Brandes Update on Russia and Ukraine

Amid increasing tensions in Ukraine as Russia moves troops into the country and sanctions start to get announced, the below gives some additional information on Brandes portfolios and our exposure to the region.

We are keeping a close eye on how events may unfold in Ukraine. Two rounds of initial sanctions have been announced by the European Union, United States and United Kingdom, with further details expected as the situation develops. The opening of the natural gas pipeline – Nord Stream 2 – from Russia to Germany has been cancelled, in the short-term leading to a rise in oil and natural gas prices. The initial sanctions have been targeted at banks, restricting Russian access to global capital markets, and targeting specific Russian government officials. The only holding thus far directly affected would be our holding in Sberbank in our Emerging Markets Equity Strategy, which has been blocked from US dollar based transactions (which account for ~10% of loans and <20% of deposits, and less than 5% of total fee income), as well as US investors being restricted in trading new equity or debt issued after March 26th, but not in trading its current equity listings.

We don’t claim to have any special geopolitical insights on how the situation may evolve, but below is a summary of the respective investment cases of our Russian holdings, as well as other European holdings which may be directly or indirectly affected. While the economic impact on Europe is estimated to be limited in absolute terms, with Germany having the strongest ties among the larger European countries but Russia only accounting for about 2% of Germany’s exports, there could be a knock-on effect to confidence if escalations continue to increase.

Summary of Russia and most Russian exposed holdings and countries (Most notably Germany given its relationship with

Russia to supply oil and gas) weights across Brandes Strategies:

Our largest exposure is in our Emerging Markets Equity strategy which had an ~8% weight and ~5% overweight to Russia as of January 31st. Outside of Sberbank, other holdings are largely a global oil company or more domestically focused companies which we believe have lower risks of direct sanctions.

Across strategies the most common holdings are a couple of oil and gas companies which could benefit from a rise in oil prices, although in the short term, as we saw during the conflict and sanctions during the annexation of Crimea in 2014, the stocks may suffer some volatility in the event of sanctions being imposed.

Mobile TeleSystems (MTS) (MBT, Financial)

MTS provides telecommunication services primarily in Russia, so it is a domestic business that should not be inordinately impacted by potential sanctions. MTS offers voice and data transmission, Internet access, pay TV, and value-added services through wireless (no.1 carrier in Russia, 34% market share, c.80m subscribers) and fixed lines (dominant broadband provider in Moscow, 3.5m subs). It also offers integration services, equipment, accessories, and software. The company also provides cloud computing services, data analysis tools, cybersecurity systems, and intelligent Internet of Things solutions for business-to-business clients. MTS has what we consider many defensive characteristics.

Sistema (MIK:AFKS)

Sistema is a publicly traded holding company in Russia. It has an investment portfolio across several industries in Russia that are predominantly domestically focused. Its major cash generator is Mobile TeleSystems, the leading wireless company in Russia, which with its 100% payout policy has generated meaningful dividends. These dividends are Sistema’s main source of funds and cover its operating expenses, interest expenses and investment into other smaller assets. OZON (Russia’s second largest e-commerce site) is now Sistema’s second largest asset, followed by Segezha (a large, export-oriented pulp & paper company), Medsi (a healthcare company) and Steppe (an agriculture company).

Detsky Mir (MIC:DSKY, Financial)

Detsky Mir is the undisputed leader in the Russian children’s goods retail market with 69% market share, so it is another domestically-focused name. The company offers a differentiated assortment of goods at attractive prices, which is important as consumers are trading down in the current economic environment. Detsky Mir runs an asset-light business model and is highly cash generative which has allowed ample returns of capital to shareholders. On February 8th, Detsky Mir announced it will launch a RUB3.5 billion share buyback running until August 2022. The >5% stock buyback comes after the company announced a RUB5.2 per share (just over 5%) dividend relating to the first nine months of 2021, with the full year dividend yet to be announced.

Lukoil (MIC:LKOH, Financial)

Lukoil is a vertically integrated oil company with predominately Russian operations. Russia accounts for 93% of oil production, 60% of natural gas, 64% of refining throughput, 87% of power generation, and 49% of retail service stations. Keeping costs low and maintaining a high dividend payout ratio has been the dominant strategy for the company over the past decade. Lukoil has a very strong balance sheet. Financial assets and liabilities are mostly held in US dollars and euros. The company’s goal is to maintain a dividend payout of 100% of adjusted Free Cashflow. In common with its global energy peers, surging oil and gas prices are lifting profits to the highest in almost a decade.

Surgutneftegas (MIC:SNGS, Financial)

Surgutneftegas is a vertically integrated oil and gas company with operations based out of Siberia. The company has generated strong free cash flow and has a substantial holding of cash and investments which currently account for nearly 4x the company’s market cap. Additionally, we own the preferred shares which have a required dividend payout which benefits from any ruble depreciation as the cash is largely held in US dollars, so earnings and therefore the required dividend payout increase during periods of ruble depreciation. Dividend yield at its ex-dividend date was 15% in 2021.

Sberbank (MIC:SBER, Financial)

At the moment, the impact on Sberbank should be a hit to Intrinsic Value related to their US dollar business and turn Sberbank into more of a domestic Russian bank. There isn’t any directive (yet) that prohibits dealing in or owning existing Sberbank equity, although that may not be off the table if Russia pushes further into Western Ukraine or attacks other NATO countries.

Sberbank is the largest bank in terms of total assets and capital not only in Russia, but in the whole Commonwealth of Independent States and Eastern European region. It is majority owned by the Central Bank of Russia (law requires it hold at least 50% + 1 share) . Times of volatility in the global economy or the oil & gas markets, or turbulence within Russia have historically provided attractive opportunities to invest in Sberbank. Russia emerged from recession in 2017 following an economic crisis in 2014-2016, precipitated by the dramatic decline in oil prices, ruble devaluation and geopolitical headwinds relating to the Crimean crisis. The bank maintains a dominant market position and as of 2/24 trades at very attractive valuation levels, even after discounting for government and country risk. Furthermore, it could be argued that Sberbank’s valuation doesn’t attribute any material value to the bank’s non-financial ecosystem business, which could be material, should management execute successfully on its ambitions.

Other holdings with exposure to Russia or indirectly impacted by the events in Ukraine

The sanctions imposed may continue to fuel a rise in energy prices and may further exacerbate inflationary pressures globally. That, in turn, may influence the pace and scale of global central bank tightening, particularly in Europe.

Several global oil companies have investments or development in Russia including our holdings such as BP which has an investment in Russian integrated oil company Rosneft and Total which has oil and gas investments in Russia as well. Recent purchase TechnipFMC, an oil services company, also has some exposure to projects in Russia. Most of our European and Global oriented companies have minimal exposure to Russian and Ukrainian markets. Cement company Buzzi Unicem and automaker Renault are two of our holdings with a slightly larger exposure to Russia and Ukraine (>5% of revenue) as Renault has exposure to Russia accounting for ~10% of revenue through its affiliate AvtoVAZ.

Given Europe’s dependence on Russian natural gas and oil, and especially Germany’s reliance on it given the potential of the Nord Stream 2 pipeline from Russia, our allocations to Germany are also highlighted above. Our exposure to Germany is largely healthcare holdings, along with some global consumer staples and materials companies (Henkel and Heidelberg Cement) which should be less affected by energy disruptions in Germany, and most of our strategies are underweight to Germany relative to their benchmarks.

We hope this helps to explain how we are approaching the current situation regarding our Russian holdings. If sanctions are passed on any Russian company we own in the portfolio, we will certainly respond if needed and make sure we are in compliance with any sanctions. We will continue to monitor the situation for any impacts on our holdings as well as evaluate if any market volatility helps create any new investment opportunities.

While no situation is exactly the same, it is also important to note that throughout our firm’s investing history, the Russian market has experienced several volatile periods before including the annexation of Crimea in 2014. Our observation has been that the initial market sell off before wars or significant geopolitical events is often sharp, but that subsequently the market has often recovered, so it is important to be watchful and not over-react.

AS OF JANUARY 31, 2022 l The securities identified and described do not represent all of the securities purchased, sold, or recommended for client accounts. The viewershould not assume that an investment in the securities identified was or will be profitable. Holdings subject to change. The portfolio characteristics shown each relate to a single account as of date noted, deemed by Brandes to be generally representative of the strategy. Not every account will have these exact characteristics. The actual characteristics with respect to any particular account will vary based on a number of factors including but not limited to: (i) the size of the account; (ii) investment restrictions applicable to the account, if any; and (iii) market exigencies at the time of investment. Data is updated on a quarterly basis