By Sid Verma
Russian equities – both domestically and internationally – are lagging behind their emerging peers. But investors still see relative value
Brazil, Russia, China and India – the so-called BRIC economies – are often talked about in the same breath. But the performance of their equity markets could hardly be more different.
Despite sustained economic growth of almost 7% a year since 1998 and an oil price explosion, Russian equities have proved a dud compared to their BRIC rivals. Morgan Stanley Capital International’s indices for last year make the point. For Brazil, they leapt 75%; in China, 63%; and, in India, 52%. But Russia’s increase was a modest – at least by comparison – 23%, and that was despite a flurry of flotations in 2007.
Russian equity capital market activity broke new ground in 2007 despite the global credit storm that started last summer. Russian companies raised a total of $29.4 billion during the year, with banking giant Sberbank amassing $9 billion and its rival, Vneshtorgbank (VTB), $8 billion, according to data from PBN Company, a strategic communications consultancy.
In addition, while western banking stocks were plummeting, last November Bank of St Petersburg became the first independent bank to launch a domestic IPO (initial public offering), raising $274 million. It was seven times over-subscribed.
“This successful deal shows investors love quality stories that have a strong funding base. They are quite happy to look at new opportunities on a case-by-case basis,” says Reinout Koopmans, co-head CEEMEA equity capital markets at Deutsche Bank and global coordinator on the deal.
One year on
But a successful 2007 hasn’t translated into an equally successful 2008.
The Russian Trading System (RTS) shed 16.8% in January, driven down by fears of a US recession. And in 2008 tumbleweed is blowing through the IPO market. By this time last year, Sitronics, Polymetal, Sberbank and Integra had already raised a total of almost $10.5 billion in IPOs. Yet – to date – not one company has floated.
Runaway inflation, uncertainty over the leadership succession and high oil taxes have tempered Russia’s equity bull run. Analysts say that taxation is the most decisive factor: any surplus profits above an oil price of $30 per barrel are sent to the government as taxes, where energy stocks account for 50% of the country’s equity market.
“When people talk about decoupling, you have to distinguish between equity markets and economies,” says Charles Lucas, head of CEEMEA equity capital markets at ABN Amro.
While the equity markets have run into difficulty, economic growth is good. “Underlying demand is strong. As a result, investors can find attractively valued companies in countries such as Russia,” says Lucas.
ECM action
Bankers say an explosion of ECM activity could be on the cards in Russia in the medium term. Several firms are positioning themselves to capitalize on the discount Russian equities offer to other emerging market stocks. Earlier this month, for example, Pictet Funds launched a retail-focused Russian equities fund, benchmarking the MSCI Russian Equities 10-40 index. Global emerging market funds will gradually turn overweight Russia.
Bankers cite the Russian government’s recent indication that it may lower taxes on oil profits, combined with planned infrastructure investments and growing domestic consumption, as reasons for increasing their exposure.
But for all the talk of investors seeking to gain exposure to the macroeconomic success story in Russia, consumer stock listings are still rare, notwithstanding the successful $365 million IPO of electronic retailer M.video last November.
“New issues from the consumer sector – apart from supermarkets – have been quite rare, especially considering all the talk about the emergence of an affluent, high-spending middle class in developing economies,” says Lucas.
But further diversification out of financial and energy listings in Russia and into utility and industrial stocks could be derailed by the lack of foreign money. “Investors are a lot choosier about what they buy, and hedge fund demand is much reduced, while demand from retail investors in Russia is limited,” says Lucas.
The GDR effect
Global depositary receipt (GDR) listings by property companies proved increasingly popular in 2007. The largest IPO came in June when residential property developer PIK Group raised $1.8 billion, listing GDRs in London. In November LSR Group, a St Petersburg property company, raised $772 million through a listing in London in tandem with an RTS float.
“Our US clients don’t like us to invest in Russian equities in the domestic market due to the delivery and payment risks, so we very much like instruments such as GDRs,” says Dariusz Sliwinski, emerging markets fund manager at Martin Currie.
But real estate issuers may have to pay high issue premiums this year, says Sliwinski: “Most Russian issuers so far have been property developers that require funding for two to three years to achieve future cash flows post-construction. But investors now want real estate companies that have an existing income-generating asset base rather than cash flows in two to three years’ time,” he says.
The RTS and Moscow Interbank Currency Exchange (Micex) have recently recovered from their January lows. They have been helped by the smooth presidential succession and the fact that investors are increasingly aware that Russian stocks still offer relative value: they are trading on average p/e ratio of 10, while Latin American ones are at 12.5.
“So far this year issuers have been preoccupied with private placements, but the capital needs of large institutions can’t be fulfilled through these sources alone, and soon they will have to access ECM. As a result, the pipeline of deals that we have in the second half of the year is at least as strong as it was at any point last year,” says Koopmans.