Investment options and industries shaping Russian stock market

Current stock market situation

To put it mildly, the first six months of the year have been difficult for Russian investors, and the frequent disruptions of trading on the Moscow Exchange were not even the most unpleasant thing. The Moscow Exchange Index lost 50% of its January value at the peak of the panic.

Experts say the current situation is reminiscent of the notorious 1998, when the future of the young Russian economy seemed bleak and unpromising.

After February 2022, non-residents faced a range of restrictions on the sale of assets and withdrawal of funds, as well as severe capital controls. The Bank of Russia sharply raised the key rate to avoid an outflow of funds from the banking system.

The recent geopolitical developments and new sanctions have seriously affected the investment climate in Russia. Due to economic uncertainty, at least 46 Russian companies refrained from paying dividends for 2021, which was definitely unwelcome news for their shareholders. The dividend yield on Russian stocks is now below the interest from deposits and below the inflation rate. This can further disappoint investors and prompt them to pull out.

The measures taken by the Russian government to stabilize the markets have had a positive effect in the second quarter; the stock market even managed to compensate for some of its prior losses. Turbulence in the Russian financial market has begun to cool down; volatility has decreased, and trading is back on track – the Moscow Exchange index has been trading in the range of 2,100-2,500 points for three months.

But European and US financial assets are now the problem in the portfolio, because the systemic risks they carry are higher than expected profits. Problems with payments and transfers of securities persist, and some brokers also face serious risks. This makes Russian investors concentrate on the domestic financial market to a greater extent.

Which companies will be at the forefront of the structural transformation of the Russian market? Mainly, businesses free from most kinds of risks (geopolitical or systemic ones). Investors are likely to focus on stocks of the growing companies that are taking the recently vacated niches in the domestic market and paying dividends consistently.

Which stocks are worth looking at?

In the oil and gas sector, the worst news was Gazprom’s decision not to pay dividends for 2021. Rosneft’s dividends of RUR 41.6 ($0.68) have not covered the 16% inflation. Rosneft shares have plummeted almost 40% since the beginning of the year, stripping investors of the expected profits. Geopolitical risks remain high in the sector due to possible problems with Russian oil and gas exports.

Most companies in the metals and mining industries decided not to pay dividends. Norilsk Nickel recently announced a review of its dividend policy due to a possible merger with Rusal. The outlook for the sector is cloudy, and there are problems caused by the sanctions and the slowdown in global economic growth.

Moreover, companies have lost their exports of value-added products to premium European markets. Expansion into other markets is hampered by more expensive logistics and high competition; they are also compelled to sell their products at a discount. Given the excessively strong ruble and a higher tax burden, exports are losing their economic efficiency. Meanwhile, the demand for metal in the domestic market is declining due to the departure of foreign engineering brands.

The financial and banking sectors are among those hit the hardest by the sanctions. The three largest companies, the Moscow Exchange, Sber and VTB, have already decided not to pay dividends. During this crisis, banks prioritize maintaining liquidity; therefore, no dividends should be expected this year.

The sectors with fewer geopolitical and systemic risks will feel significantly better.

Russia’s telecommunications sector primarily targets Russian customers and will experience far less turbulence. As the most telling example, MTS dividend stocks paid 14%. MTS shares remain at the level of early 2022 after a complete rebound. MTS is actively developing its own ecosystem and its business is stable amid the Russian economic crisis. Overall, MTS shares remain safe for conservative investors with long-term ownership plans. It is an attractive option for long-term purposes with few rivals on the market. The dividend gap may persist for several months but the stocks have a good potential.

Russia’s IT sector encompasses stocks of growth, with Yandex and Positive Technologies being the two most noteworthy companies.

These companies have no external risks although Yandex is increasingly more dependent on the development of consumer services and, therefore, customer activity. Clearly, even though the economic recession in Russia is not as painful as most experts predicted, Yandex will still feel the repercussions. The company is cutting back on investment into new projects and selling some of its business segments with plans to be more frugal. However, as many foreign companies have left the Russian market, Yandex has plenty of opportunities to expand in multiple directions – and these opportunities will be there for months ahead. And still, Yandex is not paying any dividends so far.

Positive Technologies deals with cybersecurity and, obviously, in the current conditions, cybersecurity services are and will remain in great demand. The pandemic has accelerated digital transformation and boosted the demand for solutions that protect corporate data from cyberthreats. As personal and corporate devices grow in numbers, along with hacking attempts targeting all industries, cybersecurity solutions will be highly sought-after in Russia and the entire world. With the departure of foreign vendors, the market has rearranged in favor of Russian companies. In May, the company paid the dividends of RUR 14.4 ($0.24) per share, which equals 50% of the net profit in 2021, according to the IFRS. In mid-August, Positive Technologies plans to release its consolidated IFRS statements and present the performance results of the entire group.

Russian IT companies are en masse getting listed on the Russian stock market in a new snowballing trend. At the beginning of last week, Astra Linux Group, the developer of Astra Linux and a stack of Russian software, announced plans to get listed on the Moscow Exchange. The Digital Development Ministry and the Central Bank are looking for ways to support such offerings by simplifying Moscow Exchange listings for IT companies to attract capital. The ministry is also considering co-financing private venture funds to support startups.

The current situation requires that investors focus on fundamental financial indicators, which also favors companies that still practice regular releases of financial statements. Investors will seek alternatives – and they are already emerging, with diversification options. The entire market cannot stand on three elephants and one turtle.