#7
Financial Times (UK)
27 October 2001
INVESTMENT: A market emerging cautiously:
RUSSIA: Upbeat data and buoyant investors are helping the economy to grow
By ROBERT BUDDEN
As major global economies revise downwards their expectations for future growth, Russia is one of the few expected to continue growing.
Last year its economy grew an impressive 8 per cent and this year analysts are predicting growth of up to 7 per cent, driven largely by consumer spending.
The buoyant mood is reflected in upbeat trading statements from foreign companies that have only just begun operating in the country. Ikea, the Swedish home furnishing retailer, recently established a large store in Moscow in the hope of capturing 1m customers. It is believed to have smashed through the targets by attracting more than 3m. Ikea now plans to open four more outlets in Moscow and St Petersburg.
Klaus Bockstaller, an eastern European fund manager at Baring Asset Management, says Russian companies are generating high levels of cash and are reinvesting this money in their businesses. The sharp devaluation of the rouble in 1998 has helped all companies that generate significant export sales because revenues are often generated in dollars while other costs such as wages are paid in roubles.
Given this background, you might expect share valuations to be steep. Yet share prices of Russian companies are greatly undervalued relative to other emerging markets, say fund managers.
"The market fundamentals may be solid right now," says Douglas Helfer, a Russian fund manager at Foreign & Colonial, "but Russia is still perceived as one of the riskiest markets in the world. At times like now, when investor appetite for risk falls, Russia suffers."
Investors have some reason to be cautious. Russia's recent political history is hardly rosy, but many observers believe Vladimir Putin, Russia's president, has the determination and the support to drive through legislative reforms.
Russia's economy is also very dependent on the oil price. If this fell below Dollars 15, Russia's current generous fiscal surplus would be in jeopardy. Below about Dollars 12 many oil companies would no longer be able to break even.
Finally there is Russia's banking system, in urgent need of reform.
But even against this backdrop of uncertainty, fund managers proclaim that Russia is still very cheap. Oil and gas companies, which account for about a quarter of Russia's economy, are generating huge amounts of cash; yet even the top rated companies are still only trading on price/earnings ratios of about 3, according to Helfer.
"Russia's oil companies currently have the highest net profit margins in the world, yet companies such as Petrobras (of Brazil) are on a p/e of 9 and many Asian oil companies are trading on p/e ratios of 14," he says. "Russian oil and gas company ratings could double to 6 and they would still be cheap."
Russia's oil and gas companies, which have their cost base in roubles and about a third of their sales in dollars, have been among the country's prime beneficiaries of the rouble's sharp devaluation. This, combined with the recent strength of the oil price, has also helped fuel healthy fiscal and current account surpluses.
But investors who really want to bet on a strong consumer boom are going for Russia's mobile telephone operators, Mobile Telesystems and Vimpelcom.
With fixed telephone line penetration across Russia at about 30 per cent, many believe Russia's next telephone users will bypass fixed lines altogether and graduate straight to the mobile. There is already strong evidence of this in Moscow where about 15 per cent of the population has a mobile phone. Across Russia as awhole, mobile phone penetration is about 3 per cent.
This rosy outlook for mobile operators is reflected in racier share price ratings with Russia's mobile phone companies enjoying p/e ratios of about 15, high for Russian standards but still low compared to the west.
But Helfer believes that mobile phone operators deserve these ratings. "These companies have high margins and low levels of debt. They are a great play on domestic consumer growth."
The next stage in the development of Russia's economy could be much greater foreign investment. Bockstaller believes Putin is keen to encourage foreign investment and says that some observers are predicting tax incentives for foreign direct investment on a federal level.
"Putin has already stated on several occasions that he wants foreign investment," says Bockstaller. "He has understood that a strong economy requires foreign investment. These are not just statements, he really means what he says."
Russia certainly seems to be making the right noises. However, fund managers still say investors should exercise caution. Even if Russia's economic upturn continues for some time, it could take years before this feeds through into improved share price ratings in line with many of the other major emerging economies.
Few financial advisers suggest that their clients invest money directly in Russia. However, for those investors keen to gain exposure to the country, many recommend funds with broader exposure to eastern Europe.
Favoured funds among financial advisers include Baring Emerging Europe investment trust and Thames River Capital's Dublin-listed Eastern European fund, both with around a third invested in Russia.
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