Stock market surges to near record high

The Ukrainian stock market has surged over the last year, with trading in blue chips and lesser-known stocks nearing all-time highs, as investor confidence takes root in the country's increasingly pro-Western political landscape.

Concorde Capital, a Kyiv-based investment firm, reported in its daily market comment on Feb. 13 that an influx of new investors pushed stock prices on Ukraine's First Stock Trading System (PFTS), the country's principle trading platform, to near record highs. An index of the top ten stocks increased to 388.82 the week before - a 12 percent increase since the start of this year, and close to all time highs before the financial crisis of the late 1990s.

Well-known blue chips - such as the state-owned oil and gas drilling company Ukrnafta, fixed-line telecom monopoly Ukrtelecom, and pipe producer Nyzhnyodniprovsky Pipe (NPR) - all saw gains on the trading system.

Dragon Capital, another Kyiv-based investment firm, said in its daily newsletter on Feb. 14 that the KP-Dragon Index, a free-float market cap weighted index that measures top-traded Ukrainian stocks, closed at 3,721 on Feb. 13, a change of 14.7 percent since the start of this year.

The index's growth since the beginning of this year follows a 42 percent surge in 2005, although it is still about 9 percent below its September 1997 level when it peaked at more than 4,000 just before the financial crisis.

According to Dragon Capital, Feb. 13 saw shares in Ukrnafta trading 21.4 percent higher compared with the beginning of this year.

Ukrtelecom shares grew by 32.1 percent, Azovstal shares surged by 33 percent, and shares in Ukrsotsbank, one of Ukraine's largest banks by net assets, increased by 35.6 percent during the same period.

According to the index, Ukrainian stock prices began falling in June 1998 in the wake of the financial crisis that hit the country that year, with the index plummeting to sustained lows of well under 1,000 after which the market began recuperating gradually again in 2002.

Market politics

John Suggitt, Concorde Capital managing partner, said Feb. 13 that the Ukrainian stock market is being driven by investors who've recognized the value of buying into Ukraine before the March parliamentary elections.

"In addition, Ukraine finally appeared on the emerging market map for portfolio investors last year," Suggitt said.

"There are a number of new investors taking up new positions in the country. A couple of Ukraine-dedicated funds have also opened up, which is pushing prices higher."

Suggitt said that even if the stock market were to come off its current highs within the next three months, it would be impossible for investors holding long positions in the market to lose.

"It is likely there will be a slight easing in prices during the second half of this month and up until the March elections," Suggitt said, adding that demand will likely continue to rise in line with investor confidence in Ukraine as a whole.

He added, however, that most big portfolio managers are very hesitant to invest in the current political climate.

"The most active people on the Ukrainian market in the last few weeks have been very experienced long-term Ukraine investors," he said. "Big firms are slow machines and afraid to commit any capital without more indication of who will be running the country."

Dragon Capital Managing Director Tomas Fiala links the market's resurgence to Ukraine's economic performance over the last several year and the presidential elections at the end of 2004, when widespread civil unrest overturned an attempted coup through falsified election results by political strongmen aligned with outgoing President Leonid Kuchma.

Fiala told the Post on Feb. 15 that there were three phases to the market's rebirth over the past two years. In the first phase, he said, the market finally attracted attention of investors in early 2004, on the back of four years of strong economic growth and an improving macroeconomic picture. This phase ended in early summer of 2004 when the attack on Yukos took down the Russian market and Ukraine followed suit.

"The second phase started in early fall of 2004, with investors starting to place bets on a positive outcome of the presidential election," Fiala said. "The growth accelerated on Dec. 3, 2004 following the Supreme Court ruling to carry out a re-vote of the second round and continued until early February 2005."

He said that a 20 percent correction followed and the market bottomed out in June 2005. Since then, the market has been trending up, but this time, "investors have been more selective and the index does not look like a straight line anymore." Fiala said that company-specific results are currently the main driver of individual stock prices.

"However, as we get closer to the [parliamentary] election, the political news flow is having a stronger impact."

As to the behavior of the market following the elections, Fiala said that would depend on who wins.

"The market would react positively to a strong result from the parties that supported Viktor Yushchenko in the presidential race," he said.

Fiala added that over the past 18 months, the turnover in Ukrainian shares and depositary receipts has increased from $1 million to $10 million a day. Approximately one-third of that turnover shows up on the PFTS.

"Provided we have good election results, the daily turnover should exceed $20 million by year-end."

Hot stocks

While volumes and prices remain only a fraction of those seen in more developed markets, including Russia, Ukraine's stock market has been on a hot streak.

"After years of feeble trading limited to a handful of stocks, the Ukrainian stock market exploded last year on the back of high expectations associated with the election of a pro-West president in December 2004," Dragon Capital said in a Feb. 2 press release.

"Many stocks in the banking, machine-building, mining, and steel sectors, which had been dormant for years, suddenly returned from oblivion as investors shifted from the narrow segment of well-known blue chips to undervalued second - and third-tier names," the investment firm said, adding that the most actively traded among those became members of Dragon Capital's index as of Feb. 1.

It said that KP-Dragon's new large - and mid-cap components now include Bank Aval and Ukrsotsbank, Dniprooblenergo and Zhytomyroblenergo (energy distribution), LuAZ and Mariupol Heavy Machine Building, Dniproshyna (tires), Azovstal (metallurgy), Poltavsky GOK (mining), and Zaporizhkoks (metallurgy-coke).

Prior to this, KP-Dragon consisted of generators such as Centerenergo, Dniproenergo, Donbasenergo and Zakhidenergo; Kyiv's power company Kyivenergo, pipe plant NPR, chemical factory Stirol, Ukrnafta, Ukrtelecom, and steel company Zaporizhstal.

Concorde's Suggitt said that Ukrnafta and Ukrtelecom are currently the hottest stocks trading on the PFTS.

"Rising gas prices combined with Ukrnafta's plans to begin developing its gas reserves make it a definite buy," said Suggitt.

Most of the buying in Ukrtelecom, he said, is pure speculation that the state will privatize the fixed-line provider this year or in 2007.

"The machine builders Luganskteplovoz and Mauriupol Heavy Machine Building are two of the hottest picks in less liquid names."

Suggitt said that liquidity in Ukraine has improved vastly from where it was two years ago and that it is much easier to move in and out of big positions in the top-five names on the Ukrainian stock market than ever before.

"That said, it is still a highly illiquid market. Free floats are limited and trading volumes are too small for most big funds."

He said, however, that Ukraine's investor base increased significantly last year and will continue to grow this year.

"It's only a question of time."

He also said that the Ukrainian market resembles Russia about five years ago. According to Suggitt, the surge in commodities prices for oil, gas and steel provided a big boost in investor interest in Russia over the last few years.

In addition, he said, a spate of initial public offerings, the introduction of American Depository Receipt programs and a healthy Russian asset management business in Russia have been instrumental in making it into a much more sophisticated market.

However, Suggitt said, the spreads in Russia are not at all what they used to be.

"There is much less opportunity in Russia than before. Four years from now, trading [Russian oil giant] Lukoil will be as dull and low-yield as trading Wal-Mart and Shell."

According to Dragon Capital's Fiala, the Russian market currently boasts market capitalization of more than $600 billion compared with Ukraine's $30 billion, making it about 20 times bigger, while daily turnover in Russia is approximately $2 billion - 200 times more than its southern neighbor's.

"The first reason is that the size of the Russian economy is nine times the size of Ukraine's GDP," Fiala said. "The second is the presence of some of the world's largest natural resource companies that are doing very well, given the current very high commodity prices."

Fiala said, however, that Ukraine's economy is more diversified than Russia's and that this will also be reflected on Ukraine's stock market.

He said that before the 2004 presidential election, Ukraine used to follow Russia with a time lag of approximately one week due to lower liquidity. Russia was also the main benchmark for calculating fair values for Ukrainian stocks.

But since then, he said, other emerging markets have also begun to matter, adding that this especially pertains to Central European markets, which have market sizes, economy structures and sovereign risks that are similar to Ukraine's.

"For the above reasons we find it more appropriate to benchmark Ukraine against Central European economies like Poland, the Czech Republic, and Romania. They are closer in terms of the size and structure of the economy."

Stephan Ladanaj, Kyiv Post Staff Writer
Feb 16 2006