In our view, Tenge's devaluation last week has been largely expected from 2H2014, when ruble weakened deeply. Russia is one of the largest trading partners of Kazakhstan, and appreciation of Tenge decreased cost competitiveness of the domestic products, making devaluation of KZT appealing for local producers. Devaluation was seen to resolve budget and current account deficits, halt the loss of foreign reserves and stabilize funding and lending environments. Thus, devaluation was a question of time, as the gradual devaluation would not address the concerns mentioned above. Below we provide our view on effect of KZT devaluation on equity and bond markets in Kazakhstan.
Devaluation of Tenge has a negative effect on the companies, whose revenues are in Tenge, but expenses, at least partly, in FX, namely, Kcell, KazTransOil and KEGOC. Exporting companies (KMG EP, Nostrum and Kaz Minerals), on the contrary, are beneficiaries, since the revenues are in FX, while their opex is mostly in Tenge. That said, the extent of devaluation effect should be moderate, as the market has been expecting a significant devaluation, which was staved off by the National Bank's interventions. We noted that on 20 August the changes in equity prices close-on-close were as follows: Kcell (-1.8%), KEGOC (-7.9%), KazTransOil (+1.5%), KMG EP (+4.8%), Nostrum (+1.9%), Kaz Minerals (+13.9%).
Kcell's equity price has been declining since the last summer, declining from $15/share in August to $7/share in January 2015. Besides devaluation, Kcell was pressured by the increased competition on the market after Altel entered GSM market in May 2014. Altel increased its subscriber base from 0.6m at YE2013 to 2.0m+ at end-1Q2015. Moreover, we note that the data growth has significantly slowed over recent quarters (+6% in 1Q and 2Q of 2015 vs +20% in 3Q and 4Q of 2014). The data segment has been the main source of growth and flattening of revenues in this segment is a key negative. That said, we believe that the devaluation was already expected, and is so largely neutral for Kcell. We currently maintain our target price of $8.0/share (~T1450/share). The currency debt of the Company stood at $42m at end-2014, a minor amount relative to the balance sheet (~7%).
On KEGOC the negative effect is even more moderate since its tariffs tend to rise after devaluation shocks even if with some time lag. Upon the consent of the regulator, tariffs are revised up, as the Company revalues its PPE on 'fair value' basis after devaluations. Increase in the value of PPE lifts up its 'regulatory asset base (RBA)', a basis on which normative profit rate is accrued. Tariffs are due to be revised this fall, most likely upwards. That said, the increase in tariffs due to revaluation of PPE would trickle down to RBA only gradually, in our view, based on history, with full absorption taking several years. Given the asset appraisal shield against the devaluation, currently, we maintain our 'BUY' rating and TP of $670/share. At the end of 1Q2015 loans from EBRD and IBRD were at T101bn (~18% of balance sheet).
Regarding KazTransOil, the effect is negative, which is offset by a robust increases in tariffs, growing faster than the operating expenses. In 1H2015 the increase in export tariff was 8.3%, The Company paid out T120,7/share dividend for 2014, which equates to 15.4% dividend yield given the equity's current price (T783/share). Given the strong dividend yield and that major downside factor -- devaluation -- has already materialized, we believe KTO's shares are now attractive. We will update on the Company target price once we release our valuation update. At end-1H2015 KTO had o loans outstanding.
Devaluation of tenge had a positive effect on performance of stocks of KazMinerals, KMG EP and Nostrum Oil & Gas on a day of devaluation of KZT. Thus, on August, 20, stock of KMG EP climbed by 29% while GRD increased by 5.9% and closed at 8.71 $/GDR ,or 4.8% higher the closing price of previous day. Stock of KazMinerals increased by 13.9% and closed at 177.4 GBp/share. Stock of Nostrum Oil & Gas increase by 1.92% and closed at 531GBp. Price for oil futures that day declined by 1.15%.
Obvious benefits are lower operating and possibly some part of capex (in dollar terms) expenses denominated in tenge. The positive impact of the devaluation on earnings of exporters is likely to be short-lived as this will be offset by increase of expected inflation to a double digit number . The impact on the net liabilities is neutral as their borrowings are denominated primarily in dollars. Reported net debt of KAzMinerals at the end of 2014 was $962 mln, or 78% of the market cap, net debt of Nostrum Oil & Gas at the end of 1Q2015 was $651.8 mln, or 42% of the market cap. KMG EP has a debt-free balance sheet with cash pile for 2Q2015 of $2,675, or 74% of the market cap.
We expect increase of net profit for exporters in 2015 year, but at less extend than devaluation of tenge to dollar.
We will update our recommendations for KAZMinerals, KMG EP and Nostrum Oil & Gas shortly.
Interest of investors in tenge bonds remained weak while tenge was overvalued. The only investor was ENPF managed by regulator, which was the main buyer of banks' and quasi-sovereign bonds in the absence of other sources of funding. We expect ENPF to remain the main participant in the local debt market as a part of its program to provide long-term funding to banks. However, the interest in tenge assets will recover at yields, which we observe in the money market.
The main expected effect from devaluation on the banking sector are asset quality deterioration and improvement of tenge funding conditions at market rates. In particular, we expect a conversion of deposits into tenge. The quality of assets that secured by real estate and are FX-denominated will suffer most. Retail and consumer banks are less vulnerable to asset quality deterioration, but quality demand on the consumer credit will fall due to a rise of price of durables goods, which are entirely imported.
We expect that elevated provisioning charges on old loans, which will weigh down on banks' profitability.
The banks with a significant exposure of loan portfolio to currency risks are Tsesnabank, Bank RBK and KKB - more than 40% of their loans is FX-denominated. However, the first two have relatively good asset quality in comparison with large banks thanks to high share of newly issued loans. Devaluation will boost a debt burden of quasi-sovereign issuers, which have a mismatch between tenge-denominated revenue streams and mostly FX-denominated debt (KTZh, Samruk-Energy).
KTZh generates about 80% of its revenue in tenge and 60% of its cash is held in tenge, while 70% of its debt is FX-denominated. This will increase high leverage of the company (3.3x at the end 2014), which may further rise due to an increase of operating expenses. However, the company has been increasing its tariffs historically partly to compensate cost inflation and to fund capex. During 2010-2014 the company increased tariffs by 15% on average and starting from 2015 it may use tariff indexation to the level of inflation, according too prospectus of Eurobonds. Samruk-Energy is vulnerable to currency risk, as it’s share of FX debt amounted to 41%, while most of its revenue is generated from the energy production in local market.
We expect devaluation to increase credit risks of banks, KTZh, and Samruk-Energy and raise yields on Eurobonds. However, the effect on Eurobonds will be moderate, in our view, compared to a sharp increase in yields of Kazakh issuers at the end of the year, driven by macroeconomic and geopolitical risks. Current yields of Eurobonds are about 50-200bp higher YoY, which implies a premium for increased credit risks.