Research Notes
Kuzbassrazrezugol: Where is the value created, and who are the beneficiaries?
| 09.06.10 |
We initiate coverage of Russia’s second largest coal miner, Kuzbassrazrezugol. The company accounts for 20% of the total Russian steam coal production, operates low-cost open-pit assets with huge reserves. Historically, however, the company has demonstrated a mediocre financial performance, regardless of the core market conditions. Investors have waited for the company to switch to a more transparent pricing policy for several years, and FY2009 results have encouraged market optimism; however, our scenario analysis shows that the market is already overvaluing Kuzbassrazrezugol.
We assign a SELL rating to Kuzbassrazrezugol common shares with a 12-month target price of USD 0.43.
Good assets... Kuzbassrazrezugol operates 11 coal mines with total reserves topping 2 bn tons, which is enough to maintain production at the current level for nearly 50 years. Open-pit mining keeps unit cash costs at the level of most efficient industry peers and is much safer than underground mining.
... do not always mean cash-flows for minorities. Kuzbassrazrezugol has demonstrated a mediocre financial performance over the last few years (except 2009), regardless of the market climate, which is partially due to the fact the company uses only one export trader, which is controlled by the same owners as Kuzbassrazrezugol itself. We estimate the average discount between Kuzbassrazrezugol’s actual sales prices and market prices in 2007-2009 at 22%.
An instant switch to market pricing brings 50% upside for Kuzbassrazrezugol shares. According to our DCF model, if Kuzbassrazrezugol applies a market pricing policy already in 2010; its shares price would have some 50% upside to the current market levels.
Company fair value for minorities close to zero if the current pricing policy stays forever. If the 22% discount between Kuzbassrazrezugol actual sales price and market price for coal remains intact forever, the company’s share price should slump 90% from the current market level to reach our fair value.
FY2009 results leaves some room for optimism, but... Kuzbassrazrezugol’s 2009 average sales price was almost equivalent to the market price, which was perceived by the market as a signal that the company might have made a step towards a more transparent pricing policy. Meanwhile, data for 4Q2010 alone demonstrated that the market price recovery had had no impact on the company’s finances. Moreover, the zero discount in 2009 could be due to very weak market prices, and the need to demonstrate stable cash flows to lenders. We consider it premature to speak about the company’s steady transition to market pricing.
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Sectors: Metals, CoalCompany: Kuzbassrazrezugol Coal Company