unregulated
Russian gas sector. We rate LUKoil Buy; the company enjoys strong fundamentals and we believe that its shares are currently undervalued.
Evaluation: Our 12-month target price is derived on the basis of DCF valuation. We use APT-based discounted cash flow valuation as we believe it provides a superior tool for estimating
company-specific risks compared with the CAPM model. It also enables us to account for a much wider range of fundamental factors than comparable multiples valuation, which often
fails to account for differences in capex plans, capital structure and growth rates. The key assumptions of our DCF model are an RWACC of 13.2% (RROE of 13.5%, including a standard
equity risk premium of 6.0% [2.5% is idiosyncratic, which accounts for a high risk of volatility in the Russian oil companies' cashflow due to changes in commodity prices and RUR/USD
exchange rate], a liquidity risk premium of 0%, and a corporate governance risk premium of 1.5%) and a long-term nominal growth rate of 2% - a function of expected increases in the
prices of crude and refined products, inflation, and the availability of proved, probable, and possible reserves in the companies' portfolios beyond our forecast horizon (2010-2020E).
Risks: We highlight the downside risks associated with commodity prices, cost inflation, and, more important, the execution of long-term investment projects. We continue to believe that
LUKoil's management is one of the most professional in the sector but it will now have to devise strategies to overcome the recent negative operating trends.
X5 Retail Group Ltd (PJPq.L, TP USD 51.80, price 47.00, rating: Buy) Issues: We expect the Russian food retail market to continue to grow by double digits, as rising disposable
income and 6-7% inflation pa should spur a 16% CAGR in household consumption over 2010-13E. X5 is the largest retailer in Russia with a 4.5% market share. It is a multi-format retailer
and generates 80% of its revenues in two of Russia's most powerful - from an economic point of view - cities, Moscow and St.Petersburg. Therefore, we remain positive on X5 as these
two cities will recover first, in our view. We recommend to Buy the stock because our DCF derived target price implies substantial upside potential from current price. Evaluation: Using
DCF methodology, we derived a target price using the following assumptions: We use terminal growth of 3.5% for the market's fastest grower such as X5, as we believe it will continue to
surpass market growth. To derive the cost of equity, we use a risk-free rate of 6% and an equity premium of 6%. Our beta for X5 is 0.9 since food retail is a low beta, defensive sector and
we do not make any liquidity adjustments for it. We use a debt/equity ratio of 30% for X5 as it has significant Debt burden. Risks:The main risks include, but are not limited to, declining
consumer confidence, increasing unemployment and potential entrance in the market of international players such as WalMart. Among the company-specific risks we name competition.
Unlike Magnit, X5 competes mainly with other national players. Since X5 operates mainly in St.Petersburg and Moscow, it competes mostly with other national chains. In our view, it is
tougher to compete with the national chains than with local ones because federal players have greater power over suppliers than national ones.
.
Deutsche Bank
81
Statements of risk for following the recommendations (2/4)
LSR (LSRGq.L, TP USD 12.80, price 9.75, rating: Buy) Issues: LSR has been a favorite real estate stock for the market that has so far focused on financial stability and, ultimately,
survival among real estate names. In the current environment, we believe LSR offers good exposure to state expenditure on both infrastructure and social housing through its tenders
with the Ministry of Defense and the St. Petersburg administration, while medium term, LSR should be a beneficiary not only of demand revival for residential real estate but also
construction materials, which we expect to lead a recovery in the construction sector beginning in 2011. With more capital coming from the company's SPO, LSR will be well positioned to
capitalize on recovery in demand for residential housing. Geographical diversification of sales away from the company's base in St. Petersburg (LSR is already present in Yekaterinburg
and has recently signed a number of deals in Moscow and Moscow region), vertical integration with pre-fab manufacturing facilities and building materials as well as prudent financial
management will be key to success. We continue to see upside in the company's share price as land bank gets developed and the currently implied by the share price discount to market
value of the land bank narrows. Thus we rate the shares a Buy. Evaluation: Our valuation of LSR Group is based on SOTP approach. We value LSR's yielding properties, residential and
office properties already constructed and currently under development, DSKs and building materials businesses using DCF with a WACC of 12.3% (13.3% CoE, 11.5% cost of debt and
25% debt-to-equity target ratio; we use a 3% terminal growth rate for building materials, reflecting long-term GDP trends) while we base our valuation for land bank on the last available
DTZ valuation, assigning a 20-40% discount to projects yet to be developed. We adjust the resulting valuation of LSR's assets by net debt, minorities and NPV of corporate overhead
costs to arrive at YE10e NAV of USD12.8, which is also our 12-month target price for GDRs. We set our 12-month TP for local shares at a historical 20% discount to GDRs at
RUB1,459/share and prefer more liquid GDRs. Risks: The company largely faces industry-related risks, including exposure to GDP recovery, consumption growth and demand for real
estate, price fluctuations, FX (rouble-related) as well as credit availability from the banks. In addition to these, completion of projects, including commissioning of over 40 development
projects and of a cement plant in Slantsy, that meaningfully varies from our expectations could negatively affect our valuation of the company
MTS ADR (MBT.N, TP USD 28.00, price 20.65, rating: Buy) Issues: MTS has made significant changes to its business model, evolving into an integrated player. Having acquired
Comstar, it gained access to the leading fixed broadband player in Moscow and plans to use it as a platform for a rollout of a fixed broadband business in the regions. MTS is developing
its own fully-fledged retail distribution chain and we believe it is making good progress in terms of improving its handset selection and its online content platform. We estimate MTS'
revenues to grow by 13.5-14.6% yoy revenue in 2010-11F (in USD terms) on recovery of voice usage due to improving macroeconomic situation and continued robust growth of nonvoice revenues driven by increasing internet and smartphone penetration. However, we expect MTS' EBITDA margin to decline to 44% in 2010F from 49% in 2008 due to MTS' active
development of its own retail business. We believe that MTS' growth profile and valuation multiples look attractive compared to many peers. We continue to expect significant total
shareholder return over the next 12 months: Buy. Evaluation: Our target price is based on DCF methodology, in line with the approach across our European telecoms coverage. We
model MTS in USD, as this is the company's reporting currency. We use an RFR of 6%, CoE of 13.5%, CoD of 7% and a WACC of 11%. We use the projected balance sheet capital
structure and a terminal growth rate of 1% to reflect the industry's mature market growth profile after the terminal period. Risks: In addition to a deteriorating macroeconomic situation and
regulatory risks, as well as intensifying competition, which are typical risk factors for the industry, we see the following company-specific risks: poor execution of the retail strategy;
corporate governance risks related to Sistema (asset sales); integration issues with Comstar; M&A risks.
Pharmstandard (PHSTq.L, TP USD 32.10, price 29.10, rating: Buy) Issues: Pharmstandard is a leading domestic pharmaceutical manufacturer with a portfolio of best-selling brands and
an efficient sales force. In addition, as Russia's largest domestic pharmaceutical producer, the company enjoys preferential treatment from a friendly government aiming to increase
domestic producers' share in overall market sales. The key market drivers for the medium to long term are: increased government spending on the health system; further development of
the program for additional provision of medication (DLO); introduction of a medication insurance program; and increased per capita consumption of medications amid a consumer
recovery and slowing inflation. Overall, we see 2010-13 revenue CAGR of 20%. Our target price implies attractive upside potential for both GDRs and local-listed shares. Hence we rate
these as Buys. Evaluation: We use DCF methodology to derive our target price, as the comparison universe has limitations in the EMEA pharmaceutical sector as the group is narrow
and diverse. In addition, the Indian sub-segment commands a notably different valuation from the EMEA group. We use a terminal growth rate of 4.0% as it is one of the market leaders.
To derive the cost of equity, we use a risk-free rate of 7.5% and an equity premium of 6%. Our beta for Pharmstandard is 1 because pharmaceutical is a low-beta defensive sector but its
liquidity is lower than that of other major consumer companies. We use a debt-to-equity ratio of 5% as the company is almost debt-free. Together with an after-tax cost of debt of 10% and
COE of 13.5%, we arrive at WACC of 13.a2%. Risks: The key downside risks include rouble depreciation (effectively all revenues are in roubles with a large portion of costs (up to 80%)
denominated in hard currency), a slower-than-expected recovery in Russian consumption and adverse government intervention in the sector.
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Statements of risk for following the recommendations (3/4)
PIK (PKGPq.L, TP USD 7.50, price 4.38, rating: Buy) Issues: We continue to see upside in PIK shares as the company offers the best leverage to recovery in consumer demand for
cheap housing, first evidence of which we saw in 4Q09. We expect the trend to continue, and expect it to translate into an increase in cash collections by PIK. Recovery in demand
should also allow the company to commence new projects this year after receiving additional financing from Sberbank that will provide cash flow over 2010-2012 period. We continue to
see PIK largely as a play on volumes (as opposed to prices), but geography of its on-going and planned projects (Moscow and Moscow region) may offer additional upside if prices react
positively to anticipated supply/demand imbalance as inventory of completed housing is depleted and new construction takes time to hit the market with additional supply. Given the
above and the substantial upside based upon our price target we rate the shares a Buy. Evaluation: We value PIK via SOTP approach based on DCF analysis of the actual cash flows
from core construction and development business, and net book value of the remaining assets and liabilities not captured elsewhere in the above mentioned analysis. We discount cash
flows and terminal value at 13.8%. Our WACC reflects RROE of 14.0% (based on 6.5% sovereign RFR, 7.0% standard equity risk premium and 1.0% premium for corporate governance
risk) and 16.5% cost of debt and target debt/capital ratio of 25%. We do not include the valuation of land bank in this approach as we assume it will be used to build and sell property in
the interim forecasting period and beyond. We arrive at NAV estimate of USD7.5/share at YE10, which is also our 12-month TP. Risks: One of the major risks for PIK remains
restructuring of Nomos Bank debt. Since the company does not have an ability to pay this debt in full at the moment, failure to reach an agreement with the bank will put PIK's faith in
jeopardy once again. We are inclined to believe that Nafta-Moskva-friendly Nomos Bank will be willing to restructure company's debt, removing such a risk. Other risks are largely
industry-specific: slower-than-forecasted recovery in GDP, consumption growth and demand for real estate, a more-than-anticipated decline in prices as well as lack of credit markets
recovery (both corporate and consumer).
Rosneft (ROSN.RTS, TP USD 9.80, price 8.10, rating: Buy) Issues: We rate Rosneft a Buy. The company combines substantial reserves with rapid production growth, implying fast
monetisation of assets. Rosneft has been demonstrating some of the lowest unit costs in the industry and a highly efficient capital expenditure. The company acquired Yukos' assets and
has integrated them successfully. We forecast Rosneft to increase production by nearly 5% in 2010 y-o-y, which is well above the industry average. Sizeable benefits stemming from
export duty holidays in East Siberia should enable Rosneft to grow its EBITDA considerably in 2010. Evaluation: Our 12-month target price is derived on the basis of DCF valuation. We
use APT-based discounted cash flow valuation as we believe it provides a superior tool for estimating company-specific risks compared with the CAPM model. It also enables us to
account for a much wider range of fundamental factors than comparable multiples valuation, which often fails to account for differences in capex plans, capital structure and growth rates.
The key assumptions of our DCF model are an RWACC of 12.6% (RROE of 13.5%, including a standard equity risk premium of 6.0% [2.5% is idiosyncratic, which accounts for a high risk
of volatility in the Russian oil companies' cash flows due to changes in commodity prices and RUR/USD exchange rate], a liquidity risk premium of 0%, and a corporate governance risk
premium of 1.5%) and a long-term nominal growth rate of 4% - a function of expected increases in the prices of crude and refined products, inflation, and the availability of proved,
probable, and possible reserves in the company's portfolio beyond our forecast horizon (2010-20E). Risks: Downside risks for Rosneft include lower-than-expected oil prices, failure to
negotiate access to Gazprom's pipelines, dry-hole drilling at prospective resource areas and Yukos-related litigation. We also note the execution risk the company faces: Rosneft's
management might be unable to deliver on its targets or successfully implement its planned investment projects.
Sberbank (SBER.RTS, TP USD 5.30, price 3.66, rating: Buy) Issues: We rate Sberbank a Buy. Accelerating economic growth, spurred by strong commodity prices, SME growth and
mass-adoption of standard retail banking products like mortgages and CCs should propel 20% annual sector growth. Sberbank's dominant market shares (20-50%), unrivalled distribution
power through its network of 20,000 branches and an underutilized captive client base are unique assets to capitalize on this market opportunity. Additional impetus to earnings growth
should come from efficiency gains. Evaluation: We value CEEMEA banks using a two-stage Gordon Growth Model that bases the target price on discounted terminal value, and adds
back the value of discounted interim dividends. For Sberbank we assume a mid-cycle ROE of 23%, cost of equity of 13.0%, and terminal growth of 5%. The cost of equity is derived from
a 6.5% RFR, a 6.5% ERP and a beta of 1.0. Our USD5.3 PT implies a 2012E normalized P/BV of 2.0x and a 2012E normalized PE of 11.8x. Risks: The main downside risks for
Sberbank are declining commodity prices, which would result in a slowdown in economic growth and cause renewed asset quality deterioration. Another risk is continued margin pressure
which may arise from, amongst others, a slowdown in credit demand, even fiercer competition from bond market conditions, a significant increase in demand for FX loans and / or
monetary tightening. A weakening of the ruble would cause investors to favor Russian exporters and could adversely affect the share price performance of Sberbank. The main company
specific risks include, but are not limited to, execution on the business transformation, poor cost control and potential integration issues of an acquisition in IB.
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Statements of risk for following the recommendations (4/4)
Norilsk Nickel (GMKN.RTS, TP USD 300.00, price 248.00, rating: Buy) Issues: Norilsk Nickel is the global cost leader in the nickel industry and looks likely to retain its leadership
because of its unique ore body where nickel and copper are combined with platinum group metals. As the largest and lowest-cost producer of nickel in the world, Norilsk should benefit
from what we expect to be strong nickel prices in 2011 and 2012. We also see potential for a longer-term shift of the industry supply curve, as low-cost and low-risk sources of nickel are
gradually replaced by more expensive. Norilsk is also the largest palladium producer in the world. We expect palladium to perform as a result of what we see as an ongoing substitution of
platinum by palladium and growing autocat demand, waning Russian stockpiles and supply constraints. Norilsk's PGM production offers, in our view, a diversfication into more defensive
metals and could attract a premium to Norilsk's valuation. Norilsk has, in our view, a strong balance sheet and strong cash flows. At the same time, Norilsk offers no near-term and only
remote long-term growth. It also carries company specific risks related to a shareholder conflict, government involvement, social commitments and environmental challenges. On balance
though, we believe the market does not fully appreciate the potential of Norilsk's resources: Buy. Evaluation: We value Norilsk using a DCF with a terminal growth period. Our DCF
model is based on a WACC of 11.2% (with a cost of equity of 12.6%, a pre-tax cost of debt 7% and a 25% long-term D/E) and a terminal growth rate of 3%. Our terminal growth rate
captures the longer-term cash flow opportunities of Norilsk's unique ore body and also the growth potential of expansion plans beyond our explicit forecasting period, like the project
underway in the Chita region. Our DCF yields a 12-month target price of USD300/share, which on our current earnings forecasts implies target multiples of 4.9x 2011E EBITDA and 7.5x
2011E net income. On a flat price scenario, the implied target multiples grow to 5.9x and 9.3x, which is in line with the peer group's long-term historical average. Risks: Commodity prices
represent the largest downside risk for our valuation of Norilsk Nickel. Rouble appreciation also represents a materal risk for Norilsk Nickel given its rouble cost base and dollar revenues.
Due to a longstanding shareholder conflict and lack of transparency, Norilsk has significant corporate governance risks. We also note that Norilsk, as a mono-employer, has special social
commitments and is subject to government interference and involvement. Like many mining companies, Norilsk faces risks related to export duties, although these have recently been
reduced by the announcement of new levels. There are also cash flow and sentiment risks related to the company's environmental program.
Polymetal (PMTLq.L, TP USD 22.50, price 17.50, rating: Buy) Issues: With 2009 output of 17.3 moz of silver and 311koz of gold, Polymetal is the largest silver and one of the top five
gold producers in Russia. The company is a leading growth story in the Russian metals and mining universe. We expect Polymetal to grow its gold equivalent (on metal price forecast)
production by 25% CAGR from 770koz in 2010 to 1,480koz 2012, doubling production before output plateaus on the current project pipeline. Polymetal is run by a management team with
a strong execution skills and a proven track record in both organic project execution and M&A. With the company's strategic focus shifting more and more toward the gold part of its
business, we estimate that gold will contribute 70% to Polymetal's consolidated revenue in 2015, up from 54% in 2009. We are bullish on the outlook for gold and silver, expecting gold
prices to reach USD2,000/oz in 2012 and for the gold:silver ratio to come down to 40 in 2012 with higher-beta silver outperforming as industrial demand conincides with growing financial
investment. Evaluation: "We value Polymetal based on a sum-of-the-parts DCF models of individual mining projects. We apply a dollar nominal WACC of 8.8% based on a targeted
capital structure of 75% equity and 25% debt. We estimate cost of equity at 9.6% using levered beta of 0.6x (the historical average for the stock), an equity risk premium of 6% and a riskfree rate of 6%. We assume a nominal interest rate of 8% and a tax rate of 21%. We apply a 1.8x exit multiple, in line with the benchmark P/NPV multiple for DB's South African gold
universe. Our $22.5 target price implies 8.3x 2011E EBITDA and 11.7x 2011E net earnings multiples, which is in line with the company's historical averages of 8.6x and 13.6x and
compares favourably to peers. While we believe that Polymetal's growth profile may warrant a premium, we note that the company will need to extend its reserve base to support
production longer-term and that its silver exposure makes Polymetal more cyclical than pure play gold stocks." Risk: Major risks to our forecasts and valuation are silver and gold prices,
as well as Russian macroeconomic factors such as rouble appreciation and inflation. Management risks are concentrated around the company's ability to deliver on the development of
the Amursk processing hub as well as its ability to integrate other newly acquired fields. Other risks include any changes in fiscal regime and/or mining legislations. We also highlight the
risk of the potential share overhang, should Polymetal decide to place part or all of its treasury stake. The latter would however also improve liquidity, which we would welcome, and
reduce the company's financial leverage, which we however view as manageable on current forecasts.
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Appendix 1
Important Disclosures
Additional Information Available upon Request
For disclosures pertaining to recommendations or estimates made on securities other than the primary
subject of this research, please see the most recently published company report or visit our global
disclosure look-up page on our website at http://gm.db.com.
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Special Disclosures
Analyst Certification
The views expressed in this report accurately reflect the personal views of the undersigned lead analyst(s) about the
subject. In addition, the undersigned lead analyst(s) has not and will not receive any compensation for providing a
specific recommendation or view in this report.
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Equity Rating Key
Equity Rating Dispersion and Banking
Relationships
Buy: Based on a current 12-month view of total shareholder return
(TSR = percentage change in share price from current price to
projected target price plus projected dividend yield), we recommend
that investors buy the stock.
Sell: Based on a current 12-month view of total shareholder return,
we recommend that investors sell the stock.
Hold: We take a neutral view on the stock 12 months out and, based
on this time horizon, do not recommend either a Buy or Sell.
Notes:
1. Newly issued research recommendations and target prices always
supersede previously published research.
2. Ratings definitions prior to 27 January, 2007 were:
Buy: Expected total return (including dividends) of 10% or more
over a 12-month period
Hold: Expected total return (including dividends) between -10%
and 10% over a 12-month period
Sell: Expected total return (including dividends) of -10% or
worse over a 12-month period
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Regulatory Disclosures
1. Important Additional Conflict Disclosures
Aside from within this report, important conflict disclosures can also be found at https://gm.db.com/equities under the “Disclosures Lookup” and “Legal” tabs.
Investors are strongly encouraged to review this information before investing.
2. Short-Term Trade Ideas
Deutsche Bank equity research analysts sometimes have shorter-term trade ideas (known as SOLAR ideas) that are consistent or inconsistent with Deutsche
Bank’s existing longer term ratings. These trade ideas can be found at the SOLAR link at http://gm.db.com.
3. Country-Specific Disclosures
Australia: This research, and any access to it, is intended only for “wholesale clients” within the meaning of the Australian Corporations Act.
EU countries: Disclosures relating to our obligations under MiFiD can be found at http://globalmarkets.db.com/riskdisclosures.
Japan: Disclosures under the Financial Instruments and Exchange Law: Company name – Deutsche Securities Inc. Registration number – Registered as a
financial instruments dealer by the Head of the Kanto Local Finance Bureau (Kinsho) No. 117. Member of associations: JSDA, The Financial Futures Association
of Japan. Commissions and risks involved in stock transactions – for stock transactions, we charge stock commissions and consumption tax by multiplying the
transaction amount by the commission rate agreed with each customer. Stock transactions can lead to losses as a result of share price fluctuations and other
factors. Transactions in foreign stocks can lead to additional losses stemming from foreign exchange fluctuations.
New Zealand: This research is not intended for, and should not be given to, “members of the public” within the meaning of the New Zealand Securities Market
Act 1988.
Russia: This information, interpretation and opinions submitted herein are not in the context of, and do not constitute, any appraisal or evaluation activity
requiring a license in the Russian Federation.
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Global Disclaimer
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