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Russia in the Bear Trap

18.01.2016

The financial crisis is currently in its third act. This time the victims are emerging markets and commodity producers. Russia is suffering most of all. What went wrong?

While the first act took place in the US in 2008, the second was around the Mediterranean in 2011-2012. During recent years the private sector has been reducing debt in Europe and the US, while the credit boom continued in emerging economies.

However, the past year the Chinese have put brakes on debt-financed infrastructure investments, and this has weakened growth in general and commodity appetite in particular. The latter has triggered a commodity crash.

Among the larger economies, Russia has been hit the hardest. The fall in the oil price has led to a sharp GDP contraction, currency collapse and high inflation.

Structural problems

Russia's biggest problem in the long term is not the low oil price, but corruption on African levels. In countries with corrupt courts and regulatory authorities, it is challenging to create a thriving economy.

Occasionally, crises function as a catalyst for positive change. However, there are few signs of this in Russia. Instead of spending time on solving the country's economic problems, Putin is concentrating on military and political adventures in Syria and Ukraine.

Meanwhile, the discontent is rising in the population, which is experiencing declining living standards and increasing poverty. This creates a significant risk of political upheaval.

End of magic

Russia is not the only country with such problems. The so-called African miracle after years 2000 increasingly appears like an ordinary commodity boom. The two leading economies in the region, South Africa and Nigeria, have lost all their magic.

The same applies to Brazil, where the president is feverishly working to stay out of prison and avoid impeachment instead of trying rescue the dysfunctional economy.

Norwegian headache

Crises have a bad reputation, but is often the long-term investor’s best friend. The reason is that they make it possible to buy high quality companies at heavily discounted prices. The danger is that there may be few such cases at the Oslo Stock Exchange.

The Norwegian oil industry has spent the past decade becoming the world leader in deep-water and Arctic oil production. The problem is that these high cost niches may have been ousted by shale oil. It helps little to be good at making sailing ships when customers want steamships.

With single-digit production costs DNO admittedly has potential to be a quality share. However, right now the company is primarily a textbook example of why it is a bad idea for businesses to deliver goods without getting paid.

With production costs around $20 per barrel, Russian oil companies are potential quality companies. Unlike Statoil, they do not need to borrow money to pay dividends.

Leading US shale oil producers, like Continental Resources, should also be kept on the radar screen.

Buying opportunity

This week we put a handful of major companies into the Dovre portfolio. Kongsberg Automotive and Opera are both structural bets, while Norwegian is profiting from low oil prices.

We are tempted by attractive multiples in Storebrand and reduced uncertainty about the regulatory framework, now that the Solvency II rules are introduced.

Dovre portfolio:

  • Panoro Energy
  • Frontline
  • Kongsberg Automotive
  • Norwegian
  • Opera
  • Storebrand

Inn: Kongsberg Automotive, Norwegian, Opera, Storebrand

Out: Ekornes, Biotec, Selvaag Bolig, Ganger Rolf