The summer sell-off is no reason to panic. Look for companies whose owners need the cash- they should pay handsome dividends. Dividends are back in style in Russia, and there are several reasons.

First of all, Russian companies have seen their businesses mature. The majority of large-scale investment projects have been completed, companies have gained market share, and there are fewer attractive targets for acquisition. This is true in particular in the oil and gas and telecommunications sectors. Under these conditions, companies typically prefer to distribute free cash to the owners, especially when there are few minority shareholders.

Second, increased political risk is incentivizing Russian business owners to move free cash out of the country. In an environment where a business can change ownership at any time, few risk keeping cash on the balance sheet long term, perhaps only Surgutneftegaz. Others prefer to move money to a foreign jurisdiction, and neither the crisis in Cyprus nor Switzerland’s intention to disclose information about accountholders to the Russian authorities can shake this preference. In this case, paying dividends is one of the easiest ways to get cash out of the country. It’s completely legal and the tax rate is low.

Third, the Russian budget is beginning to come apart at the seams, even with high oil prices, and this encourages officials to seek new sources of revenue. As a consequence, dividends at state-owned companies such as Gazprom and Transneft are likely to increase.

Five years ago the dividend yield on Russian stocks wasn’t more than 1-2%, but now it is about 4-5% and in many cases even higher. However, Russian stocks remain among the least expensive globally, particularly following the summer sell-off, when many names retreated to last year’s lows or even earlier levels.

However, investors should be cautious and buy into companies whose principal owners need to raise cash. This category includes, for example, mobile operators MTS and Vimpelcom - part of larger holdings (AFK Sistema and Alfa respectively), and they tend to favor cash cows for transactions in other industries. In addition, the two companies will pay an interim dividend, which means that the next payment should come in the fourth quarter of this year.

Another good example is Germany’s E.ON -- one of the few companies that still manages to make money on electricity in Russia-- and all the profits of the Russian subsidiary, E.ON Russia, are paid in the form of dividends, as required by the parent company. Minority shareholders in Norilsk Nickel are also awaiting high payouts, with the size of the dividend guaranteed by a recent agreement between major shareholders Roman Abramovich, Vladimir Potanin and Oleg Deripaska. There’s also Gazprom Neft (principal shareholder Gazprom is always in need of money, and there is an insignificant share of minority shareholders) and Surgut prefs, with the amount of the dividend guaranteed in the charter and a significant dollar cash balance, which makes profits resistant to external shocks.

What companies should be avoided? Above all, avoid those that may see a change in ownership in the near future. The TNK-BP Rosneft deal demonstrated that new owners can have their own views on dividend policy. For example, avoid Bashneft, which could be absorbed by Rosneft. Also at risk are companies that are very cheap or have a high level of debt, or names experiencing a bear market, for example Gazprom. 

07 August 2013, Forbes

equity

Read more