Evraz: Short-Term Pain, Long-Term Gain

 |  Includes: EVGPF, RSX
by: Paul Fekula

The collapse of the Russian stock market has been one of the more surprising events of the past year. Russia is probably in one of the strongest positions in the world to withstand the crisis, given its large current account surplus, relatively low leverage levels across the private sector and continued strong economic growth. While Western nations are currently panicking over the prospect of a recession, Russia is likely to produce just shy of 8% economic growth this year, and economists are predicting 5% economic growth next year. Yet despite all this, the RTS index is down around 80% from its May highs, currently trading with a P/E of about 3 (see here).

There have been a number of reasons for RTS's precipitous decline. To put it mildly, Putin hasn't exactly done a great job on the PR front this year. While the war with Georgia is debatable, his comments and actions regarding Mechel (NYSE:MTL) were just plain stupid. Nevertheless, the reaction by Western investors was also overstated. While fears of a repeat of Yukos are understandable, it is an extremely unlikely scenario for a number of reasons that I won't get into here, for the sake of brevity.

Still, Putin's comments merely served to increase investors' perceptions of Russia as a risky nation, right at a time when investors were shunning risk. Additionally, outside of the country's oligarchs, Russia has few long-term, value investors. Western hedge funds, investment banks and investment managers account for the majority of the volume on Russia's stock exchanges, resulting in a lack of long-term investors, who would be willing to put in a floor. Consequently, many foreign investors have simply pulled their money out of fear that other Western investors would pull their money, resulting in margin calls and more selling. Finally, falling commodity prices have also put significant downward pressure on the markets.

Still, the RTS is trading at such a discount right now, it seems as if some investors are pricing in the Apocalypse. While losses on the RTS will likely continue over the next month as hedge funds continue to sell off assets to meet investor redemptions, Russian stocks are a screaming buy right now. First echelon companies with strong financials like Gazprom (OTCPK:OGZPY) and Lukoil (OTCPK:LUKOY) are trading with P/Es as low as 2.5 and 1.6, respectively.

Another interesting name trading with a P/E of 2 is steel-producing Evraz (OTC:EVGPF). The company is in an extremely strong financial position, posting a 50% ROE for the year ending June 30. While steel prices are likely to decline and margins are likely to tighten for steel companies around the world in the coming year, Evraz is largely insulated from any moves in iron ore and coal, as the company is vertically integrated, being able to meet 93% of its iron ore and 100% of its coal requirements. Although the company is relatively leveraged, with a 56% debt-to-equity ratio, many of these issues are coming to maturity in the distant future. Next March, Evraz will have $300 million in eurobonds maturing, but with a debt/EBITDA of 1.57, it should have no trouble meeting its obligations.

While Evraz got into trouble with the government this summer over selling coal on the international market for less than it did on the domestic market, Evraz's international sales only account for 1% of total coal production. Additionally, given Abramovich's close relationship with Putin, it is unlikely that Putin would take significant action.

While there may still be some pain ahead for Evraz shareholders in the coming weeks, in the long term, this company is ready to come screaming back in the next two years.

Disclosure: none