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April 23, 2003Boston, Mass. The Russian Equity Market: Raising the Bar in 2003: Strong Foundations; Heading Forward?. Timothy Seymour, Managing Director, Troika Dialog Group /President, Troika Dialog USA. Overview:. Where are we? Recent events as evidence of change

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The russian equity market raising the bar in 2003 strong foundations heading forward

April 23, 2003Boston, Mass

The Russian Equity Market:Raising the Bar in 2003:Strong Foundations; Heading Forward?

Timothy Seymour, Managing Director, Troika Dialog Group /President, Troika Dialog USA


Overview

Overview:

  • Where are we? Recent events as evidence of change

  • Troika Dialog

  • Corporate Governance/Market infrastructure

    • A look back;

    • Key events to watch

  • Economic viability for growth

    • Can the economy broaden on weak financial system?

    • Sectors for growth

  • Market Valuations

  • Investment thoughts


Bar has been raised last 2 weeks

Bar Has Been Raised Last 2 weeks:

  • Yukos/Sibneft

  • Dividend pmts soar( LUK, Rostel, Yukos)

  • MTS deal fair and transparent; controlling stake

  • Transneft capitulates

  • Market forces lead change (Surgut?)

    • EXOGENOUS FACTORS KEY…BUT RUSSIA GROWS INTERNALLY


Practicing what we preach

Practicing what we Preach

  • 1991Among the first in the market Troika gets the license, to operate as a broker

  • 1992Among first in the market Troika converts to GAAPPWC is our auditor since 1998 until now

  • 1993 - 1997Troika actively participates and leads in the building of Russia's financial market infrastructure

  • 1998Troika honored all of its commercial obligations

    Troika helped launch the Coordination Center for Investor Protection

    Troika began publishing weekly CG updates

    Troika is among the founding members of 2015 Club

  • 1999The 1st CG overview report in Russia

    Troika is among the founding members of the Investor Protection Association


Building a business on good governance

Building a Business on Good Governance

  • 2000Troika is among the founding members of the WEF’s task force “Changing Corporate Governance in Russia”

  • 2001The Perception and Cost of Corporate Governance Risk survey for WEF, presented at the annual meeting in Davos

  • 2002 Troika’s president becomes a chair of the RSPP Corporate governance Committee Management buyout

  • 2003 Troika’s president recently elected a member of the National Council for Corporate Governance


Role of troika dialog as a market participant

Role of Troika Dialog as a “Market Participant”

  • Key contributor in creation of NAUFOR

  • Co-founder RTS (Russian Trading System)

  • Market infrastructure support: DCC

    • helped set up exchanges

    • helped set up rules of trade

    • helped set up settlement and safekeeping systems

    • worked with international assistance organizations

    • advised government and regulators

      These structures and standards survived intact the Banking Crisis of 1998


Troika dialog usa inc

Troika Dialog USA, Inc.

  • Est. 1999, 1st Russian Broker to receive license after crisis

  • NASD Broker/Dealer

  • SEC governed

  • Leading market share in listed and OTC Equity/Debt Securities in US to institutional investors among “local brokers”

  • 2-way flow of capital between US-Russia; distribution for key Investment Banking Projects and Asset Management (Private Equity, US Mutual fund, VC)


Corporate governance changing

Corporate Governance…changing

  • Recent Milestones

  • Hurdles


Market infrastructure 1991 2003

Market infrastructure: 1991-2003


2003 milestones

2003 milestones

  • FCSM to regulate price manipulation in the market

  • The FCSM together with the RSPP launched the National Council for Corporate Governance

  • Consolidation in the telecommunication industry

  • The natural monopoly reorganization:

    • The electricity reform program is enacted on the legal level

    • Government to proceed to reorganization of the gas sector


2003 milestones1

2003 milestones:

  • State tightens control over largest domestic companies

  • Domestic investor base to grow

  • FCSM delegates some supervisory functions to exchanges

  • FCSM to tackle the price manipulation in the stock market

  • Reforms of natural monopolies:

    • Telecommunication sector consolidates

    • Electricity Law adopted


The russian equity market raising the bar in 2003 strong foundations heading forward

China

Morocco

Colombia

Pakistan

Egypt

Philippines

India

Russia

Indonesia

Slovakia

Jordan

Sri Lanka

Kenya

Venezuela

Malaysia

Zimbabwe

CalPERS’ current Permissible Country List (Equity).

“Prohibited for investment” List

Source: Patient Pension Capital by William Dale Crist, Ph.D and Kayla J. Gillan, J.D.

http://www.calpers-governance.org/viewpoint/speeches/crist.asp


Calpers permissible country program

CalPERS' Permissible Country Program

Category

Assigned Weight, %

1

Political Risk

10

2

Market Liquidity/Volatility

15

3

Country Development

10

4

Market Regulation/Legal System/Investor Protection

20

5

Investment Restrictions

15

6

Settlement Proficiency

15

7

Transaction Costs

5

8

Technological Growth

10

9

Social Issues

N/a

Source: Patient Pension Capital by William Dale Crist, Ph.D and Kayla J. Gillan, J.D.

http://www.calpers-governance.org/viewpoint/speeches/crist.asp


Challenges that remain

Challenges that remain

  • Dividend legislation is stalled in its track

  • Voting treasury stock

    • Affiliated party regulation

    • M&A regulation


Accounting and audit reform in russia

Accounting and audit reform in Russia

  • The government to discuss the accounting reform program within the next six months

  • Accounting dodges: RUSSIA and US

“Accounting” dangers to shareholders

Russia

US

Poor accounting standards

YES

NO

Stock option plans

NO

YES

Loans to directors and top executives

NO

YES

Auditors provide additional non-audit service

YES

YES

Off-balance liabilities

YES

YES


Next steps to watch

Next steps to watch

  • UES reform is underway

    • UES to discuss 5+5 strategy program

    • Deregulation postponed?

  • Gazprom is next in line

    • Economics Ministry to submit third draft of gas industry reform program

    • No real changes until post-presidential election

    • Capex transparency?

    • Liberalization of shares?


The russian equity market raising the bar in 2003 strong foundations heading forward

Russian Economy in 2003:

-on the brink of an intense structural transformation?


The russian equity market raising the bar in 2003 strong foundations heading forward

Diversified economy and developed financial system should remove dependence on current account (i.e. oil price)


The russian equity market raising the bar in 2003 strong foundations heading forward

Themes:

  • Incomes rose rapidly and, with them, domestic demand. However, Russian companies were unable to increase production accordingly.

  • Demand shifted toward more expensive and higher-quality products, resulting in higher imports.

  • However, consumer services (which cannot be imported) are likely to have grown much faster than the 0.4% growth officially reported for 2002.

  • An expansion in small businesses was recorded in 2002, mostly in the service sector. To some extent, the economy became healthier and government efforts to de-regulate did bring results. However, a great deal still needs to be done.

  • Financial sector reform is still on the agenda.


The russian equity market raising the bar in 2003 strong foundations heading forward

Growth rates (y-o-y) slowed on back of continued strength in oil price…


The russian equity market raising the bar in 2003 strong foundations heading forward

Effective real exchange rate even depreciated slightly (by 1.7%) in 2002, while imports grew 12.7%


The russian equity market raising the bar in 2003 strong foundations heading forward

Ruble appreciates substantially: harmful for “old” economy, but may stimulate economic restructuring


The russian equity market raising the bar in 2003 strong foundations heading forward

In real terms non-interest spending grew much faster than GDP, contributing to inefficient allocation of resources...


The russian equity market raising the bar in 2003 strong foundations heading forward

Domestic borrowing limited by low monetization of economy


The russian equity market raising the bar in 2003 strong foundations heading forward

Due to oil windfalls, money market interest rates are well below refinancing rate


Russian market

Russian Market:

  • Oils have re-rated

  • What sectors lag

  • Where is growth to come from?


Rts from oils and beyond

RTS: From Oils and Beyond

600

500

400

300

200

Rest of Russia Re-rates

Russian Oils Re-rate

100

0

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

Source: DATASTREAM


Non oil sectors are at discount to their global peers

Non-Oil Sectors Are at Discount to Their Global Peers

0.6

44%

0.4

Manufacturing

0.2

Consumer

Electricity

Transport

Telecoms

Banking

Metals

0

–0.2

Oil and Gas

–24%

–25%

–26%

–0.4

–35%

–36%

–46%

–0.6

–61%

Ratio of Russian sector EV/EBITDA ‘03 to its GEM average

–0.8

Source: Troika Dialog, Bloomberg


Domestic consumption key growth driver for economy

Domestic consumption – key growth driver for economy

Food industry remains a growth leader

  • Industries targeting domestic consumption lead economic growth

  • Growth drivers:

    • Change in consumption patterns toward branded products

    • 6-7% growth in private incomes over next three years

    • Consolidation and new quality standards

    • FDI growth

Source: State Statistics Committee, Troika Dialog


Consumer sector trending beyond 2003

Consumer Sector: Trending beyond 2003

Retail and food industries have got most benefits from economy growth

  • Consumer Sector unlikely to total more than 10% of total Russian market cap.

  • 2003-2005 remain industrial export oriented

  • Growth financed by external debt and export revenue, not banking sector loans

  • Consumer Sector will see greater sophistication in brand awareness,; consumers will demand improved products and better packaging


Investment opportunities in consumer and financial sectors

Driver

Industry consolidation by global players

Structural changes in economy

Emerging of new domestic leaders

How to play

Wimm-Bill-Dann.

Upside to estimated acquisition price 50%

Danone is potential acquirer

Sberbank

Liberalization of trading with banking stock

Improved environment on reform of banking monitoring and implementation of retail deposit insurance

Incoming IPOs

Banks: MDM, Alfa-bank

Retail: Pyaterochka Seventh Continent, Perekrestok

Investment opportunities in consumer and financial sectors


New consumer good stocks provide extensive growth of the market

New consumer good stocks provide extensive growth of the market

  • Industry is on the earlier stage of consolidation

  • Current growth is financed by own profit and direct investors

  • Several companies will reach critical size to go public in 2004

  • Most IPO’s should be among retail companies

    • Low penetration promises high growth potential

    • Chains account 12% of total turnover in Russia vs. over 30% in eastern Europe

    • Low attractiveness as targets for global players

Expected IPO’s 2004 – 05


What to expect in next 2 3 years

What to expect in next 2-3 years

  • IPO calendar still light through 2004 as companies look to raise valuations in line with macro re-rating before selling out…

  • …Companies will be leveraging up

  • Gazprom is the bellwether and will prove best liquid performer in next 18months

  • Russia will go investment grade late 2004

  • Domestic flow of funds will remain driver of valuations and should provide technical out performance foundation.

  • Watch out for “ Chaebolization” effect


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