Nornickel - 2H19 IFRS Good; Strong Palladium Provides Resilience

Nornickel reported good 2H19 IFRS results, with EBITDA beating the consensus by 5% on a strong uptick in revenues. We update our commodity price deck, upgrading our palladium forecast on the back of the sharp market deficit expected in 2020. We acknowledge that M&M stocks are likely to stay under pressure in the short term due to the yet unclear impact of the coronavirus on the global economy. However, thanks to significant shortages in palladium supply and the good long-term outlook for nickel on the back of the EV story, we believe that Nornickel stock should be relatively more resilient than other industrial metals producers we cover. We upgrade our target price to $35.70 per ADR (19% total return over next 12 months) and reiterate our BUY recommendation. > EBITDA grew 13% H-o-H in 2H19 to $4.2 bln, 5% ahead of the consensus but slightly below our estimate due to higher cash costs than we expected. Despite nickel and palladium prices being 26% and 18% higher H-o-H (revenues were up 16% up H-o-H), the EBITDA margin fell 1 pp H-o-H to 58% on higher costs, primarily in materials and supplies and third-party services.> Capex came in at $824 mln in 2H19, which brought the full-year figure to $1.3 bln, in line with the guidance, which had been lowered from the initial $2.2 bln. Due to slower approval of some upcoming investment projects, the guided range for this year has been lowered 11% from $2.5-2.8 bln to $2.2-2.5 bln under Nornickel's 2020 USD/RUB assumption of 66. We thus decrease our capex forecast to $2.3 bln, but note further downside risks, as the company has a long record of underspending. LFCF came in at $2.3 bln, up 15% H-o-H on higher earnings, but below our estimate due to the lower working capital release ($60 mln actual in 2H19 versus $200 mln expected). > The final dividend for 2019 will be announced in May and paid out in July. As net debt/EBITDA as of end-2019 was 0.9, we expect a 60% EBITDA payout, according to Nornickel's dividend formula. Given that the company already paid around $3.6 bln in dividends for 1H19 and 3Q19, we expect the remaining portion will be around $1.15 bln, for a 2.2% yield.> Nornickel reiterated its neutral medium-term and bullish long-term outlook for the nickel market, with EVs expected to be the major driver for nickel demand growth. For 2020, it expects the market to be in a slight surplus of 42 kt in 2020 (versus a 28 kt deficit previously) on a growing NPI supply from Indonesia. This forecast is likely to be updated later as the impact of the coronavirus on both the supply and demand of nickel in particular becomes clearer. We reduce our 2020 average nickel price forecast to $13,500/tonne for now, acknowledging that a reduction in demand could indeed wipe out the deficit we had forecasted initially (see our report).> Nornickel reiterated the strong medium- and long-term outlook for palladium. The forecast for the deficit in the global market in 2020 was hiked by 80% to 0.9 moz, driven by a continuing increase in the amount of palladium loaded in autocatalysts for cars, which is attributable to the further rollout of the China-6 standard and introduction of RDE tests in Europe. Meanwhile, the substitution of palladium with platinum in autocatalysts is still limited because it is technologically challenging and manufacturers are now focused on meeting tighter emission standards rather than potential substitution. Despite the negative impact of the coronavirus on car production this year, it should not put a dent in the palladium deficit, which helps explain the high resilience in the metal's price. In addition, to partially offset the bigger expected deficit, Nornickel plans to increase sales from its palladium stocks this year by 25-55% to 400-500 koz from around 320 koz last year. We upgrade our palladium price forecast to $2,500/oz average for 2020.> Therefore, while we believe that the current uncertainty over the eventual impact of the coronavirus on the supply-demand balance for base metals should weigh on commodities and metals and mining stocks, Nornickel should be more resilient than other industrial metals producers thanks to its strong fundamentals in palladium and the good long-term outlook for nickel. At spot commodity prices and the current USD/RUB rate, Nornickel is trading at a 2020E EV/EBITDA of 5.5 and a dividend to be paid this year of 11% (EV/EBITDA of 5.7 and dividend yield of 11% at our commodity price assumptions). We continue to employ a scenario-based valuation for Nornickel, using a target 2020E EV/EBITDA of 6.5 (in line with the long-term historical average) and assigning a 50% probability to our base case, 10% probability to the spot case and 20% probabilities for both the bull and bear cases. We upgrade our target price to $35.70 per ADR. This implies a 19% expected total return over the next 12 months. We reiterate our BUY recommendation.