Another Angle on Commodities Investing: An Analysis of Four Transportation Stocks in Russia
Published on August 9, 2021
Commodities investing tends to focus on the price of the underlying good. Investors typically concentrate on the good or its producers. For example, in one of my first posts, I outlined various ways of playing the uranium sector.
Investors can own the metal through a holding company like Yellow Cake plc (LSE: YCA, OTC: YLLXF) or the Sprott Physical Uranium Trust (TSX: U.UN). More confident individuals could invest in companies that mine or will mine the product. The latter provide leverage to the underlying price as their costs of production are relatively inelastic.
There is another layer of commodities investing dependent less on the price of a given commodity and more on the production volume. Suppliers to the commodity industries are paid based on some derivative of the volume. For example, Caterpillar gets paid for its mining trucks, whatever the price of gold is, and oil producers usually pay pipeline companies a fixed fee per barrel for transportation, which is largely insensitive to price.
So, if investors have a stronger view on volume and production rather than price, there are other investments to focus on. Today, I will explore commodity transportation companies within Russia. These companies trade at attractive absolute multiples and relative valuations to global peers and have some tailwinds ahead related to the volume they expect to transport in the short to medium term.
First, I will delve into a bit more of the logic above related to the commodities transportation sector. Then, I’ll cover each of the following names:
- Transneft Preferreds (MICEX: TRNFP)
- Novorossiysk Commercial Seaport (MICEX: NMTP, LSE: NCSP)
- Globaltrans Investments Limited (MICEX: GLTR, LSE: GLTR, OTC: GLTVF)
- Far Eastern Shipping Co. (MICEX: FESH)
Currently, none of these names have wide coverage. Globaltrans sometimes gets coverage as a low-valuation high dividend stock, but all are basically off the radar.
Commodities Investing Through Infrastructure in Russia
When investing in commodities infrastructure and transportation, the key elements are:
- How much (volume) does the company move?
- How far (distance) are they moving it?
- What is the competitive advantage of one mode of transportation vs. another?
Let’s go through each of these in Russia’s case for the core commodities.
How Much (Volume) Does the Company Move?
Volumes are a prominent part of this analysis and, thankfully, pretty straightforward at this juncture in time. Unfortunately, with the COVID pandemic, volumes of production for oil, steel, coal, aluminum, etc, in Russia dropped off a cliff last year.
Thankfully, volumes bottomed in the summer of 2020 and have since rebounded. The graph below is Russia’s oil production according to the EIA.
Russian steel has also had a bounce.
Volumes have been moving in the right direction, and while they may ease off into the second half of this year, they will still be up year over year.
Over the longer term, I believe that markets like Russia will shoulder more heavy industry, all else being equal. Environmental and social restrictions in Europe and North America will shift steel, oil, or aluminum production from developed to developing countries.
How Far (Distance) Are They Moving It?
Distance and direction also matter. Can you move goods where they want to go? While I focus on distance as it directly impacts profits, the other important point is whether the company can move the product to the right market.
In Russia, specifically, there are two themes.
First, the initial driver is a resumption of exports to its traditional markets in Europe. This infrastructure is largely in place and with ample capacity following COVID.
The slack in the system for exports to Europe should be tightened as regular activity resumes. This is the easy play.
In the longer run, however, companies that can profitably move commodities east will capture the growth in the overall system. Since most of Russia’s main commodity production areas are in the center and west of the country, moving products east to China, Japan, and the rest of Asia is more challenging.
Given the more secular growth in Asia, cargo headed east will also be more constrained by capacity. How companies manage expansion in this direction is essential. Too much expansion too quickly can often put companies out of business.
What Is the Competitive Advantage of One Mode of Transportation vs. Another?
Russia has no large rivers that go laterally across the country. So, to move goods, one uses rail or sea for bulk goods and pipelines for petroleum products.
To tackle oil products first, once pipelines are in place, they are the most efficient means of transportation. This is why Transneft, the monopoly oil pipeline company, transports 80+% of all crude oil in Russia.
For exports, the pipelines or rail either take the crude oil to seaports or over the border. Russia has three critical oil seaports on the European side (Primorsk, Ust-Luga, and Novorossiysk), and one on the Asian side (Kozmino).
All other commodities exports are moved chiefly by rail to either seaports or export rail lines. Which export route a cargo takes depends on the end destination, the cost of the goods, and the urgency of transportation.
Rail can be faster but is generally more expensive than sea transport. Therefore, rail can make sense for goods where transportation is a small percentage of the cost or where urgency is paramount.
We will cover the tradeoff in more detail with FESH as this is a critical consideration for its business model.
Now let’s discuss the specific opportunities.
Transneft is the monopoly oil pipeline operator in Russia. I covered the company in January of this year.
Transneft is my favorite commodities investing play in Russia. It is the most straightforward story and at attractive multiples, even after the recent appreciation.
What do I mean by the most straightforward story? The narrative for investing in Transneft is simple and with less conditionality than other names I’ll review. First, let’s go through the considerations from the last section.
Transneft moves 80+% of Russia’s crude oil production. Pipeline transportation is the cheapest way to move oil, and Transneft has existing spare capacity.
Due to the pandemic, volumes for Transneft have dropped nearly 13% on a 1Q21 LTM from the record volumes in 2019. To recover those volumes, Transneft does not need to do anything extraordinary. Their clients just need to produce more oil.
Equally important, most of the revenue from the additional oil can drop straight to the bottom line. EBITDA dropped the same percentage (~13%) in the same period comparison. The company also was able to rationalize its cost base over the period so EBITDA should increase more than it decreased.
The catalyst for renewed production is the revised OPEC+ agreement announced in July. As a result, Russia’s production can increase by close to 5-10% over the next year.
Direction and Destination
Transneft can deliver oil to the Baltic and the Black Sea as well as the Pacific Ocean. So whether oil is shipped to China or Europe, they are not currently constrained by capacity or destination.
Transneft’s system is the cheapest to transport crude oil in Russia. Thus, its capacity should be the first to fill up as the country’s oil production grows.
Despite the strong position of the company, the market attaches a pretty low valuation to Transneft. According to my math—and even with the increased CAPEX for 2021—the company offers a mid-teens free cash flow yield and a straightforward and high dividend yield. It also trades at less than 4x EV/EBITDA with only a modest level of debt.
As I shared in January, there is marginal sanctions risk, but I think investors are compensated for that here. Furthermore, the valuation is compelling vs. other midstream operators in the US, which only have monopolies over certain routes. Many high-quality names there trade with a mid-teens PE multiple, but you can purchase Transneft comfortably under 10x.
I think additional sanctions remain front of mind for most investors. Even with the increased tensions over corporate sabotage and related sanctions, I think it would be a stretch and counterproductive to sanction Transneft any further. The US has bigger fish to fry with the rest of the world and with Russia. Also, as Venezuela has shown, restrictions on secondary trading do not always bring counterparties to the table.
More importantly, Transneft may face additional CAPEX to add capacity to eastern transportation routes over a longer period of time. Current valuations offer a buffer against this, but such concerns are a long-term issue for the company. Most of the marginal demand, post-pandemic bounce, will come from Asia.
Finally, Russian oil companies need to continue to produce oil. The longer-term productivity of Russian fields is a subject of debate, but I think this risk is compensated with the current multiples.
The preferreds have completed a retrace of the fast and furious breakout the shares made in June and July. On the downside, there’s support at 150,000 RUB, and the new high to beat is about 180,000.
Don’t forget that the shares went ex on a 9,224 dividend over the period, accounting for some of the price action.
In July, I added to my position close to 160,000 on the retrace and may nibble more below 160,000.
Novorossiysk Commercial Sea Port
NMTP is the largest port operator in Russia, and its activities are concentrated in the Baltic and the Black Sea regions. Most of its cargo is crude oil, and the company is 50.1% owned by Transneft (above), which consolidates NMTP.
NMTP is a play on the recovery in European oil demand. The company is the export point for Transneft’s cargo to Europe, the US, and the Mediterranean. Like Transneft as a whole, its oil handling volumes declined in 2020, and the expectation is that volumes will recover. The economy in Europe has lagged relative to Asia and the US, so European volumes should currently rebound as they possibly decelerate to the rest of the world.
NMTP is primarily an oil and non-containerized port operator. In 2019, according to company statistics, it handled approximately 142.5 million tons of cargo, 80% of which were oil products. On a current LTM basis, though March 31, 2021, oil exports through NMTP’s ports dropped 30%. The significant and immediate driver for greater volumes will be the resumption of oil exports as Europe reopens and Russia increases oil production.
Dry cargo volumes fell by nearly 25% over the same period noted above, but part of the drop is explained by NMTP’s sale of its grain handling business. In short, oil will be the big driver of volumes.
Direction and Destination
60-70% percent of exports from NMTP’s ports historically go to Europe, and nearly all of this is crude oil or petroleum products. Most of the balance goes to Asia, and that cargo is over 50% crude oil. PP 6-7 of the 2020 Annual Report offers a good visualization for that year.
Given the company’s position on the western side of Russia, this makes sense. The set-up again points to Europe as a key driver for NMTP’s business.
The company’s most significant advantage is its petroleum handling infrastructure and integration with Transneft. This makes it the preferred discharge point for all Transneft cargoes that cannot be moved exclusively through a pipeline: Europe, the Americas, Africa, and some Asian cargos.
New ports are exceedingly difficult to build both from a regulatory and investment perspective, so the company is in a great position under current conditions.
NMTP is not the cheapest company covered on absolute standards with an EV/EBITDA of 4.5x and an FCF yield of around 10%, but it merits some attention on a relative basis. Relative to its historicals, it trades at a 20% yield compared to its average FCF over the last seven years.
It is also compelling relative to other smaller port operators. In my last newsletter, I mentioned exiting Piraeus Port Authority (ATHEX: PPA) in Greece on relative valuation. That port asset was trading closer to a 5% FCF yield. PPA’s focus on container volumes is less cyclical, but I think the valuation gap is a bit extreme, particularly with the expected bounce in NMTP oil volumes.
As a subsidiary of Transneft, TRNFP’s risks largely apply to NMTP. The greater risk for NMTP is the long-run direction of oil exports for Russia. Should marginal volumes in the future go to Asia, NMTP will be in a weaker position than its parent Transneft or other port operators. Mitigants to this could be exports to Africa or North America.
Another risk is NMTP’s extensive CAPEX program. The company plans to spend nearly 1.5 billion USD over eight years to build a container terminal, fertilizer terminal, and transshipment hub at its Novorossiysk port. These investments will likely require taking on debt, and they are ancillary to the group’s primary profit center. As a result, they will be a drag on cash flows over the short run, and it will take some time to see if they meet expectations. The investment is also front-loaded, which means it will be most pronounced over the short term.
NMTP has been trending down since the summer of last year, but since July 22nd this year, it has made a thrust higher on good volume. I’ve added a small testing position on this move, but there is no confirmation that the intermediate trend has changed.
If we zoom out a bit farther, the shares are still comfortably above the lows made in the last multimonth down move in late 2018.
1-Year Daily Chart
5-Year Weekly Chart
Globaltrans Investments Limited
GLTR owns rolling stock which is used to transport client goods via railway. Rolling stock is industry jargon for railcars. If you’ve got scrap iron in Moscow that you want to move by train to St. Petersburg, call Globaltrans, and they will get you sorted.
Globaltrans looks to have a good business. They generate good returns on capital, and while the business is somewhat capital intensive, it is not prohibitive. The company’s main issue is that much of its growth and margins are slightly beyond its control. I think a long position in GLTR can make sense, but it is more speculative than the previously mentioned names.
Globaltrans focuses on moving commodities like metals, petroleum products, coal, and construction materials—basically anything that is not easily containerized. Russia exports most of these items, so the company benefits from strong global growth and local industrial production. As a result, a global rebound should continue to benefit GLTR.
The charts below also show aggregate rail volumes both in tonnes moved and tonne-kilometers.
From above, we can see that volumes in tonne-kilometers started increasing YoY in August of 2020. From the upper two charts, we can see that both measures were down, but that volumes in tonnes were down more than tonne-kilometers. This is because they moved fewer goods, but moved them farther.
Volumes do not have much to recover, if at all, from pre-COVID levels, so more growth for GLTR will be dependent on more than a resumption to normal.
Direction and Destination
GLTR charges clients for moving their goods from point A to point B. While they must be conscious of where their railcars are and how to most efficiently utilize them, the basic schedule to move the railcars is determined by the Russian state monopoly RZD, which operates the railways and nearly all the locomotives.
Fortunately, RZD is incentivized to allocate capacity and build capacity where it is most needed. So, GLTR has benefited from increased rail shipments east in terms of volumes (Asia is the marginal consumer) and distance (it takes goods longer to go east). As a result, Globaltrans is positioned to take advantage of the increased trade to Asia in a way that NMTP is not.
This is where I have uncertainty in the name. GLTR owns one of Russia’s largest fleets of rolling stock (47k+ cars) and has a reasonable market share (7.6% in its main categories). However, it does not cost a lot of money to buy rolling stock and attempt to replicate GLTR’s model.
The business seems prone to boom-busts, which is something to bear in mind. This tells me that management is solid because they have been consistently profitable despite having minimal control over pricing.
The company currently trades at a mid-teens FCF yield and a mid-single digits EV/EBITDA. Unlike NMTP, CAPEX needs should be minimal over the near term, and the company has a consistent track record of paying out FCF.
This is great for shareholders, but if I take the other side, it also means that management does not see many avenues to reinvest that cash flow profitably. The company is a low-growth cyclical one at a reasonable valuation and with a high payout.
The main risk for this company is competition pushing down rates due to a continued excess supply of gondolas, which the CEO references in his 2020 annual report letter.
Longer-term risks also include actions taken by RZD in terms of adjusting and increasing capacity, but investors should be able to see signs well in advance.
I am using the LSE listing in USD for the chart because it has a longer history.
The chart looks strong, particularly since the bottom during the second quarter of 2020. The shares recently took a big leg higher.
There may be some resistance around the 8 level but the volume traded at that level is not particularly strong. I am looking to initiate a position somewhere south of USD 7.60 or RUB 565.
Far Eastern Shipping Co.
FESH is an integrated logistics company in eastern Russia operating across shipping, ports, and railcars. They combine elements of both NCSP and GLTR, focused on Russia’s Asian trade, combined with a small fleet of container ships.
FESH’s business is different, however, in that it focuses on intermodal and containerized cargoes. This is important because it involves different underlying goods. Historically, most of Russia’s containerized exports have been timber and paper products. It imports or tranships manufactured goods both for internal consumption and transshipment to Europe.
Notably, timber products and manufactured goods are not exported and consumed respectively in the same place. So, there are many empty container runs. The underlying drivers of such trade are different from the other names we’ve discussed.
In 2020, timber export tariffs and weak demand from China shifted exports to chemicals and construction materials.
FESH’s volume trends are much less straightforward than TRNFP, NCSP, or GLTR, which are driven by global demand for commodities. FESH relies on exports of timber and paper products as well as Russian and European purchases of Asian manufactured goods. The volumes of manufactured goods are also contingent on the speed and pricing of seaborne transportation.
FESH can move a container of goods from the Russian pacific coast to Western Europe in about half the time it takes to ship by sea around Asia. This route, however, costs significantly more than by sea. So, there is a relative availability and pricing dynamic that impacts FESH’s volumes. The chart below shows an example from 2019.
I assume that FESH’s volumes will grow over the longer period but that the other names mentioned are due for a more significant boost over the short to medium term.
Direction and Destination
FESH is used to export certain containerized commodity products and import manufactured goods. Unless Russia becomes a consumption or production powerhouse, FESH will be incentivized to move certain containerized commodities east and manufactured goods west. These routes are largely fixed for the medium term.
FESH is well-positioned to lead Russian containerized trade through eastern routes. It has the port facilities, shipping, and specific rolling stock to take containers to/from Russia to Vladivostock for export/import. That’s their market.
FESH trades at mid-to-upper single-digit FCF yield and a high single-digit EV/EBITDA multiple. Port companies can trade at very high multiples. One can argue that FESH should trade at a higher multiple than NMTP, given that the latters’ volumes are heavily concentrated in more cyclical oil products.
For where we are in the cycle, I prefer the other names mentioned to FESH. I want to bet on the increased volumes of oil and base metal exports from Russia, and I think the rebound there will be more robust over the short run than FESH’s more secular drivers. FESH, however, looks cheap relative to its 10-year average FCF and EBITDA, so I may want to rotate into the name as I suspect its earnings will lag the other names discussed in this post.
FESH has concentration risk. All of its activities center around moving containers to/from Eastern Russia and the Vladivostok port. Anything that could alter those dynamics would make things difficult.
Furthermore, the company has benefited from the pandemic’s disruption of seaborne trade. Moving containers by rail has a more pandemic-friendly protocol than by sea. As seaborne trade normalizes, that will likely impact pricing and volumes for FESH’s intermodal transport.
The chart below shows the freight rate for shipping a container from China to Europe by sea, and it is not likely that this spike is sustainable.
Finally, FESH’s corporate governance is not the cleanest. The largest shareholder, Ziyavudin Magomedov, has been in jail close to three years while awaiting trial on embezzlement charges in Russia. What happens to his stake or the power play around company control has and may continue to impact things and muddy the waters.
There has also been a recent reshuffle of other large minority shareholders, which saw the US private equity firm TPG exit. The oversight of TPG may have provided some additional comfort in the past.
For all my qualms with the story, FESH has a great chart. The price has been in a solid upward trend since the March 2020 bottom and lockstep with the 50 DMA. Shares just broke up to a new higher high, and there are no immediate signs that the medium-term trend is changing direction.
This article was a survey on a different approach in commodities investing by looking at the infrastructure space in Russia. I am largely positioned in the more conservative names of TRNFP and NCSP, but GLTR and FESH can offer an opportunity for investors who are willing to go down the risk curve or are more patient long-term holders in the case of FESH.
In any event, these names all offer investors a chance to invest in a rising commodities market without having to take direct underlying price risk. They also offer the Russian valuation discount and conservative balance sheets relative to many of their global peers.
I hope this has been a helpful perspective on commodities investing and another tool in your investor’s repertoire.
The Castaway Capitalist
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IMPORTANT DISCLOSURE: As of the date of publication, the Castaway Capitalist maintains positions in YCA, TRNFP and NMTP.
Disclaimer: No content on this website is intended to provide personal financial advice. This information is provided for information purposes only. We are publishers and not financial advisors. You should consider your personal situation, conduct your own analysis, and consult with a licensed professional advisor before making any investment decision. No content on the site constitutes – or should be construed as — a recommendation to enter in any securities transactions or to engage in any of the investment strategies presented here, nor an offer of securities.
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