COMMENT: Russia in Apr-Jun - bullish despite Bear Stearns

By bne IntelliNews April 7, 2008

Roland Nash of Renaissance Capital -

Looking ahead into the second quarter, our view remains bullish for Russian assets. The credit crisis in developed markets has had only a limited impact on Russia's financial sector so far and no discernible economic fallout. There has been some slowdown in credit creation as banks struggle to raise international financing, but a brake on the very rapid expansion seen in 2006 and 2007 is arguably healthy.

M&A activity, FDI and domestic investment have remained resilient throughout, suggesting that the private sector continues to have an optimistic longer-term economic outlook, an opinion with which we would readily concur. Indeed, while the world worries about economic slowdown, credit quality and the availability of liquidity, we continue to hold that the major medium term concerns for Russia of the global credit crisis are inflation, ruble appreciation and asset bubbles.

Inflationary pressure in Russia is high, and there are indications that it will build further. While lower international borrowing has meant that some of the monetary pressure on inflation has eased, fiscal expansion seems inevitable. The two major strategies of President-elect Dmitry Medvedev's first term look likely to be an attempt to establish a better framework for a rule of law and the rebuilding of Russia's social and physical infrastructure. On top of the domestic pressure on inflation, the international credit expansion signaled by the US Federal Reserve and the (partly resulting) increase in price of commodities is pushing up inflation in Russia.

The increased economic activity, the higher commodity prices and the potential inflow of capital resulting from lower capital costs internationally should prove positive for asset prices. We remain confident that Russia will emerge from the global credit crisis as a favoured destination for capital.

Unfortunately, it seems likely that the performance of the Russian equity market in the second quarter will again be largely determined by the volatility in international markets rather than by its relative attractiveness. Risk, therefore, remains high. Developed markets may have already priced in the immediate impact of the credit crisis and the expectations of US slowdown. But the wider global economic impact remains less clear. We believe there is scope for more negative surprises in the second quarter and so remain cautious in the very near term.

The fear that surged through our markets when Bear Stearns collapsed made it very clear that the domestic liquidity that has underpinned Russian equity since 2002 is not prepared to step in to defend the market. This leaves Russian equity vulnerable to new bouts of selling, despite current valuations. In the likely event of another international scare, the RTS could sell down towards 1,500 (25% below current levels), even with the current estimated 2009 price/earnings ratio of 9 times.

Panic-selling aside, we remain convinced that Russian equity is very well placed to be one of the first to benefit when international markets find some stability. Commodities have so far been the asset class of choice. There are compelling reasons to believe that commodity equities could be next, particularly given the performance in the Middle East. The strong domestic story for Russia will mean that new capital inflow from both the developed and the new world economies will push into ruble assets. Although international volatility means that our year-end target for the RTS of 3,000 (45% upside from current levels) now looks ambitious, we continue to expect the RTS Index to rise towards that level over the next 12 months.

In this environment of positive domestic momentum against a backdrop of international uncertainty, we continue to recommend investing into the more obvious themes in the Russian economy. We like anything that is not entirely crowded among the infrastructure names (MMK and TMK), ruble appreciation (the mobiles and the best among the consumers), coal (Mechel) and agriculture (Razgulai and Cherkizovo). We also like the overlooked hydrocarbons, although this has so far this year not proved the best trade (Lukoil and Gazprom).

Roland Nash is head of research at Renaissance Capital, Russia

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