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Our man in Moscow

The Neptune Russia & Greater Russia fund is down sharply over recent months amid falls in the Russian market. Fund manager Robin Geffen has recently come back from visiting companies in Moscow and I have spoken to him on several occasions, so this is an opportune time to update you.

First, some background. The Russian market has fallen sharply for a number of reasons, including the fall in the oil price and commodities generally. Another major factor has been the problems surrounding mining and metal company Mechel, which was accused by the government of charging higher prices to Russians than to foreigners, raising fears of state interference. That problem now appears to be resolved but investors were spooked further by the conflict with Georgia in South Ossetia.

While it is perfectly true to say that the Russian economy has grown as a result of the rising oil price, Russian oil companies are relatively insulated from everyday gyrations in the price because so much is taken in tax by the state. For there to be a serious problem, the oil price would have to fall below $55 a barrel and I do not believe that this is a realistic possibility in the foreseeable future.

I do not want to get into the politics of the Georgian conflict but perhaps the politicians and press in the West need reminding that the Georgians started it. Regardless, the effect of the conflict on the Russian economy will be virtually non-existent.

The international banking crisis has had no direct detrimental effect on Russia. It would be fair to say that its banking system is relatively primitive by US, European and Japanese standards. There are no investment banks and there is very little debt, either on a corporate or personal basis.

The three big Russian banks – Sberbank, VTB Bank and Gazprom Bank – have no problems. Massive liquidity injections have been made by these banks on government instructions, sending a clear message that the stockmarket matters to Medvedev and Putin. Do not forget also that Russia has the third biggest sovereign wealth fund in the world, so capital liquidity is not a problem.

The Russian economy remains relatively strong, with 8 per cent GDP growth in the first half of 2008. Even the International Monetary Fund, never noted for its optimism, is predicting 7 per cent GDP growth in 2008 and 6 per cent in 2009. Perhaps more important, it also said that it saw no evidence of systematic banking risk in the Russian system.

In terms of Mr Geffen’s meetings with Russian companies, he asked the obvious questions about cashflow and debt. Russian companies have little debt and generally what they have is more than covered by existing cash. Capital expenditure plans have not been affected by the troubles in global markets and in some cases are being increased. This is a very different story from the one you would hear from firms in the UK, Europe, US and Japan.

Mr Geffen saw a range of his biggest holdings including Polyus Gold, the biggest gold company in Russia with $1.3bn in cash on its balance sheet at the halfway stage of 2008. It has also achieved 20 per cent growth in refined gold production over the first six months of this year while most gold companies are experiencing a fall in output.

Aeroflot, Russia’s flagship airline, has solid cashflow and has a programme of rapid fleet modernisation over the next three to five years. There is also extremely strong growth in domestic flight passenger numbers.

Global steel company Evraz is paying a $1bn dividend and currently yields over 10 per cent, variable and not guaranteed.

WimmBillDan, the leading dairy food company in Russia, grew its earnings by 25 per cent over the first half of the year, despite the significant headwind of rising milk prices. Further growth is expected in the second half.

Russia’s biggest company, Gazprom, remains in excellent shape. It continues to benefit from rising gas prices and is spending money to increase the production of liquid natural gas.

Finally, potash company Uralkali is showing record corporate profits and will probably pay a special dividend. With a price-earnings ratio half that of its peers, the company looks compelling value to Mr Geffen.

I hope this gives you an indication that the picture is still healthy at the level of individual stocks.

The Russian RTS index as a whole is trading at a price around five times its historic earnings. This is a low valuation yet the companies that Mr Geffen saw are showing very strong profit growth. At current levels, the RTS index is on a valuation of just four times next year’s earnings – the average for emerging markets is more like 10 to 12, so it looks extremely cheap.

Russia is far from immune to swings in sentiment and the oil price will continue to exert significant influence on the stockmarket.

It is an emerging market and needs to be regarded as higher risk but compared with Western markets it looks to be in rude health and any problems are surely already reflected in the price.

For the brave investor, I believe Russia now offers compelling value, provided investors can remain patient and are prepared to weather the continued volatility. Existing investors sitting on losses could average down and buy some more on days when the market has fallen.

I remain confident that an investment in the Neptune Russia and Greater Russia fund will reward long- term investors.

Mark Dampier is head of research at Hargreaves Lansdown

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