We first looked at dominant Russian bank Sberbank (MICEX:SBER) after a presentation at the Italy Value Investing Seminar in July 2013, filing it under ‘interesting’.
It barely collected any dust. The panic surrounding the Ukrainian crisis sliced more than one-third off the stock (in US dollar terms) in the first three months of 2014, and the Fund acquired a position in mid-April. The London-listed Sberbank American Depository Receipts (LSE:SBER) currently make up 2.5% of the Fund’s assets. Roughly half of the underlying Russian rouble exposure has been hedged back into US dollars, as partial insurance against greater turmoil in the region.
Sberbank dominates the Russian banking sector in a way that would make an Australian Big Four bank blush. It commands a 44% share of Russia’s retail banking deposits—partly a quirk of the 1998 crisis when a government guarantee applied to deposits with this bank alone. Every sane Russian transferred their bank account to Sberbank. It has about a third of the market for retail and corporate loans and far and away the biggest branch presence in the country. The Russian government owns a little more than half of the shares outstanding.
The bank has a significant funding cost advantage versus competitors, and this translates into a very high net interest margin (NIM)—the difference between what the bank pays on deposits and what it collects on loans—of around 6%. We are anticipating significant contraction in this figure over the coming years. But the high NIM versus competitors and the quite conservative balance sheet (for a bank) gives Sberbank ‘last man standing’ status among Russian banks in any deeper crisis. We also think any erosion of the NIM is likely to be compensated by a concurrent expansion in the loan book; Russia’s personal debt levels are extremely low by global standards.
Although the stock has risen 13% on the Fund’s average purchase price, it still trades on a price earnings ratio of about 5 and a price to book value of less than 1.0 times. This is extremely undemanding for a bank generating 20%+ return on equity, with a hardy balance sheet and an extremely impressive history of earnings per share growth.
The stock pays a 3.0% yield despite currently paying out only 15% of its earnings (versus, say, the Commonwealth Bank which pays out about 75% of its earnings). There is significant scope, and also fresh political pressure, to expand the dividend. But there are also opportunities to reinvest retained earnings at high rates of return. Either suits us fine.
We’ve gone in eyes wide open to the likely shrinking of the NIM and increase in bad debts over the coming months and years. Even allowing for that, the stock looks dirt cheap.
Of course, every investor in Russian stocks takes on some risk that their investment goes to zero. All Russian stocks, even those not controlled by the government as majority shareholders, should be viewed as a non-voting minority stake in partnership with Putin. While in the good books now, Sberbank might not always hold favour in political circles and no Russian company is completely immune from being Yukos-ed (wiped out). But we think it is considerably more likely that the Fund’s modest speculation will double or triple in value in a few short years, and feel the upside outweighs the risk.
This excerpt is from the Forager International Share Fund’s June 2014 quarterly report. Please download the report for more detail on the Fund’s recent activities.