Interest in Russian equities is picking up again as the economy recovers and earnings rise again. Russian companies had their most profitable September in three years, earning a collective RUB1,580bn ($23.7bn) in the month and cumulative profits for the year to date of RUB$154bn – about a third more than they earned over the same period a year earlier.
The growth in earnings is not reflected in the RTS index, which has been range bound at around 1000 points for the last four years, but it is reflected in the individual names, some of which have doubled in value in the last year. Moreover, the irony of the sanctions and instability is that Russia is paying the highest dividend yields in the emerging markets (EM) world; current yields are circa 7%, which about twice the benchmark MSCI EM average.
The pie has become smaller, but the slices are bigger, argues Kirill Chuyko, the head of research at BCS Global Markets. BCS is attempting to step into these gaps left in the market. It has opened offices in London and New York and at the same time expanded its Moscow research department, which now also covers the biggest and best names in neighbouring markets like Kazakhstan and Ukraine.
BA: Please give me some background of the key developments in your department and products.
KC: We have built a very strong team in the last several years and especially in the last half a year when we hired five talented new analysts, which will help us to get into a leading position for analysis.
We have a very strong product in metals and mining, which is one of the best sectors in the EEMEA [Eastern Europe, Middle East and Africa] space. Last year our research was number one and this year we got a number two ranking on the individual basis. The new hires will help us build a new franchise in all sectors.
Following the tie up with our partners, [the US based fund manager] Tigress Financial Partners, we plan to diversify our product into the US and other markets. And we started covering the CIS last year.
BA: BCS is covering all the leading companies in the CIS, but most of the biggest are still in Russia.
KC: You can look at these CIS companies and they have very solid liquidity and fundamentals, like Ukraine’s Ferrexpo or Kazakhstan’s KAZ Minerals. They enjoy healthy margins comparable to those in Russia. They have healthy liquidity so there are no problems with investors buying or selling a big stake. If you look at banks or other production assets like [Ukraine’s leading sunflower producer] MHP then investments will depend in some part on the story of the country in general. But in general they are good companies. The risk to return is not far from that in the Russian market. Our plan is expand into Georgian banks and [Kazakhstan’s leading bank] Halyk as well.
BA: How can you compete with the big boys, the Wall Street banks, most of whom are already in Moscow?
KC: A big part of the competition is barely alive, both fortunately and unfortunately. On the one hand this makes the competition relatively easy. However we would prefer much healthy competition but the market is shrinking. There is a much smaller pie for everyone. What we have seen on research side is the big brokers can no longer justify having research in Moscow. The flow has gone down substantially. The number of analysts and sales people that work on accounts was too high a few years ago, but now lots of brokers are shutting down in Moscow and cover the Russian space from London and other locations. But that is good for the local brokers. We have a better understanding of the local markets – including the politics, which is very important.
BA: The Russian market is completely out of fashion and oil prices remain volatile, which makes it risky and unpredictable too.
KC: The volumes in the Russian market are $1bn a day. It’s still a lot. The market is not going to die. Even if it falls by 50% that half a billion in daily turnover someone needs to execute it. There will still be a job for us, or someone like us.
The Russian market is unique. It is not really an emerging market. This a big theme for me, because it is not really emerging from anywhere at this point. There is no decoupling of Russia from oil and it is ultimately dependant on oil and the budget (which is also dependent on oil) and other exporters like metal and mining companies.
But this gives Russia a unique advantage as among all the other emerging markets Russia has the lowest dependence on foreign capital. Whenever foreign capital leaves other emerging markets they have a problem and can fall into recession. For Russia as long as oil is high we are good. And this makes Russia a safe haven. The Russian dividend yield right now is about 7%. It's the highest in all emerging markets.
This creates a very solid foundation for real profits for the investors into Russia. If the Russian market halves assuming unchanged oil then the dividend yields would not be 7% but 14% — it would be a crazy opportunity for investors from all over the globe.
BA: Why are dividends so good in Russia? Is it because the owners of companies now take their money out of their companies with dividends and are willing to share with investors?
KC: In Russia it’s not just because the businessmen suddenly decided to share profits. The origin of the dividend yield is mostly if you look at the highest paying sectors, which is metals and mining, the reason is because there is nowhere to invest. They earn lots of profits now but they understand that if they invest into production it will ramp up in three or four years from now. But we don't know what is going to happen in three or fours from now.
Imagine you are a Russian oligarch. You have uncertainty about the funding. Uncertainty about the markets. The uncertainty of the political and sanctions risk. Also being a metals oligarch, you have risk that your products won’t reach the market. There are all sorts of trade barriers. Other markets are not happy with lots of steel coming from Russia and China. It’s like a perfect storm now. So despite the fact they are earning crazy money, now there is nowhere to invest. So they pay dividends.
Most of the investments in the metals and mine industry were loss-making – huge losses. So the owners don't see any opportunities in Russia on a big scale, which would kill the cashflow sufficient to stop dividends. And they don't want any western exposure because all of them lost money. The only one that made money was Norilsk Nickel thanks to a stake in a gold field.