Ukraine GDP warrants: We update our model as first payment is confirmed

  • Payment of US$1.26 per warrant to be paid on 31 May for the 2019 reference year, the first payment on the GDP warrants
  • Payment could rise to US$13 in 2023, based on +4% growth this year, although there will be no payment next year
  • We estimate fair value for the warrants at US$166 on our model; retain Buy
Ukraine GDP warrants: We update our model as first payment is confirmed

Ukraine's ministry of finance confirmed in a statement published on 17 May the amount of the first payment on the GDP warrants since they were issued following the 2015 restructuring. The payment is due on 31 May. The total payment amounts to US$40.8mn (to be precise, US$40,750,645.60). With an outstanding notional amount of the warrants of US$3.2bn (US$3,239,320,000), the payment per warrant amounts to US$1.258 per US$100 (about 1% of the current price).

The payment is in respect of the 2019 reference year (given the two-year lag in payments), the first year for which payments were eligible when the warrants were created, and when both triggers – the growth trigger and the level trigger – were met. Real GDP growth in 2019 was 3.2%, modestly above the 3% growth trigger; there are no payments if growth is 3% or less. Nominal GDP in US$ terms was also above the level trigger. For background on the warrants and how they work, see here.

The payment is a bit higher than we had predicted last year. We estimated a total payment of US$28mn and a payment per warrant of US$0.9 per US$100 in research published in February 2020, after the release of the Q4 2019 GDP figure. The difference between our prediction and the final calculation is mainly related to the final figure for 2019 real GDP growth being slightly higher than the initial print (3.2% vs 3.1%), and due to changes in the GDP deflator and UAH/US$ exchange rate.

Outlook for next payment

Of course, with real GDP falling by 4.0% in 2020, well below the 3% growth trigger, due to the impact of the pandemic, there will be no payment in 2022. This is not a surprise.

The next payment is therefore likely to be in 2023 based on this year's growth, for which prospects of it being above the trigger look good. Real GDP growth in 2021 is expected to be 4.3% according to the Bloomberg consensus. Under the terms of the warrants, payments accelerate when growth is above 4% compared to growth between 3-4%, so a much bigger payment should be expected (if the consensus is right).

Plugging 4.3% GDP growth this year into our updated model, and given our assumptions for the GDP deflator and UAH/US$ exchange rate, we calculate an expected total payment of US$427mn in 2023 for the 2021 reference year and a payment per warrant of US$13.2 per US$100 on an undiscounted basis (ie not in PV terms). The undiscounted payment is 12% of the current price.

Projected payments on Ukraine's GDP warrants

Moreover, if the consensus is right about growth this year, and the central bank is right about achieving 4% growth in both 2022 and 2023, we calculate that would amount to a total payment per warrant (paid annually over 2023-2025) of cUS$30 per US$100, on an undiscounted basis, given other assumptions.

Recent economic developments and prospects

Real GDP fell 2.0% yoy in the first quarter of this year, according to the preliminary release from Ukraine's State Statistics Service on 14 May. This was a bigger decline than expected (-1.4% according to the Bloomberg survey) and a sharper deceleration than the 0.5% yoy decline recorded in the final quarter of 2020. On a sequential basis, real GDP fell by 1.1% qoq (sa) in Q1, versus expectations of -0.6%, and compared to 0.8% growth in Q4.

Weaker-than-expected GDP in the first quarter was mainly due to the reimposition of lockdown restrictions during the quarter, while a weaker harvest and weather-related weakening in construction and transport were also factors. The economy is expected to show a rebound in Q2, due to the easing of lockdown restrictions (expected from May) and, in time, the vaccination rollout, although the central bank's monetary tightening may temper activity.

The NBU revised its 2021 growth forecast down to 3.8% in its April Inflation Report from 4.2% previously. This was mainly due to the negative hit to growth expected in the first quarter from the tightening of quarantine restrictions. The central bank expects real GDP growth to accelerate to 8.7% yoy in Q2, moderating to an average rate of 3.9% in H2. It had assumed -1.5% yoy in Q1. Consumer demand is seen as the main driver of growth.

Ukraine real GDP growth (% yoy)

Updating our GDP Warrants' model valuations

Our model-derived fair value for the warrants is US$166, assuming a conservative 3% trend growth in real GDP, low growth volatility (3% standard deviation) and a cautious 10% discount rate (300bps spread over the 2033s), and after applying a 25% discount to our US$221 model value. This is some 13pts below our previous valuation under the same assumptions (from February 2020).

A more optimistic 4% trend rate of growth, consistent with the IMF's medium-term projections in the WEO, nearly doubles our fair value estimate, under the same (conservative) discount rate assumption. Our fair value estimate falls to US$119, only 10 points above current prices, under a more cautious 2.5% trend rate of growth, a growth rate which is closer to the historical average over the last twenty years.

Our updated model values are shown below over a range of trend growth rates and discount rates.

Ukraine GDP warrants - estimated model values* (US$)

Investment conclusion

We retain our Buy on Ukraine GDP warrants, with a price of US$109.4 as of cob 20 May on Bloomberg (indicative mid-price basis). Prices have risen c6% YTD, and have recovered much of their losses following the period of market volatility earlier in the year. However, they remain four points below their high for the year, which was also their historical high, in early February.

More remarkably perhaps, prices have exceeded pre-Covid levels this year, possibly because of prospects for a more sustained period of +4% growth in coming years (meaning much higher payments), as part of the post-Covid cyclical recovery, and also because the timing of payments is that bit closer. However, downside risks remain related to compliance with the IMF programme, prospects for trend growth, the appropriate discount rate, the exchange rate outlook and payment uncertainty.

Ukraine GDP warrants - price (US$)

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