DRAFT
ACTIVE
VIEWPOINT
GLOBAL EMERGING MARKETS
MAY 2017 FOR PROFESSIONAL CLIENTS ONLY
Andrew Ness
Portfolio Manager
Global Emerging Markets
TALES FROM
THE ROAD:
RUSSIA
Russian newsflow is dominated by
geopolitics, painting a picture of
heightened risk for investors. However, the
economic reality often differs greatly from
received wisdom – a fact reinforced on my
recent research trip to Moscow. I found
evidence of well-run companies that have
weathered recent economic turbulence
and, crucially for long-term investors, that
display a growing willingness to engage
on their sustainability. I also gained
clearer insight into the structural reforms
necessary to spur the country on to
greater levels of growth.
There are two distinguishing
features of Russian companies
(and the country’s economy
as a whole): resilience in the
face of adversity, and the
flexibility to come out of a
crisis in a stronger position.
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DRAFT
RUSSIA CLIMBS OUT OF RECESSION
For me, there are two distinguishing features of Russian
companies (and the country’s economy as a whole):
resilience in the face of adversity, and the flexibility to come
out of a crisis in a stronger position.
With the situation now stabilising (reserves have
recovered to nearly US$400 billion) Russia’s central
bank and Ministry of Finance have strengthened their
standings by steering the economy through the storm.
Companies, meanwhile, have played their part by
demonstrating a determination to succeed. This was
evident to me when I visited in April, from speaking to
a number of companies across different sectors which
have survived – and thrived – despite a challenging
backdrop.†
After two years of economic turmoil, Russia is emerging
with this position enhanced. The economy didn’t go into
meltdown, as it might have done in other systems, when an
oil price collapse and punitive international sanctions led to
a weaker ruble and a dramatic drop in Russia’s international
reserves (falling from more than US$530 billion to US$356
billion between 2013 and 2015).*
Fall and recovery: Russia's international reserves during sanctions and oil price weakness
600,000
6 March (US), 17 March (EU)
Asset freezes/travel bans
Oil price
16 July (US), 29 July (EU)
Sectoral
12 September (US & EU)
500,000
US$ millions
Sanctions
24 June
US$ 114.46
400,000
13 January
US$ 46.59
300,000
20 January
US$ 27.88
200,000
Source: Central Bank of Russia.
*Source: Central Bank of Russia.
†A full list of companies visited is available on request.
02
With the situation now stabilising
(reserves have recovered to nearly
US$400 billion) Russia’s central
bank and Ministry of Finance have
strengthened their standings by
steering the economy through the
storm.
Feb 2017
Dec 2016
Oct 2016
Aug 2016
Jun 2016
Apr 2016
Feb 2016
Dec 2015
Oct 2015
Aug 2015
Jun 2015
Apr 2015
Feb 2015
Dec 2014
Oct 2014
Aug 2014
Jun 2014
Apr 2014
Feb 2014
Dec 2013
Oct 2013
Aug 2013
Jun 2013
Apr 2013
100,000
DRAFT
SANCTIONS FORCING POSITIVE
CHANGE
From an investment point of view, the perception that
investors are shunning Russia can certainly be challenged
– capital inflows have increased over the last year. While
political risk undoubtedly remains high, a key factor for
the businesses I spoke to was that the sanctions put in
place in response to Russia’s manoeuvres in Crimea, have
actually helped force positive change for the economy:
•
Significant deleveraging at both a government and
corporate level has seen Russia’s total debt Russia's
total debt fall by about 30% from when sanctions
were imposed in 2014 to the end of December 2016
(from around US$733 billion to US$513 billion).*
• W
ith sanctions curtailing trade with the European
Union (EU), Russia is developing new trade partners.
For example, we are seeing deepening financial ties
with China, alongside greater gas exports and major
infrastructure programmes.
• M
ost importantly, Russia’s relative isolation has
enabled greater self reliance. In agriculture, for
example, the Kremlin’s response to EU sanctions has
been a self-imposed trade embargo on fresh produce
from the region. This has led to higher farming
production targets and a reduction in dependence
on foreign staples. In fact, agriculture has grown to
such a degree, it is now reportedly Russia’s second
largest export market – generating more income than
defence.
*Source: Central Bank of Russia.
ACTIVE VIEWPOINT: GLOBAL EMERGING MARKETS
Russia's growing agricultural strength: World wheat flour
and products trade
USA
EU
Australia
Canada
Russia
Argentina
Ukraine
Kazakhstan
2012/3
27,734
2017/8
27,000
2012/3
22,786
2017/8
31,000
2012/3
21,269
2017/8
22,000
2012/3
18,584
2017/8
22,000
11,308
2012/3
29,000
2017/8
2012/3
7,450
2017/8
2012/3
14,500
7,190
2017/8
11,000
2012/3
6,801
2017/8
7,000
Other
(inc Turkey, 2012/3
Mexico & 2017/8
Serbia)
0
24,118
17,631
5,000 10,000 15,000 20,000 25,000 30,000 35,000
(million tonnes)
Source: US Department of Agriculture. Foreign Agriculture Service, May 2017.
03
DRAFT
SELF RELIANCE AND SELF BELIEF
Russia’s growing self sufficiency in food production and
basic goods is not simply spin, it is evident at a very basic
level; the shelves in supermarkets remain fully stocked.
There may be an absence of French cheese, for example,
but stores have adapted their wares accordingly. Food
retailer Dixy, is sourcing most of its products, except exotic
foods, domestically.
The message from retailers was, however, that the
consumer environment is still extremely challenging. It
remains price sensitive and shoppers are in ‘savings mode’.
The central battleground is between convenience-store
operators, but there are interesting dynamics elsewhere
too. For example, I found hypermarket operator Lenta is
focusing its attention on the supermarket format, which it
believes is an under-served segment. It aims to increase its
selling space in this area by eight times over the next three
years. It is resolving the problem of finding the larger real
estate necessary for new developments by renovating sites,
including old Soviet cinema halls, and sharing space with
other partners. Lenta is also making effective use of the
data it has gathered from its customer base of 10.8 million
active loyalty-card holders, including personalised offers to
loyal customers where visits are declining.*
Sberbank, the state-owned bank, was also adamant
that after three years of sanctions, Russia is now in a far
stronger position. It has stress-tested its business model for
another dramatic fall in the oil price and is confident of its
survival under a scenario of US$25 per barrel. Technology
has been an important factor and it is developing its new
IT platform in-house, with the ultimate aim of shifting all
transactions from teller windows to the online channel,
making use of phone banking and peer-to-peer payments.
It has 27 million active users, and continues to see strong
growth.*
The result of this shift to home-grown software has meant
large multinationals losing a foothold in the country.
Oracle, which provided IT systems for a number of banks,
is being displaced. The same is true for hardware. Visa and
MasterCard, which had blocked transactions from some
Russian banks, now face a strong challenge from domestic
payment platform Mir. The national payment card is
accepted at 2 million operational terminals, with contactless
payment due to become operational this year, and more
than half of Russia’s credit institutions have joined the Mir
payment system. Also in Sberbank’s favour, although loan
growth might have been expected to suffer due to large
sectors such as oil, metals and chemicals focusing on debt
repayment, I found smaller and medium-sized companies
are borrowing more as they look to expand.
COMPANIES MORE ENGAGED THAN
EVER
One of the most significant insights I gained on
the research trip was the level of awareness on
sustainability issues. All too often, Russia is the poster
child for the assumption that emerging markets equates
to political difficulties and sub-optimal governance.
However, companies I spoke to were open to change
and the most engaged I have ever seen, a definite shift
in attitude from previous visits.
In part, this is due to the increased investor interest
in environmental, social and governance (ESG) issues,
and an attendant rise in due-diligence questionnaires.
I found Russian firms are keen to reach a ‘minimum
hygiene level’ for governance and therefore have
a genuine interest in what investors want to know.
However, businesses also wanted guidance on how
to navigate the channels of ESG questioning. Our
reputation on governance issues has helped in this
regard, having been awarded an A+ rating by the
PRI (Principles for Responsible Investment) for our
overall approach to responsible investment and
the appointment of David Sheasby, our Head of
Governance and Sustainability, to the PRI Engagements
Advisory Committee.†
Russia’s growing self sufficiency in
food production and basic goods
is not simply spin, it is evident at
a very basic level; the shelves in
supermarkets remain fully stocked.
* Source: Company meetings.
†A copy of the PRI Assessment for Martin Currie is available upon request. The PRI Transparency Report and Assessment Methodology are available to download from www.unpri.
org.
The information provided should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any of the securities discussed here
were, or will prove to be, profitable.
04
DRAFT
MAKING THE CASE FOR INVESTORS –
LUKOIL: A CASE STUDY
Relative to their global peers, Russian oil producers have been sheltered from oil price weakness, as variable taxation
and a weakening ruble have meant the average price per barrel in ruble terms has fallen less than the headline dollar
figure.
Oil price weakness has been less severe in local currency terms
140
Crude oil Urals Ruble
Crude oil Urals US$
120
100
80
60
40
20
0
Jul 2014
Oct 2014
Jan 2015
Apr 2015
Jul 2015
Oct 2015
Jan 2016
Apr 2016
Jul 2016
Oct 2016
Jan 2017
Apr 2017
Source: FactSet as at 11 May, 2017.
Lukoil, one of the largest global oil producers, is one of two Russian holdings in the Martin Currie emerging markets
strategies (the other being retail chain Magnit). It has featured in our strategies for more than a decade and is a
company I know well, having first met management during its initial public offering roadshow in the mid 1990s.
There are a number of positive attributes supporting the investment case for Lukoil at this stage. It has substantial
proven reserves of both oil and gas that give it a strong platform to generate sustainable cash flows for many years
to come. The company’s production profile is moving towards newly developed oil fields and this will allow Lukoil to
finally reap the benefit of tax exemptions, introduced years earlier to encourage greenfield resource development. This
will bring a welcome boost to Lukoil’s profitability – at a time when the world’s oil producing nations are signing up to
production cuts.
While this gives Lukoil something to cheer about against an otherwise lacklustre global oil industry backdrop, it is now
crucial for the company to retain the tax benefits it has taken and not suffer from future changes in oil sector taxation.
We are never fully comfortable relying on a benign tax regime in the resources sector, but the Russian government
has recognised that the country’s easily accessible oil reserves have been developed, so oil companies need to be
incentivised to develop more challenging areas.
ESG disclosure is likely to be another positive driver for Lukoil, as it attempts to attract more foreign investment. Russia
has toughened its environmental requirements (including platforms having to operate under zero-discharge principles,
and ensuring water-cleansing policies are in place) and the company is showing a notable increase in sustainability
activity. We have been encouraged by the way Lukoil has recognised the importance of managing its governance and
sustainability and, as such, we plan to share our experience in this area by advising the company on disclosure practices
and other sustainability considerations.
We are already seeing the benefit of Lukoil’s better disclosure in its communication of, and commitment to dividends.
The company has one of the highest free cash flow yields among oil companies globally and management has
committed to paying a high and rising level of dividends.
The information provided should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any of the securities discussed here
were, or will prove to be, profitable.
ACTIVE VIEWPOINT: GLOBAL EMERGING MARKETS
05
DRAFT
THE NEED FOR STRUCTURAL
REFORMS
INVESTING IN RUSSIA –
CHALLENGING PERCEPTIONS
A clear message coming from companies I met was the
urgent need for structural reform. More privatisation
(and therefore less state involvement in the running of
the economy) is necessary to support long-term growth.
To do this there needs to be a predictable environment
for business and economic policy aiding the investment
process, such as taxation and support for exports.
While it might seem nigh-on impossible to separate the
geopolitical machinations from a company’s economic
fundamentals, for us it is the latter that is paramount.
Speaking to businesses on the ground has only
strengthened this view.
The central bank is under pressure to slash interest
rates as real rates are among the highest in the world.
The Ministry of Finance, meanwhile, is facing demands
to provide relief for pensions and consumers, who have
borne the brunt of fiscal adjustments. The question of
course is how likely these reforms are to be enacted – and
the shape and pace of the reform programme is likely
to be dictated by the presidential election being held in
March next year.
We have retained long-term interest in Russia.
Structural reform will improve the investment landscape
but companies are already challenging the perception
that Russia is uninvestable and the trip reinforced our
conviction in the resilience of the country’s economy
and its businesses.
As alluded to, the most welcome aspect of the visit
was the palpable change in the approach from many
companies on governance and the willingness to
engage with investors on sustainability.
We have retained long-term interest
in Russia. Structural reform will
improve the investment landscape but
companies are already challenging the
perception that Russia is uninvestable
and the trip reinforced our conviction
in the resilience of the country’s
economy and its businesses.
ACTIVE VIEWPOINT is just one part of our range of investment materials. To access further perspectives on
our strategies and key investment themes, visit: www.martincurrie.com
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DRAFT
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