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CAPITAL MARKET

World stock markets tumble, but Slovak bourse immune

World Equity Markets News
World financial markets experienced sharp turbulence over the past two weeks as the initial Russian crises resulted in an almost complete meltdown of the local currency and equity markets. The contagion spilled over to the whole emerging world as a flight to quality by foreign investors triggered a sell-off on most emerging equity markets, sending stock prices tumbling downward. The Russian contagion, together with the release of economic data pointing to a slowdown of the U.S. economy, spurred the second largest point loss on Wall Street as the Dow Jones index fell by almost 513 points on August 31. The potential negative impact stemming from falling equity prices and a downturn in U.S. domestic consumption gave rise to worries that the 7-year expansion of the U.S. economy might come to a halt. In the context of the Russian meltdown, whose knock-on effects on emerging Europe and Latin America are yet to transpire, a post-crisis recession in South East Asia and the inability of Japan to cope with its long-tem economic problems, fears of an approaching global recession are rising.

World Equity Markets News

World financial markets experienced sharp turbulence over the past two weeks as the initial Russian crises resulted in an almost complete meltdown of the local currency and equity markets. The contagion spilled over to the whole emerging world as a flight to quality by foreign investors triggered a sell-off on most emerging equity markets, sending stock prices tumbling downward. The Russian contagion, together with the release of economic data pointing to a slowdown of the U.S. economy, spurred the second largest point loss on Wall Street as the Dow Jones index fell by almost 513 points on August 31. The potential negative impact stemming from falling equity prices and a downturn in U.S. domestic consumption gave rise to worries that the 7-year expansion of the U.S. economy might come to a halt. In the context of the Russian meltdown, whose knock-on effects on emerging Europe and Latin America are yet to transpire, a post-crisis recession in South East Asia and the inability of Japan to cope with its long-tem economic problems, fears of an approaching global recession are rising.

Regional Equity Markets

Needless to say, the Slovak equity market once again failed to react to the turmoil on the world markets. During the last two weeks the SAX increased by 0.6% and closed at 113.52 on August 31. While the Slovak market is reaping the benefits of its complete isolation from regional (let alone global) trends, our neighbours saw their markets plummet. As a result of the Russian contagion, Prague's bourse fell by 23.2% in August alone, while Hungary and Poland saw their bourses punished by 36.1% and 29.6% declines.

Economic News

The last two weeks saw announcements of unemployment, inflation and trade data. The unemployment rate reached 14.1% at the end of July, rising 0.6 of a percentage point over June. PPI rose 0.1% M-o-M and decelerated to 3.6% Y-o-Y in July. In light of the previous CPI inflation release, which showed a decline to 7.0% Y-o-Y in July, this indicates that inflation is slightly declining. The year-end inflation rate is likely to be within our downwardly revised but still very conservative target of 4.5% (PPI) and 7.5% (CPI).

The trade deficit in July widened by 5.5 billion Sk, and the cumulative trade deficit for the first seven months reached 43.9billion Sk. Slovakia ran a 18.8 billion Sk deficit with OECD countries and a 12.2 billion Sk deficit with EU countries. On the other hand, Slovakia registered a trade balance surplus of 4.5 billion Sk with CEFTA countries. Our prediction is that the current account deficit will reach 9.1% of GDP in FY98. We maintain that the widening current account deficit might trigger some pressure on currency stability in 4Q98. Apart from the trade data, which point to potential pressures on the currency in the medium term outlook, declining inflation together with falling employment and rising output are positive news for the corporate sector and hence listed equities.

Corporate Sector

The summer season is taking its toll on corporate sector news, and the last two weeks passed without any major events. In the interim, it is worth singing the praises of Slovnaft. Slovnaft has almost no export exposure to Russia and hence should be a rather defensive stock in these times of turmoil. The company has approximately an 80% market share and is well positioned to benefit from the expected high growth on the domestic market. Further earnings growth will come from penetration of neighbouring Czech, Hungarian and Polish markets.

The residue upgrade project (HPRU) coming on stream in 1999 will enable Slovnaft to reach 86% white product yields, and will add $75 million of annual operating cash flow. In our view, the market is not pricing this significant operating improvement into Slovnaft's share price. Slovnaft is severely undervalued both on fundamental grounds and relative to its main competitors.

The share target price, based on an economic profit model, is 1,117 Sk; this price rises to 1,643 Sk if the September election results in an easing of political uncertainty in Slovakia. At the current price of 680 Sk, Slovnaft trades at up to 80% discount to OMV and MOL. Investors should exploit the current price weakness and buy for significant medium-term excess returns.

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