Higher quality consumer stocks in Russia make good sector play

Managers investing in Russia’s consumer sector would do well to look at the higher value added end of the spectrum, as Russians begin to favour quality over quantity.

Research from Bank of America Merrill Lynch points to a rapidly expanding higher value added goods sector, despite a general deceleration of economic activity in the broader economy.

A sector that illustrates the shift particularly well is the car industry. Here, the more expensive global brands have taken in substantially more net new money this year than the budget local brands.

Brands like Volkswagen, BMW, Mercedes and Audi have all attracted significant inflows, while Russia’s local budget brand Lada’s sales have declined 10% year on year.

This increasing demand for better quality products has been driven by the expansion of Russia’s middle class.

According to the latest data from Russia’s statistics agency RosStat, the number of people with disposable monthly incomes above RUB35,000 (€870) in Russia has increased by more than 21% this year, reaching an all-time high of 21.3m in the first nine months.

Vladimir Osakovskiy, chief economist at Merrill Lynch in Moscow, expects the growth in Russia’s middle class to continue and even intensify over the next several years, “supported by adverse demographic trends and the resulting structural tightness of the labour market.”

Merrill Lynch forecasts a tripling of the middle class in Russia by 2020, to 66m. This would mean that nearly half of the country’s population is relatively well off.

Consequently, Russian consumer demand can be expected to shift further towards quality over quantity.

One of the sectors that is likely to profit from this expansion is the luxury goods sector, following a similar pattern to that observed in China.

Swiss & Global Asset Management, manager of the Julius Baer Luxury Brands fund, says more than 90% of the growth in the luxury sector comes from emerging markets.

Along with China, the firm names Russia, Middle East and Brazil as countries with growing luxury goods consumption.

Instead of saving for the future, Russians prefer to spend on tangible goods. This means that, as their wages grow, so does their appetite for better quality products.

Merrill Lynch says nominal wage growth in Russia remains in strong double digits, despite market volatility and economic fragility.

Osakovskiy says: “The squeeze of the Russian labour market due to adverse demographic trends will likely remain for the next 10-15 years at the very least, which should continue to support positive trends in Russian consumer demand over the long term.”

Many managers investing in Russia like the consumer sector.

Invesco and Swiss & Global are among those bullish on these stocks, despite them being relatively expensive compared to other, highly undervalued sectors of the economy.

Those managers would do well to keep their eye on the higher end of the scale in the sector, since all market fundamentals point to increasing preference for quality over quantity among Russian consumers.

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