Ukraine is looking hot to some investors. A new decade brings new dreams and new investment ideas.
After the financial collapse of 2008-2009, Ukraine’s economy is finally reviving again, with 6.1 percent growth from January to May of this year.
Long-term prospects may be bright. With assets prices still low, analysts say now is a good time to buy Ukrainian assets or securities.
The nation could look even better if several factors go Ukraine’s way: the government lives up to its ambitious new program to deepen free-market reforms; China’s economy keeps growing, stimulating demand for key Ukrainian exports such as steel; the ongoing rapprochement with Russia bears fruit; and partnerships with Europe flower.
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Plowing ahead
Liberalization that would allow the buying and selling of land could be one of the most compelling investment spurs. President Viktor Yanukovych called for the “creation of a transparent” agricultural land market in his June 3 address to the nation as part of his government’s plan.
“Now the government is determined to push land reform through as soon as possible,” according to Phoenix Capital’s Andriy Yastreb.
Land market liberalization – removing the current moratorium on land sales to creating a fully-fledged market in land – will trigger a sharp spike in the price of land. This in turn will trigger a surge in the value of agriculture companies, who currently have exclusive purchase rights on land they lease.
“Appreciation may be steep,” Yastreb said. “Ukrainian land, although widely known for its high quality, is currently cheap.”
Just how steep is illustrated by the Russian experience: Following the introduction of a private land market in Russia in 2001-2002, the price of land increased from $300 to $2,000-3,000 per hectar of black earth land equivalent to Ukraine’s.
In contrast to Russia, foreigners will most likely remain banned from owning land in Ukraine, at least at first. “But foreign investors who wish to invest in land will be able to do so through buying shares of Ukrainian agricultural companies,” Yastreb said. Ukraine’s agriculture sector has a large and increasing number of publicly listed companies both in Ukraine, but especially on foreign exchanges.
Considering that private land ownership is the foundation of efficient agriculture, and that Ukraine enjoys a competitive advantage thanks to its ultra-fertile black earth soil and favorable climate, combining the two could be a match made in heaven.
Only when large companies own their land will they both have incentives for long-term development of the land, and the collateral to secure the bank loans needed. With the government enjoying a decent majority and having declared its intentions, legislation lifting the land sale moratorium could be the start of something big.
A diamond in the rough
Ukraine’s mining and steel sector is not as picturesque as agriculture, but it is potentially just as profitable for investors. Here the investment story is not domestic reform, but China’s resource-hungry industrial powerhouse.
With Chinese growth topping 11 percent in the first quarter of 2010, the country is acting as an enormous vacuum cleaner, sucking up the world’s raw materials. China has massively ramped up its domestic steel production. In doing so, it has driven up demand for the iron ore, coke and coal – all raw materials used in steel-making – that Ukraine has to offer.
Chinese demand for iron ore consequently soared by 41 percent in 2009, and this is good news for Ukraine, sitting pretty on one of the world’s largest deposits.
“Ukraine’s location and developed infrastructure is its competitive advantage,” said Dragon Capital’s Sergei Gaida. “Low production costs and [strong logistics] enable local iron ore producers to report high margins,” he added.
Ukraine’s coke plants are equally well positioned to take advantage of a growing global deficit in coke capacities, said Phoenix Capital’s Oleksandr Makarov: “For investors looking to play the rebound on the steel market and reap rewards from developing countries’ gluttony for steel, the Ukrainian coke sector offers good opportunities and upsides of more than 100 percent.”
Ukraine is currently one of few countries in the world with idle coke capacities, and analysts believe the country could hike exports threefold over the medium-term. Past bottlenecks in securing high quality coal needed could soon be resolved by construction of deep-water ports. Major coke plants benefited from cheap credit to acquire state-of-the-art coke batteries in recent years, improving competitiveness. The main risk in the sector, apart from a downturn in China, is poor corporate governance and transfer pricing, say analysts.
Coal miners will also benefit from Chinese growth and government reform of the sector, said Gaida. “Expected coal sector privatization will enable an increase in investment, and a boost in coal production while decreasing import of coking coal.”
Ukraine boasts the seventh-largest proven coal deposits in the world, but output is still trailing at around half of Soviet-era levels, leaving plenty of room for improvement. However, pending privatization – Ukraine still has a Ministry for Coal running most of the country’s mines – there are few chances to get exposure to the sector.
Analysts at Sokrat pick out Avdiyivka Coke and mining-equipment producer Svitlo Shakhtarya as good buys.
Engineering for success
Ukraine is a monopoly supplier of helicopter engines across the Commonwealth of Independent States. It supplies 80 percent of all power transformers in the region, and is also a major railcar exporter, with Russian demand dominant in all these markets. With Russia ramping up investment in civil, defense and power engineering in an attempt to diversify its economy, Ukraine’s competitive engineering sector can benefit.
Likely European Union-Russia modernization of the country’s aging gas transit system could also benefit Ukraine’s turbine and compressor producers, say analysts. “Growing oil and gas prices stimulate demand for energy machinery and promise a steady flow of new contracts this year,” said Dragon Capital’s Taisiya Shepetko. “Modernization of the Ukrainian gas transit system and local power generation companies will also help to boost sector revenues. In addition, the continuing rebound in demand for railcars is fueling a swift recovery in the railcar industry, while aircraft construction companies benefit from new legislation providing preferential tax treatment.”
Ukraine’s devaluation and political rapprochement makes it more attractive than ever for Russia to continue sourcing machinery from Ukraine. At the same time, poor relations between Moscow and Kyiv during the previous presidency forced Ukraine’s engineering companies to diversify into new markets in India, China and Middle East, broadening demand for domestic engineering companies.
The drawback for investors to this rosy story is that many stocks in this sector have small free floats and lack liquidity.
Phoenix Capital analysts like railcar producers Kryukiv Railcar and Stakhaniv Railcar. Among the transformer manufacturers, Sokrat picks out Zaporizhtransformator, the leading producer of power transformers for the CIS.
Heading West
Ukraine’s power generation is decrepit and getting worse. The good news is it is dirt cheap, and is a candidate for privatization and deregulation, which could see the stocks surge in value.
“This year and upcoming 2011 should dramatically change the landscape of Ukraine’s power generation sector,” said Dragon Capital’s Dennis Sakva. “First, the revival of energy sector privatization scheduled for the end of 2010 and 2011 should bring private capital and expertise into the sector.
And second, the energy market liberalization which should also start in 2010 would gradually decrease the state’s influence on the sector and improve companies’ profitability.”
There is also the tantalizing prospect of exporting surplus capacity to Western Europe. Analysts estimate that around 50 percent of generation capacity is superfluous to domestic requirements. This undercuts prices for the electricity produced by power companies, leaving them loss-making – and cheap. But, on the other side of the fence, the EU looks to be facing an imminent power shortage, according to Renaissance Capital’s Derek Weaving.
EU wholesale prices are three times higher than in Ukraine, making exports potentially extremely profitable. Analysts envisage that 25 percent of Ukraine’s power could be exported by 2015, if there is the political will to overcome the technical difficulties of connecting up Ukraine’s network with Europe’s. With the new Yanukovych administration pushing for closer partnership with the EU, the political will might now be there.
Banking on Europe
Ukraine’s banks will be slower to recover from the crisis, but the seeds of a rebound are there. Anti-crisis stimulus measures mean banks now have more cash, said Boris Timonkin of Ukrsotsbank, but they still have nowhere to lend it. However, with macroeconomic recovery ongoing and the hryvnia holding its value against major currencies, loans may be on the horizon.
Ukraine’s banking sector assets are set to grow at an average 15 percent per year over the next decade, according to BG Capital’s Vitaliy Vavryschuk.
This may be far less than the 64 percent annual growth 2004-08, but it is more sustainable. BG Capital forecasts 13 percent on the year increase in lending as early as 2011.
A positive legacy of the boom years leading up to the crisis is the dominant presence of European subsidiaries at the top end of Ukraine’s banking sector.
This means banks can rely on cheaper financial backing, and investors in the banking sector enjoy high transparency in a few liquid stocks. Foyil Securities highlights Megabank, which is 36 percent Western-owned, as a good buy.
Kyiv Post staff writer Graham Stack can be reached at [email protected]
