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Russia: More than Just an Oil Producer

Think the Russian stock market is just energy equities? Think again. The fall in the oil price has led to sector diversification and the economy and companies are making gains

Karen Kwok 13 July, 2017 | 5:29PM

This article is part of the Morningstar's Guide to Emerging Market Investing. Click here to find out just what an emerging market is and which regions hold the potential to boost your investment portfolio.

Russia is well known as an oil producer. Oil and gas represented 40% of Russia’s total revenues at state level in the first three months of 2017, according to Ministry of Finance of the Russian Federation. So, when the oil price fell from $100 per barrel in June 2014 to $29 in January 2016, Russia equities fell from favour with investors.

However, investors would be wrong to write off Russia as simply an energy market. Looking at the MICEX index, the 50 most liquid stocks on the Moscow Exchange, presents a different story. The index rose 30% from 1,357 in April 2014 to 1,785 in January 2016, during which the oil price had tumbled. In January 2017, it had risen to a record high of 2,266.

Chris Bannon, senior investment manager at Pictet says investors have current US President Donald Trump to thank for the rally.

“When Trump was elected as the US President in November last year, and OPEC cut its oil production towards the end of the year, a large amount of money flowed into the Russian equity market,” said Bannon.

Despite the rise of the Russian stock market, valuations still look compelling and it is not too late for investors to snap up some bargains, according to value investor James Donald, head of emerging markets at Lazard Asset Management.

Low Oil Price Opens a Window to Investors

While the oil price halving initially had a significant negative impact on the Russian economy, it was a wake-up call – showing the powers that be they cannot be too dependent on profits from the oil sector. Matthias Siller, head of EMEA equities at Barings, said he has seen this in action.

“The economy is becoming less dependent on income from the oil sector. The budget performance in Russia is not as dependent on the oil price anymore – we think this is a direct development from falling oil prices and a lower oil price in the medium to long term. The Russian economy is still able to generate a substantial amount of growth. In a way it is growing naturally,” said Siller.

Uber Invests in Russian Food Delivery Sector

This diversification benefits the Russian economy, but it is also good news for investors – as it means lower risks and more diversification in terms of investment opportunities, such as retail and supermarket chains, said Siller.

Pictet’s Bannon agreed, saying that as the Russian retail sector grows, it is an opportunity for investors.

“The recovery of Russian consumers spending has not seen it just yet. With the macro recovery in Russia it is not a matter of is, it is a matter of when for growth in consumer spending. While retailers see growth in their earnings and they have positive cash flow, their share prices are wrongly priced. We are optimistic that gap to be closed,” said Bannon.

Disruptive taxi provider Uber has worked with a local Russian company Yandex to create a “Russian Deliveroo” food delivery service.

“This could be the next value driver for the new entity since competition is non-existent while barriers to entry are high,” said Siller. “he synergies are a great fit, with Yandex offering the necessary technology while Uber eats brings experience and delivery infrastructure to the combined entity. The internet sector also sees a fast rate of adoption of internet services in Russia. Consumers in Russia are very tech-savvy and companies benefit from this.”

Developments in the Auto Industry

The Association of European Businesses expects car sales in Russia to grow by 4% in 2017, after falling by 11% in 2016. In the first five months of 2017, car sales increased by 5.1% compared to the similar period in 2016. This is due to a improving economy, a more stable ruble and a fall of interest rates that leads to cheaper loans, Ekaterina Lipatova, an analyst at Moody’s said.

This presents opportunities for foreign auto companies to invest in Russia, Baring’s Siller added.

Software Companies Export Products and Talent

While Uber successfully conquered the Russian market with its food delivery service, it is a different story for US internet companies.

US interest companies are finding it increasingly difficult to get into the Russian market – however this provides opportunities for domestic companies in Russia to flourish, and dominate neighbouring economies.

“We have seen software companies which provide high quality products outside of Russia as well as a growth in supply of human talent, such as software engineers. As banks are becoming more digitalised, software application is increasingly adopted by these companies,” said Siller.

Agriculture Sector Escapes Recession

When the oil price went down, leading to a lower and more competitive currency, the agriculture sector in Russia benefitted. It was one of the few sectors that did not see any recession thanks to the low oil price, said Siller.

“The Russian agriculture sector is turning into an exporter, exporting products to not only China, but south east Asian countries as well,” he explained. “The country now one of the cheapest places to produce ham and pork. Accessing the Chinese agricultural sector represents a major growth opportunity for Russia.”

Estimates of Russian wheat production have also increased as perfect growing conditions could lead to yields once again reaching last year’s record highs. With increased production, Russia could become the world’s largest exporter for the first time, surpassing the European Union and the US, said Nitesh Shah, director of commodities strategies with ETF Securities. Russia last year became the world’s biggest exporter of grain, at more than 34 million tonnes. Total Russian grain production hit a record 119 million tonnes.

Lazard’s James added that this year investors could see the bottom of commodities prices, and if that happens, Russian will be a big winner.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Securities Mentioned in Article
Security NamePriceChange (%)Morningstar
Rating
Yandex NV33.19 USD2.44-
About Author Karen Kwok

Karen Kwok  is a Reporter for Morningstar.co.uk