Russian monthly equity wrap: the boom in steel stocks continued in August

Russian monthly equity wrap: the boom in steel stocks continued in August
/ bne IntelliNews
By Ben Aris in Berlin September 10, 2017

The boom in steel stocks continued in August as investors snapped up metal and mining names thanks to the high prices for ferrous metals on international markets and the expectation that demand from China will accelerate in the autumn.

Russia’s equity market is starting to attract money again as investors start switching from bonds to stocks.

“Late summer lured buyers into Russia and GEM funds. We saw the most aggressive retail buying in three months, while Institutionals placed 50% more buys than sells. We like the momentum, but warn of exhausting fundamental upside – the market became a Hold in the midst of the bounce,” BCS said in a note.

Russia’s two leading equity markets are still underwater as they have been since the start of the year, but have been winning back some of the ground they lost in the last few months.

The ruble denominated Moscow Interbank Currency Exchange (MICEX) is down 10% YTD, but was up 3% in August m/m. Likewise, its sister exchange the dollar denominated Russia Trading System (RTS) is down, but only by 4% YTD after an 8% rally in August, partly driven by the weakening dollar. The Moscow Exchange saw its equity market turnover increase 26.3% y/y to RUB809bn (€11.8bn) in August.

Still, the exchanges remain very much range bound and the RTS is trading plus/minus 100 points around the 1,000 mark, driven largely not by company results, but the price of oil. The rule of thumb is the RTS trades at around x20 the price of oil.

As the chart shows, the RTS index has been trading in a band of x18 and x22 the price of oil very consistently since April 2016. During the “silent crisis” of 2015 the stock market was clearly undervalued but it broke out above the x22 band in the first quarter of 2016 due to the “Trump bump” when investors expected the new US president to drop sanctions. However, more recently the RTS is once again approaching the upper limit of the x22 band as the market starts to gather some momentum on more traditional metrics like earnings and dividends, thanks to Russia’s ongoing economic recovery.

While the index remains chained to oil prices, at microeconomic level some individual stocks are performing extremely well, and increasingly sector stories like metals are producing some very handsome returns for the intrepid investor willing to take a punt.

China’s consumption expectations spurred a rally in base and ferrous metals and bulk materials, according to Aton’s monthly note, while in contrast, oil and gas stocks “saw little love for the second month in a row,” Aton said. Metal prices rallied — Ni +17%, Pd +10%, Cu +8% — in August and investors increased their commodity exposure by +12% in the month, says Aton.

The oligarch dynamic duo Alexander Abramov and Roman Abramovich that control Evraz were in particular favour. Evraz announced its first half 2017 financial results in August, where the top line was boosted by the recovery in steel and coal prices as well as a fair amount of cost-cutting. Revenues increased by 44% and along with a $111mn cost-cutting programme were behind a whopping 100% surge in Ebitda y/y to $1,152mn.

Investors have been impressed by the company’s efforts to reduce its debt. Evraz has resumed dividend payments for the first time in years with a very generous 8% dividend yield. Abramovich has form on this score, being the first oligarch to pay big dividends when he owned the Sibneft oil company, which he drained of cash ahead of its sale to Gazprom (the company became the basis of what is now Gazprom Neft) at the start of President Vladimir Putin’s first term in office by paying out massive dividends.

Moody's Investors Service upgraded the outlook on 'Ba3' rating of Evraz  from Stable to Positive two weeks after the company released its results.

"Our decision to change the outlook on Evraz's rating to positive mainly nods at the significant progress the company has made toward deleveraging in the past 12 months," Moody's vice president-senior credit officer Artem Frolov said in a note

The rating action expects Evraz to prioritise debt reduction over dividend pay-outs and maintain healthy liquidity levels, he added. Previously Fitch Ratings and S&P Global ratings also upgraded Evraz's outlook to Stable in May.  

Evraz net debt as of end of June stood at $4.3bn, down from $4.8bn as of the end of 2016. Net debt/Ebitda ratio decreased from 3.1x as of end 2016 to 2.0x as of the end of June. 

Rusal was doing very well too and was the top bought metal stock in August, according to BCS. However, analysts worry that it has run its course after an impressive performance in m/m terms (+21.5pts vs the Index according to BCS).

“However, even after that surge, our M&M analysts regard the stock as attractive at its 4.2x M2M P/E. Nevertheless, in terms of changes in holdings, [Russian search engine Yandex, the most bought stock in August] and Rusal look quite overheated,” BCS said in a note.

Magnitogorsk Iron and Steel Works (MMK) is amongst the top picks in the metals & mining sector and the stock price has more than doubled in the last year. However, Aton warns that the rally might be running out of legs.

“Our view is that base-metal momentum continues to build, and we recently increased our target prices for [Norilsk Nickel] and Rusal. We have adopted a more cautious stance on steel, as we don’t believe that the rally is sustainable in the mid-term; China’s production is reaching record levels, and the construction season is drawing to a close,” Aton said in a note. Aton recommends selling Rusal now after its recent rally, and taking profits.

The most sold stocks in the month were food retailers, which had an outstanding 2016. Magnit and Dixy lead the sell orders and BCS reports a rising number of short positions in this segment. High paying dividend stocks didn't attract much attention, but as most of these names have now gone ex-div it is probably too early for this theme to restart, as it surely will later in the year. 

The safe haven backstop of gold also jumped 5% in August after North Korea fired a missile over Japan and then tested a powerful thermo-nuclear bomb a week later. However, the international Trumpian drama had little other affect on Russian stocks and bonds.

All-in-all investors are still focused on the big names and especially those paying more than 7% dividend yields, so there little has changed. Russian equities continue to lead the world in terms of dividend yields.

Emerging market bonds in general, and Russian sovereign ruble bonds (OFZs) in particular, also continue to be in demand. “In August, retail investors bought Russian sovereign bonds (OFZs, +14% vs the monthly average) as persistent USD weakening and the quiet vacation season spurred interest in low-risk RUB-denominated assets,” Aton said in its note.

Bond investors are still hunting for yield and the recent issue of Belarus’s $1.4bn dual tranche Eurobond has done really well in the last months with spreads tightening by 100bp, according to Raiffeisen Bank. More of the same type of high-yield, high-risk bonds are on the way after Ukraine announced its first post-Maidan issue may happen in September and Tajikistan launched its maiden Eurobond

Foreign investors increased their holdings of Russian Eurobonds in 2017, according to data provided by the Central Bank of Russia (CBR) on September 1. A total of $12.53bn of Russian Eurobonds had been bought by foreign investors as of July 1, up from $11.68bn as of January 1. Overall, foreigners accounted for 31.7% of Russia's outstanding foreign debt, as compared to 29.9% as of the beginning of 2017.

The bond market-trading turnover on MOEX soared 204% to RUB2.7 trillion in August, driven by new placements of overnight bonds issued by VTB (RUB1 trillion). Adjusted for the latter, bond market turnover was 70% higher at RUB1.6trn.

The MOEX money market was also strongly up at +37% y/y to RUB43trn in August, but this was also a one-off effect attributable to direct bond repo operations with Bank of Russia (RUB14 trillion).

FX market turnover rose 19%, while the derivatives market contracted 20% amid falling FX volatility. Market participants' balances were 2% higher m/m edging to RUB667bn, but more importantly, the RUB balance was almost flat m/m at RUB88bn.

"The results look strong at first glance, but adjusted for one-offs, the August trading volumes are very close to the levels seen over the past two months," Aton brokerage said in a research note. 

 

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