Erdemir: Better steel exposure elsewhere (HOLD - initiation of coverage)

We initiate coverage of Erdemir with a HOLD recommendation and a TRY 4.41/share price target (PT). On the one hand, we see a business that should generate EBITDA of USD 90/tonne+ from 2018E, which would result in c.10-11% p.a. dividend yields and would probably merit a BUY rating, especially as Erdemir has significantly underperformed the Russian steels under our coverage since mid-August. On the other hand, we see a company that is facing significant short-term headwinds. Erdemir is the most exposed company under our coverage to rising coking coal prices, buying its coal in the spot market, which has trebled in price since the end of 2Q. We do not expect Turkish steel prices to rise enough to offset this increase in the cost base, and we expect the EBITDA margin to decline to 14% in 2017E from c.21% in 2016E (2017E EBITDA of TRY 1.9bn, 21% behind the consensus). We believe that coking coal and iron ore prices are likely to fall throughout 2017E, leading to margin normalisation, but weaker-than-expected 1Q17E results would surprise the market negatively, resulting in cuts in the consensus and share price weakness. For this reason, we see better EMEA steel alternatives, such as NLMK (BUY, USD 19/GDR PT), which is likely to pay a higher dividend in 2017E, has more growth potential and trades at 32%/8% discounts to Erdemir on 2017/18E EV/EBITDA.