Research Notes

Given the execution of an ambitious investment program, improvements in the company's information transparency and the introduction of low tariffs we upgraded our year-end 2008 target price for the shares of Novorossiysk Sea Commercial Port (NSCP) to $0.151, but we assign a Sell recommendation to the port's securities, whose downside potential equals 47%.

The following factors prompted us to revise our fair price for the company's shares.

• Until 2010 NSCP is looking to spend around $700 mln on rolling out and upgrading port infrastructure, which will allow the company to run close to its reloading capacity and raise cargo turnover at a compound annual growth rate (CAGR) of over 3% by 2015. In the period of the most intensive business expansion (2007-2010) CAGR, according to our forecasts, will approach 6%.

• NSCP's focus on business development primarily in the port of Novorossiysk seems to be largely justified to us in light of surplus regional demand and weak competition. On the other hand, more aggressive regional diversification could allow the company to considerably lower the risks of cargo flows being rerouted to Russia's North western ports.

• The key upside driver for NSCP's fair value was a sharp rise in tariffs (by an average 30%) in order to fund the port's capex in 2007-2008, which should lead to substantial improvements in the company's margins.

However, the company's future operations, as we believe, are closely related to a number of specific risks.

• Tariffs after 2008 remain uncertain and we do not rule out their possible reduction after scheduled investments are made, although we view such a scenario as unlikely.

• According to our estimates, within the next two years the company's cash flow will be stably negative, while the entire cash flow forming the company's value falls to 2009, a tariff policy for which has not yet been established, posing additional risks to the company.

• An important risk factor is the fact that the larger section of port facilities is state-owned and leased by NSCP at extremely favorable rates which could be revised in the future.

• Also, there is a likelihood that additional restrictions could be imposed on cargo transit through the Bosporus Strait, which could take a toll on potential cargo flows.

In early November NSCP staged an initial public offering on Russian and foreign exchanges, results of which may be read as increasingly successful for the company's major shareholder (Kadina Limited) that managed to get slightly less than $1 bln for 20% of the port's equity capital, while the port itself (valued at $4.9 bln) has turned into one of the most expensive stevedoring operators worldwide in terms of financial ratios.

The shortage of Russian port assets on the market coupled with the port's promising development strategy and a period of low tariffs translated into heightened demand for NSCP stocks. According to our estimates, the port's current stock valuations are primarily determined by strong demand rather than fundamentals.

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Vladimir Sergievskiy

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