Russian investment bank BCS has upgraded the Russian equity market to a “buy” with a 45% upside for 2023, the bank said in a note on March 27.

“Russian equity market keeps adapting. We believe that the Russian equity market is still alive, albeit [it] is in some transition period due to the need to adapt to the new environment, both global and internal,” the bank said in a research note to clients. “We thus upgrade our 12MF target for the iMOEX index to 3,480 (vs 2.800 in the last strategy), implying 45% upside from here.”

The dollar-denominated RTS Index surpassed 1,000 points during the March 27 trading session for the first time since February 8, TASS reports. As of 1:23 p.m. Moscow time, the RTS Index was up by 2.28% at 1,000.01 points.  

Despite the extreme sanctions imposed on Russia following its invasion of Ukraine just over a year ago, the economy has performed much better than economists were anticipating. At the start of the war most experts predicted a 15% GDP contraction, whereas the  full year result was a mere 2.1% fall.

The federal budget has also performed much better than expected, remaining in surplus for 11 out of 12 months, despite falling heavily in December to end the year with a 2.3% deficit. The budget got off to a bad start in January, posting a RUB1.76 trillion deficit – more than half the anticipated deficit for the full year. Indeed, the full year deficit of RUB2.9 trillion was reached in mid-March, but nevertheless both the Ministry of Finance (MinFin) and economists expect the government revenues to pick up in the second half of the year, but forecast a larger deficit on the order of RUB4.5 trillion that can be easily covered with funds in the National Welfare Fund (NWF) and new issues of Russian Finance Ministry’s OFZ treasury bills.

“Surprisingly, especially recalling our thoughts a year ago, the Russian economy is getting a much smoother drive through the obstacles. Here is another upgrade of the GDP and economy rates – we now expect -1.6% growth this year vs -2.4% before. We have also weakened the ruble forecast which fell fast, beyond even our aggressive expectations – we expect RUB76/$ by year-end vs RUB71.5/$ before.”

BCS says that it sees “green shoots” of growth that will become apparent in the third quarter of this year as the economy stabilises and adapts to the new realities of sanctions.

“As for the economy, it is also clearly doing much better than initially expected a year ago, with several upgrades going through the street and us every now and then. We still think that the slowdown is likely to last in the first half of the year, with 3Q23 showing first signs of GPD recovery as we expect the negative geopolitical factors to be more than offset by the local economy,” BCS said. “This makes the investment story in Russia at least for the next two quarters and, as always, we suggest more focus on stock picking.”

While the Russian stock market remains off limits for international investors, domestic investors are still active and after interest rates for bank deposits fell to all-time lows before the war started, Russian retail investors have become much more interested in equity investments.

Among the bank’s top picks are several raw materials producers, including the steel plants Mechel, Severstal and Magnitogorsk Iron & Steel Works (MMK) as well as oil companies Tatneft and Lukoil. BCS also recommends the leading banks Sber and the online bank Tinkoff Credit Systems as well as Russia’s largest developer, PIK. (table)

Part of the reason for these picks is the expectation of good dividend payments, a theme for Russian stock picking for many years now.

“Aside from the economy recovery, we note an even stronger theme for this year – dividend restoration,” BCS said. “A lot of the companies stopped paying dividends amidst uncertainties and potential tax innovations; however, [the] weakened ruble and [a] better commodities environment help the companies improve their financials, which is likely to translate into delayed dividends going forward, even in case of additional taxation responsibilities. We expect the Russian stock market to get back to a 6.7% dividend yield in the next 12 months, with our top dividend picks generating 13.9% return.”

Another positive factor in favour of investing into Russian stocks is that the Western sanctions seem to have run their course. EU foreign policy chief Josep Borrell said earlier this month that the West has few options left for imposing new sanctions, which have disappointed with their ineffectiveness in crushing Russia’s economy. European Commission President Ursula von der Leyen said last week that an eleventh package of sanctions is currently under discussion, but it will contain few new sanctions and largely focus on making existing sanctions work better.

“The macro landscape is key, as the sanctions lose their weight,” BCS said. “On the risk side, we admit that the macro environment is key, while additional geopolitical limitations no longer play a major role for the Russian companies.”

“The recent US financial crisis is a perfect illustration of what may push the market lower. Yes, the Russian economy is no longer directly connected with the world through the financial channels, but the connections via commodity prices obviously have the same high importance. However, our base case so far is that the impact is unlikely to be high, especially given that the Chinese economy is set to gain momentum given the recent growth targets by the government,” BCS concluded.