OREANDA-NEWS.  April 26, 2012. We initiate coverage of Norilsk Nickel with a HOLD rating and a target price of USD 19.30/GDR (USD 193/ordinary). In the absence of support from the buybacks the stock enjoyed in 2011, shareholder infighting could continue to affect sentiment and weigh on the stock’s performance, reported the press-centre of ATON.

However, as the market learns to live with the situation continuing in the background, attention could start shifting towards longer-term fundamentals affecting the company’s performance, in our view.

Shareholder conflict ongoing, but it is time to look beyond the infighting. The conflict among major shareholders has been one of the key factors affecting the stock’s performance in recent years. As a result of the 2011 buybacks, Interros and allies hold the majority stake in the company (54%, we estimate) and de-facto control the board. This brought the face-off to a standstill but is unlikely to put an end to the conflict, we believe. However, as long as there is no serious escalation of the conflict, the stock’s fundamentals could come back into focus.

Treasury stock adds M&A firepower. We have heard suggestions from management that at least part of the treasury stock could be cancelled. We believe this would be the worst outcome following the tremendous effort and money that went into accumulating it. The stock adds around USD 5.5bn in value to the company’s ‘war-chest’, which could potentially be as large as \\$15-16bn, on our estimates, giving Norilsk significant firepower to enable it to become one of the industry consolidators in Russia should management decide one day on this way to grow the business.

Unique resource base, but monetising it is slow. Norilsk’s unique resource base has a rich content of high grade by-products, bringing its cost of nickel production into negative territory. Its resources are so vast that they could last well until the end of this century at current output rates. Unfortunately this means that it could take as long to see it all monetised. The company has an ambitious investment plan aimed at modernising its processing and infrastructure. However, the output gains would be modest without the development of major projects that are some years away.

Shifting the focus away from nickel to counter challenging fundamentals. Norilsk’s development plan also envisages reducing nickel’s weight in the revenue mix from over 50% currently to around one-third of the total by 2025, with copper, PGMs and other metals taking a bigger share. This is a sound strategy, we believe, given the tough fundamentals for nickel and the more advantageous positions of copper and PGMs (palladium in particular). Moreover, this would make Norilsk better diversified and protected in times when global fundamentals turn for the worse.

Less free cash, but still plenty to share with shareholders. Norilsk’s ambitious modernisation plan calls for spending USD 35bn on legacy assets and another USD 4bn on major growth projects by 2025. This would depress its free cash generation ability at least until 2014-15. Nevertheless, we believe it will still be able to generate around USD 1.5bn in free cash annually – enough to cover generous dividend payments.

Initiating with a HOLD rating and USD 19.30/GDR target price. Our target price is based on a combination of valuation ratio (P/E, EV/EBITDA) and DCF calculations, which in our view gives a good balance between short-term market drivers and the company’s long-term growth potential. However, our target price offers just 11% upside from the current levels, prompting our HOLD rating.