MOSCOW BLOG: Russia’s equity market sets out on its fifth super cycle

MOSCOW BLOG: Russia’s equity market sets out on its fifth super cycle
Russia’s equity market sets out on its fifth super cycle
By Ben Aris in Berlin January 7, 2018

Russia’s equity market has come back to life and stock prices look to have started on the market’s fifth super cycle since inception. But as the old oil price growth model has been exhausted this time round, the returns are likely to be less, but then the volatility will also be less.

The Russian equity market rerated in 2016 as stocks prices became too cheap to ignore. The leading RTS index gained just over 50% in that year, but in 2017 it did less well, essentially ending the year flat. The outlook for 2018 is better and the index is expected to break out of its range-bound performance, oscillating between 1,000 and 1,300.

Over the last two decades investing into Russian equity has been more about getting the timing right than choosing the right names. The old adage was Russia’s equities were always the best performing market in the world – or the worst. However, unlike in the previous episodes where investors could make hundreds of percent returns, this new super cycle will not return as much. The RTS index has to a significant extent decoupled from the oil price. Instead equity prices are going to be driven by more traditional factors such as earnings growth and dividend policy.

Is this a crisis year?

The dollar-denominated Russia Trading System (RTS) was set up 22 years ago on September 1, 1995 with the index set to a nominal 100. Since then it has been a roller coaster ride for investors brave enough to take a punt on the new Russian stock market.

The index was trading at 1,194 as of January 4 – a 1000% return for investors that have been in the market since day one, but that is still not a brilliant return in annualised terms: a compound average return (CAR) of only 11.9%. In a market as risky as Russia investors would like to see a bit more back from taking a punt.

However, the market has made spectacular returns for those that get the timing right – and get out again before the periodic crashes. Timing is everything. For most of the last two decades the index was simply twenty-times the price of oil, making Russian stocks as volatile as the world’s most unpredictably commodity – oil prices.

Another rule of thumb for investors is to simply ask “is this a crisis year?” If it is not then the RTS usually returns at least 20%, but if it is a crisis year it can lose up to three quarters of its value. Not counting the crisis years of 1998 (Asia crisis), 2004 (mini-banking crisis), 2008 (Lehman Brothers), 2011 (economic growth stalled), 2014 (silent crisis) then Russia’s market has returned well over 20% in the remaining 17 years.

However, what is also clear is that since 2011 this rule of thumb has broken down and it coincides with the RTS decoupling from oil prices, which have also fallen off their $100-plus perch. Apart from the rerating in 2016 the equity market has failed to produce any meaningful returns in the non-crisis years since 2011.

RTS index performance 1996-2017

Year

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

RTS index (eop)

201

397

59

175

143

257

359

567

614

1126

1922

% change y/y

142

98

-85

197

-18

79

40

58

8

83

71

                       

Year

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

RTS index (eop)

2291

632

1445

1770

1382

1527

1443

791

757

1152

1124

% change y/y

19

-72

129

23

-22

11

-6

-45

-4

52

-2

source: Aton, Bloomberg

Four super cycles

As the chart below shows there have been four super cycles since the market was established but the chart also shows very clearly a “buy and hold” strategy does not work in Russia.

By far the most profitable cycle was the very first one that started on September 1, 1995. The value of the index quintupled in value over the next two years to reach a high of 570 in August 1997 and the mood in Moscow amongst the buccaneering investment banks was ecstatic. However, that was the year the Asia crisis began, which took a year to feed through to Russia as oil prices collapsed as a result to around $10 a barrel. By the summer of 1998 Russia went into meltdown, ending in a default on its debt and a steep devaluation on August 17. The RTS index collapsed, finally hitting an all-time low of 38.5 on October 5, 1998.

Clearly that was also the start of the next super cycle but it took a brave investor to take a punt then. But with share prices so low oligarch Roman Abramovich got the ball rolling again by snapping up the shares to take control of the Pavlovsk bus factory (PAZ) in 1999 which he bought for a song and piqued local investors' interest in the stock market.

Good money was to be made on the bounce back from the 1998 financial crisis, but Russian stocks really only became sexy again to international investors in the third super cycle that started in about 2004. Russia’s economy had clearly recovered from the 1998 meltdown and was growing at 6%-8% a year as oil prices began to soar towards $100 per barrel. The index soared too to reach an all-time high of 2487.92 on May 19 2008.

But history repeated itself: this time the external shock came from the US, which went into meltdown following the collapse of Lehman Brothers bank in September of that year, dragging oil prices down again to under $40. Russia’s economy went from 7% growth to a 7% contraction in just six months. The crash in the stock market was equally spectacular, with the index dropping to under 500 for a few weeks as Russian companies were hit with margin calls on their loans and sold stock to raise cash.

However, once again the bounce back meant that the depths of the 2008/9 crisis was an excellent buying opportunity for the brave and the index quickly recovered to around 1,000 where it has been ever since.

The final super cycle started at the beginning of 2015, but has not been so super: the RTS made a 50% return in 2016 simply as once again stocks were too cheap to ignore. The bounce was fuelled by hopes that the newly elected US president Donald Trump would drop sanctions, but stocks were already gaining before the US elections on the back of a clearly visible economic recovery. But as the chart shows this latest cycle has not been the money-maker and won't be unless the Kremlin makes long-promised deep structural reforms. There are currently no triggers in view that could send the market up other than companies grinding away at improving their earnings or profits.

At a corporate level many of the leading companies are doing just this and some individual names have seen revenues and their share prices double in 2017. But the overall RTS index value remains range bound at around 1,000 and will do for the foreseeable future.

Prospects for 2018

The nature of the Russian stock market has changed and there is unlikely to be another boom in share prices as in the previous cycles.

The silver lining in this new market regime is that investing in Russian stocks will be based on much more normal considerations: a company’s earning growth, its dividend policy, innovation and marketing. In 2017 this new modus operandi was already visible as investors increasingly focus on strong companies with clear plans to grow revenue and market share.

Russian owners are a lot more interested in the stock market than they used to be, which is increasingly playing its tradition role as a place to raise capital.

“In 2017, the Russian market was virtually flooded with equity offerings: four companies went public, while another 15 conducted SPOs. In total, the 2017 placement value exceeded $6.2bn, which is considerably more than $2.2bn in 2016,” BCS said in a note. “We anticipate at least four IPOs in 2018, followed by another six primary offerings by Russian companies in 2019.”

A raft of IPOs and SPOs are on the docket for 2018 as the equity market comes back to life. Up-and-coming broker-dealer BCS organised its two debut IPOs in the last quarter of 2017 that set the tone for 2018 as well – the listing of mid-cap shoe maker Obuv Rossii and logistics company Globaltruck. Smaller but dynamic companies with strong growth potential, working in the apolitical “real” part of the Russian economy, rather than the state-owned behemoths, are piquing investors interest. The state-owned enterprises (SOE) carry too much political risk to be predictable investments.

Russian companies are also more interested in being included in investors’ standard portfolios and there was an “avalanche” of SPOs by companies wanting to be included in the MSCI index, the main index tracking emerging market and Russian stocks, according to BCS; inclusion in the index forces index-tracking funds to buy your shares and gives your stock price a bump. Magnitogorsk Iron and Steel Works (MMK), Polyus Gold, Tinkoff Credit Systems (TCS), Metalloinvest and Norilsk Nickel all issued new shares for these reasons in 2017.

“In 2018-19, we anticipate a snowball effect on the Russian equity market, with at least four IPOs in 2018, followed by another six primary offerings of Russian companies in 2019. We expect high mid-caps’ IPO activity to persist, as Samolet, Softline, Step/Segezha, and Prosveshcheniye have announced that they are seeking to raise equity. Larger offerings include the realisation of delayed SOE privatisation plans (ALROSA, Sovkomflot), a mulled IPO of Yandex.Taxi/Uber JV, and a prospective SIBUR primary offering in 2019,” BCS said in a note.

Russian equity offerings in 2017-19E

2017

Company

Sector

Type

Seller type *

Notes

TMK

M&M

SPO

MS

TMK placed a 13% stake to repurchase its shares from VTB (one of its key lenders)

Detsky Mir

Retail

IPO

MSh

Sistema placed its high-quality asset, Detsky Mir, the leading children's retail chain in Russia

Phosagro

Fertilisers

SPO

MSh

Phosagro planned to boost liquidity and free float to improve its position in MSCI Russia

UWC

Industrials

SPO

MSh

The largest manufacturer of freight rolling stock in the CIS raised funds for investment projects

Polyus

M&M

SPO

MSh / NSh

As corporate governance improved, Polyus sought to increase liquidity for MSCI Russia inclusion

Bank St Petersburg

Financials

SPO

NSh

Raised equity to meet the requirements for recapitalisation of Deposit Insurance Agency

M.Video

Retail

SPO

MSh

Safmar sold a 25% stake purchased earlier during M.Video ‘s acquisition

MMK

M&M

SPO

MSh

MMK successfully increased its liquidity and free float to 16% to achieve MSCI Russia inclusion

Aeroflot

Transport

SPO

Govt

The government sold 5% of Aeroflot ‘s quasi-treasury shares to raise free float and liquidity

Megafon

Telecoms

SPO

Sh

Swedish Telia began to sell off its 25% stake in MegaFon; the 1st tranche included 5% of shares

Obuv Rossii

Retail

IPO

MSh / NSh

A large Russian shoe manufacturer raised funds for retail chain expansion and deleveraging

Credit Bank of Moscow

Financials

SPO

NSh

The company raised equity to improve banking regulatory ratios

Globaltruck

Transport

IPO

MSh / NSh

A leading FTL operator in Russia went public in order to raise funds for fleet expansion

En+ Group

M&M / Utils

IPO

MSh / NSh

A vertically integrated aluminium/power company conducted an IPO for deleveraging

Etalon

Real Estate

SPO

MSh

Key shareholders -CEO Zarenkov and Baring Vostok -reduced their stake (36% vs 58% at YE16)

TCS Group

Financials

SPO

MSh

CEO Tinkov sold a 7% stake to take profits after positive 3Q17 IFRS results

Nornickel

M&M

SPO

Sh

Metalloinvest sold its remaining 1.8% stake in Nornickel (vs 5% in MNOD in 2008)

RUSAL

M&M

SPO

Sh

Prokhorov continues to sell off his Russian assets, reducing his stake (6% vs 17% at YE16)

Severstal

M&M

SPO

MSh

A 2% stake placed via ABB Ð profit taking prior to low season

Detsky Mir

Retail

SPO

MSh

Sistema and RCIF place 8%Ð monetisation of the stake in DSKY and improving liquidity

2018

ALROSA

M&M

SPO

Govt

Privatisation: the government is to reduce its stake in the diamond producer to 29% vs current 33%

Samolet

Real Estate

IPO

MSh

A developer concentrated in SPMA aims to improve corporate governance

Softline

IT

IPO

MSh

A rapidly growing software provider seeks to raise finance for international expansion

GV Gold

M&M

IPO

MSh / NSh

A gold miner situated in Irkutsk claims that an IPO is possible in 2018

Azbuka Vkusa

Retail

IPO

MSh / NSh

An MMA-focused food retailer assumes an IPO could take place in 2018

TMK IPSCO

M&M

IPO

MSh / NSh

TMK's US division is preparing for an IPO, which should facilitate deleveraging

2019

Step / Segezha

Industrials

IPO

MSh / NSh

Sistema targets placing its subsidiaries ‘ shares after their EBITDA exceeds RUB10bnpa

JV Yandex.Taxi/Uber

Transport

IPO

MSh / NSh

A joint venture of Yandex.Taxi and Uber is planning to conduct an IPO in 1H19 in the US

Sovkomflot

Transport

IPO

Govt

Privatisation: a large state energy transportation company is to go public

Prosveshcheniye

Other

IPO

MSh / NSh

A Russian education holding seeking to raise funds for the development of electronic book formats

SIBUR

O&G

IPO

Sh

Russia‘s largest integrated gas processing company eyes becoming a public company

Sellers:

MSh - main shareholder

NSh - new shares

Sh - shareholder

Govt -Government

Source: ATON Research

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