In an analysis I have published last week, I have looked at emerging market sovereign risk in terms of monetary policies and debt. In this analysis I have observed that numerous emerging market economies are deteriorating fast amid the coronavirus pandemic. However, Russia together with Indonesia and the Czech Republic look to be better equipped to navigate the current economic recession and if necessary to intervene in case of further weakness.
Today, I would like to explore the Russian bond market to understand whether it is possible to find interesting notes in US dollar which can provide an rich pick up over the treasuries. Because volatility continues to be high as we approach the US election and Covid-19 cases rise globally, we believe it is crucial to minimize duration risk especially among risky assets. That’s we are looking mainly at maturities up to six years.
Before diving into the Russian bond market, I would like to invite you to read Christopher Dembik’s analysis on the Russian economy. As he explains in his latest published article, the country is going through a prolonged phase of economic contraction. Extractive industries (commodity-based companies), which are at the core of the Russian economy, have performed poorly as commodity prices stayed low throughout the year. On the other hand the manufacturing sector looks to be recovering already. Although the majority of emerging markets are facing the same problems, Russia seems to be in better conditions to navigate this crisis, and to have the necessary tools to get through another economic shock caused by a second Covid-19 wave. As a matter of facts, the country’s international reserves are solid, and monetary policy and debt have not been used as extensively as in other EMs.
It is important to note that while Russian government and corporate debt looks better compared to the one of other EMs, bond prices will most likely fall further due to the adverse global macro-economic backdrop. This is why it is crucial to reduce duration risk and cherry pick among short term maturities.
Alrosa is a Russian group of diamond mining companies, accounting for almost 30% of the global diamond extraction. After the post-pandemic slowdown in sales, the company has seen strong sales numbers in august, however as a second wave or coronavirus seems now most likely, we can expect these numbers to subside. The company is solid with a very moderate financial leverage, thus we don’t believe it will be exposed to a credit downgrade, unless Russian sovereigns are downgraded.
The company has three bonds outstanding: one with maturity November this year (XS0555493203), another with April 2024 maturity (XS1843441731) and the last one maturing in June 2027 (XS2010030919). We believe that these notes are most likely to reprice as we get closer to the US election. Indeed, the company might have difficulties to refinance the notes which will mature on November the third, as at the same time the market will be busy to recalibrate risk during amid the election results. This might be the perfect time to enter in the notes with 2024 maturity which at the moment offer a yield around 2.25%, but may come cheaper.
Gazprom and Lukoil:
Even though revenues in both companies have struggled this year because of low natural gas prices, in the past two months there has been a sensible recovery. We like both companies because their financial leverage is contained compared to the energy industry average. The yield offered by their bonds is comparable even though Gazprom’s debt structure is more complex than Lukoil’s. The main difference between these companies is that Gazprom State-owned, while Lukoil is privately owned. We therefore prefer the bonds offer by Gazprom, as they should be more resilient amid a market selloff. The Gazprom notes with maturity 2022 (XS0805570354) offer around 1.7% in yield, while Lukoil 2023 (XS0919504562) offers around 1.75% in yield
Severstal is a Russian steel company. The note with maturity 2022 (XS0841671000) offer around 2% in yield which represent a pickup of 180bps on Treasuries for a 2-year investment horizon only. Even though demand from the auto manufacturing sector has plummet, other sectors’ demand such as construction has increased. This trend helped fundamentals not to deteriorate as fast as expected. The company’s financial leverage is slightly higher than the one of Novolipetsk, however, in order to buy bonds in the latter it is necessary to stretch one investment to 2024. We believe that the opportunity to invest in short-term bonds with a considerable pick up over the Treasuries makes Severstal 2022 notes very attractive.