(This article was published in Spanish in Cotizalia on Thursday 28, 2011).
In Moscow there is no crisis. Russia is the world’s largest oil exporter, 10.2 million barrels a day, and the leading exporter of natural gas to Europe, 134 BCM per year, and it shows in all parts of the economy. The country will have its 2012 accounts in surplus at $125/bbl, but at $93/bbl still meets its goals with flying colours. Also, credit default risk is 14% below the annual average, the country has no risk of contagion from the European debt because Russia has almost nothing invested in EU bonds, the economy continues to grow by 4% annually and unemployment is at historical lows. With over $20 billion in scheduled IPOs, foreign fund flows at record highs and a reserve fund of at least 25 billion dollars to invest ahead of the elections, seems to me an environment that does not justify a discount of 40% to other emerging markets.
The Russian market (RTS) has been one of the best performers (+15%) so far this year. However, it is still trading at a discount, which in my opinion unjustified. Russia was accused of being “closed, corrupt and driven by state and oligarchic interests” Well, as half of the EU, then, in my opinion.
Not to be cynic, but I think we criticize other countries with faults that we have at home, and with many Russian companies the investor has the same guarantees as in Brazil, China or even Spain, Italy or France, increasingly interventionist countries, especially on energy. But Russia has much cheaper stocks, which enjoy higher growth, higher profitability and a better financial position than its peers in Europe.
In 2011 the average EBITDA growth of the Russian market is estimated at 49%, with margins of 29%. And with a 40% discount. I, therefore, believe that any “concern for corporate governance” is more than discounted.
My readers know I am a big supporter of several Russian energy companies, especially Novatek, Eurasia Drilling and Bashneft, which in terms of value creation, corporate governance, efficiency, and management team have nothing to envy of any international peer. Of course, my readers also know that having great stocks such as these, I’m not a big fan of integrated state-owned stocks, Rosneft or Gazprom, mainly because I never liked semi-state owned stocks (conflict between state interests and shareholders, from EDF to ENI, to Petrobras and Petrochina) or large conglomerates of any country, with the exception of Exxon and Chevron, which are the only ones who stand up to their government and defend the shareholder above all else.
To invest in Russia the first thing to do is to avoid betting that the government will do something that the rest of the world does not do (for example, thinking that the government will allow state enterprises to generate excessive profits when it does not happen in any EU country). Or that Russia is a joke and you have to go for it, as Yukos thought using state exploration licenses for private interests.
Another example is the disaster that BP has made when trying to trick its partner, TNK (25% of the reserves of BP), signing an agreement with Rosneft behind their back. BP thought that in Russia everything is arranged by dealing with the government and has seen the agreement canceled by a court of international arbitration and the most likely outlook for BP is it will have to sign a cheque for several billion (rumored $ 40 billion) to the shareholders of TNK (AAR) to “divorce” from their alliance. A partnership that was signed and prepared in detail by Tony Hayward, BP’s former CEO, where everything was tied up to the smallest detail. But his successor, Bob Dudley, thought that an agreement with a state company, Rosneft, and a supposed tacit government support would make this partnership with TNK and its shareholders interests (AAR) worthless. Bad idea.
Total, Statoil and Exxon invest in Russia with more logic.
There are several reasons to invest in Russia :
1. Despite being the most geared to oil prices, the Russian market is discounting an oil price below $90/bbl and traded only 7.2 times PER 2012. It is true that between Gazprom and Lukoil (30% of the index) there is more than a 40% discount in PE, but stock by stock the market is still significantly cheaper than the other EMs.
2. Although the economy grows by 4%, the budget is balanced at $125/bbl and corporate profits will rise 30% on average, Russia trades with a risk premium of 8.7% compared with China or Brazil at 6.5%.
3. Russia is the only country in the EU and emerging economies where I foresee widespread upward revisions to long-term profit forecasts. It is also the country where corporate and state debt is more controlled of the major economies.
4. Medvedev announced in March in Magnitogorsk a very ambitious set of measures of transparency and corporate governance. The market has not reacted yet, but we must remember that after his “Go Russia!” speech in September 2009 the market rose 22% despite the oil price staying flat.
In the energy market, Russia is, for obvious reasons, a goldmine. And it should continue to highlight four areas:
1. The creation of new oil and gas giants. Russia has decided, rightly, to support the creation of companies to develop their oil and gas fields more quickly, efficiently and cheaply than the big state conglomerates. The two beneficiaries of this process of optimizing the exploitation of natural resources are Novatek (gas) and Bashneft (oil). Total has bought 10% of Novatek, and is rumored that Statoil and Shell will participate in its flagship project, Yamal LNG. Despite the stock rally, it is still trading at just $3.33/boe (2P reserves) and 12x EBITDA for a company growing 20% annually. Bashneft, meanwhile, is trading at $ 5.6/boe (2P) and with production growing by 4%, benefiting from an agreement with Lukoil to develop the mega fields of Trebs and Titov (7 million barrels per day in 2013) it is not surprising to see consensus estimates grow by 46%.
2. The ridiculous antinuclear and anti-shale gas campaign around the EU benefits Russian gas exports. 145BCM in 2013. And the more interventionist that Europe is, the better and better for Gazprom, which could trade 40% higher if its investment plan was less “opaque” (nearly 40% of Gazprom’s investments generate returns below 7%),and this makes it trade at low multiples (5x PER). However, Novatek, domestic gas player, profits from the same environment (without such a “government-led” capex plan).
3. The goal to keep oil production at 10.2 million barrels a day and develop new fields in Siberia and the Arctic will benefit the efficient service companies, which compete with internationals as equals and have proven their effectiveness with their clients (Rosneft , Lukoil). Eurasia Drilling and Integra, two of the top ranked service companies may see its order book doubled and margins increased by 34%. Eurasia Drilling also has a very competitive cost structure and presence in countries such as Azerbaijan. From the integrated oils, Rosneft and Lukoil are obviously favorites of many funds given the large resource base, but the risks investors face is to bet that margins will recover or that taxes in Russia are reduced, which is unlikely, and investors should also take into account the risk (similar to that of all conglomerates) that these companies decide to move aggressively in their international expansion by buying assets at high prices.
4. The liberalization of utilities. The major European electric utilities have invested in Russia with great success. It is worth looking at those utilities partially controlled by European groups which generate very strong returns, with world class efficiency and transparency. E.On (OGK-4), Enel (OGK-5) and Fortum (TGK- 10) have been the first to invest large extensively. The TGKs and OGKs and trading at $250/Kw installed and 5.6x EV/ EBITDA 2012 on average. Discounts of over 20% compared with the European power groups, which are widely hit by regulatory risk and interventionism.
Many people ask me if it is too late to invest in Russia. I think not, and I think if there is a slight correction, as in May-June 2010, it can be a great opportunity to invest in a country that is becoming less “emerging”, which is the largest exporter of oil and gas to Europe and undertaking a very interesting process of reforms that recalls the one we saw in Spain in the late eighties and early nineties. But with oil and gas in abundance.