Our Opinion: 2019

Russia’s recovery is boosting region

The 40% jump in the oil price so far this year has been treated with indifference by global investors, but, at the other end of Europe, it is very good news. While Russia has been diversifying its economy away from a dependency on oil and gas and insulating it from price volatility, hydrocarbons (eg crude oil and natural gas) still account for 10% of GDP, 21% of 2017 government revenue, and 58% of export earnings, according to Prosperity Capital, one of the largest Russian focussed asset managers in the world.

Under Russia’s tax system, 90% of the extra revenue from higher prices goes to the government, which accumulates the windfall in a stabilisation fund, mostly in foreign currency. This means that the benefit flows broadly into the Russian economy, rather than providing excess profits to energy firms. In the World Bank’s ‘Ease of doing business’ survey, Krivoshapko points out Russia has climbed to 31st, alongside many EU members. Meanwhile, geopolitical concerns, US sanctions and capital outflows keep the Rouble competitive.

These reforms will accelerate the growth rate of the Russian economy from 1.5% to 2.5%, helped by an emergence of entrepreneurial spirit, notably in the technology and agriculture sectors.

At the same time, it is important to manage volatility, by diversifying across the broader region. One of the funds that I have been using for clients for more than 10 years is The Baring Eastern European Trust. Although 59% of its £115m net assets is invested in Russia, 20% is invested in Poland, 15% in Turkey and smaller amounts in Hungary, Greece and elsewhere.

Growth in Poland reached 5% last year, bringing significant increases in real incomes and retail sales. The Banks are particularly in favour, benefiting from demand for mortgages and for loans to developers, while their excess capital finances healthy dividend yields.

Turkey is in recession and its currency has fallen sharply, but the Turkish lira is now cheap, the current account is positive, and the economy has rebalanced. The portfolio includes mobile- hone operator Turkcell, and Tupras, an oil refiner close to the Aegean, which means it has good access to export markets.

Both have strong balance sheets, so they can withstand economic and financial stress, but there are opportunities in many sectors. Inevitably, Russian companies, especially the oil and gas producers, dominate the portfolio, with more than 10% invested in Lukoil, 8% in Novatek and 7% in Gazprom.

Prosperity Capital is a fan of Lukoil, because of its visible corporate governance improvements and modest valuation – it trades at less than seven times earnings and yields nearly 6%, with dividends expected to rise sharply. Novatek, as one of Russia’s largest producers and exporters, benefits from growing demand for liquefied natural gas.

9% of the portfolio is invested in Sberbank, the largest bank in Russia, trading on just six times earnings despite strong earnings forecasts. Exposure to the tech sector is provided by Mail.ru, Russia’s Facebook, and to high-tech engineering by automotive software developer Luxoft.

While media attention on the region focuses on politics, there are plenty of high-quality growing companies on reasonable valuations to invest in. Emerging Europe has outperformed western Europe over one, three and five years, so there is a good story to tell

The Discretionary Fund Managers that we work with are increasing adding exposure to Russia and Eastern Europe to the portfolios they manage on our behalf.

15th May 2019