by Ivan Martchev | April 11, 2013 7:00 am
It used to be that when the oil market zigged, the Russian stock market zigged with it — after all, it represents the emerging economy that still has the highest leverage to energy prices. Lately, however, Russian stocks have been zagging with oil prices relatively firm.
So what gives?
Much of the blame goes to Russian mega-cap Gazprom (PINK:OGZPY), which is at 52-week lows as I write this.
The Economist does have a point that, as a publicly traded arm of the Russian state, Gazprom management serves two masters, and in the end it becomes increasingly difficult to do what is necessary in the interest of the average shareholder.
But the suggestion that Gazprom should be broken up is rather comical given that it is still an instrument of power in hands of the Kremlin, making it highly unlikely that it will be given up. All indications are that President Vladimir Putin will serve the remaining five years of his term, and given that presidential terms were increased to six years in 2008, he is likely to seek yet another term. This makes it a fair bet that Gazprom will not be broken up in the near future to unlock “value.”
It is true that Gazprom shares are depressed. At last count, shares of the largest holder of hydrocarbon reserves of any publicly traded energy company on the planet trade at 2.39 times earnings and 0.37 times book value. For comparison, CNOOC (NYSE:CEO) — which too is controlled by the Chinese government and enjoys preferential treatment for many domestic energy projects — trades at triple Gazprom’s valuation of 8.3 times trailing earnings and 1.75 times book.
However, something else is troubling investors.
Russian small caps — as measured by the Market Vectors Russia Small Cap ETF (NYSE:RSXJ) — have been notably underperforming the large-cap Market Vectors Russia ETF (NYSE:RSX), even though Gazprom is part of the RSX and not part of RSXJ. Typically, when I see emerging-market small caps underperform in any market, I immediately begin to think that some investors, many of them international, are playing defense. The same is visible in the Indian market to a greater degree. (Both Indian and Russian small caps generally trade at deep discounts to their large-cap local brethren, even though of late that “depth” is extreme — and getting even more so).
Not to oversimplify the differences between the Indian and Russian situation, as Russia is excessively geared toward commodities and India is the only domestic-demand-driven major emerging market, but weak small caps in emerging markets are always a big red flag.
Russia (10.8% EU imports) is as big of a trading partner to the European Union as is the U.S. (11%), but as a percentage of Russia’s $1.95 trillion GDP, its relative exposure to the EU is huge. And the EU, as recent headlines on employment and industrial production indicate, is seeing its economy deteriorate further. In the fourth quarter of 2012, the Russian economy grew 2.1%, the slowest such growth rate since the end of the deep recession experienced post-Lehman in 2008.
Total Russian exports decreased to $39.038 billion in January 2013 from $48.568 billion in December 2012. The January-December comparison is a little misleading, as there is clear seasonality to those numbers, but January 2013 exports were still below the $39.728 billion from January 2012 and the $39.246 billion from January 2011.
I think Europe is pulling Russia down via their close trade relationship … and there is little Russia can do to stop it.
The MSCI Russia Index trades at a forward P/E of 4.24 and a price-to-book of 0.81, which is less than half of the broader MSCI Emerging Markets Index with a forward P/E of 10.28 and a P/B of 1.65. The Russian stock market also yields 3.65%, compared to the much lower 2.7% for emerging markets on average when using the same MSCI indices.
Clearly, there is value in Russian equities … but that’s unlikely to be appreciated by investors as long as its economy is so closely tied with the eurozone mess and so leveraged to commodity prices.
Ivan Martchev is a research consultant with institutional money manager Navellier & Associates. The opinions expressed are his own. Navellier & Associates holds positions in Gazprom and CNOOC for some its clients. This is neither a recommendation to buy nor sell the stocks mentioned in this article. Investors should consult their financial adviser before making any decision to buy or sell the aforementioned securities. Investing in non-U.S. securities including ADRs involves significant risks, such as fluctuation of exchange rates, that may have adverse effects on the value of the security. Securities of some foreign companies may be less liquid and prices more volatile. Information regarding securities of non-U.S. issuers may be limited.
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