Emerging markets part 3: JSFC Sistema ADRs (ISIN US48122U2042) – Is a Russian company investible (1)?
As the post got really long, I will divide it into 2 parts. Sorry for the “cliff hanger”….
Investing in Russia
Some readers may recollect that I invested into the Russian pharmaceutical company Pharmstandard last year and was very lucky to get out early before the stock subsequently lost more than 50%. My interpretation of this experience is that an actually relatively well-managed company got bullied into buying a worthless company and thereby shifting a lot of company funds to some shady people.
This should be a reminder that investing in Russia is somehow different. Although one shouldn’t be surprised too much about this. Russia is still at a very early stage in capitalism. It is only 20+ years since privatization started really kicking off. For me, the current state of Russia’s capital markets looks a little bit like the US in the 1910s and 1920s, the age of the famous “Robber Barons”. Bullying other people, “unfriendly” take overs using brute force were quite common in those times as well.
Russia itself is clearly different to any other country as well. In contrast to Turkey for instance, Russia is resource rich, on the other hand it looks like very poorly governed from the outside. Resource rich countries are always at risk to fall for the “resource curse”. This is how Wikipedia defines it:
The resource curse, also known as the paradox of plenty, refers to the paradox that countries and regions with an abundance of natural resources, specifically point-source non-renewable resources like minerals and fuels, tend to have less economic growth and worse development outcomes than countries with fewer natural resources. This is hypothesized to happen for many different reasons, including a decline in the competitiveness of other economic sectors (caused by appreciation of the real exchange rate as resource revenues enter an economy, a phenomenon known as Dutch disease), volatility of revenues from the natural resource sector due to exposure to global commodity market swings, government mismanagement of resources, or weak, ineffectual, unstable or corrupt institutions (possibly due to the easily diverted actual or anticipated revenue stream from extractive activities).
This sounds logical, although further down, Wikipedia cites some other studies which seem to contradict this to a certain extent.
So investing in Russia is clearly an adventure. But again, similar to Turkey, the problems are not a secret. The Russian stock market is currently the cheapest in the world, with a p/E of around 5x, P/B of 0,72 and a dividend yield of 4,3%. In EUR terms, the Russian stock Market lost -34,5% since the end of 2010 compared to +37% for instance for the DAX.
I have a compiled a short table, comparing performance (10 year, 5 Year, 3 Year, 1 Year) and valuation of different Emerging markets:
It is interesting to see that Russia didn’t do so bad over a 10 year horizon, but especially underperformed over the last 3 years. In contrast, the valuation level compared to other EM is really stunning. So one can assume that a lot of bad sentiment seems to be priced in.
Interestingly, I just came across this some recent study, which says that “traditional” value investing, i.e. buying contrarian and cheap, works very well in Emerging Markets, much better than small cap investing or momentum.
Fraud, quality of accounts etc.
Personally, I would not make general distinctions between EM countries, but rather on a company levels. I think fraud and fraudulent accounting is much more probable in those countries than in “developed” markets, although even in developed markets fraud might be more widespread that commonly believed. I think it is more important to look at individual companies and their track record in order to get an idea.
Another aspect is to look out for and avoid systemic fraud. I have written quite often about the so-called “German-Chinese” companies. In this case, Chinese companies sold shares abroad to raise “fresh” money mostly for old shareholders which then got transferred directly to mainland China. In many cases, if you looked at the balance sheet of those companies, there was no need to raise money at ridiculously low valuations as they were supposed to be super profitable and sitting on huge cash piles anyway. So not having a domestic listing and use foreign listings in order to help old shareholders cash out implies a high probability of fraud.
I would however make a distinction for companies which have a local listing and subsequently seek a foreign listing without issuing a ton of new shares or old shareholders cashing out. In many of those cases, companies do so in order to raise their profile and make the company more attractive to foreigners. When they do commit fraud, at least the have to face local law enforcement, no matter how weak that might be. For the German-Chinese companies in contrast, fraud has absolutely no consequences as defrauding Non-Chinese investors is not a crime in China. It looks even that in many Chinese fraud cases, authorities support the fraudulent companies in order to avoid a bad image.
Premium/Discount for Russian ADRs
For some reason, Russian ADRs in general seem to trade in relatively wide bands against local shares. At the time of writing, Sistema ADRs trade around 8-9% higher than local shares. Interestingly, there seems to be no real rule for a premium or discount. This is a list of the most traded Russian ADRs on the London exchange:
|Last Px||Premium Best|
|LSR GROUP – GDR||1.12%|
|MMC NORILSK ADR||2.14%|
|TMK-GDR REG S||-0.79%|
So Sistema trades at the 3rd largest premium, but honestly I have no idea why this is the case. For some reason, the ADR/local share arbitrage doesn’t seem to work here. The premium compared to the valuation is not huge but still should be kept in mind.
A few thoughts on Ukraine / Crimea
I don’t want to enter any political discussions here but just a few observations from my side:
– Crimea was for long time part of the Russian Empire
– It became part of Ukraine only in 1954 without being asked
– It already has an autonomous status within Ukraine
In my opinion, neither Russia nor Europe have a big interest in escalating this issue. Europe depends on the natural gas, oil and other resources from Russia and Russia depends on the money. For me from the outside this looks rather like a defensive move from the Russians in order not to loose their access to the Black Sea. But of course I could be dead wrong and this could also be the start for a real big crisis. No one knows.
Why not invest in Ukraine ?
I have looked at a couple of Ukrainian companies as well, but with most of them I do not feel comfortable. I don’t think that agricultural businesses are very attractive and for the rest I didn’t find any company which was remotely interesting to me. Ukrainian international Government bonds could be an alternative at some point in time.
Similar to Turkey, most of the people I asked have a clear opinion on Russia: It will get worse before it gets better and one should just wait a little bit when prices are cheaper and things look better and then make a “safe and cheap” investment. Interestingly, I saw this way of thinking really often but it almost always doesn’t work.
As long as a share,a sector or a market goes up, people are happily buying. As soon as something bad is happening, investors panic , sell into a crash. If they enter at all, they will buy again when prices are much higher, not when prices are low. I actually know very few people who are actually buying when things look bad and assets are cheap.
Something very similar is now happening with PIIGS stock. Two years ago, when the headlines were that the Euro zone will break within a few days, people sold stocks at absurdly low valuations just to get rid of them. Now everyone is happily jumping back into the very same stocks, although they are two or three times more expensive. Why is that so ?
I am not 100% sure but I guess much of that can be explained by the behaviour of “typical” institutional investors with a strong hierarchy. If everything goes well, of course the big boss on the top is responsible for the success. If something goes wrong and clients or analysts are calling, the safest thing to do is to get rid of the exposure as quickly as possible. In many large institutions, the number of controllers, “risk managers”, auditors etc. far outnumber the ranks of the actual risk takers. In order to justify their existence, they will show the boss that they are “on the floor” and will force people to cut risks aggressively irrespective of price level.
As a risk taker in such organisations, it is almost impossible to invest in something with bad headline news and falling prices. You buy something and the probability that it falls further is high. So you will look stupid at the end of the month and your boss and a legion of risk managers will yell at you why you are so stupid. You do this a second time and you will lose your job. So the safest thing to do is nothing, until headline news turns positive and prices are climbing, because then the chances to look good in the short term are much better and your bonus will be higher.
So in my opinion, you can’t have it both. You don’t get super cheap prices and “improving” headline news. Either you accept low prices and bad news or “better” news and (much) higher prices.
As the first company to analyse in Russia, I used Sistema, a major Russian conglomerate. Why so ? Three major reasons from my side:
– Sistema is a conglomerate, so it offers a broader exposure to Russia
– it seems to be a large and relatively well-connected company. So the risk of being bullied like Pharmstandard looks remote
– Shares of the company are listed widely, in the US, London and Germany
This is how Sistema describes itself on its homepage:
Incorporated in 1993, Sistema is now one of Russia’s top-10 companies by revenues and is one of the largest publicly traded diversified holding companies in the world. Sistema was ranked number 315 in the Fortune Global 500 list.
Valuation wise, Sistema looks ridiculously cheap as many Russian companies:
Div. Yield 2,6%
MArket Cap: 7,1 bn EUR
To be continued soon……..