OREANDA-NEWS. August 9, 2011. In this note we lower our target price for Protek from USD 3.00 to USD 2.10 per share while reiterating our BUY rating.

Operating figures for 1H11 look weak at first glance... Revenue was up a moderate 4.5% YoY in rouble terms driven mainly by retail segment growth of 19.5% YoY, while distribution segment revenue was flat vs 1H10 with a 2.7% decline in 2Q11.

…but structurally are significantly improved. The good news is that the composition of distribution revenue changed substantially towards the high-margin, commercial segment which added 4% YoY, while sales in the low-margin budget segment declined 18% YoY. Retail segment revenue growth was driven by traffic growth as well as price increases. Moreover, we note that a new tax regulation that requires pharmaceuticals retailers to start paying VAT makes the retail revenue base incomparable vs 2010. In terms of analogous figures, Protek’s gross revenue growth was even stronger than the reported figures (+19.5% YoY) at 26.5% YoY in roubles. Production segment revenue lost 11.7% in 2Q11 vs 2Q10, but Protek suffered the loss for the greater good: as of 2Q11, the share of company brands in the production portfolio had nearly doubled YoY, reaching 25%. Overall, the results look neutral for the stock in the near term; however, the revenue structure has changed towards a more profitable assortment across all business units which should be reflected in higher margins from 2Q11.

Our outlook on Protek’s FY11 performance is now more conservative. The trading update suggests that our previous revenue forecast now looks unachievable, despite the revenue-structure shift towards more profitable activities and a product range that is positive for consolidated margins. We assume a more cautious stance on Protek’s profitability and expect the company’s FY11 retail division EBITDA margin to be close to zero: increased labour costs across Russia coupled with tax growth cannot yet be fully passed on to the end-consumer given Protek's weak LfL basket performance. Consequently, we cut our revenue, EBITDA and earnings forecasts by 11%, 19% and 18% in 2011-15E, on average.

Protek would have to evidence something quite extraordinary to trigger a short-term share price increase, which is not something we expect in the next few months. However, this is not a story of instant gratification: the company is likely to show improved profitability in 2H11 as it switches to a more profitable product assortment over the period, which the market is likely to appreciate. The share looks cheap vs peers: it trades at a 30-50% discount to its global peers on 2011 valuation ratios and this discount widens when we look at 2012E and 2013E, justifying a BUY rating with 59% potential upside.