Who would have thought that three years later the country would be inching towards a devastating recession, following western sanctions and the plummeting rouble? Russia has been hit by persistent capital flight, an increase in inflation which has eroded household incomes and strains in the banking sector. Of course, this downward spiral will be endured with a distinct lack of allies.
While last week’s agreement on a ceasefire in Ukraine restored some temporary optimism, it already appears to be crumbling in spite of desperate attempts from France and Germany to patch things up.
Not a good time to invest in Russia, perhaps. Or is it?
Colin Croft, manager of the Jupiter Emerging European Opportunities fund, said: “For those who take a long-term view, I believe 2015 could present an opportunity to buy into quality businesses in the region with sustainable and growing yields.”
“A decade ago, companies in the region were generally reluctant to pay dividends. In some cases, this was for good reasons: many needed to reinvest profits in businesses that were doubling in size every two years.”
“In other cases, it was for less enlightened reasons that reflected serious corporate governance issues.”
Croft explains that a lot has changed in the last 10 years, however.
He added: “Many of the businesses that were then in the early stages of breakneck growth have now, in my view, matured to a stage where they can increasingly fund their expansion plans from cash flows, while paying progressively higher dividends.”
The manager gives the example of Magnit, Russia’s leading food retailer, as a stock that is looking attractive.
“This is still a company with considerable growth potential, in my view, due to the highly fragmented and under-penetrated nature of Russian food retail.”
“Although it is the largest player, it still only has a single-digit market share. I believe it has significant scope to grow at the expense of weaker rivals that cannot match its best-in-class logistics and scale advantage in purchasing power.”
Magnit began paying dividends in 2009, paying a total of approximately $18m to shareholders. In just four years, this grew exponentially to just under $300m.
What’s more, while the weakness of the rouble will provide a headwind this year, this could potentially be reversed if oil prices recover to a normal level.
Arguably a tenuous prospect to rely on, but for the strong-bellied investor there could be some light at the end of the tunnel.
The ‘light’ in question is the prospect that Putin could reform the Russian economy and patch up western relations. Historically, it has been noted that the Russian government becomes more ‘business friendly’ whenever the price of oil falls.
Nevertheless, a report released by Capital Economics this month predicts a gloomy outlook for anybody considering Russian investments.
The macroeconomic forecasting consultancy predicts that Russian GDP might fall by around 5 per cent this year. This would put the impending recession at a similar scale to the country’s 1998 recession.
Data shows that this recession was followed by a rapid return to 10 per cent growth rates within two years, which then averaged to 7 per cent over a decade.
However, before you start feeling confident, it seems that circumstances are very different now.
Capital Economics emerging markets economist William Jackson explained: “The unemployment rate is near a record low and capacity utilisation is near a record high. In other words, there is very little slack in the economy.”
“Admittedly, a steep recession this year is likely to create some spare capacity. However, it won’t be sufficient to support a period of strong growth rates for more than a year or so.”
Nevertheless, Russia could perform strongly as the market responds to long-term trade deals with countries such as China or hints of economic and political reform.
Gary Greenberg, head of emerging markets at Hermes Investment Management, said: “With the valuations of its currency and stock market, not to mention our investor sentiment towards the country, a substantial bounce this year cannot be ruled out.”
“We currently maintain a neutral exposure through investments in solid companies like Norilsk –high dividend yield – and Mail.ru – a beneficiary of an economic recovery.”
“Still, looking out over the next decade, it is difficult to see how Russia will emulate more successful emerging markets such as Taiwan and Korea, not to mention the developed economies it regards as its equals.”
While few would consider building their portfolio around Russia, investors are getting some very cheap deals. The MSCI Russia Index’s price-earnings ratio is 4.25, which is the lowest it’s been since 2001 and is cheap compared to the FTSE All Share P/E ratio of 16.49
Performance of index over 3yrs
Source: FE Analytics
This means that if investors embrace their bullishness and play the market right, they could potentially make a huge profit. Of course, this would have to involve playing a long waiting game and having a very strong stomach.
Croft believes that, although Eastern European markets can be volatile, they create opportunities for these types of investors when in the context of a well-diversified equity income strategy fund.
He said: “In a world where it appears that certain asset prices are being driven to unsustainably high levels by loose monetary policy, supposedly low-risk income opportunities such as western government bonds look increasingly overpriced.”
“In my view, this overpricing is transforming them into assets that are potentially riskier than one might think.”
A deep recession, a vulnerable banking sector and higher inflation are all on the horizon. What’s more, the recovery is likely to be weak in comparison to their recession in 1998. Any short-term or even medium-term investments are unlikely to reap rewards.
Capital Economics' Jackson said: “So is Russia doomed? In one word, yes. We expect a deep recession this year, accompanied by higher inflation and tighter monetary policy than most expect. The banking sector will remain a key source of vulnerability – a severe credit crunch looks likely and the government will need to expand its recapitalisation plan significantly. ”
“What’s more, unlike in 1998, the subsequent recovery is likely to be disappointingly weak. Indeed, we expect growth over the rest of this decade to be similar to that seen during the Brezhnev stagnation. ”
“The only way to avoid this outcome would be if Russia were to take steps to bring the conflict in Ukraine to an end while making wholesale reforms at home to improve the business environment. But the politics means it’s nigh on impossible to see this happening. ”
However, as some investors believe, those with resilient and willing to wait could find that buying in during such stressed times means decent gains over the long term.