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. Last Updated: 07/27/2016

Gazprom, State Top Picks for '08

Every new year starts with a few good resolutions, most of which are soon lying by the wayside. But investors in Russia will be hoping that the government keeps its promises, as they bank on big infrastructure spending to fuel stocks in the year ahead.

The benchmark RTS index is hanging short of its all-time high of 2,360 points, but strategists predict that it will go much, much higher next year.

Underpinning this confidence is a sense of political stability following President Vladimir Putin's nomination of Gazprom chairman Dmitry Medvedev as his chosen successor, and his agreement to serve as prime minister. Recent weeks have also seen a flurry of important deals, including three announced on Friday alone: RusAl winning a stake in Norilsk Nickel, VimpelCom's $4.3 billion deal to acquire Golden Telecom, and AXA's purchase of a stake in insurer RESO-Guarantia. (Stories, Page 5.)

Renaissance Capital and UralSib are leading the bulls for 2008, predicting that the RTS will breach the 3,000-point barrier by the end of next year, a 33 percent increase on current levels. It's a strong claim as the volatility on global financial markets continues to pose a real risk to economic growth prospects.

"The market here should continue to perform even if the economies in Western Europe and the U.S. do not," said Philip Townsend, head of research at Metropol. "If things do get rough, fund managers will technically still be trying to find a home for their money, and Russia will be an obvious example of where to put [it]."

Russia is going strong, with Putin saying last week that GDP growth would reach 7.6 percent for this year. And if a U.S. recession can be avoided, said Chris Weafer, chief strategist at UralSib, the RTS could even top 3,500.

Others are more cautious. Alfa Bank estimates an RTS high next year of 2,920 points, while Troika Dialog puts the figure at 2,800.

Max King, strategist at London-based Investec Asset Management, is convinced that Russia is a big-growth story among emerging markets for 2008.

"To some extent, there is a mismatch between the generalized popular perception of Russia and actually what goes on in terms of the markets," King said. "It has performed very well and people who invest in Russia have done very well. Looking around the BRIC markets, Russia has got the best potential."

Not that it has been showing that potential. The RTS has risen by a solid but unspectacular 19 percent in the year to date, underperforming China, Brazil and Turkey.

Many have attributed that lack of momentum to political uncertainty, but now investors are looking to the Putin-Medvedev "dream team" to continue the job that Putin started. To that end, the government has made promises to pump money into infrastructure in tandem with the private sector.

"It seems to us that the political priority is the modernization and diversification of the economy beyond the extractive industry," said Ron Smith, chief strategist at Alfa Bank. "If you're going to have a modern, diversified economy, you need an infrastructure to run that economy."

Steelmaker Evraz will be one of the best ways to play the infrastructure story next year, Weafer said, while analysts at Metropol said they expected the growth to shift toward value-added sectors, such as pipe makers, among them Vyksa and Chelyabinsk Pipe. Norilsk, whose stock has soared over 2007, received some support based on continuing strong metals demand from China.

With very few exceptions, analysts have identified Gazprom as their top pick for 2008. One of its main drivers is the expectation of higher profitability following recent approvals to hike domestic tariffs for industrial users.

Independent gas firm Novatek will be a big winner in the deregulation of tariffs, analysts said. Citibank noted in a report Thursday, however, that a failure to secure pipeline access from Gazprom could place downward pressure on its price.

TOP PICKS FOR 2008
RTS End-2008 Targets
RenCap - 3,000
UralSib - 3,000
Alfa - 2,920
Troika Dialog - 2,800
KIT Finance - 2,750
Aton - 2,690

Top Blue-Chip Picks
Gazprom
Sberbank
Comstar
UES*
Norilsk Nickel

Top Mid-Cap Picks
Magnit
Raspadskaya Coal
Polymetal
Moscow City Distribution Co.
Vozrozhdeniye Bank

Recommendations compiled from Alfa Bank, UralSib, Renaissance Capital, Aton, Troika Dialog, IFC Metropol, KIT Finance and Trust investment bank.

*To be wound up in mid-2008.

Despite oil prices still being within striking distance of $100, analysts and investors say oil has had its day, although Rosneft and LUKoil still made it onto some banks' top picks. Combined with the Kremlin's push for diversification, high taxation on oil firms has taken its toll, and investors are looking for rewards elsewhere.

Telecoms are a good sector to follow in 2008, Metropol's Townsend said.

"Personal incomes [are] growing about 12 percent per year. People will wish to spend it in exactly the same way as in the past, [and] ... one of the key things people spend money on is mobile telephony," said Townsend, marking out MTS and VimpelCom as interesting prospects.

The growth in disposable incomes leaks over into other sectors, too, with retailers set to be among the winners. After Gazprom, mid-cap pick Magnit emerged as the most popular prospect for 2008, while X5 also picked up some votes.

"Magnit has a really strong position in the regions," Weafer said. "And it could very easily be taken over."

Real estate is expected to continue its strong 2007 performance as residential and office-rental prices climb. PIK Group and RGI International were among the top picks here.

Sberbank is the favorite stock in the banking sector, valued for its status as a proxy for the economy. While the global credit crunch has battered some Russian banks, Sberbank has been one of the best-sheltered stocks from the external upheaval. Among smaller banks, Vozrozhdeniye and Ursa were also noted for their potential.

Unified Energy System, which will be dismantled by July, received some support. "UES is still undervalued for the basket you're going to wind up with after the breakup," Alfa's Smith said. "We like the industry very much and the way to play it is with UES, especially if you're willing to take the risk that you'll wind up with some illiquid assets."

It might not yet all be plain sailing, Weafer said. "What investors will be looking for most is evidence that the government is going to deliver on its promises on spending and reform." he said. "Any dithering or delays ... and the Russian story will suffer."