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From Russia with love

Russia is currently unloved but the long-term investment case could warm the hearts of investors

Ed Conroy
Ed Conroy

Russia is unloved and undervalued at present, with the stockmarket trading at just 5 x 2011 price earnings.

But with valuations expected to revert in due course and with fundamentals remaining sound, the opportunity for upside looks favourable.

Furthermore, prospects are enhanced by the supportive long-term investment case, as shown by low levels of government and personal leverage, rising investment levels and an abundance of natural resources, including rich deposits of oil, gas, strategic minerals and timber. Russia is also home to a well educated population of 142 million people – the biggest in Europe.

There has been a growing domestic consumption story there, which we believe is compelling. Notably, it has enjoyed a sevenfold increase in

Russian US dollar wages between 1999 and 2008.

As a result, this has spurred on a retail boom in Russia, which, by global standards, is still in its infancy.

To support this, evidence shows that consumer spend-ing has been more resilient than the broader economy during the recent turmoil.

Loans grew by 2 per cent month on month for the second month in a row in July following several months of negative or flat growth. We believe that total domestic loan demand could reach 15 per cent annualised by the end of the year.

Retail sales were up by 7 per cent in July year on year and car sales rose by a remarkable 48 per cent although admittedly from a very low base last year.

We remain very positive on the case for domestic growth. We believe we should see GDP growth in the region of 5 per cent by the end of the year.

As such, there remains an abundance of growth opportunities for manu-facturers and retailers alike. Top five retailers account for only 5.5 per cent of total market – consolidation should accelerate top line and enhance already high margins and within food retailing, the compound annual growth rate between 2006 and 2010 is 20 per cent.

Petroleum exports represent roughly 12 per cent of GDP and oil and gas companies dominate the Russian stockmarket, with their profits driven to a large extent by global oil prices. As such, there is a correlation between oil price moves and Russian equity prices. This is, to some extent, logical.

Historically, the correl-ation between Russian stock prices and the oil price has been moderate but, over the past 12 to 18 months, it has become extremely high.

This is partially because many risky assets, not just Russian equities and oil, have become more closely correlated in recent times. When oil prices are more stable, the correlation between Russian equities and the oil price tends to fall and we would expect this to happen as global financial market volatility and risk appetite normalise.

With regard to inflation, it has been muted in recent months and now is at historical lows for the post-Soviet period. As a result, interest rates have continued to fall.

They now stand at 7.75 per cent and the most recent consumer price inflation figure was just under 6 per cent, so there is arguably further room for more cuts.

However, the Russian central bank put interest rates on hold this month, partially on the back of the droughts and the poor news on the current grain harvest.

Food represents nearly 40 per cent of the CPI basket in Russia, so later in the year there may well be some inflationary pressure coming through but it seems reasonable to assume that, at this point, interest rates are on hold, which should benefit its equity market.

Ed Conroy is co-manager of the HSBC GIF Russia equity fund

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