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Russia Risk to Western Companies (Mostly) Overblown

Russia made news last week but shutting down four Moscow McDonald’s restaurants, ostensibly for health code violations. But the move is widely viewed as Russia’s latest “countersanction” against the West in retaliation for Western sanctions against Russia for its involvement in Ukraine. McDonald’s first Russian restaurant—opened in 1990 when Russia was still the communist Soviet Union—is the most-visited McDonald’s location in the world.

While Russia is one of the company’s biggest markets outside of North America, the closures are expected to be temporary and are not expected to inflict major long-term damage on McDonald’s Corp (MCD).

Other Western companies may indeed feel the pinch, and not just from sanctions or official bullying. Russia’s economy is also contracting, potentially taking consumer spending with it.

Let’s take a look at Western companies with strong ties to Russia and assess their potential Russia risk.

I’ll start with German luxury automaker Daimler (DDAIF), maker of the iconic Mercedes Benz. Daimler has been steadily increasing its presence in Russia, and as recently as July the company planned to start manufacturing Mercedes cars in Russia.

Daimler’s sales in Russia have also, up until very recently, been growing at a blistering pace. In the first half of 2014, Daimler sales in Russia were up about 20% after rising about 19% in 2013. But with Germany now leading the sanctions charge, its companies are now at risk. And Western automakers are a likely candidate in the event that there is another round of countersanctions.

Daimler’s Russia sales could come grinding to a halt, and that seems to be the fear driving investors in the stock over the past month. German stocks, as measured by the iShares MSCI Germany ETF (EWG), were down about 13% from the June peak to the early August trough, though they have recovered modestly since then. Over the same period, Daimler was hit harder, down about 18% before recovering slightly.

Should Daimler investors be worried?

No. Though Russia was a promising market for Daimler—and may be again once Ukraine fades from memory—Russia is not one of Daimler’s biggest markets. Daimler sold 1.5 million cars globally last year. Only 44,376 were sold in Russia, or less than 3% of the total. Were that amount to fall to zero—which is unlikely—it would not be catastrophic to Daimler’s business.

Taking a bigger picture, while Russia is a promising export market for Germany, Germany’s exposure to Russia is overstated. Russia accounts for only about 3% of total German imports, making Daimler pretty typical as far as German companies go.

Meanwhile, Daimler sells for a very reasonable 10 times earnings and sports a 3.6% dividend yield.

Moving on, let’s take a look at European brewers. Heineken (HEINY) recently warned that its sales volumes were down more than 10% in Russia, and this was before the effects of any countersanctions. But as a diversified global brewer, the slowdown in Russia is not particularly damaging for Heineken. Heineken’s most promising growth markets are in Africa, Latin America and Asia. The entire Central and Eastern European region, of which Russia is a part, accounted for only 10.1% of operating profit last year.

I can’t say the same for rival Carlsberg (CABGY). Carlsberg—which is based in Denmark—is the largest brewer in Russia and generates about a third of its sales by volume in the country. Carlsberg saw is beer sales volumes in Eastern Europe fall by 13% in the second quarter, and again, this is before the effects of any countersanctions by Moscow. Consumer confidence has been sagging for months, and the Russian government has been discouraging beer consumption for months as part of a public health drive.

Carlsberg is not expecting a speedy recovery either; the company indicated it might be closing some of its 10 breweries in Russia.

I’ve been a major Heineken bull for years based on its strong competitive position in Africa, and I do not see any developments in Russia having much of an impact. But I would probably steer clear of Carlsberg for the time being.

What about oil and gas companies? Russia is, of course, one of the biggest players in the global energy industry, and virtually every international oil major has some connection to the country.

One U.S. company potentially at risk is Exxon Mobil (XOM). Exxon partnered with Russian energy giantRosneft (OJSCY) in 2011 to develop Russia’s massive artic reserves in a deal that could eventually be worth as much as $500 billion. Exxon had negotiated a very favorable tax deal in exchange for its investment and expertise, and by Russian estimates the Artic region in question has as much oil and gas resources as Saudi Arabia.

As a visible symbol of American industry, you might think that Exxon would be a very easy target for Russian reprisal. Though thus far, Putin has made no indication that he intends to punish Exxon, and in fact, as recently as mid August Putin praised Exxon as an “old and reliable partner.” While Putin is no doubt itching to thumb his nose at the West, his relationship with the oil majors is simply too important to blow up over a political row.

The bigger risk to Exxon is not punishment from Russia, but rather the reality that it might not be able to invest as much as originally planned due to Western sanctions that limit the export of oil production equipment to Russia.

What about Exxon stock?

Despite being near its 52-week high, XOM is not particularly expensive, particularly by the standards of today’s market valuations. XOM trades for less than 13 times forward earnings and yields a respectable 2.8% in dividends. A deepfreeze in Exxon’s Russia operations would take a bite out of growth. But at current prices, you’re not exactly paying a premium.

XOM is a decent buy at today’s prices. Should it sell off on any escalation in tensions with Russia, I would consider it a strong buy.

About the author:

Charles Sizemore
Charles Lewis Sizemore, CFA is the Chief Investment Officer of Sizemore Capital Management. Please contact our offices today for a portfolio consultation.

Mr. Sizemore has been a repeat guest on Fox Business News, has been quoted in Barron’s Magazine and the Wall Street Journal, and has been published in many respected financial websites, including MarketWatch, TheStreet.com, InvestorPlace, MSN Money, Seeking Alpha, Stocks, Futures, and Options Magazine and The Daily Reckoning.

Visit Charles Sizemore's Website


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