Description

Sberbank is a high-quality bank with 20% ROEs trading almost the way Bank of America did back in 2011 when options prices implied a 20% chance it would close its doors. Sberbank trades at just 7x 2018 earnings for one reason and one reason only: it’s a Russian bank.

Sberbank’s quality and its cheapness are hard to dispute. Russian funny business, on the other hand, is never beyond dispute. That’s the gating issue here: will something happen—sanctions, confiscation—that interferes with your investment? It’s an important question because anytime investors ignore a stock for non-fundamental reasons, there’s opportunity. And the opportunity here offers 35-50% upside.

Sberbank is a quality asset

Sberbank is Russia’s largest bank. If you’re like me, your heart lurches a little at the words “Russian bank.” But Sberbank isn’t just a Russian bank. It is the Russian bank. It has 46% of all of Russia’s retail bank deposits. If you added up the market share of Wells Fargo, Bank of America and Chase, you’d still be well short of Sberbank’s market share in Russia.

Charlie Munger has said that he compares every investment to Wells Fargo. Being one of the largest deposit banks, and having the best distribution system, means WF has the lowest funding cost in the industry, a major advantage in anything. Sberbank has in Russia what Wells Fargo has in the US—except its market share is 4 times greater.

And Sberbank isn’t just the largest retail bank in Russia. It’s the largest in almost everything.

Contrary to fears that, because Sberbank is Russian, it’s corrupt and uninvestable, Sberbank is one of the best run banks in Europe. Net interest margins are amazing, and Sberbank has some of the highest ROEs in the world.

Banks generally are a levered play on growth. However, Sberbank has continued to achieve strong results in the face of Russia’s recent recession. That’s one of the reasons the investment is timely. You don’t have to worry about the macro doomsday scenario because it’s already happened. Oil and gas production is 30% of Russia’s economy, and oil prices plummeted from $100 a barrel in 2013 to $45 a barrel in 2016. This predictably threw Russia into its current recession, and Russia is not a country where recessions mean some mild belt-tightening. John Schindler, an ex-intelligence analyst, often describes Russia as “Mexico but with nukes.” Russia is advanced militarily, yet it is easy to forget how crushingly poor it is. 50% of the average Russian’s income is spent on groceries. This is life closer to the subsistence level than you or I will hopefully ever know.

In this climate, however, Sberbank has continued to be profitable. The chart below shows ROE vs real GDP:

Today inflation is around 2%. Since 2008, Sberbank has averaged ROEs of 18%, and it’s guiding to 20% ROE through 2020. Sberbank is one of the highest earning banks in the world in real terms, and it will continue to be. Moreover its earnings have been achieved with modest leverage: less than 9x.

But how does such a large bank grow over the long-run?

Sberbank grows not by increasing market share but because Russia’s debt market itself is growing. As a result, Sberbank has been able to grow assets by 15% a year since 2008. Book value has grown at 16%.  Even after you strip out inflation of 7% a year over the same period, these are impressive numbers.

In terms of Russia itself, Russia’s GDP will probably never grow as fast as the West’s. But it doesn’t need to. The runaway for loan growth in Russia is huge. Russia is the most underleveraged large economy in the world. Government debt is 17% of GDP. By comparison, it’s 65% in China, 41% in India and 105% in the US. Private domestic loans in Russia are just 55% of GDP. By comparison, they’re 160% in China, 50% in India and 194% in the US. The capacity for additional debt is enormous. And whereas the Western world is at the end of a debt super-cycle, Russia is just at the beginning.

This matters not just in terms of return but in terms of risk. In the West, profit margins today are high. Valuations are titanic. All of it stands on towering amounts of leverage, which will exacerbate any correction. Russia’s economy, for all its faults, isn’t resting on the same shaky foundation.

A major concern in light of Russia’s recession is potential loan losses. Non-performing loans are 4.6% of total loans today, down from a high of 5.4% in Q3 2015. Provisions for loan impairment stand at 7.2% of total loans today, providing a decent 1.5x cushion.  The lowest this cushion ever got was 1.1x, again back in Q3 2015. Since then, the number of problem loans has trended down.

Fundamentally Sberbank is strong, profitable, and it offers emerging-market levels of growth. And at 7x 2018 earnings, Sberbank is one of the last traditionally cheap businesses in the world.

Sberbank’s biggest weakness: location, location, location

Russia, as a place to invest, provokes…a certain response in the investment community. Russia has soaked foreign investors before. It’s also a kleptocracy and a police state. Mixing your capital in with all this may feel about as wise as giving a Kardashian an even firmer belief in herself.

The risk of asset seizure is vanishingly small, however. Ignoring shareholders for a moment, Sberbank itself isn’t subject to the predations of the Russian government because it’s already been preyed upon. The Russian government owns the majority of Sberbank. This is an insiders’ bank, and that isn’t a bad thing for us. On its “About Sberbank” page, Sberbank states: “Being the oldest and the largest Russian bank does not stop Sberbank from competing openly and in good faith with other banking market players…” That such a statement would even be needed, or considered reassuring, suggests that when the chips are down the opposite will be true.

The remainder of the bank, meanwhile, isn’t own by other Russians. It’s owned by the rest of the world. And not retail investors but elite financial institutions. Sberbank ships 45.6% of its profit overseas, primarily to places like Capital Group and BlackRock. Russia, after almost a century of socialism, is undergoing a nationalist moment. Why would nationalists allow their treasure to be shipped to their adversaries?

One, they need to attract foreign capital. Two, Sberbank is meant to be a symbol of Russian advancement. Everything about it oozes professionalism. Sberbank is on the cutting edge of fintech and AI, and it touts both persuasively. Sberbank, in fact, now describes itself not just as a bank but as a technology company. It releases investor presentations every month, and they’re polished and actually quite good. What all of it adds up to is this. Unlike a lot of things in Russia, Sberbank isn’t a convincing façade. It’s the real deal, and it adds to the prestige of the Russian government and the Russia people. To do this, though, Sberbank must have global ownership. Without opening it up to the rest of the world, then the rest of the world wouldn’t care.

Also there’s something rich about large institutions, domiciled in countries that criticize Russia, investing alongside the Russian government, not as equals but as minority shareholders. Putting this arrangement at risk would be cutting off your nose to spite your face. And in a country wracked with capital flight, it would be crazy. For the record, Russians are squirrelly, not crazy.

In the end, there’s likely only one reason that the Russian government would do something to impair the value of your shares, and that’s if the US government does something first. Which it will. It has to. Last summer Congress passed new sanctions on Russia as punishment for Russia’s interference in the election, and President Trump has no choice but to impose them--at least in some way. The only question is how strong they will be and what form they will take. My bet is they will be weak, and the timing of them will be like that New Yorker cartoon where a businessman says in response to scheduling a meeting: "How about never? Does never work for you?"

Russiagate

Russiagate is becoming a nakedly partisan cause, and there’s probably no better type of macro fear to bet against than that.

First of all, there’s a glaring disconnect between the reality of Russian aggression and its depiction. The media’s obsession with Russia doesn’t stem from an honest concern about Russian interference in our election. It’s them assuaging their hurt pride that, contrary to their explicit orders, the American people elected Donald Trump instead of Hillary Clinton, thus giving them and other elites the biggest middle finger in recent history.

Still even a blind squirrel finds a nut every now and then. And Russian aggression isn’t a figment of anyone's imagination. Intelligence analysts have been warning for years that Putin has been cranking the spy war into overdrive. Operations like Cozy Bear hacked into everything they could, even Western governments at scary-high levels. Finally it's pretty irrefutable at this point that Russia hacked the DNC’s emails and provided them to WikiLeaks. Russian government officials have admitted as much publicly. WikiLeaks and Russia share a link, likely a pretty strong one, and as a result, it’s hard to deny that Russia did in fact interfere in our presidential election.

As it relates to any true esclation of tensions, though, the link that matters is the one between Russia and the Donald himself. And that link doesn’t appear to exist at all. So far no real evidence has been put forward of collusion, and polls are showing public opinion divided based on party lines. Generally that’s the death rattle for these kinds of things. Without that link, without getting rid of Trump or tying his hands, there’s no way to impose truly punitive sanctions on Russia. Trump himself has made it clear that he’s interested in no such thing. And if it turns out that Russiagate was something concocted by certain members of the FBI and the DNC to spy on a presidential campaign, then it won’t be Russia on whom the axe falls.

One last point. To give you an idea of the Trump administration's enthusiasm for sanctions, Congress passed the new sanctions over the summer, and the White House still hasn't done anything to execute them. In fact on Monday, the State department said that it will not implement them at all. Why? Because it had deemed that the threat of implementing them was deterrent enough. I won't lie. That reminded me of when I was a kid, and my mom said my dad would "deal" with me when he got home. But then after a few hours she'd feel bad and let it go because it was clear I'd "already been through enough." 

In the meantime, the much-vaunted list of Russian oligarchs has just been released by the Treasury, and it’s been a non-event. Just a list of rich people, as someone described it. A Treasury official even admitted that parts of the list came from Forbes magazine. This shows you the level of zeal that went into it.

Net net, what do we make of all this as investors?

The noise says, be afraid. The signal says otherwise. Sberbank is a crown jewel asset, and it’s on display for the entire world. Russia is unlikely to jeopardize that without good reason, and the US is unlikely to give it a reason.

Valuation

Let’s start with absolute valuation. Since 2003, Sberbank has earned an average ROE of 19% a year, and it’s guided to 20% ROEs through 2020. Sberbank trades at 1.8x book value, which means expected returns would be 11% a year. That, however, assumes zero growth. I think when you account for Sberbank’s future growth, its intrinsic value goes up at least 50%. This, in turn, would raise the expected return by 50% as well— to 17% a year. 

As a sanity check, I did a 10-year DCF with the following inputs:

Discount rate: 15%

10-year annual growth: 11% (SBER’s earnings have grown at 11% over the last five years, which includes a recession)

Terminal growth: 8%

Dividend yield: 2%

Inflation: 4%

That gets me 13% returns after inflation, or 17% before, which confirms my back-of-the-envelope math above. Granted, the universe couldn’t care less about these numbers. But at a time when equities worldwide are priced for perfection, Sberbank is poised to put up 17% returns using some pretty undemanding assumptions. This also presumes the market’s perception of Sberbank never changes, which there's good reason it will.

Moving on to comps, large US banks trade at 16-20x earnings, and they don’t have Sberbank’s profitability or its potential for growth. Large Brazilian banks trade around 14x earnings. A random sampling of large Chinese banks showed they trade at around 7-8x, though their trustworthiness, along with China's debt issues, means they deserve a lower multiple than Sberbank. I think an achievable multiple for Sberbank is 11x. That entails 37.5% upside if the multiple keys off TTM earnings or 50% upside if it keys off next year's earnings. Which one is correct? Honestly I don't know. But this accounts for Sberbank’s true value and also leaves room for investors to continue imposing the Russian discount.

Ultimately Sberbank, as an investment, has the few things that matter. It's a long-term compounding machine priced as though it were a melting ice cube. You’re protected both by the quality of the business and by the deep value price you pay. And you don’t need to wait for the market to agree with you in order to earn double-digit returns. It will be interesting to see where Sberbank trades compared to the US stock market over the next five years. Stay thirsty, my friends.

Catalyst

Sberbank is looking to boost its payout ratio from 22% to 50% over the next two years. A bigger dividend draws income investors, expanding the investor base. It’s also the strongest signal a company can give the market that its earnings are sustainable.

Heightened US-Russia tensions fade over the next year or two.

When something is mispriced, it doesn’t really need a catalyst. The truth will out.