OREANDA-NEWS. April 16, 2010. We are initiating our coverage of the Russian gold sector. Following the strong sell-off during the crisis, the sector is still underperforming the gold price while its fundamentals are stronger and soon it will be supported by active production growth across all companies, reported the press-centre of VTB Capital.

While the gold price outlook for the foreseeable future is neutral, we see the sector’s earnings growth coming from an active expansion in production. All the companies which took advantage of record high gold prices in 2009 managed to reinvest into new capacities, thus setting up a solid base for production growth as early as this year. We forecast Polyus Gold to increase at a CAGR 15% over the next 5 years, and Polymetal and Petropavlovsk to post CAGRs of 12% and 13%, respectively.

We rate Polyus Gold a Buy with 31% upside potential to our 12-month TP of USD 35/GDR. The company has the biggest reserves and we now see it entering a production growth period which will unlock its value. Large-scale Blagodatnoye is already set to be started in mid-2010.

KazakhGold might become a wild card for Polyus. However, at the moment we are cautious on the current state of its assets and the capex needed to return it to effective production. We rate it a Hold, with 16% upside potential to our 12-month TP of 9.4/share.

Polymetal is our preferred stock in the universe as its project development expertise will in our view lead to effective growth. The presence of silver in the product mix will help to drive earnings as we see it outperforming the gold price. We rate Polymetal a Buy, as our 12-month TP of USD 14/GDR implies 39% upside potential.

Petropavlovsk is another name which we see presenting a big upside potential: it remains the most competitive on the cost side and the iron ore exposure is growing. It is also the cheapest on a multiple basis. We rate it a Buy with 44% upside potential to our 12-month TP of USD 29/share (GBP 19/share).

The major risks to gold pricing are macroeconomic indicators (local currency and inflation mainly). Specific risks are mostly capex requirements and execution as the companies are all high growth profile.