Strategy Note /

Russia revisited as Biden-Putin summit confirmed

  • In large EM, Russian equities, ex-Sberbank, have been left behind by Tech and passive inflow plays

  • Commodity price tailwind, geopolitical risk peak, domestic political control, troubles in EM peers ...

  • ... as well cheap value (particularly in Sberbank), suggest it may be time for Russia's equities again

Russia revisited as Biden-Putin summit confirmed
Hasnain Malik
Hasnain Malik

Strategy & Head of Equity Research

Tellimer Research
26 May 2021
Published byTellimer Research

This is an opportune time to reconsider Russian equities. The Biden-Putin US-Russia summit is scheduled for 16th June and it follows recent Blinken-Lavrov and Sullivan-Patrushev meetings at the foreign minister and security advisor levels, respectively.

Those two lower-level meetings did not give rise to the sort of public acrimony evident in Blinken's meeting with his Chinese counterparts in March. Perhaps geopolitical risk for Russia, or at least the capacity for geopolitical events to spook investors in Russia, may have peaked (although the Belarus hijacking does not help).

Russia equities look cheap relative to the MSCI Emerging Markets index and Commodity exporter peers. For example, Sberbank exhibits much lower price/book (1.2x) for much higher return on equity (19%) than almost all of the larger banks in Commodity exporter markets.

This has been the case during many periods over, at least, the past decade, as Russian equities have become ever smaller a weight in the MSCI EM index, but there are four drivers, in addition to what remains cheap valuation, why this may be a more opportune time to look at Russia than in the past:

  1. Commodity price tailwinds.

  2. Geopolitics probably cannot get worse and may be at a turning point.

  3. Domestic politics remain in the iron grip of Putin and his circle of supporters.

  4. Fresh concerns in a number of Russia’s peers in Large EM.

Russia equities, ex-Sberbank, have underperformed the MSCI EM index by almost 50% cumulatively over last decade

Russian equities decade of declining importance

Russia equities on a 25% Price/Book discount to EM, albeit this is less than the 50% average discount of the last 5 years

Russia's Sberbank stands out in Commodity exporter Banks: lowest Price/Book for highest Return on Equity

(1) Commodity price tailwind

Commodity exports equate to about 18% of GDP in Russia, compared to 7%, 15%, 28%, in Brazil, South Africa, Saudi, respectively. The Russian equity market is more skewed to commodities than these peers, with about 60% exposure compared to a range of 25-40%.

Post-Covid demand recovery (albeit a stuttering one), a recent history of restrained capex, and fears of rising US inflation and yields have all supported the rise of Oil and other Commodities over the past year and this should continue.

Ironically, Russian equities have significantly underperformed these peers in the last year, trailing Saudi, for example, by about 20 percentage points.

Russia equities skewed to Oil & Gas and Mining, EM to Tech

Russia one of 4 Large EMs reliant on Commodity exports

Russia equities most skewed to Commodities in Large EM

Russia underperformed Commodity peers in the last year

(2) Geopolitical risks (or surprises) peak

Fears over the actions (eg more severe sanctions) that might have been expected under a Biden administration that is committed – rhetorically at least – to a human rights-based foreign policy, have failed to materialise. This is despite the tests of the Navalny Affair or the Russian troop buildup around Crimea.

In addition to this, Russia's demonstrable fiscal control in recent years has built a layer of protection against further financial sanctions.

While the summit between Biden and Putin may not result in materially warmer relations, its occurrence represents quite a milestone after Biden publicly agreed to the description of Putin as a “killer”.

Russia remains an unquestionably inferior global military power to the US, but by showing its preparedness to deploy its military, it has created leverage in areas where the US has interests at stake, eg Eastern Europe and Turkey (Armenia-Azerbaijan, Syria, Libya, Eastern Mediterranean).

Furthermore, while its engagement thus far may be more surface-deep diplomacy than long-term strategic alignment, it has also established channels with China and Iran.

Russia's fiscal stance responded to oil price and geopolitical setbacks and its prudence now insulates it to these risks

Russia enjoys surprising geopolitical leverage even though the US dwarfs its military spend by 10x over the last decade

(3) Domestic political control

While the Covid crisis and the Navalny Affair have dented Putin’s popularity and, in the latter case, sparked mass protests, he likely remains unrivalled.

His approval rating is 65%, his actions against dissidents and protestors demonstrate effective centralisation of power, and the constitutional change in 2020 creates a path to maintaining his grip on the Presidency until 2036.

Putin net approval rating still high but below pre-Covid level

Pressures in Large EM peers

The Tech-heavy markets in Large EM – China, Korea, and Taiwan – now have to cope with the combination of rising risk-free rates for equity valuation, tougher domestic regulation (in China), nationalistic Tech regulation which is either restricting market access (for Chinese Tech) or creating duplication of supply chains (Korea and Taiwan Tech), and nationalistic financial regulation (which might increasingly hinder US funds' access to China Tech).

The commodity exporter peers of Brazil and South Africa are both struggling, because of dysfunctional politics, to implement structural fiscal reform necessary to deal with critically high government debt burdens.

And oil exporter peer, Saudi, faces the risk of cuts to dividends, which are the major reason for attracting domestic capital inflows into equities, because of the Shareek program which diverts corporate cash flow to projects which may maximise value for the government rather than the minority shareholder.

While these factors may not be fatal for the absolute investment case in these peers, they certainly erode the relative advantage they have enjoyed over Russia in recent years.

Valuation cheap

Russia equities are offering a forward dividend yield of about 8% on the basis of consensus forecasts. Forecast earnings cover this dividend by about 1.7x.

Russia's low PE valuation tallies with low earnings growth but looks attractive versus Brazil (shrinking), Saudi (high PE)

Russia's low PB valuation tallies with low returns on equity (outside Sberbank) but risk of rising tax burdens in peers

Russia's high dividend yield adequately backed by earnings

Related reading

Belarus hijack shock: Initial thoughts and implications, May 2021

Georgia protests a bigger risk to economy than government, February 2021

Nagorno-Karabakh deal yields benefits for Turkey and Russia, November 2020

Commodity price beneficiaries in EM, October 2020