Author: Andrew Brown, Executive Director East72 Holdings Limited
Equity Mates Media has asked Andrew Brown, a regular guest of the show, to provide an update on his comments about investment opportunities in Russia, that was first aired on our Bold Predictions podcast on 3 February 2022. This was off the back of a lot of interest from the Equity Mates Investing Podcast community about how Andrew is thinking about them now. Below is his response.
On 3 February 2022, Equity Mates Investing broadcast my “Bold Predictions” for 2022 in which, amongst other content, I discussed that we had acquired Global Depository Receipts (traded in London) in Sberbank and Gazprom, Russia’s largest bank and one of its major oil/gas producers. The US$ bought ~76roubles at the time of broadcast.
Sberbank had a market value of US$71.5billion and had announced a preliminary net profit for calendar 2021 of $16.3bn (equivalent). The brief rationale for Sberbank was that the shares were cheap (4.4x P/E) having fallen by a third in six months, returns were strong (ROE of >25%), and the Russian economy was growing as a result of strong commodity prices and volumes. Sberbank has a strong e-commerce business which would also benefit from economic growth, as well as controlling bank market shares of loans and deposits of over 40%.
Similarly, Gazprom’s then market value of U$102billion reflected valuations well below other oil majors with expected profits of (equivalent) $32billion in 2021 and $43billion in 2022 as a result of high gas prices to European customers and strong oil prices. We expected medium-term growth arising from further growth in gas volumes. Hence, I commented that the shares were on a P/E of “about 3”.
I was probably amongst the first people in Australia to come across Bill Browder’s amazing book “Red Notice” in early 2016, so there is no naivety on my part about the potential issues of investing in Russia, even in two of its very largest companies. Indeed, I noted that share prices of both stocks had been impacted by the Russian troop “exercises” on the Ukraine border, arising from instability in the East of Ukraine, but also heightened awareness of Russia’s concern over NATO’s eastwards encroachment and potential loss of buffer. In my judgement, as had been the case in the recent past, when share prices fell as a result of political “instability” in Russia, these periods had been an opportune time to acquire Russian stocks, carefully, in “tranches” with due regard for the overall exposure in your portfolio.
Over the week of 21-25 February, the rhetoric from Moscow increased, including the unhinged Putin speech of (European time) 21 February1; even still, until 24 February, focus still remained on the Eastern parts of Ukraine, which had been unstable for some time. However, the Russian Army’s advancement across Ukraine on that Thursday, changed the picture. Despite that, Russian stocks actually rallied sharply, from lower levels on Friday 25th.
We can all debate and analyse Putin’s state of mind and speeches pre-dating 25th February, and reach differing conclusions – I certainly did not believe he would invade2. What was totally unexpected by virtually all, given recent evidence, was the strength of unity and purpose shown across Europe, predominantly by the EU, to accept a level of economic pain in order to financially eviscerate Russia.
The unified and complete financial ostracisation of Russia announced over the weekend of 26/27th February – backed by USA and elsewhere – has changed the picture completely. Around half of Russia’s central bank reserves are trapped outside the country and are frozen, along with the ability for Russian companies to transact.
Russian equities are now untradeable outside of Moscow, as exchanges, clearers and prime brokers will no longer accept transactions. The US$/rouble rate is ~110 reducing notional purchasing power by 30%.
The sanctions applied to Russia, have, in one week eliminated (on paper) the equity value of an entire generation. To suggest that Putin expected such an outcome prior to this misadventure is nonsensical; by destroying the market value of Russian assets, and then freezing other non-Russian assets of its elite, Putin’s non-military support base is questioning (at least privately) his decision making, isolation and inability to understand the connectedness of Russia to the world. Whilst the iron-curtain of isolation is now being brought down again, in my view, the chances of it remaining down for too long, are negligible.
There are numerous political options in Ukraine, well outside of the scope of this piece. However, in this new environment, I believe it is reasonable to question the ability of Russia to subjugate a country of 44million people on Western Europe’s doorstep. The “New CCCP” neither has the resources, technical capability nor the will of its own population to do so, despite its expertise in repression, suggesting that Putin has probably sowed the seeds of his own demise. For sure, there are other kleptocrats and totalitarians waiting in the wings, but none with his backing and persona. Even post-Putin, Russian business practices won’t change, but what might is the country’s eventual readmission to civilized society.
It’s impossible at present to transact in Russian equities, and the evil being inflicted on the Ukrainian people reasonably won’t allow you ethically to contemplate it. But there will be a time when you reassess an investment in a country of 140million people with vast reserves of oil, gas, commodities and education. Keep in touch with it.
1https://www.nytimes.com/2022/02/23/world/europe/putin-speech-russia-ukraine.html
2Neither did many ex-pat Russians. A brilliantly written example is from Vitaliy Katsenelson of “Contrarian Edge” https://contrarianedge.com/war-in-ukraine-why-i-was-blindsided-part-1/