We attribute a decline in the value of Polymetal's shares to the US sanctions announced in April against a number of Russian individuals and companies. Despite the fact that Polymetal itself did not come under sanctions, following a conservative approach, we took into account the potential increase in the cost of capital for the Company, believing that the restrictions imposed by the US entail a reassessment of the risk associated with investments in all Russian assets. The latter also prompted us to reduce the long-term growth of the issuer to 2.5% (3.5% previously). Another reason for adjusting our 12M TP is a strong rise in oil prices, which, despite weakening correlation between oil and RUB, will put pressure on the Company’s margins. Taking into account the additional issue of Polymetal’s shares, our 12M TP is 735 GBp/share. We see a positive impetus for the business from launching and reaching the design capacity at Kyzyl (about 18% of the total production by 2020). We recommend to Buy Polymetal shares.
Potential sanctions on Polymetal. At the moment, we do not see any reasons for the US to impose sanctions on the Company’s management or on Polymetal itself. Meanwhile, a significant debt level of 1.5bn USD (total debt/capital – 1.1) and the need to finance growth projects (Nezhda and 2nd Amursk POX) make Polymetal dependent on the availability/cost of funds in foreign currency, which tend to rise in case of unfavorable market conditions.
Medium-term implications for the business. As noted in previous reports, the Company benefits from the depreciation of the Russian currency and the rise in gold prices, which both may occur due to the aggravation of the geopolitical tensions and the deterioration of the Russian economy. The sanctions imposed by the United States contribute to these conditions. On April 9, with a general decline in the Russian stock market (RTS index fell 11.4%), the ruble weakened against the US dollar by 4.3% to 60.65 USDRUB (USDRUB 62.4 at the moment). We believe that the market will initially include a higher risk premium in the Company’s price for the announced sanctions and only over time will take into account the effect of depreciation of the RUB (if it will be sustained) on Polymetal's financial results.
The sharp increase in oil price and higher operating expenses. With a direct extrapolation of the interrelations of the Company's operating expenses, an increase in oil price by 20% can be compensated by a 7.5% devaluation of RUB, KZT (not taking into account that the historical correlation and fundamental reasons assume strengthening of RUB with oil price growth). The price of oil for 5M2018 increased to 69.2 USD/barrel (+27% y/y), over the same period USDRUB was 58.8 (+1.6% y/y). Due to higher operating expenses and despite the anticipated increase in production (+6% y/y), we expect Polymetal's total cash costs in 2018 to approach the upper limit of the range forecasted by the Company at 925 USD/oz. We also expect the EBITDA margin for 2018 to amount 40% against 41% in 2017 and 43% in our previous forecast.
A decrease in 12M TP from 850 to 735 GBp/share, Buy recommendation. As of December 31, 2017, with a total debt in excess of 1.4bn USD, 57% of borrowings had a floating interest rate. We took into account the possible increase in the cost of debt and equity financing for Polymetal. In the base scenario, we expect the launch of Nezhda and 2nd Amursk POX, which will be reflected in higher capital expenditures in 2019-2022 and in the growth of production from 2021 onwards.