Russia & Ukraine: Economy & Market Implications

By Chris Weafer, March 3, 2014

impact will potentially be felt in the Ukraine economy which is already reeling from the disruption of the past three months and facing significant short-term pressures.  Macro analysis is borderline guesswork at this stage and much will depend A) on how quickly consumer and business confidence can be rebuilt and B) on how much, how quickly and on what terms the government gets external aid.

Ruble and equity indices face a knee-jerk hit. An initial negative knee-jerk reaction is inevitable in the ruble, the domestic debt market and in equities when the Moscow bourse opens Monday.

But this is not 2008. Whatever about the politics, the oil price is not collapsing, the economy is not heading into steep recession and corporate debt exposure is much better. Additionally, Russia has seen steady investor outflows since last summer while, ahead of the crisis in Qtr 3 2008, there had been a significant inflow of speculative capital. So while a knee-jerk adjustment is to be expected, it should be relatively modest. There is no basis for a hit on the sovereign Eurobond market and any adjustment which does take place ought to be short-lived.

Some Russian stocks are more vulnerable. Stocks at greatest risk include the banks (currency weakness and as Russia proxies), Gazprom (concern over gas export disruption and Ukraine debt), the mobiles (Ukraine exposure) and other names with foreign debt exposure.

Preference is for haven assets right now. LUKoil is the best big name stock to provide relative safety given its US dollar earnings and low debt. Some IT sector stocks earning in US dollars but have their cost base in rubles. In additional the high dividend payers and relatively neutral quality names, such as Novatek and Magnit, offer better relative protection.

Domestic ruble debt is more at risk than Eurobonds. Any sell-off in sovereign Eurobond debt is a buying opportunity. Domestic debt issues will reflect any further ruble weakness.

Ukraine assets remain speculative short-term. My position towards Ukraine assets remains unchanged and is mostly predicated on the deteriorating economy and likely bailout terms. The rally in equities and debt last Monday was pre-mature and speculative. The debt market has since given back some of that knee-jerk gain and should give back more tomorrow. Equities are purely speculative at this stage. The Hryvnia has continued to weaken, as expected, and we stick with a target close to 12 against the US dollar. Here also the actual number will depend on the terms of the IMF deal (see below).

Agriculture and food are safest Ukraine sectors. The safest equity plays are amongst the externally listed agriculture and food producers. MHPC LI has a market cap of $1.6 bln, a free float of 33.5% and a current year P.E. of just over 6 times. Kernel (KER PW) is valued at $870 mln, has a free float of 63% and a current year P.E. of just over 7 times.

Debt restructuring is still a big risk. A restructuring of existing Ukraine debt is still