BRIC Stepchild Is Only Cheap at Half the Price: Julian Rimmer
When strategists appraise the Russian stock market, they cheep “It’s cheap!” without fail. In this new world order, investors are meant to prize inexpensive emerging markets with flexible exchange rates, political predictability, current account surpluses and reassuring reserves. Markets like Russia’s, for instance.
So why is it that Russia languishes near the bottom of the valuations table on about five times prospective earnings, lower than Greece and Pakistan, to name but two basket cases? And why when markets suffer one of their periodic slumps is Russia, the redheaded stepchild of the BRIC economies -- Brazil, Russia, India and China -- punished accordingly, underperforming the MSCI Emerging Markets Index by 4 percentage points this year?
It doesn’t take a nuclear physicist (handy because I’m not) to deduce that the Kremlin’s economic policy is the crux of the issue. Russia’s oil and gas companies comprise the greater part of the main equity indexes, and these heavyweights are taxed into oblivion. Their profits, which might otherwise attract minority shareholders, are siphoned away to subsidize other parts of the economy.
This year, we have witnessed an escalation in the intensity of debate between various competing factions within government as to how Russia’s energy assets should be taxed. The dispute between Rosneft Oil Co. Chairman Igor Sechin, eminence grise among the “siloviki” community of former intelligence and military officers, and Alexei Kudrin, the softly spoken finance minister, has developed along personal and increasingly acrimonious lines.
Holiday Is Over
The former wants to maintain the tax holidays presently enjoyed by greenfield sites in eastern Siberia to boost production while the latter feels his ministry was tricked into the proposals originally and is determined to apply the same regime across all oil fields. That way, he controls the revenue rather than leaving it to the oligarchs.
Generating some 25 percent of its earnings before interest, taxes, depreciation and amortization in the Vankor field, Sechin’s Rosneft is extremely sensitive to changes in taxation and much of its almost 30 percent share-price decline this year can be attributed to the realization that the holiday, such as it was, is over. Either Kudrin fails to realize that Russia’s relatively pedestrian 2 percent pace of production growth will reverse and decline in 2010, or he doesn’t care.
Knowing and Caring
It’s difficult to know from a Russian investor’s standpoint which would be worse -- the not knowing or the not caring -- because his latest proposals to increase revenue from the mining extraction tax by 165 percent over the next three years will reduce the internal rate of return on some of the less prolific wells below the cost of capital.
The Rosneft case is far from unique. Across all industries, the Kremlin’s clunking fist can be seen pounding the table, demanding unthinking obedience and unswerving loyalty from its captains of industry. If inflation sprouts, then tariffs for OAO Gazprom are constrained and the conversion to regulatory asset base tariffs for utilities is delayed to keep household bills down. If miners are seen to be benefiting “excessively” from high demand, then Prime Minister Vladimir Putin upbraids them publicly and proscribes profiteering.
Making money is OK in post-Soviet Russia but you must make it in the right places.
Half the Price
So when strategists assert that Russia is cheap at half the price, they mean that literally. With fewer upward revisions for earnings growth these days, the benchmark RTS stock index is dependent on rising price-earnings ratios and no one wants to pay more for companies whose earnings are dictated by the state. Not this state anyway. Not at present.
There’s no doubt slicker international relations would reduce the discount applied to the Russian equity market. Blind optimism, that international investors will be seduced over time, won’t.
In a survey conducted by a Russian media company last week, when asked who would win the 2010 World Cup, 8 percent of respondents replied Russia would triumph even though it didn’t actually qualify.
That’s the kind of blind optimism I’m talking about.
(Julian Rimmer is a trader at CF Global Trading in London. The opinions expressed are his own. His firm or clients may own or trade securities discussed in this column.)
To contact the writer of this column: Julian Rimmer at jrimmer1@bloomberg.net
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