Polish Strategy On the right course and with tailwinds

Transcription

1 EQUITY MARKETS July 2010 Polish Strategy On the right course and with tailwinds Polish Strategy July 2010 Andrzej Knigawka Warsaw Tomasz Czyz Warsaw Adam Milewicz Warsaw Milena Olszewska, CFA Warsaw Piotr Palenik, CFA Warsaw Tamas Pletser, CFA Budapest pletser.tamas@ing.hu Dalibor Vavruska London dalibor.vavruska@uk.ing.com Jean-Baptiste Bouillaguet London (44 20) jean-baptiste.bouillaguet@uk.ing.com Alexandra Melnikova Moscow alexandra.melnikova@ingbank.com We expect modest gains for the Polish equity market in 2H10 with a year-end target level for the WIG20 index of 2,530. Diminishing supply of new share offerings, re-allocation of global capital towards EM, a stronger PLN (and weaker US$) and an increased share in MSCI indices should drive the market higher. Sector selection will be key. We favour banks over insurers, basic resources over utilities, mid-caps over blue-chips, consumer sectors over construction. Our focus list Buys are GTC, Handlowy, LPP, KGHM and PGE. PKN Orlen, Polimex and PZU are our top Sells. research.ing.com SEE THE DISCLOSURES APPENDIX FOR IMPORTANT DISCLOSURES AND ANALYST CERTIFICATION

2 Polish Strategy July 2010 Contents Equity market outlook 3 Fund flows 9 Local mutual funds...9 Local pension funds...9 Sector stance...10 Macro and politics 14 Banks 17 BPH...22 BRE...24 BZ WBK...26 Getin...28 Handlowy...30 Millennium...32 Pekao...34 PKO BP...36 Basic Resources 39 Andrzej Knigawka Warsaw andrzej.knigawka@pl.ing.com Tomasz Czyz Warsaw tomasz.czyz@pl.ing.com Adam Milewicz Warsaw adam.milewicz@pl.ing.com Milena Olszewska, CFA Warsaw milena.olszewska@pl.ing.com Piotr Palenik, CFA Warsaw piotr.palenik@pl.ing.com Tamas Pletser, CFA Budapest pletser.tamas@ing.hu Dalibor Vavruska London dalibor.vavruska@uk.ing.com Jean-Baptiste Bouillaguet London jean-baptiste.bouillaguet@uk.ing.com Alexandra Melnikova Moscow alexadra.melnikova@ingbank.com Arctic Paper...40 KGHM...42 Mondi...44 Stalprodukt...46 Chemicals 49 Ciech...50 Police...52 Pulawy...54 Synthos...56 Construction & Materials 59 Budimex...60 Cersanit...62 Kety...64 Mostostal Warszawa...66 PBG...68 Polimex MS...70 Food & Beverage 73 Astarta...74 CEDC...76 Cover photograph courtesy of istockphotos Pricing date 19/07/10 unless stated otherwise Publication date 26 July

3 Polish Strategy July 2010 Insurance 79 PZU...80 Media 83 Agora...84 Cinema City (CCI)...86 Cyfrowy Polsat...88 TVN...90 Oil & Gas 93 Lotos Group...94 PGNIG...96 PKN Orlen...98 Real Estate 101 Dom Development GTC Retail 107 EM&F LPP NG Vistula Group Technology 117 Asbis Asseco Business Solutions Asseco Central Europe Asseco Poland Comarch Comp Sygnity Telecommunications 133 Netia TPSA Utilities 139 CEZ Enea PGE Disclosures Appendix 146 2

4 Polish Strategy July 2010 Equity market outlook Key actionable changes in ratings In this note we change several actionable recommendations. We cut PZU to a Sell on price appreciation. We upgrade KGHM to a Buy on sector re-rating and record quarterly earnings expected in 2Q10. We cut our ratings on three construction companies PBG, Polimex and Mostostal Warszawa from Hold to Sell on a negative change in sector view. We believe now is the time to Buy GTC, which we upgrade from Hold on additions of new projects and a much more robust outlook for rents. We upgrade NG2 from Hold to Buy on expected strong 2Q10 earnings and gradually improving consumption patterns, which are likely to benefit mainstream brands first. We cut EM&F from Hold to Sell on price appreciation, rich valuations and more remote recovery prospects in up-scale retail segments. We rate Pulawy a Buy from Hold on price decline. We upgrade Agora to a Buy from Hold on attractive valuation. Fig 1 Key actionable stock ideas Company Rating Old rating Price (PLN) Target price (PLN) Old target price (PLN) Upside/downside (%) PZU Sell Hold KGHM Buy Hold GTC Buy Hold Polimex MS Sell Hold PBG Sell Hold Mostostal Warszawa Sell Hold NG2 Buy Hold EM&F Sell Hold Pulawy Buy Hold Agora Buy Hold Source: ING Key sector calls In terms of our core calls for 2H10, we move from neutral to overweight on the banks. Within financials our pair trade is to go long banks versus underweight PZU. We downgrade utilities from neutral to underweight with a strong preference for PGE over CEZ. We continue to underweight oil and gas. We change our stance on construction from overweight to underweight. Our new overweight sector stances are media (from neutral) and chemicals (from neutral). We maintain our overweight stance on the food and beverage sector as well as general retailers. We also have strong preference for mid-cap over blue-chip stocks, as the former offer superior earnings growth. Our last pair sector trade is consumer-related stocks with exposure to increasing consumer spending from relatively unleveraged Polish consumers over construction and capital goods producers which are likely to suffer from a squeeze in margins. Fig 2 ING sector and stock focus list Sector 1H10 return (%) ING stance Top picks Least favourite stocks Banks -1.4 Overweight from Neutral Millennium, Handlowy added, BZWBK Pekao SA, Getin added, BRE removed removed, PKO BP removed Insurance N/A Underweight PZU added Oil & gas 1.9 Underweight PKN Telecoms 0.0 Neutral TPSA added Media 10.0 Overweight from Neutral CCI, Agora added Construction 7.4 Underweight from Overweight Budimex, PBG removed Mostostal Warszawa added Real-estate -9.2 Neutral GTC added, Dom removed Retail N/A Overweight LPP, NG2 added EM&F Food and beverage 22.7 Overweight CEDC; Kernel removed Astarta added Basic resources N/A Neutral KGHM, Arctic Paper added Mondi added Chemicals 4.0 Overweight from Neutral Synthos added Ciech Building materials N/A Underweight Kety added Cersanit removed Technology -9.4 Neutral ABS added, Comp added, Asbis removed ComArch added, Sygnity removed Utilities -6.0 Underweight from Neutral PGE added; CEZ Source: ING 3

5 Polish Strategy July 2010 Fig 3 Changes in ratings and target prices Price Target price Old target price Upside/downside Rating Old rating Change Adj. EPS growth (%) (PLN) (PLN) (PLN) (%) 2010F 2011F Banks & insurance BPH Hold Hold Maintained n/a n/a BRE Hold Sell Upgrade BZ WBK Hold Hold Maintained 8 28 Getin Hold Hold Maintained Bank Handlowy Buy Buy Maintained Millennium Buy Buy Maintained 11, Pekao Hold Sell Upgrade 8 25 PKO BP Buy Buy Maintained PZU Sell Hold Downgrade Chemicals Ciech Hold Sell Upgrade n/a n/a Police Hold Hold Maintained n/a n/a Pulawy Buy Hold Upgrade n/a n/a Synthos Buy Buy Maintained Construction Budimex Hold Buy Downgrade Cersanit Hold Sell Upgrade n/a 33 Kety Buy Hold Upgrade Mostostal Warszawa Sell Hold Downgrade PBG Sell Hold Downgrade 7 1 Polimex MS Sell Hold Downgrade Food and beverage Astarta Sell Sell Maintained CEDC (US$) Buy Buy Maintained 51 6 General retailers EM&F Sell Hold Downgrade LPP 1, , , Buy Buy Maintained NG Buy Hold Upgrade Vistula Hold Buy Downgrade n/a 42 IT Asbis Hold Buy Downgrade n/a 42 Asseco BS Buy Buy Maintained 12 4 Asseco CE Buy Buy Maintained 1 12 Asseco Poland Hold Buy Downgrade -5-7 Comarch Sell Hold Downgrade Comp Buy Buy Maintained Sygnity Hold Hold Maintained n/a n/a Media Agora Buy Hold Upgrade CCI Buy Buy Maintained Cyfrowy Polsat Buy Buy Maintained TVN Hold Hold Maintained Mining and metals KGHM Buy Hold Upgrade Stalprodukt Hold Sell Upgrade Oil Lotos Sell Sell Maintained PKN Orlen Sell Sell Maintained Paper Arctic Paper Buy Buy Maintained Mondi Sell Sell Maintained Real estate Dom Development Hold Buy Downgrade GTC Buy Hold Upgrade Telecoms Netia Hold Hold Maintained TPSA Buy Buy Maintained Utilities CEZ (Kc) Hold Sell Upgrade -2 6 Enea Hold Hold Maintained 54 5 PGE Buy Buy Maintained PGNiG Hold Buy Downgrade Source: ING estimates 4

6 Polish Strategy July 2010 Fig 4 Valuation summary Price Target price Diff to Mkt cap EV/EBITDA (X) PER (X) P/BV (x) ROE (%) Div yield (%) Rec (PLN) (PLN) TP (%) (US$m) 2010F 2011F 2010F 2011F 2010F 2010F 2010F Banks & insurance BPH Hold , Neg Neg 0.0 BRE Hold , BZ WBK Hold , Getin Hold , Bank Handlowy Buy , Millennium Buy , Pekao Hold (4) 13, PKO BP Buy , PZU Sell (10) 10, Chemicals Ciech Hold Neg Neg 0.0 Police Hold Neg Neg 0.0 Pulawy Buy Neg Neg 0.9 Synthos Buy Construction Budimex Hold Cersanit Hold Kety Buy Mostostal Warszawa Sell (11) PBG Sell (9) Polimex MS Sell (12) Food and beverage Astarta Sell (17) CEDC Buy General retailers EM&F Sell (9) LPP Buy 1, , NG2 Buy Vistula Hold IT Asbis Hold Asseco BS Buy Asseco CE Buy Asseco Poland Hold , Comarch Sell (5) Comp Buy Sygnity Hold Neg Neg 0.0 Media Agora Buy CCI Buy Cyfrowy Polsat Buy , TVN Hold , Mining and metals KGHM Buy , Stalprodukt Hold (4) Oil Grupa Lotos Sell (29) 1, PKN Orlen Sell (19) 5, Paper Arctic Paper Buy Mondi Sell (29) 1, Real estate Dom Development Hold (1) GTC Buy , Telecoms Netia Hold TPSA Buy , Utilities CEZ (Kc) Hold (6) 26, Enea Hold , PGE Buy , PGNIG Hold (4) 6, ING universe Source: ING estimates 5

7 Polish Strategy July 2010 Very modest gains expected in 2H10 Fig 5 Poland vs EMEA We expect modest gains for the Polish equity market in 2H10 in zloty terms. Our bottomup derived year-end target level for the WIG20 index is 2,530 points. The WIG20 index advanced 4% in 1Q10 on flows to EMEA funds and investors expectations of earnings recovery. The index corrected by 9% in 2Q10 on significant supply of shares from the State Treasury, European fiscal worries and a declining euro. We believe equities will be supported by: (1) a narrowing supply of new share offerings; (2) a re-allocation of global capital towards emerging markets; (3) an undervalued currency; and (4) a stronger Eurodollar. On the negative side, domestic equity-related funds faced very thin inflows at PLN0.2bn in 1H10 and flows are likely to remain muted in 2H10. We struggle also to find a compelling case for corporate earnings surprises for the index heavyweights. Mid-caps offer better earnings prospects, which we believe are not priced in. For our coverage excluding WIG20 companies, we forecast a very strong 53% YoY rebound in net earnings in 2010F. Fig 6 Poland 1H10 sector returns Food Media Construction Chemicals Oil and gas Telecom Banks Energy 0 1/00 2/00 4/00 5/00 7/00 9/00 10/00 12/00 1/01 3/01 5/01 Real-estate IT MSCI Poland MSCI EMEA (10) Source: Bloomberg Source: ING estimates Sector selection is the key to delivering alpha in 2H10 Fig 7 WIG20 For at least two good reasons sector selection is the key to delivering alpha returns in what we expect to be an essentially flat market for the rest of the year. First, we expect very significant divergence of returns in individual sectors, with mid-caps likely to outperform blue-chips, and consumer-related stocks likely to beat construction and capital goods. Second, large IPOs, sell-downs and expirations of lock-ups have changed the composition of indexes significantly. Defensive stocks have a much higher weighting in the indexes, largely at the cost of banks. Banks are no longer such an easy proxy for the market. With a significant share of the indices geared to defensive sectors, we believe growth mid-cap stories are likely to attract more attention from investors. Fig 8 MSCI indices returns in 1H10 (%, US$) 3,000 2,500 2,000 1,500 Hungary Poland Czech Republic Russia South Africa 1,000 7/08 10/08 1/09 4/09 7/09 10/09 1/10 4/10 7/ Turkey Source: Bloomberg Source: Bloomberg 6

8 Polish Strategy July 2010 A sluggish total 8% YoY growth in earnings distorts the underlying differential in earnings momentum of individual sectors Zloty weakness is negative for earnings growth as exporters are underrepresented on the WSE We forecast sluggish earnings growth of 8% YoY in 2010F for our expanded Polish universe. Revised earnings momentum appears significantly weaker than the 39% that we expected in January. However, comparability is flawed by the incorporation of actual 2009 results and a broadening of coverage, including the addition of earnings-heavy blue chip companies PZU and PGE, which we expect to report declines in net earnings for the year. Our earnings growth projection for the like-for-like universe would have been 23% YoY now, 16ppt lower growth than expected in January. We cut our earnings estimates by 8% for the like-for-like universe, which explains 11ppt of the difference. Companies reported 5% higher 2009 earnings, which explains the remaining 5ppt difference. Comparable earnings growth is lower than expected in January despite an upward revision in GDP growth. Manufacturers restocking and exports have driven the upward revisions in GDP so far this year in Poland. Polish exporters are under-represented both on the WSE and in our universe versus their share of GDP. A weaker-than-expected zloty has an indirect negative impact on Polish banks earnings which make up 32% of our net earnings universe in 2010 and direct negative effect on net earnings for PGNIG, CEDC, media companies and general retailers. Fig 9 Contributions to GDP growth Fig 10 Recovery driven by supply side of economy Q04 3Q04 1Q05 3Q05 1Q06 3Q06 1Q07 3Q07 1Q08 3Q08 1Q09 3Q09 1Q10F 3Q10F Private consumption Public consumption Fixed Investments Inventories Net exports GDP Source: GUS, ING forecasts PLN offers the best fundamental value in the EMEA region /03 2/04 3/05 4/06 5/07 6/08 7/09 8/10 Source: ING estimates IP (%YoY) Export (%YoY, rhs) In our view, PLN offers the best fundamental value in the EMEA region. The zloty should rally through 4.0 versus the in the short-term and we see long-term fair value for the zloty at to the based on PPP comparisons. We expect the zloty to close at 3.9 to the at the end of 2010F and 3.6 at the end of 2011F Fig 11 trading back up... Fig 12...and PLN/ regaining ground /08 10/08 1/09 4/09 7/09 10/09 1/10 4/10 7/ /08 10/08 1/09 4/09 7/09 10/09 1/10 4/10 7/10 Source: Bloomberg Source: Bloomberg Poland is now 1.5% of MSCI EM and the share is growing Foreign flows are likely to be stronger on the back of an increase in MSCI weightings, an undervalued currency and an economy that is relatively isolated from double-dip risk. 7

9 Polish Strategy July 2010 Although the MSCI Poland index was down 19% in 1H10, the country weighting in the MSCI EM index increased to 1.48%, from 1.27% at the start of the year. There are still sell-downs planned for the next six months, but the value is likely to be significantly smaller compared with the PLN20.8bn sold by the State Treasury ytd. The only possible IPO of a state-owned company later this year is a listing of the Warsaw Stock Exchange, but it is going to be fairly small at c.pln0.8bn. The sell-down of a large block of PGE shares is likely to be postponed until As far as we are aware, there are no large listings of private companies coming to the market for the reminder of the year. Valuation premium to other EMEA markets widened in 1H10 due to a reduction in earnings estimates Based on revised estimates for our universe, the Polish equity market trades at 14.1x 2010F PER and a more attractive 10.9x 2011F PER. The MSCI Poland index trades at 11.9x 2010F PER versus a historical average of 12.5x. EMEA markets trade at an average 8.9x 2010F PER. Polish valuations are at a 37% premium to EMEA markets, a wider than historical average premium of 23%. The premium has widened slightly since January despite MSCI Poland underperforming MSCI EMEA by 7ppt, because the market has scaled back earnings expectations for Poland. Fig 13 MSCI PL vs MSCI EMEA 12m FWD PER multiple (x) Fig and premium (%) /00 2/00 3/00 4/00 5/00 6/00 Poland EMEA Poland hist avg EMEA hist avg /97 2/99 2/01 2/03 2/05 2/07 2/09 12m FWD PER premium over MSCI EMEA Avg hist premium Source: Bloomberg Source: Bloomberg 8

10 Polish Strategy July 2010 Fund flows Local mutual funds According to our calculations, domestic mutual funds recorded PLN5.6bn of cash injections in 1H10, over two times more than the PLN2.1bn attracted throughout the whole of However, 1H10 money inflows were mainly attributable to non-equity funds (money market and bonds), which collected PLN5.4bn. Equity-related funds (balanced, stable growth and pure equity) faced modest inflows of PLN0.2bn. AUM grew by 8% YTD as of end June 2010 and reached PLN99.5bn (US$30bn). However local mutual funds would need a further PLN46bn increase in AUM to approach the record high levels recorded in October 2007 (PLN145bn AUM). Equity holdings increased only slightly, by 1% YTD to PLN33bn (US$9.9bn). Fig 15 Mutual funds AUM (PLNbn) Fig 16 Net purchases of equities (PLNbn) /03 06/04 06/05 06/06 06/07 06/08 06/09 06/ Jan 07 Jan 08 Jan 09 Jan 10 70,000 60,000 50,000 40,000 30,000 20,000 10,000 0 (Index value) Equity-related funds* Other funds Net purchases of equity (lhs) WIG index (rhs) *pure equity, balanced and stable growth Source: ING estimates Source: ING estimates Fig 17 Flows to mutual funds (PLNbn) /05 5/05 9/05 1/06 5/06 9/06 1/07 5/07 9/07 1/08 5/08 9/08 1/09 5/09 9/09 1/10 5/10 Non-equity funds Equity-related funds* *pure equity, balanced and stable growth Source: ING estimates Local pension funds In 1H10 domestic pension funds purchased equities worth PLN10.7bn, more than they had bought in the whole of 2009 (PLN10bn). 1H10 equity purchases were mainly dedicated to two large IPOs (PZU and Tauron) and plenty of State Treasury placements (KGHM, Lotos, Enea, Bogdanka and Mennica). AUM increased by 8% YTD to PLN193.2bn (US$58.2bn) as of end June

11 Polish Strategy July 2010 Fig 18 Pension fund AUM (PLNbn) Fig 19 Net purchases of equities (PLNbn) /00 06/01 11/02 04/04 09/05 02/07 07/08 12/09 (PLNbn) Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 70,000 60,000 50,000 40,000 30,000 20,000 10,000 (Index value) Equities Debt instr, bank deposits, cash Net purchases of equity (lhs) WIG Index (rhs) Source: KNF Source: KNF, ING estimates Equity allocation in Polish pension funds reached 32.5% as of end-june 2010, still significantly higher than the historical monthly average of 30%. Given high equity purchases YTD, demanding levels of equity allocation and poor macro sentiment, we believe that domestic pension funds may be passive on the secondary market in the short term. Fig 20 Equity allocation of pension funds (%) /00 09/02 04/05 11/07 06/10 Equities as % of AUM Historical average of equity allocation Source: KNF Sector stance Banks We upgrade our stance on banks from neutral to overweight. There are few signs that loans may significantly accelerate but we think that the market is too focused on volume growth this year. The recent series of major rate cuts on retail deposits and increases of account prices is evidence of softening competition. As the result even in case of possible disappointments is balance sheet growth there is a meaningful chance for positive surprises in earnings (we are above consensus in most of the banks). Moreover, in 2-3 months the market will start discounting the 2011 outlook which still looks good thanks to improving macro (falling unemployment and appreciating currency should help retail lending quality, growing interest rate should support margins). Millennium and Handlowy are our top picks (Millennium because of low PBV and recovering earnings; Handlowy because of low PER). We are still positive on PKO BP, although we perceive the potential acquisition of BZ WBK as more of a risk than an opportunity. Utilities We downgrade our weighting for the utilities sector from neutral to underweight, as we expect the sector to underperform in a growing market. Even though we upgrade CEZ to Hold on valuation grounds (we no longer have downside), we continue to dislike the stock 10

12 Polish Strategy July 2010 and believe the sentiment towards CEZ will remain mediocre in the coming months; due to: (1) its hedging strategy (currently its hedged prices are below the EEX curve); (2) guidance for falling earnings in 2010 with the risk of additional costs; and (3) an outlook for flat 2011 earnings, less attractive than at Polish peers. As a result, we would switch CEZ for PGE, which is our top-pick in the segment. We like PGE as: (1) it is a leader in the generation segment in Poland, which we consider the best place to be; (2) due to its younger-than-average generation fleet it should be the key beneficiary of expected growth in electricity prices; and (3) we see 20% earnings growth in 2011 after the launch of the new Belchatow block. We remain neutral on Enea. On one hand we see growth in earnings due to the impact of RAB revaluation. On the other, we believe that there may be disappointment in the market if a strategic investor is not found for the company at prices expected by the Polish State Treasury. The electricity utilities trade at 5.8x 2010F EV/EBITDA and 5.4x 2011F. We cut our recommendation on PGNIG to Hold based on revised earnings estimates, as adverse tariff decisions show that the regulator remains openly hostile to company efforts to receive fair returns in the wholesale trade segment. PGNIG is also increasing its E&P capex on shale gas exploration, but production is unlikely to increase in the short-term. Oil and gas We expect Lotos Group and PKN Orlen to underperform in the coming months on a weaker outlook for refining margins in the second half of the year and softening retail margins. Refining economics could take a hit in the second half of the year after margin performed well in 1H10. However, as both US and European distillation units are running at full capacity after the recent large-scale maintenance shutdowns, the risk of product overhang is increasing again. Meanwhile, the demand side, especially in Europe, does not look promising. Key middle distillate crack spreads look poor given high US and Middle East imports to Europe and the lukewarm recovery of transportation. Moreover, we expect the lucrative retail margins to soften in 2010 for both companies, due to more intensified competition after Lotos ramped up refining production and slower demand growth from households and industry in Poland. Media We upgrade media from neutral to overweight on improved prospects for earnings growth. In the past GDP growth of over 3% in Poland drove high-single-digit or even double-digit growth in ad spend. We forecast 3% total ad spend growth in 2010F and an acceleration to 8%/12% in 2011F and 2012F. Internet, television and cinema advertising will lead the growth. Our top pick remains CCI. CCI offers a unique combination of high free cash flows with decent underlying growth driven by cinema openings. Management deleveraged the balance sheet and has a number of options to reinvest excess cash in the core business, including both organic development as well as M&A. We upgrade Agora to Buy as we believe the acquisition of Helios is a transforming milestone for the group, which should allow it to reduce its share of free-falling newspaper advertising to just 24% of group revenue in 2011F. The company s internet segment is seeing robust top-line growth, has captured increased market share from competitors and is expected to break even at the EBITDA level this year. We also like Cyfrowy for its ability to address the challenges of a decelerating satellite TV market in Poland. Management has a number of options to grow ARPU and revenue. We expect the share price to be driven by the market shifting attention from subscriber growth to positive trends in ARPU, solid earnings recovery and investors playing down concerns about the competition, which is either financially constrained (N) or suffering from managerial shake-up (Cyfra+). Technology We maintain our neutral weighting for the Technology sector. We believe that after a difficult 2009, 2010 is not going to be much better, as IT budgets are still under pressure. In our opinion, corporates will be willing to conduct only necessarily investments, which 11

13 Polish Strategy July 2010 may mean some growth in demand for hardware (already visible) and crucial IT systems, such as ERP software or security. However, contrary to earlier months, we believe it will not be the business model but company specific issues driving the earnings and share performance. Thus, even though we see a pick-up in hardware spending (especially in the CIS region) we downgrade Asbis to Hold, due to high FX risk. We believe that software houses will continue to prove more immune to the slowdown than integrators, but our ratings are based on the speed of expected earnings improvement. We are most positive on ABS and Asseco CE (both Buys), subsidiaries of Asseco Poland, rather than the parent company itself, which we downgrade to Hold. In ABS we like the strong earnings pattern, a consequence of cost reductions, and the possibility of acquisitions. In Asseco CE we like the attractive multiples and the gradual recovery from past problems. At Asseco Poland, however, we see a rather unattractive earnings pattern and a sizeable risk of US acquisition, financed from yet another equity issuance. Our third top-pick in the IT segment would be Comp, where we expect a scale change in 2Q10 earnings (making up for the poor 1Q10), due to the strong backlog, and we see potential for new contracts. At the same time we are disappointed with the pace of restructuring at Comarch and Sygnity. At Comarch (downgraded to Sell) we see further problems in two areas: German SoftM and new ventures, which continue from At SoftM costs have been reduced but revenues fell to a greater extent, which will mean another year of losses, in our opinion. The new ventures are disappointing, with losses expanding rather than contracting. At Sygnity we similarly believe that despite further restructuring, high losses are likely in On 12.6x 2010F PER and 12.3x 2011F PER, the sector multiples do not look demanding and selected IT companies could follow the examples of Teta or Wola Info and be taken over by international players. Retail We maintain our overweight for the late-cyclical retail sector, as we believe that the worst trends in consumption materialised in 1H10. We expect economic indicators to gradually improve, with 2010F GDP growth reaching 3.2% (versus 1.8% in 2009), private consumption growing 2.5% in 2010F and 3.7% in 2011F (versus 2.2% in 2009) and the unemployment rate stabilising at 11.9%. We believe that the strong floods have already had their negative impact on consumption. In our opinion, a gradual recovery in consumption should be visible first at the level of average Poles, thus at the level of mainstream brands. We expect like-for-likes to start building up in the coming months, coming out of negative territory around 4Q10. We believe that this picture is only likely to be spoilt temporarily by FX. We have seen the zloty in a depreciating trend versus US$ and euro, which means increased COGS and rental expenses for retailers. We believe that with gradually improving consumption patterns, retailers may be more eager to transfer the increased cost of inventory onto consumers in 2H10. Our macroeconomists expect the zloty to return to an appreciating trend in 4Q10, which could provide another share price stimulus. As a result, we would play mainstream retailers (LPP, NG2) versus up-market ones (EM&F and Vistula Group), with the mainstream players being more exposed to FX due to a lack of hedging and sizeable sourcing from China. Our top picks in the sector are LPP (Buy maintained) and NG2 (upgraded to Buy). We see strong earnings dynamics as well as attractive multiples. In the short-term, we see a better 2Q10 earnings outlook at NG2 than at LPP. However, we point out that NG2 s CEO may continue to reduce his stake in the company. In addition, both players pay dividends. We dislike EM&F (downgrade to Sell) and Vistula Group (downgrade to Hold) as these are both up-market players, operating in lifestyle and luxury, respectively, and we expect improved trends in these areas only in We see rich valuations at both companies. We believe that in the case of EM&F, the market is paying too much for security in the form of currency hedging, which we find unwarranted given our currency forecasts. We understand the more elevated multiples of Vistula Group, coming out of solvency problems. Nevertheless, we still see the company struggling with NWC, so as to finance 12

14 Polish Strategy July 2010 the increased December inventory purchases. We point out that valuations in the retail segment are starting to look rich, at 19.4x 2010F PER and 14.9x 2011F PER. Construction We downgrade Polish contractors from overweight to underweight on an expected squeeze in 2011 margins, an overly optimistic market consensus on 2011F earnings and a likely delay in signing large power construction contracts. The WIG Construction index has gained 13.3% YTD compared to a 6% increase in the WIG. Despite expectations of strong results in 2010, as a late-cyclical play the sector will be affected by margin deterioration beginning in The secured backlog of contracts should guarantee revenue growth in 2010 and 2011 in case of all major contractors, but the economic rebound will translate into increased construction materials prices and pressure from subcontractors. As a result, the impact on profitability will be negative. We also believe that expectations of supportive newsflow in 2H10 related to large power block construction contracts (including tenders for Kozienice ( 1.6bn), Opole ( 3.0bn) and Siekierki ( 0.7bn) will be pushed back until 2011 following delays in tender processes. We downgrade Mostostal Warszawa (MSW PW; Sell; TP PLN60), Polimex (PXM PW; Sell; TP PLN4.0) and PBG (PBG PW; Sell; TP PLN200) to Sell. Mostostal Warszawa is our least preferred construction company, primarily related to intensified competition in the company s core segment of infrastructure, a lack of large signings over the past few months and also a lack of diversification into cyclical construction segments. We downgrade Polimex to Sell on expectations of weak 1H10 results which will not be caught up in 2H10, resulting in flat YoY net profit in 2010F. Although the company is perceived to be the frontrunner in the award of power block tenders, delays in tender processes will also delay supportive newsflow. We downgrade PBG to Sell on worries that entry into road construction, which already constitutes 26% of the backlog, will deteriorate profit margins beginning from Chemicals We upgrade the sector rating for chemical producers from Neutral to Overweight. Among sector indices WIG Chemicals was the worst performing index in 2Q10. WIG Chemicals dropped 12.5% QoQ in 2Q10, underperforming the market by 5ppt. For fertilizer producers we expect a recovery in fertilizer prices in 2H10, driven by a rebound in grain prices caused by concerns about low harvests in FSU-12, Canada, EU-27 and India. At the same time, we agree that 2010/11 global grain ending stocks are forecast at demanding levels of 464m tonnes and thus may curb significant growth in grain prices in the medium term. All in all, we forecast 10-15% YoY growth in fertilizer prices in 2010F versus a 30-50% YoY drop in We upgrade Pulawy from Hold to Buy, as we expect a rebound in FY11F earnings driven by a recovery in nitrogenous fertilizer prices, a revival in the performance of the chemical sector and a gradual improvement in the company s export competitiveness. Our top pick is still synthetic rubber producer Synthos (Buy, TP: PLN2.24) given cheap valuations (9.4x 2010F PER, or a 25% discount to global peers) and conservative consensus for 2010F earnings (our forecasts of EBITDA and net profit are 12% higher than market expectations for both). Paper producers We have a neutral view on Polish paper manufacturers. However, we advise investors to switch from Mondi to Arctic Paper. We would be Buyers of Arctic Paper (Buy, TP: PLN17.8) given an expected decline in pulp prices (34% of operating costs) in 2H10 driven by restoration of global supply. We forecast 178% YoY growth in EPS, implying an attractive 2011F PER of 9.1x, or a 10% discount to global peers. We do not like Mondi (Sell; TP: PLN52.6) given rich valuations (30.6x 2010F PER, or a 132% premium to peers) and overly optimistic consensus for 2010F earnings (our forecasts of EBITDA and net income are 22%/37% lower than consensus, respectively). 13

15 Polish Strategy July 2010 Macro and politics The Polish economy stacks up well against other EMEA markets, with low household debt, a higher share of domestic consumption, prudent fiscal policies and relative resilience to external uncertainties. GDP growth estimates in Poland are being revised upwards as the economy wakes from a winter-related investment slump, helped by more robust German demand and post-flooding reconstruction. ING expects 3.2% GDP growth in 2010F, with the key drivers being private consumption responsible for 1.5% of the 3.2% growth and manufacturing restocking, responsible for 1.3%. Fig 21 Key macro indicators F 2011F 2012F Activity Real GDP (%ch YoY) Private consumption (%ch YoY) Private investment (%ch YoY) (0.4) (2.3) Government expenditure (%ch YoY) Industrial production (%ch YoY) (3.6) Unemployment rate (%, end period) Nominal GDP (US$bn) Gross domestic saving (% of GDP) Prices CPI (%ch YoY, annual average) PPI (%ch YoY, annual average) Enterprise sector wage rates (%ch YoY) Enterprise sector unit wage costs (%ch YoY) (13.0) 0.5 (6.4) (0.1) Fiscal balance Budget balance (% of GDP), ESA 95 (5.7) (4.3) (3.8) (2.1) (2.5) (7.1) (7.0) (6.7) (5.2) Public debt (% of GDP), ESA External balance Exports (US$bn) Imports (US$bn) Trade balance (US$bn) (5.6) (2.8) (7.0) (16.6) (24.6) (4.5) (6.0) (17.6) (30.2) Current account balance (US$bn) (10.7) (4.8) (11.1) (19.6) (28.2) (7.2) (7.2) (12.1) (30.0) Current account balance (% of GDP) (4.5) (1.8) (3.2) (4.6) (5.4) (1.7) (2.1) (2.5) (5.3) Export volume (%ch YoY) (19.0) Import volume (%ch YoY) (26.8) FX reserves (ex gold, US$bn), year end Debt indicators Gross external debt (US$bn) Gross govt. external debt Gross external debt (% of GDP) Gross external debt (% of exports) Government foreign debt service (US$bn) Government foreign debt service (% of GDP) Interest & exchange rates Broad money supply (%ch YoY) year end month interest rate (%) annual average Long bond yield (5yr, since yr, %) end Long bond yield (5yr, since yr, %)av Exchange rate (US$/PLN) year end Exchange rate (US$/PLN) annual average Euro/US$ year end Euro/US$ annual average Exchange rate (Euro/PLN) year end Exchange rate (Euro/PLN) annual average week t-bill year-end Source: ING estimates Interest rates to stay flat in 2H10 We expect interest rates will only move higher in 2011F, with no change forecast until 1Q11F. The current monetary policy council is more dovish than the previous one. Mr Marek Belka, the newly appointed Central Bank Governor, has an IMF background and will be placing stronger emphasis on global economic matters when discussing interest rate changes. With a deflationary external environment and only moderately higher 14

16 Polish Strategy July 2010 growth in private consumption, the outlook for interest rates is stable. The FRAs market is pricing two 25bp interest rate increases over the next 12 months. Low expectations for progress on reforms as the next elections are looming Fiscal reforms at a dead end The time for cheap excuses is over for the government. Civic Platform's (PO) candidate Mr Komorowski won the presidential elections in July. We struggle to see a credible reform agenda anywhere further down the legislative channel, other than near the point of conceptual discussion or drafting. We also have low expectations for reforms progress, as municipal elections are scheduled in 2010 and general elections are planned for With no unpopular reforms planned (and not too many popular reforms either) PO appears to be moving towards being able to form a one-party cabinet post the 2011 general elections. Current opinion polls indicate a reasonable chance of a one-party majority in the future parliament. The key to fiscal reform is held by the junior coalition partner, the Polish Peasants Party (PSL). The farmers pension system is a potential source of the largest single saving for the central budget in the future. But reform of the farmers pension system has faced major resistance from the PSL in the past. PO appears unable to break the deadlock. Fiscal reforms seem to be concentrated on the enhancement of tax collection as well as incentivising recipients of social benefits to actively seek jobs. In our view, the accelerating economy would have enabled the government to trim the planned central budget deficit of PLN52.2bn by PLN10-15bn, were it not for flooding-related reconstruction and spending. 15

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18 Polish Strategy July 2010 Banks 17

19 Polish Strategy July 2010 Banks Fundamental highlights for Polish banking sector: In 1Q10 margins were fairly good (only BRE recorded a QoQ contraction in NIM) ie, the expected rebound continued. However, we had been concerned that the 2Q10 outlook would be spoilt by declines in interbank rates, which would reduce deposit margins. Surprisingly, the guidance from managements was rather positive. Most of the banks highlighted the positive impact from the reduction of rates on deposits, which they offer. It clearly indicates that the deposit war is ending fairly quickly, particularly in the retail segment. It was also confirmed by several press reports complaining of poor rates offered by banks to customers. Therefore, we believe that in 2Q10 NIM will improve at most of the banks, which will be an important driver for NII improvement this quarter. The jump in cost of swaps in mid-2q10 will affect 3Q10 rather than 2Q10, and it should be smaller than last year (after s bad experience with swaps, banks extended the maturity of their hedging). The end of the deposit war is likely to be connected to the fact that there is no need for liquidity as lending volumes are still fairly weak, for the same reasons as in the past three or four quarters (weak demand for corporate loans, weak supply of cash loans). Please note that reported volumes will probably show much greater growth than in 1Q10 (when deposits fell by 0.2ppt and loans by 0.3ppt) because of the depreciating PLN that will inflate the existing stock of FX loans. Fig 22 Spreads on retail deposits (ppt) Fig 23 Spreads on corporate deposits (ppt) /05 7/05 1/06 7/06 1/07 7/07 1/08 7/08 1/09 7/09 1/10 New On stock /05 7/05 1/06 7/06 1/07 7/07 1/08 7/08 1/09 7/09 1/10 New On stock Source: NBP, Bloomberg, ING estimates Source: NBP, Bloomberg, ING estimates Fees are likely to record small growth due to good capital markets (brokerage rather than mutual funds) and loan fees (sales of corporate loans are still weak but mortgages should improve). Also, transactional fees should improve slightly due to stronger activity after a weak 1Q10. Provisions are likely to grow QoQ (by 5%). The general pressure from corporate and cash loans should decline, but there is likely to be a seasonal review of portfolios after 1H. Additionally, there is likely to be growth of provisions in mortgage lending (especially affecting Getin, BPH) and for banks there will be base effects due to positive surprises in 1Q10 (Handlowy, BZ WBK). In 2H10 the situation should start to improve and poor May data (major growth of NPLs in the banking sector) seems to be the exception rather than the acceleration of negative trends. Depreciating PLN should not affect the quality of corporate loans (companies are not over-hedged as they were in late 2008) and the impact on the quality of mortgage loans will be limited as long as CHF interest rates stay low. All in all, we believe that the peak of total NPLs will be in 2Q10 or 3Q10. 18

20 Polish Strategy July 2010 After four consecutive quarters of YoY reduction, costs are likely to pick up in 2Q10 and this trend should continue after that. However, the YoY growth rates are not likely to be high (we forecast 2% in 2Q10) and will be connected mainly with unfreezing of salaries and a small revival in marketing expenses. QoQ growth will be slightly higher (+4%) but it will be partly a seasonal effect. All in all, we think that 2Q10 will be moderately good. There will be very small growth of earnings in comparison with 1Q10 (+1% QoQ) but we should remember that 1Q10 was surprisingly good for the sector. We see a chance for positive surprises in the case of PKO BP, Pekao and Millennium. There is a risk of disappointments in the case of BZ WBK and Getin (BPH is likely to show very high losses but it was flagged by management in May so should be in the price already). Fig 24 Change in ING forecasts for profits of Polish banks Previous forecast (PLNm) New forecast (PLNm) % change 2010F 2011F 2010F 2011F 2010F 2011F BPH (117) 227 (190) BRE BZ WBK 1,001 1, , Getin Handlowy Millennium Pekao 2,688 3,392 2,615 3, PKO BP 3,007 3,985 3,056 4, Total 8,497 11,847 8,353 11, Source: ING estimates We do not make major changes to our forecasts (2010F earnings are revised down by 2%). In fact, if we exclude Getin and BPH which face problems with mortgage lending the profit forecasts for the sector would be unchanged. We slightly increase fee forecasts and slightly reduce NII. We believe that the outlook for earnings is good in the medium term, as the deposit war is softening and in 2H10 we should at last see a meaningful decline in provisions and firm signs of an upcoming turnaround in loan quality. Volumes will be weak but it is hard to believe that they will deteriorate more (we do not believe that the so called Recommendation T of banking supervision will affect lending to a major extent). The main internal risk is connected with pressure on lending margins. The external risk seems to be more important, ie, the turmoil in the financial systems of EU countries. Polish banks have negligible exposure in terms of assets/financing, but they may be hit indirectly in two ways. Firstly, if we see falling valuations in Europe it will inflate the relative valuation of Polish banks more (and they are not very cheap; although the 30/40% premium on 2010F/11F PER versus EMEA banks is the same as six months ago). Secondly, the growth of risk may increase the cost of FX swaps more, which would affect NIM (Getin, Millennium). Because internal risks are relatively small, the 2H10 earnings outlook seems to be good (we are above consensus for most of the banks) and comparatively good 1Q10 results were not factored in by the market, we upgrade our relative stance on the banks versus the Polish market from Neutral to Overweight. After the upgrade of Handlowy from Hold to BUY earlier this month, in this report we upgrade Pekao and BRE (both from Sell to HOLD). Our current order of preference for the Polish banking sector would be: Handlowy, Millennium, PKO BP, BRE, BPH, BZ WBK, Pekao, Getin. 19

21 Polish Strategy July 2010 Fig 25 Growth of loans in Poland (% YoY) /03 1/04 1/05 1/06 1/07 1/08 1/09 1/10 Corporate loans Retail loans Total loans Fig 26 Growth of deposits in Poland (% YoY) /03 1/04 1/05 1/06 1/07 1/08 1/09 1/10 Corporate deposits Retail deposits Total deposits Source: NBP Fig 27 Loans and deposits structure (May) Source: NBP Fig 28 Loan growth by segments(% YoY) 100% 80% 60% 40% 20% 0% Deposits Loans Corporate Micro companies Mortgage Cards Consumer finance Retail Corporate Public Jun-08 Dec-08 Jun-09 Dec-09 May-09 Source: NBP Fig 29 Structure of loan portfolios in 1Q10 (%) *mainly consumer loans Source: NBP Fig 30 Loans and deposits change in 1Q10 (% YoY) 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% GTN MIL BPH KRB PKO BRE PEO ING BZW BHW Mortgage Retail Corporate Deposits PEO KRB BRE BZW MIL BHW ING GTN PKO Loans Note: retail all non-mortgage retail Source: Company data Fig 31 Loans / deposits ratio in the sector (%) Fig 32 Loans / deposits ratio by banks (%) /04 6/05 12/05 6/06 12/06 6/07 12/07 6/08 12/08 6/09 12/ BHW ING BZW PEO GTN PKO KRB MIL BRE BPH 1Q09 1Q10 Source: NBP Note: BPH affected by merger with GEMB 20