Russia: A Value Trap or a Time to Buy?

 

Russia: A Value Trap or a Time to Buy?

Things have been far from rosy for the Russian financial markets; nevertheless, there is still good value in some areas such as food retail, IT and homebuilding. We spoke to Anna Väänänen, portfolio manager at Credit Suisse, to find out more.

 

 

 

Sanctions imposed by the West in response to the Ukrainian crisis are obviously impacting Russia – but what other issues explain the current malaise?

The current situation in Russia is the product of a combination of factors. Sanctions over the conflict in the Ukraine are of course the biggest concern as they limit Russian companies' access to capital markets and slow down investments. But we have also seen sharp falls in the price of oil (-45 percent) since June. This is important, as the export of crude is a major source of export revenues for Russia. The declining oil price, together with a lack of confidence in the economy due to the sanctions, resulted in the weakening currency. The Russian central bank has been working towards a freely floating ruble. The decision to let the currency float free at the same time as oil price and sanctions were hitting it resulted, in our view, to an overreaction. While the declining oil price is an outright negative for the economy, a weakening ruble is mainly positive for the export led economy. 

Do you then think sanctions will be lifted anytime soon?

Our base case scenario would be that European sanctions will not be lifted but that they will not be prolonged either. This would mean that the first (small) sanctions would end in March 2015, with the bigger sanctions expiring in late summer 2015.
Overall, with regard to Ukraine, the problems there are unlikely to be resolved quickly. It was already a broken country before the crisis and the division has now only been made deeper. However, we do believe that it will likely become another frozen conflict and move out of the headlines, allowing more of a focus on the fundamentals in Russia.

With the RTS index testing its five year lows, is now the time to buy Russian equities – or do they remain a value trap?

Currently sentiment rather than fundamentals are driving Russian equities, but both in absolute and relative terms there is value to be had in Russia. The first requirement for fundamentals to once again become the focus is the stabilization of the oil price and the ruble. Additional sweeping economic and financial sanctions are unlikely and at current valuations, investors would not have to take a very optimistic view on Russia's future to see some potential upside in Russian assets once the crisis has abated. For investors willing to see the long-term picture and invest on a three to five year horizon, now could be one of the best buying opportunities.

MSCI Russia 12-m trailing PE/MSCI EM 12-m trailing PE discount

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Where do you see value in the market – what are your favored areas?

We believe there are currently good opportunities to pick up solid, structural growth stories in a number of areas of the market. 

Food retailing is one of our favored areas. Organized retailing only represents around 50 percent of the market and with food inflation climbing and with import costs rising, many small independent retailers are struggling to keep supplying goods at reasonable prices. Organized retailers are therefore expected to gain market share from these small, unorganized retailers over the next few years.

Another attractive sector is homebuilders. Here there is a huge structural deficit of supply – this being the Soviet Union's heritage.  Due to strong demand, companies operating here are able to pre-sell the majority of their production. Leading companies in the sector are seeing robust growth in new home sales, while pent up demand is reported to be as much as seven years of current annual production. 

Within consumption, there are also some relatively new areas offering dynamic growth. IT and internet companies are increasing their sales by 25-35 percent per year.

Are there any areas of the market you are avoiding?

Within our portfolios, we are underweight in state controlled enterprises. We are currently witnessing a change in the government's attitude towards private ownership of oil and gas companies. We have seen state control increasing in the energy sector during the last few years – the acquisition of TNK-BP and Alliance Oil and Bashneft's nationalization being the last examples. Our view is that the message is clear, cash flows from the energy sector belong to the state. Especially now, when economy is weak and extra social expenditure is potentially needed in order to compensate for food price inflation, we are not optimistic regarding state companies dividend payments. While the market has started to price this in, we believe there is still room for disappointments. Most of the state owned companies are in sectors where there is little growth. Without growth and without dividends, we do not see any reasons to invest.  So yes, as things stand at the moment, many of these particular companies will be value traps.

Finally, how would you sum up the current situation for investors?

In a sentiment driven stock market sell-off, such as we have seen in Russia, company specific fundamentals are easily forgotten.This offers good opportunities for stock pickers. When the oil price stabilizes, the ruble devaluation is over and the Ukrainian crisis freezes and disappears from the daily news, we expect the extreme valuations to attract investments back to the Russian equity market. While we are looking at an overall economy that will not experience much growth over the next year or two, the fact that it is an emerging economy means it has structural areas where companies offering modern goods or services can win market share and post double digit growth. 

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