Research Notes

Stoylensky GOK: Undervalued Subsidiary of NLMK

Red hot prices for iron ore products allowed Stoylensky GOK to dramatically improve its 2007 financial indicators. As of January 1, 2008 we expect the company's sales to reach some $879 mln and net profit to total $488 mln or far stronger than the company's 2006 showings. An expected 30% spike in raw iron next year will help to improve the financial performance of NLMK's subsidiary.

Stoylensky GOK is a main mining concern in NLMK Group's mining segment. In the first six months of 2007 the company produced about 5.8 mln tons of iron ore concentrate and 800,000 tons of sintered ore, which is roughly in line with the company's operating figures in the year-earlier period.

Nearly all products manufactured by Stoylensky GOK are supplied to NLMK, thereby meeting the latter's iron ore needs. Longer term, we expect to see spikes both in iron ore product output volumes and selling prices, which will push up Stoylensky GOK's financial indicators. Another factor improving the company's financial performance is the fact that NLMK currently does not practice transfer pricing when purchasing raw material from its subsidiaries, reflecting all purchases at market prices.

In view of higher steel production in Russia in the next few years we anticipate raw iron demand to spike tangibly, which will push up raw iron prices (prices are expected to surge more than 30% in 2008 alone). This upsurge will produce a positive impact on the financial performance of mining concerns, including Stoylensky GOK. We believe this spike will enable the company to achieve record margins in coming years. As for 2007, we project the company's net margin at 55.5% or 8.1% higher than in 2006.

NLMK's investment program calls for injecting cash into Stoylensky GOK's fixed assets, with the lion's share of investments to go towards expanding and increasing the capacity of the miner's pits and mining transportation infrastructure and the construction of a 3-mln-ton palletizing facility to manufacture pellets.

A major drawback is the company's fairly low free float (only some 3%) which substantially heightens the risks associated with the violation of minority rights and the forced buyout of their holdings.

At present, the company trades on P/E, EV/S and EV/EBITDA multiples equal to 3.5, 1.5 and 2.3, respectively. These ratios are much softer than those of its foreign peers (P/E=11.7; EV/EBITDA=8.1; EV/S=3 and P/E=14.4; EV/EBITDA=9.7; EV/S=4.7), which means that Stoylensky GOK's stocks hold robust upside potential.

According to our estimates based on sector average financial ratios, the fair value of Stoylensky GOK shares should be around $943, which implies 67.8% upside to the current average market price.

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Denis Gorev

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Sector: Metals, Ore Enrichment Plants
Company: Stoylensky GOK

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