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CAPITAL MARKET

Disappointing 1-3Q97 results indicate trouble

The last two weeks haven't brought any surprises from the Slovak equity market. Lethargy continued and the SAX index went down as blue chips' prices declined. Some blue chips were traded at prices close to their all-time lows (IRB for instance). But even that didn't spur investors to buy shares because there are continuing doubts about the Slovak equity market's future, supported by recent transactions of Príroda shares. The 1-3Q97 results of most Slovak companies did not give an impetus to the markets either, as higher financial costs and stronger competition have narrowed their profit margins.

The last two weeks haven't brought any surprises from the Slovak equity market. Lethargy continued and the SAX index went down as blue chips' prices declined. Some blue chips were traded at prices close to their all-time lows (IRB for instance). But even that didn't spur investors to buy shares because there are continuing doubts about the Slovak equity market's future, supported by recent transactions of Príroda shares. The 1-3Q97 results of most Slovak companies did not give an impetus to the markets either, as higher financial costs and stronger competition have narrowed their profit margins.

SLOVNAFT - Bratislava

Slovnaft announced a 1-3Q97 pre-tax income of 2.25 billion Sk ($67.3 million) and a net income of 1.35 billion Sk ($40.4 million) on 29.9 billion Sk ($893.9 million) sales. The pre-tax profit was 67 percent higher than in the same period of 1996, with sales increasing by 20 percent. However, the improved results are a reflection of the poorer 1996 performance due to the planned maintenance shut-down. The interim results are in line with the expectations of the FY97 after-tax profit of Sk1.76 million ($52.5 million).

Net gearing increased from 17.8 percent to 31.6 percent as a result of financing a heavy capital expenditure program aimed at Heavy Petroleum Residue Upgrade. As a result of this upgrade, Slovnaft will be able to produce more high-value lighter products and will reduce its production of high-sulphur fuels. The upgrade cost $526 million and was partially covered from operating cash flow and from $250 loan provided by a bank consortium in 1996.

The project should be completed by mid 1999, and its benefits will start to be felt at the end of 1999 when the complex will increase its potential output of lighter fractions from the current 55-60 percent to around 85 percent of total production, enabling Slovnaft to meet rising petrol demand. Slovnaft trades at 898 Sk now, and in light of its significant capital expenditure program, we believe that the company offers a very attractive long-term value.

VSŽ - Košice

According to the unconsolidated SAS results of VSŽ (holding company), the steel maker made a 1-3Q97 net profit of 597 million Sk ($17.8 million), an annual decline of 39.4 percent, this despite the fact that the European steel sector is on the upside of its cycle and the company's sales of 42.7 billion Sk ($1.28 billion) represented a 21.2 percent annual increase. One reason behind the drop is the deterioration of the 1996 gross margin from 10.1 to 3.6 percent. This is partially due to the strong US dollar, in which currencyVSŽ purchases its raw materials, and the weak DM and Czech crown in which it transacts a sizeable part of its sales.

VSŽ interim results continue to surprise by being on the downside. However, the recently-announced plans to create a joint venture with U.S. Steel is very positive news for the long-term profitability of the company. We believe that an increase in the capacity of high value-added tin products together with a further improvement in quality due to cooperation with U.S. Steel will reflect in a stronger bottom line performance for the steel maker.

NAFTA - Gbely

Nafta also reported disappointing 1-3Q97 results. Net profit fell 34 percent to 209.2 million Sk ($6.3 million). The decline was caused by a fall in operating margins from 31.4 to 21.9 percent due to lower revenues and increasing storage and labor costs. The revenue drop is partially due to lower activation of drilling works.

The company also announced plans to invest 30 billion Sk ($900 million) by 2004 in building underground gas storage facilities with a capacity of 7 billion m3, of which it wants to rent out 6 billion m3 to foreign companies. In 1Q98, Nafta wants to decentralize its organizational structure and establish five joint stock companies with 100 percent Nafta ownership.

According to SES Tlmače director Štefan Ižold, the engineering company made a pre-tax profit of 59 million Sk ($1.8 million) in 1-3Q97 and FY97 pre-tax profit should total 83 million Sk ($2.5 million). The company will not pay dividends for this year, as the profit will be used to cover losses from previous years. We estimate that net profit will be 49.8 million Sk ($1.5 million) and we believe that this decline was caused mostly by higher financial costs.

PLASTIKA - Nitra

Plastika reported 1-3Q97 net profit of 41.9 million Sk ($1.3 million), up 2.5 percent compared to the same 1996 period. Sales were flat, growing by only 0.5 percent to 1.24 billion Sk ($37.3 million). Because of growing competition on the domestic market, higher costs due to the 7 percent import surcharge, higher electricity costs and mandatory contributions to the government-created export fund, the gross margin fell from 35.1 to 31.6 percent this year. At the current price of 530 Sk, the stock trades at favorable 1997 PER of 6.7 times. However, the stock has a relatively low liquidity. Plastika could be an attractive buying opportunity given the current very low valuation.

Slovakia's planned eurobond debut, worth $250 million, was postponed due to difficult market conditions. Turmoil began as Asian capital markets collapsed and investors withdrew from high-risk emerging markets, turning to safe havens such as U.S. treasury instruments.

This occurred at a time when emerging market issuers showed increased interest in tapping international markets. Falling demand and expanding supply caused the prices of emerging markets' fixed income assets to collapse, resulting in an enormous widening of spreads between these yields and U.S. treasuries. Under these conditions it would be very unfavorable to access international markets. Several other issues have been put on hold too, among them the $150 million eurobond of Slovenské Elektrárne.

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