by Ivan Martchev | August 9, 2012 1:16 pm
It’s a strange world when, to gauge the state of economic affairs in Russia, one has to look at government bond yields in Switzerland and many eurozone countries.
But that’s exactly what things have come to.
The eurozone mess is putting pressure on the Russian economy and, so far, it’s handling it well. If things don’t deteriorate further in Europe — and I have some difficulty being an optimist on that front — Russia is a bargain. If they do, it still is a bargain, just one with a much longer-term payoff.
Swiss two-year government bond yields have long stopped reflecting the economic situation in Switzerland, as they now serve as a gauge for anti-euro sentiment. Since April 24, they have spent the whole time sinking deeper and deeper into negative territory while the eurozone drama has been unfolding. They “yielded” -0.39% at last count. This is because the Swiss National Bank has drawn the line at 1.2 on the EURCHF exchange rate after pressure from the exodus of panicky euro holders drove the Swiss currency to near-parity with the euro last year.
The pressure from the EURCHF cross has now shifted onto Swiss government bonds, as they guarantee the holders payment in Swiss francs upon maturity, regardless of whether the euro is with us two years from now or not. Other relevant spreads of Spanish and Italian government bonds to German bunds — the least-risky eurozone sovereign debt instruments — are at or close to all-time highs.
I’m sure you’re wondering how this is all this relevant to Russia. Well, Russia is the No. 1 global exporter of natural gas (at 200 billion cubic meters) and the No. 2 oil exporter (at 5 million bbl/day). The largest chunk of those exports goes to Europe, and the same is true for its imports.
With 2008 still fresh in the memory of many foreign investors, this time they appear to be selling first and asking questions later, despite efforts from the local authorities to maintain economic order. In 2008, the Russian economy saw $134 billion of net capital outflows, almost all of it — $130 billion — concentrated in the fourth quarter right after the Lehman failure and the expeditious global domino effect.
This time, no such panic is evident, but in 2011 foreign investors pulled $80.5 billion out of the country, and in the first six months of 2012 they pulled out $43.4 billion in an eerily orderly manner.
While some undoubtedly will pin part of the blame for this on the re-election of Mr. Putin, it appears that the stress in Europe actually has far greater impact in this case. As things quieted down (temporarily) in Europe, the MSCI Russia Index rebounded since its June lows and now trades at a forward P/E of 4.4, a dividend yield of 3.8% and a mere 0.8 times book value. For comparison, the MSCI Emerging Markets Index trades at a P/E of 11.3, dividend yield of 3.1% and 1.6 times book value.
Buyers of Russian equities should realize that such depressed valuations generally are characteristic of economic malaise, which isn’t present in Russia at the moment. On a three-to-five-year horizon, this index-wide discount to book value is unlikely to persist, while the Russian economy is likely to grow.
There are expected moves on the tax front in 2013 to lure more foreign investors, which should provide a boost to economic growth. Credit should be given to then-Prime Minister and now President Putin for pulling off the lengthy negotiations with Exxon Mobil (NYSE:XOM) to develop Russia’s vast Arctic reserves via state-owned Rosneft. While a similar British Petroleum (NYSE:BP) deal failed because of opposition from the British energy giant’s local partners, Exxon is back in a big way after pulling back for years. (Rosneft owns the former Yukos crown jewel Yuganskneftegaz.)
This seems to be a much bigger deal for Exxon Mobil than the never-officially announced failed takeover of Yukos. Russia is willing to abolish export duty and slash the mineral extraction tax to keep taxation stable for 15 years. (At present, oil companies in Russia pay a 60% tax on oil exports).
Rosneft also gets minority stakes in Exxon projects in North America, and both companies are working toward unlocking shale oil and gas in Siberia, which Rosneft does not have the technology to extract on its own.
Rosneft has no listed ADRs in the U.S., but Exxon Mobil is another alternative. The stock market currently has a hard time discounting this deal to its present value, as any benefits will trickle to the bottom line only a couple of years from now and hit critical mass much later. But the largest undeveloped oil reserves lie in Russia’s Arctic region, and the largest global oil company by market capitalization made a giant first step toward putting them on the market.
As to the Russian stock market in general, it will remain captive to developments in Europe and the short-term gyrations of the oil price.
Many Russian companies — including Gazprom (PINK:OGZPY), the No. 1 publicly traded owner of hydrocarbon reserves in the world — have long surpassed revenue and EPS high watermarks seen during the all-time highs in Russian equity benchmark indexes in 2008, yet their shares continue to languish.
Regrettably, this cannot be considered as a timing indicator, and it might last for a long time until the situation in Europe is resolved.
Ivan Martchev is a research consultant with institutional money manager Navellier & Associates. The opinions expressed are his own. Navellier & Associates holds positions in Exxon Mobil and Gazprom for its clients. This is neither a recommendation to buy nor sell the stocks mentioned in this article. Investors should consult their financial adviser prior to making any decision to buy or sell the aforementioned securities.
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