Aeroflot: dinosaur no more 

Sberbank: the gorilla in the sector

Tinkoff Credit Systems: savers’ savings 

The rest of the banking sector has had a terrible time in the last few years, barely breaking even on aggregate. However, Tinkoff Credit Systems (TCS), set up by serial entrepreneur Oleg Tinkov, is an exception. Russia’s first purely online bank, it has been flourishing thanks to its low-cost base, which allows it to offer attractive deposit rates – something the inflation-sensitive Russian consumer pays close attention to.

However, TCS’ share price also highlights another rule of thumb for investing into Russian stocks: don't buy the IPO. TCS listed in London with much fanfare on October 22, 2013, priced at $17.50, the top of the offer range, to raise $1bn on a valuation of $3.2bn. But the share price immediately crashed as the 2015 silent crisis got underway, falling to a nadir of $1.60 in September 2015. Since then the shares have recovered strongly and were trading at $10.75 at the end of March, but they remain underwater compared to the IPO. It's a typical story as most Russian stocks are overpriced at the time of their listing and several, like the “people’s IPO” of state-owned VTB Group, never regain their offer price.

Still, if the investor gets the timing right then these IPO disappointments can turn into stellar investments. TCS has turned into an excellent proxy for Russia’s banking sector. The bank earned RUB3.7bn ($65mn) in the fourth quarter of 2016, well above consensus (RUB2.7bn), four-times more than in the same period a year earlier, as well as more than a third (37%) more than the quarter before.

“Annualised return on equity was an outstanding 51.4% (20.5% for 3Q16). Net interest income increased 39% y/y and 8% q/q to RUB9.5bn, while net interest margin (NIM) improved to 26.5% (vs 25.9% for 3Q16),” Gazprombank gushed in a research note.

And like so many of Russia’s best stock picks, TCS is happy to share its growing profits with its shareholders: in March the bank introduced a new dividend policy with a payout ratio of 50% of the previous quarter's net income. The 2017 dividends should be a minimum of RUB7bn, which implies at least a 7% dividend yield, according to analysts.

Russia’s diamond monopolist Alrosa is the new kid on the block for equity investors. Another SOE company that defies the “government is bad at business” adage, equity investors started to pay closer attention to it after 11% of the company was successfully privatised in July last year.

Located in the frozen north, Alrosa is deep in the tundra on the site of a former Gulag camp that had huge Kimberlite pipes – the rock where you find diamonds. The company reported strong January rough diamond sales of $358mn, up 60% y/y, thanks to a quicker than expected recovery of Indian demand. And analysts expect this growth to continue as diamond dealers start to restock following a very bad 2015.

The company is part of the government’s privatisation drive and, while the government has delayed most of the privatisation on the docket, the track record of those SOEs that have been privatised has been excellent: the shares of Rosneft, Sberbank, the Moscow Exchange (MOEX), and Aeroflot have all had long runs of outperforming the market following the partial privatisation of their shares. The next interesting name that should come up in the first half of this year will be the partial privatisation of Sovkomflot, a state-owned global shipping powerhouse. And more Alrosa shares are also due to be sold this year.

Part of the growing appeal of SOE shares is a switch in mindset by the government on how to profit from these names. In the 1990s the Yeltsin government lived hand to mouth by levying special taxes on Gazprom whenever it ran out of money. Today the state has decided a better way to tap the billions these companies generate is to force them to pay dividends: current all SOEs are supposed to pay 25% of their profits out to shareholders – including the minorities – and the Ministry of Finance is trying to force them to pay 50%. Many of the SOEs are resisting this push, but not Alrosa, which is expected to pay 50% of net profit in dividends for 2016. If it does they would total RUB9 per share, yielding a whopping 10.4% dividend yield. "Following the recent sell-off, we consider Alrosa as one of the most oversold stocks in the Russian metals and mining sector and reiterate our ‘overweight’ recommendation," Gazprombank said in a note in March.

Finally, the last stock to highlight is the Moscow Exchange itself. 2017 should be a good year for Russia’s leading exchange (there are about half a dozen smaller exchanges in the country) as Russian companies increasing come home in search of better liquidity. MOEX is transforming from a local exchange in an emerging market to a global player in its own right, even if the International Financial Centre programme launched several years ago is downplayed today.

The exchange was transformed following the merger of the RTS and MICEX in 2011 and hooked up to the global capital markets after it joined Clearstream and Euroclear. MOEX is unusual in that in addition to the fees it generates from the trade of stocks and bonds it also earns income from custody, settlement, derivatives and FX trading amongst other things. The exchange has pioneered good corporate governance by applying the best in practice standards to itself and has the same approach to its investor relations, treatment of minorities, and of course has the inevitable generous dividend policy: the pay out was recently increased to 55% of profits, giving a 7% dividend yield.

“The stock is valued at a 2017F price-to-earnings ratio (p/e) of 10.2x, or at a 54% discount to global emerging market peers,” VTB Capital said in a note that marked the name up to a ‘buy’ in March. “Headwinds remain, but the business is solid.”