Separatists may claim entire territories of two Ukrainian regions

23 February 2022

Russia has recognized “all fundamental documents” of the self-proclaimed Donetsk and Luhansk People’s Republics (DNR and LNR), including their “constitutions,” president Putin told a press conference on Feb. 22. He hinted that their “constitutions” envisage that their territories stretch to the entire territory of Ukraine’s Donetsk and Luhansk regions (they effectively control less than half of the regions’ territories). Putin added that the territories are “the issues” which should be resolved in negotiations between Ukraine and the “governments of the republics,” but acknowledged that such negotiations are impossible right now.


Alexander Paraschiy: On the one hand, this is positive that the DNR/LNR guys were shy enough to not include the entire territory of Ukraine or even Europe into their “constitutions”. Jokes aside, Putin’s statement increases the risk of aggression by the Russia-backed “republics” against the Ukrainian-controlled part of Donetsk and Luhansk regions. In the worst-case scenario, Russia and the DNR/LNR terrorists can occupy these territories (though we see such probability is low), and there is a bit higher risk that they will try attacking these districts to make business-as-usual there impossible.  


Among Ukrainian Eurobond issuers, the biggest exposure to Donetsk and Luhansk regions (Donbas) is with Metinvest (METINV) and DTEK Energy (DTEKUA). If they have problems in controlling or operating their Donbas-based businesses, their EBITDA might be affected by about 40%-50% for Metinvest and by 15%-20% for DTEK Energy (see more details below).


Meanwhile, DTEK Renewables (DTEREN) and DTEK Oil&Gas (DTEKOG) have no exposure to Donbas at all. Kernel (KERPW) and MHP (MHPSA) have very little exposure (less than 1% and 4% of revenue, respectively, we estimate). The companies which have customers for their products and services throughout Ukraine, including Donbas region (about 5%-10%), are Ukrainian Railways (RAILUA), Vodafone-Ukraine (VODUKR), Naftogaz (NAFTO), Oschadbank (OSCHAD) and Ukreximbank (EXIMUK). 


DTEK Energy’s exposure to Donbas: Sensitive, but not as much as price issues

Out of DTEK Energy’s eight thermal power plants (TPPs), two are located in Donbas. This includes Luhanska TPP, which is more trouble for the company than an asset. Its power output is small (about 6% of DTEK’s total) and it feels constant troubles with coal deliveries (which can be only made from Russian territory). Another one is Kurakhove TPP, second-biggest by power output (22% of DTEK’s total) and one of its most efficient. In the coal segment, DTEK Energy’s exposure to Donbas is limited to Dobropillia Coal (4% of DTEK Energy’s coal output).


We estimate that the potential loss of Donbas assets might decrease DTEK Energy’s cash flow generation potential by about 15%-20%, ceteris paribus. This looks painful for the company, whose capacity to service and smoothly repay its debt still remains questionable. On the other hand, the company’s cash flow generation potential is much more sensitive to electricity price dynamics than to a potential effect from troubles that can be inflicted by Donbas assets.


Metinvest’s exposure to Donbas: Significant, but not harmful for bond’s investment case

Dmytro Khoroshun: Metinvest’s entire iron ore business is located outside Donbas, but large portion of its coke and steel assets and all its Ukraine-located coal assets are located in Donetsk region. In particular, the city of Mariupol hosts two of Metivest’s steel mills with a total annual capacity of 9.6 mmt (out of 13.5 mmt consolidated and 17.6 mmt total, including JVs). Also, the town of Avdiivka hosts its biggest coke plant (annual capacity – 4.0 mmt, out of 7.4 mmt total). Also, the town of Pokrovsk hosts its Ukrainian coal assets (half of both its production and its needs in coking coal).


We estimate that if Metinvest loses its Donbas assets, its EBITDA would drop by up to 40-50%, all other things being equal and averaged over the long term. This drop comprises not only the loss of the contribution from these assets, but also a decrease in iron ore business profits because of the synergy with Metinvest’s two Mariupol steelmakers. Namely, Metinvest might be unable to export the entire volume of iron ore it currently processed in Mariupol, in part because of logistics constraints. Furthermore, Metinvest will earn less on iron ore volumes if it does manage to redirect from Mariupol to other markets because the logistics costs will be higher.


Nevertheless, even though Metinvest’s credit quality will suffer in the worst-case scenario, it should be able to continue servicing its debt (USD 2.2 bln in total as of end-October), we think. Namely, even in case of the loss of all of the Donbas assets, Metinvest will still have gross leverage of no more than 2x over the long term.