Buy the panic: analysts mark Russia’s stock market up to buy

Buy the panic: analysts mark Russia’s stock market up to buy
“Buy the panic” analysts mark Russia’s stock market up to buy / bne IntelliNews
By Ben Aris in Berlin April 10, 2018

Russian brokerage BSC Global Markets issued a note entitled “Buy the Panic” and marked the Russian equity market up to Buy following a rout that saw the leading indices tumble after the US government imposed new and painful financial sanctions on some of Russia’s biggest businessmen.

“We view today’s sell-off as a regulatory / liquidation driven market move, and believe it presents the best buying opportunity since mid-June 2017,” Vyacheslav Smolyaninov, BCS GM’s deputy head of equity research and chief strategist said in a note emailed to clients.

Russia’s assets were rocked by a sell off on April 9 as investors digested the implications of the release of a Specially Designated Nationals And Blocked Persons List (SDN List) issued by the US Treasury department on April 6 that bans US-based investors from working with seven oligarchs, 15 companies and 17 government officials. However, Russia-based analysts agree the sell off is probably overdone. 

“The Russian market has settled this morning and the panic selling has abated, as investors assess the repercussions of last week’s sanctions and yesterday’s market rout. While the general backdrop remains uncertain and the threat of further sanctions is unclear, we believe the Russian market is near a temporary floor. We note that the fundamentals surrounding the Russian market remain mostly unchanged and that Russian equities still provide among the healthiest dividend returns globally. We would thus ignore the current jitters and buy into the current weakness, particularly with dividend season almost upon us,” John Walsh, the chief editor at Alfa bank, wrote in a note.

The ruble-denominated Moscow Exchange index sustained its heaviest losses since the annexation of Crimea, dropping by 8.3% in the day to close at 2,090. Its sister index the dollar-denominated Russia Trading System (RTS) sold off even more, falling 11.4% in the day to close at 1,094 at the end of play on April 9.

Deripaska targeted 

Kremlin insider Oleg Deripaska and his companies were singled out for special treatment and his Hong Kong-listed aluminium producer Rusal saw the biggest falls after its stock price fell over 20%. Eight of the 15 companies listed are controlled by Deripaska, who was implicated recently in a scandal alleging he had spearheaded Russian interference into last year’s US presidential election and was offered private briefings by campaign chairman Paul Manafort.

The Russian equity sell off quickly spilled over to affect stocks that were not linked in the SDN list as investors panicked. The state-owned retail banking giant Sberbank has been one of the most popular stocks for emerging market investors over the last two years and is the most valuable company in Russia. Although it is not named in the list, it saw its share price tumble: the ordinary and preferred stock fell 17.04% and 13.44% respectively.

BCS GM’s Smolyaninov argues that the fall in the price of a company like Sberbank is not justified and that the price will bounce back, presenting investors with a golden buying opportunity. The sell off has wiped out all of the market’s gains in the year to date, but before the sell off Russia was the second most overweight country amongst international portfolio investors in the benchmark MSCI EM index at 5.3% of the index against Russia’s overall weighting of 3.5% in the index.

Smolyaninov calculates there is now a 20% upside to prices for 2018 and forecasts the RTS index will recover to 1,350 by the end of the year. The index has been rising steadily on the back of Russia’s nascent economic recovery that saw the index break out of a band between 900 and 1,200, where it has been trading since the last sell off in March 2014, after Russia annexed Ukraine’s Crimea peninsular, kicking off the current showdown with the west.

Recovery still on track 

Underpinning the expectation of a bounce back in asset prices is the macroeconomic recovery story that has not been derailed by the woes of one large company and its owner. Russia’s economy is expected to grow by 1.8% this year, according to the economy ministry, and could grow much faster.

President Vladimir Putin unveiled a very ambitious plan reform plan during his state of the nation speech on March 1. The president wants productivity growth to accelerate to 5% per year (since 2009, the average growth has been only 1%) during the next decade, the share of SMEs in GDP to go up to 40% (from the current level of 20%), the number of people employed in SMEs to go up from 19mn to 25mn people, and to halve the number of people living below the poverty line (currently 13.8% of the population or 20mn people).

“Increased market volatility rarely has a long-lasting impact on the macro dynamic, unless such volatility lasts long and, therefore, creates a new paradigm, both for the market and the economy at large. Despite the significant weakness in the ruble exchange rate seen [on April 9] (-3.8%), at this stage, we see very limited implications from that for the economy – we tend to believe the currency will soon stabilise at levels that are more in line with its current fundamentals,” Smolyaninov said.

While there has not been a broad index-wide growth in Russian share prices over the last two years, there have been some spectacular corporate stories as the leading companies consolidate their lead in their respective niches and refocus away from simply grabbing market share towards improving productivity and profitability. Ironically Rusal has been one of these names and saw its share price soar from around HKD4 to HKD6 over the last two years on the back of restructuring and the beneficial effects of a ruble devaluation in 2014. The stock is currently trading at HKD2.2 as of the time of writing on April 10.

Russian equity investors have become inured to the rollercoaster ride that investing into stocks can provide but the very volatility has made some brave investors a fortune. In 1999 Al Breach, then head of research at Goldman Sachs, persuaded his employer to mark the entire market up to a Buy as well. The RTS had fallen from circa 500 to a low of 38 following the 1998 financial crisis but rapidly recovered and grew continuously to an all time high of 2,400 in May 2008.

Likewise, the RTS tumbled from a high of 2,026 in May 2011 to 1,151 in May 2014 following the annexation of the Crimea and then continued to sink as tensions with the west escalated, falling to a low of 744.43 in February 2016 before it started to recover to its last high of 1,284.7 in February this year as the economic recovery got underway.

BCS recommends investing into the defensive stocks that will always do well as they are based on supplying commodities that are always in demand and in that sense are “stateless”.

“Our best stock specific ideas in the current environment centre on the ‘safer’ and/or most undervalued / unfairly sold-off names. We see large exporters of raw materials (to the EU specifically) as potentially better protected from sanctions, while hitting index heavyweights (MSCI) would also hurt international investors most,” says Smolyaninov. “Another safety pocket from the positioning / hedging perspective is the high-dividend space. Subsequently, our best ideas among exporters in the O&G [oil and gas] are Rosneft, Lukoil, Gazprom and Novatek, and in the M&M [metals and mining] Norilsk, Severstal, NLMK and MMK. Among the top domestic ideas we single out Sberbank, MTS, Enel Russia, X5 Retail, Yandex and Globaltrans.”

Bonds were also caught up in the bloodbath on April 9 with yields on Russia’s benchmark 10-year ruble bonds rising to 7.285%, their highest level since January as trading in these bonds surged. BCS suggests the biggest bounce in bond prices will come from those at the long end of the curve amongst the sovereign Eurobonds (Russia 47, Russia 43, Russia 42) as these bonds are underpinned by the country’s rock solid macro fundamentals.

Still, the current situation is not without its risks and BCS speculates that if the volatility persists then that will weaken the ruble to above RUB60 to the dollar for a protracted period and that will in turn spur inflation, which will hurt Russia’s economic recovery.

“This will boost inflationary risk (via higher import prices), negatively affect real income and consumption trends, and could reverse the downward trend in commercial and official rates. As a result, the economy could post a weaker growth dynamic as consumption and investment would suffer. However, we do not think that the risk of a full-blown recession is on the cards before a dire scenario of the ruble hitting RUB70/$ or above and inflation breaking 5%. Until then, we see limited risks of a downward revision for our FY18 growth forecast of 1.8% y/y,” Smolyaninov says.

More seriously Tim Ash, head of strategy at Bluebay Asset Management, makes the point that the new SDN list sanctions represent a scaling up in aggressive tactics by the US government as the nature of these sanctions were specifically designed to financially wound some of Russia’s top companies and could mark the start of the imposition of a much broader sanctions regime. Russian equity valuations have been rising in the last two years on the assumption that no new sanctions would be imposed after the initial round in 2014.

“Further I think the failure to sanction secondary trading ensures that investors in Russian assets were able to discount geopolitical risk around Russia by investing in what they saw as "safe haven" assets, I.e. already issued securities. I think markets and investors now have to throw this assumption out but also take more heed of the reality that Russia-Western relations are at a 40-year low, on a deteriorating path, with more, not less, sanctions likely, and therefore increased risks associated with holding Russian assets,” Ash said in a note emailed to clients.

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