Polish Strategy - PBG SA · Polish Strategy July 2010 3 Equity market outlook In this note we...

SEE THE DISCLOSURES APPENDIX FOR IMPORTANT DISCLOSURES AND ANALYST CERTIFICATIONresearch.ing.com

EQUITY MARKETS

July 2010

Polish StrategyOn the right course and with tailwinds

Polish StrategyJuly 2010

Andrzej KnigawkaWarsaw +48 22 820 [email protected]

Tomasz CzyzWarsaw +48 22 820 [email protected]

Adam MilewiczWarsaw +48 22 820 [email protected]

Milena Olszewska, CFAWarsaw +48 22 820 [email protected]

Piotr Palenik, CFAWarsaw +48 22 820 [email protected]

Tamas Pletser, CFABudapest +36 1 235 [email protected]

Dalibor VavruskaLondon +44 20 7767 [email protected]

Jean-Baptiste BouillaguetLondon (44 20) 7767 [email protected]

Alexandra MelnikovaMoscow +7 495 755 [email protected]

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.

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Polish Strategy July 2010

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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 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

Andrzej Knigawka Warsaw +48 22 820 5015 [email protected]

Tomasz Czyz Warsaw +48 22 820 5046 [email protected]

Adam Milewicz Warsaw +48 22 820 5031 [email protected]

Milena Olszewska, CFA Warsaw +48 22 820 5039 [email protected]

Piotr Palenik, CFA Warsaw +48 22 820 5020 [email protected]

Tamas Pletser, CFA Budapest +36 1 235 8757 [email protected]

Dalibor Vavruska London +44 20 7767 6972 [email protected]

Jean-Baptiste Bouillaguet London +44 20 7767 5888 [email protected]

Alexandra Melnikova Moscow +7 495 755 5180 [email protected] Cover photograph courtesy of istockphotosPricing date 19/07/10 unless stated otherwise Publication date 26 July 2010


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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 .........................................................................................................102 GTC ...............................................................................................................................104

Retail 107 EM&F .............................................................................................................................108 LPP ................................................................................................................................110 NG2................................................................................................................................112 Vistula Group .................................................................................................................114

Technology 117 Asbis ..............................................................................................................................118 Asseco Business Solutions ............................................................................................120 Asseco Central Europe ..................................................................................................122 Asseco Poland ...............................................................................................................124 Comarch.........................................................................................................................126 Comp .............................................................................................................................128 Sygnity ...........................................................................................................................130

Telecommunications 133 Netia...............................................................................................................................134 TPSA..............................................................................................................................136

Utilities 139 CEZ................................................................................................................................140 Enea...............................................................................................................................142 PGE ...............................................................................................................................144

Disclosures Appendix 146


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Equity market outlook 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 373.7 337.8 318.0 -10KGHM Buy Hold 94.2 110.0 101.0 17GTC Buy Hold 22.8 29.7 25.0 30Polimex MS Sell Hold 4.5 4.0 4.5 -12PBG Sell Hold 220.0 200.0 248.0 -9Mostostal Warszawa Sell Hold 67.2 60.0 67.0 -11NG2 Buy Hold 54.6 62.6 57.5 15EM&F Sell Hold 18.0 16.5 15.5 -9Pulawy Buy Hold 68.5 78.9 78.3 15Agora Buy Hold 22.7 27.1 25.0 19

Source: ING

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 removed, PKO BP removed

Pekao SA, Getin added, BRE 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

Key actionable changes in ratings

Key sector calls


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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 56.5 61.6 60.9 9 Hold Hold Maintained n/a n/aBRE 245.0 249.9 251.0 2 Hold Sell Upgrade 194 81BZ WBK 196.5 212.5 229.7 8 Hold Hold Maintained 8 28Getin 9.8 10.1 11.4 3 Hold Hold Maintained 56 44Bank Handlowy 74.1 85.9 85.9 16 Buy Buy Maintained 36 32Millennium 4.6 5.8 5.5 26 Buy Buy Maintained 11,479 92Pekao 159.9 154.0 153.2 -4 Hold Sell Upgrade 8 25PKO BP 38.5 46.8 47.6 22 Buy Buy Maintained 33 33PZU 373.7 337.8 318.0 -10 Sell Hold Downgrade -35 7

Chemicals Ciech 24.3 25.8 32.8 6 Hold Sell Upgrade n/a n/aPolice 5.0 5.1 6.2 2 Hold Hold Maintained n/a n/aPulawy 68.5 78.9 78.3 15 Buy Hold Upgrade n/a n/aSynthos 1.9 2.2 2.2 18 Buy Buy Maintained 19 -11

Construction Budimex 89.0 90.0 93.3 1 Hold Buy Downgrade 23 -13Cersanit 13.2 15.0 14.1 14 Hold Sell Upgrade n/a 33Kety 103.9 124.0 117.2 19 Buy Hold Upgrade 16 17Mostostal Warszawa 67.2 60.0 67.0 -11 Sell Hold Downgrade -17 -27PBG 220.0 200.0 248.0 -9 Sell Hold Downgrade 7 1Polimex MS 4.5 4.0 4.5 -12 Sell Hold Downgrade -3 -10

Food and beverage Astarta 59.0 49.1 44.2 -17 Sell Sell Maintained 91 -19CEDC (US$) 24.6 31.0 31.0 26 Buy Buy Maintained 51 6

General retailers EM&F 18.0 16.5 15.5 -9 Sell Hold Downgrade 75 31LPP 1,710.0 2,025.0 2,175.3 18 Buy Buy Maintained 67 17NG2 54.6 62.6 57.5 15 Buy Hold Upgrade 53 29Vistula 2.6 2.7 3.0 3 Hold Buy Downgrade n/a 42

IT Asbis 4.2 4.6 5.5 10 Hold Buy Downgrade n/a 42Asseco BS 9.2 10.5 10.5 15 Buy Buy Maintained 12 4Asseco CE 22.1 29.0 30.0 31 Buy Buy Maintained 1 12Asseco Poland 56.6 60.0 65.0 6 Hold Buy Downgrade -5 -7Comarch 83.0 78.5 98.0 -5 Sell Hold Downgrade 101 13Comp 68.2 78.5 78.7 15 Buy Buy Maintained 13 12Sygnity 12.9 14.7 15.5 14 Hold Hold Maintained n/a n/a

Media Agora 22.7 27.0 25.0 19 Buy Hold Upgrade 66 40CCI 39.5 47.0 38.0 19 Buy Buy Maintained 22 46Cyfrowy Polsat 14.3 16.2 17.7 14 Buy Buy Maintained 17 23TVN 16.5 18.0 16.0 10 Hold Hold Maintained -20 106

Mining and metals KGHM 94.2 110.0 101.0 17 Buy Hold Upgrade 57 23Stalprodukt 423.0 407.0 393.5 -4 Hold Sell Upgrade -39 25

Oil Lotos 31.0 22.0 22.0 -29 Sell Sell Maintained -90 238PKN Orlen 38.4 31.0 31.0 -19 Sell Sell Maintained -18 19

Paper Arctic Paper 14.2 17.8 17.9 26 Buy Buy Maintained -80 178Mondi 74.0 52.6 52.9 -29 Sell Sell Maintained 69 88

Real estate Dom Development 48.0 47.4 53.4 -1 Hold Buy Downgrade -54 164GTC 22.8 29.7 25.0 30 Buy Hold Upgrade -151 176

Telecoms Netia 4.8 5.0 5.0 3 Hold Hold Maintained -582 39TPSA 15.4 18.7 18.7 21 Buy Buy Maintained -28 23

Utilities CEZ (Kc) 866.8 811.5 811.0 -6 Hold Sell Upgrade -2 6Enea 18.1 20.0 20.0 10 Hold Hold Maintained 54 5PGE 21.3 25.0 25.0 17 Buy Buy Maintained -32 22PGNiG 3.5 3.3 5.1 -4 Hold Buy Downgrade -4 39

Source: ING estimates


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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 56.5 61.6 9 1,359 - - Neg 21.2 1.0 Neg 0.0BRE Hold 245.0 249.9 2 3,232 - - 19.2 10.6 1.5 9.9 0.0BZ WBK Hold 196.5 212.5 8 4,497 - - 15.0 11.7 2.2 15.3 2.0Getin Hold 9.8 10.1 3 2,148 - - 16.2 11.2 1.6 10.6 0.0Bank Handlowy Buy 74.1 85.9 16 3,035 - - 14.1 10.7 1.5 10.9 5.1Millennium Buy 4.6 5.8 26 1,758 - - 21.4 11.2 1.4 7.6 0.0Pekao Hold 159.9 154.0 (4) 13,164 - - 16.0 12.9 2.1 13.5 1.8PKO BP Buy 38.5 46.8 22 15,088 - - 15.7 11.8 2.2 14.6 4.1PZU Sell 373.7 337.8 (10) 10,122 - - 13.1 12.2 2.5 20.4 3.1

Chemicals Ciech Hold 24.3 25.8 6 213 6.8 6.2 Neg 58.8 0.8 Neg 0.0Police Hold 5.0 5.1 2 118 5.6 5.6 Neg 25.5 0.8 Neg 0.0Pulawy Buy 68.5 78.9 15 411 51.6 6.1 Neg 13.2 0.8 Neg 0.9Synthos Buy 1.9 2.2 18 789 5.6 5.6 9.4 10.5 1.3 15.0 0.0

Construction Budimex Hold 89.0 90.0 1 713 4.3 4.8 10.6 12.2 3.6 35.3 7.6Cersanit Hold 13.2 15.0 14 597 9.8 7.8 18.1 13.6 1.6 9.4 0.0Kety Buy 103.9 124.0 19 301 6.3 5.3 11.5 9.8 1.2 11.0 4.3Mostostal Warszawa Sell 67.2 60.0 (11) 422 6.7 8.0 13.7 18.8 2.4 18.9 1.5PBG Sell 220.0 200.0 (9) 927 9.4 8.8 13.5 13.4 1.9 15.3 2.2Polimex MS Sell 4.5 4.0 (12) 661 7.3 6.9 13.6 13.7 1.4 11.3 1.5

Food and beverage Astarta Sell 59.0 49.1 (17) 463 5.0 5.5 6.0 7.4 1.9 37.6 0.0CEDC Buy 24.6 31.0 26 1722 10.0 9.5 11.2 10.5 0.9 8.3 0.0

General retailers EM&F Sell 18.0 16.5 (9) 593 8.1 6.6 20.8 15.8 3.2 16.6 0.0LPP Buy 1,710.0 2,025.0 18 915 9.2 8.1 16.8 14.4 3.8 24.0 2.9NG2 Buy 54.6 62.6 15 658 12.1 9.4 16.4 12.7 4.7 36.1 1.8Vistula Hold 2.6 2.7 3 92 10.7 8.8 23.4 16.6 0.9 3.4 0.0

IT Asbis Hold 4.2 4.6 10 73 5.8 4.6 12.4 8.8 0.8 6.2 0.0Asseco BS Buy 9.2 10.5 15 96 6.7 6.3 12.3 11.8 1.2 9.8 8.2Asseco CE Buy 22.1 29.0 31 148 5.2 4.1 10.6 9.5 1.2 10.5 4.1Asseco Poland Hold 56.6 60.0 6 1,212 7.3 6.9 11.1 11.9 1.0 9.5 2.6Comarch Sell 83.0 78.5 (5) 207 9.0 6.4 15.4 13.6 1.2 5.7 0.0Comp Buy 68.2 78.5 15 102 7.3 6.1 13.3 11.8 0.9 9.1 0.0Sygnity Hold 12.9 14.7 14 48 57.5 5.5 Neg 14.9 0.6 Neg 0.0

Media Agora Buy 22.7 27.0 19 363 6.3 5.0 17.1 13.4 0.9 5.0 2.2CCI Buy 39.5 47.0 19 631 9.1 6.1 18.3 11.3 2.2 14.8 0.0Cyfrowy Polsat Buy 14.3 16.2 14 1,199 10.1 8.2 14.1 11.5 9.0 72.1 4.7TVN Hold 16.5 18.0 10 1,756 10.7 8.2 33.9 16.5 3.3 8.1 1.3

Mining and metals KGHM Buy 94.2 110.0 17 5,910 2.9 2.3 4.7 3.8 1.4 32.9 12.7Stalprodukt Hold 423.0 407.0 (4) 892 10.7 8.4 16.3 13.1 2.0 12.7 1.9

Oil Grupa Lotos Sell 31.0 22.0 (29) 1,261 9.5 7.0 41.2 12.2 0.6 1.4 0.0PKN Orlen Sell 38.4 31.0 (19) 5,152 6.5 5.8 15.3 12.8 0.8 5.5 0.0

Paper Arctic Paper Buy 14.2 17.8 26 247 8.1 5.1 25.2 9.1 1.2 4.8 1.6Mondi Sell 74.0 52.6 (29) 1,161 12.9 9.6 30.6 16.3 2.8 9.7 3.3

Real estate Dom Development Hold 48.0 47.4 (1) 370 34.4 12.4 32.7 12.4 1.5 4.6 1.7GTC Buy 22.8 29.7 30 1,569 35.1 26.1 19.8 7.9 1.2 9.9 0.0

Telecoms Netia Hold 4.8 5.0 3 589 4.2 3.6 20.9 15.0 0.9 4.6 0.0TPSA Buy 15.4 18.7 21 6,452 4.8 4.6 22.3 18.1 1.3 5.8 9.7

Utilities CEZ (Kc) Hold 866.8 811.5 (6) 26,005 6.9 7.0 10.0 9.4 2.1 22.8 6.1Enea Hold 18.1 20.0 10 2,506 3.8 4.0 10.1 9.6 0.8 8.3 2.1PGE Buy 21.3 25.0 17 11,559 5.6 5.0 13.1 10.8 1.1 8.9 3.6PGNIG Hold 3.45 3.3 (4) 6,385 8.1 7.0 17.7 12.7 0.9 5.3 2.1

ING universe 7.6 6.3 14.1 10.9 1.9 13.4 3.3



6

We expect modest gains for the Polish equity market in 2H10 in zloty terms. Our bottom-up 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 5 Poland vs EMEA

Fig 6 Poland 1H10 sector returns

0

20

40

60

80

100

120

1/00 2/00 4/00 5/00 7/00 9/00 10/00 12/00 1/01 3/01 5/01

MSCI Poland MSCI EMEA

(10) 0 10 20 30

IT

Real-estate

Energy

Banks

Telecom

Oil and gas

Chemicals

Construction

Media

Food

Source: Bloomberg Source: ING estimates

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 7 WIG20

Fig 8 MSCI indices returns in 1H10 (%, US$)

1,000

1,500

2,000

2,500

3,000

7/08 10/08 1/09 4/09 7/09 10/09 1/10 4/10 7/10

-25 -20 -15 -10 -5 0

Turkey

South Africa

Russia

Czech Republic

Poland

Hungary

Source: Bloomberg Source: Bloomberg

Very modest gains expected in 2H10

Sector selection is the key to delivering alpha in 2H10


7

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

-5

0

5

10

15

20

1Q04

3Q04

1Q05

3Q05

1Q06

3Q06

1Q07

3Q07

1Q08

3Q08

1Q09

3Q09

1Q10

F

3Q10

F

Private consumption Public consumption Fixed InvestmentsInventories Net exports GDP

-20

-15

-10

-5

0

5

10

15

20

25

30

1/03 2/04 3/05 4/06 5/07 6/08 7/09 8/10-40

-30

-20

-10

0

10

20

30

40

IP (%YoY) Export (%YoY, rhs)

Source: GUS, ING forecasts Source: ING estimates

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 3.5-3.6 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

1.1

1.2

1.3

1.4

1.5

1.6

7/08 10/08 1/09 4/09 7/09 10/09 1/10 4/10 7/10

3.0

3.5

4.0

4.5

5.0

7/08 10/08 1/09 4/09 7/09 10/09 1/10 4/10 7/10


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.

Zloty weakness is negative for earnings growth as exporters are under-represented on the WSE

Poland is now 1.5% of MSCI EM and the share is growing

A sluggish total 8% YoY growth in earnings distorts the underlying differential in earnings momentum of individual sectors

PLN offers the best fundamental value in the EMEA region


8

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 2011. As far as we are aware, there are no large listings of private companies coming to the market for the reminder of the year.

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 14 ... and premium (%)

0

5

10

15

20

25

30

1/00 2/00 3/00 4/00 5/00 6/00

Poland EMEA Poland hist avg EMEA hist avg

-40

-20

0

20

40

60

80

100

2/97 2/99 2/01 2/03 2/05 2/07 2/09

12m FWD PER premium over MSCI EMEA Avg hist premium


Valuation premium to other EMEA markets widened in 1H10 due to a reduction in earnings estimates


9

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 2009. 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)

0

50

100

150

06/03 06/04 06/05 06/06 06/07 06/08 06/09 06/10

Equity-related funds* Other funds

-10.0-8.0-6.0-4.0-2.00.02.04.06.0

Jan 07 Jan 08 Jan 09 Jan 10010,00020,00030,00040,00050,00060,00070,000

(Inde

x va

lue)

Net purchases of equity (lhs) WIG index (rhs)

*pure equity, balanced and stable growth



Fig 17 Flows to mutual funds (PLNbn)

-16-14-12-10-8-6-4-20246

1/05

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


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 2010.


10

Fig 18 Pension fund AUM (PLNbn)

Fig 19 Net purchases of equities (PLNbn)

0

50

100

150

200

250

01/00 06/01 11/02 04/04 09/05 02/07 07/08 12/09

Equities Debt instr, bank deposits, cash

-3.0-2.0-1.00.01.02.03.04.0

Dec-05 Dec-06 Dec-07 Dec-08 Dec-09

(PLN

bn)

10,000

20,000

30,000

40,000

50,000

60,000

70,000

(Inde

x va

lue)

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 (%)

18

22

26

30

34

38

42

02/00 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


11

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


12

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 2009. 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 2010. 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 2011. 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


13

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 2011. 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 2011.

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 2009. 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).


14

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

2004 2005 2006 2007 2008 2009 2010F 2011F 2012F

Activity Real GDP (%ch YoY) 5.3 3.6 6.1 6.7 4.9 1.8 3.2 3.9 4.9Private consumption (%ch YoY) 4.4 2.0 5.0 5.0 5.3 2.2 2.5 3.7 4.0Private investment (%ch YoY) 6.4 6.5 16.5 18.0 6.4 (0.4) (2.3) 4.0 9.0Government expenditure (%ch YoY) 3.1 5.2 3.9 3.6 0.0 1.8 3.2 6.0 3.0Industrial production (%ch YoY) 13.1 4.1 12.0 9.2 3.8 (3.6) 9.8 7.3 8.8Unemployment rate (%, end period) 19.0 17.6 14.8 11.2 9.2 11.9 11.9 11.3 10.3Nominal GDP (US$bn) 237.2 270.0 342.4 425.7 526.5 430.3 435.7 485.3 570.1Gross domestic saving (% of GDP) 19.0 19.8 20.6 21.5 23.6 20.2 20.4 20.6 21.8

Prices CPI (%ch YoY, annual average) 3.5 2.1 1.0 2.5 4.2 3.4 2.4 2.7 3.0PPI (%ch YoY, annual average) 7.0 0.7 2.3 2.3 2.5 3.3 2.1 2.5 2.6Enterprise sector wage rates (%ch YoY) 4.3 3.2 5.0 9.1 11.0 4.2 3.5 4.6 5.2Enterprise sector unit wage costs (%ch YoY) (13.0) 0.5 (6.4) (0.1) 6.9 3.7 2.7 5.6 4.8

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 95 45.7 47.1 47.6 45.2 44.8 51.0 53.8 55.4 54.9

External balance Exports (US$bn) 81.9 96.4 117.5 142.0 179.3 140.0 150.4 165.4 198.5Imports (US$bn) 87.5 99.2 124.5 158.6 203.8 144.4 156.4 183.0 228.8Trade 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) 28.0 18.0 20.5 16.7 21.3 (19.0) 14.7 10.0 20.0Import volume (%ch YoY) 24.9 13.6 24.1 23.2 23.6 (26.8) 15.6 17.0 25.0FX reserves (ex gold, US$bn), year end 35.3 40.9 46.4 63.0 59.9 75.9 83.7 97.0 100.4

Debt indicators Gross external debt (US$bn) 130.0 132.9 169.6 233.1 244.7 279.5 300.5 330.5 380.1Gross govt. external debt 57.8 58.8 67.8 79.2 82.0 - - - -Gross external debt (% of GDP) 54.8 49.2 49.5 54.8 46.5 65.0 69.0 68.1 66.7Gross external debt (% of exports) 158.8 137.9 144.4 164.1 136.5 199.7 199.8 199.8 191.5Government foreign debt service (US$bn) 4.1 4.2 5.3 6.7 7.3 49.0 51.1 56.2 64.6Government foreign debt service (% of GDP) 1.7 1.6 1.5 1.6 1.4 11.4 11.7 11.6 11.3

Interest & exchange rates Broad money supply (%ch YoY) year end 9.4 10.3 16.0 13.4 15.0 8.1 7.2 12.0 14.03-month interest rate (%) annual average 5.7 6.1 4.2 4.8 6.3 4.3 4.0 4.5 5.1Long bond yield (5yr, since 1999 10yr, %) end 6.2 5.0 5.0 6.1 6.1 6.2 6.1 5.9 6.0Long bond yield (5yr, since 1999 10yr, %)av 7.0 5.2 5.1 5.5 6.1 6.1 5.9 6.0 6.0Exchange rate (US$/PLN) year end 2.99 3.26 2.91 2.76 3.34 2.85 3.39 3.00 2.77Exchange rate (US$/PLN) annual average 3.90 3.64 3.09 2.76 2.46 3.11 3.23 3.12 2.88Euro/US$ year end 1.33 1.18 1.32 1.30 1.20 1.44 1.15 1.20 1.30Euro/US$ annual average 1.24 1.24 1.26 1.34 1.43 1.40 1.25 1.18 1.25Exchange rate (Euro/PLN) year end 4.08 3.86 3.83 3.58 4.01 4.11 3.90 3.60 3.60Exchange rate (Euro/PLN) annual average 4.45 4.52 3.90 3.78 3.52 4.34 4.05 3.66 3.6052-week t-bill year-end 6.3 4.4 4.1 5.8 5.6 4.2 4.2 4.9 5.1


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

Interest rates to stay flat in 2H10


15

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.

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 2011. 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.

Low expectations for progress on reforms as the next elections are looming

Fiscal reforms at a dead end


16

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17

Banks


18

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 2008-09’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)

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

1/05 7/05 1/06 7/06 1/07 7/07 1/08 7/08 1/09 7/09 1/10New On stock

-1.0

-0.5

0.0

0.5

1.0

1.5

1/05 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.


19

• 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) 205 63 -10BRE 534 970 537 971 1 0BZ WBK 1,001 1,266 958 1,225 -4 -3Getin 473 632 430 621 -9 -2Handlowy 670 887 685 902 2 2Millennium 241 488 261 502 8 3Pekao 2,688 3,392 2,615 3,267 -3 -4PKO BP 3,007 3,985 3,056 4,067 2 2Total 8,497 11,847 8,353 11,760 -2 -1


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.


20

Fig 25 Growth of loans in Poland (% YoY)

Fig 26 Growth of deposits in Poland (% YoY)

-10

0

10

20

30

40

50

1/03 1/04 1/05 1/06 1/07 1/08 1/09 1/10

Corporate loans Retail loans Total loans

-10

0

10

20

30

40

50

1/03 1/04 1/05 1/06 1/07 1/08 1/09 1/10Corporate deposits Retail deposits Total deposits

Source: NBP Source: NBP

Fig 27 Loans and deposits structure (May)

Fig 28 Loan growth by segments(% YoY)

387 433

216 238

66 42

0%

20%

40%

60%

80%

100%

Deposits Loans

Retail Corporate Public

-100

10203040506070

Corporate Microcompanies

Mortgage Cards Consumerfinance

Jun-08 Dec-08 Jun-09 Dec-09 May-09

Source: NBP *mainly consumer loans Source: NBP

Fig 29 Structure of loan portfolios in 1Q10 (%)

Fig 30 Loans and deposits change in 1Q10 (% YoY)

0%10%20%30%40%50%60%70%80%90%

100%

GTN MIL BPH KRB PKO BRE PEO ING BZW BHW

Mortgage Retail Corporate

BRE

BZW

GTN

BHW

ING

KRB

MIL

PEO

PKO

-15-10-505

1015202530

-15 -10 -5 0 5 10 15 20 25 30Loans

Dep

osits

Note: retail – all non-mortgage retail Source: Company data, ING estimates

Source: Company data

Fig 31 Loans / deposits ratio in the sector (%) Fig 32 Loans / deposits ratio by banks (%)

50

60

70

80

90

100

110

120

12/04 6/05 12/05 6/06 12/06 6/07 12/07 6/08 12/08 6/09 12/09

61 6389 91 98 97

130 112159

9061 65 78 81 87 103 103 113

230

96

020406080

100120140160

BHW ING BZW PEO GTN PKO KRB MIL BRE BPH

1Q09 1Q10

Source: NBP Source: Company data, ING estimates Note: BPH affected by merger with GEMB


21

Fig 33 Solvency ratios of listed banks (%)

Fig 34 CAR in listed banks in 1Q10 (% YoY)

8.09.0

10.011.012.013.014.015.016.0

1Q05 1Q06 1Q07 1Q08 1Q09 1Q10

Average CAR Average Tier-1

11.012.2 12.4 12.9 13.0 13.6

14.9 15.218.4 18.4

0.02.04.06.08.0

10.012.014.016.018.020.0

GTN BRE KRB BPH ING BZW MIL PKO BHW PEO

CAR Minimum required level

Note: minimum level of CAR is 8% Source: Company data, ING estimates

Source: Company data, NBP

Fig 35 Impairment ratios in 1Q10 (%)

Fig 36 Provision coverage in 1Q10 (%)

15.5

9.2 9.1 8.9 8.37.2

6.0 6.0 5.84.7

0.02.04.06.08.0

10.012.014.016.018.0

BHW BPH KRB GTN PKO PEO MIL BRE BZW ING

43

5559

66 67 6772 76 77

81

0102030405060708090

PKO MIL BZW BHW BRE KRB ING GTN PEO BPH

Source: Company data, ING estimates Source: Company data, ING estimates

Fig 37 Median NIM (%)

Fig 38 Average cost of risk* (%)

2.0

2.5

3.0

3.5

4.0

1Q05 1Q06 1Q07 1Q08 1Q09 1Q10

Median NIM (%)

0255075

100125150175200225

4Q06 4Q07 4Q08 4Q09

Average cost of risk (bps)

Note: counted on total assets; includes BPH, BRE, BZW, GTN, MIL, KRB, BSK, PEO, PKO Source: Company data, ING estimates

*provisions/loans annualised Note: includes BPH, BRE, BZW, GTN, MIL, KRB, BSK, PEO, PKO Source: Company data, ING estimates

Polish Strategy BPH July 2010

22

BPH Maintained

A few more hurdles ahead HoldPoland Market cap PLN4,331.7mBanks Bloomberg BPH PW

BPH faces more problems than it flagged last year. 2010 will be in the red and significant staff reductions are in progress. However, extremely bearish guidance from management leaves little space for negative surprises.

Investment case Last year BPH finally completed the merger with GE Money Bank (GEMB), which more than doubled size of the bank in terms of assets and loans (but not in terms of deposits as GEMB was entirely financed by loans from the parent, GE). It seemed that the completion of the legal process cleared the way to start the implementation a new ambitious strategy (published in mid-2009) and be more active in the market.

However, in May BPH cancelled the strategy and the targets thataccompanied it (eg, 17%+ ROE in 2012). The company also decided to close two important divisions ie, car loans and sales financing, which triggered planned c.1,500 staff reductions (19% of the total number). The news was very negative. Firstly, it highlighted problems with the predictability. Secondly, it meant that the restructuring will not end this year, so BPH will not focus on expansion and client acquisition soon, but it will rather engage resources in internal processes.

Nevertheless, some elements of last year’s strategy remain largely unchanged, eg, the major shift of strategic focus: from the growth of balance sheet volumes to growth in efficiency. In case of particular products, the most remarkable change was in mortgage lending: GEMB used to be a leading bank in this product, but BPH expected the combined market share of the two banks to fall. In our view, this is linked to lower expected financing from the parent GE and a much greater dependence on deposits. While the behaviour of the bank implies that financing from the parent will be a constraint in the medium term, we believe that, with improvements in global liquidity, it will become more available, which is a potential long-term opportunity.

May was very bad in terms of negative newsflow, but it was quickly factored into the price. Moreover, BPH already said that 2Q10 will be weaker than (the already very weak) 1Q10 and the later recovery will be slow. We have the impression that management realises that its credibility is under pressure due to the latest disappointments and wants to play down expectations. As a result, the risk of the further negative surprises in the future seems to be fairly low.

The P/BV ratio of BPH (at 1.0x on 2010F) is the lowest in the sector, but because the “book value” will not generate major profits its 2011F PER is the highest (in 2010F the bank reported a loss). Additionally, the low P/BV factors in problems with the credibility of the bank after so many disappointments over the past two years. Therefore, we maintain our HOLD recommendation.

Price (19/07/10) PLN56.50

Previously PLN60.91Target price (12-mth) PLN61.58

Forecast total return 9.0%

Quarterly preview After 1Q data management warned that provisions will grow and revenues will fall QoQ in 2Q10, so it is clear that this quarter will be extremely weak. We can only add that we believe that the weakness of revenues will be connected with falling NII and the costs will be additionally inflated with the reserves for the layoffs (we assume c.PLN50m). In case of provisions there is a risk of final balance sheet cleaning, which could inflate this line well above PLN300m in the worst case scenario.

2Q10F results preview

(PLNm) 1Q10 2Q10F

NII 344 334Revenues 546 535Costs (359) (408)Provisions (249) (286)Net profit (54) (130)

Source: Company data, ING estimates

Earnings drivers and outlook We expect both fees and NII to shrink. In both cases it will be due to weak sales of loans as the banks exits two segments of the market (car loans, sales financing). Additionally, NIM will suffer from fierce competition for deposits as the merged bank wants to reduce its L/D ratio. We should see mild improvement next year, although growth will not be large as the bank will still be restructuring. The positive cost effects of restructuring should be visible in 2H10, although at the level of reported costs they may be offset by the last expenses of the merger (eg,rebranding) and lay-offs. If we exclude these one-offs we should see a high single-digit decline in costs.

In 4Q09 and 1Q10 it appeared that the real quality of lending was worse than expected. While at that time the biggest issue was connected with unsecured retail lending we believe that today the biggest risk is connected with mortgage loans. GEMB used to target the lower segment of the market and it granted mainly FX loans. Getin (with a very similar high risk profile of mortgages) recorded very high provisions in mortgage in 1Q10,so we would not be surprised if we see impairments in this segment also in BPH. On the other hand, there are the first signsof a turnaround in cash loans, so the total cost of risk should stay below 300bps in 2010F and start falling quickly in 2011F.

Our DDM-based target price rises only slightly, as lower net profit forecasts (2010F loss widened by 63%, 2011F profit cut by 10%) reflect mainly short-term rather than long-term prospects.

Piotr Palenik, CFA Warsaw +48 22 820 5020 [email protected] Nowaczek London +44 20 7767 6635 [email protected]

Polish Strategy BPH July 2010

23

Newsflow

Date Description

27 May 2010 End of negotiations with trade unions (agreed 1,472 lay-offs)

1 Jun 2010 AGM (no dividend, changes in the supervisory board)

25 Aug 2010 2Q10 results

Source: Company data, ING

Major shareholders (%)

General Electric 89BZ WBK mutual funds 6


Share data

Avg daily volume (3-mth) 17,489Free float (%) 10.8Market cap (PLNm) 4,331.7Dividend yield (1F, %) 0.0


Share price performance

40

50

60

70

80

90

7/09 9/09 11/09 1/10 3/10 5/10

Price WIG20 (rebased)

Source: ING

Company profile

After the merger with GE Money Bank in 4Q09, BPHbecame the No.7 lender in Poland but it remainedretail-biased (84% of loans). It has a relatively strongposition in mortgage lending (although it plans toreduce its market share), credit cards and cash loans(targeting the lower segment of the market). BPH hasa relatively weak position in deposits (outside the top-10), which is the legacy of GE Money Bank (used tobe 99% financed by the parent). GE Money is astrategic investor (89% stake).

Risks

Upside: faster than expected improvement in loan quality; positive effects of costs restructuring.Dowside: too aggressive an approach to depositpricing would impact NIM; departure of key employeesas turmoil continues

Financials

Year end Dec (PLNm) 2008 2009 2010F 2011F 2012F

Income statement

Net interest income 1,106 1,415 1,316 1,388 1,614Net fee & commission income 627 766 735 832 1,013Net trading income 64 89 64 77 99Insurance income 0 0 0 0 0Other operating income 26 (16) (17) (20) (25)Revenues 1,823 2,253 2,098 2,276 2,701Operating costs (1,254) (1,427) (1,347) (1,327) (1,423)Pre-provision profit 569 826 751 949 1,279Total impairments (271) (690) (873) (699) (628)Other non-operating income 0 (135) (110) 0 0Pre-tax profit 298 0.4 (232) 250 651Tax 29 61 44 (47) (124)Minorities (6) (8) (2) 2 7Other adjustments 0 0 0 0 0Net profit 321 53 (190) 205 534Normalised net profit 321 162 (101) 205 534

Balance sheet

Total assets 36,678 35,215 35,186 37,151 44,061Customer loans 29,742 29,096 27,007 28,711 35,331Customer loans/assets (%) 81.1 82.6 76.8 77.3 80.2Customer deposits 10,317 10,125 12,027 14,482 17,710Loan to deposit ratio (%) 288.3 287.4 224.6 198.2 199.5Total equity 4,450 4,490 4,310 4,525 5,071Risk-weighted assets 29,495 30,314 29,585 31,904 38,143

Profitability & efficiency

Net interest margin (%) 6.7 4.3 4.0 4.1 4.2Norm'ld return on t'gble eq (%) 20.1 5.0 -3.2 6.5 15.1Reported ROE (%) 0.15 0.01 -0.04 0.05 0.11RORWA (%) 1.1 0.54 -0.34 0.67 1.5Cost income ratio (%) 68.8 63.4 64.2 58.3 52.7

Asset quality & capital

NPL/gross customer loans (%) 5.0 8.3 10.5 10.0 8.5Provision coverage ratio (%) 94.6 82.1 86.2 97.1 103.7Core Tier 1 ratio (%) 9.7 10.6 11.0 9.6 8.6Tier 1 ratio (%) 9.7 10.6 11.0 9.6 8.6T'gble equity/t'gble assets (%) 9.0 9.5 9.0 9.1 8.9Leverage (x) 8.2 7.8 8.2 8.2 8.7

Growth

Asset growth (%) n/a -4.0 -0.08 5.6 18.6RWA growth (%) n/a 2.8 -2.4 7.8 19.6Loan growth (%) n/a -2.2 -7.2 6.3 23.1Deposit growth (%) n/a -1.9 18.8 20.4 22.3Net interest income grth (%) n/a 27.9 -6.9 5.4 16.3Revenue growth (%) n/a 23.6 -6.9 8.5 18.7Rep'td pre-tax profit grth (%) n/a -99.9 n/a n/a 160.6

Valuation

PER (x) 13.5 82.0 n/a 21.2 8.1Normalised PER (x) 13.5 26.7 n/a 21.2 8.1Price/book (x) 0.99 0.99 1.0 0.98 0.88Price/tangible book (x) 1.4 1.3 1.4 1.3 1.1Dividend yield (%) 0.0 0.0 0.0 0.0 0.0

Per share data

Reported EPS (PLN) 4.19 0.689 (2.48) 2.67 6.96Normalised EPS (PLN) 4.19 2.11 (1.32) 2.67 6.96Normalised EPS growth (%) n/a -49.5 n/a n/a 160.6Dividend per share (PLN) 0.00 0.00 0.00 0.00 0.00Dividend growth (%) n/a n/a n/a n/a n/aPayout ratio (%) 0.0 0.0 0.0 0.0 0.0BV/share (PLN) 56.86 57.26 54.78 57.45 64.41Tangible BV/share (PLN) 41.66 42.44 39.96 42.63 49.59


Polish Strategy BRE July 2010

24

BRE Previously Sell

Following the capital increase HoldPoland Market cap PLN10,305.2mBanks Bloomberg BRE PW

We are not keen on the bank’s strategy, but its 2012 financial targets look reasonable. We upgrade from Sell to HOLD (the lowest 2011F PER among the banks but the most unpredictable results); DDM-based TP is now PLN249.90.

Investment case In March, BRE surprised the market with the announcement of a share issue. The surprise was not the capital increase itself, rather its size: PLN2bn (48% of the existing equity). It brings BRE’s CAR to a 15%+ level, which is well above an adequate level: even considering BRE’s high share of Tier 2 in CAR; the core Tier 1 would be around 11%.

The size of the issue cannot be justified by the new strategy(also announced in March), which is not overly aggressive. BRE wants to increase its market shares in unsecured retail lending and the public sector, but it will give up part of its share in mortgage lending. We do not like the idea, because we believe itwill be a more attractive segment (in terms of growth and risk profile) than others.

The key question about the future of the bank is connected with FX financing for mortgage loans (BRE was the only listed bank not to stop selling FX loans during the crisis). For many years this was provided by the parent, Commerzbank, but in 2009 we saw signals that it was limited (the bank reduced sales of loans complaining about demand but we do not believe in this excuse because non-listed banks, which had access to financing, had very good sales of FX loans). In 1H10, BRE secured new FXloans from Commerzbank (US$200m and SFr350m) but their size is not encouraging (SFr350m is approximately two months’sales during good times). BRE could start selling PLN loans financed from internal sources, but that would force the bank to increase sales of deposits, which will put pressure on margins (as happened in 1Q10, when the bank increased deposits much faster than the market).

We will learn more about the lending strategy development in 2Q10 and 2H10, as in May, management was assuring investorsthat sales volumes are picking up strongly.

BRE trades at a narrow discount to Polish peers on PBV (-3% on 2010F and -6% on 2011F). In PER terms, it is quite expensive this year because of the latest share issue, but it is the cheapest in the sector in 2011F thanks to the fast recovery of earnings, ie, +81% YoY (repricing, profits on inflows from the share issue, lower provision, break-even in Czech Rep and Slovakia). We agree with market opinion that, in the long term, the bank could generate much higher ROE than most of its peers. However, in the medium term, we see many more execution risks and credibility issues than at Millennium, for example. We upgrade from Sell to HOLD, and more optimism would be justified when we see more stability and predictability in the bank (in terms of provisioning, volumes and financing).

Price (19/07/10) PLN245.00



Quarterly preview BRE cut its deposit rates in March and April by 50bp altogether, which should be supportive for NII, even if there was some negative influence on volumes. Trading should benefit from high volatility in the markets in 2Q10. Provisions are fairly unpredictable, as the bank often makes a mid-year review of loan portfolios. There may also be additional gains if the bank marks to market its 0.7% stake in PZU (an extra PLN100m).


(PLNm) 1Q10 2Q10F

NII 391 418Revenues 689 727Costs (354) (378)Provisions (177) (195)Net profit 115 115


Earnings drivers and outlook We are not keen on the 2012 strategy, but we like the financial targets (20% pre-tax ROE and c.50% C/I in 2012). Both ratios are slightly weaker than our forecasts (21% and 48% respectively), but there may be upside if the foreign operations turn profitable, as expected by the management. However, in the long term the profitability of the bank is not likely to return to pre-crisis levels (when pre-tax ROE was 30%). This is the result of expected lower leverage: at present, the management targets an 8-10% Tier 1, ratio while in 2005-09 it was always below these levels, ie, higher leverage allowed to inflate ROE at that time.

After very good margins in 2009 (they were the same as in 2008), it will be difficult to improve them this year although 1Q10 data and the 2Q10 outlook look encouraging. Considering average volumes will also be poor (very weak growth in 2H09 and 1Q10), we forecast flat NII this year, which will be a decisive factor for weaker growth of total revenues (5% vs 9% in 2009).

Although BRE has a large mortgage portfolio (c.40% of all loans, 90% is FX), we are not concerned about its quality, as the bank was conservative in estimating the credit capacity of its clients. Therefore, unlike many other banks with large mortgage portfolios (eg, Getin and BPH), it should not face any problems with defaults here. As a result, no problems with cash loans (which are exhausting slowly) should mean no problems with the high cost of risk. The issue is that in the past there were so many negative surprises in this area that we are cautious about drawing overly positive conclusions.


Polish Strategy BRE July 2010

25

Newsflow

Date Description

28 Apr 2010 1Q10 results 14 May 2010 Traded ex-rights 1 June 2010 New shares fully subscribed 4 Aug 2010 2Q10 results



Commerzbank 70


Share data




160180200220240260280300320

7/09 9/09 11/09 1/10 3/10 5/10


Source: ING

Company profile

BRE was predominantly a corporate bank (specialisedin servicing foreign trade transactions), but afterlaunching mBank (in 2000) and Multibank, its share ofretail revenues started growing quickly. It is No.3 inPoland in terms of number of retail clients (3m), andNo.3 in assets (7% market share). Germany’sCommerzbank is the strategic investor.

Risks

The key risks to our HOLD rating: improved liquidity ofCommerzbank, which would increase liquidity supportfor BRE; return to dividend payouts after the latestcapital increase; a turnaround in foreign operations(upside); weak sales of FX hedging for corporatesafter last year’s problems with FX options; strugglingsales of mortgage loans; negative surprises in loanquality (downside).

Financials

Year end Dec (PLNm) 2007 2008 2009 2010F 2011F 2012F

Income statement

Net interest income 1,028 1,392 1,658 1,678 1,952 2,167Net fee & commission income 564 551 595 705 843 973Net trading income 493 491 408 428 462 499Insurance income 0 21 50 64 81 101Other operating income 117 93 75 53 66 82Revenues 2,202 2,549 2,787 2,927 3,403 3,823Operating costs (1,280) (1,550) (1,545) (1,540) (1,660) (1,822)Pre-provision profit 922 999 1,242 1,387 1,743 2,001Total impairments (77) (269) (1,097) (690) (482) (271)Provisions Other non-operating income 109 271 64 0 0 0Pre-tax profit 955 1,000 209 697 1,261 1,730Tax (207) (111) (79) (146) (265) (363)Minorities (38) (32) (2) (14) (25) (35)Other adjustments 0 0 0 0 0 0Net profit 710 857 129 537 971 1,332Normalised net profit 623 538 77 537 971 1,332

Balance sheet

Total assets 55,942 82,605 81,024 86,728 94,454 103,777Customer loans 33,683 52,142 52,469 55,400 62,174 70,433Customer loans/assets (%) 60.2 63.1 64.8 63.9 65.8 67.9Customer deposits 32,402 37,750 42,791 46,458 50,713 54,344Loan to deposit ratio (%) 104.0 138.1 122.6 119.2 122.6 129.6Total equity 3,441 4,048 4,271 6,895 7,770 8,867Risk-weighted assets 40,351 58,470 54,185 57,335 63,315 70,535


Net interest margin (%) 2.2 2.2 2.2 2.1 2.3 2.3Norm'ld return on t'gble eq (%) 25.7 17.5 2.2 10.8 14.4 17.3Normalised ROA (%) 1.3 0.78 0.09 0.64 1.1 1.3RORWA (%) 1.7 1.1 0.14 0.96 1.6 2.0Cost income ratio (%) 58.1 60.8 55.4 52.6 48.8 47.7


NPL/gross customer loans (%) 2.3 2.2 5.5 5.3 4.7 4.1Provision coverage ratio (%) 85.3 73.5 65.6 73.8 80.2 80.6Core Tier 1 ratio (%) 5.9 5.6 6.6 10.5 10.5 10.7Tier 1 ratio (%) 5.9 5.6 6.6 10.5 10.5 10.7T'gble equity/t'gble assets (%) 4.9 4.2 4.6 7.3 7.6 8.0Leverage (x) 16.3 20.4 19.0 12.6 12.2 11.7

Growth

Asset growth (%) 32.2 47.7 -1.9 7.0 8.9 9.9RWA growth (%) 25.2 44.9 -7.3 5.8 10.4 11.4Loan growth (%) 46.2 54.8 0.63 5.6 12.2 13.3Deposit growth (%) 31.3 16.5 13.4 8.6 9.2 7.2Net interest income grth (%) 41.9 35.5 19.1 1.2 16.3 11.0Revenue growth (%) 35.5 15.7 9.4 5.0 16.3 12.3Rep'td pre-tax profit grth (%) 78.6 4.8 -79.1 233.3 80.8 37.2

Valuation

PER (x) 10.2 8.5 56.5 16.4 10.6 7.7Normalised PER (x) 11.6 13.5 94.6 16.4 10.6 7.7Price/book (x) 2.2 1.9 1.8 1.5 1.4 1.2Price/tangible book (x) 2.7 2.1 2.0 1.6 1.4 1.3Dividend yield (%) 0.0 0.0 0.0 0.52 1.9 2.6

Per share data

Reported EPS (PLN) 24.00 28.89 4.34 14.97 23.09 31.68Normalised EPS (PLN) 21.07 18.13 2.59 14.97 23.09 31.68Normalised EPS growth (%) 45.6 -13.9 -85.7 477.9 54.2 37.2Dividend per share (PLN) 0.00 0.00 0.00 1.28 4.62 6.34Dividend growth (%) n/a n/a n/a n/a 261.7 37.2Payout ratio (%) 0.0 0.0 0.0 10.0 20.0 20.0BV/share (PLN) 112.08 131.17 138.77 160.16 180.78 206.65Tangible BV/share (PLN) 90.98 116.40 123.90 149.59 170.14 195.94


Polish Strategy BZ WBK July 2010

26

BZ WBK Maintained

Fundamentals versus ownership change HoldPoland Market cap PLN14,336.6mBanks Bloomberg BZW PW

BZ WBK has survived the crisis well and has strong fundamentals. But its fate (and price) depends on who will acquire the controlling stake from AIB, and how.

Investment case BZ WBK had a very good 2009 and 1Q10, as the biggest risk for the bank – defaults in the construction and real estate sectors (45% of corporate loans; 31% of total loans) – did not materialise. Just the opposite in fact – the bank benefited from these loans as there was room for upward repricing of these products. While, the short-term performance was good, we are worried by the evolution of the strategy. During the crisis,management assured that it would reduce this overexposure to real estate loans, but now it is giving up on the idea, lured by the good margins in these segments.

We like the fact that in the retail segment BZWBK has a good starting position to participate in the recovery and grow faster than its competitors. The staff reductions were moderate (-8% from the peak) and branch expansion was not cancelled (the bank plansfurther growth of the network, although based mainly on franchise outlets), so the bank has capacities. Despite not pricing aggressively BZ WBK managed to stop the outflow of retail deposits and its liquidity is still good (LDR, at 78%, is the third best among listed banks in Poland). This was achieved thanks to very visiblemarketing campaigns (often supported by foreign celebrities), which also helped to increase the number of current accounts, one of the key products now (the other being mortgage lending). The bank has been always biased to capital markets, which is positive now as we see return of inflows to mutual funds and a new wave of privatisation. The risk is that the competition is growing and it has lost a few key employees in this area (June was the tenth consecutive month of declining market share in mutual funds).

We like the fundamentals and the management team, but these are not the crucial catalysts for the price in the short-term. AIB is selling its 70% stake in BZ WBK, so the price performance will depend onthe following factors: (1) who will buy it (the more independent the bank remains the better; a merger would be a worst case scenario as we do not believe in a favourable swap ratio)? (2) What will be the price? (3) Will the public bid be announced for all the shares (according to the law it should be, but there are ways to avoid it)? Because the answers to these questions are largely guesswork we maintain our neutral view (HOLD) on the stock.

We reduced our DDM-based target price due lower profit forecasts (higher provisions; lower NII due to weak corporate volumes).

BZ WBK trades at over a 30% premium to peers on P/BV, which seems to be justified by higher profitability (as a result, on 2010F/11F PER it trades at par). Because the main driver for the price is the outcome of the ongoing tender and the outcome will not be just the function of fundamentals but also of political pressure,we maniatin our HOLD recommendation.

Price (19/07/10) PLN196.50



Quarterly preview As usually with BZ WBK, 2Q is likely to be the strongest quarter of the year thanks to the dividend from Aviva (PLN48m). We believe that NII will rebound slightly thanks to better margins in corporate loans and falling cost of deposits. Provisions are likely to be visibly higher than 1Q10, which was deflated by the PLN35m release of IBNR provisions.

2Q10F results preview (28 July)

(PLNm) 1Q10 2Q10F



Earnings drivers and outlook We expect double-digit growth of core revenues (NII+fees) this year. NII is likely to be driven by continued repricing of corporate loans (although the management’s guidance for this factor isvery volatile). Fees should driven by capital markets and insurance but also by general growth of volumes in retail banking products that will still benefit from branch expansion in 2008. The strong growth of a number of current accounts in 1H10 should betranslated into better card, loan and transactional fees in 2H10.

Costs are likely to grow due to better sales volumes because the bank usually pays relatively high bonuses (especially as a large part of the business is investment banking). The bank intends to start hiring, but the average staff number should fall 1% YoY and it will become a burden from 2011 onwards.

Because a large part of real-estate loan portfolio is late-cyclical commercial developers, we cannot exclude that despite balance sheet-cleaning in 4Q08 there may be some negative surprises in this line in 2010. Apart from this we are concerned by the sudden growth of NPLs in unsecured retail loans in 1Q10.

There is also some risk of write-offs connected with the 10% stake in the Aviva pension fund. If there are further unfavourable changes in the law the bank may be forced to write-off part of the stake (the downside does not exceed PLN100m, in our view). Moreover, we expect the dividends from the Aviva group to decline 20% this year.

Thanks to good growth in revenues BZ WBK may be the only Polish bank that will have 2010F profit at all-time high levels.


Polish Strategy BZ WBK July 2010

27

Newsflow

Date Description

30 Apr 2010 1Q10 results 5 May 2010 Traded ex-dividend (PLN4.0 per share) 12 May 2010 Fitch upgrades rating outlook from negative to

stable ; BBB+ rating confirmed 12 Jul 2010 Press reports: only PKO BP and BNP Paribas

are short-listed by AIB; the bid prices are said to be “low”

28 Jul 2010 2Q10 results



Allied Irish Bank 70


Share data




80100120140160180200220240

6/09 8/09 10/09 12/09 2/10 4/10


Source: ING

Company profile

BZW BK is the fifth largest bank in Poland in assets(5% share). The bank has corporate roots (still 38% of deposits and 70% of loans at the end of 2009), but itis also strong in selected retail products, eg, mutualfunds (No.2 in Poland, with a 12% market share) andcash loans. The loan portfolio is heavily biased to real-estate and construction sectors (one-third of totalloans portfolio, the highest share among Polish listedbanks). Ireland’s AIB is a strategic shareholder in thebank (70% stake) but plans to dispose of the stake byend-2010.

Risks

Risks to our HOLD rating include: high costs ofmarketing and expansion, further loss of market sharein mutual funds (downside); the acquisition price beinghigher than expected and there is a public bid forminorities; fast growth in the number of accounts andfees, growth of market share in mortgages (upside).

Financials


Income statement

Net interest income 1,287 1,635 1,563 1,736 1,959 2,188Net fee & commission income 1,334 1,139 1,089 1,228 1,460 1,707Net trading income 321 354 587 471 521 567Insurance income 0 0 0 0 0 0Other operating income 14 40 27 19 21 23Revenues 2,955 3,169 3,266 3,454 3,961 4,485Operating costs (1,560) (1,654) (1,622) (1,735) (1,942) (2,183)Pre-provision profit 1,395 1,514 1,644 1,719 2,019 2,302Total impairments (4) (365) (481) (379) (269) (241)Provisions Other non-operating income 0 62 0 0 0 0Pre-tax profit 1,391 1,211 1,163 1,341 1,750 2,060Tax (281) (256) (223) (308) (368) (433)Minorities (156) (99) (54) (74) (158) (185)Other adjustments 0.2 (0.8) (0.3) (0.4) (0.5) (0.6)Net profit 955 855 886 958 1,225 1,442Normalised net profit 955 805 886 958 1,225 1,442

Balance sheet






Growth

Asset growth (%) 25.1 40.0 -6.5 6.2 10.3 13.0RWA growth (%) 24.4 48.1 14.0 4.7 11.8 15.4Loan growth (%) 35.9 46.7 -1.6 1.6 11.2 17.7Deposit growth (%) 23.2 43.8 -3.7 5.0 10.1 11.1Net interest income grth (%) 24.7 27.1 -4.4 11.1 12.8 11.7Revenue growth (%) 24.5 7.2 3.1 5.8 14.7 13.2Rep'td pre-tax profit grth (%) 31.8 -12.9 -4.0 15.3 30.5 17.7

Valuation


Per share data

Reported EPS (PLN) 13.09 11.72 12.15 13.14 16.79 19.76Normalised EPS (PLN) 13.09 11.04 12.15 13.14 16.79 19.76Normalised EPS growth (%) 25.9 -15.7 10.1 8.1 27.8 17.7Dividend per share (PLN) 3.00 0.00 4.00 5.91 10.07 11.86Dividend growth (%) -50.0 -100.0 n/a 47.9 70.4 17.7Payout ratio (%) 22.9 0.0 32.9 45.0 60.0 60.0BV/share (PLN) 59.51 67.87 81.51 90.65 101.53 111.22Tangible BV/share (PLN) 57.94 65.49 79.02 88.06 98.84 108.42


Polish Strategy Getin July 2010

28

Getin Maintained

Mortgage blessing; mortgage curse HoldPoland Market cap PLN6,960.0mBanks Bloomberg GTN PW

Getin is one of the few banks to be aggressive in volumes acquisition. However, as a result of its aggressive policy, the high cost of risk extends the cyclical weakness in its profits. The potential defaults in its high-risk FX mortgage portfolio are the main concern. HOLD maintained.

Investment case Other than PKO BP, Getin is probably the only Polish bank that is really active in lending. At the start of 2010, Getin Noble Bank (a key banking subsidiary of Getin) announced its 2010-12 strategy and key targets. The growth-oriented strategy is also visible in its operational objectives. Getin Noble wants to increase branch numbers by 130 (+24%) within the next threeyears, which is probably the largest network expansion project still in progress. It will need new hires, and the bank assumes that total staff will grow by c.50% to 2012. Growth in resources is the way to achieve a top five position in all key categories in the Polish banking sector. While we believe this is achievable in the longer term, we doubt it will be possible by 2012, despite the fact that in selected products the bank has already reached leading positions (eg, in car loans; second/third in new mortgage loans).

On the assets side, the key products will be mortgages (the plan is to grow 30% in 2010F and, with 10% achieved in 1Q10, they are on track), leasing and car loans. Cash loans are too risky at present. On the liabilities side, the key objective is to increase sales of products with long maturities (deposits and structured products). Although the cost of funding such products is high, we think that this is a good move as it locks in the cost ahead of interest rate hikes. Moreover, sales of these products are so good (deposits grew 10% YTD in 1Q10) that liquidity is no longer a big problem (an LDR ratio of 87% is comparable with Pekao).

It must be underlined that faster-than-average growth is connected – as usual – to an above-average risk profile. Getin targets the lower segment of the market and it pays for this: mortgage defaults were very high in 1Q10 (especially compared with mainstream banks). High unemployment and a depreciating PLN may worsen the situation, which concerns investors, because mortgages account for 70% of all loans.

There is a concern regarding its capital position. Following the merger, Getin Noble has an 11% CAR, which may be insufficient for swift growing assets. A share issue could be a solution, but Getin denies such plans. The risk of such a scenario grew recently after the planned IPO of the Europa subsidiary failed.

After a downward revision of forecasts, the stock trades at average ratios for the sector (the exception: p/pre-provision profit of 5.0x for 2010F is the lowest). This may seem slightly stretched, considering earlier discounts and the risks connected with the mortgage book, but this is one of the very few real growth stories. We maintain our HOLD rating.

Price (19/07/10) PLN9.79



Quarterly preview The period of weak results is likely to continue. Two lines matter, in our view: provisions and NIM. NIM should improve thanks to good volumes in mortgages and margins benefiting from a softening deposit war. The key will be the NPL ratio in mortgages and losses in this sub-segment (we expect further deterioration). Net profit may be supported by minor one-offs (negative goodwill from GMAC, tax write-backs) and a revaluation of CIRS (which may have a meaningful impact but is not fully recurring).


(PLNm) 1Q10 2Q10F



Earnings drivers and outlook We expect Getin’s profit to rebound over 50% this year (vs c.30%+ for the sector), after halving in 2009 (-32% for the sector). The problem is that the quality of earnings both in 2009and 2010F is low. In 2009, they included over PLN100m in the revaluation of hedging, fees from the renegotiation of FX loan contracts and tax returns. This year, Getin also expects tax returns (c.PLN80m) and extra fees from CHF loan agreements.

Not fully recurring loan fees from 1H09 are the main reason we expect flat fees this year. At the same time, NII is likely to accelerate, owing to margin expansion, although 1Q10 results were a bit disappointing because of the aggressive pricing of deposits. In the medium term, fees are likely to grow faster than NII (cross-selling of cards, accounts, bancassurance).

We should also remember that aggressive ROE targets for Getin Noble Bank (94% subsidiary of Getin), ie, 20% in 2010F and 25% in 2012F, cannot be merely translated into ROE of Getin Group, owing to goodwill and minorities at the consolidated level.

Costs are unlikely to surprise positively, as the bank continues hiring and aggressive marketing campaigns. Losses on old cash loans are almost exhausted (new cash loans appear safe), but defaults in mortgage loans have started growing and if they get out of control we could see another dip in earnings.

We cut our DDM-based TP due to the downward revision of ourprofitability forecasts, especially in the provisions line.


Polish Strategy Getin July 2010

29

Newsflow

Date Description

21 May 2010 Financial regulator approves issue prospectus of Europa, insurance subsidiary

8 June 2010 Europa suspends IPO due to weak demand 31 Aug 2010 2Q10 results



Mr Leszek Czarnecki 56Aviva pension fund (PL) 7Pioneer Pekao mutual funds (PL) 5ING pension fund (PL) 5


Share data




6789

101112

7/09 9/09 11/09 1/10 3/10 5/10


Source: ING

Company profile

Getin has a 3% share of assets in Poland, and isstrong in the retail segments of mortgages (No.5 inPoland) and car loans (No.1). Getin has anaggressive risk approach to lending products (forbetter margins and volumes) and in the pricing ofdeposit products, but a weak position in corporateloans and deposits. As well as its key bankingsubsidiary, Getin Noble Bank, Getin controls aninsurer (Europa), a Russian leasing company(Carcade) and a financial intermediaries company(Open Finance). Getin is the only listed Polish bank tobe controlled by a private individual, Mr LeszekCzarnecki.

Risks

The main risks to our HOLD rating: problems withmortgage loans extended to 2011; growing cost ofswaps hits NIM; potential share issue (downsides);interest rate hikes (large part of deposits was fixed forlonger-term); weakening deposit war; growth ofmortgage market supporting volumes and insurancerevenues (upsides).

Financials


Income statement

Net interest income 561 1,018 978 1,302 1,597 1,922Net fee & commission income 257 242 443 426 507 606Net trading income 260 298 224 118 129 149Insurance income 258 472 450 566 668 754Other operating income (74) (163) (33) (59) (89) (107)Revenues 1,262 1,866 2,061 2,352 2,812 3,325Operating costs (586) (787) (861) (952) (1,121) (1,352)Pre-provision profit 676 1,080 1,200 1,401 1,692 1,973Total impairments (104) (379) (842) (861) (803) (807)Other non-operating income 227 (0.2) 64 85 0 0Pre-tax profit 798 700 422 625 889 1,166Tax (134) (140) (85) (119) (169) (222)Minorities (42) (52) (60) (75) (98) (117)Other adjustments 4 0.2 (0.5) (0.8) (1) (1)Net profit 626 509 276 430 621 826Normalised net profit 425 536 212 345 621 826

Balance sheet






Growth

Asset growth (%) 57.8 64.7 13.6 22.6 19.0 21.6RWA growth (%) 16.8 27.4 21.6 19.5 18.1 18.4Loan growth (%) 83.6 91.2 20.6 25.8 24.7 26.8Deposit growth (%) 58.5 92.7 40.8 25.8 20.0 20.0Net interest income grth (%) 54.1 81.4 -4.0 33.2 22.6 20.3Revenue growth (%) 83.9 47.9 10.5 14.1 19.6 18.2Rep'td pre-tax profit grth (%) 289.1 -12.3 -39.7 48.0 42.3 31.1

Valuation


Per share data

Reported EPS (PLN) 0.93 0.72 0.39 0.61 0.87 1.16Normalised EPS (PLN) 0.63 0.75 0.30 0.49 0.87 1.16Normalised EPS growth (%) 131.2 20.0 -60.4 62.7 80.0 33.0Dividend per share (PLN) 0.00 0.00 0.00 0.00 0.00 0.00Dividend growth (%) n/a n/a n/a n/a n/a n/aPayout ratio (%) 0.0 0.0 0.0 0.0 0.0 0.0BV/share (PLN) 4.37 5.06 5.39 5.99 6.87 8.03Tangible BV/share (PLN) 3.00 3.64 3.93 4.51 5.37 6.51


Polish Strategy Handlowy July 2010

30

Handlowy Maintained

Early in the cycle BuyPoland Market cap PLN9,675.3mBanks Bloomberg BHW PW

Weak volumes growth but a high chance of positive surprises in fees, costs and provisions (earlier-than-average recovery of loans quality). The safest dividend play in the Polish banking sector, in our view.

Investment case In 1Q10, Handlowy showed good profitability (thanks to costs and provisions) but disappointed with weak volumes (the bank lost market share in loans and deposits). The bank is still unwilling to grab market share if it puts its margins at risk. However, in the short term, it assures fairly good growth in earnings so there is a chance of positive surprises later this year.

We have not seen any positive impact from the new strategy as yet, however, its announcement was made only in January.According to the strategy document, Handlowy wants to focus more on the quality of its relationships rather than quantity. The main objective will be to increase its cross-selling ratio among existing clients, not to acquire new ones. It will especially target the customers with just one product (66% of total number in retail; 51% in corporate). While we agree that this is a cheap way to achieve revenue growth, we think that there are limits to this form of development.

Loan growth will result from strong relationships with clients. The bank is eager to strengthen its position in mortgages but CEO, Slawomir Sikora, has pointed out that this will not happen quickly. Therefore, we think that it will be difficult to fully utilise the bank’s current good liquidity and strong capital position with this strategy (in 1Q10, Handlowy had a 61% loan/deposit ratio –the best among the listed banks – and a CAR of 18.4% –second best). When the corporate lending market (still the key business for the banks) is weak due to low demand from deleveraging corporations, we see relatively poor prospects for asset/loan growth. Prospects for revenues are better than for assets as the bank should benefit from a revival in capital markets as it has a meaningful exposure to brokerage and mutual funds (as the agent).

The bank paid out dividends of almost 100% of its 2009 profits and it is likely to continue this policy. As the result, Handlowy is the most attractive dividend story (yields of 5%+) in the Polish banking sector.

Handlowy trades at a small discount to its peers on PBV and PER (the biggest discount, 11%, is for 2010F PER). In the case of PBV, the difference shrinks over the time due to high dividend payouts (we assume almost 100%). We maintain our BUY rating. The main catalyst for share appreciation should be good 2H10 results thanks to quickly falling provisions.

Price (19/07/10) PLN74.05

MaintainedTarget price (12-mth) PLN85.93


Quarterly preview We expect further profitability improvement at Handlowy. This time it will be the result of good fees (capital markets) and the trading result (high volatility in FX and bonds) rather than NII (margins may increase slightly but volumes are falling). There should be no negative one-offs (almost PLN11m in 1Q10 for the repurchase of Lehman Brothers’ bonds from clients).

2Q10F results preview (31 August)

(PLNm) 1Q10 2Q10F

NII 373 373Revenues 610 633Costs -325 -334Provisions -77 -85Net profit 151 167


Earnings drivers and outlook In 1Q10, Handlowy increased its NIM to a record high of 4.0% and was the leader among the listed banks. We do not think this is sustainable as competitive pressure in deposits is shifting from retail to corporate. Together with weak volumes, it means that NII will be flat. Fees are likely to be the main driver for revenues, benefiting from a turnaround in capital markets, the partial effects of price increases in mid-2009 and an increased number of accounts due to cross-selling.

As in previous years, costs should be under strict control. According to the bank, we will see a small growth in staff numbers (after severe cuts in 2008-09) but this will be due to insourcing so should not boost total costs. Provisions for NPLs are likely to fall as the bank started restructuring its retail portfolio earlier than competitors and the corporate segment will not be affected by ‘FX-options’ (PLN126m provisions in 1H09). The corporate bias of the loan portfolio and lack of mortgage loans mean that the nature of the loan book quality is early cyclical: it started deteriorating early and should recover before peers.

We do not think the 2012 targets set by management (20%+ ROE, <50% C/I, 2.5%+ ROA) will be reached. Cross-selling should boost revenues and increase ROA to c.2.5%+. However, the company’s defensive strategy does not allow a major increase in assets (> leverage), which is crucial to exceed 20% ROE (a special dividend is unlikely given the view of the banking regulators). However, low consensus estimates (4% and 8% below our 2010F and 2011F forecasts) indicate that the market is also sceptical so the risk of negative surprise is low.


Polish Strategy Handlowy July 2010

31

Newsflow

Date Description

6 May 2010 1Q10 results 28 June 2010 AGM approves DPS of PLN3.77 1 July 2010 Traded ex-dividend 6 Aug 2010 2Q10 results



Citibank 75


Share data




505560657075808590

7/09 9/09 11/09 1/10 3/10 5/10


Source: ING

Company profile

Handlowy is a mid-sized Polish bank with a 3% sharein total assets. It is corporate-biased (58% of loans,71% of profits in 2009) with a strong position in largecorporates. It has an excellent position in credit cards(the fourth in terms of number of cards, the leader ingenerated turnover) and cash loans. However, it isalmost non-existent in the mortgage lending segment(mortgages are below 5% of its loan portfolio, thelowest ratio among listed banks). Citibank holds a75% stake in Handlowy.

Risks

The main risks for our Buy rating are: increasedcompetition in the corporate sector; continuedproblems with the sale of mortgage loans; pressure onbonuses/salaries growth in investment banking; weakmarket for FX products as customers have been putoff following problems with ‘FX options’.

Financials


Income statement

Net interest income 1,204 1,366 1,505 1,513 1,533 1,593Net fee & commission income 737 619 556 641 753 867Net trading income 462 328 356 383 432 488Insurance income 0 0 0 0 0 0Other operating income 65 93 49 42 55 60Revenues 2,469 2,405 2,467 2,580 2,772 3,008Operating costs (1,523) (1,496) (1,382) (1,376) (1,427) (1,520)Pre-provision profit 946 909 1,085 1,204 1,345 1,488Total impairments 53 (153) (546) (315) (176) (89)Provisions Other non-operating income 44 0 115 0 0 0Pre-tax profit 1,043 756 654 889 1,169 1,399Tax (210) (159) (151) (205) (270) (323)Minorities 0 0 0 0 0 0Other adjustments (9) 3 0.4 2 3 4Net profit 824 600 504 685 902 1,080Normalised net profit 789 600 411 685 902 1,080

Balance sheet






Growth

Asset growth (%) 8.1 9.4 -11.6 -0.83 4.2 6.0RWA growth (%) 8.4 14.0 -14.9 2.6 5.8 7.3Loan growth (%) 20.9 12.6 -8.7 2.6 10.5 15.0Deposit growth (%) 7.6 6.6 -3.5 -0.99 5.7 5.0Net interest income grth (%) 17.4 13.4 10.2 0.53 1.3 3.9Revenue growth (%) 17.3 -2.6 2.6 4.6 7.5 8.5Rep'td pre-tax profit grth (%) 26.5 -27.5 -13.5 35.9 31.6 19.6

Valuation


Per share data

Reported EPS (PLN) 6.31 4.59 3.85 5.25 6.91 8.27Normalised EPS (PLN) 6.04 4.59 3.14 5.25 6.91 8.27Normalised EPS growth (%) 59.0 -23.9 -31.6 67.0 31.6 19.7Dividend per share (PLN) 4.75 0.00 3.77 5.19 6.84 7.44Dividend growth (%) 15.9 -100.0 n/a 37.8 31.6 8.8Payout ratio (%) 78.7 0.0 120.0 99.0 99.0 90.0BV/share (PLN) 42.88 43.06 47.45 48.92 50.64 52.07Tangible BV/share (PLN) 33.06 33.24 37.63 39.11 40.82 42.26


Polish Strategy Millennium July 2010

32

Millennium Maintained

After the storm BuyPoland Market cap PLN5,604.6mBanks Bloomberg MIL PW

After zero profits in 2009, Millennium seems to be recovering. There are still a few issues ahead (quality of mortgage, corporate volumes), but the bottom line should show improvement and PBV is fairly low. BUY maintained.

Investment case Millennium had a very difficult 2009. It was the only bank underour coverage that made no profits, as it was heavily exposed to every negative factor to appear last year (cost of SFr hedges, deposit war, FX options, liquidity problems). In addition, it madea large (38%) capital increase (completed in 1Q10).

The main risk was that in such a difficult environment the existing assets of the bank may appear unprofitable. And because most of the loan book (64%) was long-term low-margin mortgage loans, there was no chance of them being replaced or rolled over. However, most of the negative factors quickly started reversing (much faster than the markets expected): liquidity in the sector improved, FX option problems exhausted, the cost of FX hedges declined (although we saw a moderate pick-up in 2Q10 again) and the deposit war is ending. As a result, thebank’s ‘old’ portfolio has a chance of showing reasonable profitability again. Short term, the risk is connected with the quality of mortgage lending, but we think that it is better than for those banks that were aggressive in this segment in the past (eg, Getin and BPH). Rather than lose clients, Millennium competed on low price (the impairment ratio of its mortgages was 0.9% in 1Q10 versus 2.8% at Getin and 2.0% at PKO BP).

At the same time, new capital should allow the bank to acquire new assets that should show better margins. This time, the main area of growth is expected to be the corporate (SME) segment. It is a meaningful change because until end-2008 Millennium was one of the most retail-biased banks in Poland (74% of loans/68% of deposits). Initially, we had a relatively negative view on this change, remembering the heavy losses on corporate FX options, but further analysis showed that the profitability of this segment, although lower than in retail, is still satisfactory (12% ROE in 2005-1H09 versus 17% in retail). With some efficiencies of scale,it is possible that it will be better in future. The problem is that the demand is fairly weak in corporate lending and Millennium has to fight fiercely for market share. However, in the past, Millennium has proved that it is able to acquire share if necessary.

Millennium has the second-lowest PBV among the Polish banks. It trades at the highest 2010F PER due to the dilutive effect of the latest share issue, but when the new capital starts to be utilised the ratio should improve (for 2011F, it is at the average for the sector). Because of Millennium’s low PBV, low expectations about its profitability and its willingness and capacity to capture growth in an economic recovery, we maintain our BUY. Our DDM-based TP rises to PLN5.80.

Price (19/07/10) PLN4.62



Quarterly preview We expect a slight decline in profits in 2Q10 due to growth inprovisions (mainly in mortgage lending; the corporate provisions should fall) and costs (ending cost cuts; marketing campaigns). Also fees are likely to decline, because in 1Q10 they were slightly inflated by insurance bonuses (seasonal item) and smaller inflows to mutual funds. On the positive side, we expect high growth in mortgage loan sales and minimal NIM expansion due to lower competition in deposits.


(PLNm) 1Q10 2Q10F



Earnings drivers and outlook The single most important driver for Millennium’s recovery will be net interest income, although its ‘structure of growth’ will change in the future. In 2010, this line will be supported mainly by margin expansion, which benefits from lower competition in deposits, falling costs of swaps (we assume the latest hike is temporary) and repricing of corporate loans in 2009. In 2011 and beyond, the importance of volumes will increase.

At the same time, provisions should decline. The bank usually has a lower cost of risk than its competitors and this is unlikely to change. We see risks connected with defaults in mortgage loans, but they should be more than offset by the level of corporate provisions (especially that part of 2009 provisions in the area connected with FX options and 3Q09 balance sheet cleaning, which are not fully recurring).

After several quarters of squeezing personnel costs (both salaries and headcount), we believe Millennium will be forced to improve pay this year; first, because another year of low salaries would lead to the voluntary departure of high-quality employees; and second, because the current strategy is slightly more expansionary than the 2009 approach, so some bonus costs are likely to reappear.


Polish Strategy Millennium July 2010

33

Newsflow

Date Description

26 Apr 2010 1Q10 results 27 Jul 2010 2Q10 results



Banco Comercial Portugues 66Aviva pension fund (PL) 8


Share data




2.53.03.54.0

4.55.05.5

7/09 9/09 11/09 1/10 3/10 5/10


Source: ING

Company profile

Millennium is a mid-sized bank with a 4% share intotal assets (Poland’s sixth largest). It is biasedtowards the retail segment and is especially strong inmortgage lending (second largest, 11% share instock, 66% of total loans). The latest strategyassumes a shift towards the corporate segment (SMErather than large corporations). It has a large retailnetwork (474 branches, sixth largest). Portugal’s BCPis the strategic shareholder (a 67% stake).

Risks

Major risks to our Buy rating: major defaults inmortgage lending (64% of total portfolio); growingcompetition and weak growth in corporate lending,where the bank wants to expand; pressure on marginsin corporate loans; pressure on liquidity in Millenniumand in the sector if the PLN depreciates more (FXmortgage loan portfolios will expand); the latestgrowth of swap costs being continued into 2H.

Financials


Income statement

Net interest income 772 935 598 885 1,072 1,312Net fee & commission income 543 472 494 557 655 783Net trading income 333 421 342 198 211 224Insurance income 0 0 0 0 0 0Other operating income 60 19 19 21 23 25Revenues 1,708 1,846 1,453 1,660 1,961 2,345Operating costs (1,057) (1,190) (1,022) (1,046) (1,131) (1,253)Pre-provision profit 651 657 431 615 830 1,092Total impairments (67) (135) (436) (293) (212) (202)Provisions Other non-operating income 0 0 0 0 0 0Pre-tax profit 585 522 (5) 322 618 890Tax (123) (108) (0.4) (61) (117) (169)Minorities 0 0 0 0 0 0Other adjustments 0 0 7 0.6 1 2Net profit 462 413 2 261 502 723Normalised net profit 462 413 2 261 502 723

Balance sheet






Growth

Asset growth (%) 23.6 54.3 -4.7 10.4 15.0 14.6RWA growth (%) 29.1 63.8 -10.1 10.7 16.5 16.9Loan growth (%) 47.5 53.5 -0.34 12.0 18.9 19.5Deposit growth (%) 39.0 43.4 0.84 11.9 13.0 12.5Net interest income grth (%) 18.6 21.1 -36.0 47.9 21.2 22.4Revenue growth (%) 34.9 8.1 -21.3 14.2 18.1 19.6Rep'td pre-tax profit grth (%) 57.7 -10.8 n/a n/a 91.9 44.1

Valuation

PER (x) 8.5 9.5 2,483 18.2 11.2 7.8Normalised PER (x) 8.5 9.5 2,483 18.2 11.2 7.8Price/book (x) 1.6 1.4 1.4 1.4 1.2 1.1Price/tangible book (x) 1.6 1.4 1.4 1.4 1.3 1.1Dividend yield (%) 4.1 0.0 0.0 0.93 1.8 1.9

Per share data

Reported EPS (PLN) 0.544 0.487 0.002 0.253 0.414 0.596Normalised EPS (PLN) 0.544 0.487 0.002 0.253 0.414 0.596Normalised EPS growth (%) 53.5 -10.4 -99.6 13,523 63.2 44.1Dividend per share (PLN) 0.190 0.00 0.00 0.043 0.083 0.089Dividend growth (%) 11.7 -100.0 n/a n/a 91.9 8.1Payout ratio (%) 35.0 0.0 0.0 20.0 20.0 15.0BV/share (PLN) 2.97 3.31 3.28 3.36 3.71 4.20Tangible BV/share (PLN) 2.95 3.29 3.26 3.34 3.69 4.17


Polish Strategy Pekao July 2010

34

Pekao Previously Sell

Cautious as usual HoldPoland Market cap PLN41,966.1mBanks Bloomberg PEO PW

Pekao is stuck in the middle. Margins and cost of risk are good, but volumes struggle. The BZ WBK story is positive. Valuation is rich considering the past low growth and the prospects. We upgrade to HOLD.

Investment case Pekao survived last year in fairly good shape and proved to have a below-average risk profile. We had been wary of provisions connected with the corporate loan book and Ukraine, but in both cases there were positive surprises, because in the case of retail loans the bank was even more cautious than in corporate ones.We do not expect a major deterioration in loan quality this year.

On the top of this there was relatively good NIM. While low provisions were the result of past conservative lending policy, the good NIM was the effect of the current conservative strategy. The bank remained focused on margins, even at the expense of volumes. As a result its market shares in loans and deposits kept falling over 2009, although it was probably the best moment to acquire new clients by more aggressive policy (as many competitors just stopped lending and cared about costs, liquidity and capital position). The policy is continuing – in 1Q10 Pekao loans shrank by 12% YoY (the worst result among listed banks) and deposits shrank by 2% (the second worst). During the 1Q10 presentation the bank revealed monthly data showing strong growth of selected loans (SME, mortgage, cash), but we are sceptical about the figures due to short data series (Pekao is fairly inconsistent in providing sales data).

Looking to the future, we believe the market environment will improve in 2011 and the chance to grab market share will diminish, as history shows that during boom times Pekao is not willing to compete with aggressive midcap banks. Therefore, despite quite good capacity to grow (reasonable liquidity; the best capital position) we do not believe Pekao is exposed to the recovery as the strategy remains defensive.

Unicredit/Pekao expressed an interest in an acquisition of BZ WBK. It has a better capital position and more experience in M&A than PKO BP, so we can see positives to the transaction, eg, strengthening of market position at reasonable cost (as mentioned above, the organic growth is poor). On the other hand, we would not count on huge synergies after the BPH acquisition disappointed. If BZ WBK is not bought (which is more likely as press reports say that the Unicredit was not shortlisted), the bank is likely to return to high dividend payouts.

Pekao used to be the most expensive Polish bank on 2010F P/BV, but after weak performance YTD (the second weakest among Polish banks) its valuations became less stretched. On the back of this, we upgrade stock from Sell to HOLD.

Price (19/07/10) PLN159.90



Quarterly preview We expect 2Q10 to be fairly similar to 1Q10. Further NIM improvement and further decline of assets is likely. There could be a positive surprise in the trading line if part of the 1Q10 profits on the AFS portfolio (previously booked through equity) now appears in the P&L.


(PLNm) 1Q10 2Q10F

NII 1,005 1,015Revenues 1,765 1,824Costs (904) (913)Provisions (141) (141)Net profit 603 635


Earnings drivers and outlook We forecast further NIM improvement this year, although at a slower pace. It will benefit from the softening deposit war in the market. According to the bank’s representatives on the asset side,the space for further growth is exhausted. Because volumes will be weak Pekao is not likely to return NII to 2008 levels this year.

Pekao is well positioned for a rebound in capital markets. While the merger with BPH in 2007 diluted its exposure to this source of fees (to 18% of fees/6% of total revenues in 1Q10), the fact is that it controls the largest mutual funds manager in Poland. However, 1Q10 revealed pressure on other fees. It is difficult to say how much of problem this is, as management was very unclear about the background for this weakness.

The bank reduced costs by 3% YoY in 2009, but we would not jump to positive conclusions too soon as it was partly the base effect (in 2008 the bank booked over PLN100m of the merger costs). Because this year the bank will book the costs of planned rebranding, it will be difficult to reduce expenses in absolute terms. But on the other hand, in comparison with its peers Pekao is likely to show lower cost growth in both 2010 and 2011.

Pekao is one of few banks for which we forecast growing cost of risk. This is largely connected with extremely low provisions in 1Q09 and a small chance that it could go far below current quarterly provision charge (PLN130-150m). Again, as in the case of opex, 70bp cost of risk should be better than the sector average.

Our DDM-based target price is largely unchanged as lower profit forecasts (-3% for 2010F) and trading ex-dividend (PLN2.9 per share) were offset by higher payout assumptions.


Polish Strategy Pekao July 2010

35

Newsflow

Date Description

28 Apr 2010 AGM (approval of PLN2.90 DPS) 12 May 2010 1Q10 results 13 May 2010 Traded ex-dividend (PLN2.90 DPS) 12 Jul 2010 Press report: Unicredit (the parent for Pekao)

has not been shortlisted for BZ WBK 4 Aug 2010 2Q10 results



Unicredit 59


Share data




120130140150160170180190

7/09 9/09 11/09 1/10 3/10 5/10


Source: ING

Company profile

Pekao is the second largest bank in Poland in termsof assets (12% share), the second largest in terms ofbranches (1,000) and in terms of client numbers, farbehind PKO BP (4m vs 6m). Pekao is strong in mutualfunds (No.1) but relatively weak in mortgage lending(as it offers only PLN-denominated loans) and creditcards. Pekao has a very conservative risk approach. Itis controlled by Italy’s Unicredit (59% stake).

Risks

Upside: acceleration of loan sales; further fall inprovisions.

Downside: possible rebranding; further loss of marketshares in deposits.

Financials


Income statement

Net interest income 4,323 4,509 3,802 4,121 4,553 4,677Net fee & commission income 2,932 2,342 2,289 2,433 2,648 2,893Net trading income 755 729 907 800 825 885Insurance income 0 0 0 0 0 0Other operating income 126 271 117 129 148 163Revenues 8,136 7,851 7,115 7,483 8,175 8,618Operating costs (3,805) (3,802) (3,686) (3,741) (3,778) (3,885)Pre-provision profit 4,332 4,050 3,429 3,742 4,397 4,733Total impairments (320) (263) (535) (587) (478) (375)Other non-operating income 201 436 45 0 0 0Pre-tax profit 4,213 4,223 2,939 3,155 3,919 4,358Tax (805) (805) (576) (618) (768) (854)Minorities (13) (13) (10) (16) (14) (15)Other adjustments 153 123 58 95 129 161Net profit 3,547 3,528 2,412 2,615 3,267 3,650Normalised net profit 3,385 3,175 2,375 2,615 3,267 3,650

Balance sheet






Growth

Asset growth (%) 83.3 6.3 -1.0 3.0 3.7 4.7RWA growth (%) 131.4 17.9 -13.6 2.5 5.9 7.2Loan growth (%) 112.9 18.4 -3.7 0.25 6.7 9.0Deposit growth (%) 73.7 1.1 7.0 2.2 5.8 4.8Net interest income grth (%) 81.9 4.3 -15.7 8.4 10.5 2.7Revenue growth (%) 73.1 -3.5 -9.4 5.2 9.3 5.4Rep'td pre-tax profit grth (%) 99.4 0.24 -30.4 7.3 24.2 11.2

Valuation


Per share data

Reported EPS (PLN) 16.54 13.46 9.20 9.97 12.44 13.90Normalised EPS (PLN) 15.78 12.12 9.06 9.97 12.44 13.90Normalised EPS growth (%) 47.3 -23.2 -25.3 10.1 24.8 11.7Dividend per share (PLN) 9.60 0.00 2.90 9.47 11.82 13.20Dividend growth (%) 6.7 -100.0 n/a 226.9 24.8 11.7Payout ratio (%) 74.3 0.0 32.0 95.0 95.0 95.0BV/share (PLN) 56.01 60.82 69.71 77.51 80.08 81.74Tangible BV/share (PLN) 53.38 57.97 67.01 74.95 77.64 79.43


Polish Strategy PKO BP July 2010

36

PKO BP Maintained

Potential acquisition, potential problems BuyPoland Market cap PLN48,100.0mBanks Bloomberg PKO PW

PKO continues to gain market share and its profitability should benefit from falling provisions. But the potential acquisition of BZ WBK is more of a risk than an opportunity.

Investment case During the previous boom, 2005-08, PKO BP used to lose market share in the retail segment, due to strong competition from aggressive small and midcap players. From this point of view 2009 appeared to be a blessing for the bank. When the pressure from small banks eased it was able to increase its shares in retail (by 0.3% in loans/1.1% in deposits) thanks to more competitive pricing in deposits and less tight credit policy in loans. We especially like the fact that the bank managed to increase its share in mortgage lending. It sells PLN3bn of mortgages per quarter, which is close to pre-crisis highs. It has a c.30% share in new sales (PKO has just 14% share in total assets of the sector) and we believe it will be the fastest growing segment of the market in the short and medium term. Although we do not think these trends are sustainable in the long term, in the short term PKO BP should be able to outperform minor players, which still have problems with capital/liquidity/strategy.

In the case of the corporate segment, the bank has also improved its market shares, but here the key thing is to improve the profitability of the division, which was weak in the past and weakened even further during the crisis, as provisions soared.

In February the bank’s management published its 2010-12 strategy, which generally confirms the expansionary policy of the bank. However, we are slightly disappointed by the fact there were few new elements (eg, the focus on cross-selling, strong brand etc, are “old”) and most of the financial targets were overcautious.

While the operating performance is fairly good, there is still the problem with political pressure (as always). Last year the State Treasury forced the bank to carry out a capital increase and changed the CEO without providing any sensible reason for this move. A situation when the ministry directly influences operations is definitely negative. This year it seems that that the government backs the idea to bid for BZ WBK. We do not like it. PKO BP has insufficient capacity and experience to manage such a large merger. Moreover, although it has started internalrestructuring there is still plenty to do in this area and we believe the bank should finish this process before seeking new challenges.

PKO BP is the second most expensive Polish bank on 2010F P/BV, but it is traded at par on PER. On a stand-alone basis it gives good exposure to the Polish recovery thanks to strong positions in mortgage lending. Due to the company’s size and liquidity this is also the easiest play on Polish macro. Therefore, despite potential risks connected with BZ WBK, we maintain our BUY recommendation.

Price (19/07/10) PLN38.48



Quarterly preview In late May the CEO gave fairly positive guidance on provisions (“lower than in 1Q”) and ROE (should be higher than in 1Q10). Earlier management had indicated that margins should not deteriorate QoQ, which should support NII growth as volumes are growing (although slightly slower than in 1Q10). All in all, we expect good earnings thanks to small improvements at all lines.


(PLNm) 1Q10 2Q10F

NII 1,475 1,519Revenues 2,346 2,415Costs (1,014) (1,050)Provisions (425) (383)Net profit 720 783


Earnings drivers and outlook NIM was under heavy pressure in 1H09 but it started rebounding in 3Q09 and then continued to do so. We do not believe that it will reach record high levels (over 5% in 9M08) any time soon (if ever), but we should see further gradual improvement. NII should grow much faster as the bank is likely to show good volumes in both the retail and corporate segments. Stronger growth of NIM is possible when we see rate hikes in Poland (we forecast it will happen in 1H11), as PKO BP is one of the most exposed banks to this factor (due to its high share of deposit margins).

According to the company’s 2010-12 strategy, PKO BP expects 16%+ ROE in 2012. This is very low – much lower than during the precious cycle, when it was well above 20%. However, it seems that it was just an extremely cautious figure as the latest guidance from the CEO (“PLN3bn net profit in 2010 is realistic”) is definitely above the level suggested by the strategy.

Provisions are likely to fall only slightly this year. The quality of the retail portfolio is likely to be above-average, but the fact isthat the peak of retail NPLs is still ahead of us. Quality of corporate loans should start to improve soon. Total provision coverage of impaired loans is just 42% and is the lowest in Poland, although the coverage of 90+ day delayed loans (c.100%) is in line with the sector average.

We reduce our DDM-based target price, largely due to the uncertain situation with BZ WBK. A pure DDM-based target price would be higher (PLN49.3) but we include a 5% discount to reflect the risks connected with potential BZW BK acquisition.


Polish Strategy PKO BP July 2010

37

Newsflow

Date Description

25 June 2010 AGM suspended till 23 July 7 July 2010 PKO plans maximum PLN5bn subordinated

bond issue 10 July 2010 Press reports: PKO short-listed for BZWBK 23 July 2010 AGM approves conditional dividend of

PLN1.90 DPS (record day 23 Oct); paid if no acquisition completed by 10 Dec

26 Aug 2010 2Q10 results



Poland State Treasury 41BGK Bank (State-owned) 10


Share data

Avg daily volume (3-mth) 2,579,562Free float (%) 49.0Market cap (PLNm) 48,100.0Dividend yield (1F, %) 5.1



28

33

38

43

48

7/09 9/09 11/09 1/10 3/10 5/10


Source: ING

Company profile

PKO BP is the No.1 bank in Poland in terms of assets(14% share) and No.1 in terms of retail clients (6mcurrent accounts). It has also the largest branchnetwork (c.1,200 branches) and additionally 2,500agents. PKO BP is the largest mortgage lender and isbiased toward retail banking (65% of loans, 72% ofdeposits). PKO BP is controlled by the Poland StateTreasury (51% stake directly and indirectly).

Risks

The main risks to our BUY recommendation are: apotential acquisition of BZ WBK (especially if it isexpensive); mortgage loans start deteriorating late inthe cycle (although no signs so far in PKO BP);influence of the State Treasury on the strategy.

Financials


Income statement

Net interest income 4,647 6,127 5,051 6,157 7,098 7,801Net fee & commission income 2,332 2,412 2,583 2,885 3,238 3,670Net trading income 466 558 973 575 603 633Insurance income 0 0 0 0 0 0Other operating income 258 292 261 235 293 367Revenues 7,702 9,389 8,868 9,851 11,233 12,471Operating costs (4,041) (4,296) (4,244) (4,394) (4,686) (5,040)Pre-provision profit 3,662 5,092 4,624 5,457 6,546 7,432Total impairments (57) (1,130) (1,681) (1,546) (1,329) (737)Other non-operating income 0 0 0 0 0 0Pre-tax profit 3,605 3,962 2,943 3,910 5,217 6,694Tax (668) (838) (632) (839) (1,120) (1,437)Minorities (38) (19) (6) (16) (31) (40)Other adjustments 4 16 0.3 0.4 0.5 0.7Net profit 2,904 3,121 2,306 3,056 4,067 5,218Normalised net profit 2,904 3,121 2,306 3,056 4,067 5,218

Balance sheet






Growth

Asset growth (%) 7.2 24.0 16.2 10.3 8.1 12.2RWA growth (%) 41.6 36.3 6.8 11.3 14.0 17.0Loan growth (%) 29.7 32.3 15.3 9.5 15.5 18.8Deposit growth (%) 4.4 18.9 21.5 8.4 8.2 9.3Net interest income grth (%) 21.3 31.9 -17.6 21.9 15.3 9.9Revenue growth (%) 18.2 21.9 -5.5 11.1 14.0 11.0Rep'td pre-tax profit grth (%) 33.3 9.9 -25.7 32.9 33.4 28.3

Valuation


Per share data

Reported EPS (PLN) 2.90 3.12 2.05 2.44 3.25 4.17Normalised EPS (PLN) 2.90 3.12 2.05 2.44 3.25 4.17Normalised EPS growth (%) 35.1 7.5 -34.3 19.3 33.1 28.3Dividend per share (PLN) 1.09 1.00 1.57 1.96 1.14 1.46Dividend growth (%) 11.2 -8.3 56.8 24.8 -41.8 28.3Payout ratio (%) 37.5 32.0 85.0 80.0 35.0 35.0BV/share (PLN) 11.92 13.95 16.34 17.22 18.52 21.55Tangible BV/share (PLN) 10.74 12.60 15.08 15.96 17.26 20.30



38



39

Basic Resources

Polish Strategy Arctic Paper July 2010

40

Arctic Paper Maintained

Weak 2010 already in the share price BuyPoland Market cap PLN787mBasic Resources Bloomberg ATC PW

We forecast 178% YoY growth in 2011F EPS, driven by an expected easing in pulp prices. Arctic Paper trades at an attractive 2011F PER of 9.1x, implying a discount of 10% to global peers. Given that in our view the strong YoY deterioration in 2010F earnings has already been largelypriced in, we maintain our BUY recommendation with a new target price of PLN17.8.

Investment case We expect a YoY drop in EBIT margin to 3% in 2010F, from 10% in 2009. It is likely to be attributable mostly to soaring pulp prices (34% of the company’s operating costs). Given that Arctic Paper is a non-integrated paper producer, the company is forced to buy pulp from external suppliers. In 1H10, pulp prices hit all-time high levels. Global pulp supply was squeezed owing to an earthquake in Chile, which produces 7% of global pulp capacity. Moreover, the pulp market supply has been reduced because of strike action in Sweden and Finland, resulting in the closure of some pulp mills. As a result, about 12% of the global supply of pulp was blocked, pushing raw material prices up to record levels. We forecast 45% YoY growth in average pulp prices this year, which is unlikely to be counterbalanced by increases in graphic paper prices (10% YoY growth). Given that the stock has depreciated by 15% over the past three months, underperforming the market by 11ppt, we think the market has already discounted a poor 2010 outlook and is now looking at 2011.

We forecast that pulp prices will start to roll over in 2H10F as temporary disruptions are coming to an end (80% of Chilean deliveries have already been restored). Moreover, global pulp inventories grew to 27 days of supply in May after four consecutive months of decreases. Despite pulp stocks remaining low (the monthly historical average is 32 days), we believe pulp inventories should normalise in coming months, putting downside pressure on commodity prices. We forecast a 20% YoY drop in the average pulp price next year. Thus, we expect a rebound in EBIT profitability to 5% next year.

Arctic Paper trades at 9.1x 2011F PER, which translates into a 10% discount to global peers. Despite some risks connected with the stock (lack of integration with the pulp mill), we perceive this discount to be largely unwarranted, given 178% YoY EPS growth forecast for next year.

Our target price is calculated as the sum of 50% of our DCF valuation and 50% of our peer group valuation. In our comparable valuation, we use 2011F PER and EV/EBITDA multiples, to which equal weightings are applied. In our view,2011F figures reflect normalised earnings for the company. Thus, we eliminate cyclical 2010F earnings distortions. In addition, 2011F Arctic Paper multiples are approximate to cycle average valuation ratios.

Price (19/07/10) PLN14.2



Quarterly preview We expect 28%QoQ growth in revenues in 2Q10F, mainly on the consolidation of Grycksbo figures and growth in graphic paper prices. The company managed to raise paper prices by 10-12% in June. We anticipate it may not be profitable on the EBIT line in 2Q10F, given demanding levels of pulp prices (BHK pulp price of US$870/tonne in 2Q10F vs US$750/tonne in 1Q10 average). We forecast a PLN7m loss on operating activity. In our view, net profitability should be strengthened by PLN15m in positive FX differences, which should be offset by PLN10m in interest costs.

2Q10F results preview (due 31 August)

(PLNm) 1Q10 2Q10F

Revenues 479 615EBITDA 32 13EBIT 13 (7)Net profit 1 (2)EPS (PLN) 0.01 N/A


Earnings drivers and outlook We estimate a 10% YoY increase in average graphic paper prices in 2010F driven by a rebound in European graphic paper shipments after a weak 2009. However, a rally in pulp prices (we forecast 45% YoY growth in 2010F) should offset product price hikes. We believe 2010F margins are also likely to suffer from PLN appreciation against the EUR (our house view of PLN4.05/EUR in 2010F versus PLN4.34/EUR in 2009). The 2010F margin should also be worsened by hikes in local gas tariffs (Kostrzyn mill) and a rise in Swedish power prices (Munkendals and Grycksbo mills). We estimate large PLN310m capex this year (versus PLN113m last year), consisting mainly of expenditures on the acquisition of the Grycksbo mill (PLN262m). We assume flat PLN100m capex in 2011-19F.

In our view, the main downside risks are: a continuation of the rally in pulp prices, PLN appreciation against the EUR (the transaction currency for paper sales contracts), and USD (the transaction currency for pulp purchases contracts) appreciation against PLN. In the long term, we remain concerned about rising consumption of non-paper-based media, which may replace graphic paper. We think that the downside potential may come from an expansion of 4.5m tonnes of fine paper capacities in China in 2010-12F. If this comes into effect, demand for pulp should rise, which may drive raw material prices.


Polish Strategy Arctic Paper July 2010

41

Newsflow

Date Description

1 Mar 2010 Purchase of 100% stake in Grycksbo 21 Jun 2010 Ex-dividend date (PLN0.89 per shre) 31 Aug 2010 2Q10 results



Arctic Paper AB 75


Share data

Avg daily volume (3-mth) 15,402Free float (%) 25.0Market cap (PLNm) 787Net debt (1F, PLNm) 403Enterprise value (1F, PLNm) 1,190Dividend yield (1F, %) 1.6



12

14

16

18

20

22

10/09 12/09 2/10 4/10 6/10

Price WIG (rebased)

Source: ING

Company profile

Arctic Paper is a mid-sized European manufacturer ofgraphic paper (3% market share in Europe) used inthe production of books, leaflets, booklets andcatalogues. The company owns four paper mills, inKostrzyn (Poland), Mochenwangen (Germany),Munkendals and Grycksbo (both in Sweden). Arctic Paper is notably exposed to the EUR:PLN rate as63% of group revenues is denominated in EUR. Giventhat the company is a non-integrated paper producer,Arctic Paper’s profitability is sensitive to the price ofpulp (main raw material at 34% of operating costs) that is bought from external suppliers.

Risks

Continuation of the rally in pulp prices, PLNappreciation against the euro; PLN depreciationagainst the US dollar; rising consumption of non-paper-based media, expansion of 4.5m tonnes of finepaper capacities in China, increase in Swedish powerprices

Financials


Income statement

Revenues 1,240 1,270 1,809 2,428 2,263 2,248EBITDA 108 122 247 147 223 299EBIT 54 66 179 62 124 200Net interest (5) (11) (19) (19) (24) (21)Associates 0 0 0 0 0 0Other pre-tax items 0.6 0.1 (7) (8) 0 0Pre-tax profit 50 55 153 36 100 179Tax 8 (5) (21) (5) (14) (24)Minorities 0 0 0 0 0 0Other post-tax items 0 0 0 0 0 0Net profit 57 50 132 31 87 155Normalised net profit 57 33 132 31 87 155

Balance sheet

Tangible fixed assets 427 509 553 777 778 779Intangible fixed assets 9 49 43 212 212 212Other non-current assets 15 17 15 12 12 12Cash & equivalents 36 64 140 91 24 135Other current assets 385 481 430 555 611 589Total assets 872 1,121 1,180 1,647 1,637 1,726Short-term debt 92 53 23 135 74 74Other current liabilities 195 250 168 232 257 247Long-term debt 68 325 215 359 311 289Other long-term liabilities 64 117 156 262 262 262Total equity 453 375 618 660 734 854Total liabilities & equity 872 1,121 1,180 1,647 1,637 1,726Net working capital 189 224 236 290 321 309Net debt (cash) 124 314 98 403 360 228

Cash flow

Cash flow EBITDA 108 122 247 147 223 299Tax, interest & other 2 (0.6) 100 135 40 47Change in working capital (75) (3) (7) (55) (31) 12Net cash from op activities 38 85 251 169 155 266Capex (82) (111) (113) (310) (100) (100)Net acquisitions 0 0 0 0 0 0Net financing cash flow 68 189 (43) 313 (109) (22)Dividends & minority distrib'n (20) (26) 0 (49) (12) (35)Net ch in cash & equivalents 2 28 76 117 (67) 110FCF (41) 3 102 (169) 75 185

Performance & returns

Revenue growth (%) 1.2 2.4 42.5 34.2 -6.8 -0.65Normalised EPS growth (%) n/a -41.8 280.1 -80.3 177.8 78.6Normalised EBITDA mgn (%) 8.7 8.0 13.6 6.1 9.9 13.3Normalised EBIT margin (%) 4.4 3.6 9.9 2.6 5.5 8.9ROACE (%) 9.5 6.6 22.3 6.2 10.9 17.1Reported ROE (%) 13.0 12.2 26.7 4.8 12.4 19.5Working capital as % of sales 15.2 17.7 13.0 12.0 14.2 13.7Net debt (cash)/EBITDA (x) 1.1 2.6 0.40 2.7 1.6 0.76EBITDA net interest cvg (x) 19.9 10.7 13.1 7.9 9.4 14.1

Valuation

EV/revenue (x) 0.73 0.87 0.49 0.49 0.51 0.45EV/normalised EBITDA (x) 8.4 10.9 3.6 8.1 5.1 3.4EV/normalised EBIT (x) 16.7 24.3 4.9 19.2 9.3 5.1Normalised PER (x) 11.0 18.9 5.0 25.2 9.1 5.1Price/book (x) 1.4 1.7 1.2 1.2 1.1 0.92Dividend yield (%) 3.2 4.1 0.0 6.3 1.6 4.4FCF yield (%) n/a 0.5 15.6 n/a 9.6 23.5

Per share data

Reported EPS (PLN) 1.29 1.14 2.86 0.563 1.56 2.79Normalised EPS (PLN) 1.29 0.752 2.86 0.563 1.56 2.79Dividend per share (PLN) 0.449 0.581 0.00 0.890 0.222 0.625Equity FCFPS (PLN) (0.998) (0.577) 2.98 (2.57) 0.989 3.00BV/share (PLN) 10.22 8.46 11.79 11.90 13.24 15.41


Polish Strategy KGHM July 2010

42

KGHM Previously Hold

Upgrade to buy on relative valuation and record 2Q10 earnings BuyPoland Market cap PLN18,840.0mBasic Resources Bloomberg KGH PW

We upgrade KGHM to a BUY following a sector rally as well as on expectations of record high company earnings in 2Q10. The copper price is holding up well, copper inventories continue to be depleted in LME warehouses and we believe demand for copper is not at risk in the short term given the level of manufacturing recovery in some developed markets. While investors are likely to place an even higher than historical holding discount on the company valuation, at least until it divests its telecom assets, still the current level of discount appears excessive.

Investment case Our concerns about potentially weaker copper markets in 2H10 have not materialised so far. The recovery in manufacturing seen in some developed markets, such as Germany, is supportive to the copper price which is back above US$7,000/tonne. The high copper price combined with the weak zloty vs the US dollar has led to one of the best operating environments for KGHM in its history as a public company. We expect KGHM to revise its too conservative 2010F earnings guidance in 3Q10.

In August, we expect the signing of an investment agreement with Abacus regarding the joint venture to develop the Afton-Ajax copper-gold mining project in Canada. Shareholders of Abacus have approved the proposed transactions and the ball is now in KGHM's park. In our view, KGHM has selected an interesting acquisition project with low production costs, limited political risk and manageable execution challenges. The project assumes copper production of 50k tonnes pa and gold production of 100koz pa from 2013 over 23 years. Unit production costs of copper are estimated at US$2,000/tonne, using a gold price of US$700/oz for the calculation of gold credits. Gold would make up 25% of the project’s revenues.

Although KGHM blocked the IPO of Polkomtel earlier this year we believe the chances are increasing that KGHM will be able to divest its 24% stake in Polkomtel some time in 2011 in a potential private transaction. All the Polish shareholders seem to be willing to sell their stakes to a strategic partner and Vodafone is not against such a transaction either. Management is likely to reinvest potential proceeds from a Polkomtel sale into the core business in our view.

The stock trades at a 59% discount to the sector based on 2011F adjusted EV/EBITDA of 2.3x and at a 66% discount on 2011F adjusted PER of 3.8x. The discount is likely to be deeper than historically due to KGHM’s over 5% equity investment in Tauron but the current level of discount is excessive in our view. The investment in Tauron represented a departure from the company’s strategy of diversification into power through green-field investments. Our revised target price of PLN110 is based on a 2010F PER of 6.9x and a 2010F EV/EBITDA of 3.4x in addition to the standard DCF valuation.

Price (19/07/10) PLN94.20

Previously PLN101.00Target price (12-mth) PLN110


Quarterly preview We forecast record high earnings for KGHM in 2Q10 driven by a weak zloty, higher production, sales of inventory and positive revaluation of hedging positions. We forecast copper output of 134k tonnes in 2Q10, including 38k tonnes from imported concentrate and copper scrap. We forecast copper sales volumes of 139k tonnes as KGHM was likely to have sold an additional 5k tonnes of stocked copper in 2Q10.

We forecast unit production costs of PLN13,500/tonne, up 19% YoY from PLN11,380/tonne in 2Q09 and 7% QoQ from PLN12,606/tonne in 1Q10. The increased cost of imported concentrate and copper scrap as well as costs of inventory are the two major drivers of higher unit costs. The company will not recognise any actuarial provisions in 2Q10; in 1Q10 actuarial provisions lowered operating profits by PLN68m. KGHM will recognise an estimated PLN180m of positive revaluation of hedging positions as the copper price moved down from US$7,800/tonne at the end of 1Q10 to US$6,500/tonne at the end of 2Q10. We also expect PLN42m of dividend income from Polkomtel to be recognised in 2Q10.

2Q10 results preview

(PLNm) 2Q09 2Q10F

Revenues 2,772 3,846EBITDA 1,105 1,784EBIT 970 1,624Net profit 845 1,366


Earnings drivers and outlook We keep unchanged our copper price assumption for 2010F at US$7,165/tonne. We also maintain our 2011F and long-term average copper price assumptions of US$7,937/tonne and US$5,512/tonne respectively. We also keep our FX assumptions unchanged and continue to use an average PLN/US$ exchange rate of 3.22 in 2010 and 3.12 in 2011.

Excluding implications of copper and US dollar hedging, zloty appreciation of PLN0.1 over our 2010F central case assumption lowers our 2010F net profit estimate for KGHM by PLN294m, or 7%. An average copper price US$200/tonne below our central assumption of US$7,165/tonne in 2010F reduces our 2010F net profit estimate for KGHM by PLN219m, or 5%.

Our dividend estimates are based on a 60% pay-out ratio which we believe is a fair assumption given the increased M&A activity and considerable maintenance capex of KGHM.


Polish Strategy KGHM July 2010

43

Newsflow

Date Description

13 August 2010 3Q10 results August 2010 Likely Abacus deal closure 3Q10 Likely guidance revision 10 November 2010 3Q10 results



State Treasury 31.8


Share data

Avg daily volume (3-mth) 961,157Free float (%) 3,280Market cap (PLNm) 18,840.0Net debt (1F, PLNm) (3,182)Enterprise value (1F, PLNm) 15,658Dividend yield (1F, %) 12.7



80859095

100105110115120

7/09 9/09 11/09 1/10 3/10 5/10


Source: ING

Company profile

KGHM was the ninth-largest producer of copper andthird-largest producer of silver in the world in 2009,producing 503,000 tonnes of copper and 1,203 tonnesof silver. KGHM owns its own copper ore deposit andintegrated production structure, comprising threemines, two copper smelters and a wire rod plant.KGHM owns a 100% stake in Dialog, the third-largest fixed telephony company in Poland, and a 24% stakein Polkomtel, the country’s second-largest mobileoperator.

Risks

We note an increased risk of KGHM distributing lowerdividends in the future. We currently forecast a 60%dividend pay-out ratio starting from 2010F earnings tobe distributed in 2011F, which could be adverselyimpacted if KGHM were to increase further its M&Aactivity in either the core business of copper mining orthe non-core power generation segment.

Financials


Income statement

Revenues 12,183 11,303 11,061 14,291 14,938 14,382EBITDA 5,175 3,787 3,759 5,434 6,313 5,679EBIT 4,756 3,305 3,212 4,854 5,644 4,911Net interest 377 322 506 304 399 467Associates 0 0 0 0 0 0Other pre-tax items (478) (74) (650) (245) 0 0Pre-tax profit 4,655 3,554 3,067 4,912 6,044 5,378Tax (857) (633) (526) (933) (1,148) (1,022)Minorities 0 0 0 0 0 0Other post-tax items 0 0 0 0 0 0Net profit 3,799 2,920 2,541 3,979 4,895 4,356Normalised net profit 3,799 2,920 2,541 3,979 4,895 4,356

Balance sheet

Tangible fixed assets 4,833 5,538 5,938 6,943 8,270 9,538Intangible fixed assets 75 81 76 93 90 91Other non-current assets 2,480 3,108 3,496 3,496 3,496 3,496Cash & equivalents 2,616 2,505 1,238 3,199 4,301 4,517Other current assets 2,375 2,669 3,205 4,016 4,040 3,988Total assets 12,380 13,900 13,953 17,747 20,197 21,630Short-term debt 9 7 6 6 0 0Other current liabilities 1,966 1,661 1,839 2,254 2,203 2,216Long-term debt 20 17 12 12 12 12Other long-term liabilities 1,419 1,623 1,693 1,693 1,693 1,693Total equity 8,966 10,591 10,404 13,782 16,290 17,709Total liabilities & equity 12,380 13,900 13,953 17,747 20,197 21,630Net working capital 908 1,193 1,829 2,329 2,391 2,329Net debt (cash) (2,588) (2,480) (1,221) (3,182) (4,290) (4,505)

Cash flow

Cash flow EBITDA 3,799 2,920 2,541 3,979 4,895 4,356Tax, interest & other 0 0 0 0 0 0Change in working capital 177 (934) (113) (396) (75) 66Net cash from op activities 3,976 1,986 2,428 3,583 4,820 4,422Capex (873) (1,192) (942) (1,602) (1,993) (2,037)Net acquisitions 0 0 0 0 0 0Net financing cash flow 227 664 (544) 23 279 308Dividends & minority distrib'n (3,394) (1,800) (2,336) (601) (2,387) (2,937)Net ch in cash & equivalents 442 (741) (818) 1,961 1,103 217FCF 3,103 794 1,486 1,981 2,827 2,384


Revenue growth (%) 4.4 -7.2 -2.1 29.2 4.5 -3.7Normalised EPS growth (%) 5.4 -23.1 -13.0 56.6 23.0 -11.0Normalised EBITDA mgn (%) 42.5 33.5 34.0 38.0 42.3 39.5Normalised EBIT margin (%) 39.0 29.2 29.0 34.0 37.8 34.1ROACE (%) 55.5 33.7 30.5 40.1 37.5 28.9Reported ROE (%) 44.5 29.9 24.2 32.9 32.6 25.6Working capital as % of sales 7.5 10.6 16.5 16.3 16.0 16.2Net debt (cash)/EBITDA (x) (0.50) (0.66) (0.32) (0.59) (0.68) (0.79)EBITDA net interest cvg (x) n/a n/a n/a n/a n/a n/a

Valuation

EV/revenue (x) 1.3 1.4 1.6 1.1 0.97 1.00EV/normalised EBITDA (x) 3.1 4.3 4.7 2.9 2.3 2.5EV/normalised EBIT (x) 3.4 4.9 5.5 3.2 2.6 2.9Normalised PER (x) 5.0 6.5 7.4 4.7 3.8 4.3Price/book (x) 2.1 1.8 1.8 1.4 1.2 1.1Dividend yield (%) 9.6 12.4 3.2 12.7 15.6 13.9FCF yield (%) 19.1 4.9 8.4 12.7 19.4 16.6

Per share data

Reported EPS (PLN) 18.99 14.60 12.70 19.90 24.48 21.78Normalised EPS (PLN) 18.99 14.60 12.70 19.90 24.48 21.78Dividend per share (PLN) 9.00 11.68 3.00 11.94 14.69 13.07Equity FCFPS (PLN) 15.51 3.97 7.43 9.91 14.14 11.92BV/share (PLN) 44.83 52.96 52.02 68.91 81.45 88.55


Polish Strategy Mondi July 2010

44

Mondi Maintained

Too expensive to be attractive SellPoland Market cap PLN3,700.0mBasic Resources Bloomberg MSC PW

We are bearish on Mondi as we believe that market consensus for 2010F earnings is too optimistic and the valuation is demanding. Our 2010F EBITDA and net income forecasts are 22% and 37% lower than market expectations, respectively. Mondi trades at a 2010F and 2011F PER of 30.6x and 16.3x, an excessive 132% and 61% premium to global peers. We maintain our SELL recommendation with a target price of PLN52.6.

Investment case Mondi is currently experiencing high wood prices (17% of operating costs), the main raw material used to produce packaging paper. Wood price hikes have been caused by this year’s change in sales policy by the main local wood supplier,State Forests (a state-owned holding that manages publicly-owned local forests). In the past, State Forests sold 80% of itswood production to long-standing customers (such as Mondi), usually offering price discounts for the placement of large orders. As a result, Mondi benefitted from low wood prices and modest logistics costs. Mondi thus had significant cost advantages over its European competitors. Currently, just 50% of State Forests’ wood is sold in closed tenders to long-standing clients. The remaining 50% is sold in open tenders to the highest bidder. A shorter supply of local wood has been accompanied by strong demand for raw materials from the power sector as a result of rising consumption for biofuels. Thus local wood prices have grown by 30-40% YTD, approaching European price levels.

The main upside potential for the company is the introduction of an alteration of forest law proposed by the Polish government. According to the preliminary project of alteration, State Forests may be forced to sell wood ‘taking into consideration theinterests of the State Treasury and the needs of the local wood industry’. In practice it would lead to an increase in wood sales by State Forests to large local industry players at the expense ofthe foreign wood industry and small local players. Thus it would put downside pressure on the price of wood purchased by Mondi. The project of alteration is currently in consultation with interested parties: State Forests and representatives of the domestic wood industry. Given that it is still at an initial stage, we do not include its implementation and a potential decrease in wood prices in our model in 2011F. Based on our sensitivity analysis, a PLN10/m3 decline in wood prices would increaseMondi’s EBIT by c.PLN22m.

In our view, the market is underestimating the negative impact of raw material pricing pressure on the company’s earnings in 2010. We estimate 31% YoY and 89% YoY hikes in average wood and recovered paper prices in 2010F, respectively. We forecast a 2010F EBITDA margin of 16% versus market expectations of 22%.

Price (19/07/10) PLN74.0


Forecast total return -25.6%

Quarterly preview We expect an 11% QoQ increase in revenues, mainly driven by hikes in packaging paper prices (11% QoQ and 13% QoQ growths in Kraftliner and Testliner prices, respectively). We forecast improvement in gross margin from 23% in 1Q10 to 24% in 2Q10F mainly on widening spread between CCM paper and recovered paper prices. 2Q10F average spread between Testliner and OCC recovered paper price reached €276/tonne vs €258/tonne in 1Q10. Net profitability should be burdened by PLN12m interest costs.


(PLNm) 1Q10 2Q10F

Revenues 474 526EBITDA 69 84EBIT 31 46Net profit 18 34EPS (PLN) 0.36 0.68


Earnings drivers and outlook For 2010F, we forecast 20-30% YoY growth in average packaging paper prices, driven by a cyclical recovery in demand for product. Given strong YoY growth rates for average CCM paper prices in 2010F, we forecast an improvement in Mondi’s EBIT margin to 9%, from 7% in 2009 and the historical annual average of 17%. For 2011F, we assume a YoY rebound in EBIT profitability to 14%, driven mainly by a drop in recovered paperprices (we forecast a 30% YoY decline).

Mondi trades at a 2010F PER of 30.6x and EV/EBITDA of 12.9x, which implies excessive 132% and 104% premiums to peers, respectively. Despite Mondi’s cost advantages (low payroll costs) we believe this premium is, to a large extent unwarranted, given its large exposure to high wood prices. In 2011F, Mondi trades at a lower PER of 16.3x due to a YoY improvement in earnings driven by an expected decline in recovered paper prices (30% YoY drop). However, we believe that the stock is still expensive, as it trades at a 61% premium to peers.

Given Mondi’s rich valuations we maintain our SELL recommendation with a target price of PLN52.6, the outcome of DCF and peer comparison valuations, to which we apply equal weighting.

Upside potential includes a stronger-than-expected easing in recovered paper prices in 2H10 and PLN depreciation against the euro.


Polish Strategy Mondi July 2010

45

Newsflow

Date Description

1 Jul 2010 Appointment of new CFO 12 Jul 2010 First working group session on change in forest law 11 Aug 2010 2Q10 results



Framondi 66.0ING OFE 10.4Aviva OFE 7.3


Share data

Avg daily volume (3-mth) 8,805Free float (%) 34.0Market cap (PLNm) 3,700Net debt (1F, PLNm) 511Enterprise value (1F, PLNm) 4,211Dividend yield (1F, %) 0.0



455055606570758085

7/09 9/09 11/09 1/10 3/10 5/10

Price WIG (rebased)

Source: ING

Company profile

Mondi is a leading European manufacturer of CCM(corrugated case material) paper used mainly in thepackaging industry. The company holds a 5% share inthe European CCM paper market. Mondi’s marginsare subject to EUR:PLN fluctuations as nearly 70% ofthe company’s revenues is denominated in euro.Mondi’s profitability is dependent on the price oftimber (17% of costs) and recovered paper (17% ofcosts); the main raw materials used in the productionof paper.

Risks

Introduction of new wood sales policy by StateTreasury, PLN depreciation against the euro,stronger-than-expected easing of recovered papercosts in 2H10.

Financials


Income statement

Revenues 1,519 1,406 1,361 2,014 1,948 1,958EBITDA 400 306 218 327 428 454EBIT 296 195 100 176 277 304Net interest (4) (2) (15) (49) (41) (35)Associates 0 0 0 0 0 0Other pre-tax items 12 (18) (10) (1) 0 0Pre-tax profit 304 175 75 126 237 269Tax (58) (34) (3) (5) (10) (12)Minorities 0 0 0 0 0 0Other post-tax items 0 0 0 0 0 0Net profit 246 141 71 121 226 257Normalised net profit 246 141 71 121 226 257

Balance sheet

Tangible fixed assets 869 1,445 1,821 1,804 1,804 1,803Intangible fixed assets 8 6 5 4 4 4Other non-current assets 15 25 13 18 18 18Cash & equivalents 48 15 30 203 218 171Other current assets 427 390 410 464 545 537Total assets 1,367 1,881 2,280 2,494 2,589 2,534Short-term debt 101 110 33 40 40 40Other current liabilities 182 345 309 393 461 455Long-term debt 4 196 674 674 595 516Other long-term liabilities 98 165 79 81 81 81Total equity 982 1,066 1,184 1,305 1,411 1,442Total liabilities & equity 1,367 1,881 2,280 2,494 2,589 2,534Net working capital 232 32 100 69 81 80Net debt (cash) 57 291 677 511 417 385

Cash flow

Cash flow EBITDA 400 306 218 327 428 454Tax, interest & other 77 30 38 62 57 53Change in working capital (36) 54 (6) 31 (12) 1Net cash from op activities 327 301 203 310 365 409Capex (75) (524) (554) (134) (150) (150)Net acquisitions 0 0 0 0 0 0Net financing cash flow 37 195 366 7 (79) (79)Dividends & minority distrib'n (270) 0 0 0 (121) (226)Net ch in cash & equivalents 28 (33) 15 182 15 (47)FCF 233 (202) (346) 162 254 292


Revenue growth (%) 5.2 -7.4 -3.2 48.0 -3.3 0.55Normalised EPS growth (%) -8.8 -42.6 -49.5 69.2 87.5 13.7Normalised EBITDA mgn (%) 26.3 21.7 16.0 16.2 22.0 23.2Normalised EBIT margin (%) 19.5 13.8 7.3 8.7 14.2 15.5ROACE (%) 27.6 15.8 6.1 9.0 13.6 15.0Reported ROE (%) 24.8 13.8 6.3 9.7 16.7 18.0Working capital as % of sales 15.3 2.3 7.4 3.4 4.2 4.1Net debt (cash)/EBITDA (x) 0.14 0.95 3.1 1.6 0.98 0.85EBITDA net interest cvg (x) 105.4 189.1 14.5 6.7 10.5 13.1

Valuation

EV/revenue (x) 2.5 2.8 3.2 2.1 2.1 2.1EV/normalised EBITDA (x) 9.4 13.1 20.1 12.9 9.6 9.0EV/normalised EBIT (x) 12.7 20.5 44.0 23.9 14.8 13.5Normalised PER (x) 15.0 26.2 51.8 30.6 16.3 14.4Price/book (x) 3.8 3.5 3.1 2.8 2.6 2.6Dividend yield (%) 7.3 0.0 0.0 0.0 3.3 6.1FCF yield (%) 6.3 n/a n/a 4.4 6.9 7.9

Per share data

Reported EPS (PLN) 4.92 2.82 1.43 2.41 4.53 5.15Normalised EPS (PLN) 4.92 2.82 1.43 2.41 4.53 5.15Dividend per share (PLN) 5.40 0.00 0.00 0.00 2.41 4.53Equity FCFPS (PLN) 5.04 (4.47) (7.03) 3.51 4.29 5.18BV/share (PLN) 19.64 21.33 23.69 26.10 28.22 28.84


Polish Strategy Stalprodukt July 2010

46

Stalprodukt Previously: Sell

Delayed rebound HoldPoland Market cap PLN2,844.7mBasic Resources Bloomberg STP PW

Although prices of Stalprodukt’s main product transformer steel have stabilised in 3Q10, we believe the company is not in a position to pass on higher raw material prices to end customers. Unless prices rebound beginning from 4Q10, resulting in improving profitability, we believe Stalprodukt will not be a convincing growth story in 2011. HOLD.

Investment case Stalprodukt is facing a challenging 2010 with an expected 39% YoY decline in EPS, primarily related to declining transformer steel prices, which as of end-1H10 dropped 44% from its peak in 2008 but has finally stabilised at the beginning of 3Q10. A pick-up in prices is likely beginning from 4Q10 and the extent of increases will determine EPS growth in 2011. We currently see 2011F EPS growing 25% YoY.

Transformer steel segment: The core segment of activity with a 41% share of 2009 revenues and 84% share of last year's gross profit. After a 20% decline in 2H09 prices decreased by another 20% in 1H10. The CEO expects a stabilisation at levels slightly above EUR1,700 per tonne in 3Q10. Still, pressure on profit margins continues to be immense as transformer manufacturers are not willing to accept price hikes. In our view, the company is just not in a position to pass higher raw material costs to its customers, which should result in declining profitability QoQ in 3Q10. We forecast a 32% gross margin in 3Q10 compared with 36% in 1Q10 and 52% reported in 2Q09. A positive development supporting the stabilisation theory is improving sales volumes, which increased by 37% YoY in 2Q10F. In all of 2010 Stalprodukt expects 80,000 tons of volume sales (compared with 62,000 reported in 2009) and hopes for at least 10,000 tons YoY higher volume sales in 2011. Our forecasts are broadly in line with management assumptions and we see 81,000 tons and 90,000 tons of sales volumes in 2010F and 2011F, respectively.

Steel profiles: Following difficult market conditions in 2009 (4% YoY decline in volume sales in 2009) demand improved beginning from 2010. As a result, we expect sales volume growth to approach 30% YoY in 1H10, impressive despite the low base in 1H09. According to Stalprodukt, it is difficult to provide an outlook for 2H10 given macroeconomic uncertainties but the company hopes for at least double-digit growth rates YoY in 2010 vs the 210,000 sales volumes in 2009.

Following the inability to pass on higher raw material prices to customers in 3Q10, we lower our 2010 and 2011 EPS estimates by 6% and 10% to PLN175m and PLN218m, respectively.

Based on our current forecasts Stalprodukt trades at 2011F and 2012F EV/EBITDA of 8.4x and 6.8x, respectively, a 46% and 24% premium to peers. Our 12-month TP is based on DCF and peers’valuation with an 80% and 20% share applied to the methods.

Price (19/07/10) PLN423.00



2Q10 preview Revenues are likely to be solely driven by steel profiles(PLN231m in 2Q10 compared with PLN173m in 2Q09) while the transformer steel segment shold see a contraction in the top line YoY following an over 30% YoY decline in price levels, which will not be offset by the strong 5,000 ton increase in volume sales.

We forecast a deterioration of profit margins (EBIT margin at 14.6% vs 22.8% reported in 2Q09) primarily due to a sharp drop of transformer steel price levels but also an unfavourable EUR/PLN exchange rate (4.00 vs 4.44 in 2Q09).


(PLNm) 2Q09 2Q10F

Revenues 411.0 431.8EBITDA 103.1 73.5EBIT 93.7 63.0Net profit 75.0 52.0EPS 11.2 7.7


Earnings drivers and outlook Price pressure on transformer steel products will negatively affect Stalprodukt’s profit margins in 2010F. We currently forecast a 15.6% EBIT margin in 2010F versus 22.9% reported in 2009, primarily due to a transformer steel gross margin decrease, which should drive margins down to 31% versus 53% reported in 2009.

In 2011F revenues should increase by 16% YoY to PLN1.9bn, driven by a recovery of transformer steel prices. We believe the company will be in a position to raise transformer steel prices by 12.2% YoY. Also, volumes should improve to 90,000 tons sold in 2011F vs 80,000 in 2010F. In steel profiles we raise our volume sales forecasts by 20,000 tons to 260,000 tons.

Following price increases we believe profitability will improve moderately in 2011F with EBIT/net profit margin growing to 16.5% and 11.2%, respectively. Both transformer steel and steel profiles segments should see stronger gross margins in 2011F at 33% and 8%, respectively.

The main earnings and share price driver will be price levels of transformer steels. If Stalprodukt is in a position to increase prices beginning from 4Q10 the impact on results would be impressive as the company has a high operating leverage. An increase by EUR200 per tonne increases net profit by PLN56m.


Polish Strategy Stalprodukt July 2010

47

Newsflow

Date Description

31 August 2Q10 results10 November 3Q10 results



Arcelor Mittal Poland 38.96STP Investment 33.49


Share data

Avg daily volume (3-mth) 1,311Free float (%) 38.0Market cap (PLNm) 2,844.7Net debt (1F, PLNm) (94)Enterprise value (1F, PLNm) 2,777Dividend yield (1F, %) 1.9



350400450500550600650700750

7/09 9/09 11/09 1/10 3/10 5/10

Price WIG (rebased)

Source: ING

Company profile

Stalprodukt is Europe’s third-largest manufacturer ofgrain-oriented electrical steel, the main material usedin the construction of distribution and powertransformers. The company is also among the top tenPolish steel distributors and controls close to 50% ofthe Polish road guard rails market.

Risks

The company generates approximately 50% ofrevenues from export activities but applies onlynatural hedging. We estimate that Stalprodukt’s non-hedged exposure to EUR movements exceedsPLN100m. A movement in the EUR/PLN exchangerate would have a positive (in case of further PLNweakness vs EUR) or negative (appreciation of PLNcurrency) impact on company’s bottom line.

Financials


Income statement

Revenues 1,630 1,781 1,658 1,669 1,943 1,892EBITDA 451 448 380 260 321 377EBIT 427 425 348 210 261 318Net interest 7 5 5 4 3 8Associates Other pre-tax items 0 0 0 0 0 0Pre-tax profit 434 430 353 214 264 326Tax (83) (82) (68) (39) (47) (59)Minorities (0.1) 0.2 (2) 0 0 0Other post-tax items 0 0 0 0 0 0Net profit 350 349 283 175 217 267Normalised net profit 350 349 283 175 217 267

Balance sheet

Tangible fixed assets 541 819 977 1,035 1,035 1,035Intangible fixed assets 1 3 2 2 2 2Other non-current assets 11 11 9 9 9 9Cash & equivalents 192 72 114 125 195 353Other current assets 372 446 466 521 605 577Total assets 1,116 1,351 1,568 1,692 1,846 1,977Short-term debt 14 25 27 27 27 27Other current liabilities 163 163 181 183 208 180Long-term debt 14 12 5 5 5 5Other long-term liabilities 96 32 11 11 11 11Total equity 830 1,118 1,344 1,466 1,597 1,755Total liabilities & equity 1,116 1,351 1,568 1,692 1,847 1,978Net working capital 224 309 315 367 427 427Net debt (cash) (164) (35) (83) (94) (163) (322)

Cash flow

Cash flow EBITDA 451 448 380 260 321 377Tax, interest & other 77 76 63 35 44 51Change in working capital (20) (137) (24) (52) (60) 0.1Net cash from op activities 355 234 293 173 217 326Capex (232) (301) (190) (109) (60) (59)Net acquisitions 0 0 0 0 0 0Net financing cash flow (0.7) (23) (10) 0 0 0.0Dividends & minority distrib'n (67) (81) (53) (53) (87) (109)Net ch in cash & equivalents 53 (172) 42 11 70 159FCF 116 (72) 98 60 154 259


Revenue growth (%) 24.3 9.2 -6.9 0.67 16.4 -2.6Normalised EPS growth (%) 27.9 -0.32 -18.9 -38.1 24.0 23.2Normalised EBITDA mgn (%) 27.7 25.2 22.9 15.6 16.5 19.9Normalised EBIT margin (%) 26.2 23.9 21.0 12.6 13.4 16.8ROACE (%) 58.6 42.2 27.5 14.6 16.7 18.6Reported ROE (%) 50.0 36.4 23.5 12.7 14.4 16.2Working capital as % of sales 13.8 17.4 19.0 22.0 22.0 22.6Net debt (cash)/EBITDA (x) (0.36) (0.08) (0.22) (0.36) (0.51) (0.85)EBITDA net interest cvg (x) n/a n/a n/a n/a n/a n/a

Valuation

EV/revenue (x) 1.6 1.6 1.7 1.7 1.4 1.3EV/normalised EBITDA (x) 5.9 6.3 7.3 10.7 8.4 6.8EV/normalised EBIT (x) 6.3 6.7 8.0 13.2 10.4 8.0Normalised PER (x) 8.1 8.2 10.1 16.3 13.1 10.6Price/book (x) 3.4 2.6 2.2 2.0 1.8 1.6Dividend yield (%) 2.4 2.8 1.9 1.9 3.1 3.9FCF yield (%) 4.3 n/a 3.5 2.2 5.7 10.2

Per share data

Reported EPS (PLN) 52.06 51.89 42.06 26.02 32.26 39.75Normalised EPS (PLN) 52.06 51.89 42.06 26.02 32.26 39.75Dividend per share (PLN) 10.00 12.00 8.00 8.00 13.14 16.37Equity FCFPS (PLN) 18.26 (9.95) 15.35 9.54 23.34 39.77BV/share (PLN) 123.11 162.13 196.11 214.20 233.60 257.15



48



49

Chemicals

Polish Strategy Ciech July 2010

50

Ciech Previously Sell

Overcapacity is key HoldPoland Market cap PLN680mChemicals Bloomberg CIE PW

We lower our target price from PLN32.8 to PLN25.8 mainly on higher than expected depreciation of soda ash prices hit by significant overcapacity. However, we upgrade Ciech to HOLD given the recent strong underperformance of the stock.

Investment case An oversupply of soda ash led to a drop in product prices in 1Q10. Soda ash contract prices declined from €205/t as of end 2009 to €175/t in 1Q10. Thus the soda division gross margin dropped from 20% in 4Q09 to 13% in 1Q10. This division’s profitability was also impacted by poor margins generated by Romanian soda subsidiary Govora. Govora’s profitability was hit by strong downside pricing pressure from two soda factories owned by the main competitors: Solvay (in Bulgaria) and Sisecam (in Turkey).

In the organic products division we see a rebound in TDI prices driven by fairly balanced market fundamentals. TDI prices reached nearly €2,300/t in 1Q10 vs the 2009 monthly average of €1,950/t. However, in our view, TDI prices peaked in 1H10 and we do not rule out a downside correction in prices in coming months. Long term, the main risk is connected with additional TDI capacities from the third-largest European TDI producer, Hungarian Borsodchem. Chinese company Wanhua purchased a 38% stake in Borsodchem in order to enter the European market. Wanhua intends to invest in the construction of a TDI production line of 200,000t annually. We think this may cause large excess supply on the market, which may put downside pressure on TDI prices.

In April, Ciech signed an agreement with its banks on a PLN1.3bn debt restructuring. The main term of the agreement assumes a PLN400m decrease of Ciech’s debt by the end of this year. In our view this target will be very challenging. We think that PLN200-250m issuance of shares or convertible bonds may be necessary to meet this target. The company intends to reduce debt via divestments. The company wants to sell its 45% stake in insurer PTU, fertilizer unit Fosfory, glass and silicates unit Vitrosilicon and some smaller subsidiaries (Polfa, Boruta, Cheman, Transsoda and Transclean). In our view Ciech may complete the divestment of its stake in PTU in coming days. We estimate PLN80m cash proceeds from this disposal.

We expect a significant deterioration in the soda segment gross margin from 22% in 2009 to 14% in 2010F. Moreover 2010F net profitability should be burdened by high interest costs (our forecast of PLN138m). Therefore we expect Ciech may suffer a net loss (PLN7m) this year. However, given that Ciech’s share price declined by 26% in the last three months we upgrade from Sell to Hold with a new TP of PLN25.8, the outcome of our DCF valuation. Considering the risks connected with the stock we use a beta of 1.3 in our DCF valuation.

Price (19/07/10) PLN24.3



Quarterly preview We forecast a 1% QoQ decline in revenues, mainly attributable to lower TDI sales caused by temporary production line outage. We forecast 15,500t TDI sold in 2Q10F vs 17,300t in 1Q10. We expect a 20% QoQ decline in plant protection agents’ sales caused by the end of seasonal demand. We expect a PLN20m positive impact on EBIT profitability from the sale of cavern assets in 2Q10F. We expect a similar QoQ gross margin of 14% in 2Q10F, as improvement in organic segment margin (driven by a strong performance from the resins division) should be offset by a deterioration of agrochemical segment profitability (hit by poor plant protection agents’ margins). Net profitability should be burdened by PLN30m interest costs, PLN12m negative FX differences and a PLN8m loss on sale of the stake in Tarnow. We do not rule out an impairment of Govora assets in 2Q10F (but do not include this in our forecasts).


(PLNm) 1Q10 2Q10F

Revenues 962 950EBITDA 101 95EBIT 42 36Net profit (3) (14)EPS (PLN) n/a n/a


Earnings drivers and outlook Given the recent significant deterioration of soda ash prices we lower our forecast of 2010F soda division gross margin from 21% to 14%. Given the recent rally in TDI prices we upgrade our forecasts of 2010F average TDI price from €2,150/t to €2,213/t. Thus we raise our 2010 organic division gross margin forecast from 10% to 12%.

In 2010 and 2011 we forecast a respective PLN51m and PLN10m positive impact on EBIT margin from the sale of cavern assets. Given the expected squeeze in soda division profitability we downgrade our forecast of 2010F normalised group EBITDA by 14% to PLN355m. Considering higher credit margins we raise our expectations of interest costs by 17% to PLN138m. Therefore we anticipate a normalised net loss of PLN41m in 2010F vs an earlier expected PLN17m net profit.

The main upside potential is connected with the successful completion of divestments. We estimate PLN162m cash proceeds from sale of Ciech assets (excluding Fosfory and Vitrosilicon), which boosts our DCF valuation.


Polish Strategy Ciech July 2010

51

Newsflow

Date Description

21 June 2010 Appointment of new CFO 14 May 2010 Signed a letter of intent with Tarnow on sale

of Fosfory 29 April 2010 Conversion of FX options into credits 26 April 2010 Signed an agreement on debt restructuring 31 August 2010 2Q10 results



State Treasury 36.7Pioneer Pekao IM 19.6PZU OFE 6.1


Share data

Avg daily volume (3-mth) 10,051Free float (%) 63.3Market cap (PLNm) 680Net debt (1F, PLNm) 1,652Enterprise value (1F, PLNm) 2,369Dividend yield (1F, %) 0.0



20

25

30

35

40

45

7/09 9/09 11/09 1/10 3/10 5/10

Price WIG (rebased)

Source: ING

Company profile

Ciech is one of the largest chemical manufacturers inPoland. It has a diversified product portfolio, but themost important products are soda ash (32% ofrevenues, used in glass production) and TDI (12% ofrevenues, used mainly in the furniture and automotiveindustries). Nearly 50% of sales are dedicated toforeign markets, therefore the company is exposed toEUR:PLN and USD:PLN fluctuations. The StateTreasury holds a 37% stake in the company.

Risks

Upside risks: successful completion of divestments(PTU, Fosfory, Vitrosilicon), quicker than expectedrebound in soda ash prices.

Downside risks: share issuance, expansion of TDIcapacities by Borsodchem, correction in TDI prices.

Financials


Income statement

Revenues 3,415 3,787 3,684 3,931 3,903 3,886EBITDA 226 450 365 397 392 399EBIT 46 247 135 161 155 160Net interest (31) (99) (122) (132) (131) (132)Associates 0 0 0 0 0 0Other pre-tax items 6 (151) (98) (36) 0 0Pre-tax profit 22 (4) (84) (7) 24 28Tax (48) (24) (4) 0 (5) (5)Minorities (2) (10) 7 0 0 0Other post-tax items 0 0 0 0 0 0Net profit (28) (39) (82) (7) 19 23Normalised net profit 181 28 (97) (41) 12 20

Balance sheet

Tangible fixed assets 1,964 2,383 2,409 2,424 2,437 2,448Intangible fixed assets 531 193 165 156 156 156Other non-current assets 156 190 184 158 158 158Cash & equivalents 124 112 132 141 12 24Other current assets 1,458 1,468 1,134 1,129 1,162 1,155Total assets 4,234 4,347 4,024 4,007 3,924 3,941Short-term debt 453 1,331 1,000 1,131 1,000 1,000Other current liabilities 877 881 919 960 987 982Long-term debt 766 339 666 662 662 662Other long-term liabilities 1,025 897 579 402 402 402Total equity 1,112 899 860 853 873 895Total liabilities & equity 4,234 4,347 4,024 4,007 3,924 3,941Net working capital 377 515 212 167 172 171Net debt (cash) 1,095 1,558 1,534 1,652 1,650 1,638

Cash flow

Cash flow EBITDA 226 450 365 397 392 399Tax, interest & other 285 61 223 112 143 138Change in working capital (122) (148) 165 45 (5) 1Net cash from op activities 243 (30) 397 248 252 262Capex (220) (403) (244) (250) (250) (250)Net acquisitions 0 0 0 0 0 0Net financing cash flow 357 439 (68) (48) (131) 0Dividends & minority distrib'n (60) (58) 0 0 0 0Net ch in cash & equivalents (37) (75) 11 9 (129) 12FCF (116) (101) 72 144 108 119


Revenue growth (%) 57.1 10.9 -2.7 6.7 -0.73 -0.44Normalised EPS growth (%) 7.1 -84.7 n/a n/a n/a 71.2Normalised EBITDA mgn (%) 14.2 10.5 8.1 8.8 9.8 10.2Normalised EBIT margin (%) 8.9 5.1 1.9 2.8 3.7 4.0ROACE (%) 14.7 7.9 2.7 4.3 5.6 6.2Reported ROE (%) -2.6 -4.0 -9.8 -0.80 2.3 2.7Working capital as % of sales 11.0 13.6 5.8 4.2 4.4 4.4Net debt (cash)/EBITDA (x) 4.9 3.5 4.2 4.2 4.2 4.1EBITDA net interest cvg (x) 7.4 4.5 3.0 3.0 3.0 3.0

Valuation

EV/revenue (x) 0.53 0.60 0.61 0.60 0.61 0.61EV/normalised EBITDA (x) 3.8 5.7 7.5 6.8 6.2 6.0EV/normalised EBIT (x) 6.0 11.7 32.6 21.4 16.3 15.0Normalised PER (x) 3.8 24.5 n/a n/a 58.8 34.4Price/book (x) 0.64 0.80 0.83 0.83 0.81 0.79Dividend yield (%) 8.6 8.5 0.0 0.0 0.0 0.0FCF yield (%) n/a n/a 10.5 21.2 15.8 17.5

Per share data

Reported EPS (PLN) (1.01) (1.38) (2.92) (0.234) 0.689 0.811Normalised EPS (PLN) 6.46 0.990 (3.48) (1.46) 0.413 0.707Dividend per share (PLN) 2.10 2.07 0.00 0.00 0.00 0.00Equity FCFPS (PLN) 0.812 (15.46) 5.48 (0.058) 0.054 0.427BV/share (PLN) 38.13 30.34 29.39 29.16 29.85 30.66


Polish Strategy Police July 2010

52

Police Maintained

Still not profitable at EBIT line HoldPoland Market cap PLN373mChemicals Bloomberg PCE PW

We remain cautious on Police’s ability to achieve breakeven at the EBIT line this year given a slow recovery in NPK fertilizer demand and demanding raw material prices. Considering the strong underperformance of the stock over the past three months, we maintain our HOLD rating, however, with a lower target price of PLN5.1.

Investment case In 1Q10, Police did not manage to record positive EBIT profitability in spite of a seasonal rebound in fertilizer demand. Growth in fertilizer prices (10-20% QoQ) was not enough to cover high raw material costs (mainly gas, potash salt and phosphate rock). It is also worth noting that 1Q10 EBIT profitability was strengthened by some one-offs, including a PLN11m inventories writeback.

2010F profitability might come under pressure due to demanding raw material prices that may not be counterbalanced by a rebound in fertilizer prices. From 1 June, the company has seen a 3% gas tariff hike (17% of operating costs). The price of phosphate rock (16% of operating costs) is on the rise and hit US$125/tonne versus the 2009 average of US$96/tonne. Therefore, we raise our forecast 2010 phosphate rock price from US$75/tonne to US$110/tonne. A significant drop in the 1Q10 price of potash salt (17% of operating costs) came to a halt at US$345/tonne, still significantly higher than the historical average of US$240/tonne. Moreover, we do not rule out a rebound in potash salt prices in the short term. One of the most important potash export associations, BPC, signed a potash supply contract with Vietnam at US$417/tonne. This could signal an upward trend in raw material prices.

The company signed an agreement with the Industrial Development Agency to obtaining PLN150m funding. Police is obliged to pay off the loan by 25 November 2010. According to management, the company will have an opportunity to prolong the loan repayment deadline if the European Commission approves a restructuring plan prepared by the company. The restructuring plan is based on the sale of non-core assets and employment lay-offs, however, the company has not yet released details. In our model, we assume an optimistic scenario and the company should manage to prolong the repayment deadline. We implement steady repayment of the loan over the next five years. However, it is worth noting that Police cannot spend public aid on the repayment of a PLN119m gas debt (deadline of 31 August). In our view, the company may be forced to pay off debt in non-cash form with the disposal of non-core assets (power plant land or stakes in company’s subsidiaries).

Given a worsening outlook for raw material prices, we lower our target price from PLN6.2 to PLN5.1. However, considering the company’s strong underperformance of the past three months (a 24% drop), we maintain our HOLD recommendation based on our DCF valuation.

Price (19/07/10) PLN5.0



Quarterly preview We forecast a 7% QoQ decrease in fertilizer revenues burdened by a 10% QoQ average drop in fertilizer prices given a slowdown in demand. We assume 310,000 tonnes of fertilizer sold in 2Q10F versus 314,000 tonnes in 1Q10. We estimate a 22% QoQ increase in titanium dioxide sales driven by 18% QoQ higher sales volumes and 3% QoQ growth in product prices. We forecast PLN34m negative EBIT (versus a PLN8m loss on operating activity in 1Q10) mainly on depreciation of fertilizer prices, higher phosphate rock and sulphur consumption costs and a lack of inventories writeback effect. We anticipate an FX derivatives impact on net profitability at close to zero. The company has already closed its majority exposure of FX options generating negative cash flow of PLN21m in 1Q10.


(PLNm) 1Q10 2Q10F

Revenues 420 406EBITDA (14) (12)EBIT (8) (34)Net profit (3) (36)EPS (PLN) n/a n/a


Earnings drivers and outlook Given the recent rally in global wheat prices caused by concerns regarding adverse weather in Canada, Russia and Kazakhstan, we expect fertilizer prices to recover in 2H10. We expect 10% YoY growth in the average price of both urea and DAP in 2010F. However, in our view, 2010F fertilizer hikes will be largely offset by demanding levels of raw materials (gas, phosphate rock and sulphur). We anticipate 2%, 15% and 176% YoY growth in 2010F average price of gas, phosphate rock and sulphur, respectively. In our opinion, NPK fertilizer prices may continue to be under pressure in the short term given slowly progressing application of potash by local farmers. We anticipate a 10% YoY decline in the average 2010F NPK fertilizer price. Thus we do not expect a return to positive EBIT profitability this year. We forecast PLN75m negative EBIT in 2010F.

We anticipate a negative EBIT contribution from the titanium dioxide segment this year, weakened by YoY 2010F PLN appreciation against the euro (4.05 in 2010F versus 4.34 in 2009) and high fixed costs. We do not rule out that the company’s restructuring plan may assume the sale of titanium dioxide assets.


Polish Strategy Police July 2010

53

Newsflow

Date Description

8 June 2010 PLN150m loan agreement signed with ARP 30 June 2010 Gas debt repayment agreement with PGNiG 30 June 2010 PLN162m credit lines prolonged 9 July 2010 Management approval of restructuring plan 20 August 2010 2Q10 results



State Treasury 59.4Industrial Development Agency 8.8PZU OFE 5.6ING TFI 5.1


Share data

Avg daily volume (3-mth) 84,535Free float (%) 31.8Market cap (PLNm) 373Net debt (1F, PLNm) 239Enterprise value (1F, PLNm) 617Dividend yield (1F, %) 0.0



4567

89

10

7/09 9/09 11/09 1/10 3/10 5/10

Price WIG (rebased)

Source: ING

Company profile

Police is a major producer of multi-componentfertilizers (63% of revenues) and urea (16% ofrevenues). In addition, Police manufactures titaniumdioxide (9% of revenues, used in the constructionindustry) and ammonia (8% of revenues). Police’sprofitability is largely dependent on the price of potashsalt (19% of costs), gas (18% of costs) and phosphaterock (14% of costs). A large part of the company’ssales is dedicated to export (50% of revenues),therefore, Police is sensitive to EUR:PLN andUSD:PLN fluctuations.

Risks

Upside risks: PLN depreciation against the euro andUS dollar, long-term recovery in grain prices and the,successful disposal of non-core assets.

Financials


Income statement

Revenues 1,822 2,404 1,487 1,741 1,970 1,905EBITDA 235 230 (328) 3 109 106EBIT 187 164 (409) (75) 31 28Net interest (2) (3) (7) (9) (13) (13)Associates 0 0 0 0 0 0Other pre-tax items 19 (121) 9 6 0 0Pre-tax profit 204 40 (407) (78) 17 15Tax (4) (13) (17) 0 (3) (3)Minorities (0.5) 0.1 0.8 0.6 0.6 0.6Other post-tax items 0 0 0 0 0 0Net profit 200 28 (423) (78) 15 13Normalised net profit 200 28 (423) (78) 15 13

Balance sheet

Tangible fixed assets 727 810 736 738 741 743Intangible fixed assets 3 5 4 4 4 4Other non-current assets 71 111 101 103 103 103Cash & equivalents 156 139 38 60 42 22Other current assets 403 801 379 385 442 462Total assets 1,359 1,867 1,258 1,291 1,332 1,334Short-term debt 0.3 149 6 292 262 232Other current liabilities 273 527 477 376 432 451Long-term debt 4 0.0 74 7 7 7Other long-term liabilities 149 228 161 155 155 155Total equity 933 963 539 461 476 489Total liabilities & equity 1,359 1,867 1,258 1,291 1,332 1,334Net working capital 121 272 (99) 9 10 11Net debt (cash) (151) 10 42 239 228 217

Cash flow

Cash flow EBITDA 235 230 (328) 3 109 106Tax, interest & other (81) 44 (3) 5 20 18Change in working capital 12 (151) 414 (108) (1) (0.5)Net cash from op activities 174 (29) 45 (115) 90 90Capex (152) (164) (74) (80) (80) (80)Net acquisitions 0 0 0 0 0 0Net financing cash flow (57) 171 (79) 218 (29) (30)Dividends & minority distrib'n 0 0 0 0 0 0Net ch in cash & equivalents (31) (16) (104) 21 (19) (20)FCF 92 (135) 3 (139) 21 20


Revenue growth (%) 9.0 31.9 -38.2 17.1 13.2 -3.3Normalised EPS growth (%) n/a -86.0 n/a n/a n/a -12.9Normalised EBITDA mgn (%) 12.9 9.6 -22.1 0.15 5.5 5.6Normalised EBIT margin (%) 10.3 6.8 -27.5 -4.3 1.6 1.5ROACE (%) 21.9 16.0 -47.3 -10.9 4.1 3.8Reported ROE (%) 24.4 3.0 -56.8 -15.7 3.2 2.7Working capital as % of sales 6.6 11.3 -6.6 0.51 0.52 0.56Net debt (cash)/EBITDA (x) (0.64) 0.04 n/a 93.2 2.1 2.1EBITDA net interest cvg (x) 104.4 81.7 n/a 0.28 8.1 8.3

Valuation

EV/revenue (x) 0.12 0.16 0.28 0.35 0.31 0.31EV/normalised EBITDA (x) 0.97 1.7 (1.3) 240.6 5.6 5.6EV/normalised EBIT (x) 1.2 2.4 (1.0) (8.2) 19.7 21.5Normalised PER (x) 1.9 13.3 n/a n/a 25.5 29.3Price/book (x) 0.40 0.39 0.70 0.82 0.79 0.77Dividend yield (%) 0.0 0.0 0.0 0.0 0.0 0.0FCF yield (%) 24.7 n/a 0.8 n/a 5.7 5.4

Per share data

Reported EPS (PLN) 2.67 0.373 (5.64) (1.03) 0.195 0.170Normalised EPS (PLN) 2.67 0.373 (5.64) (1.03) 0.195 0.170Dividend per share (PLN) 0.00 0.00 0.00 0.00 0.00 0.00Equity FCFPS (PLN) 0.295 (2.56) (0.394) (2.60) 0.137 0.130BV/share (PLN) 12.36 12.75 7.11 6.07 6.27 6.44


Polish Strategy Pulawy July 2010

54

Pulawy Previously Hold

Looking for earnings rebound BuyPoland Market cap PLN1,309mChemicals Bloomberg ZAP PW

We expect a YoY recovery in FY11F earnings driven by: (1) a rebound in nitrogenous fertilizer prices; (2) a revival in the performance of the chemical segment; and (3) a gradual improvement in Pulawy’s competitiveness caused by expected short-term growth in European spot gas prices. Given these drivers and the strong YTD underperformance of the stock, we upgrade our Pulawy rating from Hold to BUY with a new target price of PLN78.9, offering 16% upside.

Investment case We anticipate a YoY increase in nitrogenous fertilizer prices in FY11F caused by a short-term rebound in grain prices due to concerns about low harvests in some regions. The USDA (US Department of Agriculture) revised down its 2010/11 global grain ending stock forecast from 482m tonnes to 464m tonnes (versus 471m tonnes in 2009/10) due to lower estimated yields following less favourable weather in FSU-12, Canada, EU-27 and India. In our view, growth in grain prices should boost the purchasing power of farmers in the autumn fertilizer season and thus fuel nitrogenous fertilizer prices in the short term. Following a 20-40% YoY plummet in the average nitrogenous fertilizer price in FY10F we assume a 10-15% YoY growth in FY11F. In addition, following strong declines in 1H10, we anticipate a recovery in European gas spot prices, which should led to a narrowing of the gap between local gas prices and gas spot valuations. This would improve Pulawy’s export competitiveness. In FY11F, we assume a 20% YoY increase in sales volumes of Pulawy’s main export product, UAN (following a 48% YoY decline in FY10F).

We forecast a return to positive EBIT profitability in Pulawy’s chemical segment in FY11F. Currently, we notice an increase in melamine prices driven by healthy demand. The melamine contract price has increased by 16% to €1,130/tonne at end-4QFY10. We forecast 20% YoY growth in the FY11F average melamine price. European platted caprolactam prices reached a peak in 2HFY10 and rose by 16% to US$2,410/tonne supported by a tight product market. In our view, caprolactam prices may ease in coming months, burdened by retreating benzene prices. However, product prices should stay high, keeping margins relatively high. We assume a 5% YoY decline in the average caprolactam price to US$2,189/tonne in FY11F versus an historical monthly average of US$2,023/tonne.

Based on our estimates, Pulawy trades at FY11F normalised PER (excluding proceeds from the sale of ERU certificates) of 13.2x, implying a 12% premium to global peers. However, on FY11F EV/EBITDA, the company trades at 6.1x, or a 10% discount to global peers. In our view, this discount is to large extent unjustified given expected significant rebound in earnings in FY11F. We forecast PLN207m normalised EBITDA in FY11F (versus PLN23m in FY10F). In our view, a FY10F P/BV of 0.8x looks attractive considering the lack of financial leverage and the company’s large exposure to resilient nitrogenous fertilizer sales.

Price (19/07/10) PLN68.5



Quarterly preview We forecast a 9% YoY decrease in nitrogenous fertilizer sales burdened by lower sales volumes and a decrease in product prices. The company implemented an 18-19% decline in fertilizer prices in June after a seasonal hike in product prices. In our view, Pulawy may return to positive EBIT profitability in its chemical segment in 4QFY10F fuelled by demanding melamine and caprolactam prices and strong sales volumes. 4QFY10F COGS may be lowered by around PLN50m value of ERU certificates generated by the company between May 2009 and May 2010.

4QFY10F results preview (due 2 September)

Yr to Jun (PLNm) 3QFY10 4QFY10F



Earnings drivers and outlook We forecast a YoY increase in FY11F normalised EBITDA to PLN207m (versus PLN23m in FY10F). We estimate FY11F normalised net profit at PLN99m versus PLN23m normalised net loss in FY10F. In our view, FY11F earnings should be driven by a recovery in fertilizer prices and sales volumes caused by a narrowing gap between local gas prices and European spot valuations. We forecast 6% YoY growth in nitrogenous fertilizer sales volumes in FY11F.

We assume large capex of PLN366m and PLN260m in FY10F and FY11F, respectively, to be spent on the construction of an oxygen ammonia urea plant and new fertilizer complex. The oxygen ammonia urea plant (PLN236m capex) should start operation in January 2011. Thanks to the investment, ammonia and urea capacities will be increased by 170,000 and 270,000 tonnes, respectively. It will be the base for the production of 350,000 tonnes of sulphur nitrogen based fertilizers (PLN170m capex) from FY13F. According to the company it should bring PLN210-290m revenues annually.

Given that the stock declined by 12%YTD (underperforming the market by 15ppt) and our expectations of an earnings rebound in FY11F, we rate Pulawy at BUY with a target price of PLN78.9 (the outcome of DCF and peer comparison valuations, to which we apply equal weighting).


Polish Strategy Pulawy July 2010

55

Newsflow

Date Description

2 Jun 2010 Rejection of Pulawy bid for Anwil by PKN Orlen 9 Jul 2010 PLN320m contract for the sale of melamine

signed 23 Jul 2010 Deadline for placing bids for ST stake in Pulawy 2 Sep 2010 4QFY10 results



State Treasury 50.7Kompania Weglowa 9.9ING OFE 5.2Mennica Polska 5.2


Share data

Avg daily volume (3-mth) 6,333Free float (%) 39.4Market cap (PLNm) 1,309Net debt (1F, PLNm) (132)Enterprise value (1F, PLNm) 1,178Dividend yield (1F, %) 0.9



60708090

100110120

7/09 9/09 11/09 1/10 3/10 5/10

Price WIG (rebased)

Source: ING

Company profile

Pulawy is a manufacturer of nitrogenous fertilizers(over 50% of revenues) and chemical products (40%of revenues: caprolactam, used mainly in the textileindustry, and melamine, used in the constructionindustry). Around 50% of revenues are exposed toexports, therefore, the company is sensitive toPLN:EUR moves. Pulawy is dependent on gas prices,which constitute 40% of the company’s operatingcosts.

Risks

A decrease in global gas spot prices; a lower-than-expected rebound in nitrogenous fertilizer prices; adrop in grain prices; joint privatisation with Police;additional global capacities of nitrogen; and a delay inposting profits from the sale of ERU certificates.Increase in gas tariff in 4Q10.

Financials

Yr to Jun (PLNm) 2007 2008 2009 2010F 2011F 2012F

Income statement

Revenues 2,205 2,504 2,397 2,052 2,370 2,482EBITDA 251 433 407 110 252 264EBIT 151 359 338 37 160 163Net interest 13 23 41 25 8 3Associates 0 0 0 0 0 0Other pre-tax items (6) 19 (139) (2) 0 0Pre-tax profit 159 401 241 61 168 166Tax (28) (71) (47) (14) (32) (32)Minorities 0 0 0 0 0 0Other post-tax items 0 0 0 0 0 0Net profit 130 331 195 47 136 135Normalised net profit 130 331 195 (23) 99 100

Balance sheet

Tangible fixed assets 620 662 898 1,192 1,360 1,459Intangible fixed assets 8 11 14 14 23 23Other non-current assets 30 112 22 21 48 48Cash & equivalents 450 580 575 133 55 17Other current assets 556 602 683 634 630 691Total assets 1,666 1,968 2,193 1,993 2,115 2,238Short-term debt 48 60 0.2 0.4 0 0Other current liabilities 202 231 246 228 227 249Long-term debt 61 0.0 0.3 0.5 0 0Other long-term liabilities 99 137 181 108 108 108Total equity 1,255 1,540 1,765 1,657 1,781 1,882Total liabilities & equity 1,666 1,968 2,193 1,993 2,115 2,238Net working capital 314 323 437 406 403 443Net debt (cash) (341) (521) (575) (132) (55) (17)

Cash flow

Cash flow EBITDA 251 433 407 110 252 264Tax, interest & other 15 86 70 (31) 7 32Change in working capital (61) (79) 35 31 2 (39)Net cash from op activities 148 336 320 106 205 197Capex (87) (107) (147) (366) (260) (200)Net acquisitions 0 0 0 0 0 0Net financing cash flow (65) (59) (83) (28) (10) 0.0Dividends & minority distrib'n (38) (32) (82) (156) (12) (34)Net ch in cash & equivalents 149 241 (293) (149) (78) (37)FCF 76 184 230 (175) (36) (6)


Revenue growth (%) 8.6 13.5 -4.3 -14.4 15.5 4.7Normalised EPS growth (%) -11.8 154.3 -41.2 n/a n/a 0.94Normalised EBITDA mgn (%) 11.4 17.3 17.0 1.1 8.7 8.9Normalised EBIT margin (%) 6.9 14.3 14.1 -2.4 4.8 4.9ROACE (%) 11.2 24.2 20.1 -2.9 6.7 6.6Reported ROE (%) 10.7 23.7 11.8 2.8 7.9 7.4Working capital as % of sales 14.2 12.9 18.2 19.8 17.0 17.8Net debt (cash)/EBITDA (x) (1.4) (1.2) (1.4) (1.2) (0.22) (0.07)EBITDA net interest cvg (x) n/a n/a n/a n/a n/a n/a

Valuation

EV/revenue (x) 0.44 0.32 0.31 0.57 0.53 0.52EV/normalised EBITDA (x) 3.9 1.8 1.8 51.6 6.1 5.8EV/normalised EBIT (x) 6.4 2.2 2.2 (23.7) 10.9 10.7Normalised PER (x) 10.1 4.0 6.7 n/a 13.2 13.0Price/book (x) 1.0 0.85 0.74 0.79 0.74 0.70Dividend yield (%) 2.9 2.5 6.3 11.9 0.90 2.6FCF yield (%) 5.8 14.0 17.5 n/s n/a n/a

Per share data

Reported EPS (PLN) 6.80 17.30 10.18 2.47 7.12 7.05Normalised EPS (PLN) 6.80 17.30 10.18 (1.22) 5.20 5.25Dividend per share (PLN) 2.00 1.70 4.30 8.14 0.617 1.78Equity FCFPS (PLN) 3.22 11.93 9.05 (13.60) (2.87) (0.166)BV/share (PLN) 65.68 80.58 92.35 86.67 93.18 98.45


Polish Strategy Synthos July 2010

56

Synthos Maintained

Where the rubber meets the road BuyPoland Market cap PLN2,514mChemicals Bloomberg SNS PW

We expect strong 2Q10F results fuelled by a rally in SBR prices, which should offset the high prices of raw materials. However, in our view, SBR prices have already reached their peaks and we do not rule out a downward correction in the coming months. Despite this we still think that the market underestimates 2010F Synthos earnings. Our 2010F EBITDA and net income forecasts are both 12% higher than market expectations. We maintain our BUY recommendation and raise our target price slightly to PLN2.24.

Investment case In 2Q10 European SBR contract prices increased by €400/tonne to €1,700-1,800/tonne due to tight supply and strong demand from the tyre replacement market. As of end May 2010, Europeanpassenger car tyre replacement grew by 9.8% YTD, driven by stock rebuilding by tyre dealers and significant consumption of winter tyres. The European SBR market was also strengthened by solid export demand from the US and Asia. A strong USD versus EUR and high petrochemicals costs at these regions made European synthetic rubber more attractive to non-Europeanbuyers. In our view, the SBR price rally is running out of steam. We do not rule out product declines in the coming months, mainly on retreating butadiene prices and falling Chinese demand. Asian tyre producers have ceased 3Q10 SBR contract negotiations and met their raw material needs mainly on the cheap spot market. In our view, it may put downside pressure on SBR contract prices in the coming months. However, despite the expected declines, SBR prices should stay at relatively high levels compared with historical averages, supported by high feedstock costs and relatively solid consumption of replacement tyres. We forecast an average SBR price of €1,500/t and €1,556/t in 2010/11F, respectively, versus a historical average of €1,180/t.

The company took €57.5m of credit to be spent on the construction of a high quality rubber PBR production line. The new installation should start operations in mid-2011. We estimate that the sale of PBR could add PLN40-50m EBIT in 2012F. Thus we forecast 9/13/17% YoY growth in 2012F EBITDA, EBIT and net profit, respectively.

In June the old butadiene installation was replaced by a new one that allows Synthos’ Czech unit to produce 120,000 tonnes of commodity annually (vs 90,000 tonnes previously). Given the current high price of butadiene, strengthened vertical integration should decrease SBR raw material costs in the coming quarters.

Based on our forecasts, Synthos trades at 9.4x 2010F PER, asignificant 25% discount to global peers. We believe this discount is unjustified given 19% YoY growth in 2010F adjusted EPS. Given the higher-than-expected rally in SBR prices in 2Q10, we raise ourforecast for the 2010F rubber segment EBIT margin from 15% to 16%. Given this, we increase our TP to PLN2.24 and maintain our BUY.

Price (19/07/10) PLN1.90



Quarterly preview We expect strong 2Q10F results, on the back of the strong performance of the rubber segment. We forecast 2% QoQ growth in revenues to PLN840m, mainly on higher SBR, PS and EPS prices, which should be offset to an extent by lower sales volumes of rubber and weaker power sales. We forecast a 19% rubber segment EBIT margin in 2Q10F vs 17% in 1Q10, mainly on the widening spread between SBR and raw material (butadiene and styrene) prices. We expect a 4% styrene plastics EBIT margin in 2Q10F versus 2% in 1Q10, on the back of a revival in demand for EPS and thus growth in product prices. Net profitability should be burdened by PLN10-15m negative FX differences.


(PLNm) 1Q10 2Q10F



Earnings drivers and outlook Given the higher-than-expected rally in SBR prices in 2Q10, we increase our forecast for the 2010F rubber segment EBIT margin from 15% to 16%. Thus we raise our forecast for 2010F normalised EBITDA by 2% to PLN502m. However, our forecast of 2010F normalised net income (PLN267m) remains flat given the addition of interest costs from new credit.

For 2011F we forecast an 11% YoY decline in normalised EPS. This should be attributable to a slowdown in tyre demand following the end of scrappage schemes (government programmes promoting the replacement of old cars). In our view, the negative impact on consumption of replacement tyres should materialise in 2011, putting pressure on rubber margins given that the RT market lags behinds the OE (original equipment) market by 9-15 months. We forecast a 14% rubber EBIT segment margin in 2011F (versus 16% in 2010F).

Our forecasts for styrene plastics, dispersions and power segment EBIT margins remain flat at 3/13/25%, respectively, in both 2010F and 2011F.

We value Synthos using a discounted cash flow model and multiple comparison methodologies (2010F and 2011F PER and EV/EBITDA). Our target price is calculated using an equal weighting of our DCF and peer group valuations.


Polish Strategy Synthos July 2010

57

Newsflow

Date Description

11 Jun 2010 End of collective dispute with company’s trade unions

1 Jun 2010 Agreement signed to obtain €57.5m credit 31 Aug 2Q10 results



Michal Solowow 56.9ING OFE 5.0


Share data

Avg daily volume (3-mth) 1,206,614Free float (%) 43.1Market cap (PLNm) 2,514Net debt (1F, PLNm) 297Enterprise value (1F, PLNm) 2,825Dividend yield (1F, %) 0.0



1.01.21.41.6

1.82.02.2

7/09 9/09 11/09 1/10 3/10 5/10

Price WIG (rebased)

Source: ING

Company profile

Synthos is the largest supplier of E-SBR (emulsion styrene butadiene rubber) in Europe with 32% marketshare. The company is a significant Europeanproducer of styrene plastics: EPS and PS with 11%and 5% market shares, respectively. Synthos rubbersupplies (46% of revenues, 58% of EBIT) are largelydedicated to the tyre industry. The main outlets forstyrene plastics (43% of revenues, 5% of EBIT) arethe construction and packaging industry. Synthospossesses two production plants in Poland and CzechRepublic. 30%, 20% and 50% of revenues are settledin PLN, CZK and EUR, respectively.

Risks

Continuation of intra-Solowow company transactions,a higher-than-expected decline in SBR prices in 2H10,PLN and CZK appreciation against the euro.

Financials


Income statement

Revenues 1,861 2,846 2,601 3,283 3,200 3,444EBITDA 136 265 323 502 472 513EBIT 41 141 178 350 311 352Net interest (3) (8) (5) (19) (16) (7)Other pre-tax items 375 (29) 36 20 0 0Pre-tax profit 413 104 209 351 295 345Tax 80 (13) (44) (67) (56) (66)Minorities (0.5) (0.5) (0.5) (0.5) (0.5) (0.5)Other post-tax items 0 0 0 0 0 0Net profit 493 91 164 284 238 279Normalised net profit 224 159 225 267 238 279

Balance sheet

Tangible fixed assets 1,092 1,222 1,174 1,322 1,321 1,320Intangible fixed assets 64 9 12 23 23 23Other non-current assets 196 110 412 421 416 416Cash & equivalents 476 355 559 541 562 663Other current assets 685 994 790 967 1,066 1,092Total assets 2,514 2,690 2,947 3,274 3,387 3,514Short-term debt 706 2 190 0 0 0Other current liabilities 366 278 333 360 396 406Long-term debt 0.1 822 644 838 676 514Other long-term liabilities 135 90 126 140 140 140Total equity 1,307 1,498 1,653 1,937 2,175 2,454Total liabilities & equity 2,514 2,690 2,947 3,274 3,387 3,514Net working capital 272 496 451 608 670 686Net debt (cash) 230 469 275 297 114 (149)

Cash flow

Cash flow EBITDA 136 265 323 502 472 513Tax, interest & other (517) 82 130 122 89 95Change in working capital 137 (174) 44 (156) (62) (17)Net cash from op activities 271 74 413 293 333 424Capex (665) (145) (161) (300) (160) (160)Net acquisitions 0 0 0 0 0 0Net financing cash flow 979 48 47 (8) (152) (162)Dividends & minority distrib'n 0 0 0 0 0 0Net ch in cash & equivalents 456 (75) 254 (18) 21 102FCF (384) (71) 173 (16) 191 270


Revenue growth (%) 58.8 52.9 -8.6 26.2 -2.5 7.6Normalised EPS growth (%) 105.7 -29.0 41.3 18.8 -10.8 17.0Normalised EBITDA mgn (%) 9.4 10.9 16.2 15.3 14.8 14.9Normalised EBIT margin (%) 4.3 6.5 10.6 10.7 9.7 10.2ROACE (%) 5.7 8.5 11.5 13.3 11.1 12.1Reported ROE (%) 47.5 6.6 10.5 15.9 11.7 12.1Working capital as % of sales 14.6 17.4 17.3 18.5 20.9 19.9Net debt (cash)/EBITDA (x) 1.7 1.8 0.85 0.59 0.24 (0.29)EBITDA net interest cvg (x) 46.0 34.8 61.4 26.1 29.2 70.6

Valuation

EV/revenue (x) 1.5 1.1 1.1 0.86 0.83 0.69EV/normalised EBITDA (x) 15.8 9.7 6.7 5.6 5.6 4.6EV/normalised EBIT (x) 34.6 16.2 10.2 8.1 8.5 6.8Normalised PER (x) 11.2 15.8 11.2 9.4 10.5 9.0Price/book (x) 1.9 1.7 1.5 1.3 1.2 1.0Dividend yield (%) 0.0 0.0 0.0 0.0 0.0 0.0FCF yield (%) n/a n/a 6.9 n/a 7.6 10.7

Per share data




58



59

Construction & Materials

Polish Strategy Budimex July 2010

60

Budimex Previously: Buy

Safe and sound HoldPoland Market cap PLN2,272.0mConstruction & Materials Bloomberg BDX PW

Budimex’s shares gained 28% YTD (incl. dividend), strongly outperforming its Polish peers. We believe the company will be in a position to prevent margin deterioration in 2010 with an increase in the sales of residential units. Despite our rating downgrade from Buy to HOLD, Budimex remains our top pick in the construction sector following attractive valuations, sound financials and expectations of 2010-11F earnings delivery ahead of consensus.

Investment case CEO Dariusz Blocher expects 2010 top-line growth at 10-20% YoY, which would imply up to PLN4.0bn revenues this year. With expectations of 18% YoY revenue growth in 2010 the market is in line with management’s assumptions.

The CEO also believes Budimex will be in a position to improve its net profit margin YoY vs the 5.3% reported in 2009. Based on market consensus, net profit margin will drop to 4.8% and 2010 net profit should reach PLN187m. In 2011 market consensus sees EPS declining by 7% YoY. Our 2010F and 2011F expectations are 14% and 7%, respectively, ahead of net profit consensus.

With a portfolio of contracts amounting to PLN7.5bn, Budimexhas the highest backlog among Polish construction companies. As of beginning 2010 backlog amounted to PLN5.2bn andPLN3.2bn as of end 1H09. The strong increase is related to the award of contracts worth PLN3.5bn over the last six monthscompared to PLN3.9bn new signings in 2009 and PLN2.9bn in 2008. Current backlog is split into infrastructure (70% or PLN5.3bn), residential development (5% of backlog) and other general construction contracts (25%). As of end May 2010, close to 40% or PLN3.0bn of the company’s backlog consisted ofcontracts with an execution date in 2010.

Despite a very harsh winter, Budimex posted solid 1Q10 results following the sale of c.400 housing units vs 471 in 2009. Management believes that the residential development division will be the major growth driver in 2010. Out of 930 housing units inventory (as of end-1Q10), Budimex plans to dispose of at least 600 until year-end and approach 1,000 units sold this year. With just 300 units remaining for sale in 2011 residential development will hardly provide a safety cushion for Budimex in times of deteriorating profitability of the infrastructure division. In 2012 Budimex aims to reach 1,000 sold units again and has thus recently initiated two new projects for 315 housing units and will launch up to another four residential development projects in the coming months. Budimex expects 25% gross margin on new projects.

Budimex seems attractively valued with 2010F PER of 10.6x or a 28% discount to its peers. In 2011F following declining EPS the stock trades at a PER of 12.2x, still a 6% discount to its peers.Our DCF and peer valuation derived target price is PLN90.

Price (19/07/10) PLN89.00



2Q10F results preview We expect a strong set of results. There should be a growth in revenues due to increasing backlog and more than double sales of residential units. We forecast higher EBIT and net profit YoY despite a negative fx impact (PLN16m negative revaluation of fx instruments compared to a PLN27m positive impact in 2Q09), driven by a higher contribution of the residential segment.


(PLNm) 2Q09 2Q10F

Revenue 829.8 1,059.8EBITDA 56.6 60.0EBIT 51.2 54.8Net profit 37.1 47.8EPS 1.5 1.9


Earnings drivers and outlook The market’s outlook of 4.8% net profit margin in 2010 and expectations of strong margin deterioration in 2011 seems too pessimistic. Although we admit that following increased pressure from construction materials prices, and declining volume sales of residential units (300 expected in 2011F compared to 1,000 envisaged in 2010F), the company is unlikely to beat 2010 results next year, profitability deterioration should be smoother than consensus expectations.

We expect 22% YoY revenue growth in 2010F to PLN4.0bn and another 7% to PLN4.3bn in 2011F. After a strong 1Q10, Budimex should post solid 2Q10 and 3Q10 numbers, resulting in PLN214m net profit in the entire 2010F (5.3% net profit margin). Following a declining contribution of the residential unit to EBIT next year (15% in 2011F vs 27% in 2010F), we estimate a 13% YoY decrease in 2011F EPS but remain 7% above consensus expectations.

In our view, Budimex remains a dividend story; in 2009 it paid PLN6.8 per share dividend (dividend yield of 7.6%). Given its strong net cash position we believe 2011 dividend will be similar.

CEO Blocher confirmed recently that the company is looking for acquisition targets in the railway segment. Even if Budimex does not acquire a railway unit on too-high price expectations, we believe it will get a foothold in the sector. Although negative in the short term due to entry costs (we doubt that first contracts will be profitable), Budimex should manage to run the railway operations at reasonable margins approaching 8% gross in the long run.


Polish Strategy Budimex July 2010

61

Newsflow

Date Description

31 Aug 2010 2Q10 results 27 Oct 2010 3Q10 results



Ferrovial Agroman 59.1PZU pension fund 5.7


Share data

Avg daily volume (3-mth) 14,157Free float (%) 41.0Market cap (PLNm) 2,272.0Net debt (1F, PLNm) (1,089)Enterprise value (1F, PLNm) 1,183Dividend yield (1F, %) -7.6



65

75

85

95

105

115

7/09 9/09 11/09 1/10 3/10 5/10

Price WIG (rebased)

Source: ING

Company profile

Budimex is the third-largest Polish constructioncompany in terms of revenues and the second-largest contractor in road construction after Skanska. Thecompany is majority owned by the Spanish company,Ferrovial (with a 59% stake in the company).

Risks

Sharp increase in construction materials prices ismain risk factor to company's profitability.

Financials


Income statement

Revenues 3,076 3,274 3,290 4,017 4,293 4,232EBITDA 52 54 222 276 229 196EBIT 28 32 201 253 205 172Net interest (16) 15 22 14 24 33Associates Other pre-tax items 2 3 2 0 0 0Pre-tax profit 14 49 224 268 230 205Tax 0.5 (32) (51) (54) (44) (39)Minorities Other post-tax items 0.9 0 0 0 0 0Net profit 15 17 174 214 186 166Normalised net profit 15 17 174 214 186 166

Balance sheet

Tangible fixed assets 201 192 173 213 235 247Intangible fixed assets 5 4 4 4 4 4Other non-current assets 300 267 341 341 341 341Cash & equivalents 539 826 1,150 1,252 1,288 1,296Other current assets 1,299 1,998 1,672 1,790 1,918 1,893Total assets 2,344 3,286 3,340 3,600 3,786 3,780Short-term debt 106 136 63 63 63 63Other current liabilities 1,386 2,154 2,272 2,623 2,846 2,805Long-term debt 171 255 230 100 50 50Other long-term liabilities 144 179 188 188 188 188Total equity 536 562 586 627 639 675Total liabilities & equity 2,344 3,286 3,340 3,600 3,786 3,780Net working capital 505 1,008 717 832 883 872Net debt (cash) (262) (434) (857) (1,089) (1,176) (1,183)

Cash flow

Cash flow EBITDA 53 57 223 276 229 196Tax, interest & other 16 17 29 39 19 6Change in working capital (131) (621) 289 (93) (50) 11Net cash from op activities (78) (564) 512 182 179 206Capex (18) (44) (3) (62) (45) (36)Net acquisitions 0 0 0 0 0 0Net financing cash flow 41 46 (98) (130) (50) 0Dividends & minority distrib'n 0 0 (149) (174) (174) (130)Net ch in cash & equivalents 37 161 435 141 56 13FCF (95) (608) 510 120 134 170


Revenue growth (%) 1.1 6.4 0.48 22.1 6.9 -1.4Normalised EPS growth (%) 286.9 14.8 904.3 23.3 -13.2 -10.7Normalised EBITDA mgn (%) 1.7 1.6 6.7 6.9 5.3 4.6Normalised EBIT margin (%) 0.91 0.96 6.1 6.3 4.8 4.1ROACE (%) 3.6 3.6 21.9 30.4 26.6 22.4Reported ROE (%) 2.8 3.2 30.3 35.3 29.4 25.3Working capital as % of sales 16.4 30.8 21.8 20.7 20.6 20.6Net debt (cash)/EBITDA (x) (5.1) (8.1) (3.9) (4.0) (5.1) (6.0)EBITDA net interest cvg (x) 3.2 n/a n/a n/a n/a n/a

Valuation

EV/revenue (x) 0.65 0.56 0.43 0.29 0.26 0.26EV/normalised EBITDA (x) 38.9 34.2 6.4 4.3 4.8 5.6EV/normalised EBIT (x) 71.7 58.3 7.1 4.7 5.3 6.3Normalised PER (x) 150.8 131.4 13.1 10.6 12.2 13.7Price/book (x) 4.2 4.0 3.9 3.6 3.6 3.4Dividend yield (%) 0.0 0.0 -6.6 -7.6 -7.6 -5.7FCF yield (%) n/a n/a 36.0 10.2 12.2 15.6

Per share data

Reported EPS (PLN) 0.590 0.677 6.80 8.39 7.28 6.50Normalised EPS (PLN) 0.590 0.677 6.80 8.39 7.28 6.50Dividend per share (PLN) 0.00 0.00 (5.84) (6.80) (6.80) (5.10)Equity FCFPS (PLN) (3.74) (23.82) 19.97 4.71 5.24 6.67BV/share (PLN) 21.00 22.00 22.96 24.55 25.03 26.43


Polish Strategy Cersanit July 2010

62

Cersanit previously Sell

Timid signs of recovery HoldPoland Market cap PLN1,904.2mConstruction & Materials Bloomberg CST PW

As the company plans to raise up to PLN250m, Cersanit’s ESM will vote on up to a 72m rights issue on 3 August. With a decline of 18% YTD following weaker-than-expected 1Q10 results and negative sentiment related to the rights issue, Cersanit was one of the worst performing stocks in our universe. 2Q10 should not yet surprise positively, but the first signs of a rebound in demand in Russia and Ukraine should translate into a rebound in profits in 2011 and 2012.

Investment case Cersanit plans to conduct a rights issue, raising equity by up to 50% or 72m shares. The company wants to collect between PLN150m and PLN250m, primarily in order to repay debt and to strengthen its equity. We have not yet included the rights issue in our model as it has not yet been approved by the ESM. The swap ratio was set at two shares for one right. The implied price of one right would be PLN2.8, assuming a PLN0.2bn issue.

A slowdown in demand on almost all markets of operations resulted in a 7% YoY decline in revenues in 2009. Demand has recovered slowly since the beginning of 2010. Although the company’s capacity utilisation remains at 80%, double-digit growth rates of sales volumes in Russia, Ukraine and Romania signal a positive development in the coming quarters, translating into improving operating margins in 2010F (we forecast a 12.2% EBIT margin in 2010F versus 11.5% in 2009) improving further in 2011F to 14.7%.

In June, Cersanit signed an agreement with Meissen Keramik Vertriebs GmbH on the distribution of the company’s products in Germany, Austria and the Benelux. Cersanit will now be present in DIY stores, which should enable a gradual increase in volume sales in these markets. The company targets annual sales volumes in ceramic tiles to increase over the next five years from less than 2m m² in 2009 to 10m m² in 2014. Cumulated revenues following the agreement are expected to reach €350m, close to 15% of the company’s 2010-14F revenues.

In the tiles segment (64% of 2009 revenues), the company plans to sell 53m m² of ceramic tiles this year, compared with 48m m² of volumes in 2009. Poland will still be Cersanit’s core market with a 50% contribution to 2010 sales. The second largest market for Cersanit is Russia, with expected volume sales of c.11m m² in 2010 compared with 8m m² sales in 2009. Also Ukraine, where the company has a market share of close to 40%, is expected to post double-digit growth rates this year, with planned sales volumes approaching 10m m². Among smaller markets, Romania and Germany should each contribute 2m m² of sales.

We upgrade Cersanit to HOLD following expectations of strong earnings recovery in 2011 and 2012, with a DCF-derived 12-month target price of PLN15.0. The company trades at a 2010/11F EV/EBITDA of 9.8x/7.8x, a 54%/39% premium to global peers.

Price (19/07/10) PLN13.20

previously PLN14.10Target price (12-mth) PLN15.00


2Q10 preview We forecast a moderate 3% YoY increase in revenues following the pick up in sales in Russia and Ukraine, with Polish operations 10% lower YoY. EBIT should be 8.5% higher on moderately higher gross margin (40.5% versus 39.2% in 2Q09) and cost control (SG&A expenses at 25.6% of revenues versus 26.8% in 2Q09). Net profit could be distorted by an estimated PLN45m negative impact from the revaluation of FX debt.


(PLNm) 2Q09 2Q10F

Revenue 369 380EBITDA 77 82EBIT 48 52Net income (1.4) (6.4)EPS (PLN) (0.01) (0.04)


Earnings drivers and outlook The planned rights issue should have a negative impact on the share price in the short term, especially as PLN0.2bn cash proceeds will primarily be dedicated for working capital purposes and debt repayments, leaving investments in new capacities aside.

In 2010F we expect revenue growth to reach a moderate 3.8% following higher capacity utilisation rates both in ceramic tiles and sanitary ware (78% and 70% in 2010F, compared with 72% and 65% in 2009, respectively). As the competitive environment remains demanding, primarily in Poland, we assume slight single-digit decreases in ceramic tile and sanitary ware prices YoY in 2010F. We forecast a 12.2% EBIT margin in 2010F compared with 11.9% reported in 2009. Market consensus is 13% above our estimates, with an expected EBIT margin of 13.4% this year. We believe it will be difficult for Cersanit to deliver on expectations in 2010 given the strong competitive environment and only a moderate rebound in demand. Management has a 2010 EBIT margin of 12-13% as an internal target.

In 2011F we forecast 13% YoY revenue growth, driven both by higher price levels and capacity utilisation at 82% and 77%,respectively. Cersanit’s EBIT margin should improve to 14.7% in 2011F. Market consensus is for a 2011 EBIT margin of 15.4% and PLN183m net profit. These are demanding targets, especially as the company would be happy to see a 15% EBIT margin next year. However, given the high operating leverage, 2011consensus is achievable, if market conditions turn favourable.


Polish Strategy Cersanit July 2010

63

Newsflow

Date Description

3 Aug 2010 ESM on rights issue17 Aug 2010 Rights date31 Aug 2010 2Q10 results15 Nov 2010 3Q10 results



Michal Solowow 48.6ING pension fund 12.6Aviva pension fund 11.3


Share data

Avg daily volume (3-mth) 56,132Free float (%) 51.4Market cap (PLNm) 1,904.2Net debt (1F, PLNm) 1,032Enterprise value (1F, PLNm) 2,936Dividend yield (1F, %) 0.0



1213141516171819

7/09 9/09 11/09 1/10 3/10 5/10

Price WIG (rebased)

Source: ING

Company profile

Cersanit is the second-largest manufacturer ofceramic products in CEE and the CIS and is executinga strategy that should place it among the largestglobal producers (currently seventh-largest global tilesmanufacturer). Current capacities amount to 65m m2of ceramic tiles and 6.5m units of sanitary ware.

Risks

Given Cersanit’s high debt burden at 1.0x netdebt/EBITDA and close to 4.0x net debt/12-month EBITDA, it is unlikely that the company will financeany further investments in new production capacitiesthrough bank debt. A potential share issue mighttherefore take place at the end of 2010 if the companydecides to invest in production capacities in Romaniaor Russia. The value of issue is estimated atPLN0.2bn. There are upside and downside risksdepending on the success or otherwise of thepotential rights issue.

Financials


Income statement

Revenues 1,455 1,517 1,415 1,468 1,654 1,795EBITDA 322 340 285 300 363 487EBIT 232 234 168 179 243 371Net interest (28) (48) (59) (70) (67) (70)Associates Other pre-tax items (39) (156) (117) 21 0 0Pre-tax profit 165 30 (8) 130 175 301Tax (26) (24) (0.4) (25) (35) (60)Minorities (18) 2 0.4 0 0 0Other post-tax items 0 0 0 0 0 0Net profit 121 8 (8) 105 140 240Normalised net profit 121 8 (8) 105 140 240

Balance sheet

Tangible fixed assets 1,061 1,199 1,165 1,090 1,054 1,155Intangible fixed assets 284 405 383 383 383 383Other non-current assets 18 27 22 23 26 28Cash & equivalents 389 717 106 218 365 437Other current assets 725 1,016 948 965 1,031 1,026Total assets 2,477 3,364 2,625 2,679 2,859 3,029Short-term debt 607 788 270 250 282 306Other current liabilities 344 399 341 256 264 292Long-term debt 506 1,074 947 1,000 1,000 950Other long-term liabilities 17 52 1 1 2 2Total equity 1,003 1,052 1,066 1,171 1,312 1,480Total liabilities & equity 2,477 3,364 2,625 2,679 2,859 3,029Net working capital 423 555 509 622 668 625Net debt (cash) 724 1,145 1,110 1,032 916 819

Cash flow

Cash flow EBITDA 175 38 49 131 158 226Tax, interest & other (93) (229) (177) (74) (102) (202)Change in working capital (162) (211) (35) (103) (60) 30Net cash from op activities (26) (328) (104) 49 97 185Capex (567) (244) (83) (45) (84) (218)Net acquisitions 0 0 0 0 0 0Net financing cash flow 484 793 (623) 34 32 (26)Dividends & minority distrib'n 0 0 0 0 0 (72)Net ch in cash & equivalents (118) 99 (787) 38 45 (131)FCF (593) (572) (187) 4 13 (33)


Revenue growth (%) 91.4 4.3 -6.7 3.8 12.6 8.6Normalised EPS growth (%) -17.3 -93.9 n/a n/a 33.0 71.6Normalised EBITDA mgn (%) 22.1 22.4 20.1 20.4 21.9 27.1Normalised EBIT margin (%) 15.9 15.4 11.9 12.2 14.7 20.6ROACE (%) 12.9 9.3 6.5 7.6 9.7 13.9Reported ROE (%) 15.3 0.82 -0.77 9.4 11.3 17.2Working capital as % of sales 29.1 36.6 36.0 42.3 40.4 34.8Net debt (cash)/EBITDA (x) 2.2 3.4 3.9 3.4 2.5 1.7EBITDA net interest cvg (x) 11.5 7.0 4.8 4.3 5.4 6.9

Valuation

EV/revenue (x) 1.9 2.0 2.1 2.0 1.7 1.5EV/normalised EBITDA (x) 8.7 9.0 10.6 9.8 7.8 5.6EV/normalised EBIT (x) 12.0 13.1 17.9 16.4 11.6 7.3Normalised PER (x) 14.5 238.3 n/a 18.1 13.6 7.9Price/book (x) 2.1 1.8 1.8 1.6 1.5 1.3Dividend yield (%) 0.0 0.0 0.0 0.0 0.0 3.8FCF yield (%) n/a n/a n/a 0.15 0.47 n/a

Per share data

Reported EPS (PLN) 0.911 0.055 (0.056) 0.730 0.971 1.67Normalised EPS (PLN) 0.911 0.055 (0.056) 0.730 0.971 1.67Dividend per share (PLN) 0.00 0.00 0.00 0.00 0.00 0.500Equity FCFPS (PLN) (4.46) (4.12) (1.29) 0.030 0.093 (0.231)BV/share (PLN) 6.34 7.25 7.39 8.12 9.09 10.26


Polish Strategy Kety July 2010

64

Kety Previously Hold

An attractive alternative to Polish contractors BuyPoland Market cap PLN958.55mBasic Resources Bloomberg KTY PW

Kety’s 2010-15 strategy implies an aggressive 16% CAGR in EPS. Our forecasts of 13% CAGR in EPS are below management’s expectations, nevertheless we perceive Kety as an attractive investment alternative to Polish contractors.Low valuations, double-digit EPS growth, strong positioning in segments of operations and a stable dividend policy justify our upgrade to BUY.

Investment case Key figures of the 2010-15 strategy are 10% CAGR in revenues and 16.2% CAGR in EPS. The 2015F EPS target amounting to PLN19.0 is ambitious and 22% above our estimates. Shouldmanagement deliver on its promises, Kety’s perception of a value story would turn into a growth story again. Even based on our more bearish assumptions, we perceive Kety as an attractive investment alternative to Polish construction companies trading at 2010F and 2011F PER of 11.5x and 9.8x, respectively. While we believe the construction sector might face a deterioration of profit margins beginning from 2011F, Kety seems well positioned in its business segments and has scale to improve profitability and deliver double-digit EPS growth YoY in 2010F and 2011F.

Kety’s 2010 guidance amounts to PLN1.2bn revenues, PLN118m EBIT and PLN81.5m net profit, which implies a 6%YoY increase in the top line and 15% YoY growth at the bottom line, but a 5% YoY decrease of EBIT. Growth will be drivenprimarily by the extruded profiles segment, which should deliver a 20% YoY increase in revenues to PLN431m, following the recovery of aluminium prices to an average of US$2,000 peraluminium tonne compared with US$1,675 in 2009. Volume sales in extruded profiles should grow by low single-digit per cent YoY. In 2009, Kety processed 30,500 tons extruded profiles and 37,000 tonnes in 2008. Overall we expect extruded profiles will amount to 37% of revenues in 2010, compared with 32% in 2009 (excluding internal sales). Still, Kety’s raw material hedging policy results in the recognition of hedging on the financial level, which distorts actual single-digit growth YoY of the operating profit. The 2010 net profit market consensus is less optimistic than management, with expectations of PLN78m net profit, which still implies a 10%YoY increase in net profit.

After two years of declining capex, Kety finally plans an increase in investment outlays to PLN115m this year compared with PLN34m in 2009 and PLN80m in 2008.

We raise our recommendation from Hold to BUY. Strong positioning in all major segments of operations, quality management as well as attractive valuations justify our BUYrecommendation. Our DCF-based 12-month TP is now PLN124.

We expect PLN4.5 dividend per share out of 2010F net profit, an implied dividend yield of 4.3%.

Price (19/07/10) PLN103.90



2Q10F results preview We expect a moderate 3% YoY revenue increase, following higher aluminium prices (US$2,125 in 2Q10 vs US$1,524 in 2Q09).

EBIT adjusted by commodity hedging transactions would come in flat YoY at PLN28m. Lower net profit following PLN7m negative impact from the revaluation of FX debt.

After 1H10, net profit should reach PLN30m, or only 37% of 2010 net profit guidance.


(PLNm) 2Q09 2Q10F

Revenues 278 285EBITDA 51.5 44.0EBIT 35.5 26.0Net profit 20.6 15.0EPS 2.2 1.6


Earnings drivers and outlook A pick-up in extruded profile volume sales and favourable FX exchange rates will likely be the main drivers of the share price.

Our 2010 forecasts see extruded profiles volume sales flat YoY at 30,500 tonnes followed by a recovery of demand to 33,000 tonnes in 2011F. However, Kety noted that as of beginning 3Q10 monthly volume sales improved to c.3,500 tons. This is positive if volume sales in excess of 3,000 tonnes are to be maintained. Kety has managed to increase prices for extruded profiles and flexible packaging products beginning from 3Q10, which should translate into significantly stronger 3Q10 results QoQ.

The currency environment for Kety is unfavourable, with a strong USD (over 40% of costs, mainly aluminium, are USD-denominated) and a weak EUR (c.60% of Kety’s sales are EUR-denominated), the most important macro drivers for Kety’s profitability. In 2Q10, the average EUR/USD exchange rate amounted to 1.27 and 1.38 in 1Q10. If the USD remain strong vs the EUR, Kety’s margins might deteriorate in 2H10, resulting in missing 2010 guidance.

Between 7,000-8,000 tonnes or 15-20% of Kety’s aluminium profiles capacities are located in Ukraine. In 2009, production amounted to only 1,000 tonnes, with profitability of the Ukrainian plants around break-even at the EBITDA level. Eastern operations might provide upside to Kety’s results should the Ukrainian market rebound beginning from 2011.


Polish Strategy Kety July 2010

65

Newsflow

Date Description

12 Aug 2010 2Q10 results27 Oct 2010 3Q10 results



ING pension fund 17.8Aviva pension fund 10.2Pioneer mutual funds 6.9Raiffeisen Zentrabank 5.7PZU pension fund 5.1


Share data

Avg daily volume (3-mth) 13,300Free float (%) 100.0Market cap (PLNm) 958.55Net debt (1F, PLNm) 207Enterprise value (1F, PLNm) 1,165Dividend yield (1F, %) -3.8



80

90

100

110

120

130

7/09 9/09 11/09 1/10 3/10 5/10

Price WIG (rebased)

Source: ING

Company profile

Kety is the leading Polish producer by market share ofextruded profiles (23% of revenues in 2009),aluminium systems and shutters (35% of revenues)and flexible packaging (26% of revenues). The mostimportant clients are from the construction, food andautomotive industries. Around one-third of sales comefrom exports.

Risks

Among the risks to our recommendation, we seeanother decrease in demand for steel profiles,favourable FX exchange rates (strong US$, weakeuro) and significant cuts in interest rates.

Financials


Income statement

Revenues 1,253 1,171 1,107 1,184 1,298 1,384EBITDA 193 188 188 184 214 226EBIT 141 127 124 114 138 147Net interest (19) (56) (32) (12) (17) (18)Associates Other pre-tax items 0 0 0 0 0 0Pre-tax profit 122 71 92 103 121 129Tax (24) (10) (20) (20) (23) (25)Minorities (0.2) (0.3) 0.0 (0.2) (0.2) (0.2)Other post-tax items 0 0 0 0 0 0Net profit 98 61 71 83 98 105Normalised net profit 98 61 71 83 98 105

Balance sheet

Tangible fixed assets 706 722 694 739 764 785Intangible fixed assets 92 91 84 80 76 71Other non-current assets 50 46 42 44 46 48Cash & equivalents 17 46 108 123 130 232Other current assets 450 410 361 393 414 423Total assets 1,314 1,315 1,290 1,380 1,429 1,559Short-term debt 224 258 222 250 250 250Other current liabilities 230 194 185 203 225 246Long-term debt 146 148 82 80 50 100Other long-term liabilities 0 0 0 0 0 0Total equity 714 715 801 847 904 962Total liabilities & equity 1,314 1,315 1,290 1,380 1,429 1,559Net working capital 306 293 249 266 267 258Net debt (cash) 353 360 196 207 170 118

Cash flow

Cash flow EBITDA 193 188 188 184 214 226Tax, interest & other 43 65 53 31 40 42Change in working capital (15) (8) 43 (16) 0.4 10Net cash from op activities 135 115 179 137 174 194Capex (149) (80) (34) (115) (100) (100)Net acquisitions 0 0 0 0 0 0Net financing cash flow 37 21 (84) 30 (26) 54Dividends & minority distrib'n (37) (37) 0 (37) (42) (46)Net ch in cash & equivalents (19) 29 62 15 6 102FCF 5 91 177 33 91 112


Revenue growth (%) 18.7 -6.6 -5.4 6.9 9.6 6.6Normalised EPS growth (%) 12.4 -37.9 17.0 16.6 18.0 6.7Normalised EBITDA mgn (%) 15.4 16.1 17.0 15.6 16.5 16.4Normalised EBIT margin (%) 11.3 10.8 11.2 9.7 10.7 10.6ROACE (%) 13.8 11.5 11.1 10.0 11.6 11.7Reported ROE (%) 14.3 8.6 9.4 10.1 11.2 11.2Working capital as % of sales 24.4 25.0 22.5 22.5 20.6 18.7Net debt (cash)/EBITDA (x) 1.8 1.9 1.0 1.1 0.80 0.52EBITDA net interest cvg (x) 10.0 3.4 5.8 16.0 12.4 12.7

Valuation

EV/revenue (x) 1.1 1.1 1.0 0.98 0.87 0.78EV/normalised EBITDA (x) 6.8 7.0 6.1 6.3 5.3 4.8EV/normalised EBIT (x) 9.3 10.4 9.3 10.2 8.2 7.3Normalised PER (x) 9.8 15.7 13.5 11.5 9.8 9.2Price/book (x) 1.4 1.3 1.2 1.1 1.1 1.00Dividend yield (%) -3.8 -3.8 0.0 -3.8 -4.3 -4.8FCF yield (%) 0.40 6.9 15.3 2.9 8.1 10.4

Per share data

Reported EPS (PLN) 10.63 6.60 7.72 9.00 10.62 11.34Normalised EPS (PLN) 10.63 6.60 7.72 9.00 10.62 11.34Dividend per share (PLN) (4.00) (4.00) 0.00 (4.00) (4.50) (5.00)Equity FCFPS (PLN) (1.51) 3.80 15.65 2.38 8.00 10.20BV/share (PLN) 76.76 77.46 86.84 91.85 97.97 104.31


Polish Strategy Mostostal Warszawa July 2010

66

Mostostal Warszawa Previously: Hold

The good times, the bad times SellPoland Market cap PLN1,344.0mConstruction & Materials Bloomberg MSW PW

We downgrade Mostostal Warszawa to SELL on expectations of margin deterioration in 2010 and 2011, primarily related to intensified competition in the company’s core segment, infrastructure, but also a lack of large signings over recent months. Mostostal Warszawa is our least preferred play among contractors. We set our DCF-and peer valuation-based 12-month target price at PLN60.

Investment case In 2008 Mostostal Warszawa signed new contracts amounting to PLN3.5bn. In the following year its portfolio of contracts increased by only PLN1.6bn, primarily related to intensified competition and MSW’s cautious budgeting approach. In 2010 the company has focused on small- and mid-size tenders, at last translating into a growing number of contract awards, with PLN1.3bn new signings YTD and another PLN0.6bn to follow in the coming weeks. According to CEO Jaroslaw Popiolek, this should lead to c.10% YoY revenue growth in 2010 to close to PLN3.0bn, but also secure at least flat revenues in 2011. Market consensus is broadly in line with the company’s expectations and expects PLN2.9bn revenues in 2010 and PLN3.0bn in 2011.

On the secured sales figures, profitability is a concern. CEO Popiolek recently stated it will be difficult in 2010 to top 2009 net profit of PLN120m. The major reasons behind the expected margin pressure are: (1) intensified competition in the company’s core segments; (2) lack of cyclical subsidiaries with above-average profitability, which would help the company offset the declining margins of the infrastructure and civil engineering segments; and (3) an overly conservative budgeting approach throughout 2009. Profitability deterioration is a fact, the scale remains a question. Market consensus sees the company’s net profit dropping 11% YoY in 2010 to PLN106.5m and another 11% YoY to PLN95m in 2011. We are significantly below the market with expectations of PLN98m/PLN71m net profit, respectively.

MSW’s current backlog amounts to PLN3.4bn (of which PLN2.8bn is contracts at Mostostal Warszawa on a standalone basis and PLN0.6bn is collected by subsidiaries) vs c.PLN3.5bn as of end 1H09. The backlog is almost equally split between infrastructure construction and civil engineering. The company hopes to sign another PLN0.6bn of new road construction contracts in the coming weeks. The average contract value in 2010 is PLN83m compared with PLN146m of contracts signed in 2008.

We downgrade Mostostal Warszawa from Hold to SELL with a revised target price of PLN60, the outcome of a DCF valuation and peers valuation with a 60% and 40% share applied to the methods. Mostostal Warszawa trades at 13.7x/18.8x 2010/11F PER, and is our least preferred infrastructure play as a result of margin deterioration and demanding valuations.

Price (19/07/10) PLN67.20



2Q10 preview We forecast a 12% YoY increase in revenues related to 14% YoY backlog growth. EBIT should be 32% YoY lower following profitability deterioration of the general construction business (net profit margin at 5.0% compared with 10.1% reported in 2Q09), but also a lower bottom line contribution from listed subsidiaries Remak and Mostosal Plock due to a more competitive business environment. Consequently, we forecast net profit down 22% YoY, following PLN2m financial income in 2Q10 versus a PLN3m financial expense in 2Q09.


(PLNm) 2Q09 2Q10F

Revenue 626.1 701.3EBIT 51.2 34.9Net profit 34.4 26.9EPS 1.7 1.3


Earnings drivers and outlook We expect Mostostal’s profit margin to deteriorate from 3Q10 and intensify in 2011. In 2010 we forecast a 3.3% net profit margin, split into 3.7% in 1H10 and 3.0% in 2H10. In 2009, its record year, the company’s net profit margin amounted to 4.5%. Contracts awarded in recent tenders are characterised by below-average profitability, but the impact on results will be delayed. As a result, we believe the worst is still to come in 2011, with a forecast net profit margin decrease to 2.2%.

Share price triggers in the coming months will be not so much the quarterly results, but the intensification of power block construction contracts. Following the intensification of competition in road construction, MSW has put more emphasis on smaller and mid-sized projects, but also wants to be an active player on the power block construction market. As the company participates in large power tenders, the announcement of the winning parties of the €1.6bn Siekierki and €3.0bn Opole power block contracts might result in positive newsflow given the large contract size. MSW’s share in the bidding consortiums amounts to 40% and 33%, respectively. Tender completion is scheduled for the end of 2010 and beginning of 2011. Even if Mostostal Warszawa is awarded one of these contracts, the impact on 2011 figures will be negligible. Positive newsflow as well as expectations of above-average profit margins on power industry contracts beginning from 2012 would likely result in outperformance of MSW’s shares.


Polish Strategy Mostostal Warszawa July 2010

67

Newsflow

Date Description

31 Aug 2010 2Q10 results15 Nov 2010 3Q10 results



Acciona SA 50.1PZU pension fund 17.8


Share data

Avg daily volume (3-mth) 12,637Free float (%) 49.9Market cap (PLNm) 1,344.0Net debt (1F, PLNm) (354)Enterprise value (1F, PLNm) 1,077Dividend yield (1F, %) -2.1



55606570

758085

7/09 9/09 11/09 1/10 3/10 5/10

Price WIG (rebased)

Source: ING

Company profile

Mostostal Warszawa is the fifth-largest Polish construction company by revenues, active in generaland infrastructure construction. Company also owns apower industry construction arm, Remak (11.5% of1H09 revenues). Spanish strategic investor, Acciona,controls a 50% stake in the company.

Risks

The award of large power industry tenders (MSW’sshare amounting to a total of PLN4.5bn) would securethe company’s backlog for 2012-15 with high margined contracts and result in positive newsflow.

Financials


Income statement

Revenues 1,928 2,211 2,712 2,944 2,876 2,857EBITDA 78 145 209 162 129 105EBIT 59 122 181 126 95 71Net interest 1 1.0 (5) 11 8 8Other pre-tax items 2 (3) (7) 0 0 0Pre-tax profit 62 119 169 137 103 79Tax (4) (27) (43) (26) (20) (15)Minorities (6) (11) (9) (13) (12) (12)Other post-tax items 0 0 0 0 0 0Net profit 53 81 117 98 71 52Normalised net profit 53 81 117 98 71 52

Balance sheet

Tangible fixed assets 151 188 285 344 401 416Intangible fixed assets 1 2 2 2 2 2Other non-current assets 32 56 75 78 82 85Cash & equivalents 288 309 429 484 536 514Other current assets 537 720 715 795 767 753Total assets 1,009 1,276 1,506 1,703 1,787 1,770Short-term debt 29 21 30 30 30 30Other current liabilities 601 806 844 917 938 921Long-term debt 16 29 60 100 100 50Other long-term liabilities 18 17 14 14 14 14Total equity 344 403 556 639 703 752Total liabilities & equity 1,009 1,276 1,505 1,701 1,786 1,769Net working capital 59 219 156 179 170 210Net debt (cash) (242) (259) (339) (354) (405) (434)

Cash flow

Cash flow EBITDA 76 89 105 131 106 91Tax, interest & other (2) (26) (49) (43) (31) (21)Change in working capital 148 34 85 17 51 4Net cash from op activities 224 122 190 120 137 80Capex (31) (60) (125) (94) (92) (49)Net acquisitions 0 0 0 0 0 0Net financing cash flow 14 (33) 61 40 0 (50)Dividends & minority distrib'n 0 0 0 (28) (20) (14)Net ch in cash & equivalents 200 5 108 34 22 (36)FCF 193 62 66 26 45 32


Revenue growth (%) 62.3 14.7 22.7 8.6 -2.3 -0.67Normalised EPS growth (%) 166.2 53.2 44.6 -16.5 -27.1 -27.4Normalised EBITDA mgn (%) 4.1 6.5 7.7 5.5 4.5 3.7Normalised EBIT margin (%) 3.1 5.5 6.7 4.3 3.3 2.5ROACE (%) 16.6 28.9 33.0 17.8 11.8 8.5Reported ROE (%) 20.8 26.1 28.6 18.9 12.3 8.3Working capital as % of sales 3.1 9.9 5.8 6.1 5.9 7.3Net debt (cash)/EBITDA (x) (3.1) (1.8) (1.6) (2.2) (3.1) (4.1)EBITDA net interest cvg (x) n/a n/a 41.1 n/a n/a n/a

Valuation

EV/revenue (x) 0.60 0.52 0.40 0.37 0.36 0.36EV/normalised EBITDA (x) 14.8 8.0 5.2 6.7 8.0 9.7EV/normalised EBIT (x) 19.7 9.4 6.0 8.5 10.9 14.4Normalised PER (x) 25.4 16.6 11.5 13.7 18.8 25.9Price/book (x) 4.7 4.0 2.8 2.4 2.2 2.1Dividend yield (%) 0.0 0.0 0.0 -2.1 -1.5 -1.1FCF yield (%) 16.7 5.4 6.1 2.4 4.4 3.1

Per share data

Reported EPS (PLN) 2.65 4.06 5.87 4.90 3.57 2.59Normalised EPS (PLN) 2.65 4.06 5.87 4.90 3.57 2.59Dividend per share (PLN) 0.00 0.00 0.00 (1.40) (0.979) (0.714)Equity FCFPS (PLN) 9.67 3.12 3.28 1.28 2.27 1.58BV/share (PLN) 14.24 16.88 24.12 27.62 30.21 32.09


Polish Strategy PBG July 2010

68

PBG Previously Hold

It’s all about the roads SellPoland Market cap PLN3,144.9mConstruction & Materials Bloomberg PBG PW

Over the last two months, PBG has signed new contracts worth PLN2.4bn, increasing its backlog by around 40%. Coupled with bullish statements by management suggesting an upward revision of 2010 guidance and double-digit EPS growth expected in 2011, the company seems to be one of the few growth stories among Polish contractors. However, we worry about profitability deterioration related to low-margin road contracts and see 2011F EPS growing only 1% YoY vs 15% YoY EPS growth based on consensus. We downgrade to SELL, with a revised 12-month TP of PLN200.

Investment case CEO Jerzy Wisniewski announced recently that PBG will consider an upward revision of its 2010 revenue and net profit guidance, amounting to PLN3.0bn and PLN220m respectively, at the beginning of 4Q10. This might be possible as a result of a large number of new contract signings throughout 2010 which have not been included in PBG’s guidance. Based on current guidance, PBG trades at a 2010 PER of 14.3x, a 4% premium to its peers. Upside related to a potential guidance revision is limited, as the current market consensus already partly anticipates higher earnings and sees 2010 net profit at PLN227m.

PBG is also bullish for 2011. Based on management statements, it will continue to target a double-digit increase in revenue and net profit YoY next year. Growth rates will range between 10% and 20% YoY on all levels of operations. This would imply 2011 revenues in excess of PLN3.3bn and net profit ranging from PLN240m to PLN260m.

Over the last two months, PBG has signed contracts worth PLN2.4bn, including PLN0.9bn for an LNG terminal and PLN1.4bn in new road contracts, increasing its backlog to PLN5.7bn compared with PLN4.0bn at beginning 2010. Of the backlog, c.PLN2.0bn will be executed in 2010, which given PLN0.5bn revenues reported in 1Q10 and another PLN0.7bn expected in 2Q10F secures the PLN3.0bn revenue guidance. The backlog is dominated by oil & gas contracts with a 40% share of portfolio. Following recent signings, road contruction has also become a crucial segment, with a 26% share of backlog.

According to PBG, growth drivers in the coming years will still be road construction, but also the power industry, where PBG has allied with Alstom for tenders in the construction of power blocks.

We downgrade PBG to SELL, with a revised DCF and peer valuation-based 12-month TP of PLN200. Based on our revised forecasts, PBG trades at a 2010/11F PER of 13.5-13.4x, in line with Polish peers in both years. Unless PBG manages to attract at least one large power block construction contract, a premium is not justified in our view, given the risks related to the entrance into lower margin road segment.

Price (19/07/10) PLN220.00



2Q10 preview Revenue growth at 20% stemming primarily from industrial contracts (three Euro 2012 football stadia) executed by its subsidiary, Hydrobudowa Polska. EBIT margin down to 8.2% from 12.0% in 2Q09 following PLN13m OOI in 2Q09 (adjusted EBIT margin at 9.8%), but also the entry into lower margin industrial and road contracts. EPS flat YoY following 6% dilution related to shares issue in 2009.


(PLNm) 2Q09 2Q10F

Revenue 599.4 718.0EBITDA 80.9 68.8EBIT 71.7 58.6Net profit 46.9 49.3EPS 3.5 3.5


Earnings drivers and outlook Following a 7% YoY increase in EPS in 2010F, we expect a challenging 2011. In order to fill its declining backlog and secure 2011 turnover, PBG has entered lower-margin road contracts which will have a contribution to revenues in excess of 20% beginning from 2011. As a result, we believe PBG will not be in position to keep net profit margins in excess of 7.0%. We forecast only 1% YoY EPS growth in 2011, which implies 6.8% net profit margin vs 7.0% in 2010F and 8.2% reported in 2009.Market consensus is significantly above our forecasts, with expectations of 15%YoY EPS growth in 2011.

Drivers of PBG’s earnings and simultaneously the share price in the coming months will be any announcement on large contracts with above-average profitability, power industry and hydro engineering, and to a smaller extent the revision of 2010 net profit guidance.

PBG is one of the bidding parties at the €3.0bn Opole power plant contract. We estimate PBG’s share in the consortium at 35% or €1.0bn. Annoucement of the winning party is expected at the turn of 2010 and 2011. In order to win the €1.6bn Kozienice power block construction tender, PBG has allied itself with Alstom of France. Investors will select the contracting party in 1H11. In hydro engineering, PBG will bid for two large contracts,the retention tank in Raciborz and the water tam in Nieszawa. The two contracts amount to PLN2.7bn, with tender completion scheduled for early 2011.


Polish Strategy PBG July 2010

69

Newsflow

Date Description

31 Aug 2010 2Q10 results 15 Nov 2010 3Q10 results



Jerzy Wisniewski 29.6Pioneer mutual funds 11.3Aviva pension fund 9.4ING pension fund 8.8


Share data

Avg daily volume (3-mth) 19,468Free float (%) 70.4Market cap (PLNm) 3,144.9Net debt (1F, PLNm) 233Enterprise value (1F, PLNm) 3,606Dividend yield (1F, %) 0.64



180200220240260280300320

7/09 9/09 11/09 1/10 3/10 5/10


Source: ING

Company profile

PBG is the largest Polish construction company activein hydro engineering and oil & gas construction.Traditionally active in oil & gas in the years 2005-07 PBG entered the environmental protection sector(acquisition of three companies). It is also active inhighway construction (beginning from this year). In thecoming years, roads but also power industryconstruction will be drivers of growth.

Risks

Risk factors remain the execution of stadiumcontracts, given the technical difficulty and timelimitations, which might pose unexpectedexpenditures next year. Upside risk to ourrecommendation is the award of a power blockconstruction contract, which would almost doublePBG’s backlog with above-average profit margins.

Financials


Income statement

Revenues 1,407 2,091 2,578 3,304 3,457 3,410EBITDA 164 267 328 385 386 331EBIT 139 226 286 339 337 283Net interest 7 (10) (24) (27) (23) 14Associates Other pre-tax items 0 0 0 0 0 0Pre-tax profit 146 216 263 312 314 297Tax (27) (26) (41) (59) (60) (56)Minorities (15) (32) (11) (20) (19) (19)Other post-tax items 0 0 0 0 0 0Net profit 104 158 211 233 235 221Normalised net profit 104 158 211 233 235 221

Balance sheet

Tangible fixed assets 365 437 391 344 330 317Intangible fixed assets 13 15 33 33 33 33Other non-current assets 340 466 607 613 613 613Cash & equivalents 410 290 660 808 753 518Other current assets 1,131 1,651 2,318 2,632 2,598 2,571Total assets 2,259 2,859 4,008 4,430 4,327 4,051Short-term debt 467 671 642 500 500 200Other current liabilities 675 663 1,181 1,454 1,457 1,382Long-term debt 259 370 493 541 250 250Other long-term liabilities 73 40 69 69 69 69Total equity 785 1,114 1,623 1,866 2,051 2,151Total liabilities & equity 2,259 2,859 4,008 4,430 4,327 4,051Net working capital 540 1,031 1,182 1,238 1,202 1,229Net debt (cash) 315 752 475 233 (3) (68)

Cash flow

Cash flow EBITDA 96 194 195 213 220 245Tax, interest & other (200) (527) (216) (142) (46) (70)Change in working capital (16) (147) (210) (38) (7) (37)Net cash from op activities (73) (441) (162) 119 250 182Capex (123) (114) 15 0 (35) (34)Net acquisitions 0 0 0 0 0 0Net financing cash flow 620 335 381 (83) (291) (300)Dividends & minority distrib'n 0 0 0 (20) (70) (141)Net ch in cash & equivalents 323 (303) 96 24 (145) (315)FCF (195) (556) (147) 119 215 148


Revenue growth (%) 108.5 48.6 23.3 28.2 4.6 -1.4Normalised EPS growth (%) 64.4 50.4 29.6 6.5 1.2 -6.0Normalised EBITDA mgn (%) 11.6 12.8 12.7 11.7 11.2 9.7Normalised EBIT margin (%) 9.9 10.8 11.1 10.3 9.8 8.3ROACE (%) 12.3 12.3 11.7 12.0 11.8 10.5Reported ROE (%) 18.6 18.9 18.1 15.3 13.7 12.0Working capital as % of sales 38.4 49.3 45.9 37.5 34.8 36.0Net debt (cash)/EBITDA (x) 1.9 2.8 1.4 0.60 (0.01) (0.21)EBITDA net interest cvg (x) n/a 27.6 13.8 14.3 16.7 n/a

Valuation

EV/revenue (x) 2.5 2.0 1.5 1.1 0.98 0.98EV/normalised EBITDA (x) 21.4 15.3 11.7 9.4 8.8 10.1EV/normalised EBIT (x) 25.1 18.1 13.4 10.6 10.0 11.8Normalised PER (x) 28.1 18.7 14.4 13.5 13.4 14.2Price/book (x) 3.9 3.2 2.3 1.9 1.7 1.7Dividend yield (%) 0.0 0.0 0.0 0.64 2.2 4.5FCF yield (%) n/a n/a n/a 3.3 6.3 4.4

Per share data

Reported EPS (PLN) 7.83 11.78 15.27 16.27 16.47 15.49Normalised EPS (PLN) 7.83 11.78 15.27 16.27 16.47 15.49Dividend per share (PLN) 0.00 0.00 0.00 1.40 4.88 9.88Equity FCFPS (PLN) (14.67) (41.37) (10.63) 8.33 15.05 10.33BV/share (PLN) 55.90 69.11 97.61 114.60 126.20 131.81


Polish Strategy Polimex MS July 2010

70

Polimex MS Previously: Hold

Winter, flood, SELL SellPoland Market cap PLN2,320.1mConstruction & Materials Bloomberg PXM PW

At the beginning of 2010 CEO Konrad Jaskola announced the company will target 4.0% net profit margin for this year. Following the long winter in 1Q10 and floods in 2Q10 we expect disappointing results in 1H10, translating into only a 3.3% net margin in 2010F. We downgrade Polimex from Hold to SELL with a revised 12-month TP of PLN4.0.

Investment case CEO Konrad Jaskola recently cited that 2010 top-line growth will be in a range of 5% to 10%, which implies PLN4.6-4.8bn revenues this year. Net profit margin is unlikely to approach the 4% level envisaged at the beginning of 2010, primarily due to the long winter and floods on several of Polimex’s construction sites in 2Q10. The CEO, however, did not withdraw from plans to increase net profit YoY vs the PLN156m reported in 1H10, although investors should expect weaker 1H10 results YoY with stronger execution in 2H10. Based on that we expect 1H10 net profit to decrease by 42% YoY to PLN42m which, despite a stronger 2H10, will result in flat net profit in all of 2010. The current 2010 market consensus is a bit more optimistic and sees revenues growing 8% YoY to PLN4.7bn and net profit 3% YoY to PLN161m, which implies a net profit margin of 3.4%.

Polimex’s current backlog amounts to PLN7.4bn vs PLN6.8bn as of end-1H09. Out of the current backlog approximately PLN3.1bn is attributable to 2010F while the majority of the remaining PLN4.7bn should be executed primarily in 2011F and to a small extent in 2012F. The backlog is dominated by road&railway (PLN2.5bn) and general construction (close to PLN2.0bn), and the impressive backlog for 2010 and 2011 fully covers our 2010 revenues forecasts and 89% of our 2011 revenues forecasts.

In 4Q09 Polimex announced plans to acquire minority stakes of seven subsidiaries, thereof listed Energomontaz Polnoc (EPN PW; NR, PLN16.15) and Naftobudowa (NFT PW; NR, PLN27.4). In mid July Polimex shareholders and shareholders of the acquired entities finally agreed on share swap parities and approved the merger. The company will issue 56.6m shares (12% of equity) in exchange for the acquired stakes. We believe the transaction will be value accretive to PXM's shareholders based on attractive valuations of the acquired companies. The share issue is expected to be completed by end-3Q10 and we have implemented it in our model. After the acquisition Polimex's 2010F net profit should increase by PLN5m and PLN20m in 2011F on minorities.

Based on our 2010F Polimex trades at a PER of 13.6x, in line with Polish peers. In 2011F we forecast a 13% YoY decrease in EPS, which results in PER valuations at 15.0x, a double-digit premium to peers. Based on our DCF model (60%) and peer comparison (40%) we downgrade Polimex to SELL with a revised 12-month TP of PLN4.0 (previously PLN4.5).

Price (19/07/10) PLN4.54



2Q10 preview Profitability will suffer from weak performance of the steel production division (low demand and high zinc prices resulting in gross margin decrease to 12.0% in 2Q10F compared with 21.2% reported in 2Q09) and higher costs related to flooding of several construction sites.


(PLNm) 2Q09 2Q10F

Revenues 1,176 1,078EBITDA 86.8 70.1EBIT 65.8 44.2Net profit 37.9 25.2


Earnings drivers and outlook We expect Polimex’s EPS to decline by 3% YoY in 2010 primarily following deteriorating profit margins in the production segment (14.6% in 2010F compared with 20.8% in 2009) but also intensified competition in tenders, translating into margin decline in the divisions construction and road&railway.

In 2011 the trend of declining margins in traditional construction segments should intensify (especially roads, where we forecast 6.8% gross margin in 2011F vs 8.8% in 2010F) but will be partly offset by a rebound of the production division (17.4% gross margin in 2011F vs 14.6% in 2010F) as well as higher margined power industry tenders. As a result, we expect net profit to come in flat YoY in 2011F at PLN154m but EPS to drop 10% YoY following dilution related to the share issue.

Positive newsflow can be expected from large tenders for the construction of power blocks, and the first announcement on the winning parties should take place at the end of 4Q10. Polimex, traditionally active in the power construction segment (PLN1.0bn revenues generated annually), is perceived to be one of the major beneficiaries as the company is bidding on all major power plant projects, including Siekierki (EUR0.7bn), Opole (EUR3.0bn) and Kozienice (EUR1.6bn). Power industry contracts areexpected to be of above-average profitability, which today is hard to question given the lack of a track record of power block contracts in the past in Poland. Announcements on the acceleration of power block construction contracts should therefore be a share price driver, despite the recognition of first revenues in Polimex’s P&L, but not earlier than in 2H11.


Polish Strategy Polimex MS July 2010

71

Newsflow

Date Description

31 Aug 2010 2Q10 results 9 Nov 2010 3Q10 results



Pioneer mutual funds 8.9ING pension fund 8.7PZU pension fund 8.7Aviva pension fund 5.9


Share data

Avg daily volume (3-mth) 681,973Free float (%) 94.0Market cap (PLNm) 2,320.1Net debt (1F, PLNm) 138Enterprise value (1F, PLNm) 2,458Dividend yield (1F, %) -0.88



3.5

4.0

4.5

5.0

5.5

7/09 9/09 11/09 1/10 3/10 5/10


Source: ING

Company profile

Polimex MS is the largest Polish constructioncompany, with operations in four areas: chemicals;power industry; general construction; and production(steel structures and galvanising services). Thecompany controls a number of companies specialisingin its chosen industries, including listed powercompany, Energomontaz Polnoc, and the oil & gasconstruction company, Naftobudowa.

Risks

A strong pick-up in profitability already in 3Q10 as wellas award of the Opole and Siekierki power blockcontracts by Polimex would definitely improvesentiment and move the company to the top pick inthe Polish construction sector.

Financials


Income statement

Revenues 3,720 4,062 4,397 4,677 4,726 4,865EBITDA 205 298 344 336 318 306EBIT 160 228 265 237 219 214Net interest (15) (72) (56) (33) (28) (16)Associates Other pre-tax items 4 3 6 0 0 0Pre-tax profit 149 159 216 205 191 198Tax (33) (18) (40) (39) (36) (38)Minorities (17) (20) (19) (10) 0 0Other post-tax items 0 0 0 0 0 0Net profit 100 120 156 156 154 161Normalised net profit 100 120 156 156 154 161

Balance sheet

Tangible fixed assets 426 711 948 976 957 947Intangible fixed assets 458 530 544 544 544 544Other non-current assets 99 141 194 194 194 194Cash & equivalents 143 295 437 620 747 923Other current assets 1,675 1,762 1,705 1,763 1,641 1,690Total assets 2,801 3,439 3,828 4,097 4,082 4,297Short-term debt 229 318 155 155 155 400Other current liabilities 1,028 1,318 1,472 1,591 1,613 1,664Long-term debt 330 436 603 603 450 300Other long-term liabilities 128 199 214 214 214 214Total equity 1,086 1,169 1,383 1,531 1,649 1,717Total liabilities & equity 2,801 3,439 3,828 4,095 4,081 4,296Net working capital 798 575 351 317 175 177Net debt (cash) 416 458 321 138 (142) (223)

Cash flow

Cash flow EBITDA 128 98 159 195 188 194Tax, interest & other (30) (22) (91) (53) (66) (59)Change in working capital (492) 224 234 34 142 (2)Net cash from op activities (360) 413 397 245 330 192Capex (217) (355) (316) (126) (80) (83)Net acquisitions 0 0 0 0 0 0Net financing cash flow 316 149 55 2 (153) 95Dividends & minority distrib'n (5) (5) (5) (19) (37) (93)Net ch in cash & equivalents (22) 42 54 114 61 117FCF (577) 58 82 119 249 110


Revenue growth (%) 50.9 9.2 8.2 6.4 1.1 2.9Normalised EPS growth (%) 32.7 10.5 30.3 -3.2 -9.9 3.5Normalised EBITDA mgn (%) 5.5 7.3 7.8 7.2 6.7 6.3Normalised EBIT margin (%) 4.3 5.6 6.0 5.1 4.6 4.4ROACE (%) 13.7 12.8 13.0 10.7 9.6 9.2Reported ROE (%) 15.0 11.8 13.6 11.3 9.7 9.5Working capital as % of sales 21.4 14.2 8.0 6.8 3.7 3.6Net debt (cash)/EBITDA (x) 2.0 1.5 0.93 0.41 (0.45) (0.73)EBITDA net interest cvg (x) 13.4 4.1 6.2 10.3 11.3 19.7

Valuation

EV/revenue (x) 0.76 0.71 0.63 0.53 0.46 0.43EV/normalised EBITDA (x) 13.8 9.7 8.1 7.3 6.9 6.9EV/normalised EBIT (x) 17.7 12.7 10.5 10.4 10.0 9.8Normalised PER (x) 18.9 17.1 13.1 13.6 15.0 14.5Price/book (x) 2.1 2.0 1.7 1.5 1.4 1.4Dividend yield (%) -0.25 -0.23 -0.23 -0.88 -1.6 -4.0FCF yield (%) n/a 2.0 2.9 4.8 11.4 5.2

Per share data

Reported EPS (PLN) 0.240 0.266 0.346 0.335 0.302 0.313Normalised EPS (PLN) 0.240 0.266 0.346 0.335 0.302 0.313Dividend per share (PLN) (0.011) (0.010) (0.010) (0.040) (0.072) (0.180)Equity FCFPS (PLN) (1.38) 0.128 0.181 0.255 0.488 0.214BV/share (PLN) 2.12 2.27 2.68 2.94 3.15 3.28



72



73

Food & Beverage

Polish Strategy Astarta July 2010

74

Astarta Maintained

At the top of the cycle SellUkraine Market cap PLN1,473.8mFood & Beverage Bloomberg AST PW

We cannot ignore changes in Ukraine’s sugar supply-demand balance from a sugar deficit over the past two years to oversupply. We believe sugar prices in Ukraine will decline following additional supply from the new harvest and the decline in international sugar prices. Given that sugar-related business represents 76% of Astarta’s revenue, we believe a correction in the stock price is inevitable. We rate Astarta a SELL with a PLN49.1 target price.

Investment case We believe that Astarta’s share price has over-reacted to the recent high cyclical global increase in sugar prices. We think prices are now moving back to their mid-cycle level of US$296/t, as the one-off problem with sugar cane in India is likely to be resolved this year, normalising the supply/demand balance in the global sugar market. Indeed, global sugar prices have declined 40% over the past ten weeks. Ukrainian demand for sugar outstrips local supply. Thus, Ukrainian sugar prices reflect import parity prices (ie, international raw sugar prices plus import taxes, transportation and processing fees). They have been historically higher than global raw sugar prices by about US$150/t. We expect Ukrainian sugar prices to fall from US$760/t to US$569/t as global sugar prices correct.

We expect Astarta’s costs to increase going forward despite a number of cost-control and efficiency-improvement initiatives. Hryvnia stability in 2010F and double-digit inflation in Ukraine (CPI average 9.5% in 2010F and 12.7% in 2011F) will put pressure on the cost base. We forecast Astarta’s EBITDA margin to decrease by 7ppt to 37% in 2011F, when the effect of increased sugar prices will become less pronounced.

We maintain our SELL rating for Astarta as we believe the stock price will follow sugar prices downwards this year despite strong organic volume growth. We increase our target price slightly to PLN49.1 mainly on the change in macro forecasts and one-year forward move in our DCF model (from 2010-17F to 2011-17F). Astarta is trading at a 2011F PER of 7.4x, a 36% discount to developed international peers and a 43% discount to Asian peers. More importantly, it is trading at a 2011F EV/EBITDA of 5.5x. This is a 5% discount to developed international peers and a 14% discount to Eastern European peers. Given that we believe that Astarta’s stronger organic volume growth is more than outweighed by Ukrainian political and economic risks, we believe at least a 20% discount to 2011F EV/EBITDA multiples of developed peers is more appropriate.

Price (19/07/10) PLN58.95

previously PLN44.20Target price (12-mth) PLN49.10


Quarterly preview We expect Astarta to report one more strong quarter, as new harvest sugar will be available only from 3Q10. A slight decrease in QoQ revenue is a function of a c.10% decline in sugar prices and well as lower grain volumes at the end of the season.

Lower profitability is mainly due to the decline in sugar prices but also to several one-off items reported in 1Q10. We do not expect any unusual items below the EBITDA line.

2Q10 preview

(UAHm) 1Q10 2Q10F

Revenue 421.0 401.8EBITDA 215.5 183.7EBITDA margin (%) 51 46Net income 198.6 169.3


Earnings drivers and outlook We expect the performance of the sugar segment to be stable in 2Q10. But following the availability of the new harvest in 2H10, we expect the correction in sugar prices to be followed by a decline in sugar-related revenue.

Grain sales should actually be better than last year on strong volumes (because of the good harvest and increase in land bank) and the international uptick in wheat and, potentially, corn prices.

Astarta remains very sensitive to hryvnia/US$ movements, because of the company’s unfavourable foreign exchange exposure, particularly its dollar-denominated debt. We do not envisage any major devaluation risk but suggest monitoring potential hryvnia moves.

Alexandra Melnikova Moscow +7 495 755 5180 [email protected]

Polish Strategy Astarta July 2010

75

Newsflow

Date Description

August 2010 2Q and 1H10 results November 2010 3Q and 9month 2010 results April 2011 2010FY results



Victor Ivanchyk 40Valeriy Korotkov 35


Share data

Avg daily volume (3-mth) 5,638Free float (%) 25.0Market cap (PLNm) 1,473.8Net debt (1F, Uhm) 739Enterprise value (1F, Uhm) 4,417Dividend yield (1F, %) 0.0



20

30

40

50

60

70

7/09 9/09 11/09 1/10 3/10 5/10


Source: ING

Company profile

The biggest sugar producer in Ukraine with a landbank above 160,000ha, Astarta is a solid agricultureplay; although vulnerable to fluctuations in softcommodities, sugar prices as well as currency moves.

Risks

The main risks for the company remain potentialincreases, higher than we expect, in grain and sugarprices. Changes in local regulations, in particular tothe subsidy system, might have an effect on the P&L.

Financials

Year end Dec (Uhm) 2007 2008 2009 2010F 2011F 2012F

Income statement

Revenues 615 971 1,355 1,995 2,105 2,189EBITDA 151 222 411 884 773 679EBIT 116 149 318 742 616 509Net interest (52) (344) (138) (93) (93) (93)Associates Other pre-tax items 95 78 148 0 0 0Pre-tax profit 159 (116) 329 649 523 416Tax 0.6 27 (5) (32) (26) (21)Minorities (10) (0.6) 0.1 0.1 0.1 0.1Other post-tax items 0 0 0 0 0 0Net profit 150 (90) 323 617 497 396Normalised net profit 150 (90) 323 617 497 396

Balance sheet

Tangible fixed assets 577 818 1,220 1,360 1,502 1,590Intangible fixed assets 1.0 55 43 43 43 43Other non-current assets 56 68 169 169 169 169Cash & equivalents 8 60 22 244 430 612Other current assets 641 953 1,186 1,451 1,630 1,763Total assets 1,282 1,954 2,640 3,267 3,774 4,177Short-term debt 333 915 376 376 376 376Other current liabilities 93 180 186 196 206 213Long-term debt 48 134 606 606 606 606Other long-term liabilities 47 76 136 136 136 136Total equity 761 648 1,335 1,952 2,449 2,845Total liabilities & equity 1,282 1,954 2,640 3,267 3,774 4,177Net working capital 428 693 909 1,164 1,333 1,459Net debt (cash) 373 989 960 739 553 371

Cash flow

Cash flow EBITDA 194 (44) 422 791 680 586Tax, interest & other 8 238 167 32 26 21Change in working capital (150) (215) (322) (255) (169) (126)Net cash from op activities 17 (47) 158 504 485 440Capex (157) (293) (118) (282) (300) (258)Net acquisitions 0 0 0 0 0 0Net financing cash flow 136 403 (89) 0 0 0Dividends & minority distrib'n 0 0 0 0 0 0Net ch in cash & equivalents (12) 52 12 222 186 182FCF (95) (284) 145 222 186 182


Revenue growth (%) 42.1 57.8 39.6 47.3 5.5 4.0Normalised EPS growth (%) 267.6 n/a n/a 90.8 -19.4 -20.4Normalised EBITDA mgn (%) 24.5 22.9 30.4 44.3 36.7 31.0Normalised EBIT margin (%) 18.8 15.4 23.5 37.2 29.3 23.3ROACE (%) 12.9 10.5 15.9 28.3 19.4 14.0Reported ROE (%) 26.7 -13.2 32.8 37.6 22.6 15.0Working capital as % of sales 69.6 71.4 67.1 58.3 63.3 66.6Net debt (cash)/EBITDA (x) 2.5 4.5 2.3 0.84 0.72 0.55EBITDA net interest cvg (x) 2.9 0.64 3.0 9.5 8.3 7.3

Valuation

EV/revenue (x) 6.6 4.8 3.4 2.2 2.0 1.8EV/normalised EBITDA (x) 27.1 21.1 11.3 5.0 5.5 6.0EV/normalised EBIT (x) 35.2 31.3 14.6 6.0 6.9 8.0Normalised PER (x) 24.6 n/a 11.4 6.0 7.4 9.3Price/book (x) 5.1 5.8 2.8 1.9 1.5 1.3Dividend yield (%) 0.0 0.0 0.0 0.0 0.0 0.0FCF yield (%) n/a n/a 3.1 5.0 4.4 4.5

Per share data

Reported EPS (Uh) 5.99 (3.60) 12.94 24.68 19.89 15.83Normalised EPS (Uh) 5.99 (3.60) 12.94 24.68 19.89 15.83Dividend per share (Uh) 0.00 0.00 0.00 0.00 0.00 0.00Equity FCFPS (Uh) (5.22) (13.45) 1.72 8.87 7.43 7.28BV/share (Uh) 29.06 25.49 53.38 78.06 97.94 113.76


Polish Strategy CEDC July 2010

76

CEDC Maintained

Focus on organic growth BuyPoland Market cap US$1,735.1mFood & Beverage Bloomberg CEDC US

We expect visible growth in sales volumes in Russia from 3Q10. The departure from the Nemiroff acquisition improved sentiment while divesment of the Polish distribution business should transform the company into a pure vodka producer and an attractive target for corporate raiders. We maintain our BUY rating for CEDC with a DCF-based target price of US$31.

Investment case The Russian vodka market remains very fragmented and we continue to see CEDC as a major consolidator. CEDC grew its market share with key accounts in Russia and lost some share in its traditional trade channel. Management deployed large trade marketing budgets in 2Q10 to drive volume growth in small shops in Russia, which should spur visible growth in volumes from 3Q10.

Management did not proceed with the acquisition of the Nemiroff brand in Ukraine. The risks of running the company after the acquisition must have had prevailed over its attractions. Confronted with a choice of striking a hard sell deal or focusing on organic growth in Russia, management opted for the latter.Management plans to use proceeds from the disposal of its Polish distribution business to buy-back shares, reduce debt and/or buy-out the controlling stake in Whitehall.

Management intends to address the decline of share in small shops in Russia by redirecting an existing US$50m marketing budget for 2010F. So far, the marketing effort has included more than ten projects for all the RAG brands. The plan is to cut a number of marketing projects and promotions to just a few important ones and use the budget to provide kick-backs to regional distributors and retailers. CEDC will also launch a new mainstream vodka brand in Russia in the mainstream category. Effects should be visible shortly. We expect the company to return to growth in sales volumes in Russia from 3Q10.

We understand CEDC is in negotiations to take operating control over Whitehall and replace Whitehall as the partner in the joint-venture with LVMH. Current terms of the joint venture between Whitehall and LVHM are valid until June 2013, at which point LVMH will have the option to acquire the remaining shares of the entity. We understand that the potential consideration for a 51% voting stake and a 20% equity stake is likely to be in the range of US$60-70m.

CEDC trades at an 18% discount to its global peers based on a 2010F PER of 11.2x, and at a 13% discount based on a 2010F EV/EBIDA of 10.0x. The discount is deeper when compared with the three largest spirit companies Diageo, Remy and Pernod, which trade on a 2010F PER range of 15.5-19.7x and 2010F EV/EBITDA range of 11.0-14.4x.

Price (19/07/10) US$24.56

MaintainedTarget price (12-mth) US$31.0


Quarterly preview For vodka sales we are looking for a visible 15% QoQ recovery in volumes in Russia from a very low base of 1Q10 and a modest recovery of 5% QoQ in Poland. In Russia, we also factor in a 5% QoQ price increase in RUB terms, which the company introduced across its portfolio at the end of 1Q10. Russia should generate revenue of US$113m, Poland US$47m and Hungary US$6m in 1Q10. We assume a gross profit margin of 52%, up from 49% in 1Q10. The SG&A cost ratio should fall to 30% as we expect integration synergies in Russia. We forecast EBIT of US$36.5m, of which Russia should make up US$21.0m and Poland US$13.5m. Net interest costs should reach US$26.6m and we expect a US$3.0m contribution from associated company, Whitehall. With the release of its 2Q10 results, we expect CEDC to reiterate its full year 2010 guidance for revenue of US$900-1,050m, EBIT of US$262m and comparable EPS of US$2.1-2.2.


(US$m) 2Q09 2Q10F

Revenues 362.1 166.1EBIT (2Q09 is adjusted for one-offs) 41.9 36.5Comparable net profit 18.6 11.1Comparable EPS (US$) 0.38 0.16


Earnings drivers and outlook We forecast vodka volume sales of 20.3m 9l cases in 2010F, up from an estimated 18.0m cases in 2009F. More aggressive trade marketing in traditional channels (small shops) and market share gains from weaker competition should drive this growth in volumes. We forecast sales volumes of 19.5m 9l cases in 2011F as a result of an assumed 20% increase in excise tax, which seem conservative given recent comments by the government that the excise tax increase should remain at 10% in 2011.

The Polish vodka market fell by an estimated 5% in 2009F to 29.2m 9l cases. CEDC’s share slid to 27% as it lost market share to Stock Polska. Management expects to recoup market share in Poland, from 27% to 30%, over the next two years. We forecast volume sales of 8.8m cases in 2010F and 9.3m cases in 2011F, which should allow CEDC to grow its market share to 28% in 2011F. The launch of a new mainstream vodka brand, as well as price increases at a major competitor, should underpin growth in Poland.


Polish Strategy CEDC July 2010

77

Newsflow

Date Description

4 August 2010 2Q10 results August 2010 Disposal of Polish distribution business to

Eurocash



Blackrock Inc 7.0Bill Carey 5.6Wellington Management 3.7Morgan Stanley IM 3.6Vanguard Group 3.3


Share data

Avg daily volume (3-mth) 926,730Free float (%) 93.0Market cap (US$m) 1,735.1Net debt (1F, US$m) 936Enterprise value (1F, US$m) 2,694Dividend yield (1F, %) 0.0



20

25

30

35

40

45

7/09 9/09 11/09 1/10 3/10 5/10


Source: ING

Company profile

CEDC is a leading producer of vodka in Russia,Poland and Hungary. The company holds severalbrands, such as Green Mark, Zhuravli, Absolwent,Bols, Soplica, Zubrowka and Royal. CEDC holds an80% stake in Whitehall, an importer of wines andspirits to Russia, and holds a 50% equity stake in ajoint venture with LVMH, which has sole rights for thedistribution of Moet Hennessy wines and spiritportfolio in Russia.

Risks

The 2011 excise tax increase in Russia is a major riskfactor for CEDC and we assume the excise tax will beincreased by 20%. CEDC is facing particularly fiercecompetition in the small shops segment in Russiawhere Synergy regional brands and Five Lakesbrands have gained some market share from CEDCthis year. CEDC’s results are sensitive to a move inthe US dollar and its share price displays a closecorrelation with the currency.

Financials

Year end Dec (US$m) 2007 2008 2009 2010F 2011F 2012F

Income statement

Revenues 1,190 1,647 1,507 939 1,003 1,141EBITDA 128 214 230 268 269 326EBIT 118 199 216 259 257 310Net interest (36) (50) (80) (107) (88) (86)Associates 0 (9) (13) 23 28 31Other pre-tax items 12 (133) (16) 0 0 0Pre-tax profit 94 7 106 175 197 255Tax (16) (13) (23) (30) (33) (44)Minorities (1) (10) (6) 0 0 0Other post-tax items 0 0 0 0 0 0Net profit 77 (17) 78 145 164 211Normalised net profit 70 128 128 145 164 211

Balance sheet

Tangible fixed assets 81 281 298 323 350 376Intangible fixed assets 1,123 1,316 2,505 2,384 2,384 2,384Other non-current assets 11 121 27 27 27 27Cash & equivalents 88 108 634 461 505 685Other current assets 479 658 983 624 663 733Total assets 1,782 2,484 4,447 3,819 3,928 4,205Short-term debt 45 112 646 163 163 163Other current liabilities 352 448 578 367 400 427Long-term debt 470 823 1,313 1,234 1,147 1,185Other long-term liabilities 100 106 202 202 202 202Total equity 816 994 1,708 1,853 2,017 2,228Total liabilities & equity 1,782 2,484 4,447 3,819 3,928 4,205Net working capital 230 319 533 319 344 399Net debt (cash) 427 827 1,325 936 805 663

Cash flow

Cash flow EBITDA 140 72 201 291 297 358Tax, interest & other 60 201 92 114 94 99Change in working capital (72) (64) 12 147 (6) (43)Net cash from op activities 24 83 99 279 142 153Capex (26) (23) (19) (11) (11) (11)Net acquisitions (141) (652) (1,055) 0 0 0Net financing cash flow 56 636 1,513 (562) (87) 38Dividends & minority distrib'n 0 0 0 0 0 0Net ch in cash & equivalents (71) 20 526 (173) 44 180FCF 37 117 165 495 219 228


Revenue growth (%) 26.0 38.4 -8.5 -37.7 6.8 13.8Normalised EPS growth (%) 35.6 67.8 -18.1 -7.5 6.1 29.0Normalised EBITDA mgn (%) 10.8 13.0 13.4 28.6 26.9 28.6Normalised EBIT margin (%) 9.9 12.1 12.4 27.6 25.7 27.2ROACE (%) 10.3 12.2 6.7 7.5 7.8 9.0Reported ROE (%) 11.5 -1.9 5.9 8.3 8.6 10.1Working capital as % of sales 19.3 19.4 35.4 34.0 34.3 35.0Net debt (cash)/EBITDA (x) 3.3 3.9 5.8 3.5 3.0 2.0EBITDA net interest cvg (x) 3.6 4.2 2.9 2.5 3.1 3.8

Valuation


Per share data

Reported EPS (US$) 1.91 (0.376) 1.45 2.20 2.33 3.01Normalised EPS (US$) 1.73 2.90 2.38 2.20 2.33 3.01Dividend per share (US$) 0.00 0.00 0.00 0.00 0.00 0.00Equity FCFPS (US$) 0.026 1.52 1.57 5.89 1.87 2.02BV/share (US$) 20.10 19.98 24.28 26.11 28.45 31.46



78



79

Insurance

Polish Strategy PZU July 2010

80

PZU Previously Hold

Weak leverage to macro SellPoland Market cap PLN32,295.6mInsurance Bloomberg PZU PW

Last year’s agreement between the main shareholders and this year’s IPO clear the way to smoother management of PZU, but the changes will be difficult in a challenging environment. After the latest price rally its valuations have become demanding considering the low EPS growth in the future. We downgrade to SELL.

Investment case The settlement of a ten-year dispute between the Polish State Treasury and Eureko clarified the situation of the company and allows management to increase restructuring efforts. The current strategy assumes that the company will cut its staff numbers by 4,000 FTEs (c.25%) by 2012, centralise part of the operations (claims handling), stop falls in market share in attractive products (eg, life insurance) and increase prices in loss-making ones.

We view PZU’s current management as one of the best among state-owned companies. However, we also believe that after ten years of “suspension” and frequent changes in management it will be difficult to implement all the changes quickly. Additionally, we perceive the competitive environment as fairly unfriendly. PZU has good market shares (37% in non-life and 33% in life insurance), the market is fragmented and its closest rivals have much lower shares (c.10%). However, these companies are mainly controlled by foreign strategic investors that are eager to increase market share. There is growing pressure from direct channels (telephone and internet), which are weak at PZU. The advantage connected with the recent or planned changes of ownership at competitors (AIG, ING) looks short term and the new owners will probably also be aggressive.

There is also the issue of profitability of life insurance, which accounts for the majority of profits (69%). While the existing portfolio is relatively profitable, the margin on new business (13%), is much lower than in Western competitors (c.40%). It is partly connected with weak margins in bankassurance products but we think this is also the effect of strong competition and internal inefficiencies. For this reason it should be traded around 1.0x-1.1x P/EV, which is also the level of European peers. The current ratio of 1.3x is too high. The stock is also expensive on 2010F P/BV and PER (50% and 172% premium to Western peers, respectively). One could argue that Polish stocks were always expensive versus Western Europe. However, PZU is also fairly expensive in comparison with Polish banks (its 2010-11F P/BV is higher than in any bank, 2011F PER is 7% higher than banks average and the only ratio which is lower is 2010F PER, ie, -17%). At the same time it offers much weaker growth of earnings due to weaker leverage to macroeconomic recovery (eg, banks earnings are still heavily depressed by high provisions, volumes are likely to grow faster than in insurance). Therefore, after the recent rally, we downgrade the stock from Hold to SELL. We increase our target price – which is based on a comparative valuation – due to changes in the peer group (we put more weight on Polish banks as many investors compare PZU with them).

Price (19/07/10) PLN374.00



Quarterly preview We expect weak results in PZU. The claims ratio is likely to remain high due to floods in 2Q10, although we do not expect further growth as flood losses were estimated to be c.PLN156m, which is similar to claims from snowfalls in 1Q10 (PLN161m). What will decide whether net profit is weak will be the profits from investment, which will suffer from depreciation of both equities and bonds (WIG was -7% in 2Q10 versus +6% in 1Q10; 2Y bond yields grew from 4.57% in March to 4.85% in June).


(PLNm) 1Q10 2Q10

Net premiums 3,841 3,879Net claims (2,459) (2,484)Operating profit 1,029 451Net profit 807 342


Earnings drivers and outlook This year PZU will probably record a major decline in profits after a record high 2009. The main reasons will be the payout of the PLN12.75bn special dividend last year (it will substract PLN0.5bn interest income per annum); large losses connected with natural disasters (heavy snowfalls in 1Q10, heavy floods in 2Q10 and possible drought in 3Q10). We expect also lower releases of reserves in life insurance, which are connected with the conversion of long-term contracts into 1Y revolving contracts (last year it was PLN1.3bn but this source will be exhausted soon as most of the contracts have already been converted).

2011-12 earnings are likely to show only high single-digit growth (c.7% pa), which will be the result of the low growth in premiums (further fall of market shares) and still falling releases of reserves from the conversion of long-term contracts in life insurance. These will be offset with an improvement in costs (staff reductions) and the claims ratio in the P&C business (restructuring of corporate motor insurance; fewer natural disasters next years).

We expect a mild improvement in the equity markets in the medium term, which should stabilise earnings changes. This is important as in the situation of a c.100% combined ratio in the P&C segment and low growth of premiums in life and non-life business, the volatility of investment income, especially equities, is decisive for volatility of earnings, eg, pre-tax profit changed +PLN1.6bn YoY in 2009 and -PLN1.5bn in 2008, while the result on equities, after unit-linked contracts, changed +PLN2.3bn and -PLN2.4bn, respectively).


Polish Strategy PZU July 2010

81

Newsflow

Date Description

17 May 2010 1Q10 result; shares included into WIG20 index 10 Jun 2010 AGM approves additional dividend of PLN10.91

(ex-div on 23 Aug) 10 Jun 2010 End of stabilisation period for PZU shares 26 Aug 2010 2Q10 results



Polish State Treasury 45.2Eureko 13.0


Share data




300

320

340

360

380

400

5/10 5/10 6/10 6/10 7/10 7/10

Price DJStoxx Insurance (rebased)

Source: ING

Company profile

PZU is the largest Polish insurer, controlling around athird of the market in property & casualty and liveinsurance (in both segments it is #1 with a largeadvantage over peers). Life insurance accounts for56% of consolidated gross premiums and 70% ofoperating profits. Altogether PZU has 16m clients. Ithas small operations in Lithuania and Ukraine (1% oftotal assets; 2% of gross premiums of PZU group).

Risks

The main risks to our Sell rating are: stronger-than-expected equity markets (boosting investment gains),faster-than-expected effects of cost restructuring, fastappreciation of PLN (lowering cost of claims in motorsegment); weaker competition due to problems at theforeign strategic investors of competitors.

Financials


Income statement

Gross written premiums 14,080 14,565 14,365 14,154 14,529 15,256Property & casualty 8,196 8,435 8,024 7,623 7,737 8,124Life 5,884 6,130 6,341 6,531 6,792 7,132Segmental operating profitsLife 2,908 2,015 3,319 2,501 2,494 2,579Property & casualty 1,491 943 1,300 653 888 1,007Asset management Other businesses Net interest 0 0 (36) (58) (58) (58)Corporate expenses/consd 24 (27) (17) (20) (20) (20)Operating profit 4,422 2,931 4,566 3,077 3,304 3,508Net capital gains (losses) Non-op income (expense) 0 0 0 0 0 0Pre-tax profit 4,422 2,931 4,566 3,077 3,304 3,508Tax (862) (601) (803) (615) (661) (702)Minorities 0 0 0 (7) (7) (7)Other post-tax items 0 0 0 0 0 0Net profit 3,560 2,330 3,763 2,454 2,636 2,800IFRS net operating profit 3,560 2,330 3,763 2,454 2,636 2,800

EEV income statement

Life new business value 170 79 95 117 142EEV operating profit 0 3,098 3,125 2,220 2,436 2,574Tax EEV net profit 0 2,077 3,494 2,220 2,436 2,574Opening embedded value 31,078 33,155 23,899 25,177 26,629Closing embedded value 0 33,155 23,899 25,177 26,629 28,146

Balance sheet

Opening shareholders funds 14,326 17,836 20,052 11,267 12,786 14,445Closing shareholders funds 17,836 20,052 11,267 12,786 14,445 16,194Ordinary equity 17,836 20,052 11,267 12,786 14,445 16,194Hybrid capital Preferred equity Equity 17,836 20,052 11,267 12,786 14,445 16,194Minorities 0 0 0 0 0 0Total equity 17,836 20,052 11,267 12,786 14,445 16,194Total debt 0 0 4,779 4,779 4,779 4,779Total capital 17,836 20,052 16,046 17,565 19,224 20,973


APE (new business) mgn (%) n/a 14.8 9.1 10.3 12.2 14.1PVNBP margin (%) n/a 1.4 0.82 0.94 1.1 1.3P&C combined ratio (%) 93.5 91.3 99.0 101.0 96.8 97.0IFRS net op profit growth (%) n/a -34.6 61.5 -34.8 7.4 6.2BV growth (%) n/a 12.4 -43.8 13.5 13.0 12.1Embedded value growth (%) n/a n/a -27.9 5.3 5.8 5.7Life ROEV (%) n/a 10.0 9.4 9.3 9.7 9.7Reported ROE (%) 39.9 12.3 24.0 20.4 19.4 18.3Solvency ratio (%) 573.0 587.1 326.5 359.2 395.1 434.6Gearing (%) 0.0 0.0 29.8 27.2 24.9 22.8

Valuation

Price/embedded value (x) n/a 0.97 1.4 1.3 1.2 1.1Price/book (x) 1.8 1.6 2.9 2.5 2.2 2.0Price/tangible book (x) 1.8 1.6 2.9 2.5 2.3 2.0PER (IFRS net op EPS) (x) 9.1 13.9 8.6 13.2 12.3 11.5Dividend yield (%) 0.0 0.0 42.4 3.0 3.3 3.5

Per share data

IFRS net operating EPS (PLN) 41.23 26.98 43.58 28.42 30.53 32.42IFRS net op EPS growth (%) n/a -34.6 61.5 -34.8 7.4 6.2Dividend per share (PLN) 0.00 0.00 158.56 11.40 12.24 13.00EEV per share (PLN) 0.00 383.95 276.76 291.57 308.38 325.94BV/share (PLN) 206.55 232.21 130.47 148.07 167.28 187.54Tangible BV/share (PLN) 204.86 231.17 129.26 146.83 166.00 186.23



82



83

Media

Polish Strategy Agora July 2010

84

Agora Previously Hold

Deceptively cheap BUY with wider exposure to electronic media BuyPoland Market cap PLN1,156.3mMedia Bloomberg AGO PW

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. We increase our DCF- and earnings-multiples-based target price to PLN27.0 following the incorporation of the cinema business into our model, and raise our recommendation to BUY.

Investment case Agora has signed an agreement to buy at least an 84% equity stake in cinema network Helios for a maximum of €26m. Helios runs 26 cinemas with 136 screens in 24 cities in Poland. The company sold 7.7m tickets in 2009 and held a 24% share of total cinema admissions in Poland, ranking third behind CCI (46% share) and Multikino (30% share) in the Polish cinema market. Revenue reached PLN186m with EBITDA of PLN34m, implying a healthy EBITDA margin of 18%.

We estimate Agora paid 6.1x 2010F EV/EBITDA and 5.6x 2011F EV/EBITDA for Helios. We believe Agora paid a reasonable price for the asset, which should allow it to establish a firm market position in the promising cinema market, tap a greater share of advertising budgets and reduce dependence on declining traditional media segments. There is significant execution risk related to the acquisition as Agora’s track record with new acquisitions has been disappointing, but we believe management has a good opportunity to extract additional value from this transaction.

Internet advertising is growing by double digits YoY in Poland. We believe the increasing share of internet in Polish ad spend is a strong secular trend and Agora is rebuilding its internet business model to capture this structural change. Agora’s internet arm is significantly outperforming the market so far this year. The group continues to narrow the gap to its largest competitors through increased reach, a well-managed sales effort and selective small-scale acquisitions of internet niche websites and specialist internet software companies such as AdTaily. Management will continue to put traditional media content onto its portals and add multimedia content to improve page clicks and stickiness of its pages. We forecast internet advertising to make up 9% of group revenue in 2010F and 13% in 2010F. Agora's internet segment was EBITDA positive in 1Q10 and we expect it to break even in 2010F.

Our 2011F EBITDA estimate includes a PLN37m contribution from Helios. We consider Agora’s shares to be visibly undervalued based on a 2011F EV/EBITDA multiple of 5.0x. European diversified traditional media stocks trade at 6.4x 2011F EV/EVITDA. We raise our target price to PLN27 and our recommendation to BUY. We expect the share price to be driven by the integration of the cinema business and an increasing recognition of the benefits of this transaction to company prospects and earnings.

Price (19/07/10) PLN22.70



Quarterly preview We forecast a 13% YoY decline in revenues, driven by an 8% YoY decline in newspaper advertising, despite the low base of 2Q09 which saw a record decline in newspaper advertising revenue of 43%. Advertising revenue at Gazeta fell by 9% due to a significant decline in the advertising revenue of Gazeta’s local editions. Metro ad revenue was flat YoY in 2Q10. Ten days of national mourning in April did not affect advertising revenue as newspapers increased the number of advertising pages in the following weeks. In outdoor we expect an 8% YoY decline as the shortened presidential campaign failed to boost sector advertising revenues. Agora outperformed the outdoor market, which fell by c.10% YoY in 2Q10. The internet did very well and we expect a 25% YoY increase in internet segment revenue, underpinned by a surge in display advertising.

Operating expenses increased by 9% YoY excluding a PNL7.7m non-cash software impairment charge. Falling promotional expenses (10% decline YoY) and costs of materials (10%) drove the drop.


(PLNm) 2Q09 2Q10F

Revenues 298 271EBITDA 35 25EBIT 15 4Net profit 12 3


Newspaper advertising continues to decline and we forecast Agora's newspaper advertising revenue to decline by 11% in 2010F and 8% in 2011F. Since, at 31%, it still represents the largest share of Agora’s total revenue in 2010, it will impact the group revenue trend. However, the acquisition of Helios will change the picture significantly, as we expect the share of newspaper advertising to fall to 24% in 2011F and to 21% in 2012F. The share of all Agora's electronic media should reach 32% in 2011F and 39% in 2013F, up from only 9% in 2007. Helios cinemas operate at a significantly higher EBTDA margin than the group average and we forecast a Helios EBITDA margin of 17% in 2011F and thereafter. We increase our EBITDA estimates for Agora by 10% in 2010F and by 28% in 2011F, reflecting the consolidation of Helios. We raise our 2010/11F net profit estimates by 21% and 40%, respectively.


Polish Strategy Agora July 2010

85

Newsflow

Date Description

3 August Dividend payment day 12 August 2Q10 results 15 November 3Q10 results



BZ WBK AIB AM 37.0Agora Holding 13.1


Share data




1416182022242628

7/09 9/09 11/09 1/10 3/10 5/10


Source: ING

Company profile

Agora is a leading media group in Poland. It publishesthe largest opinion-forming newspaper, Gazeta, as wellas controlling the largest outdoor advertising companyin Poland, AMS. In addition, the group has interests inmagazines, radio stations, the free sheet Metro, as wellas the internet portal, www.gazeta.pl. The company isalso about to break into the cinema market as it hasannounced plans to acquire Helios, a country-wide network of cinema multiplexes.

Risks

The migration of advertisers from traditional media toelectronic media is the largest risk factor to ourestimates for Agora. We expect newspaper advertisingto decline by 10% in 2010F. We expect outdoor adspend to increase by 5% and internet ad spend to growby 15% after a 10% increase in 2009. The companycould miss our earnings estimates should our ad spendassumption prove too optimistic.

Helios plans network expansion in both existing andnew cities. Development capex could impact thedividend and buy-back plans of Agora in the future, should the capex turn out to be significant.

Financials


Income statement

Revenues 1,272 1,278 1,110 1,112 1,300 1,347EBITDA 199 156 134 155 192 189EBIT 120 72 53 73 111 109Net interest 9 (22) 3 4 3 5Associates 0.1 (2) (1) (1) (1) (1)Other pre-tax items 0 0 0 0 0 0Pre-tax profit 129 48 54 76 112 113Tax (29) (25) (17) (15) (22) (22)Minorities (0.1) 0.1 0 0 (5) (5)Other post-tax items 0 0 0 0 0 0Net profit 100 23 37 61 86 86Normalised net profit 100 23 37 68 86 86

Balance sheet

Tangible fixed assets 616 651 613 602 586 574Intangible fixed assets 290 397 394 394 394 394Other non-current assets 47 44 16 120 120 120Cash & equivalents 401 264 279 238 314 386Other current assets 269 269 236 228 229 234Total assets 1,623 1,625 1,538 1,582 1,643 1,708Short-term debt 35 60 42 0 0 0Other current liabilities 203 233 200 193 194 198Long-term debt 104 95 52 112 112 112Other long-term liabilities 66 69 48 45 45 45Total equity 1,216 1,167 1,196 1,232 1,293 1,354Total liabilities & equity 1,623 1,625 1,538 1,582 1,644 1,709Net working capital 128 96 85 82 83 85Net debt (cash) (262) (109) (184) (126) (202) (274)

Cash flow

Cash flow EBITDA 158 60 104 133 153 155Tax, interest & other (20) (47) (15) (10) (19) (16)Change in working capital (11) 36 3 1 (0.1) (0.8)Net cash from op activities 167 143 122 144 171 170Capex (55) (223) (41) (71) (65) (67)Net acquisitions 0 0 0 0 0 0Net financing cash flow (1) 16 (60) 17 0 0Dividends & minority distrib'n (82) (28) 0 (25) (25) (25)Net ch in cash & equivalents 65 (137) 15 (41) 76 72FCF 121 (102) 84 78 109 108


Revenue growth (%) 12.2 0.42 -13.1 0.18 16.9 3.6Normalised EPS growth (%) 213.1 -76.3 69.7 80.8 27.6 0.19Normalised EBITDA mgn (%) 15.6 12.2 12.1 14.6 14.7 14.0Normalised EBIT margin (%) 9.5 5.6 4.8 7.3 8.5 8.1ROACE (%) 9.0 5.4 4.0 6.1 8.1 7.6Reported ROE (%) 8.4 2.0 3.2 5.0 6.8 6.5Working capital as % of sales 10.1 7.5 7.7 7.4 6.4 6.3Net debt (cash)/EBITDA (x) (1.3) (0.70) (1.4) (0.81) (1.1) (1.5)EBITDA net interest cvg (x) n/a 7.0 n/a n/a n/a n/a

Valuation


Per share data



Polish Strategy Cinema City (CCI) July 2010

86

Cinema City (CCI) Maintained

Mean and lean cash machine BuyPoland Market cap PLN2,022.4mTravel & Leisure Bloomberg CCI PW

CCI offers a rare combination of high free cash flows and yet decent underlying growth driven by cinema openings and solid organic growth in ticket sales. The company is a play on accelerated ticket sales, driven by a strong line-up of movies as well as cinema openings in the region and higher ticket prices underpinned by 3D productions. Following the divestiture of its real estate business, CCI has a strong balance sheet to expand through organic growthand/or selective acquisitions. We increase our target price by 24% to PLN47 based on higher earnings estimates and lower discount rate assumptions.

Investment case Following a complete disposal of the real estate business in April 2010, we see CCI now as a mean and lean cinema business. We forecast FCF of €22m in 2010F (excluding cash proceeds from the disposal) and €42m in 2011F, implying FCF yields of 4.5% and 9.3% respectively. We forecast a decline in net debt from €84m at the end of 2009 to €45m at the end of 2010 and the company should turn net cash positive in 2011F. We forecast net debt to equity to fall to 20% at the end of 2010. Management will soon face the pleasant dilemma of what to do with excess cash. We understand that CCI is sympathetic to the idea of dividend payments but shareholders, including institutional shareholders, prefer to reinvest cash into operations. We believe CCI will continue to pursue its organic growth strategy with its long-term target to run 1,000 screens by the end of 2012. Margins will be supported by digitalisation as digital projectors should service up to 30% of screens by 2012. Management will also actively seek acquisitive opportunities in both existing and new emerging markets of Europe.

Shrek 4 saw a rather slow start in Poland as record temperatures encourage outdoor entertainment rather than cinema going but the movie reported decent box office results in other CCI markets. The line-up of movies for the rest of the year is solid, including four 3D releases in 3Q and five 3D releases in 4Q. The most awaited premieres are Wall Street 2: Money never sleeps, Harry Potter and the Deathly Hallows, Step Up 3 and Salt. Local productions look strong for 2H10 with potentially successful movies such as Sluby Panienskie, Skrzydlate Swinie and Million Dolarow.

Based on our revised estimates, CCI is trading at a 2011F EV/EBITDA of 6.1x and a 2011F PER of 11.3x. Our peer group consists of four developed market cinema operators and two cinema chains in emerging markets. The peer group trades at an average 2011F EV/EBITDA of 6.7x and an average 2011F PER of 11.1x. We believe CCI should trade at a sustainable 20% premium to the sector given significantly lower tickets sales per capita in CCI's markets, its strong free cash generation and deleveraged balance sheet.

Price (19/07/10) PLN39.50



Quarterly preview After record ticket sales in 1Q10, admissions fell back to normalised levels in 2Q10. Total cinema admissions increased 9% YoY to 5.9m tickets in 2Q10 according to our estimates. However, we estimate organic growth was a negative 5%. A fall in ticket sales in older cinemas was driven by Poland, which suffered from a weaker line-up of movies, ten days of national mourning in April and spectacularly good weather in June. Sales in other markets were also affected by the World Cup games. Ticket sales in Poland fell by 4% YoY in 2Q10 to 2.9m tickets. Elsewhere, we forecast growth in total ticket sales for the quarter of 4% YoY in Israel, 7% YoY in Hungary, and 24% in Czech Republic. Romania should more than double tickets sales to 550k from a low base in 2Q09. More expensive 3D tickets made up circa 15% of all ticket sales, up from 11% in 2Q09 but significantly less than the 35% in 1Q10 due to a lower number of premier 3D productions.

Appreciating local currencies helped company earnings in 2Q10. Our EBITDA estimate includes a €3.5m gain on the disposal of real estate assets. In 2Q09, CCI recognised a real estate disposal gain of €4.1m so we forecast a 33% YoY surge in comparable EBITDA from cinema operations for CCI in 2Q10.


(€m) 2Q09 2Q10F

Revenues 38.6 48.7EBITDA 9.5 10.7EBIT 5.6 5.7Net profit 3.9 4.0


Earnings drivers and outlook We forecast ticket sales of 32.6m in 2010F and 35.8m in 2011F, up from 27.5m in 2009 driven by new openings as well as increasing ticket sales per capita. CCI plans to open five cinemas during the rest of 2010, in Stara Zagora, Arad, Russe, Bytom and Walbrzych with 43 screens. In 2011, CCI aims to open between 8-10 cinemas with 80-100 screens.

We raise our 2010F cinema EBITDA estimate by 7% to €54.4m due to stronger than expected earnings in 1Q10 and more favourable FX assumptions in some of the key markets such as Poland and Israel. Our 2011F EBITDA estimate is increased by 20% to €72.6m on stronger currencies and improved operating margins.


Polish Strategy Cinema City (CCI) July 2010

87

Newsflow

Date Description

31 August 2010 2Q10 results 19 November 2010 3Q10 results



IT International Theaters 64.4Aviva BZWBK 12.8BZ WBK AM 5.2


Share data

Avg daily volume (3-mth) 22,667Free float (%) 35.6Market cap (PLNm) 2,022.4Net debt (1F, €m) 6Enterprise value (1F, €m) 497Dividend yield (1F, %) 0.0



15202530

354045

7/09 9/09 11/09 1/10 3/10 5/10


Source: ING

Company profile

CCI is the largest multiplex cinema operator in CEE.At the end of 2009, CCI operated 70 theatres with 670screens. Poland represented 56% of ticket sales in2009 with contributions from Israel, Hungary, theCzech Republic, Bulgaria, and Romania of 15%, 14%,6%, 3% and 6%, respectively.

Risks

CCI is susceptible to declines in admissions and the movie pipeline can result in up to 5% volatility intheatre revenues in a given year. Depreciation of localcurrencies would impact on revenue and earnings asthe company reports in euro. We use a long-term PLN/€ rate of 3.6 (but a much weaker PLN/€exchange rate of 4.05 for 2010), ILS/€ rate of 4.89and a RON/€ rate of 4.18. New cinema openings are critically dependent on real estate developers' abilityto completed shopping centres on time. Commercialreal estate markets are improving slowly in Polandand in the Czech Republic but remain difficult inRomania and Bulgaria. The failure to open newcinemas might lead to lower earnings in the future.

Financials

Year end Dec (€m) 2007 2008 2009 2010F 2011F 2012F

Income statement

Revenues 157 189 212 266 321 344EBITDA 35 49 46 58 73 80EBIT 19 31 30 37 52 60Net interest (3) (2) (2) (4) (2) 0.1Associates 0 0 0 0 0 0Other pre-tax items (1) (0.4) (0.1) 0 0 0Pre-tax profit 15 28 28 33 50 60Tax 0.6 (1) (2) (4) (7) (9)Minorities 1 1 0.6 0.8 0.8 0.8Other post-tax items (0.4) (2) (2) 0 0 0Net profit 17 27 24 30 44 52Normalised net profit 12 21 16 27 44 52

Balance sheet

Tangible fixed assets 183 182 202 198 193 189Intangible fixed assets 1 1 1 1 1.0 1.0Other non-current assets 13 32 45 45 45 45Cash & equivalents 11 49 62 60 115 155Other current assets 35 37 40 50 60 65Total assets 243 302 350 354 413 455Short-term debt 19 34 13 16 19 0Other current liabilities 27 35 52 65 78 84Long-term debt 35 67 94 51 51 51Other long-term liabilities 8 9 11 5 5 6Total equity 154 157 180 217 261 315Total liabilities & equity 243 302 350 354 413 455Net working capital 24 24 27 34 41 45Net debt (cash) 43 53 45 6 (45) (105)

Cash flow

Cash flow EBITDA 29 41 38 42 55 62Tax, interest & other (3) (4) (4) (8) (9) (9)Change in working capital (5) 6 18 (3) 2 1Net cash from op activities 23 47 56 39 57 64Capex (41) (38) (38) (17) (15) (16)Net acquisitions 1 (34) (3) 0 0 0Net financing cash flow (32) 35 (9) (32) 4 (16)Dividends & minority distrib'n 0 0 0 0 0 0Net ch in cash & equivalents (45) 4 10 (2) 54 40FCF (18) 8 18 22 42 48


Revenue growth (%) 9.5 20.1 11.9 25.8 20.6 7.3Normalised EPS growth (%) -16.4 75.0 -24.3 68.6 62.4 18.4Normalised EBITDA mgn (%) 18.6 22.0 17.2 20.4 22.6 23.3Normalised EBIT margin (%) 12.2 16.5 14.3 13.9 16.2 17.5ROACE (%) 9.0 13.4 11.1 13.0 17.0 17.3Reported ROE (%) 11.5 17.1 14.2 14.8 18.1 17.8Working capital as % of sales 15.1 12.5 12.8 12.8 12.8 13.1Net debt (cash)/EBITDA (x) 1.2 1.1 0.96 0.11 (0.62) (1.3)EBITDA net interest cvg (x) 12.6 20.8 24.9 14.6 35.8 n/a

Valuation

EV/revenue (x) 3.4 2.9 2.5 1.9 1.4 1.1EV/normalised EBITDA (x) 18.3 13.1 14.7 9.1 6.1 4.8EV/normalised EBIT (x) 27.7 17.4 17.7 13.4 8.5 6.4Normalised PER (x) 40.9 23.4 30.9 18.3 11.3 9.5Price/book (x) 3.1 3.1 2.7 2.2 1.9 1.6Dividend yield (%) 0.0 0.0 0.0 0.0 0.0 0.0FCF yield (%) n/a 1.6 3.4 4.5 9.3 12.4

Per share data

Reported EPS (€) 0.328 0.534 0.480 0.586 0.857 1.01Normalised EPS (€) 0.236 0.413 0.313 0.527 0.857 1.01Dividend per share (€) 0.00 0.00 0.00 0.00 0.00 0.00Equity FCFPS (€) (0.358) 0.167 0.358 0.439 0.810 0.934BV/share (€) 3.08 3.15 3.60 4.32 5.16 6.22


Polish Strategy Cyfrowy Polsat July 2010

88

Cyfrowy Polsat Maintained

A number of options to explore BuyPoland Market cap PLN3,823.3mMedia Bloomberg CPS PW

Cyfrowy is in an optimum position to address the challenges of a decelerating Polish satellite TV market.Management has a number of options to grow ARPU and revenue. We reduce our TP on lower earnings estimates due to weaker currency, and maintain our BUY rating.

Investment case We forecast 1.34m new contract subscribers in the next three years in Poland. Satellite TV contract subscriber penetration should reach 48% in 2012F, up from 39% in 2009F, implying 7.06m subscribers vs 5.71m today. The market is fragmented into four platforms, therefore attractive programming is spread widely. Cyfrowy should capture 0.46m new subscribers, or 34% of new contract additions by 2012F vs 53% in 2007-09, to reach 3.66m subscribers by 2012F (including TPSA and excluding TNK). The share of new additions of paying contract subscribers will be higher, since some of TPSA’s new subscribers generate very low revenue as TPSA offers satellite TV in a bundled package.

Cyfrowy has captured a dominant market share and is now exploring a number of strategic options to maintain growth in revenue and earnings. The company is successfully migrating subscribers into more expensive packages. At present, the overwhelming majority of its subscribers buy just a single satellite TV service. The saturation of its subscriber base with HD, NVOD and broadband is in the low single digits. Its triple-play service isa compelling cross-selling offering and should become an important differentiator, allowing Cyfrowy to reduce churn rates.We believe market is underestimating ARPU growth potential for the company.

Broadband entry has strong business logic. We expect 25% growth in this market in the next three years. More importantly, the addition of broadband should compress churn rates in the core business. We forecast wireless broadband market to grow at a CAGR of 25% in the next three years, from an estimated 1.72m subscribers to 3.32m subscribers in 2012F, with Cyfrowy capturing 10% market share. At this level, the internet and MVNO segment should become EBITDA-positive, according to our estimates.

We maintain our BUY rating for Cyfrowy. Our target price of PLN16.2 is based on the average of three valuation methodologies: DCF, a 2010F EV/EBITDA multiple of 6.7x and a 2010F PER multiple of 15.2x. 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+).

Price (19/07/10) PLN14.25



Quarterly preview It was a slow quarter for subscriber additions, as the change in T&CA increased considerably churn rates, particularly for the more expensive Familijny package subscribers. We forecast gross additions of 120k subs, and net additions of 20k, of which Familijny subs should decline by 15k and Mini and Mini Maxsubs should grow by 35k. Weak subscriber numbers should represent no surprise to investors, as management had communicated the impact of a change in T&CA on subscribers' growth. We expect churn to peak in 2Q10 and start falling thereafter.

We forecast Familijny APRU at PLN41.5, up 4% YoY, and MiniARPU at PLN10.7, up 20% YoY. Blended ARPU should be flat YoY at PLN35.3. We forecast subscription revenue of PLN345m, up 19% YoY but down 2% QoQ owing to increased churn.

On the cost side, content costs increased 18% to PLN105m and DMR costs (distribution, retention and marketing) grew 11% to PLN68m. Cyfrowy will also consolidate the mPunkt dealer shop network for the first time, which is likely to contribute a small EBITDA loss in 2Q10. As a result, we forecast a 25% YoY rise in EBITDA and a 14% YoY growth in net profit for Cyfrowy in 2Q10.


(PLNm) 2Q09 2Q10F



Earnings drivers and outlook We lower our 2010/11F EBITDA estimates by 7%/2% and 2010F/11F net profit estimates by 8%/3% respectively, reflecting a weaker zloty and higher content costs. We maintained our year-end subscriber target of 3.42m, including 2.74m Familijnypackage subscribers. Our subs estimates are based on 220k new additions and an additions share of 35%. The bulk of new additions should materialise in the last four months.

As subscriber growth is decelerating in Poland, ARPU becomes the key value driver. A change in T&CA, a decline in the number of base period contracts, a higher share of expensive packages and new services such as VOD should drive 4/4/5% growth in ARPU pa in 2010/11/12F respectively. Our ARPU projections exclude any uplift from purchases of premium programming.


Polish Strategy Cyfrowy Polsat July 2010

89

Newsflow

Date Description

26 August 2Q10 results 5 November 3Q10 results



Polaris Finance 65.2


Share data




12141618

202224

7/09 9/09 11/09 1/10 3/10 5/10


Source: ING

Company profile

Cyfrowy Polsat is the largest satellite TV platform inPoland, with a market share of 56% in contractsubscribers. Cyfrowy had 3.2m subscribers at the endof 2009. The platform sells satellite TV subscriptionsin three starting packages (Familijny, Mini and Mini Max), which generated 94% of its revenue in 2009. In1Q10, Cyfrowy launched a commercial wirelessbroadband service. Cyfrowy also offers an MVNOservice.

Risks

Changes to T&CA have thrown up a significant increase in churn, and we expect the quarterly churn to 5.5% in 2Q10. We also see significant executionrisks in wireless broadband project related to a slowerthan expected increase in technology reach, a highly competitive wireless broadband market with tumblingdata transfer prices and a lack of company controlover licences or infrastructure. With 49% of operatingexpenses and a large part of capex linked to the USdollar and the euro, our earnings projections arehighly sensitive to foreign exchange assumptions.

Financials


Income statement

Revenues 797 1,098 1,266 1,517 1,717 1,901EBITDA 166 348 327 401 490 567EBIT 145 324 285 335 411 476Net interest (7) 3 3 (0.4) 1 2Associates Other pre-tax items 2 6 6 0 0 0Pre-tax profit 140 334 294 335 412 479Tax (27) (64) (56) (64) (78) (91)Minorities Other post-tax items 0 0 0 0 0 0Net profit 114 270 238 271 334 388Normalised net profit 114 270 238 271 334 388

Balance sheet

Tangible fixed assets 97 126 171 258 332 400Intangible fixed assets 11 12 14 13 10 10Other non-current assets 55 63 156 175 208 239Cash & equivalents 151 246 99 26 84 162Other current assets 281 310 335 402 459 515Total assets 595 757 775 874 1,093 1,326Short-term debt 298 264 260 256 283 309Other current liabilities 102 142 154 182 204 223Long-term debt 134 46 0 0 0 0Other long-term liabilities 1 12 31 13 13 13Total equity 61 293 330 423 594 781Total liabilities & equity 595 757 775 874 1,093 1,326Net working capital 209 215 254 322 379 434Net debt (cash) 281 63 161 230 199 147

Cash flow

Cash flow EBITDA 175 369 336 401 491 569Tax, interest & other 40 76 56 64 78 91Change in working capital (24) 19 17 (15) (9) (10)Net cash from op activities 107 320 297 322 403 469Capex (55) (56) (65) (138) (134) (141)Net acquisitions 0.6 0.1 (25) 0 0 0Net financing cash flow (5) (100) (48) (47) 0 0Dividends & minority distrib'n 0 (38) (201) (179) (163) (200)Net ch in cash & equivalents 41 96 (147) (73) 58 78FCF 65 277 232 184 269 328


Revenue growth (%) 65.0 37.8 15.3 19.8 13.2 10.7Normalised EPS growth (%) 83.3 82.4 -11.7 13.9 23.1 16.2Normalised EBITDA mgn (%) 20.9 31.7 25.9 26.5 28.5 29.8Normalised EBIT margin (%) 18.2 29.5 22.5 22.1 23.9 25.1ROACE (%) 38.0 59.2 47.8 52.8 52.8 48.4Reported ROE (%) -14,686 152.2 76.4 72.1 65.7 56.4Working capital as % of sales 26.2 19.5 20.1 21.2 22.1 22.8Net debt (cash)/EBITDA (x) 1.7 0.18 0.49 0.57 0.41 0.26EBITDA net interest cvg (x) 23.3 n/a n/a 994.9 n/a n/a

Valuation


Per share data



Polish Strategy TVN July 2010

90

TVN Maintained

Leveraged play on accelerated GDP growth HoldPoland Market cap PLN5,606.6mMedia Bloomberg TVN PW

We increase our DCF-based target price for TVN to PLN18.0 based on higher EBITDA estimates for 2010F and 2011F. With Polish GDP growth of 3.2% in 2010F and 3.9% in 2011F, TV advertising spend is likely to grow by 7% in 2010F and by 10% in 2011F, supporting revenue growth in the company’s TV segment.

Investment case Historically, GDP growth in excess of 3% has triggered much stronger TV ad spend in Poland. This positive scenario should materialise once again. Management is cautiously optimisitic, indicating improving visibility of advertising booking, which reached six weeks for the mainstream stations up from four weeks at the beginning of the year. Advertisers’ budgets are unchanged or marginally higher for 2010F but we see more robust ad spending in 2011F. We expect TV ad spend to grow by 7% in 2010F and 10% in 2011F. As in the past, TVN should be able to capture market share as its channels maintain a superior profile of audiences and its sales team outperform the competition. Earnings growth will be additionally supported by improving profitability of thematic channels that gradually gain subscribers and advertisers. N increased its basic package prices by PLN6 in 2Q10, which we see as an attempt to improve ARPU and profitability. The platform should be able to breakeven at the EBITDA level in 2Q10 and 3Q10 but not in 4Q10 and not for the year yet. The paid TV market has been fairly quiet so far this year with players preparing compelling promotions for the critical last four months of the year. The key challenges for N remain churn and programming expenses management. Competition remains tough and N’s closest competitor, Cyfra+, is suffering from a huge internal churn and very expensive promotions to the point where it changed its CEO in 2Q10. We increase our DCF-based target price to PLN18 following an upward revision to earnings estimates in 2010F and 2011F. The TVN story looks interesting going into 2H10 and 2011. The group is in the sweet spot to grow operating profit and cash flow as increasing advertising spend underpins revenue growth in the TV and internet segments. Programming costs are being kept in check and we understand the group’s other costs are running below budget for most divisions. Cash burn at N is still huge but the platform is growing and should visibly narrow the EBITDA loss this year. TVN trades at an EV/EBITDA of 10.7x in 2010F and 8.2x in 2011F. CME trades at a 2011F EV/EBITDA of 9.1x and the market values CTC Media at a 2010F EV/EBITDA of 9.6x. We argue that the real discount in TVN's valuation is likely to be even higher. TVN's EV-based multiples are significantly inflated by weak currency as 81% of TVN’s total debt of PLN2.6bn is denominated in euro, and the PLN-value of company debt is artificially high at current exchange rates.

Price (19/07/10) PLN16.45



Quarterly preview National mourning in April reduced the company’s advertising revenue in its TV segment. The TVN channel was not able to compensate fully for the April advertising break in May and June, despite extending the line-up of premiere formats until the end of June. We forecast 3% YoY revenue growth in the TV segment with an EBITDA margin of 50%, up from 49.4% in 2Q09.

At N, we expect net subscriber additions of 20,000 to 744,000 and ARPU of PLN61, which should generate revenue of PLN145m, including PLN11m of revenue from pre-paid service, TNK. We expect N to report zero EBITDA in 2Q10. Investors will focus on the implication of package price increases on expected ARPU and churn rates.

The online segment enjoyed healthy growth rates as the internet advertising market grew by 20% in 2Q10. We forecast a 20% increase in revenue for TVN's online division driven by display advertising as well as increased revenue of new ventures such as sympatia.pl, zumi.pl and VOD service.

An unrealised FX loss of PLN168m on euro bonds and an accrued tax charge of PLN14.0m will drive net earnings into a loss.


(PLNm) 2Q09 2Q10F

Revenues 580.0 647.3EBITDA 190.5 214.4EBIT 138.5 151.7Net profit 141.8 (92.9)


Earnings drivers and outlook We increase our 2010F and 2011F EBITDA estimates by 2% and 5%, respectively, based on higher assumed EBITDA margins in the TV segment which we now expect to reach 44% and 45%, respectively, up from 43% in 2009. The mainstream channel, TVN, continues to target a roughly unchanged programming budget for the mainstream station and the programming expenses of thematic channels (apart from TVN24) are also being kept in check. Prudent cost policies should result in improved profitability in the TV segment once TV advertising spend accelerates into high-single digits in 2H10 and 2011F.

For N, we forecast 900,000 contract subscribers in 2010F and 1.1m subscribers in 2011F. N should narrow its EBITDA loss to PLN30m in 2010F and we forecast EBTIDA profit of PLN38m in 2011F. The platform is on track to turn free cash flow positive in 2012.


Polish Strategy TVN July 2010

91

Newsflow

Date Description

12 August 2010 2Q10 results and analyst meeting 10 November 2010 3Q10 results



ITI Holdings 56.4


Share data




11

13

15

17

19

21

7/09 9/09 11/09 1/10 3/10 5/10


Source: ING

Company profile

TVN is the largest commercial TV broadcaster inPoland, as measured by advertising revenue. Itoperates 14 TV channels and holds a 100% stake inthe leading Polish internet portal, onet.pl. TVadvertising accounts for an estimated 70% of grouprevenue, followed by TV non-advertising at 16%, andthe internet at 14%. The company has a 100% equitystake in N, the third largest SatTV platform in Poland.

Risks

The Polish Sat TV market is very competitive as fourplatforms seek to sign subscribers. TVN's platform, N, will not breakeven at the EBITDA level in 2010F asincrease in APRU is slower than expected. N requiressubstantial funding before it turns EBITDA positive in2011F and cash flow positive in 2012F and N'sfunding needs will reflect adversely on TVN's ability topay dividends. In an attempt to drive faster growth inAPRU, N had recently increased the prices of itspackages and it remains to be seen if subscribersaccept higher bills. Churn management of N has beenmixed to date and we expect an increase in churnrates in 2H10, which could widen a likely EBITDA lossin 4Q10.

Financials


Income statement

Revenues 1,555 1,897 2,113 2,527 2,957 3,425EBITDA 554 712 795 687 866 1,065EBIT 482 632 612 436 575 726Net interest (92) (95) (272) (197) (171) (169)Associates 0 (94) (39) 0 0 0Other pre-tax items (92) 6 80 (37) 0 0Pre-tax profit 297 448 381 203 405 557Tax (54) (84) (35) (70) (64) (95)Minorities 0 0 75 3 0 0Other post-tax items 0 0 0 0 0 0Net profit 243 364 421 136 340 462Normalised net profit 319 362 209 165 340 462

Balance sheet

Tangible fixed assets 258 647 800 936 950 1,100Intangible fixed assets 1,697 1,703 2,560 2,560 2,560 2,560Other non-current assets 144 202 361 409 408 415Cash & equivalents 135 650 629 483 545 685Other current assets 511 551 634 725 789 870Total assets 2,745 3,753 4,983 5,113 5,252 5,629Short-term debt 3 56 22 0 0 0Other current liabilities 346 412 653 778 892 1,015Long-term debt 791 1,465 2,632 2,601 2,439 2,439Other long-term liabilities 175 173 390 390 390 390Total equity 1,430 1,647 1,285 1,344 1,531 1,785Total liabilities & equity 2,745 3,753 4,983 5,112 5,252 5,629Net working capital 400 408 347 383 405 441Net debt (cash) 659 871 2,026 2,118 1,894 1,754

Cash flow

Cash flow EBITDA 288 358 384 302 569 708Tax, interest & other (254) (226) (612) (267) (235) (264)Change in working capital (182) (68) (81) (91) (46) (53)Net cash from op activities 144 476 304 478 757 920Capex (124) (156) (672) (386) (305) (489)Net acquisitions (60) (324) (522) 0 0 0Net financing cash flow 80 644 1,123 513 (162) 0Dividends & minority distrib'n (128) (171) (194) (74) (153) (208)Net ch in cash & equivalents 6 391 128 (146) 62 140FCF (72) 224 (640) (105) 282 261


Revenue growth (%) 33.5 22.0 11.4 19.6 17.0 15.8Normalised EPS growth (%) 44.9 12.9 -41.6 -19.8 105.7 35.8Normalised EBITDA mgn (%) 35.7 37.4 25.0 27.2 29.3 31.1Normalised EBIT margin (%) 31.0 33.3 29.0 17.3 19.4 21.2ROACE (%) 22.4 23.5 17.2 11.1 14.5 17.7Reported ROE (%) 18.2 23.7 25.6 8.1 18.9 22.9Working capital as % of sales 25.7 21.5 16.4 15.1 13.7 12.9Net debt (cash)/EBITDA (x) 1.2 1.2 2.5 3.1 2.2 1.6EBITDA net interest cvg (x) 6.0 7.5 2.9 3.5 5.1 6.3

Valuation

EV/revenue (x) 4.0 3.4 3.4 2.9 2.4 2.0EV/normalised EBITDA (x) 11.3 9.1 13.8 10.7 8.2 6.6EV/normalised EBIT (x) 13.0 10.2 11.9 16.9 12.4 9.6Normalised PER (x) 17.9 15.8 27.1 33.9 16.5 12.1Price/book (x) 4.0 3.5 3.4 3.3 3.0 2.6Dividend yield (%) 3.0 3.0 3.5 1.3 2.7 3.7FCF yield (%) n/a 3.5 n/a n/a 4.0 3.7

Per share data

Reported EPS (PLN) 0.700 1.05 1.22 0.399 0.999 1.36Normalised EPS (PLN) 0.920 1.04 0.606 0.486 0.999 1.36Dividend per share (PLN) 0.490 0.490 0.570 0.219 0.450 0.611Equity FCFPS (PLN) 0.057 0.918 (1.07) 0.269 1.33 1.27BV/share (PLN) 4.12 4.71 4.83 5.01 5.56 6.31



92



93

Oil & Gas

Polish Strategy Lotos Group July 2010

94

Lotos Group Maintained

Any serious bridegrooms? SellPoland Market cap PLN4,019.6mOil & Gas Bloomberg LTS PW

The Polish government has announced it is looking for a strategic partner to buy its 53% majority stake in Lotos Group. We doubt it will be successful as domestic buyers are out of funds, while we see no interest coming from investors outside Poland.

Investment case The Polish government hopes to invite bids in September for its majority stake in oil refiner Lotos Group, according to Treasury Minister Aleksander Grad. The minister said the cabinet has agreed to start procedures but that a final decision on whether to sell the stake would be made after the government receives the initial bids. The Treasury holds 53.18% of Lotos, Poland's no. 2 refiner. Grad declined to comment on whether the government would amend the current energy sector policy to allow Poland's largest refiner PKN Orlen to participate in the bid. Under current policy, to maintain two independent and competing refiners, PKN Orlen would not be allowed to buy Lotos.

We have our doubts that the sale will be successful. First, if we look at the two serious Polish candidates, PKN Orlen andPGNiG, we see several issues that could block the sale.

PKN Orlen would be the top candidate to acquire its smaller peer as this merger would make the most of potential synergies. Due to their hostile relationship, the two companies have not set up any product swaps, which could save both parties millions of zloty. However, we see several reasons against PKN’s involvement. First, we doubt that PKN Orlen could divest either Polkomtel or Mazeikiu Nafta before the end of the year, which would be necessary to free up the appropriate PLN4.5-5.0bn needed to take over Lotos Group. We do not think that the Polish government would accept PKN shares as payment. Second, PKN Orlen would take on approximately PLN6bn of debt with Lotos, which could push its already high debt of PLN10.3bn to a level unacceptable to its lenders. Finally, Lotos Group has been able successfully to lobby against takeover overtures from PKN Orlen in the past and we believe it could be successful this time too. The merger would also create some anti-trust problems and may oblige the two companies to sell assets in a depressed market. This is less of an issue for PGNiG but the Polish gas firm has a large capex commitment, which makes this acquisition less affordable. We would expect Lotos to lobby strongly against this merger as well.

We see less interest from international investors. Currently some 1.2m bbl of refining capacity is available for sale in the US and Europe and interest has been lacklustre for these assets. Lotos’ large debt also makes buyers cautious. We doubt therefore that there would be a bid from overseas satisfactory enough to get the nod from the Polish government. We maintain our DCF-based target price of PLN22.0 and our SELL recommendation.

Price (19/07/10) PLN30.95



Quarterly preview We expect Lotos Group to report good 2Q10 operating figures, driven by a higher downstream margin (North Sea Brent margins were flat at US$3/bbl, while Ural/Brent spread widened to US$2.0/bbl from US$1.1/bbl) and upstream earnings. Seasonally 2Q10 is a good period with stronger production of high value-added products like diesel. On the financial side, the stronger US dollar and weakening euro vs US dollar will have hit earnings: Lotos is mainly indebted in US dollar, while we expect the strengthening dollar vs. the euro to lead to some hedging losses. Overall we expect Lotos to be in red at net level.


(PLNm) 2Q09 2Q10F

Revenues 3,448 4,400EBITDA 226 265EBIT 151 185Net profit 739 -315


Earnings drivers and outlook Lotos Group’s earnings are driven primarily by two external factors: refining margins and crude oil prices. We expect only a gradual recovery in refining margins: our forecasts are US$2.0/bbl for 2010, US$2.5/bbl for 2011 and US$3.0/bbl for 2012, with a possible return to mid-cycle margins of US$4.0/bbl by 2013. In terms of crude oil prices, we expect only a limited upside to around US$85/bbl by 2013.

The development of the Gdansk refinery, the so called 10+ programme, is due for completion by the end of this year, when the new MHC unit is finished. The company is already operating the new CDU/VGU units, which increases primary distillation capacity to about 8m tonnes this year from 6m tonnes, while the MHC unit will improve the overall product mix. In 2011 we expect the Gdansk refinery to ramp up production and reach the maximum nameplate capacity of 10.5m tonnes. We forecast EBIT above PLN1bn by 2012, as margins improve and the new units run at full speed.

The company has an upstream target of 1m tonnes of crude oil compared with the current 250k tonnes. The company’s Norwegian YME field is due to start production from 2H10 and could add 400k tonnes pa to overall production. Lotos recently stated that its 1m tonne production target is achievable post-2012, which we believe is more realistic due to high financial gearing.

Tamas Pletser Budapest +36 1 235 8757 [email protected]

Polish Strategy Lotos Group July 2010

95

Newsflow

Date Description

26 August 2010 2Q10 results4 November 2010 3Q10 report



State Treasury 53.19ING 5.02Free float 41.79


Share data




2224262830323436

7/09 9/09 11/09 1/10 3/10 5/10


Source: ING

Company profile

Lotos Group is Poland’s number two oil refiner. The company fully owns the 10.5m tonne Gdansk refinery, operates 313 filling stations in Poland, and holds themajority stakes of two small Southern Polishrefineries. Lotos Group is the 99.3% owner ofPetrobaltic, the Baltic sea oil producer.

Risks

The major risk to our Sell recommendation is if thePolish government successfully sells its majority stakein Lotos Group to a strategic investor, which underPolish law could lead to a buy-out offer for the minorityshareholders. A faster recovery in refining marginsand a higher crude oil price are the major upside risksfrom an operational perspective.

Financials


Income statement

Revenues 13,125 16,295 14,321 20,141 24,522 24,280EBITDA 1,020 169 705 1,056 1,348 1,717EBIT 714 (146) 420 435 708 1,129Net interest 3 (45) (154) (265) (252) (220)Associates 0 0 0 0 0 0Other pre-tax items 287 (286) 861 (50) (50) (50)Pre-tax profit 1,004 (477) 1,126 120 406 859Tax (190) 114 (198) (23) (77) (163)Minorities (37) (64) (21) 0 0 0Other post-tax items 0 0 0 0 0 0Net profit 777 (427) 908 97 329 696Normalised net profit 777 (427) 908 97 329 696

Balance sheet

Tangible fixed assets 3,471 5,533 9,362 9,241 9,201 9,213Intangible fixed assets 123 101 136 131 127 123Other non-current assets 914 1,477 438 279 279 279Cash & equivalents 1,049 1,019 409 413 416 420Other current assets 4,164 4,058 4,717 5,387 6,294 6,118Total assets 9,720 12,188 15,063 15,451 16,318 16,153Short-term debt 591 551 778 868 951 974Other current liabilities 1,762 1,975 1,941 1,904 3,046 2,971Long-term debt 852 3,589 5,243 5,534 4,830 4,028Other long-term liabilities 363 287 387 333 351 344Total equity 6,151 5,786 6,714 6,811 7,140 7,836Total liabilities & equity 9,720 12,188 15,063 15,451 16,318 16,153Net working capital 2,406 2,172 2,827 3,533 3,299 3,197Net debt (cash) 395 3,121 5,611 5,990 5,365 4,582

Cash flow

Cash flow EBITDA 1,120 (48) 1,213 719 969 1,284Tax, interest & other (63) 418 (245) 15 35 10Change in working capital (901) 391 (268) (625) 267 100Net cash from op activities 189 339 711 109 1,271 1,393Capex (682) (2,479) (3,331) (500) (600) (600)Net acquisitions 66 (2) (16) 0 0 0Net financing cash flow 530 1,966 2,158 406 (667) (789)Dividends & minority distrib'n (50) (3) (2) 0 0 0Net ch in cash & equivalents (147) (112) (470) 14 4 4FCF (693) (2,076) (2,613) (391) 671 793


Production growth (%) -27.0 14.0 -13.6 136.8 55.6 0.0Reserve replacement (%) 0 0 0 0 0 0Revenue growth (%) 2.5 24.1 -12.1 40.6 21.7 -0.98Normalised EPS growth (%) 14.3 n/a n/a -89.9 237.5 111.5Normalised EBITDA mgn (%) 7.8 1.0 4.9 5.2 5.5 7.1Normalised EBIT margin (%) 5.4 -0.89 2.9 2.2 2.9 4.6ROACE (%) 10.4 -1.7 3.7 3.4 5.4 8.8ROACE - WACC (%) 0.15 -11.9 -6.5 -6.9 -4.8 -1.5Reported ROE (%) 14.1 -7.6 15.1 1.4 4.7 9.3Net debt (cash)/equity (%) 6.4 53.9 83.6 87.9 75.1 58.5Net debt (cash)/EBITDA (x) 0.39 18.4 8.0 5.7 4.0 2.7EBITDA net interest cvg (x) n/a 3.7 4.6 4.0 5.3 7.8

Valuation

EV/DACF (x) 25.1 22.3 13.6 92.5 7.4 6.2EV/capital employed (x) 0.63 0.76 0.76 0.76 0.73 0.67EV/normalised EBITDA (x) 4.7 44.5 13.7 9.5 7.0 5.0Normalised PER (x) 4.5 n/a 4.2 41.2 12.2 5.8Price/book (x) 0.61 0.65 0.60 0.59 0.57 0.52Dividend yield (%) 0.0 0.0 0.0 0.0 0.0 0.0FCF yield (%) n/a n/a n/a n/a 7.1 9.2

Per share data

Reported EPS (PLN) 6.84 (3.74) 7.44 0.751 2.53 5.36Normalised EPS (PLN) 6.84 (3.74) 7.44 0.751 2.53 5.36Dividend per share (PLN) 0.00 0.00 0.00 0.00 0.00 0.00Equity FCFPS (PLN) (6.09) (18.21) (21.42) (3.01) 5.16 6.11BV/share (PLN) 51.15 47.40 51.41 52.16 54.70 60.05


Polish Strategy PGNIG July 2010

96

PGNIG Previously Buy

Downgrade on lower earnings estimates HoldPoland Market cap PLN20,355.0mOil & Gas Bloomberg PGN PW

The recovery in earnings is likely to hit the wall in 2H10. We cut our earnings multiples-based target price from PLN5.10 to PLN3.3, based on downward revisions to our 2010F earnings estimates on the back of the adverse tariff regime in the trade segment, higher crude oil prices and US dollar rate assumptions. With a negative expected total return of -2% we cut PGNIG from Buy to HOLD.

Investment case In June PGNIG obtained more favourable tariffs in distribution (we understand the current RAB return is 8.8%). Since last year the relatively small segment of storage has enjoyed good returns with RAB return of 10.5%. However, PGNIG struggled to secure fair returns in by far its largest segment of gas wholesale trade. In our view, the energy regulator (URE) remains openly hostile to company efforts to obtain a fair tariff regime in the trade segment. This hostility is underlined by recent tariff decisions, which were delayed and failed again to meet company expectations both in terms of the magnitude of the tariff increase as well as the tariff duration. As a result, we forecast PGNIG to report an EBITDA loss of PLN139m in the T&S segment in 3Q10. The outlook for the critical 4Q10 is uncertain, as the current tariff remains in place until November and the company would like to shorten it until the end of September, in line with its tariff application. In our model we factor in 8.5% wholesale gas tariff increase from 1 October, but even with this relatively robust increase we anticipate also an EBITDA loss of PLN288m in the T&S segment in 4Q10.

To date Poland has awarded over 50 five-year licenses for unconventional gas exploration to a number of oil and gas companies, including ExxonMobil, Chevron, Conoco Philips, and Marathon Oil. PGNIG holds 11 licenses covering areas that have the potential to contain shale gas Furthermore, the company filed applications for two other license areas. The first wells have already been drilled in Eastern Poland with prospective results. PGNIG increased its capex to include a larger budget for shale gas drilling. We increased capex estimates for 2010 and 2011 to PLN3.2bn pa to bring it in line with company guidance, which includes increased spend on shale gas projects.

Based on our revised estimates, PGNIG trades at 8.1x 2010F EV/EBITDA and 17.7x 2010F PER, premiums of 3% and 26% toEuropean utilities, respectively. The sector trades at an average 7.0x 2010F EV/EBITDA and 10.6x 2010F PER. Our revised TP is based on 8.4x 2010F EV/EBITDA and 12.7x 2010F PER. We believe PGNIG will trade at a 20% premium to the sector as PGNIG’s tariff regime is currently suboptimal in the T&S segment and should change favourably in future, once Poland opens up its gas market fully. Also, PGNIG’s valuation should benefit from the shale gas potential of Poland as the company appears to be the best local partner for international gas companies seeking shale gas in Poland.

Price (19/07/10) PLN3.45



Quarterly preview Cold April weather and improving manufacturing demand helped to drive distribution sales volumes 7% higher YoY to 2.7bn m³ of gas in 2Q10. A 5% increase in distribution tariff from June 2010 gave additional support to the profitability of this segment.

The seasonal maintenance shutdown of the Dembo crude oil field for four weeks in May reduced crude oil output and sales. We forecast sales of 95k tonnes, down from 138k tonnes in 2Q09. We foresee a positive impact on profits from the higher market price of crude oil. We expect the company to communicate increased capex with the release of 2Q10 results due to planned spending on E&P.

In the trade segment PGNIG bought imported gas at c.US$320 per 1,000m³ in 2Q10, which left it already above its wholesale distribution tariff. We forecast thin EBITDA profit in the T&S segment of PLN64m, as the company also sold some cheaper in-house produced gas from storage.


(PLNm) 2Q09 2Q10F

Revenues 3,874 3,820EBITDA 152 545of which: E&P 158 338 T&S (64) 64 Distribution 89 147 Other (31) (4)EBIT (240) 170Net profit (94) 146


Earnings drivers and outlook We cut our 2010F EBITDA/net profit estimates by 33%/51%, respectively, on the back of: (1) an increase in our 2010F crude oil price assumption from US$70/bbl to US$76/bbl; (2) higher US$ exchange rate of 3.23 versus 2.83 before; and (3) an unsatisfactory rebalancing of the wholesale gas tariff. We also lower our 2011F EBITDA/net profit estimates by 30%/44% respectively, on a higher crude oil price of US$80/bbl, up from US$75/bbl, and a higher US dollar exchange rate of 3.12, up from 2.82.

Gas demand in Poland is improving as manufacturing output is accelerating. Recovery from the long winter, post-flooding reconstruction and more robust German imports are driving manufacturing output in Poland, and we expect these positive trends to continue in 3Q09. We forecast gas volume sales of 14.0bn m3 in 2010, up from 13.7bn m3 before, representing growth of 5.5% YoY.


Polish Strategy PGNIG July 2010

97

Newsflow

Date Description

July 2010 €bond offering on the local market July 2010 Markowola field shale gas drilling results

announcement 2Q10 results 31 August 2010 4Q10 €bond offering on the international markets



State Treasury 72.8


Share data

Avg daily volume (3-mth) 6,060,300Free float (%) 27.2Market cap (PLNm) 20,355.0Net debt (1F, PLNm) 4,338Enterprise value (1F, PLNm) 24,703Dividend yield (1F, %) 2.1



3.03.54.04.5

5.05.56.0

7/09 9/09 11/09 1/10 3/10 5/10


Source: ING

Company profile

PGNIG’s main business is the distribution of naturalgas in Poland, in which the company has a monopolyposition in the market. PGNIG also exploits crude oiland natural gas from onshore deposits in Poland aswell as providing drilling, geological and geophysicalservices for other crude oil and natural gas companiesin a number of markets in Asia, Europe and theMiddle East.

Risks

PGNIG’s earnings are mostly sensitive to the level oftariffs in the wholesale trade and distribution of gas,as well as prices of imported gas and PLN/US$exchange rates. Adverse changes in tariffs, costs ofimported gas and a depreciation of the zloty versusthe US dollar could have a material negative effect onour earnings projections.

Financials


Income statement

Revenues 16,652 18,432 19,290 19,533 21,528 22,906EBITDA 2,291 2,226 2,830 3,046 3,685 3,887EBIT 861 801 1,334 1,528 2,092 2,214Net interest 47 54 (2) (106) (113) (139)Associates (16) 0 0 0 0 0Other pre-tax items 120 81 111 0 0 0Pre-tax profit 1,012 935 1,443 1,421 1,979 2,075Tax (87) (70) (238) (270) (376) (394)Minorities (1) (0.4) (2) 0 0 0Other post-tax items 0 0 0 0 0 0Net profit 924 865 1,202 1,151 1,603 1,681Normalised net profit 2,242 865 708 1,151 1,603 1,681

Balance sheet

Tangible fixed assets 18,716 20,587 22,889 24,573 26,179 27,707Intangible fixed assets 85 152 173 173 173 173Other non-current assets 3,331 1,835 1,603 1,303 1,303 1,303Cash & equivalents 1,584 1,422 1,196 1,385 751 189Other current assets 4,687 5,750 5,221 5,283 5,794 6,147Total assets 28,402 29,745 31,082 32,718 34,201 35,519Short-term debt 2,515 4,094 4,717 4,119 4,402 4,597Other current liabilities 986 876 1,183 1,183 1,183 1,183Long-term debt 31 41 44 1,604 1,604 1,604Other long-term liabilities 3,848 4,018 3,736 3,680 3,681 3,682Total equity 21,022 20,716 21,402 22,132 23,332 24,453Total liabilities & equity 28,402 29,745 31,082 32,718 34,201 35,519Net working capital 4,547 5,438 4,939 5,001 5,512 5,865Net debt (cash) 962 2,713 3,566 4,338 5,254 6,012

Cash flow

Cash flow EBITDA 2,315 2,274 2,460 2,293 2,707 2,821Tax, interest & other (135) (164) (114) (376) (489) (533)Change in working capital 427 846 (227) (28) 228 158Net cash from op activities 2,688 2,989 2,600 2,641 3,424 3,511Capex (2,934) (2,707) (3,051) (3,202) (3,200) (3,200)Net acquisitions 0 0 0 0 0 0Net financing cash flow (644) 729 453 1,227 0.5 3Dividends & minority distrib'n (153) (171) (260) (421) (403) (561)Net ch in cash & equivalents (1,956) (162) (226) 189 (634) (562)FCF (205) 331 (501) (667) 111 172


Production growth (%) -4.7 -1.4 1.2 3.5 6.1 6.7Reserve replacement (%) Revenue growth (%) 9.6 10.7 4.7 1.3 10.2 6.4Normalised EPS growth (%) 68.9 -61.4 -18.1 62.5 39.2 4.9Normalised EBITDA mgn (%) 20.2 12.1 12.6 15.6 17.1 17.0Normalised EBIT margin (%) 13.1 4.3 4.4 7.8 9.7 9.7ROACE (%) 8.8 3.3 3.3 5.7 7.3 7.4ROACE - WACC (%) -0.73 -7.8 -7.6 -4.7 -3.2 -3.2Reported ROE (%) 4.4 4.1 5.7 5.3 7.1 7.0Net debt (cash)/equity (%) 4.6 13.1 16.7 19.6 22.5 24.6Net debt (cash)/EBITDA (x) 0.42 1.2 1.3 1.4 1.4 1.5EBITDA net interest cvg (x) n/a n/a 1,516 28.6 32.5 28.0

Valuation

EV/DACF (x) 7.8 7.6 9.2 9.7 7.7 7.8EV/capital employed (x) 0.90 0.93 0.91 0.89 0.87 0.86EV/normalised EBITDA (x) 6.3 10.4 9.8 8.1 7.0 6.8Normalised PER (x) 9.1 23.5 28.7 17.7 12.7 12.1Price/book (x) 0.97 0.98 0.95 0.92 0.87 0.83Dividend yield (%) 0.75 0.84 1.3 2.1 2.0 2.8FCF yield (%) n/a 1.4 n/a n/a 0.43 0.65

Per share data

Reported EPS (PLN) 0.157 0.147 0.204 0.195 0.272 0.285Normalised EPS (PLN) 0.380 0.147 0.120 0.195 0.272 0.285Dividend per share (PLN) 0.026 0.029 0.044 0.071 0.068 0.095Equity FCFPS (PLN) (0.043) 0.047 (0.085) (0.095) 0.038 0.053BV/share (PLN) 3.56 3.51 3.63 3.75 3.95 4.14


Polish Strategy PKN Orlen July 2010

98

PKN Orlen Maintained

Still waiting for the breakthrough sale of non-core assets SellPoland Market cap PLN16,424.0mOil & Gas Bloomberg PKN PW

PKN Orlen is looking to divest its non-core assets – Polkomtel, Anwil and Mazeikiu Nafta – its chances of achieving this have improved but the timing is still very unclear.

Investment case PKN Orlen is still looking to solve its key problem, reducing its mounting PLN10.2bn net debt. In 1Q10, the company signed a deal with Lambourn to divest part of its strategic reserves, which freed up some PLN0.8bn from the PLN6bn of mandatory reserves. The company is working on a similar, though smaller, deal in 3Q10. The real solution to the mandatory reserves issue, however, would be the proposed government scheme which is likely to be achieved no earlier than 5-10 years.

Outside of this Lambourn success, Orlen has not yet overcome the main obstacles facing its other key divestment deals. There have been some developments: Polkemtel’s major shareholders have agreed to sell their stakes collectively, probably in 1H11, but the problem remains of finding a strategic buyer for the company, which has an estimated market capitalisation of PLN12-13bn. Orlen is also aiming to buy the remaining stakes in Anwil, increasing its holding from 85% to 100%. The plan would then be to split up the firm and sell the fertiliser and chemical parts separately. Orlen was in negotiations with Pulawy to buy its majority stake, but the talks failed when Orlen rejected the price.

We believe there is now greater commitment from PKN Orlen to divest its ill- fated refinery Mazeikiu Nafta, but the company has not been able to conclude a deal with the Lithuanian government to acquire Klapeidos Nafta, the major port for oil products, which would significantly cut the logistics costs at Mazeikiu. Crude is still not being received at Mazeikiu by the Druzhba pipeline, which would also boost profitability.

Its high net debt makes it difficult for PKN Orlen to pursue growth via acquisitions and new investments. The company is over the peak of its previous capex cycle and may now be looking for new investment opportunities. We do not see the rationality of building up an upstream business, especially as only a meagre PLN700m is devoted to this side of the business. We expect a new 460MW gas powered CCGT power plant to be built in Wloclawek. Refining and petrochemicals, however, remain the main focus of operations, and the company’s future still largely depends on the development of these margins and the state of the Polish, German and Baltic economies. We expect retail’s high profitability in these markets to soften as competition intensifies and as the high prices weaken demand.

The next two years are likely to remain difficult for PKN Orlen as we expect the environment to remain harsh. The successful divestment of a major asset such as Polkomtel or Mazeikiu Nafta at an attractive valuation would be a major upside catalyst. We maintain our DCF based target price of PLN31 and our SELL recommendation.

Price (19/07/10) PLN38.40



Quarterly preview 2Q10 saw good downstream margins: we estimate PKN’s indicator margin rose to US$4.7/bbl from US$4.0/bbl in 1Q10, while the Ural/Brent differential rose to US$2.0/bbl from US$1.4/bbl in 1Q10. The petrochemical business should also have benefited from rising margins. The complex margin rose to €600/t from €540/t in 1Q10 and €430/t in 2Q09. We expect around PLN300m in inventory gains, primarily due to the strengthening of the USD vs. PLN. The financial line however could see a loss of around PLN200m on foreign-exchange denominated loans. Overall we expect 2Q10 to be a good quarter for PKN Orlen.


(PLNm) 2Q09 2Q10F

Revenues 16,770 18,500EBITDA 1,317 1,480EBIT 661 830Net profit 1,171 540


Earnings drivers and outlook PKN Orlen’s future earnings are still primarily driven by downstream and petrochemical margins. We expect only a gradual recovery in refining margins: our forecasts are US$2.0/bbl for 2010, US$2.5/bbl in 2011 and US$3.0/bbl in 2012. Petrochemical margins are expected to follow a similar path.

On a short-term outlook, we expect the strong refining and petrochemical margins seen in 1Q-2Q10 to ease in 2H10 owing to higher capacity utilisation, new capacities and slowing European economic growth. This could dent profit growth, and the company may also suffer in the short term from the weak zloty against the US dollar and euro, as PKN Orlen finances itself primarily through euro-denominated loans.

We expect PKN’s stock price also to be driven by news on its divestments. The company could announce the further sale of mandatory reserves (similar to the Lambourn transaction), during the latter part of the year. The Polkomtel sale could take place in 1H11, and we expect further developments on the divestments of Anwil and Mazeikiu, again during 2011 rather than 2010. These divestments would be major catalysts for the stock price, but unfortunately we do not see these catalysts being realised in 2010.

Tamas Pletser Budapest +36 1 235 8757 [email protected]

Polish Strategy PKN Orlen July 2010

99

Newsflow

Date Description

29 July 2010 2Q10 trading statement31 August 2010 Half-yearly report21 October 2010 3Q10 trading statement10 November 2010 3Q10 report



State Treasury 27.52ING OFE 5.17Aviva OFE 5.08Free float 62.2


Share data




262830323436384042

7/09 9/09 11/09 1/10 3/10 5/10


Source: ING

Company profile

PKN Orlen is Poland’s flagship oil & gas company.The company has 6 refineries with a combined CDUcapacity of 33.3m tonnes and a network of 2,570filling stations in Poland, Germany, Czech Republicand the Baltic countries. Orlen controls CzechRepublic’s Unipetrol (63% stake) and Lithuania’sMazeikiu Nafta with a 100% holding.

Risks

The major upside risks to our recommendation are astrong improvement in the environment for refiningand petrochemical companies and quicker thanexpected divestment of its non-core assets includingPolkomtel, Anwil and Mazeikiu at attractive valuations.We also estimate shrinking per unit profitability in thecompany’s retail business: it would be a positive surprise to us should the company maintain its retailmargins in the future.

Financials


Income statement

Revenues 63,793 79,533 67,928 95,637 100,939 107,315EBITDA 5,035 888 3,665 4,400 4,850 5,381EBIT 2,604 (1,603) 1,097 1,579 1,867 2,222Net interest 140 (1,579) 71 (534) (440) (485)Associates 0 0 0 0 0 0Other pre-tax items 267 267 272 241 229 217Pre-tax profit 3,011 (2,915) 1,441 1,286 1,656 1,954Tax (531) 389 (140) (231) (305) (363)Minorities (68) 21 8 19 (72) (201)Other post-tax items 0 0 0 0 0 0Net profit 2,412 (2,505) 1,309 1,074 1,279 1,391Normalised net profit 2,412 (2,505) 1,309 1,074 1,279 1,391

Balance sheet

Tangible fixed assets 25,535 27,830 28,472 28,814 28,992 29,490Intangible fixed assets 531 645 690 609 588 569Other non-current assets 724 806 565 633 709 637Cash & equivalents 1,690 1,396 2,973 3,820 3,850 3,880Other current assets 17,673 16,299 16,460 18,045 19,465 18,279Total assets 46,153 46,976 49,160 51,921 53,604 52,855Short-term debt 1,719 11,282 1,594 1,110 860 800Other current liabilities 10,841 10,528 12,617 14,137 15,157 13,541Long-term debt 8,743 2,752 11,744 12,213 11,783 11,593Other long-term liabilities 2,312 1,882 1,498 1,699 1,690 1,644Total equity 22,538 20,532 21,707 22,762 24,113 25,277Total liabilities & equity 46,153 46,976 49,160 51,921 53,604 52,855Net working capital 8,064 7,031 4,539 4,583 4,961 5,369Net debt (cash) 8,772 12,639 10,364 9,503 8,794 8,514

Cash flow

Cash flow EBITDA 5,460 (157) 3,282 4,518 5,035 5,568Tax, interest & other 561 (122) (586) 643 701 816Change in working capital (2,867) 1,332 1,813 (38) (416) (408)Net cash from op activities 1,965 3,617 5,162 4,249 4,314 4,797Capex (3,585) (3,969) (2,671) (2,919) (2,979) (3,481)Net acquisitions (294) (537) (1,018) (8) 0 0Net financing cash flow 27 1,307 (1,025) (584) (1,406) (1,386)Dividends & minority distrib'n 0 (693) 0 0 0 0Net ch in cash & equivalents (853) (154) 1,597 839 30 30FCF (816) (3,264) 3,271 1,330 1,335 1,316


Production growth (%) n/a n/a n/a n/a n/a n/aReserve replacement (%) 0 0 0 0 0 0Revenue growth (%) 20.7 24.7 -14.6 40.8 5.5 6.3Normalised EPS growth (%) 21.5 n/a n/a -18.0 19.1 8.7Normalised EBITDA mgn (%) 7.9 1.1 5.4 4.6 4.8 5.0Normalised EBIT margin (%) 4.1 -2.0 1.6 1.7 1.8 2.1ROACE (%) 8.0 -4.7 3.2 4.4 5.1 6.0ROACE - WACC (%) -1.7 -14.4 -6.5 -5.2 -4.6 -3.7Reported ROE (%) 12.5 -13.3 7.1 5.5 6.2 6.4Net debt (cash)/equity (%) 38.9 61.6 47.7 41.8 36.5 33.7Net debt (cash)/EBITDA (x) 1.7 14.2 2.8 2.2 1.8 1.6EBITDA net interest cvg (x) n/a 0.56 n/a 8.2 11.0 11.1

Valuation

EV/DACF (x) 14.0 32.3 5.8 6.7 6.5 5.8EV/capital employed (x) 0.84 0.92 0.84 0.79 0.76 0.74EV/normalised EBITDA (x) 5.5 35.8 8.0 6.5 5.8 5.2Normalised PER (x) 6.8 n/a 12.6 15.3 12.8 11.8Price/book (x) 0.83 0.92 0.86 0.82 0.77 0.73Dividend yield (%) 4.2 0.0 0.0 0.0 0.0 2.6FCF yield (%) n/a n/a 11.1 4.7 4.8 4.7

Per share data

Reported EPS (PLN) 5.64 (5.86) 3.06 2.51 2.99 3.25Normalised EPS (PLN) 5.64 (5.86) 3.06 2.51 2.99 3.25Dividend per share (PLN) 1.62 0.00 0.00 0.00 0.00 1.00Equity FCFPS (PLN) (1.96) (0.531) 7.76 3.11 3.12 3.08BV/share (PLN) 46.52 41.65 44.51 47.02 50.01 52.26



100



101

Real Estate

Polish Strategy Dom Development July 2010

102

Dom Development Previously Buy

Slower 2Q. Will the buyers return after the summer break? HoldPoland Market cap PLN1,155.5mReal Estate Bloomberg DOM PW

We downgrade our rating on Dom Development from Buy to Hold and cut our earnings forecasts for 2010 and 2011. The company pre-announced weaker than expected new unit sales in 2Q10. We also expect the summer months to be slow in terms of new unit sales, with potential improvement expected in September and in 4Q10.

Investment case Dom has recently finalised the acquisition of two land slots in Warsaw, located in the Bemowo and Wola districts. Management expects the gross profit margin to reach 25-30% on both projects at current market prices and construction costs 10% higher than prevailing on the market. Both projects could be launched commercially in 2011. Dom introduced four housing projects with 638 units for sale in 1Q10, including phase 2 of the highly popular Saska Kepa project, and two projects in 2Q10 in Bialoleka district. In addition, Dom is ready to begin eight housing projects with 1900 housing units but the introduction of these projects depends on September’s new unit sales and a return of buyers in 4Q10. We assume Dom will start four projects with circa 900 units in 2H10. If new monthly unit sales in the last four months of the year exceed 120-140 units per month, the company might start more projects in early 2011. New starts should allow the company to maintain its target level of unit stock at 12m historical rolling unit sales.

We lower our 2010 earnings estimates due to expected provisioning for future client claims. Based on legal opinion, purchasers of housing units could claim compensation for construction faults from developers for up to ten years after handover. Such a long construction warranty period requires an increase in future claim provisions. We assume Dom will put aside PLN8.0m in future claim provisions in 2010F, which will lower reported earnings with no impact on cash flows. We assume provisions will represent 2.5% of company revenue going forward. Our 2011 earnings estimates are also affected by delays in the handover of housing units.

Despite weaker than expected earnings in 2010F, the company will be free cash flow positive in 2H10 with cash proceeds from clients of c. PLN370m, construction cash costs of PLN125m, land purchases at PLN120m and debt repayment of PLN50m. Dom drew an additional construction loan of PLN100m to fund the new projects it plans to start in 2H10. We regard Dom’s liquidity position as comfortable with cash of PLN161m in 1Q10, net debt of PLN301m and likely positive free cash flow in 2Q10.

We cut our target by 12% to PLN47.4 due to downward revision in earnings in 2010F and in subsequent years. Our target price is based on a discounted cash flow model as well as a 2011F PER multiple of 10.0x, as we believe 2010F earnings are generally reflective of past trends in demand.

Price (19/07/10) PLN48.00



Quarterly preview We forecast new sales of 310 housing units in 2Q10, down 10% qoq and up 99% yoy. This will bring 1H10 sales to 653 units vs 262 units in 1H09. Dom noticed a reduced number of prospective clients visiting sales offices and fewer closed transactions. Unit handovers were 33% lower qoq and 62% lower yoy at 181 units. We expect the gross profit margin to increase to 24.0%, up from 21.6% in 1Q10 but down from 27.0% in 2Q09. High-margin Grzybowska project handovers kick in on a larger scale in 2Q10. In 2Q10 Dom handed over 45 units at Grzybowska project. However, the company is also offloading the stock of unprofitable units in two unsuccessful projects of Regaty and Laguna, where we expect 39 handovers at very low margins in 2Q10. The company placed two projects, Debry 11 and Debry 20, on the market in 2Q10 with 177 housing units.


(PLNm) 2Q09 2Q10F



Earnings drivers and outlook Housing sales volumes, housing prices, construction costs and land prices are the key earnings drivers for Dom. Sales volumes recovered well until 1Q10 but slumped in 2Q10, which we believe is somewhat worrying.

We cut our handover target from 656 to 575 in 2010 due to slow sales and handovers at Grzybowska project. We also cut our handover target from 2,138 to 1,376 units in 2011F as postpone expected handovers on Gorczewska, Targowek and Regaty IV, Regaty V, Regaty VI projects.

Construction costs are stable and the company is able to sign contractors at PLN3,000-3,500/sqm, excluding costs of land. We believe construction costs are likely to be higher in the medium and long term, so it makes sense for the company to perhaps build the units and increase stock somewhat. For Gorczewska project, which is likely to be the next launch,management signed contractors at fairly low unit construction costs of PLN3,300/sqm.


Polish Strategy Dom Development July 2010

103

Newsflow

Date Description

August 24 2Q10 resultsNovember 11 3Q10 results



Dom Development BV 63.1Jarosław Szanajca 6.2Grzegorz Kiełpisz 5.2


Share data




3035404550556065

7/09 9/09 11/09 1/10 3/10 5/10


Source: ING

Company profile

Dom Development is the largest housing developer inWarsaw by number of units sold, as well as byrevenue and earnings, with a 12% market share in2009. The company develops desirable flats,apartments, luxury apartments and houses in Warsawand Wroclaw. Dom sold 13,700 housing unitsbetween its inception in 1996 and the end of 2009.

Risks

Housing developers are greatly dependent on banks’’ willingness to fund housing development projects.Banks are slowly facilitating easier access tomortgage funding, although the share of cheaper fxmortgages fell to c. 25% of new signings. At themoment Dom sells c. 90% of housing units onmortgage credit.

Financial statements

P&L account, PLNm 2009 2010F 2011F 2012F

Revenue 704 300 894 701% change (20) (57) 198 (22)EBITDA 113 41 121 84% change (59) (64) 198 (30)Margin, % 16.0 13.5 13.5 12.0EBIT 111 39 118 82Pre-tax 105 45 120 81Tax (20) (9) (23) (15)Minorities 4 5 6 7Net profit 80 37 97 66% change (64) (54) 164 (32)Margin, % 11.4 12.2 10.8 9.4


Balance sheet

PLNm 2009 2010F 2011F 2012F

Cash 557 164 428 53Other current assets 1,136 1,489 1,432 1,711Total current assets 1,693 1,654 1,860 1,765PPE 7 7 7 7Other 12 12 12 12Intangibles 1 1 1 1Other fixed assets 3 3 3 3Total fixed assets 22 22 22 22Total assets 1,716 1,676 1,882 1,788ST debt 85 150 150 50Other cur liabilities 381 259 378 341Total current liabilities 466 409 528 391LT debt 434 434 434 434Other LT liabilities 24 24 24 24Total LT liabilities 458 458 458 458Minorities 0 0 0 1Equity 792 808 896 938Total liabilities & equity 1,716 1,676 1,882 1,788


Cash flow

PLNm 2009 2010F 2011F 2012F

CF from operations 123 (64) 188 41CF from investment 169 (395) 76 (316)CF from funding 159 65 0 (100)Change in cash 451 (393) 264 (375)Cash last year 106 557 164 428Cash year end 557 164 428 53


Forecasts and ratios

Year to Dec 2009 2010F 2011F 2012F

Revenue (PLNm) 704 300 894 701EBITDA (PLNm) 113 41 121 84Net income (PLNm) 80 37 97 66EPS (PLN) 3.20 1.47 3.87 2.64PER (x) 15.0 32.7 12.4 18.2EV/EBITDA (x) 11.6 34.4 12.4 17.8P/BV (x) 1.5 1.5 1.3 1.3ROE (%) 10.5 4.6 11.4 7.2


Polish Strategy GTC July 2010

104

GTC Previously Hold

Out of the U-turn and shifting into higher gear BuyPoland Market cap PLN5,001.7mReal Estate Bloomberg GTC PW

We increase our SOTP-based target price by 19% following additions of new projects, announced disposal of offices at favourable valuations and a much more robust outlook forrents. With 30% upside to our revised target price we upgrade GTC to a Buy. Asset appreciation, positive revaluations, increasing rents and slowly declining capitalisation rates in the region should drive growth in NAV and push the share price higher.

Investment case The commercial real estate markets of Central Europe are slowly but steadily improving. Office demand is improving in Poland, as office rents in Warsaw hit the bottom in late 2009 and early 2010 and stabilised. Prague is doing better as well, while the Budapest market is weaker. Rents in Warsaw outside CBD are around €14-15/sqm, Prague rents out for €13-14/sqm and Budapest at €10-11/sqm, excluding service charges. Office rents remain under pressure in the secondary cities of the region. Retail rents remain stable across locations but visitors' numbers and turnover remain visibly below 2008 levels.

Office markets in the region, particularly in Warsaw and Prague, are likely to tighten in the course of 2011 with a likely supply gap providing a more robust backdrop for office rental operations. So far management planned to spend €200-250m pa on project development, a level it deemed appropriate given the tough market conditions and funding at hand. Now we expect the management to accelerate longer-tail of the current pipeline of projects. Based on our revised model which reflects up-to-date development plans, completions should reach 91k m2 in 2010F, 161k in 2011F and a record high 440k m2 in 2012 in both office and retail segments.

At the end of 1Q10 GTC held cash of €193m, an undeveloped land bank of €529m, its leverage ratio was 63% and average loan to value ratio was 49%. Of the total debt of €1.4bn, debt maturing within the next three years was only €210m. We estimate present value of company office and retail pipeline at €1.14bn based on current construction costs, excluding projects under construction. In our NOI-valuation we assumed 75% of this project value will be started and completed with the next five years.

After NAV erosion in 2009 we expect NAV growth of 5%/13%/28% in 2010/11/12F in € terms for GTC. Asset appreciation should drive P/NAV down to 0.96x in 2010F and 0.92x in 2011F. We regard these valuation levels as attractive for a company with a proven track record of selective decision making and region-unmatched ability to source funding for projects. We expect GTC to trade back at a premium to NAV once investors recognise the asset appreciation potential of GTC.

Price (19/07/10) PLN22.8



Quarterly preview We forecast rental and service revenue of €31.3m in 2Q10, up 43% yoy and 2% qoq, with qoq growth driven by increasing occupancies at City Gate building in Bucharest following completion in 4Q09 and signing of next rental agreements. Housing revenue should remain at a similar level to 1Q10, or at €6.5m in 2Q10.

We forecast a small positive revaluation of €5.0m in 2Q10 coming from office properties under construction which the company is slowly renting out. GTC did not change its assumptions on capitalisation rates or rental rates despite announcing the recent disposal of two office buildings in Warsaw at capitalisation rates which we believe are below the capitalisation rates used in real-estate portfolio valuation.

We estimate net interest costs were €13.7m, unchanged qoq. Income from associates should reach €2m and we also expect a minorities loss of €2.2m.


(€m) 2Q09 2Q10F

Revenues 38.3 37.8EBIT 10.8 20.6Profit from cont'd ops (17.9) 25.6Net profit (12.0) 13.3


Earnings drivers and outlook We expect rental income to rise due to openings of new office and shopping centres as well as an expected increase in rental rates for office which are slowly recovering from the lows of 2009. We forecast 9%/32% yoy growth in rental (and service) revenue in 2010/11F with stable gross rental margins of 75%. GTC made a strategic decision last year to downshift the scale of its housing operations including redesigning some of the projects into commercial real estate. We forecast a housing revenue decline of 43% yoy in 2010F to €35m.

For GTC’s portfolio we expect a 25bp downward shift in cap rates in 2010F to 7.75% and a 50bp decline to 7.25% in 2011F. Appreciation of investment property will support positive revaluation of €76m in 2010F, vs a revaluation loss of €172m in 2009. Due to an expected decline in cap rates as well as growing number of completed projects and high space of completed building, revaluation should increase to €233m in 2011F.


Polish Strategy GTC July 2010

105

Newsflow

Date Description

August 31 2Q10 resultsNovember 15 3Q10 results



GTC RE 43.1ING NN 8.1AVIVA CU BZWBK 7.2


Share data




20222426

283032

7/09 9/09 11/09 1/10 3/10 5/10


Source: ING

Company profile

GTC has 15 years of experience as the leadingdeveloper of retail, office and housing real estate inCentral Europe, the Balkans and the CIS. GTC’scurrent portfolio includes 442,000m² of net rentablearea. The company is expected to complete 1.8m m²of commercial and housing space, currently at various stages of the pipeline, in 10 countries.

Risks

Restricted access to bank funding or capital marketsfor projects in the pipeline, severe falls in occupancyand rental rates, residential prices and negativerevaluations are the major risk factors for GTC. Our valuation assumes GTC will start and commission75% of projects in the pipeline, excluding projectsunder construction. Failure to source funding for theseprojects might result in lower completions,,revaluations and consequently a lower share price.

Fin

Income statement

(€m) 2007 2008 2009 2010F 2011F 2012F

Rental and service 52 72 96 104 137 194Housing 21 42 60 34 78 81Total revenue 74 115 156 139 215 275% change (9) 56 37 (11) 55 28EBITDA 28 40 34 71 106 421% change (8) 41 (16) 108 50 296EBIT 28 40 55 69 104 419Revaluation of existing property 93 33 (138) 51 147 115Revaluation of new property 199 203 10 25 86 172Profit from continuing operations 323 284 (117) 146 339 708Net interest (7) (5) (37) (78) (95) (109)Other financial (22) (10) (3) 0 0 0Associates 5 (1) (3) 16 0 0Pre-tax 299 268 (160) 84 244 600Tax (38) (79) 25 (13) (46) (114)Minorities (27) (24) 11 (8) (24) (60)Net profit 234 165 (123) 63 173 426% change 20 (30) (174) (151) 176 146


Balance sheet

(€m) 2007 2008 2009 2010F 2011F 2012F

Cash 346 201 215 358 339 126Other current assets 296 426 324 341 383 427Total current assets 641 627 539 699 723 553PPE 286 1 1 150 271 515Goodwill &intangibles 8 1 0 0 0 0Investment property 861 1,828 1,972 2,115 2,469 3,000Other fixed assets 65 101 110 126 126 126Total fixed assets 1,220 1,931 2,083 2,391 2,866 3,641Total assets 1,861 2,558 2,623 3,089 3,589 4,195ST debt 32 54 65 65 65 65Other current liabilities 66 110 86 65 118 138Total current liabilities 98 164 151 130 183 203LT debt 578 926 1,234 1,650 1,900 2,000Other LT liabilities 196 312 227 227 227 227Total LT liabilities 775 1,239 1,461 1,877 2,127 2,227Minorities 29 57 47 55 79 139Equity 959 1,099 964 1,027 1,200 1,625Total liabilities & equity 1,861 2,558 2,623 3,089 3,589 4,195


Cash flow statement

(€m) 2007 2008 2009 2010F 2011F 2012F

CF from operations (125) 6 36 (55) (23) 177CF from investment (88) (395) (220) (232) (243) (488)CF from funding 282 243 309 318 248 98Change in cash 68 (145) 125 31 (18) (213)Cash last year 278 346 201 327 358 339Cash year end 346 201 215 358 339 126


Forecasts and ratios

(€m) 2006 2007 2008 2009 2010F 2011F 2012F

Revenue 81 74 115 156 139 215 275Profit from cont. ops. 233 323 284 (117) 146 339 708EBITDA 31 28 40 34 71 106 421Net income 195 234 165 (123) 63 173 426EPS (PLN) 3.54 4.04 2.66 (2.43) 1.15 2.89 6.99PER (x) 6.4 5.6 8.6 (9.4) 19.8 7.9 3.3P/BV (x) 1.77 1.46 1.11 1.26 1.25 1.16 0.85P/NAV (x) 1.25 1.10 0.87 0.96 0.96 0.92 0.72NAVPS growth (%) 23 13 27 (9) (0) 4 28



106



107

Retail

Polish Strategy EM&F July 2010

108

EM&F Previously Hold

More further into e-business SellPoland Market cap PLN1,867.1mRetail Bloomberg EMF PW

EM&F’s share price has been a stable performer. We believe the good outlook for 2Q10 is priced in, while the market isconcentrating too much on the transaction with Merlin(relatively small and expensive) and forgetting about dilution from the new option plan and the expensive multiples paid for ‘safety’ in the form of currency hedging. With a new DCF-based TP of PLN16.5, we downgrade the stock to SELL.

Investment case EM&F’s business model is oriented towards lifestyle goods. Even though average ticket prices are only high in the F&B businesses, we expect demand for such goods to pick up not earlier than in 2011. Factoring in organic expansion plans in Poland, CIS countries and Germany and latest transaction with Merlin, we expect sales to grow at a 2009-12F CAGR of 14%.

We believe that the Media & Entertainment (M&E) division will remain dominant. All of Empik’s sales should be generated domestically, as due to a reduction in ownership the Ukrainian Bukva stores are no longer consolidated. Smyk’s sales should remain more diversified, due to its presence in Germany (via the Spiele Max subsidiary only, liquidation of two stand-alone shops), CIS and fledgling operations in Turkey and Romania, in addition to Poland. Fashion & Beauty (F&B) has higher average prices and thus we believe its LFL sales should be more sensitive to weak trends in consumption. In Poland the operations of Ultimate Fashion should be supported by the introduction of two new concepts (New Look and Peacocks), with the latter already proven in the CIS-oriented Maratex subsidiary.

We believe EM&F’s EBIT margins should gradually recover from the bottom in 2009. The key reasons should be: (1) moderate new opening plans for 2010, translating into an acceptable increased fixed-cost base; (2) cost reductions conducted within 2009 (especially in costs of shops and stronger bulk discounts at suppliers); and (3) currency hedging for the majority of FX positions, securing the budget attainment. We expect the adjusted EBIT margin to be around 5% in the medium-term.

EM&F announced its intention to merge its Empik.com businesswith Merlin.pl. EM&F is to conduct an in-kind contribution of those assets to Merlin.pl in exchange for a 60% stake in combined assets. The price for 40% of the combined assets (Merlin.pl) was set at PLN115-130m. Although the cash payments in the coming months are low, we do not like the multiples of the transaction, which are above those of Amazon.com. Our forecasts for the combined business are in line with those of EM&F management.

At 20.8x 2010F PER, EM&F trades at a 7.5% premium to domestic peers. We believe the premium to LPP and NG2 is not warranted due to: lower EBIT margins and ROE, no dividend payments and more generous stock option plans.

Price (19/07/10) PLN18.00



Quarterly preview We expect EM&F to report good 2Q10 numbers on 26 August. We forecast 2Q10 group sales of PLN636m, flat YoY, with floorspace from continued operations up c.7% YoY. Due to changes in cost recognition, we expect the gross profit margin to deteriorate to 43.4% in 2Q10 versus 47.6% in 2Q09. We expect the cost reductions to be visible, translating into 2Q10 EBIT of PLN21.4m, up 80% YoY on a reported but 37% on an adjusted basis. Factoring in PLN6.5m of net financial costs and the statutory tax rate, we forecast 2Q10 earnings of PLN10.5m, flat YoY on a reported basis but up 17.4% YoY.


(PLNm) 2Q09 2Q10F

Sales 633.3 635.9EBITDA 31.8 44.4EBIT 11.9 21.4Net income 10.5 10.5


Earnings drivers and outlook

We forecast 2010F group EM&F sales of PLN3.1bn, up 14.6% YoY. We factor in the opening of 85 new shops, which translates into eop floorspace from continued operations of c.307,000m². We forecast M&E sales of PLN2.3bn, up 16.8% YoY. Within M&E, we expect Empik sales of PLN1.2bn with Smyk sales (including Spiele Max) at PLN0.9bn. Languages and Licomp sales should remain far smaller revenue contributors. We expect F&B sales of PLN0.8bn, up 8.5% YoY, with PLN0.35bn from Maratex and PLN0.2bn from Ultimate Fashion (which is developing at a smaller pace than in the rebounding CIS countries) in 2010.

We expect the gross profit margin to gradually improve in 2010 to 41.3%, from 40.8% in 2009, due to: (1) a more favourable FX and hedging strategy; and (2) better purchasing terms from suppliers. On the SG&A line, we believe that cost-cutting undertaken in the areas of HR and rental expenses (mostly euro-denominated), should support the EBIT line. We also point out that group EBIT should no longer be charged with excessive shop closing. We forecast 2010 EBIT of PLN142.5m (up 64% YoY), with adjusted EBIT at PLN150.5m, up 44.4% YoY.

We forecast net financial activity to be in the red by PLN25m in 2010. We do not forecast any tax one-offs for 2010 (there was a PLN16.8m one-off in 2009) and forecast 2010 net earnings of PLN89m, up 66% YoY, with adjusted at PLN90m, up 76% YoY.


Polish Strategy EM&F July 2010

109

Newsflow

Date Description

30 Jul 2010 EGM on stock option plan 26 Aug 2010 Publication of 1H10 results 15 Nov 2010 Publication of 3Q10 results



Empik Centrum Investments 60.2Aviva pension fund 11.9Pioneer funds 6.5BZ WBK funds 5.2


Share data




10

12

14

16

18

20

7/09 9/09 11/09 1/10 3/10 5/10


Source: ING

Company profile

EM&F is one Poland's largest retailers, specialising inlifestyle goods. Its operations are diversified amongcosmetics distribution, clothing and accessories(Mexx, Hugo Boss, Aldo, Esprit, New Look, Peacocksfranchises), children's products (Smyk) and books andnewspaper stores (Empik). Apart from Poland, EM&Foperates in other CEE countries (Czech Republic andSlovakia with cosmetics distribution), CIS (Russia andUkraine, franchise clothing stores and Smyk outlets),Germany, Turkey and Romania. At end-2Q10, EM&Fhad 678 locations and 283,187m2 of floorspace.

Risks

Upside risk lies in a stronger-than-expected reboundin CEE/CIS economies. Both upside and downsiderisks lies in the hedging policy of EM&F. Upside riskalso could come from the company’s furtheracquisition plans in online, while there is downsiderisk from a potential overpayment in suchtransactions.

Financials


Income statement

Revenues 1,585 2,297 2,720 3,117 3,546 4,026EBITDA 157 243 204 245 298 337EBIT 109 80 87 143 183 202Net interest (8) (28) (33) (30) (27) (22)Associates 7 14 0.4 2 2 2Other pre-tax items (1) 80 29 5 3 (0.5)Pre-tax profit 107 147 83 119 161 182Tax (24) (21) 4 (23) (32) (37)Minorities 1 (2) (4) (7) (10) (5)Other post-tax items 0 (5) (29) 0 0 0Net profit 84 118 54 89 119 140Normalised net profit 63 79 51 90 120 142

Balance sheet

Tangible fixed assets 377 505 524 586 653 715Intangible fixed assets 357 373 378 375 372 370Other non-current assets 161 169 74 81 87 93Cash & equivalents 202 312 296 218 213 201Other current assets 567 872 892 1,025 1,152 1,293Total assets 1,663 2,231 2,164 2,285 2,478 2,674Short-term debt 188 229 173 100 71 128Other current liabilities 625 822 825 928 1,027 1,137Long-term debt 64 317 328 284 242 98Other long-term liabilities 371 357 341 368 398 431Total equity 415 506 497 604 739 879Total liabilities & equity 1,663 2,231 2,164 2,285 2,478 2,674Net working capital (72) 16 27 52 75 98Net debt (cash) 51 234 205 166 101 25

Cash flow

Cash flow EBITDA 157 243 204 245 296 336Tax, interest & other 0.9 (76) (38) 65 79 79Change in working capital 77 (222) (107) (38) (31) (33)Net cash from op activities 186 (29) 63 203 259 289Capex 1 0.1 (0.3) 0.0 0.1 0.1Net acquisitions (198) (218) (151) (157) (174) (187)Net financing cash flow 34 87 (50) (147) (26) 35Dividends & minority distrib'n 72 145 (17) 9 (67) (140)Net ch in cash & equivalents 105 (15) (154) (103) (25) (104)FCF 187 (29) 63 203 259 290


Revenue growth (%) 40.2 44.9 18.4 14.6 13.8 13.5Normalised EPS growth (%) 26.3 24.7 -35.6 74.7 31.3 17.3Normalised EBITDA mgn (%) 8.2 8.1 7.2 8.1 8.5 8.4Normalised EBIT margin (%) 5.1 5.0 3.8 4.8 5.3 5.1ROACE (%) 14.5 13.2 10.2 15.2 18.4 19.0Reported ROE (%) 22.9 26.1 10.9 16.6 18.3 17.9Working capital as % of sales -4.5 0.72 1.00 1.7 2.1 2.4Net debt (cash)/EBITDA (x) 0.32 0.96 1.0 0.68 0.34 0.07EBITDA net interest cvg (x) 20.4 8.7 6.1 8.1 10.9 15.5

Valuation


Per share data



Polish Strategy LPP July 2010

110

LPP Maintained

Top pick in general retail BuyPoland Market cap PLN2,985.8mPersonal & Household Goods Bloomberg LPP PW

LPP’s share price has been a stable performer in the past two months, with the positive earnings outlook offset by a depreciating zloty. With a decent outlook for 2Q10, we maintain our BUY rating with a DCF-based TP of PLN2,025.

Investment case The economic slowdown has proven a harsh one for retailers, not sparing LPP and its five mainstream brands. We are seeing the first positive signs in consumption patterns, with May and June revenues showing YoY growth. We would expect the situation to gradually improve along with rising employment and salaries in Poland. Still, on top of like-for-likes we expect the top-line to grow along with floorspace development. LPP thoughtfully, in our opinion, used the weakness of its competitors, cheaply obtaining stores from bankrupt competition. Management wants to maintain rapid growth with c.40,000m² of floorspace to be opened in 2010. We believe that in 2010 the expansion will still be oriented on Poland, while from 2011 onwards stronger weight will be put on foreign expansion. We forecast 2009-12F sales CAGR of 11.6%.

We expect group margins to expand in the coming years, due to expected: (1) improvements in gross profit margin (even though we have factored in less favourable FX assumptions, we believe that with improved demand these could be transferred onto the consumer to a greater extent); (2) cost cutting conducted; and (3) stronger consumer demand from 2011. We expect the group’s gross profit margin to be in the region of 59% in the coming years. We also believe that SG&A should remain under control, after the deep cuts of the past year, although we point out that the majority of rentals are in euro. As a result, we expect the operating margin to be in the range of 11-13% in the medium term.

Seeing LPP’s organic development plans and that it took over shops rather than its competitors at the bottom of the market, we believe LPP is unlikely to take the role of consolidator now. We very much like the cash flow improvement conducted by LPP –implementation of the JIT system resulted in inventory per m²falling by c.30%, freeing cash and space at the new logistics centre. As a result, LPP was able to pay out a dividend for the first time in its history from 2009 earnings (PLN86m, c.3% yield, payment day 4 October). We believe that operating cash flow should remain strong in the coming years, proving that last year’s convertible bonds issuance (conversion at PLN1,600) was unnecessary.

At 16.8x 2010F PER, LPP trades at 13% discount to domestic peers, which we do not find warranted, due to the strong earnings outlook, deliverable management and high ROE. We also believe that LPP should be the biggest beneficiary of expected further zloty appreciation. The cut in valuation results from lower forecasts incorporating worse-than-expected consumption in 1H10.

Price (19/07/10) PLN1,710

Previously PLN2,175Target price (12-mth) PLN2,025


Quarterly preview We expect LPP to report decent 2Q10 numbers on 27 August. Group sales should be PLN479m, down 2.4% YoY, (already reported), with the YoY fall showing the impact of the economic slowdown. As the floorspace is up c.19% YoY, this points to double-digit negative like-for-like dynamics. Contrary to sales,the gross profit margin should expand from 52.6% in 2Q09 to 56.5% in 2Q10F (also announced), showing the impact of an appreciating zloty in earlier months. We believe that SG&A costs were under control, but taking into account growing floorspace, we expect 2Q10F group EBIT of PLN42.2m, up 6% YoY. Factoring in financial charges and FX gains, we expect group 2Q10 earnings at PLN31.7m, up 5.3% YoY.


(PLNm) 2Q09 2Q10F



Earnings drivers and outlook We expect LPP’s group sales to come in at PLN2,157m in 2010F, up 7.7% YoY, fuelled largely by floorspace development (up 14.7% YoY), as we expect to see more favourable trends in consumption from 4Q10. We expect foreign sales to contribute 29.5% of sales but 32.5% of floorspace. We believe that the most mature Reserved brand will remain the biggest contributor, with revenues reaching PLN1.3bn, up 12% YoY, followed by the teenage-oriented Cropp brand (at PLN0.4bn, up 19% YoY), still exceeding the contribution of House. The youngest Esotiq and Mohito concepts are likely to remain of low importance.

Although the recent FX trends have not been favourable, we still expect the gross profit margin to expand to 58.5% in 2010F from the low 52.8% base. We expect monthly SG&A per m² to reach c.PLN270 versus c.PLN280 in 2009, factoring in the full-year impact of cost reductions, which translates into 2010 EBIT of PLN243m, up 34% YoY, and an EBIT margin of 11.2%.

Assuming no FX gains and losses and a statutory tax rate, we expect reported net earnings of PLN175.5m in 2010, up as much as 67.6% YoY.


Polish Strategy LPP July 2010

111

Newsflow

Date Description

27 Aug 2010 Publication of 1H10 results 10 Sep 2010 Dividend record date 4 Oct 2010 Dividend payment date 10 Nov 2010 Publication of 3Q10 results


Major shareholders (%) equity/votes

Marek Piechocki, CEO, founder 18.53/32.53Jerzy Lubianiec, founder 12.93/29.4Grangefont 20.00/11.11Treasury shares 1.22/0.68


Share data

Avg daily volume (3-mth) 507.0Free float (%) 47.3Market cap (PLNm) 2,985.8Net debt (1F, PLNm) 159Enterprise value (1F, PLNm) 3,145Dividend yield (1F, %) 2.9



1,3001,4001,5001,6001,7001,8001,9002,0002,100

7/09 9/09 11/09 1/10 3/10 5/10


Source: ING

Company profile

LPP is one of the largest clothing retailers in Poland.Aside from Poland, LPP has stores in several foreigncountries: Czech Rep., Slovakia (franchise only),Hungary, Russia, Ukraine, Lithuania, Latvia, Estonia, Bulgaria and Romania. Following the merger withArtman, the group operates five brands: Reserved(mainstream general brand), Cropp and House(brands for teenagers), Esotiq (underwear) andMohito (mainstream brand for women). The majorityof clothes are sourced from China. In 2Q10, the grouphad 875 stores and 299,412m2 of floorspace.

Risks

Downside risk lies in the economy, which could showfurther negative trends in consumption. A second negative lies in FX, as LPP’s earnings could suffer ifthere is a strong depreciation of the zloty against the US$ and/or euro.

Financials


Income statement

Revenues 1,274 1,623 2,003 2,157 2,452 2,783EBITDA 225 281 277 340 380 424EBIT 175 215 181 243 277 322Net interest (6) (18) (28) (24) (20) (20)Associates 0 0 0 0 0 0Other pre-tax items (3) 16 (14) 0.4 0.0 (0.4)Pre-tax profit 166 213 139 219 257 301Tax (31) (46) (35) (44) (51) (60)Minorities 0 0.0 0 0 0 0Other post-tax items 0 0.0 (0.1) 0 0 0Net profit 135 167 105 176 206 241Normalised net profit 142 169 105 176 206 241

Balance sheet

Tangible fixed assets 258 469 442 443 435 429Intangible fixed assets 12 275 274 275 276 277Other non-current assets 18 23 24 26 29 33Cash & equivalents 56 90 198 216 295 334Other current assets 354 569 424 438 505 584Total assets 697 1,426 1,362 1,398 1,540 1,658Short-term debt 57 247 82 102 179 213Other current liabilities 190 280 240 237 262 297Long-term debt 28 306 343 273 203 133Other long-term liabilities 16 28 11 11 13 15Total equity 406 565 686 775 884 1,001Total liabilities & equity 697 1,426 1,362 1,398 1,540 1,658Net working capital 160 284 176 193 235 277Net debt (cash) 29 463 227 159 87 11

Cash flow

Cash flow EBITDA 225 281 277 340 380 424Tax, interest & other 103 122 102 125 145 164Change in working capital (42) (67) 126 (19) (46) (47)Net cash from op activities 173 195 318 268 285 319Capex (98) (253) (95) (90) (96) (98)Net acquisitions 0 (331) 0 0 0 0Net financing cash flow (53) 418 (139) (74) (16) (60)Dividends & minority distrib'n 0 0 0 (86) (97) (123)Net ch in cash & equivalents 23 36 108 18 78 40FCF 75 (57) 223 178 189 221


Revenue growth (%) 56.3 27.4 23.4 7.7 13.7 13.5Normalised EPS growth (%) 260.0 19.5 -39.0 67.5 16.9 16.7Normalised EBITDA mgn (%) 18.3 17.4 13.8 15.8 15.5 15.2Normalised EBIT margin (%) 14.4 13.3 9.0 11.2 11.3 11.6ROACE (%) 41.0 26.9 16.3 21.5 23.0 24.6Reported ROE (%) 39.8 34.5 16.7 24.0 24.8 25.5Working capital as % of sales 12.6 17.5 8.8 8.9 9.6 10.0Net debt (cash)/EBITDA (x) 0.13 1.6 0.82 0.47 0.23 0.03EBITDA net interest cvg (x) 36.3 15.9 10.0 14.4 18.7 20.7

Valuation


Per share data



Polish Strategy NG2 July 2010

112

NG2 Previously Hold

Focused on ambitious targets BuyPoland Market cap PLN2,096.6mRetail Bloomberg CCC PW

The NG2 shares have been a stable performer over the past month. As we expect to see more favourable trends in mainstream consumption in 2H10 and with an outlook for good 2Q10 numbers, we upgrade the stock to BUY with a new DCF-based 12-month forward target price of PLN62.6.

Investment case NG2 continues to focus its growth strategy on organic development in the domestic market, as its Czech operations are unlikely to reach a material scale within the next few years. The revised long-term plans show the target number of shops at 1,070 (1,000 in Poland) versus 1,490 previously, due to concentration on larger towns. The plans encompass: 400 CCC stores in Poland (100 franchise), 70 CCC stores in Czech Republic, 100 Quazi stores and 500 Boti stores (100 franchise). The medium-term targets are even more ambitious. NG2 wants to have a 20% share in the shoe market in Poland in 2012 (c.PLN1.8bn sales) versus a current market share of c.11%. We expect a 2012 market share of 15%, leaving upside potential. This implies a 2009-12F sales CAGR of 13%.

NG2’s operating margins are the highest among the general retailers we cover and we believe this is likely to be maintained, as NG2 also has its own – albeit limited – production facilities. The operating cost structure seems lean, thus we believe that margin expansion could only come from the operating leverage effect. We also point out that slower expansion should positively impact the EBIT margin as the proportion of new shops in the overall number of stores should be lower and thus lessen the burden on profitability. Overall, we expect 2010-12 cumulative net earnings adjusted for the impact of the stock option plan ofPLN472m, which is above the minimum target of PLN450m needed to trigger the management stock option plan (but this includes the impact of the tax optimisation policy).

In order to secure medium-term shop expansion, NG2 is makinginvestments in the back office. NG2 has started the construction of a new logistics centre which should become operational in November 2011. The overall cost should reach PLN97m, but PLN38.8m is to be financed from EU subsidies. The logistics centre is going to be financed from its own cash proceeds and bank debt. We do not believe that the usage of the approved upto 10% equity issuance (issuance price at three-month average) will be needed. However, we point out that ahead of the investment cycle a moderate dividend of PLN1 per share (versus DPS of PLN1-2 signalled) will be paid in 2010.

At 16.4x 2010F PER, NG2 trades at a 15% discount to its domestic peers. We do not believe a discount is warranted given it has the highest margins in the sector. We expect the macro environment in Poland in 2010 to be more favourable for mainstream retailers such as NG2. There is a risk that the CEO will continue to reduce his stake.

Price (19/07/10) PLN54.60



Quarterly preview We expect NG2 to report good 2Q10 numbers on 31 August. 2Q10 sales of PLN245m have been announced. These represent a 4% YoY contraction, showing the impact of the slowdown. We expect the gross profit to improve, as a result of past appreciation of the zloty versus US$ and bulk discounts, from c.54% in 2Q09 to c.57% in 2Q10. We expect SG&A costs to come in at c.39% of sales in 2Q10 versus 37.6% in 2Q09, as we expect PLN2.2m of additional taxes from the Swiss operations to be booked. Assuming PLN1m of FX gains, we expect group EBIT of PLN42.9m, up 9.4% YoY. We expect a PLN18.7m one-off tax asset to be recognised. We forecast reported 2Q10 earnings of PLN51.9m, with adjusted earnings at PLN35.1m, up 14% YoY.


2Q09 2Q10F



Earnings drivers and outlook We believe that in 2010 NG2 will exceed the threshold of PLN1bn in revenues. We expect 2010 sales of PLN1,061.9m, up 15% YoY. We have factored in that NG2 plans to slow its expansion in 2010. For 2010 we assume the closure of 11 franchise stores (eight at CCC and three at Boti). We assume the opening of 20 company-owned stores CCC in Poland and ten in the Czech Republic, five new CCC franchise stores, ten new Quazi stores, 40 new company-owned Boti stores and two new franchise Boti stores. Thus, at the end of 2010 NG2 should have 768 stores with 167,000m² of floorspace. We forecast that the CCC brand will remain the most important (Polish operations stronger than Czech ones), with Boti and Quazi being of lesser importance.

We expect the gross profit margin to improve to 54.6% in 2010 from 52.2% in 2009. Expanding gross profit, coupled with SG&A costs under control, should make the operating leverage work in favour of the company. As a result, we expect the reported EBIT margin to grow to 15.3% in 2010F, from 11.7% in 2009. An improvement on the operating line triggers growth on the bottomline. We forecast 2010 reported earnings of PLN141.5m, up 69% YoY. We forecast earnings adjusted for the impact of tax issues and the stock option programme at PLN128.2m, up 53% YoY. The increase in our DCF comes from new macro assumptions.


Polish Strategy NG2 July 2010

113

Newsflow

Date Description

31 Aug 2010 Publication of 1H10 results 10 Sep 2010 Dividend record date 27 Sep 2010 Dividend payment date 15 Nov 2010 Publication of 3Q10 results


Major shareholders (%) equity/votes

Dariusz Milek, CEO 44.92/48.84Leszek Gaczorek 10.94/13.21ING pension fund 6.45/5.5Pioneer funds 8.52/7.26


Share data




35

40

45

50

55

60

7/09 9/09 11/09 1/10 3/10 5/10


Source: ING

Company profile

NG2 is the largest Polish retailer, importer andproducer of footwear. The company operates mostlyin Poland, where it has three brands: the mainstreamCCC, upper market Quazi and low end Boti. The onlyforeign operations are based in the Czech Republic.NG2 operates both company-owned and franchisestores. At end-2Q10 NG2 had 706 stores in Poland:329 CCC stores, 49 Quazi stores and 288 Boti storeswhile in the Czech Republic there were 40 CCCstores. In 2009 own factory supplied 17% of goods. In2009 NG2 sold 15.4m pairs of shoes (55.8% women,27.5% children, and remainder to men).

Risks

Downside risk lies in the economy and in consumerspending. A second downside risk would be a sharp zloty depreciation against US$ and euro, which would hurt operating margins (via growing COGS andrentals). A third risk is the further sale of shares by theCEO.

Financials


Income statement

Revenues 544 754 922 1,062 1,181 1,317EBITDA 72 145 127 179 226 265EBIT 63 132 108 162 208 241Net interest (4) (9) (7) (8) (9) (8)Associates 0 0 0 0 0 0Other pre-tax items (1) (0.7) (1) (1) (0.9) (0.9)Pre-tax profit 58 122 100 153 199 233Tax (11) (20) (16) (12) (40) (47)Minorities 0 0 0 0 0 0Other post-tax items 0 0 0 0 0 0Net profit 48 102 84 141 158 186Normalised net profit 48 102 84 128 165 193

Balance sheet

Tangible fixed assets 127 177 203 246 258 254Intangible fixed assets 0.3 1 1 5 6 6Other non-current assets 4 6 6 7 8 9Cash & equivalents 11 15 61 95 120 184Other current assets 185 292 280 409 458 512Total assets 327 492 551 762 850 965Short-term debt 82 96 40 156 147 146Other current liabilities 47 85 88 100 110 123Long-term debt 0.2 13 80 60 45 34Other long-term liabilities 4 3 3 3 3 3Total equity 193 295 340 443 545 659Total liabilities & equity 327 492 551 762 850 965Net working capital 137 204 190 306 345 385Net debt (cash) 71 93 59 121 72 (5)

Cash flow

Cash flow EBITDA 72 145 127 179 226 265Tax, interest & other 13 30 17 21 50 56Change in working capital (29) (82) 21 (117) (40) (42)Net cash from op activities 31 44 125 50 146 176Capex (39) (58) (46) (64) (30) (19)Net acquisitions 0 0 0 0 0 0Net financing cash flow 59 19 4 86 (34) (23)Dividends & minority distrib'n (38) 0 (38) (38) (57) (71)Net ch in cash & equivalents 2 4 46 34 25 64FCF (8) (15) 78 (15) 115 157


Revenue growth (%) 35.8 38.5 22.3 15.1 11.2 11.5Normalised EPS growth (%) -10.5 115.0 -18.4 53.3 28.8 16.6Normalised EBITDA mgn (%) 13.3 19.2 13.7 17.3 19.6 20.5Normalised EBIT margin (%) 11.6 17.5 11.7 15.8 18.1 18.7ROACE (%) 26.3 38.9 25.0 29.9 30.6 31.3Reported ROE (%) 25.3 42.0 26.3 36.1 32.0 30.8Working capital as % of sales 25.2 27.0 20.6 28.8 29.2 29.3Net debt (cash)/EBITDA (x) 0.98 0.64 0.47 0.68 0.32 (0.02)EBITDA net interest cvg (x) 19.1 16.1 18.0 23.3 25.8 33.6

Valuation


Per share data



Polish Strategy Vistula Group July 2010

114

Vistula Group Previously Buy

NWC in the spotlight HoldPoland Market cap PLN292.20mPersonal & Household Goods Bloomberg VST PW

Vistula’s management has done a good job in reducing costs. However, with increased floorspace and high debt, the company is now trying to find financing for the increased scale of operations at debtholders, which may put pressure on its credit premium. With a new DCF-based target price of PLN2.7, we downgrade the stock to HOLD.

Investment case During the past two years Vistula Group has undergone sizeable changes. The merger with W.Kruk Group, which added jewellery and upmarket women’s clothing, pushed the group’s positioning further towards the higher-end of the market. To counteract this,the current management took action to lower the positioning of the Vistula and Wolczanka brands, in order to make them less susceptible to the slowdown. The strongest underperformance,however, took place at the megastore Galeria Centrum (GC) brand, which is currently under Chapter 7. We believe that due to its up-market positioning, more positive trends in sales are likely to emerge in 2011.

Long-term financing no longer seems to be a burning issue for Vistula Group. At the end of July 2009, Vistula Group signed a long-term bank loan agreement with Fortis Bank, which allows the company to repay PLN198m of debt and €4m in guarantees by 5 January 2018. The remaining PLN50m is to be repaid by 5 January 2012. This was supported by Fortis Bank itself acquiring 8.25m of new issuance shares at PLN4.85 (far above the current market price). The PLN40m obtained in the issuance was used to reduce debt and Fortis Bank is now a c.7% shareholder. With the increased scale of operations (especially these of W.Kruk), Vistula is now looking for PLN50m of debt financing in order to pay another crediting bank and finance the inventory acquisition for December. Although we believe this is likely to be successful, it could also raise the credit premium.

To motivate management and key employees, the AGM agreed to issue 5.4m shares based on share performance and financial results. The share price targets were set for December 2009, 2010 and 2011 at PLN3, PLN4 and PLN4.5, respectively. 2010 targets imply net earnings of c.PLN28m.

We believe that as long as Alma Market (the WSE-listed upmarket delicatessen network and franchise of luxury brands) remains a shareholder (9.3% stake), the market will speculateabout a potential merger between these two players, with the idea of creating a diversified holding.

On a 2010F PER of 23.4x, Vistula Group trades at a 21% premium to its domestic peers. Given the expectations for a recovery in distressed earnings and our forecasts being strongly below management targets for 2010-11F, we do not believe that the PER itself is the best multiple to look at. The cut in our DCF comes from factoring in lower-than-expected 1H10 sales.

Price (19/07/10) PLN2.59



Quarterly preview We expect Vistula Group to report decent 2Q10 results on 31 August. We forecast 2Q10 sales of PLN87.5m, down 11% YoY, with the fall showing the impact of the economic slowdown on upmarket brands, especially the jewellery brand W.Kruk. We expect only a moderate gross profit margin improvement, due to favourable FX relationships in the past and less intensive sell-offs, from 55.5% in 2Q09 to 56.6% in 2Q10. We assume PLN1m one-off charges related to the liabilities of Galeria Centrum (under Chapter 7). We forecast EBIT of PLN7.5m, down 74% YoY, but up 52% YoY on an adjusted basis. Assuming negative net financial activity, PLN1.5m of FX losses and the statutory tax rate, we expect reported net earnings of PLN0.4m, down 98% YoY. We expect adjusted earnings of PLN1.4m in 2Q10 versus PLN1m in 2Q09.


(PLNm) 2Q09 2Q10F



Earnings drivers and outlook We forecast 2010 group revenues of PLN372.2m, down 9% YoY. The fall results from the lack of consolidation of GC, which is now under Chapter 7, and which in 1Q09 added PLN30.5m to group sales. On a comparable basis we expect a 2% YoY fall. In line with management statements, we assume the opening of 15 new stores, which translates into eop floorspace of 25,800m², up 4% YoY. In our forecasts we assume that the jewellery brand W.Kruk will remain the biggest contributor (at PLN151.4m), followed by Vistula (PLN93m) and Deni Cler (PLN46.7m). The fall also results from expectations of reduced revenues from licence brands, wholesale and exports.

We expect the group’s gross profit margin to improve in 2010 to 55.1%, versus 51.5% in 2009. With reductions in SG&A costs we expect group EBIT of PLN30.3m in 2010, with adjusted EBIT ofPLN32.5m versus PLN5m in 2009. We believe that in 2010, like in 2009, the financial line will constitute a sizeable charge against earnings. We expect reported net earnings of PLN10.2m in 2010, with adjusted earnings at PLN12.3m versus a loss of PLN11.6m in 2009. Our expectations are below management targets.


Polish Strategy Vistula Group July 2010

115

Newsflow

Date Description

31 Aug 2010 Publication of 1H10 results 15 Nov 2010 Publication of 3Q10 results



PZU pension fund 17.85ING pension fund 9.66W.Kruk and family 9.30Alma Market 9.25Fortis Bank 7.30


Share data

Avg daily volume (3-mth) 100,623Free float (%) 81.5Market cap (PLNm) 292.20Net debt (1F, PLNm) 222Enterprise value (1F, PLNm) 514Dividend yield (1F, %) 0.0



2.02.22.42.62.83.03.23.4

7/09 9/09 11/09 1/10 3/10 5/10


Source: ING

Company profile

Vistula Group is an up-market retailer, whosebusiness model is oriented on: i) jewellery, with 63stores W.Kruk stores, ii) 30 Deni Cler stores, up-market women clothing, and iii) Vistula andWolczanka (V&W) brands, offering mainstream toupper-market men formalwear. At end of 2Q10, thecompany had 234 shops with 23,725m2 of floorspace.Galeria Centrum is now under Chapter 7 protection.Vistula Group is a restructuring story, with thecompany almost going bankrupt in 2009, due toexcessive debt taken for expensive W.Krukacquisitions.

Risks

We see upside risk from a rebound in the economy,while downside in: (1) PLN depreciation versus the euro; (2) a possible merger with Alma Market; and (3) possible issuance (the debt remains high andmanagement may be tempted to issue shares,especially if there is a rally in the stock price).

Financials


Income statement

Revenues 412 505 408 372 394 426EBITDA 73 (110) 58 46 55 66EBIT 59 (130) 40 30 38 50Net interest (0.6) (21) (27) (20) (20) (20)Associates 0 0 0 0 0 0Other pre-tax items 6 (7) (2) 2 0.4 (0.1)Pre-tax profit 64 (159) 11 13 19 31Tax (5) (0.7) 6 (2) (4) (6)Minorities 0 0 0 0 0 0Other post-tax items 0 0 0 0 0 0Net profit 59 (159) 17 10 15 25Normalised net profit 22 (8) (12) 12 18 25

Balance sheet

Tangible fixed assets 86 128 81 86 89 93Intangible fixed assets 158 363 363 365 364 364Other non-current assets 10 15 20 17 17 18Cash & equivalents 64 28 21 11 12 20Other current assets 166 268 166 151 157 168Total assets 484 802 651 630 639 663Short-term debt 15 317 46 23 40 53Other current liabilities 106 109 57 49 53 60Long-term debt 30 43 206 210 180 155Other long-term liabilities 10 96 45 41 44 47Total equity 322 238 297 307 323 347Total liabilities & equity 484 802 651 630 639 663Net working capital 58 155 109 102 103 107Net debt (cash) (19) 331 231 222 208 188

Cash flow

Cash flow EBITDA 73 (110) 62 47 55 67Tax, interest & other (61) 148 (59) 16 25 29Change in working capital (8) (30) 47 9 (1) (5)Net cash from op activities (0.9) (22) 29 49 52 59Capex (37) (44) (20) (15) (18) (19)Net acquisitions 0 (295) 0 0 0 0Net financing cash flow 3 290 (19) (37) (35) (33)Dividends & minority distrib'n 0 0 0 0 0 0Net ch in cash & equivalents (17) (37) (6) (2) 0.7 8FCF (38) (66) 9 33 34 39


Revenue growth (%) 127.6 22.6 -19.1 -8.9 5.9 8.0Normalised EPS growth (%) 207.2 n/a n/a n/a 41.5 40.4Normalised EBITDA mgn (%) 7.5 8.9 5.6 12.9 14.4 15.6Normalised EBIT margin (%) 4.0 4.8 1.2 8.7 10.3 11.8ROACE (%) 5.0 5.1 0.88 6.0 7.5 9.2Reported ROE (%) 20.2 -57.0 6.3 3.4 4.9 7.4Working capital as % of sales 14.0 30.7 26.7 27.5 26.2 25.2Net debt (cash)/EBITDA (x) (0.26) n/a 4.0 4.9 3.8 2.8EBITDA net interest cvg (x) 114.2 n/a 2.1 2.3 2.8 3.4

Valuation

EV/revenue (x) 0.66 1.2 1.3 1.4 1.3 1.1EV/normalised EBITDA (x) 8.9 13.9 23.1 10.7 8.8 7.2EV/normalised EBIT (x) 16.8 25.5 103.9 15.8 12.3 9.5Normalised PER (x) 9.3 n/a n/a 23.4 16.6 11.8Price/book (x) 0.65 0.96 0.97 0.95 0.91 0.84Dividend yield (%) 0.0 0.0 0.0 0.0 0.0 0.0FCF yield (%) n/a n/a 1.7 6.5 6.8 8.2

Per share data

Reported EPS (PLN) 0.748 (1.97) 0.165 0.091 0.137 0.219Normalised EPS (PLN) 0.277 (0.096) (0.113) 0.110 0.156 0.219Dividend per share (PLN) 0.00 0.00 0.00 0.00 0.00 0.00Equity FCFPS (PLN) (0.484) (0.816) 0.088 0.298 0.299 0.349BV/share (PLN) 4.01 2.70 2.66 2.72 2.86 3.08



116



117

Technology

Polish Strategy Asbis July 2010

118

Asbis Previously Buy

Beware of FX HoldPoland Market cap PLN233.10mTechnology Bloomberg ASB PW

The Asbis share price has been a stable performer over the past month. Factoring in less favourable FX, along with depreciation of local currencies versus the US dollar, we downgrade our rating to HOLD with a new DCF-based target price of PLN4.6.

Investment case Asbis business model is a multi-country one. After 19 years of existence, Asbis is servicing some 30,000 active customers in 75 countries. Of four regions present, CEE was the most important in 2009 (39.4% of sales), outpacing the CIS region (32.1% of sales) that has been more affected by economic slowdown. In 2009, exposure to low-growth Western Europe remained limited (9.5% of sales), but exposure to high-growth Middle East and Africa should reach 15.7%. We believe that in 2010, CIS is likely to develop at a far quicker pace than CEE, with both regions having similar 35%/36.5% stakes respectively.

We believe that organic growth is the preferred method of development for Asbis, in both existing and new markets. We expect Asbis to concentrate on: (1) strengthening private labels; and (2) broadening its product portfolio. On both private labels, Canyon and Prestigio, Asbis aims to sell higher margin products. At the Prestigio brand, the company is changing the product offering, moving away from more premium and sophisticated products to simpler solutions. The management’s long-term target is 10% of private labels in sales.

An improvement in product offering is taking place in several ways. First, new distribution agreements with hardware producers have been signed, with Western Digital, Lenovo and Apple being the most important. The aim of these agreements is to increase the contribution of A-branded finished goods in sales. Second, Asbis is working on expanding the distribution of software (here, contracts with Microsoft were signed). Both these actions should translate into improvement in the gross profit margin. We expect the product portfolio to continue to be augmented in 2010. We do not assume any acquisitions in our model. Although Asbis seems to be open to discussion, we see no acquisitions materialising shortly.

We expect a sizeable earnings recovery at Asbis in 2010, from a US$3.2m loss in 2009 to US$5.9m profit. The key reason behind the growth should be: (1) a rebound in demand, especially in the CIS, Slovakia and MEA regions; (2) the full-year impact of cost reductions conducted in 2009. However, we reduce our earnings estimates from US$8.9m, after factoring in less favourable FX assumptions.

On a 2010F PER of 12.4x, Asbis trades in line with its domestic peers, but a discount appears on 2011F multiples. It looks more attractive on other valuation measures, such as EV/sales (0.06x in 2010F, 54% discount) or P/BV (0.75x in 2010F, 29% discount), although we believe these are offset by sizeable FX risk.

Price (19/07/10) PLN4.20



Quarterly preview We expect Asbis to post mediocre 2Q10 numbers on 11 August. We expect sales of US$285.1m, up 23.3% YoY, due to an expected rebound in CIS and an improved performance in CEE and MEA. We expect CEE and CIS to be the biggestcontributors, with sales of US$92.7m (up 42% YoY) and US$102m (up 13% YoY) respectively. We assume PLN1m in FX losses, and thus expect a gross profit margin of 4.7% in 2Q10 versus 5.1% in 2Q09 (but flat YoY after adjusting for FX). After the SG&A cuts, we expect 1Q10 EBIT of US$0.7m (up 71% YoY). We expect a net loss of US$0.7m in 2Q10 versus a loss of US$0.3m in 2Q09 (tax asset in the base).


(US$m) 2Q09 2Q10F

Sales 231.3 285.1EBITDA 1.1 1.5EBIT 0.4 0.7Net income (0.3) (0.7)


Earnings drivers and outlook We expect 2010 revenues of US$1,304.9m, up 12.3% YoY. We expect CEE to lead with 2010 sales of US$476m, due to a strong performance in Slovakia and the Czech Republic, but the CIS countries should follow closely (at US$457m) due to a rebound visible in Russia and Ukraine. Western Europe should remain the smallest contributor (2010 sales of US$111m), while MEA should continue to develop at a fast pace (sales of US$183m), supported by Turkey. We expect private labels to reach 6.4% of 2010 sales, up from 5% in 2009.

We expect gross profit margin of 4.9% in 2010, up from 4.6% in 2009, with the positive effect of higher contribution of private labels, and higher expected margins at both private labels and mainstream products, partially offset by US$2m in assumed FX losses. We expect the SG&A expense ratio to improve from 4.3% in 2009 to 4.1% in 2010, following the inclusion of the full-year impact of cost reductions made in 2009 (mostly HR costs and the closure of the Amsterdam distribution centre). We expect 2010 EBIT of US$11.4m versus US$3.6m in 2009.

We expect 2010 net earnings of US$5.9m, with the growth being a consequence of operating margin expansion. The cut in our target price results from a reduction in earnings, caused by assuming a less favourable FX environment.


Polish Strategy Asbis July 2010

119

Newsflow

Date Description




KS Holdings Ltd (CEO) 46.26Maizuri Enterprises Ltd 8.65Alpha Ventures 5.77Yurij Ulasovich (key manager) and his wife 5.05


Share data

Avg daily volume (3-mth) 8,395Free float (%) 34.3Market cap (PLNm) 233.10Net debt (1F, US$m) 9Enterprise value (1F, US$m) 83Dividend yield (1F, %) 0.0



1.52.02.53.03.54.04.55.05.5

7/09 9/09 11/09 1/10 3/10 5/10


Source: ING

Company profile

Asbis is an IT distributor with wide EMEA coverage:CEE, CIS, Western Europe, MEA. The group ispresent in 75 countries, of which the key ones areRussia, Slovakia, Ukraine, Cz. Rep., Belarus, UAE,Saudi Arabia and Qatar. Asbis is a complex providerof servers, PCs and laptops, but also components andperipherals. Asbis offers solutions from globalcompanies such as Intel, AMD, Seagate, Samsungand Microsoft, and two private labels, Canyon andPrestigio. The group attempts to be a “one-stop-shop” for its customers. Apart from its Cyprus headquarters,Asbis has 33 warehouses.

Risks

The upside risk to our rating comes from the macrosituation (especially retail and corporate demand forhardware); the downside risk is from FX exposure, with Asbis being affected by the depreciation of regional (CEE, CIS) currencies versus the US$.

Financials

Year end Dec (US$m) 2007 2008 2009 2010F 2011F 2012F

Income statement

Revenues 1,397 1,495 1,162 1,305 1,386 1,466EBITDA 28 19 6 14 17 18EBIT 26 16 4 11 14 15Net interest (5) (7) (6) (5) (4) (3)Associates 0 0 0 0 0 0Other pre-tax items 0.1 (2) (0.4) 0.5 0.2 0.2Pre-tax profit 21 7 (3) 7 10 11Tax (3) (3) (0.2) (0.9) (2) (2)Minorities 0 (0.1) (0.2) (0.2) (0.4) (0.4)Other post-tax items 0 0 0 0 0 0Net profit 19 4 (3) 6 8 9Normalised net profit 19 4 (3) 6 8 9

Balance sheet

Tangible fixed assets 16 24 25 26 27 28Intangible fixed assets 1 2 3 3 4 4Other non-current assets 0.1 0.2 0.6 0.6 0.7 0.7Cash & equivalents 45 41 53 13 17 23Other current assets 303 295 305 281 295 311Total assets 366 363 386 323 344 367Short-term debt 41 54 36 20 21 22Other current liabilities 221 204 251 199 211 224Long-term debt 2 5 4 2 1 0.8Other long-term liabilities 6 4 4 5 5 5Total equity 96 95 91 97 106 115Total liabilities & equity 366 363 386 323 344 367Net working capital 83 88 54 81 84 87Net debt (cash) (2) 18 (13) 9 5 0.6

Cash flow

Cash flow EBITDA 28 19 6 14 17 18Tax, interest & other 4 0.4 14 1 2 2Change in working capital (21) (5) 21 (27) (2) (3)Net cash from op activities 1 (0.6) 34 (17) 10 10Capex (8) (14) (5) (5) (5) (5)Net acquisitions 0.0 (0.7) 0 0 0 0Net financing cash flow 24 1 (7) (18) (0.3) 1Dividends & minority distrib'n (1.0) (3) 0 0 (0.3) (0.4)Net ch in cash & equivalents 16 (16) 24 (40) 4 5FCF (7) (15) 29 (22) 5 4


Revenue growth (%) 38.5 7.0 -22.3 12.3 6.2 5.8Normalised EPS growth (%) 99.6 -81.6 n/a n/a 41.7 10.5Normalised EBITDA mgn (%) 2.0 1.2 0.56 1.1 1.2 1.2Normalised EBIT margin (%) 1.9 1.0 0.31 0.87 1.0 0.99ROACE (%) 22.3 10.7 2.5 9.0 11.2 11.0Reported ROE (%) 24.0 4.2 -3.5 6.2 8.2 8.4Working capital as % of sales 5.9 5.9 4.7 6.2 6.0 5.9Net debt (cash)/EBITDA (x) (0.08) 0.96 (2.0) 0.65 0.27 0.03EBITDA net interest cvg (x) 5.9 2.7 1.1 2.9 4.4 5.2

Valuation

EV/revenue (x) 0.05 0.06 0.05 0.06 0.06 0.05EV/normalised EBITDA (x) 2.5 4.9 9.3 5.8 4.6 4.2EV/normalised EBIT (x) 2.7 5.8 16.7 7.3 5.6 5.1Normalised PER (x) 3.3 18.1 n/a 12.4 8.8 7.9Price/book (x) 0.66 0.77 0.80 0.75 0.70 0.64Dividend yield (%) 1.5 4.6 0.0 0.0 0.40 0.57FCF yield (%) n/a n/a 48.9 n/a 6.2 6.0

Per share data

Reported EPS (US$) 0.389 0.072 (0.058) 0.106 0.150 0.165Normalised EPS (US$) 0.394 0.072 (0.058) 0.106 0.150 0.165Dividend per share (US$) 0.020 0.060 0.00 0.00 0.005 0.007Equity FCFPS (US$) (0.147) (0.264) 0.530 (0.400) 0.087 0.081BV/share (US$) 1.99 1.71 1.64 1.75 1.89 2.05


Polish Strategy Asseco Business Solutions July 2010

120

Asseco Business Solutions Maintained

Strong outlook for 2Q10F BuyPoland Market cap PLN307.45mTechnology Bloomberg ABS PW

ABS’s share price has fallen 9% over the past three months, underperforming the WIG index by 3.5ppt. We find such a mediocre performance unwarranted. With a strong outlook for 2Q10 we maintain our BUY rating with a DCF-based TP of PLN10.5.

Investment case Despite the double-digit growth expected in the Polish ERP market in the medium term, the market was difficult in 2009 and the situation is improving only gradually in 2010, as IT is not the core of small and medium companies’ businesses. Nonetheless, we believe that ABS should remain a strong player, due to its diversification into Oracle and Microsoft software and synergies offered by Anica’s SFA products. According to ComputerWorld Top200 in 2008, ABS was the second-biggest ERP company in Poland, coming after SAP but ahead of Oracle. For 2009 the statistics show only ERP revenues (we think rather licences) and ABS ranks seventh.

In our forecasts suggesting 2009-12F revenues and earnings CAGRs of 3.5% and 6.4%, respectively, we do not take into account the impact of new products. ABS has recently implemented new solutions for factoring companies (the market for which is estimated at PLN20m). New solutions for the Softlab system are prepared, with new interfaces, web access and budgeting functionality. We note that there is also potential upside to our forecasts from intra-group transactions, as the ABS Softlab ERP system is to be the primary solution for the entire Asseco group. In the first stage the focus could be on unifying the accounting solutions used by Asseco group. The first foreign implementation should take place at Asseco DACH. Once the implementation is successful, further contracts could follow, with Asseco SEE and Asseco Spain being the most likely candidates.

Despite paying out a record high PLN25m dividend in 2010, we believe that ABS’s cash position should remain strong. We expect normalised dividend payments from 2010 earnings, as we believe that the cash generated is likely to be used for acquisitions. ABS has stated that it is looking for software producers, whose products would be complementary rather than competitive versus its own solutions. ABS has said it is looking at several small and medium-sized players. We consider M&A likely in 2011. We also believe that in future Asseco will have a group ERP division similar to current attempts to create a regional banking pillar. We think that preliminary work on stronger integration of the ERP divisions within Asseco group (ERP software is in Czech, Slovakia and Germany) may start around the end of 2010.

On a 2010F PER of 12.3x ABS trades at a 2% discount to its domestic peers, which grows in 2011F. We believe that ABS deserves to trade at a premium to its peers, due to its focus on software and resultant superior operating margins.

Price (19/07/10) PLN9.20



Quarterly preview We expect ABS to post strong 2Q10 figures on 19 August. We forecast group sales of PLN38m, up 1%. We believe that the revenue split should improve YoY. We expect ERP revenues of PLN32.5m, up 7.6% YoY, in 2Q10, while we expect the reduction to take place in outsourcing and other revenues along with ABS’s policy of concentrating on higher-margin software solutions. We believe that an improved sales mix should allow for some gross profit margin expansion, despite the ERP segment being competitive. We expect the gross profit margin to be 30.7% in 2Q10 vs 30.0% in 2Q09. Factoring in cost reductions, we expect SG&A costs to come in at 13.5% of sales vs 18% in 2Q09. We expect EBIT of PLN6.6m, up 34.5% andearnings of PLN5.6m, up 35.3% YoY on 2Q09.


(PLNm) 2Q09 2Q10F



Earnings drivers and outlook

We forecast ABS 2010 sales of PLN155.8m, flat YoY, with 90% of revenues coming from ERP and the salesforce application systems. We believe that ERP revenues should be fuelled by investments in the partner network for the box-type WA-PRO solutions as well as by an upgraded product offering (eg, the improvement in the factoring applications as well as upgrades in the core Softlab system).

We believe that by concentrating on higher-margin software and cost restructuring, ABS has the potential to record above-average margins. We expect the gross profit margin to expand to 33.2% in 2010 from 32.4% in 2009. We expect SG&A to come in at PLN22m, down 10% YoY, in 2010. We do not expect any negative effects related to the move to new offices in Lublin. We expect 2010 EBIT of PLN30m, up 12% YoY, implying an EBIT margin of 19.2% in 2010 versus 17.1% in 2009.

We forecast 2010 net earnings of PLN25m, up 12%. As our numbers are above consensus, we would expect the latter to continue to upgrade.


Polish Strategy Asseco Business Solutions July 2010

121

Newsflow

Date Description




Asseco Poland 46.47Amplico pension fund 10.37Mr. Wojciech Barczentewicz 3.0Mr. Piotr Maslowski 2.8Mr. Romuald Rutkowski 1.3Mr. Mariusz Lizon 0.7


Share data

Avg daily volume (3-mth) 3,445Free float (%) 53.5Market cap (PLNm) 307.45Net debt (1F, PLNm) (40)Enterprise value (1F, PLNm) 268Dividend yield (1F, %) 8.2



6

7

8

9

10

11

7/09 9/09 11/09 1/10 3/10 5/10


Source: ING

Company profile

Asseco Business Solutions is one of the largestdomestic ERP companies. ABS is 46.5% owned byAsseco Poland, and was created from the merger offive companies: Incenti, Safe, Softlab, WAPRO andAnica Systems. The company has both Oracle andMicrosoft platform-oriented products and salesforceapplications. The company employs 660 people.

Risks

We believe ABS’ biggest risk lies in the economy. TheERP segment was among the hardest hit and the riskis that SMEs will take time to recover and investmentsin IT will not be a priority. Secondly, acquisition riskexists – even though management has proven that itis able to consolidate businesses. Thirdly, we see a risk that Asseco Poland could in future be interestedin delisting ABS.

Financials


Income statement

Revenues 96 168 156 156 164 173EBITDA 20 39 37 40 42 43EBIT 15 29 27 30 31 33Net interest 0 0.4 0.9 0.8 0.7 0.5Associates 0 0 0 0 0 0Other pre-tax items 0.4 0.6 0.4 0.3 0.3 0.3Pre-tax profit 15 30 28 31 32 33Tax (1) (6) (6) (6) (6) (6)Minorities (0.7) (1) 0 0 0 0Other post-tax items 0 0 0 0 0 0Net profit 13 23 22 25 26 27Normalised net profit 13 23 22 25 26 27

Balance sheet

Tangible fixed assets 18 18 18 18 20 21Intangible fixed assets 132 181 182 182 182 182Other non-current assets 2 3 1 1 2 2Cash & equivalents 20 34 49 43 54 60Other current assets 44 48 38 39 42 46Total assets 215 284 289 284 299 311Short-term debt 0.6 0.8 0.6 3 6 8Other current liabilities 25 21 20 17 17 18Long-term debt 1 2 0.8 0.8 0.8 0.8Other long-term liabilities 9 10 8 4 4 4Total equity 180 251 259 259 270 280Total liabilities & equity 215 284 289 284 299 311Net working capital 18 26 18 21 24 27Net debt (cash) (18) (32) (48) (40) (46) (52)

Cash flow

Cash flow EBITDA 20 39 37 40 42 43Tax, interest & other 2 4 8 5 6 6Change in working capital (5) (4) 4 (7) (3) (3)Net cash from op activities 14 28 39 27 33 34Capex (6) (14) (10) (11) (12) (13)Net acquisitions (73) (0.8) 0 0 0 0Net financing cash flow 58 (2) (1) 2 4 0.8Dividends & minority distrib'n 0 0 (14) (25) (15) (17)Net ch in cash & equivalents 13 19 15 (6) 10 6FCF 7 14 29 16 21 22


Revenue growth (%) 226.0 75.5 -7.3 -0.23 5.4 5.5Normalised EPS growth (%) 132.4 1.7 -7.5 11.6 3.9 4.0Normalised EBITDA mgn (%) 20.6 22.8 23.5 25.7 25.4 25.0Normalised EBIT margin (%) 15.6 16.9 17.1 19.2 19.0 18.9ROACE (%) 13.8 13.0 10.4 11.4 11.5 11.5Reported ROE (%) 12.8 10.9 8.8 9.7 9.8 9.8Working capital as % of sales 18.9 15.2 11.3 13.6 14.8 15.8Net debt (cash)/EBITDA (x) (0.92) (0.82) (1.3) (0.99) (1.1) (1.2)EBITDA net interest cvg (x) n/a n/a n/a n/a n/a n/a

Valuation


Per share data



Polish Strategy Asseco Central Europe July 2010

122

Asseco Central Europe Maintained

Step by step improvement BuyPoland Market cap PLN472.70mTechnology Bloomberg ACS PW

Asseco CE’s share price has been a poor performer over the past two months, largely due to the unfavourable Uniquare transaction. As we expect decent group 2Q10 numbers, we maintain our BUY recommendation for the stock with a new DCF-based target price of PLN29.

Investment case After a difficult 2009, we believe that 2010 is likely to be only mildly better. For Czech and Slovak corporates IT spending is not apriority, while some of the large public tenders still wait to be signed. In such a difficult environment Asseco CE seems to be doing well, with several new contracts signed. In Slovakia contracts for proprietary banking solutions were signed with Wuestenrot Group and Poistovna VZP, in addition to the new appendix for development and support at Erste’s Slovak operations. In the Czech Republic contacts with the Ministry of Finance and the Czech depository followed. Management signalled that there is more to come, both in Czech and in Slovakia.

The slowdown was mostly visible in Austria, with Uniquare’s operations being the biggest underperformer. With limitedoutlook for improvement (earnings are dependent on the sale of new licences) Asseco CE decided to divest its 60% stake to the original owner. The €17.8m amount was split into: (1) €12.3m with which source codes to the front-office software were purchased; and (2) €5.5m cash to be obtained by the end of 2011. We view this transaction negatively. We would have preferred Asseco CE to change the CEO and manage Uniquare itself. Purchasing of its software results in the creation of intangible, depreciated and thus decreased earnings from 2011. We believe the potential benefits from the software will come at Asseco Poland.

Seeing mediocre developments on the organic growth side, Asseco CE has intensified its focus on cross-selling opportunities within the group. Several potential contracts are on the agenda, including cooperation with Asseco Systems (part of Asseco Poland) on its datawarehouse system; participation with Asseco Poland in the e-toll tender announced by the Polish Ministry of Transportation; cooperation with Asseco SEE in introducing GlobeNet healthcare software in hospitals in the region; and offering the LCS ERP system in the DACH region.

We believe that the M&A activity will continue in 2010, but it is likely to be focused on the CEE region. The end of 2009 and early 2010 have seen the acquisition of two Hungarian companies: a 70% stake in Statlogics (consumer credit applications) and a 60% stake in GlobeNet (healthcare player). A further opportunity is a Slovak ERP player, which is at the pre-due diligence stage.

At 10.6x 2010F PER, Asseco Slovakia is the most attractively priced Polish software IT company in our coverage (with a 16% discount). We find the scale of the discount warranted, due to the group’s high margins and net cash position.

Price (19/07/10) PLN22.13



Quarterly preview We expect decent 2Q10 numbers to be reported on 19 August. The group structure has changed YoY, with the consolidation of Hungarian Statlogics and 2M of Uniquare losses. We expect group 2Q10 sales at €30.6m, up 3.5% YoY, still showing the impact of the economic slowdown. We forecast Asseco Czech to be the biggest contributor (at €8.4m) followed by the Asseco CE parent company (at €6.8m) and Slovanet (€8.1m). We expect the gross profit margin to deteriorate from 32.4% in 2Q09 to 28.9% YoY in 2Q10F. However, we expect cost reductions to be visible and offset the €0.4m loss at Uniquare, translating into group EBIT of €2.8m, up 5.6% YoY. We forecast 2Q10 group earnings of €0.5m. Adjusting for a €1.5m loss on the sale of Uniquare, we expect earnings of €1.7m, down 40% YoY (tax asset in the base).


(€m) 2Q09 2Q10F



Earnings drivers and outlook We expect Asseco CE group revenues of €143.3m, up 4.3% YoY, in 2010, showing only a gradual YoY recovery, as IT is not a priority for corporates at present. We believe that the three biggest revenue contributors should be: Asseco Czech parent, Asseco CE parent (supported by key banking and health segments) and Slovanet. From 2H10 we incorporate the acquisition of the Hungarian company Globenet.

We assume a gross profit margin of 34.2% in 2010F, largely flat YoY, as we expect the pressure on prices from customers to be partially offset by the cost reductions that have been conducted. We incorporate 5M losses at Uniquare in 2010 and Globenet consolidation from 2H10. We assume that Datalock and MPI will be in the red in 2010, though we point out the latter was recently incorporated to the Slovak parent company. As a result, we forecast 2010 EBIT of €14.2m, up 27% YoY, implying the operating margin rising from 8.2% in 2009 to 9.9% in 2010F.

We assume a €1.5m loss on the sale of Uniquare to be booked in net financial activity. Factoring in tax liabilities as well as minorities, we expect reported earnings of €9.7m, down 10% YoY, while at €10.8m, flat YoY, after adjusting for the loss on the sale.


Polish Strategy Asseco Central Europe July 2010

123

Newsflow

Date Description

19 Aug 2010 Publication of 1H10 results 5 Nov 2010 Publication of 3Q10 resulst



Asseco Poland 40.07ING IM 6.59


Share data

Avg daily volume (3-mth) 4,116Free float (%) 59.9Market cap (PLNm) 472.70Net debt (1F, €m) (12)Enterprise value (1F, €m) 106Dividend yield (1F, %) 4.1



2022242628303234

7/09 9/09 11/09 1/10 3/10 5/10


Source: ING

Company profile

Asseco Central Europe (formerly Asseco Slovakia) isa diversified software house, 40.1%-owned by AssecoPoland. Following the sale of the Austrian Uniquarebanking company (May 2010), Asseco CE operates in three countries: Slovakia (top three IT company; Slovakparent company recently merged with MPI, DatalockERP company, Slovanet telco operator), Czech Republic(top ten player; Czech parent company merged withBerit and LCS ERP company) and Hungary(Statlogics and GlobeNet). Key revenue sources are:banking, ERP, telco, healthcare, integration andpublic. The group employs c.1,800 people.

Risks

Both upside and downside risks to our rating lies inthe economic performance of the CEE countries. Wesee a downside risk in shorter depreciation of theUniqaure software. There is upside and downside riskfrom Asseco Poland’s strategy, which may involve anincorporation and price/ parity risk.

Financials

Year end Dec (€m) 2007 2008 2009 2010F 2011F 2012F

Income statement

Revenues 73 143 137 143 151 159EBITDA 13 24 17 20 24 25EBIT 11 17 11 14 17 18Net interest 0.6 0.5 0.3 (0.2) (0.6) (0.7)Associates 0.0 0.3 0.2 0.0 0.0 0.0Other pre-tax items (0.3) 0.9 0.1 (2) (0.1) 0.2Pre-tax profit 11 19 12 12 16 17Tax (2) (3) (1) (2) (3) (3)Minorities (2) (2) 0.4 (0.6) (0.9) (1.0)Other post-tax items 0 0 0 0 0 0Net profit 7 13 11 10 12 13Normalised net profit 7 13 11 11 12 13

Balance sheet

Tangible fixed assets 9 17 16 16 16 15Intangible fixed assets 25 72 64 65 64 64Other non-current assets 3 3 3 3 4 4Cash & equivalents 18 43 25 24 31 38Other current assets 45 40 35 42 45 48Total assets 100 175 144 151 159 169Short-term debt 13 6 5 4 3 3Other current liabilities 28 45 25 30 31 33Long-term debt 6 27 9 9 9 9Other long-term liabilities 4 4 11 10 10 10Total equity 49 93 93 98 107 113Total liabilities & equity 100 175 144 151 159 169Net working capital 14 (7) 7 9 10 12Net debt (cash) 0.9 (11) (10) (12) (19) (25)

Cash flow

Cash flow EBITDA 13 24 17 20 24 25Tax, interest & other 3 0.3 (1) 3 4 4Change in working capital (12) 5 (3) (4) (1) (2)Net cash from op activities (0.4) 24 11 14 20 20Capex (4) (15) (5) (7) (7) (7)Net acquisitions (42) (9) (13) 0 0 0Net financing cash flow 7 28 (1) (4) (1) 0.7Dividends & minority distrib'n (5) (6) (10) (5) (5) (7)Net ch in cash & equivalents (13) 25 (19) (0.6) 7 6FCF (5) 9 6 8 13 13


Revenue growth (%) 93.0 94.4 -3.7 4.3 5.4 5.1Normalised EPS growth (%) 25.4 54.7 -23.0 1.2 12.3 7.3Normalised EBITDA mgn (%) 18.4 16.5 12.5 14.3 16.0 16.0Normalised EBIT margin (%) 14.7 12.2 8.2 9.9 11.1 11.1ROACE (%) 20.5 18.0 9.6 13.0 14.6 14.5Reported ROE (%) 19.8 21.2 12.0 10.5 12.4 12.5Working capital as % of sales 19.4 -5.1 5.0 6.4 6.9 7.7Net debt (cash)/EBITDA (x) 0.07 (0.45) (0.60) (0.57) (0.80) (1.00)EBITDA net interest cvg (x) n/a n/a n/a 129.4 42.9 38.7

Valuation

EV/revenue (x) 1.7 0.76 0.78 0.74 0.66 0.60EV/normalised EBITDA (x) 9.5 4.6 6.2 5.2 4.1 3.7EV/normalised EBIT (x) 11.9 6.2 9.5 7.5 5.9 5.4Normalised PER (x) 12.8 8.3 10.8 10.6 9.5 8.8Price/book (x) 2.3 1.3 1.3 1.2 1.1 1.1Dividend yield (%) 5.5 5.0 8.8 4.1 4.2 6.4FCF yield (%) n/a 8.0 5.4 7.4 13.4 14.3

Per share data

Reported EPS (€) 0.429 0.687 0.503 0.452 0.572 0.613Normalised EPS (€) 0.419 0.648 0.499 0.505 0.568 0.609Dividend per share (€) 0.293 0.267 0.470 0.220 0.226 0.343Equity FCFPS (€) (0.298) 0.443 0.271 0.367 0.624 0.632BV/share (€) 2.33 4.18 4.21 4.45 4.79 5.06


Polish Strategy Asseco Poland July 2010

124

Asseco Poland Previously Buy

One bridge too far HoldPoland Market cap PLN4,390.2mTechnology Bloomberg ACP PW

Despite an equity issuance, Asseco Poland’s share price has been a stable performer. With plans for another issuance to finance the US acquisition and a mediocre outlook for 2Q10, we downgrade our rating from Buy to HOLD with a new DCF-based target price of PLN60.

Investment case Asseco Poland’s group revenues come from two sources: domestic medium-term contracts and foreign subsidiaries. We believe that in 2010 and beyond the company should continue to be a beneficiary of the dedicated solutions implemented at key customers (ZUS, PZU, ARMiR, TPSA) but we expect the level of business with PKO BP to shrink as the implementation phase of the Alnova system has been completed. We expect foreign subsidiaries to add 46% to 2010 revenues and remain at around this level. Even though the number of foreign companies grows each year, their contribution will be negatively affected by expected PLN/EUR appreciation. The current backlog of PLN2.2bn, covers 72.5% of our 2010 forecast. We expect a 2009-12F sales CAGR of 2.3%.

We point out that due to the medium-term contracts and strict cost cautiousness, the situation at Polish companies is superior to foreign subsidiaries, where the slowdown was felt to a greater extent. We believe that stronger improvement at the foreign operations should be visible from 2011 onwards. Expected zloty appreciation eats into any recovery, translating into a 2009-12Fadjusted EPS CAGR of negative 4.5%.

Asseco Poland wants to continue purchases in 2010 in order to become a global IT company in 2011. PLN209m was obtained from the equity issuance in May, with the cash scheduled to go towards acquisitions in Western Europe. Target companies are being sought in Scandinavia, Spain, Italy and Switzerland. In addition, Asseco SEE plans further purchases within the SEE region (including entry into Turkey), while Asseco CE group is considering further investments in the core CEE region.

However, Europe is not enough. By the end of 2010, Asseco Poland hopes to acquire a majority stake in a US-listed company. Little information has been released, but with still so much to do in terms of integration of the European businesses and obtaining revenue synergy, we believe that a US acquisition is premature. We perceive the potential acquisition as a craving for growth rather than value creation. We point out that any potential US acquisition is likely to result in Asseco Poland selling its remaining 5.4m treasury shares to the market. We think it is likely that the SPO price would be lower than PLN54 achieved in the May issuance, putting pressure on the share price.

On a 2010F adjusted PER of 11.1x, Asseco Poland trades at an 11% discount to its peers, which we find warranted given the share overhang and the scale of the risk of a US acquisition. We cut our target price in line with our forecast reductions.

Price (19/07/10) PLN56.60



Quarterly preview We expect Asseco Poland to report mediocre 2Q10 numbers on 27 August. We expect group sales of PLN720m, up 2% YoY, with growth restricted by the limited impact of new assets and a slowdown in the region. Seeing pricing pressure from customers, we expect the gross profit margin to come down to 35.1% in 2Q10 from 36.7% in 2Q09. Factoring in cost reductions (in addition to EU subsidies obtained), we expect EBIT of PLN129m, down 6.6% YoY. We expect net financial activity at a loss of PLN31m (PLN20m goodwill write-off). Factoring in the statutory tax rate and PLN40m of tax asset, we expect reported earnings at PLN111m, up 10% YoY. We expect adjusted 2Q10 earnings at PLN96m, down 5.2% YoY.


(PLNm) 2Q09 2Q10F



Earnings drivers and outlook We expect 2010 group sales of PLN3.1bn, flat YoY, with full-year consolidation of assets offset by the impact of economic slowdown. From 2010, the parent company was merged with ABG, thus we expect a boost to parent sales at PLN1.2bn versus PLN946m in 2009. We expect a contribution from Asseco CEgroup of PLN577m and Asseco SEE of PLN451m. We expect foreign sales to constitute 46% of 2010F sales.

We expect 2010 group EBIT of PLN506m, down 3.7% YoY. Similarly to sales, the EBIT of the parent company should be supported by the merger with ABG and EU subsidies obtained. Thus, the merger will hide the impact of a lower PKO BP contribution. We expect parent company EBIT of PLN296m, down 4.4% YoY. The parent constitutes 58.5% of 2010F group EBIT. The remaining EBIT contributors are diversified, with ABS adding PLN30m, Asseco Slovakia group adding PLN57m and Asseco SEE PLN57m. We expect the normalised EBIT margin to fall to 16.9% in 2010F from 17.1% in 2009 (still high).

Below EBIT we expect several one-offs (goodwill write-offs, financial gains and tax assets). We forecast group reported net earnings at PLN373m, flat YoY. On a normalised basis, we expect 2010F net income at PLN359m, down 2.4% YoY.


Polish Strategy Asseco Poland July 2010

125

Newsflow

Date Description




CEO, Mr Adam Goral 10.4Treasury shares 7.0Aviva pension fund 9.6ING pension fund 7.2PZU pension fund 5.5


Share data




50

55

60

65

70

75

7/09 9/09 11/09 1/10 3/10 5/10


Source: ING

Company profile

Created through a series of M&A, Asseco Poland isthe biggest Polish IT company and a WIG20 member.Within the CEE region, the company is among theleading IT companies in Poland, Czech and Slovakia,and is developing its Hungarian operations. AssecoSEE is among the leading IT companies in SouthEastern Europe region. Asseco Poland is graduallyexpanding its Western European operations, with apresence currently in Germany, Spain and Denmark.Asseco Poland’s software solutions are provided tobanks, corporates and public (largely dedicatedsystems). The group employs c.8,000 people.

Risks

Upside risk lies in the economies of CEE/SEE regionand Western Europe. Downside lies in stronger-than-expected zloty appreciation and ACP choosing thewrong partners in the M&A process. The third risk isshare overhang, treasury shares (7% of equity) could be sold to finance a potential US purchase.

Financials


Income statement

Revenues 1,282 2,787 3,050 3,063 3,122 3,270EBITDA 274 592 646 650 663 664EBIT 237 494 526 506 514 509Net interest 0 0 0 0 0 0Associates (3) 3 2 2 2 2Other pre-tax items 2 (4) (13) (6) (5) (8)Pre-tax profit 235 493 514 501 511 502Tax (45) (94) (77) (61) (105) (102)Minorities (30) (78) (65) (68) (68) (68)Other post-tax items 0 0 0 0 0 0Net profit 161 322 373 373 338 333Normalised net profit 161 296 368 359 345 339

Balance sheet

Tangible fixed assets 93 334 367 397 428 396Intangible fixed assets 1,700 3,822 3,918 3,929 3,933 3,932Other non-current assets 505 125 138 138 139 143Cash & equivalents 258 484 360 615 798 1,064Other current assets 700 963 933 964 989 1,034Total assets 3,256 5,729 5,715 6,042 6,286 6,567Short-term debt 61 128 126 26 22 24Other current liabilities 496 761 565 567 560 583Long-term debt 412 669 338 216 170 147Other long-term liabilities 166 388 369 370 377 391Total equity 2,121 3,783 4,318 4,863 5,157 5,423Total liabilities & equity 3,256 5,729 5,715 6,042 6,286 6,567Net working capital 107 120 297 326 357 376Net debt (cash) 215 313 103 (373) (606) (892)

Cash flow

Cash flow EBITDA 274 592 646 650 663 664Tax, interest & other (17) (50) 20 61 107 102Change in working capital (118) 134 (63) (28) (28) (12)Net cash from op activities 49 488 439 557 529 543Capex (39) (122) (126) (165) (172) (122)Net acquisitions (459) (516) (126) (20) (13) 0Net financing cash flow 594 (95) (75) (12) (50) (21)Dividends & minority distrib'n (19) (33) (70) (105) (112) (135)Net ch in cash & equivalents 202 164 (110) 254 183 266FCF 10 365 312 392 358 422


Revenue growth (%) 157.7 117.3 9.5 0.41 1.9 4.8Normalised EPS growth (%) 64.7 43.3 8.1 -5.1 -6.6 -1.7Normalised EBITDA mgn (%) 21.4 21.4 20.7 21.2 21.2 20.3Normalised EBIT margin (%) 18.4 18.2 17.1 16.9 16.7 15.8ROACE (%) 15.9 14.2 11.2 10.5 10.0 9.4Reported ROE (%) 14.2 12.1 10.5 9.5 7.9 7.4Working capital as % of sales 8.3 4.3 9.8 10.6 11.4 11.5Net debt (cash)/EBITDA (x) 0.79 0.53 0.16 (0.57) (0.91) (1.3)EBITDA net interest cvg (x) n/a n/a n/a n/a n/a n/a

Valuation


Per share data



Polish Strategy Comarch July 2010

126

Comarch Previously Hold

Problems in Germany continue SellPoland Market cap PLN660.73mTechnology Bloomberg CMR PW

Comarch’s share price has been a weak performer recently due to disappointing 1Q10 figures. With an even worse outlook for 2Q10, we downgrade our recommendation from Hold to SELL with a new DCF-based target price of PLN78.5.

Investment case ComArch is a diversified software house that sells its solutions in Poland and abroad. The company offers proprietary solutions for: telecoms, banking and finance, industry and trade (including successful ERP and loyalty systems) as well as public administration, for which dedicated solutions were created. We believe that in the coming years moderate sales growth rates will be possible in Poland, unless sizeable contracts in the public sector materialise. We believe that Comarch will wish to spur its growth abroad, where the company still holds a cost advantage, with the CEO indicating the need to invest in branches and people (especially in Germany and France).

Comarch’s German acquisition, SoftM, is proving painful. Cost reductions (largely HR lay-offs) resulted in the lowering of the fixed cost base. However, we expect losses to continue in SoftM in 2010 (contrary to the CEO’s statements about break-even), as we believe that the revenues obtained are insufficient to cover even the decreased cost base. We believe a rebound could take place themoment sentiment towards IT spending improves on the German market and once the product offering is augmented (the best selling solution is the Java-based Semiramis ERP product). We also point out that Comarch no longer holds an 81% stake in SoftM (nowrenamed Comarch). The stake has fallen to c.49% as a result of a capital increase conducted by a venture related to the CEO.

We recognise Comarch’s devotion to further development of its new ventures. Currently six new ventures are running. However, we find the current results disappointing. With PLN8.3m of EBIT loss in 2009 (larger than guided), we believe break-even in 2010 is unlikely. We also see Comarch is focused on developing the Asian markets. Offices in China and Vietnam have been established and demand for software is being tested. Comarch was also considering running a JV with Inspur, a key Chinese IT company, to promote its ERP products. Nevertheless,cooperation has not been established so far.

Although the above-mentioned businesses contribute negatively to group EBIT, we believe that these could bring value in the medium term. However, we fail to see value generation in investments in sports clubs. The CEO stated that PLN30m of equity increase forCracovia is being considered and could materialise this year.

On an adjusted 15.4x 2010F PER, ComArch trades at a 23% premium to its domestic peers, which we find excessive given theearnings outlook. There is a new stock option plan for 2011-13,which entitles employees to 3.6% of the growth in market cap. The reduction in our TP comes from lower forecasts for 2010F onwards.

Price (19/07/10) PLN83.00



Quarterly preview We expect Comarch to publish weak 2Q10 figures on 31 August. We expect SoftM to record €8.8m sales (down 11% YoY), while Comarch and new ventures should add PLN110m (down 8% YoY), translating into group sales of PLN147 (down 10% YoY). We expect group EBIT to be PLN11.8m in the red, flat YoY. We expect SoftM’s loss to shrink and reach €0.9m. We forecast Comarch stand-alone EBIT at PLN5.2m and the loss of new ventures at PLN2m. Still, we believe that a PLN10m goodwill write-off on SoftM will be needed. We expect reported loss ofPLN7.9m in 2Q10 versus PLN4.3m in 2Q09. Correcting for the goodwill impairment, we expect adjusted earnings of PLN2.1m versus a loss of PLN3.7m in the base.


(PLNm) 2Q09 2Q10F

Sales 163.8 147.0EBITDA 2.3 (4.1)EBIT (12.8) (11.8)Net profit (4.3) (7.9)


Earnings outlook We expect Comarch group 2010 sales of PLN749.2m, up 2.7% YoY. We expect Comarch stand-alone sales at PLN587.3m(including the expected PLN3.6m contribution from new ventures), up 5% YoY. Growth is supported by 2010 backlog data, at PLN396.5m, up 4% YoY, covering 67.5% of our full-year forecasts. We expect SoftM group revenues at PLN161.9m, down 4.6% YoY, due to expected appreciation of PLN versus EUR eating up euro-based dynamics.

We expect EBIT improvement in 2010, visible on all lines. However, we point out that after weak 1Q10 numbers and with a poor outlook for 2Q10, we have sizeably cut our earnings expectations. We expect Comarch’s old business to show PLN41.3m EBIT (including the PLN10m goodwill write-off, flat YoY after adjustments). We expect losses at SoftM to continue, though decrease YoY, both in euro and PLN terms. Thus, we forecast a PLN7.5m loss at SoftM. We expect the new ventures to decrease EBIT by PLN5.9m. Overall, we expect group EBIT ofPLN27.9m versus PLN14.4m in 2009.

Assuming favourable net financial activity and higher minorities at SoftM, we expect group earnings of PLN31m (flat YoY), withadjusted earnings of PLN43.4m in 2010 vs PLN21.4m in 2009.


Polish Strategy Comarch July 2010

127

Newsflow

Date Description




Janusz Filipiak, CEO 32.54Elzbieta Filipiak, CEO’s wife 10.51BZWBK AIB funds 34.23


Share data

Avg daily volume (3-mth) 3,261Free float (%) 57.1Market cap (PLNm) 660.73Net debt (1F, PLNm) (62)Enterprise value (1F, PLNm) 616Dividend yield (1F, %) 0.0



60708090

100110120

7/09 9/09 11/09 1/10 3/10 5/10


Source: ING

Company profile

Comarch is a diversified software house operatingdomestically and actively targeting exports (Europeand the US). Comarch offers its software in fivesectors: banking, telco, trade/services, industry andpublic. Via its venture fund, Comarch is developingstart-up businesses (currently six). Comarch owns a48.6% stake in German ERP producer, SoftM, as wellas 49.15% in Cracovia football club. The group(excluding the sports club) employs c.3,300 people.Comarch also owns real estate, largely officebuildings in the special economic zone in Cracow.

Risks

Upside risk lies in a potential stronger-than-expectedrebound in IT spending and lower losses on newventures and from the JV in China. Downside riskcomes from Comarch’s ability to obtain high margincontracts, covering for the high fixed-cost base.

Financials


Income statement

Revenues 581 701 729 749 776 840EBITDA 61 66 56 65 90 100EBIT 44 46 14 28 54 63Net interest (0.8) 8 4 4 4 6Associates 3 0.0 (0.5) (0.2) 0 0.1Other pre-tax items (1.0) 190 0.3 0.2 0.2 0.2Pre-tax profit 46 245 18 32 58 69Tax (3) (43) 8 (0.2) (9) (11)Minorities 0.4 (2) 6 (0.6) 0.5 (0.6)Other post-tax items 0 0 0 0 0 0Net profit 43 199 32 31 50 57Normalised net profit 43 60 21 43 49 56

Balance sheet

Tangible fixed assets 183 257 256 274 277 285Intangible fixed assets 39 125 127 117 118 119Other non-current assets 21 24 30 32 35 40Cash & equivalents 77 222 218 178 200 228Other current assets 239 287 264 296 306 332Total assets 558 915 895 898 936 1,004Short-term debt 5 27 13 48 43 47Other current liabilities 119 109 120 112 118 131Long-term debt 78 94 83 68 53 38Other long-term liabilities 56 151 125 94 97 105Total equity 301 534 554 576 625 683Total liabilities & equity 558 915 895 898 936 1,004Net working capital 109 170 136 176 180 192Net debt (cash) 6 (101) (122) (62) (104) (143)

Cash flow

Cash flow EBITDA 61 66 56 65 90 100Tax, interest & other 4 (104) (43) (42) 8 13Change in working capital (21) (20) 54 (36) (6) (17)Net cash from op activities 39 54 87 (9) 78 79Capex (60) (90) (37) (55) (40) (46)Net acquisitions 0 (45) (32) 0 0 0Net financing cash flow 25 22 (26) 16 (25) (15)Dividends & minority distrib'n 0 0 0 0 0 0Net ch in cash & equivalents 5 147 (12) (39) 21 28FCF (21) (36) 51 (64) 38 33


Revenue growth (%) 18.2 20.6 4.1 2.7 3.6 8.3Normalised EPS growth (%) -14.0 39.7 -64.5 100.9 13.4 14.3Normalised EBITDA mgn (%) 10.7 11.4 8.1 9.1 11.5 11.9Normalised EBIT margin (%) 7.8 8.5 2.4 5.5 6.9 7.5ROACE (%) 13.0 11.5 2.7 6.2 7.6 8.5Reported ROE (%) 16.2 50.9 6.3 5.7 8.5 9.0Working capital as % of sales 18.8 24.2 18.6 23.5 23.1 22.8Net debt (cash)/EBITDA (x) 0.09 (1.5) (2.2) (0.96) (1.2) (1.4)EBITDA net interest cvg (x) 78.0 n/a n/a n/a n/a n/a

Valuation


Per share data



Polish Strategy Comp July 2010

128

Comp Maintained

Good outlook for 2Q10 BuyPoland Market cap PLN323.81mTechnology Bloomberg CMP PW

Comp’s share price has been stable in the past two months, despite the buy-back that was conducted. With a good outlook for 2Q10 and improving prospects at the Novitus subsidiary, we maintain our BUY recommendation with an almost unchanged DCF-based target price of PLN78.5.

Investment case In the coming years, we believe Comp will be a key beneficiary of security expenditure by corporates and public institutions, as a result of its leadership position and broad offering (both hardware-and software-oriented solutions), strengthened by past M&A activity. As outlays for security are not vital in all sectors, we believe that recovery in spending will rather take place from 2011. With top-line supported by the SDE project and a high 2010 backlog of PLN157m, we expect 2009-12F sales CAGR at 4%.

We believe that the SDE project for the Ministry of Justice for electronic supervision of prisoners (worth PLN185m overall) will be an important EBIT contributor in the coming years. Due to a highcontribution from proprietary services, the margins on the contract should be high. The contract should last for five years, although we would expect maintenance revenues to continue after 2014. We also see a possibility for Comp to obtain a sizeable exports contract – the Czech government would also like to introduce electronic supervision system, with Comp’s offer being on the shortlist.

We point out that Comp managed to keep a high 9.5% operating margin during the slowdown of 2009, due to cost reductions, the SDE contract and the expansion of the Safe Computing group. We believe the margin could be expanded in 2010 on the back of an improved economic outlook (especially if the delayed corporate security projects are finalised), as well as in the years to come, when we expect the operating margin to be in the region of 11%.

We also see favourable developments taking place at the level ofthe Novitus subsidiary. We point out that the latter was strengthened by the shift of retail assets from Comp. After the failure to increaseequity at LSI Software and acquire a stake in this retail software producer, Novitus began consolidation in its core cash registersmarket. Novitus acquired 2.24/9.88% of equity/votes in Elzab, a cash registers producer, with the agreement signed to acquire a12.62/19.54% stake overall. Cost and revenue synergies from a potential merger seem obvious, though agreements with the remaining Elzab shareholders need to be signed.

Comp has also managed to conduct a buyback. 7% of equity was acquired at PLN70, meaning an outlay of c.PLN23m. Overall, the company has an approval for the buyback of up to 12% of equity, with the shares to be purchased at PLN40-75 per share by the end of 2010. On 13.3x 2010F PER, Comp trades at a 6% premium to its peers, which we believe is warranted by its services-oriented model, stable cash position and outlook for new contract signing.

Price (19/07/10) PLN68.20



Quarterly preview We expect the Comp group to report good 2Q10 numbers, which are due to be published on 30 August. We expect group sales at PLN62m, up 14% YoY (a consequence of the growing backlog). However, we expect the structure to be more biased towards sales of goods. Thus, we expect the gross profit margin to fall to 40% in 2Q10, from 41.4% in 2Q09. We expect SG&A to come in at 32% of sales in 2Q10 versus c.37% in 2Q09, as we expect cost reductions to be visible, despite likely losses at Safe Computing group. We forecast group EBIT at PLN4.8m, up 138% YoY. With PLN0.3m negative net financial and a PLN1.1m contribution from Novitus, we expect group income at PLN4.4m, up c.92% YoY.


(PLNm) 2Q09 2Q10F



Earnings drivers and outlook Despite the high backlog, the contribution from the SDE contract and the full-year consolidation of new assets, we conservatively assume flat YoY revenues in 2010, at PLN258.9m. We expect revenues from the SDE contract to reach PLN31.4m in 2010 (versus c.PLN20m in 2009), translating into parent company sales of PLN208.9m in 2010 (flat YoY). We expect the subsidiaries’ contribution to reach PLN55.2m in 2010 (up 7.5% YoY), as we assume no further deterioration at Safe Computing and consolidate Safe Technologies.

After weak 1Q10 numbers and a shift of retail assets to the Novitus subsidiary, we lower our EBIT expectations. We now expect Comp’s group 2010 EBIT to be PLN26.4m, up 9% YoY. We believe the parent company should remain the biggest contributor, adding PLN14.9m in 2010 (PLN12.3m in 2009). We expect the contribution from subsidiaries to fall from PLN12.8m in 2009 to PLN11.6m in 2010F, as we assume lower margins in corporate security.

We point out that following the divesture of assets there was a PLN7m gain on discontinued operations. With a growing contribution from the Novitus subsidiary we expect reported earnings of PLN30.6m, with adjusted at PLN23.6m, up 9% YoY, below Comp’s guidance for double-digit earnings dynamics.


Polish Strategy Comp July 2010

129

Newsflow

Date Description




Jacek Papaj, CEO 17.2Amplico pension fund 9.7Pioneer funds 9.8Novitus 8.7Pekao pension fund 8.2


Share data

Avg daily volume (3-mth) 178.0Free float (%) 75.8Market cap (PLNm) 323.81Net debt (1F, PLNm) (8)Enterprise value (1F, PLNm) 252Dividend yield (1F, %) 0.0



60

65

70

75

80

85

7/09 9/09 11/09 1/10 3/10 5/10


Source: ING

Company profile

Comp specialises in security, both qualified (public institutions) and corporate (software and hardwaresolutions). With the CSS merger, Comp broadened itsproduct offering in the services segment. Comp ownsa 46% stake in Novitus, which is the leading cashregister producer and is present in the trade market(software for retailers). Comp employs c.690 people.

Risks

Both upside and downside risk lies in the macrosituation and IT outlays, especially in the key publicadministration. Upside risk could come from newacquisitions, both at the level of Comp and the Novitus subsidiary. Downside risk could come fromproblems with the conduct of the large SDE contract.

Financials


Income statement

Revenues 181 317 255 259 273 286EBITDA 31 25 32 34 37 40EBIT 27 18 24 26 29 31Net interest 0 0 0 0 0 0Associates 2 4 4 5 6 6Other pre-tax items 1 (1) (2) 5 (2) (3)Pre-tax profit 30 20 26 37 32 35Tax (4) (3) (5) (6) (6) (7)Minorities (2) (0.1) (0.8) (0.5) (0.7) (0.8)Other post-tax items 0 0 0 0 0 0Net profit 24 17 21 31 25 27Normalised net profit 22 17 22 24 25 27

Balance sheet

Tangible fixed assets 12 12 19 20 21 23Intangible fixed assets 160 172 193 193 193 193Other non-current assets 73 62 72 72 72 73Cash & equivalents 25 23 30 18 38 60Other current assets 162 184 105 115 121 127Total assets 431 453 420 418 445 475Short-term debt 18 15 15 6 5 5Other current liabilities 75 91 51 52 54 57Long-term debt 19 12 6 4 2 1Other long-term liabilities 20 25 12 12 13 14Total equity 299 310 336 344 370 398Total liabilities & equity 431 453 420 418 445 475Net working capital 76 87 47 56 59 61Net debt (cash) 11 4 (9) (8) (30) (54)

Cash flow

Cash flow EBITDA 31 25 32 34 37 39Tax, interest & other 2 1.0 1 6 6 7Change in working capital (15) (3) 20 (9) (3) (3)Net cash from op activities 14 19 46 30 32 34Capex (8) (9) (8) (9) (10) (10)Net acquisitions 0 (2) (23) 0 0 0Net financing cash flow 39 (12) (10) (34) (3) (1)Dividends & minority distrib'n 0 0 0 0 0 0Net ch in cash & equivalents 3 (2) 9 (13) 20 22FCF 6 9 38 22 22 24


Revenue growth (%) 31.4 75.5 -19.5 1.4 5.4 4.9Normalised EPS growth (%) 77.0 -46.8 23.5 13.3 11.9 6.2Normalised EBITDA mgn (%) 17.2 8.0 12.6 13.3 13.7 14.0Normalised EBIT margin (%) 15.0 5.8 9.5 10.2 10.6 10.8ROACE (%) 11.1 5.5 7.0 7.4 7.9 7.9Reported ROE (%) 12.2 5.6 6.6 9.1 7.2 7.1Working capital as % of sales 42.3 27.3 18.4 21.5 21.4 21.4Net debt (cash)/EBITDA (x) 0.37 0.18 (0.29) (0.23) (0.81) (1.4)EBITDA net interest cvg (x) n/a n/a n/a n/a n/a n/a

Valuation


Per share data



Polish Strategy Sygnity July 2010

130

Sygnity Maintained

Smaller but profitable… from 2011 HoldPoland Market cap PLN152.86mTechnology Bloomberg SGN PW

Sygnity announced a 2010-12F strategy which promises earnings in 2011-12, but we expect high losses to persist in 2010. With a poor outlook for 2Q10, the weakest among peers, we maintain our HOLD recommendation with a new 12-month DCF-based target price of PLN14.7.

Investment case Sygnity has faced serious management changes in the past few months, starting with the resignation of the former CEO, Mr Piotr Kardach, and the dismissal of the COO, Mr Andrzej Marciniak. Three new members have been appointed in that time, including the CEO, Mr Norbert Biedrzycki. In addition, recently the CFO of the company was also replaced, with Ms Ilona Weiss nominated as a board member (formerly at Sage). Although we understand that fresh blood is needed, especially in this troubled organisation, we point out that of the five board members, only one has more than a six-month term at Sygnity.

The new management has identified the company’s main problems and started to address the burning issues. The key measures undertaken include: intra-group consolidation, a new organisation model, concentration on the key sectors (banking, public and utilities), creation of targets for employees and for business units, as well as tools for their verification, and creation of a technology strategy for Sygnity (which should provide the major source of new revenues in coming years).

The realisation of this strategy should lead to an end to revenue contraction from 2011 onwards. Taking into account the impact of: (1) the planned sale of unprofitable assets; (2) further HR reductions (a target of 1,500 employees versus c.1,960 at the end of 2Q10); and (3) renegotiation of agreements with subcontractors, Sygnity aims to achieve revenues of PLN650-700m and an EBIT margin of 5-7% by 2012, which translates into 2012 EBIT of PLN32.5-49.0m, significantly above consensus. Our forecasts are lower as we believe such an EBIT margin could only be achieved if the majority of sales were services and products, which may prove challenging. Our margin forecasts are far lower than management’s expectations.

Even though management gave a bright outlook for 2012 and promised EBIT and earnings in the black in 2011, we believe that 2010 numbers will still be in the red. We believe the effects of the restructuring are likely to appear from 2011 onwards, due to notice periods for the laid-off employees. We expect a PLN29.5m loss in 2010 (assuming no goodwill impairment).

We believe that in the coming months, Sygnity will continue to depend on corporate bonds to a greater extent than debt. Due to expected losses in 2010 and Sygnity barely breaking even in 2011, we believe that only 2012 multiples are comparable and the market will rather be looking for signs of recovery or deterioration rather than at multiples.

Price (19/07/10) PLN12.86



Quarterly preview We expect Sygnity to report weak 2Q10 numbers, the worst in the sector, on 31 August. We expect group revenues to come in at PLN101m, down 28.5% YoY, due to contracting demand for Sygnity’s product offering. We point out that the gross profit and operating margins are not comparable YoY, as PLN60.3m of provisioning was booked in 2Q10. We expect the group gross profit margin to come in at 16.4% in 2Q10 versus a negative 22.5% in 2Q09. We expect SG&A costs of PLN35m versus PLN62.5m in 2Q09. We forecast group 2Q10 EBIT at a loss of PLN18.6m in 2Q10 – the base adjusted for provisions showed an operating loss of PLN25.1m. We expect the net financial activity to be PLN1.7m in the red. Assuming no taxes, we expect the bottom line to be PLN17.8m in the red. We point out that the number is higher than the PLN13m loss signalled in our latest update, as we have factored in additional provisioning that may be conducted by the new CFO.


(PLNm) 2Q09 2Q10F

Sales 141.1 100.9EBITDA (78.1) (11.4)EBIT (85.4) (18.6)Net income (75.5) (17.8)


Earnings drivers and outlook Please note that in our forecasts we do not include the impact of the to-be-sold assets, due to the lack of data provided. The last reported backlog came in at PLN366m, showing some 8% YoY fall, and 66% coverage of our 2010 forecasts. We expect 2010 sales at PLN554.3m, with the percentage of hardware at c.20%. We expect banking revenues at PLN162m, public administration sales at PLN177.5m, and utilities revenues at PLN215m in 2010. We expect the gross profit margin to come in at 18% in 2010versus 12.4% in 2009, with growth coming from increased utilisation rather than product mix change. We believe that the positive effects of the restructuring should rather appear in 2011 onwards, eg, there are three-month-long notice periods and bonuses are paid to the leaving employees. As a result, we expect EBIT to come in at a loss of PLN26m in 2010. Assuming a tax asset, we expect the net loss to reach PLN29.5m in 2010. We point out that the slightly lower valuation results from new macro assumptions and the inclusion of additional provisions in 2010.


Polish Strategy Sygnity July 2010

131

Newsflow

Date Description




Legg Mason AM 12.47Pioneer IM 8.59ING IM 6.15


Share data

Avg daily volume (3-mth) 26,239Free float (%) 93.3Market cap (PLNm) 152.86Net debt (1F, PLNm) 19Enterprise value (1F, PLNm) 174Dividend yield (1F, %) 0.0



1012141618202224

7/09 9/09 11/09 1/10 3/10 5/10


Source: ING

Company profile

Sygnity is an IT integrator, created through the mergerof the former ComputerLand and Emax. The companyoperates largely in Poland, in three key areas:banking (banks, brokerage houses, insurance); publicadministration; and utilities (including industry andtelecommunications). The company employs c.2,000people.

Risks

The key risks to our forecasts include: (1) slower-than-expected growth of the Polish IT market; (2) continuedlosses leading to breaking covenants on bank debt;(3) investment in new technologies, which could meanincreased technological advantages or R&D write-offs; (4) continuing losses may lead to the necessity forgoodwill write-offs reducing the equity.

Financials


Income statement

Revenues 1,202 996 563 554 621 711EBITDA (16) 57 (63) 3 31 42EBIT (72) 12 (98) (26) 4 17Net interest (12) (10) (8) (7) (6) (6)Associates 0.0 0.2 0.0 0.0 0.0 0.0Other pre-tax items (1) 1 0.9 1 1 1Pre-tax profit (85) 3 (106) (32) (0.8) 12Tax 4 (4) 7 3 2 (0.9)Minorities 16 (0.2) (0.2) (0.2) (0.2) (0.3)Other post-tax items 0 0 0 0 0 0Net profit (66) (1) (99) (30) 1.0 11Normalised net profit (69) 3 (103) (19) 10 20

Balance sheet

Tangible fixed assets 42 32 20 20 23 26Intangible fixed assets 252 231 213 200 191 185Other non-current assets 24 18 20 19 21 24Cash & equivalents 58 91 74 21 29 37Other current assets 486 402 209 222 245 276Total assets 862 773 536 483 509 549Short-term debt 172 98 69 38 41 39Other current liabilities 248 200 90 98 110 130Long-term debt 3 5 2 2 2 2Other long-term liabilities 93 94 106 104 113 125Total equity 347 376 270 241 242 253Total liabilities & equity 862 773 536 483 509 549Net working capital 232 159 99 103 112 121Net debt (cash) 118 12 (4) 19 15 4

Cash flow

Cash flow EBITDA (16) 57 (63) 3 31 42Tax, interest & other 14 5 6 (4) (0.6) 4Change in working capital 0.3 14 62 (4) (6) (6)Net cash from op activities (7) 58 10 (6) 23 33Capex (31) (20) (7) (16) (19) (22)Net acquisitions (4) 0 0 0 0 0Net financing cash flow 15 (45) (42) (31) 4 (2)Dividends & minority distrib'n (10) 0 0 0 0 0Net ch in cash & equivalents (8) 43 (11) (53) 7 9FCF (38) 38 3 (22) 4 11


Revenue growth (%) 29.6 -17.2 -43.4 -1.6 12.1 14.4Normalised EPS growth (%) n/a n/a n/a n/a n/a 93.7Normalised EBITDA mgn (%) -3.3 4.5 -14.6 0.55 5.0 5.9Normalised EBIT margin (%) -6.4 1.5 -18.4 -2.4 2.5 3.9ROACE (%) -13.7 3.0 -25.3 -4.2 5.6 9.6Reported ROE (%) -20.2 -0.41 -30.9 -11.7 0.40 4.5Working capital as % of sales 19.3 16.0 17.6 18.7 18.0 17.0Net debt (cash)/EBITDA (x) n/a 0.22 n/a 6.2 0.48 0.09EBITDA net interest cvg (x) n/a 5.7 n/a 0.40 5.1 7.6

Valuation

EV/revenue (x) 0.23 0.17 0.27 0.31 0.27 0.22EV/normalised EBITDA (x) (6.9) 3.7 (1.8) 57.5 5.5 3.8EV/normalised EBIT (x) (3.6) 11.1 (1.5) (13.2) 10.8 5.7Normalised PER (x) n/a 49.0 n/a n/a 14.9 7.7Price/book (x) 0.40 0.41 0.57 0.64 0.64 0.61Dividend yield (%) 7.3 0.0 0.0 0.0 0.0 0.0FCF yield (%) n/a 22.7 2.2 n/a 2.2 7.0

Per share data

Reported EPS (PLN) (6.95) (0.125) (8.33) (2.49) 0.081 0.920Normalised EPS (PLN) (7.36) 0.263 (8.71) (1.62) 0.866 1.68Dividend per share (PLN) 0.938 0.00 0.00 0.00 0.00 0.00Equity FCFPS (PLN) (4.04) 3.22 0.274 (1.88) 0.322 0.936BV/share (PLN) 31.77 31.38 22.56 20.07 20.16 21.08



132



133

Telecommunications

Polish Strategy Netia July 2010

134

Netia Maintained

Consolidation: one step closer? HoldPoland Market cap PLN1,899.8mTelecommunications Bloomberg NET PW

Are things different this time? M&A noise across the telecom industry has increased, involving the mobile companies (P4, Polkomtel) and also fixed lines (Exatel, Dialog) and cables (Aster). Speculation regarding potential consolidation of the Polish telecoms market is not new. We view a few elementshinting that things are now heading towards consolidation. First, the Polish press reports that financial and legal advisors have been or are about to be mandated for the sale of Exatel and Aster. Second, some of the potential targets published improved financials in 2009 (Exatel, Dialog), which should help the valuation. Moreover, some potential acquirers are working on raising money. Third, operators are now emphasising and developing non-historical businesses: TPSA is pushing its TV operation, Aster became an MVNO and satellite operators are now bundling broadband services together with TV.

Investment case What does this mean for Netia? Netia’s management has repeatedly flagged its interest in both Exatel and Dialog. Although these companies are similar in size, acquiring one or the other would be a very different deal. Dialog has a retail strategy and a regional network, while Exatel focuses its strategy on the corporate segment through a national network. PGE, Exatel’s shareholder, confirmed that it hopes to sell Exatel as soon as possible and that the process has already started. Hence, we think Exatel is likely to be Netia’s next M&A attempt (rather than Dialog). Moreover, we understand the book value of Exatel should not be a constraint as it could be for Dialog, making the sale easier.

Risks. We think an acquisition of Exatel would be riskier than Dialog, because of uncertainties. Indeed, a significant number of its clients are public administration or state-owned companies, and we think these contracts could be seen as risky once the link with the government is broken. Moreover, the Tele2 business was purely wholesale-based, targeting retail clients. As a result, Netia appeared the most obvious buyer, and network synergies were appealing. In the case of Exatel, we think potential buyers would include mobile companies looking for a fixed-line infrastructure (Polkomtel), but also other fixed-line operators, such as GTS. Therefore, bidding should prove more competitive. A key question concerns Polkomtel’s real intentions and PGE’s shareholding in both Polkomtel and Exatel. Indeed, it means: (1) should Polkomtel want to buy Exatel, PGE as a shareholder of both companies, may favour Polkomtel; (2) should Polkomtel not be willing to buy Exatel, it may just be a tactic to increase the pressure on bidders.

How to deal with consolidation? Although the number of telecom participants is high, listed ones are far more limited (TPSA, Netia and some TV/telecom companies). For us, Netia appears the best available vehicle to deal with consolidation.

Price (19/07/10) PLN4.88



First, its recent record of M&A deals is reasonably good. The acquisition of Tele2 marked a tipping point in the company’s strategy and financials, the price paid looked reasonable, and the company delivered on synergies. Second, we also think that the reported interest from Polkomtel for Exatel confirms the rationale for mobile operators to acquire a fixed-line network. Netia could come next.

Quarterly preview Netia will publish its 2Q10 results on 5 August; we expect no surprises.

On the subscriber acquisition front, the second quarter is traditionally quiet, and the Smolensk air crash did not help. On the pricing side, the new broadband tariff only affects the highest speed. The cost plus methodology was due in June, so its postponement is not affecting the second quarter result.

Overall, we expect Netia to gain 21,000 broadband subscribers, and to publish revenues up 4.0%, together with a margin in line with its full year guidance (around 23%).

Thus, we think investors would focus on non-operational developments such as Exatel and the implementation of the margin squeeze test.


(PLNm) 2Q09 2Q10F

Revenues 373,679 388,978EBITDA 73,752 89.465EBIT (4,984) 14,465Net profit (14,521) 9,975


Earnings drivers and outlook Over recent quarters, Netia has significantly improved its profitability and should improve it further, thanks to its cost saving initiatives, the migration to LLU and scale effects.

Nine months after TPSA signed its deal with the regulator, there is still no margin squeeze test. TPSA is likely to launch new commercial offers once this test is sorted out.

Jean-Baptiste Bouillaguet London +44 20 7767 5888 [email protected] Vavruska London +44 20 7767 6972 [email protected]

Polish Strategy Netia July 2010

135

Newsflow

Date Description

5 August 2010 2Q10 results 26 July 2010 EGM



Third Avenue Management 24.1ING OFE 10.3SISU Capital 10.0Pioneer Pekao 10.0Free float 45.6


Share data




3.84.04.24.44.64.85.05.25.4

7/09 9/09 11/09 1/10 3/10 5/10


Source: ING

Company profile

Netia mainly offers direct voice (own network andWLR) and broadband services (own network, LLU,BSA) to retail and business clients. The companyhas a broadband-driven growth strategy andtargets the 1m broadband subscriber milestone in2012.

Risks

Netia’s business model relies on a favourableregulatory environment, and any changes couldaffect the company significantly. Netia is anindependent company in the midst of an economicstorm, and unlike other participants, it is notbacked by a strong international group.

Financials


Income statement

Revenues 838 1,121 1,506 1,567 1,607 1,642EBITDA 171 171 313 371 391 412EBIT (104) (100) 14 82 114 140Net interest 2 0.8 (13) 13 19 22Associates Other pre-tax items (165) 331 0 0 0 0Pre-tax profit (267) 232 1 96 133 161Tax (2) (1) 88 (5) (7) (8)Minorities (0.6) 0 0 0 0 0Other post-tax items 0 0 0 0 0 0Net profit (269) 231 89 91 126 153Normalised net profit (269) 231 89 91 126 153

Balance sheet

Tangible fixed assets 1,409 1,416 1,368 1,315 1,295 1,286Intangible fixed assets 268 411 414 416 418 420Other non-current assets 195 61 61 61 61 62Cash & equivalents 58 195 243 392 505 543Other current assets 141 200 277 290 297 304Total assets 2,071 2,283 2,361 2,474 2,576 2,613Short-term debt 7 0 0 0 0 0Other current liabilities 234 328 416 436 447 457Long-term debt 87 0 0 0 0 0Other long-term liabilities 14 27 36 38 39 39Total equity 1,728 1,928 1,910 2,000 2,091 2,117Total liabilities & equity 2,071 2,283 2,361 2,474 2,576 2,613Net working capital (89) (121) (127) (133) (137) (140)Net debt (cash) 37 (195) (243) (392) (505) (543)

Cash flow

Cash flow EBITDA 6 501 387 380 403 425Tax, interest & other 172 (323) (65) 2 1 1Change in working capital 39 (7) (22) 6 3 3Net cash from op activities 217 171 300 389 408 429Capex (235) (257) (238) (239) (259) (265)Net acquisitions (167) (133) (115) 0 0 0Net financing cash flow 94 (108) (7) 0 0 0Dividends & minority distrib'n 0 0 0 0 (36) (126)Net ch in cash & equivalents (86) 135 (12) 150 112 38FCF (12) 382 113 150 149 165


Revenue growth (%) -2.8 33.8 34.3 4.1 2.5 2.2Normalised EPS growth (%) n/a n/a -61.6 2.5 39.2 21.3Normalised EBITDA mgn (%) 20.4 15.2 21.4 23.0 24.4 25.1Normalised EBIT margin (%) -12.4 -8.9 0.94 5.2 7.1 8.5ROACE (%) -5.5 -5.3 0.74 4.2 5.6 6.6Reported ROE (%) -14.7 12.6 4.6 4.6 6.2 7.3Working capital as % of sales -10.6 -10.8 -8.4 -8.5 -8.5 -8.5Net debt (cash)/EBITDA (x) 0.22 (1.1) (0.78) (1.1) (1.3) (1.3)EBITDA net interest cvg (x) n/a n/a 23.8 n/a n/a n/a

Valuation

EV/revenue (x) 2.3 1.5 1.1 0.96 0.87 0.83EV/normalised EBITDA (x) 11.3 10.0 5.1 4.2 3.6 3.3EV/normalised EBIT (x) (18.7) (17.1) 116.8 18.3 12.2 9.7Normalised PER (x) n/a 8.2 21.4 20.9 15.0 12.4Price/book (x) 1.1 0.99 0.99 0.95 0.91 0.90Dividend yield (%) 0.0 0.0 0.0 1.9 6.7 8.1FCF yield (%) n/a 22.4 6.8 9.9 10.7 12.1

Per share data

Reported EPS (PLN) (0.692) 0.592 0.228 0.233 0.325 0.394Normalised EPS (PLN) (0.692) 0.592 0.228 0.233 0.325 0.394Dividend per share (PLN) 0.00 0.00 0.00 0.093 0.325 0.394Equity FCFPS (PLN) (0.031) 0.982 0.291 0.385 0.383 0.423BV/share (PLN) 4.44 4.95 4.91 5.14 5.37 5.44


Polish Strategy TPSA July 2010

136

TPSA Maintained

Enough of Wonderland, it’s time to show results BuyPoland Market cap PLN20,569.0mTelecommunications Bloomberg TPS PW

We have revised our model ahead of the 2Q10 results release. We cut our forecasts following weak operational results in the last two quarters and slower than expected implementation of the regulatory deal, which has also impacted the roll-out of TPSA’s new commercial policies. That said, we think that the essence of our story, which is based on more balanced regulation and industry consolidation, remains intact. We remain BUYers of TPSA.

Investment case Our DCF fair value is PLN18.8 and our 12m ex-div target isPLN19.3. We think that the 10% dividend yield is both attractive and sustainable in the medium term.

Still awaiting key catalysts. We are waiting not only for regulatory announcements about the BSA margin squeeze tests, which are expected to be followed by TPSA’s new broadband offers, but also for clarity about issues such as the DPTG legal case, EU regulatory cases or the 4G licence tender. After years of regulatory attacks, TPSA is naturally vulnerable, and hence long-awaited clarity on these subjects is crucial.

Time to doubt our positive story? Nine months after TPSA signed its deal with the regulator there is still little clarity about the parameters of the key margin squeeze test. TPSA appears to be delaying its investments, pointing to a tough winter in 1Q10 and floods in 2Q10. Hence, the regulatory deal has so far failed to have much direct impact on TPSA’s operating trends, although reduced regulatory hostility is positive. Doubters may say that the importance of the deal has been exaggerated and that TPSA’s cat and mouse game with the regulator is ongoing. There are concerns that the negotiations are getting difficult and that the EU might create additional obstacles. We remain optimistic, but aware that lack of progress on the key issues entails risks. We still hope for clarity on BSA and the new commercial offers by the end of the summer. Otherwise, we would have to assess whether the ‘regulatory peace’ is bringing the desired benefits.

Flow of positive surprises is not guaranteed, but remains reasonably likely, while dividend yield provides downside protection. It appears that TPSA’s new mobile marketing campaign launched in April has been a success. Competitive trends in fixed-line might have softened. The company is claiming PLN0.8bn for USO services and it is poised to sell assets (including TP Emitel). Selected acquisitions (for example of cable TV or wireless assets) during the upcoming consolidation might also help, in our view.

Price (19/07/10) PLN15.40

Target price (12-mth) PLN18.68


Quarterly preview TPSA will report its 2Q10 results on 28 July 2010. In the previous quarters TPSA posted disappointing numbers, which still reflected the company’s past strategy of confronting the regulator. This strategy not only escalated regulatory hostility towards the company, but also discouraged business expansion, which all affected the top line starting in the year 2007. Although TPSA signed a deal with the regulator in October, this has not yet had any major impact on operating trends. In 1Q10, TPSA lost 10.2% of revenue and 14.3% EBITDA y-o-y. We expect the trends to start improving in 2Q10, but only gradually. So far, we see the improvements driven primarily by changes in the commercial strategy in mobile and the fact that the flow of adverse regulatory news is now limited.


(PLNm) 2Q09 2Q10F

Revenues 4,185 3,884EBITDA 1,556 1,438EBIT 500 488Net profit 375 292


Dalibor Vavruska London +44 20 7767 6972 [email protected] Bouillaguet London +44 20 7767 5888 [email protected]

Polish Strategy TPSA July 2010

137

Newsflow

Date Description

28 July 2010 2Q10 results 27 October 2010 3Q10 results 24 February 2011 FY10 results



France Telecom 49.8State Treasury 4.1Other shareholders 46.1


Share data

Avg daily volume (3-mth) 5,051,624Free float (%) 46.1Market cap (PLNm) 20,569.0Net debt (1F, PLNm) 6,375Enterprise value (1F, PLNm) 26,958Dividend yield (1F, %) 9.7



1415161718192021

7/09 9/09 11/09 1/10 3/10 5/10


Source: ING

Company profile

TPSA is one of central Europe’s leading telecomoperators, an integrated incumbent operator inPoland. It is controlled by France Telecom. Its mobilesubsidiary, Orange Polska, is one of the country’sthree similarly-sized leading mobile operators. In2006-09 TPSA’s business suffered substantially as aresult of incumbent-unfriendly regulation, initiallytargeting the fixed-line business, later also focusing onmobile. In 2010, the overall regulatory framework inPoland has stabilised, partly reflecting a deal betweenTPSA and the regulator. We expect marketconsolidation to follow.

Risks

Regulation continues to pose a key risk to our positivecase on TPSA. Other risks include possiblemacroeconomic challenges, TPSA’s commercial,execution and competitive challenges, and risks related to TPSA’s role as an acquirer in theanticipated telecom market consolidation in Poland.

Financials


Income statement

Revenues 18,244 18,165 16,560 15,530 15,421 15,930EBITDA 7,687 7,649 6,246 5,625 5,855 6,109EBIT 3,248 3,332 2,096 1,698 1,892 2,193Net interest (418) (718) (499) (556) (489) (467)Associates Other pre-tax items 0 0 0 0 0 0Pre-tax profit 2,830 2,614 1,597 1,142 1,403 1,726Tax (555) (405) (315) (217) (267) (328)Minorities (2) (2) (2) (2) (2) (2)Other post-tax items 0 0 0 0 0 0Net profit 2,273 2,207 1,280 923 1,134 1,396Normalised net profit 2,273 2,207 1,280 923 1,134 1,396

Balance sheet

Tangible fixed assets 21,120 19,589 17,743 19,190 18,639 18,092Intangible fixed assets 7,091 6,908 6,783 6,033 5,276 4,512Other non-current assets 749 483 641 661 681 702Cash & equivalents 642 1,640 2,218 621 617 637Other current assets 2,820 2,614 1,971 1,876 1,841 1,896Total assets 32,422 31,234 29,356 28,381 27,053 25,840Short-term debt 4,077 2,114 464 449 386 327Other current liabilities 7,195 5,301 4,758 4,454 4,193 4,197Long-term debt 1,920 5,075 6,094 6,547 6,412 5,862Other long-term liabilities 1,457 1,514 1,447 1,418 1,418 1,418Total equity 17,773 17,230 16,593 15,512 14,643 14,035Total liabilities & equity 32,422 31,234 29,356 28,381 27,053 25,840Net working capital (1,649) (953) (773) (687) (568) (510)Net debt (cash) 5,355 5,549 4,340 6,375 6,182 5,552

Cash flow

Cash flow EBITDA 7,687 7,435 6,117 5,515 5,745 5,999Tax, interest & other 173 647 705 661 644 683Change in working capital 300 381 (35) (209) (225) (52)Net cash from op activities 6,214 6,645 5,541 4,641 4,872 5,260Capex (4,356) (3,591) (2,308) (4,624) (2,655) (2,606)Net acquisitions 0 0 (9) 0 0 0Net financing cash flow (444) 855 (635) 438 (197) (609)Dividends & minority distrib'n (1,869) (1,960) (2,003) (2,003) (2,003) (2,003)Net ch in cash & equivalents (402) 2,594 620 (1,597) (4) 20FCF 2,333 4,149 3,650 463 2,596 3,011


Revenue growth (%) -2.0 -0.43 -8.8 -6.2 -0.70 3.3Normalised EPS growth (%) 8.5 -2.9 -42.0 -27.9 22.9 23.0Normalised EBITDA mgn (%) 42.1 42.1 37.7 36.2 38.0 38.4Normalised EBIT margin (%) 17.8 18.3 12.7 10.9 12.3 13.8ROACE (%) 13.1 13.8 8.8 7.4 8.6 10.5Reported ROE (%) 12.7 12.6 7.6 5.8 7.5 9.7Working capital as % of sales -9.0 -5.2 -4.7 -4.4 -3.7 -3.2Net debt (cash)/EBITDA (x) 0.70 0.73 0.69 1.1 1.1 0.91EBITDA net interest cvg (x) 18.4 10.7 12.5 10.1 12.0 13.1

Valuation


Per share data




138



139

Utilities

Polish Strategy CEZ July 2010

140

CEZ Previously Selll

Management guidance at risk HoldCzech Republic Market cap Kc466,330mUtilities Bloomberg CEZ CP

The CEZ share price has fallen c.8% within the last month, largely owing to a mediocre 2010-11F earnings outlook and the sale of energy assets on the WSE. As we no longer have downside, we upgrade CEZ to HOLD with a new 12-month target price of Kc811.5.

Investment case The EEX electricity price curve has rebounded from this year’slows caused by oversupply of gas and speculation on shale gas applications. The curve is an upward sloping one. We believe that CEZ will not be a full beneficiary of the rebound, owing to itshedging strategy. CEZ is fully hedged for 2010. Moreover, 68% of volumes for 2011 are hedged at €52, 24% of volumes for 2012 are hedged at €51 while 4% of 2013 volumes at €52-53.

We believe the financial gearing of CEZ is likely to rise, along with more ambitious capex plans, both retrofit and newbuild and potentially acquisitions. We point out that CEZ increased its organic capex guidance for 2010 from Kc67.5bn to Kc92.5bn, with the aim of benefiting from subsidiaries for solar plants. Other outlays include scheduled upgrades and the retrofitting of existing power plants (Dukovany, Tusimice, Prunerov) and construction of new CCGTs. On top of those come payments for Turkish assets (instalment for Sedas, SPO at Akenerji) and the purchase of PT and Dalkia CR.

We point out that the net debt levels will also depend on the Czech State Treasury, which may use CEZ to support the budget. With the current government, we believe there is little likelihood of an additional dividend payment from CEZ. However, we believe that at some point in the future, following the actions of the Polish State Treasury, the Czech government may decide to reduce its stake in CEZ and funds, eg, pension reform.

As a result of hedging of electricity prices, growing interest expenses and the still limited contributions from newly acquired companies, we see earnings falling 7% in 2010F and flat in 2011F. Our forecasts are largely in line with the 2010 management guidance indicating 2010 EBITDA at Kc88.7bn and earnings at Kc46.7bn. In our forecasts, we do not factor in the Kc1-2bn threat to the guidance signalled by CEZ from higher payments for solar energy distribution.

With the listing of PGE, Tauron and Enea, CEZ is no longer the sole investable CEE utility. We believe CEZ would like to establish a foothold in the Polish electricity market, although it is not willing to overpay. CEZ has rejected filing a bid for ZEPAK (lignite PP) and is considering filing a bid for Energa. We believe Energa will go to PGE, leaving CEZ with Enea as the sole possibility (CEZ declined to file a bid for it last year).

On a 2011F adjusted EV/EBITDA of 7.0x, we continue to find CEZ expensive versus the Polish energy companies.

Price (19/07/10) Kc866.80

Previously Kc811.00Target price (12-mth) Kc811.50


Quarterly preview We expect group 2Q10 revenues of Kc42.5bn, flat YoY. We expect CEE to contribute Kc35.9bn (largely the CEZ parent company), negatively influenced by falling electricity prices, while SEE should add Kc6.6bn (already with Albania). We expect growing costs, especially purchased power, and thus expect group EBIT at Kc14.3bn, down 11% YoY (the majority from CEE). We expect net financial activity at a small negative, with interest charges partially offset by expected Kc0.7bn gain on MOL. We forecast group earnings at Kc11.4bn, down 9% YoY.


(Kc bn) 2Q09 2Q10F



Earnings drivers and outlook We expect CEZ group 2010 revenues of Kc208bn, up 6% YoY, owing to the inclusion of new assets (PT and Dalkia CR) and higher generation volumes partially offsetting falling hedged electricity prices. Despite decreasingly favourable hedging, we believe generation should remain by far the biggest contributor, fuelled by the Czech parent company. We expect the group to generate 69.3TWh, up 8% YoY, of which CEZ’s parent company should add 63.8TWh (up 7% YoY, slightly above CEZ’s guidance of 63.6TWh). We already factor in the impact of the launch of Romanian WPP. Distribution revenues should be supported by higher tariffs in the Czech Republic and full-year impact of Albanian OSSH.

We expect group EBITDA of Kc89.9bn, down 1.3% YoY, not factoring in the potential charges from solar energy distribution. We believe that like sales, generation should remain the biggest item, despite the negative impact of hedged electricity prices. The CEE region should still generate the majority of EBITDA, owing to the CEZ parent company (Polish operations remain small), but SEE should increase its contribution, along with the Romanian WPP exceeding that of Varna).

Factoring in YTD gains on the MOL option, growing financial leverage (and thus rising interest expenses), as well as the impact of equity-method consolidated companies, we should see earnings falling 7% in 2010F to Kc47.9bn.


Polish Strategy CEZ July 2010

141

Newsflow

Date Description

10 Aug 2010 Publication of 2Q10 numbers 09 Nov 2010 Publication of 3Q10 numbers



Czech government 69.78


Share data

Avg daily volume (3-mth) 113,073Free float (%) 30.2Market cap (Kcm) 466,330Net debt (1F, Kcm) 197,789Enterprise value (1F, Kcm) 618,336Dividend yield (1F, %) 6.1



800

900

1,000

1,100

1,200

1,300

7/09 9/09 11/09 1/10 3/10 5/10

Price PX 50 (rebased)

Source: ING

Company profile

CEZ is a vertically integrated electricity conglomerate.The group is based in Czech Republic, but presentalso in Poland, Bulgaria, Romania, Turkey, Albaniaand Germany. At the end of 1Q10 installed full-method capacity reached 14,383MW, with CEZ groupoperating: coal, nuclear, gas and renewables.Generation assets are based primarily in CzechRepublic (largely nuclear and lignite (62% in housesupply, developing solar projects), with smallercapacities based in Poland and Bulgaria (hard coal)and Turkey (gas and renewables). Distribution andtrade assets are in Czech Rep. and the SEE region.

Risks

Upside risk could come from the electricity price curvemoving upwards from current price levels orsteepening for future years. Downside risk comesfrom the appreciating Czech koruna to the euro, whichcould make it difficult for CEZ to continue to hedge atthe current favourable levels.

Financials

Year end Dec (Kcm) 2007 2008 2009 2010F 2011F 2012F

Income statement

Revenues 174,563 183,958 196,352 207,970 218,649 231,619EBITDA 75,326 88,701 91,075 89,892 91,070 93,338EBIT 53,203 66,654 68,199 63,459 64,009 65,841Net interest (791) (1,261) (804) (2,916) (2,483) (5,083)Associates 40 12 2,996 1,427 1,942 1,953Other pre-tax items (1,301) (4,689) (5,445) (2,476) (2,176) (2,076)Pre-tax profit 51,151 60,716 64,947 59,494 61,292 60,635Tax (8,387) (13,365) (13,091) (11,304) (11,646) (11,521)Minorities (1,209) (841) (308) (268) (569) (636)Other post-tax items 0 0 0 0 0 0Net profit 41,555 46,510 51,547 47,922 49,078 48,479Normalised net profit 41,600 50,883 47,498 46,599 49,201 48,602

Balance sheet

Tangible fixed assets 277,165 290,826 328,805 392,533 435,620 484,987Intangible fixed assets 19,060 18,074 18,654 22,525 22,014 21,344Other non-current assets 16,856 37,337 67,497 90,860 115,864 140,080Cash & equivalents 13,518 17,630 27,077 18,547 18,389 16,563Other current assets 44,343 109,308 88,227 93,104 97,912 103,603Total assets 370,942 473,175 530,259 617,569 689,798 766,578Short-term debt 21,274 39,875 37,889 103,525 150,835 203,623Other current liabilities 36,174 104,551 95,095 100,609 106,011 109,870Long-term debt 48,855 65,045 118,921 112,811 109,146 106,946Other long-term liabilities 80,413 78,294 71,679 74,110 76,398 79,064Total equity 184,226 185,410 206,675 226,515 247,408 267,076Total liabilities & equity 370,942 473,175 530,259 617,569 689,798 766,578Net working capital (6,874) (56,271) (39,845) (40,310) (41,085) (39,470)Net debt (cash) 56,611 87,290 129,733 197,789 241,593 294,006

Cash flow

Cash flow EBITDA 75,326 88,701 91,075 89,892 91,070 93,338Tax, interest & other 8,076 14,807 19,691 16,464 17,262 17,266Change in working capital (5,357) (257) 6,023 1,157 997 (1,344)Net cash from op activities 59,219 70,583 87,354 80,941 83,321 81,013Capex (34,066) (46,186) (70,791) (91,890) (73,407) (79,813)Net acquisitions (2,460) (874) (12,445) (5,355) 0 0Net financing cash flow (28,426) 15,301 48,791 59,526 43,645 50,588Dividends & minority distrib'n (11,694) (21,218) (26,561) (28,351) (28,753) (29,447)Net ch in cash & equivalents (17,934) 4,496 10,563 (8,530) (159) (1,825)FCF 25,153 24,397 16,563 (10,949) 9,914 1,200


Revenue growth (%) 17.1 5.4 6.7 5.9 5.1 5.9Normalised EPS growth (%) 55.3 30.4 -6.8 -1.9 5.6 -1.2Normalised EBITDA mgn (%) 43.2 48.3 45.2 42.8 41.7 40.4Normalised EBIT margin (%) 30.5 36.3 33.5 30.1 29.3 28.5ROACE (%) 20.9 24.5 20.1 15.5 13.5 12.2Reported ROE (%) 22.7 27.0 27.6 22.8 21.3 19.4Working capital as % of sales -3.9 -30.6 -20.3 -19.4 -18.8 -17.0Net debt (cash)/EBITDA (x) 0.75 0.98 1.4 2.2 2.7 3.1EBITDA net interest cvg (x) 95.2 70.3 113.3 30.8 36.7 18.4

Valuation

EV/revenue (x) 3.2 3.1 2.9 3.0 2.9 2.9EV/normalised EBITDA (x) 7.4 6.4 6.5 6.9 7.0 7.1EV/normalised EBIT (x) 10.5 8.5 8.7 9.9 10.0 10.1Normalised PER (x) 11.9 9.1 9.8 10.0 9.4 9.6Price/book (x) 3.0 3.0 2.3 2.1 1.9 1.8Dividend yield (%) 2.3 4.6 5.8 6.1 6.2 6.3FCF yield (%) 4.5 4.3 2.9 n/a 1.6 0.18

Per share data

Reported EPS (Kc) 72.91 87.00 96.24 89.47 91.63 90.51Normalised EPS (Kc) 72.98 95.18 88.68 87.00 91.86 90.74Dividend per share (Kc) 20.00 40.00 50.00 52.93 53.68 54.98Equity FCFPS (Kc) 44.13 45.64 30.92 (20.44) 18.51 2.24BV/share (Kc) 289.34 292.55 372.43 408.80 446.58 481.96


Polish Strategy Enea July 2010

142

Enea Maintained

Awaiting the bids HoldPoland Market cap PLN8,104.9mUtilities Bloomberg ENA PW

Enea’s share price has been stable over the last two months. We believe the outlook for growing earnings in 2010 was offset by risks relating to the potential ZEPAK acquisition (now gone), and the appearance of a strategic investor. With our DCF-based 12-month forward target priceof PLN20, we maintain our HOLD rating on the stock.

Investment case

Enea is the third-largest vertically integrated electricity conglomerate in Poland. Its business model concentrates on three key areas: i) energy generation (hard-coal Kozienice plant and small hydro plants); ii) distribution; and iii) supply. With 2.9GW, Enea generated 12.2TWh (largely from the c.36 year old Kozienice plant), while it sold 20.6TWh, implying a short positionin generation. Enea is ranked fourth in distribution in Poland, with 16.3TWh of electricity distributed in 2009.

We believe it was its short position in generation that was worrying Enea’s management, and was the reason behind interest in ZEPAK (2.5GW lignite plant). We are in favour of the decision to step away from the transaction, as we considered the risk of buying a non-controlling stake to be too high versus the potential profits. We also believe the resignation from the ZEPAK acquisition increases Enea’s chances of finding a strategic investor. In our opinion, GDF, CEZ or Kulczyk Holding could be among the bidders. The decision on the sale of Energa, which seems to be a preferred Polish asset, will be crucial. We believe Energa will be sold to PGE, leaving the other companies with Enea or nothing. Last year, the sale of Enea did not proceed (RWE backed out) owing to the state’s high price expectations. If a similar situation materialises this year, we believe the government may decide to sell some or its entire stake in Eneato financial investors, which creates a share overhang risk. We believe a final decision will be taken this year, so as to boost the budget inflows.

In our opinion, newsflow related to the sale of the stake would be more important than fundamentals. We expect Enea’s 2010Fearnings to be PLN793m, up as much as 54% YoY. Subsequently, we assume more normalised growth rates. We believe that the key reason for the earnings growth could be the distribution segment, fuelled by higher tariffs as a consequence of a RAB increase. We are cautious about the cost reductions targeted by the company, as employment guarantees last until 2018/2019. The CEO guided for PLN1bn net profit in 2011, which we find too optimistic on an underlying basis.

On 2011F EV/EBITDA of 4.0x, Enea trades at a discount to PGE. We find the discount warranted, owing to its limited presence in the generation segment, which we consider to bethe best place to be in the Polish energy market, and lack of own coal resources (thus, dependence on suppliers).

Price (19/07/10) PLN18.1



Quarterly preview We expect Enea to publish good 2Q10 numbers on 31 August. We forecast group revenues at PLN1.85bn, up 8% YoY, largely owing to increased tariffs in distribution. Before consolidation exclusions, we believe the sale of the energy segment should be the largest revenue contributor, while generation should be the smallest. We expect group EBIT of PLN253m, up 26.5% YoY, similar to revenues fuelled by the key distribution segment. Assuming a positive impact from net financial activity, we expect group earnings of PLN242m, up 27% YoY, in 2Q10.


(PLNm) 2Q09 2Q10F

Revenues 1,707 1,850EBITDA 359 417EBIT 200 253Net profit 190 242


Earnings drivers and outlook We expect Enea’s group 2010F revenues to be PLN7.4bn, up 2.2% YoY. Without the impact of consolidation exclusions, we believe that the sale of the energy segment will be the largest revenue contributor, at PLN4.8bn. We expect 2010F revenues from the generation and distribution segments should be similar, at PLN2.7bn and PLN2.4bn. We assume Enea will generate 12.3TWh of electricity (up 0.6% YoY), while selling 17TWh (up 1.4% YoY) in 2010F.

We believe trends in EBIT excluding G&A costs (as reported by Enea) should differ from revenues. Apart from consolidation exclusions and G&A costs, generation should be the biggest contributor, followed by distribution (the impact of the revised RAB) and sale of energy segments (hit by a shortage in certificates). Overall, we expect Enea’s group 2010F EBIT ofPLN0.85bn, up 85% YoY, implying an 11.5% operating margin.

Factoring in the favourable net cash position as well as a statutory tax rate, we expect 2010F earnings of PLN0.8bn, up 54% YoY. We point out that 2010F free cash flow is likely to be barely in the black; later we expect negative free cash flows due to construction starting on the new Kozienice block and retrofit capex.

Tamas Pletser, CFA Budapest +36 1 235 8757 [email protected] Olszewska, CFA Warsaw +48 22 820 5039 [email protected]

Polish Strategy Enea July 2010

143

Newsflow

Date Description

31 August 2010 2Q10 results



State Treasury 60.4Vattenfall 18.6Free float 20.9


Share data

Avg daily volume (3-mth) 141,933Free float (%) 20.9Market cap (PLNm) 7,990.1Net debt (1F, PLNm) (1,835)Enterprise value (1F, PLNm) 6,179Dividend yield (1F, %) 2.1



16182022

242628

7/09 9/09 11/09 1/10 3/10 5/10

Price WIG (rebased)

Source: ING

Company profile

ENEA is the third-largest energy company in Poland.It has interests in the three segments of the industry;generation (the Kozienice hard coal power plant,hydro stations in north-west Poland); distribution(north-west Poland covering 58,000km²) and supply (2.3m Polish wholesale and retail customers). It holdsa 20% and 14% share in the Polish distribution andsupply segments, based on 2009 data. Its coal planthas capacity of 2,880MW, while its hydro powerstations have 56MW. The company provides 8% ofthe country’s electricity needs and plans furtherinvestment to increase output.

Risks

The major risk for ENEA is the change of electricitymarket regulation in Poland, which could affect all ofits business segments. ENEA is running anoperational risk at its generation and distributiondivisions, while its Kozienice power plant has a hardcoal supply risk, because it receives coal from fewsources. The stock price could be affected by thegovernment’s decision on whether to sell the majority holding to a strategic investor or to financial investors.

Financials


Income statement

Revenues 5,515 6,239 7,246 7,407 8,925 9,497EBITDA 554 883 1,167 1,619 1,796 1,960EBIT 83 251 506 854 970 1,079Net interest 45 92 173 152 157 139Associates 0 0 0 0 0 0Other pre-tax items (19) (51) (25) (27) (96) (125)Pre-tax profit 109 293 653 979 1,031 1,092Tax 413 (78) (139) (186) (196) (208)Minorities 0 0 0 0 0 0Other post-tax items 0 0 0 0 0 0Net profit 522 215 514 793 835 885Normalised net profit 522 215 514 793 835 885

Balance sheet

Tangible fixed assets 7,876 8,135 8,251 8,885 9,459 9,778Intangible fixed assets 41 37 48 46 44 42Other non-current assets 34 33 81 75 875 2,375Cash & equivalents 993 2,726 2,611 2,947 2,332 1,429Other current assets 872 1,056 1,239 1,258 1,516 1,613Total assets 9,816 11,986 12,230 13,211 14,226 15,237Short-term debt 70 53 48 70 85 113Other current liabilities 1,593 1,390 1,359 1,397 1,591 1,689Long-term debt 521 593 516 1,042 1,429 1,871Other long-term liabilities 867 925 934 934 935 936Total equity 6,766 9,024 9,373 9,769 10,186 10,629Total liabilities & equity 9,816 11,986 12,230 13,211 14,226 15,237Net working capital 76 185 235 220 265 282Net debt (cash) (403) (2,080) (2,047) (1,835) (818) 555

Cash flow

Cash flow EBITDA 522 851 1,185 1,667 1,804 1,968Tax, interest & other 0 52 (7) 101 136 194Change in working capital 0 (13) (328) 19 (64) 1Net cash from op activities 522 825 850 1,570 1,589 1,759Capex 0 (632) (764) (1,400) (2,200) (2,900)Net acquisitions 0 (287) (1,584) 1,597 0 0Net financing cash flow 0 1,855 (33) 674 412 679Dividends & minority distrib'n 0 (101) (203) (396) (417) (442)Net ch in cash & equivalents 522 1,680 (1,718) 2,045 (615) (903)FCF 522 147 (19) 92 (662) (1,145)


Revenue growth (%) 1.4 13.1 16.1 2.2 20.5 6.4Normalised EPS growth (%) 126.1 -71.2 94.0 54.4 5.3 6.0Normalised EBITDA mgn (%) 10.0 14.1 16.1 21.9 20.1 20.6Normalised EBIT margin (%) 1.5 4.0 7.0 11.5 10.9 11.4ROACE (%) 2.3 3.0 5.2 8.2 8.6 8.9Reported ROE (%) 15.4 2.7 5.6 8.3 8.4 8.5Working capital as % of sales 1.4 3.0 3.2 3.0 3.0 3.0Net debt (cash)/EBITDA (x) (0.73) (2.4) (1.8) (1.1) (0.46) 0.28EBITDA net interest cvg (x) n/a n/a n/a n/a n/a n/a

Valuation

EV/revenue (x) 1.4 0.95 0.82 0.83 0.81 0.90EV/normalised EBITDA (x) 13.7 6.7 5.1 3.8 4.0 4.4EV/normalised EBIT (x) 91.1 23.6 11.8 7.2 7.4 7.9Normalised PER (x) 8.7 30.2 15.6 10.1 9.6 9.0Price/book (x) 0.67 0.89 0.85 0.82 0.79 0.75Dividend yield (%) 1.6 2.1 2.5 2.1 5.0 5.2FCF yield (%) 6.9 2.5 n/a 1.5 n/a n/a

Per share data

Reported EPS (PLN) 2.09 0.600 1.16 1.80 1.89 2.00Normalised EPS (PLN) 2.09 0.600 1.16 1.80 1.89 2.00Dividend per share (PLN) 0.281 0.382 0.460 0.382 0.898 0.946Equity FCFPS (PLN) 2.09 0.593 0.232 0.384 (1.38) (2.58)BV/share (PLN) 27.05 20.37 21.18 22.08 23.02 24.02


Polish Strategy PGE July 2010

144

PGE Maintained

The leader in Polish energy BuyPoland Market cap PLN31,323.3mUtilities Bloomberg PGE PW

PGE has been a stable performer in the past month. We believe once the employee share overhang and mediocre 2Q10 numbers have passed (both end-August), the market will concentrate on the strong outlook for 2011. With an unchanged DCF-based 12-month forward TP of PLN25, we maintain our BUY rating.

Investment case With its 12.4GW of capacity and 53.8TWh of electricity generated, PGE is the leader in the generation segment of the Polish electricity market. We believe this is the best place to be, as we see electricity prices growing because of ageing capacity; tightening reserve margins due to scheduled decommissioning and low interconnection possibilities. PGE’s position is strengthened further by: a younger-than-average generation fleet (27 years vs more than 30 on average); low variable cost lignite plants (53% of capacity in 2009) and a long position in generation (we believe that owing to the limited contribution from large industrial customers, volumes sold to end customers are likely to grow more slowly than generation).

We expect PGE earnings to fall 16% to PLN2.8bn in 2010, largely because of falling PPA compensation (PLN1.5bn in 2009 versus PLN0.4bn in 2010F). Following the CFO’s guidance, we believe the market’s expectations have been properly adjusted, although consensus has not caught up yet. However, in 2011 we expect earnings to grow 20% and see 2009-12F NI CAGR at 14% (adjusted for PPAs), owing to: (1) growth in electricity prices; (2) the launch of the 858MW new lignite block at Belchatow; (3) RAB transition path (the value of distribution assets grew from c.PLN5.4bn to c.PLN13.4bn). Note that in our forecasts we do not incorporate changes in minorities.

PGE estimates 2009-12F capex at c.PLN39bn, excluding the nuclear power plant. However, we believe that the 2GW target for renewable investments is unlikely to be met. Thus, taking into account the dividend policy of 40-50% payout (a decent 3.6% yield), we expect the generation base to rise from 12.4GW in 2009 to 15.5GW in 2019F. We point out that the cash position(PLN2.9bn net cash in 2009) should be improved by the sale of non-core assets stakes in Polkomtel, Exatel, Autostrady Wielkopolskie) that we value at PLN4bn (book value PLN2.2bn).

We believe 2011F multiples show the trends in the sector more appropriately. On 2011F EV/EBITDA of 5.0x, PGE trades at a 25% premium to Enea and a 29% discount to CEZ. We believe a higher premium to Enea is warranted by Enea’s short generation position. We believe the discount to CEZ should be lower. Even though the share overhang from the state is higher at PGE, the earnings pattern is superior.

Price (19/07/10) PLN21.30



Quarterly preview We expect mediocre 2Q10 numbers from PGE on 31 August 2010, which will partially be incomparable, because of a different consolidation approach. We see group 2Q10 revenues at PLN5.0bn, down 13% YoY, owing to an expected reduction in PPAs, and a decline in EBIT for the same reason. We expect group EBIT at PLN1bn, down 25% YoY, and a PLN0.2bn contribution from the distribution segment, PLN0.6bn from generation, while the remainder comes from the sale of the energy segment. We see a neutral impact of net financial activity and forecast group earnings at PLN0.7bn, down 25% YoY, in 2Q10.


(PLNm) 2Q09F 2Q10F

Sales 5,752.6 4,995.9EBITDA 2,007.9 1,672.8EBIT 1,318.3 992.8Net income 921.5 690.5


Earnings drivers and outlook We expect group revenues at PLN20.7bn in 2010, down 4% YoY and the sale of the energy segment to remain the largest revenue contributor with revenues from wholesale and retail at PLN26.1bn in 2010, up 4.2% YoY. Generation revenues, the second biggest revenue contributor, should reach PLN13.3bn in 2010, down 4%, with the fall coming from an assumed sizeable reduction in PPA compensations, as we keep the electricity price flat YoY. We forecast distribution revenues to reach PLN4.9bn in 2010, up 5.8% YoY, showing the impact of increased tariffs.

We expect group EBIT at PLN4.2bn in 2010, down 21% YoY, and the generation and mining segment to remain the key contributor, adding PLN2.8bn, down 30% YoY. The majority of the contribution should come from conventional generation, while the fall stems from an expected decline in PPA compensations (PLN1.5bn in 2009, PLN0.4bn in 2010F). We believe that the sale of energy segment should be the second largest EBIT contributor; the contribution should reach PLN0.9bn (PLN0.55m from wholesale and PLN0.35bn from retail). We forecast distribution EBIT at PLN0.4bn. Our forecasts imply a reported 2010 operating margin of 20.5%.

We expect PGE earnings down 16% to PLN2.8bn in 2010, largely owing to falling PPA compensation (PLN1.5bn in 2009 versus PLN0.4bn in 2010F).



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Newsflow

Date Description

3 Aug 2010 EGM on merger of PGE with PGE GiE and PGE Energia




State Treasury 85


Share data

Avg daily volume (3-mth) 567,206Free float (%) 15.0Market cap (PLNm) 31,323.3Net debt (1F, PLNm) (1,454)Enterprise value (1F, PLNm) 38,275Dividend yield (1F, %) 3.6



19

21

23

25

27

29

12/09 1/10 2/10 3/10 4/10 5/10 6/10 7/10


Source: ING

Company profile

PGE is a vertically integrated electricity conglomerate.It is the largest energy company in Poland, andsecond largest in CEE, after CEZ. PGE in its currentform was created only in 2007. The groupconcentrates on three key areas: (1) generation(12.4GW, both conventional and renewables) andmining (lignite only); (2) distribution; (3) trade (bothwholesale and retail customers). PGE is the leader ingeneration in Poland (by capacity installed andvolume generated), in the supply segment by numberof customers, and holds second place in distribution(to Tauron, by a narrow majority).

Risks

Key external risk factors are: electricity prices, risk oftariffs, RAB revision, state ownership, changes in the energy law, CO2 emission risk and rising coal prices.The internal risk factors are: streamlining of PGE’soperations, attainment of cost-cutting targets, PPAs,delays in investments. We also consider theexpensive purchase of Energa a risk factor.

Financials


Income statement

Revenues 23,091 19,409 21,623 20,716 21,745 22,967EBITDA 5,975 5,847 7,983 6,943 8,136 9,088EBIT 2,134 3,262 5,345 4,237 5,196 5,852Net interest (240) (102) (122) 64 61 (74)Associates 239 239 242 210 204 199Other pre-tax items 1,689 (229) (86) (104) (106) (108)Pre-tax profit 3,823 3,170 5,379 4,406 5,355 5,868Tax 948 (499) (1,041) (837) (1,017) (1,115)Minorities (803) (750) (967) (725) (926) (1,011)Other post-tax items 0 0 0 0 0 0Net profit 3,968 1,920 3,371 2,844 3,412 3,742Normalised net profit 757 1,691 3,561 2,806 3,412 3,742

Balance sheet

Tangible fixed assets 37,025 39,317 40,326 43,945 48,539 53,781Intangible fixed assets 139 142 153 171 222 278Other non-current assets 1,257 1,242 1,485 1,431 1,492 1,565Cash & equivalents 3,432 2,551 7,931 3,740 3,480 3,319Other current assets 3,457 3,939 4,552 4,420 4,595 4,823Total assets 45,309 47,191 54,448 53,706 58,329 63,766Short-term debt 1,312 3,038 970 2,286 3,492 4,291Other current liabilities 3,353 2,892 3,216 3,106 3,231 3,379Long-term debt 5,739 4,471 4,056 0 0 1,000Other long-term liabilities 5,484 6,615 7,324 7,179 7,413 7,685Total equity 29,420 30,176 38,882 41,136 44,193 47,411Total liabilities & equity 45,309 47,191 54,448 53,706 58,329 63,766Net working capital 24 929 1,105 1,088 1,133 1,206Net debt (cash) 3,619 4,958 (2,905) (1,454) 12 1,972

Cash flow

Cash flow EBITDA 5,975 5,847 7,983 6,943 8,136 9,088Tax, interest & other (3,934) 1,085 1,818 533 770 1,102Change in working capital 58 (454) (454) (12) (11) (32)Net cash from op activities 5,683 5,387 7,299 5,958 7,018 7,945Capex (3,635) (4,124) (4,022) (6,343) (7,585) (8,535)Net acquisitions 0 (1,916) (265) 0 0 0Net financing cash flow (2,761) (228) 2,840 (2,869) 1,094 1,571Dividends & minority distrib'n 0 (300) (942) (1,315) (1,280) (1,535)Net ch in cash & equivalents (589) (586) 5,569 (4,270) (482) (310)FCF 2,048 1,262 3,277 (384) (567) (590)


Revenue growth (%) -5.1 -15.9 11.4 -4.2 5.0 5.6Normalised EPS growth (%) -97.5 50.9 107.5 -32.0 21.6 9.7Normalised EBITDA mgn (%) 25.2 28.9 38.0 33.3 37.4 39.6Normalised EBIT margin (%) 8.6 15.5 25.8 20.2 23.9 25.5ROACE (%) 5.0 8.1 13.7 9.6 11.4 11.7Reported ROE (%) 16.3 8.7 12.5 8.9 10.1 10.4Working capital as % of sales 0.10 4.8 5.1 5.3 5.2 5.3Net debt (cash)/EBITDA (x) 0.61 0.85 (0.36) (0.21) 0.00 0.22EBITDA net interest cvg (x) 24.9 57.1 65.4 n/a n/a 122.2

Valuation

EV/revenue (x) 1.9 2.2 1.7 1.8 1.9 1.9EV/normalised EBITDA (x) 7.4 7.8 4.4 5.6 5.0 4.8EV/normalised EBIT (x) 21.7 14.5 6.5 9.1 7.8 7.5Normalised PER (x) 28.0 18.5 8.9 13.1 10.8 9.8Price/book (x) 1.5 1.4 1.2 1.1 1.1 0.99Dividend yield (%) 0.0 0.96 2.6 3.6 3.5 4.2FCF yield (%) 4.8 2.9 9.1 n/a n/a n/a

Per share data

Reported EPS (PLN) 3.99 1.31 2.26 1.64 1.97 2.16Normalised EPS (PLN) 0.762 1.15 2.39 1.62 1.97 2.16Dividend per share (PLN) 0.00 0.204 0.544 0.760 0.740 0.887Equity FCFPS (PLN) 2.06 0.858 2.20 (0.222) (0.328) (0.341)BV/share (PLN) 14.45 15.51 18.03 18.92 20.15 21.43



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RATING DISTRIBUTION (as of end 2Q10) RATING DEFINITIONS

Equity coverage Investment Banking clients*

Buy 49% 55%Hold 42% 45%Sell 10% 46% 100% * Percentage of companies in each rating category that are Investment Bankingclients of ING Financial Markets LLC or an affiliate.

Buy: Forecast 12-mth absolute total return greater than +15%

Hold: Forecast 12-mth absolute total return of +15% to -5%

Sell: Forecast 12-mth absolute total return less than -5%

Total return: forecast share price appreciation to target price plus forecast annual dividend. Price volatility and our preference for not changing recommendations too frequently means forecast returns may fall outside of the above ranges at times.

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