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17February2011

EQUITYRESEARCH

METALS&MINING

RUSSIAN
STEELMAKERS
Remain Cautious as Costs Take Centre Stage
$84.3bn
16%

Figure1:Russiansteelheadingforanotherrollercoasterridein2011?

Target Potential
Rating Rating
price
upside
(old) (new)
($/share)
(%)

180

HOLD
BUY
BUY
BUY

160
140
120
100

SeverstalGDR

Rus s i ans te el ma kers ha repri cei ndex


Rus s i ans te el pri cei ndex

EvrazGDR
SBBRebarTracker

Dec10

Feb11

Source:Bloomberg,MetalExpert

SBBHRCTracker

Coststakecentrestagein2011.Webelievecostpressureswillriseaslabour,energy
andotherexpensesaddtorawmaterialpricehikes.Wedoubtthecurrenteconomic
environmentwouldallowforcoststobefullypassedontocustomers,sosteelmakers
mayhavetoabsorbsomeoftheburden,tothedetrimentoftheirmargins.

ArcelorMittal
RTSIndex
NLMKGDR

Baosteel
BBGIron/SteelCo
Index
MMKGDR
0%

Nov10

Mechel ADR

The2010correctionmayhavebeenlinkedtoEUdebtworries
Nov09

80

Oct09

3Mstock,indexandsteelperformance

Sep10

BUY
BUY
HOLD
BUY

Aug10

10.7%
17.2%
13.6%
24.9%

Jun10

42.30
16.20
49.40
22.10

May10

EvrazGroup
MMK
NLMK
Severstal

Willweseetheboombustpatternof2010repeatingitselfin2011?
200

Mar10

Company

Feb10

Potential upside

Dec09

Sector target value

WeraiseourtargetpricesforRussiansteelmakersEvraz,MMK,SeverstalandNLMKto
reflectstrengtheningsteelprices.However,weadvocateaselectiveapproachtostock
pickingin2011astheindustrycontinuestofaceanumberofchallengeswhichwe
believearenotyetreflectedinmarketforecasts.

10% 20% 30% 40%

Assteelpricessoftenmarginsmaybedepressedfurther.Januarysawasharpincrease
insteelprices,bothdomesticallyandinexportmarkets.Webelievethatpartofthe
increasewasduetorestockingandmaynotbesustainable.Therearealsosignsthatend
customersmaynotbereadytoacceptsubstantiallyhighersteelpriceswhenfacedwith
uncertaintyintheirownmarkets.Lackofrealdemandmayleadtoasteelprice
correctionin2011,depressingsteelmakersmarginsfurther.

Source:Bloomberga

Wemayseefurthervolatilityinsteelnamesasmarketexpectationsadjust.Current
marketforecastsforRussiansteelmakers2011financialsassumemarginimprovement
vs2010.Thismaybethecaseassteelpricesstrengthenovertheyear.However,ascost
pressuresbecomemoreapparent,wemayseeexpectationsreducedleadingto
downgradesinfairvaluecalculationsforsteelstocks.

WACCadjustedtoreflectlowercostofequity,forecastingperiodextendedto2016.As
aresultofa50bptsreductioninourcountryspecificequityriskpremiumourbasecost
ofequityhasbeencutto11.7%.CompanyspecificWACCshavebeenadjustedfurtherto
reflecttheirliquidity,debtloadandcurrentcostofdebt.

YtDstock,indexandsteelperformance
SBBHRCTra cker
SBBRebarTra cker
Baoste el
MechelADR
EvrazGDR
RTSIndex

SeverstalGDR

RemainbullishonRussiansteel,butfocusonnameswithshorttermvaluetriggers.
WeexpectRussiansteelperformancetobecloselycorrelatedwithsteelpricesand
companiesabilitytoprotecttheirmargins.Werecommendfocusingonnameswith
shorttermvaluetriggersasweexpectthemtooutperformtheirpeers.Severstal
(reiterateBUY)mayseeanimprovedperformanceintheUS,whileNLMK(upgradeto
BUY)couldbenefitfromacquiringtheremainingDufercoJVstake.MMKs(reiterate
BUY)performancecouldbedrivenbyagrowingshareofHVAproductsinitssalesmix.
Evraz(downgradetoHOLD)maynotseethefullbenefitofincreasedconstruction
activityinRussiauntil2012.

ArcelorMittal
BBGIron/Ste elCo
Index
MMKGDR
NLMKGDR
10%

0%

10%

20%

Source:Bloomberga

DINNURGALIKHANOV+7(495)2130338
Dinnur.Galikhanov@aton.ru

ILYAMAKAROV+7(495)7779090ext.2644
Ilya.Makarov@aton.ru

Note:Pricesasofclose15Feb2011throughoutthereport.Localsharedataisforinformationonlyandwas
calculatedusingeachcompanyscommonshare/GDRratioandprevailingUSD/RUBexchangerate

Forprofessionalinvestorsonly.Thisdocumenthasnotbeenpreparedinaccordancewithlegal
requirementsdesignedtopromotetheindependenceofinvestmentresearch.Pleaserefertoimportant
disclosuresandanalystcertificationattheendofthisdocument

Contents

InvestmentCase...........................................................................................3
CostsStarttoTakeCentreStage................................................................................. 3
WedonotyetSeeCostPressuresReflectedin2011MarketForecasts.................... 5

RussianSteelValuationsPremiumstoGlobalPeersStillJustified ................10
SummaryDataforSteelStocksunderCoverage ...........................................12
PriceForecastsUpgradedduetoStrongGainsinRecentMonths................15

CompanyPages ..........................................................................................19
EVRAZGROUP ............................................................................................21
ForecastChangesandValuation............................................................................... 21
FinancialAccounts..................................................................................................... 22

MAGNITOGORSKIRONANDSTEEL...............................................................24
ForecastChangesandValuation............................................................................... 25
FinancialAccounts..................................................................................................... 26

NOVOLIPETSKSTEEL ...................................................................................28
ForecastChangesandValuation............................................................................... 29
FinancialAccounts..................................................................................................... 30

SEVERSTAL .................................................................................................32
USBusinessmayHoldtheKeyto2010MarginExpansion....................................... 33
ForecastChangesandValuation............................................................................... 34
FinancialAccounts..................................................................................................... 35

Investment Case
Russiansteelstockshaveenjoyedastrongrunfollowingthecorrectionofmid2010.The
gainshavebeensupportedbyagradualrecoveryindemandandpricesandencouraging
Russianeconomicdata.However,weareincreasinglywaryofgrowingcostpressures
andthefragilestateofrealdemandwhichcouldmakeitdifficultforsteelmakersto
protecttheirmarginsin2011,letalonerecordgrowthatthelevelsachievedin2010.

AshighlightedinourJan2011issueofStratonomics,weremainfundamentallybullish
ontheRussiansteelsectorduetotheeconomicrecovery,appreciatingsteelpricesand
steelmakershighdegreeofverticalintegration.However,weareconcernedthatrecent
steelpriceincreases,drivenbycostinflationandseasonalrestocking,areunsustainable
inthemediumtermduetothelackofsupportfromrealdemand.Atthesametime,raw
materialcostpressures,exacerbatedbyrisingenergyandlabourcosts,continueto
depressmargins.

Russiassteelmakerscurrentsharepricesmaynotfullyreflectthechallengesthe
industryisstillfacing.Russiansteelstockshaveperformedstronglysincethe
publicationofourreportRoundupYourFlats,ShortWaitforLongs(25Oct2010),
gaininganaverageof35%beforeacorrectionattheendofJanuary.Whiletheoverall
gainsinsharepriceswerebroadlyinlinewithourexpectations(apartfromNLMKwhich,
despiteourHOLDrating,gainedaround45%,reachingapeakof$51.30/GDRon4Jan),
thepaceofsharepriceappreciationhassurpassedourexpectations.

Althoughsomeofthesharepricemovementcouldbeexplainedbytherapidgainsin
steelpricesattheendof2010andthebeginningof2011,aswellasencouragingdata
onRussiaseconomicdevelopment,wethinkthisexuberancemaybeunfoundedgiven
thattheindustrystillfacesanumberoftoughchallenges.

CostsStarttoTakeCentreStage
Rapidrawmaterialcostrisescamebackintofocusin2H10
Thefirsthalfof2010wasaperiodofcontinuedimprovementinmarginsforRussian
steelmakersasgrowingproductionvolumesandstrengtheningsteelpricesoffsetrising
rawmaterialcosts.Steelmakerswerealsoquitesuccessfulinkeepingnonrawmaterial
costsundertightcontrol,ascanbeseenfromFigures2and3,whichdepictcompanies
withahighdegreeofverticalintegrationEvrazandSeverstal.

Figure2:EvrazCashcostsandEBITDAmarginprogression
Figure3:Severstal*CashcostsandEBITDAmarginprogression
100%
80%

10.1%
36.2%

60%
40%
20%

100%

15.0%

18.1%

21.3%

25.8%

28.9%

24.1%

18.5%

19.1%

18.6%

19.2%

16.9%

36.0%

36.5%

35.2%

42.4%

2009

1Q10

2Q10

3Q10

80%
27.1%

34.6%

60%
16.6%

16.7%

15.6%

37.1%

34.7%

38.2%

1H09

2H09

1H10

40%
20%

24.6%
19.0%
14.0%

0%

0%

Mate ri al Cos ts

Energy+La bour

Cas hSG&Aa ndothe r

EBITDA

Ma teri a l Cos ts

Energy+La bour

Ca s hSG&Aandother

EBITDA

Meanwhile,Figures4and5showthemarginprogressionfortwocompanieswitha
lowerdegreeofverticalintegrationMMKandNLMK.

*Note:abovefiguresareforRussianSteelandSeverstalResources
Source:Companydata,Atonestimates

Figure4:MMKCashcostsandEBITDAmarginprogression

Figure5:NLMKCashcostsandEBITDAmarginprogression

100%
80%
60%

100%
25.3%
15.3%
15.6%

22.0%

21.1%

18.9%

17.0%

17.6%

15.4%

17.3%

13.7%

14.3%

80%
60%

40%
20%

40%
43.9%

43.7%

47.6%

2009

1Q10

2Q10

51.4%

20%

0%

29.1%

22.7%

35.9%

31.1%

22.4%
14.2%

17.9%

20.3%

16.1%

15.9%

27.4%

34.5%

33.7%

35.1%

4Q09

1Q10

2Q10

3Q10

26.8%
16.7%

0%

Mate ri al Cos ts

Energy+La bour

Cas hSG&Aa ndothe r

EBITDA

3Q10

Ma teri a l Cos ts

Energy+La bour

Ca s hSG&Aandother

EBITDA

Source:Companydata,Atonestimates

Inthesecondhalfof2010severalfactorstookaturnfortheworseforsteelcompanies,
notjustinRussia,butglobally:

Demandforsteelfaltered,leadingtosharppricecorrections

Steelcompanieswereforcedtocutoutputtobringitinlinewithdemand

Pressurefromrawmaterialcostscontinuedtoincrease

ThecombinationofthesefactorsledtomargindeteriorationforallRussiansteelmakers
in3Q10,ascanbeseeninFigures25.

WhileRussiansteelmakershavenotyetpublishedtheir4Q10financials,guidance
providedbycompaniesduringrecentannouncementsofoperatingresultshintsata
furthermargindeclineinthelastquarterof2010.

Forinstance,Evrazs4Q10operatingresultshighlightedacontinuousincreaseinraw
materialprices,exacerbatedbyrisinglabourandenergycosts.Consequently,despite
strongerthanexpectedoutputandpricerealisationsduringthequarter,its4Q10
EBITDAguidanceremainedunchangedfromtheprevioustradingupdate.NLMKhasalso
indicatedthatits4Q10EBITDAmarginshouldbearound25%,significantlydownfrom
the30%achievedin3Q10,partlyduetosteelpriceweaknessattheendoftheyear,but
mainlyasaresultofgrowingcosts,inourview.

Costinflationspreadstononrawmaterialcostsin2011
While2H10costincreasesweredrivenprimarilybyrawmaterials,in2011,weestimate
thatpricesforlabour,transportation,utilitiesandenergywillaccountforagrowing
portionofcashcosts.

AccordingtodatafromRussiasMinistryofEconomicDevelopment(MED),thecountrys
electricitytariffsforindustrialusersareestimatedtohaverisenby18%YoYin2010,
with1316%increasesexpectedin2011.Theincreaseinwholesalenaturalgaspricesin
2010wasevengreater,currentlyestimatedat26.7%YoY,while2011willlikelysee
pricesrisinganother15%andthisisjustfortheregulatedmarket.Finally,rail
transportationtariffsgained9.4%in2010andareexpectedtorise8%in2011(see
Figure6).

Figure6:Tariffsonnaturalmonopolies(%increaseYoY)

2008
Electricity:regulatedandunregulatedtariffsforallusers(excludinggeneralpublic)
22.4%*
Naturalgas:regulatedpricesforallusers(excludinggeneralpublic)
25.0%
Railfreighttransportation(annualaverages)
16.3%
*includesgeneralpublic

2009
20.0%
15.9%
12.4%

2010E
18.0%
26.7%
12.4%

2011E
1316%
15.0%
8.0%

2012E
1113%
15.0%
7.4%

Source:RussianMinistryofEconomicDevelopment

Inaddition,weanticipatesteelmakerslabourcostsrisingatleastinlinewithdomestic
inflation.AccordingtopreliminaryMEDestimates,inflationtotalled8.8%in2010andis
expectedtoreach78%in2011.However,giventhatRussiansteelcompanieskept
labourcostsundertightcontrolduringthecrisis,theactualincreasescouldbeeven
higher,inourview.

Forexample,accordingtotheRussianindustryjournalMetalSupplyandSales
(MetallosnabzhenieiSbyt),ZapSiboneofEvrazssteelproductionunitsinRussia
recentlyheldanemployeeconferencewhereacollectiveagreementfor201112was
finalised.Itwasagreedthataveragesalarieswouldincreaseby7%from1Mar2011and
byanother7%from1Oct2011anincreaseofover14%fortheyear.Weexpectother
Russiansteelmakerstoagreetosimilarlabourcostincreasesfor2011.

Roublestrengthmayaddtocostpressures
AshighlightedinourrecentreportTimetoStartAppreciatingtheRouble(21Dec2010),
theRussiancurrencyisstronglycorrelatedtotheoilprice.Basedonourmodels,an
averageoilpriceof$79/bblfor2011(AtonOilandGasteamestimate)wouldimplythe
rouble/$exchangeratestrengtheningtoRUB29/$byYE11,averagingaroundRUB30/$
fortheyear.Withoilnowtradingataround$100/bbl,ourforecastisbeginningtolook
conservative.

SincemostRussiansteelcompanycostsareroubledenominated,localcurrency
appreciationinflatescosts,althoughthisissomewhatoffsetbyastrengthenedrevenue
line.

ThedomesticcurrencystrengthenedtoRUB29.42/$in1Q10andthenweakenedto
RUB31.24/$in2Q,whichwebelievewaslikelyoneofthefactorsthatallowedRussian
steelmakerstodemonstratestrongerfinancialperformancevs1Q10.Thecurrencythen
appreciatedtoaroundRUB30.60/$in3Q4Q10,exacerbatingcostpressures.

WeDoNotYetSeeCostPressuresReflectedin2011MarketForecasts
Ascoststakecentrestagein2011,weseelittlereflectionofthemincurrentBloomberg
consensusforecastsfortheyear.Wehaveanalysedchangesto201011consensus
forecastsbetweenJuly2010,whentheoutlookforthesteelmarketandpriceswasstill
positive,andFeb2011,whenthefirstsignsof2H10margindeteriorationbecamevisible
andtheriskoffurtherdeteriorationin2011becameclear.

AscanbeseeninFigure7,BloombergconsensusEBITDAmarginforecastsfor2010saw
someminoradjustmentsastheyearprogressed.However,expectationsfor2011
marginssawlittledownwardrevisionbetweenJuly2010andFeb2011.Infact,in
Severstalscasetheforecastfor2011actuallyimproved(althoughthiscouldbe
explainedbyexpectationsofmarginimprovementsinthecompanysUSbusiness,which
maybejustifiedgiventhecurrentstrongrecoveryintheUSsteelmarket).

Figure7:EBITDAmarginforecastprogression(July10Feb11)

2010

Evrazf'cast

2010

MMKf'cast

2011

NLMKf'cast

2010

2011

1.65

1.79
Feb'11

0.67
Feb'11

2010

Jul'10

0.98

3.53
Feb'11

2011

Jul'10

3.35

2.16
Feb'11

2010

Jul'10

2.35
Jul'10

3.03

2.91

Jul'10

1.01

Feb'11

Jul'10

Feb'11

2011

Feb'11

2.68

1.86

3.25
Jul'10

20.2%
Feb'11

1.48

2010

2011

SVSTf'cast

0.03

19.1%
Jul'10

Jul'10

18.5%
Feb'11

2010

3.5
2.5
1.5
0.5
0.5

Feb'11

17.1%

32.0%

Feb'11

2010

Consensus2011EPSforecastssawlittlerevisioninthelastsixmonths

Jul'10

32.1%

29.1%
Feb'11

Jul'10

29.2%

Feb'11

2011

Jul'10

22.5%

22.1%

20.0%

Jul'10

Feb'11

2011

Jul'10

22.5%

20.9%

Feb'11

23.3%
Jul'10

20.3%
Jul'10

Feb'11

40%
35%
30%
25%
20%
15%

16.2%

Mostconsensus2011EBITDAmarginforecastshavehardly
changeddespitesharpdeteriorationofmarginsin2H10

Figure8:EPSforecastprogression(July10Feb11)

2011

EvrazEPSf'cast MMKEPSf'cast NLMKEPSf'cast SVSTEPSf'cast

Source:Bloombergconsensus

WeseeasimilarpictureinconsensusEPSforecastsfor201011:while2010EPS
estimateshavebeenreviseddownwardconsiderably(exceptforNLMK),themarkets
2011EPSexpectationshaveremainedbroadlyunchangedandinsomecases(NLMK,
Severstal)haveactuallyimproved(seeFigure8).

Webelievethelackofdownwardrevisionto2011forecastsfromJuly2010toFeb2011
canbeexplainedbythefollowingfactors:

Anexpectationofhighersteeloutputvolumesin2011whichwouldtranslateinto
improvedtoplineperformance

Anassumptionthatsteelmakerswouldbeabletoprotectorevenimprovetheir
marginsbypassingmost,ifnotall,cashcostincreasesontotheircustomers
throughhighersteelprices

Thecombinationofthesetwofactorswouldintheoryhaveallowedsteelmakersto
protecttheirmarginswhileimprovingbottomline.

Lackofrealdemandmayhampersteelmakersfrompassingcostsontocustomers
Whilethetwofactorsnotedabovetoplineimprovementsandsuccessinpassingcosts
ontocustomerscouldinfactmaterialisein2011,webelieveswiftresultsareunlikely
andnoteseveralriskfactorsthatmaydelaythefullpositiveeffectfrombeingfeltin
2012.

Firstly,steelpriceappreciationattheendof2010andthebeginning2011shouldnotbe
confusedwithasustainedpricerecovery,whichisverymuchdependantonarecovery
inrealdemandforsteel.Rather,webelievethisisagaintheresultofrestocking,which
mayhavebeencausedbyexpectationsofhighersteelpricesin1Q2Q10drivenbyrising
rawmaterialcosts.Thisisperhapssimilartothesteelpricerallyseenatthebeginningof
2010.

Secondly,forpriceincreasestobesustainable,realdemandneedstorecovertolevels
sufficienttoabsorbtheincreasedvolumeofsteelsuppliedtothemarket.AstheRussian
economycontinuestorecover,soshouldrealdemand.Atthemomentthesignsare
encouraging:ascanbeseenfromFigure9,bothindustrialproductionandfixed
investmentarefirmlyinpositivegrowthterritory.However,growthrateshavestabilised
atlevelsthatarestillbelowthepeaksreachedatthebeginningof2008.

Figure9:FixedinvestmentandIPgrowthinpositiveterritory
Industrialproduction

30%

Figure10:RussianGDPtogrowbyaround6%in201112

Fixedinvestment

10%
8%
6%
4%
2%
0%
2%
4%
6%
8%
10%

Industrialproductionandfixed
investmentgrowthrateshave
stabilisedatstronglevels

20%
10%
0%
10%
20%
30%
Jan08

Jul08

Jan09

Jul09

Jan10

Jul10

Source:Rosstat

7.1%

6.4%

7.4%

8.1%
5.9% 5.50%

5.6%
4.0%

7.9%
2004

2005 2006

2007 2008 2009 2010E 2011E 2012E

Source:Rosstat,Atonestimates

Moreover,theAtonStrategyandEconomicsteamforecastthattherateofeconomic
growthin2011willnotexceed6%.Althoughthiswouldbeanimprovementon2010,it
isstillfarbelowtheratesachievedbyRussiaintherunupto2008(Figure10).Inthis
macroeconomicsettingwedoubtthatrealdemandforsteelcouldreturnto200708
levelsthisyear.

Infact,thecurrentdisputebetweenRussiansteelcompaniesandautomakers
demonstratesthatnotallsteelconsumersarereadytoabsorbpriceincreaseswhen
uncertaintyontheirownmarketsisstillhigh.Thissuggests,inourview,thatitcouldbe
difficultforsteelmakerstopassonthefullextentofcostinflationtotheircustomers.

Automakersarenottheonlycustomerswhoarefeelingtheeffectofrisingsteelprices.
Russiantubemakers,workinginmuchbettermarketconditionsa$100/bbloilworld
arealsofeelingtheheat.TMKandChTPZrecentlyapproachedRussiasFederal
AntimonopolyService(FAS)askingthemtoinvestigatesharppriceincreasesbytheir
mainsuppliers,MMKandSeverstal.

Weshouldalsonotdiscountthegovernmentsdesiretokeepdomesticmarketpricesin
checkascontaininginflationcomesintofocusduringtherunuptoparliamentary
electionsin2011andpresidentialpollsin2012.Inthissituation,webelievethe
governmentcouldintroducemeasuresaimedatcontrollingdomesticpriceincreases.
Thegovernmenthasalreadybroachedtheideaofexporttariffsonrolledsteelandiron
oreasonepotentialmeasure.Wethinkthisapproachcouldleadtoashortterm
oversupplyofsteelonthedomesticmarketandaneventualcurtailmentofproduction
byRussiansteelmakers.

Finally,highersteelpricescouldenticesteelmakerstoincreaseoutput,whichinthe
absenceofstrongrealdemandcouldleadtooversupply.Thiswouldputadditional
downwardpressureonsteelprices,likelyleadingtoasharpcorrectionsimilartowhat
wasseenin2010.However,thistimearound,wethinkstrongerexportmarketscould
helpoffsetsomeofthepotentialweaknessathome.Nevertheless,thiscouldalsobe
shortlivedasindustrynewswires(MetalBulletin,SteelBusinessBriefing)arealready
reportingsofteningsteelpricesinseveralkeyexportmarkets.Inanycase,theexport
offeringsofRussiansteelmakersarelimitedprimarilytolowvalueaddedproducts.

Mostofthesefactors,inoneformoranother,wereinplayin2010,whenprices
increasedinthefirstthreetofourmonthsoftheyearoverexpectationsofhigherraw
materialcosts,leadingtopanicrestocking.Thiswasfollowedbyasharpprice
correctionduringthesummermonthsandonlyaslightrecoveryinsteelpricescloserto
theendoftheyear.

Steelsharescouldseearepeatof2010pricevolatility

MMKs tockpri ce i nde x


NLMKs tockpri cei ndex
Fl a ts te el pri cei ndex

Jan11

Nov10

Oct10

Sep10

Jul10

Jun10

Apr10

Mar10

Feb10

Dec09

Nov09

Jan11

Nov10

Oct10

Sep10

Jul10

80

Jun10

100

80

Apr10

100
Mar10

120

Feb10

140

120

Dec09

160

140

Nov09

180

160

Oct09

180

Oct09

GivenhowcloselycorrelatedRussiansteelstocksaretosteelprices,wecouldseea
repeatofthe2010correctionin2011,inourview.Figures11and12showthatRussian
steelcompanysharepricesmovedinanticipationofchangesinsteelprices,gaining
throughthelatterpartof2009andthebeginningof2010andthenreversingdirection
evenbeforethefullextentofthesteelpricecorrectionwasapparent.

Figure11:MMKandNLMKshareperformancevsflatsteelprices Figure12:Evrazshareperformancevslongsteelprices

Evrazs tockpri cei ndex

Longs te el pri cei ndex

Source:Bloomberg

Althoughreportsfromsteelcompaniessuggestthatstrongrisesinsteelpricesshouldbe
expectedin1Q11,sharepricesstartedtocorrectwhensteelpricessoftenedafter
supportfromtherestockingdrivebegantodiminish.Giventhatasteelpricecorrection
couldbecomearealityasearlyas1Q11,wewouldnotruleoutthepossibilityoffurther
volatilityinRussiansteelstocksinthecomingquarters.

Notallisdoomandgloom
Whilesteelandcommoditypricesshouldcontinuetobethemaindriverofshareprice
performanceforRussiansteelmakers,webelievethatshareswithadditionalvalue
catalystsshouldoutperformtheirpeersin2011.Belowaresomeofthedriversthatmay
supportRussiansteelsharesin2011:

Severstal:

ArecoveryintheUSsteelmarketleadingtoupsidesurprises.WethinkSeverstal
UScouldrepeatitspositive2Q10performanceonthebackofstrongerUSprices
andgrowingcapacityutilisation.AswingtopositiveEBITDAin2Q10cameona15%
QoQincreaseinsalesvolumesandan8%QoQincreaseinaveragerealisedprices.

NordgoldIPOmaysoonbebackonthecards.Althoughthemarketsreceptionof
theIPOwaslukewarm,webelievethatavaluationintherangeof$3.54bnisstill
realisticandcouldoffer1015%upsidepotentialtothecurrentshareprice.

MMK:

RisingshareofHVAgoodscouldhelpoffsetcostpressures.ThecompanysMill
5000isnowoperatingatfullcapacity(1.5mntpa)withitsorderbookfullatleastto
theendof1H11.

NLMK:

AcquisitionoftheremainingstakeinJVwithDuferco.NLMKisshortofinhouse
rollingcapacityandusestheJVasanoutletforitsexcessslabproduction.The
acquisitionwouldallowittorecordhighersalesmarginswithinthegroup.

Evraz:

RecoveryinconstructionactivityinRussiaandUkraine.Evrazcouldbeastockto
watchin2011giventheexpectedrecoveryinRussiasconstructionindustry.
However,weviewexpectationsofanystrongsharepricehikesaspremature,given
thatthefullextentofincreasedconstructionactivitywouldprobablynotbefelt
untilwellinto2012.Werecommendwaitinguntilearly2Q11toreassessthe
progressofRussiasconstructionindustrybeforeincreasingpositionsinthestock.

Russian Steel Valuations Premiums to Global Peers Still Justified


Despiterisingcostpressuresandtheresultingdeteriorationofmargins,webelieve
thatRussiansteelmakersvaluationpremiumstointernationalpeersarejustified.
Whileincreasingcostpressuresareaworldwidephenomenon,Russiancompanies
verticalintegrationgivesthemanimportantedgeoverglobalpeers,actingasa
cushionandlimitingthenegativeimpactofhighercostsonmargins.

Ourvaluationmethodusesacombinedmultiplesbasedapproach(P/EandEV/EBITDA)
andDCF.Thetwomultipleseachaccountfor25%oftheweightedaveragevaluation,
withtheDCFvaluationprovidingtheremaining50%.Themultiplesvaluationallowsus
toaccountforacompanysshorttomediumtermfinancialperformanceanddebtload,
whiletheDCFcalculationaimstoreflectthegrowthpotentialofeachstockandhence
hasahigherweightinginourvaluations.

Oneminoradjustmentfromourpreviouscalculationsisachangetothebasecostof
equityduetotherecentrevisionofourcountryspecificriskpremium,whichwas
reducedfrom3.7%to3.2%.Asaresult,thebasecostofequitydeclinedfrom12.2%to
11.7%.TheWACCforeachindividualcompanyalsotakesintoaccountitsliquidityand
debtposition.

Russiansteelspremiumtoglobalpeersisstilljustified,inourview
Figures13and14arebasedonBloombergconsensusforecastsofthe2011EBITDA
marginsofRussiancompaniesandaselectionofinternationalpeersinbothdeveloped
andemergingmarketsatthetimeofourpreviousupdateon25Oct2010(Figure13)
andnow(Figure14).ThechartsshowthatthemarketstillexpectsRussiansteelmakers
tooutperformtheirpeersin2011.TheaverageEBITDAmarginforecastforfiveRussian
steelmajorsin2011isapproximately25%vstheemergingmarketaverageof16%and
thedevelopedmarketaverageof11%(seeFigure14).

Figure13:Consensus2011EEBITDAmargins(25Octupdate)
Figure14:Consensus2011EEBITDAmargins(currentupdate)
32.2%

35%
26.9%

12.7%

15%

0%

Avg.Int.
Emerging
Markets
Avg.Int.
Developed
Markets

0%

Severstal

5%
Evraz

5%
MMK

10%

Mechel

22.4%

20.7%
16.4%

15%

10%

NLMK

22.3%

20%

16.3%

10.0%

Avg.Int.
Emerging
Markets
Avg.Int.
Developed
Markets

19.4%

Severstal

20%

25.9%

25%

Evraz

20.9%

MMK

21.1%

25%

31.9%

30%

Mechel

30%

NLMK

35%

Source:Bloomberg

Evenifweassumethe2011estimatesforRussiansteelmakersareoverlyoptimisticand
theywilleventuallybereviseddownward,wethinktherewillstillbeenoughofalead
overinternationalpeerstojustifythepremiumsatwhichRussiansteelmakerscurrently
trade.

OurapproachtovaluingRussiansteelsreflectsourexpectationsofsustained
profitabilityleadershipoverinternationalpeers
Globalsteelmakersarecurrentlytradingat2011P/Esrangingfrom9xto16xfor
emergingmarketpeersand1218xforsteelmakersindevelopedmarkets.Therangefor
EV/EBITDAis511xforemergingmarketsand58xfordevelopedmarkets(foramore
detailedbreakdown,seeFigure15).

1
0

Figure15:Comparativemultiplesofpeersbasedonestimatesfor201112E

MktCap
($mn)

Country

EV/EBITDA

2011E
Developedmarkets

ArcelorMittal
Luxembourg
57,986
7.1
ThyssenKrupp
Germany
21,132
4.5
Voestalpine
Austria
7,555
6.9
NucorCorp
USA
15,262
8.0
USSteel
USA
8,949
6.5
AKSteel
USA
1,815
5.3
NipponSteel
Japan
24,877
6.8
JFEHoldings
Japan
20,070
6.6
BluescopeSteel
Australia
4,145
8.5
Median,DMpeers

6.8
Emergingmarkets

POSCO
SouthKorea
37,468
5.3
HyundaiSteel
SouthKorea
10,410
7.3
ChinaSteelCorp
Taiwan
15,460
11.1
BaoshanIron&Steel
China
19,082
4.8
WuhanIron&Steel
China
5,389
5.8
MaanshanIron&Steel
China
4,330
5.1
AngangSteel
China
9,108
6.4
TataSteel
India
12,993
6.7
Gerdau
Brazil
19,242
6.6
Usiminas
Brazil
14,300
8.8
Median,EMpeers

6.5
Russia

EvrazGroup
Russia
16,731
7.2
MagnitogorskSteel
Russia
11,879
7.4
Mechel
Russia
13,154
6.2
NovolipetskSteel
Russia
26,071
8.5
Severstal
Russia
17,836
6.4
Median,Russianpeers

7.2
Russiansteelproducerspremium/discounttointernationalpeers:
EvrazGroup

8%
MagnitogorskSteel

11%
Mechel

7%
NovolipetskSteel

27%
Severstal

4%

2012E

5.8
3.6
6.1
6.1
5.2
4.1
6.3
6.0
5.6
5.8

4.9
6.9
9.9
4.3
5.2
4.7
5.7
6.1
5.3
6.3
5.5

5.9
5.4
5.5
6.2
5.4
5.5

5%
5%
2%
10%
4%

P/E
2011E

13.1
15.7
12.0
18.9
15.9
17.5
17.3
17.6
53.7
17.3

9.4
9.6
13.3
8.7
12.9
13.1
13.5
9.2
11.5
17.4
12.2

16.7
14.6
8.6
13.4
11.1
13.4

13%
1%
42%
9%
25%

2012E

9.2
9.9
9.6
13.0
11.0
11.1
12.9
11.9
14.6
11.1

8.7
8.8
10.9
7.5
9.6
11.9
10.4
8.1
9.3
11.9
9.4

10.6
8.9
8.4
9.5
8.8
8.9

4%
14%
18%
8%
14%

EBITDA
margin(%)

Netmargin
(%)

2011E

12%
8%
14%
11%
8%
6%
12%
14%
6%
11%

21%
16%
17%
16%
14%
12%
14%
14%
18%
20%
16%

22%
21%
26%
30%
19%
22%

2011E

5%
2%
4%
4%
3%
2%
3%
3%
1%
3%

12%
9%
13%
6%
3%
3%
4%
6%
8%
9%
7%

7%
8%
13%
18%
9%
9%

Source:Bloomberg,Atonestimates

WestillbelievethatRussiansteelmakersshouldbevaluedatapremiumtointernational
peers,giventheirsuperiorfinancialperformancetodateandmarketandour
expectationsthattheywillsustainthisleadershipintheshorttomediumterm.
Nevertheless,weremainconservativeandusemultiplesof14xP/Eand7xEV/EBITDAin
ourcalculations(exceptforNLMK,whichwevalueusingaP/Eof16xandanEV/EBITDA
of8xtoreflectitsprofitabilityleadership,mediumtermgrowthprospectsandthe
uniquemixofhighvalueproductsinitssalesportfolio).

However,wearemoreconservativethantheconsensusinour2011forecasts
AsFigure22demonstrates,wearemoreconservativethantheBloombergconsensusin
our2011forecastsforRussiansteelmakers.Thisisintendedtoreflectthepressures
steelcompaniescouldfacethisyear.However,wealsobelievethatasmarketsrecover
in2012,steelcompaniesshouldbewellplacedtotakeadvantageofrisingdemandand
prices.

Therefore,wehaveusedtheaverageofour201112EEBITDAandnetincomeforecasts
asthebasisforourmultiplesvaluations.

1
1

Summary Data for Steel Stocks under Coverage

ThissectionprovidessummaryinformationforstocksunderAtoncoverage.

InFigure16wesummarisethechangestoourtargetpricesandratings.

Figure16:Ratingsummary
Company

EvrazGroup(GDR)

MMK(GDR)
MMK(Local)

NLMK(GDR)
NLMK(Local)

Severstal(GDR)
Severstal(Local)

Ticker

Target
price
(old)

Target
price
(new)

Target
price
change

Current
price

Upside
potential

Rating
(old)

Rating
(new)

EVRLI

MMKLI
MAGNRM

NLMKLI
NLKMRM

SVSTLI
CHMFRM

($/share)
35.33

15.33
1.18

35.55
3.56

18.57
18.57

($/share)
42.30

16.20
1.25

49.40
4.94

22.10
22.10

(%)
19.7%

5.7%
6.0%

39.0%
39.0%

19.0%
19.0%

($/share)
38.21

13.82
1.07

43.50
4.35

17.70
17.62

(%)
10.7%

17.2%
16.6%

13.6%
13.5%

24.9%
25.4%

BUY

BUY
BUY

HOLD
HOLD

BUY
BUY

HOLD

BUY
BUY

BUY
BUY

BUY
BUY

Source:Bloomberg,Atonestimates

Figure17reflectsthechangesinourtargetpricesifwealteranyofthekeyvaluation
criteriaforthestocksundercoverage.

Figure17:Valuationrangesforthestocks
Company

EvrazGroup(GDR)
MMK(GDR)
NLMK(GDR)
Severstal(GDR)

Current
share
price

Target
price

($/share)

($/share)

Base
+1%

Base
WACC

Base
1%

12x

14x

16x

6x

7x

8x

38.21
13.82
43.50
17.70

42.30
16.20
49.40
22.10

35.15
13.00
50.73
17.86

42.83
15.44
59.24
20.69

53.36
18.69
70.92
24.32

35.30
15.11
32.84
21.62

41.18
17.63
38.32
25.22

47.07
20.15
43.79
28.83

33.77
13.26
26.01
18.13

42.27
16.12
30.70
21.91

50.77
18.99
35.38
25.70

201112E
averageP/E

DCFWACCRate

201112E
averageEV/EBITDA

Source:Bloomberg,Atonestimates

Thefollowingtablesprovidesomeusefulperformanceandfinancialdataforthestocks.

Figure18:Stockperformancedata

1M
3M
YtD
1Y
52weekhigh($)
52weeklow($)
Combineddailyt/o($mn)
Freefloat(%)
Freefloat($mn)

EvrazGroup
3.2%
27.4%
6.5%
15.1%
42.72
21.80
47.1
17.4%
2,911

MMK
11.0%
8.0%
5.0%
8.1%
16.23
8.90
8.2
13.4%
1,592

NLMK
7.6%
15.8%
8.8%
42.2%
51.00
25.04
19.9
12.9%
3,363

Severstal
7.0%
27.0%
5.0%
42.9%
19.78
9.35
46.9
17.6%
3,139

Source:Companydata,Bloomberg,Atonestimates

1
2

Figure19:Keyvaluationdata

Valuationsummary:
Targetprice($/GDR)
Currentprice($/GDR)
Potentialupside/downside(%)
Rating(GDR)
Targetpricelocal($/share)
Currentpricelocal($/share)
Potentialupside/downside(%)
Rating(local)
Keyvaluationmetrics:
Commonsharesinissue(mn)
CommonshareGDRequivalent(mn)
Marketcap($mn)
Netdebt($mn)
EV($mn)
BV($mn)
Keyvaluationratios:
P/Eratios(x)
2009
2010E
2011E
2012E
EV/EBITDAratios(x)
2009
2010E
2011E
2012E
P/BVratio(x)

EvrazGroup

42.30
38.21
10.7%
HOLD
n/a
n/a
n/a
n/a

146
438
16,731
7,219
24,269
10,312

n/a
n/a
16.7
10.6

MMK

16.20
13.82
17.2%
BUY
1.25
1.07
16.6%
BUY

11,174
860
11,879
2,928
15,228
10,128

51.1
49.5
14.6
8.9

NLMK

49.40
43.50
13.6%
BUY
4.94
4.35
13.5%
BUY

5,993
599
26,071
1,148
27,333
9,556

97.7
17.4
10.4
9.2

Severstal

22.10
17.70
24.9%
BUY
22.10
17.62
25.4%
BUY

1,008
1,008
17,836
4,331
22,448
7,718

n/a
n/a
11.1
8.8

19.6
14.9
15.8
26.5
10.2
10.6
9.2
8.0
7.2
7.4
6.9
6.4
5.9
5.4
6.0
5.4
1.6
1.2
2.7
2.0
Source:Companydata,Bloomberg,Atonestimates

Figure20:Keyfinancials

Revenue($mn)
2009
2010E
2011E
2012E
AdjustedEBITDA($mn)
2009
2010E
2011E
2012E
EBITDAmargin(%)
2009
2010E
2011E
2012E
Netincome($mn)
2009
2010E
2011E
2012E
Netmargin(%)
2009
2010E
2011E
2012E

EvrazGroup

9,772
12,382
15,365
16,835

1,237
2,368
3,361
4,081

12.7%
19.1%
21.9%
24.2%

1,251
54
1,002
1,574

12.8%
0.4%
6.5%
9.4%

MMK

5,081
7,597
10,038
12,091

1,023
1,437
2,059
2,837

20.1%
18.9%
20.5%
23.5%

232
240
812
1,342

4.6%
3.2%
8.1%
11.1%

NLMK

6,140
8,382
10,905
13,524

1,370
2,384
3,233
4,397

22.3%
28.4%
29.6%
32.5%

215
1,332
1,949
2,753

3.5%
15.9%
17.9%
20.4%

Severstal

13,054
15,021
18,767
20,823

846
2,804
3,508
4,121

6.5%
18.7%
18.7%
19.8%

1,037
87
1,603
2,029

7.9%
0.6%
8.5%
9.7%

Source:Companydata,Atonestimates

1
3

Figure21summariseschangesmadetoourkeyestimates(EBITDAandnetincome)
sinceourpreviousupdate.

Figure21:Atonestimatesoldvsnew

EBITDA

Netincome

Company

2010E

2011E

2012E

3Y
average

2010E

2011E

2012E

3Y
average

EvrazGroup:
Newestimate($mn)
Oldestimate($mn)
Changevsold(%)
MMK:
Newestimate($mn)
Oldestimate($mn)
Changevsold(%)
NLMK:
Newestimate($mn)
Oldestimate($mn)
Changevsold(%)
SVST*:
Newestimate($mn)
Oldestimates($mn)
Changevsold(%)

2,368
2,373
0.2%

1,437
1,535
6.3%

2,384
2,424
1.6%

2,804
3,315
15.4%

3,361
3,431
2.0%

2,059
2,423
15.0%

3,233
3,263
0.9%

3,508
3,961
11.4%

4,081
4,040
1.0%

2,837
2,737
3.7%

4,397
3,700
18.8%

3,508
4,155
15.6%

0.4%

5.9%

5.4%

14.2%

54
112
n/a

240
270
11.2%

1,332
1,208
10.3%

87
9
n/a

1,002
826
21.3%

812
872
6.8%

1,949
2,011
3.1%

1,603
1,598
0.3%

1,574
1,297
21.4%

1,342
1,058
26.8%

2,753
2,293
20.1%

2,029
1,802
12.6%

21.3%

2.9%

9.1%

6.4%

*PreviousSeverstalforecastsincludedLucchini
Source:Atonestimates

Finally,Figure22comparesourestimatesforsteelstockswiththecurrentBloomberg
consensusview.Wearemoreconservativethanconsensusinour2011forecasts.
Meanwhile,ourexpectationsfor2012areeitherinlinewithoraheadofconsensus,as
webelievethebenefitofincreaseddemandandhighersteelpriceswillnotbefullyfelt
in2011,butshouldbepushedbackto2012.

Figure22:AtonestimatesvsBloombergconsensus

EBITDA

Netincome

Company

2010E

2011E

2012E

3Y
average

2010E

2011E

2012E

3Y
Average

EvrazGroup:
Atonestimates($mn)
Bloombergconsensus($mn)
Atonvsconsensus(%)
MMK:
Atonestimates($mn)
Bloombergconsensus($mn)
Atonvsconsensus(%)
NLMK:
Atonestimates($mn)
Bloombergconsensus($mn)
Atonvsconsensus(%)
SVST:
Atonestimates($mn)
Bloombergconsensus($mn)
Atonvsconsensus(%)

2,368
2,384
0.7%

1,437
1,557
7.7%

2,384
2,400
0.7%

2,804
2,930
4.3%

3,361
3,553
5.4%

2,059
2,414
14.7%

3,233
3,370
4.1%

3,508
3,831
8.4%

4,081
4,068
0.3%

2,837
2,799
1.4%

4,397
3,959
11.1%

3,508
4,016
12.6%

1.9%

7.0%

2.1%

8.5%

54
103
n/a

240
380
36.8%

1,332
1,311
1.6%

87
1,002
n/a

1,002
1,208
17.1%

812
1,047
22.4%

1,949
2,047
4.8%

1,603
1,818
11.8%

1,574
1,442
9.2%

1,342
1,360
1.3%

2,753
2,373
16.1%

2,029
1,970
3.0%

3.9%

20.2%

4.3%

4.4%

Source:Bloomberg,Atonestimates

1
4

Price Forecasts Upgraded Due to Strong Recent Gains


Wehaveupgradedourpriceforecastsforsteelandrawmaterialpricestoreflectthe
stronggainsrecordedinrecentmonths.Exportpricesforflatsteelhaveseenasolid
recoveryandnowtradeataslightpremiumtodomesticsteel.Longsteelpriceshave
alsotrendedhigheronagradualrecoveryinconstructionactivity.Inrawmaterials,
cokingcoalpricessawamajorappreciationduetothedeficitthatfollowedthe
Raspadskayamineaccidentin2010.

Highrawmaterialprices,inparticularforcokingcoalandsteelscrap,willlikelycontinue
toputpressureonRussiansteelproducersmargins,asitwillbedifficultforthemto
passonthefullextentofcostincreasestocustomerswhilethedemandpictureremains
uncertain.

HRCprices:weexpectasofteningin2H11
HRCpricesexperiencedexceptionalgainsatthebeginningof2011,whichweexpectto
continueintheseasonallystronger2Q11:weestimateaveragepriceswillrangefrom
$700/tto$800/tinthefirsthalfoftheyear.However,weexpectpricestosoftenin
2H11,withafullyearaverageof$740/tforthedomesticmarketand$760/tforexports
(seeFigure23).

Figure23:HRCpricesstrongin1H11,softeningin2H11($/t)
Figure24:CISHRCuparound13%vsourpreviousforecast($/t)
HRCCISproduce rpri ce NEW
HRCCISproduce rpri ce OLD

HRCCISexportpri ce
900

588

663

666

650

604

516
601
3Q10

2Q10

500
400

731

4Q11E

600

4Q11E

3Q11E

2Q11E

1Q11E

3Q10

2Q10

1Q10

4Q09

3Q09

2Q09

1Q09

300

4Q10

400

642

700

Weassumeprice
softeningin2H11,similar
to2H10correction

1Q10

500

742

695

4Q10

600

200

781

800

3Q11E

700

2Q11E

Exportpricesstarttrading
atapremiumtodomestic

800

631

1Q11E

HRCCISproduce rpri ce

Source(Figures32and33):MetalExpert,Bloomberg,Atonestimates

OurnewdomesticHRCpriceestimatesfor2011areanaverageof13%higherthanour
previousforecast(seeFigure24).

Rebar:strongrecoveryatend2010andstartof2011
Rebarpricesenjoyedastrongerrecoverythanweexpectedin4Q10,averagingaround
$590/tvs$550/tinourOctoberforecast.Wehaverevisedourestimatestotakeinto
accountthepricestrengthseeninJanuaryandFebruary.Onceagain,weexpect3Q
4Q11tobeseasonallyweak,bringingtheaveragepricefor2011toaround$700730/t,
withdomesticpricesexpectedtoreachapremiumtoexport(seeFigure25).

1
5

Figure25:Rebarstrongerrecoveryin4Q10vsforecast($/t)
Domesticpricesimproveas
constructionactivitypicksup

900
800

600

618

751

732

621

605

599

663
589

579

600
474

4Q10

3Q10

2Q10

400

550

577
1Q11E

500
4Q11E

3Q11E

2Q11E

1Q11E

3Q10

2Q10

1Q10

4Q09

3Q09

2Q09

1Q09

300

4Q10

400

200

700

Weassumeprice
softeningin2H11,similar
to2H10correction

1Q10

500

762

4Q11E

700

3Q11E

800

Re ba rCISproduce rpri ce NEW


Re ba rCISproduce rpri ce OLD

Re ba rCISe xportpri ce

2Q11E

Re ba rCISproducerpri ce

Figure26:Rebarpriceestimateup20%vsearlierforecast($/t)

Sources:MetalExpert,Bloomberg,Atonestimates

Ournewpriceassumptionsforrebarare2021%higherthanourOctoberestimates(see
Figure26).

Flatsteelmaintainsanarrowingpremiumoverlongproducts
Longsteelpriceshaveundergoneastrongrecovery,narrowingthediscounttoflatsteel
toaround3%in4Q10.AlthoughweexpectHRCtocontinuetradingatapremiumto
rebargoingforward,wethinkthepremiumwillbelower:around5%in2011vs10%in
ourpreviousforecast(Figure27).

Figure27:Longssteeldiscounttoflatexpectedtonarrow($/t)
CISDomes ti cFl atStee l Bas ke t
CISDomes ti cLongStee l Bas ke t
900
Flatsteelisstill
expectedtotradeat
apremiumtolong...

800
700

4Q11E

3Q11E

2Q11E

1Q11E

3Q10

1Q10

4Q09

3Q09

2Q09

4Q10E

1Q09

500

2Q10

butthediscountisexpectedtonarrow
asconstructionactivitypicksup

600

Source:MetalExpert,Bloomberg,Atonestimates

Pressurefromhighrawmaterialpricessettorolloverinto2011
Weexpecthighrawmaterialpricestocontinuepressuringsteelmakersmargins.This
shouldbeespeciallypronouncedincokingcoalin2011(duetotheRaspadskaya
accidentlastyearandastructuralshortageofhighquality,locallyproducedcoking
coal).Amajorincreaseinscrappricescanbeexpectedfrom2012onthebackof
insufficientscrapgenerationandaddeddemandfromnewelectricarcfurnace(EAF)
capacity.

Wethinktheincreaseinironorepriceswillbelesspronouncedvscokingcoalsince
Russiaisnotcurrentlyexperiencinganyshortageofthismaterial(seeFigure28).

1
6

Figure28:StrongincreaseincokingcoalpriceduetoRussiandeficit($/t)
Coki ngcoa l (Rus s i adome s ti cGZhtype)
Ironoreconcentrate(Rus s i adomes ti c)
250

4Q11E

3Q11E

2Q11E

1Q11E

4Q10

3Q10

2Q10

1Q10

4Q09

3Q09

2Q09

1Q09

Shortageofdomesticoutput
200 supportscokingcoalprices
158 166 168 164
134
125 124
150
92 103
100 51 49 58
88 81 82 92 94 95 94
50
62
36 48
0 33 32

Source:MetalExpert,Bloomberg,Atonestimates

Raspadskayarecentlyannouncedan11%increasein1Q11pricesforcokingcoal.
However,weexpectthisupwardmomentumtoslowfrom2Q11,asRaspadskayastarts
torecovertheoutputlostfollowinglastyearsaccident.Weexpect1Q113Q11pricesto
averagearound$160165,softeningin4Q11(seeFigure29).Weestimateanaverage
2011cokingcoalpriceofaround$165/t,35%higherthanin2010.

Figure29:Cokingcoalpricessupportedbycontinueddeficit($/t) Figure30:Ironorepricestrengtheningonhigherdemand($/t)
Coki ngcoa l (Rus s i a dome s ti cGZhtype)NEW
Coki ngcoa l (Rus s i a dome s ti cGZhtype)OLD

124

103

146

157

88

100
153

151

135

75

81

62

92

94

95

94

82

80

84

86

85

4Q11E

125

125

125

164

3Q11E

150

134

168

2Q11E

175

166

1Q11E

158

4Q10

200

Ironoreconcentrate (Rus s i adomes ti c)NEW


Ironoreconcentrate (Rus s i adomes ti c)OLD

82

3Q10

2Q10

50

1Q10

4Q11E

3Q11E

2Q11E

1Q11E

4Q10

3Q10

2Q10

75

1Q10

100

Sources(Figures29and30):MetalExpert,Bloomberg,Atonestimates

Weexpectironoreconcentratepricestoincreasemodestlyovertheyear,averaging
$95/t,up20%YoY(seeFigure30).

Forsteelscrap,weforecastapriceincreaseofapproximately15%YoYin2011toaround
$270/t.Thisis16%higherthanourearlierforecast,mainlyduetoincreasedlongsteel
pricesandthereforeelevateddemandforscrap.

Ourpriceassumptionsforthemainsteelproductsandrawmaterialsaresummarisedin
Figures3132.

1
7

Figure31:AtonrawmaterialandsteelpriceassumptionsFeb2011($/metrictonne)

Rawmaterialprices,FCA,exVAT:
Ironoreconcentrate

Cokingcoalconcentrate(GZhtype)

Steelscrap

Domesticprices,exworks,exVAT:
HRC

Rebar

Exportprices,FOB,exVAT:
Slab

Billet

HRC

Rebar

old
new
%chg

old
new
%chg

old
new
%chg

old
new
%chg

old
new
%chg

old
new
%chg

old
new
%chg

old
new
%chg

old
new
%chg

2010

79
79
0.5%

122
122
0.2%

230
233
1.5%

589
587
0.3%

555
565
1.8%

532
533
0.2%

517
532
3.0%

595
605
1.7%

548
563
2.6%

2011E

83
95
14.6%

152
164
8.1%

231
268
16.0%

653
737
13.0%

601
727
21.0%

561
669
19.4%

548
687
25.2%

626
764
22.1%

583
702
20.4%

Annualprices
2012E 2013E

88
85
101
101
15.7% 18.8%

157
156
181
179
15.1% 15.2%

257
272
314
345
22.1% 26.9%

667
655
825
803
23.6% 22.6%

632
633
844
838
33.6% 32.4%

574
563
755
731
31.6% 29.8%

576
578
817
823
41.7% 42.4%

640
628
866
843
35.2% 34.2%

613
614
811
805
32.3% 31.1%

2014E

80
97
21.0%

152
174
14.5%

272
349
28.5%

639
778
21.7%

618
812
31.2%

549
708
28.8%

564
797
41.2%

613
816
33.2%

600
780
29.9%

2015E

76
92
21.5%

150
168
12.2%

272
347
27.5%

630
757
20.3%

607
790
30.2%

541
689
27.3%

554
776
40.1%

604
795
31.6%

589
759
28.9%

3Q10

84
84

124
124

211
211

598
588

579
579

514
514

528
528

574
574

562
562

Quarterlyprices
1Q11E 2Q11E 3Q11E 4Q11E

80
84
85
84
93
96
96
96
16.2%
14.9% 13.7%
13.7%

146
157
153
151
158
166
168
164
8.1%
5.6%
9.9%
8.8%

218
234
237
234
249
267
281
274
14.1%
14.1% 18.7%
16.9%

631
663
666
650
695
781
742
731
10.0%
17.9% 11.4%
12.6%

577
621
605
599
663
762
751
732
14.8%
22.8% 24.0%
22.2%

543
570
573
558
599
674
708
697
10.4%
18.3% 23.6%
24.8%

527
567
552
547
635
698
716
698
20.4%
23.2% 29.6%
27.6%

605
636
639
623
710
799
779
767
17.3%
25.7% 21.9%
23.2%

560
602
587
581
651
732
721
703
16.2%
21.6% 22.8%
21.0%
Source:MetalExpert,Atonestimates

4Q10

83
84
2.0%

135
134
0.8%

207
221
6.5%

601
604
0.4%

550
589
7.1%

517
521
0.8%

502
564
12.4%

577
618
7.1%

534
592
10.9%

Figure32:Rawmaterialandsteelpriceassumptions(Feb2010)periodonperiodprogression(%)

Rawmaterialprices,FCA,exVAT:
Ironoreconcentrate
Cokingcoalconcentrate(GZhtype)
Steelscrap
Domesticprices,exworks,exVAT:
HRC
Rebar
Exportprices,FOB,exVAT:
Slab
Billet
HRC
Rebar

YoYchangeinprices
2011E 2012E 2013E

20%
6%
1%
35%
10%
1%
15%
17%
10%

26%
12%
3%
29%
16%
1%

26%
13%
3%
29%
19%
1%
26%
13%
3%
25%
16%
1%

2010

83%
95%
39%

35%
34%

43%
35%
33%
28%

1
8

2014E

4%
3%
1%

3%
3%

3%
3%
3%
3%

2015E

5%
3%
1%

3%
3%

3%
3%
3%
3%

3Q10

4%
1%
15%

8%
6%

14%
1%
12%
3%

4Q10

0%
8%
5%

3%
2%

1%
7%
8%
5%

QoQchangeinprices
1Q11E 2Q11E 3Q11E 4Q11E

10%
4%
1%
1%
18%
5%
1%
3%
13%
8%
5%
3%

15%
13%
5%
2%
13%
15%
2%
3%

15%
13%
5%
2%
13%
10%
2%
3%
15%
13%
3%
2%
10%
13%
2%
2%
Source:MetalExpert,Atonestimates

Companies

1
9

EVRAZ
GROUP
Hold on a Little Bit Longer

WeincreaseourtargetpriceforEvrazto$42.30/GDR(up20%from$35.33/GDR
previously)onstrongersteelpricesandencouragingsignsfromtheRussian
constructionsector.However,wedowngradeourratingtoHOLDaswethinkthe
shareshaverunslightlyaheadoffundamentals:whilearecoveryinconstruction
seemstobeunderway,weneedmoreevidencetobesureitissustainable.

Figure33:Evrazssteelsalescontinuetoberelativelyflat(000tonnes)

HOLD
Target price

$42.30

5,000

11%

3,000

Potential upside

Steelsalesvolumesremained
relativelyflatoverlastsixquarters

4,000
2,000

Sharedata
No.ofordinaryshares(mn)
No.ofordinaryGDRs(mn)
No.ofprefshares(mn)
3Maveragedailyt/o($mn)
Freefloat(%)
Marketcapitalisation($mn)
Enterprisevalue($mn)
Majorshareholders
LanebrookLimited
FINANCIALS($mn) 2009
Revenue
9,772
EBITDA
1,237
EBIT
(1,047)
Netincome
(1,251)
EPS
(9.30)

VALUATION

P/E(x)
P/CF(x)
EV/EBITDA(x)
EV/Sales(x)
P/BV(x)
RoCE(%)
RoE(%)

PERFORMANCE

(13.4)
15.8
19.6
2.5
1.6
6.9%
12.2%

4Q10

3Q10

2Q10

1Q10

Cons tructi onproducts


Fl atrol l e dproducts
Othe rs te el products

Source:CompanyData

Operatingresultsfor2010broadlyinlinewithexpectations.Outputin4Q10recovered
acrossmostproductgroupsafterplannedmaintenancein3Q10.Asaresult,2010crude
steelproductionincreased6.6%YoYto16.3mnt.Rolledproductsalesgained3%YoYto
14.7mnt.Encouragingly,salesofconstructionsteelcontinuedtoshowpositiveQoQ
dynamics,whichwehopereflectsagradualrecoveryintheRussianconstruction
industry.Inmining,Evrazproduced19.4mntofironoreproducts(up9%YoY)andmined
7.5mntofcokingcoal(down27%YoYduetooperationalissues).

ButconservativeEBITDAguidanceconfirmsourcostconcerns.Despiteencouraging
72.39%
operatingdata,Evrazmaintainedits4Q10EBITDAguidanceataround$595mn(inline
with3Q10)highlightinggrowingcostpressuresfromrawmaterials,energyandwages
10E
11E
12,382 15,365 thateffectivelycancelledoutgainsinoutputandprices.
2,368
3,361
514
1,795 Verticalintegrationshouldprovidesomemarginprotection.Evrazenjoysahighdegree
(54)
1,002 ofintegrationinironore(closeto90%in2010)andcokingcoal,whereselfsufficiencyis
(0.37)
6.87 expectedtoincreasefrom85%currentlytoover100%onceoutputfromRaspadskaya

recovers.EvrazsinternationalfootprintallowsittotakeselfsufficiencybeyondRussia

byexportingsemifinishedsteeltounitsintheUSandtheEU.
(307.0)
16.7
25.5
13.3 Russianstatisticsareencouragingbutsustainabilityisuncertain.Russiapostedfixed
10.2
7.2
investmentgrowthof6%YoYin2010,whileproductionofcement,bricksandplywood
2.0
1.6
roseanaverageof15%YoY.However,weneedtoseesustainedgrowthinthese
1.6
1.4
productsoveralongerperiod(probablyto2Q11)tobeconfidentthattheyreflectareal
0.3%
5.6%
0.5%
8.4% recoveryinconstructionandnotjustseasonalrestockingpatterns.

DowngradetoHOLDdespiteincreasedtargetpriceof$42.30/GDR.Aftergainingover

34%sinceourinitiationtoahighof$42.00/GDRinJan2011,Evrazhelditsground

duringtherecentcorrectionandisnowtradingat$38.21/GDR.Althoughweraisedour

TPto$42.30/GDRonstrongersteelpricesandsignsofarecoveryinRussian

construction,thisoffersonly11%upsidepotential,sowedowngradethestocktoHOLD.

Weneedtoseeasustainedrecoveryindomesticconstructionbeforewecanbelievethe

stockcouldofferanygreaterupside.

146
438
n/a
47
17.4%
16,731
24,269

1month(%)
3.2%
3month(%)
27.4%
12month(%)
15.1%
52weekhigh($)
42.72
52weeklow($)
21.80
Source:Bloomberg,Atonestimates

Se mi fi ni s he dproducts
Rai l wayproducts
Tubul arproducts

4Q09

38.21
n/a
10.7%
1:3

3Q09

Price(ordinaryGDR,$)
Price(pref,$)
Upsidepotential
Ordinary:GDRratio

2Q09

EVRLI
HK1q.L

1Q09

1,000

Bloombergcode
Reuterscode

2
0

Forecast Changes and Valuation

Figure34:EvrazAtonestimates,newvsold

YearendDecember:
Newestimates($mn)
Oldestimates($mn)
Changevsold(%)

2010E

EBITDA
2011E

2012E

2,368
2,373
0.2%

3,361
3,431
2.0%

4,081
4,040
1.0%

3Yaverage

0.4%

2010E

Netincome
2011E

2012E

54
112
n/a

1,002
826
21.3%

1,574
1,297
21.4%

3Yaverage

21.3%

Source:Atonestimates

Figure35:EvrazAtonestimatesvsconsensus

YearendDecember:
Atonestimates($mn)
Bloombergconsensus($mn)
Atonvsconsensus(%)

EBITDA
2011E
3,361
3,553
5.4%

2010E
2,368
2,384
0.7%

2012E
4,081
4,068
0.3%

3Yaverage

1.9%

2010E
54
103
n/a

Netincome
2011E
1,002
1,208
17.1%

2012E
1,574
1,442
9.2%

3Yaverage

3.9%

Source:Bloomberg,Atonestimates

Figure36:EvrazValuationbreakdown
DCFcalculation($mn):
EBIT
Lesstaxation
Taxadj.EBIT
Depreciation
Lesscapex
Changeinworkingcapital
Freecashflow
Terminalvalue
NPVoffreecashflow
NPVofterminalvalue

Discountedcashflowvaluation:
NPVoffreecashflow
NPVofterminalvalue
Enterprisevalue
Plus:otherassets
Less:minorities
Less:netdebt
Equityvalue
Less:preferredstockvalue
Commonequityvalue
No.ordinaryshares(mn)
Valuepercommonshare
CommonsharestoGDRratio
ValueperGDR

Multiplesbasedvaluation:
Ratios:
14
7
Weightedaveragevaluation:

DCF
P/E
EV/EBITDA
Valuepershare($/GDR)
Potentialupside(%)

($mn)
8,547
17,746
26,293

319
7,219
18,755

18,755
146
128.50
0.3
42.83

Multiple
xEarnings
xEBITDA

2011E
1,795
(449)
1,346
1,566
(1,100)
(556)
1,256

1,056

(%)
32.5%
67.5%
100.0%

Value($mn)
18,034
18,509

2012E
2,472
(618)
1,854
1,609
(1,250)
(435)
1,778

1,573

$/GDR
41.18
42.27

Valuation
$/GDR
42.83
41.18
42.27

2013E
2014E
2,409
1,838
(602)
(460)
1,807
1,379
1,635
1,635
(1,000)
(750)
(222)
(10)
2,220
2,254

1,796
1,668

WACCcalculation:
Riskfreerate
Standardequityriskpremium
Countryspecificequitypremium
Liquidityriskpremium
Othercompanyspecificriskpremiums
Totalcostofequity
Currentcostofdebt
Effectivecorporatetaxrate
Costofdebtaftertax
Targetgearing(debt/equity)
WACC

Terminalgrowthrate

Weightings
Netvaluation
%
$/GDR
50%
21.42
25%
10.30
25%
10.57
100%
42.28

10.7%

2015E
1,409
(352)
1,057
1,635
(750)
20
1,963

1,328

2016E
1,198
(299)
898
1,635
(750)
37
1,820
28,679
1,126
17,746

%
4.50%
4.00%
3.20%
0.00%
1.00%
12.70%
7.00%
25.00%
5.25%
45.00%
9.35%

3.00%

Source:Atonestimates

2
1

Financial Accounts

Figure37:EvrazIFRSnetincomestatement($mn)

Revenue
Costofrevenueandotheroperatingcosts(exDD&A)
Unallocatedexpenses
EBITDA
EBITDAmargin
DD&A
Otherincome/(expenses)
EBIT
Netfinancialexpenses
Otherpretaxincome/(expenses)
Profitbeforetax
Incometaxexpenses
Profitaftertax
Minorityinterests
Profitattributabletoequityholdersofthecompany
Netmargin
Earningspershare:
BasicEPSperordinaryshare
No.ofordinaryshares
No.ofGDRs(1GDR=1/3ordinaryshare)

2008
20,380
(13,944)
(221)
6,215
30.5%
(1,195)
(1,388)
3,632
(598)
17
3,051
(1,192)
1,859
62
1,797
8.8%

14.6
123
370

2009
9,772
(8,399)
(136)
1,237
12.7%
(1,632)
(652)
(1,047)
(637)
84
(1,600)
339
(1,261)
(10)
(1,251)
12.8%

(9.3)
134
403

2010E
12,382
(9,964)
(50)
2,368
19.1%
(1,735)
(119)
514
(602)
45
(43)
(13)
(56)
(2)
(54)
0.4%

(0.4)
146
438

2011E
15,365
(11,954)
(50)
3,361
21.9%
(1,566)

1,795
(463)
45
1,377
(344)
1,033
31
1,002
6.5%

6.9
146
438

2012E
16,835
(12,704)
(50)
4,081
24.2%
(1,609)

2,472
(365)
45
2,153
(538)
1,615
40
1,574
9.4%

10.8
146
438

2013E
17,156
(13,061)
(50)
4,045
23.6%
(1,635)

2,409
(276)
45
2,178
(545)
1,634
41
1,593
9.3%

10.9
146
438

2014E
16,685
(13,162)
(50)
3,473
20.8%
(1,635)

1,838
(180)
45
1,703
(426)
1,277
32
1,246
7.5%

8.5
146
438

2015E
16,303
(13,208)
(50)
3,044
18.7%
(1,635)

1,409
(83)
45
1,371
(343)
1,028
26
1,002
6.1%

6.9
146
438

Source:Companydata,Atonestimates

Figure38:EvrazIFRSbalancesheet($mn)

Cashandcashequivalents
Inventories
Receivables
Othercurrentassets
Totalcurrentassets
Property,plantandequipment
Intangibleassets
Goodwill
Othernoncurrentassets
Totalnoncurrentassets
Assetsclassifiedforsale
Totalassets

Payables
Shorttermloansandleaseliabilities
Provisions
Totalcurrentliabilities
Longtermloans
Otherlongtermliabilities
Liabilitiesassociatedwithassetsclassifiedforsales
Totalnoncurrentliabilities

Shareholders'equity
Minorityinterests
Totalequity
Totalequityandliabilities

2008
930
2,416
2,349
589
6,284
9,012
1,108
2,167
873
13,160
7
19,451

2,538
3,937
63
6,538
6,064
1,932

7,996

4,672
245
4,917
19,451

2
2

2009
675
1,886
1,559
120
4,240
14,941
1,098
2,211
921
19,171
13
23,424

1,694
2,009
35
3,738
5,931
3,146
1
9,078

10,284
324
10,608
23,424

2010E
406
2,186
2,013
76
4,681
14,156
1,016
2,165
1,025
18,362
113
23,156

1,884
1,758
38
3,680
5,431
3,129
48
8,608

10,548
320
10,868
23,156

2011E
503
2,457
2,415
76
5,451
13,689
1,016
2,165
1,025
17,895

23,346

2,000
1,658
38
3,696
4,281
3,129

7,410

11,920
320
12,240
23,346

2012E
1,110
2,776
2,632
76
6,594
13,331
1,016
2,165
1,025
17,537

24,131

2,101
1,508
38
3,647
3,431
3,129

6,560

13,604
320
13,924
24,131

2013E
2014E
2015E
1,995
2,884
3,544
2,784
2,863
2,885
2,724
2,689
2,649
76
76
76
7,579
8,511
9,154
12,695
11,810
10,924
1,016
1,016
1,016
2,165
2,165
2,165
1,025
1,025
1,025
16,901
16,016
15,130

24,481
24,527
24,284

1,980
2,012
2,015
1,358
1,208
1,058
38
38
38
3,376
3,258
3,111
2,581
1,731
881
3,129
3,129
3,129

5,710
4,860
4,010

15,075
16,089
16,844
320
320
320
15,395
16,409
17,164
24,481
24,527
24,284
Source:Companydata,Atonestimates

Figure39:EvrazIFRScashflowstatement($mn)

Netincome
Adjustments:
Depreciation,depletionandamortisation
Othernoncashadjustments
Operatingprofitbeforechangesinworkingcapital
Changesinworkingcapital
Netcashprovidedbyoperatingactivities
Cashflowfrominvestingactivities:
Purchasesofproperty,plantandequipment
Otherinvestingactivities
Netcashusedforinvestingactivities
Cashflowfromfinancingactivities:
Proceedsfromissuanceofsharecapital,netoftransactioncosts
Proceedsfrombankloansandpromissorynotes
Repaymentofbankloansandpromissorynotes,includinginterest
Dividendspaidbytheparententitytoitsshareholders
Otherfinancingactivities
Netcashprovidedbyfinancingactivities
Effectsofexchangeratechangesoncashandcashequivalents

Cashandcashequivalentsatbeginningoftheperiod
Netincreaseincashandcashequivalents
Cashofdisposalgroupsclassifiedasheldforsale
Cashandcashequivalentsattheendoftheperiod

2
3

2008
1,859

1,195
1,672
4,726
(163)
4,563

(1,103)
(2,633)
(3,736)

(1)
5,657
(3,949)
(1,276)
(558)
(127)
(97)

327
603

930

2009
(1,261)

1,632
675
1,046
654
1,700

(441)
624
183

310
3,427
(4,987)
(90)
(809)
(2,149)
11

930
(255)

675

2010E
(56)

1,735
200
1,879
(516)
1,364

(950)
12
(938)

1,750
(2,500)

110
(640)
(55)

675
(269)
(21)
406

2011E
1,033

1,566
418
3,017
(556)
2,461

(1,100)

(1,100)

750
(2,000)
(14)

(1,264)

406
97

503

2012E
2013E
2014E
2015E
1,615
1,634
1,277
1,028

1,609
1,635
1,635
1,635
320
231
135
38
3,543
3,500
3,048
2,702
(435)
(222)
(10)
20
3,108
3,278
3,037
2,722

(1,250)
(1,000)
(750)
(750)

(1,250)
(1,000)
(750)
(750)

250
250
250
250
(1,250)
(1,250)
(1,250)
(1,250)
(250)
(394)
(398)
(311)

(1,250)
(1,394)
(1,398)
(1,311)

503
1,110
1,995
2,884
607
885
889
661

1,110
1,995
2,884
3,544
Source:Companydata,Atonestimates

MAGNITOGORSK
IRON AND STEEL
Growing HVA Output Offsets Cost Pressures

WeincreaseourtargetpriceforMMKto$16.20/GDR(up6%from$15.33/GDR)to
accountforstrongersteelpricesanditsgrowingexposuretoHighValueAdded(HVA)
products,whichshouldmitigatesomeoftherisingpressurefromcosts.Ournew
targetpriceoffers17%upsidepotentialfromthecurrentlevel,allowingustoreiterate
ourBUYratingonMMK.

Figure40:Domesticmarketremainsthefocusforhighvalueaddedproductsales

BUY
Target price

Regi ona l s a l es s tructure (3Q10)

$16.20

Potential upside

Asia&
FarEast

17%

Middle
East

Domes ti cs a l es bys ector(3Q10)


Auto
industry

Other
8%

5%

10%

Bloombergcode
Reuterscode
Price(ordinaryGDR,$)
Price(pref,$)
Upsidepotential
Ordinary:GDRratio

Sharedata
No.ofordinaryshares(mn)
No.ofordinaryGDRs(mn)
No.ofprefshares(mn)
3Maveragedailyt/o($mn)
Freefloat(%)
Marketcapitalisation($mn)
Enterprisevalue($mn)
Majorshareholders
MinthaHoldingLimited
FulnekEnterprisesLimited

MMKLI
MAGNq.L

Domesticmarket
Machine
building

37%
21%
Spotsales
Russia&CIS

Source:Companydata

Financialsfor3Q10highlightgrowingcostpressures.MMKs3Q10IFRSresultsclearly
reflectthecostpressuresitfacesasoneofRussiasleastintegratedsteelmakers:EBITDA
wasdown11%QoQto$388mnduetohighercosts,withEBITDAmarginslippingto
18.9%from21.1%in2Q10(seeFigure41).

Figure41:MMK3Q10IFRSresultssummary($mn)

45.62%
41.01%

13%

Pipe
production

FINANCIALS($mn)
2009
10E
11E
Revenue
5,081
7,597 10,038
EBITDA
1,023
1,437
2,059
EBIT
288
643
1,219
Netincome
232
240
812
EPS
0.02
0.02
0.07

VALUATION

P/E(x)
51.1
49.5
14.6
P/CF(x)
15.2
11.1
153.8
EV/EBITDA(x)
14.9
10.6
7.4
EV/Sales(x)
3.0
2.0
1.5
P/BV(x)
1.2
1.2
1.1
RoCE(%)
1.9%
1.8%
5.7%
RoE(%)
2.3%
2.4%
7.7%

PERFORMANCE

1month(%)
11.0%

3month(%)
8.0%

12month(%)
8.1%

52weekhigh($)
16.23

52weeklow($)
8.90

Source:Bloomberg,Atonestimates

12%

Construction
12%

77%

13.82
n/a
17.2%
13:1

11,174
860
n/a
8
13.4%
11,879
15,228

Other
5%

2
4

3Q10
actual

2Q10
actual

QoQ
change

EBITDA
EBITDAmargin
Netincome

388
18.9%
43

437
21.1%
53

11.2%

18.9%

3Q10
Atonest.

3Q09
actualvs
Atonest.

3Q10
Interfax
consensus

3Q09
actualvs
consensus

404
4.0%
381
1.8%
19.7%

18.8%

78
44.9%
85
49.4%
Source:Companydata,Interfax,Atonestimates

Operatingresultsbelowexpectationsin4Q10,promptingrevisiontoFY10forecast.
MMKs4Q10productionnumberscameinbelowourexpectationswithQoQreductions
acrossmoststeelproductgroups;rolledproductoutputwasdown6%QoQto2.7mn
tonnes.ThenotableexceptionwasHVAproduction,whichaccountedfor42%of4Q10
shipments(upfrom38%in3Q10).AsaresultwerevisedourFY10netincomeforecast
down11%from$270mnto$240mn.

HVAproductsandverticalintegrationshouldhelpinprotectingmargins.The
companysMill5000,whichaccountsforalargeshareofHVAproductiongrowth,isnow
operatingatitsfullcapacityof1.5mntpaofthickplate.Togetherwithgrowingself
sufficiencyincokingcoal,thisshouldmitigatesomeofthecostpressuresexpectedin
2011.Onthedownside,theprofitabilityofitsAtakasJVremainsuncertain.Weestimate
MMKcouldeasilyadd3mnt(27%)ofsteelproductionfromexistingfacilitiesifmarket
conditionsimprove,quicklytranslatingintobetterfinancialperformance.

Targetpriceuppedto$16.20/GDR;BUYratingreiterated.Ournewtargetpriceimplies
17%upsidepotentialfromcurrentlevels,supportingourBUYratingonthestock.Future
reviewswilldependonMMKsabilitytomanageitscostexposureandprotectmargins
fromfurtherdeterioration.

Forecast Changes and Valuation

Figure42:MMKAtonestimates,newvsold

YearendDecember
Newestimates($mn)
Oldestimates($mn)
Changevsold(%)

EBITDA
2011E
2,059
2,423
15.0%

2010E
1,437
1,535
6.3%

2012E
2,837
2,737
3.7%

3Yaverage

5.9%

2010E
240
270
11.2%

Netincome
2011E
812
872
6.8%

2012E
1,342
1,058
26.8%

3Yaverage

2.9%

Source:Atonestimates

Figure43:MMKAtonestimatesvsconsensus

YearendDecember
Atonestimates($mn)
Bloombergconsensus($mn)
Atonvsconsensus(%)

EBITDA
2011E
2,059
2,414
14.7%

2010E
1,437
1,557
7.7%

2012E
2,837
2,799
1.4%

3Yaverage

7.0%

2010E
240
380
36.8%

Netincome
2011E
812
1,047
22.4%

2012E
1,342
1,360
1.3%

3Yaverage

20.2%

Source:Bloomberg,Atonestimates

Figure44:MMKValuationbreakdown
DCFcalculation($mn):
EBIT
Lesstaxation
Taxadj.EBIT
Depreciation
Lesscapex
Changeinworkingcapital
Freecashflow
Terminalvalue
NPVoffreecashflow
NPVofterminalvalue

Discountedcashflowvaluation:
NPVoffreecashflow
NPVofterminalvalue
Enterprisevalue
Plus:otherassets
Less:minorities
Less:netdebt
Equityvalue
Less:preferredstockvalue
Commonequityvalue
No.ordinaryshares(mn)
Valuepercommonshare
Commonshares:GDRratio
ValueperGDR

Multiplesbasedvaluation:
Ratios:
14
7
Weightedaveragevaluation:

DCF
P/E
EV/EBITDA
Valuepershare($/GDR)
Potentialupside(%)

($mn)
4,810
11,811
16,621

421
2,928
13,272

13,272
11,174
1.19
13
15.44

Multiple
xEarnings
xEBITDA

2011E
1,219
(274)
945
840
(1,000)
(707)
77

65

(%)
28.9%
71.1%
100.0%

Value($mn)
15,076
13,786

2012E
1,907
(429)
1,478
930
(950)
(386)
1,072

940

$/GDR
17.63
16.12

Valuation
$/GDR
15.44
17.63
16.12

2013E
2014E
1,644
1,328
(370)
(299)
1,274
1,029
969
1,019
(850)
(650)
(96)
(27)
1,297
1,372

1,034
993

WACCcalculation:
Riskfreerate
Standardequityriskpremium
Countryspecificequitypremium
Liquidityriskpremium
Othercompanyspecificriskpremiums
Totalcostofequity
Currentcostofdebt
Effectivecorporatetaxrate
Costofdebtaftertax
Targetgearing(debt/equity)
WACC

Terminalgrowthrate

Weightings
Netvaluation
%
$/GDR
50%
7.72
25%
4.41
25%
4.03
100%
16.16

17.2%

2015E
1,121
(252)
869
1,037
(500)
31
1,437

945

2016E
1,009
(227)
782
1,063
(500)
49
1,393
19,758
833
11,811

%
4.50%
4.00%
3.20%
1.00%
0.00%
12.70%
5.00%
22.50%
3.88%
30.00%
10.05%

3.0%

Source:Atonestimates

2
5

Financial Accounts

Figure45:MMKIFRSnetincomestatement($mn)

Grossrevenue
Costofgoodssold
Selling,distributionandadministrativeexpenses
Otheroperatingexpenses/(income)
EBITDA(reported)
EBITDA(adjusted)
EBITDA(adjusted)margin
EBIT
Netforeignexchangegain/(loss)
Othernonoperatingincome/(loss)
Netinterestexpense
Otherincome/(expenses),net
Incomebeforetaxandminorityinterest
Incometax
Incomebeforeminorityinterest
Minorityinterest
Netincome
Netmargin
Earningspershare:
BasicEPSperordinaryshare
No.ofordinarysharesoutstanding
No.ofGDRs(1GDR=13ordinaryshares)

2008
10,550
(6,890)
(1,163)
(378)
2,204
2,119
20.1%
1,174
16
1
(18)
(67)
1,106
(25)
1,081
(6)
1,075
10.2%

0.10
11,160
858

2009
5,081
(3,205)
(802)
(51)
1,285
1,023
20.1%
288
9
180
(76)
(144)
257
(38)
219
13
232
4.6%

0.02
11,099
854

2010E
7,597
(4,944)
(1,064)
(152)
1,566
1,437
18.9%
643
(40)
10
(136)
(168)
310
(68)
242
(2)
240
3.2%

0.02
11,116
855

2011E
10,038
(6,322)
(1,556)
(100)
2,059
2,059
20.5%
1,219

(160)

1,059
(238)
821
(8)
812
8.1%

0.07
11,116
855

2012E
12,091
(7,259)
(1,874)
(121)
2,837
2,837
23.5%
1,907

(158)

1,749
(394)
1,356
(14)
1,342
11.1%

0.12
11,116
855

2013E
2014E
2015E
12,330
12,327
12,107
(7,682)
(7,945)
(7,951)
(1,911)
(1,911)
(1,877)
(123)
(123)
(121)
2,613
2,348
2,158
2,613
2,348
2,158
21.2%
19.0%
17.8%
1,644
1,328
1,121

(128)
(87)
(40)

1,516
1,241
1,081
(341)
(279)
(243)
1,175
962
838
(12)
(10)
(8)
1,163
952
830
9.4%
7.7%
6.9%

0.10
0.09
0.07
11,116
11,116
11,116
855
855
855
Source:Companydata,Atonestimates

2010E
248
202
1,249
1,084
203
2,986
12,218
34
299
25
562
154
13,292
16,277

972
1,151
23
2,146
2,378
1,403
3,781
5,927
405

9,945
16,277

2011E
246
202
1,650
1,299
182
3,579
12,378
34
299
25
562
154
13,452
17,031

1,022
1,039
23
2,084
2,578
1,403
3,981
6,065
405

10,560
17,031

2012E
490
202
1,817
1,388
165
4,062
12,398
34
299
25
562
154
13,472
17,534

922
892
23
1,837
2,328
1,403
3,731
5,568
405

11,560
17,534

2013E
2014E
2015E
958
1,557
2,270
202
202
202
1,773
1,773
1,741
1,421
1,469
1,470
168
174
174
4,523
5,176
5,858
12,279
11,910
11,373
34
34
34
299
299
299
25
25
25
562
562
562
154
154
154
13,352
12,983
12,446
17,875
18,159
18,305

822
722
622
789
816
817
23
23
23
1,634
1,561
1,462
2,078
1,828
1,578
1,403
1,403
1,403
3,481
3,231
2,981
5,115
4,792
4,443
405
405
405

12,355
12,962
13,457
17,875
18,159
18,305
Source:Companydata,Atonestimates

Figure46:MMKIFRSbalancesheet($mn)

Cashandcashequivalents
Otherinvestments
Accountsreceivables
Inventories
Othercurrentassets
Totalcurrentassets
Plant,propertyandequipment
Intangibleassets
Goodwill
Investmentsinaffiliates
Otherinvestments
Othernoncurrentassets
Totalnoncurrentassets
Totalassets

Shorttermloansandleaseliabilities
Accountsandnotespayable
Othercurrentliabilities
Totalcurrentliabilities
Longtermdebtandcapitalleases
Othernoncurrentliabilities
Totalnoncurrentliabilities
Totalliabilities
Minorityinterests

Totalshareholders'equity
Totalliabilitiesandshareholders'equity

2008
1,106
138
980
996
408
3,628
9,751
36
45
228
358
151
10,569
14,197

1,295
1,321
24
2,640
431
1,274
1,705
4,345
189

9,664
14,198

2
6

2009
165
221
941
856
247
2,430
11,276
37
309
22
627
132
12,403
14,833

828
928
21
1,777
1,290
1,441
2,731
4,508
368

9,957
14,833

Figure47:MMKIFRScashflowstatement($mn)

Operatingactivities:
Netincome
Adjustmentsfornoncashitems:
Depreciationandamortisation
Incometax
Netfinancecost
Otheradjustmentsfornoncashitems
Operatingprofitbeforechangesinworkingcapital
Changesinworkingcapital
Cashgeneratedfromoperations
Interestpaid
Incometaxrefund/(paid)
Netcashgeneratedbyoperatingactivities
Investingactivities:
Acquisitionofproperty,plantandequipment
Otherinvestingactivities
Netcashusedforinvestingactivities
Financingactivities:
Proceedsfromborrowings
Repaymentofborrowings
Dividendspaid
Otherfinancingactivities
Netcashprovidedbyfinancingactivities
Effectsofexchangeratechangesincashandcashequivalents

Cashandcashequivalentsatbeginningoftheperiod
Netincreaseincashandcashequivalents
Cashandcashequivalentsattheendoftheperiod

2
7

2008

1,075

945
25
18
715
2,778
(269)
2,509
(104)
(480)
1,925

(2,112)
1,133
(979)

3,974
(3,562)
(314)
(36)
62
(158)

256
850
1,106

2009

232

735
38
76
(115)
966
(127)
839
(109)
135
865

(1,613)
(76)
(1,689)

2,935
(2,974)
(16)
15
(40)
(77)

1,106
(941)
165

2010E

240

794
68
136
224
1,461
(245)
1,216
(110)
(70)
1,036

(2,118)
10
(2,108)

2,500
(1,250)
(48)
3
1,205
(50)

165
83
248

2011E

812

840
238
160
30
2,080
(707)
1,373
(165)
(217)
991

(1,000)

(1,000)

500
(250)
(203)
(40)
7

248
(2)
246

2012E
2013E
2014E
2015E

1,342
1,163
952
830

930
969
1,019
1,037
394
341
279
243
158
128
87
40
31
8
4
8
2,854
2,609
2,342
2,158
(386)
(96)
(27)
31
2,468
2,513
2,315
2,189
(172)
(170)
(152)
(135)
(376)
(345)
(285)
(243)
1,920
1,999
1,877
1,810

(950)
(850)
(650)
(500)

(950)
(850)
(650)
(500)

(350)
(350)
(350)
(350)
(336)
(291)
(238)
(207)
(40)
(40)
(40)
(40)
(726)
(681)
(628)
(597)

246
490
958
1,557
244
468
599
713
490
958
1,557
2,270
Source:Companydata,Atonestimates

NOVOLIPETSK
STEEL
Profitability Leader Despite Margin Pressures

WeupgradeourratingonNLMKfromHOLDtoBUYwitha12MTPof$49.40/GDR,
implying14%upsidepotential.Whileupsidemaybelimitedcomparedtoothersteel
stocks,NLMKsassetquality,healthybalancesheetandstrongprofitabilitymakeita
soundpotentialadditiontoanysteelcompanyportfolio,inourview.

Figure48:Salesandrevenuearefinelybalancedovermajormarkets
Regi ona l s a l es s tructure (3Q10)

Re gi onal revenue s tructure(3Q10)

BUY
Target price

$49.40

Potential upside
Bloombergcode
Reuterscode
Price(ordinary,$)
Price(pref,$)
Upsidepotential
Ordinary:GDRratio

Sharedata
No.ofordinaryshares(mn)
No.ofordinaryGDRs(mn)
No.ofprefshares(mn)
3Maveragedailyt/o($mn)
Freefloat(%)
Marketcapitalisation($mn)
Enterprisevalue($mn)
Majorshareholders
FletcherGroupHoldings

14%

USA
17%

NLMKLI
NLMKq.L
43.50
n/a
13.6%

5,993
599
n/a
19
12.9%
26,071
27,333

Russia
35%

USA
13%

Europe
22%

Russia
40%

Europe
21%

Source:CompanyData

Outlookfor4Q10highlightschallengingcostenvironment.NLMKreportedastrongset
of3Q10results,outperformingbothourandconsensusestimatesbyasubstantial
margin,recordingEBITDAof$695mnandnetincomeof$516mn(seeFigure49).

Figure49:NLMK3Q10USGAAPresultssummary($mn)

85.5%

2009
6,140
1,370
892
215
0.04

10E
8,382
2,384
1,882
1,332
0.22

11E
10,905
3,233
2,673
1,949
0.33

P/E(x)
P/CF(x)
EV/EBITDA(x)
EV/Sales(x)
P/BV(x)
RoCE(%)
RoE(%)

PERFORMANCE

121.2
101.5
20.0
4.5
3.0
1.9%
2.5%

19.6
100.1
11.5
3.3
2.7
10.7%
13.7%

13.4
76.5
8.5
2.5
2.3
14.3%
17.5%

1month(%)
7.6%

3month(%)
15.8%

12month(%)
42.2%

52weekhigh($)
51.00

52weeklow($)
25.04

Source:Bloomberg,Atonestimates

Other
12%
Middle
East
14%

HVAproductsunderpinprofitabilityleadership.AlthoughHVAproducts(e.g.pre
painted,transformeranddynamosteels)accountforonly30%ofNLMKssalesvolumes,
thepremiummarginstheseproductscommandunderpinitsprofitabilityleadershipover
peers,evenintimesofrisingcosts.Increasedlongsteeloutputshouldprovide
additionalupsideonceRussianconstructionactivityrecovers,inourview.

10:1

FINANCIALS($mn)
Revenue
EBITDA
EBIT
Netincome
EPS

VALUATION

Other
11%
Middle
East
15%

2
8

3Q10
actual

2Q10
actual

QoQ
change

EBITDA
EBITDAmargin
Netincome

695
30.5%
516

750
34.8%
466

7%

11%

3Q10
Atonest.

3Q09
actualvs
Atonest.

3Q10
Interfax
consensus

3Q09
actualvs
consensus

612
14%
646
8%
29.1%

30.2%

309
67%
409
26%
Source:Companydata,Interfax,Atonestimates

However,thecompanysoutlookfor4Q10highlightsthecostpressuresthebusinessis
facing:EBITDAmarginisexpectedataround25%vs31%in3Q10.

BuyingremainingstakeinDufercoJVcouldbeakeyvaluecatalyst.NLMK's
internationalexpansionhasfocusedonacquiringsteelrerollingassetstocompensate
forashortageofrollingcapacity.TheJVwithDuferco(SteelInvest&FinanceS.A.)aimed
togiveNLMKanoutletforitsexpandingslabproduction.Buyingtheremaining50%in
theJVcouldbecomeapowerfulvaluedriversupportinghighermarginsviasalesto
internationalmarkets(providedthepriceisrightandNLMKcanreturnthefacilitiesto
profitability).

TPraisedto$49.40/share,upgradetoBUY.Thestockhascorrectedaround15%from
itsJanuarypeakof$51.30/GDR.WhileournewTPimpliesjust14%upsidefromcurrent
levels,wehaveupgradedourratingtoBUYonNLMKsassetquality,strongbalance
sheetandprofitabilityleadershipvsglobalpeers,whichshouldkeepthestockamong
thetoppicksforanysteelfocusedportfolio,inourview.

Forecast Changes and Valuation

Figure50:NLMKAtonestimates,newvsold

YearendDecember
Newestimates($mn)
Oldestimates($mn)
Changevsold(%)

EBITDA
2011E
3,233
3,263
0.9%

2010E
2,384
2,424
1.6%

2012E
4,397
3,700
18.8%

3Yaverage

5.4%

2010E
1,332
1,208
10.3%

Netincome
2011E
1,949
2,011
3.1%

2012E
2,753
2,293
20.1%

3Yaverage

9.1%

Source:Atonestimates

Figure51:NLMKAtonestimatesvsconsensus

YearendDecember
Atonestimates($mn)
Bloombergconsensus($mn)
Atonvsconsensus(%)

EBITDA
2011E
3,233
3,370
4.1%

2010E
2,384
2,400
0.7%

2012E
4,397
3,959
11.1%

3Yaverage

2.1%

2010E
1,332
1,311
1.6%

Netincome
2011E
1,949
2,047
4.8%

2012E
2,753
2,373
16.1%

3Yaverage

4.3%

Source:Bloomberg,Atonestimates

Figure52:NLMKValuationbreakdown
DCFcalculation($mn):
EBIT
Lesstaxation
Taxadj.EBIT
Depreciation
Lesscapex
Changeinworkingcapital
Freecashflow
Terminalvalue
NPVoffreecashflow
NPVofterminalvalue

Discountedcashflowvaluation:
NPVoffreecashflow
NPVofterminalvalue
Enterprisevalue
Plus:otherassets
Less:minorities
Less:netdebt
Equityvalue
Less:preferredstockvalue
Commonequityvalue
No.ordinaryshares(mn)
Valuepercommonshare
Commonshares:GDRratio
ValueperGDR

Multiplesbasedvaluation:
Ratios:
16
8
Weightedaveragevaluation:

DCF
P/E
EV/EBITDA
Valuepershare($/GDR)
Potentialupside(%)

($mn)
9,643
27,123
36,766

115
1,148
35,504

35,504
5,993
5.92
10
59.24

Multiple
xEarnings
xEBITDA

2011E
2,673
(601)
2,071
560
(1,800)
(491)
341

290

(%)
26.2%
73.8%
100.0%

Value($mn)
26,246
21,206

2012E
3,756
(845)
2,911
640
(1,500)
(478)
1,574

1,391

$/GDR
43.79
35.38

Valuation
$/GDR
59.2
43.8
35.4

2013E
2014E
3,923
3,953
(883)
(889)
3,040
3,063
696
710
(900)
(700)
(266)
(71)
2,570
3,002

2,077
2,219

WACCcalculation:
Riskfreerate
Standardequityriskpremium
Countryspecificequitypremium
Liquidityriskpremium
Othercompanyspecificriskpremiums
Totalcostofequity
Currentcostofdebt
Effectivecorporatetaxrate
Costofdebtaftertax
Targetgearing(debt/equity)
WACC

Terminalgrowthrate

Weightings
Netvaluation
%
$/GDR
50%
29.62
25%
10.95
25%
8.85
100%
49.41

13.6%

2015E
3,748
(843)
2,905
709
(700)
(39)
2,875

1,943

2016E
3,635
(818)
2,818
709
(700)
(39)
2,788
43,887
1,723
27,123

%
4.5%
4.0%
3.2%
0.0%
0.0%
11.7%
5.0%
22.5%
3.9%
30.0%
9.4%

3.0%

Source:Atonestimates

2
9

Financial Accounts

Figure53:NLMKUSGAAPP&Lstatement($mn)

Totalrevenue
COGS
Grossprofit
SG&A
Otheroperatingincome/(expense)
Operatingincome(EBIT)
EBITDA
DD&A
Netinterestincome/(expense)
Associates
FX(loss)/gain
Others(recurring)
Pretaxprofit
Tax
Equityinnetlosses/(earnings)ofassociates
Netincome(preexceptionals)
Minorityinterest
Netincome(postexceptionals)
EPS($/GDR)
DividendperGDR($)
NumberofGDRs(mn)

2009
6,140
(4,150)
1,990
(1,054)
(44)
892
1,370
(478)
(111)

(78)
(108)
595
(182)
(315)
98
117
215
0.36
0.07
599

2010E
8,382
(5,399)
2,982
(1,097)
(3)
1,882
2,384
(503)
(54)

(54)
(13)
1,761
(423)
(29)
1,310
22
1,332
2.22
0.31
599

2011E
10,905
(7,033)
3,872
(1,200)

2,673
3,233
(560)
(78)

2,595
(584)
(43)
1,969
(20)
1,949
3.25
0.98
599

2012E
13,524
(8,280)
5,244
(1,488)

3,756
4,397
(640)
(90)

3,666
(825)
(60)
2,781
(28)
2,753
4.59
1.38
599

2013E
2014E
2015E
14,839
15,184
15,298
(9,284)
(9,561)
(9,867)
5,555
5,623
5,431
(1,632)
(1,670)
(1,683)

3,923
3,953
3,748
4,619
4,662
4,457
(696)
(710)
(709)
(65)
(6)
70

3,858
3,947
3,818
(868)
(888)
(859)
(63)
(65)
(63)
2,927
2,994
2,896
(29)
(30)
(29)
2,898
2,964
2,868
4.83
4.95
4.78
1.45
1.48
1.44
599
599
599
Source:Companydata,Atonestimates

2010E
1,268
1,247
1,475
131
4,121

8,613
760
468
122
9,963
14,084

1,094
600
19
1,714

2,100
396
140
2,636
4,350
(108)

9,734

14,084

2011E
722
1,622
1,922
131
4,396

9,853
760
468
122
11,204
15,599

1,425
600
19
2,045

1,900
396
140
2,436
4,481
(108)

11,118

15,599

2012E
540
2,011
2,263
131
4,944

10,713
760
468
122
12,063
17,007

1,678
600
19
2,298

1,100
396
140
1,636
3,934
(108)

13,073

17,007

2013E
2014E
2015E
2,027
3,971
5,978
2,207
2,258
2,275
2,537
2,613
2,696
131
131
131
6,902
8,972
11,080

10,917
10,907
10,898
760
760
760
468
468
468
122
122
122
12,267
12,257
12,248
19,168
21,230
23,328

1,882
1,938
2,000
600
600
600
19
19
19
2,501
2,557
2,619

1,000
900
900
396
396
396
140
140
140
1,536
1,436
1,436
4,037
3,994
4,056
(108)
(108)
(108)

15,131
17,236
19,272

19,168
21,229
23,328
Source:Companydata,Atonestimates

Figure54:NLMKUSGAAPbalancesheet($mn)

Cash&shortterminvestments
Accountsreceivable
Inventory
Othercurrentassets
Totalcurrentassets

PP&E
Intangibleassets
Investments
Otherlongtermassets
Totalnoncurrentassets
Totalassets

Accountspayable
Shorttermdebt
Othercurrentliabilities
Totalcurrentliabilities

Longtermdebt
Deferredtaxliabilities
Othernoncurrentliabilities
Totallongtermliabilities
Totalliabilities
Minorityinterests

Totalshareholdersequity

Totalliabilitiesandequity

2009
1,699
913
1,134
131
3,877

7,316
760
468
81
8,625
12,502

841
557
19
1,417

1,939
396
140
2,475
3,892
(108)

8,610

12,502

3
0

Figure55:NLMKUSGAAPcashflow($mn)
2009
98
478
859
(41)
1,394
(1,121)

(651)
(1,771)
(2)

(533)
(535)
2,159
(912)
1,247

Netincome
DD&Aaddback
(Increase)/Decreaseinworkingcapital
Otheroperatingcashflowitems
Cashflowfromoperations
Capitalexpenditure
Acquisitions
Otherinvestingcashflow
Cashflowfrominvesting
Dividendspaid
Share(repurchase)/issue
Increase/(decrease)interestbearingliabilities
Cashflowfromfinancing
Cashandcashequivalentsatbeginningofyear
Netincrease/(decrease)incashandcashequivalents
Cashandcashequivalentsatendofyear

3
1

2010E
1,310
503
(422)

1,391
(1,800)

(1,800)
(185)

164
(21)
1,247
(431)
817

2011E
1,969
560
(491)

2,038
(1,800)

(1,800)
(585)

(200)
(785)
817
(547)
270

2012E
2,781
640
(478)

2,944
(1,500)

(1,500)
(826)

(800)
(1,626)
270
(182)
88

2013E
2014E
2015E
2,927
2,994
2,896
696
710
709
(266)
(71)
(39)

3,357
3,633
3,567
(900)
(700)
(700)

(900)
(700)
(700)
(869)
(889)
(860)

(100)
(100)

(969)
(989)
(860)
88
1,575
3,519
1,487
1,944
2,007
1,575
3,519
5,526
Source:Companydata,Atonestimates

SEVERSTAL
Unloved and Undervalued

WeupgradeourtargetpriceforSeverstalto$22.10/GDRandreiterateourBUYrating
ontheshares.PostponementofthecompanysgoldbusinessIPOwasa
disappointmentasitwasthemaindriverbehindthestockpriceappreciationseenin
recentmonths.Nevertheless,Severstaloffersplentyofupsideinitscurrentform,
whileapotentialswingbacktoprofitabilityintheUScouldleadtoupsidesurprises.

Figure56:NorthAmericaandEuropestillplayamajorroleinrevenuegeneration
Sa l es bybus i nes s (3Q10)

BUY
Target price

$22.10

Potential upside
Bloombergcode
Reuterscode
Price(ordinary,$)
Price(pref,$)
Upsidepotential
Ordinary:GDRratio

Sharedata
No.ofordinaryshares(mn)
No.ofordinaryGDRs(mn)
No.ofprefshares(mn)
3Maveragedailyt/o($mn)
Freefloat(%)
Marketcapitalisation($mn)
Enterprisevalue($mn)
Majorshareholders
AlexeyMordashov

10E
15,021
2,804
1,848
87
0.09

P/E(x)
P/CF(x)
EV/EBITDA(x)
EV/Sales(x)
P/BV(x)
RoCE(%)
RoE(%)

PERFORMANCE

n/a
11.0
26.5
1.7
2.3
7.9%
13.2%

n/a
15.0
8.0
1.5
2.0
0.7%
1.0%

Mining
excl.gold
15%

Europe
13%

North
America
31%

GoldbusinessIPOnotyetoutofthepicture.WhilepostponementoftheNordgold
IPOwasadisappointment,wedonotthinkSeverstalhascancelleditsplanstotakethe
companypublic.Ourownvaluationforthebusinessrangedfrom$2.4bnto$5.1bn.
Whilereachingthetopendoftherangecouldhavebeenhardtoachieve(especially
giventhecompetitionoftwoothersectorIPOsandthesaleof10%ofVTB),westillthink
thatNordgoldcouldpotentiallyachieveavaluationofaround$3.54bn,withupside
potentialof1015%overitscurrentvaluationasaSeverstalasset.

RecentfinancialshighlighttheUSswingfactorinprofitgeneration.Asexpected,
Severstals3Q10EBITDAdeclinedonloweroutputandprices.EBITDAmarginfellto19%
from22.5%in2Q10mostlyonincreasedcosts,butalsoduetotheUSbusinessturning
11E
EBITDAnegativeagain.Netincomeof$368mnwasaheadofourforecast,mainlydueto
18,767
positiveforexmovements(seeFigure57).
3,508

2,626
Figure57:Severstal3Q10IFRSresultssummary($mn)
1,603
1.59

11.1
41.5
6.4
1.2
1.9
11.6%
16.9%

1month(%)
7.0%

3month(%)
27.0%

12month(%)
42.9%

52weekhigh($)
19.78

52weeklow($)
9.35

Source:Bloomberg,Atonestimates

Russia
43%

Source:Companydata

1,008
1,008
n/a
47
17.6%
17,836
22,448

82.37%

2009
13,054
846
399
1,037
1.03

Gold
4%

Asia
8%

Russian
Steel
46%

USA
24%

SVST.LI
CHMFq.L
17.70
n/a
24.9%

FINANCIALS(mn)
Revenue
EBITDA
EBIT
Netincome
EPS

VALUATION

Other
China& 5%

Europe
11%

25%

1:1

Re gi onal s al e s s tructure(3Q10)

3
2

3Q10
actual

2Q10
actual

QoQ
change

EBITDA
EBITDAmargin
Netincome

751
19.1%
368

955
22.5%
192

21.4%

91.7%

3Q10
Atonest.

3Q09
actualvs
Atonest.

3Q10
Interfax
consensus

3Q09
actualvs
consensus

747
0.5%
748
0.4%
19.8%

19.4%

286
28.7%
315
16.8%
Source:Companydata,Interfax,Atonestimates

USbusinessmaybethekeytoupsidesurprises.Webelievetherecoveryinsteel
outputcurrentlyunderwayintheUScombinedwithstrengtheningsteelpricesmaylead
toanimprovedfinancialperformancebySeverstalsUSassets.Inourview,thiscould
helpoffsetmarginreductionsinRussia,leadingtopositivefinancialresultssimilarto
whatwasseenbrieflyin2Q10.

WereiterateourBUYrating,TPincreasedto$22.10/GDR.Weincreaseourtargetprice
forSeverstalby19%to$22.10/GDR,implying25%upsidepotentialtocurrentlevels.We
maintainourBUYratingaswebelievethestockoffersplentyofupsideevenwithoutthe
shorttermdriverofthepotentialNordgoldIPO.ArecoveryintheUSmarketcould
resultinupsidesurprises,inourview.

US Business May Hold Key to 2011 Margin Expansion


DespiteongoingdiscussionsonSeverstalsplansforitsUSbusinessunit,thecompany
stillhasastrongpresenceinAmerica.Whilethecontinuedreorganisationand
rationalisationofitsUSholdingsmaybeoneofSeverstalsprioritiesfor2011,the
businessmaybenefitfromtheongoingrecoveryintheUSsteelmarket.

UScapacityutilisationhasimprovedsubstantiallysincetheendof2010
UtilisationofinstalledsteelmakingcapacityintheUShasbeenslowlyrecoveringsince
reachingalowat33.5%attheendofDec2008.Utilisationaveragedaround70%in
2010,risingtoabout75%bymidsummer;formostoftheperiodsinceOct2010,itsat
below70%.However,utilisationratesrecoveredstronglyfrom68%attheendofDec
2010to74%inthefirstweekofFebruary.Thisequatestonearly600ktofmonthlyUS
steeloutput,uparound9%onDec2010(seeFigure58).

Figure58:UScapacityutilisationisupsharply
Figure59:andsoareUSsteelprices
CapacityutilisationintheUSissharplyup,
reaching74%attheendofJan2011...

Feb11

Jan11

Dec10

Oct10

Sep10

Aug10

Nov10

Source:Bloomberg

Jul10

Jan10

Feb11

Jan11

Dec10

Nov10

Oct10

Sep10

Aug10

Jul10

Jun10

May10

Apr10

Mar10

Jan10

60.0%

Feb10

vs67%attheendofJan2010

Jun10

66.9%

65.0%

May10

70.0%

Apr10

170
160
150
140
130
120
110
100
90

73.7%

Rebarpri cei ndex

USsteelpricesarealsoup
sincethebeginningof2011

Feb10

74.8%

75.0%

HRCpri cei ndex

Mar10

80.0%

Source:Bloomberg

USsteelpricesseemtoberising,too
Figure59showsthesharpincreaseinUSsteelpricesfromDec2010toJan2011:HRC
pricesincreasedanaverage40%from$595600/tonto$825845/ton,whilerebarprices
gainedapproximately16%,risingfrom$650660/tonto$750775/ton.

Evenifweassumethatrecentcapacityutilisationratesandpriceincreaseswerepartly
drivenbyseasonalrestockingandshouldweakengoingforward,westillestimatethat
1Q11pricesandcapacityutilisationwillexceedtheDec2010levels.

SeverstalsUSunitneedsaminorupliftinoutputandpricestobecomeEBITDA
positiveagain
Severstalsurprisedontheupsidelastyearbyreporting2Q10resultsfaraheadofmarket
expectations.ThebiggestgaincamefromitsUSbusiness,whichproducedEBITDAof
$59mnafteralossof$83mnin1Q10(andlossesinthefivepreviousquarters).
Moreover,thebusinessnearlybrokeevenattheoperationallevelwithalossofonly
$1mn.Thisimprovedperformancewasdrivenbya15%QoQincreaseinsalesvolumes
andan8%QoQincreaseinaveragerealisedprices.GiventheapparentdirectionofUS
capacityutilisationandprices,webelievethatarepeatofthestrong2Q10performance
isachievablein2011andcouldperhapsbemoresustainablethantheperformanceseen
lastyear.

3
3

Forecast Changes and Valuation

Figure60:SeverstalAtonestimates,newvsold

YearendDecember
Newestimates($mn)
Oldestimates($mn)
Changevsold(%)

EBITDA
2011E
3,508
3,961
11.4%

2010E
2,804
3,315
15.4%

2012E
3,508
4,155
15.6%

3Yaverage

14.2%

2010E
87
9
n/a

Netincome
2011E
1,603
1,598
0.3%

2012E
2,029
1,802
12.6%

3Yaverage

6.4%

Source:Atonestimates

Figure61:SeverstalAtonestimatesvsconsensus

YearendDecember
Atonestimates($mn)
Bloombergconsensus($mn)
Atonvsconsensus(%)

EBITDA
2011E
3,508
3,841
8.7%

2010E
2,804
2,942
4.7%

2012E
3,508
4,016
12.6%

3YAverage

8.7%

2010E
87
1,061
n/a

NetIncome
2011E
1,603
1,849
13.3%

2012E
2,029
1,970
3.0%

3YAverage

5.1%

Source:Bloomberg,Atonestimates

Figure62:SeverstalValuationbreakdown
DCFcalculation($mn):
EBIT
Lesstaxation
Taxadj.EBIT
Depreciation
Lesscapex
Changeinworkingcapital
Freecashflow
Terminalvalue
NPVoffreecashflow
NPVofterminalvalue

Discountedcashflowvaluation:
NPVoffreecashflow
NPVofterminalvalue
Enterprisevalue
Plus:otherassets
Less:minorities
Less:netdebt
Equityvalue
Less:preferredstockvalue
Commonequityvalue
No.ordinaryshares(mn)
Valuepercommonshare
Commonshares:GDRratio
ValueperGDR

Multiplesbasedvaluation:
Ratios:
14
7
Weightedaveragevaluation:

DCF
P/E
EV/EBITDA
Valuepershare($/GDR)
Potentialupside(%)

($mn)
8,209
17,262
25,471

281
4,331
20,859

20,859
1,008
20.69
1
20.69

Multiple
xEarnings
xEBITDA

2011E
2,676
(669)
2,007
832
(1,552)
(857)
429

363

(%)
32.2%
67.8%
100.0%

Value($mn)
25,426
22,089

2012E
3,244
(811)
2,433
877
(1,311)
(464)
1,535

1,327

$/GDR
25.22
21.91

Valuation
$/GDR
20.69
25.22
21.91

2013E
2014E
3,308
3,121
(827)
(780)
2,481
2,341
882
879
(1,073)
(823)
(78)
72
2,211
2,468

1,720
1,728

WACCcalculation:
Riskfreerate
Standardequityriskpremium
Countryspecificequitypremium
Liquidityriskpremium
Othercompanyspecificriskpremiums
Totalcostofequity
Currentcostofdebt
Effectivecorporatetaxrate
Costofdebtaftertax
Targetgearing(debt/equity)
WACC

Terminalgrowthrate

Weightings
Netvaluation
%
$/GDR
50%
10.35
25%
6.31
25%
5.48
100%
22.13

24.9%

2015E
3,023
(756)
2,267
877
(573)
80
2,651

1,670

2016E
2,720
(680)
2,040
877
(545)
100
2,472
30,448
1,401
17,262

%
4.50%
4.00%
3.20%
0.00%
1.00%
12.70%
8.50%
25.00%
6.38%
25.00%
11.12%

3.0%

Source:Atonestimates

3
4

Financial Accounts

Figure63:SeverstalIFRSnetincomestatement($mn)

Grossrevenue
Costofgoodssold
Grossprofit
SGAanddistributionexpenses
Otheroperatingincome/(expense)
EBITDA
EBITDAmargin
Operatingprofit
Nonoperatingexpenses
EBIT
Netfinancingexpense
Forexdifferences
Pretaxprofit
Incometax
Profit/(loss)fromdiscontinuedoperations
Profit/(loss)beforeminorityinterest
Minorityinterest
Profit/(loss)fortheyear
Netmargin
Earningspershare:
BasicEPSpercommonshare
No.ofcommonsharesoutstanding
No.ofGDRs(1GDR=1commonshare)

2008
22,393
(16,500)
5,893
(2,145)
468
5,366
24.0%
4,216
(1,009)
3,207
(353)
(275)
2,579
(517)

2,062
(33)
2,029
9.1%

2.01
1,007
1,007

2009
13,054
(11,356)
1,698
(1,600)
(244)
846
6.5%
(145)
(253)
(399)
(497)
(205)
(1,101)
(18)

(1,119)
82
(1,037)
7.9%

(1.03)
1,005
1,005

2010E
15,021
(11,010)
4,011
(1,694)
(344)
2,804
18.7%
1,973
(125)
1,848
(436)
(50)
1,362
(341)
(1,115)
(93)
6
(87)
0.6%

(0.09)
1,005
1,005

2011E
18,767
(13,661)
5,107
(2,081)
(350)
3,508
18.7%
2,676
(50)
2,626
(361)
(50)
2,215
(554)

1,661
(58)
1,603
8.5%

1.59
1,005
1,005

2012E
20,823
(14,928)
5,895
(2,300)
(350)
4,121
19.8%
3,244
(50)
3,194
(341)
(50)
2,804
(701)

2,103
(74)
2,029
9.7%

2.02
1,005
1,005

2013E
20,778
(14,839)
5,938
(2,281)
(350)
4,190
20.2%
3,308
(50)
3,258
(245)
(50)
2,963
(741)

2,222
(78)
2,145
10.3%

2.13
1,005
1,005

2014E
20,394
(14,687)
5,706
(2,235)
(350)
4,000
19.6%
3,121
(50)
3,071
(121)
(50)
2,900
(725)

2,175
(76)
2,099
10.3%

2.09
1,005
1,005

2015E
20,029
(14,471)
5,558
(2,186)
(350)
3,899
19.5%
3,023
(50)
2,973
15
(50)
2,938
(734)

2,203
(77)
2,126
10.6%

2.12
1,005
1,005

Source:Companydata,Atonestimates

Figure64:SeverstalIFRSbalancesheet($mn)

Cashandcashequivalents
Shorttermbankdeposits
Receivables
Inventories
Othercurrentassets
Assetsheldforsale
Totalcurrentassets
Plant,propertyandequipment
Intangibleassets
Othernoncurrentassets
Restrictedcash
Totalnoncurrentassets
Totalassets

Shorttermdebtandcurrentportionoflongtermdebt
Payables
Liabilitiesrelatedtoassetsheldforsale
Othercurrentliabilities
Totalcurrentliabilities
Longtermdebt
Othernoncurrentliabilities
Totalnoncurrentliabilities
Totalliabilities
Minorityinterests
Totalshareholders'equity

Totalliabilitiesandshareholders'equity

2008
2,653
819
2,006
4,272
927
9
10,685
9,827
1,511
469
22
11,829
22,514

2,039
1,600
0
1,199
4,838
6,227
1,896
8,123
12,961
501
9,051

22,514

3
5

2009
2,853
96
1,484
2,974
753
24
8,185
9,485
1,369
587
18
11,459
19,644

1,478
1,395
12
943
3,828
5,749
1,691
7,440
11,268
498
7,878

19,644

2010E
1,459
165
1,881
2,715
861
24
7,105
9,212
1,369
587
18
11,186
18,290

889
1,146

916
2,951
4,653
1,691
6,344
9,295
220
8,775

18,290

2011E
210
165
2,406
3,556
987
24
7,348
9,736
1,369
587
18
11,710
19,058

789
1,712

985
3,486
4,153
1,691
5,844
9,330
220
9,508

19,058

2012E
319
165
2,691
3,977
1,031
24
8,208
10,145
1,369
587
18
12,119
20,327

639
1,968

1,015
3,622
3,153
1,691
4,844
8,466
220
11,640

20,327

2013E
2014E
2015E
1,101
2,204
3,580
165
165
165
2,778
2,727
2,678
3,964
3,923
3,865
1,030
1,024
1,016
24
24
24
9,062
10,068
11,329
10,311
10,231
9,902
1,369
1,369
1,369
587
587
587
18
18
18
12,285
12,204
11,876
21,347
22,272
23,205

489
339
189
1,962
1,942
1,913

1,015
1,010
1,004
3,466
3,290
3,106
2,153
1,153
153
1,691
1,691
1,691
3,844
2,844
1,844
7,310
6,134
4,950
220
220
220
13,816
15,918
18,035

21,347
22,272
23,205
Source:Companydata,Atonestimates

Figure65:SeverstalIFRScashflowstatement($mn)

Operatingactivities:
EBIT
Adjustmentsfornoncashitems:
Depreciationandamortization
Impairment/(reversalofimpairment)ofassets
Otheradjustmentsfornoncashitems
Operatingprofitbeforeworkingcapitalchanges
Changesinworkingcapital
Cashgeneratedfromoperations
Interestpaid(excludingbankingoperations)
Incometaxpaid
Netcashprovidedbyoperatingactivities
Investingactivities:
Additionstoproperty,plantandequipment
Otherinvestingactivities
Netcashusedforinvestingactivities
Financingactivities:
Proceedsfromdebtfinance
Repaymentofdebtfinance
Otherfinancingactivities
Netcashprovidedbyfinancingactivities
Effectsofexchangeratechanges

Cashandcashequivalentsatbeginningofyear
Netincreaseincashandcashequivalents
Cashandcashequivalentsatyearend

2008

3,207

1,087
1,540
74
5,909
(1,018)
4,891
(363)
(1,094)
3,434

(2,031)
288
(4,811)

7,542
(3,686)
(1,432)
2,424
(17)

1,623
1,030
2,653

3
6

2009

(399)

957
219
(284)
493
1,722
2,215
(552)
(52)
1,611

(946)
692
(254)

4,355
(5,421)
(92)
(1,158)
2

2,653
200
2,853

2010E

1,848

781
100

2,730
(431)
2,299
(601)
(341)
1,357

(638)
(98)
(736)

(1,685)

(1,685)
(330)

2,853
(1,394)
1,459

2011E

2,626

832
25

3,483
(857)
2,625
(543)
(554)
1,529

(1,552)
73
(1,478)

(1,300)

(1,300)

1,459
(1,249)
210

2012E

3,194

877
25

4,096
(464)
3,632
(419)
(701)
2,511

(1,311)
58
(1,252)

(1,150)

(1,150)

210
109
319

2013E
2014E
2015E

3,258
3,071
2,973

882
879
877
25
25
25

4,165
3,975
3,874
(78)
72
80
4,086
4,046
3,955
(349)
(257)
(165)
(741)
(725)
(734)
2,996
3,064
3,055

(1,073)
(823)
(573)
8
13
44
(1,065)
(810)
(529)

(1,150)
(1,150)
(1,150)

(1,150)
(1,150)
(1,150)

319
1,101
2,204
782
1,103
1,376
1,101
2,204
3,580
Source:Companydata,Atonestimates

DisclosuresAppendix
This investment research has been prepared by ATON LLC, regulated by the Federal Service for Financial Markets of the Russian Federation, and, except as otherwise specified herein, is
communicatedbyATONLINELIMITED,regulatedbytheCyprusSecuritiesandExchangeCommission.
Theinvestmentresearchisnotfordistributiontothepublicoralargenumberofpersons,anditisnotanadvertisementtoanunlimitedgroupofpersons,ofsecurities,orrelatedfinancial
instruments,butitispersonaltonamedrecipients.Allrecipientsarepersonswhohaveprofessionalexperienceinmattersrelatingtoinvestmentsorhighnetworthentities,andotherpersons
towhomitmayotherwiselawfullybecommunicated(allsuchpersonstogetherbeingreferredtoasnamedrecipients).Thisinvestmentresearchmustnotbeactedonorreliedonbypersons
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Thesecuritiesdescribedintheinvestmentresearchmaynotbeeligibleforsaleinalljurisdictionsortocertaincategoriesofinvestors.Options,derivativeproductsandfuturesarenotsuitable
forallinvestorsandtradingintheseinstrumentsisconsideredrisky.Pastperformanceisnotnecessarilyindicativeoffutureresults.Thevalueofinvestmentsmayfallaswellasriseandthe
investormaynotgetbacktheamountinitiallyinvested.Someinvestmentsmaynotbereadilyrealisablesincethemarketinthesecuritiesisilliquidorthereisnosecondarymarketforthe
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Russia,otherCISandemergingmarketssecuritiesinvolvesahighdegreeofriskandinvestorsshouldperformtheirownduediligencebeforeinvesting.
This document has been prepared in accordance with legal requirements designed to promote the independence of investment research. This investment research is not subject to any
prohibitionondealingaheadofthedisseminationofinvestmentresearch.Ithasbeenpreparedwithallreasonablecareandisnotknowinglymisleadinginwholeorinpart.
Theinformationinthisinvestmentresearchdoesnotconstituteanoffer,solicitationorrecommendationforthepurchaseorsaleofanysecuritiesorotherfinancialinstrumentsnordoesit
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