The ‘Russian discount’ does not stem from the quality of assets, instead it arises from investment governance, in our view.
Investments have limited pass-through into corporate profits for two reasons: i) the dominant share of maintenance capex and ii) low marginal returns on expansion projects.
We calculate that economic profit is tangibly lower than accounting profit, realised returns are worse and actual valuation is richer. Adjusted P/E is at 7.8x for RTSI vs. 6.0x calculated on the basis of P&L.
Marginal returns on expansion projects across our coverage universe stand at just under 7% (driven down by state-owned companies), well below the perceived cost of equity for the Russian market.
2014 is likely to be a transition year before structural reforms (the first tangible steps were observed in 2013) yield their results.
Our macro team has cut its Russia 2014 real GDP growth forecast to 1.3% (from 2.2%). We are resetting our RTSI YE14 target at 1,600 ex-dividend (previous: 1,750).
For the model portfolio, we choose dividend-paying exporters and defensive domestic names – discounters, mobiles and internet, where demand elasticity is the lowest or whose services provide cheaper consumption options.