The Russian Eagle. May 2021 - Earnings Lifts Offsetting Other Drags

Reflation remains the key driver for global markets. Equity indexes are trading at multi-year or record highs in developed countries. Importantly, this rally has been driven not by multiples rerating but rather by earnings upgrades, suggesting that these gains are substantiated. We believe that Russia will likely follow this pattern in the medium term, with earnings upgrades driving stock gains, in particular in commodities. In the meantime, we see little scope for Russia's multiples to rerate amid rising interest rates and ongoing political headlines.> Multiples declining against earnings upgrades. The RTS has remained range-bound YTD as perceived political risks and rising rates have offset earnings upgrades. The index's 2021E P/E has slid from 8.3 to 7.3 while earnings estimates have been upgraded 15% YTD.> P/E will likely stabilize at current levels. All major components of cost of equity seem to be in equilibrium. The CBR's switch to a tighter monetary policy is already priced in by the OFZ market. ERP has stabilized around historical averages. Acute political risks have hopefully faded following more conciliatory remarks from all sides regarding Ukraine, but investors may continue to price in political risks at or above the recent years' average until news flow between Russia and US and European governments materially improves.> Further earnings upgrades are the market's driver. While Brent trades above pre-Covid levels, the consensus EPS estimate for the RTS Index is still 25% below that level. Earnings upside looks highest in the resource names, ranging from 15% to 120% for 2021E.> End hopefully in sight for Covid-19 in Russia. Russia's vaccination progress does not look impressive by global standards. Some 7.5% of the population has received at least one dose of vaccine, a figure just slightly above the global average but way behind the US, UK and even the EU. However, immunity obtained from past infection looks much higher. A government survey implied as many as 25-50% of Russians have antibodies, depending on their region. This means that government claims that herd immunity will be achieved by autumn appear realistic.> Top picks. As the reflation trade rolls on, we find it hard to favor anything other than cyclical stocks. We like Severstal, NLMK, MMK and Evraz, even though we recognize that regulatory risks will induce near-term volatility. In energy, we like Gazprom, Rosneft and Lukoil. Among domestics, banks are the most exposed to the cyclical recovery.