Some of the most enticing values are found in one of the least-liked markets.
Uncertainty correlates negatively with value. When uncertainty rises, value falls – and vice versa. Uncertainty is running high in Russia. Not surprisingly, valuations are running low.
Russia’s low valuation is a by-product of a number of factors: Rising political strife due to on-going military tension with Ukraine. Economic sanctions imposed by the United States and Western Europe impeded. Weakening of the ruble, which makes life difficult for Russian companies to service debt denominated in foreign currencies.
A lot of bad news, a lot of uncertainty, to be sure. But I see a lot of deep value, particularly in Market Vectors Russia ETF (NYSE: RSX). The fund owns 49 different Russian stocks, with a concentration in energy.
There is certainly contrarian value in Russian energy companies. The world’s largest natural-gas producer, Gazprom, trades at less than three to three times EPS estimates. Lukoil trades at less than five times. Most large integrated energy companies trade between 9 and 12 times EPS.
In Russia’s financial sector, bank holding company Sberbank trades at just over four times forward EPS. Wells Fargo (NYSE WFC), in comparison, trades at 12 times.
Some very large Market Vector holdings are trading at some very small multiples.
|Stock||Sector||Market Cap||Percent of Portfolio||P/E Multiple||Yield|
|Gazprom OAO||Integrated Energy||$78.4 Billion||8.4%||2.6||4.7%|
|Lukoil||Integrated Energy||$41.9 Billion||7.5%||4.5||6.5%|
|Mobile TeleSystems||Telecom||$12.1 Billion||4.3%||8.6||9.5%|
|Surgutneftegas||Natural Gas||$28.9 Billion||3.5%||4.4||2.6%|
Not surprisingly, Market Vector Russia ETF shares are also trading at some very small multiples — at only 5.7 times current EPS and 0.73 times book value. The shares also yield over 3.4%.
Despite the turmoil and the ceaseless stream of negative news, Russian shares are showing little inclination to move lower. This suggests that all the bad news is baked into the market. Therefore, I see little downside risk and plenty of upside potential. My thesis is grounded in history.
This isn’t the first time Russian stocks have been pummeled into submission. But once the pummeling ceased, prices recovered with a vengeance.
In the summer of 1998, Russia’s economy was staggering under falling productivity, soaring fiscal deficits, and artificially high fixed exchange rates. In August 1998, Russia’s central bank had no choice but to devalue the ruble and default on its debt. The MICEX (Russia’s stock market) collapsed to 20.
Time to panic? Hardly. The subsequent recovery was almost immediate. Less than a year later, in June 1999, the MICEX was trading at 120.
Instincts tell us to wait until uncertainty clears. The problem is that once uncertainty clears, so clears a low entry price. Russian equities will be bid up before tensions ease and sanctions are lifted. Also remember that market prices are based on anticipating the unknown.
Market Vector shares are down 24% year to date. But if past is prologue – and it frequently is – today’s low price suggests an excellent entry point for risk-insensitive, contrarian investors.
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