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CAPITAL MARKET

Slovnaft boosts exports, IRB must wait for foreign investor

The market lost 2.1 percent of its value between March 19 and April 2, pushing the SAX index down further to 135.9. Foreign investors have been turning their backs on the Slovak stock market for some time now, due to the low earnings growth of listed companies, political uncertainty and inadequate capital market regulations.
The Moody's Investor Service's decision to downgrade the Slovak sovereign debt to Ba1 will not encourage the inflow of foreign funds to the Slovak equity market. However, this announcement was widely expected, and we do not expect a significant short-term impact on financial markets and asset pricing.

The market lost 2.1 percent of its value between March 19 and April 2, pushing the SAX index down further to 135.9. Foreign investors have been turning their backs on the Slovak stock market for some time now, due to the low earnings growth of listed companies, political uncertainty and inadequate capital market regulations.

The Moody's Investor Service's decision to downgrade the Slovak sovereign debt to Ba1 will not encourage the inflow of foreign funds to the Slovak equity market. However, this announcement was widely expected, and we do not expect a significant short-term impact on financial markets and asset pricing.

Moody's explained the downgrade as a consequence of the continuing twin deficits, which are increasingly financed by short-term foreign loans. The agency is also skeptical of the chances that a new government would address accumulated problems in a satisfactory manner, and maintains that the Slovak economy is becoming increasingly susceptible to external shocks and swings in public confidence.

Corporate developments

Deputy Prime Minister Sergej Kozlík stated as a fundamental condition that any new owner of the IRB commercial bank must bring new capital to the bank, and added that a single domestic financial institution would not be able to do so.

According to Kozlík, it would be ideal if a certain combination of domestic and foreign investors were found. Such a solution would not hurt IRB's current owners. Finance Ministry State Secretary Peter Staněk added that the IRB must be sold within two months, and tried to lure investors by saying that the potential foreign investor would be granted various forms of tax and duty relief. As an example, Staněk stated, two thirds of IRB's overall bad loans, worth 15 billion Sk, are loans provided to energy companies and which could be capitalized.

The view of government officials is fully in line with our opinion, as we have stressed that IRB will not be able to recover and reestablish its credibility without the participation of a strong foreign banking institution.

Slovnaft has announced some of its basic unconsolidated results for 1997. Last year, Slovnaft processed 5.23 million tons of crude oil, up 1.6 percent compared to 1996. The company's unconsolidated sales increased by 11.9 percent to 40.17 billion Sk, while exports totaled 20.305 billion and recorded a 15.3-percent growth rate. Among significant markets, the highest growth was seen in sales to Poland (67.7 percent), Austria (36.2 percent) and Germany (22.1 percent). The Czech market, which absorbed 38.2 percent of the company's exports and recorded an annual growth rate of 13.7 percent, remained its main export market.

The refinery reported an unconsolidated pre-tax income of 3.113 billion ($87.69 million), up 34.5 percent from 1996. The significant profit increase, however, is due mostly to the relatively low profit total for 1996, which was caused by a maintenance shutdown, the high prices of crude oil and the low prices of petrochemical products.

The profit recovery would have been even more robust had the company not suffered substantial foreign exchange losses. The company was hit by a strengthening of the US dollar vis-á-vis the Deutsche mark, as it purchases raw materials in dollars but sells its products mostly for marks.

We estimate that Benzinol, Slovnaft's retail subsidiary, will add 500 million Sk to the group's consolidated pre-tax profit. This implies a net consolidated profit of 1.988 billion Sk ($56 million) after deducting minority interest. This figure is, however, based on the Slovak Accounting Standards (SAS), according to which the company reports its unconsolidated results. Final consolidated results may differ from our estimate due to differences between SAS and International Accounting Standards.

We expect Slovnaft to post a moderate earnings growth in 1998, but after completing its refining technology upgrade (HRPU) in 1999, it will significantly enhance its profitability via increasing petrol yields. We continue to recommend that investors buy into Slovnaft at the currently very low valuations, as we believe that prospects for Slovnaft's earnings growth in 1999 and 2000 have not been factored in to the current share price.

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