The Globe and Mail

  Cautious on contrary Russia


Monday, December 29, 2014

Odds are that if Pyotr Ilyich Tchaikovsky somehow had access to the world today, he would be far less concerned about the price of oil and the gyrations of the Russian economy than about how many places are playing his creation, The Nutcracker. Perhaps global stress would be reduced if more people dropped their gazes from how much it costs to fill up the tank and watched his (arguably) greatest work.

Let’s face it: the Russian economy is a mess. Earlier this month, the interest rate was pumped from 10.5 percent to 17 percent, like a nightmare from A Town Called Panic. A primary goal was to reduce the fall of the cascading ruble, which seems to be going down almost in tandem with the slippery slide of oil prices. Plus, the powers that be in Mother Russia hope to restrain capital flight as corporations and citizens do not want to be caught with a currency that is rapidly losing its buying power.

The government has been extolling the virtues of the lid on inflation to the citizenry, although that cap could be blown asunder with the assault on the ruble’s value.

As contrarians, when a catastrophe is the order of the day, our attention turns to the investment opportunity, and Russia is certainly easier to buy into than the old days. There are numerous ETFs that will cater to those wanting Russian exposure, as well as a number of American Depository Receipts listed in the United States.

One that is on our Stock Watch List is Mechel OAO. This is a huge mining and steel outfit that had revenues of about $8.6 billion last year. But it lost more than $2.9 billion — the second year in a row the bottom line was particularly ugly.

The first nine months of this year showed no improvement; revenue continued to tumble to $5 billion and the red ink bled to the tune of $1.2 billion. The stock price that tickled $57 in 2008 and started this year above $2.50 currently is fighting to tread water at 75 cents.

It might get worse quickly; the company has suspended principal and dividend payments on the fat debt of almost $8 billion. That news led Moody’s to downgrade the company to a limited default designation.

Bankruptcy is quite possibly looming on the horizon, although a deal was just announced with the Eurasian Development Bank, pushing out some payments to 2016. The extent of the problems made us decide to view this one from a distance.

There is also another major reason to stay away. Corruption is rife in Russia, and doing business there can be difficult, with different parties often taking their piece of "skin." Given the level of dishonesty, we simply find it better to invest in safer climates.

It can’t be ignored that President Vladimir Putin can change the rules pretty much on a whim, and that means more instability for investors. This does not preclude us from buying into this market; it simply means that the positives have to be really powerful to counteract the negatives.

These problems have impacted our view of Kinross Mining, a classic contrarian play. The stock price was hammered with the battering of the gold price and the enterprise’s heavy debt load. In addition, the corporation garners about a quarter of its revenue from Russia, and many potential investors — including us — are quite concerned that President Putin might decide that Kinross should suffer repercussions, perhaps even become a Russian entity, as he engages in verbal fisticuffs with Prime Minister Stephen Harper.

Overall, this company, which currently trades at around $3 (down from north of $20 in 2009) is attractive by many metrics. The cost of production last quarter was only $698 Au eq. oz; all-in sustaining cost was $911 Au eq. oz. The current debt is a mere $60 million, with the repayment timetable on the $2 billion of long-term debt fairly reasonable.

In addition, the company has a rich history, operating since 1972, and has been able to ride out previous storms in the commodity patch. At this point, we are watching it closely, comparing it with other gold producers in the field, none of which are close to slam dunks in our minds as investments.

However, that Russian bear is unpredictable, and people choosing to buy into this company are taking on significant risk. It is akin to playing Russian roulette.

Undoubtedly it will be a long, dark winter for the citizens of Russia. The music of Tchaikovsky might help soothe the senses in a land where drastic transformations can happen quickly and unexpectedly. Fortunately, the classics are immutable.