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Oil price bring back on the track Russian market

Since the middle of 2008 the Russian market has tracked the oil price; the rule of thumb that the Russian RTS Index is the oil price times 20 has been the somewhat uninspiring reality.

Oil price bring back on the track Russian market

 

 

Since the middle of 2008 the Russian market has tracked the oil price; the rule of thumb that the Russian RTS Index is the oil price times 20 has been the somewhat uninspiring reality. Given that both price earnings (PE) multiples and index earnings are highly oil-price dependent, there were good reasons for this link in a world where oil prices and markets were volatile. But greater oil price stability should encourage investors to look afresh at Russian markets as a high-growth, low-debt story, linked to the Asian boom. Provided oil stays near current levels, we expect the RTS index to end the year at 2,000, up over 30 per cent from today and still 20 per cent below its peak.


A good starting point is that the market and the currency are cheap. At $70 oil, we forecast a 2010 PE ratio of 8.4, and a price to book ratio of 1.1; across a series of sectors from oil to base metals to retail, Russian stocks trade at a 20–30 per cent discount to their emerging market peers. It was not always thus; the market has in the past traded at a premium to emerging markets and at PE multiples in the low teens. Meanwhile, the ruble trades at two thirds of its purchasing power parity fair value, and the country runs a large current account surplus.


Russia has tremendous growth potential, as penetration levels for most goods and services are well under half those in Western Europe; mortgage penetration for example is 3 per cent of GDP and only 20 per cent of people have cars. For those companies that have been able to seize the opportunity, the rewards have proven tremendous, and Russia now boasts the largest markets in Europe for mobile subscribers, beer or white goods. Meanwhile Russia is the world’ s greatest repository of natural resources, and Russian companies are blessed with colossal amounts of commodities, valued at a fraction of their global peers.


Contrary to the various scare stories you may have heard during the crisis, debt levels are low in Russia. Government debt and household debt are both under 10 per cent of GDP, bank loans to GDP are 39 per cent, and in the recent McKinsey study of the global credit bubble, Russia stands out for its extremely low level of total debt to GDP (71 per cent), half that of China and a quarter that of developed markets. Consequently, Russia will not be held back by the deleveraging facing other markets.


And into this relatively benign mix comes a catalyst which we believe will electrify the story in 2010 – disinflation. For the first time since the end of the Soviet Union, inflation has now fallen into single digits for an extended period. From 13 per cent in 2008, inflation fell to 9 per cent in 2009 and is currently running at around 6 per cent, where we think it will end the year. The government will thus be able to continue to cut the cost of money, and we anticipate a further 150 basis points of rate cuts this year. All of this leads to growth: in 2010, we expect loan growth of 20 per cent, GDP growth of at least 5 per cent, and earnings growth of 41 per cent.


There are a number of other factors that we believe will help the story. The modernisation programme being pushed by both President Medvedev and Prime Minister Putin will over time yield results in economic diversification, greater power for the courts, and a more modern administration; Russia continues to shift its centre of gravity to the growth markets of the East with the building of pipelines and infrastructure; and relations with the West continue to improve. The usual counter to a positive stance on Russia is to cite transparency, corporate governance, and corruption. On transparency, the environment has changed radically in the last few years, with Russian companies adopting international accounting standards and disclosure. On corporate governance, a number of high profile cases such as Mechel, Vimpelcom or Uralkali were favourably resolved over the last year; in a world of Madoffs and Enrons, Russia is perhaps no worse than its peers. Corruption remains a problem and a drag on growth, albeit an issue that the government is seeking to address.


Fears of a new Cold War were always far-fetched given Russia’ s new capitalist direction, and we are likely to see much less concern about this given a new government in Ukraine and more accommodating US policy. The main issue which should concern investors is the oil price, given that the ruble, government finances, and profits are heavily dependent upon this. Below $60 a barrel the market gets nervous, and below $40 a barrel the whole macroeconomic framework looks fragile. Few predict low oil prices currently, but this is the main tail risk that we fear.
 



Author: Kingsmill Bond


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