Ukraine Markets Daily (July 14, 2015)

Market news

  • Cabinet of Ministers to propose a 50% cut to natural gas royalties to the Parliament 
  • AEG downgrades its 2015 wood chip volumes target to 400,000 tonnes due to delays in equipment installation and commissioning 
  • Ukrzaliznytsya secured a restructuring agreement on 82% of its domestic borrowings

Market comment

The UX Index was up by 0.9% in UAH terms on Monday, and down by 0.2% in the US dollar. The PFTS index was down by 0.2% in UAH terms. Eight out of ten companies in the UX index were up in UAH terms, with the largest increase recorded for Kryukiv carriage (4.7%), Avdiivka coke (3.6%) and Ukrnafta (3.1%).

On the interbank exchange market, the USD/UAH was up by 1.1% to 22.20 (mid price) on Monday, according to Bloomberg. The official exchange rate reported by the NBU was UAH 21.96.

Ukraine 5-year CDS were down by 2.8% on Monday.

 

Cabinet of Ministers to propose a 50% cut to natural gas royalties to the Parliament

According to the statement of Ukraine’s Minister of Finance Natalie Jaresko during the US-Ukraine Business Forum in Washington, the Cabinet of Ministers will propose the Parliament to decrease the natural gas royalties by 50% starting from October 1, 2015. The rate is to be decreased from 55% to 29% for gas wells with depth of up to 5 km, and from 29% to 14% for gas wells deeper than 5 km. Furthermore, for investments in new wells, the Ministry proposes as of January 1, 2016 a 20/10 royalty rate, maintaining the existing corporate income tax rate, but adding an additional corporate surcharge tax at a 30% rate. Ministry of Finance believes that these measures can increase private production of natural gas to 8.5 bcm annually by 2025 from current levels of 3.5 bcm per year.  By 2035, the Ministry aims to bring private production to 11 bcm annually.

“By properly unleashing the potential of our domestic resources we can improve national security and create more competition which in turn will create more jobs in the energy sector and put less pressure on our balance of payments” said Jaresko. “What we are putting on the table is a carefully thought through proposal:  we have made considerable effort to hear what business needs, expects and requires to make these investments.  We have balanced these business expectations with our own fiscal needs. And we have looked carefully at what has worked in other markets”.

Our view:

The news is POSITIVE for oil&gas producers in Ukraine, namely JKX Oil&Gas [JKX LN], Serinus [SEN PW], Cub Energy [KUB CN], Hawkley Oil&Gas [HOG AU], Regal Petroleum [RPT LN]. We expect that the Ukrainian parliament will vote for the proposed bill, as it will spur new investment into the oil&gas sector and increase domestic production. Furthermore, we estimate that the new taxation scheme will decrease the effective tax burden (royalties and income taxes compared to sales) from 60% to 49% for old gas wells with depth of up to 5 km, while also increasing the net present value of new wells by about 10-15% (factoring in that according to the current legislation new gas wells receive a royalty rate of 30.25% for the first two years of production).

 

AEG downgrades its 2015 wood chip volumes target to 400,000 tonnes due to delays in equipment installation and commissioning

Yesterday Active Energy Group [AEG LN], an international supplier of wood chip and forestry and natural resources development company, published a trading update for its wood chip division. AEG commented that it has invested in a significant expansion of its hardwood wood chip facilities at Yuzhny Port, with the purchase of new handling equipment and a high-volume stationary wood chipper capable of quadrupling its existing production capacity. However, the company expects that the new equipment will only be fully operational in late-August 2015, which will result in a reduction in the forecast hardwood wood chip volumes for 2015, although the Board still expects overall volumes for the year to be more than double the 2014 figure (154 ths tonnes).

AEG also noted that the new softwood wood chip line will come online later than expected (in October 2015) due to delays in ordering the necessary equipment and a longer than anticipated lead-time for installation and commissioning. This is expected to result in a reduction of 100,000 tonnes in forecast softwood wood chip volumes for 2015, which are now expected to be 50,000 tonnes.

As a result of the foregoing, AEG anticipates reduced wood chip volumes from its Ukraine facility, and is forecasting total production for FY2015 of approximately 400,000 tonnes.  However, revenues for the segment are still expected to be more than double the 2014 figure (USD 17 mn). AEG noted that the company’s operating margins are expected to improve during the remainder of the year, which will partially offset the impact of the reduction in total production volumes.

Our view:

The news is moderately NEGATIVE for the company. Compared to the previous announcement, the target for 2015 was slashed by 50,000 tonnes, although AEG’s comment on better margins in 2H2015 might improve the overall outlook for 2015. However, most of the company’s value is still derived from its joint venture with the Canadian Metis settlements (to commercialize 250,000 hectares of mature forestry assets), in which AEG has a 45% stake. Thus, we reiterate our BUY recommendation with a target price of GBp 16.08, or an upside of 160% to the current market price of GBp 6.18.

 

Ukrzaliznytsya secured a restructuring agreement on 82% of its domestic borrowings

The Ukrainian Railway Company Ukrzaliznytsia reached an agreement with private creditors on a restructuring of 82% of its domestic debt, according to a press statement of the company. The agreement covers up to UAH 17 bn of domestic debt out of the UAH 20 bn targeted by the company, according to the information release. A restructuring of domestic debt, being a first step in the overall debt reprofiling endeavor of the company, will allow easing the debt burden on the company. This will in its turn create the preconditions for timely servicing of outstanding debt, repayment on state guaranteed loans, and secure a steady functioning of the railway transport sector, while ensuring safe railway traffic, according to the company.

According to the operating results of the company, freight transport volume in 2014 amounted to 390 million tonnes, declining by 12.2% y/y, mostly due to the cessation of the Crimean peninsula from the country and the ongoing military operations in the eastern part of the country. Freight turnover fell by 5.8% y/y in 2014 and amounted to 211 billion tonne-kilometers, whereas passenger turnover declined by 24.1% y/y and amounted to 37 billion passenger-kilometers.

Ukrzaliznytsa had about USD 1.4 bn of interest-bearing debt, up to USD 250 mn of domestic bonds, and a USD 500 mn Eurobond by end of 1H2014 according to the latest available financial statement of the company, dated June 30, 2014.

Our view: 

The news is POSITIVE with consideration to the current adverse financial and economic conditions. In our opinion, a preliminary agreement on domestic debt will allow the company to contemplate a more investor-friendly debt reprofiling offer to its foreign private investors. On another hand, however, the saving on debt operation will earn the company nothing without expedient introduction of needed reforms in the railway sector of Ukraine.

 

Disclaimer

Although the information in this report has been obtained from sources which Empire State Capital Partners believes to be reliable and was collected in good faith, we do not represent or warrant its accuracy, except with respect to information concerning Empire State Capital Partners, its subsidiaries and affiliates, either expressly or implied, and such information may be incomplete or condensed. Nor has the information and/or data been independently verified, and so is provided without further caveat regarding its reliability, suitability for commerce or specific purpose. 

This report does not constitute a prospectus and is not intended to provide the sole basis for an evaluation of the securities discussed herein. All estimates and opinions included in this report constitute our judgment as of the date of the report and may be subject to change without notice. Empire State Capital Partners or its affiliates may, from time to time, have a position or make a market in the securities mentioned in this report, or in derivative instruments based thereon, may solicit, perform or have performed investment banking, or other services (including acting as advisor, manager) for any company referred to in this report and may, to the extent permitted by law, have used the information herein contained, or the research or analysis upon which it is based, before its publication. Empire State Capital Partners will not be responsible for the consequences of reliance upon any opinion or statement contained herein or for any omission. This report is confidential and is being submitted to select recipients only. It may not be reproduced (in whole or in part) without the prior written permission of Empire State Capital Partners.

Any recommendations, opinions, forecasts, estimates or views herein constitute a judgment as at the date of this report. This document has been produced independently of Empire State Capital Partners and the recommendations, forecasts, opinions, estimates, expectations, and views contained herein are entirely those of the research analyst(s). While all reasonable care has been taken to ensure that the facts presented herein are accurate and that the respective recommendations, forecasts, opinions, estimates, expectations, and views are fair and well considered, none of the research analyst(s), Empire State Capital Partners or any of its directors, managers or employees has verified the contents of this document and, accordingly, no research analyst, Empire State Capital Partners or any of its respective directors, managers or employees shall be in any way responsible for its contents.