Russian stocks are trading at the most expensive relative valuations since September 2008 after surging oil prices spurred mutual funds to pour record amounts of money into the world’s largest energy exporter.
The Micex Index (INDEXCF) trades at 1.4 times net assets, its smallest discount to the MSCI Emerging Markets Index in 30 months, after a 4.9 percent gain this year that beat every major developing nation except Hungary. Russian shares, the cheapest among the world’s 15 largest markets for more than two years, are now more expensive than stocks in France and trade in line with Germany and South Korea, data compiled by Bloomberg show.
Investors should reduce Russian holdings after $2.5 billion of mutual fund inflows since December, according to Deutsche Bank AG and HSBC Holdings Plc. The government needs crude at $115 a barrel to balance its budget, the highest-ever breakeven level, and Russian companies are spending more of their revenue on capital investments than any other emerging market, putting stocks at risk if oil retreats, data compiled by Bloomberg show.
“You’ve got a lot of people staying there as long as oil remains high,” John-Paul Smith, the London-based emerging- market strategist at Deutsche Bank, said in an interview. “But they’re aware of the structural problems in Russia, and something that begins as a small fall in the market could quite quickly turn into something bigger.”
Russian stocks trade at lower valuations than emerging- market peers amid concerns related to financial reporting and legal protection. OAO Gazprom, the nation’s gas-export monopoly, was among eight energy companies identified by Transparency International and Revenue Watch Institute this month as having the world’s worst reported anti-corruption policies.
OAO Yukos Oil Co., once Russia’s largest oil producer, went bankrupt in 2006 after Vladimir Putin’s government claimed more than $30 billion in back taxes. Moscow-based United Co. Rusal, the world’s largest aluminum producer, was barred from marketing to individuals for its Hong Kong initial public offering in January 2010. Regulators delayed Rusal’s IPO at least twice on concern about the company’s debt.
Investors boosted holdings of Russian shares this year after the Micex surged 229 percent from its bear-market low in October 2008 through December, the top performance among benchmark indexes in the world’s 30 largest markets.
Middle East Turmoil
This year’s inflow into Russian funds was bigger than in any first quarter since at least 2001 even as emerging-market funds worldwide lost $11.7 billion, EPFR Global data show. Developing-nation money managers have their top “overweight” holdings in Russia, according to Bank of America Corp.
Bets that Russia would outperform have paid off so far after oil jumped 15 percent since December. The MSCI emerging- market index fell 2.4 percent to yesterday on concern political turmoil in the Middle East and Japan’s biggest earthquake would slow global economic growth. Brazil’s Bovespa lost 2.2 percent and India’s Bombay Stock Exchange Sensitive Index tumbled 11 percent. The Hang Seng China Enterprises Index rose 0.5 percent.
While Russian stock valuations climbed, shares in the other so-called BRIC markets have gotten less expensive. The Hang Seng China Enterprises Index trades at 2.2 times net assets, a 15 percent discount to its five-year average, while the 3.1 times price-to-book ratio on India’s Sensex is 16 percent cheaper than the average since March 2006, according to data compiled by Bloomberg. The Bovespa is valued at 1.7 times book value, a 14 percent discount to the MSCI emerging-market index, the biggest gap since August 2007, monthly data compiled by Bloomberg show.
Germany’s DAX Index (DAX) trades at 1.48 times book value, while the MSCI South Korea Index is valued at 1.45 times and France’s CAC 40 Index (CAC) has a ratio of 1.3, according to data compiled by Bloomberg.
Strategists are sticking to calls for gains in emerging- market stocks this year. The average year-end projection for the MSCI emerging-market gauge from forecasters at five of the world’s largest banks is 1,428, or 27 percent higher than yesterday’s level of 1,123.62, and compares with a 1,463 average estimate four months ago, data compiled by Bloomberg show.
UBS AG’s Nicholas Smithie is the most bullish forecaster with a 1,700 estimate, while Morgan Stanley’s Jonathan Garner has the lowest projection of 1,290. The MSCI emerging gauge trades for 2 times book value, almost double its nadir of 1.1 times in October 2008, data compiled by Bloomberg show.
The Micex’s price-to-book ratio has more than tripled from its bear-market low near 0.5, according to data compiled by Bloomberg. Russian shares are now valued 32 percent less than global stocks, a smaller discount than the average of 43 percent since 1996, MSCI Inc. data show.
Gazprom trades at 0.9 times book value, the most expensive level since November 2008 relative to the MSCI Emerging Markets Energy Index, according to data compiled by Bloomberg. The Moscow-based gas producer has a dividend yield of 1.1 percent, or 35 percent below the average for global peers.
“Russia now appears over-owned,” John Lomax, HSBC’s London-based emerging market strategist, wrote in a March 11 research report. He cut his rating on Russian shares to “neutral” from “overweight.”
There are signs investors are starting to pare their bets on Russia. Mutual funds had their first outflow in 16 weeks in the period ended March 16, a $58 million withdrawal, according to EFPR Global. Metals companies ChelPipe and OAO Koks called off plans to sell shares last month as money managers demanded lower valuations.
Short sales of the Market Vectors Russia exchange-traded fund, the biggest U.S-listed Russian ETF, jumped to 11 percent of shares outstanding on Feb. 28, the highest level in a year, data compiled by Bloomberg show. Short sellers sell borrowed shares, hoping to buy them later at a lower price and return them to the lender.
“We are reducing Russian risk,” Adrian Mowat, the chief Asia and emerging-market strategist at JPMorgan Chase & Co. in Hong Kong, wrote in a March 18 report. “A decline in the oil price is likely to be the catalyst for a rotation out.”
Russia’s prospects are tied to more than just commodities. The country may join the World Trade Organization “soon,” European Commission President Jose Barroso said last month at a Brussels conference with Putin, Russia’s prime minister. WTO Membership may add 1 to 3 percentage points a year to Russia’s economic growth as increased foreign investment in services industries diversifies sources of growth, according to Troika Dialog.
The nation’s earnings estimates are climbing faster than the average for emerging markets. Analysts have increased their forward 12-month income growth projections for Micex companies to 32 percent from 22 percent at the beginning of the year, according to about 300 forecasts compiled by Bloomberg. Profits in the MSCI emerging-market index are projected to climb 24 percent, the data show.
The Micex is valued at 7.2 times profit estimates, the lowest among 21 major emerging markets, according to data compiled by Bloomberg.
“Russia is in pretty good shape at the moment,” said Julian Mayo, a London-based money manager who helps oversee about $3.5 billion in developing nations at Charlemagne Capital Ltd. and has “overweight” holdings. “I think it will continue to outperform.”
While Russian profits are increasing because of higher oil prices, Deutsche Bank’s Smith says long-term returns may disappoint investors as companies restrict payouts to minority shareholders and boost spending on projects that may lead to losses if crude retreats.
Companies in the Micex pay dividends equivalent to 1.5 percent of their share prices, the least in about 11 months and the lowest level compared with the 7.6 percent yield on Russia’s benchmark five-year ruble bonds since the debt was issued in July, data compiled by Bloomberg show.
Russian firms are spending more money to maintain and expand their businesses than in any other emerging market, even as economic growth trails the developing-nation average. The 25 percent average capital expenditure to sales ratio for Micex companies compares with 14 percent for global emerging markets and 18 percent for China, data compiled by Bloomberg show.
Russia’s economy will probably expand 4.5 percent this year, slower than the 6.5 percent rate in emerging markets and 9.6 percent in China, according to January estimates by the Washington-based International Monetary Fund.
OAO Mobile TeleSystems, Russia’s largest mobile-phone company, spends about 20 percent of its sales on capital expenditures, compared with 8.7 percent for Sao Paulo-based Vivo Participacoes SA and 16 percent for Turkcell Iletisim Hizmetleri AS, Turkey’s biggest mobile phone company, data compiled by Bloomberg show.
Gazprom’s capital expenditures amount to about 27 percent of revenue, according to data compiled by Bloomberg. Irving, Texas-based Exxon Mobil Corp. (XOM) and PetroChina Co. of Beijing, the world’s largest energy companies, had levels of 7.9 percent and 18 percent, respectively.
“A disproportionate amount of investment is going to commodity-related projects” in Russia, said Deutsche Bank’s Smith. “The economy is more dependent on oil, and to a lesser extent other commodities, than ever before.”
Russia may balance its budget this year if oil averages about $115 a barrel, Finance Minister Alexei Kudrin said on March 14. That would be the highest level ever required to eliminate the gap between government expenditures and revenue, according to data compiled by Bloomberg. Urals crude, Russia’s main export blend, has averaged $101.44 a barrel this year.
Increased government spending ahead of 2012 presidential elections, along with record world food prices, have helped boost Russia’s inflation rate to 9.5 percent, within 0.1 percentage point of the highest level since October 2009, according to government data.
The central bank raised its benchmark refinancing rate by 25 basis points, or 0.25 percentage point, to 8 percent on Feb. 25 and may lift borrowing costs another 25 basis points tomorrow, according to Societe Generale SA. The central bank has also loosened control of the ruble to tame inflation, fueling an 8 percent appreciation against the dollar this year.
The Micex peaked about three months after the central bank began raising interest rates in 2008.
The 55 percent surge in oil prices since May, driven by the global economic recovery and spreading unrest in the Middle East that sparked regime changes in Tunisia and Egypt and a war in Libya, might cause economic growth to slow and lead to lower demand over the longer term. An 85 percent to 90 percent annual gain in the cost of crude led a U.S. recession or growth shock six times since the early 1970s, according to New York-based Morgan Stanley.
When oil jumped during December 2002 and January 2003 on speculation an American invasion of Iraq would curb supplies and derail the economic recovery, the Micex lost 4.2 percent and underperformed the MSCI emerging-market index, which slid 3.9 percent during the period.
“It’s a double-edged sword when the oil price goes up for Russia,” Roland Nash, chief investment strategist at Verno Capital, said at the Bloomberg Link Hedge Fund conference in London on March 17. “By making it less necessary to do reforms, arguably a higher oil price sets Russia up for a fall in the future.”
To contact the reporter on this story: Michael Patterson in London at firstname.lastname@example.org.
To contact the editor responsible for this story: Gavin Serkin at email@example.com.