COMMENT: Picking through the Ukrainian remains

By bne IntelliNews February 23, 2009

Lucas Romriell of Galt & Taggart -

Being a Ukrainian/Georgian broker in the current climate is a bit like being the uninvited guest at the party: no one wants to ruin the party by throwing you out, but no one wants to talk to you either.

Ukraine has been downgraded by Standard & Poor's to join Jamaica and Mongolia in the 'B'-rated category, leaving it only slightly ahead of Rwanda, Bolivia and Lebanon. The downgrade was a bitter pill to swallow for most local brokers after the rapid progress made over the last two years. The only silver lining is that it has opened up a world of opportunities in the Eurobond market, where returns have risen to levels normally only posted by undervalued equities. Meanwhile, the falling value of the hryvna is finally allowing the country to realize its natural advantages of cheap commodities and low labour costs.

From the outside, Ukraine may look like a country that is about to collapse: the International Monetary Fund is hemming and hawing over the next $1.9bn tranche of a $16.4bn bailout loan signed in November; the president and prime minister are locked in a battle to the death; the country's finances are uncertain; and the prospect of greater Russian influence looms on the horizon.

But surviving the crisis in Ukraine and other frontier CIS markets requires taking bold bets on a few of the region's leading companies and cash cows. It offers value investors a chance to finally pick up stakes in large, cash-generating companies at discount prices, while fixed-income investors can lock in yield-to-maturities of 40-70% per annum on a few key Eurobond issues.

Eurobonds - certain money

Eurobonds are the easiest and safest way to profit on the region's economic tumult. They offer high returns on companies, while allowing investors to isolate themselves against local currency risk, as the outlook for the hryvna will remain uncertain for the first half of the year.

Azovstal, Bank of Georgia 2012s, Ukraine Sovereign 2009 floaters and Mironovsky Khleboproduct 2011s offer returns in the low 40s to high 70s and don't require buyers to take on longer risk than three years. In the case of Ukraine's sovereign debt, investors can lock in a yield-to-maturity of Libor plus 77% by June. Many fail to realize that the $500m payment is the only debt issue scheduled for payment this year. No other payments are due until 2011, when the economic situation will be considerably improved.

Steeled for recovery

Ukraine's flagship industry, steel, has been battered by the recent crisis and the fourth-quarter numbers will no doubt show the effects of what has been a weak steel price climate. Equity prices may react negatively in the short term, but the country's leading steal companies have become value plays. Prices are beginning to pick up as demand from Asia is on the rise and even suggest that the lows in the market may be at an end. During the lull, Ukraine's currency depreciated more than 50%, restoring the country's export advantage.

Iron ore producer Ferrexpo has rallied more than 60% since the beginning of year, but local stocks have yet to catch up with this trend. Certain steel stocks such as Azovstal, Enakievka and even Alchevsk offer investors value opportunities with 2009 EV/Ebitda multiples of 1.1 and lower.

Meanwhile, the decline in the currency's value makes Ukrainian exporters more competitive on international markets, as well as cuts back on their payroll and input costs. Most factories will avoid the risk of higher gas prices by shifting to coal.

Grist for the mill

Agriculture is likely a trickier sector to invest in than most investment bankers will have you believe. Few of us have ever been farmers and even fewer want to admit how many years it takes to build a successful agricultural business. That said, Mironovsky Khliboproduct, the largest chicken producer in Ukraine, will benefit from the decline in incomes as poorer households turn to consuming cheaper meals at home, and chicken meat has never been expensive. With a London listing to boost liquidity, demand for the stock is high and sellers are scarce, but those who can get their hands on shares should take the chance. Other agricultural producers, particularly land plays, offer much less certainty in the near term and investors should be cautious of them before the spring planting season ends.

Among the rubble

It is still too early to plough into real estate and financial services stocks. Value is undoubtedly lying among the rubble, but many companies have to prove that they can survive a market where sales are non-existent except at cutthroat prices and debt is impossible to come by. Others need to prove that they won't go bankrupt. In the financial sector, investors would do well to wait and see which banks will survive the squeeze. There is no reason to put your hard-earned money at risk buying overleveraged banks that made their fortunes lending money to buy washing machines and cellular phones.

Don't look back in anger

The last four years put Ukraine on the map for better or for worse. Local companies have tasted capital markets and won't lose their appetite for investor capital as markets improve. In spite of the bubble, many companies finally discovered the virtues of raising money abroad and will be back when conditions improve. In the meantime, those willing to put their money to work betting on the country's tigers will be sure to win.

Lucas Romriell is managing director of sales and trading at Galt and Taggart Securities in Kyiv, Ukraine. He has been trading CIS stocks for the past four years and has lived in the former Soviet Union for nearly 10 years. Galt and Taggart is a 100%-owned subsidiary of the Bank of Georgia.

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COMMENT: Picking through the Ukrainian remains

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