Russian equities: attractive valuations and high dividend yield

Alexandre Dimitrov, Manager des Aktienfonds ERSTE STOCK RUSSIA

Equity investors had every reason to be cheerful last year: share prices were up pretty much across the board in 2019. The Dow Jones gained almost a quarter, while the US technology share index Nasdaq even soared by 38 percent. But these were outdone by the shares listed on the Moscow stock exchange, which increased by 47 percent (see the table below).

In this interview, Alexandre Dimitrov, fund manager of ERSTE STOCK RUSSIA, explains the reasons behind the share price gains. He expects growth to speed up in 2020.

Change in stock market value 2019 (in Euro)

Source: Bloomberg

The Russian equity market saw a fantastic year 2019, contrary to the expectations of most observers. Where did this strong performance come from?

This positive performance was due to a variety of factors: on the one hand, the oil price rose by 27 percent (Brent; in euro; source: Bloomberg), which also drove shares in the oil sector up. OPEC had announced production cuts. The share price of Lukoil reached an all-time high, while Gazprom gained 80 percent. On average, oil shares gained 47 percent in 2019. The interest rate cuts by the Russian central bank from 7.75 percent to 6.25 percent also contributed significantly to the newly sparked bull market. In addition, the foreign exchange reserves of the central bank increased to USD 500bn, which gives the bank quite a bit of leeway with regard to its interest rate policy. Lastly, the rouble gained 12 percent relative to the euro over the year 2019 (source: Bloomberg).

All of that sounds very positive, but the sanctions against Russia and also the economic growth, which is on the weaker side, could result in a slowdown in 2020?

To be fair, the political framework has been challenging since the Ukraine crisis, and we have lived with the sanctions for a number of years as well. Investors have to take this into account as political risk. But I should also point out that three quarters of the Russian equities are held by US investors. Things may therefore not be as bad as they seem. Of course, new conflicts could crop up at any time and affect stock exchange performance. As investors, we get our bearings by looking at the economic framework, the interest rate policy, and the earnings history and forecasts in the corporate sector. This approach has paid off, because it is these parameters that are relevant on the stock exchange in the long run.

What is the outlook for Russian equities in 2020 according to Erste Asset Management?

At +1 percent in real terms, the Russian economy recorded rather restrained growth last year. The consensus expects an acceleration to +1.8 – 2.0 percent for 2020 (source: consensus estimates, Bloomberg). The rising real income, driven by the low unemployment rate of 4.6 percent, is a positive factor. Much like 2019, the entire equity market will be fuelled by the high dividend yield of about 7 percent and rising dividends by state-affiliated companies in 2020. As for the interest rate policy, the central bank has room to manoeuvre for further rate cuts. Stock exchanges are fond of falling interest rates and stable prices.

Price/earnings ratio relative to Europe and Austria

This means that as a tendency, company earnings will be on the rise?

Yes, telecom companies could post earnings growth of about 17 percent, consumer goods even 20 percent. In the financial and real estate sectors, earnings are expected to rise by 10 percent to 20 percent. All in all, the earnings situation therefore comes with upside potential. At a price/earnings ratio of 7x and a dividend yield of 7 percent, Russia commands the lowest equity valuation and at the same time the highest dividend yield among its stock exchange peers.

Expected dividend yield 2020 for Russia, Europe, and Austria

What companies have caught your eye?

A good example (heavyweight in the portfolio) for the market performance and the expectations is Lukoil. This oil company is now paying out 100 percent of the free cash flow it generated and has also already launched its second share buyback programme. Overall, we expect the dividend yield to rise above 10 percent in the coming two years. Lukoil is heavily weighted in the equity fund ERSTE STOCK RUSSIA. Other prominent examples of companies that have stepped up their dividend payouts considerably are the mining company Norilsk Nickel, one of the main beneficiaries of the demand for batteries, the world’s largest natural gas producer, Gazprom, and the largest Russian mobile telephony provider, Mobile TeleSystems.

It is not straightforward for retail investors to buy Russian shares directly. Equity funds such as ERSTE STOCK RUSSIA offer investors a comfortable opportunity to buy several of the most attractive shares, starting from EUR 50 per month. What is your current positioning in the fund? What sectors do you prefer for 2020?

ERSTE STOCK RUSSIA holds a concentrated portfolio of 27 shares that we regard as attractive and imbued with upside potential. Energy accounts for 40 percent, but given that the sector already posted significant gains in 2019, we have now slightly shifted our focus to financials, consumer goods, and telecoms. We continue to find good investment opportunities in the metal and mining sector. Generally speaking, we prefer companies with strong balance sheets and high dividend payouts; and ideally, they should be market leaders in their segment.

Conclusion:

After the strong year of 2019 at the stock exchange, chances are that share prices will continue to rise on the Moscow stock exchange in 2020. The accelerating economic growth, the extremely low share price valuation, and the high dividend payout ratio make Russian shares one of the most attractive stock exchange segments. The political situation should neither improve nor deteriorate. Investors have to be prepared for share price fluctuations, be it up or down. A long holding period is advisable.