Over the next several weeks, Gateway2Russia will present highlights from this year’s Expert 200, Expert RA Rating Agency’s annual rating of Russia’s 200 biggest and most dynamic companies.

Part II: Aggregate Efficiency and the Russian Financial Markets

Big business capitalization

Despite confident growth on the stock market, the quality of the overwhelming majority of stocks remains low. Companies with minimal credit risks that are able to react adequately to changes in market conditions attract funds via bonds.

The stock market

The total value of the top 200 Russian companies grew by 1.8 times over the last year and exceeded pre-crisis, 1997 levels, reaching $189 billion. The stock market growth that began in 2001 continued this year, though the reasons behind the index upswings changed. While in 2002 the main growth factor was investors returning to the Russian market due to the unstable situation on Western markets, in 2003 the reason stock prices rose was the latest redistribution of manufacturing assets.
The Russian stock market is close to its maximum. Any further increase in prices will cause the market to overheat. Thus, for example, one basic indicator—the ratio of a company’s market value to its sales per share (P/S ratio)—reached 1.24 in 2003 and for the first time exceeded the world average (1.7). It is important to recall that even when the US stock market overheated recently, the P/S ratio for major companies was 2.
At the same time, Russian companies’ profitability does not justify investors’ very optimistic attitude toward the Russian market. The average P/E ratio (ratio of stock price to net earnings) for the 200 biggest Russian companies totals only 9.81 compared to a world average of 20.86.
While the market seems to have reached its limit this year in terms of “depth,” it reached its maximum “breadth” last year. The liquidity of the stocks of the 200 largest Russian companies in terms of capitalization declined dramatically. While last year only companies whose shares had been traded made the list, this year the list includes 67 (i.e. one third!) companies with a D liquidity level (low liquidity: prices are listed but no trades have been recorded). The main reason behind this collapse is technical: the restructuring of the telecom industry. The seventy some regional telecom companies have been replaced by seven holding companies. In the not-so-distant future, AO-energo companies will also disappear for a similar reason, meaning that in a year or two companies that are even a little liquid will barely number a hundred.
It is furthermore highly unlikely that any new companies will appear on the stock market. The main reason why: the market still does not allow companies to attract investment via public offerings. This means that there is no motivation to bring securities to the market. In the last two years, only two IPOs have taken place on the Russian market, RBK Information Systems and 36,6 Drugstores.
The outlook for development on the market is reflected by the fact that 24.5% of all trades are made in stocks that investors feel very optimistic about. This group of stocks only increased by a third. The six newcomers are companies from the energy sector, including the Sayano-Shushensky HPP (municipal electric grid), the leader among the “optimists” this year. Second and third place among companies with an optimistic outlook did not go to oil companies, but to MTS and RBK Information Systems. The diversification in terms of industries on this list compared to previous years testifies to the fact that investors are gradually starting to give their preference to stocks of companies with a clear and transparent business structure. These companies do not have to belong to the real sectors of the economy. It is only important that their shares are traded.
Accordingly, the stocks that investors have a low opinion of are practically not traded. The total trading volume for the shares of 30 such companies did not exceed $4 million last year (by comparison, trading volume for the top 200 was $54 billion). At the top of this list is a Murmansk company, Apatit, whose shares were recently embroiled in scandal. It is noteworthy that the number of electric companies on this list has fallen substantially and that the stocks with the worst market outlooks belong to companies from traditional sectors of the economy.

The bond market

The only possibility at present for companies to attract funds from the market is via corporate bonds. Since 1999, the bond market has expanded exponentially.
Early in the year, market fluctuations did not have a significant effect on the primary corporate bond market. Issuers issued bonds almost immediately (two weeks) after registering their issues with the Federal Securities Commission. Everyone thought that the bond market would be capable of absorbing any size placement. Every month, five to ten new companies appeared on the market.
This euphoria reached its peak in April-May 2003. Due to excessive bank liquidity, the real rates on bonds became negative. A paradoxical situation emerged, as banks were willing to pay companies for taking loans. The reaction from Russian issuers was not long in coming. From June to August, the largest number of issues in the entire history of the Russian market was planned with a total value of 50 billion rubles. Yet only a handful of the more than 60 potential issuers managed to place their bonds at yields lower than inflation.

Why the sluggishness?

Why didn’t the majority of Russian companies succeed in placing their issues in the spring when the bond market was bursting with excess liquidity? There are two reasons.
One is due to the inadequate organization of procedures among the issuers themselves. The decision to issue bonds can take months at many companies. As a result, preparations for a one-year bond issue can take six months or even more.
The second reason lies in the infrastructure of the bond market itself. First of all, there are problems with preparing registration documents. If all goes well, this requires three to four weeks. If the commission is not happy with something in the documentation, it can take months to get approval and the process might end in rejection. At the same time, the Federal Securities Commission introduced the institution of financial consultants last April. Not only does this increase the costs to companies entering the market by 0.3-0.4%; finding a financial consultant presents yet another headache for issuers. A third problem involved with the infrastructure of the bond market is the tax on issues, which has yet to be eliminated. The problem is not only that the tax increases costs and brings little benefit to the federal budget. Even worse, this tax must be paid when the issue is registered, when a company does not know if it will be able to place the bonds or not.

Adaptation

Since June, market conditions have worsened dramatically. Insufficient free ruble liquidity and the gradual weakening of the ruble versus the dollar led to a reduction in investor demand for bonds. In April-May, the demand for initial placements exceeded supply by one-and-a-half times, while in June this ratio began to fall consistently to less than one unit.
It has become obvious that the real limit of investor demand on the market is currently 12-15 billion rubles a month. This means that at present market conditions are negative and in the coming month, it is unlikely to change for the better. Thus, companies should start thinking about strategies for entering the bond market. Let’s take a look at two possibilities.
One is suggested by the Russian legislation, which stipulates the time allowed for preparing for an initial auction. An issue that has already been registered can be placed by a company within a year of its registration with the Federal Securities Commission. This means companies have more than enough time to wait for better market conditions.
On the other hand, reliable issuers can borrow at low rates on the market even now. Investors either estimate the credit risks on bonds themselves or are guided by generally accepted ratings. There is obvious evidence to support this, as bonds in different rating categories differ in terms of yield (Chart 17). More reliable bonds are traded at 1-2 percentage points lower on average than those of issuers with only satisfactory reliability ratings.

See also Part I  Trends in big business