Zaporizhie Abrasives

Zaporizhie Abrasives is the largest in the CIS countries and one of the leading abrasive tools producers in Europe. The company
manufactures abrasive materials and tools, the need in which is
satisfied by only several companies across the world. By the end of
2008, the company plans to increase its disks production capacities to
10 mn pieces, which will amount to almost 80% of the Ukrainian
market.

Stirol

Stirol (STIR) is Ukraine’s major private nitrogen fertilizer producer, processing 60% of its ammonium into derivatives, such as urea and
ammonium nitrate. The company strategy consists of strengthening
its existing positions on nitrogen fertilizer market, as well as moving
into other business segments. One area is construction materials,
with Stirol aiming for a target output of 75,000 tons of polystyrene per
annum. Another niche under development is biodiesel.

Among competitive advantages of Stirol are favorable global prices
for ammonia and urea, high efficiency in ammonia production, strong
diversification in output and improved transparency in the process of
preparation to IPO.

Chemicals

Ukrainian chemical sector is largely disputed as reliant on gas consumption where import prices are constantly revised upwards. It
concerns most of all the nitrogen fertilizers producers, where the
global price increase has outpaced domestic inputs prices markedly in
2008. As a result, export revenues of domestic fertilizers’ producers
have been up by impressive 72% y-o-y in 7M08.

Ukrainian nitrogen fertilizer manufacturers are divided into three
categories – efficient (Stirol, Odessa Port Plant, Cherkasy Azot,
Rivneazot), in transition (Severodonetsk Azot), and inefficient
(Dniproazot).

Centerenergo

Centerenergo is Ukraine’s second-largest generating company after
Dniproenergo. It has 7.6 GW of installed capacity, or 28% of Ukraine’s
thermal generating capacity and 15% of total generating capacity
nationwide. The company operates three thermal power plants. The
company’s generating assets have a convenient geographical
location: Tripilska TPP is the main energy supplier for Kyiv and
region, while Vuglegirska TPP and Zmiivska TPP are located in the
industrially developed regions of Donetsk and Kharkiv, respectively.

Utilities

The majority of utilities’ stocks, after surging by more than 200% on
average in 2007 have plummeted by a similar percentage. However,
the sector remains rather attractive in view of the expected
implementation of Regulatory Asset Based pricing methodology in
distribution and the implementation of full-fledged market of bilateral
agreements in generation. High intensity of energy consumption
creates the preconditions for wide-scale reforms in the sector. The
shares of 27 issuers are listed on PFTS which represent the energy
industry. The majority of them are energy-distribution companies
(oblenergos), comprising 23 positions. More than half of them trade
actively, while another portion can be considered as conventionally
liquid securities. All traded gencos are blue chips and are part of the
PFTS index basket.

Mariupol Heavy Machinery Plant

Transportation machinery showed the fastest output growth in 2007
(42.3%) and its dynamics is not expected to slow down markedly in
2008. Mariupol Heavy Machinery Plant, a part of Azovmash Group, has successfully launched the mass production of automobile
transportation railcars in 2008. It is expected to bring almost $200 mn
in sales in 2008.

MZVM successfully supplies converters and other steel plant equipment to a large market. As Ukrainian steel plants modernizing
their facilities to replace their outdated open-hearth furnaces with
converters, MZVM is expected to benefit as one of the largest producer in CIS. It is capable of supplying up to 30% of the converters
required by the CIS market.

Enakievo Steel Plant

Enakievo Steel Plant is by far the most technologically advanced steelmaker in Ukraine, producing all of its steel with progressive
converters and casting 80% of it with continuous casting machines.
This is significantly higher than the industry averages of 55% and
40%, respectively, which drastically reduces gas consumption, as well
as raises steel quality and rolled product yield. The technologies used
by Enakievo Steel Group are more advanced than those used by the
majority of Ukrainian companies. They do not use the open-hearth
method for steel production – the company has three 160-ton
converters.

The company is conducting the modernization program costing
$700 mln, which began in 2001 and is expected to be completed by
2012. At least $300 mln must still be invested. The company will
modernize two blast furnaces, construct two more continuous casting
machines, eliminate its outdated blooming stage and add a new
rolling mill.

Machine engineering

2008 proved to be another successful year for engineering sector,
especially for export-oriented companies. The automotive sector
growth, partly driven by consumer boom looks set to slow down as
new cars’ purchases have barely grown in the summer months.
Access to credit, which enabled more than 60% of new cars
purchases, has become more limited while WTO entrance is posing
new threats for domestic players.

Overall, 24% y-o-y increase in machine engineering output in 8M08
has become possible mainly due to strong export demand. Export
revenues of railway machinery and locomotive producers surged by
65% in the reported period as a number of enterprises began fulfilling
their orders more actively. As a result, sector earnings have again
shown near record annual growth of 2.2x.

Sector, which contributes near 15% to the total industrial output, is
expected to display a slowdown in its growth rate in 2009 as its
skyrocketing growth rates in the last 2 years stemmed from
comparatively low base. High demand from Russia and other
neighboring markets is expected to ensure stable orders for industry
for the next 3-4 years.

Motor Sich

Motor Sich is one of the largest aircraft engine producers in CIS. In addition to aircraft engines the company manufactures gas-turbine plants, equipment for power stations and consumer goods. The company exports its products to more than 120 countries of the world,
with almost 50% of its exports going to the Russian market. Motor
Sich is successfully operating on the CIS aircraft engine market and
will supply motors for major aviation projects, which are expected to
double company’s sales by 2011.

Azovstal

Azovstal is Ukraine’s third-largest steel plant in terms of production volumes. Azovstal’s product mix consists of 50% semi-finished steel
(slabs and billets), 30% flat product and 20% long product. Azovstal is a full-cycle enterprise that produces steel, rolled steel and pig iron. It is Ukraine’s monopoly producer of railroad sleepers and brackets.
Azovstal continues to implement its modernization program, launched in 2004. In 2007, the implementation reached its peak after the
company put into operation a turbo-generator, which will be an
important element of the company’s energy-saving project.

Steel and mining

No sector has played such an important role in both industry and
stock market as steel and mining. 70-80% hike in steel prices during
1H08 contributed largely to the exports while output volumes have
been up by only 4% in the reported period. Despite lagging behind the
leading producers such as China, Ukraine remained 8th largest steel
producer in the world. Insufficient production inputs in particular
coking coal shortage was one of the core problems for Ukrainian
steel-makers in 2008. As a result, they were forced to increase its
imports and domestic coking coal producers have benefited largely
from demand shock. Iron ore producers and steel plants possessing
large iron ore resource bases have also benefited the most from
immense price hike by 70-85% YTD.

Starting from July 2008 global steel prices began reverting, which has
affected orders of the leading producers. 25-30% drop has been
registered in the most sorts of steel over the last three months.
Shortening in demand has, however, not been significant to affect
domestic plants to decrease their output markedly, or to result in
inventories accumulation. Earnings in the sector grew by 45.1% y-o-y
in 8M08, reaffirming strong positions of Ukrainian steel-makers
despite increase in their production inputs and steel prices reversal.

The following developments are expected to dominate in the steel
sector in 2009:
• Prices are to decline from their peak of June 2008 but will
definitely stay above the last year’s low, thus strong margins of
at least 10% will be supported
• Further modernization of production facilities. In Ukraine, most
facilities in the steel sector are regarded as obsolete. Widescale
modernization has been launched in 2007 by leading
groups as SCM, IUD. As much as 33% of all steel in Ukraine is
made by the open-hearth method, whereas this figure makes
just 2.4% worldwide. Oxygen-convertor steelmaking comprises
56.4%, while electric furnace steelmaking accounts for 9.8% of
production. The reinvested profits of Ukrainian steelmakers are
sufficient to fulfill the needs in modernization for the
subsequent years.
• Domestic demand will gain even a higher importance as
machine-building industry will keep its growth pace in 2009,
construction sector will grow at the cost of infrastructure
renovation within Euro-2012 framework and pipe industry will
rebound from negative output dynamics of 2008. In fact, steel
sector’s reliance on exports is diminishing as the overall
proportion of exports in GDP.

STOCK MARKET OUTLOOK

After 135% of gains in Ukrainian PFTS index in 2007 the market has
become one of the most expensive by P/E. This ratio stood at 22x in
December 2007 while the banks were traded above 4x of their book
value. Second fastest growing market in the world has become
overvalued and a number of factors contributed to 67.7% market
decline YTD:
• negative perceptions of foreign investors towards Ukrainian
economy (record 10-years inflation, more than 2x widening in trade
deficit y-o-y as of 1H2008, lack of progress in privatization, liquidity
deficit and cost of funds increase)
• expectations of drop in steel prices and declining margins of steel
and mining companies
• speculations on imported gas price in 2009 and on inability of
domestic industrial companies to cope with gas price appreciation
• speculations on decreasing orders in engineering sector from Russia
• a more cautious stance of investors towards EM in general

The above-mentioned expectations proved to be hardly justified so
far, however the equity market declined precipitously, becoming
rather undervalued with average P/E falling below 9 in September. A
massive sell-off has been additionally triggered by hryvnya
appreciation but low liquidity has also played an important role. As
total market free float stands at a negligible 4% (compared to 24% in
Russia) even small sell-off results in a notable drop. Total free float of
Ukrainian equities, which exceeded $4 bln in late 2007 has declined
to $1.9 bln in October 2008.

As interest to EM is renewed, current valuations are attractive enough
to lure foreign equity funds and to drive the market upwards. We see
the highest growth potential in steel and mining sector, agriculture,
engineering and chemicals. We have chosen 7 most liquid stocks with
the highest upside potential from 3 sectors.

Where will the money come from to finance growth needs?

Inflationary years are always accompanied by worsening savings’
dynamics as it was the case in 2008. Savings to disposable income
ratio ranged between 7.6% and 7.8% during 2008 though it stood well
above 10% in 2004-2006. Real interest rates for private deposits were
negative and especially high in early 2008 keeping the households
from savings. We expect the moderating inflation and current hike in
deposit interest rates exceeding 19% for hryvnya and 13% for US
dollar to begin driving savings in late 2008 and in early 2009. In
addition, spending boom is also near its peak and estimated UAH 610
bln ($ 120 bln) of households’ spending in 2008 will likely to be held
down by moderating inflation and more incentives to deposits.
In addition to the households’ savings, needs in financing fixed capital
investment will be covered by enterprises’ funds, whose growth was
twice as low in 2008 as that of households’ funds, mainly as a result
of credit crunch.

Finally, foreign investors’ funds, which surged by 21% y-o-y in 1H08
and are expected to add $9.5 bln to the total FDI in 2008, will
continue growing in 2009 mainly in the mining sectors, agriculture,
chemicals and steel tubes production where the most IPOs are
scheduled.

Fiscal Policy a Drag on Economy?

Fiscal plans of Tymoshenko government for 2008 were more than just
ambitious. They envisioned more than UAH 20 bln of State Savings to
be covered by privatization. As mush as 10% of the planned
privatization revenues have been raised as for October 1.

Furthermore, the expected budget deficit of UAH 18.6 bln had to be
partly financed by domestic borrowings of UAH 7.3 bln. In fact,
domestic credit crunch made primary auctions on state treasuries
(OVDP) placements barely interesting for domestic players and just
below 10% were raised as of early October. Raising placement yields
to nearly 13% (for 3-years maturity bonds) has hardly helped and
UAH 1.26 bln of the planned revenues have been raised so far.

The inability of government to find the source of funding the budget
deficit in 2008 has questioned its solvency. It was followed by a
massive sell-off in Ukrainian Eurobonds and cut in ratings’ outlook.
Non-residents have also sold almost $0.4 bln worth of OVDPs since
April 2008 in part due to hryvnya appreciation.

The new State Budget draft for 2009 envisions the deficit of 1.4% to
GDP to be covered by domestic borrowings of UAH 1.2 bln and UAH
8 bln of foreign borrowings. It becomes obvious that interest burden
for Ukrainian government will be gradually increasing. Despite the
difficulties with budget deficit financing in 2008 Ukraine is one of a few
emerging markets boasting relatively low state foreign debt of $14.8
bln, or slightly more than 8% of GDP.

Devaluation is not destroying the economy

2009 promises to be the hard test for hryvnya exchange rate stability.
First, the current level of NBU reserves is not likely to be supported as
domestic banks will face the necessity to refinance their debts at
higher rates. The interest rates are unlikely to be lower than this year
while the demand for retail loans will slow down dramatically. Banking
sector foreign debt, currently standing at $38.5 bln, is likely to
decrease throughout 2009, and this, coupled with trade balance
remaining in red, will not create preconditions for appreciation. FDI
inflows will be among the factors supporting the capital inflows
(another $9 bln are expected to come as FDI in 2009). The outcome
of these trends will be the rate ranging between 5.1-5.2 UAH/$ within
2009.

Though devaluation may be negative in the short-term posing the
threats for capital inflows, its effects will be limited:
• Nominal devaluation in terms of moderating inflation will trigger
real devaluation thus improving the competitiveness of the
leading exporters even in case of worsening global price
environment
• NBU is not expected to afford the massive devaluation by more
than 5% as it may undermine households’ confidence to
hryvnya deposits. In fact, based on previous experience, 1% of
official hryvnya devaluation to US dollar results in 14.9%
increase in withdrawals of hryvnya deposits from the banks
and leads to 13.8% of foreign currency deposits accumulation.
• NBU is likely to start shifting to the multi-basket pegging as in
Russia to mitigate the global currency fluctuations as more
than 40% of its reserves are already in euro.

NBU’s mistake not to be repeated

The above factors of temporary hryvnya stability have assumed that
temporary portfolio capital inflows are sufficient for strengthening
hryvnya rate. As NBU has been pursuing the managed float
exchange rate policy it has allowed for unjustified hryvnya
appreciation in April when temporary debt capital inflows were
exceeding trade deficit by especially large volume.

Among the negative effects of appreciation were:
• Profit-taking by foreign investors and massive sell-off of state
treasuries (OVDPs) by non-residents in amount of UAH 1.6
bln. It was the additional factor pushing the non-resident equity
funds to shorten their positions.
• More expensive hryvnya resources as banks focused on US
dollar and euro lending where the demand prevailed.
• Real effective appreciation of hryvnya to the main trading
partners by 9.4% YTD and worsening competitiveness for
leading exporters.

The NBU stayed away from interventions when foreign currency
supply exceeded the demand and interbank rate appreciated to 4.6
UAH/$, much below its official 4.85 UAH/$. It intervened during the
summer months bringing its gross foreign exchange reserves to the
new record of $38 bln. When foreign currency deficit started in
September due to lack of portfolio capital inflows and necessity of
$1.5 bln payment for imported gas, the interbank rate devalued to the
level above 5.00 UAH/$, which triggered the expectations of further
devaluation by households. They began massively purchasing foreign
currency and bought $1.3 bln more than they sold in September.
The NBU has been keeping its official rate close to 4.85 UAH/$
anyway. The Monetary Policy Guidelines for 2009 approved by NBU
Council allow for the fluctuation within 4.6-5.1 UAH/$ band but we
doubt the NBU will let hryvnya appreciate in tougher conditions of
2009.

Devaluation, what next

Factors of hryvnya stability are questionable
It is quite obvious that hryvnya stability has in the last 3 years been
artificially supported by portfolio capital inflows. Negative trade
balance since 2005 was offset by huge corporate borrowings, mainly
in the banking sector, which are likely to subside in 2009. Current
account deficit is expected to reach all-time high in 2008. It made $7.5
bln in 8M08, according to preliminary NBU estimates (6% of GDP) but
balance of payments was positive in this period (+$6.2 bln). Corporate
borrowings made $10.6 bln during 8 months with banks again
dominating in their structure ($6.4 bln). FDI totaled $8.1 bln while nonresidents
brought in $2 bln as bank deposits.

On this background trade deficit worsened further and made $9.2 bln
(merchandise $10.9 bln deficit and $1.7 surplus in services) in 8M08.
Rising demand for imports was to a large extent attributed to the
growing machinery imports (32% of the total merchandise imports).
Nearly half of it resulted from consumer demand for cars’ purchases,
which is beginning to subside, while the growth in other half is
explained by enterprises modernizing their facilities.

Another 30% of merchandise imports increase came from minerals’
imports, including oil and gas. It occurred mainly as a result of price
increases though the volumes have barely changed. Imports of
chemicals occupying the third position in merchandise imports have
grown markedly in 2008 and the balance of trade with chemicals was
negative as fertilizers were the only substantial contributors to
chemical exports.

Merchandise exports were traditionally dominated by steel (48%),
engineering (15%) and agriculture (12%). Steel sector exports rose
dramatically in 2008 (more than 50%) but largely due to favorable
price environment in 1H08 while output volumes grew by just 3.5%
during that period. Reversal in steel prices will definitely be mirrored
in export revenues. Other 2 largest contributors to merchandise
exports, engineering and agriculture, are not expected to show drop
in their revenues. Heavy reliance of the leading domestic engineering
producers on orders from Russia and other neighboring countries will
help them to continue increasing exports while this year’s rebound of
the agricultural sector output will positively impact further increase in
exports.



Resuming the above, this year’s forecasted record total trade deficit
of $13.5 bln will show lower value in 2009 as demand for imports,
especially passenger cars, is subsiding, basic materials’ imports will
slow down on declining prices (with natural gas being an exception).
Engineering and agricultural exports will offset the inevitable decline
in revenues from steel and mining industries.

Inflation is not a threat any more

Preconditions for deflation in Ukraine are currently as good as they
were in 2002 when annual CPI hit -0.5%. Annual CPI has for the first
time in 10 years exceeded 30% in early 2008 in part due to global
food price inflation but also as a result of a number of domestic
factors. Among them were negative harvest yields of 2007 and more
than 10% annual drop in cattle and pork population; retail lending
boom of 2006-2007, which boosted spending; nominal wages rising
by more than 40% annually on the back of expanding economy and
harsh competition for employing the labor force; expansive fiscal
policy of Ukrainian government in 2006 and 2007, aimed at increasing
social spending by 40-45% annually; very low (7.7%) savings’ ratio
pushing the households’ incomes to purchases rather than to
deposits in banks. Last but not least, Ukraine was hit especially
severely by global food deficit as food items dominate its consumer
basket (55% in 2008).

The impact of global commodities boom has been felt by a number of
sectors, in particular by steel and mining industry, fertilizers’
producers. They took advantage from global demand shock and kept
their margins high but they raised prices domestically, thus negatively
affecting the construction sector and certain agricultural enterprises.

We see the inflation as inevitably diving under 10% mark in 2009
based on the following assumptions.
• Food prices will grow rather moderately as 2008 has seen one
of the best harvest yields and increase in agricultural output by
25% y-o-y (8M08). As global food prices are reverting from
their peak of 60% annually in May 2008 to 9.8% in October
2008 (according to Economist Commodities Price Index) heavy
focus of Ukrainian CPI on food will this time be an advantage
for CPI.
• End of consumer lending boom will lead to deceleration in
spending dynamics.
• Reduction in fiscal expenditures are expected as a result of
government’s inability to raise money through traditional
sources of covering the budget deficit (borrowings,
privatization) and interest burden for Ukrainian government will
be especially high in 2009.
• Wage increase will moderate to 20% in 2009 down from 32%
expected in 2008 as current low productivity growth is limiting
further wage bargaining.

End of consumer lending boom

In early 2004 total retail loans outstanding were barely reaching an
equivalent $1 bln. During 4 years their amount was rising dramatically
to make $40 bln, or $920 per person in early Oct 2008. Their
contribution to the households’ spending peaked at 15% in 2007 but
began to subside throughout 2008 as banks tightened their lending
standards and faced the shortage of foreign funding (bank raised 10%
less funds from abroad in 1H08 compared to the same period a year
ago). Rising interest burden for households was another impediment
for retail loans growth as effective rate for consumer loans in certain
cases exceeded 60%. Finally, real disposable income grew at a
slower pace in 5 years and is expected to show 8.8% rise in 2008 as
real wage growth is decelerating.

The above factors led to a notable slowdown in retail lending growth
dynamics. They are set to rise by some 45% y-o-y in 2008 compared
to 134% and 98% annual growth in 2006 and 2007 respectively. It is
not likely to grow by more than 25% in 2009 as banks will face higher
borrowing costs, will not be able to refinance all of the previously
raised debts from foreign lenders ($38 bln for the moment) and further
deceleration in real disposable income growth will expose the current
interest payments to more risks.

We regard this brisk reversal in retail lending as positive based on the
following:
• As much as 32% of all retail loans fall on mortgage loans. The
other 68% are the loans are mainly those linked to imports.
Imports of passenger cars made $7 bln in 2007 and an
estimated $11 bln in 2008. As more than 60% of all passenger
cars are purchased on credit, and as the proportion of
passenger cars in merchandise imports makes some 17%,
these car loans contributed directly to the total trade deficit in
2007 and 2008. They have thus subtracted some 0.5% of the
real GDP growth.
• The juicy interest margins of retail lending business (above
20% in hryvnya) have to a certain extent distracted domestic
banks from their traditional corporate lending. In fact,
deceleration in corporate loans growth was much slower
compared to that in retail loans and their proportion in the total
loan portfolio has been below 37% in 2007. Yet, when costs of
funding affected banks severely in 1H08 and they were forced
to raise rates by 4-5% on average, it made lending for
enterprises rather expensive additionally stimulating the
inflation. Lending rates increase would, otherwise, have been
less notable if the competition for retail customers was not as
strong as in 2008.

Ukrainian market in 2008,

After equity prices rose 136% in 2007, the Ukrainian equity market lost nearly 80% in 2008, wiping out all the gains for the last several years in the process. By the start of 2009, Ukraine was one of the cheapest markets in the world in terms of P/E ratios. Only Russia is cheaper.




"Ukraine’s premiums over Russia are justified in our view, as the Ukrainian economy is to a large extent hedged against decreasing commodity prices," explain analysts at Galt & Taggart. "The country is a large net importer of hydrocarbons, which impact directly on production costs for energy-intensive Ukrainian industries. We believe any potential natural gas price hike in 2009 is more likely to be symbolic. Despite Gazprom’s fear-mongering rhetoric, reference prices are falling and Ukraine holds the transit and storage keys to the bulk of Russian gas exports to Europe. In addition, a bottom-up inspection offers a number of national champions like Enakievo Steel and Ukrsotsbank, among others, which have some of the lowest valuations in their Eastern European peer groups."

But comparisons to Russia are of limited value due to the vast difference in the size of the markets. Daily trading volumes on the Russian markets are in the billions of dollars whereas in Ukraine the volumes have crashed from between $30m-60m down to about $1m a day as of the end of 2008. Such tiny liquidity makes prices extremely susceptible to shocks.

"Given the liquidity and volatility issues are likely to plague the Ukrainian market until the world finds answers to the financial upheaval, we recommend investors look at shares traded abroad, namely London and Warsaw. Liquidity on those markets remains better than on the local market due to stricter disclosure requirements, better market infrastructure and the presence of 'quality' long-term investors. For all intents and purposes, the Ukrainian agricultural sector is represented only on foreign bourses and we see the sector as a solid performer in uncertain times," says G&T.

Ukraine in 2009

Ukrainian economy faced a serious stability test in 1H08 after a set of
negative factors: annual CPI exceeding 30%, trade deficit widening
almost 3x annually in 8M08 and government’s inability to raise funds
to cover the planned budget deficit. External factors, in particular the
end of commodities’ price boom and steel prices reversal, questioned
the ability of the largest industrial sector to adjust to a negative
demand shock. In addition, lack of credible monetary policy
conducted by NBU has undermined the investor’s confidence in
Ukrainian stock market. After hryvnya appreciation to 4.6 UAH/$ in
1Q08, which was allowed by NBU due to huge portfolio capital
inflows, lack of corporate borrowings in 3Q08 coupled with investors’
profit-taking resulted in foreign currency deficit and subsequent
devaluation above 5.00 UAH/$.

The above developments were accompanied by political instability;
break up of the parliamentary coalition in Sept 2008 and massive selloff
of Ukrainian stocks and sovereign Eurobonds, which brought their
prices to near historical lows. Negative sentiments have been
fostered by global investor’s stance to EM and search for new
investment havens like US treasuries, gold, silver. Massive sell-off of
Chinese, Russian and other equities and bonds indicated on a precrisis
situation. Against this backdrop, the Ukrainian market drop by
70.4% YTD did not look extraordinary. Decelerating industrial output
in these and other EM, brisk decline in inflation after global
inflationary shock, narrowing trade surpluses have made the term
“overheating” to be used more frequently. Yet, a number of leading
indicators say that it is still premature to talk about crisis or
overheating in Ukrainian economy.

Real GDP rose by 7.1% in 8M08. Though its growth was largely
supported by rebounding agricultural sector (+25% y-o-y increase in
the reported period), the other GDP constituents such as wholesale
and retail trade (+10.7%) and manufacturing (+5.6%) confirmed
economy’s ability to rely on global trends on a lesser extent. In fact,
exports make just below 40% of GDP compared to above 60% in
early 2000.

Two subsequent deflationary months pointed to a certain
saturation of private consumption.
Agricultural sector’s rebound from 2007 slump creates
preconditions for the food prices stabilization.
Corporate earnings growth at 83% y-o-y in 7M08. Global
commodities price boom has in part contributed to this but such a
robust growth is an indicator of enterprises’ ability to remain highly
profitable in conditions of inputs’ prices hike.

Banks’ margins remained strong. Strong corporate loans demand
in terms of global credit crunch helped domestic banks to expand
their corporate lending portfolio by 28% in 8M08, an insignificant
slowdown compared to 2007. Banks’ earnings rose by 60% in the
reported period as a result of faster increase in lending rates
compared to their cost of funds.

Improved investment climate. FDI in Russia totaled $11.1 bln in
1H08, which implies 30% y-o-y drop. In the meanwhile, Ukrainian FDI
reached another all-time high of $7 bln in the reported period, or 21%
increase. Though near a half of all FDI raised were in the banking
sector, the agriculture gained importance as 3 private placements
have been made in so far in 2008.

Increased role of investment in the economic growth. The
proportion of fixed investment in GDP surged to 27% in 2008 though
it was barely reaching 20% just a few years ago. The inevitable
overheating in consumption will thus be offset by stable growth in
fixed capital investment, which will contribute markedly to the GDP
growth in 2009-2012. Even assuming tougher lending conditions for
the corporate customers in 2009, strong growth in the corporate
earnings will enable to reinvest them with lower reliance on banks. In
fact, the proportion of own funds in total fixed capital investment has
been close to 60% in the last years, compared to 13-15% for bank
loans. Additional factor fostering the role of investment will be
preparations to Euro-2012 Football Championship where total
investments are estimated at $22 bln.

Ukravto

Ukrainian Automotive Corporation (Ukravto) is the largest distributor of autos and relevant services provider in Ukraine. The holding’s retail network is the largest in Ukraine and includes over 400 show-rooms and service stations. Tariel Vasadze,
the MP, controls the corporation.

Amid total cut of production by international automotive concerns due to decline
in solvable demand, the situation in Ukravto does not look like a critical one. The
corporation sells both the autos of its affiliated manufacturer and a number of
imported brands. Such diversification together with political lobby is able to
support the company during the financial crisis.

Avdeevka Coke

Avdeevka Coke is the largest coke producer in Ukraine. The company, controlled by SCM, produces almost 40 types of products, the major of which is
metallurgical coke. In Ukraine, the share of Avdeevka Coke in the blast-furnace coke gross output amounts to nearly 20%.

In October 2008, the company output shrank 35% as compared with the October
2007 to 229 thousand tonnes. For 10M08 the increment amounted to 24% to 3.6
mn tonnes, which evidences a rather stable position of the company in the
industry, explained by relatively small downturn in production volumes of
steelmaking companies that belong to SCM group.

Ukrsotsbank

Ukrsotsbank is a financial institution from the top-10 largest banks of Ukraine, which provides services to all client segments. By its total assets and net profit
the bank holds the 4th and 3rd places in Ukraine, accordingly. It regional networks
includes over 450 branches. By number of indicators this bank's market share
exceeds 5%.

In the second half of 2008, the bank issued its new shares for 5% of its registered
capital at $0.31, which significantly exceeded the shares market price at that
moment. It allowed to increase the equity of the financial institution by 23% to
$815 mn.

Despite that Standard&Poor's and Fitch downgraded the number of the bank
ratings in the second and third quarters, it still managed to finalize the private
placement of its 4-year bonds of H series for $103 mn.
Its parent group – UniCredit – provides financial aid to its Ukrainian structure as
well, and this September it extended a 7-year loan for $360 mn.

Krukovka Carriages

Krukovka Carriages is one of the largest carriages producers in Ukraine. The company produces wagons (flat wagons, tanks, bunker and gondola cars) and passenger carriages, as well as spare parts and bogies for freight cars, wheel
pairs, spare parts for metro cars and escalators, containers and road-building
machinery. The company is in the sphere of influence of TAS group, which is
owned by Sergey Tigipko, a Ukrainian businessman.

Amid crisis the company is gradually re-orienting its core production from freight
to passenger carriages. This step is quite reasonable taking into account the
deficit of passenger carriages in the Ukrainian market. Meanwhile, the key risk for
the company is a low solvency of its major domestic client – State Railroad
Administration (Ukrzaliznytsia).

Centerenergo

The overall deceleration of the Ukrainian economy affected the level of electricity
consumption as well, primarily, the energy consumption by industrial enterprises.
Yet, the sectoral risks in the power industry are not high in the mid-term, since
this sector is a systemic one for the entire infrastructure.

Centerenergo is the second-largest thermal power generating company in Ukraine. Its aggregate capacity is 7,575 MW, while 5 in 18 of its power units use natural gas and fuel oil for energy production.

The critical situation with accumulating of coal in the warehouses of generating
companies on the eve of the heating season forced Centerenergo to launch the idle gas and fuel oil capacities, which had a negative impact on the company’s profit margins in the quarter.

Despite sales growth in January-September 2008 versus the comparable period
last year by almost 60%, the operating profit dropped 29%, and EBITDA – 16%.
Meanwhile, the company net profit surged 76%, whereas the net profit margin for
three quarters increased insignificantly – from 2.4% to 2.6%.

Motor Sich

Motor Sich is one of the largest aircraft engines producers in the former USSR. In addition to aircraft engines, the company produces gas-turbine drivers,
equipment for electric stations and consumer goods. Motor Sich exports its
products to over 120 external markets, while 50% of its export falls at Russia.
The management fully controls the corporation.

The financial crisis, bankruptcies of some air carriers and cut of non-profitable
flights by remaining operators will no doubt be able to affect the sales of Motor Sich. Yet, we do not expect any serious problems in the company operations.
The range and types of products manufactured by the company are in some
cases unique, while its sales markets are sufficiently diversified.

Ukrnafta

Ukrnafta is a large company producing over 90% of oil and almost 17% of gas in Ukraine. The company is in the center of the long-lasting corporate conflict between two groups of the majority shareholders – the state and Privat group,
while the latter exercises direct control over the company now. In addition to the
upstream divisions, Ukrnafta also owns a large retail network of petrol stations – over 500.

This January-October Ukrnafta cut its oil production as compared with the similar period last year by 4%, a decline in gas production for the same period amounted to 3.2%. The financials of the company for three quarters in 2008 in relative
terms have improved: sales boosted 92%, earnings before interest, taxes and
amortization – 44%, and its net profit soared by over 120%.

Naturally, the oil prices decline worldwide and affect the Ukrnafta financials, which in addition to hydrocarbon production, also retails the products of their refinery. However, after the rental payments for oil and gas condensate production were pegged to the oil price on exchange, Ukrnafta benefitted from lowering of fiscal load on the company.

Alchevsk Iron and Steel

Alchevsk Iron and Steel is a company with complete technological cycle. The key
activity of the company is the pig and cast iron production, as well as of billets,
sheets, steel and sinter. In addition, the company produces low magnetic and
titanium-alloy grades of steel, and is the monopolistic producer in Ukraine of
stainless plates, steel two-layer place and steel shots.

After collapse of the global prices for steel, the company was forced to suspend
its large-scale investment program. Yet, the first benefits of this program
emerged this summer, when by production volumes Alchevsk Iron and Steel
almost reached the level of top-3 steelmakers. However, the crisis affected its
output in autumn 2008, when the company’s capacities were utilized by
approximately 25%. Since the company experiences its hard times, the
management was forced to send on non-paid vacations some 25% of its workers.
Nonetheless, the market overestimated the company problems scale, which, as
we expect, will be solved in the second half of 2009. As a result, the company
shares plunged almost 18 times – from $0.143 to $0.008, and now look too
cheap even despite the high risks.

Enakievo Steel

Enakievo Steel is one of the oldest and high-tech companies in steel industry of
Ukraine. The company is specialized in production of various section bars –
beams, channel bars, angle iron. The company is the second-largest steel asset
of SCM after Azovstal.

The decline in output at Enakievo Steel like at Azovstal is not as significant as at
their competitors. Despite a 36% decrease in steel output in October vs. October
2007, for 9 months overall it even increased (by 6%) to 2.4 mn tonnes. This being
the case, by its output volumes the company ascended from the 7th place across
the country, held for many years, to the 5th place.

Azovstal

Azovstal is one of three largest steelmakers in Ukraine. Its capacities allow to
produce almost 6 mn tonnes of iron, over 7 mn tonnes of steel and 4.5 mn tonnes
of rolled products a year.

In October, the steel output of the company shrank 29% vs. October 2007, while
the other largest steel companies’ output fell more than twofold.
Meanwhile, in January-October, the steel output fell by just 3%, and in
September-October the company by its output took the first place in the country.
Besides, the fact that the company paid out dividends in amount of UAH 1.3 bn
evidences that its financial position is stable.