Dispatches from Moscow
Transcription
Dispatches from Moscow
Dispatches from Moscow: In wintry Russia, signs of a thaw Pictet Asset Management I For professional investors only Q&A How do you describe the economic climate in Moscow? HB. Even as the temperature plunged below -20c in Moscow, the city was functioning reasonably well, as far as I could see. True, the economy is expected to contract by as much as 5 per cent and inflation is likely to hit 18 per cent this year as the value of the RUB halved since last year. Even President Vladimir Putin himself admitted that Russia's economy will suffer two "most unfavourable" years. March 2015 However, there is little sign of stress in the labour market, and the dozen or so corporate executives we met had no plans for massive layoffs. We can find many domestic companies that have sound fundamentals to deal with an economic slowdown. What is more, the country’s overall savings rate stands at a comfortable 29 per cent of GDP,1 higher than in the previous crises. Hugo Bain, Senior Investment Manager, Russian equities Alain Defise, Head of Emerging Corporate Bonds Moscow and Kiev agreed a ceasefire deal that may help end fighting in eastern Ukraine which killed nearly 6,000 and took a heavy economic toll on Russia. Pictet Asset Management’s Hugo Bain and Alain Defise discuss the business outlook for Russia and share insight from their recent trip to the capital. AD. Russia has experienced economic hardships before, notably in 1998 and 2008. It seems to me that the government and companies already have a template to deal with a crisis. Sanctions may be hitting some parts of the economy and the food imports ban means oligarchs may not be able to find their mozzarella cheese. But there is a spirit of pragmatism and perseverance pervading the country. Indeed, the companies we invest in are sufficiently capitalised to withstand the odd liquidity shortage. Some of them have cash holdings equivalent to four or five times their short-term debt. How has the decline in the RUB affected Russian companies? AD. The sharp decline in the RUB is a boon for many Russian corporations, especially exporters whose revenues are in the USD but whose cost base is in local currency. One metal company in our emerging corporate debt portfolio had so much cash on its balance sheet that it offered to repay its short-term debt ahead of schedule in a tender; we did not participate because we believe we are better rewarded in holding the debt for the time being. We’re likely to see more evidence of companies using their cash pile to reduce leverage. HB. The energy sector is another beneficiary of the decline in the RUB. For example, an official from a state-owned energy giant told us that some 70 per cent of its capex base 1 Gross national savings, National Statistical Office, 2013 is in RUB. Despite a sharp decline in energy prices, RUB-denominated oil prices have stayed largely steady over the past year except for a period of volatility in December. Some Russian companies, such as those in energy and mining sectors, have free cash flow – operating cash flow minus capital spending – of 30 per cent, which is the highest level we have seen in the country.2 In our view it seems unlikely that the RUB, which is closely correlated with oil prices, would decline much further. According to our economists, the RUB is now trading nearly 60 per cent below its long-term fair value against the USD (Fig 1). FIG. 1 – RUB HAS FALLEN SHARPLY BELOW ITS FAIR VALUE % 80 — What is the government doing to tackle the financial crisis? AD. The government has launched a USD35 billion anticrisis plan, like the ones it implemented in 2008 and 2012. It promises state support for 199 strategic companies which make up 70 per cent of the country's gross national income and employ more than a fifth of all Russians at work (Fig. 2). This would help support key sectors such as energy, steel and mining. However, the financing environment is expected to remain tough for small and medium-sized enterprises, which make up around a quarter of Russia's economy.3 FIG. 2 – RUSSIA’S ANTI-CRISIS PLAN RUB overvalued Deviation from equilibrium +/- 1 standard deviation Russian banks with at least RUB 25 billion in capital and willing to increase lending to key sectors of the economy will be able to participate in a RUB1 trillion recapitalisation plan 60 — 40 — The central bank has relaxed regulation of banks and is considering further steps to ease on burden on banks 20 — 0— The Economy Ministry has listed 199 strategic companies which will be eligible for state support -20 — -40 — -60 — Source: Reuters RUB undervalued 20 15 20 13 20 11 09 20 07 20 05 20 03 20 01 20 9 19 9 19 97 5 19 9 19 9 3 -80 — Source: Thomson Reuters Datastream What is the impact of higher interest rates and inflation on corporate Russia, and what is your outlook for monetary policy? AD. We did see some signs of stress building up in the banking sector, which is natural when your central bank raises interest rates by 12 percentage points. Every corporate executive we met complained that the high interest rates imposed on them were a significant challenge. One agricultural company told us that its clients were having difficulty securing financing to buy its products. HB. The central bank did cut its main lending rate to 15 per cent from 17 per cent in January, in a move which we think implies a shift in the bank’s priorities away from reigning in inflation to supporting growth. From what we have heard, the central bank has now become more pragmatic in dealing with economic challenges such as slow growth after a recent personnel change in the team under Governor Elvira Nabiullina. From officials we’ve spoken to, I got an impression that emergency monetary tightening in December, when the central bank raised rates by 6.5 percentage points, is likely to be removed in the short to medium term. Inflation – which has risen as a result of the RUB decline and Moscow’s self-imposed ban on Western food imports – should come down this year because slower growth has a disinflationary impact, helping the central bank focus on supporting growth. 2 Bloomberg The government plans to distribute up to RUB1 trillion of OFZ treasury bonds issued late last year to state-owned banks including VTB, Gazprombank and Rosselkhozbank, all under Western sanctions HB. Companies we met, especially in the cyclical sector, are re-drafting their business plans, changing assumptions based on new and more realistic economic forecasts. What is your investment outlook for Russia this year and what are downside risks? HB. I expect portfolio flows to gradually return to Russia, whose equity markets are now among the most attractively valued in the world. The central bank expects a net capital outflow of USD118 billion this year, but much of that reflects corporate foreign debt repayments. The Russian equity market is attractively valued and under-owned by international investors. In the PictetGlobal Emerging Market equity fund, we have taken the opportunity to increase what was a small overweight position, adding holdings of export companies that should benefit from a weak RUB and others which are significantly undervalued. We are underweight consumer-focused companies that purely generate revenues from domestic markets. However, investors should keep an eye on political risks, even though the ceasefire seems to be slowly coming into force in eastern Ukraine. The West is still threatening Russia with additional economic sanctions, which could weigh on the economy. AD. The RUB is expected to remain under pressure and the central bank can only help slow its slide, given that it has lost nearly a quarter of its FX reserves last year. Since 3 European Investment Bank energy provides 70 per cent of Russian export earnings and half the government revenues, the central bank coffers are unlikely to be replenished quickly. In the Pictet-Emerging Corporate Bond fund, we have also recently added positions in Russian energy producers and gold exporters, and as a result we are overweight the country. Those investors who have not sold Russia by December are unlikely to leave now. Given extreme valuations, this gives us a great opportunity to invest in the inherent strength of Russian corporates and the potential for a long-term economic recovery. There are many examples of undervalued corporate bonds. For example, we have invested in this corporate bond issued by a Russian oil company which we think is unjustifiably tainted by the country's economic troubles. Its credit rating of BBB- is better than that of government bonds after both Standard & Poor's and Moody's cut Russia's sovereign ratings below investment grade. With the bond's yield spread at an attractive 540 basis points and the yield to worst of over 7 per cent, we are amply compensated for taking the risk and volatility especially as the company has solid fundamentals. I think Russia offers a great opportunity for investors. As they say in the Russian proverb: stormy weather cannot stay all the time, the red sun will come out, too. RETAIL ACTIVITY PICKING UP? Azerbaijan’s PNN Group plans to open two stores selling Superdry clothing label in Moscow shopping malls with floor space of 850 and 900 square metres at end-April, before adding more than 10 stores in Russia before 2020. Russia’s top food retailer Magnit attracted strong demand from foreign investors, raising RUB9.8 billion by selling down its stake to fund a separate investment. It also plans to open as many stores in 2015 as never before in one year, confident it can win crisis-hit customers without giving up much profitability. Hugo Bain, Senior Investment Manager, Russian equities Hugo Bain joined Pictet Asset Management in 2009 as a Senior Investment Manager in the Emerging Markets Equities team, specialising in EMEA. Before joining Pictet, he spent five years with Fleming Family & Partners Capital Management LLP (FCM) and was a founding partner and co-manager of the FCM European Frontier Fund. He began his career in 1997 at ING, where he remained until 2002 as Head of Russian, Emerging Europe, Africa and Latin America Sales. In 2002 he joined Merrill Lynch as Specialist in EMEA sales. Hugo has an MA in Modern History from the University of St Andrews. Alain Nsiona Defise, Head of Emerging Corporate Bonds Alain Nsiona Defise joined Pictet Asset Management in 2012 as head of the emerging corporate bond team. Previously, Alain was at JP Morgan in London where he managed the emerging corporate business, worth over USD 2 billion. Prior to that, he worked for nine years at Fortis Investments where he started as a senior credit analyst focusing on the high yield market and later worked as a senior emerging fixed income portfolio manager building the emerging corporate business. Alain holds a Master's degree in Business Engineering from Solvay Business School, Brussels and a Diploma in Financial Analysis from the European Federation of Financial Analysts Societies. US carmaker Ford plans to roll out six new models in Russia this year. Source: Reuters This material is for distribution to professional investors only. However, it is not intended for distribution to any person or entity who is a citizen or resident of any locality, state, country or other jurisdiction where such distribution, publication, or use would be contrary to law or regulation. 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