JULY 26, 2016

MACROECONOMICS

RUBLE: RUNNING LOW ON FUEL 

Ruble’s relative strength vs. oil in July has sparked a debate on further FX movements. This month the exchange rate remains stable at RUB/USD 65 despite the decline in oil from $52/bbl to $45/bbl, defying the RUB/Brent correlation seen YTD. This dynamic has even attracted attention of the authorities, who expressed concern about the ruble’s strength. As a result, the market is asking two key questions regarding the FX rate 1) can the ruble continue to post gains without support from oil prices past 3Q; and 2) will the authorities take action to prevent such strengthening.



Near-zero current account and persisting net capital outflow call for weaker ruble as a base case. In 2Q16, the Russian current account surplus dipped to as low as $3 bln and under the current oil price and ruble exchange rate is set to shrink to $1-2 bln in 3Q16, in our view. At the same time, even with the recent improvement in official expectations, the net capital outflow is expected to reach $14 bln in 2H16 after $11 bln in 1H16. This suggests that the current divergence between the ruble and oil is temporary and unlikely to last past mid-August. Under a $45-50/bbl oil price in 2H16, the exchange rate should gradually return to a more appropriate range of RUB/USD 70-75.



CBR intervention is not our base case scenario. The logic of inflation targeting and ruble free-float prevents the monetary authorities from interfering in ruble market pricing. In our view, the CBR will refrain from taking action or even commenting on the ruble at current levels. Further ruble appreciation, if supported by oil price growth, also should not create discomfort for the CBR, as it would not threaten the stability of Russia’s current account. Only the unrealistic event of speculative portfolio inflows causing the ruble to outperform the oil price increase and drive it towards RUB/USD 50-55 would enable the CBR to consider intervention.



Impact on fixed income. Across the FI space, a weaker ruble would be largely positive for names in the metals and mining, fertilizers and, to a lesser extent, oil and gas sectors. The heaviest impact would be felt by TMT issuers. The opposite is largely the case in case of a stronger ruble, with TMT clearly being the main beneficiary. Although not present in the eurobond universe, but noticeable in the local bond space, large food retailers, in our view, are largely immune to changes in the exchange rate.



Impact on equities. In this note, we also provide a list of stocks that would benefit in scenarios of ruble appreciation (to RUB/USD 50) or depreciation (to RUB/USD 70). Select companies with a domestic focus (financials, TMT, utilities) would benefit from ruble appreciation, especially regarding dividend distribution, while exporters (oil, metals and mining, fertilizer producers) stand to benefit from a weaker ruble.

Research Department

1

Dmitry Dolgin +7 (495) 287 61 00 (ext. 5 17 68) [email protected] Research department +7 (495) 287-61 00

Copyright © 2003-2016. Gazprombank (Joint Stock Company)

JULY 26, 2016

MACROECONOMICS

MACRO

Dmitry Dolgin +7 (495) 287 61 00 (ext. 5 17 68) [email protected]

In the last couple of weeks, two important events have put the Russian FX market into the spotlight. First, since the end of June the ruble has diverged from the oil price: while appreciation from the January low of RUB/USD 83 to 64 as of mid-year was justified by the $20/bbl increase in the Brent price, this month the exchange rate has stabilized at RUB/USD 65 despite the decline in oil from $52/bbl to $45/bbl (Chart 1). Second, last week a number of high-ranking state officials and representatives of large corporates expressed concern about the ruble’s recent strengthening. As a result, after the ruble posted a 12% YTD gain versus the dollar — the second-best performance among peers after the Brazilian real (Chart 2) — two key questions arise: 1) can the ruble continue to post gains without support from oil prices past 3Q; and 2) will the authorities take action to prevent such strengthening. Chart 1. RUB/USD vs. Brent price YTD

Chart 2. RUB vs. peers YTD YTD APPRECIATION/DEPRECIATION TO USD, %

JUN 16

MAY 16

APR 16

MAR 16

FEB 16

JAN 16

60

DEC 15

CURRENT OIL PRICE JUSTIFIES RUB70/$ EXCHANGE RATE

RUB

65

50

HUF

70

45

PLN

75

40

INR

80

35

TRY

85

$/RUB

$/BBL $/RUB, LHS

21%

BRL

55

12% 2% -1% -2% -4%

MXN-8%

30

-10%

BRENT, $/BBL, RHS

-5%

0%

Source: Bloomberg

5%

10%

15%

20%

25%

Source: Bloomberg

1. We believe the divergence is temporary The answer to the first question is an outright ‘no’, as the opposite would contradict Russia’s longstanding model of a current account surplus, typical for an oilexporting country (oil accounts for 60-70% of Russia’s export revenues). The abovementioned correlation between the oil price and the ruble is not coincidental but rather represents a self-adjustment mechanism built into Russia’s current account. The logic behind this mechanism is that whenever the oil price is not sufficiently high enough to maintain a current account surplus, the ruble depreciates to levels required to boost the current account via lower imports. The useful side-effect of this mechanism is that it also keeps the ruble oil price within a narrow range, protecting the budget’s oil revenues (50% of federal revenues) from negative oil price movements. In 2Q16, the current account surplus dipped to as low as $3 bln (Chart 3), the second-lowest surplus for 2Q in 10 years, and under the current oil price and ruble exchange rate is set to shrink to $1-2 bln in 3Q16, in our view. Based on historical experience, this calls for an adjustment through either an oil price increase or exchange rate depreciation. The only situation in which ruble depreciation can be avoided in the event of a zero or negative current account is when the country sees a significant net capital inflow. However, as the sanctions against Russia are forcing persistent net foreign debt redemptions, such a scenario would be too optimistic to consider. While the capital account improved to -$2 bln in 2Q16 amid a light debt redemption schedule, and might even have turned positive in July thanks to the inflow of portfolio investment to EM following the Brexit vote, further improvement is under question. 2

JULY 26, 2016

MACROECONOMICS

Clearing the official CBR expectations of foreign debt redemptions from the interest payments, the net redemption should intensify to $6 bln in 3Q16 and $17 bln in 4Q16. As a result, even after the recent improvement the official CBR expectations of the capital account for 2016 imply a net capital outflow of $14 bln in 2H16 after $11 bln in 1H16. Even though these figures might not seem substantial, they do pose a threat to the exchange rate in an environment of a near-zero current account surplus. Therefore, our base-case scenario is that the current divergence between the ruble and oil is temporary and unlikely to last past mid-August. Under a $4550/bbl oil price in 2H16, the exchange rate should gradually return to a more appropriate range of RUB/USD 70-75. Continued ruble appreciation is possible only in case of resumed oil price growth and/or a continued inflow of portfolio investments, allowing improvement in the capital account. In that case, we would not exclude the exchange rate strengthening to RUB/USD 50-55, though such a scenario is less likely. Chart 3. Quarterly current account, capital flow, $/RUB

Chart 4. Net corporate foreign debt redemption, $ bln

SHRINKING CURRENT ACCOUNT CALLS FOR WEAKER $/RUB

25 27

39 16

6 10

25 2 0

8

26

12 6 14

30

35 16

8 13 13 3

-5

-6

-8

-4

-6

-10 -17

-20 2Q15

1Q16

3Q15

1Q15

85 3Q14

-80 1Q14

-15

3Q13

75 1Q13

-60 3Q12

-10

1Q12

65

3Q11

-40

1Q11

55

3Q10

-20

1Q10

1

0

45

NET CAPITAL FLOW, $ BLN CURRENT ACCOUNT BALANCE, $ BLN AVERAGE $/RUB, RHS

4Q16F

17

3Q16F

30 23

2Q16

5 12

1Q16

0

18

5

4Q15

20 33

CAPITAL ACCOUNT TO COME UNDER PRESSURE OF FOREIGN DEBT REDEMPTIONS IN 2H16

3Q15

40

NET CHANGE IN CORPORATE FOREIGN DEBT, $ BLN Source: CBR

Source: CBR, Gazprombank estimates

2. Intervention is uncalled for To answer the second question — on the possibility of CBR intervention — it is important to keep in mind that since 2014 Russia has pursued an inflation-targeting regime, which requires that the monetary authorities avoid direct involvement in the FX market as a rule. Only during periods of exceptionally sharp currency movements does the CBR conduct intervention under inflation targeting in order to limit the potential inflationary shock from a devaluation that is already underway or could occur after a sharp and unjustified appreciation, as was the case during the rapid devaluation from RUB/USD 40 to 72 in 4Q14 and subsequent rebound to RUB/USD 49 by end 1H15. We therefore believe that neither of the two scenarios we are discussing requires CBR action: depreciation to RUB/USD 70-75 would represent an adjustment to levels justified by the oil price, while appreciation to RUB/USD 50-55, if supported by oil price growth, would not increase risks to the balance of payments. Only the unrealistic event of speculative capital inflows driving the RUB/USD rate to 50-55 amid an unchanged oil price would enable the CBR to engage in intervention.

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JULY 26, 2016

MACROECONOMICS

FIXED INCOME

Evgeniy Khilinskiy +7 (495) 287 61 00 (ext. 5 16 43) [email protected]

Across the FI space, a weaker ruble would be largely positive for names in the metals and mining, fertilizers and, to a lesser extent, oil and gas sectors. The heaviest such impact would be felt by TMT issuers. The opposite is largely true in case of a stronger ruble, with TMT clearly being the main beneficiary. Although not present in the eurobond universe, but noticeable in the local bond space, we believe that large food retailers are largely immune to changes in the exchange rate. In the oil and gas space, the share of FX debt among most bond issuers is 85-90% of the total, which is largely offset by the material correlation of the exchange rate with the oil price: an increase in debt (in ruble terms) and lower dollar revenues are thus compensated by much higher revenues in ruble terms. Moreover, the peculiarities of the Russian tax system limit the downside of exporters on the EBITDA side. However, within the group the magnitude of the impact is different, as Russian issuers differ by the share of FX-denominated revenues: those of Lukoil and Rosneft remain at around 80%, while the figure for NOVATEK stands at 55%. Gazprom Neft, whose domestic retail exposure is higher than that of Rosneft and Lukoil, also benefits less in case of a weaker ruble. At the consolidated level, Gazprom derives around 60% of its revenues from exports. Therefore, the former group would be the main beneficiaries from a weaker ruble. Metals and mining and fertilizer names would benefit from a weak ruble, as global metals and fertilizer prices have no impact on the ruble exchange rate. In metals and mining, FX-denominated debt comprises around 85-95% of the total, while exports generate 65-90% of revenues (with the exceptions of Severstal and TMK with a 30-35% export share). However, given that a large share of domestic prices are linked to international prices, and given their ruble-dominated cost base, they are well positioned to benefit from a weaker local currency. Uralkali and PhosAgro face similar circumstances: their FX debt, comprising more than 90% of the total, is offset by the large difference between their ruble cost base and the large share of FX-denominated revenues. For PhosAgro, the effect seems stronger given its larger export share (80% vs. 72% for Uralkali). On the contrary, TMT names, namely VimpelCom, MTS (and thus its holding company Sistema) and Russian Railways in transportation are net winners in a stronger ruble scenario. At the same time, their debt positions are still vulnerable (FX debt share of around 40-80%) to ruble weakness, albeit to a lesser extent compared with previously discussed sectors. VimpelCom’s debt book is more than 80% FX-denominated vs. nonRussia generated revenues of 52% in 2015, while MTS’ non-domestic revenues comprised 10% of sales in 2015, compared to 42% of FX on its debt book. For Russian Railways the impact of stronger ruble is also mainly positive: the share of FX debt stands at 47% vs. our estimated share of FX in revenues at roughly 17%. Retailers (Magnit, X5, Lenta and O’Key) are the most immune to FX volatility, in our view. They have very small or no FX debt alongside largely ruble-linked revenues and costs. Although a weaker ruble in the medium term may have an adverse effect on household spending capacity, the food segment is still the most resilient to reduced consumption.

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JULY 26, 2016

MACROECONOMICS

Top equity picks SECTOR

RUB/USD 50

Oil and gas

Gazprom Neft The downside risks for cash flows of Russian oil and gas companies appear limited under a scenario of ruble appreciation. Further, ruble appreciation will result in an FX gain for oil and gas players with large exposure to FXdenominated debt (Gazprom Neft), which will positively affect their dividends.

Metals and mining

RUB/USD 70

Negative The ruble tends to appreciate when oil prices (and often those of other commodities, including metals) increase. Thus, if the ruble appreciates and metals prices rise, the negative effect might be diluted significantly or even disappear.

Financials

Moscow Exchange, Sberbank Moscow Exchange offers a resilient cycle-free business model, is a top dividend story and shows an attractive valuation. The stock should be a strong performer under both ruble appreciation and moderate depreciation scenarios. Sberbank is sensitive to the ruble exchange rate through capital and asset quality metrics. The stock’s current high market price leaves upside only under a ruble appreciation scenario.

TMT

MTS, Yandex MTS is exposed to exchange rate risk (about 50% of capex and 20% of debt is USD-denominated). Given a strong ruble, MTS has a comparative advantage in terms of potential for a dividend increase. Yandex is also exposed to exchange rate risk (about 50% of capex, part of debt and some labor costs are FXdenominated).

Rosneft, SurgutNG, Bashneft, Tatneft A scenario of further ruble weakening against hard currencies amid practically flat global oil prices will be beneficial for the cash flows of Russian oil and gas companies. Under a scenario of ruble deprecation, we favor Russian oil producers (Rosneft, SurgutNG, Bashneft and Tatneft). Evraz, NLMK, Severstal, MMK, Raspadskaya, RUSAL The revenues of Russian metals and mining companies are mostly USD-denominated, or denominated in rubles but correlated (often with a time lag) with USD-denominated global metals prices. Thus, if the ruble depreciates, they are among the key beneficiaries (unlike when the ruble appreciates). The most sensitive names to ruble depreciation include Evraz, NLMK, Severstal, MMK, Raspadskaya and RUSAL. That said, while Evraz and Raspadskaya could benefit from ruble depreciation in the short term due to their high sensitivity to the ruble, we do not like the names fundamentally.

Moscow Exchange

None

Lenta, Dixy Russian food retailers have little exposure to exchange rate risk, since most of their capex and debt are RUBdenominated. We believe that shares of Lenta and Dixy are currently undervalued relative to other retailers and show upside potential.

Lenta, Dixy Russian food retailers have little exposure to exchange rate risk, since most of their capex and debt are RUBdenominated. We believe that shares of Lenta and Dixy are currently undervalued relative to other retailers and show upside potential.

Fertilizers

None In case of ruble appreciation, fertilizer producers should be avoided on margins contraction and the expectation of lower dividends.

PhosAgro The fertilizers sector is one of the most sensitive to the RUB/USD rate. Most producers generate USD-denominated revenues (75-90% of total revenues) and RUB-denominated costs (some 70-80% of costs). Thus, PhosAgro, as one of the best dividend plays in the industry, would be one of the top-picks in case of ruble devaluation, as the company will likely share its devaluation gains with shareholders.

Utilities

Positive The FX impact on Russian utilities is limited in terms of revenues, as all sales by generation and distribution companies involve domestic consumers and thus there is no direct impact on profits.

Negative Operationally utilities have slightly negative sensitivity to a weaker ruble, with the exception of Inter RAO. Moreover, for foreign investors, who measure their returns in FX terms, Russian utilities become more attractive when the ruble is strong.

Consumer

Source: Gazprombank estimates

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JULY 26, 2016

MACROECONOMICS

OIL AND GAS

Alexander Nazarov +7 (495) 980 43 81 (ext. 5 43 81) [email protected]

In a scenario of ruble strengthening against hard currencies, we assume that substantial appreciation (e.g. to a RUB/USD level of 50) will be a function of a certain increase in global oil prices. Further, in the case of ruble strengthening faster than oil price growth, we believe that the authorities will try to limit the magnitude of ruble appreciation to sustain at least the current ruble price level per barrel (~RUB 3,000/bbl at Brent of $44/bbl in 2016) in order to fulfill the federal budget. Thus, in our view, the downside risks for cash flows of Russian oil and gas companies are limited under a scenario of ruble appreciation. Further, ruble appreciation will result in an FX gain for oil and gas players with large exposure to FX-denominated debt (Gazprom Neft), which will positively affect their dividends. At the same time, the scenario of ruble appreciation is negative for SurgutNG, whose dividends show an inverse relationship to the FX rate. A scenario of further ruble weakening against hard currencies (e.g. to a RUB/USD level of 70) amid practically flat global oil prices will be beneficial for the cash flows of Russian oil and gas companies. The bulk of revenues of Russian oil and gas producers are directly or indirectly (via export netbacks) linked to hard currencies and ruble depreciation has a positive effect on their top lines, while the ruble-based nature of their operating costs and capex supports their profitability and cash flows. Under a scenario of ruble deprecation, we favor Russian oil producers (Rosneft, SurgutNG, Bashneft and Tatneft). Lukoil is less exposed to a weaker ruble due to its large share of overseas liquids production and sales. We also exclude Gazprom Neft from our top picks under this scenario, as the company will incur a substantial FX loss on debt revaluation as a result of ruble depreciation. Finally, the impact of a weaker ruble will be less significant or even neutral for oil and gas producers with large exposure to domestic gas sales (ruble-based tariffs) — Gazprom and NOVATEK, respectively, as well as for the pipeline operator Transneft.

6

Evgenia Dyshlyuk +7 (495) 980 41 29 [email protected]

JULY 26, 2016

MACROECONOMICS

METALS AND MINING

Natalia Sheveleva +7 (495) 983 18 00 (ext. 2 14 48) [email protected]

The revenues of Russian metals and mining companies are mostly USD-denominated, or denominated in rubles but correlated (often with a time lag) with USD-denominated global metals prices. While many raw materials are also USD-denominated or correlated with global prices, most Russian producers have high vertical integration in raw materials. Thus, if the ruble depreciates, Russian metals and mining companies are among the key beneficiaries (unlike when the ruble appreciates). Rusal, Evraz, NLMK, Severstal, MMK and Raspadskaya are the most sensitive to changes in the ruble and are key beneficiaries should the ruble depreciate. Of this group, Rusal and Raspadskaya are the most sensitive to the FX rate. That said, we note that while Evraz and Raspadskaya could benefit from ruble depreciation in the short term due to their high sensitivity to the ruble, we do not like these names fundamentally. The ruble tends to appreciate when oil prices (and often those of other commodities) increase. Thus, if the ruble appreciates and metals prices rise, the negative effect from stronger ruble might be diluted significantly or even disappear. Alternatively, if the ruble depreciates but metals and mining prices decrease, the positive effect might be diluted significantly or even disappear.

7

JULY 26, 2016

MACROECONOMICS

FINANCIALS

Andrey Klapko +7 (495) 983 18 00 (ext. 2 14 01) [email protected]

Moscow Exchange offers a resilient cycle-free business model, is a top dividend story and shows an attractive valuation. The stock should be a strong performer under both ruble appreciation (RUB/USD 50) and moderate depreciation (RUB/USD 70) scenarios. Sberbank is sensitive to the ruble exchange rate through capital and asset quality metrics. The stock’s current high market price leaves upside only under a ruble appreciation (RUB/USD 50) scenario.

TMT

Sergey Vasin +7 (495) 983 18 00 (ext. 5 45 08) [email protected]

MTS is exposed to exchange rate risk (about 50% of capex and 20% of debt is USDdenominated). Ruble depreciation would likely weigh on FCF generation, net income and dividends. However, given a strong ruble, MTS has a comparative advantage in terms of potential for a dividend increase.

Anton Fokin +7 (495) 287 61 00 (ext. 5 16 95) [email protected]

Yandex is exposed to exchange rate risk (about 50% of capex, part of debt and some labor costs are FX-denominated). Therefore, the company has limited upside potential (if any) under a weak local currency scenario.

CONSUMER

Sergey Vasin +7 (495) 983 18 00 (ext. 5 45 08) [email protected]

Russian food retailers have little exposure to exchange rate risk, since most of their capex and debt are RUB-denominated. Moreover, we believe that shares of Lenta and Dixy are currently undervalued relative to other retailers and show upside potential.

Anton Fokin +7 (495) 287 61 00 (ext. 5 16 95) [email protected]

FERTILIZERS

Alexander Nazarov +7 (495) 980 43 81 (ext. 5 43 81) [email protected]

The fertilizers sector is one of the most sensitive to the RUB/USD rate. Most producers generate USD-denominated revenues (75-90% of total revenues) and RUBdenominated costs (some 70-80% of costs). Thus, PhosAgro, as one of the best dividend plays in the industry, would be one of the top-picks in case of ruble devaluation, as the company will likely share its devaluation gains with shareholders. On the contrary, in case of ruble appreciation, fertilizer producers should be avoided on margins contraction and the expectation of lower dividends.

8

JULY 26, 2016

MACROECONOMICS

UTILITIES

Matvey Tayts +7 (495) 980 43 89 (ext. 5 43 89) [email protected]

The FX impact on Russian utilities is limited in terms of revenues, as all sales by generation and distribution companies involve domestic consumers and thus there is no direct impact on profits. The only exception is Inter RAO, an electricity exporter. The company’s EBITDA from trading activities in 2015 comprised 13% of total EBITDA and thus the positive impact from a weak ruble is rather limited. On the cost side, a weak ruble may lead to a medium-term increase in opex, as utilities companies use some imported equipment and the cost of spare parts and services may increase. However, the impact would unlikely be felt any time soon, as the majority of the companies’ contracts are RUB-denominated and price revision would probably not have a significant impact on financials this year. The debt of the largest companies is mostly RUB-denominated and thus we do not expect a significant negative impact from a weaker ruble. The bottom line is that operationally utilities have slightly negative sensitivity to a weaker ruble, with the exception of Inter RAO. Moreover, for foreign investors, who measure their returns in FX terms, Russian utilities become more attractive when the ruble is strong.

9

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