Russian Stocks Draw A Whole New Crowd

Yeltsin's win has comforted mainstream investors

Officials at Mosenergo, Moscow's local power company, can be forgiven for acting a little giddy. They and their employees are big holders of Mosenergo shares, which rocketed from 18 cents in mid-March to 78 cents on July 29. Mosenergo is a star performer of the Russian stock market this year, but it's far from unique. As foreign investors grew more confident this spring that President Boris Yeltsin would win his reelection bid on July 3, they began gobbling up Mosenergo and other Russian blue chips. By July 4, the day after Yeltsin's victory, the Moscow Times' dollar-based index hit a peak of 150.92, up more than 175% from its record low on Mar. 19.

Although the index has pulled back by 37% since then, to 109.5, perceptions of the market have changed, perhaps for good. Since they first started trading three years ago, Russian stocks have attracted mainly risk-takers such as hedge-fund managers and specialized, closed-end country funds. Now that a reversion to communism is a fading possibility, mainstream investors are getting excited about Russian stocks. "It is becoming an investment market as opposed to a speculative market," says William F. Browder, managing director of Moscow-based Hermitage Capital Management.

POOR HEALTH. Of course, investors who plunge into Russian stocks should be prepared for a bumpy ride. The market's small size makes it very volatile. And Yeltsin's win by no means wiped out political uncertainty. If his ill health prevents him from serving a full four-year term, Russia will face another presidential election and period of instability. The two most likely candidates, Prime Minister Viktor Chernomyrdin and security czar Alexander Lebed, are both generally promarket and proreform. But Lebed, a career military man, is still formulating his political and economic views. Meanwhile, the government is grappling with a fiscal crisis and a banking crisis.

The preelection boom was fueled by speculators betting that reform would continue. But the next wave of institutional money--adding up to billions--will judge Russia on the strength of its companies. Many Russian blue chips reported 1995 earnings growth of 50% to 300%, yet their price-earnings multiples still average only 7.5. Even allowing for different accounting practices, Western analysts agree that Lukoil's stock price, for example, reflects oil assets valued at 23 cents per barrel, compared with $6 for Mobil Oil Corp.'s.

International Finance Corp.'s decision in late June to include Russian stocks in its emerging-markets index is another factor likely to lure money into Russia. IFC estimates that $7 billion is invested using its index. As of Sept. 30, Russian stocks will account for 2% of it, meaning that emerging-market investors who want to match the index performance will replicate the IFC country weightings in their portfolios. "This completely changes the players in the market," says James Fenkner, research director at CenterInvest Securities, a Moscow investment company. "It's a move from hedge funds to mutual funds."

Improved shareholder rights have also contributed to the new interest. In 1994, tales abounded of companies erasing shareholders' names from registries and of diluting investor stakes by surreptitiously issuing new stock. Now, most Russian companies that seek foreign capital have transferred their registries to independent companies. Many well-capitalized custodians are setting up shop, making it easier for strictly regulated U.S. pension and mutual funds to invest in Russian shares or depositary receipts.

CLEAR TREND. So far, most of the trading has been in a handful of blue chips: Lukoil, Mosenergo, Unified Energy System, Norilsk Nickel, and Rostelekom. But investor attention is already shifting to second-tier stocks. Especially interesting are smaller oil companies, such as Purneftegaz and Orenburgneft, which have increased their oil output. Local utilities such as Irkutskenergo are also gaining popularity.

Barring a budget crisis that would reignite inflation, the long-term trend is clear. Attracted by Russian companies' cheap assets and high earnings, the big investors will come. Says Dorian Foyle, a portfolio manager with Templeton Global Advisers in Nassau, Bahamas: "For the long-term investor, there are few investments in the world that rival Russia." If he's right, the post-election correction may give those nonspeculative investors the chance they need to get in before the market really takes off.