Diamonds In The Russian Rough

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The recent activity between Ukraine and Russia has brought volatility to the capital markets. Indeed, Russia’s activities in Crimea has beleaguered equities and the currency ever since the crisis first sent the benchmark MICEX index down almost 11 percent on March 3. As the U.S. and European Union announced fresh sanctions against Russia on Monday, the index had fallen 14.7 percent so far this year. But Credit Suisse analysts do not consider the sudden decline a broad-based buying opportunity, saying that the potential reward is outweighed not just by the risks of the crisis deepening but by more prosaic concerns as well: namely, the Russian economy isn’t in very good shape.

 

They suggest this despite what can be described as ‘mouth-watering’ valuation differentials: Russian equities are trading at a 51 percent discount versus emerging markets as a whole. That’s close to the 56 percent discount Russian markets registered at the worst point of the global financial crisis, Credit Suisse analysts Alexander Redman and Arun Sai said in a report entitled “Russian Equities: Mispriced Either Way.” Russian equities are also trading at a 59 percent discount versus emerging markets on a trailing price-to-book-value basis, the largest gap since the 80 percent discount posted during the 1998 Russian financial crisis, according to Redman and Sai.

 

On Monday, U.S. and European Union officials announced travel bans and asset freezes against some Russian and Ukrainian officials believed to have played a role in a Sunday referendum in which Crimeans voted to leave Ukraine and become part of Russia. But Russian stocks gained ground as markets appeared to have interpreted the new sanctions as mild because they only affected individuals rather than hurting international trade or the Russian economy. Accordingly, the MICEX index rose 3.9 percent to 1,285 points on Monday, its first rally in five days. The ruble, which depreciated 2.1 percent in the first two weeks of March, strengthened 1 percent to 36.27 against the dollar.

 

The rally could prove short-lived, however, as President Barack Obama also threatened more severe sanctions if Russia continued to escalate tensions with Ukraine. Former Russian Finance Minister Alexei Kudrin said last week that financial sanctions against Russia could trigger capital outflows of $50 billion per quarter, or an annualized 9.4 percent of GDP. The only time Russia has reported outflows of a greater magnitude was in the fourth quarter of 2008, when capital flight caused the currency to weaken to 41 rubles against the central bank’s target basket comprised of the U.S. dollar and euro. If Kudrin’s projected outflows come to pass, Credit Suisse thinks the currency could weaken to 44 rubles against the dollar-euro basket, down from 42.70 today.

 

In other words, “Russia” may not be a buy. But for the adventurous investor, there are a number of individual equities trading at depressed valuations that just might be. Credit Suisse’s report lists a handful of stocks that are trading at less than 80 percent of their five-year average forward earnings multiple and at least 15 percent below their 200-day moving average price. They include Outperform-rated LSR Group Limited and Etalon Group (both real estate companies), Dixy Group and Magnit (food retailing), Globaltrans (transportation), M Video (retail), TMK (energy) and Sberbank (financial). For these stocks, this could prove to be a solid buying opportunity. Then again, it might not be. That’s the thing about the future: you can never know what it’s going to be until it happens.

 

Above: Demonstrators in support of Ukraine and Crimea on the Kremlin Square in Vologda, Russia on March 10, 2014. Photo by Kichigin / Shutterstock.com

 

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