Stocks/International

Lyn Alden Schwartzer

Filtering Through the Noise to Find Value

This Stock Grows by 12% and Yields 6%, But You Won't Like It

Sberbank (OTC: SBRCY) is the largest bank in Russia, and one of my top long-term aggressive stock ideas. An aggressive stock idea in this case is one that has high risk/reward potential, but is usually best kept as a smaller position due to tail risks or other factors.

Sberbank of Russia

In the United States, we often think of the “Big 4” banks as being too big to fail. For Russia, Sberbank is equal to two or three big banks combined relative to the country’s banking system. It’s by far the largest bank in Russia without any close competitors.  

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Source: Sberbank September 2019 Presentation

Sberbank has nearly as many branches as Wells Fargo, JPMorgan Chase, and Bank of America combined. They have more employees than any individual U.S. bank. They control between one-quarter and one-half of bank market share in Russia, depending on which line of business one focuses on. It’s an extremely large and wide-moat business, and it trades for a fraction of what these U.S. banks trade for.

Sberbank currently has a P/E ratio of about 6x, a P/B ratio of about 1.3x, and a dividend yield of about 6%.

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Source: F.A.S.T Graphs

(black line = stock price, blue line = stock price if at 10 P/E)

Sberbank grew earnings by 12.8% per year from 2011 through 2018, during a period that included a recession for Russia when oil prices crashed. During normal times, it has a strong return on equity of over 20%, which is very high. During the hardest times, its return on equity dropped to a still-respectable 10%. Very solid.

The company reports strong digital adoption; a very tech-savvy customer base and good app roll-out. Their app has strong downloads, and they have better digital adoption than most other banks globally.

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Source: Sberbank September 2019 Presentation

For the past 12 years, since 2007 and during this strong period of performance and positive change, Herman Gref has been the CEO. Prior to 2007 he was the Russian Minister of Economic Development and Trade. The company’s reported efficiency ratios have been extremely high under his leadership, and earnings and dividend payouts have grown substantially.

Sberbank is 50.1% owned by the Russian Federation. It’s a state-controlled organization, in other words, which is a turn-off for a lot of people. And that does warrant a valuation discount. However, in some ways, this is actually a good thing for shareholders based strictly on the numbers and practical realities. The Russian Federation currently has a target of a 50% dividend payout ratio for its state-controlled companies like Gazprom, Sberbank, and some others. In a country with high levels of corruption, they have a stated goal of making sure the companies are running reasonably efficiently, and they want their dividend payouts because it’s a meaningful contributor to the Russian government’s revenue. Small shareholders that want good dividend yields and dividend growth get to piggyback on what is basically a huge activist investor that owns the controlling stake in the company. High payout ratios make it harder for companies to fake numbers or do other wacky things with their books. In other words, as IQT founder Geraldine Weiss famously wrote, “Dividends Don’t Lie”. Sberbank gives shareholders and the Russian government about a 6% fistful of pure hard cash truth every year while still growing its core business, which is a strong indicator that the reported numbers actually mean something.

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Source: Sberbank September 2019 Presentation

The Russian Discount

All stocks in Russia are cheap. According to MSCI, the Russian large-cap index has a dividend yield of over 7%, a P/E of a little over 5, and a P/B of a bit under 1. Star Capital lists the Russian CAPE ratio as 7 for the country, while Siblis Research says it’s closer to 10. In comparison, the CAPE ratio in the United States is 30, the P/E is 20, and the P/B ratio is over 3.

A lot of this is because of sector mix. The Russian large-cap space is heavily focused on energy production, commodities, and then some banking from Sberbank. However, the Russian small-cap MVIS index is a lot more diversified, but still nearly as cheap.   

Russia is growing at a sub-2% real GDP growth rate due to stagnant population and has among the highest rates of corruption in the world as measured by third party groups. It deserves to be cheap.

However, the main second-level question is, does Russia deserve to be this cheap? My answer for the long-run is no, and these days likely represent a strong buying opportunity for patient investors as part of a diversified portfolio, although there are some tail risks.

The Russian Financial Fortress

Analyzing a bank is useless without understanding the country’s macro situation and currency fundamentals. Fortunately, Russia has among the strongest currency fundamentals of any country in the world. This isn’t the late-90’s Asian Financial Crisis defaulting Russia. This is the late-2010’s Russia that has substantially hardened its financials and built up massive reserves over the past decade.

Fitch, Moody’s, and S&P all boosted the country’s credit rating to investment-grade status in 2018 and 2019. That doesn’t mean a whole lot (they said subprime securities were fine in 2008), so let’s look at the numbers.

Russia has less debt as a percentage of GDP than most other countries by a wide margin:  

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Data Source: BIS

Russia also has very large foreign-exchange reserves as a percentage of GDP:

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Data Source: Various central banks, Trading Economics, CIA World Factbook

A significant portion of these reserves consist of gold. Russia has a been a consistent buyer of gold month-after-month, including straight through their 2015 recession:

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Chart Source: Trading Economics

Russia is now the fifth-largest official holder of gold, and they are in striking distance of leap-frogging France and Italy to reach the #3 spot behind the United States and Germany. (China is often thought to have more gold than it reports, but that’s another discussion.)

What’s particularly notable is how tight Russia’s money supply is. Their reserve-to-GDP ratio is a solid 27-31% (depending on time period), but their reseve-to-M2 ratio is extremely high at over 60%:

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Big money-printers like China and Japan have a larger broad money supply than GDP. Russia’s money supply is much tighter, and over 60% of it is backed up by reserves. Based on how much gold they have relative to money supply (approaching 15%), Russia is arguably the country closest to being able to put its currency on a gold standard if for some reason it wanted to. They won’t and they shouldn’t, but they almost could.

Russia’s 10-year government bond yield currently pays 7%, while inflation in Russia is 4.3%, representing a 2.7% real yield.

The Russian government has a fiscal surplus. The country has a positive trade surplus and positive current account.

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The Dollar Problem

Currently, there is a global U.S. dollar liquidity squeeze which is pushing the USD to high levels. While this may very well get worse before it gets better, the U.S. financial system is straining as demonstrated by multiple consecutive days requiring Fed repo activity, and will likely need to restart QE to monetize government deficits sooner than a lot of market participants realize. The long-term trajectory of the USD is down.

This chart shows U.S. GDP as a percentage of world GDP in nominal and purchasing power parity (PPP) terms over the past three decades:

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Data Source: World Bank

With about 4% of the world’s population, the U.S. represents about 15% of the world’s GDP based on purchasing power parity (our actual ratio of goods and services created), but a whopping 24% of the world’s GDP based on nominal USD GDP. This is because the dollar is very strong right now.

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Chart Source: St. Louis Fed

In 1985, 2000, and currently, the USD has had these big currency strength spikes. But fundamentally, the U.S. has large fiscal deficits and a structural current account deficit, and after decades these problems are starting to cause tangible strains on the U.S. financial system (and elsewhere).

If the USD were to drop in relative value to where it was in 2012/2013, that would be a 20-25% currency devaluation.

The Russian currency is on the other side of the spectrum due to sanctions and other issues. The Economist considers the Russian currency to be 43-65% undervalued compared to the U.S. dollar in 2019, which puts it near the very bottom of the spectrum of currencies despite the fundamental numbers of the currency.

As long as Russia’s currency is this cheap, it has a huge advantage in agricultural exports, and is taking market share from the U.S. and Europe due to lower costs.  

Sum of Parts and Weak Hands

Sberbank grew earnings at more than 12% per year over the past seven years, pays a 6% yield, has a P/E ratio of 6, and trades in a currency that is arguably over 40% undervalued compared to USD.

Suppose conservatively that, going forward, the company only grows earnings 5% per year, pays a 5% yield, grows to a P/E ratio of 8 over the next five years, and the Russian currency appreciates 20% vs the dollar over the next five years.  

Investors would make annual returns from 5% growth, 5% dividends, 6% average annual valuation improvements, and 3% average annual currency improvements, for a total of 19% annual returns. That won't necessarily happen, but it's not hard for a model to approach that as a baseline. 

There are various tail risks with owning Russian equities, like maybe one day the Russian government decides to own 100% of its state-owned enterprises, or sanctions prevent you from owning shares anymore and you have to sell at an inopportune time, etc. Russian equities deserve a discount.

The whole point of diversification is to spread an investor's types of risk out. Most investments have risk related to the economic cycle. However, at face value, an investment in Sberbank would find it difficult not to make money over the next 5+ years straight through most economic problems, as long as certain tail risks don’t occur. As a small position, it’s a way of spreading out your risk profile.  

This is the type of stock that could go down 50% before it goes up 100%, regardless of fundamentals in the intermediate term. It's not a stock suitable for investors with "weak hands", in other words. Investors should only consider it if they do their own due diligence and have high conviction to stick with it as a small part of a diversified portfolio.

Lyn Alden Schwartzer covers North American stocks and international equity ETFs with a focus on fundamental valuation. Her background is a blend of engineering and finance, and she uses a dispassionate long-term quantitative and qualitative approach to filter through the noise and find value in stocks and markets around the world.
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