Russia Looks Rich & Cheap

In the previous post, I made the long-term case for commodities. In this post, we’ll consider an indirect way to get exposure to them. It’s common knowledge that emerging market economies tend to be correlated with commodity prices. That’s because emerging markets are often dependent on the export of natural resources, making them “banana republics,” if you will. One notable exception is China, which is both a leading commodities producer and importer. In addition to being the exception to the rule, China also tends to get much of the emerging market spotlight. People seem to forget that there are three other big names in the “BRIC” acronym, with the “R” standing for Russia.

Despite what some may think, Russia has much more to offer than just stiff vodka and camaraderie. For example, Russia is rich with a wide range of natural resources, including timber, metals, coal, rare earth elements, and one of the world’s largest natural gas reserves. Russia is also one of the largest exporters of steel and aluminum. In addition, and surprising to many, Russia is the world’s largest producer and exporter of oil. Yes, that is correct–Russia produces and exports more oil than any country in the Middle East. These facts correlate well with my secular outlook for commodities, but that is not the only reason why I like Russia right now.

Compared to other emerging market countries, I think the Russian economy looks financially strong and healthy. Figure 1 shows some key economic statistics for the BRIC countries as of the end of 2012. Notice that Russia has the highest current account surplus and lowest levels of debt (relative to GDP) compared to Brazil, India, and China. Brazil and India, in particular, have the highest Debt/GDP levels. While Russia’s GDP growth is not “on fire” like China’s, I think it is within a healthy and sustainable range. Russian inflation and unemployment are a bit on the high side, but they are by no means the worst (unemployment is lower in Russia than in the US). In addition, both measures have fallen significantly from their recent double-digit levels, and they are both projected to continue improving according to the International Monetary Fund.

Figure 1

 

 

With those things in mind, the fact that the Russian equity market is trading with a P/E multiple of 5x and a P/B of 0.68x makes it worth looking at, in my opinion. Of course, emerging market equities tend to have lower valuations relative to developed markets due to their perceived risks. Valuation swings, as measured by standard deviation, also tend to be more volatile. That being said, it is hard to say that Russian equity market valuation is not low in absolute terms. Figure 2 shows a comparison of P/E and P/B measures for BRIC equity markets.

Figure 2

 

 

Risks include the obvious. As mentioned above, emerging market equities can be very volatile. That is especially true for a country like Russia that is heavily dependent on oil exports. For unhedged investments, foreign exchange risk via the Ruble would also be a consideration. Other common concerns regarding Russia are corruption and productivity issues. Many regard Vladimir Putin to be more of a dictator than a president. Political favors seem to run rampant, and heavy Russian state involvement in private industry is widely seen as a burden on innovation and efficiency. Then again, these issues are not unique to Russia, and may even be considered common in emerging markets. From that perspective, I think Russian equities still look relatively attractive.

The bottom line is that I think a rich natural resource base, strong financial position, and cheap valuation make the Russian equity market an attractive long-term investment opportunity.  At the same time, there is no shortage of risks ranging from political to currency.  As always, I think positions should be taken in moderation, built slowly over time on price weakness, and as part of a properly diversified portfolio appropriate for your needs and objectives — and of course, only at your own risk.

Victor K. Lai, CFA

This blog is for informational purposes only. Nothing on this blog constitutes investment, tax, or legal advice. You should conduct proper due diligence and / or consult with professional advisers before taking any investment action.

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