Under its 2011-25 development program, Norilsk Nickel intends to spend $37 bln to modernize its legacy assets in Russia and commission two medium-scale projects - Maslovskoye and Chita. We argue that this aggressive spending is a derivative of frugal investment by the company in its asset base in the 1990s and 2000s, which has now left it underinvested. The issue is aggravated by the maturing status of the mining operations at the Polar division, and the assets' environmental footprint.
Of the Russian assets' $37 bln in capex, $13 bln (35%) will be invested in legacy assets to increase ore volumes at the Polar division and modernize the concentrators and smelters. Another $15 bln (41%) should go to infrastructure (gas supplies, transport and utilities). A further $2.5 bln (7%) will be spent to launch the Chita assets, though we find their economics mediocre. Finally, $2 bln (5%) will be spent to develop Maslovskoye, but it is long-dated with commissioning in 2023.
Overall production at the Russian assets should be kept at constant levels as grade declines are offset by increasing ore tonnage. Upon commissioning in 2016, the Chita projects will add 66 kt of copper with by-products, while Maslovskoye will contribute from 2023 onwards. The repercussions for the cost line are less certain: a structural grade decline should be offset by greater efficiencies at the concentrating and smelting stages.
The new $37 bln investment program through 2025 in Russia is front-end loaded and provides for annual investment to the tune of $3-4 bln in the short term, gradually declining to $2.0-2.5 bln.
In 2012, we derive free cash flow generation of just $1.4 bln (5% yield), an unpretentious result for a company of this profile. We argue that the company's copious free cash flow generation has allowed it to pay regular dividends and undertake sizable buybacks. Additionally, the consistency and sustainability of underlying free cash flow generation on the back of the unique resource endowment has allowed the stock to fetch reasonably high multiples, despite the corporate governance scandals. We do not feel that the market is currently pricing in the impaired free cash flow generation capacity.
We have rerun our model, and increased capex is offset by higher commodity price assumptions and lower export tariffs post the WTO accession. We increase our target price from $17.61 to $20.05 per GDR and raise our recommendation from SELL to HOLD.
Mikhail Stiskin
