Does It Make Sense To Invest In Russia Now?

November 30, 2017

Does It Make Sense To Invest In Russia Now?

  • Russia is looking better and better from an economic perspective.
  • However, the risks are always there and they have to be accounted for when contemplating such an investment. I’ll share my opinion on investing into such risk reward plays.
  • Individual investments in Russia still offer opportunities.



Introduction

I mentioned in a recent article about international diversification that Russia is one of the cheapest markets out there when looking at fundamentals.

In today’s article, I want to analyze the Russian market a bit more in depth to distinguish between oil and gas related cheapness and other sectors. I’ll analyze the risks and potential rewards and then conclude with what might be the best way to get exposure to such a market.

Russian Economy

What’s important to note is that the Russian economy has really recovered lately and higher oil prices will certainly help create more growth.

Figure 1: Russian GDP growth in the last 3 years. Source: Trading Economics.

What I also like about Russia is its debt to GDP ratio which has doubled in the last 10 years but is still just 17% of GDP. This really doesn’t put much pressure on Russia’s future growth potential.

Figure 2: The Russian debt to GDP ratio is among the lowest out there. Source: Trading Economics.

Now, it’s important to mention that Russia isn’t really a great place to invest as there are many issues, especially on the political field. The country is still under sanctions due to the Ukrainian issue from a few years ago. Further, Russia is more corrupt than Brazil and China and on top of everything, Russia is a huge country with many geographic differences making it really difficult to manage. Nevertheless, what matters for investors is what the risks are compared to the rewards.

Investing In Russia

The only reason I love ETFs is because they give me a good starting point when investigating a market or sector to invest in.

The iShares MSCI Russia Capped ETF (NYSEARCA: ERUS). The ETF has almost doubled since January 2016 but is still in negative territory since inception.

Figure 3: ERUS since inception. Source: iShares.



Nevertheless, the price to earnings ratio of the ETF is just 7.3 and the price to book value is 0.78 with a dividend yield above 3%, which are all incredible parameters from a current global investing perspective. Let’s dig deeper into the constituents of the ETF.

SBERBANK (OTCPK: SBRCY, XLON: SBER)

Sberbank is the dominating financial force in Russia, and, logically, the biggest weight in the ETF with almost 20%. The company is the leader in most market segments and is owned by the Russian government (50%) and foreign institutional investors (45.6%).

Figure 4: SBER’s position in the market. Source: SBER.

SBER’s PE ratio is 7 and its dividend yield is 2.4% as the bank is heavily investing in the still undeveloped Russian market where mortgage loans to GDP are just 5%, compared to 50% in the U.S.

Nevertheless, a look at SBER’s stock price will show how cheap an emerging market stock can get when financial turmoil, inflation, and political issues hit such a market. The stock dropped to a low of $3.7 in January 2015 while now it’s already at $16.

Figure 5: SBER’s stock price in the last 5 years. Source: CNN Money.

Perhaps SBER is now just a relatively good investment while it was an extreme bargain two years ago. However, those who invested in it during the last few years have certainly been on a rollercoaster.

When investing in countries like Russia, you really have to know what can happen and adjust your strategy accordingly. What I often see is that investors mostly wait for the situation in a country to completely stabilize before investing. From my perspective, waiting for perfect investing conditions is the wrong way to invest in emerging markets. If you start with the notion that the most important risk factor is the price you pay, then SBER was much less risky at $3.7 than it is now at $16.

Institutional investors are doing the opposite and are flocking to Russia now as the higher the stock price is, the higher their investing confidence is. My point is that it’s highly unlikely that there won’t be any kind of political of financial turmoil in Russia in the next 10 years and that will be the best time to invest.

Let’s look at other investment opportunities in Russia.

If you look at the remainder of the ERUS top 10 stocks, it’s mostly about energy and materials.

Figure 6: ERUS top 10 holdings. Source: iShares.

As with all energy and mining stocks, their performance really depends on commodity prices where the current rise in oil and metal prices certainly helps all Russian stocks.



Conclusion

I personally find Russia an interesting environment to invest in, but not one to be excited about extreme future potential growth or political stability. Therefore, I’ll look at Russia again when it’s extremely cheap, not just relatively cheap, for a general investment.

What do I mean by extremely cheap? I would invest in Russia when the earnings yield is above 20% and the dividend yield above 10%. However, this is exactly the opposite of what most global investors do. It’s up to you to choose how to invest globally, but I hope I have given you some food for thought. Regardless, the trend surrounding Russia is still positive and will probably continue as I noted three months ago.

As for individual investments, especially for commodity plays, I would definitely look at Russia as many players are still profitable and paying nice dividends despite the slump in their respective commodities. Think of Norilsk Nickel for nickel, or PhosAgro for fertilizers.

Another country that is getting cheap again is Brazil. I’ll look at the environment there to see whether there are bargain investing opportunities.

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