As I’m writing this, the Russian ETF (ERUS) has lost 12% in one day. As many value investors know, you need to buy stocks when there is blood in the streets so I’ve had many questions about whether this is an opportunity or a trap.
Let’s take a look at what’s going on, look at the fundamental perspective, and the stock market perspective on investing in Russia.
What Happened Over The Weekend
On Friday, Trump designated sanctions on 7 Russian oligarchs and 12 companies they own or control, 17 Russian government officials, and a state-owned Russian weapons trading company. The reasons are, according to Treasury secretary Mnuchin, that the Russian government engages in a range of malign activity around the globe. So U.S. persons are generally prohibited from dealings with them and a non-U.S. person could also face sanctions for facilitating their transactions.
The companies impacted are: Norilsk, Gazprom, Renova, and Rusal among those traded on U.S. stock exchanges, where Rusal’s CEO Deripaska is also being investigated for money laundering and has been accused of extortion and racketeering.
And I thought that in the U.S. you weren’t guilty until proven otherwise in a courtroom.
Nevertheless, this is exactly the risk I’ve been discussing when investing in Russia. Even though it’s the cheapest stock market today, it is so for a reason.
If all holders of the ERUS ETF from the U.S., or from Europe, are forced to sell their holdings because they would otherwise be facilitating Deripaska and others with capital, the price will go very low. So, investing in Russia is a political thing but as always, if you don’t have any constrains from Trump’s sanctions, it’s also an opportunity.
Let’s take a longer term look.
In the 2014 – 2015 period, the Russian ETF lost 50% on lower oil prices and sanctions. Then there was a bit of a quiet period and, slowly, people have been forgetting about the risks with higher commodity prices as the Russian ETF is 37% oil related. However, those who bought when there was blood in the street did well with a 50% return since January 2016.
The key now is to see whether there is blood in the streets and whether the sanctions will have an impact on the actual businesses and your ownership of them. The best way to look at whether there is blood in the streets is to look at fundamentals.
ERUS’s PE ratio is 6, the price to book value is 0.8, and the yield is 5.7%. However let’s take a look at what happened in the last round of sanctions.
Sberbank, the largest Russian bank, had a PE ratio of 2 in 2015 and was trading at below $5.
Another interesting company is Norilsk which mines nickel, copper, gold, and palladium which are products that will be sold to China at global market prices because it’s unlikely that China puts sanctions on Russia. So the company will continue to operate as is and won’t see its business impacted as Sberbank will continue to provide liquidity and the high metal prices will lead to profits.
However, if there is some retaliation from Russia, the EU will get in on the sanctions, a commodity bear market that hits profits and cuts dividends will start where we see another 2015 situation, those stock prices that seem cheap now might be even cheaper in the future. The key takeaway here is that if stock prices can fall 20% in a day, as was the case for Norilsk, it can fall much more it there is more turmoil.
So, what’s the strategy for investing in Russia?
The key is to implement the political component into the risk story where one can take advantage of the selloffs, thus buy when there is blood in the streets. As much as I hate politics, it’s a factor that has to be assessed when doing such investments and proper portfolio allocation has to be implemented. This means that if you are heavily overweight Russia, you are going to get hit because the oligarchs don’t care about the stock prices, they are not going to sell their golden gooses. What they care is about the dividends that pay for their luxuries.
So, you have to see what the cyclical dividend yield for a specific Russian company is, what the company risks are, and how much risk you can take. If another 1998, 2009, or 2015 happens, would you be happy or not?
The key is to be patient and constantly rebalance around the positions as the volatility will definitely be there as people in the world don’t really like Putin or his friends. The key is that if you are able to buy in a 50% or larger decline that later grows back to a valuation of 6 from 2, you cover for all your losses on the smaller part of the portfolio that you hold when there are no risks in sight and commodity prices are high as was the case last week.
I have also found information that U.S. citizens have to sell their stocks in Rusal and En+ by May 7.
The takeaways are:
If you are a U.S. citizen, this might be the beginning and what happens if you have to sell at the bottom like is the case from En+ which fell 50% when you account for the decline in the ruble.
If you aren’t a Russian citizen and you understand the risks where your money can be confiscated or similar things can happen, you might want to take advantage of the swings by carefully allocating a small part of your portfolio to such trades.