The growth rate of Russia’s manufacturing PMI declined for the second month in a row in April.
Nevertheless, the indicator remains above the 50-point threshold (52.6 points), indicating improved operating conditions in the manufacturing sector on the back of increased production and new orders. Demand is boosted by the substitution of domestic products for fallen imports, as well as the emergence of new markets that have emerged in the reorientation of trade from the West to the East. At the same time, companies continue to increase the employment rate at their production facilities, which reduces work-in-progress and increases inventories. We believe that market conditions in Russian industry will remain favourable in Q2 2023.
Freight: beneficiaries of trade diversion to the East
Russian Railways’ operational indicators continue to show a recovery: network loading in January-April 2023 increased by 0.2% (y/y) to 411mn tonnes, while cargo turnover, which largely correlates with the revenue dynamics of railway operators, increased by 1.8% (y/y) to 899.1bn tariff ton-km.
In addition, there is a steady upward trend in the dynamics of rental rates in the gondola segment after the summer-fall dip, with rates in May rising to RUB 2,583 per day versus a low of RUB 2,072 per day in October.
We believe that continued high gondola rental rates, further expansion of the Eastern Region’s infrastructure capacity amid a reorientation of export shipments from the West to the East, including through increased trade cooperation with China, will have a favourable impact on the railway operators’ business.
Globaltrans is one of the largest rail freight operators in Russia and the CIS. The company transports metallurgical and petrochemical cargoes, and also transports oil products and oil, coal and construction materials.
Sanctions risks for Globaltrans are minimal, as the company’s core business is concentrated in Russia, key customers are large Russian companies with fulfilled service contracts – at the end of 2022 Globaltrans still had 6 long-term service contracts in place.
Globaltrans has demonstrated strong financial performance in 2022, reduced its debt burden and improved operational efficiency ratios. Bucking the negative trend in cargo turnover dynamics on Russian Railways’ network, favorable pricing environment in open wagons and tank cars segments, as well as the company’s long-term service contracts will positively affect Globaltrans’ financial metrics in 2023.
We have assigned Globaltrans stock a “Buy” rating with a target price of RUB 601 per share, implying an upside of 38.1% from the current price level.
Another beneficiary of the trade diversion to the East will be Sovcomflot, Russia’s largest shipping group of companies and one of the world leaders in the offshore transportation of liquefied gas, crude oil and petroleum products, as well as the servicing and support of offshore hydrocarbon production. The company is involved in servicing major energy projects in Russia and beyond: “Sakhalin-1, Sakhalin-2, Varandey, Prirazlomnoye, Novy Port, Yamal LNG, and Tangguh (Indonesia).
Drivers of growth in Sovcomflot shares will be the continued growth of Russian oil exports to Asia at high tariffs and an increase in LNG supplies amid a ban on pipeline gas supplies from Russia. The company has demonstrated an impressive rate of growth in its financial performance in 2022, despite sanctions pressure and the forced sale of part of its fleet.
In April, Sovcomflot’s board of directors recommended a dividend of 50% of net profit for 2022, i.e. RUB 10.2bn or RUB 4.29 per share with a yield of 6.8%. The decision on the dividends will be taken at the annual meeting of Sovcomflot’s shareholders to be held on 15 June. If the dividend is approved, the record date will be July 5.
We recommend BUYing Sovcomflot shares with a target price of RUB 84.2 per share and expect them to yield 34.3%.
The airline industry continues to recover
Despite the challenges faced by the aviation industry in recent years, the operating performance of Russian air carriers is recovering – in Q1 2023, Russian airlines increased passenger traffic by 4.5% (YoY) to 20.7 million people. The Federal Air Transport Agency estimates that the 2023 passenger target is 103 million passengers (95.1 million in 2022), while the Association of Air Transport Operators (AETO) anticipates that, at the current rate of recovery, the figure could reach the 2021 level of 111 million.
The industry’s strong performance was largely due to extensive support from the government. The federal budget allocated 25.3 billion rubles in 2023 to reimburse operating costs of airlines for actual passenger turnover on domestic flights in November 2022 – March 2023, of which 11.6 billion rubles were allocated to Aeroflot group. The Ministry of Transport is currently discussing extending subsidies for flights within Russia for the summer season. At the same time, 17 airlines (including Aeroflot) continue flying on 308 routes within the subsidy program for regional air travel around Moscow, for which 7.5 billion rubles are allocated.
In terms of the airline sector, we look positively on the shares of Aeroflot, the Russian airline market leader and state-owned company, which has managed to get through the crisis thanks to access to funding through an additional issue, subsidies, etc.
Aeroflot Group increased its passenger traffic by 20.3% (YoY) to 12.8 million people, with both domestic (+16.7% (YoY)) and international lines (+37.0% (YoY)) in accordance with its operating figures for the 4 months of 2023. Separately, Aeroflot carried 6.6 million passengers (+41.9% (YoY)) in January-April, of which 4.7 million (+40.6% (YoY)) – on domestic flights, 1.9 mln (+45.3% (YoY)) – on international flights.
The percentage of passenger seat occupancy for 4 months of 2023 on the group increased by 9.0 p.p. (YoY) to 86.4% (on international routes – by 14.7 p.p. to 82.4%, on domestic routes – by 6.9 p.p. to 88.5%). The rate for Aeroflot alone rose by 14.2 p.p. (YoY) to 84.7% (on international routes – by 18.9 p.p. to 81.9%, on domestic routes – by 11.0 p.p. to 87.1%).
The Group’s airlines increased the intensity of flights in January-April: the number of flights increased by 9% (YoY) to 87.2 thousand, and the fleet flying time increased by 13.5% (YoY) to 249.1 hours. The number of Aeroflot’s flights rose by 17% (YoY) to 42.4 thousand flights and the number of hours flown by its fleet grew by 24.4% (YoY) to 137.5 hours.
Our rating on Aeroflot shares is “Buy”, the target price is RUB 54 per share, with an upside potential of 35% from the current level.
The real estate sector is stagnating
The Russian real estate market overheated in 2022 after a strong rise in new building prices in the 2020-2021 covids, so there are currently no significant drivers of demand and price growth in the sector, given also the tightening of conditions under the preferential mortgage programme and the phasing out of near-zero mortgages from developers. Nevertheless, Q1 2023 indicators are close to what they were a year ago: demand for new buildings grew by 4.8% (y/y), primary housing prices have stabilised and in most large regions the price change does not exceed 2-3% (y/y). Mortgage origination decreased by 12% (YoY) to 346 thousand loans and by 4% (YoY) in volume to RUB 1.3 trillion. However, demand for mortgage products increased in April and banks extended more than 500 thousand housing loans worth RUB 1.8 trillion (443 thousand loans worth RUB 1.7 trillion in 2022) in the four months of 2023, however the increase was due to the low base of April last year due to the collapse of demand for mortgages after the Central Bank raised its rate to 20%.
The primary housing market has seen actual lending rates rise to 5.3% (+1.7p by the end of 2022), and we believe that banks’ lending policies will continue to tighten in order to buy down the risks of declining mortgage portfolio quality amid general economic uncertainty, falling personal income levels and a possible rise in unemployment. Rising mortgage rates, in turn, will have an adverse effect on the nature of demand for new construction. However, the construction industry plays an important role in the economy of the country, so the government will develop new tools to support the sector. Vladimir Putin has already instructed the government to develop additional preferential mortgage programmes for young people by 1 July 2023. In addition, the issue of increasing the limit on family mortgages in cities with a population of millions of people from 6 million to 12 million roubles has also been discussed.
Despite the weak real estate market conditions at the moment, we remain optimistic about the stock of Samolet, which we consider the most interesting investment case among other Russian developers.
The Samolet Group is one of Russia’s largest development and PropTech corporations. The company is among the backbone organisations of the Russian economy, ranking 2nd both in terms of current construction volumes as of May 2023 and housing commissioning in 2023.
“Samolet delivered impressive financial and operational growth in 2022, effectively doubling the scale of its business despite challenging market conditions. As a result, the valuation of the group’s assets increased by 40% year-on-year to RUB 761bn, while the land bank increased by 58% (YoY) to 45.9m sq m, becoming the largest in the industry. In addition, the developer entered the suburban real estate market, and the residential real estate business portfolio is already valued at over RUB 80 billion. As of the end of 2022, over 3% of all real estate transactions in the country are processed through the digital service Plane Plus, a digital platform bringing together all services for buying, selling and renting real estate across Russia.
We see the main growth drivers for Samolet’s stock as expanding its geographical footprint and reducing its dependence on the Moscow region, the growth of its residential real estate business, and the further development of its digital projects.
Diversification of the business allows the company to be more resilient in the current difficult period in the real estate market, which is why we give the developer’s shares a “Better than market” rating.