Rosetti ($RSTI) / $FEES – Russian Grids at bargain prices

I bought both of these the other week.  They are both very, very cheap and I believe are high quality assets that will rise in price as performance improves and Russia becomes a more ‘normal’ country.

 

FEES – Fsk Yees Pao is the largest grid company in Russia. 80% of the shares are owned by Rosetti, 88% of Rossetti shares are owned by the Russian government.  It is listed in Moscow and London via a GDR – I believe the Moscow shares are cheaper to buy and hold due to fees associated with the GDR. The likely yield is 8-10%.

The Russian government has a policy that all state owned companies should pay 50% of earnings in dividends.  Though earnings can (seemingly) be determined in many different ways.  This means a likely rise in the yield as by my estimate they are not paying 50% but it really is up to them.  The PE is about 3-4, decent cash flow, net debt / EBITDA <1.5.  They are investing quite a lot, limiting the amount they can pay out but seemingly earning little in additional revenue / profit as is often the way in Russian state owned companies.  There is a great deal of cross-subsidy across Russian grid cos with the strong supporting the weak.  I suspect non-economic deals are being done but still, given the valuation there is money to be made here.

Rates in Russia are falling quite quickly.  They were 7.75% at the start of the year and are now 6.25%.  FEES has bond-like qualities so as long as they continue to operate in a stable way the price should go up. I bought at 0.1939 and it is now 0.206 – I added more last week, still plenty of opportunity to make more.

The risk here, as ever in Russia is expropriation. There is a controlling shareholder and it is possible for deals to be done adversely affecting minorities whilst the Russian government shrugs its metaphorical shoulders and paints it as a dispute between two private companies.  This didn’t really happen when the predecessor of these companies was restructured which provides some measure of comfort. There is little sign of this being the case at present, except the opaque cross-subsidies but if it does happen there is little one can do.

To mitigate this risk and as an investment in its own right I have also put some money into Rosetti – the parent.  This is equally cheap – it has a PC of 1-2 and is on a price to book of c 0.2.  The yield is about 4%  It owns stakes in lots of Russian grid companies, including FEES, Moscow, St Petersburg. There is even more cross-subsidy and uneconomic deal making going on here.  They have said that they will cut capex over the next few years and this will leave substantial cashflow for dividends.

I suspect that the very high capex over the past few years is catching up with a lack of investment over many years during the 90s / 00s but I can’t really substantiate this.

My view is that these companies are just too cheap.  The regulation seems reasonably robust – with a regulator / rate of return calculation.  The Russians clearly recognise the need for incentives and that companies are better run when not publicly held.  They will be selling down their stake between now and 2022. This could be taken negatively – as there is a large seller in the market.  The stock is up on the announcement / rumours thereof – I believe as it will mean that there will be less cross-subsidy and inefficiency.

There is also the possibility that a stake sale gives sufficient liquidity to get this in the MSCI Russia – raising the price. I believe they need 15% free float to get in.

Another way to play this is to buy the preference shares.  They are trading at c 1.5 Rubles.  The preference share is on a higher yield of about 5.09%.  They avoid (somewhat) some of the cross-subsidy issues.

The formula for the dividend is given in the articles as

5.3. Preference share holders shall be entitled to a fixed annual dividend. The total amount to be paid as a dividend on each preference share shall be equal to ten (10) percent of the Company’s net profit for the reporting year divided by the number of shares constituting twenty-five (25) percent of the Company’s authorized capital. If the amount of dividends payable by the Company on each ordinary share in a certain year exceeds the amount payable as a dividend on each preference share, the size of the dividend payable on the latter shall be increased to the size of the dividend payable on ordinary shares.Dividends shall be paid to preference share holders annually within the time periods specified in paragraph 8.5 of these Articles of Associationand, additionally, on the date of dividend payment for ordinary shares if, subject to this paragraph, the size of the dividend on preference shares shall be increased to the size of the dividend payable on ordinary shares.

5.4. The Company shall not be entitled to pay dividends on preference shares following a procedure different from the procedure provided for in these Articles of Association.

I suspect as the company is made more attractive for privatisation / investment and cross subsidy decreases profit may well increase.  If so this may be an attractive way to play it but to me right now I think the preferred are too highly priced, but I am a bit torn on this one.

Weight on FEES is currently 2.9% and on RSTI 1.8%.  In aggregate my Russian Stocks (MOEX, GLTR, FEES, HYDR, RSTI) are now c14% of the portfolio, I have a bit of scope to add a couple more ideas to get it to c 20%, or up existing weights. They are by far the best performing bit of my portfolio right now.

 

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