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CAPITAL MARKET

Market thinning on losses to Slovnaft, Slovakofarma

During the two weeks ending April 29, the market lost 1.4% of its volume, while the SAX index fell to an all-time low of 130.67 on April 30, driven down mostly by losses to two major blue chips closely observed by foreign investors. Slovnaft lost 6.2% to close at 780 Sk and Slovakofarma lost 0.7% and closed at 4,070 Sk. Sharp price declines for Váhostav (28.3%) and Železiarne Podbrezová (16.7%) are also worth noticing.
Nafta, the gas storage company, recorded total operating revenues of 3.597 billion Sk in 1997, down 1.8% compared to 1996. Sales increased by 1.1% to reach 3,079 million Sk, while drilling and construction works declined by 19.2% to 464 million Sk. A sharp decline in the latter was partially caused by a slowing of construction work on Pozagas, Nafta's storage joint-venture with SPP and Gas de France.

During the two weeks ending April 29, the market lost 1.4% of its volume, while the SAX index fell to an all-time low of 130.67 on April 30, driven down mostly by losses to two major blue chips closely observed by foreign investors. Slovnaft lost 6.2% to close at 780 Sk and Slovakofarma lost 0.7% and closed at 4,070 Sk. Sharp price declines for Váhostav (28.3%) and Železiarne Podbrezová (16.7%) are also worth noticing.

Nafta, the gas storage company, recorded total operating revenues of 3.597 billion Sk in 1997, down 1.8% compared to 1996. Sales increased by 1.1% to reach 3,079 million Sk, while drilling and construction works declined by 19.2% to 464 million Sk. A sharp decline in the latter was partially caused by a slowing of construction work on Pozagas, Nafta's storage joint-venture with SPP and Gas de France. Simultaneous increases in wage costs and depreciation charges by 10.0% and 10.2%, respectively, were the main driving forces behind Nafta's 4.6% annual decline in operating margin. Accordingly, operating profit declined 19.2% to 772 million Sk. The company suffered hard on the financial side as its net financial loss increased by 160.4% to 174 million Sk. Lower operating efficiency, a sharp increase in financial costs and a higher effective tax rate due to the non-deductibility of some cost items led to a 38% decline in net profits, which were 318 million. We believe that the company's management is not creating value for its shareholders, an opinion which is corroborated by fact that company stock is trading at mere 0.34x of its economic book value.

Drug producer Slovakofarma presented its first estimates for 1Q98 results. 1Q98 overall sales declined by 18.7% on the back of a 28% decline in sales to the Czech Republic and a 31.5% drop on other export markets. On the Slovak market, though, the company registered a 5.8% rise fuelled by robust growth in the sales of substances (by 73%) and a 6.4% rise in the sales of finished drugs. Net profit is estimated to be between 150 million and 170 million Sk by international accounting standards. We maintain that Slovakofarma is fairly valued at its current share price of 4,070 Sk and we remain optimistic that the company will hit its 1998 net profit target of 550 million Sk, as we believe that price increases on the Czech market and a resumption of growth in exports to other countries later in the year will compensate for lower 1Q98 revenues. However, any additional share price appreciation (above the market performance) will require stronger-than-expected earnings growth. Otherwise, we expect that the share price will perform in line with the market.

The AGM of the oil refiner Slovnaft approved dividends of 30 Sk per share, distributing 494 million Sk to shareholders, which implies a 27.2% dividend payout ratio, up from 20.8% in 1996. Slovnaft management also announced that 1Q98 unconsolidated pre-tax income was about 1 billion, up from 790 million in the same period of 1997. The steep increase in profits is due to the low cost of crude oil in the first quarter, a savings which Slovnaft did not translate into lower product prices, thereby inflating its gross margin. Slovnaft's total sales were 8.5 billion, of which exports were 5 billion Sk. Slovnaft announced its 1997 consolidated net profit was 1.816 billion Sk, up 14.9% compared to 1996. The earnings growth was accompanied by a 17.5% increase in invested capital. Therefore, the return on invested capital remained stable at 8.0%, lagging significantly behind the company's cost of capital, which is reflected in a low price-to-book ratio of 0.53x. We believe that the massive growth of invested capital will begin to bring higher operating earnings after 1999. This will narrow the current gap between the return on capital and cost of capital. Regardless of the currently weak market sentiment, we envisage a short-term share price appreciation on the back of the announced higher dividend payout and strong 1Q97 preliminary results.


Vladimír Zlacký is an equity analyst with ING Barings.

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