Russian stocks have been hit hard by Western sanctions, so are there some value plays hanging around Moscow? Many Russian equities that look cheap trade on the London Stock Exchange, such as the large and mid-cap companies we analyzed in this previous AlphaNow article. Let’s sit by the samovar and look at Rosneft Oil Co. (ROSNq.L), one of the largest companies in the important energy sector.
There’s a huge disconnect here – investors seem far more pessimistic about growth expectations than analysts, even though analysts are already calling for earnings to shrink for the sector over the next five years.
Source: StarMine
That sinking feeling
As you can see in the chart above, analysts expect earnings to shrink by almost 2% a year for the next five years for the energy sector in Russia. Yet the markets’ outlook is really dark. Using the StarMine Intrinsic Value model, markets are expecting earnings to shrink by 25% every year for the next five years. To put this in context, if we assume that the current earnings are $100, the market is pricing stocks such that they are expecting earnings to be just $24 in five years, less than a quarter of their current earnings.
Source: Eikon/StarMine
Drilling for answers
We look at Rosneft Oil to try and understand the discrepancy between analyst estimates and market expectations. The company seems cheap by almost every measure, including the StarMine valuation models. It scores a best possible score of 100 on the StarMine Relative Valuation model that combines several of the most comonly used valuation metrics. It compares the company to its peers and ranks it accordingly, and it looks like Rosneft may be one of the cheapest companies around. The current forward 12M P/E is 4.7, below its historical five year median of 6.3 as seen in the chart above. You’ll be hardpressed to find many cash generating companies trading at P/Es of less than 5.
Source: Eikon/StarMine
Why the red flags?
Analysts have become pessimistic on earnings growth based on the recent political instability involving the Ukraine and the StarMine projected growth rate of -4.7% reflects just that. What that means is that analysts expect earnings to shrink by almost 5% every year for the next five years. Market expectations, based on current price however are much lower, equating to earnings shrinking by 26% a year for the next five years. Despite falling oil prices and the crumbling rouble, that still appears overly pessimistic.
However, given that oil prices have been falling (they are down by 30% over the past three months), and the political uncertainty in the region, perhaps the markets are overreacting? After all, Rosneft does continue to generate strong cash flows from operations, and is currently giving out 3.4% dividend yield. It has doubled revenues over the past three years.
The company does have several large capex projects that may be delayed or cancelled if oil prices continue to fall, but those expenditures seem to be funded by strong cash flow from operations. Another positive is that BP plc (BP.L) owns a 20% stake in Rosneft, and recently signed a deal with Rosneft to receive at least $1.5 billion dollars worth of deliveries from Rosneft. So while western sanctions may hit other Russian companies hard, Rosneft might have a cushion in its partnership with BP.
Source : Eikon/StarMine
Looking behind the numbers
Analysts have been pessimistic on Rosneft, lowering earnings estimates for Rosneft by 16% and 18% for this year and next year respectively. The fact that the markets are even more pessimistic, could indicate some value here, assuming that oil prices do not keep falling indefinitely. The weakness in the rouble could also be a headwind, but with strong quality earnings, Rosneft is one example of a stock in a politically uncertain region that may be a better value than its comrades.
