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Russia: Rapid currency appreciation creates risks for industry cash flows – Deutsche Bank

Discussion in 'Fundamental Analysis' started by FXStreet_Team, Mar 15, 2016.

  1. FXStreet_Team

    FXStreet_Team Well-Known Member Trader

    Oct 7, 2015
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    Pavel Kushnir, Research Analyst at Deutsche Bank, notes that the Rouble hit their year-end target of 71 and from here their forecasts look optimistic.

    Key Quotes

    “The Russian oil sector is in better shape. That is relative, however. One would think that operating environment has greatly improved following a near 50% rally in crude oil price. We believe the second factor, Russian rouble exchange rate, is more important and that has also staged an impressive recovery. RUB/USD has already reached our year-end forecast of 71. We see risks to our earnings and cashflows forecasts if rouble continues to appreciate as Brent climbs towards our USD50/bbl year-end target. We remain oil sector neutral.

    5% stronger rouble relative to forecasts means 10% lower earnings: Deutsche Bank’s view is that the rouble will be at 71 against the US dollar at the end of 2016 when Brent crude oil price hits USD50/bbl. The rouble recovery, however, turned out to be way faster than we had anticipated and is already at the 71 mark. Assuming that our crude oil price growth assumptions are correct, the rouble may appreciate further towards the end of 2016, bypassing our forecast on the way up. Given high industry earnings and cashflows’ sensitivity to the rouble FX rate, this creates risks that are not yet reflected in our forecasts.

    Our sensitivity analysis demonstrates that a further 5% rouble appreciation towards year-end may reduce oil sector earnings by almost 10% relative to our current forecasts. The FCF reduction may reach 15-25% depending on the capex level. Should the rouble come 10% stronger than our year-end forecast, the hit on the bottom-line earnings may reach nearly 20%, while the FCF would suffer to a 30-50% extent. There is a similar earnings and FCF sensitivity for 2017 assuming 5% and 10% stronger rouble relative to our year-end base-case forecast of RUB68/USD at USD57/bbl Brent.

    Idiosyncratic FX component in DCF takes some care of the stronger rouble risk: In our DCF discount rates, we apply a risk-free rate of 6.0% and an equity risk premium of 5.0-8.5% for all companies. That being said, we believe there are additional idiosyncratic risks related specifically to the Russian energy sector, which have intensified in terms of their impact on the companies’ earnings and cash flows.

    In particular, we note idiosyncratic risks stemming from volatility in the cash flows of the oil and gas companies as a result of changes in exchange rates. That is the only idiosyncratic risk that we use in our DCF discount rates. For all the Russian oil companies we apply 2%. This reflects a possibility that the RUB/USD exchange rate comes stronger than the level that we currently use for forecasting earnings and cashflows. That said, the negative effect of the potential rouble strengthening on earnings and financial multiples is not captured by the DCF idiosyncratic exchange rate risk component.

    Valuation and risks: We use an APT-based DCF valuation as our primary basis for assigning investment ratings as we believe it is a strong tool for estimating company-specific risks vs. the CAPM model. We derive our discount rates from several components, including risk-free rate and sovereign risk, standard equity risk, liquidity risk and corporate governance risk. Downside risks include lower-than-expected oil prices, rouble strength, capex overruns and inability to control costs. For our Hold-rated stocks, among the key upside risks, we highlight higher-than-expected crude oil and gas prices and greater operating and investment cost efficiency as well as weaker rouble.”
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