COMMENT: Russia mines a richer seam

By bne IntelliNews June 5, 2015

Mark Adomanis in Philadelphia -


I’ve written before about Russia’s banking system and the annus horribilis of 2014. With the possible exception of Sberbank, Russia’s other large banks have been beset on all sides, massively writing down the value of loans they had previously extended to Russian corporations and also taking huge hits on various investments, and derivative and currency positions. Several banks have already needed government assistance, and many others are likely to require it if they want to avoid turning into “zombie banks” like those of Japan in the early 1990s.

But in the “real” economy the story has been a lot less negative. Steel manufacturer Severstal, for example, was mentioned several times in a remarkably upbeat article in Newsweek about the Russian economy’s unexpected resilience in the face of sanctions.

In reality, Severstal's performance wasn't all that great. Yes its gross profit was up marginally (about 0.9%) and its profit before financing and taxation was up by quite a bit more (about 34%), but its net income was sharply lower, a loss of $1.6bn in 2014 versus a profit of $89mn in 2013. Almost all of this change was driven by the titantic $1.8bn hit that Severstal took on foreign exchange losses. You can argue that these losses aren't "real" because they are more the result of temporary (and even irrational) fluctuations in currency markets, but even if you totally remove the adjustments for 2013 and 2014, net income still slumped by roughly 30%. It's not in nearly as bad a position as some large resource exporters (like Gazprom), but a look at the financials suggests that reports of Severstal's resurgence have been a bit overstated.

Other Russian resource companies, however, appeared to be in much better shape.

Rusal et al

Norilsk Nickel, despite also taking a roughly $1.6bn hit on forex translations, saw its operating profit double and its net income almost triple from in 2014. Some of that is due to a few particularly ill-advised investment decisions that the company made in 2013 (which had to be fully impaired and which reduced 2013 net income by about $500mn). But a good deal of this improvement appears very much genuine. Sales went up by 3.2% while the costs of those sales (COGS) went down across the board: COGS was down by 13%, while Selling, General & Administrative expenses (SG&A) were down by 19%. With increasing revenue and decreasing costs, particularly considering the crisis is roaring through large sections of the Russian economy, life was remarkably good for Norilsk Nickel in 2014.

Rusal also had, all things considered, a pretty decent 2014. Measured in dollars its revenue was down marginally (about 4.5%), but its COGS were down by a substantially larger amount (14.5%). Rusal's operating profit (gross profit minus its operating expenses) increased by more than $1bn, from a small loss in 2013 to an almost $1.1bn profit in 2014. There was still a large hit from forex expenses that pushed net income down into negative territory, but after posting a $3.3bn loss in 2013 (of which about $1.9bn was due to various restructuring-related expenses) the company suffered a net loss of only $90mn in 2014. It even had positive pre-tax income, which was very far from being the case in 2013. While net losses are obviously less desirable than net profits, and while it seems unlikely that Rusal's board will be throwing a huge party for the management team anytime soon, a more than $1bn positive swing in a single year is a quite dramatic improvement.

Other commodity producers (like Magnitogorsk Iron & Steel works) saw a broadly similar pattern: revenue that, in dollar terms, was essentially flat year over year, costs that were down between 10% and 20%, large forex losses, and a sharp improvement in overall net income.

Now that the ruble has broadly stabilised against the dollar, it seems unlikely that there will be further benefits (or losses) on the scale that was observed in 2014. That kind of enormous forex volatility is just not common. While there are exceptions, the financial statement seem to indicate that, on average, most Russian commodity producers had a net benefit from the ruble’s slide: with ruble-based cost-structures their sales and administrative expenses were usually 10-20% lower than the previous year. That’s not sustainable in the long term, the ruble can’t collapse against the dollar every year, but it shows that the common story of universal doom and despair omits some very important parts of Russia’s economy. 

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