1 / 37

Russia’s Capital Markets Drivers of Investment Returns in 2001-02

Russia’s Capital Markets Drivers of Investment Returns in 2001-02. March 2001. Chris Weafer.

yakov
Download Presentation

Russia’s Capital Markets Drivers of Investment Returns in 2001-02

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Russia’s Capital MarketsDrivers of Investment Returns in 2001-02 March 2001 Chris Weafer

  2. This will be a good year to be invested in Russian equities, especially relative to other world markets. If emerging markets are ‘flat’ in 2001 then the RTS should appreciate by 50%. If EM asset class increases, then the RTS will rise more. Fixed Income returns should also be good, but look more assured over the first half. Year to Date RTS +22% World Emerging – 3 % World Total –13% NASDAQ Comp. –22% Dow Jones Ind. –10% To what extent this strong relative performance is extended into 2002 will depend on the trend in the economy, political change, the outcome of corporate restructuring, etc.

  3. Russian Equities & Fixed Income12 months The trend in equities and fixed income yields had been broadly similar until equities collapsed with other emerging markets in October. F.I. Yields have recovered with the trend in global yields and declining interest rates.

  4. Main Drivers of Relative Performance • Economic Predictability • Political Stability • Peer Group Asset Class • Corporate Governance • Valuations The drivers of ‘Absolute Performance’ for any ‘Emerging Market’ are global liquidity flows and domestic investor participation.

  5. Economic Predictability • The economy has recovered very well from the 1998 crisis but is fast approaching a major transition • President Putin is more active in managing the economy than his predecessor, and on some issues is the de facto prime minister. He has been highly supportive of Gref’s reform plan. He has also taken a strong stance on debt: it must be paid, but the government must also seek ways to lighten the debt burden. • Economic policy is now more consistent and in significant respects improved. There is an awareness of why liberal economic reforms have failed so far, and these problems are now being addressed. • These include the linked problems of the too-powerful bureaucracy, and the weak courts. In Soviet times ministerial policy was more important than law. The ministries have tried to continue this.

  6. Economic Predictability (cont’d)Saved by Increased Oil & Gas Revenues and Devaluation 1997 1998 1999 2000 2001F GDP growth (y-o-y) +0.70% –4.6% +3.2% +7.7% +3.5% Note: each $1 p/bbl increase in oil is worth $1 bln p.a. in exports(1/3 rd accrues to the federal budget) and + 0.50% to GDP growth.

  7. Economic Predictability (cont’d)Russia’s Vital Statistics 1997 1998 1999 2000 2001F GDP growth, y-o-y +0.7% –4.6% +3.2% +7.7% +3.5% Ave. Oil (Urals), $p/bbl $18.4 $11.9 $17.2 $26.6 $21.0 Oil Export Revenues, $’bln $15.1 $9.9 $14.8 $25.0 $21.0 Gazprom Exports, $‘bln $10.7 $9.4 $8.6 $14.3 $14.5 CBR Reserves (ex Gold), $’bln $12.9 $7.8 $8.5 $24.3 $31.5

  8. Economic Predictability (cont’d)Russia’s Total Debt is $176.3 bln (72% of 2000 GDP, 62% of 2001) Internal Debt $20.4 bln Outstanding Traded OFZ’s $6.5 bln OFZ’s in CBR portfolio $12.1 bln Other loans to Economy $1.8 bln External Debt $155.9 bln Paris Club $48.4 bln Former COMECON countries $14.5 bln Other ‘Official Debt’ $ 3.1 bln London Club $29.8 bln Other ‘Commercial’ debt $ 9.3 bln IMF $11.0 bln World Bank $ 7.0 bln Sovereign Eurobonds $15.6 bln Sovereign OVVZ’s $11.0 bln Dollar Debt to CBR $ 6.2 bln Debt Servicing Costs, $ bln 2000$10.2 (27% of budget revenues) 2001 $14.0 (30% of budget revenues) 2002 $14.0 2003 $18.0 2001-03 includes $3.5 bln of Paris Club

  9. Economic Predictability (cont’d)Currency Stability and Inflation Control Currency trendsince presidential election Inflation Trend, y-o-y 1997 11.0% 1998 84.5% 1999 36.7% 2000 20.0% 2001(f) 20.0%

  10. Economic Predictability (cont’d)Main Economic Numbers 1997 1998 1999 2000 2001F GDP +0.7% -4.6% +3.2% +7.7% +3.5% Industrial Prod. +2.0% -5.2% +8.1% +9.0% +4.0% Trade Balance, $ bln +14.8 +14.4 +33.2 +69.0 +44.0 Current A/C, $ bln +2.1 +0.7 +25.2 +44.0 +28.0 Inflation +11.0% +84.5% +36.7% +20.0% +20.0% Ruble/$ Rate 6.0 20.7 27.0 28.2 32.0 Urals, average, $ p/bbl 18.3 11.9 17.3 26.6 21.0

  11. Economic Predictability (cont’d)Easy Ride is nearing end • Oil price of $20 p/bbl means tight budget • Full service of foreign debt will mean dipping into reserves • Erratic industrial production growth trend • High start to year inflation rate • Confusion on economic policy implementation A recent study by the World Bank on Russia found that only 20% of the economy is competitive, market-orientated and capable of sustaining growth.

  12. Economic Predictability (cont’d)Agenda for Economy • Reforms in key areas of Legal, Banking, Land, etc. • Debt restructuring or confirmation of ability to service • Debt rating upgrade • IMF deal – to improve credibility • WTO membership • PSA deals • Need to attract liquidity back and build new FDI The lack of structural reforms may not stop growth altogether, but it makes more unpredictable and volatile macroeconomic variables, such as the exchange rate.

  13. Economic Predictability (cont’d)Foreign Direct Investment 1997 1998 1999 2000 2001F $ bln 5.3 3.3 4.2 4.3 4.5 % of GDP 1.2% 1.2% 2.3% 1.8% 1.6% Main Source Countries (2000) US 46% Holland 8% Cyprus 8% Germany 7% UK 6% Main Target Industries (2000) Trading Companies 23% Transportation 22% Food 19% Fuel 10% Machinery 5% $100 bln of Russian capital is held outside the country and an estimated $50 bln is held by Russian citizens in cash.

  14. Political Stability • Stable political structure (relative) for first time since Soviet era • Duma co-operates with the Kremlin • Communists and Oligarchs are no longer influential • ‘Kremlin Family’ appear to be on the wane • Regional Governors are under control • Popular leadership • Support of the security forces ButPresident has not shown that he is able to exert full control, particularly against bureaucrats.

  15. Political Stability (cont’d) • Plans for ‘economic reforms’ have been well developed by Economic Ministry, but so far obstructed by bureaucrats • Government has not been able to enact a new PSA • Slow progress on Gazprom and UES restructuring • Moscow cellular licenses fiasco • Not able to install own choice in prosecutor’s office • Putin seems unable/unwilling to deal with obstructive bureaucrats It is clear that there will have to be a major restructuring of the government bureaucracy if there is to be any progress on the reform program.

  16. What Putin will do • Legal Reforms are the priority. • These will make bureaucrats accountable, by making the courts more independent. • This year will see legislation to reduce the powers of the bureaucracy. • The government will be restructured, to streamline decision making.

  17. Political Stability (cont’d)Creeping Return to Tight Central Government Control? ‘capital markets dislike indecision or lack of effective control by central government’. Strong leadership, pushing an economic reform program designed to stimulate investment and growth, is always good for investment returns. Legal reforms will bring the bureaucracy under control and will create a more transparent playing field.

  18. Peer Group Asset Class Russia became an ‘emerging market’ in March 2000, after the first phase of political change was completed. • in 1996-97 it was a roulette wheel • in 1998 it was in retreat with other ‘risk’ • in 1999 it was recovering from crisis & undergoing change From now, Russian assets should derive directional performance & valuation benchmarks from the EM asset class.

  19. Peer Group Asset Class (cont’d) Russia has the highest Beta in the EM asset class. This is because of a steep discount and high risk perception. The RTS has a strong ‘directional correlation’ with world emerging markets. The high ‘Beta’ has meant that sharp out-performance on the upside and equally steep under-performance on the downside. This is likely to remain a feature until the current high discount on Russian assets closes to a more appropriate level.

  20. Corporate Governance The perception of bad corporate governance in Russia greatly increases market volatility (beta), generally has kept liquidity out of the market and has held back valuations. We estimate that this poor image on CG is currently depressing the value of quoted shares in Russia by over $50 bln on a simple valuation model. How much bad CG costs: Gazprom $11.4 bln UES $10.2 bln Norilsk $6.6 bln LUKoil $6.5 bln YUKOS $2.3 bln SUAL Holdings, one of the world’s largest aluminum producers, had 2000 sales of $1 bln but has a market capitalization of only $35 mln.

  21. Corporate Governance (cont’d)The Solution? • The cynical viewControlling shareholders realize that the opportunity to force changes through in an abusive way is declining and that current changes represent the end of the cycle. They also know that by adopting good standards afterwards, the company rating significantly improves. • Government actionIt is expected that the government will introduce new legislation over the next few months to tighten up existing laws to block the traditional methods of abusive action. They recognize that this poor image is a major obstacle in attracting foreign investors to Russia. • External pressureInitiatives such as the ‘seven point’ international standards adopted by the World Economic Forum, in association with CalPERS, are exposing the bad practice in Russia even more starkly. This increases pressure for change.

  22. Corporate Governance (cont’d)However, • Companies need to do more than just adopt corporate governance charters and hire PR agencies. While this approach will take their rating away from the depths reached during the course of the ‘abusive action’, it is not a substitute for real ‘interaction’ with shareholders • Companies will need to show that they are operating for the benefit of all shareholders (e.g. a full dividend policy) and that managers are incentivised through profit enhancement schemes. • The government will have to show that it is willing to protect minorities and evidence will be sought in Sberbank, UES, Gazprom - all of which have a large State involvement This is the only way that proper long-term relative stock valuations can begin to be addressed

  23. Valuations • Russian assets are cheap, but have been for good reason – the perception of high country specific risk. • Stock market ratings should have closed the significant gap that exists with the ‘emerging market’ average after last year’s political change but the fact of low liquidity flows to this asset class delayed this. • If EM’s behave as expected this year, then this ‘step-up’ will occur in 2001. The ‘evolution’ of some existing corporate governance ‘events’ will aid this. The RTS needs to appreciate 50% relative to the emerging market average to achieve this ‘more appropriate’ rating*. * this is based on Troika’s earnings model for the RTS and the ‘target’ relative rating which is constructed from consensus earnings in related sectors in the emerging market universe, less an ‘appropriate’ discount for lingering country risk.

  24. Valuations (cont’d)Long term • The market is valued off an earnings base. • The rating associated with that ‘earnings base’ can be improved by corporate action (clearer strategy presentation, dividend policy, corporate communications, etc.) and by a general reduction in country risk. • Long-term earnings growth will depend on the extent of broadening and restructuring in the economy. • Russian assets are unlikely to achieve and sustain a premium rating until domestic investor activity becomes the dominant market driver.

  25. Summary ExpectationsTalking Points • Economy and Debt restructuring to be more of a market issue/concern in the 2nd half, particularly for Fixed Income • Reforming the government bureaucracy • Renewed push on reforms to stem from this restructuring • Attempt to legislate tighter corporate governance laws • PSA • Initiatives to curtail capital flight and incentivize FDI. • W.T.O. membership • Attack on old Kremlin family • Gazprom, UES and Sberbank

  26. Summary ExpectationsActual • GDP growth of 3.5% if Urals price stays at $20-$22 p/bbl • Inflation to be brought under control (target of 20% y-o-y for 2001) • Debt servicing out of reserves (no matter how dressed up) • Putin to demonstrate his power base with some ‘confrontational’ action • Emerging Markets to start reversing the past 4-year decline with new liquidity flows from summer • Russian equities to out-perform this rising EM trend by 50% • Fixed Income yields to fall further on reducing global interest rates over 1st half but risk running into problems in 2nd half because of domestic concerns

  27. Risks • Confusion on economic policy or ‘who is controlling it” • Inflation does not decline • Industrial growth remains “erratic” • Decline in budget revenue collection • Debt servicing out of ‘reserves’ and deadlock on restructuring talks • ‘Token’ government restructuring • Course of restructuring on government controlled enterprises - UES, Sberbank, Gazprom - i.e. abusive course allowed. • Global market collapse extended into 3rd quarter - could delay deployment of liquidity to emerging markets • Crisis in China’s financial markets

  28. EquitiesEmerging vs Mature Markets Emerging markets have been affected by the collapsing NASDAQ over the past year but rallied in January. Longer term, EMs have been under-performing since early 1997.

  29. EquitiesRTS and Emerging Markets Russia is taking its directional lead from emerging markets – it still has a 50% relative clawback to recover. Having initially declined with other emerging markets (sympathetic), the RTS under-performed as a result of the ‘98 default and has been slowly clawing back the relative relationship.

  30. EquitiesRTS (broad market) and MSCI (Blue Chip & Liquid) MSCI Shares (% of EMEA) Gazprom 1.57% Irkutskenergo 0.72% LUKoil common 13.98% LUKoil pref. 1.53% Norilsk Nickel 2.06% Rostelecom common 1.23% Rostelecom pref. 0.17% Surgutneftegaz common 10.50% Surgutneftegaz pref. 1.84% Tatneft 2.31% UES 8.15% Total 44.07%

  31. Fixed Income Russian debt yields are driven by the trend in the emerging debt market (left graph). The trend in US interest rates (right graph) is less of a factor, other than as a contributory driver of emerging market debt yields

  32. Russia – Long Term Game Russian equities offer one of the best long-term growth opportunities in the emerging market world. If faster economic growth can be stimulated by the successful implementation of major reforms and capital repatriation + FDI, the current balance sheet potential valuations will be translated into above average earnings growth and ratings expansion. The major risk to this is that there is a lingering perception of weak political will and control which is compounded by a deterioration in US relations. This could cause disruption in debt restructuring, WTO entry and FDI flows. Domestically, opposition to an increase in FDI may grow because of a perception that ‘assets are too cheap to sell’

  33. Major IndicesMSCI $ based (except where stated) – March 26, 2001 2001 ytd 2000 1999 3 years 5 years Russia RTS +22% –19% +202% –49% +135% World Emerging – 3% –30% +66% –21% –29% Emerging Asia +3% –39% +68% –19% –49% Emerging Lat.Am. –4% –16% +62% –19% +18% Emerging Europe –15% –35% +81% –30% +3% World Total –13% –14% +24% –1% +40% Dow Jones Ind. –10% –6% +25% +9% +71% NASDAQ Comp. –22% –39% +86% +6% +76% Czech –6% +1% +4% –11% –20% Hungary –19% –28% +11% –48% +61% Poland –20% –5% +31% –27% –17% Turkey +7% –46% +244% –34% +7% China – Shanghai A +1% +51% +19% +13% +146%

  34. Troika’s Stock Picks for 2001 • Restructuring StoriesAeroflot United Heavy Machinery Severstal • Recovering corporate governance ‘risk’Gazprom local Norilsk Nickel Tatneft UES YUKOS • Quality, undervalued, under-appreciatedLUKoil Sberbank • Speculative RecoveryGolden Telecom

  35. Russian EquitiesYear to date (March 26, 2001) performance 2001 ytd 1 year Severstal +113% +111% Good financials, pro-active management, clear strategy United Heavy M. +83% +10% Pro-active management, clear winner in increasing arms exports Norilsk Nickel +64% +3% Declining corporate governance risk, very cheap rating Golden Telecom +59% –80% Speculative recovery from very bad 2000 price performance YUKOS +47% +259% Very strong recovery from CG problems. Traded from May Aeroflot +45% +66% Pro-active management talking about new strategy & expansion Mosenergo +38% –45% Tariff increases plus expansion plans UES +28% –50% Recovering from high restructuring risk, prospect of tariff increase Sberbank +26% –33% Cheap rating RTS +22% –27% Tatneft +17% –37% Declining corporate governance risk, cheap in sector – improving Gazprom (local) +12% +4% Uncertainty on long awaited restructuring, but improving earnings Surgutneftegaz +11% –21% Well managed plus good acreage but concern on strategy LUKoil +6% –37% Delay on US GAAP accounts plus uncertain strategy VimpelCom +2% –69% With NASDAQ GAZ –5% –56% High corporate governance risk Rostelecom –8% –82% Unclear future growth or strategy Irkutskenergo –15% –32% High corporate governance risk on takeover rumors

  36. Playing The Risk Markets

More Related