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(DENIS SINYAKOV)
(DENIS SINYAKOV)

Emerging markets

Stars begin to align for Russia's downtrodden stocks Add to ...

After years of being shunned by Western investors, Russia’s stock market has emerged as a surprising star in recent months and observers say more gains lie ahead.

So far this year, Russia’s Micex Index and broader RTS Standard Index are up 4.4 per cent and 4.9 per cent, respectively, in U.S. dollar terms. Elsewhere in the BRIC group of developing nations, China’s main stock market has nudged up only 2.7 per cent, while India’s has fallen 11.5 per cent and Brazil’s is off 7.9 per cent.

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A surging oil price has helped to lift the Russian economy, but observers say that’s just one reason for investors to look closer at the world’s largest exporter of commodities. Russia’s stock market is among the cheapest in the world, and the country is likely to reap benefits from playing host to the 2014 Winter Olympics and 2018 World Cup in soccer.

“We could see the Russian market go up by 25 per cent by year-end based on current fundamentals,” says Douglas Helfer, a London-based manager with HSBC Global Asset Management (U.K.) Ltd.

Among the BRIC countries, “Russia is the best value market,” said Mr. Helfer, who co-manages the HSBC BRIC Equity Fund. The Russia market trades at a price equivalent to just over seven times its estimated forward earnings. It is considerably cheaper than China (12 times earnings), India (16) and Brazil (13).

The biggest reason for those low prices? Russia is often regarded as the black sheep of the BRICs. Memories linger of the country defaulting on its debt in 1998 and corporate governance remains a concern. Its economy is growing at about 4.5 per cent a year – a healthy pace but only about half as fast as that of China. In addition, the country faces a demographic challenge: the average Russians is in his or her early 40s, far older than the average Chinese or Indian citizen and thus less inclined to spend.

Many investors were scared out of the Russian market after it plunged more than 70 per cent during the 2008 global credit crisis, Mr. Helfer said. “It is still down between 25 to 40 per cent from mid-2008, depending on the index.”

Energy Helps

But rising crude prices have given Russia a new lease on life as oil and gas exports provide nearly half of the tax base in Russia. London Brent crude for June delivery settled at $112.73 (U.S.) a barrel on Monday, down from a peak of $127 last month, but up considerably over the past year. “We feel comfortable forecasting an average price of $100 per barrel for the next 12 months,” Mr. Helfer said.

Valuations are still attractive in the Russian energy arena, particularly in the country’s natural gas sector, which trades at five times forward earnings, he said. Russia’s gas customers are in Europe, where the contract price for gas is linked to the price of oil in the previous nine months, he added. “We will see those prices [for gas]increasing dramatically by the middle of the year.”

Russia is also benefiting from a delayed economic rebound, as consumers begin to open their wallets and disposable incomes rise. “[The country]is currently building what is best described as a late cyclical recovery,” says Matthias Siller, a portfolio manager with Baring Asset Management Inc. in London.

The recovery is likely to pick up pace in coming months. With a presidential election looming in 2012, the Russian government is busy redistributing cash from higher oil prices to its citizens so “it will be expanding fiscally rather than retrenching,” said Mr. Siller, who also manages the Excel Emerging Europe Fund.

While oil and gas are a big part of his portfolio, Mr. Siller likes the banking sector, too. He owns shares in Russia’s largest bank, Sberbank, which is expected to get a lift as the country’s economy recovers and lending increases. He also finds mobile phone companies, such as Mobile TeleSystems, attractive because many of their costs are in U.S. dollars and so they benefit from a ruble that is rising versus the greenback.

John Connor, a portfolio manager with New York-based Third Millennium Investment Advisers, is a fan of Russian retailers because of the country’s rising middle class. In his mutual fund, he owns retailers such as X5 Retail Group. “They have these hypermarkets that make Wal-Mart look like a corner store,” Mr. Connor said. He also holds food retailers such as Magnit and Dixy.

Russia’s economy is poised to gain momentum as the country plays host to the 2014 Winter Olympics in Sochi and the 2019 World Cup in soccer, HSBC’s Mr. Helfer said. “There has been a pledge by the state to spend money on infrastructure spending.”

Still, the upbeat scenario for the Russian market could be derailed if oil plunges to well below $100 a barrel, or there is a big shock to global growth, such as euro-zone country defaulting on its debt, he acknowledged. “We think the probability is not high, but it is still there.”





WAYS TO PLAY RUSSIA



U.S.-listed pure plays on Russia:





iShares MSCI Russia Capped ETF

Holds 29 stocks with 54 per cent in energy and 17 per cent in materials. Gazprom is the largest at 25 per cent.



SPDR S&P Russia ETF

Includes 38 stocks with 51 per cent in energy and 20 per cent in materials. Gazprom accounts for 22 per cent.



Market Vectors Russia ETF

Tracks 49 securities with 44 per cent in energy and 17.6 per cent in iron and steel. Sberbank and Gazprom are the largest at 8 per cent each.



Market Vectors Russia Small-Cap ETF

Tracks 35 companies with at least 50 per cent of revenue from Russia. Utilities, materials and energy each account for more than 17 per cent.







Canadian mutual funds with Russian exposure:





Excel Emerging Europe Fund

This fund is 56 per cent invested in Russia. Gazprom, Sberbank and Lukoil are the top three names at nearly 10 per cent each.



HSBC BRIC Equity and Templeton BRIC Corporate Class

These two funds are, respectively, invested 16 per cent and 24 per cent in Russia.

 
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