Analysis: Cheap Russia pick of the BRICs for 2011

LONDON Wed Dec 8, 2010 10:57am EST

People walk along Red Square, with Saint Basil's Cathedral in the background, in central Moscow December 2, 2010. REUTERS/Denis Sinyakov

People walk along Red Square, with Saint Basil's Cathedral in the background, in central Moscow December 2, 2010.

Credit: Reuters/Denis Sinyakov

LONDON (Reuters) - Russian stocks, unloved for many months, have shot to the top of the 2010 performance tables and look set to rise further as funds like Goldman and HSBC tip Moscow as their favored emerging market play for 2011.

Price may be Russia's selling point: in terms of forward earnings, it trades 40 percent below emerging peers.

But there are other catalysts too. Russia stages the Winter Olympics in 2014 and the soccer World Cup in 2018; a $32 billion privatization program kicks off next year; and a 17-year wait to join the World Trade Organisation should end in 2011.

Thanks to late-year gains, Russia has emerged as the top 2010 performer of the BRICs, a group that also includes Brazil, China and India. It is up 20 percent year-to-date and a Reuters poll forecast Moscow to outpace the BRICs next year too.

That is vindication of sorts for Jim O'Neill, chairman of Goldman Sachs Asset Management (GSAM) (GS.N), who last December forecast Russia to outperform in 2010. O'Neill, who coined the BRIC term, is sticking with that bet for next year as well.

"In the BRIC world, controversially, I like Russia the most," O'Neill told the Reuters 2011 Investment Outlook Summit. "It's very unfashionable to say so but Russia looks cheap to me."

The Moscow index has jumped 7.5 percent in December, after FIFA awarded the 2018 soccer World Cup to Russia and Pepsico Inc acquired local juicemaker Wimm-Bill-Dann for $5.8 billion. That compares with a 4 percent gain this month for emerging equities .MSCIEF and 3 percent for MSCI's BRIC index.

O'Neill is mistaken on one count though - far from being controversial, being overweight Russia now seems the consensus.

Nick Timberlake, who runs $10 billion at HSBC, also sees a strong valuation case for Russia, which trades 6.3 times forward 12-month earnings, versus the five-year average of 9 times.

Versus fellow-BRICs, it is even cheaper. India is at 17 times forward earnings or three times pricier.

"We have our most significant overweight position in Russia today. Russia is our favorite market for next year," Timberlake said at the summit, forecasting Moscow to outgun the 10-30 percent gains he expects on broader emerging equities in 2011.

Russian companies' 2011 and 2012 earnings growth is seen at 15 percent and 18 percent respectively -- in line with emerging markets. That means the valuations gap is based on equity risk premium rather than expectations of falling earnings.

Timberlake noted that Pepsico had paid a 35 percent premium to the price of shares in Wimm-Bill-Dann before the deal.

"This gives an idea of the value hidden in the market."

WHAT HAS CHANGED?

Detractors point out Russia has been cheap for a while. Political and corporate governance risks are considered high and the bourse is skewed toward oil and mining stocks, whose valuations always tend to be lower.

But investors say a re-rating is due, given the shifting global and domestic outlook.

Oil prices at two-year highs and rising U.S. yields suggest a tentative pick-up in the U.S. economy.

Economists have upped U.S. growth forecasts for 2011 which bodes well for Russia's cyclical growth stocks.

"We like Russia because it is a commodity play, it's a call on 'this will all pan out'," BNP Paribas Investment Partners' chief investment officer William de Vijlder told the summit.

INFRASTRUCTURE SPENDING

Russia should also up spending on infrastructure ahead of the 2014 Winter Olympics and the 2018 World Cup. Big privatizations will kick off next year.

And Moscow finally looks set to join the World Trade Organisation next year with entry adding three to 11 percent to the economy, the World Bank estimates.

Russian steel and carmakers are among those expected to benefit.

Chris Weafer, chief strategist at Uralsib Bank, said oil's recent rise to around $90 a barrel is giving Russia an extra $750 million a day -- money that in a pre-election year should find its way to consumers' pockets via higher state spending.

Weafer expects a 30-40 percent upside next year for Moscow, with some banking and property stocks gaining 50-70 percent.

OTHER BRICS AND RUSSIAN RISKS

If Russia is the consensus overweight, India is seen as the opposite in 2011.

Dominated by consumer-oriented stocks, Mumbai did well when the world growth outlook was looking shaky but has fallen from favor.

"The market we do not like is India," said Allan Conway, fund manager at Schroders. "It's one of the more expensive markets, we (also) have some interest rate and current account concerns which are holding us back."

Conway likes Russia and China, the two commodity BRICs.

There are risks to the bullish view on emerging markets, for example a too sharp a rise in U.S. yields or a big geopolitical crisis in hotspots such as Iran.

Greater-than-expected Chinese tightening is also a risk, especially for commodity prices.

The 2008 meltdown hit Russia disproportionately -- it fell 70 percent versus a 50 percent decline for emerging markets.

"Russia was hit so badly in 2008 because of corporates' overseas debt. That led to a fall in the rouble," said Michael Konstantinov who helps manage $2.7 billion in BRIC stocks at Allianz's RCM. "They are in better shape now."

(Editing by David Cowell)