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Strategy: Russia After the Storm

November 10, 2009

After the storm. While there remains much debate on whether the global crisis is over, we take greater stability as our central scenario, examine how the Russian market looks, identify which companies have overshot or undershot in the bounce, and consider what global factors could once more send Russian stocks plunging.

Upgrading top-down drivers for 2010 to reflect a more stable world. We upgrade our 2010 forecast oil price from $60/bbl to $70/bbl, our average ruble/dollar rate from R32/$1 to R29/$1, our long-term bond yield from 6.75% to 5.75%, and our ERP from 6.0% to 5.0% as the result of the government’s more market-friendly attitude.

Upgrading domestic drivers. Alone among the major markets, we continue to see a significant disinflation trade in Russia. We improve our inflation estimate for this year from 10% to 9%, reduce our 2010E banking sector provisions from 5% to 4%, anticipate the refinancing rate falling from 9.5% to 7.0%, and reiterate our 2010 GDP forecast of 5% growth.

Upgrading the 2010 RTS Index target. As a result of these changes, our forecast 2010 earnings rise by 18%, giving a 2010E P/E of 8.2, with a discount of over 30% to GEM. Our 2010 index target moves from 1,500 to 2,000, which is 10 times 2011E earnings and a 20% discount to GEM.

Risks abound. The market’s path will clearly not be smooth in 2010, with plenty of potential shocks to a deep cyclical commodity-focused market like Russia, centered mainly on the impact of global drivers on the oil price. We examine the impact on the market of the main global risks, such as the end of the dollar carry trade, strong US growth, a “W” shaped recession, and the potential return of inflation or deflation.

But emerging markets remain in the sweet spot. Under the central consensus scenario that the world continues to muddle through, with low rates in the West and high growth in Asia, Russia will continue to benefit as the cheapest major emerging market, and one clearly tied to Asian growth.

Top picks for a strong domestic environment. We continue to like domestic plays, from Sberbank and MTS to NOVATEK, X5 Retail Group, Comstar-UTS, Wimm-Bill-Dann and Pharmstandard.

Relative value stories. If the dust does start to settle, we see some interesting relative value plays where certain stocks have run up too much in the bounce. We like Petropavlovsk against Polyus Gold, Rosneft against LUKoil, NOVATEK against Gazprom, Magnitogorsk Steel against TMK, and Sberbank against VTB.

 

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