Russian equities, the ultimate value investing market

Russia’s RTS Index year-to-date is the best performing stock market globally with +37% return in U.S. dollar terms, ahead of 2nd best performer Greece with +34.5%.

Russian equities, the ultimate value investing market
Rainer Michael Preiss, Portfolio Strategist at Taurus Family Office

Whilst Greece and the Euro increasingly have poorer fundamentals and Greek equites are a re-bound momentum story from overly pessimistic levels, the good fundamentals of low debt-to-GDP ratio Russian economy are increasingly again coming on the radar screen of Global investors who now take a more strategic interest in Russian stocks as the ultimate value investing market.

Russia’s debt to GDP ratio is just around 20%. Brazil’s for example is close to 80%. China’s total corporate, household and government debt rose to 303% of GDP, according to the Institute of International Finance. Russia’s household debt to gross domestic product ratio in comparison is 14% according to Moody’s.

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The global FX (Foreign Exchange) market has also started to notice Russia’s better debt dynamics and fundamentals as RUB (Russian Ruble) is now the world’s best performing currency against the U.S. dollar with +16.4% total return this year.

Since 2014, the U.S. and the European Union have imposed some of the strictest economic sanctions on Russian companies in modern history.

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For some global investors the RUB is increasingly seen as a Gold backed currency as the Central Bank of Russia has reduced U.S. dollar reserves and has instead bought physical gold. Both Russia and China have furiously accumulated gold this year. China added 106 tonnes of gold to its official reserves in 2019, while Russia acquired an additional 145 tonnes, making Russia now the 5th largest holder of Gold globally with 2219 tonnes according to the World Gold Council.

At the same time we are seeing some “internationalization” of the Ruble.  Turkey is planning to sell sovereign bonds in rubles, according to Russian Deputy Finance Minister Alexey Moiseev, as the two Black Sea powers tighten financial ties. Turkey is reviewing banks, including international lenders as well as a Russian one, to organize the sale of a “considerable amount”. Russia has sought to expand its local bond market to international issuers, but only neighboring Belarus has placed RUB debt so far.

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Russia’s sovereign bond yields are near historical lows while Russian equity dividend yield is still close to historical highs.

In addition to higher dividend payments, Russian stocks also benefited from a pause in the implementation of new U.S. or EU sanction with the risk of new sanctions being levelled against Russian firms at its lowest since 2014

While the global interest rate cycle may have peaked and European interest are negative and the U.S. Federal Reserve has cut U.S. dollar interest rates three times this year, the Russian Ruble offers attractive high interest rates in the global context.

Russian equities with a dividend yield of 6.38% on the RTS Index and P/E of 6.48x are the definition of value investing.  U.S. equities this month reached a new ALL time record high and the S&P 500 Index now trades at P/E of 20.33x and a dividend yield of 1.87%.

Russian equity market capitalization is now half of what it was at the peak in 2008 at over USD 1.5 trillion and now is only at 663 billion or 3.8% of the MSCI Emerging Market Index. In terms of total EM (Emerging Markets) capitalization, Russia stands at 0.7% compared with 0.9% for Brazil and 2% for India and 11.6% for China.  Many U.S. Investors who had a lot of exposure to Chinese stocks have now realized that U.S. -China Trade War or more accurately “cold War” could leading to more portfolio re-balancing out of China and into other Emerging Markets.

Russia’s Market Capitalization accounted for 34.8 % of its Nominal GDP in Dec 2018 according to the World Bank.  U.S. in comparison is now at 146.3% stock market cap to GDP ratio. 

While the Media talks a lot about U.S. sanctions on Russia, it is important to note that U.S. and U.K investors are still by far the largest institutional investors in Russian equities.

Dividend yields are sustainable. Russia is not yet at the top of the corporate profits cycle, SOE payouts have some more upside and corporate leverage (partly due to Western sanctions) is low and declining. Equity supply is shrinking as companies buy back stock while new equity placements are scarce.

Russian equities yield gap to emerging markets is currently close to historical highs. Russian dividend yield at 6.7% compared to the EM average of less than 3%.

Russian companies have also increased their dividend payouts this year — especially firms in which the Russian government is the majority shareholder, such as Sberbank and Gazprom. 

Sberbank paid out 361.4 billion roubles ($5.62 billion) in 2018 dividends, or 16 roubles per share, spending 43.5 percent of its net profit under the international financial reporting standards on payouts to shareholders. These are the highest dividends that have ever been paid by a Russian company. Gazprom announced earlier in the year that its dividend payout ratio would rise to 50% of net profit under International Financial Reporting Standards in two to three years.

Based on conventional valuation metrics, Russia stands out as a clear value outlier in the EM equities space. Russia aggregate dividend yield is close to 7% with a 50% pay-out ratio. No other market in the world provide such a high yield with additional optionality for expansion.

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