From Russia with Gas

06/01/2010 2:44 pm EST

Focus: GLOBAL

Andrew McHattie

Editor, Investment Trust Newsletter

The manager of the Eastern European Trust in London says Gazprom isn't getting the respect—or valuation—it deserves, writes Andrew McHattie in the Investment Trust Newsletter.

The Eastern European Trust (London: EST) is planning a package of measures, including new tender offer arrangements and an issue of subscription shares. These are not due to be put to shareholders until July, but we had the opportunity to meet the manager of the trust, Sam Vecht, who told us more about his style of management and the trust’s prospects.

A year ago, BlackRock [and Sam] took over the management mandate from Pictet Asset Management, and has done well since. Sam is not sure that the immediate future will be quite so easy. He can see a series of speed bumps on the global horizon which might make the second half of 2010 a tricky period for global equities, although he still thinks that places with cheap valuations and growth are “best placed.”

He indicated that the trust has started to use options to hedge certain positions and provide some protection, adding “we have a full set of tools at our disposal.” This is perhaps especially important for Eastern European Trust, which has more than half of its assets in Russia, because as Sam notes, “when Russia goes down, it goes down very savagely.”

Eastern European trust has around 64% of assets in Russia, with Poland, Hungary, and Turkey the next largest allocations. The trust has a strategic underweight position in Turkey, which has yet to pay off, but it has done well from its sectoral and stock-specific bets. The trust is overweight energy and utilities and underweight financials and materials, and Vecht says the portfolio is “a whole collection of pretty punchy bets.”

Gazprom (OTC: GZPFY, London: GAZ) is one of the trust’s largest holdings, and Sam thinks it could become the most profitable company in the world in 2010, overtaking Exxon Mobil (NYSE: XOM). The company’s recent results beat market expectations by 50%, and it is trading on just four to five times earnings. Against a collection of the world’s largest and most profitable companies, Gazprom stands out as looking remarkably cheap—Sam says it is a “totally ridiculous outlier.” In part, this is because “people’s perceptions of Russia are almost universally negative and almost universally wrong,” he says. (Gazprom closed Monday at $19.30—Editor.)

With Russian trade looking increasingly to the east, Russia is arguably the cheapest way to access Chinese growth. The price-to-book ratio in China is something like 2.3x and 2.5x in Brazil, whereas in Russia it is only 1.3x. Sam believes there is a something of a “double standard” from investors who criticize Russian politics, yet don’t have a problem investing in China. He can see “significant tax reform in the Russian energy sector” perhaps changing some perceptions in the last quarter of this year or the first quarter of 2011. He thinks this could be “game-changing” and could see Russian companies becoming much more investor-friendly.

On a 14.8% discount to net assets, Eastern European shares offer decent value ahead of these new measures designed to further limit the discount volatility. (The trust closed at £266.50 in London trading Monday—Editor.)

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