Putin Punishing Utilities Means Cheapest Stocks Falling More

President Vladimir Putin’s power-industry tariff freeze and delays to state-asset sales mean the shares of electricity providers are poised to tumble from their cheapest valuations in three years, according to Alfa Capital.

MSCI Inc.’s Russia Utilities Index slumped 24 percent this year and trades at a 64 percent discount to the MSCI Emerging-Markets Utilities Index on a price-to-book basis, the biggest gap since March 2009. The gauge is the worst performer in 2012 among six Russian industry indexes compiled by MSCI.

Putin delayed tariff increases to slow inflation before his March 4 election bid. Prospects for the government selling a stake in power distributor OAO MRSK Holding faded after the company said it would merge with Federal Grid Co., the high-voltage transmission monopoly, triggering Goldman Sachs Group Inc. and HSBC Holdings Plc to recommend selling shares of Federal Grid. Utility stocks slid further after Putin added key power companies to a list of state assets that won’t be sold.

“Everyone is afraid that the government will cancel privatization reforms, freeze tariffs,” Vladimir Bragin, head of research at Moscow-based Alfa Capital, which manages $1 billion, said by phone. “Now the state has created a list of strategic companies that are banned from privatization. In the short-term, we expect the stocks to tumble.”

‘Disappointment’

The MSCI Russia Utilities Index is trading at 7.1 times estimated earnings, compared with a ratio of 11 times estimated profit for the MSCI gauge for the industry in developing nations, according to data compiled by Bloomberg.

“These cheap valuations show investors’ disappointment and may remain for a long time until we see some progress on the reforms,” Roland Nash, chief investment strategist at Moscow-based Verno Capital, which manages more than $200 million, said by phone.

State-run Federal Grid has lost 32 percent in 2012, the biggest decline in the four-member gauge of Russian power companies. MRSK Holding has dropped 26 percent, while OAO Inter RAO UES has retreated 23 percent. OAO Mosenergo, Moscow’s dominant power generator, has fallen 18 percent this year.

Former President Dmitry Medvedev pledged in June last year to relinquish government control of some of the biggest state companies, including MRSK’s subsidiaries and OAO RusHydro, the country’s largest hydropower producer, along with OAO Rosneft, VTB Group, and OAO Alrosa, saying it was time to reverse the policy of strengthening the state’s presence. Medvedev was appointed prime minister on May 8. None of the sales has started.

Uncertainty

Federal Grid will take over management of MRSK, the holding company said on May 11, citing a government decision. Consolidating management of the high-voltage transmission and local power grids should help raise efficiency of the industry, it said. The shares have tumbled 23 percent since the announcement. The government holds 78 percent of Federal Grid and 56 percent of MRSK, according to data compiled by Bloomberg.

MRSK was created in July 2008 as part of the reorganization of OAO Unified Energy Systems, Russia’s state-run electricity monopoly, which was broken up into more than 25 companies to foster competition in the industry. The government established MRSK as a legal entity to keep majority control of 12 regional power distributors.

“Investors are scared of uncertainty -- they were expecting privatization of the MRSKs, right now they are worried that this decision may mean a delay in or cancellation of the privatization plans,” Dmitry Bulgakov, an analyst at Deutsche Bank AG in Moscow, said by phone. “Serious decisions are being made without much discussion with the companies and investors.”

‘Effective’

MRSK’s assimilation under Federal Grid will help the companies coordinate the development of Russia’s electricity distribution sector and raise the subsidiaries’ “effectiveness,” Dmitry Klokov, an Energy Ministry spokesman, said in an e-mailed statement May 12. Spokesman Dmitry Gryzunov declined to comment when contacted by e-mail May 28.

“Integration of management will help make the Russian electricity grid infrastructure more efficient,” Alexei Demidov, MRSK’s chief financial officer, said by e-mail today. The deal will ensure “effective investment and regional policies throughout the grid sector,” he wrote.

A spokeswoman for Federal Grid declined to comment when reached by e-mail. Rushydro’s press office didn’t return calls and e-mails seeking comment.

Federal Grid has lost 29 percent this month as Goldman Sachs downgraded the stock and Russia’s Federal Tariff Service raised the prices the state company will charge for the next three years by less than analysts anticipated.

Rosneftegaz

Goldman cut its recommendation on the stock to sell from buy, citing “uncertainty about the target structure of the power transmission and distribution sector,” analysts wrote in a report on May 14. “Associated merger and acquisitions risks” have increased after the merger announcement, they said.

Federal Grid and MRSK Holding tumbled today after Kommersant reported Rosneftegaz, the state company chaired by former Deputy Prime Minister Igor Sechin, may be given control of the energy companies. MRSK lost 4 percent to 1.71 rubles by the close in Moscow, the lowest level since August 2009 for the shares trading on the Micex Index. Federal Grid fell 1.8 percent to 19.15 kopeks after tumbling as much as 5.4 percent earlier.

The government plans to propose a single team of directors for the boards of the two companies, Kommersant reported, citing people familiar with the situation. At the same time, stakes in MRSK and Federal Grid will be transferred to a unit of Rosneftegaz, according to Kommersant.

Political ‘Hostage’

The plan would keep the Russian grid under Sechin’s “strong influence,” even after his departure from the Cabinet, Igor Goncharov, an analyst at ING Bank Eurasia ZAO, said in an e-mailed note. “This would be negative for investors’ sentiment.”

Putin delayed power-price increases due in January by six months to bolster his campaign ahead of the March 4 presidential vote as thousands of Russians took to the streets, protesting his bid for a third term. Federal Grid tumbled 16 percent last week after Russia’s Federal Tariff Service confirmed a smaller-than forecast tariff increase from July 1.

“One of the sector’s problems is that tariffs somehow became hostage to the political cycle,” Deutsche Bank’s Bulgakov said.

Strategic Assets

Russia started selling its stakes in utilities including power distributors and generators in 2007, under former UES Chief Executive Officer Anatoly Chubais, in a bid to modernize and expand power plants and infrastructure as aging equipment and constrained capacity threatened to slow economic growth.

While the state-asset sales focused on generating companies, Medvedev’s vow last year to sell state-owned controlling stakes raised the possibility that Federal Grid and MRSK would be opened further to investors. The companies extended their declines last week when Interfax reported that they had been added to a government list of strategic assets that may preclude their share offerings.

“If a positive scenario of modernization plays out, power stocks will have a lot of room to grow in valuations,” Irina Filatova, an analyst Broker Credit Service in Moscow, said by phone. “If the government doesn’t start a wave of modernization in the sector in the near future, we may be left without electricity.”

To contact the reporter on this story: Ksenia Galouchko in Moscow at kgalouchko1@bloomberg.net

To contact the editor responsible for this story: Gavin Serkin at gserkin@bloomberg.net

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