investment outlook second quarter 2014 updatesource: epfr, vtbc investment management investors...

Investment Outlook

Second Quarter 2014 Update

April 2014

VTB Capital IM Equity and FI Research Team

For Professional Investors Only

The Russian Investment Case

Geopolitics

Macro

Fixed Income

Equities

FX

Appendix

Contacts

Content

Emerging Markets (EM)

Assets

75% of the world‘s land mass

87% of global population

86% of global oil reserves

91% of global gas reserves

77% of global FX reserves

Liabilities

11% of global external debt

Economic Output, Growth and Ratios

45% of global PPP Adjusted GDP

4.5% Average GDP growth rate

24% Total Debt to GDP (PPP Adjusted)

Policy rates have peaked

People motivated to improve their lives

Developed Markets (DM)

Assets

25% of the world’s land mass

13% of global population

14% of global oil reserves

9% of global gas reserves

23% of global FX reserves

Liabilities

89% of global external debt

Economic Output, Growth and Ratios

55% of global PPP Adjusted GDP

1.5% Average GDP growth rate

162% Total Debt to GDP (PPP Adjusted)

Policy rates have troughed

People bloated on excess consumption

Sources: Barclays Capital, IMF, Bloomberg, CIA World Fact Book

Despite these supportive

demographics and fundamentals,

equity allocations to EM are only

12%.

EM vs. DM – Fundamentals Support Higher EM Allocations

Higher Returns over the Long Term

0

200

400

600

800

1000

1200

1400

RTS Shanghai SE Ibovespa Brazil Sensex India S&P 500

Normalized Returns as of 1996

Source: Bloomberg, VTB Capital IM Research estimates

Sources: Bloomberg, VTCIM Research

Within Emerging Markets, Russia Stands Out with Value Country MCAP (USD) PE EPS GR PEG PB ROE PB/ROE EY CDS 5yr L R S&P

China 2 459 356 052 082 8,13 10,70 0,76 1,39 13,87 0,10 9,6% 89 AA-

Korea 1 095 182 050 715 12,00 6,75 1,78 1,16 3,41 0,34 0,7% 64 A+

S. Africa 878 497 525 994 14,27 8,27 1,73 2,29 11,89 0,19 5,5% 190 BBB

Taiwan 841 927 811 475 15,10 6,01 2,51 1,83 10,29 0,18 5,2% n.a. AA-

Brazil 790 664 966 215 10,09 8,14 1,24 1,18 6,94 0,17 5,9% 159 BBB-

Russia 538 274 437 500 4,68 -0,43 n.m. 0,61 11,76 0,05 18,5% 245 BBB

India 621 045 648 114 14,28 13,44 1,06 2,71 16,59 0,16 5,7% 219 BBB-

Mexico 335 320 168 273 18,39 8,25 2,23 2,71 12,66 0,21 4,4% 86 BBB+

Poland 123 559 169 492 13,71 6,23 2,20 1,35 9,41 0,14 6,9% 73 A-

Chile 185 623 406 900 16,04 6,48 2,47 1,70 8,32 0,20 4,7% 77 AA-

MSCI EM 7 614 945 500 000 10,88 4,79 2,27 1,50 12,90 0,12 8,5%

Data as of : 15-Apr-14

0

10

20

-5 0 5 10 15

PE R

atio

EPS Growth

MSCI EM

China

Brazil

Taiwan

India

Chile

Korea

Russia

S. Africa

Mexico

Poland 0,0

0,5

1,0

1,5

2,0

2,5

3,0

-12 -6 0 6 12 18

Pric

e t

o B

oo

k

Return on Equity

ChinaKoreaS. AfricaTaiwanBrazilRussiaIndiaMexicoPolandChileMSCI EM

Source: Bloomberg, VTB Capital IM Research estimates Note: bubble size is proportional to market capitalization

Investment Summary DM economies stay within the low-inflationary growth environment. GDP growth numbers are being revised up while

inflation forecasts continue to trend down. EM economies are still struggling – economic surprise indices look worse compared to DMs, forecast revision momentum remains negative.

G-4 central banks are keeping the accommodative policy stance. The Fed is gradually tapering the asset purchase program with the first rate hike expected in 2015. BRICS’ central banks raise interest rates to defend currencies.

Rising geopolitical tensions due to Crimea / Ukraine developments demand a higher risk premium for Russian assets. Equities and local money market rates were hit the most.

Deeply discounted asset prices have triggered interest from distressed and contrarian investors. Trading volumes rose 2-3 times compared to February levels, a significant rotation of the investor base is seen in many segments / names. Russian equities have seen USD 589mn of inflows through all fund categories since the beginning of March.

The Russian economy continues to cool down with the growth of key macro indicators decelerating. The cyclical improvement in developed market economies is likely to support growth in 2014.

CBR unexpectedly hiked the key rate by 150bps in March. FX interventions were also increased. The purpose of the tightening was to dampen capital outflows and prevent excessive ruble weakening in the wake of developments in Ukraine.

Local bonds are likely to deliver more than 9% returns over the next 12 months in both government and corporate segments under a low-inflationary scenario.

We expect Russian Eurobond returns within 4-11% range in USD over the next 12 months depending on the macro scenario.

The top-down scenario-weighted upside for the RTS index is more than 60% according to our estimates. Market cap weighted aggregate upside to our DCF estimated fair values provides more than 60% upside in 2014. Dividends and share buy-backs remain the key forces for unlocking fundamental value in the short term. Higher corporate efficiency, less corruption and lower political risk remain the long term drivers. Russian equities must more than double in order to close the accumulated five-year performance gap with fixed income. Double-digit EPS growth is quite realistic in certain cyclical sectors and export oriented sectors will benefit from the weaker ruble.

Source: US Government, EU Council, media, VTB Capital IM

Western sanctions against Russia – moderate impact Russia’s annexation of Crimea was

not recognized by the West, which in

response imposed sanctions.

The first stage of sanctions affected

military and political cooperation with

Russia and individual Russian

politicians. These sanctions will

have almost no impact on the

Russian economy.

The second stage of sanctions

targeted a small circle of Russian

businessmen and companies and

will have a limited impact on the

Russian economy.

The third stage of sanctions would

have the biggest impact on the

Russian economy, however, at this

point this is unlikely and will depend

on further developments in Ukraine.

Other costs to Russia may include

higher capital outflows for the next

year or two, lawsuits in courts

against Russia all over the world

seizing Russian assets to settle

Ukrainian claims, higher cost of

capital for debt refinancing, etc.

Type of sanction Russia Politicians Businessmen Companies Economic

sectors

Limitations on cooperation 1

Military cooperation 1

Political cooperation 1

Visa restrictions 1 2

Travel restrictions 1 2 2 3

Asset freezes 1 2 2 3

Other economic sanctions 2 3

Western sanctions are moderate

Active sanctions Potential sanctions

1 stage – light sanctions, 2 stage – medium sanctions, 3 stage – heavy sanctions

The second stage of sanctions has been imposed on a small circle of Russian

businessmen and companies; it will have a minimal impact on the Russian

economy.

Source: EPFR, VTBC Investment Management

Investors React with Inflows

YTD cumulative outflows

from Russian equities

through funds tracked by

EPFR stood at $1,7bn as of

09.04.2014.

However, investors reacted

rather positively to the

moderate sanctions

imposed on Russia by the

West.

From the beginning of

March to the start of April

net inflows to all categories

of Russian equity funds

totaled $589 mln.

The biggest inflow during

this period was seen in

Russia-focused ETF funds

totaling $912 mln.

It seems that foreign

investors expected more

serious sanctions against

Russia, and this did not

materialize.

589

(252)

912

139

(223)

(34)

47

(500) - 500 1 000

Russia Net Flows Total

Actively managed Funds

ETFs

GEM Funds

EMEA Funds

BRIC Funds

Others

Fl ows into Russian equities by fund categor y

over the last month (05.03.2014 - 02.04.2014)

(800)

(600)

(400)

(200)

-

200

400

600

Fl ows into Russian equities by fund cat egory, $ mn - significant inflows by inst itutional invest ors

Others BRIC Funds

EMEA Funds GEM Funds

ETFs Actively managed Funds

Source: MOEX, Cbonds, CBR, Bloomberg, VTBC Investment Management

What is the geopolitical discount for Russian assets?

The political situation in

Ukraine took a sharp turn on

the night of 21 February when

an agreement was signed

between the government and

the opposition.

After this Russian assets came

under considerable pressure,

and a geopolitical discount

emerged due to the risk of a

further escalation in the crisis.

The biggest effects were seen

in stocks and the ruble money

market, where the geopolitical

discount was highest.

The least affected were the

various ruble bond segments,

where the share of non-

residents is rather low.

On the whole the geopolitical

discount remains in Russian

assets, and the size of this

discount will heavily depend on

how events develop in Ukraine.

70,0

75,0

80,0

85,0

90,0

95,0

100,0

Index

sin

ce 2

1.02.2

014

(H

igh

=10

0)

Per for mance since 21.02.2014 - when Ukr anian tensions significant ly escal ated -

money mar ket and equit ies suf fer ed the most

High Low Close, end of March '14

Source: MSCI Barra, Bloomberg, VTBC Investment Management

Could Russia become a periphery market?

There have been many

instances where markets

were re-categorized from

emerging to periphery.

The clearest examples are

Argentina in 2009 and

Malaysia in 1998, with both

countries losing their EM

status after placing controls

on capital operations.

Malaysia subsequently

returned to the EM

category.

Currently Russia does not

meet any of MSCI Barra’s

criteria for a downgrade.

In terms of liquidity,

accessibility, share of equity

free-float and access for

non-residents, Russia fully

meets the criteria for an

EM.

* Current Venezuela information [in brackets] given on date 04.01.2008 before it was removed from MSCI Indices. Index Member information not available

** The Malaysian stock market was returned to the category of EM in May 2010 as a result of increasing investor access and raising market liquidity

MSCI Index Downgrades in Classification

MSCI

Country

Index

From To Moving

Date

P/E

Ratio at

Moving

Date

Current

P/E

Ratio

Index

Market

Capital at

Moving

Date (USD

bn.)

Current

Index

Market

Capital

(USD bn.)

No. of MSCI

Index

Members at

Moving

Date

Current

No. of

MSCI

Index

Members

MSCI Reasons given for Downgrade

Argentina Emerging

Markets

Frontier

Markets May 2009 7 6 4,1 18,7 4 6

Governmental controls on capital flow

decrease foreign investment accessibility.

Jordan Emerging

Markets

Frontier

Markets

November

2008 12 15,5 14,1 9,11 4 3

Most constituents of MSCI Jordan did not

meet the size and liquidity requirements for

EM Indices.

Pakistan Emerging

Markets Stand alone

December

2008 4,8 9,9 10, 3 30,1 8 12

Deteriorated investability conditions prevailing

in equity market.

Sri Lanka Emerging

Markets Stand alone June 2001 - 14 0,0252 3,96 6 3

Large decline in equity market – insufficient

size and liquidity of companies in the Index.

Trinidad &

Tobago

Frontier

Markets Stand alone May 2011 13,2 13,2 2,84 4,04 2 2 Persistent deterioration of liquidity.

Venezuela* Emerging

Markets Stand alone May 2006 12 [5,8] [3,3] [16,6] - -

Continued presence of investability

restrictions linked to the foreign exchange

regime of February 2003, lack of liquidity of

constituents and continued weight decrease

of the Index in previous years.

Greece Developed

Markets

Emerging

Markets May 2013 8 8,7 7,86 65,4 2 10

Decreased market accessibility – trading

controls implemented, increased difficulty of

stock lending and short selling. Decreased

capitalization of stocks in Index.

Morocco Emerging

Markets

Frontier

Markets

November

2013 14,1 16 20,9 36,1 3 8

Failed EM liquidity criteria for several years

and showed no sign of reversal.

Malaysia Emerging

Markets Stand alone May 1998 15 16,8 48, 6 349 77 44

Capital outflow restrictions; prohibition of

offshore ringgit trading.

Memorandum items:

Russia Stand

alone

Emerging

Markets

December

1997 0,2 4,6 - 493 - 22 ---

Source: IMF, Bloomberg, VTB Capital IM Research estimates

Developed economies are

moving toward a low

inflationary cycle – GDP

forecast revision

momentum is positive and

CPI momentum is negative.

The economic surprise

index of G-10 countries has

worsened over the last 3

months, which is slightly

worrying.

Developing economies are

still under pressure and

restrain global economic

growth. EMs’ economic

surprise index looks much

worse than that of DMs.

Also the momentum of GDP

and CPI revision looks bad

in EMs.

The forecasted GDP growth

for developed economies is

close to long-term potential.

DMs look worse, as they

are in slowdown.

Global economy – developing versus developed economies

DM

67%

EM

37%

NORTH

AMERICA

27%

EUROPE

25%PACIFIC

11%

EMEA

7%

LATAM

8%

ASIA ex.JAPAN

22%

Nominal GDP Br eakdown -DMs ar e st ill bigger than EMs,

2013

0,00

1,00

2,00

3,00

4,00

5,00

6,00

7,00

DM EM Global

YoY, %

GDP gr owth should be back on t r end in DM, EMs should

fol low

LT GDP growth Real GDP growth, conensus Bloomberg '14

-0,40

-0,30

-0,20

-0,10

0,00

0,10

0,20

0,30

DM EM Global

pp

The weakness of the global economy is st il l

concent rated in EMs, where GDP growth momentum is

negative and CPI growth momentum is positive

Real GDP revision momentum (3 months), consensus Bloomberg '14

CPI revision momentum (3 months), consensus Bloomberg '14

-30,00

-15,00

0,00

15,00

DM EM Global

Index

Economic Surpr ise Index has worsened in DMs and EMs

over the last 3 months

Economic Surprise Index, current Economic Surprise Index, average, last 3 months

After the transition from a

planned to a market

economy in the 1990s

Russia mainly followed a

stagflation cycle.

In the 2000s the economy

began to actively accumulate

investments during the

commodity boom, following

an inflationary growth cycle.

Over the past few years

Russia has suffered a

slowdown due to softer

demand for commodities and

high-base effect coming into

play.

But for the first time in recent

history the Russian economy

is entering a new period of

low and stable inflation.

* Negative overall effect seen when economic growth comes on the back of an increase in spending without productivity growth

Source: Rosstat, IMF, VTB Capital IM Research estimates

Russian economy – a long way to low-inflationary growth

35%

14%10%

6%

9,2х

0,0

2,0

4,0

6,0

8,0

10,0

0,0%

10,0%

20,0%

30,0%

40,0%

50,0%

CPI is cool ing af ter t r ansition per iod of 90's and

commodity super cycle of 2000's

Average CPI, % yoy, l.s. Average CPI, multiplier yoy, r.s.

2%

6%

4%2%

-10%-12,0%

-8,0%

-4,0%

0,0%

4,0%

8,0%

Al so GDP gr owth is deceler at ing af ter stagf lat ion

per iod of 90's and inflat ionar y uptur n of 2000's

Average GDP growth, % yoy

5% 5% 5% 4%

18%

2% 1%1%

14%

12%

8%

5%

4%

4%

3%

2%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

Incre

menta

l gro

wth

yoy,

%

Final consumption government Final consumption households

Net export of goods and services Gross capital formation

Cont ribut ion t o Nominal GDP gr owth by Expenditur es

1 415

2 062

3 3889 423 15 411

-15,0%

-10,0%

-5,0%

0,0%

5,0%

10,0%

15,0%

Re

al G

DP g

row

th y

oy,

%

GDP per capita, $

One of the r easons of t he GDP deceleration is the diseconomy of scale*

The bubble size indicates nominal GDP per capita

The Russian economy remains

in the inertial scenario, which is

accompanied by decelerating

key macro indicators.

However, the cyclical

improvement in developed

economies and ruble

depreciation will support

Russian economic growth this

year.

In 2014 we believe a global low-

inflationary scenario is most

likely, with oil prices holding at

around $100/bbl.

This will support positive growth

rates for key indicators,

however, for more substantial

improvements higher oil prices

or structural reforms are

necessary.

Current state of the Russian economy – through the bottom

* Scenarios presented on the basis of the global economic cycle

Source: Rosstat, CBR, Finance Ministry, VTB Capital IM Research estimates

Russian E conom y – E stim ates and Forecasts

Indicators 2012 2013

fact fact Recessionary Low Inflationary Inflationary Upturn

Real GDP, % 3,4% 1,3% 0,8% 1,8% 2,7%

Industrial Output, % 2,6% 0,3% 0,5% 1,4% 2,2%

Fixed Asset Investments (FAI), % 6,7% -0,3% -0,3% 0,8% 1,9%

Real Retail Sales, % 5,9% 3,9% 1,1% 3,6% 6,0%

Real Wages per capital, % 7,8% 5,2% 3,8% 5,2% 6,3%

CPI, % average per year 5,1% 6,8% 5,7% 6,1% 6,6%

CPI, % December YoY 6,6% 6,5% 5,7% 6,5% 7,7%

Trade Balance, $ bln 192 179 134 165 189

Federal Budget Revenues, $ bln 12 854 13 020 11 405 13 019 14 368

Federal Budget General Deficit(-)/Surplus(+), % -0,2% -0,5% -3,6% -1,3% 0,6%

Money Supply (M2), % YoY 11,9% 14,6% 6,9% 13,8% 21,6%

Gross International Reserves (GIR), $ bln 538 510 423 491 544

Crude Oil Price, average, $/bbl 111 108 80 101 125

Scenario Probability, % 10% 65% 25%

2014 forecast

Ruble depreciation and flat

crude oil prices have a strong

positive impact on the federal

budget.

Our USDRUB sensitivity

analysis shows that the federal

budget looks quite balanced at

oil prices of 100 $/bbl and the

USDRUB at 33-35 rub./$.

Therefore, the Finance Ministry

doesn’t need to tighten fiscal

policy or reduce budget

expenditures that could be

dangerous for fragile economic

growth.

Additionally, the Finance

Ministry may reduce activity in

the bond market, as the current

yields of government debt look

elevated.

Source: CBR, Minfin, Bloomberg, VTB Capital IM Research estimates

USDRUB sensitivity analysis – stabilization of federal budget

Federal Budget surplus (+) / deficit (-), % of GDP

Crude oil prices, Urals $/bar

50 60 70 80 90 100 110 120 130 140 150 U

SD

RU

B a

vera

ge

40 -5,0% -3,2% -1,3% 0,5% 2,3% 4,2% 6,0% 7,8% 9,7% 11,5% 13,3%

39 -5,6% -3,8% -2,0% -0,1% 1,7% 3,5% 5,4% 7,2% 9,0% 10,8% 12,7%

38 -6,3% -4,5% -2,6% -0,8% 1,0% 2,9% 4,7% 6,5% 8,4% 10,2% 12,0%

37 -6,9% -5,1% -3,3% -1,4% 0,4% 2,2% 4,0% 5,9% 7,7% 9,5% 11,4%

36 -7,6% -5,8% -3,9% -2,1% -0,3% 1,6% 3,4% 5,2% 7,1% 8,9% 10,7%

35 -8,2% -6,4% -4,6% -2,8% -0,9% 0,9% 2,7% 4,6% 6,4% 8,2% 10,1%

34 -8,9% -7,1% -5,2% -3,4% -1,6% 0,3% 2,1% 3,9% 5,8% 7,6% 9,4%

33 -9,6% -7,7% -5,9% -4,1% -2,2% -0,4% 1,4% 3,3% 5,1% 6,9% 8,8%

32 -10,2% -8,4% -6,5% -4,7% -2,9% -1,0% 0,8% 2,6% 4,4% 6,3% 8,1%

31 -10,9% -9,0% -7,2% -5,4% -3,5% -1,7% 0,1% 2,0% 3,8% 5,6% 7,5%

30 -11,5% -9,7% -7,8% -6,0% -4,2% -2,4% -0,5% 1,3% 3,1% 5,0% 6,8%

Russian Federal Budget is balanced at a crude oil price of 100 $/bar and the

USDRUB at 33-35 rub./$

Ruble depreciation and flat

crude oil prices also have a

strong positive impact on the

current account.

Our USDRUB sensitivity

analysis shows that the current

account is positive at an oil

prices of 100 $/bbl and

USDRUB at around 32-33

rub./$.

The weaker ruble is stimulating

import substitution of goods

and services, which have a

positive impact on the trade

balance and ultimately on the

current account balance.

Finally, the expected

improvement in the current

account balance is a factor in

supporting above zero

economic growth in 2014.

Source: CBR, Bloomberg, VTB Capital IM Research estimates

USDRUB sensitivity analysis – improvement in the current account

Current account balance, % of GDP

Crude oil prices, Urals $/bar

50 60 70 80 90 100 110 120 130 140 150 U

SD

RU

B a

vera

ge

40 -5,0% -2,4% 0,2% 2,9% 5,5% 8,1% 10,7% 13,3% 16,0% 18,6% 21,2%

39 -5,9% -3,3% -0,6% 2,0% 4,6% 7,2% 9,8% 12,5% 15,1% 17,7% 20,3%

38 -6,8% -4,1% -1,5% 1,1% 3,7% 6,3% 8,9% 11,6% 14,2% 16,8% 19,4%

37 -7,7% -5,0% -2,4% 0,2% 2,8% 5,4% 8,1% 10,7% 13,3% 15,9% 18,5%

36 -8,5% -5,9% -3,3% -0,7% 1,9% 4,6% 7,2% 9,8% 12,4% 15,0% 17,6%

35 -9,4% -6,8% -4,2% -1,6% 1,0% 3,7% 6,3% 8,9% 11,5% 14,1% 16,8%

34 -10,3% -7,7% -5,1% -2,5% 0,2% 2,8% 5,4% 8,0% 10,6% 13,3% 15,9%

33 -11,2% -8,6% -6,0% -3,3% -0,7% 1,9% 4,5% 7,1% 9,7% 12,4% 15,0%

32 -12,1% -9,5% -6,9% -4,2% -1,6% 1,0% 3,6% 6,2% 8,9% 11,5% 14,1%

31 -13,0% -10,4% -7,7% -5,1% -2,5% 0,1% 2,7% 5,4% 8,0% 10,6% 13,2%

30 -13,9% -11,2% -8,6% -6,0% -3,4% -0,8% 1,8% 4,5% 7,1% 9,7% 12,3%

Current account balance of Russia is positive at a crude oil price of 100 $/bar

and USDRUB around 32-33 rub./$

Ruble bonds – expected returns

Local ruble bonds are likely

deliver total returns in the

range of 4-9% over the next

12 months depending on the

scenario.

Under a low-inflationary

scenario both the government

and corporate segments are

likely to deliver total returns in

excess of 9%. A moderate

decrease in the CBR key rate

is highly probable under this

scenario.

All in all, ruble bonds present

an attractive alternative to

bank deposits despite the

latest hike by CBR.

Source: Cbonds, MOEX, VTB Capital IM Research estimates

Ruble BondsCurrent

Value

Recessionary

Scenario

Low

Inflationary

Scenario

Inflationary

Upturn Scenario

Corporate Bonds Z-spread to OFZ, bps 161 365 154 227

Weighted Average Duration, years

OFZ (RGBI Index) 5,5 5,5 5,5 5,5

Corporate Bonds (IFX-Cbonds Index) 1,6 1,6 1,6 1,6

Target Yield-to-Maturity RUB terms, %

OFZ (RGBI Index) 8,5% 10,0% 8,4% 8,9%

Corporate Bonds (IFX-Cbonds Index) 9,3% 13,4% 9,1% 10,3%

Expected Total Return RUB terms, % per annum

OFZs (RGBI Index) 1,9% 9,1% 7,1%

Corporate Bonds (IFX-Cbonds Index) 6,7% 9,4% 8,7%

Average Expected Return RUB terms, % per annum 4,3% 9,3% 7,9%

Weighted average of 3 scenarios 0,0% 8,4% 0,0%

Scenario probability, % 10% 65% 25%

In 1Q14 ruble bonds

remained under pressure,

associated with risk aversion

in EMs, geopolitical risks in

Ukraine and interest rate

hikes by the CBR.

According to CBR statistics,

the share of non-residents in

the OFZ market decreased

from 28% to 22% over the

last 12 months.

For the last three months the

biggest jump in the curve

was seen in OFZs with a 3-5

year duration.

Corporate ruble bonds also

came under pressure,

especially quasi-sovereign

issues. The first-tier

corporate ruble bond curve

has become inverted.

Ruble bonds – key trends

Source: Bloomberg, Cbonds, MOEX, VTB Capital IM Research estimates

5,50

6,50

7,50

8,50

9,50

10,50

11,50

12,50

0 1 2 3 4 5 6 7 8 9 10 11

Yiel

d to

Ma

turi

ty, %

Duration, Years

OFZ Yield Curve

Corporate Bonds Yield Curve

Fir st -t ier Ruble denominated gover nment and corporate bonds

0

100

200

300

400

Cor por ate Ruble bonds Z-SPREAD, basis points

Corporate Ruble Bonds

4

6

8

10

12

Russian debt YTMs, %

OFZ Corporate Ruble Bonds

0

50

100

150

200

250

4,0

5,0

6,0

7,0

8,0

9,0

1Y 2Y 3Y 5Y 7Y 10Y 15Y

Ch

an

ge in

yield

, bp

s

Yie

ld to

matu

rity

, %Duration, years

Change OFZ yield Curve over the last 12 months

Change in Yield to Maturity over past 3 months

OFZ yield curve as of 31.03.2014



Based on our factor model, in

the base scenario (low-

inflation) we see a fair level

for the 10-year real ruble rate

at 153 bps, which suggests a

nominal rate of 7.52-8.02%.

Alternatively, global investors

could value the 10-year ruble

nominal rate in terms of {Yield

on 10Y UST + Russian CDS +

premium for forex risk}.

The dynamics of this

expression starting from end-

2011 well resembles 10-year

OFZ yields.

Based on our forecasts for the

UST curve and Russia CDS,

we see a fair level for the 10-

year nominal ruble rate at 9%

in our base case scenario.

Weighted for both

approaches, the nominal rate

for the base case is

8.51%=8.02*50%+9*50%.

Long-term RUB interest rates: through the prism of inflation


0 100 200 300

Average historical indicator for realrate (weight 25%)

Real GDP growth rate (weight 25%)

Dynamics of RU CDS5-10Y (weight25%)

Average level of local curvessteepnesses for EMs (weight 25%)

Real interest rate Fair Value

Rea l Ra te FV absed on a particular factor

Fac

tors

Sc oring of Fair Level for 10-year RUB Real Rates

-200 0 200 400

Turkey

Russia

Chile

South Korea

Poland

Philippines

EM Average (incl. US for Ref.)

Czech

South Africa

US

Hungary

Indonesia

Brazil

Mexico

EM C urves Steepness, bps (10Y Local Rate - 3M Rate*)

* Based on NDF3M; for Hungary 3M interbank deposit rate is used

-400

-200

0

200

400

600

800

1000

EM 10Y Real Yield, bp* (2005 – present, exc luding 2H08 – 2009)

Current Average* Calculated as {10Y Local Rate - Local CPI y-0-y}

6.5%

7.0%

7.5%

8.0%

8.5%

9.0%

9.5%

10.0%

10.5%

11.0%

11.5%

10 Y OFZ nominal Yield and its replication {ust 10y yie ld + ru cds 10Y + fx risk premium}

{ust 10y yield + ru cds 10Y + fx risk premium}10Y nominal OFZ yield

Average spread is about 100-150 b.p.

Russian Eurobonds – expected returns

We see 10Y UST yields

rising towards 3% under our

low-inflationary scenario,

which we believe to be the

most probable.

Moderately rising yields

should be the result of a

gradual economic recovery

and Fed policy normalization.

Russian Eurobonds could

deliver total returns in the

range of 4-11% over the next

12 months in USD terms,

which makes them look

attractive across all

scenarios.

Source: Merrill Lynch indices, Bloomberg, VTB Capital IM Research estimates

Russian EurobondsCurrent

Value

Recessionary

Scenario

Low

Inflationary

Scenario

Inflationary

Upturn

Scenario

Govt OAS Spreads, bps

Sovereign Eurobonds (GDRU Index) 243 258 149 196Investment Grade Corporate (ERUI Index) 345 380 204 274High Yield Corporate (ERUH Index) 635 727 317 476Weighted Average Duration, years

Sovereign Eurobonds (GDRU Index) 5,9 5,9 5,9 5,9Investment Grade Corporate (ERUI Index) 4,6 4,6 4,6 4,6High Yield Corporate (ERUH Index) 3,8 3,8 3,8 3,8Target Yield-to-Maturity, %

10-year US Treasury Bonds 2,8% 2,0% 3,0% 4,0%Sovereign Eurobonds (GDRU Index) 4,5% 3,9% 3,9% 5,3%Investment Grade Corporate (ERUI Index) 4,9% 4,5% 3,7% 5,4%High Yield Corporate (ERUH Index) 7,8% 8,0% 4,9% 7,5%Expected Total Return USD terms, % per annum

Sovereign Eurobonds (GDRU Index) 7,7% 7,9% 0,8%Investment Grade Corporate (ERUI Index) 6,5% 9,0% 3,0%High Yield Corporate (ERUH Index) 7,5% 16,1% 8,8%Average expected return USD terms,% per annum 7,2% 11,0% 4,2%Weighted average of the 3 scenarios 8,9%Scenario probability, % 10% 65% 25%

In 1Q14 Russian Eurobonds

were under pressure for the

same reasons as ruble

bonds. The sovereign

Eurobond curve continued to

shift up.

For the last three months the

biggest jump in the curve –

more than 150 bp – was

seen in sovereign Eurobonds

with a 10-15 year duration.

The yields to maturity on

government Eurobonds

reached 4.5%, high-grade

corporate Eurobonds – 5%,

and high-yield corporate

Eurobonds – 8%.

The biggest widening in

spreads over UST was seen

in high-yield corporate

Eurobonds.

Russian Eurobonds – key trends

Source: Merrill Lynch indices, Bloomberg, MOEX, VTB Capital IM Research estimates

VTB 22 Perp T1; 9,34

0,00

1,00

2,00

3,00

4,00

5,00

6,00

7,00

8,00

9,00

10,00

0 2 4 6 8 10 12 14 16

Yiel

d to

Ma

turi

ty, %

Duration, Years

Russian Eur obonds - sover eign and cor por ate issues above "BBB-"

Sovereign Eurobonds Yield Curve

Corporate Eurobonds Yield Curve

0

200

400

600

800

1000

Russian Eur obond Govt OAS spr eads, bps

Sovereign Eurobonds High Grade Corporate Eurobonds

High Yield Corporate Eurobonds

0

2

4

6

8

10

12Russian Eur obond YTMs, %

Sovereign Eurobonds High Grade Corporate Eurobonds

High Yield Corporate Eurobonds

0

50

100

150

200

250

300

0

1

2

3

4

5

6

7

2Y 5Y 7Y 10Y 15Y 30Y

Ch

an

ge in

yield

, bp

YTM

, %

Duration, years

Change in Sover eign Eur obond Yiel d Cur ve over the l ast 12

months

Change in Yield to Maturity over past 3 months

Yield Curve as of 31.03.2014



According to our base (low-

inflation) scenario, the UST

curve will probably shift

upward by +50 /+60 b.p. (2-

10y part of the curve) in the

following 12 months, implying

the Russian sovereign

Eurobond curve has already

priced in such a move.

The current situation is still

rather attractive in terms of

exploiting the roll-down effect

remaining in Russian

sovereign Eurobonds with a

4-5 year duration (around

105 bps per year), as well as

7-8 year papers (around 75

bps per year).

The main risk in a roll-down

strategy in Eurobonds with a

7-8 year duration is a long-

term increase in yields on

USTs with a similar duration.

* Roll-down effect is represented by price appreciation towards the maturity date as the bond moves to the left on the yield curve


Russian sovereign Eurobonds – tactical ideas

1

2

3

4

5

6

7

8

9

2Y 3Y 4Y 5Y 6Y 7Y 8Y 9Y 10-15Y

%

C urrent and Impled (according to scenarios) Forms of Russia Sovereign Eurobonds Curve (USD)

Base (Low-Inflation Scenario)

Current (as of 07.04.2014)

Recession Scenario

Inflation Scenario

0

10

20

30

40

50

60

70

3M 2Y 3Y 5Y 7Y 10Y

UST Curve Yields' Likely Changes Under Base (Low-Inflation) Scenario

1.0

2.0

3.0

4.0

5.0

6.0

7.0

2Y 3Y 4Y 5Y 6Y 7Y 8Y 9Y 10-15Y

%

Russia Sovereign Eurobonds Curve (USD) and Its Replication by means of {UST + RU CDS}

Curve {UST + RU CDS} as of 07.04.2014

Russia Sovereign Eurobonds Curve, USD (07.04.2014)

0,0

0,5

1,0

1,5

2,0

2,5

3,0

3,5

4,0

4,5

5,0

3M 2Y 3Y 5Y 7Y 10Y%

C urrent and Implied (according to scenarios) Forms of UST Curve

Base (Low-Inflation) Scenario

Current as of 07.04.2014

Recession Scenario

Inflation Scenario

Russian equities have lagged fixed income for too long

The last five years have proved exceptionally favorable for fixed-income investors and vastly disappointing for equity investors.

Equities must double in order to compensate for the gap in relative performance, assuming that bond yields remain flat.

Public companies continue to perform equity buybacks, and for the first time in many years the balance of cash distributions in favor of minority shareholders and equity issuance has become significantly positive.

Russia's fixed-income market capitalization is now double the equity market free float. Should investor preferences reverse at some point in the future, too much money will begin chasing too few assets.

-19

-29

3

-7

-2-6

7 63 3 4

2 3 46 6

14 4

04

2

10

3

-22,4

-36

-5,4-8,6 -8,8

-11,6-9

-3

-40

-30

-20

-10

0

10

20

2006 2007 2008 2009 2010 2011 2012 2013

$ b

n

Balance Dividends Share buybacks Equity placements

For the first t ime in many year s the balance of cash

distr ibut ions ar e in favour of minor ity shar eholder s and equity issuance becomes meaningful ly positive

0

50

100

150

200

250

300

350

99 00 01 02 03 04 05 06 07 08 09 10 11 12 13

Rela

tive

perf

orm

ance in

dex

Russian equit ies total r eturn r elat ive t o

bonds t otal r eturn start ing fr om 1999

MSCI Russia Total Return / EMBI+ Russia Total Return

Normalized trend (7% p. a.)

0%

50%

100%

150%

200%

250%

300%

350%

99 00 01 02 03 04 05 06 07 08 09 10 11 12 13

Devi

ation f

rom

tre

nd

, %

% Deviat ion f rom normal ized t rend


274

325

88

187223

203 217236

180

237 246288

345 358

435

505

0

100

200

300

400

500

600

2006 2007 2008 2009 2010 2011 2012 2013

$ b

n

Russia's Fixed Income Mkt Cap Is Now 2x

Lar ger Than Equit y Market Freefloat

RTS freefloat Mkt Cap, $ bn Fixed income Mkt Cap, $ bn

Russian stocks: a top-down view


Rising geopolitical tensions

due to Crimea / Ukraine

developments demand a

higher risk premium for

Russian assets which

translates into lower P/E

multiples. We have raised

our required ERP

assumptions by 200-300bps

for our top-down scenarios.

The RTS Index EPS could

grow by 10% p. a. in 2015-

2017 from the cyclically low

base (see slide XX.)

Russian equities trade at

4.5x-6.2x EPS during last 3

years. We argue that this

range is not fair in a low

interest rate environment.

According to our estimates

the probability-weighted

upside for the RTS index is

over 60%.

RTS Index Top-Down Scenarios (Next 12 months)

Recessionary

Scenario

Low Inflation

Scenario

Inflationary Upturn

Scenario

EPS 2013, $ 250,0 250,0 250,0 % change 2014 vs 2013 -26% -1% 16%EPS 2014E, $ 186,2 247,5 289,1Russian Sovereign Risk, % 3,9% 3,9% 5,3%Russian ERP, % 25,0% 11,0% 14,0%Terminal earnings growth, % 3,0% 3,0% 3,0%Current RTS Index Value 1208 1208 1208Target P/E multiple 3,9 8,4 6,1RTS Index Fair Value 719 2087 1771Upside/Downside, % -40,5% 72,8% 46,6%Dividend Yield, % 3,9% 5,1% 6,0%Total Return, % -36,6% 77,9% 52,6%Probability-weighted return, % 60,1%

Estimated probability, % 10% 65% 25%

50

110

170

230

290

350

2009 2010 2011 2012 2013 2014

RTS Index EPS Scenarios

2006-2010 Forward 12 months Low Inf lat ion Scenario

Inflationary Upturn Scenario Recessionary Scenario

Long-term EPS trend

0

3

6

9

12

15

07 08 09 10 11 12 13 14



RTS Index Target P/ E Scenar ios

Russian stocks trade close

to 2008 lows on price / trend

EPS and price to book

measures. There is no global

financial meltdown at

present.

The situation is different in a

way that low valuations

reflect mostly country-

specific rather than global

risks.

Based on available history

Russian equities returned

60% on average over the

following 12 months after

P/E valuations reached the

4x-5x range.

RTS index is trading at half of book value

0,0

0,5

1,0

1,5

2,0

2,5

3,0

3,5

07 08 09 10 11 12 13 14

RTS Index P/ BV Val uat ion

0

4

8

12

16

06 07 08 09 10 11 12 13

RTS Index Pr ice / Tr end EPS Valuat ion


144,0%

130,3%

60,2%

-4,4%

9,4%

41,4%

24,7%33,8%

8,2%

-20%

0%

20%

40%

60%

80%

100%

120%

140%

160%

< 3 3 - 4 4 - 5 5 - 6 6 - 7 7 - 8 8 - 9 9 - 10 10+Ave

rage

ind

ex

retu

rn fo

r th

e fo

llow

ing

12

m

Starting P/ E valuation

Average index 12m return depending on starting P/E valuation (based on data since 2003)

0,4%2,6% 3,5%

9,2% 9,4%

18,1%

7,8% 7,7%

41,4%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

< 3 3 - 4 4 - 5 5 - 6 6 - 7 7 - 8 8 - 9 9 - 10 10+

% o

f ob

serv

ati

on

s

Starting P/ E valuation

% of observations falling within each valuation band(based on data since 2003)

50

110

170

230

290

350

2009 2010 2011 2012 2013 2014

RTS Index EPS Scenarios



Long-term EPS trend

EPS scenarios for 2014

We revised our EPS

projections up 2-3%

across our scenarios to

reflect the positive impact

of the ruble devaluation

on export sector profits.

Our EPS projections for

2014 are fairly

conservative and well

below the LT trend.

Market expectations for

basic materials, electric

utilities and Gazprom

have been revised down

significantly, which

creates room for positive

surprises.

Normalization of sector

ROEs towards mid-cycle

average levels could

bring the RTS Index ROE

to 14-15%, which offers

significant upside to the

current consensus.

-3%

+15%

-26%


12,7%11,8%

12,9%13,7%

22,2%

16,9%

12,6%10,9%

15,8%

19,1%

14,3%

12,5%11,1%11,5%

8,7%

13,5%

0%

5%

10%

15%

20%

25%

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014F

RO

E

RTS Index ROE

Reported 2002-2013(F) Consensus Forecast Low Inflation Sce nario

Recessionary Scenario Inflationary Upturn Scenario

3,0

3,4

1,0

0,7

0,6

0,3

-1,3

-1,7

-0,1

-4,0 -2,0 0,0 2,0 4,0

RTS Index total

Metals & Mining

Consumer Staples

Oil

Consumer Cyclicals

Electric Util ities

Banking

Gas

Others

Sector cont ribution to RTS Index EPS change in 2014 vs

2013 (pr obabil ity-weighted for 3 scenar ios), pp

-12,7%

-23,6%

-51,7%

-11,8%

-32,6%

10,5%

-22,4%

0%

-6%

-8%

-2%

100%

16%

1%

14%

6%

11%

2%

309%

22%

18%

-100% 0% 100% 200% 300% 400%

Oil

Gas

Banking

Telecoms

Metals & Mining

Electric Util ities

Total - RTS Index

RTS Index EPS Scenar ios For 2014 By Sector

Recession

Low Inflation

Inflation

Russian corporate earnings and the oil price

The oil price is the single

most important factor

driving RTS Index EPS

due to structural reasons.

At the same time, the

exact form of this

dependency is evolving

over time.

Starting from the beginning

of 2007 to mid-2008 oil

price changes explained

nearly 90% of the variation

in next 12m consensus

EPS estimate. If we look at

the May’11 – Dec’13

period, the oil price factor

has shrunk to only 20%

based on a linear

regression model.

We think that cost

efficiency and operational

improvements will be

detrimental for the bottom

line during the next several

years.

Oil

32%

Gas

36%

Banks

16%

Metals &

Mining

4%

Telecoms

6%

Electric utilities

3%

Other

3%

RTS Index EPS by sector (2013E)

90%

59%

20%

0%

20%

40%

60%

80%

100%

Jan'07 - Jun'08 Jun'08 - May'11 May'11 - Dec'13

%

% Of RTS Index EPS variat ion expl ained by the

changes in oil pr ice

100

120

140

160

180

200

220

240

260

280

300

30 80 130

RTS

In

de

x EPS

Oil (Brent)

EPS Dependency On Oil Price Is Evolving

Over Time

Jan'07 - Jun'08 Jun'08 - May'11 May'11 - Dec' 13

20

40

60

80

100

120

140

160

50

110

170

230

290

350

07 08 09 10 11 12 13

Russian Corporate Earnings are Highly

Dependent On The Oil Price

RTS Index EPS Oil Brent (rhs)


Top-line growth is constrained, cost efficiency is key to long-

term EPS growth

25,1

20,4

16,4

15,2

14,9

13,8

13,3

11,2

4,3

-1,8

-5 0 5 10 15 20 25 30

Utili ties

Gas

Oil

Metals & Mining

RTS index shares

PPI

Financials

CPI

Consumer

Telecoms

Aver age Unit Cost Inflat ion By Sector ,

2002-12 (% p. a.)

0

200

400

600

800

1000

1200

1400

1600

1800

2000

2013E20122011201020092008200720062005200420032002

Sale

s p

er sh

are

RTS Index Sales per share

Top-l ine gr owth f l attens

12,2

14,4

16,516,1

13,313,2

18,7

22,0

20,4

13,213,013,0

0

5

10

15

20

25

2013E20122011201020092008200720062005200420032002

Ne

t In

co

me

Marg

in, %

RTS Index Profit Margin, %

Pr of it Margins Trend Down Due To Cost Pr essure...

15,7%

17,2%16,2%

15,1%15,9%

17,4%

15,5%14,9%

10,3%

8,9%9,8%10,0%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

2013E20122011201020092008200720062005200420032002

Cap

ex

to s

ale

s rati

o, %

RTS Index Capex/ Sales ratio, %

...Whil eCapex / Sal es Ratio Remains El evated

Given the limited

opportunities to maintain

top-line growth typical of

the commodity super-

cycle era, the only viable

means to boost the

bottom line is cost-

cutting.

During the boom years

most of Russia’s

industry sectors

exhibited unit cost

growth well above

inflation.

Based on that, the most

pronounced

opportunities to boost

EPS through improved

efficiency are

concentrated in electric

utilities and Gazprom.

Telecoms and consumer

staples seem to have

little room for additional

efficiency gains.


2015-2017 EPS CAGR of 10% looks realistic

Oil

32%

Gas

36%

Banks

16%

Metals &

Mining

4%

Telecoms

6%

Electric utilities

3%

Other

3%

RTS Index EPS by sector (2013E)

2,6%

5,0%

5,6%

11,0%

11,1%

12,6%

13,0%

13,6%

21,4%

27,0%

11,7%

-10% -5% 0% 5% 10% 15% 20% 25%

Mobil es

Oil

Discos

Gol d

Base Metal s

Ret ail

St eel

Gazprom

Banking

Gencos

Tot al - RTS Index

EPS 3Y CAGR t o be back on t rend LT EPS Trend growt h, % pa 3Y EPS CAGR

Sector Contr ibut ion to Next 3Y EPS Gr owth

-80,5%

-55,0%

-40,0%

-37,8%

-36,4%

-26,7%

-26,7%

-6,0%

2,6%

8,6%

104,0%

-120% -70% -20% 30% 80% 130%

Steel

Base Metals

Gencos

Discos

Fertilizers

Gazprom

Fixed-Line Telcos

Mobiles

Oil

Banking

Retail

Consensus EPS Revisions 2011-2013 (peak to t r ough), %

Given that consensus EPS

expectations were

significantly revised down

from early 2011, double-

digit EPS growth is not

outside the realm of

possibility through the

combination of a low-base

recovery in cyclical sectors

and strong underlying

growth in domestically-

oriented sectors.

Only ~40% of the RTS

Index’s EPS comes from

sectors with low LT growth

potential (i. e. oils and

telecoms).

The other 60% are

dominated by either

cyclical recovery

(Gazprom, metals) or

domestic demand stories

(banking, retail)

Source: Moscow Exchange, Bloomberg, VTB Capital IM Research estimates

0

200

400

600

800

1 000

1 200

2007 2008 2009 2010 2011 2012 2013 2014

RTS sector EPS trends (2007 = 100)

Oil & gas M&Mining Financials Telecoms

Consumer Industrial Utilities

0%

8%

15%

23%

30%

38%

45%

2005 2006 2007 2008 2009 2010 2011 2012 2013

Russian Equity Risk Premium (E/ P-BY+g), %

At what P/E multiple should Russian stocks trade?

A low inflationary recovery

scenario assumes that the

P/E for the Russian market

will rerate to ~8.6x assuming

11% ERP and a 3% terminal

growth rate.

An inflationary scenario

assumes a target P/E value

of 7.8x, due to higher interest

rates and risk premiums

compared to a low-

inflationary scenario.

A recessionary scenario

assumes a P/E of 3.9x.

We expect Russia’s P/E

discount to emerging

markets to narrow from the

current 60% to 20-25%,

which is justified given the

sector structure of the

Russian market.

Recessionary Scenario = 25%

Low Inflationary Scenario= 11%

Inflationary Scenario = 14%


0

3

6

9

12

15

07 08 09 10 11 12 13 14



RTS Index Target P/ E Scenar ios

-70,0%

-60,0%

-50,0%

-40,0%

-30,0%

-20,0%

-10,0%

0,0%

10,0%

2005 2006 2007 2008 2009 2010 2011 2012 2013

P/ E next 12m Pr emium (+) / Discount (-) :

MSCI Russia vs MSCI EM

Premium (+) / Discount (-) MSCI Russia vs MSCI EM

Average Discount (2005−11)

Russia

Brazil

China

IndiaIndonesia

Philippines

Thailand

South Africa

Turkey

Egypt

Mexico

Argentina

0,0

5,0

10,0

15,0

20,0

25,0

0% 5% 10% 15% 20%

P/E

LT EPS Growth, %

Russia Should Tr ade 10x-12x Next 12m EPS Given The

Cur r ent EM Valuat ions

Russia -

2013

Russia -

2006

Russia -

2015F

0%

20%

40%

60%

80%

100%

120%

5% 10% 15% 20% 25% 30%

Div

idend Pa

yout, %

ROE, %

As ROE declines, incr easing dividend payouts ar e

just if ied

Dividends to help unlock fundamental upside

Compared with other

emerging markets, Russia

has the lowest dividend

payout ratio.

In the past Russian

companies generated high

returns on equity, justifying

the reinvestment of income.

As ROEs decline, a rise in

dividend payouts is a

natural development.

The dividend yield for the

RTS index could reach

4.5% based on 2013

financials, with a payout

ratio of 20%.

Over the next 3-5 years,

Russian companies are

likely to raise dividend

payout ratios to 35-50%.

Source: Bloomberg, MOEX, VTB Capital IM Research estimates

30%

23%

20%20%

18%17%

21%

12%

18%

13%

0%

5%

10%

15%

20%

25%

30%

35%

2015F2014F2013F2012201120102009200820072006

Div

ide

nd

Pa

you

t, %

of

ne

t in

co

me

Long-term t rend of increasing dividend payouts, with pl enty

of r oom t o continue

0%

1%

2%

3%

4%

5%

6%

7%

2008 2009 2010 2011 2012 2013

Div

idend Yie

ld, %

Russia now of fer s a dividend yiel d pr emium

to emer ging mar kets

Russia Emerging Markets (MSCI EM)

16%

19%

19%

21%

24%

30%

32%

35%

44%

48%

49%

65%

67%

67%

88%

98%

0% 20% 40% 60% 80% 100% 120%

S. Korea

Russia

Turkey

Argentina

India

China

ThailandPhil ippines

IndonesiaMalaysia

Brazil

Taiwan

Columbia

S. Africa

Peru

Egypt

At the same t ime Russia has the lowest dividend

payout r at io (% of 2013E net pr ofit ) among emer ging

mar kets


Since March 3, the CBR

unexpectedly tightened

monetary policy by raising its

key rate by 150 bps.

Simultaneously, the CBR has

increased the cumulative level

of FX interventions, which is

used to trigger the shift of the

dual currency basket by 5

kopecks, from USD350 mn to

USD1.5 bn.

Monetary policy was

tightened to fight capital

outflows and prevent

excessive ruble depreciation

on the back of geopolitical

tensions over the situation in

Ukraine.

CBR tightens its monetary policy

1,5

3,0

4,5

6,0

7,5

9,0

Nov-

10

Feb-1

1

May-

11

Aug-1

1

Nov-

11

Feb-1

2

May-

12

Aug-1

2

Nov-

12

Feb-1

3

May-

13

Aug-1

3

Nov-

13

Feb-1

4

Main Inter est Rates of the CBRand Mospr ime -

inter est r ate cor r idor at 2 pp

CBR Fixed REPO Rate Overnight, %

CBR Fixed Deposit Rate Overnight, %

MosPRIME Rate Overnight, %

CBR REPO Auctions Min Rate 1 Week, %

25

27

29

31

33

35

37

39

-3,0

-2,5

-2,0

-1,5

-1,0

-0,5

0,0

0,5

1,0

11.0

1.11

11.0

3.1

1

11.0

5.1

1

11.0

7.1

1

11.0

9.1

1

11.1

1.11

11.0

1.12

11.0

3.1

2

11.0

5.1

2

11.0

7.1

2

11.0

9.1

2

11.1

1.12

11.0

1.13

11.0

3.1

3

11.0

5.1

3

11.0

7.1

3

11.0

9.1

3

11.1

1.13

11.0

1.14

11.0

3.1

4

USD

RU

B

Net s

ale

FX (-)

/ p

urc

hase F

X (+), U

SD

bn

CBR has been incr eased FX cumulative inter ventions to

f ight r uble depr eciat ion

CBR interventions on the domestic FX market, $ bn USDRUB Curncy

On March 3 CBR

interventions exceeded

USD11 bn. per day.


Many developing countries

have started to raise interest

rates in response to capital

outflows earlier than Russia

did.

For example countries such as

India, Turkey, Brazil and

S.Africa reduced pressure on

national currencies by raising

interest rates.

Half a month after the interest

rate hikes, the currencies of

the above countries had

appreciated vs the US dollar.

After the CBR raised interest

rates, the USDRUB began to

appreciate, and this process

still looks incomplete.

Prospects of Russian ruble in light of latest CBR actions

30,00

33,00

36,00

39,00

42,00

45,00

Russian CBR is t ar get ing dual -cur r ency oper at ional

bands at a wide r ange and significantl y incr eased FX

inter vent ions to suppor t r uble

CBR lower BandCBR Upper BandBI-BASKET (55%USD/ 45%EUR)

20,0

50,0

80,0

110,0

140,0

170,0

Real exchange rate per $ (Dec'97=100)

Real exchange rate per € (Dec'97=100)

RER bi-currency basket (dec'97=100)

Over the l ast 12 months USDRUB has depr eciated in nominal

and r eal t er ms

-1,0%

0,0%

1,0%

2,0%

3,0%

4,0%

5,0%

6,0%

-45-40-35-30 -25-20 -15 -10 -5 0 5 10 15 20 25 30 35 40 45

Days before and after interest rate increases

National currency movement before and after

interest rate hikes in 2014 - India, Turkey, Brazil ,

S.Af r ica cases, average

-2,0%

0,0%

2,0%

4,0%

6,0%

8,0%

10,0%

12,0%

-45-40-35-30 -25-20 -15-10 -5 0 5 10 15 20 25 30 35 40 45

Days before and after interest rate increases

USDRUB movement befor e and after CBR interest

r ate hikes in Mar ch'14

Based on oil prices the

USDRUB rate should be

about 33.

Based on purchasing power

parity (PPP) the USDRUB

should be in the range of 27-

30.

Based on key macro factors

(e.g. no-oil federal budget

balance, current account

balance, GIR to import ratio)

USDRUB looks fairly valued

around 34 rub.

Market expectations for

USDRUB have increased

from 34 to 36.5 rub due to

geopolitical tensions in

Ukraine.

All in all, summarizing the

above factors, the fair value

of USDRUB shifted to the

range of 32.5-33.5 rub and

ruble still looks significantly

oversold at current levels.

* Macro factors such as non-oil federal budget balance, current account balance, GIR to import ratio

Source: IMF, CBR, Minfin, Rosstat, Bloomberg, VTB Capital IM Research estimates

What is the FV of USDRUB?

15,0

20,0

25,0

30,0

35,0

40,0

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

Based on macr o factor s* USDRUB fair ly valued

at 33.8-34.4

USDRUB actual FV USDRUB based on macro factors

1 2 2 35

7 7 8 911

1314

1618 18

21

2425

27 2728 2930

0

5

10

15

20

25

30

35

40

95

96 97

98

99

00 01

02

03

04

05

06 07

08

09 10 11 12 13

14 F

15 F

16 F

17 F

USDRUB PPP, IMF USDRUB official exchange rate, (eop)

USDRUB is undervalued on a PPP basis

33,2

36,5

22

26

30

34

38

20 40 60 80 100 120 140

USD

RU

B14

eop

Crude oil price, USD/bbl average

USDRUBis undervalued based on oil pr ices

Trailing 2000-2008

Trailing 2009-2013

USDRUB based on oil prices (2014, eop)

Bloomberg Consensus (2014, eop)

27,0

29,0

31,0

33,0

35,0

37,0

39,0

Bl oomberg consensus USDRUB shifted to 36.5 for the

end of 2014 due to geopol itical tensions in Ukraine

USDRUB Bloomberg consensus (2014 eop)

USDRUB current

USDRUB NDF 3 months

Our sensitivity analysis shows

that a 10% RUB depreciation

versus USD has a 5-7%

positive impact for EPS in

energy and basic materials.

Consumer discretionary and

financials are hit the most.

Given that the sector structure

of the market is significantly

skewed towards energy, the

net impact on EPS from ruble

weakness is positive.

Ruble devaluation impact on EPS

25

27

29

31

33

35

37

39500

700

900

1100

1300

1500

1700

1900

2100

2009 2010 2011 2012 2013 2014

RTS Index ver sus USD/ RUB

RTS Index USD/RUB

-15% -10% -5% 0% 5% 10%

Financials

Consumer

Uti li ties

Communications

Basic Materials

Energy

Impact of a 10% RUB depreciation

Sensitivities to the 10 % RUB depreciation


FinancialsConsumer

Utilities

Communications

Basic M aterials

Energy

-30%

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

-20% -15% -10% -5% 0% 5% 10%

Sector performance , % YTD'14

Impact

of a 1

0%

USD

RU

B d

epre

ciatio

n

YTD performance vs expected EPS impact in 2014E

Equities: sector preferences

Sector Selection Scorecard

FactorFactor

weight, %

Metals&

MiningOil&Gas

Mobile

Telcos

Fixed-line

Telcom

Electric

Gencos

Electric

GridsBanking Retail Fertilizers

Multiples vs growth 8% 0 0 0 0 1 1 1 0 -1

Cycle-adj P/E vs hist avg 14% -1 0 -1 0 0 1 1 -1 0

P/BV vs ROE 9% -1 1 0 0 0 0 1 -1 0

Valuation vs EM peers 9% -1 0 0 0 1 1 1 -1 0

6m ERM 20% 0 0 0 0 -1 -1 0 1 -1

DY vs payout 8% -1 1 0 0 0 1 0 0 -1

FCF Yield 2016 8% 0 0 0 1 1 -1 0 -1 0

Risks / Governance 8% 0 0 0 0 -1 -1 0 0 0

Contrarian 8% 0 -1 0 0 0 0 1 -1 0

Economic Cycle 8% 0 0 1 1 1 1 0 1 0

Aggregate score 100% -0,4 0,09 -0,06 0,16 0,05 0,11 0,48 -0,2 -0,36

Scoring methodology: -1=UW, 0=Neutral, 1=OW


-0,4-0,36

-0,2

-0,06

0,050,09 0,11

0,16

0,48

-0,5

-0,4

-0,3

-0,2

-0,1

0

0,1

0,2

0,3

0,4

0,5

0,6

Sector Aggr egate Scor e

3%

19%23%

34% 35%

43%

54%

60%

67%

0%

10%

20%

30%

40%

50%

60%

70%

80%

DCF Upside/ Downside

Banks and utilities look

attractive based on a

combination of relative

valuation metrics.

Retail, mobile and

fertilizer sector

valuations look

stretched.

Metals & mining sector

valuations should be

considered with an

understanding that

profitability is at

historical lows.

* - P/E multiple is used for banks instead of EV/EBITDA. Last 5Y average valuations of EM Utilities were used as a benchmark due to lack of adequate data

for Russian Utilities

Sector relative valuations


Metals&Mining

Oil&Gas

Mobile Telecoms

Fixed-line Telecoms

Electricity Gencos

Electricity Discos Banking

Consumer Staples

Retail

Transportation

Fertilizers

0,0

2,0

4,0

6,0

8,0

10,0

12,0

14,0

16,0

18,0

0% 5% 10% 15% 20% 25%

P/E

2014

E

EPS CAGR 14-17E

P/ E Mul t iples versus expected growth

At t ract ive

Expensive

104%

99,9%

96%

93%

71%

70%

57%

33%

29%

28%

0% 20% 40% 60% 80% 100% 120% 140%

Met al s&Mining

Mobil e Tel cos

Fer t il izer s

Ret ail

Tr anspor t at ion

Fixed-l ine Tel com

Oil &Gas

El ect r ic Gr ids

El ect r ic Gencos

Consumer st apl es

EV/ EBITDA 2014E as % of Last 5Y Aver age*

Metals&Mining

Oil&Gas

Fixed-line Telecoms

Electricity GenerationBanking

Consumer staples

Retail

TransportationFertilizer

0,0

0,5

1,0

1,5

2,0

2,5

3,0

3,5

4,0

5% 10% 15% 20% 25% 30%

P/B

V M

ultip

le

ROE 2013E, %

P/ BV vs ROE

At t ract ive

Expensive

81%

79%

75%

49%

48%

47%

44%

42%

35%

26%

5%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90%

Mobil e Tel cos

Ret ail

Oil &Gas

Fixed-l ine Tel com

Banking

Met al s&Mining

Transpor t at ion

Consumer st apl es

Fer t il izer s

El ect r ic Gencos

El ect r ic Gr ids

P/ BV as % of Last 5Y Average*

Russian electric utilities

and oil & gas names on

average trade with

hefty discounts to

international peers on

key valuation metrics.

It is best to avoid

mobile telecoms,

energy and retail,

searching for value

instead in electric grids

from an opportunistic

point of view.

Sector relative valuations (continued)


Metals&Mining

Oil&Gas

Mobile Telecoms

Fixed-line TelecomsElectricity Generation

Electric Grids

Banking

Consumer Staples

Retail

TransportationFertilizer

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

10% 20% 30% 40% 50% 60% 70% 80%

P/B

V a

s %

of La

st

5Y A

vg

% Buys

El ectr ic Ut il it ies / Metals&Mining wor th a l ook based on a contrar ian approach. Retail and Mobile t elecom sectors l ook overheated

Cheap and

Unpopul ar

Expensive and

Popul ar

0%

-7%

-25%

-32% -33%-37%

-54%

-62%-70%

-60%

-50%

-40%

-30%

-20%

-10%

0%

EV/ EBITDA 14E Pr emium/ Discount vs

Inter national Peers

29,0%

-20%

-49%

-62% -64% -66% -67%

-83%-94%

-120%

-100%

-80%

-60%

-40%

-20%

0%

20%

40%

P/ BV Pr emium / Discount Rel at ive to


32%

-27%

-38% -38% -39%

-55% -58% -60%

-81%-100%

-80%

-60%

-40%

-20%

0%

20%

40%

P/ E 14E Pr emium/ Discount Rel ative to


Equities: cycle-adjusted valuations

All key sectors (except retail

and mobile) presently trade

with significant discounts to

historical average P/E

ratios, using their long-term

EPS trend in the

denominator.

The normalization of sector

ROEs toward long-term

sustainable levels could

provide a substantial

earnings boost for the

metals & mining sector as

well as electric utilities.

However, profitability in

banking and retail names

looks vulnerable in the long

term.


12,2%

-15,6%

-21,4%

-33,4%

-48,4%

-52,8%

-53,0%

-67,0%

-72,4%

-72,4%

-100% -80% -60% -40% -20% 0% 20%

Ret ail

St eel

Mobil es

Oil

Gencos

Base Metal s

Gazprom

Discos

Banking

Gol d

Tr end P/ Es as % of Histor ical Aver age

21,4%

-1,0%

-1,8%

-8,5%

-15,8%

-19,8%

-22,8%

-22,9%

-26,9%

-44,9%

-60% -40% -20% 0% 20% 40%

Ret ail

Mobil es

Discos

Oil

Banking

Gazprom

Gol d

Base Metal s

St eel

Gencos

Consensus For war d 12m EPS as % of Long-Ter m Tr end

-80,5%

-55,0%

-40,0%

-37,8%

-36,4%

-26,7%

-26,7%

-6,0%

2,6%

8,6%

104,0%

-120% -70% -20% 30% 80% 130%

Steel

Base Metals

Gencos

Discos

Fertilizers

Gazprom

Fixed-Line Telcos

Mobiles

Oil

Banking

Retail

Consensus EPS Revisions 2011-2013 (peak to t r ough), %

239,6%

202,0%

105,2%

42,7%

28,5%

21,1%

19,7%

1,5%

-11,1%

-17,6%

-27,0%

-75% -25% 25% 75% 125% 175% 225% 275%

El ect r ic Gr ids

Fer t il izer s

El ect r ic Gencos

Transpor tat ion

Metal s&Mining

Oil &Gas

Consumer st apl es

Fixed-l ine Tel com

Mobil e Tel cos

Ret ail

Banking

EPS Revisions Result ing For m ROE Normal izat ion

Which growth rates are discounted by the market?

Based on a two-stage

DDM, all sector valuations

except for retail, metals &

mining and fixed-line

telecoms imply negative

growth rates for the next

five years.

Growth sector valuations

look stretched compared

with those of value

sectors.

Rising bond yields should

support the

outperformance of value

stocks versus growth

stocks because growth

stocks have higher

sensitivity to the discount

rate used.

Assumptions: During next 5 years dividends gradually increase to the

level warranted by LT sustainable ROE and payout ratios, Risk-free

rate assumption is 3.5%, ERP = 8%. Source: Bloomberg, VTB Capital IM Research estimates

Sector

Forward

12m

P/E

LT ROE

Dividend

payout,

%

Target

P/E

Implied

Growth (5y)

Oil&Gas 4,5 12,0% 70% 8,7 -15,0%

Metals&Mining 16,0 15,0% 70% 9,8 13,1%

Banking 5,5 15,0% 50% 12,1 -17,7%

"No-growth" Sector 8,9 12,0% 50% 8,9 0,0%

Mobiles 9,3 20,0% 80% 10,5 -3,0%

Fixed Line 11,5 15,0% 70% 9,8 4,1%

Utility Gencos 7,4 11,0% 90% 8,5 -3,4%

Utility Discos 3,9 11,0% 90% 8,5 -17,9%

Consumer Goods 5,7 15,0% 60% 10,6 -14,6%

Retail 28,3 15,0% 50% 12,1 23,8%

RTS Index 5,7 15,0% 70% 9,8 -12,7%

DDM-implied Next 5-year Growth Rates

23,8%

13,1%

4,1%

0,0%

-3,0%

-3,4%

-12,7%

-14,6%

-15,0%

-17,7%

-17,9%

-30% -10% 10% 30%

Ret ail

Metal s&Mining

Fixed Line

"No-gr owth" Sect or

Mobil es

Util it y Gencos

RTS Index

Consumer Goods

Oil &Gas

Banking

Util it y Discos

5Y EPS CAGR, %

DDM-impl ied EPS CAGR for the next 5 year s

60

70

80

90

100

110

120

130

140

Rel

ati

ve p

erfo

rm

an

ce

Val ue under per for mance ver sus Gr owth Star ts

t o Rever se

Growth Performance Relative to Value (based on MSCI Russia sub-indices)

0

1

2

3

4

5

6

0,5

0,6

0,7

0,8

0,9

1,0

1,1

1,2

1,3

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

10Y

US

T YT

M

Rel

ati

ve p

erfo

rm

an

ce

Rising yields ar e l ikely to r ever se value

under per for mance ver sus Gr owth

Val ue per f or mance r el at i ve t o Gr owt h (Gl obal ) UST 10Y Yiel d (RHS)

Disclaimer

This is a marketing communication. It is not a research report. This document has been prepared by VTB Capital Investment Management Limited and/or one of its affiliates (“VTB

Capital IM"), for information purposes only and is solely intended for the use of the intended recipient(s). This document may include an indicative summary of the terms and conditions

of the securities/transaction described herein and may be amended, superseded or replaced without notice. The conditions of the securities/transaction will be set out in full in the

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Not an offer: This document does not constitute an underwriting commitment, an offer of financing, an offer to sell, or the solicitation of an offer to buy or sell any securities described

herein, which shall be subject to VTB Capital IM internal approvals.

Not advice: VTB Capital IM is acting solely as principal and not as advisor or fiduciary. You must independently determine, with your own professional advisors, the appropriateness of

any contemplated transaction or investment. No part of this material constitutes tax, legal, accounting, financial or investment advice and should not be construed as such.VTB Capital

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Contacts Vladimir Potapov, CFA Tim McCarthy

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Tel.: +7 (495) 725 55 40 Email: [email protected]

E-mail: [email protected]

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Head of International Distribution Head of Research

VTB Capital Investment Management VTB Capital Investment Management

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E-mail: [email protected] Email: [email protected]

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E-mail: [email protected] Email: [email protected]

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