Dividend Disappointments For Russia ETFs

It was not supposed to be like this. Russia, the "R" in the famous BRIC acronym and often one of the most heavily discounted emerging markets in terms of valuation, was supposed to become one of the more attractive dividend destinations in the developing world. Last year, President Vladimir Putin unveiled a plan to push RSX and the iShares MSCI Russia Capped Index Fund ERUS are off an average of 15 percent. Putin was successful in getting OAO Rosneft, Russia's largest oil company, to go along with the 25 percent of net income dividend plan, Bloomberg reported, but getting other large Russian firms to follow suit has been difficult. The lack of success on the dividend front is proving punitive as Russia tries to reshape its image in the eyes of global investors, attempting to shake a reputation for corruption, lack of transparency and an opaque legal system in the process. ETF Impact Rosneft acquiescing to Putin's dividend demands can only go so far to help ERUS and RSX because the stock accounts for just over four and five percent, respectively, of those funds. Neither ETF is stellar in the way of yield. RSX's 30-day SEC yield is 0.94 percent while ERUS has a 30-day SEC yield of 2.34 percent. However, that 2.34 percent comes with a beta of 2.21 against the S&P 500, indicating that on a risk-adjusted basis high-grade U.S. corporate bonds could be a better yield play than Russian equities. Other companies' dividend reluctance is hurting Russia ETFs. For example, natural gas giant OAO Gazprom previously said it would lower its 2012 payout only to raise it for 2013. Sounds OK, but there is more to the story. Gazprom's 2012 dividend is equal to 25 percent of net income based on domestic accounting rules, but it is equivalent to 12 percent of profit using international norms, Bloomberg reported. The stock accounts for over 17 percent ERUS's weight and nearly eight percent of RSX. Other companies are resisting the 25 percent of net income dividend plan as well. Sberbank and VTB Bank OJSC are planning dividends that amount to 17 percent of net income. Those are Russia's two largest banks and the two stocks combine for over 16 percent of ERUS and 9.5 percent of RSX, the largest Russia ETF by assets. Valuations Still Low Russia's dividend disappointments have had the predictable impact of lowering the already low valuations on Russian equities, which historically trade at discounts relative to the broader emerging markets universe. For example, ERUS currently has a P/E ratio of 8.28 and a price-to- book ratio of 1.55, implying the ETF is cheaper than the comparable Brazil and China ETFs. Earlier this year, Russian stocks were seen trading at steep discounts to the MSCI Russia Index's historical P/E. RSX, which does not track that index, is no exception. The $1.4 billion ETF had a P/E below 6.4 and a price-to-book ratio below one at the end of April, according to Market Vectors data. Even Russian small-caps are cheap. The Market Vectors Russia Small-Cap ETF RSXJ had a P/E of about 7.8 and a price-to-book below one at the end of April. Curiously, that ETF has a 30-day SEC yield of almost 8.7 percent. Last month, Russia bulls found some solace in news that Putin proposed a plan that would push state-run firms to to pay 35 percent of their profits in dividends. That sounds great for the government and outside shareholders, but if the 25 percent plan was a failure, the 35 percent plan may be no more than a pipe dream. Failures on both fronts combined with investors' skepticism about emerging markets will combine to keep valuations low for ERUS, RSX and Russian stocks in general. For more on ETFs, click here.