Much has been said about the negative 3.8% performance year-to-date of the MSCI Emerging Markets Index, hailing it as some piece of proof that developed markets offer superior investment returns over emerging markets — they don’t.
Over the long-term, emerging market economies grow faster with lower debt levels and have positive demographics, so the stock markets will surely follow. Plus, there are emerging markets that are doing much better than the headline MSCI EM Index, the S&P 500 and other BRIC indexes.
BRICs Never Come in Same Shapes and Sizes
I had a lot of great things to say about Russia investments in January, and so far, my thesis that there is a massive rerating of their stock market continues to materialize. Russia is up 11.3% this year, while BRIC cousin India is down 12.6%. This massive outperformance is due not only to the fact that it is a great inflation hedge, but because the Russian government is finally getting serious about mending fences with foreign investors who felt alienated after two decades of problems. The investing climate, which got a little off track in the past decade, is now much better than the wild years of the 1990s. And if Mr. Putin is serious this time, it may change dramatically in the next 10 years.
How much room for rerating is there for Russia? The Russian benchmark Micex Index has a P/E of 7.3 based on 2011 earnings estimates. That compares with 10.6 times for Brazil’s Bovespa, 13.6 for the Shanghai Composite Index, and 16.7 for India’s Sensex. In other words, Russian stocks are half as expensive as Chinese stocks and a little less than half when compared to Indian stocks.
Check out the chart below that compares to the Russian RTS Index (RTSI) and the Bombay Stock Exchange (BSE):
A good way to track the Russian benchmark index and play that valuation catch-up over the long haul is the Market Vectors Russia ETF (NYSE: RSX).
A Cheap Russian Oil Play
I almost entered InvestorPlace’s 10 Best Stocks for 2011 stock-picking contest, but instead, I made a side bet with the organizer and entered it in unofficial capacity — my pick is Lukoil (OTC: LUKOY).
Lukoil is attractive because the huge overhang due to the sale of ConocoPhillips’ (NYSE: COP) 20% stake is finally through — COP had to liquidate a $9 billion position. This kept the stock depressed in 2010 at a time of elevated oil prices. With COP out of the picture, Lukoil has a lot of room to run in 2011. In 2010, Lukoil traded at one point with a hefty P/E of 5, and after the current share recovery, it now trades at the gargantuan P/E of 7.
For 7 times earnings you get 1.1% of global oil reserves and 2.3% of global oil production — the third largest non-state publicly traded oil company worldwide by proven reserves of hydrocarbons. Sounds like a good deal to me.
There is another smaller convertible overhang in 2011, which may or may not be a big deal depending on oil prices. In December 2010, Lukoil issued $1.5 billion 2.625% senior unsecured convertible bonds due June 2015. The bonds are convertible into ADRs listed on the London Stock Exchange. The bonds were issued at par and will mature after four-and-a-half years past their issue date with the conversion price set at $73.71 per ADR.
Bond holders will be able to convert their bonds into ADRs at any point from 40 days after the issue date to the sixth dealing day prior to the final maturity date, while Lukoil will have the right to redeem the bonds at any time after Dec. 31, 2013. It seems to me that management saw that their stock was depressed due to the COP sales in 2010, so they decided to pay a cheap interest rate on the convertible bonds — essentially turning this into a delayed secondary offering of shares considering that the conversion price is very close to the present price right now (not the case at time of issuance). By the way the stock is trading, it does not look like this $1.5 billion of soon-to-be secondary offering of shares is bothering investors.
A Bonus Brazilian Oil Play
Another stock that needs to play catch-up in 2011 is Petrobras (NYSE: PBR). Brazil is similar to Russia in its reliance on natural resources, but it is a better balanced economy considering the extreme leverage that Russia has to oil and metals’ prices.
The Brazilian oil giant also underperformed massively due to share sales and financing arrangements it had to make in 2010 in order to develop its deep-sea oil finds. The whole $224 billion financing has not been completed yet, but I don’t think that shares will wait to start moving.
Anyone telling you that they have a reasonably exact idea of how much it would cost PBR to extract the deep-sea oil is probably lying. The only thing you can say is that the higher the oil price goes, the better for Petrobras. I think this current $100 oil price will be the perfect catalyst for the stock to get it moving in the right direction. Valuation metrics for Petrobras are a mess without the completed financing, as you cannot be sure about the ratio of equity to debt outstanding. The only thing you can be sure of: PBR management loves a triple-digit oil price.