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Market takes negative view of risky financial stocks

Market Comment

A stagnant mood on the Slovak equity market continued over the last two weeks. The market saw an unimpressive gain of 0.4% as the SAX climbed to 115.2. VSZ, Figaro and Vahostav, which showed double digit gains, were the best performing stocks. With positive interim earnings surprises unlikely and market sentiment depressed by pre-election political uncertainty, a market recovery is not likely during the next two weeks.

Economic News

According to preliminary estimates, the June trade deficit was 6.1 billion Slovak crowns ($175.8 million). The cumulative trade deficit for 1H98 thus has reached 38.4 billion Slovak crowns ($1.1 billion), approximately 11% of GDP. The trade deficit will probably increase further during 2H98, although at a slightly subdued pace, and will likely reach 9% of 1998 GDP. The deficit will be financed mostly by the governmental Eurobond issue ($1billion) and loans to large state-controlled companies. However, this could prove insufficient in 4Q98 and there could be significant pressure on currency stability. Currency depreciation would be positive news for export oriented companies, and Slovakofarma would be the main listed beneficiary.

Financial Sector News

VÚB, the country's largest commercial bank, made a 1H98 net profit of 73.6 million Slovak crowns ($2.1 million), down 75% from 1H97. The bank needs serious restructuring as estimates say that classified loans represent 30 percent of its loan portfolio. Furthermore, it continues to report unimpressive results even without taking radical steps towards provisioning against these classified loans. Exposure to the stock is inadvisable.

Investičná a rozvojová banka (IRB) announced that it lost 2.32 billion Slovak crowns ($66.9 million) in 1H98; the loss is 41.6% higher compared to 1H97. The announced results show there has been no change in the bank's poor performance since it was put under central bank administration. The only positive change is the fact that the bank took stronger provisioning as net transfers to provisions reached 944 million Slovak crowns ($27.2 million) in 1H98. The bank's poor performance is bad news for the bank itself and also for its main shareholder, the country's largest insurer, Slovenska Poisťovňa (SP), which purchased the entire 2 billion crowns ($57.6 million) in a recent IRB share issue. Investors are advised to sell both IRB stock.

SP share capital increase

The shareholders of SP approved an increase in the SP's share capital of 375 million Slovak crowns to 1.875 billion Slovak crowns ($54 million) at an EGM on July 24. The increase was proposed by the large steel company which owns more than 20% in SP. The first round of underwriting took place on August 3 and 4 and 41.65% of the new issue was underwritten. Since the FNM did not participate in the first round, it will not be allowed to participate in the following rounds and its stake in SP will be reduced from the current 50.5% to 40.4%. We reiterate our view that the insurance company has not been transparent and its activities not consistent with maximising shareholder's value in the past. We are also concerned about the future performance of the company under the potential new controlling shareholder. Furthermore, the rights issue is not in compliance with several laws and hence there is a considerable risk that the issue will be nullified by the courts. Lastly, the subscription price is equal to share nominal value of 1,000 Slovak crowns, implying a 25% premium over the market price of 800 Slovak crowns. For these reasons, investors should not exercise their preemptive rights and should avoid exposure to the stock.

Slovnaft's interim results

Slovnaft reported that its unconsolidated 1H98 pre-tax profit slumped by 26.6% Y-o-Y to 1,069 million Slovak crowns, implying a net profit of 641million Slovak crowns ($18.5 million). The 13.5% decline in operating profit and 16% increase in financial losses are behind the profit decline. The management said that it revalues its inventory semiannually and a strong decline in crude oil prices between December 1997 and June 1998 meant that the company posted a 418 million Slovak crowns loss on inventory revaluation. As well, the company said that it created provisions for potential foreign exchange losses worth 118 million Slovak crowns and accounted for some unspecified annual charges in 2Q98. Management feels confident in achieving its unconsolidated FY98 pre-tax profit target of SK2,970m. The company still offers good value - the market is not discounting into the share price a strong profitability improvement after 1999 when the company puts on stream its residue upgrade unit which will bring an additional $70-75 million of operating cash. While the market may react nervously to the 1H98 results announcement, the company is fundamentally undervalued and deserves a buy recommendation.

Vladimír Zlacký is an equity analyst with ING Barings.

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