Friday July 18 2008 11:27
=DJ FOCUS: Inflation A Growing Concern For Russia Investors

By Andrew Langley and Will Bland
Of DOW JONES NEWSWIRES

MOSCOW (Dow Jones)–As Russian inflation hovers around a five-year high, investors should retreat into coal, fertilizer and mobile phone stocks while keeping close tabs on government intervention and possible drops in global commodity prices, market participants say.
Russia’s consumer price index is up by more than 15% on the year, the highest rate since December 2005. Prices of staples, from bread to gasoline, continue to surge, prompting employees to demand higher wages and leaving the government’s latest full-year target of 10.5% seemingly out of reach.
Many firms have been able to hike salaries as the prices for their products also boast strong upward momentum. But analysts and investors warn that this may not be sustainable, with commodities like crude oil already at record levels.
In addition, they say, increases in the prices of many household essentials are outstripping wage growth, putting strain on lower-income Russians and possibly cheap food retailers. As a result, the government may be tempted to freeze prices or halt increases in state-regulated tariffs for fixed-line telecoms providers, as it has in the past.
“Russia is experiencing inflation across the board: raw materials prices, labor and even the cost of money are increasing rapidly,” said Kingsmill Bond, chief strategist at investment bank Troika Dialog in Moscow.
Driving that inflation are both global factors, such as record crude and metals prices and rising global food prices, and domestic issues, such as last year’s jump in government spending ahead of parliamentary and presidential elections.
The central bank has struggled to tame price growth, despite raising borrowing rates and mandatory reserve levels and allowing the local currency to appreciate.
The situation may improve somewhat in the second half of the year as the effect of those measures kicks in. But with the headline rate expected to remain as high as 14%, investors have been left wondering how best to tackle the higher prices.
“Inflation favors hard assets. The further up the value chain you can move the better,” said James Beadle, a portfolio manager at Pilgrim Asset Management. “Buy agriculture rather than food distributors and raw materials over products.”
Among the most popular in these categories, local brokerages cite coal producers such as OAO Raspdskaya (RASP.RS), potash fertilizer firms like OAO Uralkali (URKA.RS) and agriculture plays including OAO Razgulay Group (GRAZ.RS).
All three have enjoyed bumper profits of late as demand for steel in India and China drives sales of coking coal – a key input in production of the metal – and higher global food prices prove a boon for fertilizer and grain makers.
Their shares have duly risen and remain close to their highs, like those of integrated steel companies such as OAO Mechel (MTL) and Evraz Group N.V. (EVR.LN), which have in-house production of coking coal and other raw materials like iron ore and are, therefore, less exposed to surging coal prices.
Analysts also recommend cellular stocks like OAO Mobile TeleSystems (MBT) and OAO VimpelCom (VIP), where rising usage is offsetting higher staff salaries and the appreciating ruble has boosted dollar-denominated earnings.
Shares of those two firms took a dip in June, along with most of the Russian market, leaving them 25% off their winter highs.
“It’s exporters like oil companies who could take it in the neck,” said Ian Hague, a fund manager at New York-based Firebird Management.
Producers such as OAO Rosneft (ROSN.RS) and OAO Lukoil Holdings (LKOH.RS), which pay ever-rising ruble costs and make sales in dollars, depend on growth in already-lofty crude prices to compensate for higher wages and transportation, he said.
Others highlight electricity distributors and fixed-line telecoms operators, whose state-regulated tariffs could be frozen at around current levels by the government to avoid putting further pressure on low-income members of the population.
Illustrating this, regional telcos OAO Dalsvyaz (ESPK.RS) and OAO Uralsvyazinform (URSI.RS) in March halted planned tariff hikes amid political pressure, albeit ahead of the May presidential election that saw Dmitry Medvedev, the protege of outgoing leader Vladimir Putin, win by a landslide.
Some believe the spending power of many less affluent Russians is being eroded, with wage hikes not able to compensate for surging prices for daily essentials like bread and milk, which have risen by as much as 30% since January, according to some estimates.
Despite robust margins so far, they reckon poorer, price-sensitive shoppers at London-listed pair X5 Retail Group (FIVE.LN) and OAO Magnit (MGNT.RS) could revert back to buying goods at open-air markets in a bid to reduce household overheads.
Retailers, as well as food producers, also face the threat of government price caps, a tool already employed once during the last year on household essentials like milk.
OAO Wimm-Bill-Dann (WBD), the country’s largest dairy firm, suffered from those measures, but was able to offset their impact somewhat by lifting output of high-margin products like yoghurt drinks.
-By Andrew Langley and Will Bland Dow Jones Newswires; +7 495 974 80 55; william.bland@dowjones.com

(END) Dow Jones Newswires
18-07-08 0927GMT
Copyright (c) 2008 Dow Jones & Company, Inc.

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