research reports

Highlights

• US real GDP growth slowed to an annualized 2.1% (advance estimate) in 2Q19, after 3.1% growth in 1Q19. Unemployment rate was 3.7% in July 2019, unchanged from the previous month.
• EU19 real GDP grew by 1.1% y/y in 2Q19 after 1.2% y/y growth in 1Q19. Unemployment rate in EU19 was 7.5% in June 2019, down from 7.6% in the previous month.
• In June 2019, economic growth was 5.0% y/y in Georgia, 4.3% y/y in Kazakhstan, 3.4% y/y in Armenia and 1.9% y/y in Russia, based on preliminary data. In 1H19, real GDP growth was 2.4% y/y in Azerbaijan and 0.9% y/y in Belarus.
• Annual inflation in the US was 1.8% in July 2019, up from 1.6% in previous month. Based on the Eurostat flash estimate, annual inflation in EU19 was 1.1% in July 2019, down from 1.3% in June 2019.
• In July 2019, annual inflation was above the target level in Georgia (4.6%), Russia (4.6%), Belarus (6.0%), Ukraine (9.1%) and Turkey (16.7%); inflation was within the target range in Kazakhstan (5.4%), and below the target in Armenia (1.7%). Annual inflation was 3.7% in Azerbaijan in July 2019.
• As of 19 August 2019, monetary policy rate was cut by 0.25bp to 8.25% in Azerbaijan and to 7.25% in Russia, by 0.50bp to 9.5% in Belarus and to 17.0% in Ukraine and by 4.25bp to 19.75% in Turkey. Key rate has remained unchanged in other countries.
• Fitch reaffirmed Georgia’s rating at BB with a stable outlook and upgraded Russia’s rating to BBB from BBB- with a stable outlook in August 2019.

Please see the full report for detailed coverage of the fixed income markets of Georgia, Armenia, Azerbaijan, Belarus, Kazakhstan, and Ukraine.

GOGC released audited FY18 results. Reduced demand on natural gas due to mild winter decreased both, the revenue and expenses of the company. Revenue was down 5.3% y/y to US$ 253.6mn and operating expenses decreased 3.4% y/y to US$ 182.5mn. Notably, less favorable contractual terms for pipeline rentals and one-off costs related to legal fees weighed on profitability in 2018. Therefore, adjusted EBITDA decreased 7.4% y/y to US$ 86.8mn. Importantly, expected growth in gas consumption and related increase in gas purchase costs will temporarily deteriorate profitability metrics in 2019. Significant cash outflows related to the Gardabani 2 construction is another channel effecting negatively the net-debt-to-adjusted EBITDA ratio, which expected to reach 3.1x in 2019, still below Eurobond covenant of 3.75x. From 2020, Gardabani 2 commissioning and availability of increased cheap gas volumes from SCP are seen as major channels supporting significant improvement in GOGC’s profitability. Notably, Fitch upgraded company’s credit rating to BB in March 2019 matching that of Sovereign, backed by GOGC’s solid financial position, diversified cash flow streams and strong monopoly in Georgia’s energy sector.

Mild winter reduced revenue. FY18 revenue was down 5.3% y/y to US$ 253.6mn as gas sales volume reduced due to favorable weather conditions. Gas sales decreased 5.7% y/y in 2018, still remaining largest revenue item (56.3% of the total). Electricity sales made up 32.5% of total revenue and increased 3.6% y/y to US$ 82.5mn. Revenue from rent of pipelines dropped 30.4% y/y to US$ 16.6mn due to revised contractual terms, which are less favorable.

Lower gas purchases reduced operating expenses. Cost of gas, the largest operating expense category (79.4% of the total) was down 7.4% y/y to US$ 145.0mn in 2018. Operating expenses were down 3.4% y/y to US$ 182.5mn, driven by lower gas purchase costs, while one-off costs related to legal fees increased. Low demand limited gas purchase costs, with average prices remaining flat y/y at US$ 95.4/mcm in 2018. These flows resulted in 6.4% y/y reduction in adjusted EBITDA, which came in at US$ 86.8mn in 2018.

Expected gas demand growth to deteriorate profitability in 2019 before significant improvement from 2020. We expect the average gas purchase price to increase 13.0% y/y to US$ 107.9 in 2019 as enhanced SCP’s throughput will be still insufficient to satisfy the growing gas consumption. As a result, 2019 adjusted EBITDA expected to slide to US$ 54.9mn compared to US$ 86.8mn in 2018. The trend is set to reverse from 2020, helped by increased share of cheap gas from SCP and launch of Gardabani 2.

Electricity will make up c. 45% of revenue from 2020. Commissioning of Gardabani 2 from 2020 expected to generate c. US$ 66.0mn in revenue from electricity sales and add c. US$ 26.0mn to 2020 EBITDA. This revenue stream and decreased cost of gas expected to significantly strengthen GOGC’s financial position from 2020. We forecast adjusted EBITDA to rise to US$ 90.1mn and US$ 96.9mn in 2020-21, respectively.

KfW approved US$ 150mn loan for gas storage construction, which is expected to be finalized by 2022-23.

Temporary deterioration of the company’s profitability and credit metrics will push net-debt-to adjusted EBITDA from 1.4x in 2018 to 3.1x in 2019. However, improved financial position from 2020 expected to bring the ratio back to around 1.5x over 2020-21.

Georgia’s economic growth was strong at 4.9% in 1H19, helped by continued improvement in trade balance as well as supportive monetary and fiscal policies. The monetary policy rate cut in the beginning of 2019 stimulated GEL lending making credit portfolio growth healthier. At the same time, acceleration of public infrastructure spending made fiscal stance expansionary but fiscal deficit projected below 3.0% of GDP in 2019 with contained current spending.

Improved external balance enabled NBG to build reserves in 1H19, which stood at record-high US$ 3.7bn. NBG’s FX purchases along with other measures strengthened GEL liquidity. This stimulated de-dollarization and growth, but limited GEL’s appreciation trend - short-term cost for long-term benefit.

Rise in inflation from March-19 mostly reflected one-off factors of higher tobacco excises, keeping currency pressures muted on prices as demand was weak. Russia’s flight ban and temporary political uncertainty triggered by the visit of the Russian parliament delegation at the end of June weighed further on currency through negative expectations. The GEL reached its historic lows at GEL2.97/$ on 1 August 2019, as negative expectations were mounting despite better than expected tourism data in July and positive macroeconomic dynamics.

With an aim to limit market overreaction, the NBG intervened on the FX market and sold US$ 32.8mn out of offered US$ 40mn on 1 August. As a result of this intervention the GEL quickly strengthened by 2.9% from GEL2.97/$ to 2.89 during 1-2 August, before weakening again. The intervention followed the central bank’s statement that despite positive foreign and domestic macroeconomic dynamics, the GEL’s recent excessive depreciation related to tourism shock and negative expectations, created risks to price stability. NBG also committed to use other monetary policy tools to support the currency if needed. Importantly, the GEL’s REER and NEER weakened by more than 10% y/y, hinting at excessive undervaluation of the currency. 

As fundamentals remain strong and fresh data on July tourism is better than projected, the GEL reflects the lack of confidence currently. Lower GEL deposit growth and a shift from GEL to FX-deposits along with stronger GEL borrowing cause short-term currency pressure.

With GEL’s REER and NEER weakened and CA deficit set to shrink in 2019 helped by lower imports, we see GEL extremely undervalued – by 10-13% currently. We expect GEL to strengthen toward 2.75-2.80 against US$ through 2019 and further to 2.60-2.65 in 2020. Moreover, recent rise in treasury yields indicate that market already priced in possible policy rate hike from NBG on 4 September meeting, which will also be GEL-positive. 

Georgian Economy - Stay Confident - Fundamentals are Strong (English)
Georgian Economy - Stay Confident - Fundamentals are Strong (Georgian) - Executive Summary Only

• International visitor growth (tourists and same-day combined) slowed to 4.3% y/y (0.9mn persons) in July-19 after 19.9% y/y growth in Jun-19. This growth was predominantly driven by 11.1% y/y increase in same-day arrivals.  Tourist arrivals slowed but still posted growth of 1.0% y/y in July 2019 despite Russia’s ban on direct flights to Georgia from 8 July 2019. The number of Russian arrivals reduced softer than expected - down 6.4% y/y in July. This was largely compensated by increased Russian arrivals through land border and via alternative transit flights. 
• Visitors from the EU were up 14.4% y/y to nearly 55k visitors, with Germany (+33.7% y/y) and Poland (+15.7% y/y) driving growth in July.
• Tourism generated US$ 428mn revenues in July-19 by our estimates, down 1.1% y/y. This figure reflects reduced Russian arrivals via air, which usually are considered high spenders than those crossing the land border. In 7M19, tourism revenues stood at US$ 1.9bn, up 5.0% y/y. We expect tourism revenues to be flat y/y in 2H19 at US$ 1.9bn as we estimate tourism revenue loss of US$ 200mn in 2019 from reduced Russian arrivals. For the full 2019 year we project tourism revenues at US$ 3.4bn

Please see the full note here, which brings together tourist arrival data for reporting month, most recent statistical information available in the sector and 2019 forecast.