The dollar-denominated Russia Trading System (RTS) index is down 13% this year and fell briefly below the psychologically important 1000 mark, making some investors ask if the market was so cheap it was worth a punt as June came to a close, according to a report by the Russian Aton brokerage.

Russian stocks have always been a wild ride, famously either being the best performing market in the world, or the worst for most of the 1990s. At the moment they are worst again. With the RTS index at 1,000 and losing 13% YTD it has badly underperformed its peers and is the worst EM performer relative to South Africa (which is up +0.2% YTD) and Brazil (+3%). However, several brokerages have upgraded their outlook for this year and believe the market should return 15% or more over the next six months. 

Already cheap because of the traditional “Russia risk” discount Russians stocks have always had versus its peers, Russia has an addition “conflict” discount since the annexation of Crimea threw the Kremlin into confrontation with Washington and Brussels. However, after the pre-summer sell off Russians stocks have become even cheaper.

The Russian price-to-earnings ratio (p/e) discount to other EMs has now expanded to 52% vs a 40-45% three-year historical average, according to Aton. Russia’s equity market is currently trading at a p/e of 6.1x vs the 7.0x average for 2016, and the peak of 7.8x achieved in December 2016. This compares to the other emerging markets that enjoy p/e ratios in the early teens.

The story on the ruble-denominated Moscow Interbank Currency Exchange (MICEX) index is similar – it is down by 15% YTD. Financials (down -18%) and oil and gas (-16%) have been the worst affected sectors on MICEX, while transport has performed the best, adding 16.5% YTD, reports Aton.

If the Russian market continues its long tradition of moving in cycles then all this should represent a buying opportunity. Following the annexation of Crimea in May 2014 the market sold off heavily and was depressed for all of 2015. But with a possible reset in the world after US President Donald Trump was elected, the market rallied in 2016, gaining just over 50% in a year. That enthusiasm faded in the first quarter of this year as it became clear Trump was not going to take Russians sanctions off fast.

Since then regular markets forces have taken over driving the story and investors are looking at regular indicators such as earnings and profits. Russia’s economy has now clearly moved out of its two-year recession and the leading companies have benefited from the crisis by consolidating their market share and improving efficiencies during the downturn. That means while there is no general recovery in the stock market there are a lot of “cherries” to pick that offer strong earnings growth and, most importantly, increasingly attractive dividends.

With the ruble widely expected to weaken in the second half of this year, brokers are pushing exporters that benefit from a falling ruble.

“Our clients – domestic and international fund managers — prefer to expand their positions in export-oriented sectors, including metals and mining (like NLMK and Evraz) and oil majors. We note that Novatek looks oversold. There is good demand for transport stocks (Globaltrans, Aeroflot, NCSP Group) as they combine still-low valuations with good growth and dividends,” Aton said in a recent note. “Some clients have reduced exposure to the finance sector, particularly Moscow Exchange and Sberbank, as they see no short-term triggers in these names amid falling interest rates. International clients are interested in real estate stocks (LSR and Etalon) as a direct play on Russia’s macro recovery, while domestic funds have a more sceptical view, pointing to limited demand for newly-built apartments.”

The reason analysts are expecting the ruble to weaken is the deterioration in the current account position. The current account surplus fell from $23bn in the first quarter to $2bn in the second and as the macroeconomic recovery gets underway and real wages continue to rise that will probably suck in more imports and the surplus could turn into a deficit in the second half of the year.

“We think that fundamental RUB levels above RUB60/USD are fully justified in 2Q17, assuming the expected current account deterioration vs the strong 1Q17,” said Aton. “We think the RUB will be bound in a RUB60-62/USD range in the summer months, unless oil dips below $40/bbl.”

 

Aton top stock picks for 2H17, drivers

Company	Ticker	TP	Upside potential	Key drivers
Sberbank	SBER RX	RUB210	43%	The bank trades at a 2017 P/E of 5.0x and P/BV of 1.0, which is well below EM peers. It enjoys high and sustainable ROE above 20%. Dividend payout ratio can be increased after 2017. Best liquidity in the market and strong corporate governance.
Alrosa	ALRS RX	RUB125	43%	Trades at 4.7x 2017 EV/EBITDA, offering a discount to global diversified miners (5.3x) and Norilsk Nickel (6.6x). Recent stock underperformance caused by sanction concerns (Alrosa is a state-owned company) is unjustified, in our view. We expect the stock to be supported by strong summer monthly sales as well as its FY16 dividends (10% yield). Alrosa generates strong FCF yielding 15% and has low debt of 0.6x.
Unipro	UPRO RX	RUB3.55	41%	Turnaround story: we expect bright 2017 earnings with further momentum supported by the Berezovskaya unit’s relaunch. One of the best high-conviction dividend plays in the sector.
TCS Group	TCS LI	$15.2/GDR	35%	Management guides for 25-30% EPS growth in 2017, the highest in the sector. Strong 1Q17 IFRS results suggest the bank is on track to reach its FY guidance. Dividend policy assumes a 50% payout ratio from IFRS net income on a quarterly basis. The stock trades at a P/E of 9.0x, high compared to peers, but for this reason the bank operates at the highest ROE in the sector (40%+).
Etalon	ETLN LI	$4.7/GDR	32%	This year should be a strong for the company in terms of earnings growth: we expect EBITDA and EPS to increase by 53% and 50%, respectively, driven by falling inventories from built flats. The share of more value-added projects in Moscow has increased to 50% of total portfolio, which in turn should lead to better margins. Finally, debt burden is the lowest vs other developers, allowing Etalon to boost its dividends. We believe Etalon’s dividend yield may reach 9% for 2017, overtaking LSR Group.
Rosneft	ROSN LI	$7.3/GDR	24%	The highly likely approval of MET benefits for the Samotlor high watercut field in the coming months could become a strong trigger for the name: we estimate a +5-6% effect on annual EBITDA. The dividend payout increase to 50% is an additional supportive factor.
MMK	MAGN RX	RUB41.5/GDR	24%	MMK’s shares have fallen 20% from the 1Q17 high and it remains one of the cheapest steel names globally at 3.8x EV/EBITDA for 2017. Steel industry is recovering and the steel over bulks premium in China is expanding; MMK, which has the lowest integration into raw materials, is the key beneficiary.
Novatek	NVTK LI	$133/GDR	17%	The stock has been considerably oversold on the back of the crude oil slump and has not yet recovered. Timely launch of Yamal LNG along with the new strategy presentation in 2H17 are key drivers for a re-rating, in our view.
Globaltrans	GLTR LI	$8.7/GDR	13%	This year should be successful for the company, because the deficit of gondola cars on the rail network has led to rising tariffs, which have already achieved RUB1,500 per rail car per day. As a result, we see upside risk to our earnings estimates. Additionally, the company may pay interim dividends for 1H17, while the annual dividend yield is close to