Russian stocks won’t stay cheap

Russia: worth the risk

There’s a new twitter account called @SochiProblems which consists of snarky tweets and pictures from Western journalists covering the Sochi Olympics.

Now, from the point of view of a pampered Western journalist, Russia is a bit of a culture shock . Sochi must seem pretty rough around the edges for these guys. Things work differently in Russia, no doubt about it.

But for me, that’s why Russia’s such a great opportunity. Great investments have “warts”… they have obstacles to overcome, and a chance of failure. That’s how you can get in at a great price.

A quick look at @SochiProblems tells you that investing in Russia isn’t a bed of roses. But I’m convinced that there’s a lot of potential there. I mean, the FTSE 100 trades on 14 times earnings, offering a 3.3% yield.  Russia trades on 5.6 times earnings (ie nearly a third of the price!) with a largely similar yield.

And in today’s Right Side, I want to bring you five examples of great Russian companies which are worth the risk.

Let’s take a look.

These giant companies are dirt cheap

In terms of proven oil and gas reserves, the second largest oil major in the world is Russia’s Lukoil. As well as production, Lukoil owns facilities and retail outlets across eastern Europe as well as the USA.

Now, what would you expect to pay for a global player like this? I mean, we’re talking about pretty stable earnings, and an understanding political regime behind it…

How about four times earnings!

I know that most Western oil majors aren’t exactly expensive, but this is verging on ridiculous. Most of the Western investment community don’t want anything to do with Russia. And this is the result. Still, that leaves more for the rest of us.

Sberbank’s history dates as far back as Tsarist Russia. As Gorbachev introduced market reform during the 80s, Sberbank was split out of the central bank. It was allowed to plough its own furrow as the people’s savings bank. Needless to say, as the third largest bank in Europe, Sberbank has a good market position.

Indeed, Oleg Biryulyov, the manager of the JP Morgan Russia Investment Trust argues that it’s probably the most profitable bank in the world. And yet this jewel in the crown trades on a price/earnings (p/e) ratio of less than six times. Now remember, despite its many ills, Russia has a growing middle class which offers this bank a massive growth opportunity.

And what are people bidding for this old nag? Try 16 times profits. But most UK investors don’t want any part of it. I guess they’re more impressed by the likes of Lloyd’s, a bank so in need of growth that it skinned its customers for ill-advised loans insurance – you know, the PPI thing.

Magnit is a retail giant, which has very quickly amassed a portfolio of some 8,100 stores covering about 1,900 towns and cities (you get the scale of this country!). Last year, sales grew at a rate of nearly 30%, while profits romped ahead by 38%.

Now, let’s be clear, not everything on the Russian market is dirt cheap. Investors have bid up the stock to the tune of 25 times earnings. But let’s just put that in context.

Last year turnover was up 30% and converted into earnings growth of 38%.

Sounds alright? Well, yes… but bear in mind this company could have converted the growth in turnover into much better profits, had it not been reinvesting so much in growth (new stores).

Magnit knows that it’s sitting pretty – it sees the opportunities. And so it re-invests. That’s what makes the p/e ratio look so high. This is a case of jam tomorrow – and that’s great for us.

Novatek Energy has seen spectacular growth over the past decade. Having started off as a mid-sized gas producer, it’s now Russia’s second-largest gas firm behind Gazprom. This firm produces enough gas to meet the annual demand of a country the size of Italy.

The company is increasingly diversifying into liquefied natural gas (LNG) – a massive growth area for Russia. As I mentioned last week, Russia is closely allied with China, and there’s no doubt that Russia is set to provide much of China’s energy needs going forward. And on that score, Novatek is developing a major Arctic LNG project together with partners Total and China’s CNPC.

Exciting times for this particular player!

Norilsk Nickel is one of those stocks that just goes to show that Russia is more than just an energy colossus.

Norilsk mines key metals such as nickel, palladium, platinum and copper. But more importantly, it knows what to do with them. The Russians are right up there in the field of metallurgy, and Norilsk benefitted from much of the scientific knowledge gleaned during the Cold War.

Recent Norilsk acquisitions in the field have transformed the group into a multinational with operations in Australia, Botswana, Finland, Russia, South Africa, and the United States.

I’ve been following Norilsk for several years. And it’s a prime example of Russia’s hidden talents and economic potential.

In Russia, your money goes a long way

The five companies I’ve just described make up 41% of my favourite Russia play, JP Morgan Russian Securities PLC. I first wrote about that one it back in March of 2013.  I like the fund, and as you can see I like the companies it’s built on. I’ll be coming back to this story.

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  • James Shutiak

    The reason for those “cheap” multiples is the huge risk involved. Mr. Putin may not allow profits to be taken out of Russia, or he may decide the government must take over the assets at low prices. Why would anyone trust him after what he has done to other former USSR countries or fellow Russians? Ask Mr. Kordovsky a former rich Russian if he trusts Putin even though Putin had him released from prison.

    James Shutiak CPA EMBA CMC CFE (retired)

  • Sargam

    Bengt, normally I appreciate yr. articles for their independent analysis and balanced style.

    The advice-letter community are all jumping on the Russia bandwagon right now. However, you’d do well to read The Economist’s current analysis, written in 10x the level of detail of any letter. It is quite sobering. Bottom line – Russian money, insiders, is leaving and Russia’s growth is probably not sustainable. Even if their market somehow stays level the floating ruble is a risk.

    Probably best to stick to yr. knitting.

  • Rob Mackenzie

    Bengt, I always like your writing style, but PLEASE …

    “Russia is set to provide much of China’s energy needs going forward”

    No no no no no. That’s ghastly management-speak. Try …

    “Russia is set to provide much of China’s energy” or
    “Russia is set to provide much of China’s future energy needs” or something like that.

  • DW

    Well said, Rob Mackenzie.

    MoneyWeek writers should recognise that we readers do not need key drivers or ongoing platforms in the solution space either.

  • IJ1

    Sargam – for all the level of detail the Economist’s analyses may offer, there is no worse place to go for investment advice. Often when you read a “sobering” article in the Economist about some country or other, it’s a very good time to invest in that very place. After the 1998 crisis, when oil collapsed to $9, they were predicting that oil would stay in single digits for many years to come, that Russia would embark on a brutal civil war and disintegrate. Anyone who went against their advice and bought Russian shares back then could have made 38 times (no typo!) their money in the subsequent 10 years! All the points you make re risks are valid, but i would argue largely priced in.

  • Moderator

    Hey guys, thanks for touching base re creating a reading-space free from management speak gobbledegook. That’s certainly on our radar as a deliverable, and we’ll pipeline that for future action. We’ll cascade your idea shower down to the editorial community, and they’ll leverage it going forward.

  • Ptolemy

    1. The ‘cheap’ market (Russia) is down nearly 20% since your last article in March 2013, whilst an ‘expensive’ market (the USA) is up by approx. the same. And no mention.

    2. I don’t think any article can talk sensibly about country investing without ever mentioning the currency and the balance of payments.

  • NickB

    I wouldn’t touch Russia with a bargepole! It’s an obnoxious regime regardless of the risk/reward ratios.

  • Gordon

    One thing I need to know. Are Moneyweek authors incentivised to mention “favourite” funds?

    • Moderator

      Gordon – No, absolutely not. There are very strict rules about what our writers can and cannot recommend.

  • David Cockburn

    I’m very glad to hear you have strict rules about ‘incentives’ for your writers.
    As a subscriber I believe MoneyWeek would be further improved if you had all you writers declare their interest in the stocks they discuss.

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