Weekly Digest UKRAINE FIXED INCOME RESEARCH. February 21 27, 2018

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1 UKRAINE FIXED INCOME RESEARCH February 21 27, 2018 Weekly Digest Output of key economic sectors in January increased by 3.8% YoY Ukraine s total capital investment grew by 22% in 2017 to $15.5bln Fitch has assigned an expected B- rating to Ukreximbank s upcoming hryvnia LPNs DTEK s 4Q17 EBITDA increased by 1% YoY to $273mln Output of key economic sectors in January increased by 3.8% YoY, as measured by our COI indicator. Industrial production was up by 3.6% YoY (2.9% in seasonally adjusted terms) vs last month s flat dynamic. Agriculture increased by 1.1% YoY following a 1.5% decline in December. Passenger and cargo transportation shrunk by an estimated 4.2%. Domestic trade continued booming, demonstrating a growth rate of 11.2%, with wholesale leading at 13.0%. Construction output stabilized, losing 0.5% YoY for the first time in 2 years. Our view: Excluding the fact that construction seems to have slowed down (was a major output driver last year), the data brought mostly positive surprises. Both agriculture and food processing did not post any declines despite this season s harvest of grains and oilseed standing 8-11% below that of last year. Trade volumes continued to demonstrate double digit growth for a second month in a row. Industrial output was propelled forward despite the expected low base effect still being a month away (extraction of coal decreased starting last February and electricity generation dropped as of last March due to Ukrainian assets being seized by Russia-backed separatist forces). Largest contributors to higher manufacturing volumes were metals (steel and pig iron), chemicals (mostly fertilizers), and machinery which were up 8%, 56%, and 22%, YoY respectively. Though given the possibility of one-off effects, we currently refrain from upgrading our 1Q18 real GDP growth forecast from the present 2.5% estimate, we note that the probability of doing so is significant if February s data demonstrates similar trends. Real GDP growth vs the COI indicator growth 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% Note: The Composite Output Index represents the weighted average performance of industrial production, retail sales, wholesale sales, transportation, and agricultural output Source: SSSU, Adamant Capital estimates 2.5% 1Q17 2Q17 3Q17 4Q17E 1Q18E Composite Output Index Real GDP Ukraine s total capital investment grew by 22% in 2017 to $15.5bln. As a share of nominal GDP the figure was up by 40bps to 14.1%. Sectors with the largest amount of spending were agriculture, construction, transportation, domestic trade, state services (including the military) and power generation. Financing mostly came from corporate equity (70% of the total) and the state budget (13%). Loans funded just 5% of the projects. Our view: Thought the country s overall capex level as a share of GDP is on the rise, it seems nowhere near high enough to support a rapid economic recovery and is thus in line with our (and consensus) expectations of relatively slow growth in With respect to financing, the breakdown confirms the decline in lending (by 79% from 2013) to be the largest bottleneck for domestic capital, as corporate equity has essentially shrunk in line with the total value added. Foreign funding has never been a significant part of the picture and thus offers substantial potential if tapped via implementation of reforms. Capital investment by sector points towards likely real GDP growth drivers for the near term: agriculture, domestic trade (already booming), transportation, and, possibly, construction (though January output results demonstrate a slowdown). Capital investment and its funding sources, $bln 30 17% 16% 20 15% 14% 10 13% 0 12% State Corporate equity Loans Foregin capital Other Total as % of GDP Source: SSSU Konstantin Fastovets fks@adamant-capital.com

2 Fitch has assigned an expected B- rating to Ukreximbank s upcoming hryvnia LPNs. According to the press release obligations under the loan will rank equally with the bank s other senior unsecured and unsubordinated debt. The notes will be issued by Biz Finance Plc, a UK-based special-purpose vehicle. Coupon payments and principal amortization will bet settled in US dollars at the prevailing UAH/$ exchange rate. As per the local media, preliminary maturity has been set at 3 years and the yield at %. Our view: The bank looks to be making use of the recent boom of foreign investor interest in hryvnia denominated bonds (non-resident holdings have increased by c. $250mln since the beginning of February), which has likely been driven by the stability of the exchange rate in combination with a sharp tightening of monetary policy by the NBU. The preliminary interest rate guideline looks to us to be fair, considering that Ukreximbank is essentially a part of the state balance sheet, and that recent sovereign placements with a similar maturity were priced at below 16% (essentially implying an inverted yield curve). DTEK s 4Q17 EBITDA increased by 1% YoY to $273mln, according to condensed unaudited results. Revenues were down by 4% YoY and up 25% QoQ to $1.5bln. Net income came in at -$72mln. Since annual EBITDA totaled $870mln vs $600mln last year, the leverage ratio fell by some 30% YoY to 2.5x. Our view: Quarterly EBITDA came in 14% above our estimates, possibly due to a lower than expected spread between DTEK s average TPP tariff and that of the market (we assumed a 3% difference). Given that the annual EBITDA figure deviated from our guidance by just 4% we retain our previous outlook on the company s future earnings unaltered (2018 EBITDA at $1.0bln, which reflects benefits from the introduction of RAB tariffs, before the distribution segment is spun off at the end of the year). All in all, given the company s current yield spread to the sovereign curve of c. 300bps we reiterate a Buy recommendation on its eurobonds. As noted previously, although potential restructuring risks are increasing (the company can amortize the notes at par at any time without penalty), DTEK s ability to attract new creditors will be limited while it is still in default on some of its obligations with Russian banks. DTEK 4Q17 financial results, $mln 4Q17 4Q16 YoY 3Q17 QoQ Revenues 1,536 1,606-4% 1,231 25% EBITDA % % EBITDA margin 18% 17% 1pps 16% 2pps Net income nm 1 nm Net income margin -5% 10% nm 0% -5pps Operating cash flow % % CAPEX % 62 58% Free cash flow % % Elec. price 2, UAH/MWh 1,622 1,721-6% 1,469 10% Elec. price, $/MWh % % Elec. generation, TWh % 9.6 5% Coal mining (ROM), kt % 6.2 8% EBITDA/MWh output, $ % % Net debt 2,090 2,051 2% 2,100 0% Net debt/ltm EBITDA % % (1) Excludes impairments (2) The average for all Ukrainian TPPs disclosed by the state regulator Energoryok Source: Company data, Energorynok, Adamant Capital estimates 2

3 Appendix Banking system 3m liquidity (lhs, UAHbln) vs NBU CD rates (%) Nov 13-Dec 28-Dec 12-Jan 27-Jan 11-Feb 26-Feb NBU CDs Accounts at NBU Reserve requirements NBU o/n CD rate, % Interbank o/n rate, % NBU o/n refinancing rate, % Source: NBU, Adamant Capital estimates Banking system inflows from the state treasury and the DGF Nov 10-Dec 23-Dec 5-Jan 18-Jan 31-Jan 13-Feb 26-Feb Note: in UAHbln Source: NBU Local market liquidity (as measured by the aggregate amount of NBU correspondent accounts and investment CDs) has increased by UAH 5.14bln to UAH bln over the last week. On February 27 the Ministry of Finance conducted local hryvnia denominated placements maturing in May, August and November of 2018 with yields of 16.00%, 16.45% and 16.50%, respectively, and maturing in October 2022 with yield of 15.79%. A total of UAH 0.99bln was raised as a result. The UAH/USD interbank rate appreciated by 0.5% over the week, starting out with and closing at FX interbank trade volume (lhs) and FX rate (rhs), past 12 months Feb-17 Apr-17 Jun-17 Aug-17 Oct-17 Dec-17 Feb-18 Trade volumes, $mln Note: Exchange rate figures are from official interbank data Source: NBU UAH/USD exchange rate Local market yield curve: yield (lhs, %) and maturity (rhs, days) NBU CDs Minfin UAH bonds Source: NBU, Bloomberg, Adamant Capital estimates 3

4 Ukraine vs selected countries: 10y USD yield spread, bps Ukraine eurobonds: yield (lhs, %) vs duration (years) Metinvest DTEK FIUB 2018 Oschadbank Ukraine Railway 2021 Ukreximbank 2022 Oschadbank 2025 Ukreximbank 2025 Kernel 2022 MHP Feb-17 Apr-17 Jun-17 Jul-17 Sep-17 Nov-17 Dec-17 Feb-18 US Russia Turkey Malaysia China 4.9 MHP Corporate Eurobonds Government Eurobonds State and NBU next 12m FX debt repayment schedule, $bln Feb-18 Apr-18 Jun-18 Aug-18 Oct-18 Dec-18 Feb IMF Local FX bonds Quasi-Sovereign bonds Foreign FX Bonds Note: Interest included in each category (1) Debt of state owned enterprises (2) Includes USAID guarantees State and NBU FX debt repayment schedule , $bln IMF Local FX bonds Quasі-soveregin bonds 2 Other state debt Foregin FX bonds Note: Interest included in each category (1) Debt of state owned enterprises (2) Includes USAID guarantees 1 Global commodity price indices, past 12 months Ukraine 24m trailing trade (lhs) and CA balance (rhs) Feb-17 Apr-17 Jun-17 Aug-17 Oct-17 Dec-17 Feb-18 Steel Iron Ore Wheat WTI Brent Corn Dec-15 Apr-16 Aug-16 Dec-16 Apr-17 Aug-17 Dec-17 Current account, $bln Exports, $bln Imports, $bln Source: NBU 4

5 Key macroeconomic indicators 4Q Q17 2Q17 3Q17 4Q17E 2017E 2018E Real GDP growth, YoY 4.8% 2.2% 2.5% 2.3% 2.1% 1.8% 2.2% 3.1% Nominal GDP, UAHbln Nominal GDP, $bln GDP deflator growth YoY, % 17.2% 17.2% 25.1% 20.0% 20.2% 19.1% 20.5% 12.0% Period average CPI YoY, % 12.3% 14.9% 14.0% 13.8% 16.1% 14.0% 14.5% 12.2% End of period CPI YoY,% 12.4% 12.4% 15.1% 15.6% 16.4% 13.7% 13.7% 10.1% Consolidated budget deficit, % of GDP 1 3.2% 2.3% -0.7% -7.3% 1.3% 9.6% 1.4% 3.0% Broad public sector deficit, % of GDP % 8.6% 3.8% -7.3% 4.0% 12.1% 3.8% 3.0% Public debt as % of LTM GDP, UAH 80.8% 80.8% 77.7% 74.3% 73.4% 73.0% 73.0% 66.4% Public external debt as % of LTM GDP, $ % 49.0% 47.1% 47.7% 46.9% 44.4% 44.4% 40.7% Total external debt, $bln Export of goods and services, $bln Import of goods and services, $bln Trade balance, $bln Current account, $bln Financial account, $bln End of period NBU reserves, $bln Average interbank exchange rate, UAH/$ EOP interbank exchange rate, UAH/$ EOP key policy rate NBU, % 14.0% 14.0% 14.0% 12.5% 12.5% 14.5% 14.5% 15.0% (1) Includes net loans given out to state enterprises from the central budget (2) Includes quasi-fiscal expenditures such as the recapitalization of Naftogaz, state banks, and the DGF. Also accounts for state guarantees. (3) GDP calculated in $ according to the average UAH/$ exchange rate for the year (4) As per the 6 th edition of the IMF s Balance of payments and international investment position manual (5) Based on official NBU data of average daily interbank rates. Not weighted by volume traded Source: NBU, SSSU, State treasury, Ministry of Finance, IMF, Adamant Capital estimates Indicative Eurobond prices, yields, and recommendations Bond name Recommendation Rec date Coupon Maturity Bid Yield Bid Price 1 week Δ Dur, yrs Out, $mln Ukraine 2019 Hold 1-Dec Sep Ukraine 2023 Hold 1-Dec Sep ,355 Ukraine 2027 Hold 1-Dec Sep ,307 Ukraine 2032 Hold 1-Dec Sep ,000 MHP 2020 Hold 30-Jan Apr MHP 2024 Hold 30-Jan May DTEK 2024 Buy 27-Feb Dec ,309 Ferrexpo 2019 Buy 21-Nov Apr Metinvest 2021 Buy 6-Feb Dec ,187 Ukrlandfarming 2018 Sell 17-Jun Mar-18 nm na 543 Avangard 2018 Sell 5-Dec Oct-18 nm FUIB 2018 Buy 7-Nov Dec Privatbank 2018 (10.250) Sell 21-Nov Jan-18 nm nm 200 Privatbank 2018 (10.875) Sell 21-Nov Feb-18 nm nm 175 Oschadbank 2023 Buy 7-Nov Mar Oschadbank 2025 Buy 7-Nov Mar Ukreximbank 2022 Buy 7-Nov Apr Ukreximbank 2025 Buy 7-Nov Jan Ukrainian Railway 2021 Buy 20-Feb Sep Mriya 2018 Hold 14-Nov Apr-18 nm Kernel 2022 Hold 23-Jan Jan Fixed Income 2 week event calendar Event Type Date Kernel - H Financial Report Exact 28-Feb NBU - Decision on the key policy rate Exact 1-Mar NBU - Balance of payments monthly data Exact 2-Mar NBU - International reserves monthly data Exact 7-Mar SSSU - Monthly inflation Exact 7-Mar MHP - Financial results for Q Exact 7-Mar 5

6 Contacts Adamant Capital 5-B Volodymyrska Street, 2nd floor Kyiv, Ukraine Portfolio Management Yuriy Sozinov Research Konstantin Fastovets Liudmila Dunaieva PR Inna Zvyagintseva Disclaimer This report has been prepared solely for information purposes and is not intended to be an offer, or a solicitation of an offer, to buy or sell any securities. Descriptions of any company or companies or/and their securities, or markets, or developments mentioned herein are not represented to be complete. There is no responsibility on our part to revise or update any information or correct any inaccuracies contained in this report on an on-going basis. Although the information in this material has been obtained from sources that Adamant Capital believes to be reliable, we do not guarantee its completeness or accuracy. In making their investment decisions investors are expected to rely on their own analysis of all risks associated with investing in securities. Adamant Capital, its top executives, representatives and employees accept no liability whatsoever for any direct or consequential loss arising from the use of the material or its contents. Adamant Capital, third parties related to it, its directors and/or employees, and/or any persons connected with them, may have interests in the companies or provide services to one or more companies discussed herein and/or intend to acquire such interests and/or to provide any such services in the future. All estimates and opinions expressed in this report reflect the judgment of each research analyst, who is fully or partially responsible for the contents of the document, and may differ from the opinions of Adamant Capital. This document, or any part hereof, may not be reproduced or copies circulated without the prior express consent of Adamant Capital. 6