Russian Fixed Income Daily
- Mechel plans to issue two large rouble bonds
- Buy recom. for RZhD-6 reiterated
- Expect a reduction in ST rates next week...

• Mechel plans to issue two large rouble bonds
• Buy recommendation for RZhD-6 reiterated with YTM target 7.25%
• We expect a reduction of short-term rates next week

Rouble bond market

On Wednesday, the domestic bond market demonstrated wonders of strength, having not corrected downwards on the Tuesday downward shift in US Treasuries and 9% overnight rates. The prices of rouble bonds on average remained stationary and trading activity was quite substantial.
The spread of Russia’30 over US10Y is currently 114(+0)bp (fair, with a compression potential of 20bp from an historical standpoint), while the spread of OFZ 46018 over Russia’30 is 93(-1)bp (below the lower bound of the fair range 100-120bp, compression potential only in the long run).

Mechel plans to issue two large rouble bonds
Yesterday heard news that the board of directors of Mechel, the fifth-largest steel producer in Russia, had decided that the company would place two new rouble bonds: for five and seven years, each RBL5bn in size.
The company already has two bonds outstanding (Mechel-TD and Mechel-SG) with a total size of RBL5bn. Both will soon have put options exercised, on June 16 and May 25 respectively, so it is easy to suggest that the new issues could be placed before this in order to refinance the existing liabilities. On the other hand, for the outstanding bonds Mechel has flexibility in setting coupon rates until their maturities, so in fact, it may opt not to rush with the new issues, but simply offer attractive coupons for the outstanding bonds in order to induce market participants not to sell Mechel-TD and Mechel-SG to the company.
As a result, for the time being it is hard to judge when exactly the new bonds will be offered to the public. If their auctions were to happen right now, the 5-year paper would most probably be placed somewhere in the range of 8.25-8.5%.

Secondary trading
Price changes of high-grade bonds: OFZ 46018 -10bp, Moscow-39 +0bp, Gazprom-4 -2bp, Lukoil -31bp, RZhD-6 +6bp, FSK UES-2 -10bp. Second-tier issues: VolgaTel-3 +1bp, WBD-2 -20bp, Pyaterochka-2 -1bp, Salavat-2 +8bp.
RZhD-6, placed by Russian Railways in November 2005, traded yesterday approximately at 7.5% to maturity in 2010, having a duration of 3.9 years. Currently, the credit spread of RZhD-6 is close to 100bp, while in February 2006 it was 25bp lower, at 75bp. Naturally, the spread widening happened as a result of the large amount of new placements made by RZhD in recent months, but we believe that this increase in debt burden is natural for the monopoly, as the company at its creation had almost no debt at all – a situation, which was completely unsustainable taking into account the investment programme of RZhD. Therefore, the wider spread currently presents a good opportunity to acquire quasi-government credit with a significant premium over the OFZ curve. Our YTM target for RZhD-6 previously set at 7.25% remains in place. Russian Railaways are rated BBB-/Baa2/BBB by S&P/Moody’s/Fitch.
Other top picks among long bonds.
OFZ 46020, duration 12.1 years, +3bp yesterday, now at 6.98% YTM, our target located at 6.85%.
MosReg-5, duration 2.9 years, closed for coupon payment, last seen at 7.16% YTM, our target – 6.75%. Moscow region is rated BB-/Ba3 by S&P/Moody’s.
RusAl-3, duration 2.3 years, -2bp yesterday, now at 7.65% YTM. This medium-term paper can be used both in passively managed portfolios and for speculative trading. We estimate a fair point for it at YTM 7.5%.
Pyaterochka-2, duration 3.9 years, -1bp yesterday, now at 8.71%YTM, our medium-term target is 8%. Pyaterochka is rated BB-/Ba3 by S&P/Moody’s.
VolgaTel-3, duration 3.1 years, +1bp yesterday, now at 8.54% YTM, our target is 8.15%. VolgaTelecom is rated B+ by S&P.
Attractive short-term papers.
Kopeika, term to put 9 months, now at 8.31% YTP. The company is rated B- by S&P.
RZhD-4 (Russian Railways), term to maturity 15 months, now at 6.8% YTM. Russian railways are rated BBB-/Baa2/BBB by S&P/Moody’s/Fitch.
TuranAlem, term to put seven months, now at 7.2% YTP. Bank TuranAlem is rated BB/Ba1(Pos)/BBB- by S&P/Moody’s/Fitch.

Short-term market view
The first days of April are likely to demonstrate a notable reduction of money market rates from their current high level. This will foster buying activity on the secondary market, provided US Treasuries do not give any dramatically unpleasant surprises. Here the possible harm in the short-term perspective is likely to be limited to the test of the 4.9% area for US10Y. In addition, Russian Eurobonds, including Russia’30, have a spread compression potential versus US Treasuries, which will help the local market in the medium term. As a result, we maintain our general Hold recommendation for long rouble bonds, and recommend accumulating the cheapest papers mentioned above.

Dmitry Dudkin, Moscow (7 495) 755 5480