On September 4, Severstal released its consolidated 1H 2008 financials. The record results are attributable to favorable price trends on the market and consolidation of overseas assets. The net profit soared by 68%, with growth partially attributed to the acquisition of Sparrows Point at a price lower than the value of the company's net assets. The sale of Kuzbassurgol to Arcelor for USD 225 million is another one-off factor that has enabled the company to boost its profits. The company's profit margins on core operations largely stayed the same as 2007, with price rises on coal and iron ore offset by the company's own coal and iron ore assets.
Table. Severstal: financial indices for 1H 2008, USD mn
| Indicator | 1H2008 | 1H2007 | 1H2008/1H2007 |
|---|
| Revenue | 10 547.1 | 7 738.6 | +36.29% |
| Gross profit | 3 154.0 | 2 552.1 | +23.58% |
| Gross margin | 29.9% | 32.98% | -3.08% |
| EBITDA | 2 756.6 | 2 053.2 | +34.26% |
| EBITDA margin | 26.14% | 26.53% | -0.4% |
| Operating profit | 2 254.5 | 1 678.3 | +34.33% |
| Operating margin | 21.38% | 21.69% | -0.31% |
| Net profit | 1 991.7 | 1 188.7 | +67.56% |
| Net margin | 18.88% | 15.36% | 3.52% |
| Adjusted net profit | 1 517.7 | 1 188.7 | +27.68% |
| Adjusted net margin | 14.39% | 15.36% | -0.97% |
Source: Severstal, Finam estimates
Severstal's strategy for active business development through M&As has been rewarded by a rapid growth of financial indicators; however, the resource needs of the US division presents the company with a dilemma; whether to invest funds into American assets or to start developing new markets. Given Alexei Mordashov's position, voiced during a phone conference, Severstal intends to move in two directions simultaneously, both towards raising its resource base and towards the acquisition of assets on emerging markets.
The implementation of its plans depends on the company's ability to generate free cash flow. This in turn should be backed by favorable market environment and a moderate upturn in cost of primary resources. However, in the last few months, an opposite trend has taken shape: with rising prices for metallurgical resources, steel prices have undergone a considerable correction from their high July levels and fallen by 30-40% on average.
In spite of unfavorable short-term trends in the industry, we view Severstal shares as fundamentally undervalued and recommend that investors Buy them with a target price of USD 25.5 per share.
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