Russian Small Cap ETF: High-Risk Fund On Sale At 2.2 Times Cash Flow

Apr.29.14 | About: VanEck Vectors (RSXJ)


RSXJ is diversified across industries and trades at a price/book ratio of 0.51.

This ETF has the lowest price/cash flow multiple available.

If sanctions are lifted/avoided then the ETF could rise 250%+.

Rationally, it's in Russia's best interest to avoid (prolonged) sanctions.

The Market Vectors Russian Small Cap (NYSEARCA:RSXJ) underlying assets trade at just a 2.2 times weighted average Cash Flow. This ETF also has the largest weighted average discount to Book Value; a weighted average of Price/Book 0.51 is very low for a basket of stocks diversified across industries.

One of the reasons this is an interesting ETF, is because it is not as concentrated in energy as other Russia ETF's. Its largest sectors are basic materials, utilities, industrials, real estate and finally energy. This is important because when global sanctions are imposed, they are likely to affect entire sectors at a time. Year-to-date the ETF got decimated because money is being withdrawn from Russia as the conflict between Russia and Ukraine continues.

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RSXJ data by YCharts

The large discount of Price/Cash Flow the underlying assets trade at compared to those in other ETF's is most likely a result of the market having a healthy fear of the sanctions that could be imposed on Russia by neighbor countries and the West.

As you can see in the chart below, YTD the ETF underperformed ETF's focused on geographically close locations like Finland, Poland and Mongolia by a wide margin.

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RSXJ data by YCharts

An important difference between these markets is the likelihood they will be severely affected by global sanctions.

That's not to say, that's the only risk of an investment into a basket of Russian listed companies. The downside risk of such an investment is surely equal to your full investment. It doesn't require a lot of effort to think of scenarios where investors would be left without any equity. Hence, the widespread flight of money away from Russia.

However the upside of this bet is not limited to 100%.

A weighted average Price/Cash Flow ratio of 2.2 of underlying assets is very modest, even when compared on this basis to ETFs of other politically unstable countries with corporate governance practices that leave a lot to be desired.

For example, the Global X FTSE Argentina 20 ETF (NYSEARCA:ARGT) trades at 7.18 times weighted average Cash Flow of underlying securities, iShares MSCI Peru Capped (NYSEARCA:EPU) at 7.13, iShares MSCI Turkey (NYSEARCA:TUR) at 7.85 times and iShares MSCI India Small Cap (BATS:SMIN) at 7.68 times. If the RSXJ were to equal these levels of valuation, it would need to appreciate ~250%. No doubt, this would require Russia to avoid or have future sanctions lifted. Even if the weighted average of underlying securities appreciates 250% it won't break pre-financial crisis highs.

To balance this optimistic view let me say that; although valuations of 2.2 times weighted average Cash Flow of a diversified basket of underlying securities are almost unimaginably low to U.S and Western European standards, the country is so investor unfriendly that lower valuations are warranted.

In this Morningstar article, There is value in Russia's future, Alexey Navalny, a leader of Russia's opposition movement, is profiled as a defender of minority shareholder rights. Emphasis, he is in the opposition movement. His critique of corporate governance is harsh:

He alleges a theft of $4 billion from pipeline operator Transneft that the government refuses to prosecute. In addition, Navalny points out that few management boards have independent directors, and even though by law just 2 percent of shareholder votes are sufficient to nominate a director, all nominations are done by the state. Even relatively investor friendly Sberbank has only one independent director out of 17.

Transneft is the largest holding, at 8%, within the ETF. The top 25 holdings of the RSXJ are listed in the table below:

Company % of ETF # of shares Country YTD return P/E
Transneft OJSC 8 1,350 Russia -11.51 -
OJSC Pharmstandard GDR 6.2 251,363 Russia -17.3 4
PIK Group OJSC GDR 5.84 907,262 Russia 1.08 6.62
OAO TMK GDR (OTCQX:TMKXY) 5.22 237,240 Russia -35.11 7.43
Aeroflot Russian Airlines JSC (OTC:AERAY) 5.02 1,284,672 - 46.18 10.56
Inter RAO UES OJSC 4.9 8,679,783,000 Russia -30.16 -
OJSC LSR Group GDR (OTC:LSRGL) 4.87 614,507 Russia -33.11 8.82
ITE Group PLC (OTCPK:ITEGY) 4.3 417,601 United Kingdom -25.4 16
Globaltrans Investment PLC GDR (OTC:GLTIL) 4.27 167,371 Cyprus -43.4 6.81
CTC Media Inc (NASDAQ:CTCM) 4.22 171,709 United States -36.85 8.86
JSC Federal Grid Company Of Unified Energy System 4.1 916,080,400 Russia -38.57 18.94
QIWI PLC ADR (NASDAQ:QIWI) 3.59 44,389 Russia -50.8 27.62
O'Key Group SA GDR 3.3 136,169 Luxembourg -29.41 16.75
Raven Russia Ord 3.28 1,089,463 - -16.96 -
JSC Russian Grids 3.08 87,339,400 Russia -43.11 -
C A T Oil AG (OTC:CAOJF) 3.08 51,208 Austria -27.33 15.11
Vostok Nafta Investment DR (OTC:VNHIF) 3.08 162,488 - 29.06 -
Etalon Group Ltd GDR 3.07 306,128 United Kingdom -33.96 6.39
Mechel OAO ADR (NYSE:MTL) 2.71 526,650 Russia -28.52 -
OJSC Magnitogorsk Iron & Steel Works GDR 2.45 434,865 Russia -34.12 -
Petropavlovsk PLC (OTCPK:PPLKY) 2.14 550,097 United Kingdom 15.12 -
Otisifarm Ojsc 2.12 175,600 - - -
JSC Acron 1.99 23,443 Russia -2.01 -
TCS Group Holding PLC GDR Repr Class -A- Reg-S 1.85 109,436 Cyprus -61.62 5.75
JSC OGK-2 (OTC:OGKJL) 1.72 107,789,000 Russia -21.61 -
Click to enlarge

The Russian market has all the characteristics of a tough investment. You can't explain this investment to your boss or your spouse, there is great uncertainty caused by politics and on top of that corporate governance is terrible.

Yet, you can't buy a stream of cash at lower prices anywhere in the world or a basket of assets that is available with such a large discount to book value. Without politics, FCF ultimately drives valuations.

Perhaps naively, I expect Russia to act rationally to some extent. Global sanctions that affect the diversified holdings in the RSXJ will have a strong effect on its broader economy. In fiscal 2014 through March International sanctions on Iran caused its economy to shrink by 5%. That's a massive blow, which would be very noticeable to the people of Russia. It appears to me that it's in Russia and its leaders' best interest to either avoid sanctions or quickly act in such a way they become lifted after they are imposed.

If tensions abate, valuations could normalize and the investment could reap the reward. Perhaps the best thing is that it doesn't have to work out 50% of the time to be a profitable bet.


The table data, Cash Flow data and Book Value data are Morningstar provided data. These are weighted average of the price/cash flow ratios of the stocks in a fund's portfolio. In computing the average, Morningstar weighs each portfolio holding by the percentage of stock assets it represents; larger positions thus have proportionately greater influence on the fund's final price/cash flow ratio. Exact definitions on Cash Flow and Price/Book of Funds can be found here and here.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.