- Net result for the period was USD –38.72 mln (January 1, 2008–March 31, 2008: 160.76). Earnings per share was USD –0.53 (3.49).
- The net asset value of the company was USD 275.48 mln (December 31, 2008: 247.89) on March 31, 2009, corresponding to USD 2.99 (5.39) per share. Given a SEK/USD exchange rate of 8.2557 the corresponding values were SEK 2,274.27 mln and SEK 24.71, respectively.
- The group’s net asset value per share in USD decreased by 44.44% over the period January 1, 2009–March 31, 2009. Excluding the effects from the new share issue the development would have been –15.58%. During the same period the RTS index increased by 9.14% in USD terms.
- During the period Vostok Nafta has completed a rights issue, whereby 46,020,901 shares were issued for a consideration of SEK 12 each. Net of transaction costs, the proceeds from the right issue amounted to USD 66.20 mln (SEK 537.86 mln). The number of outstanding shares at the end of the period was 92,041,802.
- The reported net asset value per share of Vostok Nafta as of April 30, 2009 was USD 3.85 (SEK 30.96). Adjusted for changes in the fair value of Tinkoff Credit Sytems and Vosvik/Kontakt East, the net asset value per share of Vostok Nafta as of April 30, 2009 was USD 3.71 (SEK 29.81).
The company will host a telephone conference with an interactive presentation on Tuesday May 26, 2009 at 16:00 Central European Time (CET). For call-in details, see separate press release issued Tuesday, May 19, 2009 at www.vostoknafta.com.
Background
Vostok Nafta Investment Ltd was incorporated in Bermuda on April 5, 2007 with corporate identity number 39861. Since July 4, 2007, the Swedish Depository Receipts of Vostok Nafta (SDB) are listed on the NASDAQ OMX Nordic Exchange Stockholm, Mid Cap segment, with the ticker VNIL SDB.
As at March 31, 2009 the Vostok Nafta Investment Ltd Group consists of one Bermudian parent company, one wholly owned Bermudian subsidiary, two wholly owned Cypriot subsidiaries, three wholly owned Russian subsidiaries and one wholly owned Swedish subsidiary.
Starting from January 1, 2009 Vostok Nafta will report its operations in two segments:
- Portfolio Investments; which are the Group’s investments in associated companies, financial assets at fair value through profit or loss and loan receivables; and
- Venture Capital Investments; which will comprise investments in operating companies were the Group holds more than 50 per cent of the votes. As at March 31, 2009 the Group’s only investment within this segment is ZAO Baikal Energy. Since the segment does not meet any of the quantitative thresholds to be considered reportable, and separately disclosed, Vostok Nafta does not report information separately about the segment in this report.
The financial year is January 1–December 31.
Group – results for the period and net asset value
During the period, the result from financial assets at fair value through profit or loss amounted to USD –20.54 (86.32) mln, where a change in the fair value of the holdings of equity in Tinkoff Credit Systems has impacted the result with USD –8.00 mln. Result from investments in associated companies was USD 11.24 (70.45) mln, which includes a change in the fair value of the stockholdings in Vosvik/Kontakt East with USD –4.20 mln. Result from loan receivables was USD –4.55 (1.23) mln, which is mainly a foreign exchange loss when revaluating the loan receivables denominated in Russian Roubles into US dollars. Dividend income was USD 3.98 (3.27) mln.
Net operating expenses (defined as other operating income less operating expenses) amounted to USD 1.49 (–1.49) mln.
Net financial items were USD –4.30 (0.33) mln.
Net result for the period was USD –38.72 (160.76) mln.
Total shareholders’ equity amounted to USD 275.48 mln on March 31, 2009 (December 31, 2008: 247.89).
New share issue and loan repayments
In February 2009, Vostok Nafta completed a rights issue, whereby 46,020,901 shares were issued for a consideration of SEK 12 each. Net of transaction costs, the proceeds from the right issue amounted to USD 66.20 mln.
Subsequent to the new share issue, the Company has repaid USD 15.25 million of outstanding debt. After the end of the period, the Company has also repaid the outstanding short-term bond loan of EUR 10.0 million. As at March 31 2009, the Group’s borrowings, which are entirely relating to the short-term bond, amounted to USD 14.01 mln.
Liquid assets
The liquid assets of the group, defined as cash and bank deposits adjusted for concluded but not yet settled share transactions, amounted to USD 26.27 mln on March 31, 2009 (Dec 31, 2008: 29.20). Adjusting also for the Company’s outstanding EUR 10 mln bond, which was repaid on April 15, 2009, liquid assets as at March 31, 2009 was USD 12.26 min.
Parent company
The parent company finances the Cypriot subsidiary's operations on market terms. The net result for the period was USD 1.48 (2.55) mln.
Annual General Meeting
An Annual General Meeting in Vostok Nafta Investment Ltd was held on May 14, 2009.
At the meeting, the shareholders considered a number of items, some of which were the following.
- The profit and loss account and the balance sheet as well as the consolidated profit and loss account and the consolidated balance sheet showing total loss for the financial year January 1–December 31, 2008, in the amount of USD 279,836 thousand were adopted. The directors' proposal that no dividends be paid was approved.
- Eight directors were re-elected, namely Al Breach, Per Brilioth, Paul Leander-Engström, Torun Litzén, Ian H. Lundin, Lukas H. Lundin, William A. Rand and Robert J. Sali. Lukas H. Lundin was appointed Chairman of the Board.
- PricewaterhouseCoopers AB was re-elected as the Company's auditors.
Management report
The Russian economy continued to contract in the first quarter of 2009 where preliminary estimates from the Economics Ministry point to a 9.5 percent decline. The background to the development is the same as described in our previous report: a lack of global liquidity as well as domestic (as a result of the rouble valuation pre-devaluation) stopped private sector investment. The fall in economic activity has started to ease due to credit stabilising (both from external and internal sources), the inventory cycle coming to an end and government spending. Inflation, now at annualized rate of 11 percent, has started to slow which in turn has enabled the Central Bank to cut basic interest rates which is positive as it will contribute to the revival of lending and economic activity. Having said that the return of activity is not yet strong enough to offset a contraction for the full year which is now expected at around 6 percent.
The “green shoots” of activity in the US and China has also given some respite to the oil price. A return of activity and the consequent demand for oil is what will drive the price from depressed levels in the short term. Deeper-than-expected OPEC cuts have also limited supply and reduced the near term risks of very low oil prices for a sustained period. Longer term we believe that the return to USD 100 per barrel range is driven by problems on the supply side with a combination of geologic maturity and geopolitical challenges.
The oil price helps the valuation of the rouble and thus also rouble credit markets. The underdeveloped state of the Russian banking system makes the flow back of credit frustratingly slow. Although it has developed immensely over the past ten years it is not equipped to smoothly handle the large change in external flows resulting from the global financial crisis. The external lending to Russian corporates directly and indirectly through the domestic banking system abruptly changed over the course of last year and we are still feeling the effects of this flow drying up.
Corporate Russia’s debt situation was never on the scale seen in other parts of Eastern Europe but 2009 is a year when a large part of the outstanding debt is due. So far about a third of it has been rolled over with the rest paid back. Some restructurings are taking place although no major bankruptcy has (yet) been experienced. Without boasting a full data set it seems like bondholders have suffered more than shareholders, an emerging market phenomenon and a result of weak bankruptcy laws and procedures as well as the importance of the incumbent management (often the same as the majority shareholder). The willingness of foreign banks to roll over their lending will however improve as the oil price trends higher.
Russian asset pricing has also come back to life. Up 75 percent from the lows, asset prices have gone through a normalisation process from the overshoot to the downside that we witnessed during the autumn. Again, a return to the levels seen 12 months ago will require that the “green shoots” in the world economy turns into signs of spring if not full bloom. In the meantime it seems like equity flows seem to be supporting the Russian equity market as international investors reappraise Russia on the back of reduced risk aversion.
The reassessment of asset prices and the resulting valuations often follow a typical cycle. As such initial improvements were seen in the credit space and blue chip equities have followed suit. We now are starting to see interest and volumes also show up within the small-to-medium cap sphere as sentiment improves and buyers with longer time horizons and unconstrained by illiquidity come in. Within the private equity space readjustments often lag the general market as buyers’ and sellers’ perception of value lies further apart and the adjustment process to find a common level takes longer. Thus, valuations of private investments have yet to see similar improvements to that of the general market.
Consequently remeasurements of fair value have led to adjustments in the carrying value of a couple of our unlisted holdings at the end of the quarter. While Russian asset prices and valuations have broadly improved recently, the macroeconomic environment in general – and for both Tinkoff Credit Systems and Kontakt East Holding in particular – remains challenging. Given the uncertainty that resides over the economic outlook we believe a conservative approach is called for, why more cautious assumptions regarding future developments has resulted in reductions of the carried value of the investments.
While the current near term outlook remains uncertain there is cause for careful optimism. Given our investment criteria and time horizon there is also reason to be opportunistic. We intend to be meticulous regarding new investments and have used the first months of this year to carefully add to positions where we want to increase the percentage shareholding. Valuations – whether it is over earnings or book – continue to put Russia at the very bottom compared to other markets. Thus we continue to be on the lookout for opportunities and evaluate them as they present themselves with a clear focus in mind.
Vostok Nafta’s portfolio development
Vostok Nafta's net asset value per share in USD decreased by 44.44% over the period January 1, 2009–March 31, 2009. Excluding the effects from the new share issue the development would have been 15.58%. During the same period the RTS index increased by 9.14% in USD terms.
(For picture see attached file.)
Black Earth Farming
Black Earth Farming (BEF) continues to grow and strengthen its operational platform. During the start of 2009 the company has continued to sell crops out of its inventory, which at the end of 2008 amounted to around 335 thousand tons of crops under storage. Timing of sales can be handled in a more optimized way, due to BEF’s investments in storage facilities. Meanwhile, spring planting for the company’s fourth harvest has commenced. BEF does not intend to spend capital on ploughing fallow land in 2009, which should have positive effects on the near term results.
The Russian Agricultural ministry stated in April that they forecast the 2009 grain harvest to be approximately 85 to 90 million tons, a 20 percent decline from 2008. The final global wheat area for the 2009 harvest is still uncertain and will depend on major crops still to be planted in Canada, Argentina and Australia. Yet global areas for grain cultivation will likely decline in 2009, as data of winter planting in the US and UK showed declines. In addition, global productivity will likely be lower as farmers scale back their use of fertilizers and plant protection due to weaker grain prices. Droughts have affected several countries, including Argentina and Ukraine, with lost crops and diminished yields as a consequence. In China, 43 percent of the country’s crops of winter wheat have been negatively affected by drought. The demand picture remains vague as the effects on demand for agricultural products from the global economic downturn are still unclear. In general, demand for food staples is less elastic than most other goods. Grain prices remain soft – wheat prices were down 46 percent year-on-year in mid April 2009 – but the catalysts for price appreciation, both in the short and long term, are still present.
In February, the company’s shares were upgraded to trade on First North Premier, which is a new segment within First North, reserved for companies that make a conscious decision to comply with higher disclosure and accounting standards than the regular First North rules. Companies on Premier are committed to following the main market disclosure rules. Right from the start there has been a high aim for the Company in terms of transparency, market communication and governance, which this upgrade confirms.
RusForest
In the beginning of May 2009, Varyag Resources announced that it will acquire Vostok Nafta’s 50 percent stake in RusForest in exchange for newly issued shares in Varyag. Following the completion of the transaction, RusForest will be fully owned by Varyag and Vostok Nafta will own 44.4 percent of the share capital and votes in Varyag. The acquisition is a part of restructuring Varyag in order to change its business strategy and structure from a private equity company to a fully fledged forestry company. As a result, Varyag intends to change its name to RusForest and Aleksandr Williams, currently the Managing Director of the management company Taiga Capital Ltd, will be appointed as CEO. The company also intends to initiate the process of applying for listing at Nasdaq OMX Stockholm.
RusForest has reached a considerable scale, controlling around 1 million hectares of forest land and an Annual Allowable Cut (AAC) of 1.6 million cubic metres. Additionally, major progress has been made regarding the company’s consolidated sawn wood capacity, which is set to increase to around 400 thousand cubic metres, over time. The company is now at a stage where focus can shift from acquisitions and land bank growth towards finalising projects and improving operational efficiency. In order to utilize the competitive advantages of having access to an abundance of cheap raw material and low energy costs, RusForest seeks to increase productivity and efficiency throughout its value chain. An organizational structure to support this aim will likely be beneficial for the company.
During 2008, RusForest utilized 49 percent of its consolidated AAC, and the intention is to steadily increase this figure to around 80 percent, or 1 million cubic metres, by 2010. Sawn wood production is also planned to increase to approximately 400 thousand cubic metres on an annual basis, following the completion and commissioning of the Boguchansky and Magistralny sawmills. The planned increase in harvesting volumes will allow for a larger internal supply of raw material, which reduces costs and risks related to supply. Achieving these production capacity increases is important in order for RusForest to match its sawn wood production, as Russia intends to implement export duties on roundwood (raw logs), which is likely to be enforced in the medium term.
Tinkoff Credit Systems
Tinkoff Credit Systems (TCS) continues its defensive stance as the market environment remains challenging. Credit card issuance has been kept at a minimum since the fall of 2008, in order to conserve cash while maintaining operations. Costs related to acquiring new customers have therefore been reduced significantly, as employees have been transferred to collection. As a result, the ratio of costs to income has declined, from 82 percent last August to 52 percent. The extreme market situation has eased competition within the segment, which has led to a further improvement in TCS’s gross yields to around 80 percent.
Focus continues to be on cash collections in order to minimise losses from loan defaults. During the quarter credit losses measured as first payment defaults increased. The share of loans where the first scheduled payment was not made, reached 7.1 percent in February 2009, up from 5.5 percent in December 2008. Collection rates of loans overdue have also declined and therefore charge-off rates will likely be significantly higher than the 12 percent expected at the end of 2008. As a result of higher loan loss provisions than expected the company issued a profit warning for the first quarter of 2009. At the operating level, TCS performed slightly above plan. Operating Income was higher than forecast due to increased yield, ongoing cost-reduction and bond repurchases. Yet due to higher provisions TCS expects to show a result of minus RUB 39 million based on provisional results. Full IFRS accounts are expected by the end of May 2009.
(For picture see attached file.)
The Russian Rouble bottomed versus the Euro/US Dollar basket in February 2009 as capital outflows eased and the price of oil found its footing. In 2008 the currency fluctuation caused an accounting loss of USD 10.5 million as well as a breached bond covenant that was fixed in USD. During April 2009, the bondholders voted in favour of the company’s proposal to restructure the bond, whereby bondholders’ cash flows are accelerated at expense of the shareholders who will defer and subordinate their coupon. As a result, TCS’s cash flows remain unaffected of the bond restructuring. The company has no debt to refinance until 2011, as cash flows from operations are sufficient to service debt given the high gross yield.
TNK-BP Holding
TNK-BP’s production figures for the four first months of 2009 showed encouraging signs, given the current situation in the sector. The company produced 1.38 million barrels of oil per day in April, which was an increase of 1.3 percent year-on-year. By comparison, the total Russian production of 9.8 million barrels per day was roughly flat from 2008. Output at TNK-BP was boosted by the Uvat greenfield project in western Siberia which came on stream in February. Refining throughput at TNK-BP for the first months of 2009 also increased by 3 percent year-on-year compared to a decline by 1 percent for the Russian industry in total. Domestic demand for oil products declined 13 percent, hitting a four-year low while exports increased 15 percent to a four year high. The collapse in domestic demand, exemplified by a 40 percent drop in Russian car sales, and the weaker ruble sent domestic prices tumbling. Thus, the advantage on an EBITDA per barrel basis, of oil from lower taxed downstream operations over crude exports seen during the last years, diminished during the start of 2009. Total Russian crude exports rose 4.1 percent, meaning that every marginal barrel of oil in Russia no longer went to downstream operations as before, but to crude exports.
Despite the challenging conditions, TNK-BP remains a highly cash-generative company, where a significant part of the cash flows are dispersed to shareholders. Viktor Vekselberg, TNK-BP board member and chairman of the Renova group, recently commented on TNK-BP’s dividend policy: “We have an established dividend policy, which implies payment of 40 percent of the net profit. We have no reasons to change it.” He assured that the shareholders of TNK-BP, “including minority shareholders, will get all dividends.”
Kontakt East Holding
The Russian advertising sector declined sharply during the first quarter of 2009, with early estimates indicating a negative yearly growth rate of some 30 percent. The development during the rest of 2009 is remains highly uncertain. Kontakt East’s Yellow Pages business felt the impact of the down-turn later than the advertising market in general, but during the first quarter of 2009, the decline hit the company very hard.
Yellow Pages experienced a decline in sales of a full 49 percent compared to the first quarter in 2008. Cash collections were strong during January and February, but started to decline in March. Lately, the decline appears to have levelled out, but it is too early to tell if the market has stabilized. To counter the drop in revenues, further cost cutting has been implemented. By the end of the second quarter 2009, Yellow Pages will have cut back-office staff to approximately 100 employees, down from around 250 at the end of 2008. The redundancies have also enabled cuts in other indirect costs. As can be expected, the redundancies have resulted in a high work-load for management and the rest of the organization, and the lay-offs are naturally disappointing to the employees during these challenging times. Incorporating these cost savings, Yellow Pages should attain profitability on a going concern-basis at yearly sales of RUB 250 million, or 52 percent below 2008 sales.
Some of the drop in sales could also be attributable to the ongoing restructuring of the sales organization, whereby a smaller, and more “westernized” organization and business processes are established. Management, however, firmly believes that these are necessary steps to build for the future. The implemented sales and cost savings have resulted in a much more lean and efficient Yellow Pages, which should be well positioned for profitable growth. A key priority during the second quarter is to capitalize on the strong trend for the Yellow Pages online products.
Avito – Kontakt East’s Consumer eCommerce business offering classified ads – launched a new marketing campaign during the first quarter. The campaign has been successful, as key performance indicators for the site look good and traffic growth has been strong.
The financial results for the Kontakt East Group were far below projections, due to the significant drop in Yellow Pages’ revenues. This was only partly offset by lower costs within Yellow Pages, Consumer eCommerce and Group headquarters. During the first quarter of 2009, Vosvik AB, owned by Vostok Nafta and Kinnevik, purchased all shares from the minority shareholders in Kontakt East and subsequently owns 100 percent of Kontakt East. To finance investments in Consumer eCommerce and restructuring within Yellow Pages, Vostok Nafta and Kinnevik each provided SEK 7.5 million of financing to Kontakt East in the form of a convertible bond during the first quarter of 2009.
Transneft
The regulated Federal Tariff Service (FTS) head Sergey Novikov stated in April that the average tariff which Transneft charges oil companies may "quite likely" be raised from June 1. Transneft had requested a 4 percent mid-year tariff hike. Such an increase in June would raise the company's estimated 2009 EBITDA to USD 6 billion, almost precisely the 2008 level despite the rouble depreciation (Transneft charges in roubles). The EBITDA margin would thus reach an impressive 62 percent.
An important driver of Transneft's value remains its capital expenditure program, as upon completion of the ongoing projects, the company can shift its cash flows to shareholders. The first phase of the East Siberian-Pacific Ocean (ESPO) pipeline is nearing completion which is positive as it will turn the project into a revenue-generator. Despite reports that the estimated cost for the project will now amount to RUB 491 billion, up from the RUB 450 billion estimate given by CEO Nikolai Tokarev in January, the FTS demonstrates its willingness to compensate Transneft for its capital expenditures and higher debt-servicing costs with higher tariffs.
Priargunsky
Priargunsky (PGHO), Russia’s dominant uranium mining company, released a healthy set of numbers for 2008 and the first quarter of 2009. For the full year 2008, the company increased revenues 27 percent year-on-year to RUB 8.1 billion. Operating profit was up 40 percent to RUB 510 million and net income rose 50 precent from the year before to RUB 264 million. Thus the net margin remained stable at about 2 percent with an operating margin of 6 percent. The results for the first quarter of 2009 also look robust, with revenues up 19 percent to RUB 2.0 billion, and operating profit climbing from RUB 120 million in 2008 to RUB 348 million 2009. PGHO’s total debt was RUB 2.4 billion as at the end of March 2009. The uranium price which the company realizes on its production is regulated at around USD 25 per lb of U3O8, which is equal to their cash costs, so the profit comes from market sales of coal and electricity. In comparison PGHO’s western competitors have announced long term price contracts during the quarter at around USD 50 per lb.
The company produces about 3 thousand tons of uranium concentrate per year. Last year, it became part of Atomredmedzoloto (ARMZ), the Russian uranium mining holding, which was created by state-owned corporation, Atomenergoprom. Following the government’s ambitions to create a fully integrated nuclear company, Atomenergoprom modelled on French Areva, has been created to consolidate the civil nuclear sector in Russia. PGHO is the key Russian mining asset within the group and will likely be able to realize higher prices on its output to fund investment needed to increase its production to 5 thousand tons in the medium term.
Construction Materials
April statistics from Russian Railways, which account for 85 percent of total cargo transportation, showed that the construction materials segment continues to be weak. Transportation volumes of building materials were down 39 percent year-on-year, compared to a 15 percent downturn in general volumes. The downturn in construction material volumes has abated somewhat from the 50 to 60 percent decline rates seen during the start of 2009. Industrial production figures for February 2009 also show significant output drops; cement production was down 34 percent from 2008 and continued to decline substantially in March. The near term demand for building materials such as cement continues to be hampered by scarcity of credit, which impedes construction. As a result, capacity utilization rates are around 35 to 40 percent, with cement prices expected to average USD 50 to 60 per ton in 2009. State budget revisions, on the back of lower economic growth forecasts, should however, be coming to an end as the oil price finds a bottom. In order to uphold its political capital the government has increased social spending to counter the negative economic effects to the consumer, at the expense of fixed investment such as infrastructure.
(For picture see attached file.)
The long term picture for cement remains compelling, however, as there is a pent-up demand from the main end markets; housing and commercial construction as well as infrastructure development. The Russian Government is reportedly ready to maintain the volume of completed residential construction in 2009 at the same level as last year, when it stood at 63 million square metres. In addition Russia’s infrastructure has suffered from years of under-investment in comparison to other parts of the world, as illustrated by the figure above. The state of the transportation network is infamous, and a number of initiatives are in the pipeline to counter the situation – even though the timing remains unclear. These include the development of mineral resources in Siberia, the Sakhalin projects, modernisation of eastern Russia, and several major international events including the 2014 Winter Olympics in Sochi.
At the same time cement supply is also relatively constrained. The industry is characterized by high barriers for entry, with the main being capital. The cost of building and commissioning a cement plant varies with its specifications. Based on previously announced projects regarding capital expenditure and capacity, an average cost of new capacity can be estimated to around USD 200 per ton, which is high. The region also has a limited supply of limestone which is a key input in the production. Given that cement is quite heavy in relation to its value, it is economically unviable to transport it over larger distances. Port capacity is also highly limited which curtails imports. These characteristics result in a segmented industry, where producers are focused on local markets and therefore have regional oligopolies with limited competition, which, in turn, reduces the risks of “price wars”. Given the current market environment, a majority of previously announced capacity additions have been postponed. Thus, when demand recovers – which it eventually will – the industry runs the risk of returning to the conditions of a year ago, where capacity deficits were covered by imports, motivated by exceptionally high prices.
(For picture see attached file.)
Steppe Cement (Kazakhstan)
Steppe Cement completed a new share issue, during which the company offered to shareholders at a record date on April 14, 2009 to buy a pro-rata share of 40,000,000 newly issued ordinary shares of USD0.01 each at 25 British Pence per share (at circa 25% discount to the market). The new shares represented approximately 35% of the pre-issue and approximately 26% of the post-issue capital. The net proceeds of the issue will be used principally to repay a portion of the Company's bank loans and for working capital purposes after the Company's financial position has been affected by a marked slowdown in Kazakhstan as a consequence of the global economic downturn.
According to the company’s management, whether Steppe Cement will soon need to return to the shareholders for a new portion of capital will depend on the dynamics of cement prices in Kazakhstan and, as a result, the company’s ability to generate operating cash flows. As expected, the company should have enough resources to operate normally in the next 15 to 18 months in case cement prices stay at the level of USD 47/tn (net of VAT and transportation costs) observed during the [slow] months of 1Q2009. Operating cash flows should also provide funds for debt servicing, with current guidance that they would allow:
- to cover both interest and principal amounts of maturing debt in case cement prices rise above USD 55–58/tn
- to cover only interest in case cement prices stay around USD 51/tn
- to provide no contribution to debt servicing in case cement prices go below USD 45/tn
The management also indicated that the reviving construction market in Kazakhstan is already pushing market prices for cement to the levels of USD50/tn, with expectations of a further increase to USD 55/tn during the summer of 2009.
Alrosa
Alrosa announced that it will reduce its planned 2009 production by 22 percent as the global financial crisis dents demand for gems. The company, which had previously expected to keep production levels unchanged this year from the USD 2.4 billion produced in 2008, has now decided to reduce this amount to USD 1.9 billion worth of diamonds, measured in 2008 prices. The 2009 target for rough diamond sales was set at USD 1.6 billion, which is a 37 percent decline from 2008. CEO Vybornov predicted that Alrosa's net profits will fall by more than 40 percent, from USD 113.1 million to USD 65.6 million in 2009.
The global diamond market is being reshaped due to the current crisis, as former market leader De Beers of South Africa has been severely affected. Market prices for rough diamonds have dropped 75 percent from its peak as De Beers, which is prohibited under an EU antitrust agreement from stockpiling, has scrambled to cut production and close mines. Output reportedly tumbled by 90 percent year-on-year during the first quarter of 2009. As a result, Alrosa has become a price setter of global diamond prices. Its decisions on production and sales will determine the value of diamonds on rings and in jewellery stores for years to come.
Since the autumn of 2008 Alrosa has withdrawn from the market place and sold its output to the state depository fund, Gokhran, reportedly still at 2008 prices. The state fund provides pricing support to the market, but also volume support to Alrosa in order to avoid lay-offs at the company’s mines. The total purchases by Gokhran for both gold and diamonds is merely USD 1.34 billion, at current prices. Therefore, Alrosa has been seeking to jump-start demand by selling gems under long-term contracts to wholesale buyers in Belgium, Israel, India and elsewhere. Under these contracts, six of which have been signed, prices are set at a midpoint between the peak last August and this winter, and fixed for a period of several years.
Coal
The early expectations that global coal prices would resume its growth as demand starts recovering by early 2009 did not materialize, and the annual negotiations between suppliers and consumers of both coking and thermal coal proved to be a stumbling block for these hopes. As the new marketing year in the coal sector started in April, the biggest part of the global trade is still happening on a prepayment and/or spot basis. As a result, global volumes in April were weak. South African exports were unexpected 24 per cent down YoY, the biggest drop since July 2008, with prices 44% lower YoY at average USD58.50/tn. The end of a strike at a Colombian rail company combined with the end of weather disruptions in Australia could help push thermal coal prices further,down to USD55.00/tn.
With the global economy mired in a deep recession and persisting uncertainties about the future economic health, the coal market participants are slow in signing annual supply contracts for the 2009-2010 marketing year. In the coking coal market, Nippon Steel and BMA have agreed to a price of USD128/tn for the year beginning April 1:st, almost 60% down from the previous year’s contract price of $300/tn. This drop marked a dramatic end to six consecutive years of price increases, yielding 500% in total. In the thermal coal market, Xstrata, the Swiss mining group, and Chubu, the Japanese power company, have agreed to a price of USD70/tn for the year starting in April, down 44% from previous year’s USD125/tn. However, other Japanese and Korean utilities are yet to settle and are pushing for prices of about USD60/tn.
Russian thermal coal exporters have enjoyed healthy margins over the last four years. Yet, 2009 is likely to be a testing year, and the period between 2010 and 2012 may be a difficult time for some Russian thermal coal exporters who once again could find themselves as the marginal producers. Whilst industrial electricity demand remains depressed in Europe, coal has become competitive against USD8.00/mmBTU natural gas, causing some renewed buying interest from European utilities in 1Q2009. The question currently is whether coal could retain its market share in Europe vis-à-vis weakening gas prices?
Another question is whether the cost structure of the Russian exporters would allow them to withstand the pressure of new lower cost Colombian, Indonesian and Australian supply entering the European market? So far, the emerging EU demand growth (Poland, Germany, Turkey) gives some hope to Russian suppliers, particularly as South African coal increasingly targets the growing Indian market, and Colombian coal is focusing on South American and US demand. The Pacific market, where Russia is continuing to build infrastructure to capture Asian demand growth, is proving to be very competitive, with established Indonesian and Australian supply priced adequately to maintain market share.
In the domestic market, price pressures from
- 6% lower YoY electricity demand recorded in the recent months,
- potential delay in the deregulation of natural gas prices, and
- overhang from some grades of coking coal
do not provide much support either, meaning that the thermal coal producers would need to focus more on cost controls than on output growth in 2009–2010.
SystemSeparation
During the quarter, a change in strategy at SystemSeparation was initiated with an overall goal to establish a group with a clear focus on energy and environmental technology through investments in new business areas. At the end of March 2009 SystemSeparation took the first step under the new strategy by acquiring the wood pellets producer Eastern Bio Holding (EBH). To finance the completion of EBH's manufacturing plant in Ystad and otherwise strengthen the financial position, the Board decided in April to conduct a rights issue. After the acquisition, operations are conducted within two business areas: Power Chemicals, which manufactures fuel additives for power plants; and Biomass Fuels, consisting of the acquired EBH. The intention is to acquire additional activities in environmental technologies that either complement existing businesses or form new separate business areas. Potential acquisitions will be focused on Russia and Eastern Europe, as environmental issues in these regions are at an early stage and, therefore, competition is moderate.
Ukraine
The Ukrainian economy started to show early signs of the results brought by the efforts of the Cabinet and the National Bank of Ukraine (NBU) to contain the economic fall-out during the first quarter. First, the hryvnia exchange rate has stabilized following the last attack on it in mid-February. Now, April figures of inflation show that NBU’s prudent monetary policy, current stability of the hryvnia and a slowdown in withdrawals from retail deposits resulted in reduced internal price pressures. According to Ukraine’s State Statistics Committee, CPI decreased to 0.9% MoM in April vs 1.4% in March, resulting in 4M2009 growth of 6.9%, vs 13.1% a year ago, with YoY inflation declining to 15.6% in April from 18.1% in March. The main trigger for the drop in inflation was a notable slowdown in non-food CPI and services CPI, while, at the same time, food inflation remains comparably high. MoM PPI growth in April dropped to 0.4%, less than 1.1% MoM in March, with slowdown in the growth seen in almost all sectors; except sugar production (+8% MoM) and refining (+6.3%MoM).
The signs of the Ukrainian authorities’ so far keeping the dramatic economic situation in the country relatively under control helped Ukraine to continue secure support from the IMF. Following the delay in the disbursement of the second tranche of the two-year stand-by agreement (SBA), which was announced in February after the IMF got increasingly disappointed by the Ukrainian anti-crisis measures (including the inevitably spiraling budget deficit), the combined efforts by the Rada, the Cabinet and the NBU to approve emergency laws and regulations returned the IMF back to the country. As a result, in early May the IMF Executive Board approved the immediate disbursement of the second USD 2.8bn (SDR 1.8bn) tranche of the SBA (bringing the total amount drawn down to USD 7.3bn) to be used to service Ukraine’s outstanding external state debt in order to free up budgetary funds to meet pension fund and other domestic obligations. After reviewing Ukraine’s economic performance, the IMF granted waivers of non-observance of performance criteria pertaining to central government cash reserves, the state budget (the revised economic program is now targeting a budget deficit of 4% of GDP in 2009 versus a balanced budget planned before), exchange rate restrictions, multiple currency practices, and import restrictions.
The major political forces even managed to downplay the recurring stand-off between the three branches of power – the president, the Cabinet and the parliament – while they were focusing on the need to adhere to the IMF demands. In a major move widening the rift, the parliament overwhelmingly voted (401 deputies out of 450) to schedule presidential elections for October 25, 2009, thus ignoring the president’s proposal for the elections to be held on January 17, 2010, in accordance with the amendments to the Constitution effected in 2006. Although Rada’s move heightened its confrontation with president Yushchenko and raised expectations that the latter may seek an excuse to disband the legislature until his power to do this ceases half a year prior to the presidential elections, the incumbent’s only action, in view of the need to maintain talk with the IMF, was to appeal the parliamentary resolution with the Constitutional Court, which finally announced a ruling that overturned the parliament’s resolution on presidential elections. The legislature now has to approve a new date for the vote, as required by the Constitution, for the election campaign to begin in due course.
Finally, although it was already long anticipated by the foreign investor community and local market participants, a major piece of the market-oriented legislation, the Law on Joint Stock Companies became effective April 29, 2009, six months after it was approved and published. The new company law, which fully complies with the principles of corporate governance adopted by relevant EU directives and recommended by the OECD, replaces the completely outdated Law on Business Associations acting since 1991 and introduces a comprehensive regulatory framework with respect to establishing, managing, merging, splitting and liquidating joint stock companies as well as puts in place regulations to protect minority shareholder interests. Although the existing JSCs (including all currently listed domestic companies) still have two years until April 29, 2011 to bring their charters and bylaws in compliance with the new legislation, investors see as a substantial progress the new law’s provisions dealing with corporate transparency and protection of minority shareholders’ rights, including (but not limited to):
- cumulative voting as the only method of electing Supervisory Board members for public JSCs
- mandatory share buyback in case a shareholder voted against change in share capital, merger or split, change in company status, or any material transaction (involving over 25% of company assets)
- buyout offer to other shareholders at market price is required from the buyer of a 50%+ stake in a company
- number of provisions aimed at preventing illegal raider attacks on companies (e.g. mandatory vote by ballot at shareholders’ meetings of public JSCs; requirement that shareholders’ meetings take place within the territorial unit where the JSC is located, etc.).
Investments
During the period net investments in financial assets were USD –2.56 (3.29) mln.
Portfolio structure
The investment portfolio stated at market value as at March 31, 2009 is shown on next page. Vostok Nafta’s three biggest investments are Black Earth Farming (25.38%), RusForest (18.37%) and Tinkoff Credit Systems (TCS; 12.72%).
(For full report see attached file.)
