Reticent About Russia

As long as world oil prices keep increasing, or at least remain high, Russian energy companies will keep generating record profits. If that happens, count on Russian consumers to keep enjoying he resultant bonanza, thanks to spin-off benefits that will boost consumer-sector profits (leading to the creation of products that consumers actually can buy). However, Russia is the least sound of the BRIC economies, and is the one that I would least like to be invested in over the long term.

Politically, Russia has pretty much reverted to the pre-1991 Soviet system.

Today, just like then, there’s only one real party: The United Russia party, which controls 315 of the 450 seats in the Duma (essentially the lower house of parliament) and whose leader is one Vladimir Vladimirovich Putin. There is considerable censorship of the media, and dissident reporters and editors have a habit of disappearing - not that there are many left now. There is huge emphasis on military power, and on throwing Russia’s weight around in foreign policy.

There is, however, a significant economic difference from the pre-1991 Soviet Union: While the state still controls most property, it does not control all of it as before.

Another difference: Before 1991, Politburo members were relatively impoverished and notorious for their lack of fashion sense and trademark baggy Soviet suits; these days the top brass, and especially Putin, are telegenic, snappy dressers with broad wardrobes of Italian clothes - and hefty bank accounts to match.

Economically, the Putin regime has produced huge economic growth - averaging nearly 10% per annum since 2000, including growth of 8.1% in 2007. A certain percentage of this was a "dead cat bounce" from Russia’s debilitated state in 1998-99, while some was the effect of a Reaganesque tax reform passed in 2001, which produced a "flat tax" income tax system at a rate of 13%.

Since 2004, Russia’s economic growth has been almost entirely driven by high oil prices. With Putin’s partial seizure of the Royal Dutch Shell PLC (ADR: RDS.A, RDS.B) concessions in 2006 and the BP PLC (ADR: BP) properties earlier this year, it’s become obvious that the Russian state will control all economic activity in the energy sector. As a result, output has now stopped increasing; in the first quarter it actually declined slightly. New Russian President Dmitry Medvedev has announced an ambitious target of expanded output, but I remain skeptical that Russia will achieve this with its government-dominated economic system.

However, if you still find Russia alluring, you need to keep certain things in mind. Most important of all, remember that this is a highly speculative market, and you should be ready to sell if U.S. interest rates are raised, which could well signal that commodity and energy bubbles are up for a tumble. But since Russia is primarily a play on energy prices, two of the three suggestions are energy companies:

• OAO Gazprom (Pink Sheets ADR: OGZPY), the state-owned natural-gas monopoly, has ambitions to control Western Europe’s gas supplies. Since its ambitions don’t yet extend to the U.S. market, it is quoted only on the Pink Sheets. The shares are trading at 10 times trailing earnings, but gas prices and Gazprom’s dominance are both rising.
• Lukoil (Pink Sheets: LUKOY.PK) is the largest state-controlled oil company; but again, its shares only are available through the Pink Sheets. This one has a trailing P/E of only 6, based on 2007 earnings, but that was back when the average oil price was about $80 a barrel. It’s a good, but speculative, play on an additional run-up in oil prices, a trend that Investment Director Keith Fitz-Gerald has repeatedly predicted will continue.
• Vimpel-Communications (ADR: VIP) is a mobile telephone company with 55 million subscribers and mobile operations in Russia, Kazakhstan, Ukraine, Uzbekistan, Tajikistan, Georgia and Armenia. It trades at 14.3 times trailing earnings and has a decent dividend yield of 1.9%.