Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15

15 April 2010
MARKETING MATERIAL

METALS AND MINING

RUSSIAN COPPER AND ZINC PRODUCERS
Treasures of the Urals

Urals Base Metal Producers – Looking for Hidden Value: With this report we initiate
coverage of three Russian base‐metal producers that usually slip under the radar of
Coverage MktCap $1,042mn mainstream emerging markets investors: Gaisky GOK, Uchalinsky GOK and
Uralelectromed – three subsidiaries of the Urals Mining and Metallurgical Company
Fair MktCap $1,796mn (UMMC). The companies provide exposure to growing infrastructure investment in
Russia and to the economic recovery that we expect, both domestically and globally.
Potential upside 72%
Russian copper – sharp rise in exports limits production downside: Despite Russia’s
apparent copper consumption falling by over 50% YoY in 2009, Russian copper output
Company FV ($/share) Upside potential dipped only 4%, primarily due to a doubling of exports. Russian copper, while high‐
purity, is not currently London Metals Exchange (LME) certified which means that the
Gaisky GOK 671 124%
Uchalinsky GOK 20.60 42%
companies can sell the metal in export markets at a discount, undercutting their
Uralelectromed 118 96% competitors without attracting the wrath of the regulators. We expect Russian copper
exports to remain strong, supported further by restocking in the EU and US as well as
continued strong demand from China.
12M Stock, Metals and Index performance

RTS‐2 Russian zinc – proving resistant to external factors: The Russian zinc industry has
GGOK shown strong resistance to external economic influences. Production was down just
UELM
1% YoY in 2009, at 262kt; net exports were 27% lower YoY, which led to a 6% YoY
increase in apparent consumption to 222kt. While we admit that the full increase
RTS
cannot be attributed to real demand, we believe that Russian zinc consumption is
FTSE 350 Mining relatively stable vs certain other metals, driven by a strong recovery in the steel
LME 3M Copper industry – the main consumer of zinc in Russia. Moreover, we expect Russian zinc
consumption to see further expansion as a result of its exposure to the growing
LME 3M Zinc
construction sector.
Silver
Gold We see global economic trends as supportive for commodities, although price
UGOK volatility is set to continue: The environment for commodities is likely to remain
volatile as competing market forces continue to influence investor sentiment.
0% 100% 200% 300% Nevertheless, while we do not expect commodities to repeat their stellar 2009

Source: Bloomberg performance this year, there should be enough downside protection. We anticipate a
number of market triggers that we believe should be commodity‐price supportive.
YtD Stock, Metals and Index performance While dollar strengthening continues to cause short‐term volatility, key markets for
UELM commodities – the EU and US – are starting to show some signs of a sustained
RTS‐2
economic recovery, though demand for commodities in those regions could be limited
to restocking at this time. Moreover, liquidity tightening in China is yet to have any
GGOK
noticeable effect, while strengthening Chinese exports should sustain strong demand
RTS for a wide range of commodities.
FTSE 350 Mining
Silver
Initiating with a BUY based on upside potential and exposure to the recovery: The
companies under our coverage may be less visible contrasted with Norilsk Nickel or
LME 3M Copper
Rusal, but nevertheless, they play a substantial role in the sector: UELM is one of the
Gold largest copper refineries in the world; GGOK is Russia’s second‐largest copper
UGOK producer, while UGOK is the largest supplier of zinc to the Russian market. We believe
the companies offer substantial potential upside (ranging from around 40% to over
LME 3M Zinc
100%), which would justify taking on the higher risks associated with investing in these
‐20% 0% 20% 40% 60% lesser known, less transparent and less liquid stocks.

Source: Bloomberg
Note: Prices as of 13:00 on 12 Apr 2010 throughout the report (unless otherwise stated)
Dinnur Galikhanov: +7 495 777 6677 (ext. 2677) For professional investors only. This document has not been prepared in accordance with legal

Dinnur.Galikhanov@aton.ru requirements designed to promote the independence of investment research. Please refer to important
disclosures and analyst certification at the end of this document

Contents
Investment Case...................................................................................................3
Company Fact Cards.............................................................................................7
Setting Metal Prices In Line With Consensus.......................................................8
Highlighting the Risks...........................................................................................9
Russian Copper: Counting On Economic Recovery and Export Strength ..........11
Copper Industry Overview ....................................................................................... 11
Russian Copper Producers – Exports Save the Day.................................................. 12
Russian Zinc: Resisting the Elements .................................................................17
Zinc Industry Overview............................................................................................. 17
Global Factors: Supportive For Commodities But Conducive To Volatility........22
A Stronger US Dollar – Still a Factor or Just a Distractor? ........................................ 22
Liquidity tightening in China is yet to have any noticeable impact.......................... 23
Real Demand or Just Stockpiling and Speculation?.................................................. 23
Companies Section
GGOK: Copper Whopper……………………………………………………………………………………….28

UGOK: Strength in Zinc; Growing Exposure to Copper ………………………………………….37

UELM: Breaking Away From Old Misconceptions …………………………………………………47

Appendix I – UMMC Copper Production Flows .................................................57
Appendix II – Russian 2020 Strategy for the Metals Industry............................58
Appendix III – UELM Product Flow.....................................................................60

2

Investment Case
With this report we initiate coverage of three copper and zinc‐producing subsidiaries
of the Urals Mining and Metallurgical Company – UMMC – two mining companies,
Gaisky GOK (GGOK) and Uchalinsky GOK (UGOK), and the copper refinery
Uralelectromed (UELM). We assign BUY ratings to all three as we believe that the
companies offer substantial upside potential and could be exposed to the resumption
of infrastructure investment in Russia and a gradual recovery in key global markets.
Moreover, we believe that the recent commodity price rally has not been fully
reflected in the stocks’ share prices.

Figure 1 : Fair value and rating summary
Fair value per Current share Upside
Company Ticker Rating
share ($) price ($) potential
Gaisky GOK GGOK RU 671 300 124% BUY

Uchalinsky GOK UGOK RU 20.60 14.50 42% BUY
Uralelectromed UELM RU 118 60 96% BUY
Source: Bloomberg, Aton estimates

Valuations still lag global peers
We base our company valuations on a weighted average of our DCF calculation, 6x our
forecast 2010 P/E and 4x our forecast 2010 EV/EBITDA, in a 50:25:25 ratio.

To arrive at our valuation multiples we assessed trailing P/E and EV/EBITDA multiples
for peers from both developed (DM) and emerging markets (EM). The history of the
majority of Russian listed stocks does not go back far enough to analyse their
behaviour during the previous economic crises, but we believe that an analysis of their
pricing trends prior to and following the recent crisis gives an indication of the
potential for price appreciation. Therefore, we based our peer group analysis on two
distinct periods: pre‐crisis (2006‐07) and trough‐to‐recovery period (2008‐09).

Looking at the pre‐crisis valuation multiples for the peer group, we can see that DM
companies were trading at P/E multiples of around 10‐15x, at times rising to 20x. On
an EV/EBITDA basis, the same companies were trading at approximately 5‐6x, with
some copper producers touching EV/EBITDA ratios as high as 8x. In emerging markets,
metal producers have historically traded at P/Es of 8‐10x and EV/EBITDA multiples of
2‐5x, although some Chinese companies (e.g. Xinjiang Xinxin, Tongling Nonferrous)
have traded as high as 14‐15x (P/E) and 5‐10x (EV/EBITDA) at pre‐crisis peaks.

During the pre‐crisis period Russian copper producers traded at P/Es of between 4x
and 8x, and EV/EBITDAs of 2‐4x. In rough terms these levels put them at a 50%
discount to their DM peers and a 40% discount to their EM peers on a P/E basis. In
terms of the EV/EBITDA multiple, Russian companies traded at a 50% discount to their
DM, and a 25% discount to their EM comparables.

As illustrated in Figure 2, global peers are currently trading at 2010 P/Es of around 13‐
14x in developed markets and 18‐19x in emerging markets (based on Bloomberg
estimates).

3

Figure 2: Global comparisons
2010E 2011E
P/E P/S EV/S EV/EBITDA P/E P/S EV/S EV/EBITDA
(x) (x) (x) (x) (x) (x) (x) (x)
Russian peers (mean) 2.8 0.6 1.0 2.4 2.5 0.6 0.9 2.2
Russian peers (median) 2.8 0.5 1.1 2.4 2.4 0.4 1.0 2.2
Developed markets (mean) 13.6 2.3 2.5 7.7 13.3 1.9 2.1 6.3
Developed markets (median) 13.4 2.1 2.5 7.1 10.6 1.9 2.2 5.8
Emerging markets (mean) 18.7 2.7 2.7 11.0 14.6 2.3 2.4 8.6
Emerging markets (median) 19.0 2.4 2.3 10.8 12.7 2.1 1.9 7.8
Average DM Discount ‐80% ‐74% ‐59% ‐67% ‐79% ‐73% ‐58% ‐64%
Average EM Discount ‐85% ‐78% ‐59% ‐78% ‐82% ‐77% ‐56% ‐73%
Source: Bloomberg

On an EV/EBITDA basis (consensus 2010 estimates), DM peers are trading at multiples
of 7‐8x, while the ratios for their EM peers stand at 10‐11x. Assuming that both DM
and EM ratios revert to their historical norms, we believe that the three stocks under
our coverage could be valued at around 4‐8x 2010 P/E and 3‐5x 2010 EV/EBITDA. We
therefore use midpoint multiples of 6x forecast 2010 P/E and 4x forecast 2010
EV/EBITDA as the basis for our valuation.

While a multiples‐based method allows us to compare the stocks’ share price
performance in relation to their global peers, a valuation based on DCF gives a better
reflection of the companies’ medium‐term growth potential. Therefore, we assign a
greater weighting to our DCF forecast when calculating the companies’ fair values. Our
DCF models incorporate a terminal growth rate of 1% and WACC assumptions ranging
from 11.5% to 12.6% depending on each stock’s assumed debt cost and gearing levels.

In Figure 3 below we provide a summary of the valuation ranges for our covered
stocks:

Figure 3 : Valuation ranges for the stocks
Current share Fair value 2010E P/E 2010E EV/EBITDA
DCF
price ($/share) ($/share) 4x 6x 8x 3x 4x 5x
Gaisky GOK 300 671 563 560 840 1120 452 717 982
Uchalinsky GOK 14.50 20.60 16.32 17.09 25.63 34.18 17.69 24.13 30.56
Uralelectromed 60 118 100 87 131 174 93 139 186
Source: Aton estimates

4

In Figures 4‐7 below we summarise key valuation ratios, performance information, and
production and financial data for the three stocks under our coverage.

Figure 4 : Key valuation ratios
Gaisky GOK Uchalinsky GOK Uralelectromed
Key valuation metrics
Common shares in issue (mn) 0.6 38.1 5.1
MktCap ($mn) 185 552 304
Net debt ($mn) 212 61 238
EV ($mn) 397 614 542
BV ($mn) 233 514 370
P/E ratios (x)
2008 22.0 9.0 7.4
2009E 5.3 5.3 12.3
2010E 2.1 3.4 2.8
2011E 1.9 3.2 2.4
EV/S ratios (x)
2008 1.2 1.2 0.8
2009E 1.4 1.5 0.9
2010E 1.1 1.1 0.7
2011E 1.0 1.0 0.6
EV/EBITDA ratios (x)
2008 5.3 4.8 4.5
2009E 4.4 3.8 6.4
2010E 2.4 2.5 2.3
2011E 2.2 2.4 2.0
P/B ratio 2009E (x) 0.8 1.1 0.8

Figure 5 : Recent stock performance
1M 9% 7% 10%
3M 16% 5% 38%
6M 25% 38% 50%
YtD 16% 5% 38%
1Y 216% 21% 106%
52‐week high ($) 300 15.50 60
52‐week low ($) 95 8.00 21
Daily t/o ($) 24,683 42,952 19,500
Free float (%) 15.4% 11.5% 18.4%
Free float ($mn) 28 64 56

Figure 6 : Key production figures
Copper in concentrate (kt)
2008 75 91 ‐
2009E 78 96 ‐
2010E 79 96 ‐
2011E 85 98 ‐
Zinc in concentrate (kt)
2008 6 116 ‐
2009E 6 109 ‐
2010E 6 104 ‐
2011E 6 99 ‐
Refined copper (kt)
2008 ‐ ‐ 348
2009E ‐ ‐ 330
2010E ‐ ‐ 350
2011E ‐ ‐ 361
Source: Company data, Aton estimates

5

Figure 7 : Key financial figures ($mn)
Revenue ($mn)
2008 325 497 685
2009E 282 422 583
2010E 369 544 772
2011E 412 585 837
EBITDA ($mn)
2008 75 127 122
2009E 91 160 84
2010E 164 245 236
2011E 183 258 269
Net income ($mn)
2008 8 61 41
2009E 35 105 25
2010E 87 163 111
2011E 97 171 128
EBITDA margin (%)
2008 23% 26% 18%
2009E 32% 38% 14%
2010E 44% 45% 31%
2011E 44% 44% 32%
Net margin (%)
2008 3% 12% 6%
2009E 13% 25% 4%
2010E 23% 30% 14%
2011E 23% 29% 15%

6

Company Fact Cards

GGOK – large copper concentrate producer Gaisky GOK (GGOK RU) – Copper concentrate production growth story
GGOK's share of Russian copper in Overview
concentrate production (2009E)
Second‐largest copper concentrate producer in Russia, operating one of the largest
GGOK copper deposits in the country – “Gai”. Produces copper and zinc concentrates, gold,
Other
11% UMMC ‐ and silver. Copper concentrate accounts for approximately 70% of revenues and gold a
Co's
other
3% further 17% (2009E)
17%
Bull points
 One of the most undervalued stocks among copper producers, by our estimates
Norilsk
69% (124% potential upside to the current share price).
 Company expects ore processing capacity to increase 33%, to 8mntpa, by YE13.
 Share price lags far behind the ongoing copper price rally.
Source: Reuters, InfoGeo, Research Centre “Mineral” Bear points
 Majority ownership by UMMC results in low transparency; minority shareholder
rights may potentially be at risk (Free‐float of 15.4%); Low stock liquidity
 Reports under Russian Accounting Standards (RAS) may be less reliable than IFRS

UGOK – largest zinc concentrate producer Uchalinsky GOK (UGOK RU) – Large zinc concentrate producer; strong balance sheet
UGOK's share of Russian zinc in Overview
The largest zinc concentrate producer and third‐largest copper concentrate producer
UMMC ‐ in Russia. Zinc concentrate accounts for around 21% of sales, copper concentrate 57%,
other gold 12%, and silver 6% (2009E).
4%
UGOK
70% Bull Points
 The company plans to increase ore processing capacity 20% by YE12, to 6.5mnt pa.
Other  Downside protection provided by zinc demand – the company remains Russia’s
Co's single largest supplier of zinc concentrate
26%  Growing copper concentrate output increases exposure to higher priced copper
 Low debt level, strong balance sheet
Source: Reuters, Company data Bear Points
 Reduction in zinc concentrate output by 26% by 2015 due to falling ore grades
 UMMC’s majority ownership leads to lower transparency; potential risk to minority
shareholders due to low free‐float (11.5%); low liquidity
 Financials under RAS – not as reliable as under IFRS

UELM – Russia’s largest copper refinery Uralelectromed (UELM RU) – Russia’s largest copper refinery with growing capacity
UMMC's share of Russian refined Overview
copper production (2009E)
The largest single copper refinery in Russia and among the top‐20 largest in the world.
Capable of producing up to 380ktpa of refined copper and copper products. “Good
Others Delivery” status from LBMA for gold and silver, in the process of receiving LME
UMMC
38%
RMK 1% certification for its copper cathode output.
16%
Bull Points
 Tolling scheme remains misunderstood, despite UELM’s tolling fees being
Norilsk reasonably high ($250‐300/tonne) vs global benchmarks (2009 RC of $165/tonne).
45%
 UELM plans to increase refining capacity 32% by YE12, to 500ktpa.
 Lags behind global peers, offering 96% potential upside to the current share price.

Source: Company data, Reuters Bear Points
 Tolling scheme usage in Russia still has negative connotations and is thus feared by
the market; this may cause negative sentiment among investors.
 Possible delay to refinery expansion due to financial crisis.
 UMMC’s control may lead to low transparency and potential risks to minority
shareholders (free‐float: 18.4%). RAS based accounting is less reliable than IFRS.

7

Setting Metal Prices In Line With Consensus

Our models rely on price assumptions that are based on the current Bloomberg
consensus. This is based on price forecasts from at least 15 analysts, which we believe
gives a reasonable reflection of the current market sentiment.

The summary of current consensus price forecasts is given in Figure 8.

Figure 8: Metal price assumptions set in line with consensus
2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E
LME 3M Copper ($/t) 3,507 6,679 7,103 6,886 5,199 6,875 7,358 7,743 6,668 6,500
LME 3M Zinc ($/t) 1,393 3,248 3,249 1,901 1,689 2,307 2,513 2,423 2,232 2,200
Spot Gold ($/oz) 445 605 697 872 974 1,150 1,187 1,035 989 950
Spot Silver ($/oz) 7.32 11.59 13.39 14.97 14.70 18.00 19.00 16.45 15.40 15.00
Source: Bloomberg consensus (as of 12 Mar 2009), Aton estimates

Base metals – return to pre‐crisis levels in 2010 and continue aiming higher
The market currently expects prices for the majority of base metals to recover to their
pre‐crisis averages in 2010 and to continue rising through 2011‐12 on the back of
improved economic conditions and growing demand (Figures 9, 10).

Figure 9: Copper price assumptions Figure 10: Zinc price assumptions
10000 4500
9000
43
4000
58
77
48
49
03
73
86
75
32
32
8000
71
79
68
3500
68
00
68
66
66
65
7000
13
3000
23
25
99
07
24
32
00
6000
51
23
22
22
2500
01
$/t
$/t
19
89
5000
07
16
2000
35
93
90
4000
13
37
27
1500 64
11
10
40
89
3000
4
99
90
78
7
84
18
17
79
15
15
2000 1000
1000 500
0 0
2010E
2011E
2012E
2013E
2010E
2011E
2012E
2013E
LT
LT
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009

Source: Bloomberg consensus, Aton estimates

Gold and silver still used as inflation hedges and safe havens
The expectation in the market is for gold to trade at around $1,150‐1,190/oz in 2010‐
11, while silver is expected to reach $18‐19/oz through that period (Figures 11, 12).

Figure 11: Gold price assumptions Figure 12: Silver price assumptions
1400 25.00
87
50
11
11
0
.0
35
1200
0
19
.0
10
18
20.00
4
5
98
0
97
.4
95
0
16
0
.4
7
2
.0
1000
.9
87
15
.7
15
14
14
. 39
13
15.00
7
9
69
.5
800
11
$/oz
$/oz
5
60
600
5
32
44
10.00
0
68
41
7.
4
36
6.
1
95
89
31
9
61
1
400
38
27
27
4.
4.
4.
4.
5.00
200
0 0.00
2010E
2011E
2012E
2013E
2010E
2011E
2012E
2013E
LT
LT
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009

Source: Bloomberg consensus, Aton estimates

8

Highlighting the Risks

We have a positive outlook on the companies covered by this report and believe that
some of the risks usually mentioned in connection with Russian stocks may be
outdated or based on erroneous concepts. However, we still need to draw investors’
attention to the risks that may still be relevant for the stocks under our coverage.

Low free‐float: This is often quoted as the main risk associated with investing in
Russian stocks. The aversion to holding minority shares in companies with low free‐
float may stem from the colourful history of Russian business rivalries from the
relatively recent past. At the time some Russian companies were known to act with
complete disregard for minority shareholders, using hostile and dilutive share issues as
instruments of gaining control.

These days low free float is still a common feature of Russian stocks, including well‐
known names, listed on international stock exchanges. Rusal, the latest entrant to the
equity markets, has a free‐float of just under 11%, while the five largest listed Russian
steelmakers have free‐floats ranging between 13% and 28%. Norilsk Nickel has the
largest free‐float among the Russian metals and mining names, at just under 40%.

The free‐floats of the companies under our coverage (GGOK, 15.4%, UGOK, 11.5%,
UELM, 18.4%) have remained stable since at least 2006, according to company filings.
With UMMC busy investing in growing and modernising the business, preferring to
finance the process through debt, rather than turning to shareholders, we see the risk
of actions that abuse the rights of minority shareholder as low at the moment.
Nevertheless, the risk should not be discounted completely.

One of the situations where we see this risk arising is in preparation for a possible IPO,
which has been mentioned on countless occasions, but in our view remains unlikely in
the short term. The holding company, UMMC, may wish to consolidate its control over
the subsidiaries prior its entry into the equity market. It could try to purchase the
subsidiaries’ shares in the open market or, more likely, make a tender offer in
exchange for cash or equity in the holding company. There is a risk that such an offer
could be made based on valuations that discount the true value of the subsidiaries.
Should this situation materialise, the shareholders would have to assess the merits of
selling their shares at a discount vs the likely gain from the parent company’s potential
IPO.

Low liquidity: As a result of a limited free‐float and low capitalisation, the liquidity of
the stocks covered in this report remains quite low, with daily trading volumes in the
past three months averaging as low as $19,500 and up to around $43,000, depending
on the company. Investors have to take this risk into account when making investment
decisions regarding the stocks: it may not always be possible obtain accurate
indications of the stocks’ trading price, market capitalisation or transaction costs. It
may also be difficult to adjust positions in the stocks within timeframes desired by
investors.

Inadequate corporate governance standards: Russian companies’ corporate
governance standards are a well‐researched topic and it is broadly understood that
they still have a long way to go, with the current progress slow and arduous. The
recent acquisition of a controlling share in Chelyabinsk Zinc Plant by UMMC and
Russian Copper Company (RMK) once again raised concerns over a potential worsening
of corporate governance at Chelyabinsk Zinc – the internationally listed company.
While we cannot discount the possibility of that happening, we may also see this as an
opportunity for UMMC to use its experience managing a large, publicly listed company
to gain a better appreciation of international corporate governance requirements and
standards prior to its own potential entry into the equity market.

9

With respect to the companies covered in this report, we are encouraged that Andrey
Kozitsyn, General Director of UMMC, is an active member of the Russian National
Council on Corporate Governance (NCCG), a non‐profit organisation, which unites top
managers from listed Russian companies, investment professionals and federal
government representatives. The council is chaired by Vladimir Potanin, majority
shareholder in Norilsk Nickel. It acts as an advisory body aiming to improve legislation
and introduce modern standards of corporate governance to Russian companies.

Low transparency and inadequate reporting standards: Russian accounting standards
(RAS) are often viewed as inadequate in comparison with IFRS or US GAAP. While we
do not necessarily share this view completely, we agree that Russian accounting
reports often leave much to be desired in terms of quality of reporting and the
disclosure of key financial and operational facts. Reporting to shareholders is often
kept to the minimum specified by the current legislation.

According to numerous comments made by UMMC’s management in the past, the
holding company has been reporting its financials under IFRS since 2003 (although the
reports were aimed at credit institutions and are currently not available publicly).
However, the holding’s subsidiaries are still reporting under RAS.

Our experience with the UMMC subsidiaries has generally been positive, both in terms
of financial reporting (making allowances for certain shortcomings of the Russian
financial reporting standards) and in terms of direct contact with the companies. The
companies were generally open with respect to discussing the main aspects of their
businesses: operational factors, product flows, revenue and cost drivers, capital
budgets, work plans, etc. However, when analysing the areas of the business, which
were considered commercially sensitive by the companies, we had to rely on our own
judgement when making conclusions.

Political risks: The recent history of Russian listed companies has numerous examples
of the negative consequences a comment by a government official or a change in
political priorities may have on an enterprise. While no Russian listed companies may
be considered immune to the risk, those listed as “strategic enterprises” by the
Russian government, of which UMMC is one, could be better insulated.

Financial risks: UMMC subsidiaries have substantial investment programmes aimed at
modernising their businesses and increasing operating capacity. At the onset of the
crisis the parent company risked breaching covenants on some of its loans. However,
by cutting costs and deferring some of its capital projects, the company managed to
stabilise its financial position. It refinanced its debt obligations, which currently stand
at around $3bn in total for the group, according to the UMMC management’s
comments in the media. The company currently relies on support from government‐
owned banks, however, there is no guarantee that such relationships will continue or
will be supported by the government in the future.

1
0

Russian Copper: Counting On Economic Recovery and Export Strength

Russia was ranked among the top‐10 global copper producers and consumers in 2008
and its substantial reserve base has subsequently allowed it to play an important
role in the international copper trade. The Russian government expects the industry
to remain export‐oriented in the short‐to‐medium term, and forecasts the country’s
apparent consumption to return to pre‐crisis levels only by around 2015.
Copper Industry Overview
Copper is one of the most widely used of the industrial metals, finding its way into a
multitude of different applications. As can be seen from Figure 13, electrical (e.g.
cables, wires) and construction applications (e.g tubes, building parts, fittings) account
for around 70% of global copper consumption.

Figure 13: World copper consumption trends
World refined copper consumption World copper consumption
by end‐use (2008) by region (2008)
Industrial
machinery
Transportation 9% Japan
12% Australia China 7%
Consumer Rest of
1% 26%
products Asia
Construction
9% 21%
28% Africa
2%
Electrical USA Europe
Rest of
42% 11% 26%
America
6%

Source: CRU

China consumes over a quarter of the world’s copper output with Asia as a whole
accounting for around 55% of global copper consumption. Consumption of the metal
in Europe and the US is nonetheless also quite substantial.

Global copper reserves are relatively abundant. The US Geological Survey puts the
world’s total proved reserves at around 540mnt (which alone should be sufficient for
around 35 years of production at current output levels). Chile, the US and Peru
accounted for around half of global copper production in 2008, while Russia was in
sixth place, with around 750kt of mine output (Figure 14).

Figure 14: Top mined copper producers (ranked by 2008 output)
Mine production (kt) Reserves (kt)
Country 2005 2006 2007 2008 2009E
Chile 5,320 5,360 5,560 5,330 160,000
US 1,140 1,200 1,170 1,310 35,000
Peru 1,010 1,049 1,190 1,270 63,000
China 755 890 946 950 30,000
Australia 927 859 870 886 24,000
Russia 700 725 740 750 20,000
Indonesia 1,070 816 797 651 31,000
Canada 567 607 589 607 8,000
Zambia 436 476 520 546 19,000
Poland 523 512 452 430 26,000
Kazakhstan 402 457 407 420 18,000
Mexico 429 338 347 247 38,000
Other countries 1,720 1,835 1,840 2,030 70,000
World total (rounded) 15,000 15,100 15,400 15,700 540,000
Source: US Geological Survey, Mineral Commodity Summaries, Jan 2010

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The copper manufacturing cycle can be subdivided into three rough stages:

1. Mining and copper concentrate production
2. Smelting and refining (at times separated into two stages)
3. Semi‐finished and finished product fabrication

As with all base metals, the main driver behind mine and concentrating‐operations
locations is the availability of sufficient metal content in the ore/soil to make copper
extraction economic. Smelting and refining facilities, on the other hand, rely on the
availability of fuel and electricity and are therefore located in the areas in which these
energy sources are available cheaply and in abundance. Finally, fabrication plants tend
to be located in close proximity to the ultimate consumers.

Depending on a range of operational and economic factors (e.g. the availability of
economically exploitable metal deposits, their location, transport infrastructure,
availability of power, etc.) countries and/or companies may have significant presence
in all three stages or specialise in a particular one.

Chile, for instance, the world’s largest copper producer, produced an equivalent of
5.3mnt of the metal in mined production in 2008. However, only 3.1mnt of this was
refined in the country, with the rest being exported, primarily to Asia. Finally, only
0.1mnt of refined metal was consumed in the manufacture of copper‐based products
(Figure 15).

Figure 15: Copper mining, refining and consumption trends (2008, kt)
Mined production Refined production Refined usage
Chile 5,328 3,058 103
United States 1,335 1,282 2,020
Peru 1,268 464 55
China 951 3,791 5,198

Russia 705 862 650

Source: ICSG

Chinese mines, in contrast, produced the equivalent of just under 1mnt of copper in
2008. It is however the world’s biggest copper refiner and consumer, using copper
concentrate imported from elsewhere to produce around 3.8mnt of refined copper.
The country consumes close to 5.2mnt of refined copper, with the balance covered by
imports of refined product, and internal and external copper scrap supplies.

Russian Copper Producers – Exports Save the Day
The Russian copper industry is reasonably balanced between the three manufacturing
stages, although exposure to each manufacturing stage differs by producer, as we
discuss below.

The current circumstances of the Russian copper industry, not dissimilar to other
metals operations in Russia, are dominated by their Soviet legacy with some of the
largest metals deposits located in the Soviet republics, which are now independent
states. As a result, after the demise of the Soviet Union, many Russian base metal
producers found that their main or only suppliers of raw materials were now
independent companies and relationships had to be rebuilt and based on an entirely
different, free‐market oriented approach. Aluminium and zinc producers were the
hardest hit with the copper industry less affected given that Russia’s own copper
reserve base is sufficiently large to satisfy the local industry’s requirements.

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In this report we focus on UMMC companies operating in the two main stages of the
copper manufacturing process (see Appendix I for the outline of UMMC’s exposure
to different stages of copper production):

 Mining and concentrate production (GGOK, UGOK), and
 Refining (UELM)

The market is highly concentrated at both stages, with only three companies, Norilsk
Nickel, UMMC and Russian Copper Company (RMK), controlling almost the entire
market. The situation may change in the near future when the large Udokan copper
deposit in East Siberia, which is currently being developed by Metalloinvest and state‐
owned Rostechnologii (Russian Technologies), commences production.

The market is slightly less concentrated at the fabrication stage, although all three
companies have been actively consolidating assets in this space and now have a very
sizeable footprint in this portion of the market.

Mining and copper concentrate production
Russian official statistics do not disclose copper‐concentrate output breakdown by
enterprise, citing commercial confidentiality. Consequently we have relied partly on
company data, but largely on a variety of other statistical sources (both international –
the Reuters Base Metals Database and the International Copper Study Group (ICSG) –
and Russian: statistical data maintained by InfoGeo and the research bureau ‘Mineral’)
to arrive at what we believe is a reasonably accurate estimate of the major producers’
concentrate output.

Norilsk Nickel dominates the Russian market in terms of copper‐concentrate output
(just shy of 70%, on our estimates). This is not surprising given that the company
controls some of Russia’s largest deposits, where copper is produced as a by‐product
of nickel manufacturing. UMMC is the second‐largest producer, supplying around 29‐
30% of the country’s copper concentrate. The rest is supplied by RMK and some other
smaller enterprises (Figure 16).

Figure 16: Large deposits make Norilsk the leading copper‐concentrate producer
Share of ABC1 reserves of largest UMMC subsidiaries as % of Russian
Russian producing deposits (2007) copper conc. production (2009E)
Volkovskoe UMMC ‐
Gai GGOK
(UMMC) other
11% UGOK
Talnakhskoe (UMMC) 5%
7% 11%
(Norilsk) 15% Yubileynoe
25% (UMMC)
5%
Oktyabrskoe Norilsk Other
(Norilsk) 68% Co's
50% 3%

Source: Source: Reuters, InfoGeo, Research Centre ‘Mineral’, Aton estimates

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In Figure 17 we provide an estimated breakdown of copper‐concentrate production by
Russia’s main producers.

Figure 17: Russian copper concentrate production by company (kt)
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Norilsk Nickel 425 453 455 465 485 495 505 505 505 505
UMMC 136 149 158 179 187 187 195 205 209 206
of which:
Gaiskiy GOK 59 66 69 72 75 73 74 75 75 78
Uchalinsky GOK 28 34 35 46 48 48 50 51 55 50
Safyanovskaya Med (part of UELM) 28 26 29 30 32 32 32 32 32 32
Other UMMC assets 21 23 25 31 32 34 40 46 46 46
RMK total 10 11 13 14 14 14 14 14 14 14
Others 10 15 15 11 10 10 10 10 10 10
Gross total 581 628 641 669 696 707 725 734 738 736
Source: Reuters, Company data, InfoGeo

Refined copper production
With respect to processing copper concentrate into refined copper, the balance of
control shifts significantly away from Norilsk Nickel, which produces around 45% of
Russia’s refined copper, on our estimates. The remainder is processed by UMMC
(around 38%) and RMK (around 16%) and several other small companies (Figure 18).

Figure 18: Refined copper producers Figure 19: The world’s top‐20 copper refineries by capacity, 2009 (ktpa)
900
1000
UMMC's share of Russian refined
800
copper production (2009E)
500
490
600
470
450
450
415
400
400
400
395
390
380
380
380
360
350
350
345
330
330
UMMC Others 400
RMK 1%
38%
16% 200
0
Iio Refinery
Guixi
Codelco Norte
Jinlong
Olen
Morenci
Sterlite
Birla
Hamburg
Norilsk
Amarillo
El Paso
Jinchuan
Yunnan
CCR‐Montreal
Pyshma‐UELM
Toyo/Niihama
Escondida
Onsan
Chuquicamata
Las Ventanas
Norilsk
45%

Source: Company data, Reuters, Aton estimates Source: ICSG

UMMC owns one of the largest copper refineries in the world by installed capacity –
Uralelectromed (UELM) in the Russian town of Pyshma (Figure 19). ICSG estimates
UELM’s capacity at 390ktpa, although we believe that this figure could include refined
copper produced by UMMC’s other smaller subsidiaries. UMMC itself reported UELM’s
nameplate annual capacity at 300kt, but confirmed that the plant is currently able to
produce around 350‐380kt of refined copper per year, with an increase in its capacity
to 500kt planned by YE12.

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In Figure 20 we give a summary of refined copper output by the main Russian
enterprises.

Figure 20: Russian refined copper production by company (kt)
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Norilsk Nickel 413 475 454 467 447 452 425 423 419 402
UMMC 315 330 333 296 345 355 357 381 351 333
RMK Total 76 80 66 86 121 137 170 175 144 139
Others 5 6 6 6 6 6 6 6 6 6
Gross Total 803 891 859 856 919 950 957 985 920 880

Reliance on exports remains significant
Modern Russia is a net exporter of refined copper. We analysed recent trends in
Russian copper production and trade, based on data provided by the Russian
government’s recently adopted Strategy on the Development of the Russian
Metallurgical Industry to 2020 (‘Metals Strategy 2020’) and the latest official statistics.

The country’s copper imports are insignificant, while its exports averaged around
350kt per year, or roughly around 35‐40% of its total refined copper output between
2003 and 2008. However, as the consumption of refined copper by manufacturers of
copper based products within the country increased, the share of exports gradually
decreased, falling to 28% of total output (270kt) in 2006.

Nevertheless, exports reliance was once again confirmed in 2009, when net exports of
refined copper more than doubled, rising from 290kt in 2008 to 590kt. This was largely
as a result of falling demand within Russia.

Reliance on copper is expected to remain significant: the Russian ‘Metals Strategy
2020’ assumes three modes of development for the sector: passive (or inert); resource
oriented; and innovative (see Appendix II for a detailed description). Depending on the
approach, the state expects production of refined copper to remain at around 850‐
900kt in 2010‐11, rising to around 950‐1050kt by 2015 (Figure 21).

Figure 21: Russian refined copper production and consumption (kt)
Production (inert) Production (innovative)
Net import (inert) Net import (innovative)
Apparent cons (inert) Apparent cons (innovative)
1200
1000 900
800 750
600 520 715
684 390 650
400 623 664
591
515 430
200 372 284 310
0
‐200
‐400
‐600
2010E
2011E
2015E
2020E
2003
2004
2005
2006
2007
2008
2009

Source: Russian 2020 Metals Strategy, InfoGeo, Aton estimates

As can be seen from Figure 21, internal consumption of refined copper is not expected
to return to pre‐crisis levels until sometime between 2011 and 2015. As a result,
‘Metals Strategy 2020’ forecasts exports to be in the region of 450‐550kt in 2010‐11.

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While the importance of China as an export destination for Russian producers is
gradually increasing, Europe and the Middle East remain its main markets. In this
regard, the current gradual improvement in copper demand being seen in the
European markets on the back of restocking should play into the Russian producers’
hands and provide further support for their exports.

Moreover, both Norilsk Nickel and UELM have already applied to list their copper
cathodes as brands for delivery at the LME, with tests of UELM’s copper for branding
already proceeding. The move should allow Russian copper producers to boost their
profits as LME branding would allow them to sell their copper at LME‐quoted prices,
while non‐LME registered material is sold at a discount. While we believe selling at a
discount was an advantage during the time of the crisis, allowing the lower priced
Russian material to gain larger market share, in a fully fledged recovery, differentiation
based on quality, rather than price, would be more beneficial, in our view.

We note that UELM’s gold and silver are already included on the “Good Delivery” list
of the London Bullion Market Association (LBMA).

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Russian Zinc: Resisting the Elements

Russia’s contribution to world zinc output is relatively modest by global standards
despite its reserve base being among the largest in the world. The country’s industry
was little affected by the economic crisis mainly thanks to the strong performance of
galvanised steel manufacturers. We believe the Russian zinc industry will likely focus
on supplying the country’s internal needs, with demand growth being boosted by the
construction sector, in particular.
Zinc Industry Overview
Zinc is predominantly used as a coating for steel and iron in order to protect these
metals against corrosion (galvanising). This is gradually replacing more traditional
methods such as colour‐polymer coating and painting. Zinc is also widely used in alloys
such as brass and in a variety of chemical applications. Globally, around half of zinc
production is used in galvanising, and over 30% is utilised in alloys (Figure 22).

Figure 22: Global and Russian primary zinc usage
Global zinc usage by first use Russian zinc usage by first use
(2007) (2008)
Other Other
11% 6%
Chemicals Chemicals
9% 14%
Galvanising
47% Alloys Galvanising
Alloys
18% 62%
33%

Source: Global – LME, Russia – Chelyabinsk Zinc

In Russia galvanising is by far the largest application for zinc, accounting for over 60%,
with alloy and chemical production consuming another 32%.

In terms of global mined zinc production, Russia plays a relatively modest role, with
the top producers being China, Peru and Australia (together producing around 44% of
the world’s output of zinc (Figure 23).

Figure 23: Top mined‐zinc producers (ranked by 2008 output)
Mine production (kt) Reserves (kt)
Country 2005 2006 2007 2008 2009E
China 2,547 2,844 3,048 3,186 33,000
Peru 1,202 1,202 1,444 1,603 19,000
Australia 1,329 1,338 1,498 1,479 21,000
Canada 667 638 630 716 8,000
US 748 727 803 779 14,000
India 472 503 558 616 10,000
Kazakhstan 364 410 446 459 17,000
Mexico 476 469 452 442 14,000
Ireland 445 426 401 398 2,000
Other countries 1,896 1,890 1,849 2,024 62,000
of which Russia 156 163 171 171 40,000
World total (rounded) 10,146 10,447 11,129 11,702 540,000
Source: ILZSG, US Geological Survey, Mineral Commodity Summaries, Jan 2010

Nevertheless, Russian zinc reserves are among the largest in the world. The estimates
of these reserves differ by source (we use ABC1 reserves quoted in Russian sources);
however, it ranks among the top‐three.

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Ironically then, Russia is at present essentially short of zinc concentrate. This is
another legacy of the Soviet times. Following the break‐up of the Soviet Union, around
80% of the reserve base and around 50% of the concentrate processing capacity was
lost (the majority of zinc mining and concentrating capacity was based in Kazakhstan,
with some in Uzbekistan). As a result, the current Russian zinc concentrate output can
cover only around 70% of the internal zinc refining capacity. In Figure 24 we
summarise Russian zinc concentrate output by enterprise.

Figure 24: Russian zinc concentrate production by company (kt of contained metal)
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
UMMC 96 102 115 123 124 124 129 124 122 115
of which:
Gaiskiy GOK 12 10 13 12 12 9 8 8 6 6
Uchalinsky GOK 84 92 102 111 112 115 121 117 116 109
RMK Total 11 12 12 10 12 12 18 28 30 23
Dalpolimetal 20 18 23 22 19 19 16 19 19 15
Gross total 127 132 150 156 155 156 163 171 171 153

UMMC and RMK remain the main suppliers to the Russian market, with UMMC
producing around three quarters of the current Russian zinc concentrate output
(Figure 25).

Figure 25: Uchalinsky GOK remains the main zinc concentrate supplier in Russia
UGOK's share of Russian zinc in
UMMC ‐
other
4%
UGOK
70%
Other
Co's
26%

Source: Reuters, Company data

Dalpolimetal’s location in the Far East of Russia makes the transportation of zinc
concentrate to smelters in the western parts of the country uneconomic. Therefore, its
zinc‐concentrate output is exported. Russian zinc refineries have to rely on imports
from Kazakhstan, Uzbekistan and non‐CIS countries to satisfy their production
requirements.

Russian zinc concentrate production could increase by over 100% by YE13 when the
Ozernoe deposit is expected to come on stream, with forecast capacity of around 250‐
300kt of zinc equivalent in concentrate at peak production, according to operator, East
Siberian Metals Corporation (MBC). Ozernoe could be followed by Holodninskoe
deposit (also operated by MBC) shortly after that. About 50% of the output from those
deposits could be exported. These developments along with some smaller fields, as
well as capacity increases at existing facilities, should ensure that Russian refined zinc
production becomes almost fully self‐sufficient in zinc concentrate by 2020, as
envisaged by the Russian ‘Metals Strategy 2020’.

In terms of refined zinc production, the Russian market is even more concentrated
than for copper. During Soviet times Russia had three refineries. One of them, Belovo
Metallurgical plant has been idle for a considerable length of time and no plans to

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revive the plant have been announced. As a result the Russian market is supplied by
two refineries: Chelyabinsk Zinc and Elektrotsink in Vladikavkaz, controlled by UMMC
(Figure 26).

Figure 26: Only two companies produce all of Russia’s refined zinc
Breakdown of Russian
refined zinc production (2009E)
Chelyabinsk
Zinc
55% Elektrotsink
45%

Source: Reuters, Company Data

The market has become even more concentrated after UMMC and Russian Copper
Company (RMK) completed the purchase of a 58% holding in Chelyabinsk Zinc. As a
result UMMC has become practically a monopoly in refined zinc production in Russia.
Figure 27 below gives a breakdown of Russian refined zinc output by plant.

Figure 27: Russian refined zinc production by company (kt)
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Chelyabinsk Zinc 146 156 166 177 152 116 148 165 166 120
Elektrotsink 81 81 88 75 81 90 88 88 98 90
Gross total 227 237 254 252 233 206 236 253 264 210

Refined zinc usage – steelmakers in the lead
In terms of zinc refining and refined zinc consumption, the world’s largest steel
producing countries are, unsurprisingly, in the lead (Figure 28).

Figure 28: Major refined zinc consuming countries (2008)
Refined zinc production Refined zinc usage
China 3,913 4,015
US 286 1,003
Japan 616 485
Germany 292 564
South Korea 739 504
Russia 262 222
Source: ILZSG, ‘Metals Strategy 2020’

The situation is not surprising given that the majority of global zinc production is used
in protecting zinc and iron against corrosion, as discussed above.

In terms of final application (i.e. areas of final use for zinc based or zinc‐covered
products) about 32% of global refined zinc output is used in the production of vehicles,
machinery and engineering, with around 45% of zinc used in construction. The
remainder goes to various consumer goods and electrical equipment (Figure 29).

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Figure 29: Russian zinc use in construction and other areas is still low
Global zinc usage by end use Russian zinc usage by end use
(2003) (2007)
Other
Consumer, Transport, 10%
electrical general
23% engineering Construction
32% 20% Transport,
machinery,
Construction engineering
45% 70%

Source: International Zinc Association, Russian 2020 Metals Strategy

In Russia, the ultimate uses of zinc and zinc products differ considerably from global
trends, with the majority ending up in vehicle and machinery manufacturing and
general engineering. Only about 20% of refined zinc is accounted for by construction‐
related applications.

Exposure to machinery and vehicle production was one of the reasons that, we
believe, allowed Russian zinc consumption to remain reasonably robust during the
economic crisis. As can be seen from Figure 30, following a difficult 4Q08 – 2Q09,
production of Hot Dip Galvanised (HDG) sheet by Russian steelmakers has recovered
strongly, even approaching pre‐crisis levels in 3Q09. The dip in 4Q09 was mainly
seasonal, in our view, and the recent steel production figures (Jan‐Feb 2010) remain
quite strong.

Figure 30: Russian HDG trade dynamics
Production Export Import Apparent consumption
788
800
623 618 599
584
527 501
600 481
450
358 329
'000 tonnes
400 260
200
‐200
1Q07
2Q07
3Q07
4Q07
1Q08
2Q08
3Q08
4Q08
1Q09
2Q09
3Q09
4Q09

Source: Metal Courier

State support of the auto sector, as well as increased infrastructure spending, were the
main drivers behind the revival of demand for galvanised steel, in our opinion. In
addition, Russian steel producers managed to increase their export sales, primarily to
the CIS countries.

As a result, the apparent consumption of zinc in Russia was marginally up during 2009,
increasing by just over 6% YoY, to around 220kt (Figure 31)

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Figure 31: Russian zinc production and consumption trends
Production (inert) Production (innovative)
Net import (inert) Net import (innovative)
Apparent cons (inert) Apparent cons (innovative)
500
410
400
267 300
300 322
217
246 267
200 222
195 206 209 219
174
100
115
83
0
‐100
2010E
2011E
2015E
2020E
2003
2004
2005
2006
2007
2008
2009

Source: Russian 2020 Metals Strategy, InfoGeo, Aton estimates

We expect higher infrastructure spending to be the main driver behind refined zinc
consumption growth in Russia in the short‐to‐medium term. A number of
infrastructure projects are either under construction or already approved – the Sochi
Olympics, the 2012 APEC summit, to name just a few, together with a whole host of
federal road and bridge construction projects (see our Special Situations team’s report
Bridge over Troubled Water, 23 Mar, for a detailed review of the main Russian
transportation infrastructure projects). These schemes will call for increased amounts
of zinc, given its primary function as a protector of steel used in construction.
According to UMMC, Russia has over 40 enterprises providing galvanising services
(including the recently commissioned plant at UELM). A number of steel galvanising
facilities are currently being built around Russia to enable wider use of steel
galvanising for construction purposes.

The Russian ‘Metals Strategy 2020’ envisages that the share of construction in total
zinc consumption will rise from the current 20% to around 33% by 2020. As a result,
Russian refined zinc consumption is forecast to increase from around 200ktpa (2010)
to between 260‐300kt by 2015 and 300‐400kt by 2020 (Figure 31).

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Global Factors: Supportive For Commodities But Conducive To Volatility

Russian metals and mining companies are well integrated into the world economy
and rely on exports for a large part of their earnings. Therefore, their fortunes are
closely linked to the changing tides in the global commodity markets. We see price
volatility remaining firmly in place in the metals markets in months to come as
competing global factors (1) dollar strength; (2) Chinese liquidity tightening and (3)
real demand, pan out and contribute to general market uncertainty. However, we
believe one should look beyond the short‐term unpredictability and focus on the
global fundamentals, which, in our view, remain supportive for commodities in the
medium‐to‐long term.
A Stronger US Dollar – Still a Factor or Just a Distractor?
The inverse relationship between the dollar and commodities is a well publicised and
researched phenomenon and the relationship remained firmly behind commodities’
stellar performance in 2009. Moreover, as investors sought to diversify away from the
depreciating dollar, they cast a wider net in search of alternative investment assets
and, in addition to gold – the usual safe haven – actively increased their exposure to a
much wider range of commodities, allowing the majority of base metals to appreciate
back to their pre‐crisis levels.

Likewise, the US currency’s recent appreciation has prompted concern over the
sustainability of the commodity price rally. However, as our Strategy and Economics
team wrote in their 3 Mar report, Domestic Tailwinds in a Turbulent Climate,
commodity prices have displayed resilience to the recent dollar rally.

Here we have replicated the chart from the abovementioned report, updated for the
most recent price and currency levels (Figure 32). Only gold remains firmly correlated
with fluctuations in the dollar/euro exchange rate, while other commodities have
continued to appreciate despite the dollar appreciating by another percentage point vs
the euro since our strategy report was published.

Figure 32: Commodity price moves vs dollar appreciation (1 Dec 2009 to date)
58%
60%
50%
So far only gold has reacted
40%
to Dollar appreciation vs Euro
30% 27%
20% 16%
11% 13%
8%
10% 2%
0%
‐10% ‐3%
Copper
Gold
Zinc
Nickel
Oil
Steel
Platinum
appreciation
$/€

Source: Bloomberg

Nonetheless, in our view, the inverse relationship between the dollar and commodity
prices remains intact, and could still be a threat to the latter should the appreciation
prove sustainable. However, we believe that other factors (for instance, demand for
commodities, the outlook for economic growth and arbitrage) are currently proving to
be stronger drivers for commodity prices than dollar appreciation. Nevertheless, any
sharp currency moves should continue to contribute to short‐term commodity price
volatility.

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Less publicised is the Chinese currency’s role…The Chinese renminbi (RMB) remains
closely pegged to the dollar, virtually replicating the US currency’s moves against other
currencies (including the euro, for instance). Therefore, we believe that Chinese
demand for commodities should not be affected to any great extent by future dollar
appreciation. On the contrary, any weakness in commodity prices on the back of a
stronger dollar could once again be used by the Chinese as an opportunity to restock.

Rouble appreciation is more concerning for the Russian producers. What is more
serious for Russian base metal producers is not the strength of the dollar vs the euro,
but rather the ongoing strengthening of the rouble against both currencies on the back
of stable oil prices. A stronger rouble means that when translating company financials
into US dollars for valuation purposes, we end up with considerably higher dollar
denominated costs, squeezing the profit margins on which we rely for our assessment
of the company’s investment appeal.
Liquidity tightening in China is yet to have any noticeable impact
The recent jump in the Chinese CPI rate has reignited fears of liquidity tightening by
the country’s government, which may result in a contraction in demand for
commodities. These worries are overrated, in our view.

The Chinese government has already put in place a number of measures to reduce
bank lending and limit excess liquidity: the pace of YoY growth in bank lending slowed
from around 34% to 30% throughout 4Q09. And while we are certain that the
government will continue this agenda, we tend to agree with market commentators
who expect the Chinese authorities to favour gradual cooling over abrupt and drastic
cuts. Indeed, as we see from the reports on international news wires, the government
appears to be aiming for an approximately 10% annual growth rate, which would be a
major bullish factor for commodities. Moreover, judging by the recent official statistics
on commodity imports into China, liquidity‐tightening measures have yet to have any
noticeable impact on the country’s commodities appetite.

Figures 33 and 34, illustrate the recent trends in two of China’s main commodity
imports, copper and iron ore, often used as proxies for demand for these materials in
the global market. Chinese unwrought copper and copper products imports rose 42%
MoM in March, to 456kt (just below the all‐time high of 477kt reached in June 2009).
Iron ore imports also increased in March, rising 20% MoM, to just over 59mnt.

Figure 33: Chinese March copper imports rise 42% MoM… Figure 34: …while iron ore imports go up 20% MoM
China copper imports Copper import growth MoM (%) China iron ore imports Iron ore stocks at Chinese ports
90 Iron ore stocks at Chinese ports increased only
Tight scrap market pushes March import of
copper and copper products up 42% MoM 80 marginally in February‐March 2010...
500 100%
400 80% 70
mn tonnes
300 60% 60
200 40%
50
100 20%
40
0 0% …despite the holidays and iron
‐100 ‐20% 30 ore imports rising 6% and 20%
MoM, respectively, in Feb‐March
‐200 ‐40% 20
Jul‐08
Sep‐08
Nov‐08
Jul‐09
Sep‐09
Nov‐09
Jan‐08
Mar‐08
May‐08
Jan‐09
Mar‐09
May‐09
Jan‐10
Mar‐10
Jun 08
Jul 08
Aug 08
Sep 08
Oct 08
Nov 08
Dec 08
Feb 09
Apr 09
Jun 09
Jul 09
Aug 09
Sep 09
Oct 09
Nov 09
Dec 09
Feb 10
Jan 09
Mar 09
May 09
Jan 10
Mar 10

Source: Bloomberg Source: Bloomberg
Real Demand or Just Stockpiling and Speculation?
The unprecedented growth in Chinese commodity imports throughout 2009 and the
lack of transparency with regards to the real state of the country’s economy and

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manufacturing have led many to believe that the increase in imports was due to
stockpiling and speculation rather than an indication of growing real demand for
commodities. One of the major concerns among investors is that Chinese producers
had stockpiled sufficient raw material inventories to last for several months without
the need for replenishment.

We would agree that the increase in commodity imports in 1H09 was driven primarily
by the desire to replenish raw material inventories while prices were low. However,
imports have subsequently normalised and, while a speculative element may still be in
play, our view is that the current commodity import levels give a more accurate
reflection of real demand in the country. There is plenty of statistical and anecdotal
evidence in the market to support this.

Returning to Figure 34, it is interesting to note that despite the short month of
February (further shortened by the Chinese New Year holidays) iron ore stocks at
Chinese ports increased only marginally during the month. Stocks stood at 69.6mnt at
the end of February, up just 2% from the end of January, while iron ore imports into
China increased 6% MoM in February. This, we believe, would imply that stock
drawdown by steelmakers remained strong in February, suggesting that at least a part
of the iron ore imports went straight into steel production, rather than simply being
accumulated. The pace of drawdown became even more apparent in March, with iron
ore imports increasing 20% MoM, while port stocks increased to around 71.5mnt,
which is growth of less than 3%.

Moreover, according to Marcelo Awad, CEO of Antofagasta, one of the major copper
producers, speaking at the Reuters Mining Summit recently, the company’s sales
representatives to China have reported that the fabricating plants, which are among
the main consumers of refined copper, were running close to capacity. As such, the
company believes that current import demand is very much real.

Chinese internal production levels cannot be used as an independent indication of
demand unless there is evidence that the output is generating revenue instead of
simply being added to inventory. In this regard, we believe that Chinese exports may
be one of the main driving forces behind the country’s manufacturing efforts. In
February and March these have continued their surge, posting increases of 46% and
24% YoY, respectively. The figures were quite obviously driven by the low base factor
(the value of exports in Feb 2009 came in at around $65bn; in Mar 2009 it was just
over $90bn). We have therefore looked at the absolute level instead of simple YoY
comparisons. As can be seen from Figure 35, despite the seasonal slowdown in Jan‐Feb
2010, exports in 1Q10 were actually slightly better than in 2008, the year of record
exports from China ($105bn in 1Q10 vs $102bn in 1Q08).

Figure 35: Yet another year of record exports in the making? Figure 36: Although, not all exports are surging yet
Value of Chinese exports Chinese export YoY change % Steel product import Steel product export Net export
2009 average export value The period of being net importer
Chinese export values in Jan‐Mar '10 are similar to 8000
levels of Jan‐Mar of 2008, the year of record exports of steel was short‐lived...
7000
70 140 6000
60 120 …although Chinese steel exports
50 100 5000 are yet to recover to past peaks
40 80 4000
'000 t
30 60
3000
$bn
20 40
%
10 20 2000
0 0 1000
‐10 ‐20
‐20 Chinese exports sustained their ‐40 0
‐30 positive growth momentum in March ‐60 ‐1000
‐40 ‐80 ‐2000
Jul‐08
Sep‐08
Nov‐08
Jul‐09
Sep‐09
Nov‐09
Jul‐08
Sep‐08
Nov‐08
Jul‐09
Sep‐09
Nov‐09
Jan‐08
Mar‐08
May‐08
Jan‐09
Mar‐09
May‐09
Jan‐10
Mar‐10
Jan‐08
Mar‐08
May‐08
Jan‐09
Mar‐09
May‐09
Jan‐10


2
4

Given the state of the economies of China’s main trading partners, we would not go as
far as suggesting that China is on the verge of repeating its stellar 2008 export
performance. As Figure 36 shows, not all industrial exports are doing well. The
anaemic steel export level could be explained by the lack of real demand for steel in
the regional markets that have not experienced the same amount of stimulus‐driven
growth as China. Moreover, Chinese exports of certain types of steel were restrained
by restrictive quotas imposed by the US and EU. Finally, growing infrastructure
spending in China on the back of stimulus spending could also have diverted a large
part of the steel output towards internal projects. This picture could change in the
coming months, once the rest of the world enters the restocking phase.

Restocking – when will the rest of the world follow suit?
While China has been in restocking mode for over a year, the same cannot be said for
other major economies. The results of the economic crisis have been so severe and the
recovery so slow in coming that the manufacturing industries in the US and Europe
have spent almost two years in destocking mode (i.e. running down the build‐up of
excess stock rather than manufacturing new products). Industrial production in the US
and EU had fallen by as much as 13% and 20% YoY, respectively by the middle of 2009
and has just started to move into positive growth territory, helped to a large extent by
the low base factor (Figure 37).

Figure 37: Industrial production in key economies (YoY change %) Figure 38: GDP growth in key economies (YoY change %)
China China 5Y average US Eurozone China US Eurozone
20%
After the surge of '09, Chinese IP growth China GDP growth rate
25% continues to gain momentum...
rate is back to its 5Y average levels... 15%
20%
15%
10% 10%
% chg yoy
% chg yoy
5%
0% 5%
‐5%
‐10% 0%
‐15% …while both US and Europe are starting
‐20% ‐5% …while US and EU appear
to show some signs of recovery
‐25% to have stabilised
Apr‐06
Jul‐06
Oct‐06
Apr‐07
Jul‐07
Oct‐07
Apr‐08
Jul‐08
Oct‐08
Apr‐09
Jul‐09
Oct‐09
‐10%
Jan‐06
Jan‐07
Jan‐08
Jan‐09
Jan‐10
1Q03
4Q03
3Q04
2Q05
1Q06
4Q06
3Q07
2Q08
1Q09
4Q09


And this industrial production recovery in the US and EU is gradually being reflected in
the rates of economic growth. Although quarterly GDP growth rates in the developed
world still remain in negative territory, they are trending up, raising hopes of positive
growth in 2010 (Figure 38).

We expect that the early stages of that growth will be driven by restocking, rather than
the recovery of real demand, as the manufacturing sector will have to rebuild heavily
depleted inventories. We have already seen some evidence of restocking in steel and it
appears that the process is about to commence in the base metals market.

Figure 39 illustrates the drawdown of LME copper inventories during 2009 on the back
of Chinese buying. The process took place in two stages: initial purchases at the
beginning of the year were followed by a much stronger drawdown in Apr‐May 2009,
the traditional season for copper market restocking. As a result, LME copper
inventories dipped 53% from the peak of around 550kt at the end of Feb 2009 to the
low of around 257kt in mid‐July 2009.

2
5

Figure 39: Copper restocking in 2Q10 could indicate the true state of demand
LME stock ('000 tonnes) Cancelled warrants as % of LME stock
600 Judging by the number of cancelled warrants, 30%
copper stock at LME is expected to go down...
500 25%
400 20%
300 15%
...but 2Q withdrawals
200 are key to a sustained 10%
stock reduction
100 5%
0 0%
01 Jul 08
01 Sep 08
01 Nov 08
01 Jul 09
01 Sep 09
01 Nov 09
01 Jan 08
01 Mar 08
01 May 08
01 Jan 09
01 Mar 09
01 May 09
01 Jan 10
01 Mar 10

Source: Bloomberg

This process may be repeated this year, albeit at a less dramatic pace due to reduced
purchases by China. The number of cancelled warrants, the main indicator of the size
of the copper inventory waiting to leave the LME warehouses, has risen through 1Q10
and stood at just over 5% of the total stock in mid‐March. As a result the LME copper
inventory has fallen 8% from the 555kt peak at the end of Feb 2010 to around 511kt at
the time of writing.

The key difference between the Mar 2009 and Mar 2010 figures is the geographical
spread of the cancelled warrants (LME has warehouses around the world to ease the
delivery of physical metal to customers). In 2009, around 55% of cancelled warrants
were for deliveries from warehouses in Asia, with the rest being in Europe. The US
warehouses saw virtually no activity at the time. This time, however, around 32% of
the cancelled warrants relate to deliveries from the US warehouses, 45% from Europe
and just 23% from Asia. This could indicate that some interest in copper is re‐emerging
in the US and Europe. Indeed, copper manufacturers have reported an increase in
orders from those economies.

While it is too early to interpret the above picture as an indication of demand
resurgence in the US and EU, we could interpret it as a sign that restocking by
manufacturers in those markets is already underway. As we move into the April‐May
restocking period for key copper consumers, we will watch the drawdown of LME
copper inventories closely as an indication of the supply‐demand balance in the
market and the pace of restocking in the key global economies.

2
6

Companies

2
7

GAISKY
Copper Whopper
GOK

We initiate coverage of Gaisky GOK (GGOK) with a BUY rating and a fair value
BUY estimate of $671/share, representing 124% upside potential. The company looks
Fair value $671 undervalued both in terms of our DCF valuation and a comparison with developed
and emerging market peers. Moreover, the recovery in base metal prices has yet to
Potential upside 124% be reflected in the stock’s performance.

Bloomberg code GGOK RU
Figure 1: GGOK: Russia’s second‐largest copper concentrate producer

Reuters code GGOKI.RTS GGOK's share of Russian copper in Share of ABC1 reserves of largest
Price (ordinary, $) 300.0 concentrate production (2009E) Russian producing deposits (2007)
Price (preferred, $) n/a Volkovskoe
Potential upside (%) 124% GGOK Other Gai
UMMC ‐ (UMMC)
Potential upside, prefs (%) n/a 11% Co's (UMMC)
other Talnakhskoe 5%
ADR ratio (x) n/a 3% 15% Yubileynoe
17% (Norilsk)
(UMMC)
25%
Share data 5%
No. of ordinary shares (mn) 0.6 Oktyabrskoe
Norilsk
No. of preferred shares (mn) n/a (Norilsk)
69%
Daily turnover ($mn) 0.02 50%
Free float (%) 15.4%
Market capitalisation ($mn) 185
Source: Reuters, InfoGeo, Research Bureau ’Mineral’, Company data, Aton estimates
Major shareholders
UGMK 84.6% Organic growth expected through capacity expansion. GGOK’s investment
programme is aimed at increasing the throughput capacity of its enrichment plant by
FINANCIALS ($mn) 2009E 2010E 2011E 33% (from 6mtpa to 8mtpa) by end‐2013, which will boost copper and zinc output.
Revenue 282 369 412
Gross profit 97 172 192 The company expects a 42% increase in copper concentrate production by end‐2013.
EBITDA 91 164 183 Copper concentrate and gold output make up around 86% of the company’s total
Net income 35 87 97 sales. With the expansion of the enrichment plant capacity, the company believes its
EPS (USD) 57 140 157 copper concentrate production should jump by up to 42% by end‐2013. GGOK has also
Gross debt 232 283 298 indicated that its gold and silver output would remain flat going forward.
Equity 233 320 416

Assets 510 644 760
Most base metal prices expected to recover to pre‐crisis levels in 2010. The

Bloomberg consensus estimates that we use in our calculation show the market
VALUATION
expects copper prices to return to pre‐crisis levels in 2010, implying an average price
P/E (x) 5.3 2.1 1.9
of $6,875/t, up 32% YoY, ($7,265/t in 1Q10), before hitting a new average high of
EV/EBITDA (x) 4.4 2.4 2.2
Earnings growth (%)
around $7,358/t in 2011. Zinc is expected to rise 37% YoY in 2010, to around $2,307/t
319% 145% 12%
P/B (x) 0.8 0.6 0.4
($2,306 in 1Q10), before trading at an average of $2,513/t in 2011.
RoA (%) 6.9% 13.4% 12.7%

RoE (%) 15.1% 27.1% 23.2% Our valuation suggests the stock has upside potential of 124%. Both our DCF model
and comparative analysis suggest that the market has significantly undervalued GGOK:
PERFORMANCE the company trades at a 66% discount on 2010E EV/EBITDA to developed market
1M (%) 9% competitors and a 77% discount to emerging market competitors, while our DCF
3M (%) 16% valuation of $565/share suggests 88% upside potential to the current share price. In
12M (%) 216% addition, while most metals prices have almost recovered to pre‐crisis levels, GGOK
52‐week high ($) 300.00 still trades at half its pre‐crisis peak, which is not justified, in our view.
52‐week low ($) 95.00

2
8

Company background
GGOK is the second‐largest copper concentrate producer in Russia, after Norilsk Nickel.
The total lifespan of GGOK assets is Copper concentrate and gold bars are its main products, which we expect contributed
around 50 years, disregarding follow‐up up to 86% of sales in 2009. We forecast 2009 copper in concentrate production of 78kt
exploration (+4% YoY) and gold output of 1.6 tonnes (‐4% YoY). GGOK sells its concentrate to
majority owner UMMC and its gold bars to Gazprombank. Concentrate transactions
are at a 48‐49% discount to LME copper and zinc prices.

GGOK operates three polymetallic deposits, with total ore reserves of more than
300mnt, and a limestone mine (Figure 2). At the current enrichment plant capacity of
6mntpa, the assets’ lifespan is calculated to be around 50 years (disregarding any
follow‐up exploration).

Figure 2: Reserves
Ore reserves, Annual mining Lifespan,
Deposit Mineral
mnt capacity, ktpa years
Gaiskoye Cu, Zn, Au, Ag 300 5,000 50
Kamenskoye Au, Ag 1 300 1
Osennee Cu, Zn, Au, Ag 7 500 2
Severo‐Irklinskoye Limestone
Source: Company data

GGOK owns four other deposits in various stages of development, but we expects this
supplementary resource base to substitute retired deposits to allow the company to
maintain production at current levels rather than boost its production volumes.

Ownership and dividends
Free‐float is 15%, or $26mn based on its Urals Mining and Metallurgical Company (UMMC) is the majority owner of GGOK. Total
current market cap free‐float amounts to around 15%, allowing the daily volume traded to average around
$25,000 over the past three months.

Figure 3: Ownership structure
UMMC, Free
84.6% float,
15.4%


A low free‐float and the presence of a single major shareholder are often cited as risks
for minority shareholders in Russia. Moreover, in GGOK’s case the low transparency of
the parent company may pose a higher corporate governance risk. In the past some
Russian companies have launched hostile and dilutive share issues and engaged in
other activities that have flouted the wishes and rights of their minority shareholders.

On the positive side, GGOK’s free‐float has remained stable since 2006. Moreover, the
company currently finances its expansion programme by increasing borrowings, not

2
9

through issuing equity. Hence we consider the risk of new share issues and free‐float
dilution to be low.

GGOK has not paid any dividends since 1993, when it was incorporated into an open
joint stock company (OJSC). With the current investment programme in full swing, we
would not expect any dividend payments in the near future.
Production growth through capacity expansion
GGOK produces copper and zinc concentrates, gold and silver. Through 2005‐08
Copper and gold remain key products, copper concentrate output remained relatively flat at around 75ktpa. Changes in
generating 86% of revenue, with zinc production of other metals were also insignificant. Copper concentrate production
and silver contributing another 7% should account for around 93% of the company’s output and around 70% of sales.
Although the share of precious metals to total production is minor, it accounts for
around 22% of sales (Figure 4).

Figure 4: Sales volumes and revenue breakdown by product
Sales volume breakdown (2009E) Revenue breakdown (2009E)
Gold Silver Other

Silver 7%
0.002% 0.03%
5%
Zinc
6.6%
Gold
17%
Copper
Copper 69%
93.4% Zinc
2%


Recently, the company reported that in 2009 its output of copper in concentrate grew
4% YoY, to 78kt, although gold output fell 4% YoY to 1.6 tonnes.

The current capacity of GGOK’s enrichment plant is around 6mntpa of ore processing.
By the end of 2013 the company plans to increase its capacity by 33% to 8mntpa. This
Copper output forecast to increase by should result in efficiency improvements, leading to an increase in copper and zinc
up to 42%, to 111kt by 2013 production. The company expects the expansion of the enrichment plant to boost
copper in concentrate production to 111kt (up 42%) and zinc to 7.7kt (up 39%)
respectively by YE13, although we have modelled a more gradual increase in output
(Figure 5). The company has also indicated that its gold output would remain relatively
flat going forward.

Figure 5: Production schedule
Copper, kt Zink, Kt
130
120
8
110 7
100 7
90 6
6
80 8 6 6 111
6 104
97
70 85 90
75 75 78 79
60
50
2009E
2010E
2011E
2012E
2013E
2014E
2015E
2007
2008


3
0

Financials – production growth and metal prices are the major drivers
GGOK showed a considerable improvement in financials through 2003‐08, mainly on
the back of metal price increases. In particular, revenue grew at a CAGR of 44%, from
$88mn in 2003 to $260mn in 2006, when EBITDA and net income margins reached
peaks of 43% and 26%, respectively. However, margins were subsequently curbed by a
considerable increase in CoGS and SG&A expenses, pushing the 2008 EBITDA margin
down 23% and the net margin to 3%, although we believe that part of that reduction
was due to the sharp fall in copper prices in 2H08 (Figure 6).

Figure 6: Breakdown of key financials
Net income Income tax
Other expense (net) Interest expense, (net)
SG&A CoGS
100%
80%
60%
40%
20%
0%
2009E
2010E
2006
2007
2008


Our 2009 forecast is based on GGOK’s 3Q09 RAS financial results and recently released
production volumes. While we expect a 13% YoY reduction in revenue to $282mn on
the back of lower copper and zinc prices in 1H09, we forecast margins to improve on
the back of effective cost control. The company managed to bring down its 9M09 CoGS
by around 29% vs 9M08.

We do not expect the cost reduction to be fully sustainable going forward, and
therefore forecast GGOK’s CoGS to grow at a CAGR of 12% in 2010‐12 vs a 9% CAGR in
revenues during that period. However, we do anticipate that the lower cost base will
have a positive impact on margins, as summarised in Figure 7 below.

Figure 7: Key financial figures ($mn)
2005 2006 2007 2008 2009E 2010E
Sales 148 260 302 325 282 369
EBITDA 37 111 104 75 91 164
EBITDA margin 25% 43% 34% 23% 32% 44%
Net income 17 67 53 8 35 87
Net margin 12% 26% 18% 3% 13% 23%

We forecast revenue growth of 31% YoY for 2010, to $369mn, driven by higher metal
prices and an increase in copper output, which we expect to rise 2% YoY to about 79kt.
We expect this to generate an increase in EBITDA of 79% YoY to $164m, with net
income climbing 145% YoY to $87mn, demonstrating the firm’s operational leverage.

3
1

Debt load is manageable
GGOK’s debt position remains manageable, in our view. By the end of 2009 we expect
gross debt of around $232mn, with long‐term debt accounting for more than 90% of
Gross debt/EBITDA ratio is around 2.5x the total. This implies a gross debt/EBITDA ratio of 2.5x, down from 3.2x at the end of
2008 (Figure 8).

Figure 8: Debt load
Gross debt (LHS ‐ $mn) EBITDA (LHS ‐ $mn)
Gross debt/EBITDA (RHS)
400 4.0
300 3.0
200 2.0
100 1.0
0 0.0
2009E
2010E
2011E
2012E
2013E
2014E
2015E
2005
2006
2007
2008


Due to the ongoing expansion programme we expect the debt load to remain stable in
the near future. Nevertheless, we consider the current level of debt to be manageable
as we believe that internally generated cash flows should be more than sufficient to
service future repayment commitments. Moreover, GGOK should be able to rely on
the ongoing support of its parent company, UMMC, for which it is the key producing
asset.

Valuation
We base our valuation on a weighted average of our five‐year DCF calculation, with a
combination of 6x 2010 forecast P/E and 4x 2010 forecast EV/EBITDA multiples, taken
in proportion 50:25:25, respectively. Our DCF model assumes a terminal growth rate of
1% and a WACC of 11.9%. This results in a fair value estimate of $671 per ordinary
share, implying 124% upside potential (Figure 9). We therefore rate the stock a BUY.

Figure 9: Elements of fair value calculation ($/share)
1000 840
800 717 671
600 563
400 300
200
0
EV/EBITDA
P/E
DCF
Current
Fair value
share
price


Within this valuation, we believe our DCF calculation allows us to incorporate not just
the current financial position of the company but also its visible future development
opportunities. We summarise our DCF approach in Figure 10 below.

3
2

Figure 10: GGOK – DCF model ($mn, unless otherwise stated)
2010E 2011E 2012E 2013E 2014E 2015E
NOPLAT 114 128 127 78 59 63
Amortisation 28 31 33 31 32 34
Capex ‐100 ‐83 ‐67 ‐31 ‐32 ‐34
Change in WC ‐6 ‐10 ‐11 3 ‐8 ‐5
FCFF 36 66 83 81 51 58
WACC (%) 11.9%
Discounted FCFs 270
Terminal value 290
Net debt, 2009E 212
Fair equity value 348
Number of shares (mn) 0.6
Fair value ($/share) 563

Our DCF valuation incorporates GGOK’s growth plans, and results in a fair value
estimate of $563 per share. In our downside scenario, we also considered a scenario
where production volumes remain flat, with the company simply seeking to maintain
margins at their five‐year historical average. This would result in a DCF of $455/share,
which represents 52% upside to the current share price.

We have also looked at the sensitivity of our fair value calculation to various WACC and
terminal growth rate assumptions, as summarised in Figure 11 below.

Figure 11: Fair value sensitivity to WACC and terminal growth rate assumptions
Terminal growth rate
WACC 0.0% 0.5% 1.0% 1.5% 2.0%
9.9% 730 747 765 786 809
10.9% 686 699 713 729 747
11.9% 649 659 671 683 697
12.9% 618 626 635 645 656
13.9% 591 598 605 614 622

Our comparative analysis gives an idea of GGOK’s upside potential in light of the
current market environment and general investor attitude towards the sector. We
have compared GGOK with Russian peers and copper producers from both developed
markets (DM) and emerging markets (EM).

As shown in Figure 12 below, the company is significantly undervalued vs DM and EM
peers on both 2010E and 2011E multiples. In particular, GGOK trades at 84% and 89%
discounts to DM and EM peers, respectively, based on its forecast 2010E P/E multiples
(Figure 12).

Figure 12: GGOK comparison with peers (median valuation ratios)
2010 2011
P/E (x) P/S (x) EV/S (x) EV/EBITDA (x) P/E (x) P/S (x) EV/S (x) EV/EBITDA (x)
Russian peers 2.8 0.5 1.1 2.4 2.4 0.4 1.0 2.2
Developed markets 13.4 2.1 2.5 7.1 10.6 1.9 2.2 5.8
Premium/(Discount) ‐79% ‐76% ‐57% ‐66% ‐78% ‐76% ‐57% ‐62%
Emerging markets 19.0 2.4 2.3 10.8 12.7 2.1 1.9 7.8

Gaisky GOK 2.1 0.5 1.1 2.4 1.9 0.4 1.0 2.2
DM Premium/(Discount) ‐84% ‐76% ‐57% ‐66% ‐82% ‐76% ‐57% ‐62%
EM Premium/(Discount) ‐89% ‐79% ‐53% ‐77% ‐85% ‐79% ‐49% ‐72%

3
3

Based on our forecast 2010E EV/EBITDA multiples, GGOK trades at a 66% discount to
DM companies and a 77% discount to EM ones.

We based our valuation of GGOK on 6x 2010 forecast P/E and 4x 2010 forecast
EV/EBITDA, resulting in valuations of $840/share and $717/share, respectively.

A summary of our fair value’s sensitivity to various P/E and EV/EBITDA multiples is
given in Figure 13.

Figure 13: Fair value sensitivity to P/E and EV/EBITDA multiple assumptions
P/E
EV/EBITDA 4.0 5.0 6.0 7.0 8.0
2.0 468 503 538 573 608
3.0 535 570 605 640 675
4.0 601 636 671 706 741
5.0 667 702 737 772 807
6.0 733 768 803 838 873

A final thought: GGOK’s shares still lag the recovery in metal prices
We have looked at the performance of GGOK’s stock vs the copper price recovery
since the beginning of 2009. Figure 14 below reveals two distinct periods in the price
performances of copper and GGOK’s share price. While in the pre‐crisis period GGOK’s
shares tracked changes in the copper price, they have failed to do so since the start of
the recovery.

Figure 14: Performance of GGOK shares vs copper price
Copper, $/t (lhs) GGOK, $/share (rhs)
10000 1000
8000 800
6000 600
4000 400
2000 200
0 0
Apr‐07
Jul‐07
Oct‐07
Apr‐08
Jul‐08
Oct‐08
Apr‐09
Jul‐09
Oct‐09
Apr‐10
Jan‐07
Jan‐08
Jan‐09
Jan‐10

Source: Bloomberg

We note that while the copper price is approaching its pre‐crisis highs and has almost
returned to $8,000/t recently, GGOK’s shares are trading at less than half their earlier
levels. This divergence is not justified in our view, and hence we see the potential for
an upward correction in the share price.

3
4

Key Financials

Figure 15: Income statement (RAS, $mn)
2008 2009E 2010E 2011E 2012E 2013E 2014E 2015E
Sales 325 282 369 412 439 410 423 446
CoGS ‐245 ‐185 ‐197 ‐220 ‐245 ‐277 ‐312 ‐329
Gross profit 80 97 172 192 194 132 111 117
SG&A ‐34 ‐28 ‐36 ‐40 ‐43 ‐40 ‐41 ‐44
Operating profit 46 70 136 152 151 92 69 73
EBITDA 75 91 164 183 185 124 101 107
Interest expense, (net) ‐7 ‐27 ‐20 ‐23 ‐23 ‐14 ‐10 ‐11
Other income 12 32 29 33 35 33 34 36
Other expense ‐39 ‐33 ‐37 ‐41 ‐44 ‐41 ‐42 ‐45
EBT 12 42 108 121 120 70 51 53
Income tax ‐1 ‐7 ‐22 ‐24 ‐24 ‐14 ‐10 ‐11
Net income 8 35 87 97 96 56 40 43
Margins (%)
Gross 25% 35% 47% 47% 44% 32% 26% 26%
Operating 14% 25% 37% 37% 34% 23% 16% 16%
EBITDA 23% 32% 44% 44% 42% 30% 24% 24%
Net 3% 13% 23% 23% 22% 14% 10% 10%

Figure 16: Balance sheet (RAS, $mn)
2008 2009E 2010E 2011E 2012E 2013E 2014E 2015E
PP&E 126 123 146 164 174 174 174 174
Construction in progress 282 263 313 347 370 370 370 370
Total non‐current assets 408 387 460 512 545 545 545 545
Inventories 35 45 40 42 44 49 56 59
Accounts receivable 22 41 45 56 66 62 64 67
Other 27 17 19 20 21 21 23 23
Cash 3 20 80 129 177 116 121 157
Total current assets 88 122 185 248 308 249 262 306
Total assets 496 510 644 760 853 794 808 851
Total equity 199 233 320 416 512 569 609 652
Long‐term loans 219 215 252 265 262 153 128 130
Deferred tax liabilities 9 9 9 9 9 9 9 9
Total long‐term liabilities 227 224 261 274 271 162 137 139
Short‐term loans 20 17 31 33 33 21 19 14
Accounts payable 49 36 32 36 37 42 43 45
Total short‐term liabilities 70 52 64 69 70 63 61 60
Total liabilities 297 277 325 343 341 225 199 199
Total liabilities & equity 496 510 644 760 853 794 808 851

3
5

Figure 17: Cash flow statement (RAS, $mn)
2008 2009E 2010E 2011E 2012E 2013E 2014E 2015E
Cash flow from operations
Net income 8 35 87 97 96 56 40 43
Amortisation 29 21 28 31 33 31 32 34
Changes in WC 79 ‐41 ‐4 ‐9 ‐10 4 ‐7 ‐4
Other changes ‐5 9 ‐2 ‐1 ‐1 ‐1 ‐1 ‐1
Total cash flow from operations 112 24 109 118 118 90 64 72
Cash Flow from Investing
Capex ‐225 ‐1 ‐100 ‐83 ‐67 ‐31 ‐32 ‐34
Other changes 19 0 0 0 0 0 0 0
Total cash flow from investing ‐206 ‐1 ‐100 ‐83 ‐67 ‐31 ‐32 ‐34
Cash flow from financing
Increase in debt 91 ‐7 51 15 ‐3 ‐120 ‐28 ‐2
Total cash flow from financing 94 ‐7 51 15 ‐3 ‐120 ‐28 ‐2
Net change in cash 0 17 60 50 48 ‐61 5 36
Cash at the start of the period 3 3 20 80 129 177 116 121
Cash at period end 3 20 80 129 177 116 121 157

3
6

UCHALINSKY GOK

Strength in Zinc; Growing Exposure to Copper
We initiate coverage of Uchalinsky GOK (UGOK) with a BUY rating and a fair value
BUY estimate of $20.60/share, representing 42% upside potential. Although our DCF
model shows only modest upside (due to falling zinc output) the stock still looks
Fair value $20.60 undervalued compared to its peers. Despite the lower upside compared to GGOK or
UELM, the stock offers a strong balance sheet, with lower debt compared to its
Potential upside 42% peers.

Bloomberg code UGOK RU
Figure 1: UGOK – Russia’s largest zinc concentrate producer
Reuters code UGOKI.RTS
Price (ordinary, $) 14.50 UGOK's share of Russian zinc in UGOK's share of Russian copper in
Price (preferred, $) n/a concentrate production (2009E) concentrate production (2009E)
Potential upside (%) 42%
UMMC ‐ UGOK
Potential upside, prefs (%) n/a Other
other 7% UMMC ‐
ADR ratio (x) n/a other Co's
4%
Share data UGOK 3%
21%
No. of ordinary shares (mn) 38.1 70%
No. of preferred shares (mn) n/a
Daily turnover ($mn) 0.04 Other Norilsk
Free float (%) 11.5% Co's 69%
Market capitalisation ($mn) 552 26%
Major shareholders
UGMK 88.5%
Source: Reuters , Company data, Aton estimates

FINANCIALS ($mn) 2009E 2010E 2011E
Company plans to increase plant capacity by 20% in 2012. Copper and zinc
Revenue 422 544 585
concentrate sales account for around 77% of UGOK’s revenues. We estimate that
Gross profit 188 283 299
EBITDA
UGOK (including its Sibay subsidiary) produced 96kt of copper concentrate (up 5%
160 245 258
Net income 105 163 171
YoY) and 109kt of zinc in concentrate (down 6% YoY) in 2009. The company intends to
EPS (USD) 2.8 4.3 4.5 increase its enrichment plant capacity by 20%, from 5.4mntpa to 6.5mntpa by 2012,
Gross debt 95 118 129 boosting its copper concentrate production by 8%.
Equity 514 677 848
Assets 678 859 1,042 Zinc concentrate production to fall. We have incorporated company guidance on zinc
concentrate output in our model, assuming a 26% reduction in production in the next
VALUATION five years, from 109kt currently to 81kt in 2015. As a result, we expect zinc’s share in
P/E (x) 5.3 3.4 3.2 revenue generation to decrease from the current 21% to 17% in 2015.
EV/EBITDA (x) 3.8 2.5 2.4
Earnings growth (%) 71% 55% 5% Most base metal prices expected to recover to pre‐crisis levels in 2010. We use
P/B (x) 1.1 0.8 0.7 Bloomberg consensus estimates in our calculation, which imply base metal prices
RoA (%) 15.5% 18.9% 16.4% returning to pre‐crisis levels in 2010, with the average copper price at $6,875/t (up
RoE (%) 20.4% 24.0% 20.1% 32% YoY), before hitting a new average high of around $7,358/t in 2011. Zinc is

expected to rise 37% YoY in 2010, to around $2,307/t, trading at an average of
PERFORMANCE
$2,513/t in 2011.
1M (%) 7%

3M (%) 5%
Rated BUY as fair value estimate of $20.60/share represents 42% potential upside.
12M (%) 21%
Although our DCF model shows only modest upside, mainly due to limited growth
52‐week high ($) 15.5
52‐week low ($) 8.0
potential in zinc, on a comparative basis the stock still looks significantly undervalued
vs its international peers, trading at an average discount of 78% on a 2010E P/E basis

and a 71% discount on 2010E EV/EBITDA. While the potential upside UGOK offers may
not be as high as that available from UGOK or UELM, we still rate it a BUY on the back
of its dominant position in Russian zinc concentrate production and solid balance
sheet with low debt.

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7

Company background
UGOK is the largest zinc concentrate producer and third‐largest copper concentrate
producer in Russia. It consolidates the operations of two companies: Uchalinsky GOK
and its Sibay subsidiary. Copper and zinc concentrates are the major products, which
we expect to contribute up to 77% of sales in 2009. We expect 2009 consolidated
production of copper in concentrate to be 96kt (up 5% YoY), while zinc concentrate
output should be around 109kt (down 6% YoY). In addition to copper and zinc
concentrates, UGOK produces gold and silver as by‐products.

Total lifespan of UGOK assets is around UGOK operates five polymetallic deposits, with total ore reserves of more than
25 years, disregarding follow‐up 132mnt, as well as the Yuldashevskoye limestone mine (Figure 2). At the current
exploration enrichment plant capacity of 5.4mnt of ore per year, the company’s reserves should
last for around 25 years (disregarding any follow‐up exploration).

Figure 2: Reserves
Ore reserves, Annual mining Lifespan,
Mineral
mnt capacity, ktpa years
Uchalinskoye Cu, Zn, Au, Ag 18 1,600 12
Uzelginskoye Cu, Zn, Au, Ag 64 2,600 24
Molodeznoye Cu, Zn, Au, Ag 5 400 10
Talganskoye Cu, Zn, Au, Ag 2 300 7
Zapadno‐Ozernoye Cu, Zn, Au, Ag 43 400 100
Yuldashevskoye Limestone

UGOK operates three other deposits, which are at various stages of development, but
as with its sister company GGOK (with which it shares a majority owner), we expect
these to substitute retiring fields to allow the company to maintain current output
levels.

Urals Mining and Metallurgical Company (UMMC) is the major shareholder of UGOK,
Free‐float is 12%, or $61mn based on its
with an approximately 88% holding. This leaves free‐float of around 12%. Due to low
current market cap
free‐float the stock’s daily liquidity has averaged at around $43,000 over the past
three months.

Free‐
float
11.5%
UMMC
88.5%


Low free‐float is often viewed as a threat to minority shareholders, particularly in
Russia. In the past some Russian companies have acted with complete disregard for
minority shareholders, with hostile and dilutive share issues being common. Judging
by UGOK’s financial reports, free‐float has remained stable since at least 2006. The
only change in UMMC’s ownership has been a rationalisation of the shareholding

3
8

between the holding company’s internal structures in 2007, although this had no
impact on UGOK’s free‐float. Moreover, UMMC is busy investing in growing and
modernising the business, preferring to finance the process through borrowing than
turning to shareholders. Therefore, while limited free‐float could still be viewed as a
risk, in the current environment we rate the risk as reasonably low. By way of
reference, the current free‐float of the five largest listed Russian steelmakers ranges
between 13% and 28%. Rusal’s free‐float is 10.8%, while Norilsk Nickel has the largest,
at just under 40%.

UGOK does not pay dividends at present. According to the company’s reports, it has
made only two pay‐outs in the past: a quarterly dividend for 1Q04 and an annual
dividend for 2006. The pay‐out ratio at the time did not exceed 3% of net income.
Given the ongoing capex programme, we see the likelihood of dividend payments as
low.

Production mix is gradually shifting in favour of copper
The company consistently grew its output through 2005‐08, with production of copper
in concentrate increasing at a CAGR of around 10%, while output of zinc in concentrate
remained relatively flat.

Copper output expected to increase by For 2009 we expect copper concentrate production of 96kt (up 5% YoY) and zinc
8%, to around 103ktpa by 2012 concentrate output of 109kt (down 6% YoY). Output is currently constrained by the
processing plant capacity, which is around 5.4mntpa. The company is planning to
increase its capacity by 20%, to 6.5mntpa by the end of 2012. Based on the guidance
we received from the company, we expect the expansion of UGOK’s enrichment plant
capacity to boost copper concentrate output by 8%, to 103kt by 2013, while zinc
concentrate production should see a reduction due to deteriorating ore grades, as the
company has indicated to us (Figure 4).

Figure 4: Production schedule
Copper, kt Zinc, kt
250
200
150 117 116 109 104 99 94 90 85 81

115 121
100
50 80 91 96 96 98 101 103 103 103

68 69
‐
2009E
2010E
2011E
2012E
2013E
2014E
2015E
2005
2006
2007
2008


Zinc production peaked in 2006, when total zinc concentrate output was 121kt, and
Zinc production forecast to fall to has been falling gradually ever since. According to company guidance, no increase in
81ktpa (26%) by 2015 due to lower zinc output is expected as a result of the improved plant capacity. We have therefore
grades modelled a 26% reduction in zinc output to 81kt in 2015.

Precious metals augment the sales mix
UGOK’s output is dominated by zinc and copper concentrates, with precious metals
contributing less than 0.1% to overall sales volumes. However, the presence of
precious metals gives a considerable boost to UGOK’s revenues. We forecast gold’s
share of 2009 revenue to be around 12%, with silver contributing another 6% (Figure
5).

3
9

Figure 5: Sales volumes and revenue breakdown by product
Sales volume breakdown (2009E) Revenue breakdown (2009E)
Gold Silver Silver Other

0.001% 0.03% 6% 4%
Gold
12%
Copper
Zinc Copper
46.7%
53.2% Zinc 57%
21%
Copper and zinc remain key products,
generating 78% of revenues, with gold
and silver contributing another 18%
Financials – improvements expected on the back of higher metal prices
UGOK delivered consistent improvements in financials from 2003‐06 on the back of
increased production volumes (in particular copper concentrate) and higher metal
prices. Revenues grew from $94mn in 2003 to $432mn in 2006 (a CAGR of 66%), while
net income rose from $9mn to $138mn in the same period (a CAGR of 152%). As a
result, UGOK’s net income margin reached a peak of 32% in 2006. However, growing
production and sales volumes have led to an inevitable increase in CoGS and SG&A
expenses, reducing the net margin to 24% in 2007. A sharp fall in copper prices in 2008
led to a further weakening of the net margin, to 12% (Figure 6).

Figure 6: Breakdown of key financial margins
Other expense, (net) Interest expense, (net)
SG&A CoGS
100%
80%
60%
40%
20%
0%
2009E
2010E
2006
2007
2008


Our 2009 forecast is based on UGOK’s 3Q09 RAS financials and a recent update on
FY09 net income, which came in at $105mn. We estimate that this implies an EBITDA
margin of 38% and a net margin of 25%, taking UGOK back to pre‐crisis levels. This
improvement was due to substantial cost reduction (9M09 CoGS was down 37% vs
9M08), as we forecast a 15% YoY fall in revenue for FY09. While we do not expect the
reduction in costs to be fully sustainable going forward, a lower cost base should
nevertheless have a positive impact on future margins (Figure 7).

4
0

Figure 7: Key financials ($mn)
2005 2006 2007 2008 2009E 2010E
Sales 219 432 544 497 422 544
EBITDA 56 210 214 127 160 245
EBITDA margin 26% 49% 39% 26% 38% 45%
Net income 25 138 132 61 105 163
Net margin 12% 32% 24% 12% 25% 30%

For 2010 we forecast sales of $544mn (up 29% YoY), supported by higher metal prices
and greater copper output, offset somewhat by a decrease in zinc concentrate
production. As a result, we forecast EBITDA to increase 53% vs 2009 to $245mn and
net income to rise 55% YoY to $163mn.

Debt load to remain benign
The company has a relatively low debt load. We forecast gross debt to be around
Gross debt/EBITDA ratio $95mn in 2009 (net debt of $61m) with long‐term debt accounting for around 85% of
forecast at 0.6x the total. This implies a forecast gross debt/EBITDA ratio of around 0.6x and net
debt/EBITDA of 0.4x (Figure 8).

Figure 8: Debt load remains benign
300 1.5
250
200 1.0
150
100 0.5
50
0 0.0
2009E
2010E
2011E
2012E
2013E
2014E
2015E
2005
2006
2007
2008


With the facilities upgrade ongoing, we expect UGOK’s debt to remain at these levels
in the near future.

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1

Valuation
We base our valuation of UGOK on a weighted average of our DCF calculation
combined with 6x forecast 2010 P/E and 4x forecast 2010 EV/EBITDA multiples, taken
in 50:25:25 proportion, respectively. Our DCF model incorporates a terminal growth
rate of 1% and a WACC of 12.6%. We arrive at fair value of $20.60 per ordinary share,
implying 42% upside potential. We therefore assign the stock a BUY rating.

One of the main risks to our valuation comes from the expected reduction in zinc
output, as indicated to us by the company. Our DCF model incorporates a 26%
reduction in zinc production between 2009 and 2015. As a result, our DCF valuation of
$16.32/share gives just 13% upside potential over the current share price of
$14.50/share (Figure 9). This, we believe, is the downside valuation for the stock.

Figure 9: UGOK DCF model ($mn, unless otherwise stated)
2010E 2011E 2012E 2013E 2014E 2015E
NOPLAT 177 186 168 99 95 94
Capex ‐130 ‐125 ‐100 ‐85 ‐68 ‐58
Change in WC 80 ‐9 ‐3 19 10 1
FCFF 155 82 95 59 63 63
WACC (%) 12.6%
Discounted FCFs 394
Terminal value 288
Net debt, 2009E 61
Number of shares (mn) 38
Fair value ($/share) 16.32

Figure 10 below summarises the sensitivity of our fair value calculation to a range of
WACC and terminal growth rate assumptions.

WACC 0.0% 0.5% 1.0% 1.5% 2.0%
10.6% 21.54 21.79 22.07 22.37 22.71
11.6% 20.85 21.05 21.27 21.50 21.77
12.6% 20.26 20.42 20.60 20.79 21.00
13.6% 19.76 19.89 20.04 20.19 20.36
14.6% 19.33 19.44 19.55 19.68 19.82

As the output of zinc concentrate falls and copper concentrate increases, the share of
copper in UGOK’s production mix should increase substantially: from around 47%
currently to 55‐60% in 2015, by our estimates. This allows us to value the company
based on a comparison with other major copper producers from Russia and peers from
developed and emerging markets (zinc is one of the main by‐products in many copper
deposits around the world, often accounting for up to 40‐50% of output). The stock is
currently trading at an average discount of 78% to its DM and EM peers on a 2010E P/E
basis and a 71% discount on 2010E EV/EBITDA (Figure 11), on our numbers.

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2

Figure 11: UGOK comparison with peers (median valuation ratios)
2010E 2011E
Russian peers 2.8 0.5 1.1 2.4 2.4 0.4 1.0 2.2

Uchalinsky GOK 3.4 1.0 1.1 2.5 3.2 0.9 1.0 2.4
DM Premium/(Discount) ‐75% ‐51% ‐55% ‐65% ‐70% ‐50% ‐53% ‐59%
EM Premium/(Discount) ‐82% ‐58% ‐51% ‐77% ‐75% ‐55% ‐45% ‐69%

We base our valuation of UGOK on 6x 2010E P/E and 4x 2010E EV/EBITDA multiples,
resulting in valuations of $25.63/share and $24.13/share respectively. In Figure 12
below we summarise the sensitivity of the company’s valuation to a range of P/E and
EV/EBITDA multiples used in our fair value calculations.

Figure 12: Fair value sensitivity to PE and EV/EBITDA multiple assumptions
P/E
EV/EBITDA 4.0 5.0 6.0 7.0 8.0
2.0 15.25 16.31 17.38 18.45 19.52
3.0 16.85 17.92 18.99 20.06 21.13
4.0 18.46 19.53 20.60 21.67 22.74
5.0 20.07 21.14 22.21 23.28 24.34
6.0 21.68 22.75 23.82 24.88 25.95

While limited growth upside due to falling zinc output, as reflected in narrow upside
on our DCF calculation (Figure 13), may be of concern, we would highlight UGOK’s
strong balance sheet and low debt as definite attractions. We believe the debt load
would remain low as the current expansion programme is not very capital intensive.

Figure 13: Breakdown of company valuation ($/share)
30
25.63 24.13
25
20.60
20 16.32
14.50
15
10
5
0
EV/EBITDA
P/E
DCF
Current
Fair value
share
price


Moreover, the company has a near monopoly position as a supplier of zinc concentrate
to the Russian market, a position it is likely to maintain for at least the next two‐to‐
three years. Its growing exposure to copper should also have a positive impact on the
stock’s mid to long‐term financial performance.

We therefore assign the stock a BUY rating as we believe that, despite limited organic
growth potential (compared to its sister companies, GGOK and UELM) its solid
foundation in zinc offers a degree of downside protection, while growing copper
exposure could provide reasonable upside on the back of higher metal prices.

4
3

A final thought: UGOK’s shares have some catching up to do with base metal prices
We have assessed the stock’s performance vs the recovery in copper prices from the
troughs reached at the end of 2008. We looked at the relative performances of the
stock and copper from 1 Jan 2009 – a rough starting point for the current rally in
metals, as shown in Figure 14 below.

Figure 14: Performance of UGOK shares vs copper price
Copper, $/t (lhs) UGOK, $/share (rhs)
10000 27.5
8000 22.5
6000 17.5
4000 12.5
2000 7.5
0 2.5
Apr‐07
Jul‐07
Oct‐07
Apr‐08
Jul‐08
Oct‐08
Apr‐09
Jul‐09
Oct‐09
Apr‐10
Jan‐07
Jan‐08
Jan‐09
Jan‐10

Source: Bloomberg

UGOK shares have been slow in reacting to gains in commodity prices, staying flat
throughout most of 2009 and only recently starting to recover towards pre‐crisis
levels. Assuming that at least some of the base metal price rally is still to be reflected
in the stock price, the shares could see an upward correction in the coming months, in
our view.

4
4

Key Financials

2008 2009E 2010E 2011E 2012E 2013E 2014E 2015E
Sales 497 422 544 585 591 527 509 504
CoGS ‐333 ‐234 ‐261 ‐286 ‐313 ‐343 ‐331 ‐328
Gross profit 164 188 283 299 278 184 177 176
SG&A ‐68 ‐53 ‐65 ‐70 ‐71 ‐63 ‐61 ‐60
EBITDA 127 160 245 258 236 147 142 140
Other income 15 24 22 23 24 21 20 20
Other expense ‐27 ‐25 ‐32 ‐34 ‐35 ‐31 ‐30 ‐30
EBT 84 124 203 213 192 108 105 104
Income tax ‐19 ‐19 ‐41 ‐43 ‐38 ‐22 ‐21 ‐21
Net income 61 105 163 171 153 87 84 83
Margins (%)
Gross 33% 45% 52% 51% 47% 35% 35% 35%
Operating 19% 32% 40% 39% 35% 23% 23% 23%
EBITDA 26% 38% 45% 44% 40% 28% 28% 28%
Net 12% 25% 30% 29% 26% 16% 16% 16%

2008 2009E 2010E 2011E 2012E 2013E 2014E 2015E
PP&E 232 224 303 390 460 531 577 611
Other 29 38 39 40 41 42 43 44
Inventories 52 64 65 71 73 75 68 67
Cash 0 34 196 273 341 342 390 440
Total assets 494 678 859 1,042 1,185 1,231 1,311 1,392
Total equity 411 514 677 848 1,001 1,088 1,171 1,254
Long‐term loans 0 80 98 103 94 59 57 56
Short‐term loans 14 15 20 26 24 15 14 14
Total liabilities & equity 494 678 859 1,042 1,185 1,231 1,311 1,392

4
5

2008 2009E 2010E 2011E 2012E 2013E 2014E 2015E
Net income 61 105 163 171 153 87 84 83
Amortisation 27 29 30 26 25 25 0 0
Changes in WC 45 ‐150 80 ‐8 ‐3 19 10 1
Other changes ‐5 1 ‐1 ‐1 ‐1 ‐1 ‐1 ‐1
Total operating cash flow 133 ‐19 269 190 179 131 118 108
Cash flow from investing
Capex ‐129 ‐47 ‐130 ‐125 ‐100 ‐85 ‐68 ‐58
Other changes ‐11 16 0 0 0 0 0 0
Increase in debt 2 81 23 11 ‐11 ‐45 ‐2 ‐1
Deferrals 1 2 0 0 0 0 0 0
Total cash flow from financing 4 83 23 11 ‐11 ‐45 ‐2 ‐1
Net change in cash ‐2 34 162 77 68 1 47 50

4
6

URALELECTROMED
Breaking Away From Old Misconceptions

We initiate coverage of Uralelectromed (UELM) with a BUY rating and a fair value of
BUY $118 per share, representing 96% upside potential. UELM is one of the largest
copper refineries in the world and the key subsidiary of UMMC, consolidating most
Fair value $118 of the group’s copper flows. We like its organic growth potential, while poor
corporate transparency and low stock liquidity are the main risks.
Potential upside 96%
Figure 1: UELM – One of the world’s largest copper refineries by capacity (kt)
900
Bloomberg code UELM RU 1000
Reuters code UELMI.RTS
Price (ordinary, $) 60.0 800

Price (preferred, $) n/a
500
600 490
470
450
450
Potential upside (%) 96%
415
400
400
400
395
390
380
380
380
360
350
350
345
330
330
Potential upside, prefs (%) n/a
400
ADR ratio (x) n/a
200
Share data
No. of ordinary shares (mn) 5.1 0
Iio Refinery
Guixi
Codelco Norte
Jinlong
Olen
Morenci
Sterlite
Birla
Hamburg
Norilsk
Amarillo
El Paso
Jinchuan
Yunnan
CCR‐Montreal
Pyshma‐UELM
Toyo/Niihama
Escondida
Onsan
Chuquicamata
Las Ventanas
No. of preferred shares (mn) n/a
Daily turnover ($mn) 0.02
Free float (%) 18.4%
Market capitalisation ($mn) 304
Major shareholders
UGMK 81.6%

Source: International Copper Study Group (ICSG)

FINANCIALS ($mn) 2009E 2010E 2011E Tolling scheme viewed as a hindrance – erroneously, in our view: We estimate that
Revenue 583 772 837 around 80‐90% of UELM’s copper output is produced under a tolling scheme, with the
Gross profit 118 280 317 company receiving a pre‐agreed fee for processing UMMC’s raw materials. The
EBITDA 84 236 269 scheme is similar to those used by the majority of global copper producers, which pay
Net income 25 111 128 treatment and refining charges to copper smelters and refiners due to a lack of captive
EPS ($) 4.9 21.8 25.2 processing capacity. According to the company its refining fee is $250‐$300/t, which
Gross debt 239 378 430 compares favourably with the current benchmark refining charge of about $103/t
Equity 370 480 608 ($0.0465/lb) recently agreed by global refiners, down from $165/t in 2009.
Assets 779 962 1,119

UMMC plans to increase UELM’s capacity by about 32% by end‐2012: UELM’s design
VALUATION capacity is 300ktpa, however the plant is able to process up to 380ktpa of copper
P/E (x) 12.3 2.8 2.4 (achieved in 2007) and is currently operating at a run‐rate of 350ktpa. The ongoing
EV/EBITDA (x) 6.4 2.3 2.0
modernisation programme should increase capacity by 32% to 500ktpa by end‐2012.
Earnings growth (%) ‐40% 347% 15%
Operating at that level would allow a 40% increase in output from current levels.
P/B (x) 0.8 0.6 0.5
RoA (%)

3.2% 11.5% 11.4%
RoE (%)
Metals price recovery to boost company financials: UELM is a copper producer in its
6.7% 23.0% 21.0%

own right, albeit a small one, through ownership of the Safyanovskaya Med copper
PERFORMANCE
mining subsidiary. Captive copper production is sold at market prices, and
1M (%) 10%
strengthening copper prices should give an additional boost to UELM’s financials.
3M (%) 38%
12M (%) 106% The stock offers upside potential of 96%, on our numbers. UELM looks undervalued
52‐week high ($) 60.0 based on both our DCF calculation and comparative valuation multiples. We value the
52‐week low ($) 21.0 stock at $118/share, representing potential upside of 96% to the current share price.
Moreover, we believe the ongoing copper price rally has not been fully reflected in the
share price.

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7

Company background
UELM is UMMC’s key asset, Uralelectromed is one of the largest copper refineries in the world by installed
consolidating most of its copper flows capacity and the biggest in Russia. It is one of the key assets in UMMC’s production
chain and consolidates most of the group’s copper flows (see Appendix I). In 2009 it
produced about 330kt of refined copper, down 5% on 2008. The company has
indicated that the fall in production was largely due to a sharp reduction in the supply
of copper scrap (which accounts for around 20% of raw material inputs), rather than
operational or financial reasons.

The current business plan for 2010 targets production of around 357kt of refined
copper (up 8% YoY), which should put UELM within easy reach of Norilsk Nickel’s
output, which is expected to be around 363kt this year, according to Norilsk’s
management. We have remained conservative in our modelling, keeping UELM’s
production at 350kt in 2010‐11.

Production and revenues
UELM’s main products are copper cathodes, copper rod, copper powder and precious
metals. In addition, the company produces a considerable amount of copper sulphate
as well as selenium, tellurium, refined lead, sulphuric nickel and galvanising materials,
all of which are reported under the “other” category (Figure 2). An overview of UELM’s
main production flows is given in Appendix III.

Figure 2: Production volumes and revenue breakdown by product (2008)
Producion volume breakdown Revenue breakdown
Copper Precious Copper
Copper Copper Precious
sulphate metals Sulphate
powder powder Metals
6.9% 0.1% 7.3%
1.6% 8.3% 14.2%
Copper Copper
Other Other
rod rod
9.2% 19.7%
7.4% 29.1%
Cathodes
74.8% Cathodes
21.3%


Refined copper products and precious metals accounted for around 73% of total
revenues in 2008, and we estimate their proportion of sales to have remained
relatively steady in 2009. Despite being the largest output article by volume (about
75%), copper cathodes only account for around 21% of revenues. We believe this is
due to fact that the majority of copper cathode is produced from material received
under the tolling arrangement with UMMC.

Tolling scheme – a misinterpreted concept
By far the largest proportion of UELM’s activity is focused on providing refining
services to other copper‐producing entities of UMMC group under a tolling scheme.
The company also processes its own raw materials, produced by mining subsidiary
Safyanovskaya Med, although their share of total output is relatively low.

By analysing UELM’s financial reports, we calculate that materials supplied under
Around 80‐90% of output is produced
under tolling arrangement with UMMC tolling arrangements account for around 80‐90% of the total volumes produced. The
exact fees are not disclosed, but the company has indicated that the refining fee is in

4
8

the region of $250‐300/t of blister copper processed. The processing fees for precious
metals are around 10‐15% of the corresponding spot prices.

Tolling arrangements are often viewed negatively by commentators on Russian
companies. This dates to the period after the collapse of the Soviet Union when whole
industries broke down, with large parts of what were once integrated mechanisms
suddenly located in newly independent, separate states. The companies often faced
ruin as they lacked the financial and administrative resources to rebuild relationships
with what were newly foreign enterprises looking to do business in hard currency
rather than Soviet roubles.

An enterprising group of Russian businessmen and traders came to serve as
middlemen between these new autonomous companies. Tolling was one of the
schemes used. For instance, metals traders would buy the necessary raw materials
from the now‐foreign mining companies and supply them to a processing plant. Since
the processors had no means of buying the raw materials outright, the traders would
retain title to the raw materials and the processed output, paying the processing
company a fee (or toll) for their service. However, the system was greatly abused by
the middlemen: the fees were kept to a bare minimum, allowing the companies to
stay afloat but leaving them with practically no prospect of modernising and growing
their businesses. Moreover, the traders provided loans to the companies with large
equity stakes used as collateral. The companies were rarely able to service the loans,
allowing the lenders to acquire large stakes for a relatively minor outlay.

We believe the tolling arrangement between UELM and UMMC should not be viewed
in the same light as these historical schemes. There are several important factors that
differentiate the current arrangement:

 UELM is one of UMMC’s key assets that allows the company to process its
copper from a relatively low‐value form into an internationally marketable
commodity.

 Instead of running the asset into the ground, the group is investing heavily into
modernising the plant and upgrading its capacity.

Tolling scheme is akin to processing  The global copper industry works under arrangements akin to that between
arrangements used by global players UELM and UMMC. Copper producers lacking the capacity to process their own
copper concentrate pay fees (treatment and processing charges or TC/RCs) to
third‐party smelters and refiners to do it for them, while often retaining the
title to the finished product. Refining charges for 2010 agreed by Japanese
smelters and mining companies were set at US¢4.65/lb or $103/t, down from
UELM’s tolling fee looks respectable $165/t in 2009. In this light, UELM’s tolling fee of $250‐$300/t looks quite
compared to global benchmarks respectable, although we assume that UELM’s costs are higher and efficiency
lower than those of modern Japanese refiners, resulting in higher processing
costs.

 Finally, tolling should not be confused with transfer pricing, which is a scheme
used by some Russian companies to minimise their tax burden by selling their
product to an offshore affiliate at a reduced price, allowing the affiliate to
retain the majority of the profits, while understating the financial results of the
actual producers.

Total free‐float of 18.4%, or $50mn At 18.4%, UELM has the highest free‐float among the three UMMC companies under
based on the current market cap our coverage, with UMMC controlling the remaining 81.6% (Figure 3). Nevertheless,
the stock’s daily turnover remains low, averaging around $20,000 over the past three
months.

4
9

Low free‐float can be a risk for investors in Russia, with a large number of companies
having carried out hostile and dilutive share issues or having abused minority
shareholder rights in other ways in the past. However, we note that UELM’s
shareholder structure has remained relatively stable since 2006, with free‐float
reducing marginally, from 19.1% in 2006 to 18.4% currently. We therefore view the
risk of future free‐float dilution as relatively limited.

Other
18.4%
UMMC
81.6%


Moreover, in the current economic environment we would hardly expect action of this
kind from UELM, which is investing heavily in growing its business and finding it
relatively easy to secure financing from the debt market.

Finally, a quick look at major Russian metals companies, trading both in Russia and
internationally, shows that their free‐float ranges from around 11% (Rusal) to about
28% (Evraz), with only Norilsk Nickel having a free‐float approaching 40%.

UELM has not paid any dividend since at least 1998 (according to publicly available
records). We therefore see the likelihood of dividend payments as low.

Capacity increase on the way
The company is in the process of expanding its processing capacity, which it expects to
Plans to increase plant capacity by 32% increase to 500ktpa of refined copper by the end of 2012, a 32% rise from the current
to 500ktpa by end‐2012 – with potential peak capacity of 380ktpa. Given that 2009 capacity utilisation was about 87%, taking
to boost output by 52% from 2009 production up to 500ktpa would result in a 52% increase in output. We have again
levels remained conservative in our assumptions and assumed a 40% increase to around
460ktpa (about 92% operating efficiency).

Figure 4: Refined copper output (kt) Figure 5: Capex schedule ($mn)
500 460 460 120 110 107
435
400
378 361 100 88 89
400 348 352 348 350
330
80 71
300 60 59
60 54 54 54
200
40 31
100 20
0 0
2009E
2010E
2011E
2012E
2013E
2014E
2015E
2009E
2010E
2011E
2012E
2013E
2014E
2015E
2005
2006
2007
2008
2005
2006
2007
2008


5
0

We do not have confirmation of an up to date capex figure estimate, however, the
company’s past reports to the media put it at around $130mn between 2008 and
2012. The work programme was cut sharply in 2009 due to the financial crisis, and we
have therefore modelled a reduction in capex to about $30mn for that year. The
company has some catching up to do, but management is confident the expansion
project will be completed on time.

The increased capacity should allow UELM to boost its revenue from both tolling and
processing its own material. Moreover, we believe there will be opportunities for
third‐party business, should spare capacity become available. We have modelled a
relatively modest 40% increase in output, which means there could be further upside
to our numbers should the company manage to operate the plant at above the 92%
utilisation rate that we are currently assuming.

Financials
A look at UELM’s historical reports shows a considerable improvement in financials
between 2003 and 2006, with the EBITDA margin reaching a peak of 39% and the net
income margin rising to 20% in 2006. The increase in sales, which grew from $278mn
in 2003 to $634mn in 2006 (a CAGR of 32%), was the main driver behind the
improvements in the EBITDA and net income margins. However, as production and
sales grew, the inevitable upward cost‐creep had a negative impact on financials. As a
result, EBITDA declined to 18% in 2008, while the net income margin shrank to 6%
(Figure 6), although the figures were also influenced by falling copper prices.

Figure 6: Breakdown of financials
Other expense, (net) Interest expense, (net)
SG&A CoGS
100%
80%
60%
40%
20%
0%
2009E
2010E
2006
2007
2008


Our 2009 forecast is based on UELM’s 3Q09 RAS financials. We expect weaker sales of
approximately $583mn on the back of sharply lower copper prices in 1H09. This should
result in a 31% YoY reduction in EBITDA, to $84mn (with the EBITDA margin down to
14%) and a 40% fall in net income to $25mn (with the net margin down to just 4%).

We would expect UELM’s financials to improve in 2010 on the back of marginally
higher production and stronger copper prices, leading to a 32% increase in revenue to
$772mn. EBITDA is forecast to more than double from the 2009 level, to $236mn, with
net income up to $111mn (Figure 7).

Figure 7: Key financial figures ($mn)
2005 2006 2007 2008 2009E 2010E
Sales 400 634 665 685 583 772
EBITDA 102 250 161 122 84 236
EBITDA margin 26% 39% 24% 18% 14% 31%
Net income 47 126 80 41 25 111
Net margin 12% 20% 12% 6% 4% 14%

5
1

Debt load is large, but manageable
UELM’s debt level is relatively high but remains manageable in our view. By the end of
2009 we expect gross debt to stand at $239mn. As the parent company usually
accumulates all excess cash from subsidiaries, we believe that gross debt/EBITDA
offers a better indication of UELM’s debt load. We expect this ratio to reach a peak of
around 2.8x by the end of 2009 (Figure 8).

Figure 8: UELM’s debt load remains manageable
600 3.0
500 2.5
400 2.0
300 1.5
200 1.0
100 0.5
0 0.0
2009E
2010E
2011E
2012E
2013E
2014E
2015E
2005
2006
2007
2008


In early Mar 2010, UELM exercised a call option on its five‐year RUB3bn bond
(maturing in 2012) and received the majority of securities outstanding for repayment
at par value. We estimate the company spent around $100mn on this transaction,
implying a rather strong cash position. UELM set a new coupon rate for the remaining
proportion of the bonds of 8.25%, which may be used as a proxy for its cost of debt.
However, we have used a more conservative rate of 11% pre‐tax.

Due to the ongoing investment in capacity expansion, we believe the company will
need to raise further cash and so continue to access debt financing. However, due to
the forecast increase in EBITDA generation, we would expect the gross debt/EBITDA
ratio to fall steadily to a level of 1.2x by 2013, in line with the level before 2008.

5
2

Valuation
We have estimated UELM’s fair value using a DCF calculation, combined with 6x 2010
forecast P/E and 4x 2010 forecast EV/EBITDA comparative valuations, which we have
weighted in 50:25:25 proportions. We have assumed a WACC of 11.5% and a terminal
growth rate of 1%. Based on those assumptions we have arrived at a valuation of
$118/share, implying potential upside of 96% to the current share price and prompting
us to assign a BUY rating to the stock. A breakdown of our valuation is given in Figure 9
below.

Figure 9: Elements of fair value calculation
160 139
131
140 118
120 100
100
80 60
60
40
20
0
EV/EBITDA
P/E
DCF
Current
Fair value
share
price


For our downside case we have looked at the plant without future capacity expansion
and with no major improvement in margins. This scenario results in a fair value of
$79/share, which still represents a 32% premium to the current share price.

In Figures 10 and 11 below we summarise our DCF model and a range of sensitivities
based on various WACC and terminal growth rate assumptions.

Figure 10: UELM – DCF‐model ($mn, unless otherwise stated)
2010E 2011E 2012E 2013E 2014E 2015E
NOPLAT 167 191 218 153 136 109
Capex ‐107 ‐89 ‐71 ‐54 ‐54 ‐54
Change in WC ‐116 ‐37 ‐25 2 ‐8 ‐7
FCFF ‐33 90 149 128 100 75
WACC (%) 11.5%
Discounted FCFs 349
Terminal value 397
Net debt, 2009E 238
Number of shares (mn) 5.1
Fair value ($/share) 100

WACC 0.0% 0.5% 1.0% 1.5% 2.0%
9.5% 128 131 134 138 142
10.5% 120 123 125 128 131
11.5% 114 116 118 120 122
12.5% 109 110 112 113 115
13.5% 104 105 106 108 109

5
3

We have also carried out a comparative valuation using a selection of copper
producers from Russia and various developed and emerging markets. The stock is
currently trading at an average discount of 82% to its DM and EM peers on a 2010E P/E
basis and a 73% discount on a 2010E EV/EBITDA basis (Figure 12).

Figure 12: UELM comparison with peers (median valuation ratios)
2010E 2011E
Russian peers 2.8 0.5 1.1 2.4 2.4 0.4 1.0 2.2
Premium/(discount) ‐79% ‐76% ‐57% ‐66% ‐78% ‐76% ‐57% ‐62%
Premium/(discount) ‐85% ‐79% ‐53% ‐77% ‐81% ‐79% ‐49% ‐72%

Uralelectromed 2.8 0.4 0.7 2.3 2.4 0.4 0.6 2.0
DM premium/(discount) ‐79% ‐81% ‐72% ‐68% ‐78% ‐81% ‐71% ‐65%
EM premium/(discount) ‐85% ‐84% ‐70% ‐79% ‐81% ‐83% ‐66% ‐74%

We have used our standard multiples of 6x 2010 forecast P/E and 4x 2010 forecast
EV/EBITDA for our comparative valuation, resulting in fair values of $131/share and
$139/share respectively. In the following table we test our fair value calculation using
a range of P/E and EV/EBITDA multiples (Figure 13).

Figure 13: Fair value sensitivity to PE and EV/EBITDA multiple assumptions
P/E
EV/EBITDA 4.0 5.0 6.0 7.0 8.0
2.0 84 89 94 100 105
3.0 95 101 106 112 117
4.0 107 112 118 123 129
5.0 118 124 129 135 140
6.0 130 136 141 146 152

UELM still lagging far behind the copper price
As with other stocks in this report, we note that UELM now trades at levels last seen in
mid‐2005, when the copper price averaged at around $3,500/t for the year. Following
the sharp drop at the end of 2008, copper has almost recovered to its pre‐crisis peaks,
touching $8,000/t on several occasions intraday in the past few days. UELM’s share
price, in the meantime, has remained close to its three‐year low. In our view, this is not
justified for a company with direct exposure to copper and hence leaves room for
further growth (Figure 14).

Figure 14: Performance of UELM shares vs copper price
Copper, $/t (lhs) UELM, $/share (rhs)
10000 140
120
8000
100
6000 80
4000 60
40
2000
20
0 0
Apr‐07
Jul‐07
Oct‐07
Apr‐08
Jul‐08
Oct‐08
Apr‐09
Jul‐09
Oct‐09
Apr‐10
Jan‐07
Jan‐08
Jan‐09
Jan‐10

Source: Bloomberg

5
4

Key financials

2008 2009E 2010E 2011E 2012E 2013E 2014E 2015E
Sales 685 583 772 837 909 849 860 860
CoGS ‐503 ‐465 ‐492 ‐520 ‐550 ‐582 ‐615 ‐651
Gross profit 181 118 280 317 359 267 245 210
SG&A ‐80 ‐51 ‐67 ‐73 ‐79 ‐74 ‐75 ‐75
EBITDA 122 84 236 269 307 219 196 161
Other income 36 37 31 33 36 34 34 34
Other expense ‐56 ‐42 ‐55 ‐60 ‐65 ‐61 ‐62 ‐62
EBT 65 34 156 180 209 137 117 87
Income tax ‐24 ‐10 ‐46 ‐53 ‐61 ‐40 ‐34 ‐25
Net income 41 25 111 128 148 97 83 62
Margins (%)
Gross 26% 20% 36% 38% 39% 31% 28% 24%
Operating 15% 11% 28% 29% 31% 23% 20% 16%
EBITDA 18% 14% 31% 32% 34% 26% 23% 19%
Net 6% 4% 14% 15% 16% 11% 10% 7%

2008 2009E 2010E 2011E 2012E 2013E 2014E 2015E
PP&E 189 194 232 324 403 436 463 490
Other 74 144 146 147 149 151 152 154
Inventories 108 126 135 150 158 167 177 187
Other 19 119 119 119 119 120 120 120
Cash 1 2 49 127 234 107 126 109
Total assets 655 779 962 1,119 1,279 1,182 1,241 1,264
Total equity 354 370 480 608 756 853 936 998
Long‐term loans 105 115 182 208 222 127 114 93
Short‐term loans 151 124 195 223 238 136 122 100
Total liabilities & equity 655 779 962 1,119 1,279 1,182 1,241 1,264

5
5

2008 2009E 2010E 2011E 2012E 2013E 2014E 2015E
Net income 41 25 111 128 148 97 83 62
Amortisation 20 18 23 25 28 26 26 26
Changes in WC ‐5 164 ‐116 ‐37 ‐25 3 ‐7 ‐6
Other changes ‐21 9 ‐2 ‐2 ‐2 ‐2 ‐1 ‐2
Total cash flow from operations 35 216 16 114 148 124 100 80
Cash flow from investing
Capex ‐110 ‐31 ‐107 ‐89 ‐71 ‐54 ‐54 ‐54
Other changes ‐12 ‐167 0 0 0 0 0 0
Cash flow from financing
Increase in debt 86 ‐17 139 53 30 ‐198 ‐28 ‐42
Total cash flow from financing 86 ‐16 139 53 30 ‐198 ‐28 ‐42
Net change in cash 0 1 48 78 107 ‐128 19 ‐16

5
6

Appendix I – UMMC Copper Production Flows

In this report we focus on three UMMC subsidiaries that represent two separate stages
of copper production: mining with concentrate production (GGOK, UGOK) and copper
refining (UELM). We note however UMMC has significant presence at all stages of
copper production from mining to finished product fabrication. In Figure 46 we
summarise UMMC’s involvement at various stages of copper production.

UMMC simplified copper production flow–chart
Copper
Scrap
Copper Copper Refined Semi‐Fabricated

Concentrate Blister Copper and Finished Copper
Production Production Production Goods
Sredneuralsky Copper Semi‐Fabrication:

Gaisky GOK
Smelter (SUMZ) (rolled products, alloys)
UELM
Svyatogor Copper
Uchalinsky GOK
Smelter Electrical Goods:
(cables and wires)
Safyanovskaya Med Mednogorsk Copper
(UELM) Smelter
Precious Metals Automotive Goods:
(radiators, spares)
Other mines and Other smelters and
concentrating plants processing plants Chemicals
Other Products
Legend:
‐ Companies Under Coverage
‐ Other UMMC and Third‐party Companies

Source: Company Data

5
7

Appendix II – Russian 2020 Strategy for the Metals Industry

The strategy was adopted by the Russian government in Mar 2009 and envisages three
scenarios for the development of the country’s metals industry to 2020:

1) Inert Case – Based on the assumption that the country’s enterprises would be hard
hit by the financial crisis and would be forced to cut long‐term investment
programmes, which would lead to lower competitiveness of locally manufactured
products in the global markets. Internal demand growth would be driven primarily by
the developing construction industry. Capacity growth would be based on
modernisation of the existing facilities.

2) Resources Oriented Case – Based on the assumption that Russian enterprises would
be able to utilise their competitive advantages fully and build their growth on the
export of raw materials, and moving higher up the processing chain. The industry’s
development would be based on the development of new enterprises as well as the
modernisation of existing facilities. However, the overall product mix would be skewed
in favour of output with less value added.

3) Innovative Case – This scenario was selected as the main target for the
development of the Russian metals industry. It assumes that, in addition to the
utilisation of their competitive strengths in natural resource extraction, Russian
enterprises would adopt mid and high‐technology based production techniques,
expand the output of high value‐added products, increase product diversification and
develop new production techniques and technologies.

Below we summarise the expected impact on Russian copper and zinc production
depending on the development scenario.

Strategic scenarios for the Russian copper industry:

Russian copper industry development – Inert case
2005 2006 2007 2008 2009E 2010E 2011E 2015E 2020E
Production '000 tonnes 961.9 951.4 949 881.2 800 850 900 950 1020
Net import '000 tonnes ‐309.4 ‐268.8 ‐285.3 ‐289.8 ‐589.8 ‐539.8 ‐469.8 ‐299.8 ‐305.8
Apparent consumption '000 tonnes 652.5 682.6 663.7 591.4 210.2 310.2 430.2 650.2 714.2
Source: Strategy for the Development of the Metals Industry in Russia to 2020

Russian copper industry development – Resource oriented case
2005 2006 2007 2008 2009E 2010E 2011E 2015E 2020E
Net import '000 tonnes ‐309.4 ‐268.8 ‐285.3 ‐289.8 ‐579.8 ‐519.8 ‐459.8 ‐314.8 ‐330
Apparent consumption '000 tonnes 652.5 682.6 663.7 591.4 230.2 345.2 460.2 725.2 860

Russian copper industry development – Innovative case
2005 2006 2007 2008 2009E 2010E 2011E 2015E 2020E
Net Import '000 tonnes ‐309.4 ‐268.8 ‐285.3 ‐289.8 ‐569.8 ‐499.8 ‐429.8 ‐320 ‐340
Apparent consumption '000 tonnes 652.5 682.6 663.7 591.4 260.2 390.2 520.2 750 900

5
8

Strategic scenarios for the Russian zinc industry:

Russian zinc industry development – Inert case
2005 2006 2007 2008 2009E 2010E 2011E 2015E 2020E
Production '000 tonnes 213.9 244 262.8 264.2 180 190 220 315 370
Net import '000 tonnes ‐39.9 ‐49 ‐56.4 ‐55 ‐40 ‐53 ‐56 ‐48 ‐48
Apparent consumption '000 tonnes 174 195 206.4 209.2 140 137 164 267 322

Russian zinc industry development – Resource oriented case
2005 2006 2007 2008 2009E 2010E 2011E 2015E 2020E

Russian zinc industry development – Innovative case
2005 2006 2007 2008 2009E 2010E 2011E 2015E 2020E

5
9

Appendix III – UELM Product Flow

UMMC Material Own Material
(tolling) (Safyanovskaya Med)
Copper blisters, copper
and precious metals scrap
Copper Smelting
Plant
Copper Anodes
Electrolytic Copper
Refining Plant
Copper Cathodes Electrolyte Slurry and Slugs
Copper Copper Powder Semi‐Fabrication Sulfate Chemical &

Cathodes Plant and Fabrication Plant Metallurgical Plant
For Sale Companies
Copper Copper Nickel

Gold Tellurium
Powder Sulfate Sulfate
Copper Rods, Alloys
Electrolytic Wires, Cables,
Copper Powder Powder Products Rolled Products, Silver Selenium
For Sale Plant Radiators, Car Spares, etc.
Concentrate of
Structural, electrical, friction‐proof products Platinum Group Metals
made of copper, bronze and bronze‐
graphite; Copper rods made of
dispersion‐reinforced composites Legend:
‐ Main Production Stages
‐ Inputs and Output Products
‐ Main Sales Products
‐ Other Processing and Manufacturing Companies of UMMC Group

Source: Company Data

6
0
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Vlad Nigmatullin Mikhail Pak
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Alexey Evstratenkov Consumer Goods & Retail Nikita Melnikov

+7 (495) 777 6677 (ext. 2679) Ivan Nikolaev +7 (495) 777 6677 (ext. 2659)
alexey.evstratenkov@aton.ru +7 (495) 777 6677 (ext. 2646) nikita.melnikov@aton.ru
ivan.nikolaev@aton.ru
Technical Analysis Banks
Natalia Vigodina Svetlana Kovalskaya
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natalia.vigodina@aton.ru svetlana.kovalskaya@aton.ru
Editorial
Head of Editorial and Production Editor Editor Translator
Lauren Mandy Andrew Risk Anna Bogdanova Elena Korzhenevskaya
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lauren.mandy@aton.ru andrew.risk@aton.ru anna.bogdanova@aton.ru elena.korzhenevskaya@aton.ru

Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15

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Aton - Dinnur Galikhanov - Russian Smaller Copper and Zinc Producers - 2010.04.15

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Dinnur Galikhanov: +7 495 777 6677 (ext. 2677) For professional investors only. This document has not been prepared in accordance with legal

Gaisky GOK GGOK RU 671 300 124% BUY

Company Fact Cards

Setting Metal Prices In Line With Consensus

Highlighting the Risks

Russian Copper: Counting On Economic Recovery and Export Strength

Russian Zinc: Resisting the Elements

Global Factors: Supportive For Commodities But Conducive To Volatility

Gold Silver Other

150 117 116 109 104 99 94 90 85 81

50 80 91 96 96 98 101 103 103 103

Gold Silver Silver Other

Appendix I – UMMC Copper Production Flows

Copper Copper Refined Semi‐Fabricated

Sredneuralsky Copper Semi‐Fabrication:

Appendix II – Russian 2020 Strategy for the Metals Industry

Appendix III – UELM Product Flow

Copper Cathodes Electrolyte Slurry and Slugs

Copper Copper Powder Semi‐Fabrication Sulfate Chemical &

Copper Copper Nickel

Head of Equity and Fixed Income Head of Sales Head of Trading Head of Research

Strategy & Economics Oil & Gas Telecoms & Media

Alexander Sivolobov Slava Bunkov Irina Skvortsova

Utilities Metals & Mining Special Situations & Small Caps Group

Alexey Evstratenkov Consumer Goods & Retail Nikita Melnikov

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