Description

I own shares in Sberbank, Russia’s largest bank. Sberbank dominates the Russian banking sector, controlling 29% of the country’s assets, 34% of corporate lending, 33% of retail lending, and 46% of retail deposits. Its retail branch network is over 10x the size of its nearest competitor. Due to a unique history that has led to a large depositor base and branch network, Sberbank enjoys a significant funding cost advantage relative to its competitors.

This dominance has led to some of the highest NIMs (6.1% in 2012), ROE (24.2% in 2012) and ROA’s (2.7%) in the global banking coverage universe. In addition, Russia remains a significantly underbanked market, providing Sberbank substantial runway for future growth.

Yet despite its low-cost advantage and enormous growth potential, Sberbank, like most Russian stocks, suffers from the “Russian Discount”. Investors can acquire the business for only 6.5x LTM P/E and 1.3x TBV. 

I think Sberbank’s dominance warrants an 18x P/E and 3.0x TBV. As a result, Sberbank is fundamentally worth 200% more than its current price.

Key points: 
1) Russia’s economy can absorb substantial increased lending capacity, and there remains substantial opportunity to grow the depositor base
2) Sberbank, specifically, has competitive advantages that will allow it to deploy large amounts of incremental capital at returns well in excess of its cost of capital
3) Despite being government-controlled, Sberbank is a well-run bank with responsible lending
4) Russian stocks are amongst the cheapest in the world due to the “Russian discount” – Sberbank’s importance to Russia’s reputation and its shareholder friendly culture leave us to believe that minority shareholders will be able to reap the economic benefits of their investment
5) As a result of the above points, Sberbank is a wholly mispriced asset at only 6.5x EPS; I think the stock has 200% upside.

Russia Remains Substantially Underbanked

On numerous metrics, Russia has substantial capacity for additional corporate and household debt, and remains underbanked and generally underlevered as a country. Here are some statistics:

-          2012 Household Debt to GDP for Russia was 13%, compared to 31% for China, 67% for France, 78% for the United States, and 98% for the UK (bit.ly/Gzs2N4)
-          2012 Domestic loans to private sector as a percentage of GDP was 48%, compared to 57% for China, 68% for Brazil, 102% for Germany, 179% for UK and 194% for US (bit.ly/Gzs2N4)
-          Non-financial corporate debt to GDP is 40% in Russia, compared to nearly 80% in US, more than 100% in China, 110% in UK and more than 120% in Spain (econ.st/19iGy2o)
-          Financial Debt as % of GDP is less than 30% of GDP in Russia, compared to 40% in US, 90% in Germany, etc. (econ.st/19iGy2o)
-          Total banking assets as a % of GDP is a small fraction of other countries: (bit.ly/15GbR6R)
-          Bank deposits to GDP are also much lower than other countries: (bit.ly/19cm5Ce)

Viewed in a global context, Russia is underlevered and underbanked.

The implication is that the Russian banking system has a lengthy runway to experience future growth as it catches up to the penetration levels of other countries. Deposits and loans are almost certain to grow rapidly year after year, for the next 10 to 20 years.

The 2011 to 2015 OECD CAGR forecast for bank loans for Russia is 17%, compared to 4% for the USA and 3% for the UK. For Sberbank, deposits grew 10% in 2012, 28% in 2011 and 19% in 2010.

Non-interest income is also growing rapidly. Fees and commission income grew 28% in the most recent quarter. Card fees grew 48% in 2012. Insurance sales agency fees grew 21% in 2012. The number of credit cards issued grew 97% in 2012.

I expect this rapid growth to continue for many years to come. Over the next decade, more and more Russians will deposit their earnings in banks and lever themselves up in the rapid global leveraging that is the hallmark of modern day capitalism.

Sberbank’s Competitive Position

Sberbank’s history traces back to 1841. It is the largest bank in Russia and Eastern Europe, and the 3^rd largest bank in all of Europe. Its operating profits and regional market share are superior to any other major European bank.

Sberbank was created as part of the Russian banking overhaul under Mikhail Gorbachev in the 1980’s. Separate state-owned banking enterprises were established to service different sectors of the Russian economy; Sberbank was established in 1988 to focus on retail deposits. In the 1990’s, Sberbank was organized as a joint stock company.

Though Sberbank faced significant competition during the 1990’s from thousands of independent banks, various financial crises, culminating in the Russian Ruble crisis in 1998, cemented Sberbank’s dominant deposit base. Amid the 1998 currency collapse, Russian depositors were given the opportunity to transfer their deposits to Sberbank with an explicit government-backed deposit guarantee. Sberbank’s market share and reputation as a “safe” bank, effectively backstopped by the Russian government, has given Sberbank a significant funding advantage for retail deposits relative to most of its competitors. The Russian government has been gradually selling down its stake in the bank, recently selling 8% in 2012, bringing its stake down to 50.1%. 

Today, Sberbank dominates Russian banking. It controls an incredible 46% of Russia’s retail deposits and 32% of its loans. It controls 28% of Russian banking assets, 28% of banking capital, 32% of corporate loans, 32% of retail loans and 43% of debit and credit cards. Its 18,625 branches compares to 1,583 branches for its next largest competitor, Russian Agricultural Bank, and 1,257 for VTB. As can be seen from this link (bit.ly/1hfFFfS), although other banks have significant assets relative to Sberbank, SBER has the far larger retail footprint.

This massive market dominance has led to among the highest NIMs, ROEs and ROAAs among global banks. Its 2.4% ROAA is industry-leading. Its NIM has exceeded 6% for the past few years, and should remain well above 5% for the foreseeable future. ROAE was 21% in 2010, 28% in 2011, and 24% in 2012. More than half of its deposits are retail, which should continue to fuel lofty NIMs.

It is important to note that a large segment of Sberbank’s lending is in very “standardized” products where its cost advantage is difficult to overcome through superior underwriting.

Credit Quality and Capitalization

Credit quality and capitalization have both been reasonable.

NPL % in loan portfolio is 3.2% and Sberbank’s NPL coverage ratio (ratio of provision for loan impairment to NPLs) is 1.6x.

Sberbank’s ratio of equity to assets is 11%, higher than the 10% average in the United States, 7% in Brazil and 6% in China.

Loans are well-diversified, with 25% to retail, 21% to corporates, 33% commercial, 14% to SMEs, and 6% to the agricultural sector. Its corporate loan portfolio is also well diversified amongst different industries, with no alarming exposures to high-risk sectors. Construction loans stand at 6%, energy at 6%, metallurgy at 5% and oil/gas at 2%.

Russian Macro Statistics

The central risk to the Russian economy is its overall dependence on the oil and gas sector. If oil and gas prices decline, the Russian economy and government will receive numerous disruptions. This economist article (econ.st/19NNTba) discusses some of the risks that Russia faces as the U.S. shale revolution begins to encroach on the country’s oil and gas revenue.

Beyond this oil and gas risk, however, Russia’s long-term future appears relatively healthy. Russia’s government debt to GDP is quite low, at less than 8% of GDP. China’s ratio is 32%, Brazil’s is 59%, and America’s is 73% (1.usa.gov/16U2ccl). Russia has a healthy trade surplus, with a 2012 surplus at 3.7% of GDP, providing a cushion should oil and gas prices weaken. Finally, Russia has large international currency reserves. International reserves comprise 30% of GDP. That compares to 46% for China and 23% for Japan. Foreign reserves at 30% of GDP is one of the highest in the world.

It’s unclear exactly how badly Russia’s economy would suffer if oil prices declined to $70. Some analysts have estimated that the impact on Russia wouldn’t be as dramatic as would be otherwise feared. The country’s fortress balance of reserves and low government debt level may provide a fair amount of protection as the government readjusts its expenditures to a new revenue environment if energy prices were to decline.

Generally speaking, the Russian economy doesn’t appear to be in serious danger anytime in the near future.

Valuation

Given Sberbank’s promising runway, the current valuation is dirt cheap. The company trades at 100 rubles per share, and I think it’s worth 300. A fast-growing bank with a 6% NIM, 20% ROAE and 2%+ ROA should trade between 2x to 3x TBV. Some emerging market banks with Sberbank’s range of operating statistics trade north of 3x.

The typical explanation for Sberbank’s heavily discounted valuation is that it’s a Russian bank, and therefore plagued with corruption. I’m not sure this stigma is justified. Sberbank mostly makes money from a large spread between the diversified collection of retail deposits it holds and the diversified array of loans it makes. Short of a collapse of the Ruble, I’m not sure Sberbank’s future is in much jeopardy, and I have difficulty understanding why Sberbank would be any more corrupt than the largest banks of many other emerging markets. Furthermore, I haven’t seen any evidence that Russian corporates or individuals are heavily insolvent, which is often cited as the reason behind the low multiples of China's banks. On the contrary, Russia as a whole appears to have more capacity for additional leverage than any other major country in the world.

Governance and Minority Shareholder-Friendly Culture

Though Sberbank is 50.1% owned by the Russian government, we believe that it is focused on being friendly towards minority shareholders.

First, Sberbank has a committee appointed to represent minority interests (bit.ly/1azVeNP).  Sberbank has implemented a number of the committee’s corporate governance recommendations. The Minority Shareholders Committee includes a Deloitte partner, a director at a non-profit whose mission is to protect shareholder interests, a lawyer / public activist, etc. This link (bit.ly/19KsX64) discusses Sberbank’s corporate governance efforts more broadly.

Second, part of Sberbank’s cash flow is being returned to investors.  The bank pays a healthy dividend of 2.6%. The government is considering enacting a directive requiring state-owned entities to increase their dividend payout ratios to 35%. Ultimately, Sberbank will grow faster if it can reinvest profits to grow its business, but the existence of a reasonable dividend demonstrates a willingness to return capital to shareholders, which is comforting to see in an emerging market company.

Third, it's worth noting the importance of Sberbank to Russia’s reputation.  As a large, liquid, publicly traded state-controlled institution, the treatment of minority shareholders in Sberbank will have a meaningful impact on Russia’s reputation as an investable country for foreign capital.  Thus far, Sberbank’s governance, shareholder orientation and culture appear to be superb.

The bank’s management team seems quite competent. Herman Gref was appointed CEO in 2007 and has transformed Sberbank from a bumbling state bank to a modern, innovative powerhouse. The bank’s operating metrics and statistics are best-in-class globally, and Gref exudes a welcome level of competence. The company’s disclosures to investors are excellent, and Sberbank is working hard to communicate its story to the investment community, as can be seen by their informative investor relations site, regular equity research conference appearances, frequent posts of translated speeches to youtube, and other outreach efforts. Sberbank has won awards for “Best Interactive Annual Report” and other graphic design oriented awards for its investor presentations. While this may sound trivial, ultimately Sberbank trades at a discount because investors don’t trust Russia, or trust it less than other emerging markets like Turkey, Poland, Mexico, Brazil, Indonesia and other countries where banks boasting metrics like Sberbank’s trade at 3x TBV. I don’t see enough evidence to believe that Russia is any more corrupt than the countries mentioned above, at least when it comes to the actions of large banks, and proactive investor communication may help drive that point home. At some point, management’s investor advocacy should stop falling on deaf ears.

A video of the company’s annual meeting is available here: (bit.ly/15BXhNK). Their promotional video at minute 12:30 rivals the KPMG corporate anthem (bit.ly/16dxj6W) in terms of corporate motivational multimedia.

Finally, Russia is trying to change its image abroad with respect to corporate governance. Recently, the Russian government ‘encouraged’ Rosneft to buy out minority shareholders in a situation where it was being criticized for being unfriendly to minority holders (abcn.ws/19eswyN). Having watched its stock market trade down to one of the lowest valuations in the world (Russia’s P/E ratio is approximately 5x), the government has finally recognized that it needs to be proactive in boosting its country’s investor image abroad.

Conclusion

Sberbank has phenomenal metrics, among of the best in the world among global banks. Russia’s financial system is underdeveloped relative to other emerging markets, and Russia’s banks have many years of growth ahead. Despite this, Sberbank trades at 1.3x TBV and 6.5x P/E. I think this is due to the fact that it is Russian, and investors don’t trust Russia. I think this concern is overblown, and don’t understand why Russia is deemed to be any more corrupt than Indonesia, Mexico, Brazil, Colombia, etc., where a bank with Sberbank’s metrics would be trading at 2x to 3x TBV. Outside of a meltdown in global energy prices, Russia should continue to grow nicely macroeconomically, and Sberbank should have a bright future.


Risks:

Government Ownership

Sberbank is 50.1% owned by the Russian government. Government ownership of banks pose risks. First, in certain countries, government-owned banks become increasingly less competitive than privately-owned banks and thus lose market share to privately-owned banks. India is a good example of this, where privately-owned banks have grown faster, generate higher returns on capital and therefore trade at materially higher multiples than state-owned banks. Privately-owned banks can attract more talented employees given their ability to pay higher wages, tend to be more innovative, tend to be more profit and ROIC-focused, feature less bribery and corruption, etc.

Additionally, in a time of economic distress, the government may pressure Sberbank to make an uneconomical decision in order to support the overall Russian economy.

In Russia, many of the largest banks are currently publicly-owned, so the risks to Sberbank are not on the near-term horizon. Secondly, the management team led by Herman Gref that took over in 2008 seems keenly focused on running Sberbank as if it were privately owned. Gref appears to be in favor of the Russian government further privatizing the bank.

Sberbank is Dependent on the Health of the Russian Economy

The Russian economy is fueled by oil and gas exports, and therefore is overly reliant on oil and gas prices. To the extent energy prices decline, Russia may see GDP declines and will be forced to cut government spending. The severity of the recession would test the credit quality of Sberbank’s loan book, and the stock would probably trade down until it becomes clear the level at which NPLs would stabilize. While Sberbank is well-capitalized, especially when compared with Western banks, it does not have the same large capital buffers seen at banks in other emerging markets like Turkey or Brazil. 

Sberbank's Operating Metrics are at Peak Levels and Will Decline to More Normalized Levels Over Time

Currently, Sberbank benefits from a relatively consolidated banking landscape with far less competition than a country such as the United States. Over time, smaller and more nimble competitors should gain market share from Sberbank, and this increased competition should reduce Sberbank's NIMs, ROAE and ROAA. However, the company's valuation multiple is sufficiently low, and this competitive pressure sufficiently longer term, that the stock still seems attractive even though NIMs, ROAE and ROAA will ultimately begin approaching the levels we see from other emerging market banks.
 

Sberbank May Allocate Capital Poorly

Sbernank has bought foreign banks where there are no synergies with its Russian operations. It bought Denizbank in Turkey and bought certain assets from Volksbank, and to no one's surprise, the acquisitions haven't been notably successful (on.ft.com/GNF0aS). Hopefully, they don't keep buying foreign banks. 

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