Separatists may claim entire territories of two Ukrainian regions

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.