Russia: Buying Twice The Growth For Half The Price

by: Elliott Auckland

With Russian PE multiples close to their 2009 lows and GDP growth expected to come in at a "decent" 3.5%, Russian equities are spectacularly cheap. Looking at the alternatives also, Russia is by far the most attractive:

Country and Index Recent P/E ratio range 2012 GDP Growth forecast*
Russia - Micex 5-6x 3.5%
US - S&P 14-15x 2.2%
Germany - Dax 14-15x 0.4%
Spain - IBEX 10-11x -1.4%
France - Cac 10-11x -0.1%
India - Sensex 15-16x 6.9%
China - Shanghai 12-13x 8.2%
Brazil - Bovespa 13-14x 3.3%
Poland - WIG 9-10x 2.1%
Click to enlarge

*Economist Poll

While it is true GDP growth does NOT correlate 100% with P/E growth, the two are logically linked, and it does not make sense for European companies to be trading at a higher multiple than Russian counterparts, especially in areas like Energy where the product is generally homogeneous.

It is also interesting to note Russian PE levels over the past few years:

Year PE Ratio range
2004 7-13
2005 7-13
2006 10-13
2007 10-13
2008 3-12
2009 4-22
2010 9-11
2011 5-9
2012 YTD 5-6
Click to enlarge

By Russia's own standards they are trading very cheaply x5.5x, at around half of their 10-year PE average of 10x.

Gazprom (OTCPK:OGZPY) vs. Western energy Majors. Gazprom trades on a P/E of 3.3x, while their counterparts achieve 7-11x (still very modest in itself). Perhaps, what is most surprising about this is the fact that Gazprom is a national champion and essentially dictates Russian political and energy affairs. While companies like BP or Chevron (NYSE:CVX) occasionally suffer from the political scapegoat - recent fines for Macondo and Brazilian wells respectively are an example of this. Gazprom should trade at a premium to others, if one considers that by reserves of boe, Gazprom is the largest private enterprise in the world (x2 Exxon). In my article I highlighted how Russia's removal of domestic price limits on gas will drive Gazprom's profits to record levels and thus why I think it is a fantastic buying opportunity.

For instance, Randgold (NASDAQ:GOLD) vs Petropavlovsk (OTC:PPLKF) is an interesting example. Gold is a completely homogeneous product, the cost of mining and the geopolitical risks associated with those mines are large drivers of P/E. However, Randgold, despite having large African mines trade at a premium on U.S. and UK markets of 22x compared with a P/E of 5.8x for Petropavlovsk on the UK market, which has Russian mines. Here there is a very clear mispricing of political risk. Russia, with Putin has seen the longest standing leader of any European nation in over 60 years. This compares with the common uprisings in Africa, where only last week Mali saw a Coup d'etat; a country in which Randgold operates several large mines. Certainly, if one wants gold exposure then Petropavlovsk offers a cheap way to do this.

Maybe a comparison that is a bit murkier is Norilsk Nickel (OTCPK:NILSY) and Lonmin (OTCPK:LNMIY) as they both produce a variety of different metals, at different points on the cost curve. However, the price disparity is present: London quoted and South African-mined Lonmin has a PE of 13x vs. the Russian Norilsk's 6.5x.

These are but a few example of Russian listed or Russian asset backed companies that are wrongly undervalued by the market. You are buying cheap companies that have strong growth potential and I think not only a normalization of PE multiples in Russia to their historic 10x average will occur, but a further re-rating to a higher PE as Russia joins the WTO and is perceived over time to be internationally more friendly.

Disclosure: I am long OTCPK:OGZPY.