Aton - Dinnur Galikhanov - Russian Steel Makers - 2010.10.25 (Eng)

25 October 2010
EQUITY RESEARCH

METALS & MINING

RUSSIAN STEELMAKERS

Round up Your Flats, Short Wait for Longs

With this report we initiate coverage of four major Russian steelmakers: Evraz, MMK
and Severstal with BUY ratings, and NLMK with a HOLD due to its strong
Sector target value $70.5bn performance in recent months. We believe that these companies offer a unique set
of features that make them attractive in the currently uncertain economic climate.
Potential upside 15%
Russian steel output is on a steady recovery path, in our view. It took the sector over
a year to rebound from the lows of 2008 and demonstrate reasonable upward output
Target
Potential dynamics. Despite facing challenges on numerous fronts, once the steel market began
Company Ticker Rating price
($/share)
upside showing signs of recovery, Russian steelmakers managed to cut costs, arrest margin
deterioration and improve their profitability.
Evraz Group EVR LI BUY 35.33 18%
MMK BUY

MMK 15.33 22%
NLMK NLMK HOLD 35.55 1%
Some capacity still on hold, which offers additional upside for domestic producers.
Severstal SVST BUY 18.57 24%
Demand for some steel products (especially long steel) has not yet recovered fully due
to the lack of construction activity and infrastructure spending. While the resulting
reduction in revenue has a negative impact on financials in the short term, longer term
3M stock, index and steel performance we may see additional upside once the demand for long steel products recovers.
Severstal GDR

MMK GDR
High degree of vertical integration drives profitability improvements. Russian steels
Evraz GDR
are reasonably well integrated into raw materials. Although the level of integration
varies from producer to producer, overall it is quite high compared to international
NLMK GDR
peers. This was one of the major factors that allowed Russian steelmakers to markedly
Baosteel
improve their financial performance in 1H10. It should also allow the companies to
SBB Rebar Tracker
maintain their lead in profitability over international peers going forward.
RTS Index
BBG Iron/Steel Co
Index Active debt market participation reduces debt woes. There has been a flurry of debt
SBB HRC Tracker
market activity as all major Russian steelmakers have accessed the markets on
Mechel ADR
numerous occasions in 2009‐10 for both rouble‐denominated and foreign currency
Arcelor Mittal
debt and continue doing so as the cost of debt continues to fall. As a result, while
‐20% 0% 20% 40% some steelmakers remain heavily indebted, the maturity of that debt has lengthened,

Source: Bloomberga giving them the breathing space much needed during times of economic uncertainty.

Further economic recovery in Russia should continue to benefit steel companies. As
the Russian economy enters 2011, the positive effect of the low base will diminish.
YtD stock, index and steel performance However, we see several factors that should continue to support the country’s
Severstal GDR economic growth and the performance of steelmakers in particular: growing consumer
SBB Rebar Tracker discretionary spending, increased fixed investment and government support for steel‐
SBB HRC Tracker intensive industries.
Mechel ADR
NLMK GDR We believe flat steel (MMK, NLMK, Severstal) has better prospects than long (Evraz)
MMK GDR in the short‐to‐medium term. Government stimuli and discretionary consumer
RTS Index spending support demand for goods containing a high proportion of flat steel (white
Evraz GDR goods, automobiles, machinery and equipment). As a result, Russian output of flat
BBG Iron/Steel Co steel has already recovered to near pre‐crisis levels: while actual consumption remains
Index
Arcelor Mittal
below 2008 levels, the overall trend appears positive, in our view.
Baosteel

The long steel market has yet to recover fully from the crisis. A sharp drop in
‐50% 0% 50% 100%
construction activity following the recent financial crisis means the market for long
Source: Bloomberga steel is taking much longer to bounce back, with the recovery prone to volatility and
wide seasonal swings. We believe that growing fixed investment and a renewed focus
on Russian infrastructure development should start to improve the situation, although
the recovery will continue to be sluggish and prolonged in our opinion.
Note: Prices as of close 21 Oct 2010 throughout the report. Local share data is for information only and was
calculated using each companies’ common share / GDR ratio and prevailing USD/RUB exchange rate
Dinnur Galikhanov +7 (495) 213 0338 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
Ilya Makarov +7 (495) 777 9090 ext. 2644
Ilya.Makarov@aton.ru

Contents

Investment Case...................................................................................................3
Drilling Down on the Main Sector Drivers .........................................................10
Economic Backdrop – Growth without the Base Effect ........................................... 10
Global Steel Output – Excess Capacity Still on Hold................................................. 11
US and EU Steel Output – Two Different Recovery Stories...................................... 12
China – Enough Domestic Demand to Keep Pressure off Export Markets............... 14
Russia Showing Tentative Signs of Steel Market Recovery ...................................... 16
Price Forecasts ...................................................................................................21
EVRAZ GROUP ....................................................................................................26
Recent Financial Performance and Forward Projections ......................................... 27
Valuation .................................................................................................................. 28
Financial Accounts.................................................................................................... 29
MAGNITOGORSK IRON & STEEL.........................................................................31
Strategy Firmly Focused on the Domestic Market ................................................... 32
Valuation .................................................................................................................. 34
NOVOLIPETSK STEEL...........................................................................................37
Investment Case....................................................................................................... 38
Valuation .................................................................................................................. 42
SEVERSTAL..........................................................................................................45
Potential Gold IPO – Lessons from Norilsk’s Polyus Spin‐Off................................... 46
US Expansion Put on Hold ........................................................................................ 48
Valuation .................................................................................................................. 50

2

Investment Case
We initiate coverage of Russian steel producers at a time when a wide range of
global economic factors are drawing investor attention and perhaps obscuring the
current situation and its implications for short‐to‐medium‐term growth. However,
several key indicators support our positive outlook for the Russian economy and the
country’s steelmakers in particular.

Russia’s steel market is enjoying a rapid pace of recovery. Russia’s steel market
suffered a severe downturn as a result of the financial crisis, with monthly crude steel
output falling by over 50% from the peak of 6.8mn tonnes in May 2008 to the low
point of 3.3mn tonnes in December of that year (Figure 1).

Figure 1: Russian crude steel output showing some signs of recovery
Rus s i a Steel Output (mnt)
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0
Jan 08 Jul 08 Jan 09 Jul 09 Jan 10 Jul 10

Source: World Steel Association

The recovery was unsteady, but the government’s support of steel‐intensive industries
provided a needed boost to domestic demand. As we discuss later in the report, it is
too early to assume a full recovery, as Russian steelmakers still face many challenges.
However, the pace of recovery in Russia has been more encouraging to date than in
developed markets such as the US and EU.

In contrast to its international counterparts, the Russian government has been quite
active ‐ and selective ‐ in providing support to key industries, most of which
(automobile manufacturing, machine building, oil and gas and energy) are major
consumers of steel. While the US Senate continues to debate new stimulus measures
and EU governments are forced to enact austerity policies, the Russian government
has committed itself to supporting the country’s manufacturing industries.

A higher degree of vertical integration allows Russian steelmakers to outperform
their global peers. Russian steelmakers enjoy one of the highest degrees of vertical
integration among their industry peers. While the degree of self‐sufficiency varies from
company to company, the overall degree of vertical integration is quite high compared
to global peers (Figure 2).

3

Figure 2: Raw material self‐sufficiency of Russian steelmakers – 1H10 (%)
NLMK Severstal
Coking Coal 100%
Iron Ore 100%
Scrap 80%
Coking Coal 0%
Iron Ore 100%
Scrap 100%
MMK
Coking Coal 35%
Iron Ore 30%
Evraz
Coking Coal 84%
Iron Ore 91%
0% 20% 40% 60% 80% 100%

Source: Company data, Aton estimates

In fact, the degree of integration for most of the Russian steelmakers far exceeds the
levels achieved by industry leaders such as ArcelorMittal (60% self‐coverage in iron
ore, 20% in coal in 4Q09). Even MMK, which has long been one of the least integrated
of the Russian steel companies, has the potential to bring its self‐sufficiency in coal up
to 80% and in iron ore to 50% in the medium term

Russian steelmaker margins recovered strongly in 2010, with the market broadly
expecting outperformance over global peers to continue in 2011. Russian steelmakers
demonstrated a significant improvement in financial performance in the first half of
2010. Behind the improvements are factors such as successful cost reduction (some of
which was due to the availability of own raw materials, as described above), the
quicker pace of steel market recovery compared to some other major regions,
improved product mix on the back of modernisation, which allowed steelmakers to
increase the share of high value‐added products, and many others.

As a result, the average EBITDA margin of the five major Russian steelmakers is
expected to reach 24% in 2010 (based on Bloomberg consensus) vs the 2009 average
of less than 15% (see Figure 3 for a breakdown by company).

Figure 3: Margin recovery in 2010 forecast for Russian steels Figure 4: Leadership in profitability expected to continue in 2011
2009 EBITDA ma rgi ns 2010E EBITDA ma rgi ns 2011E EBITDA ma rgi ns
32.6% 35% 32.2%
35%
26.2% 30% 26.9%
30%
22.3% 21.6% 21.6% 25% 21.1% 20.9%
25% 20.1% 19.3% 19.4%
20% 16.3%
20% 12.7%
15% 11.3% 12.7% 15%
6.2% 10%
10%
5%
5%
0%
0%
Emerging
Developed
NLMK
MMK
Mechel
Evraz
Avg. Int.
Severstal
Markets
Avg. Int.
NLMK
MMK
Mechel
Evraz
Markets
Severstal

Sources (Figures 3 and 4): Bloomberg consensus

Despite continued pressure from costs, the market expects Russian steelmakers to
maintain their leadership (at least in a financial sense) going into 2011. The numbers in
Figure 4 are based on Bloomberg consensus for Russian companies and a selection of
international peers in both developed and emerging markets. Again, the average
EBITDA margin forecast for our five Russian majors in 2011 is around 24% vs the
emerging markets average of 16% and the developed markets average of 12%.

4

Debt refinancing has helped prolong maturities, reducing the pressure on
steelmakers. The Russian steelmakers covered in our report, particularly Evraz and
Severstal, continue to be encumbered by high debt loads (Figure 5).

Figure 5: Debt load ($mn) – still high for some but with longer maturities
Net debt ($mn) Cash ($mn) Net debt / 12M EBITDA ratio (x)
10,000 10.0
8,000 8.0
6,000 6.0
4,000 4.0
2,000 2.0
0 0.0
YE09
1H10
YE09
1H10
YE09
1H10
YE09
1H10
NLMK MMK Severstal Evraz


Steelmakers have taken advantage of the market’s appetite for corporate lending to
refinance their debt, prolong maturities and in most cases significantly reduce interest
rates.

Dividend payments may again be a possibility for some stocks. After a break in
dividend payments during 2009, following the financial crisis, a resumption of
payments is possible for some stocks. MMK and NLMK have been quite conservative in
their dividend policies, with payout ratios never rising far above 30% in good times and
falling to around 15‐20% following the onset of the crisis in 2008 (Figure 5).

Figure 5: MMK and NLMK stick with conservative dividend policies
Amount ($mn) 2007 Amount ($mn) 2008
Pa y out ra ti o (%) 2007 Pa y out ra ti o (%) 2008
1,400 Most balanced 66.1% 70%
60.3%
1,200 dividend policies 60%
1,000 50%
800 32.5% 31.4% 42.0% 40%
37.7%
600 30%
400 20%
20.7% 15.9%
200 10%
0 0%
SVST
EVR
NLMK
MMK

Source: Company data

Both companies have a relatively benign debt load and are now in a position to resume
their dividend programmes on the back of improved financials. NLMK has already
announced a 1H10 dividend of rouble 0.62/share, a payout of around 21% of its US
GAAP net income for the period. MMK paid a dividend of rouble 0.37/share in 1H10
following strong FY09 results. We expect MMK and NLMK to continue paying dividends
going forward, gradually bringing their payout ratios back to pre‐crisis levels.

Russian steel company valuations should reflect their expected outperformance, in
our view. Apart from NLMK and Evraz, Russian steelmakers are currently trading at a
relative discount to their international peers on P/E basis, with the discount ranging
from 2% to 9%. At the same time the stocks are trading at a premium on EV/EBITDA
basis, ranging from 1% to 9%, apart from Severstal and Mechel, which are trading at a
deep discount (Figure 6).

5

Figure 6: Comparative multiples of peers based on 2011E‐2012E market estimates
MktCap EBITDA Net margin
Country EV/EBITDA P/E
($mn) margin (%) (%)
2011E 2012E 2011E 2012E 2011E 2011E
Developed markets
Nucor Corp US 11,957 6.6 5.1 15.8 10.4 11% 4%
Nippon Steel Japan 22,109 5.5 4.9 11.9 10.1 13% 4%
US Steel US 6,063 4.9 4.1 9.3 6.9 9% 3%
ArcelorMittal Luxembourg 54,575 5.9 5.1 10.1 8.2 14% 6%
ThyssenKrupp Germany 18,928 3.9 3.3 13.0 8.8 8% 2%
Median, DM peers 5.7 4.9 12.1 8.8 11% 2%
Emerging markets
Gerdau Brazil 15,900 5.0 4.3 8.0 6.8 20% 9%
Tata Steel India 12,791 6.5 5.8 9.3 7.9 14% 6%
China Steel Taiwan 13,617 10.0 9.5 12.2 10.1 18% 13%
Baoshan Iron & Steel China 19,217 5.2 4.9 9.9 8.4 16% 6%
POSCO South Korea 37,442 4.9 4.6 8.3 8.0 23% 14%
Wuhan Iron&Steel China 6,103 6.0 5.4 12.0 9.4 14% 4%
Maanshan Iron&Steel China 4,576 4.3 4.6 14.1 10.9 15% 3%
Hyundai Steel South Korea 8,121 6.7 6.1 8.4 7.4 15% 8%
Median, EM peers 5.9 5.1 10.5 8.6 16% 7%
Russia
Novolipetsk Steel Russia 21,036 7.1 6.0 11.5 9.4 32% 19%
Severstal Russia 15,116 5.4 4.8 9.8 8.2 20% 9%
Evraz Group Russia 13,141 6.1 5.5 11.9 8.8 22% 7%
Magnitogorsk Steel Russia 10,762 5.6 4.6 11.6 8.9 21% 9%
Mechel Russia 9,620 5.6 4.9 7.4 6.4 26% 12%
Median, Russian peers 5.6 4.9 11.5 8.8 22% 9%
Russian steel producers
Premium/Discount of:
Novolipetsk Steel 23% 20% 2% 9%
Severstal ‐6% ‐4% ‐13% ‐5%
Evraz Group 6% 10% 5% 1%
Magnitogorsk Steel ‐4% ‐9% 2% 3%
Mechel ‐3% ‐2% ‐34% ‐26%
Source: Bloomberg

Our approach to the valuation of Russian steels reflects our expectations of
sustained profitability leadership over international peers. Russian steelmakers are
now trading at what could be considered peak‐cycle valuations, around 11‐12x P/E and
5‐6x EV/EBITDA. We believe these valuation multiples are currently justified given the
companies’ financial performance to date and expectations that they will be able to
sustain their financial outperformance in the short‐to‐medium term.

However, we remain conservative in our valuation approach and, with the exception
of NLMK (which we value using a P/E multiple of 12 and EV/EBITDA multiple of 6 due
to its leading financial position among Russian steelmakers and unique mix of high‐
premium products), we value the stocks based on 10x 2011E earnings and 5x 2011E
EV/EBITDA. The two multiples account for 25% each of the weighted average
valuation, with a DCF valuation providing the remaining 50%. The multiples valuation
allows us to account for the companies’ short‐to‐medium term financial performance
and debt load, while the DCF calculation aims to reflect the growth potential of each
stock and hence has a higher weighting in our valuations.

6

Figure 7 summarises our target prices for the stocks under coverage.

Figure 7: Ratings summary
Current Target Upside
Company Ticker Rating
price price potential
$/share $/share (%)
Evraz Group (GDR) EVR LI 30.01 35.33 18% BUY
MMK (GDR) MMK LI 12.52 15.33 22% BUY
MMK (Local) MAGN RM 0.95 1.18 24% BUY
NLMK (GDR) NLMK LI 35.10 35.55 1% HOLD
NLMK (Local) NLKM RM 3.52 3.56 1% HOLD
Severstal (GDR) SVST LI 15.00 18.57 24% BUY
Severstal (Local) CHMF RM 15.05 18.57 23% BUY
Source: Bloomberg, Aton estimates

In the following tables we provide a quick summary of valuation sensitivities and other
useful financial and performance data for the stocks.

Figure 8: Valuation ranges for the stocks
Current
Target
Company share DCF – WACC Rate 2011E P/E 2011E EV/EBITDA
price
price
Base Base Base
$/share $/share 8x 10x 12x 4x 5x 6x
+1% WACC ‐ 1%
Evraz Group (GDR) 30.01 35.33 42.43 50.25 60.45 15.10 18.87 22.64 14.13 21.96 29.80
MMK (GDR) 12.52 15.33 17.10 20.31 24.63 8.11 10.14 12.16 7.74 10.55 13.37
NLMK (GDR) 35.10 35.55 31.07 35.32 40.80 26.84 33.55 40.27 20.40 25.84 31.29
Severstal (GDR) 15.00 18.57 18.50 21.70 25.88 12.68 15.85 19.02 11.08 15.01 18.94

Figure 9: Stock performance data
Evraz Group MMK NLMK Severstal
1M 6.8% 3.6% 5.6% 11.5%
3M 19.9% 32.3% 17.2% 37.1%
YtD 6.1% 12.2% 16.9% 91.7%
1Y ‐2.0% 19.0% 19.0% 80.8%
52‐week high ($) 37.90 14.31 35.75 12.80
52‐week low ($) 7.50 2.32 8.96 3.25
Combined daily t/o ($mn) 34.6 9.0 15.0 72.0
Free float (%) 17.4% 13.4% 12.9% 17.6%
Free float ($mn) 2,286 1,442 2,714 2,660
Source: Company data, Bloomberg, Aton estimates

7

Figure 10: Key valuation data
Valuation summary:
Target price ($/GDR) 35.33 15.33 35.55 18.57
Current price ($/GDR) 30.01 12.52 35.10 15.00
Potential upside / downside (%) 17.7% 22.4% 1.3% 23.8%
Rating BUY BUY HOLD BUY

Target price ‐ Local ($/share) n/a 1.18 3.56 18.57
Current price ‐ Local ($/share) n/a 0.95 3.52 15.05
Potential upside / downside (%) n/a 23.8% 1.1% 23.4%
Rating n/a BUY HOLD BUY

Key valuation metrics:
Common shares in issue (mn) 146 11,174 5,993 1,008
Common share GDR equivalent (mn) 438 860 599 1,008
Market Cap ($mn) 13,141 10,762 21,036 15,116
Net Debt ($mn) 7,219 2,634 948 4,452
EV ($mn) 20,679 13,801 22,071 19,788
BV ($mn) 10,312 9,673 8,796 7,034

Key valuation ratios:
P/E ratios (x)
2009 n/a 46.3 97.7 n/a
2010E n/a 39.8 17.4 n/a
2011E 15.9 12.3 10.4 9.5
2012E 10.1 10.2 9.2 8.4

EV/EBITDA ratios (x)
2009 16.7 13.5 15.8 23.4
2010E 8.7 9.0 9.2 6.0
2011E 6.0 5.7 6.9 5.0
2012E 5.1 5.0 6.0 4.8

P/BV ratio (x) 1.3 1.1 2.4 1.9

8

Figure 11: Key financials
Revenue ($mn)
2009 9,772 5,081 6,140 13,054
2010E 12,229 7,741 8,167 17,632
2011E 13,950 9,661 10,074 19,563
2012E 14,848 11,045 11,875 21,131

Adjusted EBITDA ($mn)
2009 1,237 1,023 1,370 846
2010E 2,373 1,535 2,424 3,315
2011E 3,431 2,423 3,263 3,961
2012E 4,040 2,737 3,700 4,155

EBITDA margin (%)
2009 12.7% 20.1% 22.3% 6.5%
2010E 19.4% 19.8% 29.7% 18.8%
2011E 24.6% 25.1% 32.4% 20.2%
2012E 27.2% 24.8% 31.2% 19.7%

Net income ($mn)
2009 ‐1,251 232 215 ‐1,037
2010E ‐112 270 1,208 9
2011E 826 872 2,011 1,598
2012E 1,297 1,058 2,293 1,802

Net margin (%)
2009 ‐12.8% 4.6% 3.5% ‐7.9%
2010E ‐0.9% 3.5% 14.8% 0.1%
2011E 5.9% 9.0% 20.0% 8.2%
2012E 8.7% 9.6% 19.3% 8.5%

Figure 12: Aton estimates vs Bloomberg consensus
EBITDA Net income
3Y 3Y
Company 2010E 2011E 2012E 2010E 2011E 2012E
average average
Evraz Group:
Aton estimates ($mn) 2,373 3,431 4,040 ‐112 826 1,297
Bloomberg consensus ($mn) 2,456 3,336 3,681 331 1,104 1,498
Aton vs consensus (%) ‐3.4% 2.9% 9.8% 3.1% ‐133.9% ‐25.2% ‐13.4% ‐57.5%
MMK:
Aton estimates ($mn) 1,535 2,423 2,737 270 872 1,058
Bloomberg consensus ($mn) 1,639 2,285 2,786 460 932 1,204
Aton vs consensus (%) ‐6.3% 6.0% ‐1.7% ‐0.7% ‐41.3% ‐6.4% ‐12.1% ‐19.9%
NLMK:
Aton estimates ($mn) 2,424 3,263 3,700 1,208 2,011 2,293
Bloomberg consensus ($mn) 2,400 3,149 3,720 1,287 1,823 2,233
Aton vs consensus (%) 1.0% 3.6% ‐0.5% 1.4% ‐6.2% 10.3% 2.7% 2.3%
SVST:
Aton estimates ($mn) 3,315 3,961 4,155 9 1,598 1,802
Aton vs consensus (%) 17.6% 11.9% 4.5% 11.4% ‐98.8% 4.0% ‐1.9% ‐32.3%

9

Drilling Down on the Main Sector Drivers
Economic Backdrop – Growth without the Base Effect
With the end of 2010 approaching, Russia will soon be taking stock of the
achievements and setbacks of the year. A harsh winter followed by a summer with
abnormally high temperatures and forest fires precluded the country’s economy from
realising its full growth potential. However, active government involvement in a wide
range of producing industries, aimed at saving industry from decay and stimulating
growth, coupled with a low‐base effect, should allow the Russian economy to record a
5% YoY increase in GDP for the year, based on Aton’s estimates.

As the country enters 2011, the main question is whether Russia will be able to sustain
its positive growth dynamics. The low‐base effect will have a much lower impact going
forward; however due to slower than expected growth in 2010, we should still see it
making a positive difference to 2011 numbers. Nevertheless, we believe that even
without the help of the low‐base factor, Russia has real potential to continue on its
growth path next year driven by robust consumer spending, a gradual recovery in
industrial production and a rising contribution from fixed investment.

China is often viewed as a benchmark, particularly when it comes to judging the impact
of its economic development on the global steel and commodities markets. Russia’s
economy and its growth are very much dependent on developments in the commodity
markets, so it is therefore interesting to compare and contrast the two economies
from their pre‐crisis peaks to troughs and their eventual recovery. Both economies
have demonstrated broadly similar behaviour in recent years.

As can be seen from Figure 13, industrial production in both China and Russia suffered
substantial reductions during the crisis. From the end of 2009 to the beginning of 2010,
both economies managed to recover some of the lost ground, helped by the low‐base
effect, as well as government stimuli and the resulting improvement in demand for
industrial products. Despite continued volatility – due in some cases to a reduction in
the base effect, but also to either government intervention (e.g. curbs on energy
supply in China) or external factors (e.g. the extreme heat wave in Russia) – industrial
production in both countries is now firmly in positive territory, oscillating around their
pre‐crisis five‐year averages.

Figure 13: Industrial production – back to historical averages Figure 14: GDP growth – a large gap to close
Chi na IP growth Chi na pre‐cri s i s 5Y a vg Chi na Rus s i a
Rus s i a IP growth Rus s i a pre‐cri s i s 5Y a vg
15%
20%
10%
10% 5%
% chg yoy
% chg yoy
0%
0% Following sharp
IP growth is back to ‐5%
drop in 2009...
its normal averages, ‐10%
‐10%
both in China... …the Russian economy
‐15%
…and Russia is gradually recovering
‐20% ‐20%
Jan‐07 Jul‐07 Jan‐08 Jul‐08 Jan‐09 Jul‐09 Jan‐10 Jul‐10 1Q07 3Q07 1Q08 3Q08 1Q09 3Q09 1Q10

Sources (Figures 13 and 14): Bloomberg, Rosstat

Economic growth rates in the two countries have also moved in broadly similar trends,
with the collapse of 2009 turning into growth in 2010 thanks to the low‐base effect
and government stimuli. However, we note that as things stand at the moment, there
is still a gap that the Russian economy must cross before its growth rate differential
returns to pre‐crisis levels (Figure 14).

1
0

Comparing industrial production with fixed investment growth, we can see that fixed
investments have underperformed considerably following the crisis. The situation may
be about to change as growth in fixed investment has finally overtaken the rate of
growth in industrial production (Figure 15). An increase in fixed investment, in our
view, would become one of the key drivers of Russian economic growth in the absence
of low‐base effects and could be an element supporting our positive view on the
nation’s steel sector.

Figure 15: Growth in Russian fixed investment to overtake IP Figure 16: Russian GDP to grow by 5‐6% annually in 2010‐11
Indus tri a l producti on Fi xed i nves tment 10% 8.1%
7.1% 7.4%
40% 8% 6.4% 6.1%
Fixed investment saw a 5.6% 4.9%
30% 6%
sharp recovery in August
4%
20%
2%
10% 0%
0% ‐2%
‐4%
‐10%
‐6%
‐20% ‐8%
‐30% ‐10% ‐7.9%
Jan‐07 Jul‐07 Jan‐08 Jul‐08 Jan‐09 Jul‐09 Jan‐10 Jul‐10 2004 2005 2006 2007 2008 2009 2010E 2011E

Source: Rosstat Source: Rosstat, Aton Estimates

The Russian economy continues to be driven by commodity prices, so developments in
China, one of the biggest commodity consumers and importers, will play a major role
in our view.
Global Steel Output – Excess Capacity Still on Hold
Data from the World Steel Association shows that global monthly steel output reached
its all‐time high of 125mn tonnes in May 2010 (we will use this point as a benchmark in
our further analysis of steel output in terms of Historical Peak Rate Utilisation).

Most of the recent jump in production was due to China, where monthly output
reached an all‐time high of 56mn tonnes in May 2010. World output is currently down,
with Sep 2010 production coming in at around 112mn tonnes, 90% of the high in May.
The reduction was partly due to seasonal factors. However, we think that economic
uncertainty and the lack of visible growth in real demand are much stronger factors
that have forced steelmakers to scale down their output (Figure 17).

Figure 17: World steel output – large portion of installed capacity still unutilised
Output (mnt) % of Pea k Ca p. uti l i s a ti on (%)
140 Peak output, not peak 100%
120 capacity utilisation 90%
100 80%
80 70%
60 60%
40 50%
20 40%


1
1

In fact, data from the World Steel Association shows that only around 74% of global
installed capacity was utilised in September (approximately 82% was utilised in the
peak month of May). Based on these figures, the world’s steelmakers can currently
produce up to 150‐155mn tonnes of steel per month. This means that global steel
output in September was approximately 35‐40mnt short of its peak potential or, to put
it another way, over 25% of the global installed capacity remained idled during that
month.

This notion was confirmed during our recent meeting with MMK management, when
the company’s VP for Finance and Economics, Oleg Fedonin, stated that under their
estimates, global excess steel capacity was currently around 360mn tonnes (i.e. 30mn
tonnes per month).

This excess capacity could pose a risk to the recovery of steel prices. Steelmakers may
be encouraged to bring capacity back online as steel prices start to recover again (e.g.
on the back of seasonal restocking). If manufacturers’ decision to bring that excess
supply of steel to the market is based purely on price dynamics (as opposed to clear
signs that real demand for steel has restored) the fragile supply/demand balance could
be upset again, pushing steel prices down.

However, it appears that steel producers learned well from the recent crisis, when
they had to resort to output cuts to avoid oversupply and any sharp correction in
prices. It is hard to tell whether the current level of production cuts is sufficient to limit
downward pressure on prices. However, the steel price correction during the summer
months may have been a signal that steel output surpassed demand. Nevertheless,
steelmakers were reasonably quick to react, reducing output to limit the negative
impact on prices.

In the absence of tangible evidence that real demand for steel is recovering, we
believe it would be difficult for steelmakers to pass on any cost inflation to their
consumers. Production discipline by steelmakers would therefore remain an effective
tool in protecting steel prices from a sharp downward correction in the short‐to‐
medium term, thereby helping producers to preserve their margins.
US and EU Steel Output – Two Different Recovery Stories

Europe and the US are two major markets where Russian steel producers expanded
aggressively prior to the financial crisis. With output in Russia climbing close to 100%
of installed capacity and major capacity expansion projects still in gestation, assets in
the US and EU (for Russian steelmakers who have them) may provide an additional
short‐term output boost. However, as we will see below, the two markets are not
equal when it comes to the recovery of steelmakers’ fortunes.

Too early to write off the US
The pace of the recovery of US steel output has been disappointing to date. Capacity
utilisation has barely edged above 70% since the start of 2010, while most industry
analysts forecasted this level to be exceeded in 2H09. Longer than expected inventory
de‐stocking and the resulting lack of real demand for steel were the main factors
behind the slow output recovery, in our view. However, despite being far from ideal,
the state of the US steel industry is not as bad as it may seem.

Figure 18 shows US monthly steel output peaking at around 8.7mn tonnes in May 2008
(we will refer to this as the 100% Peak Rate Utilisation). However, even at that point,
US capacity utilisation was around 90%, based on data from the American Iron and
Steel Institute (AISI), a difference of around 10% or 1mn tonnes of monthly output.

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2

Figure 18: US steel output – recovery is slow but steady
US Steel Output (mnt) Pea k Ra te Uti l i s a ti on (%)
Ca pa ci ty Uti l i s a ti on (%)
100.0%
10 100%
76.1%
8 89.7% 80%
6 70.8%60%
43.5%
4 40%
2 33.5% 20%
0 0%

Source: World Steel Association, AISI

US capacity utilisation averaged around 71% during Sep 2010 (the latest figure, for the
week ending 18 Oct 2010, stands at around 67% according to AISI). It is important to
note that US steel output in September was already equal to around 76% of the 2008
peak, showing slow but steady progress in a positive direction.

The recovery of US steel production could receive a further boost if the new
infrastructure spending plan recently announced by the Obama administration is
passed by the US legislature. The plan calls for $50bn of additional infrastructure
spending on top of the $105bn allocated in the 2009 American Recovery and
Reinvestment Act (ARRA).

Among Russian steelmakers, Severstal and Evraz should benefit from higher
infrastructure spending and the resulting increase in construction activity.

EU Steel output – a sharp decline in output is worrying
European steel output saw some encouraging jumps in late 2009 – early 2010, with
output from the EU27 countries reaching approximately 16.5mn tonnes in May 2010,
or about 86% of the pre‐crisis peak. However, recent data suggest that European
steelmakers probably overestimated the pace of economic recovery in Europe and real
demand for steel, which resulted in a sharp price correction. Consequently, European
steel output suffered a sharp decline, falling by approximately 26% to around 12mn
tonnes in August, or about 64% of the 2008 peak (Figure 19).

Figure 19: Europe disappoints with a sharp output slump during the summer
EU27 Steel Output (mnt) Pea k Ra te Uti l i s a ti on (%)
20.0 100%
86.5%
15.0 74.8%80%
10.0 63.6% 60%
5.0 47.5% 40%
0.0 20%


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3

Interestingly, Italy, Greece and Spain, the countries most affected by the recent
sovereign debt crisis, saw some of the sharpest drops between the May 2010 highs
and August, falling 56%, 77% and 32%, respectively. During the same period steel
output among two other major European producers, Germany and France, was down
15% and 45%, respectively.

The austerity measures currently being implemented in these countries lead us to
believe that state support for infrastructure spending, a key element in the revival of
steel demand during a crisis, will be limited at best. Therefore, despite European steel
output recording a healthy increase in September, we expect a long and painful
recovery in the European steel sector – a situation that could potentially have a
negative impact on Russian steelmakers with exposure to that market.
China – Enough Domestic Demand to Keep Pressure off Export Markets

China is always closely watched, not just as a barometer of growth for the global
economy, but also as a threat to the steel market supply‐demand balance and hence
the recovery of global steel prices. The country’s ability to redirect significant amounts
of steel onto export markets was well demonstrated both during the peak of 2008 and
the period of relative steel market strength in the first half of 2010.

While we can never discount the threat of cheap Chinese steel flooding the market,
with its attendant severe pressure on prices, we believe this threat is overrated at the
moment for several reasons.

September production cuts – too little to upset the overall growth trend
The news of Chinese production cuts attracted significant attention in September. The
cuts were aimed primarily at energy inefficient and outdated capacity, although we
doubt the cuts had any major effect on overall Chinese output. In fact, we believe the
reduction in output volumes in September was broadly in line with recent output
trends. The World Steel Association’s numbers for September show China’s output at
48mn tonnes, down 15% from the record of 56mn tonnes in May 2010 (Figure 20).

Figure 20: Chinese steel output fell gradually in June‐Sept 2010
Chi na Steel Output (mnt) Pea k Ra te Uti l i s a ti on (%)
60 100%
50 85.4% 80%
40 60%
61.3%
30 40%
20 20%
10 0%


Although September output cuts reduced China’s monthly steel production
considerably, it is still about 3% higher than the pre‐crisis peak of 46.6mn tonnes
reached in June 2008. Therefore, we believe that, compared to Europe (with a 26%
production fall in June – Aug 2010 as discussed above) China’s steel market remains in
reasonably good shape.

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4

Chinese prices are up on production cuts and remain uncompetitive internationally
In another move to limit the output of inefficient steelmakers, Chinese authorities
removed tax rebates on steel exports from 15 June, which had an immediate effect on
the country’s net export balance, which fell 65% between June and Aug 2010 (Figure
21).

Figure 21: Chinese steel exports still off historical highs
Steel product i mport Steel product export
Net export
The period of being net importer
of steel was short‐lived...
8
…although Chinese steel exports
6 are yet to recover to past peaks
mn tonnes
4
2
0
‐2
Jan‐08 Jul‐08 Jan‐09 Jul‐09 Jan‐10 Jul‐10

Source: Bloomberg

The news of production cuts caused a short‐term increase in prices, both in China and
abroad (Figure 22). This resulted in some buying activity on the export markets, with
China’s net steel exports increasing 17% MoM in September to 1.7mn tonnes.

Figure 22: Chinese steel prices recover in Aug – Sep 2010 ($/t, FOB‐Shanghai)
HRC ‐ Domes ti c (ex VAT) Reba r ‐ Domes ti c (ex VAT)
HRC ‐ Export Reba r ‐ Export
700
650
600
550
500
450
400
350
Feb‐09
Apr‐09
Jun‐09
Jul‐09
Aug‐09
Sep‐09
Oct‐09
Nov‐09
Dec‐09
Feb‐10
Apr‐10
Jun‐10
Jul‐10
Aug‐10
Sep‐10
Jan‐09
Mar‐09
May‐09
Jan‐10
Mar‐10
May‐10

Source: Bloomberg

However, Steel Business Briefing (SBB) reports that following a short period of higher
prices, China’s steel market started to deteriorate again on the back of weaker‐than‐
expected real demand. Nevertheless, Chinese steel prices remain uncompetitive on
export markets. The situation is being exacerbated by the gradual appreciation of the
RMB against the dollar.

Steel price weakness obscures increased domestic demand
One of the obvious conclusions from the apparently sluggish increase in Chinese
domestic steel prices through 2009‐10 could be that internal demand is lagging far
behind current supply. However, we would advise against this kind of easy reasoning.

In Jan‐Sept 2010, China’s steel output was close to 475mn tonnes, an increase of
almost 13% from the 420mn tonnes produced in the same period of 2009. On an
annualised basis, Jan‐Sept production would equal 630mn tonnes – an increase of just
under 12% from the 2009 result of 570mn tonnes. Even if we assume that the
September output cuts continue for the rest of the year due to a seasonally weaker

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5

year end, we should still see roughly a 7‐8% YoY increase in steel output in China this
year to approximately 600‐610mn tonnes, which is 20‐22% higher than in pre‐crisis
2008.

Given this enormous increase in production and the fact that net steel exports from
China are still far from their 2008 peaks, we would argue that most of the additional
output is finding buyers in China, as we find it highly unlikely that such large volumes
would merely be dumped into stockpiles.

Government measures to cool down the property market and reduce output from
inefficient producers would skim the excess froth from steel supply, with inefficient
producers losing market share to bigger, more competitive and profitable rivals.

As a final supporting point for our argument, we turn to Chinese iron ore import
statistics in Figures 23 and 24 below.

Figure 23: China’s steelmakers use iron ore price dips to buy… Figure 24: …and build up their stocks “on the cheap”
Ba l ti c Ca pes i ze Index Chi na i ron ore i mports
Spot Iron Ore Fi nes CFR Chi na ($/tonne) Iron ore s tocks a t Chi nes e ports
6000 200 100
…although some of iron ore
Iron Ore ‐ US$/tonne
Baltic Capesize Index
90
5000 180 ends up in port stockpiles
80
mn tonnes
4000 160 70
3000 140 60
50
2000 Iron ore price weakness 120 Chinese iron ore imports are
40
used as buying opportunity up again in September...
1000 100 30
Jan‐10 Mar‐10 May‐10 Jul‐10 Sep‐10 Jul 09 Sep 09 Nov 09 Jan 10 Mar 10 May 10 Jul 10 Sep 10

Source: Bloomberg Source: Bloomberg

As can be seen from Figure 23, spot iron ore prices saw two periods of weakness in the
past few months – July and September. At the same time, Figure 24 suggests that
Chinese iron ore importers used those periods as buying opportunities, with Chinese
iron ore imports in July and September jumping 9% and 18%, respectively MoM (to
51.3mn tonnes in July and 52.6mn tonnes in September). Interestingly, while iron ore
stocks at Chinese ports reached record highs in July, the increase in September was
sharp but limited, with stocks already on the way down as some Chinese steel
producers raised or restarted production.

The points we presented above suggest that excess Chinese steel capacity does not
currently pose a major threat to the fragile supply/demand balance on the global steel
market. The country’s economy is growing fast enough to take up at least some of the
additional steel supplied by its domestic producers. At the same time, measures
introduced by the country’s government and gradual currency appreciation should
limit excess steel exports with only the most efficient producers able to compete on
international markets.
Russia Showing Tentative Signs of Steel Market Recovery

Along with most of their global peers, Russian steelmakers were severely affected by
the economic slowdown with output falling by over 50% from the May 2008 peak of
6.8mnt to the trough of 3.3mnt in Dec 2008. However, steel production recovered
quite quickly throughout 2009, with output reaching 5.6mn tonnes in Oct 2009 before
falling slightly in the seasonally slow winter period. Russian steel output saw more
growth in 2010, but the pace of recovery slowed considerably: Sept 2010 output was
only 5.6mnt, or around 82% of the pre‐crisis high (Figure 25).

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6

Figure 25: Russia: Growth in capacity utilisation is flattening out
Rus s i a Steel Output (mnt) Pea k Ra te Uti l i s a ti on (%)
7.0 100%
6.0 90%
5.0 80%
82.3%
4.0 70%
3.0 60%
2.0 50%
48.6%
1.0 40%
0.0 30%


By breaking output down into various steel types, the recovery can be more clearly
seen in flat steel markets, while long steel output (and by association consumption) is
recovering at a much slower pace.

Flat steel – a stronger driver for growth
Russia’s flat steel market was severely affected by the crisis. We use the example of
the most basic flat steel product, HRC, to demonstrate the effect of the crisis on flat
steel production and consumption in Russia and the current state of the market, which
appears to have recovered to a reasonably healthy level of consumption.

Apparent consumption of HRC in Russia suffered a massive 80% drop from the peak of
780,000 tonnes in July 2008 to 155‐160,000 tonnes in December (Figure 26). Apparent
usage remained volatile in 1H09 with a sharp increase to around 525,000 tonnes by
Mar 2009 and a reduction to 335,000 tonnes in June. However, in 2H09, apparent
consumption averaged about 500,000 tonnes per month and then increased further in
2010, peaking at a healthy level of around 650,000 tonnes in Aug 2010, which is similar
to the monthly average in pre‐crisis 1Q08.

Figure 26: Russian HRC trade and consumption (‘000 tonnes) Figure 27: Russian HRC usage shows signs of recovery
1200 1200 75.1% 80%
The apparent consumption of
1000 Apparent HRC usage 70%
800 HRC is gradually recovering 62.4%
gradually recovering
800 60%
400 54.4% to pre‐crisis levels
600 50%
0
400 40%
‐400 200 30%
26.5%
‐800 0 20%
Jan‐08 Jul‐08 Jan‐09 Jul‐09 Jan‐10 Jul‐10 Jan‐08 Jul‐08 Jan‐09 Jul‐09 Jan‐10 Jul‐10
Appa rent cons umpti on ('000 tonnes )
Domes ti c output us ed Import Export Appa rent cons umpti on a s % of domes ti c output
Actua l HRC Output ('000 tonnes )

Source: Metal Expert Source: Metal Expert

Rising apparent demand in itself does not reveal real demand, so we look at it as a
function of the country’s total HRC output. Our argument is that the higher the
demand for HRC in Russia, the greater the proportion of this steel that will go to
internal use, as opposed to export sales. In 2008, apparent consumption of HRC
accounted for more than 50% of all HRC produced in Russia, peaking at around 75% in
July 2008. During the crisis, Russian steel producers used export markets to offload

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7

excess HRC with apparent consumption accounting for just over 25% of the country’s
output in Dec 2008 (see Figure 27 above).

The situation improved substantially through 2009‐10, with apparent consumption
accounting for over 60% of Russian HRC output. With HRC output returning to pre‐
crisis levels and the proportion of HRC used internally back to healthy levels, we can
conclude that real demand for flat steel in Russia has recovered, if not to pre‐crisis
peaks, at least to a level where Russian HRC supply can be considered close to the
balancing point with real demand.

The apparent strength of the flat steel market is not surprising given its exposure to
auto and machinery manufacturing and the oil and gas sectors – areas of the economy
which saw considerable state involvement and support. As can be seen from Figure 28,
car sales in Russia have recovered strongly from the lows of 2008‐10 on the back of the
Russian government’s “cash for clunkers” scheme and market protectionism.

Figure 28: Russian auto sales – further growth expected (‘000 units, including LCVs)
300 Old car imports Positive sales dynamics
bosted 2008 figures in 2010 and 2011
250
200
150
100
50
‐
Aug
Aug
Aug
Apr
Apr
Apr
Feb
Jun
Feb
Jun
Feb
Jun
Oct
Oct
Oct
Dec
Dec
Dec
2008 2009 2010 2011
Reported Sales Forecast

Source: Rosstat, Aton estimates

In fact, “cash for clunkers” was so successful in supporting local car manufacturing that
the Russian government has approved an extension to the scheme and is even
considering extending it to cover light commercial vehicles (LCVs) and heavy trucks.

We see similar developments in machinery manufacturing and oil and gas. For
instance, according to the estimates of one of Russia’s leading rail transport firms, First
Freight Company (a subsidiary of Russian Railways), Russian and CIS rail car makers are
expected to produce up to 85,000 units in 2010 alone on the back of a modernisation
drive by state‐owned Russian Railways (RZD) and the general shortage of modern
rolling stock in Russia.

These actions by the state should continue to support demand for flat steel in the
short‐to‐medium term, despite the slow pace of recovery in other sectors of the
economy, including the construction sector.

Long steel – held back by weak construction activity
The situation on the domestic long steel market presents a stark contrast to the
market for flat steel mainly as a result of the continued crisis in the Russian
construction industry.

The effects of the crisis on the long steel market were less pronounced when
compared to the flat steel market. The apparent consumption of rebar, the backbone
of the long steel market and the main product used in the construction industry, fell by
approximately 65% (compared to an 80% reduction in apparent HRC consumption)

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8

from the peak of 665,000 tonnes in July 2008 to the trough of 240,000 tonnes in Dec
2008.

However, in contrast to HRC, the recovery in apparent rebar consumption has been
sluggish and prone to volatility, further exacerbated by seasonality (Figure 29).

Figure 29: Russian rebar trade and consumption (‘000 tonnes) Figure 30: Apparent demand recovery is still sluggish
800
The recovery in apparent rebar usage 800 Apprent rebar usage has 160%
600 is slower and more seasonal 700 stabilised, but at lover 140%
124.3%
600 levels vs pre‐crisis peaks 120%
400
98.8%
500 100%
200 96.1%
400 80%
0 300 60%
62.4%
‐200 200 40%
Jan‐08 Jul‐08 Jan‐09 Jul‐09 Jan‐10 Jul‐10 Jan‐08 Jul‐08 Jan‐09 Jul‐09 Jan‐10 Jul‐10
Appa rent cons umpti on ('000 tonnes )
Domes ti c output us ed Import Export Appa rent cons umpti on a s % of domes ti c output
Actua l Reba r Output ('000 tonnes )

Source: Metal Expert Source: Metal Expert

Moreover, apparent consumption of rebar is around 99% of total production, which
stood at just 470,000 tonnes in Aug 2010, 20% below the Mar 2008 peak of 590,000
tonnes. Apparent rebar consumption is significantly below the 2008 peak, when it
accounted for almost 125% of domestic output, i.e. Russia had to import significant
amounts of steel to satisfy domestic demand (Figure 30).

The situation has changed considerably: output of long steel is now struggling to
recover due to limited demand, primarily linked to the weak state of the domestic
construction industry, which is still hampered by the effects of the financial crisis and
in particular the lack of available credit financing.

In Figure 31 we see that construction volumes (measured in useful area put into
service) fell by around 7% YoY in 2009. This decline could have been sharper were it
not for projects already begun in 2008. Construction activity had a slow start in 2010,
with 1H10 additions amounting to just under 32mn m2, 33% of the 2009 total.
However, since most residential construction is put into service in the last quarter of
the year, this number may not be fully indicative of full‐year results. Nevertheless,
even under a very optimistic forecast, we would only expect the total for 2010 to
barely exceed the level for 2009.

Figure 31: Russian construction activity – mn m2
Res i denti a l Non‐res i denti a l
120 Construction in
2010 is expected to
100
be below 2008 peak
80
60
40
20
0
2010E
3Q10E
4Q10E
2000
2003
2004
2005
2006
2007
2008
2009
1Q10
2Q10

Source: Rosstat, Aton estimates

1
9

Since access to credit remains limited for Russian property developers (and what is
available comes with high interest rates), we expect construction activity to remain
sluggish in the near term. State involvement in the industry is currently limited to a
handful of large scale projects; apart from the Sochi Olympics and Far Eastern
infrastructure development in preparation for the 2012 APEC summit, there are no
major state projects set to start in the near term that could revitalise demand for long
steel.

One exception could involve demand for rails driven by the ongoing modernisation of
Russia’s infrastructure. Nevertheless, we doubt that a surge in demand for this
specialised and relatively low‐volume product would be sufficient to improve the
overall picture.

This situation may change in 2011, when the new construction season starts. We are
already seeing an increase in the production of construction‐related products (bricks,
cement, etc.) in preparation for December‐January restocking by builders and property
developers. However, a recent Russian government decree, which reduced export
duties on cement to zero to help producers struggling to sell their products
domestically, suggests to us that a real recovery in building activity should not be
expected soon.

For information we give an estimate of exposure to long /construction steel for each
company under our coverage in the following figure.

Figure 32: Breakdown of long steel vs other steel products by company (%)
Other s teel (i nc. s emi ‐fi ni s hed) Long / cons tructi on s teel
100% 8% 5%
14%
80% 35%
60%
86% 92% 95%
40%
65%
20%
0%
Evraz (3Q10) NLMK (3Q10) MMK (2Q10) Severstal
(2Q10)


2
0

Price Forecasts
For the reasons outlined in the previous section, we believe that (barring seasonal
factors) flat steel products should enjoy stronger support on the demand side. Lack
of construction activity, on the other hand, will weigh down prices for long steel
products and we do not expect a significant improvement until well into 2011. As a
result, we expect flat steel to maintain its premium over long in the short‐to‐medium
term.

In terms of export markets, we see continued weakness, especially in Europe. As a
result, we forecast Russian domestic steel prices will maintain their premiums over
export prices.

High raw material prices, in particular for coking coal and steel scrap, will likely
continue to pressure margins for Russian steel producers, as it will be difficult for them
to pass on the full extent of cost increases to customers while the demand picture
remains uncertain.

HRC prices – gradual recovery should continue in 2011

We expect prices for HRC, along with other flat products, to continue recovering in
2011 as demand for flat products grows. We forecast 4Q10 prices will remain broadly
flat at around $600/tonne on the back of price recovery in the beginning of the
quarter, offset by a seasonal slowdown as winter approaches. We expect an average
quarterly increase of around 5% in 1Q‐3Q11, slowing in 4Q11 (Figure 33).

Figure 33: HRC prices – gradual recovery to continue in 2011 Figure 34: Domestic HRC – premium to export prices established
Avera ge CIS Domes ti c Pri ce Avera ge CIS Export Pri ce Avera ge CIS Domes ti c Pri ce Avera ge CIS Export Pri ce
1200 700
1000 Government stimuli should ensure 650

$/metric tonne
$/metric tonne
flat steel enjoys steadier recovery
600
800
550
600 Domestic flat prices are expected to
500 maintain premium over exports due
400 450 to better demand fundamentals
200 400
4Q 10E
1Q 11E
2Q 11E
3Q 11E
4Q 11E
1Q 08
2Q 08
3Q 08
4Q 08
1Q 09
2Q 09
3Q 09
4Q 09
1Q 10
2Q 10
3Q 10
2010 E
2011 E
2012 E
2013 E
2014 E
2015 E
2009

Sources (Figures 32 and 33): Metal Expert, Bloomberg, Aton estimates

We forecast that the average HRC price in 2011 will be around 10‐11% higher than in
2010 at $650‐655/tonne, with a further 2% increase expected in 2012 to $665‐
670/tonne. Domestic HRC should maintain an average 4‐5% premium to the export
price in the short‐to‐medium term (Figure 34), in our view.

Rebar

Rebar prices are forecast to be more volatile than HRC: we project a 5% QoQ reduction
in 4Q10 prices, to $550/tonne. We may then see a 5% recovery in 1Q11 to $575‐
580/tonne on the back of seasonal restocking, but we do not expect a major recovery
in prices until the latter part of 2Q11, with quarterly rebar prices expected to average
around $620/tonne, up 7.5% QoQ (Figure 35).

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1

Figure 35: Rebar prices – short‐term weakness expected Figure 36: Domestic rebar regains its premium over export
Avera ge CIS Domes ti c Pri ce Avera ge CIS Export Pri ce Avera ge CIS Domes ti c Pri ce Avera ge CIS Export Pri ce
1200 Long steel prices are forecast to 700
1000 weaken further due to seasonal 650

$/metric tonne
$/metric tonne
factors and low fixed investments...
600
800
550
600 Domestic prices are expected to
500
regain their premium over exports
400 450
...but we may see some pick‐up in activity (and prices) in 2011
200 400
4Q 10E
1Q 11E
2Q 11E
3Q 11E
4Q 11E
1Q 08
2Q 08
3Q 08
4Q 08
1Q 09
2Q 09
3Q 09
4Q 09
1Q 10
2Q 10
3Q 10
2010 E
2011 E
2012 E
2013 E
2014 E
2015 E
2009

Sources: Metal Expert, Bloomberg, Aton estimates

We expect domestic rebar prices to average around $600/tonne in 2011 with a 5%
increase in 2012 to $630‐635/tonne. Again, we expect Russian rebar prices to maintain
a premium over export markets that averages approximately 3% going forward (Figure
36).

Flat steel should maintain premium over long products driven by stronger demand
We anticipate that flat steel prices will maintain their current premium to long steel.
Our basket of flat steel products (HRC, CRC, HDG and thick plate) is forecast to trade at
an average premium of around 9‐10% to the basket of long products (rebar, wire rod,
merchant bar and structural steel) (Figure 37).

Figure 37: Flat steel expected to maintain its premium to long
CIS Domes ti c Fl a t Steel Ba s ket
CIS Domes ti c Long Steel Ba s ket
800
Flat steel price to
750 strengthen on the
$/metric tonne
700 back of growing
demand
650
600 Seasonality and lack of fixed
investments continue to have
550
greater effect on long steel
500
4Q10E
1Q11E
2Q11E
3Q11E
4Q11E
1Q09
2Q09
3Q09
4Q09
1Q10
2Q10
3Q10

Source: Metal Expert, Bloomberg, Aton estimates

We do not expect long steel products to regain the premium to flat that was seen in
2008 until real demand for long products recovers sufficiently to allow producers to
fully pass on their cost increases to customers. Given the state of the construction
industry in Russia, we do not expect this to occur within the next couple of years.

Raw material prices maintain pressure on margins
We expect continued pressure from raw material prices on steelmakers’ margins. The
pressure is expected to be especially pronounced in coking coal in 2011 (due to the
recent Raspadskaya incident and a structural shortage of high‐quality, locally produced
coking coal). A major increase in scrap prices can be expected from 2012 on the back
of insufficient scrap generation and added demand from new EAF capacity.

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2

The situation in Russia’s coking coal market provides a stark contrast to international
markets, where the benchmark price for hard coking coal was negotiated down by 7%
by Japanese steelmakers, although the reduction was not as deep as they had hoped.

Our coking coal forecast for Russia assumes a continued increase in prices through
4Q10 and most of 2011 (Figure 38). Mechel announced during its 2Q10 results
teleconference that they expect a 10% QoQ increase in Russian coking coal prices in
4Q10, with a further 10‐15% YoY increase in 2011. NLMK also confirmed recently that
it had agreed to a 5‐6% increase in coking coal prices.

Figure 38: Russian coking coal prices – producers expect to secure further gains
Ha rd Coki ng Coa l ‐ Interna ti ona l Benchma rk
Avera ge CIS Domes ti c Pri ce
350
Despite the expected reduction in
300
US$/metric tonne
the international benchmark price...
250
200
150
100
…Russian prices are tipped
50
to enjoy further gains
0
4Q 10E
1Q 11E
2Q 11E
3Q 11E
4Q 11E
4Q 08
1Q 09
2Q 09
3Q 09
4Q 09
1Q 10
2Q 10
3Q 10


We forecast that Russian coking coal (type GZh) prices will rise 24% YoY in 2011 to
$150‐152/tonne, with a smaller 4% increase in 2012 to $157/tonne, as we anticipate
that new production will cover some of the coal shortage.

Russian steelmakers, with the notable exception of MMK, are reasonably self‐sufficient
in iron ore. We therefore expect Russian iron ore price dynamics to reflect global
trends. Rio Tinto recently announced that it expects the global iron ore market to
soften going into 2011 before picking up again from around 2Q11. Current market
consensus forecasts a 7% reduction in iron ore prices in 1Q11 (Figure 39).

Figure 39: Russian iron ore prices – follow the global trends
Benchma rk ‐ BHP Bi l l i ton Fi nes (Export to Ja pa n)
Avera ge CIS Domes ti c Pri ce
150
Global benchmark is expected to
US$/metric tonne
130
soften before going up again...
110
90
70
50 Russian prices are not
immune to global
30
d
4Q 10E
1Q 11E
2Q 11E
3Q 11E
4Q 11E
1Q 08
2Q 08
3Q 08
4Q 08
1Q 09
2Q 09
3Q 09
4Q 09
1Q 10
2Q 10
3Q 10


Similarly, Russian iron ore concentrate prices are expected to soften further in 4Q10‐
1Q11, following a 4% QoQ reduction in 3Q10, to around $84/tonne. Our forecast for
the 2011 average price is $83/tonne, just 5% higher than in 2010. We expect another
5% increase, to $88/tonne in 2012.

2
3

For steel scrap, we forecast an increase of around 2% YoY to $235/tonne in 2011.
However, as production of long steel recovers, we may start seeing some shortages in
2012 – a view recently highlighted by MMK. We assume a 9% YoY increase in 2012 to
$255/tonne.

Our price assumptions for the main steel products and raw materials are summarised
in Figure 40 below.

Figure 40: Aton raw material and steel price assumptions (Oct 2010)
Annual prices Quarterly prices
$/metric tonne 2009 2010E 2011E 2012E 2013E 2014E 2015E 3Q10 4Q10E 1Q11E 2Q11E 3Q11E 4Q11E
Domestic raw material prices, FCA:

Iron ore concentrate 43 79 83 88 85 80 76 84 83 80 84 85 84
% change period‐on‐period 81.7% 5.3% 5.4% ‐3.2% ‐5.5% ‐5.0% ‐4.0% ‐1.6% ‐3.6% 5.0% 1.5% ‐0.5%
Coking coal concentrate (GZh‐type) 62 122 152 157 156 152 150 124 135 146 157 153 151
% change period‐on‐period 95.6% 24.4% 3.7% ‐1.1% ‐2.6% ‐1.1% ‐0.9% 8.8% 8.0% 7.5% ‐2.5% ‐1.5%
Steel scrap 168 230 235 255 263 261 258 211 207 218 240 242 240
% change period‐on‐period 36.6% 2.1% 8.7% 3.2% ‐1.0% ‐1.0% ‐15% ‐1.5% 5.0% 10.0% 1.0% ‐1.0%

Domestic steel prices, Ex‐works:

HRC 436 589 653 667 655 639 630 598 601 631 663 666 650
% change period‐on‐period 35.3% 10.7% 2.3% ‐1.9% ‐2.4% ‐1.5% ‐6.7% 0.5% 5.0% 5.0% 0.5% ‐2.5%
Rebar 422 555 601 632 633 618 607 579 550 577 621 605 599
% change period‐on‐period 31.5% 8.2% 5.1% 0.2% ‐2.3% ‐1.9% ‐6.3% ‐5.0% 5.0% 7.5% ‐2.5% ‐1.0%

Export steel prices, FOB:

Slab 372 535 557 586 578 572 568 514 527 553 567 547 561
% change period‐on‐period 43.7% 4.2% 5.2% ‐1.5% ‐1.0% ‐0.8% ‐14% 2.5% 5.0% 2.5% ‐3.5% 2.5%
Billet 393 530 611 639 624 618 610 528 555 610 595 616 622
% change period‐on‐period 34.9% 15.3% 4.6% ‐2.3% ‐1.0% ‐1.2% 1.3% 5.0% 10.0% ‐2.5% 3.5% 1.0%
HRC 456 595 626 640 628 613 604 574 577 605 636 639 623
% change period‐on‐period 30.6% 5.2% 2.3% ‐1.9% ‐2.4% ‐1.5% ‐12% 0.5% 5.0% 5.0% 0.5% ‐2.5%
Rebar 439 548 583 613 614 600 589 562 534 560 602 587 581
% change period‐on‐period 24.9% 6.3% 5.1% 0.2% ‐2.3% ‐1.9% ‐3.4% ‐5.0% 5.0% 7.5% ‐2.5% ‐1.0%

Source: Metal Expert, Aton estimates

2
4

COMPANY PAGES

2
5

EVRAZ GROUP

Taking Self-Sufficiency beyond Russia’s Borders

We initiate coverage of Evraz with a BUY rating and a target price of $35.33/GDR.
Strong mining exposure supports a high degree of self‐sufficiency, while the ability to
adapt semi‐finished steel output quickly to changing market conditions allows the
company to take that self‐sufficiency beyond Russia’s borders.
BUY
Figure 1: Mining and vanadium businesses enhance EBITDA margins
Target price $35.33 2Q10 Revenue Brea kdown 2Q10 EBITDA Brea kdown
Potential upside 18% Vanadium
Other Other
Vanadium
4% 5% 7%
Bloomberg code EVR LI 6%
Mining
Reuters code HK1q.L
15%
Price (ordinary GDR, $) 30.01 Mining
Price (pref, $) n/a 30% Steel
Steel
Upside potential 18% 57%
76%
GDR ratio (x) 1 : 3

Share data
No. of ordinary shares (mn) 146

Source: Company Data
No. of ordinary GDRs (mn) 438

No. of pref shares (mn) n/a
Solid position in mining provides margin protection. The company’s mining division
3M average daily t/o ($mn) 35
Free float (%) 17.4%
plays an important role in securing the profitability of Evraz's steel business. Evraz is
Market capitalisation ($mn) 13,141 almost fully self‐sufficient in iron ore (91% coverage at end‐1H10). Its self‐coverage in
Enterprise value ($mn) 20,679 coal following the tragic accident at Raspadskaya fell from over 100% to 84% at end‐
Major shareholders 1H10. However, as coal output at the company's Yuzhkuzbassugols mine gears up
Lanebrook Limited 72.39% following the opening of new production seams, we expect a return to full coverage.

FINANCIALS ($mn) 2009 10E 11E International footprint provides hedge against a downturn. Evraz followed a strategy
Revenue 9,772 12,229 13,950 of active international expansion prior to the financial crisis, building a portfolio of
EBITDA 1,237 2,373 3,431 assets in the US, Europe, South Africa and Ukraine. While this strategy is behind the
EBIT (1,047) 525 1,674 company's current credit woes, it provided greater exposure to plate and pipe making.
Net income (1,251) (112) 826 This is an important factor behind the current solid performance of the steel division,
EPS (9.30) (0.77) 5.66 which would have been hard‐hit due to its strong exposure to Russia’s construction
market.
VALUATION
P/E (x) n/a n/a 15.9 Flexibility in production of semi‐finished products takes vertical integration beyond
P/CF (x) 12.3 21.4 8.8
Russia’s borders. Evraz can easily switch between the output of slab and billet, which
EV/EBITDA (x) 16.7 8.7 6.0
allows it to supply its international units with the inputs needed to produce higher
EV/Sales (x) 2.1 1.7 1.5
value‐added products. This strategy proved itself at Vitcovice steel, when the supply of
P/BV (x) 1.3 1.2 1.1
RoCE (%) ‐6.9% ‐0.6% 4.6%
pig iron was cut off due to a commercial dispute. Evraz also supplies slabs to its
RoE (%) ‐12.2% ‐1.1% 7.0% American units. This approach allows it to keep higher margins in‐house instead of
selling lower value‐added, semi‐finished steel on the open market.

PERFORMANCE We initiate coverage of Evraz with a BUY rating and a target price of $35.33/GDR,
1 month (%) 6.8% which implies upside potential of 18% to current share price levels. The company has
3 month (%) 19.9% exposure to the attractive plate and pipe‐making markets, while the gradual
12 month (%) ‐2.0% restoration of construction demand in Russia should allow it to utilise its leading
52‐week high ($) 37.90 position as a long steel manufacturer, in our view.
52‐week low ($) 7.50

2
6

Recent Financial Performance and Forward Projections

1H10 results mixed, but outlook improved
Evraz’s 1H10 results were mixed with EBITDA rising 50% vs 2H09 to $1.15bn, slightly
below the Interfax consensus of $1.18bn. Moreover, EBITDA was at the lower end of
earlier management guidance of $1.15‐1.25bn.

The company reported a 1H10 net loss of $270mn (vs a net loss of $262mn in 2H09),
which was significantly below the consensus forecast of $22mn net profit. However,
the bottom line was affected by $554mn of one‐off items, including a charge of
$416mn resulting from changes in accounting principles and a $138mn loss from
various impairments and asset revaluations.

The company’s net debt stood at $7.12bn, which was slightly higher than the 1Q10
figure of $7.16bn, mainly due to less cash. Encouragingly, the share of long‐term debt
rose to 78% from 66% at the end of 1Q10, reflecting an improved debt maturity
picture. The net debt/12M EBITDA ratio stood at 3.74x at end‐1H10 vs 5.84x at YE09.

The results show that although business conditions are improving, the company still
faces serious challenges in 2H10, mainly in its steel division, where EBITDA margins
remain depressed (12.7% in 1H10 vs 9.1% in 1H09).

However, the company’s outlook has improved considerably since publication of the
1H10 results. Management increased its 3Q10 EBITDA guidance from $480‐550mn to
$550‐600mn, linked to shorter scheduled downtime than it expected, which we
believe resulted in lower output losses.

Improved output ups our 2010E EBITDA forecast to $2.4bn
We have used the latest 3Q10 EBITDA guidance to fine tune our FY10 forecast for
Evraz. We now expect a recovery in output volumes in 4Q10, a limited reduction in
steel prices and a relatively benign cost environment during the quarter, which should
allow Evraz to generate around $2.3‐2.4bn in EBITDA in FY10E.

Our EBITDA forecasts for 2011E and 2012E stand at $3.4bn and $4bn, respectively,
which is 3% and 10% above current Bloomberg consensus (Figure 2).

Figure 2: Evraz ‐ Aton estimates vs consensus
EBITDA Net income
3Y average 3Y average
Year‐end: Dec 2010E 2011E 2012E 2010E 2011E 2012E
Aton estimates ($mn) 2,373 3,431 4,040 ‐112 826 1,297
Aton vs consensus (%) ‐3.4% 2.9% 9.8% 3.1% ‐133.9% ‐25.2% ‐13.4% ‐57.5%

We expect negative net income in 2010 as the company must still meet interest
payments; we assume higher DD&A charges due to changes in accounting principles.
However, we expect net income to turn positive from 2011E, reaching $826mn and
improving further to $1.3bn in 2012E. We note that our forecasts are 25% and 13%
respectively below consensus due to higher DD&A and interest charge assumptions
and a more conservative view on Russia’s construction market.

We initiate coverage with a BUY rating and a target price of $35.33/GDR, implying
18% upside potential to the current price. We like the company’s exposure to the high‐
value plate and pipe markets while an upside surprise in construction activity in Russia
could lead to further improvements in profitability.

2
7

Valuation

Evraz – Valuation breakdown
DCF calculation ($mn): 2010E 2011E 2012E 2013E 2014E 2015E
EBIT 525 1,674 2,212 2,251 2,042 1,903
Less taxation (131) (418) (553) (563) (510) (476)
Tax adj. EBIT 394 1,255 1,659 1,688 1,531 1,428
Depreciation 1,709 1,758 1,828 1,852 1,852 1,852
Less capex (950) (1,100) (1,250) (1,000) (750) (750)
Change in working capital (537) (413) (189) (126) 8 20
Free cash flow 615 1,500 2,048 2,414 2,642 2,549
Terminal value 33,666
NPV of free cash flow 112 1,401 1,729 1,844 1,825 1,593
NPV of terminal value 21,036

Discounted cash flow valuation: ($mn) (%) WACC calculation: %
NPV of free cash flow 8,504 28.8% Risk free rate 4.5%
NPV of terminal value 21,036 71.2% Standard equity risk premium 4.0%
Enterprise value 29,540 100.0% Country specific equity premium 3.7%
Plus: other assets ‐ Liquidity risk premium 0.5%
Less: minorities 319 Other company‐specific risk premiums 1.0%
Less: net debt 7,219 Total cost of equity 13.7%
Equity value 22,002 Current cost of debt 9.0%
Less: preferred stock value ‐ Effective corporate tax rate 25.0%
Common equity value 22,002 Cost of debt after tax 6.8%
No. ordinary shares (mn) 146 Target gearing (debt / equity) 45.0%
Value per common share 150.75 WACC 10.6%
Common shares : GDR ratio 0.3
Value per GDR 50.25 Terminal growth rate 3.0%

Multiples based valuation:
Ratios: Multiple Value ($mn) $/GDR
10 x Earnings 8,262 18.87
5 x EBITDA 9,618 21.96

Weighted average valuation:
Valuation Weightings Net valuation
$/GDR % $/GDR
DCF 50.25 50% 25.12
P/E 18.87 25% 4.72
EV/EBITDA 21.96 25% 5.49
Value per share ($/GDR) 100% 35.33
Potential upside (%) 17.7%
Source: Aton estimates

2
8

Financial Accounts

Evraz – IFRS net income statement ($mn)
2008 2009 2010E 2011E 2012E 2013E 2014E 2015E
Revenue 20,380 9,772 12,229 13,950 14,848 14,997 14,767 14,588
Cost of revenue and other operating costs (ex DD&A) (13,944) (8,399) (9,781) (10,469) (10,758) (10,844) (10,823) (10,783)
Unallocated expenses (221) (136) (75) (50) (50) (50) (50) (50)
EBITDA 6,215 1,237 2,373 3,431 4,040 4,103 3,894 3,755
EBITDA margin 30.5% 12.7% 19.4% 24.6% 27.2% 27.4% 26.4% 25.7%
DD&A (1,195) (1,632) (1,709) (1,758) (1,828) (1,852) (1,852) (1,852)
Other income / (expenses) (1,388) (652) (139) ‐ ‐ ‐ ‐ ‐
EBIT 3,632 (1,047) 525 1,674 2,212 2,251 2,042 1,903
Net financial expenses (598) (637) (659) (577) (465) (347) (222) (92)
Other pre‐tax income / (expenses) 17 84 45 45 45 45 45 45
Profit before tax 3,051 (1,600) (89) 1,142 1,792 1,950 1,865 1,857
Income tax expense (1,192) 339 (27) (285) (448) (487) (466) (464)
Profit after tax 1,859 (1,261) (116) 856 1,344 1,462 1,399 1,392
Minority interests (62) 10 4 (30) (47) (51) (49) (49)
Profit attributable to equity holders of the company 1,797 (1,251) (112) 826 1,297 1,411 1,350 1,344
Net margin 8.8% ‐12.8% ‐0.9% 5.9% 8.7% 9.4% 9.1% 9.2%
Earnings per share:
Basic EPS per ordinary share 14.6 (9.3) (0.8) 5.7 8.9 9.7 9.2 9.2
No. of ordinary shares 123 134 146 146 146 146 146 146
No. of GDRs (1 GDR = 1/3 ordinary share) 370 403 438 438 438 438 438 438

Evraz – IFRS balance sheet ($mn)
2008 2009 2010E 2011E 2012E 2013E 2014E 2015E
Cash and cash equivalents 930 675 411 766 1,712 2,877 4,210 5,434
Inventories 2,416 1,886 2,186 2,412 2,431 2,358 2,377 2,372
Receivables 2,349 1,559 1,994 2,233 2,317 2,362 2,340 2,318
Other current assets 589 120 76 76 76 76 76 76
Total current assets 6,284 4,240 4,667 5,486 6,536 7,673 9,003 10,199
Property, plant and equipment 9,012 14,941 14,182 13,525 12,947 12,095 10,993 9,891
Intangible assets 1,108 1,098 1,016 1,016 1,016 1,016 1,016 1,016
Goodwill 2,167 2,211 2,165 2,165 2,165 2,165 2,165 2,165
Other non‐current assets 873 921 1,025 1,025 1,025 1,025 1,025 1,025
Total non‐current assets 13,160 19,171 18,388 17,731 17,153 16,301 15,199 14,097
Assets classified for sale 7 13 113 ‐ ‐ ‐ ‐ ‐
Total assets 19,451 23,424 23,168 23,217 23,689 23,974 24,201 24,296

Payables 2,538 1,694 1,879 1,930 1,845 1,690 1,695 1,688
Short‐term loans and lease liabilities 3,937 2,009 1,758 1,658 1,508 1,358 1,208 1,058
Provisions 63 35 38 38 38 38 38 38
Total current liabilities 6,538 3,738 3,675 3,626 3,391 3,086 2,941 2,784
Long‐term loans 6,064 5,931 5,431 4,281 3,431 2,581 1,731 881
Other long‐term liabilities 9,928 12,223 11,689 10,539 9,689 8,839 7,989 7,139
Liabilities associated with assets classified for sales ‐ 1 48 ‐ ‐ ‐ ‐ ‐
Total non‐current liabilities 15,992 18,155 17,168 14,820 13,120 11,420 9,720 8,020

Shareholders' equity 4,672 10,284 10,565 11,860 13,418 14,858 16,080 17,182
Minority interests 245 324 320 320 320 320 320 320
Total equity 4,917 10,608 10,885 12,180 13,738 15,178 16,400 17,502
Total equity and liabilities 19,451 23,424 23,168 23,217 23,689 23,974 24,201 24,296

2
9

Evraz – IFRS cash flow statement
2008 2009 2010E 2011E 2012E 2013E 2014E 2015E
Net income 1,859 (1,261) (116) 856 1,344 1,462 1,399 1,392
Adjustments:
Depreciation, depletion and amortisation 1,195 1,632 1,709 1,758 1,828 1,852 1,852 1,852
Other non‐cash adjustments 1,672 675 277 532 420 302 177 47
Operating profit before changes in working capital 4,726 1,046 1,870 3,146 3,592 3,616 3,427 3,291
Changes in working capital (163) 654 (501) (413) (189) (126) 8 20
Net Cash provided by operating activities 4,563 1,700 1,369 2,733 3,403 3,489 3,436 3,311
Cash flow from investing activities:
Purchases of property, plant and equipment (1,103) (441) (950) (1,100) (1,250) (1,000) (750) (750)
Other investing activities (2,633) 624 12 ‐ ‐ ‐ ‐ ‐
Net cash used for investing activities (3,736) 183 (938) (1,100) (1,250) (1,000) (750) (750)
Cash flow from financing activities:
Proceeds from issuance of share capital, net of transaction costs (1) 310 ‐ ‐ ‐ ‐ ‐ ‐
Proceeds from bank loans and promissory notes 5,657 3,427 1,750 750 250 250 250 250
Repayment of bank loans and promissory notes, including interest (3,949) (4,987) (2,500) (2,000) (1,250) (1,250) (1,250) (1,250)
Dividends paid by the parent entity to its shareholders (1,276) (90) ‐ (28) (207) (324) (353) (337)
Other financing activities (558) (809) 110 ‐ ‐ ‐ ‐ ‐
Net cash provided by financing activities (127) (2,149) (640) (1,278) (1,207) (1,324) (1,353) (1,337)
Effects of exchange rate changes on cash and cash equivalents (97) 11 (55) ‐ ‐ ‐ ‐ ‐

Cash and cash equivalents at beginning of the period 327 930 675 411 766 1,712 2,877 4,210
Net Increase in cash and cash equivalents 603 (255) (264) 355 946 1,165 1,333 1,224
Cash of disposal groups classified as held for sale ‐ ‐ (21) ‐ ‐ ‐ ‐ ‐
Cash and cash equivalents at the end of the period 930 675 411 766 1,712 2,877 4,210 5,434

3
0

MAGNITOGORSK IRON & STEEL

Focused on Domestic Value Creation
We initiate coverage of Magnitogorsk Iron and Steel Works (MMK) with a BUY rating
and a target price of $15.33/GDR. The company is focused on raising its share of the
premium domestic steel market and enhancing margins via downstream expansion
into value‐added products.
BUY
Figure 1: High value‐added product output focused on domestic market
Target price $15.33 Domes ti c Sa l es Structure (1H10) Export Sa l es Structure (1H10)
Potential upside 22% Cold rolled steel Slabs and Billets Others
Long steel 1%
12% 13%
Bloomberg code MMK LI 12% Hot rolled Cold rolled steel
Reuters code MAGNq.L steel and 12%
Price (ordinary GDR, $) 12.52 Downstream plate
Hot rolled steel
Price (pref, $) n/a Products
55% 74%
Upside potential 22% 21%
GDR ratio (x) 13 : 1

Share data

No. of ordinary shares (mn) 11,174

No. of pref shares (mn) n/a Core strategy: supplying the Russian market with high value‐added products. MMK is
3M average daily t/o ($mn) 9 committed to expanding its offering of high value‐added (HVA) products in the Russian
Free float (%) 13.4% market. The company has successfully completed construction of Mill 5000 to produce
Market capitalisation ($mn) 10,762 thick plate aimed at satisfying growing demand from Russian pipe‐making, shipbuilding
Enterprise value ($mn) 13,801 and infrastructure construction industries. The company is now focused on Mill 2000,
Major shareholders targeting expected demand growth for high‐strength steel from Russia’s developing
Mintha Holding Limited 45.62% automobile industry. MMK plans to increase the share of HVA products in its product
Fulnek Enterprises Limited 41.01% mix from 35% currently to 50% by 2014.

FINANCIALS ($mn) 2009 10E 11E
Revenue 5,081 7,741 9,661
More production upside is available. MMK’s production facilities are currently
EBITDA 1,023 1,535 2,423
operating at around 80% capacity. This is not due to any lack of demand, but the result
EBIT 288 699 1,452 of a conscious decision to generate maximum value from each marginal tonne of steel
Net income 232 270 872 produced, while keeping costs at bay. The company can easily add around 3mn tonnes
EPS 0.02 0.02 0.08 of output from existing facilities. Another 2.3mn tonnes of steel will be produced at
MMK’s JV with Atakash, while the expansion of iron making and oxygen converter
VALUATION facilities could add another 2‐2.5mn tonnes of steel output. MMK expects its
P/E (x) 46.3 39.8 12.3 steelmaking capacity to grow by 60‐65% in the period to 2014.
P/CF (x) ‐14.8 15.4 7.4
EV/EBITDA (x) 13.5 9.0 5.7 Increasing self‐sufficiency in raw materials. MMK’s self‐sufficiency in raw material
EV/Sales (x) 2.7 1.8 1.4
improved considerably following the acquisition of Belon, which satisfies around 35‐
P/BV (x) 1.1 1.1 1.0
50% of its coal requirements. This is expected to increase to 80% by 2013 as coal
RoCE (%) 1.9% 2.0% 6.4%
output grows. In iron ore, the company is currently 30% self‐sufficient, but has options
RoE (%) 2.3% 2.7% 8.2%
to develop the Prioskol deposit, which could improve its self‐coverage rate.

PERFORMANCE

1 month (%) 3.6% We initiate coverage of MMK with a BUY rating and a target price of $15.33/GDR,
3 month (%) 32.3% implying 22% upside potential to the current share price. MMK has successfully
12 month (%) 19.0% modernised its production facilities and plans to continue expansion of its HVA product
52‐week high ($) 14.31 offering.
52‐week low ($) 2.32

3
1

Strategy Firmly Focused on the Domestic Market

MMK currently generates around 65% of its sales on the domestic market and plans to
raise the share of HVA in its product mix from 35% currently to 50% by 2014. The
company benefits from reasonably strong domestic steel prices, which continue to
show a premium to export prices (Figure 2).

Figure 2: Russian flat steel maintains premium over export markets
Avera ge CIS Domes ti c Pri ce Avera ge CIS Export Pri ce
700
650
$/metric tonne
600
550
Domestic flat prices are expected to
500 maintain premium over exports due
450 to better demand fundamentals
400
2010 E
2011 E
2012 E
2013 E
2014 E
2015 E
2009


Figure 1 shows that the company sells the majority of its HVA products in the domestic
market, while export sales are limited primarily to upstream products. In the domestic
market, pipe manufacturing, machine and automobile building and construction
remain the main consumers of MMK products. Spot sales are deliberately limited to
around 24% (Figure 3).

Figure 3: Domestic market accounts for 65% of MMK’s sales
Regi ona l Sa l es Structure (1H10) Domes ti c Sa l es by Sector (1H10)
Auto Other
industry
Other
Europe 11% 11% Pipe
6%
10% Construction production
Middle East 12% 33%
15% Domestic market
14% 24%
64%
Spot sales ‐
Machine Russia & CIS
building


Overseas expansion based on organic growth
When its Russian peers were vigorously expanding internationally by buying assets in
the US and Europe, MMK adopted an organic growth strategy, entering into a JV with
Turkey’s Atakash to build a full‐cycle steel production facility there aimed at satisfying
growing Turkish and Middle Eastern demand for steel. The project is nearing
completion with hot steelmaking expected to start in 2011. However, given the high
cost of production, the success of the project will depend on the pace of regional
economic development.

3
2

2Q10 results reveal no surprises – outlook in line with company strategy
MMK’s 2Q10 IFRS results revealed no surprises as the financials were in line with
expectations. Its 2Q10, EBITDA reached $437mn, only slightly below the Interfax
consensus of $441mn and 17% higher than 1Q10 EBITDA of $374mn. Despite increased
pressure from raw material costs, MMK maintained solid EBITDA, which declined only
slightly from 22.6% in 1Q10 to 21.1% in 2Q10.

Net profit came in below expectations in 2Q10 at $53mn. However, the figure was
affected by one‐off charges (mainly related to foreign currency losses and allowances
for doubtful accounts receivable). Excluding the one‐offs, net profit was $122mn, only
slightly lower than consensus expectations of $125mn and up from $94mn in 1Q10.

MMK still has one of the lowest debt levels among Russian steelmakers. Total debt at
end‐2Q10 stood just below $2.9bn (vs $2.1bn at YE09), with the share of long‐term
debt increasing to 68%, up from 61% at YE09. MMK currently holds around $950mn in
cash.

Management’s outlook for 3Q and 4Q10 was a bit disappointing: the company expects
output levels in the final two quarters of 2010 to be broadly in line with 2Q10.
However, it believes this is in line with the company’s chosen strategy of generating
maximum returns from each tonne of steel produced and capping production at a level
that does not lead to unnecessary cost pressures.

Moreover, management expects cost setting to remain relatively benign in 2H10,
which should help the company maintain its margins at a reasonably high level, in our
view.

Our 2011E EBITDA forecasts are ahead of consensus due to our positive view on
MMK’s growth prospects
Our financial forecasts for MMK reflect our positive view on its growth potential and
ability to maintain high margins by increasing the proportion of HVA products in its
sales mix.

We expect 2010 EBITDA to be around $1.5bn, or approximately 6% below the current
Bloomberg consensus. However, our 2011E forecast of $2.4bn is 6% higher than
consensus, while 2012E EBITDA estimate of $2.7bn is only 2% below the current
consensus (Figure 4).

Figure 4: MMK ‐ Aton estimates vs consensus
EBITDA Net income
Aton estimates ($mn) 1,535 2,423 2,737 270 872 1,058
Bloomberg consensus ($mn) 1,639 2,285 2,786 460 932 1,204
Aton vs consensus (%) ‐6.3% 6.0% ‐1.7% ‐0.7% ‐41.3% ‐6.4% ‐12.1% ‐19.9%

Our forecast for 2010E net income of $270mn is 41% below consensus, reflecting our
expectations of higher DD&A and interest charges. However, we are only 6% below
consensus for 2011E at around $870mn and 12% below consensus in 2012 with a net
income estimate of $1.1bn.

We initiate coverage of MMK with a BUY rating and a target price of $15.33/GDR,
implying 22% upside potential to the current price. Our valuation reflects our belief
that MMK should benefit from its growing exposure to Russia’s HVA market, while
increased self‐sufficiency in raw materials should help the company maintain healthy
margins.

3
3

Valuation

MMK – valuation breakdown
EBIT, $mn 699 1,452 1,700 1,687 1,543 1,437
Less taxation (175) (363) (425) (422) (386) (359)
Tax adj. EBIT 524 1,089 1,275 1,266 1,157 1,078
Depreciation 836 972 1,037 1,046 1,055 1,064
Less capex (2,118) (1,000) (950) (850) (650) (500)
Change in working capital (292) (575) (268) (18) 48 28
Free cash flow (1,049) 485 1,094 1,443 1,609 1,669
NPV of free cash flow (191) 456 936 1,124 1,142 1,079

Discounted сash flow valuation: $(mn) % WACC calculation: %
No. ordinary shares (mn) 11,174 Target gearing (debt / equity) 35.0%
Common shares : GDR ratio 13

10 x Earnings 8,717 10.14
5 x EBITDA 9,077 10.55

$/GDR % $/GDR
DCF 20.31 50% 10.15
P/E 10.14 25% 2.53
EV/EBITDA 10.55 25% 2.64
Source: Aton estimates

3
4

Financial Accounts

MMK ‐ IFRS net income statement ($mn)
2008 2009 2010E 2011E 2012E 2013E 2014E 2015E
Gross revenue 10,550 5,081 7,741 9,661 11,045 11,061 10,793 10,627
Cost of goods sold (6,890) (3,205) (4,929) (5,644) (6,486) (6,503) (6,415) (6,373)
Selling, distribution and administrative expenses (1,163) (802) (1,122) (1,497) (1,712) (1,715) (1,673) (1,647)
Other operating expenses / (income) (378) (51) (155) (97) (110) (111) (108) (106)
EBITDA (reported) 2,204 1,285 1,627 2,448 2,762 2,758 2,622 2,525
EBITDA (adjusted) 2,119 1,023 1,535 2,423 2,737 2,733 2,597 2,500
EBITDA (adjusted) margin 20.1% 20.1% 19.8% 25.1% 24.8% 24.7% 24.1% 23.5%
EBIT 1,174 288 699 1,452 1,700 1,687 1,543 1,437
Net foreign exchange gain / (loss) 16 9 (15) ‐ ‐ ‐ ‐ ‐
Other non‐operating income / (loss) 1 180 12 25 25 25 25 25
Net interest expense (18) (76) (136) (163) (160) (132) (86) (31)
Other income / (expenses), net (67) (144) (190) (140) (140) (140) (140) (140)
Income before tax and minority interest 1,106 257 370 1,174 1,425 1,440 1,342 1,291
Income tax (25) (38) (97) (293) (356) (360) (335) (323)
Income before minority interest 1,081 219 273 880 1,069 1,080 1,006 968
Minority interest (6) 13 (3) (9) (11) (11) (10) (10)
Net income 1,075 232 270 872 1,058 1,069 996 958
Net margin 10.2% 4.6% 3.5% 9.0% 9.6% 9.7% 9.2% 9.0%
Earnings per share:
Basic EPS per ordinary share 0.10 0.02 0.02 0.08 0.10 0.10 0.09 0.09
No. of ordinary shares outstanding 11,160 11,099 11,116 11,116 11,116 11,116 11,116 11,116
No. of GDRs (1 GDR = 13 ordinary shares) 858 854 855 855 855 855 855 855

MMK ‐ IFRS balance sheet ($mn)
2008 2009 2010E 2011E 2012E 2013E 2014E 2015E
Cash and cash equivalents 1,106 165 237 5 354 1,111 2,046 3,042
Other investments 138 221 202 202 202 202 202 202
Accounts receivables 980 941 1,272 1,588 1,660 1,591 1,552 1,529
Inventories 996 856 1,080 1,160 1,240 1,203 1,186 1,179
Other current assets 408 247 203 162 147 143 141 140
Plant, property and equipment 9,751 11,276 12,213 12,241 12,154 11,959 11,554 10,991
Intangible assets 36 37 34 34 34 34 34 34
Goodwill 45 309 299 299 299 299 299 299
Investments in affiliates 228 22 25 25 25 25 25 25
Other investments 358 627 562 562 562 562 562 562
Other non‐current assets 151 132 154 154 154 154 154 154
Total assets 14,197 14,833 16,280 16,432 16,832 17,281 17,754 18,155

Short‐term loans and lease liabilities 1,295 828 972 872 797 747 697 647
Accounts and notes payable 1,321 928 1,148 928 797 668 659 655
Other current liabilities 24 21 23 23 23 23 23 23
Long term debt and capital leases 431 1,290 2,378 2,178 2,028 1,928 1,828 1,728
Other non‐current liabilities 1,274 1,441 1,403 1,403 1,403 1,403 1,403 1,403
Total liabilities 4,345 4,508 5,924 5,404 5,048 4,769 4,610 4,456

Total shareholders' equity 9,664 9,957 9,952 10,623 11,378 12,107 12,739 13,294
Total liabilities and shareholders' equity 14,198 14,833 16,280 16,432 16,832 17,281 17,754 18,155

3
5

MMK ‐ IFRS cash flow statement ($mn)
2008 2009 2010E 2011E 2012E 2013E 2014E 2015E
Operating activities:
Net income 1,075 232 270 872 1,058 1,069 996 958
Adjustments for non‐cash items:
Depreciation and amortisation 945 735 836 972 1,037 1,046 1,055 1,064
Income tax 25 38 97 293 356 360 335 323
Net finance cost 18 76 136 163 160 132 86 31
Other adjustments for non‐cash items 715 (115) 162 24 1 (10) (13) (14)
Operating profit before changes in working capital 2,778 966 1,501 2,323 2,612 2,598 2,459 2,361
Changes in working capital (269) (127) (269) (575) (268) (18) 48 28
Cash generated from operations 2,509 839 1,232 1,749 2,345 2,579 2,507 2,389
Interest paid (104) (109) (110) (169) (175) (160) (150) (142)
Income tax refund / (paid) (480) 135 (91) (253) (341) (356) (333) (322)
Net cash generated by operating activities 1,925 865 1,031 1,326 1,829 2,064 2,024 1,926
Investing activities:
Acquisition of property, plant and equipment (2,112) (1,613) (2,118) (1,000) (950) (850) (650) (500)
Other investing activities 1,133 (76) 10 ‐ ‐ ‐ ‐ ‐
Net cash used for investing activities (979) (1,689) (2,108) (1,000) (950) (850) (650) (500)
Financing activities:
Proceeds from borrowings 3,974 2,935 2,500 ‐ ‐ ‐ ‐ ‐
Repayment of borrowings (3,562) (2,974) (1,250) (300) (225) (150) (150) (150)
Dividends paid (314) (16) (54) (218) (265) (267) (249) (240)
Other financing activities (36) 15 3 (40) (40) (40) (40) (40)
Net cash provided by financing activities 62 (40) 1,199 (558) (530) (457) (439) (430)
Effects of exchange rate changes in cash and cash equivalents (158) (77) (50) ‐ ‐ ‐ ‐ ‐

Cash and cash equivalents at beginning of the period 256 1,106 165 237 5 354 1,111 2,046
Net increase in cash and cash equivalents 850 (941) 72 (232) 349 756 935 996
Cash and cash equivalents at the end of the period 1,106 165 237 5 354 1,111 2,046 3,042

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6

NOVOLIPETSK STEEL

Strong Growth with High Exposure to HVA Products

We initiate coverage of Novolipetsk Steel (NLMK) with a HOLD rating and a 12‐month
target price of $35.55/GDR, implying 1% upside potential. NLMK is a quality asset
with a healthy balance sheet and the highest profitability among Russian steel names
HOLD (24% EBITDA margin vs the 18% industry average).

Target price $35.55 Figure 1: Significant HVA capacity expansion expected by 2012E
Potential upside 1%
Exi s ti ng New
6,000
400
5,000
Bloomberg code NLMK LI 4,000
Reuters code NLMKq.L 3,000
5,300 1500
Price (ordinary, $) 35.10
2,000
Price (pref, $) n/a 300
1,000 200 70 1900
Upside potential 1% 900
0 400 500
GDR ratio (x) 10 : 1
HVA longs
HRC
painted
Plates
Galvanized
Pre‐
Share data


3M average daily t/o ($mn) 15
Free float (%)
HVA player with a high degree of vertical integration. By 2012 NLMK plans to raise its
12.9%
Market capitalisation ($mn) crude steel capacity by almost 5mntpa to 17.4mntpa. Along with midstream capacity
21,036
Enterprise value ($mn) 22,071
expansion, NLMK will raise its downstream HVA capacity, including galvanized, pre‐
Major shareholders painted, transformer and dynamo steels. Construction of a mini‐mill in Kaluga with an
Fletcher Group Holdings 85.5% annual capacity of 1.5mtpa should raise total long steel capacity to 3.6mntpa.

FINANCIALS ($mn) 2009 10E 11E Development of mining assets to raise vertical integration. In‐house coke, iron ore
Revenue 6,140 8,167 10,074 and scrap collection assets make NLMK nearly 100% self‐sufficient in major raw
EBITDA 1,370 2,424 3,263 materials. Development of the Zhernovskoye‐1 coking coal deposit with an estimated
EBIT 892 1,912 2,661 3.4mntpa production should cover 50% of NLMK’s annual coking coal requirements.
Net income 215 1,208 2,011
EPS 0.36 2.02 3.36 M&A strategy proved correct during the crisis. NLMK's balanced international
expansion policy of acquiring mainly rolling assets (Dan Steel, JV with Duferco, Beta
VALUATION Steel) proved sound during the crisis; in contrast to Severstal’s US crude steel assets, it
P/E (x) 97.7 17.4 10.4 was easier to scale down production when faced by weak demand with no significant
P/CF (x) 23.5 ‐151.3 36.5 impairment of overall profitability.
EV/EBITDA (x) 15.8 9.2 6.9

EV/Sales (x) 3.5 2.7 2.2
Balanced debt portfolio. NLMK is moderately leveraged compared to Severstal, Evraz
P/BV (x) 2.4 2.2 1.9
and Mechel. We expect a YE10 net debt/EBITDA ratio of 0.6x, a more than comfortable
RoCE (%) 1.9% 9.8% 14.9%
RoE (%) 2.5% 12.6% 18.2%
level that implies plenty of room for further growth and the ability to finance the
second stage of the company’s modernisation programme.

PERFORMANCE Initiating with a HOLD rating, suggest adding the stock on price weakness. NLMK’s
1 month (%) 5.6% stock enjoyed a strong performance, gaining 17% in the past three months. As a result,
3 month (%) 17.2% our target price of $35.55 implies just 1% upside from the current level, prompting a
12 month (%) 19.0% HOLD rating. Nevertheless, we believe in the quality of the stock and recommend
52‐week high ($) 35.75 adding it at times of price weakness.
52‐week low ($) 8.96

3
7

Investment Case
We initiate coverage of Novolipetsk Steel (NLMK) with a HOLD rating and a 12‐month
price target of $35.55 per GDR. We view NLMK as an interesting investment idea for
mid‐term and long‐term investors who want a quality asset with a strong product mix
of high value‐added products, solid balance sheet and balanced development strategy.
Our HOLD rating is based purely the stocks recent share price performance, which we
believe already prices in most of the short‐term upside potential.

Despite our HOLD rating, we recommend that mid‐ and long‐term investors use any
serious stock price weaknesses as a buying opportunity, as we believe NLMK will
remain the best performer among Russian steel names going forward.

NLMK enjoys a high level of vertical integration and an advantageous geographical
location close to Russia's major sea ports, which help make it the undisputed leader
among Russian steel names in terms of profitability.

Capacity expansion and upgrades key to future outperformance.
Over the next two years, NLMK plans to raise its crude steel capacity by almost 5mntpa
from the current level of 12.4mntpa. This will be accomplished along with downstream
capacity expansion to support production of high value‐added products such as
galvanized and pre‐painted steel, dynamo and transformer steels, as well as long steel.
Around 3mntpa of additional rolling and processing capacity should be added by 2012
based on company plans (Figure 2).

Figure 2: NLMK crude steel capacity expansion by 2012 (mntpa)
Current EAF BF No.7
20,000
15,000 3,400
12,400 1,550
10,000 8,200 9,100
12,400
5,000
0
2000 2006 2010E 2012E


By the beginning of 2012 more than 90% of NLMK’s blast furnace pig iron production
facilities should be equipped with a pulverized coal injection (PCI) technology,
according to company plans. This should reduce its coke and gas consumption by 20%
and 70%, respectively.

Vertical integration is a key competitive advantage
NLMK continues to foster its vertical integration by developing existing resources and
adding additional raw material capacity. Stoilensky GOK, the company’s in‐house iron
ore producer, plans to raise production capacity by 2mnpta to 14.5mntpa by 2011 to
ensure 100% self‐sufficiency in low‐cost iron ore. The group is also considering the
construction of a palletising plant with a capacity of 6mntpa.

A quality company with strong profitability drivers
Based on the quality of its main production assets, its balance sheet, geographic
location and vertical integration, business strategy and profitability, we view NLMK as
one of the leading steel companies in the Russian steel universe. Those qualities

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8

ensure continued outperformance in terms of profitability and valuations when
compared to its international peers. As a result NLMK now trades at 26% and 9%
premiums to its international peers based on EV/EBITDA (2011E) and P/E (2011E).

Figure 3: NLMK has clear lead in terms of EBITDA margins (%, 2011E)
35% 32%
30% 27%
25% 19% 21% 21%
20% 16%
13%
15%
10%
5%
0%
NLMK
MMK
Mechel
Evraz
Severstal
international
international
Average
Average
DM
EM

Source: Peers – Bloomberg consensus estimates, NLMK – Aton estimates

We see opportunity for higher dividends when capex programme is completed.
The large‐scale investment programme aimed at raising the group’s production
capacity is putting some pressure on free cash flows at the moment. As soon as the
investment programme is completed (2010‐11), NLMK’s free cash flow generation
ability should improve significantly, which could give the company an opportunity to
increase its dividend payouts, in our view (payout is currently set at 30%).

Figure 4: Dividend policies of Russian steel companies Figure 5: NLMK’s cash flows – free cash from positive from 2011E
Amount ($mn) 2007 Amount ($mn) 2008 Ca pi ta l expendi tures ($mn) Free ca s h fl ow ($mn)
Pa y out ra ti o (%) 2007 Pa y out ra ti o (%) 2008
2,500
1,400 Most balanced 66.1% 70%
60.3% 2,000
1,200 dividend policies 60%
1,500
1,000 50%
800 31.4% 42.0% 40% 1,000
32.5% 37.7%
600 30% 500
400 20%
20.7% 15.9% 0
200 10%
0 0% ‐500
2010E
2011E
2012E
2013E
2014E
2006
2007
2008
2009
SVST
EVR
NLMK
MMK

Sources (Figures 4 and 5): Company data, Aton estimates

Historical data show that NLMK’s dividend policy is more balanced than other Russian
steel names with a minimum payout ratio of 20% and a target ratio of 30%. Companies
like Evraz and Severstal, which paid generous dividends before the crisis (and pursued
aggressive expansionary policies abroad) have ended up with substantial debt burdens
on their balance sheets and we do not expect these companies to pay any significant
dividends in the short term.

Moderate leverage leaves room for possible value‐accretive acquisitions.
NLMK entered the crisis with an extremely healthy balance sheet which allowed it to
remain the most profitable Russian steel company despite the slump in steel demand
and sharp fall in prices.

NLMK's balanced international expansion policy based on acquiring primarily rolling
capacity (Dan Steel, JV with Duferco and Beta Steel) proved reasonable during the
crisis. In contrast to Severstal’s crude steel producing assets in the US, NLMK was able

3
9

to scale down its output during the periods of weak demand without any significant
damage to profitability.

Figure 6: NLMK debt breakdown ($mn) Figure 7: Debt repayment schedule ($mn)
Pre‐export fi na nci ng Bonds Other
1,000 50
539
800
500 100
600
20 320
400
1,828
200 380 380
250 300
0
2010E
2011E
2012E
2013E
LT debt ST debt

Source: Company data Source: Company data

At 30 June 2010, NLMK’s total debt amounted to $2.37bn, $500mn of which was short
term. Balanced by $1.4bn in cash and short‐term investments, the company had a net
debt position of $948mn. With our forecast EBITDA (2010) of $2.4bn, the net
debt/EBITDA ratio should reach 0.6x, a comfortable level that could support either
acquisitions or modernisation programmes.

1H10 results and 2H10 expectations: NLMK remains a leader in profitability
In 1Q10 the seasonal decline in demand on the domestic and several international
markets had a negative impact on sales structure and average prices. The first quarter
of 2010 was marked by a large‐scale reorientation of sales towards the most
favourable markets, allowing NLMK to partially offset the impact of seasonal factors.
For instance, product sales to developed markets increased significantly. Deliveries to
the EU increased 34% QoQ to 30% of total sales. The share of North American sales
increased by almost 2.5 times to 8%, mostly driven by increased sales by Beta Steel. As
a result, 1Q10 sales amounted to 2.8 mn tonnes, flat QoQ and rising by 19% YoY.

Improved demand for steel driven by trader restocking, as well as greater purchases by
end‐consumers fostered a seasonal pick‐up in prices and sales in 2Q10. On the back of
flat QoQ production costs, NLMK’s EBITDA jumped to 35%.

Figure 8: NLMK’s QoQ financial performance
Revenue ($mn) EBITDA ($mn)
EBITDA ma rgi n (%)
10,000 40%
8,000 35% 35%

29% 28%
6,000 30% 30%
4,000 25%
23%
2,000 20%
0 15%
1Q10 2Q10 3Q10E 4Q10E 2010E


By the end of 2Q, the market witnessed an upward trend in supply that was not
supported by adequate demand growth. As a result, prices fell from the May‐April
peak of $700 per tonne of HRC to $580/tonne in the second half of August. We expect

4
0

steel prices to continue to fluctuate in the second half of the year. The upward price
trend that emerged at the end of 3Q10 will likely be restrained by still‐significant
excess capacity and relatively low utilisation rates in the global steel sector. All in all,
we expect to see the company’s EBITDA margin decline QoQ in 3Q10 and remain flat in
4Q bringing annual EBITDA margin to 30%, still the highest among Russian steels.

Our forward‐looking forecasts are ahead of consensus
Our financial forecasts for NLMK reflect our positive view on the company’s growth
potential and its unique offering of HVA products in Russia.

We expect 2010 EBITDA of around $2.4bn, approximately 1% above the current
Bloomberg consensus. Our 2011E‐12E forecasts of $3.3bn and $3.7bn respectively are
3.6% ahead and 1% below the current consensus (Figure 9).

Figure 9: NLMK ‐ Aton estimates vs consensus
EBITDA Net income
Aton estimates ($mn) 2,424 3,263 3,700 1,208 2,011 2,293
Bloomberg consensus ($mn) 2,400 3,149 3,720 1,287 1,823 2,233
Aton vs consensus (%) 1.0% 3.6% ‐0.5% 1.4% ‐6.2% 10.3% 2.7% 2.3%

Our forecast for 2010E net income of $1.2bn is 6% below consensus; however, we are
10% ahead of consensus for 2011E, with net income forecast of $2bn, and 3% ahead of
consensus in 2012E with an estimate of $2.3bn.

We initiate coverage of NLMK with a HOLD rating and a target price of $35.55/GDR.
The target price implies just 1% upside to the current share price levels, prompting a
HOLD rating. However, given the quality of the stock, its profitability leadership among
Russian peers and quality of its balance sheet, we would view the company as good
long‐term investments and recommend buying the stock on price dips.

4
1

Valuation

NLMK – valuation breakdown
EBIT, $mn 1,912 2,661 3,013 2,874 2,736 2,578
Less taxation (382) (532) (603) (575) (547) (516)
Tax adj. EBIT 1,529 2,129 2,410 2,299 2,189 2,063
Depreciation 512 603 687 743 754 751
Less capex (1,800) (1,800) (1,500) (900) (700) (700)
Change in working capital (381) (357) (356) (120) (47) (24)
Free cash flow (139) 575 1,241 2,022 2,197 2,089
NPV of free cash flow (25) 536 1,042 1,530 1,498 1,284

Discounted cash flow valuation: $(mn) % WACC calculation: %
Less: minorities (118) Other company‐specific risk premiums 0.0%
Less: net debt 948 Total cost of equity 12.2%

12 x Earnings 24,132 40.27
6 x EBITDA 18,750 31.29

$/GDR % $/GDR
DCF 35.32 50% 17.66
P/E 40.27 25% 10.07
EV/EBITDA 31.29 25% 7.82
Source: Aton Estimates

4
2

Financial Accounts

NLMK – US GAAP P&L statement ($mn)
2009 2010E 2011E 2012E 2013E 2014E 2015E
Total revenue 6,140 8,167 10,074 11,875 12,396 12,571 12,632
COGS (4,150) (5,272) (6,305) (7,555) (8,159) (8,452) (8,664)
Gross profit 1,990 2,895 3,769 4,319 4,237 4,119 3,968
SG&A (1,054) (980) (1,108) (1,306) (1,364) (1,383) (1,390)
Other operating income/(expense) (44) (3) ‐ ‐ ‐ ‐ ‐
Operating income (EBIT) 892 1,912 2,661 3,013 2,874 2,736 2,578
EBITDA 1,370 2,424 3,263 3,700 3,617 3,491 3,329
DD&A (478) (512) (603) (687) (743) (754) (751)
Net interest income/(expense) (111) (107) (133) (131) (95) (56) (11)
Associates ‐ ‐ ‐ ‐ ‐ ‐ ‐
FX (loss)/gain (78) (234) ‐ ‐ ‐ ‐ ‐
Others (recurring) (108) (28) ‐ ‐ ‐ ‐ ‐
Pre‐tax profit 595 1,543 2,528 2,882 2,779 2,680 2,567
Tax (182) (370) (506) (576) (556) (536) (513)
Equity in net losses/(earnings) of associates (315) 6 9 10 10 10 9
Net income pre‐exceptionals 98 1,178 2,031 2,316 2,233 2,154 2,063
Minority interest 117 30 (20) (23) (22) (22) (21)
Net income (post exceptionals) 215 1,208 2,011 2,293 2,211 2,132 2,043
EPS ($/GDR) 0.36 2.02 3.36 3.83 3.69 3.56 3.41
Dividend per GDR ($) 0.07 0.31 1.01 1.15 1.11 1.07 1.02
Number of GDRs (mn) 599 599 599 599 599 599 599

NLMK – US GAAP balance sheet ($mn)
2009 2010E 2011E 2012E 2013E 2014E 2015E
Cash & short term investments 1,699 1,188 862 521 1,714 3,136 4,613
Accounts receivable 913 1,215 1,498 1,766 1,844 1,870 1,879
Inventory 1,134 1,441 1,723 2,064 2,230 2,310 2,367
Other current assets 131 131 131 131 131 131 131
Total current assets 3,877 3,973 4,213 4,482 5,917 7,445 8,989

PP&E 7,316 8,604 9,801 10,615 10,771 10,717 10,666
Intangible assets 760 760 760 760 760 760 760
Investments 468 468 468 468 468 468 468
Other long‐term assets 81 122 122 122 122 122 122
Total non‐current assets 8,625 9,954 11,151 11,965 12,121 12,067 12,016
Total assets 12,502 13,927 15,364 16,446 18,039 19,512 21,005

Accounts payable 841 1,069 1,278 1,531 1,654 1,713 1,756
Short term debt 557 600 600 600 600 600 600
Other current liabilities 19 19 19 19 19 19 19
Total current liabilities 1,417 1,688 1,897 2,151 2,273 2,333 2,376

Long term debt 1,939 2,100 1,900 1,100 1,000 900 900
Deferred tax liabilities 396 396 396 396 396 396 396
Other non‐current liabilities 140 140 140 140 140 140 140
Total long‐term liabilities 2,475 2,636 2,436 1,636 1,536 1,436 1,436
Total liabilities 3,892 4,324 4,334 3,787 3,809 3,769 3,812
Minority interests (108) (108) (108) (108) (108) (108) (108)

Total shareholders equity 8,610 9,603 11,031 12,659 14,229 15,743 17,193

Total liabilities and equity 12,502 13,927 15,364 16,446 18,039 19,512 21,005

4
3

NLMK – US GAAP cash flow ($mn)
2009 2010E 2011E 2012E 2013E 2014E 2015E
Net income 98 1,178 2,031 2,316 2,233 2,154 2,063
DD&A add‐back 478 512 603 687 743 754 751
(Increase) / decrease in working capital 859 (381) (357) (356) (120) (47) (24)
Other operating cash flow items (41) ‐ ‐ ‐ ‐ ‐ ‐
Cash flow from operations 1,394 1,310 2,277 2,647 2,856 2,862 2,790
Capital expenditure (1,121) (1,800) (1,800) (1,500) (900) (700) (700)
Acquisitions ‐ ‐ ‐ ‐ ‐ ‐ ‐
Other investing cash flow (651) ‐ ‐ ‐ ‐ ‐ ‐
Cash flow from investing (1,771) (1,800) (1,800) (1,500) (900) (700) (700)
Dividends paid (2) (185) (603) (688) (663) (640) (613)
Share (repurchase)/issue ‐ ‐ ‐ ‐ ‐ ‐ ‐
Increase/(decrease) interest bearing liabilities (533) 164 (200) (800) (100) (100) ‐
Cash flow from financing (535) (21) (803) (1,488) (763) (740) (613)
Net increase/(decrease) in cash and cash equivalents 2,159 1,247 736 410 69 1,262 2,684
Cash and cash equivalents at beginning of year (912) (511) (326) (341) 1,193 1,422 1,477
Cash and cash equivalents at end of year 1,247 736 410 69 1,262 2,684 4,161

4
4

SEVERSTAL
All Eyes on Gold

We initiate coverage of Severstal with a BUY rating and a target price of $18.57/GDR.
We see the main short‐term driver for stock performance in expectations of the
upcoming IPO of the company’s gold producing business. A swing back to
profitability in the US and European units could provide upside in the medium term.

BUY Figure 1: Gold business offers substantial EBITDA expansion
Sa l es by bus i nes s (2Q10) EBITDA by bus i nes s (2Q10)
Target price $18.57 Europe
Potential upside 24% Europe USA

5%
12% 6%
Bloomberg code SVST.LI Russian

USA Gold Russian
Reuters code CHMFq.L Steel
27% 8% Mining Steel
Price (ordinary, $) 15.00 44%
excl. 50%
Price (pref, $) n/a Mining gold
Upside potential 24% excl gold 31%
ADR ratio (x) 1 : 1 Gold
14%
3%
Share data

No. of ordinary GDRs (mn) 1,008
Potential IPO of the gold business remains one of the main drivers for the stock.
3M average daily t/o ($mn)
Although the company had not revealed the dates and a possible structure of the
72
Free float (%) potential IPO of its gold business (recently renamed Nord Gold), it has confirmed that
17.6%
Market capitalisation ($mn) 15,116
it is considering such an options. To illustrate a possible re‐rating of the stock, we
Enterprise value ($mn) 19,788 examined Norilsk Nickel’s experience with the Polyus spin‐off and the impact it had on
Major shareholders Norilsk’s share price. Based on the gold business’s current margins, we believe it could
Alexey Mordashov 82.37% be worth anywhere between $2.4 and $5.1bn, a potential upside of around 15% to
20% to its current valuation as an asset consolidated within Severstal.
FINANCIALS (mn) 2009 10E 11E
Revenue 13,054 17,632 19,563 Recent financials show it is too early to write‐off Severstal’s international assets.
EBITDA 846 3,315 3,961 Severstal’s 2Q10 results surprised the market on the upside, with the biggest surprise
EBIT ‐145 1,921 2,637 seen in the return of its US and European businesses to positive EBITDA. We believe it
Net income ‐1,037 9 1,598 is too early to write‐off Severstal’s involvement in the US and Lucchini, as these
EPS ‐1.03 0.01 1.59 businesses may swing to profitability once economic conditions in the developed
CFPS countries improve.
VALUATION
P/E (x) n/a n/a 9.5 We continue to include Lucchini in our valuation of Severstal. We consolidate
P/CF (x) 9.2 14.1 11.5
Lucchini in our forecasts for Severstal, as we believe a return to profitability may bring
EV/EBITDA (x) 23.4 6.0 5.0
these assets back into the company’s fold. The company also believes its audited
EV/Sales (x) 1.5 1.1 1.0
financial numbers will continue to include Lucchini due to the structure of the deal
P/BV (x) 1.9 1.7 1.4
RoCE (%) ‐7.9% 0.1% 11.1%
with Alexei Mordashov, which allows the company to buy back Lucchini for its original
RoE (%) ‐13.2% 0.1% 15.3% sale price of €1.

Initiating with a BUY rating and a target price of $18.57/GDR. Our target price implies
PERFORMANCE 24% upside potential to the current price. A gold business IPO remains the clearest
1 month (%) 11.5% short‐term driver and could possibly add some 15‐20% on top of that upside. In
3 month (%) 37.1% addition, improvements in developed economies may bring US and European units
12 month (%) 80.8% back into profit, providing further upside to our current financial forecasts.
52‐week high ($) 12.80
52‐week low ($) 3.25

4
5

Potential Gold IPO – Lessons from Norilsk’s Polyus Spin-Off

A potential IPO of Severstal’s gold assets remains one of the main attractions of the
stock – this event could be a catalyst for a significant re‐rating of Severstal in our view.
In this section, we examine potential parallels with Norilsk Nickel’s spin‐off of Polyus
Gold several years ago, to assess the likely impact of a similar move on Severstal.

Severstal’s gold assets. Severstal’s current gold portfolio consists of the following:
 Former Celtic Gold assets: the Suzdal and Zherek fields. Severstal’s attributable
resources are around 2.0mn oz (resource estimates available at acquisition).
 High River Gold (HRG): 70.4% interest; Severstal attributable resources total is
around 5mn of gold equivalent oz, based on HRG’s latest data. HRG, in turn, owns:
 84.94% of Buryat Zoloto (BRZL), giving Severstal a 42.6% holding in BRZL
 90% in Taparko, giving Severstal a 45.1% holding
 Nerengri Metallik and ZAO Mine Alekperovo (Tobornoe and Pogromnoe fields):
Russian C1+C2 category resources of approximately 600k oz (18mn tonnes) of gold
 Semgeo (Kazakhstan): C1+C2 category reserves of around 30mn tonnes
(approximately 1mn oz) of gold
 Severnaya Zolotorudnaya Kompaniya: Russian P1+P2+P3 resources of around 8mn
oz of gold
 Prognoz silver deposit: 50% interest, around 1mn oz of gold equivalent resources

Severstal also holds 93.38% of Oslo‐listed Canadian miner Crew Gold Corporation
(SVST attributable resources of approximately 4.9mn oz). Severstal’s total resource
base has been reported at 23.8 mn of gold equivalent oz under JORC classification.

Background to Polyus spin‐off. Norilsk Nickel spun off its gold producing assets into
Polyus Gold (PLZL) in 2006. The newly formed company was listed in Russia in mid‐
2006; its ADRs were listed in London in Dec 2006. At the time of Polyus’s Russia listing,
Norilsk’s market cap was around $29bn. Polyus was valued at $13bn for its Russian
listing, although the market cap fell to just over $9bn at the time of the London listing.

Between Polyus’s Russian debut and London listing, Norilsk’s market cap rose above
$37bn (a 30% or $8.6bn increase – just below Polyus’s market cap at the time of its
London listing).

Polyus is currently valued at around $9.6bn in Russia, or $11.8bn based on its GDR
price in London. This values the company at 14.3x 2010E EV/EBITDA and 24.3x 2010E
P/E (based on the current London valuation). In terms of mineral resources data, the
company is valued at approximately $100 per troy oz of YE10E Measured, Indicated
and Inferred resources (around 95mn oz by our conservative estimates).

Suggested valuation range for Severstal’s gold assets. As can be seen from Figure 2
below, Severstal’s 2009 gold production was about 45% of that of Polyus, while 2009
margins for its gold assets were also broadly comparable to those of Polyus (e.g.
EBITDA margin of 45.6% in 2009 vs Polyus’s 45.8%). However, while consolidated
within Severstal its gold business continues to be valued at parent company’s “steel”
multiples. Based on the consensus 2011E financials these are currently 5.4x for
EV/EBITDA, 9.8x P/E. Based on those multiples, gold business is valued at only around
$1.6‐2.1bn.

In our assessment of a potential value of Severstal’s gold asset as a stand‐alone
business we used multiples similar to those at which Polyus is currently valued
($100/oz of resources, 14x EV/EBITDA, 24x P/E). We were somewhat conservative in
our 2010E financial estimates for Severstal’s gold business, which gave us valuations
ranging from $2.4bn to $5.1bn (and that is ignoring potential growth in 2011). This
would mean that an IPO of the gold assets could realise additional $2.3‐3.1bn of value
for Severstal shareholders (around 15‐20% of Severstal’s current market cap).

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6

Figure 2: Polyus Gold, Norilsk Nickel and Severstal Gold operating, financial and valuation data
Units Polyus Norilsk Nickel Severstal’ gold assets
2005 2006 2009 2010E 2009 2010E
Average spot gold price $/troy oz 445 605 974 1250 974 1250

Key operating and financial data:
Production troy oz 1,038,000 1,215,000 1,261,000 1,390,000 534,000 650,000
Gold sales $mn 473 735 1,199 1690 518 810
Operating profit $mn 119 212 432 670 Reported
EBITDA $mn 175 306 549 805 236 365
EBITDA margin % 37.0% 41.7% 45.8% 47.6% 45.6% 45%
Net income $mn 112 1,158 322 485 Estimated  130 165
Net margin % 27% 28.7% Assumed  25% 20%

Mineral resources:
Measured + Indicated + Inferred gold equiv. oz 119,951,394 119,951,000 110,215,000 95,000,000 Reported  23,800,000

Market caps:
Market cap at PLZL Russia listing (12.05.2006) $bn 12.9 28.8
Market cap at PLZL London listing (18.12.2006) $bn 9.3 37.4
Severstal
Market cap current (Russia) $bn 9.6 9.6 34.3 15.1
Market cap current (London) $bn 11.8 11.8 35.3 15.1

PLZL valuation matrix:
$/oz of Measured + Indicated resources $/oz 152 119 148
$/oz of Measured + Indicated + Inferred resources $/oz 78 87 101 Gold business Gold business Value
EV/EBITDA x 25.4 21.0 14.3 valued on valued on difference As % of SVST
P/E x 8.0 36.7 24.3 “steel” “gold” vs “steel” current
P/Sales x 12.7 9.8 7.0 multiples multiples multiples market cap
($bn) ($bn) ($bn) (%)
Current “steel” multiples for Severstal (based on 2011E consensus):
EV/EBITDA x 5.4 2.0
P/E x 9.8 1.6
Valuation estimates for Severstal's gold business:
$ per oz of Measured + Indicated + Inferred resources x 100 2.4
EV/EBITDA x 14 5.1 3.1 21%
P/E x 24 4.0 2.3 16%

4
7

US Expansion Put on Hold

Severstal was one of the first Russian companies to start expanding overseas and it
was the first such company to make a major investment in the US. The acquisitions
turned Severstal into one of the largest steel producers in America (it is currently
ranked the fourth‐largest US producer by installed capacity). The company’s strategy
was to acquire underutilised, underperforming assets with the intention of applying its
business turnaround experience, targeted capital investment and increased
operational synergies to transform the performance and profitability of these units.

Severstal’s North American expansion plans came to a grinding halt when the US
economy fell into recession. The output by the domestic auto industry, Severstal’s
main target customer in the US, declined sharply, reducing demand for flat steel from
the company’s facilities. Similarly to its Russian peers, Severstal was heavily in debt
and faced a bleak future both in Russia and the US. This prompted many
commentators to write‐off Severstal’s investments in the US as a complete failure.

Too early to write off Severstal’s North American involvement
US steelmakers were among the worst hit in the economic downturn compared to
their global peers. They cut their crude steel out sharply and operated at below 50%
capacity for about seven months (Dec 2008 – June 2009) (Figure 3).

Figure 3: US steel output – a long, unsteady recovery
US Steel Output (mnt) Pea k Ra te Uti l i s a ti on (%)
Ca pa ci ty Uti l i s a ti on (%)
100.0%
10 100%
78.6%
8 89.7% 80%
6 70.2% 60%
43.5%
4 40%
2 33.5% 20%
0 0%


Severstal was forced to gradually shut down hot metal output at its plants and
recognise an impairment loss of around $1bn in 2009.

Despite the losses, we do not think the US investment is a lost cause. The company
started implementing an active cost reduction programme through headcount
reductions in 2009. With time, lower raw material costs have also helped.
Nevertheless, while the company hoped to bring it US business EBITDA to breakeven in
3Q09, the unit remained loss making on EBITDA well into 2010.

However, Severstal’s cost management efforts finally paid off in 2Q10, when the US
business returned a positive EBITDA of $59mn after six loss‐making quarters. The
business is not yet out of the woods, but encouragingly, it nearly broke even in 2Q10
on the operational level with an operating loss of only $1mn.

1H10 results – ahead of expectations, encouraging outlook
Severstal’s 2Q10 IFRS results surprised the market on the upside. The company’s 2Q10
EBITDA reached $955mn, 11% ahead of Interfax consensus of $857mn and nearly
double its 1Q10 EBITDA of $492mn. The company reported a 2Q10 net profit of

4
8

$192mn (vs a net loss of $785mn in 1Q10). This was affected by the loss recognised on
the sale of the Lucchini stake. Excluding this loss, net profit was $393mn, significantly
ahead of consensus expectations of $267mn.

In contrast to some other Russian steelmakers, Severstal management’s guidance for
2H10 was cautiously positive, which gave a boost to positive sentiment on the stock.
The company expects to see higher output levels and higher prices due to the gradual
improvement in steel markets through the end of 2010 on the back of restocking and
higher demand.

Forward‐looking forecasts – EBITDA ahead of consensus on inclusion of Lucchini
After a meeting with the company, we have decided to keep Lucchini within our
estimates as the deal with Severstal’s owner, Alexei Mordashov, is structured so that
audited results may end up consolidating Lucchini back within the group. In addition,
keeping Lucchini in allows for better historical comparisons in our view.

In terms of EBITDA, we expect Severstal to generate around $3.3bn in 2010 (nearly
four times its 2009 EBITDA of $844mn, but still below the peak of $5.4bn generated in
2008). We forecast further improvements in 2011‐12E with EBITDA reaching $4bn and
$4.2bn respectively. Our forecasts for 2010E, 2011E, 2012E are 18%, 12% and 5%
ahead of Bloomberg consensus, respectively.

On the net income line we expect a positive performance in 2010 limited to just $9mn
– this is substantially lower than consensus expectations of $766mn, which we believe
once again is due to the treatment of Lucchini (we continue to include 2010 loss from
that business in our numbers). We expect the situation to improve considerably in
2011E and 2012E, with net income reaching $1.6bn and $1.8bn respectively. This is 4%
above and 2% below consensus estimates, respectively.

We provide a summary of our forecasts for 2010‐12E in Figure 4 below.

Figure 4: Severstal ‐ Aton estimates vs consensus
EBITDA Net Income
3Y Average 3Y Average
Aton estimates ($mn) 3,315 3,961 4,155 9 1,598 1,802
Aton vs consensus (%) 17.6% 11.9% 4.5% 11.4% ‐98.8% 4.0% ‐1.9% ‐32.3%

Initiate with a BUY and a target price of $18.57/share. Our BUY rating is based on the
potential 24% upside to the current share price implied by our target price. We believe
the share price does not yet fully reflect the potential upside from re‐rating that could
follow the potential gold asset IPO, which could create some $2‐3bn of additional
value for shareholders. Moreover, while Russian steel and mining assets are expected
to continue performing strongly, we could see an upside surprise from Severstal’s US
and European businesses, once steel markets there recover.

4
9

Valuation

Severstal – valuation breakdown
EBIT, $mn 1,921 2,637 2,851 2,793 2,706 2,686
Less taxation (480) (659) (713) (698) (676) (672)
Tax adj. EBIT 1,441 1,977 2,139 2,095 2,029 2,015
Depreciation 957 1,059 1,095 1,092 1,088 1,086
Less capex (779) (1,583) (1,525) (1,275) (1,025) (775)
Change in working capital (1,106) (378) (399) (55) 93 77
Free cash flow 512 1,074 1,310 1,857 2,186 2,403
NPV of free cash flow 93 1,004 1,107 1,419 1,511 1,503

Discounted cash flow valuation: ($mn) % WACC calculation: %

10 x Earnings 15,980 15.85
5 x EBITDA 15,134 15.01

$/GDR % $/GDR
DCF 21.70 50% 10.85
P/E 15.85 25% 3.96
EV/EBITDA 15.01 25% 3.75
Source: Aton Estimates

5
0

Financial Accounts

Severstal – IFRS net income statement ($mn)
2008 2009 2010E 2011E 2012E 2013E 2014E 2015E
Gross revenue 22,393 13,054 17,632 19,563 21,131 20,922 20,522 20,222
Cost of goods sold (16,500) (11,356) (13,444) (14,529) (15,736) (15,615) (15,347) (15,103)
Gross profit 5,893 1,698 4,188 5,034 5,395 5,307 5,175 5,119
SGA and distribution expenses (2,145) (1,600) (1,926) (2,149) (2,296) (2,266) (2,221) (2,185)
Other operating income / (expense) 468 (244) (341) (248) (248) (248) (248) (248)
EBITDA 5,366 846 3,315 3,961 4,155 4,042 3,950 3,898
EBITDA margin 24.0% 6.5% 18.8% 20.2% 19.7% 19.3% 19.2% 19.3%
Operating profit 4,216 (145) 1,921 2,637 2,851 2,793 2,706 2,686
Non operating expenses (1,009) (253) (125) (50) (50) (50) (50) (50)
EBIT 3,207 (399) 1,796 2,587 2,801 2,743 2,656 2,636
Net financing expense (353) (497) (350) (329) (261) (179) (71) 54
Forex differences (275) (205) (50) (50) (50) (50) (50) (50)
Pre‐tax profit 2,579 (1,101) 1,396 2,208 2,490 2,514 2,535 2,641
Income tax (517) (18) (349) (552) (623) (629) (634) (660)
Profit / (loss) from discontinued operations ‐ ‐ (1,037) ‐ ‐ ‐ ‐ ‐
Profit / (loss) before minority interest 2,062 (1,119) 10 1,656 1,868 1,886 1,901 1,981
Minority interest (33) 82 (1) (58) (65) (66) (67) (69)
Profit / (loss) for the year 2,029 (1,037) 9 1,598 1,802 1,820 1,834 1,911
Net margin 9.1% ‐7.9% 0.1% 8.2% 8.5% 8.7% 8.9% 9.5%
Earnings per share:
Basic EPS per common share 2.01 (1.03) 0.01 1.59 1.79 1.81 1.82 1.90
No. of common shares outstanding 1,007 1,005 1,005 1,005 1,005 1,005 1,005 1,005
No. of GDRs (1 GDR = 1 common share) 1,007 1,005 1,005 1,005 1,005 1,005 1,005 1,005

Severstal – IFRS balance sheet ($mn)
2008 2009 2010E 2011E 2012E 2013E 2014E 2015E
Cash and cash equivalents 2,653 2,853 848 310 207 697 1,571 2,740
Short‐term bank deposits 819 96 165 165 165 165 165 165
Receivables 2,006 1,484 2,208 2,508 2,731 2,797 2,744 2,704
Inventories 4,272 2,974 3,315 3,782 4,192 4,171 4,099 4,034
Other current assets 927 753 942 1,018 1,061 1,058 1,048 1,039
Assets held for sale 9 24 24 24 24 24 24 24
Plant, property and equipment 9,827 9,485 9,134 9,634 10,038 10,197 10,109 9,773
Intangible assets 1,511 1,369 1,369 1,369 1,369 1,369 1,369 1,369
Other non‐current assets 469 587 587 587 587 587 587 587
Restricted cash 22 18 18 18 18 18 18 18
Total assets 22,514 19,644 18,610 19,416 20,392 21,083 21,735 22,453

Short‐term debt and current portion of long‐term debt 2,039 1,478 889 589 439 289 139 (11)
Payables 1,600 1,395 1,400 1,821 2,075 2,064 2,029 1,996
Liabilities related to assets held for sale 0 12 ‐ ‐ ‐ ‐ ‐ ‐
Other current liabilities 1,199 943 953 997 1,020 1,018 1,012 1,007
Long‐term debt 6,227 5,749 4,653 3,653 2,653 1,653 653 (347)
Other non‐current liabilities 1,896 1,691 1,691 1,691 1,691 1,691 1,691 1,691
Total liabilities 12,961 11,268 9,586 8,751 7,877 6,715 5,523 4,336

Total shareholders' equity 9,051 7,878 8,804 10,444 12,294 14,148 15,991 17,896

5
1

Severstal – IFRS cash flow statement ($mn)
2008 2009 2010E 2011E 2012E 2013E 2014E 2015E
Operating activities:
EBIT 3,207 (399) 1,796 2,587 2,801 2,743 2,656 2,636
Adjustments for non‐cash items:
Depreciation and amortization 1,087 957 957 1,059 1,095 1,092 1,088 1,086
Impairment/(reversal of impairment) of assets 1,540 219 100 25 25 25 25 25
Other adjustments for non‐cash items 74 (284) 139 ‐ ‐ ‐ ‐ ‐
Operating profit before working capital changes 5,909 493 2,991 3,670 3,922 3,860 3,769 3,747
Changes in working capital (1,018) 1,722 (1,155) (378) (399) (55) 93 77
Cash generated from operations 4,891 2,215 1,836 3,292 3,523 3,805 3,862 3,825
Interest paid (excluding banking operations) (363) (552) (601) (479) (367) (275) (189) (103)
Income tax paid (1,094) (52) (349) (552) (623) (629) (634) (660)
Net cash provided by operating activities 3,434 1,611 886 2,261 2,533 2,901 3,040 3,062
Investing activities:
Additions to property, plant and equipment (2,031) (946) (779) (1,583) (1,525) (1,275) (1,025) (775)
Other investing activities 288 692 (98) 85 38 14 9 31
Net cash used for investing activities (4,811) (254) (877) (1,499) (1,487) (1,261) (1,016) (744)
Financing activities:
Proceeds from debt finance 7,542 4,355 ‐ ‐ ‐ ‐ ‐ ‐
Repayment of debt finance (3,686) (5,421) (1,685) (1,300) (1,150) (1,150) (1,150) (1,150)
Other financing activities (1,432) (92) ‐ ‐ ‐ ‐ ‐ ‐
Net cash provided by financing activities 2,424 (1,158) (1,685) (1,300) (1,150) (1,150) (1,150) (1,150)
Effects of exchange rate changes (17) 2 (330) ‐ ‐ ‐ ‐ ‐

Cash and cash equivalents at beginning of year 1,623 2,653 2,853 848 310 207 697 1,571
Net increase in cash and cash equivalents 1,030 200 (2,006) (537) (104) 490 874 1,168
Cash and cash equivalents at year end 2,653 2,853 848 310 207 697 1,571 2,740

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2
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Aton - Dinnur Galikhanov - Russian Steel Makers - 2010.10.25 (Eng)

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Aton - Dinnur Galikhanov - Russian Steel Makers - 2010.10.25 (Eng)

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25 October 2010

0% 20% 40% 60% 80% 100%

Drilling Down on the Main Sector Drivers

120 capacity utilisation 90%

10.0 63.6% 60%

5.0 47.5% 40%

1000 Government stimuli should ensure 650

1000 weaken further due to seasonal 650

Recent Financial Performance and Forward Projections

MAGNITOGORSK IRON & STEEL

Strategy Firmly Focused on the Domestic Market

10,000 8,200 9,100

8,000 35% 35%

Potential upside 24% Europe USA

Bloomberg code SVST.LI Russian

Potential Gold IPO – Lessons from Norilsk’s Polyus Spin-Off

US Expansion Put on Hold

Strategy & Economics Oil & Gas Telecoms & Media

Andrew Risk Metals & Mining Special Situations & Small Caps Group

Vlad Nigmatullin Consumer Goods & Retail Nikita Melnikov

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