Emerging Markets: Sberbank ADRs (ISIN US80585Y3080)- Buying Russia in one stock

Warning: The stock discussed is very risky and the risk of a complete loss is high. In any case this should be seen at best as a very small part of a diversified Emerging Markets portfolio and in no case as a concentrated “bet”.

After a short visit in Hongkong, back to Russia, the currently cheapest Emerging market.

Sberbank is the largest publicly listed bank in Russia, with a market cap of around 32 bn EUR. As many Russian stocks, the stock price has suffered severely, especially if you look at the EUR price including the Rubel devaluation:

The current valuation looks attractive as with most Russian stocks:

P/E 4.2
P/B 0.8
Dividend yield 4,5%

Clearly, there are a lot of banks which have lower P/B Ratios, but Sberbank has, despite some volatility, shown ROEs of ~25% on average over the last 11 years (low: 3% in 2009, high 44% in 2001) combined with remarkable growth (in Ruble, EPS increased from 1 RUB in 2004 to 17, CAGR of 132%). This supports my thesis that banking in high interest rate countries is much more interesting than in low-interest rate environments.

What about current situation Russia ?

Standard and Poors just downgraded Russia from BBB to BBB-. This forced the Russian central bank to increase short-term rates from 7 to 7,5% after increasing it from 5% to 7% in March. Clearly, this will not support the currently weak economy in Russia.

And there is certainly a big risk that the situation in Russia and Ukraine gets worse. As with Sistema, the argument that it can get much worse before it gets better is clearly valid. Nevertheless, I think it will be difficult to really hit the bottom and as Mark Moebius has said “If you see the end of the tunnel it is already too late to invest”, I think investing when everyone expects worse to come is usually the better strategy with Emerging Markets.

What many people forget: Despite the big headline issues, from a financial point of view Russia looks very solid. Super low government debt (~15% of GDP), low consumer debt etc. Russia is a pretty “underleveraged” country, so the impact of devaluation, higher interest rates etc. on the economy are less significant than for instance in highly leveraged countries. Although certain Oligarchs may disagree for their personal portfolios….

Why a bank ?

Well, first of all, Sberbank is not a bank in Russia but the biggest bank of Russia. 52% of the voting rights are held by the Russian Central bank, so it is effectively Government controlled.

Investing into a bank is clearly a leveraged bet on the whole economy. If the economy tanks and debtors default, banks are getting hit hard. If the economy recovers, banks often profit strongly.

In Sberbanks case, I assume due to the ownership stake of the Russian Central bank that they will not have any funding problems in local currency. Clearly, getting dollars might be a little bit trickier, but Russia as a whole as Oil and commodity exporter should be USD positive.

Why Sberbank

Sberbank has quite good reporting in place including a brand new investor presentation. Interestingly, even in a 0% GDP growth scenario, they still project double-digit growth in loans.

The highlights of Sberbanks market position are:

+ 11x the number of branches of the next competitor
+ ~30-40% market share in all areas
+ one of the most profitable banks globally (ROA)

Clearly, there are also a lot of issues. Corporate Loan defaults could easily double or triple in a worst case scenario. Nevertheless, if they manage only a part of their ambitious goal (doubling their profit until 2018), the potential upside could be significant.

Other considerations

When looking at Russian companies, fraud, missing property rights etc. are always an issue. You can bet that in such a large organization like Sberbank a lot of fraudulent stuff is going on. On the other hand, es we have seen in 2008/2009 this is a general issue with banks in all jurisdictions. Sberbank has a history of fruads like this one or that one. Although if we compare that for instance with the two massive frauds at Citigroup’s Mexican subsidiaries it doesn’t look that spectacular.

Subjectively I would say that Sberbank is quite transparent compared to other Russian companies and that there were no obvious attempts to screw shareholders in the last few years.

One thing needs to be mentioned here: The Sberbank shares traded outside Russia are “ADRs”, American Deposit Receipts. I have no idea if somehow US authorities could seize those ADRs or do anything else to cause problems for ADR holders. I assume not as this would kill the ADR business but you never know.

Summary

Sberbank is stand alone not a “value investment” as there is clearly a risk of permanent loss in a very adverse scenario. However as a small part of an Emerging markets portfolio, I think it could be an interesting play on a normalization in Russia.

I will therefore invest a 1% portfolio position at around 5,80 EUR into Sberbank ADRs as part of my Emerging market basket (currently Sistema 1%, Koc 2,5%, Ashmore 2,5%).

22 comments

  • Is there any way to buy the original stocks of Russian companies in Europe? As far as I know from my bank (DAB bank) most brokers stopped trading the original stocks so that only ADRs are available.

    ADRs are generally less preferable, because of the double source tax in Russia and at the US banks.

  • After reading all these comments, I see that SBERBANK scaries even aware investors. That’s a good point, and maybe another reason for buying : “be greedy when others are scary” said the Master…
    Very interesting bet. Thank you for this post.

  • Agree fully with what jerobeam said. I have seen firsthand how russian banks were forced to refinance loans western banks would not like to refinance. However, as the overall leverage in the economy is not that big, the absolute amount of “dumb” loans should be somewhat limited.
    That beeing said I have only had positive experiences, from a micro management perspective that is, with russian banks. Sberbank’s staff is professional and motivated and management is not of the old-school-type, so prevalent in continental european comercial banks, where the board members behave like politicians…

  • Why do you think that “Russia from financial point of view looks very solid”? Russia is “under-leveraged” for good reasons. Issuing a loan does require not only money, but also trust (belief) that at some point you will get this money back. That’s why USA is “over-leveraged”. There are many other countries in the world which are probably “under-leveraged” like Somalia, Syria etc.

    In my opinion the only “strength” of Russian economy is price of oil. If price of oil falls below 90-80 USD then that’s it. Game over. Is it possible? I don’t know. Back in 80’s price of oil was so low that it destroyed economy of USSR. Russia today is not much different from USSR. In some aspects it is even worse. Western world would definitely benefit from lover oil price.

  • that’s true, but Euro utilities are squeezed for far different reasons. And the european (and especially german) consumer is squeezed even worse than the utilities. In Russia, the opposite is true. Electricity and heat is basically “for free” in Russia, whereas in Europe we have at least a more or less market-based price (which however only accounts for a small part of the retail price because of all the taxes and government fees that come on top). A large part of the buildings in Russia do not even have meters, and people just open the windows if it is too hot, while keeping the heating on at all times.
    At the same time, the utilities are “encouraged” to build more and more plants that are doomed to be unprofitable, unless you have a “special agreement” with the government or a specific consumer (like E.ON Russia managed to do – compare the E.ON Rossiya chart to, say, OGK-2, Mosenergo, Federal Grid, Rosseti etc – marked difference!).

    • I would challenge the claim that we have a market based price of electricity in Germany.

      Clearly, I would not want to invest in a Russian utility, that’s why I have chosen Sistema and Sberbank.

  • Russian companies could be extremely profitable if the government wouldn’t force them to be unprofitable. Just look at the epic value destruction in the russian utility sector, because the government freezed tariffs for “social reasons”. Russia has the highest waste in electricity because it costs nearly nothing for the consumer (this is as true for Masha&Ivan as for Deripaska’s aluminium smelters). This is not how you make the economy more productive!
    I fear Sberbank is a bad bet because the banking sector is next in line for the government’s “please the people so they vote for Putin” agenda – forcing them to make unprofitble and risky loans to businesses and consumers in the face of foreign financial sanctions/repression.

  • The real risk imo is not that the bank goes bankrupt, the risk is that Moscow decides to screw foreign investors and disown those that are stupid enough to own Russian stocks. Why wouldn’t they – once you are pariah, you can pretty much as you please.
    And in this case, I can’t see western governments jumping over themselves to help out same investors or should I say speculators?

    • #Feuerball, this is clearly a risk. On the other hand I think they are clever enough to know that they need foreign capital. The question is: Are those risks priced in or not ?

      • You can’ really price in the political risk to get disowned (or at least screwed in meaningful way) you can only handicap it. Worst case, the political intervention leads to a total loss, imo.

        Russia is close to loosing access to the foreign capital markets due to possibly sliding into junk rating and/or sanctions. Once they have lost access to foreign capital, what is their incentive to play nice with foreign investors? Why continue to have companies pay dividends to foreigners in hard currency?

        • I don’t belive that ratings playsuch a big role. As you can see with Greece, bond investors will buy almost anything these days at surprisingly low yield.

          And Russia,other than Greece or Portugal has always Oil to sellfor hard currency.

  • Why such a scary disclaimer? Do you really think the risk of a complete loss is high?

    IMO, the real risk is the consumer loan book. It’s been growing like a weed (for SBER and for other Russian banks), it’s been a great boost for their NIM in an environment where rates are falling for all other loans, and, anecdotally, the quality has been deteriorating. People have been talking about a consumer credit bubble in the country for a while now, which, coupled with the deteriorating economy, is really worrisome.

    Some more info here:
    http://www.fico.com/en/about-us/newsroom/news-releases/russian-consumers-credit-health-stable-two-year-decline-according-fico-nbki-data/
    http://www.ft.com/intl/cms/s/0/42629d66-51df-11e3-8c42-00144feabdc0.html#axzz2zvrOu62C

    • The disclaimer is scary because this is not the normal “Boring” stocks that i am writing baout.

      Thanks for the hint. Internationally, consumer debt in Russia on average is still low but clearlya point to watch.

  • A P/E of 4.2 is certainly interesting for such a company, but probably you pay much more. The EPS are 16.78RUB = 0,336€ in 2013. With the mentioned price this implies a P/E=5.80€/0.366€ = 17.25. Is there a mistake in my calculation?

    Thanks for sharing your ideas.

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