This High-Yielder Will Make You Reconsider Russian Stocks

Richard Robinson's picture

Tuesday, February 6, 2018 - 2:30pm

by Richard Robinson

Contrarian investors like to buy stocks other investors despise. This is how value investors find stocks with the potential to produce outsized returns. And it works, too. After all, Warren Buffet and Seth Klarman have made good livings finding and investing in value stocks.

And if it works for them, it will work for investors with a lot less money to invest. But the problem is that U.S. stock markets sit near record levels, meaning even marginal companies have seen stock prices rise for no good reason. This is the result of several years of interventionist Federal Reserve policies.

This explains the nosebleed levels where many financial metrics reside. For example, the S&P 500's price-to-earnings ratio (P/E) is 26.7 -- a 70% premium to its average. A better predictor of valuation is the cyclically adjusted price-to-earnings ratio (CAPE). Presently, the CAPE ratio sits at 34.59 -- more than 105% above its mean. Even the price-to-book ratio, at 3.58, is 30% higher than its long-term average.

So what's an investor to do?

Value investors have little choice but to seek value plays outside of the United States. And that's the reason I'm looking for value in an unusual place -- Russia. Now, I know Russian stocks are some of the most hated stocks on the planet. But that begs the question...

Of all of the hated Russian stocks available to investors, are they all bad?

Of course not. There are many safe stocks that prudent investors should consider placing inside their portfolio. Better yet, Russian stocks are dirt cheap, too. The CAPE ratio for Russian stocks sits around 6, roughly 82% lower than U.S. stocks.

But, before considering any Russian stocks, you must understand the macro-economic environment in Russia. You see, the Russian economy revolves around oil. In fact, crude oil makes up 33% of its exports, and refined oil products add another 16%. In other words, Russian stocks almost mirror the movements in the price of oil, as illustrated in the following chart.

Now, I can almost hear the chorus of analysts deriding the idea that Russian stocks are undervalued in light of oil prices that most believe will continue channeling in the mid-50s range.

That's okay, because evidence is building that they're wrong. Almost without exception, the data suggests that as oil inventories continue drawing down, oil prices will continue rising for an extended period before production is able to recover. The only real question is how quickly producers can increase production to offset the drawdown that started 18 months ago.

And my feeling is oil prices are headed higher for longer than anyone ever anticipated. And that's bullish for Russian stocks.

The Verizon Of Russia
That's led me to look for Russian stocks that meet my requirements with a large float and solid fundamentals. In turn, that led me to Mobile TeleSystems (NYSE: MBT). MBT is the leading provider of cellular phone service in Russia, as well as fixed-line broadband and pay-TV services. The company boasts 80 million subscribers in Russia, along with another 25 million subscribers in Ukraine, Armenia, and Turkmenistan.

Think of it as the Verizon (NYSE: VZ) of Russia.

Now, as you can see from the chart, the stock didn't do much in 2017, rising just 8.7%. But that's likely to change going forward. You see, MBT's parent company, Sistema, reached an agreement with Rosneft, Bashneft, and the Republic of Bashkortostan (a federal subject of Russia). The agreement ends a two-year battle that has put significant downward pressure on MBT shares.

This isn't the only headwind to MBT shares. Much like we see in the United States, the competition for dominance in the Russian market for cellular domination is fierce. This has resulted in narrow margins and falling prices.

But that, too, seems to be over. MBT and its competitors have reported an end to falling prices. In addition, they have announced plans to cut the number of retail locations, thereby reducing overhead. This should serve to solidify margins.

With its parent company's legal troubles behind it, and an end to cutthroat competition, shares of MBT should recover steadily. Of course, this will be further boosted by steadily higher prices for Russian oil.

The stock is priced right, too. MBT trades with a trailing P/E of 6.3. But a better measure is the enterprise value (EV) divided by earnings before interest, taxes, depreciation, and amortization (EBITDA). At 3.7, MBT's EV/EBITDA makes for a compelling buying opportunity, and indicates the company is undervalued -- even by Russian standards. This is underscored by recent upgrades and recommendations by JP Morgan Research and Morgan Stanley.

Making the deal even sweeter is MBT's 7.6% yield that pays investors handsomely while awaiting the basic investment thesis of this moneymaker to unfold.

And it makes MBT a must-have stock for any value investor.

Risks To Consider: At the end of the day, Russia is still an emerging market, and is therefore more volatile than markets in the United States or Western Europe. Patience is required to invest here. Furthermore, investors face currency risk that could impact returns. Lastly, the investment thesis underwriting this recommendation is the future of oil. Should oil prices fall to previous levels, all Russian stocks will feel the impact.

Action To Take: Buy shares of MBT up to $13. Mitigate risk by applying no more than 3% of your portfolio into shares of MBT. Use a hard stop at $7.50 to protect your portfolio. This is a value play that may take more than 12-24 months to fully develop, so be patient. As such, this recommendation is best suited for investors with a time horizon greater than 24 months.

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does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.