Russian Fixed Income Daily
- US10Y driven up by soft PCE deflator
- Money inflow lowers short-term rates
- Salavat-2 is one of the most attractive long bonds...

FX and money market

Nostro balances are continuing to increase and have reached RBL450.6bn (+50.5bn) as expected and mentioned in our previous reports. The MoF is making budget expenditures in cash form, which is likely to result in solid liquidity up to the end of the year. Typically, liquidity spikes seasonally in January, but this year the MoF’s active spending in December has created support for the money market already this month. Interbank overnight interest rates dropped yesterday to 3.5-4% and today we expect a further drop to 1.5-2%. Nevertheless, we can’t rule out that the situation in the money market will remain volatile in the coming days.

Yesterday, the rouble exchange rate moved in the narrow range of RBL/USD28.83-28.84 on the back of calm trade of the euro/dollar. Today, we see the rouble at RBL/USD28.75-28.82 while trading volumes are likely to remain substantial.

Tax payments schedule:

26 December – mineral resource tax, some excises – cumulatively, around RBL110bn;

28 December – profit tax – potentially about RBL160bn.

Olga Golub, Moscow (7 495) 755 5176

Rouble bond market

On Thursday trading in the government sector was quite strong, especially in the middle of the curve where liquid OFZs experienced notable growth. This caused a consequent revival of buying activity in the municipal sector, although corporate papers remained still and did not respond to this positive impulse.

PCE release drives Treasuries up

Yesterday’s release of personal income data for November helped traders break the previous short-term downward tendency on the American bond market. The PCE deflator turned out to be significantly weaker than in October, having increased only 2.7% YoY versus the previous 3.3%.

Since the PCE deflator is one of the measures of inflation used by the Fed, the news caused immediate buying of long-term US Treasuries, which took US10Y from 4.49% at the opening to the current 4.43%. This, however, still does not change the technical picture: the benchmark rate is still in the range of 4.42-4.51. If the rate closes below 4.42%, this will signal the development of a short-term move towards the region of 4.15-4.2%.

Significant improvement on the money market expected to help prices grow

The notable inflow of roubles before the year’s end finally helped ease the liquidity squeeze that has been limiting buying activity on the domestic bond market throughout November and December. Right now, overnight rouble rates are close to 2%, although dealers remain cautious about the holidays as the longer rates going into 2006 are still at 6-7%.

We believe that the reduction of money market rates that we expected to see already in the beginning of December should help the market erase the losses it previously incurred, especially in the corporate sector.

Secondary trading in the corporate sector

Price changes of high-grade bonds: Gazprom-4 -15bp, Lukoil -8bp, RZhD-3 +4bp, FSK UES +3bp. Second-tier issues: Megafon-3 +8bp, Salavat-2 +4bp, SibTel-4 +34bp, UrSI-4 -2bp, CenTel-4 -5bp.

As indicated, SibTel-4, which we yesterday added to our buy list, grew 34bp reducing its YTM from 8.22 to 7.97%. Currently the bond appears to be properly priced, trading inline with its peers UrSI-4 and NWTel-2, so we are downgrading the paper from Buy to Hold.

Among long bonds, we continue to recommend buying Salavat-2, which continued trading in the 8.6% area for 48 months. The spread of the bond to the OFZ curve is now 223bp, while in October 2005 it was seen at 140bp. Such a widening fully justifies the purchase of this paper for speculative purposes. Our target for Salavat-2 is located at 8.35%.

Inmarko primary placement

Auction date: Friday, December 23, 2005.

Bond parameters. Title: Inmarko, size: RBL1bn, term to maturity: three years, semiannual coupons, one-year put option. Initially the bond will be traded to put, being effectively a one-year paper.

Inmarko claims to be Russia’s largest ice-cream producer having an approximately 9% market share. Structurally, it consists of a group of companies uniting two producing plants and three distribution firms, with its main facilities located in the city of Omsk.

A 28.9% stake of the group is owned by EBRD. The rest is also closely held.

The company reports audited consolidated financials according to GAAP. It is unrated by major agencies.

Fig 1Key financials of Inmarko
Reported items (US$m) 2003 2004 3Q2005 Ratios 2003 2004 3Q2005

Sales 43.7 63.2 80.7 Gross Mgn 41.1% 38.7%
GP 18.0 24.5 EBITDA Mgn 14.9% 7.1% 19.6%
EBITDA 6.5 4.5 15.8 EBIT Mgn 11.2% 2.0%
EBIT 4.9 1.3 Net Mgn 9.0% 0.5% 12.6%
NI 3.9 0.3 10.2
Debt/EBITDA 1.41 3.24 0.84
Assets 40.7 51.6 71.7 Debt/EBIT 1.87 11.33
ST Debt 6.1 2.6 0.2 EBIT/Int 52.3 1.3
LT Debt 3.1 11.9 17.5
Equity 30.5 32.0 43.9 LT Debt/Cap 0.09 0.27 0.29
Capital 33.6 43.9 61.4 Debt/Assets 0.23 0.28 0.25

CFO 0.8 6.3 ST Debt/Debt 66.3% 17.8% 0.9%
CFI -12.4 -11.7
CFF 11.3 5.6 ROC 11.7% 0.8% 22.0%
ROA 9.6% 0.7% 18.9%
CapEx 9.9 12.5 ROE 12.8% 1.1% 30.8%
Depreciation 1.6 3.2
Curr Ratio 2.53 2.42
FCFE -11.6 -5.3 Quick Ratio 0.58 0.70
FCFF -11.5 -4.6

CFO/Debt 0.08 0.44
FCFF/Debt -1.25 -0.32
CFO/CapEx 0.08 0.51
Source: Company data
The data for 3Q2005 was not audited.

Notes on the presented figures.

The company is definitely smaller in scale, than say, Wimm-Bill-Dann, one of the leading food producers placing its new bond today. In 2005 the aggregate sales of the group may reach US$100m and this will be a large gain, as revenue growth will in this case significantly exceed 50%.
The income statement of the group appears to be very unstable, as strong margins in 2003 were followed by a notable fall in efficiency in 2004. The first nine months of 2005 appear to be the best period in the company’s reported history (Inmarko has an EBITDA margin of almost 20%), but the data for the period is unaudited and should be viewed with caution.
Correspondingly, it is hard to determine the ‘natural’ level of the Debt/EBITDA ratio for the company, as it has been jumping wildly in recent years following the ups and downs of the company’s earnings. The latest ratio confirmed by the auditors was 2004’s 3.24 and an interest coverage ratio of 1.3.
The leverage figures of Inmarko are naturally more stable: LT Debt occupies slightly less than 30% of the company’s capital, and the total Debt/Assets ratio is also close to 30%. Inmarko is planning to spend up to 77% of the new issue (about US$25) on refinancing its bank loans (to lower the financing costs), while 23% of the raised money will be used for Capex and working capital increase. This means that the new bond is unlikely to significantly raise the debt burden of the group.
In 2005 the company succeeded in increasing the duration of its liabilities, as only 0.9% of its interest-bearing debt was qualified as short-term at the end of 3Q2005.
An additional positive factor relating to ice-cream producers in general is that the ice-cream market in Russia is still very far from being developed, which allows for aggressive share capturing. The known industry leaders together occupy much less than 50% of the market, while the rest is covered by regional ice-cream producers. As a result, Inmarko’s target of 20% of the market share appears attainable.

Regarding the market pricing of the issue, we can say that trading to a one-year put, Inmarko will have to pay a premium to KrVostok, a very well known beer producer, which is currently located at 10.1% for 14 months. Another possible market peer of Inmarko, Baltimor-3, is located at 10.45% for 11 months. Apart from the fact that Baltimor is a ketchup and juice producer, Inmarko is very similar to it, first of all in scale. The pluses of Inmarko relative to Baltimor are its GAAP financials and EBRD support, while the pluses of Baltimor are that it is a known brand and has had a presence on the bond market for quite a long time already.

As a result, we believe that a fair YTP of Inmarko at the auction in current market conditions can be estimated at 10.5%. It is important to know, though, that the issue managers are marketing the coupon rate of 9.9-10%, which is below our estimation. Taking into account the improvement of money market conditions, we may assume that additional demand may appear driving the yield down, but at the same time we still believe it very unreasonable from a credit standpoint to buy Inmarko at YTP below 10.25%.

Short-term market view

Continuing inflow of fresh liquidity coupled with a reduction of the volume of new primary placements promises at least a stable market until the end of December. In addition, the recent growth of US Treasuries relieves the pressure from the Eurobond side, so overall the situation on the domestic bond market is becoming more positive. Our general recommendation regarding long bonds remains a Hold.

Dmitry Dudkin, Moscow (7 495) 755 5480

S&P upgrades City of Moscow

S&P upgrades City of Moscow’s rating by one notch to BBB

Yesterday, S&P upgraded City of Moscow’s rating by one notch to BBB, which is positive news, although it had been generally expected after the sovereign rating upgrade a week ago. The agency has fully acknowledged the role of the city of Moscow as the main political, economic, and financial centre of Russia, with its diversified economy, highly developed services sector, and the country’s highest living standard (almost triple Russia’s average). The agency upgraded City of Moscow stressing further improvements in its fiscal performance and ability to service debts (the City of Moscow managed to reduced its debt pressure below 20% of budget revenues in 2005).

Saying that the news is positive, we welcome even further improvement of City of Moscow’s image in the eyes of international and local investors. Without any new sovereign Eurobond issuances and the inaccessibility of domestic sovereign debt for non-resident investors, City of Moscow instruments are playing an increasing role as Russia’s benchmark, which makes the upgrade important. Nevertheless, the impact of the upgrade on markets was not very strong as investors were already confident in the credit quality of City of Moscow’s instruments.

Investment implications: We welcome S&P’s decision to upgrade City of Moscow to BBB, which is important as it is playing the role of the best “proxy” for Russia’s sovereign risk. As expected, the immediate reaction of the markets was not very strong.

Julia Tsepliaeva, Moscow (7 495) 755 5489