vk.com/id446425943

Russian sector performance 2018 YTD

60% 40% 20% 0% 20% 40%

Source: Sberbank CIB Investment Research

Earnings revisions in Russian stocks

Domestics Exporters USD/RUB (rhs, inverted)

Note: 100 = January 1, 2018.

Source: Bloomberg, Sberbank CIB Investment Research

GEM EPS growth forecast over time

25%

20%

15%

10%

5%

Source: Bloomberg, Sberbank CIB Investment Research

Margin estimates in EM defensive and cyclical sectors

9.5%

9.0%

8.5%

8.0%

7.5%

7.0%

6.5%

6.0%

The remaining contributors are listed after each respective section

INVESTMENT RESEARCH

RUSSIA | STRATEGY

DECEMBER 10, 2018 | 13:15 MSK

The Russian Eagle

2019 Strategy: Standing Against

the Headwinds

█One of the best performers in 2018. GEM equities have experienced a tough year, with most deep in the red YTD. Meanwhile, Russian indexes are set to close the year flat in dollar terms and deliver a total return of 5%. Russia’s outperformance has been driven mainly by earnings upgrades, while multiples have continued to fall and Russia now trades at a forward P/E of 5.3. However, most of the outperformance has come from exporters, while domestic stocks have been beaten down heavily.

█Global headwinds likely to extend into next year. The flattening of the US yield curve points to a high risk of a cyclical slowdown. So far, we see no signs that this factor is properly reflected in consensus estimates. Top line numbers have not seen any meaningful revisions in the developed world, while EM earnings downgrades have primarily been driven by weaker currencies, staying unchanged in real terms. Should a slowdown materialize, we would expect another wave of earnings downgrades across the board. Alternatively, if US growth holds up, this would leave more room for further Fed monetary tightening. In that case, the dollar could strengthen further, putting more pressure on EMs.

█Staying constructive on the Russian market. Despite global headwinds, Russia has a certain valuation cushion. We argue that the equity risk premium (ERP) expansion observed in 2018 is not fundamentally justified, and we expect it to contract by some 200 bps. This could raise the market P/E from 5.3 to 6.3.

█We set our end 2019 index target at 1,400. P/E expansion and modest EPS growth translates into an RTS target of 1,400. This scenario does not imply any meaningful improvement in geopolitical news flow. In an alternative scenario in which new sanction fears evaporate, we could see much more significant upside. Energy stocks fit for both scenarios – either they benefit from the ruble staying weak, or they get rerated with the market. Banks are likely to benefit the most from the optimistic outcome, as they are the highest beta plays to Russia’s key risk.

█Top picks. We like Lukoil for its high dividend yields and accelerating buyback, Novatek in anticipation of further developments with Arctic LNG 2, Norilsk Nickel for its double digit dividend and decent development plan, TCS Bank for its impressive ROE and EPS growth, and InterRAO for its deep value. While global tech stocks are falling out of favor, we still like Yandex and Mail.ru Group for fundamental reasons.