AFK Sistema is back in profit after a hard year.

At the end of 2014, the Russian conglomerate, with its founder under house arrest and the authorities circling, was forced to hand over to the state its shares in oil producer Bashneft, and then was hard hit from the sharp devaluation of the ruble. However, Sistema’s diversified portfolio in 18 different sectors means its business has been robust enough to weather the storm: most are now making money again, though the temperature of the hospital depends on which room you go into, says Vsevolod Rozanov, Sistema’s chief financial officer.

“We have not seen the bottom of the crisis yet, which means we have to look at the composition of what we do, but we are in reasonable shape, at least in the major industries into which we have invested,” Rozanov tells bne IntelliNews in an exclusive interview.

As Russia’s leading conglomerate, Sistema is exposed to the full range of Russia’s current economic problems. “Inflation is slowing now and where it is next year will depend on how aggressive your assumptions are concerning the price of oil: plus or minus $5 will make a big difference.”

Yet Rozanov insists there is “no crisis”at the company. “Some of our industries are not feeling particularly well – the tourism industry will take time to catch up and there were some difficulties with liquidity in at the start of this year – but we have already more or less returned to normal,” says Rozanov. “And those that are focused on export are doing very well, especially the paper and pulp businesses, as Russia is a cost leader globally now.”

Devaluation hurt Russian business in general, but for those few companies that enjoy good export potential it has been a boon. Sistema took over the vertically integrated pulp and paper holding Segezha Group earlier last year and its exports have grown fast. Countries that used to be too far away to export to, have been moved a lot closer to Russia in terms of the cost of transport by the collapse in the value of ruble. “We can now transport anywhere,” claims Rozanov.

Sistema is also a big investor in agriculture, which has been another big winner from the falling transport costs. Russia is now on track for a bumper harvest of about 106mn tonnes of grain, according to recent estimates issued by the Ministry of Agriculture. “In the last year Egypt has become the biggest buyer, but now we have orders from 15 countries in Southeast Asia, Mozambique, Tanzania and elsewhere. The significant margins mean we can transport far away.”

And Sistema’s investments in the oil services business are also doing well. “This business is independent from oil prices and the government needs the money, so they are pressuring the companies to produce. That means we are doing well,” says Rozanov.

Retail remains another big winner despite the sanctions and recession, and the company has continued to aggressively expand its Detsky Mir chain of children toyshops.

Out of all Sistema’s business lines, mobile phone operator Mobile TeleSystems (MTS) remains by far the biggest, accounting for 60% of the conglomerate’s revenues. However, the golden years of fast growth are clearly over with mobile telephony in Russia now a mature business. In September, MTS reported that revenue from data had overtaken voice for the first time; data revenue exceeded voice revenue by 5% in July, and in August that gap widened to about 10%, where the company expects it to stay until the end of the year. “MTS is now a mature business and like its counterparts in the West needs to reinvent itself,” says Rozanov. “We are already trying new approaches like personal finance and offering value-added services. The business is not going to double in size each year as in the past and even growing in the middle single digits is a dream.”

The growth of data revenue has been driven by the increased coverage of MTS’ LTE network (4G), which has doubled over the past year, and the promotion of internet-focused devices at MTS’ own retail chain. MTS estimates its LTE subscriber base in Moscow, where it launched earlier this year, at more than 2mn. Additionally, as of the end of June 70% of new subscribers in Moscow opted for tariff plans that included data, compared with 65% at the beginning of the year. Today, MTS already controls a third (37%) of the Russian mobile data market.

Share recovery

The return to normalcy has shown up in the company’s bottom line after it reported IFRS profit of RUB481mn ($7.3mn) in the third quarter compared with a net loss of RUB5.53bn for the same period of 2014, the company reported on November 26.

That loss was related to its oil-producing division Bashneft, which Sistema founder and chairman Vladimir Evtushenkov was forced to hand back to the state with money-laundering charges hanging over his head. This led to fears that Sistema was going to suffer the same fate as Mikhail Khodorkovsky's Yukos, which was broken up by the Kremlin and had its assets sold off to state structures for a song. As a result, Sistema was the worst performing Russian stock in 2014.

However, a deal with the state that saw Sistema compensated to a degree for the loss of Bashneft plus the release from house arrest of Evtushenkov soothed investor nerves, and the stock in the year to December 9 has rebounded almost 250% to stand at $6.25.

Even so, the third-quarter profit this year was modest due to heavy foreign exchange losses of RUB9.6bn incurred after the devaluation of the ruble last December. On the flip side, revenues in ruble terms were up a robust 14.3% year on year (y/y) to RUB184.2bn in the same period – and as the currency stabilizes the company is looking forward to better revenues and profits next year.

With a RUB81bn cash pile Sistema has enough liquidity to run its empire without many funding problems. However, even with the high interest rates at the moment, the company is still borrowing at home and abroad. It has total debt of some RUB170bn, says Rozanov, if commercial debt is counted in. “For the banks the question is if you are a quality borrower or not, and we tick all the boxes so have become a ‘most desired borrower’,” claims Rozanov.

With its track record as a major player in most of its sectors, its London listing and high standards of corporate governance, as well as a long established track record of making money, Sistema can take advantage of its blue chip status to tap the credit markets. “And we get better rates than companies with no track record,” says Rozanov.

The same is true for borrowing abroad; despite the financial sanctions imposed on Russia by the West, Sistema has still been borrowing from international banks. “The foreign creditors have become very picky,” says Rozanov. “The difficulty is not just raising things like trade finance, but simple things like getting them to sign any sort of contract at all. There was a scarcity of liquidity, especially in the first half of this year, but now things are returning to normal. Indeed, in some cases we can get funds that are cheaper than they were in 2014.”

Sistema has already got many funding deals in place that continue to work at the pre-devaluation rates and while the cost of borrowing is rising now due to more expensive domestic rates, the blend of pre- and post-crisis debt in the company’s loan book means the costs are not rising dramatically.

The company has also turned to the ruble bond market to raise money, especially the variable interest rate bonds as the expectation is that rates will fall over the next year. “Ruble bonds has become part of our funding [even though] the market can’t give us the volumes we would like, but it has become a more visible part of our portfolio,” says Rozanov. “The advantage is that it is the simplest way to fund ourselves: you can buy and sell as needed. The margin is slightly higher than the commercial debt, but banks often impose much stricter restrictions on you.”

The company’s ability to borrow could be put to the test in the new year when it has to refinance or pay down a RUB32bn debt in India in the first quarter of next year as part of a merger agreement for mobile asset Sistema Shyam TeleServices (SSTL) with Reliance Communications. In addition, the company is in negotiations with the Russian State Property Agency over a debt of $777mn owed as part of an existing option for SSTL shares. “We are asking the government to delay the payment for five years, paid in installments, with the biggest payment up front,” says Rozanov. “But if that doesn't work then we will refinance using commercial debt. That is not a problem as the Western and Asian banks have capital to lend.”

Future brightening

Sistema is coping well with the challenges of today, but Rozanov becomes philosophical when discussing what the longer term holds for both the company and the country. “The biggest problem Russia faces today is our people are working more hours than our peers in the EU, but producing less,” says Romanov. “The productivity is not comparable, but then neither is the pay.”

This is both a problem but also a huge opportunity for Russia. In the 1990s the situation was similar, but with the economy on its back there was not much anyone could do about it. Today, after a decade and half of fast growth, most of the necessary infrastructure is in place; the only challenge is working out how to make better use of it.

“Now is the perfect time. Of course, we need to make some structural reforms, but the changes we have just been through is also a huge opportunity. We need to change the way we work. The new normal will be more modest, the people less flashy, less intoxicated, than they were before the 2008 crisis, but we have already emerged from this crisis and thinking about where we will go next.”