Year of oilers and bankers

Large-scale business has two clear centers of growth – oil and gas sector and service sector. Neither of them properly encourages development of manufacturing industry

By Dmitry Grishankov, Dmitry Kabalinsky

Let us begin with statistics. Aggregated earnings of 400 largest Russian companies reached record 15.6 trillion rubles or about 554 billion dollars in 2005. The proceeds have grown by 33.1%, which tops the achievements of the last five years. Index-deflator adjustment, used to calculate real GDP growth, shows the increased earnings of the leaders by 11%. Even assuming that proceeds of companies should not be directly compared with the volume of GDP, one can safely say: big business in Russia grows much faster than its economy. It may seem proper to award “best workers" for their contribution to the development of the national economy and popularize their experience among those lagging behind.

But a thorough and attentive look reveals a not-too-happy picture. The claims of big business to leadership are quite appropriate, but so far it can not perform functions of a locomotive. It does not give a good pull to our economy. Neither by supplying good managers (like in post-crisis period), since all relatively qualified and smart personnel are sucked in by fuel and energy complex. Nor by creating investment demand (like two years ago) or multiplicative effect. Nor by encouraging innovations, so much talked about recently.

Diagram 1. Industrial companies gradually lose ground in "Expert-400" rating

Diagram 2. Banks took the lead in dynamics of development in 2005

Industrial roll-back

The three last years witnessed a sustained trend of graduate reduction of industrial share in the Rating general structure. This year “Expert- 400" industrial sector has lost another 2.3 percentage points – down to 68.4% (see diagram 1). But deceitful drifting of large business towards post-industrial economy should not make you feel overjoyed. In the past the real sector companies, being less dynamic in growth comparing with non-industrial corporations, developed quite rapidly, but the current Rating clearly demonstrates loss of momentum by all significant industries except one – oil.

Nominally (volume of sales) construction materials are in the lead (+92.1%), but oil industry has no equals as to level of influencing “Expert- 400" final indicators. 2005 revenues increased by 57.4% and secure 35.7% of aggregated earnings of the 400 largest companies (table 1). Round-the-year oil rally helped oil companies to move from strength to strength in the Rating. The most striking example is Lukoil with its second line in “Expert-400" . The gap between Lukoil and long-time leader Gazprom was minimized down to 2.6 billion dollars in 2005 (table 2) – the figure is insignificant considering the companies turnover. Actually, Gazprom managed to retain the leadership by acquiring Sibneft. Three months of Sibneft operations as a part of the gas monopolist added up to Gazprom another 3 billion dollars, which was considered in consolidated accounts. True, most part of the year Sibneft remained independent. That is why it is still there in our list of the largest companies, occupying line 8 before saying good-bye. Next year Sibneft (Gazpromneft) would leave the Rating, to be dissolved in the books of Gazprom.

As a matter of fact, increased oil prices were not the only factor to ensure increased revenues in the oil industry. Unfortunately, the other factor has nothing to do with improved productivity of oil companies. Oil recovery in 2005 grew up in Russia by only 2.2%, natural gas recovery increased by mere 0.5%. Regrouping of assets turned into a gold mine for some of them. Rosneft absorbed Yuganskneftegaz and increased its revenues by 3.8 times. Upon acquiring such a valuable enterprise Rosneft improved its status by 16 points and moved to line six in our Rating and to line three in the amount of balance profit (table 3).

The Rating general dynamics were sped up mechanically by cumulative action of oil business climate and partial oil industry restructuring. Had there been no “oil support", the total growth rate of “Expert- 400" participants would have gone down by about 10 percentage points to reach 23.6%. Downfall in industry would have been even more noticeable, with the growth rate decreasing almost two times, from 33.7% to 16.6%.

Business environment. You may pin down slow rates of the “Expert- 400" industrial sector development on business climate twists or saturation of the market. For instance, this year leading iron and steel companies increased their revenues by insignificant 12.4%, comparing with last year 83% growth. The reason is obvious – drastic fall of the world prices for rolled metal. Similar factors are partially accountable for decreased rate of development in other export-oriented branches of industry. The only positive exception is chemical industry. High prices for mineral fertilizers (potassium, in particular) and petrochemical products, still in place in the markets abroad, plus growing domestic demand secured significant increase of turnover for chemical industry (+33% comparing to the level of 2004). But the industry also slows down its pace, since the previous year chemical enterprises in our list showed the increase by about 38%. It was unrealistic to expect new acceleration in food industry. The previous five years have seen dynamic growth of the largest market players, therefore objective reasons for new breakthrough are simply not there.

Investment demand. The flunk in machine-building can not be explained by this kind of logic, though. The current issue of our Rating showed just 15.4% of the increased output of sold products by machine-building companies (previous Rating – 20.5%, two years ago – 23.1%). Since last year average growth of manufacturing prices was 18.2%, the situation in machine-building sector may be described as real recession, not just stagnation. Mostly it may be ascribed to limited investment resources in oil and energy sectors, hence no full-scale demand for machine-building core products.

The government attaches strategic importance to the development of oil and energy equipment. The approach seems to be quite appropriate. If Russia strives to position itself as the energy superpower, it has to be very much concerned about fuel and energy machine-building development. As a matter of fact, domestic manufacturers have certain technological potential and stable niches abroad at their disposal. But the state limits itself to rigorously curbing foreign investors' attempts to purchase some significant stock of our specialized companies in the area. So far, no real investments by the fuel and energy complex are encouraged by the state.

And it is wishful thinking to expect some selfless initiatives from oil companies. Their current expenses are easily covered by what is left after paying excise taxes and other dues and fees. And there is no point in becoming engaged in expensive investment projects, considering current share of exaction (about 90% of earnings due to increased oil prices). No wonder, that investments to recovery of oil and energy natural resources went down by 2.6% in 2005 (Rosstat information). Only 41.8 billion rubles were invested to development of refining capacities (+4% to the last year level). It is a drop in the ocean, considering the real needs of the sector. Modification of domestic refinery complex has long been overdue. Our refineries are 35%-40% less efficient than their Western counterparts, hence high cost of petroleum products. And growing petrol prices are no longer a surprise. But price moratoriums would never present a drastic solution to the problem. The more efficient way is to encourage oilmen to build new refineries, using tax benefits in combination with more rigorous technical control. In the long run such a policy would set grounds for cutting prices and developing core branches of machine-building.

The near future would not bring gigantic orders to machine-builders from energy sector, as well. True, the current growth of their revenues (+12.7% to the level of 2004) is not bad at all, considering “inflation minus" tariff indexing for electric power. But it is not enough for quick replacement en masse of energy companies' obsolete equipment. It is absolutely necessary to attract private investments, but it can hardly happen overnight. But lingering with investments may bring about unpleasant situations, like Moscow blackout last May and energy supply limitations last winter. Recently RAO EES made a list of regions with possible energy cuts during this winter. The list covers 16 regions. And these are just individual cases, but, in principle, lack of energy may seriously hamper the growth of the national economy. Energy sector surely has no own funds to resolve the issue. Individual companies in the power engineering industry show corresponding results. For instance, Silovye mashiny holding earned 1.1% less in 2005. Other companies in the sector demonstrate very modest growth: Energomash group increased its revenues by insignificant 10.2%, Energomashinostroitelny alians – by 13.6%.

Still, there are cases of machine-building companies developing due to investment demand. In 2005 Transmashholding revenues went up by 90%. The kind of growth may be explained by roaring competition in the field of railroad transportation. Changed tariffs for cargo transportation in 2003 caused the appearance of numerous independent operators with their own rolling stock. They quickly managed to take some of the RZHD (Russian railways) share in transporting most profitable cargoes (oil, petroleum products, mineral fertilizers, metals). According to RZHD, share of private operators in transporting cargo by rail was 34% in 2005 (about 27% previous year). Private owners make active investments to renovation of rolling stock. The operators invested about 80 billion rubles to form their own fleet of cars, total number of cars under their control amounted to 281 000 units in the first half of 2006. The second component of the Transmashholding success is corporate building: last year the holding acquired two enterprises, Vagonmash and Kolomna plant.

Military-industrial complex is another dynamic segment of machine-building industry. Increased export contracts and amassed annual growth of defense orders permit our armourers to build their own island of stability in domestic machine-building, otherwise losing momentum. But there are negative exceptions. Aircraft engineering companies, recently having been at the top of the list of the most profitable companies in defense sector, do not show fast development in the current Rating. It is rather the other way around. At best they stick to the previous year results. Sometimes it is a real downfall. For instance, revenues of Sukhoi in 2005 went down three times.

This seems to be the price you pay for low diversification of your sales and dealing almost entirely with limited number of foreign buyers. Irkut has only managed to retain its earnings but can hardly report any dynamic growth. The sales grew up by mere 12.3%. MIG has achieved much better results under the leadership of Irkut managers. Last year MIG revenues went up by 52.4%. The most dynamic results are shown by manufacturers and developers of missile systems – Takticheskoe raketnoe vooruzhenie corporation and Heating engineering institute.

But relative stability of domestic military-industrial complex is still based on technological reserves of the Soviet era. New developments are still quite exceptional. And without them resources to develop defense machine-building complex are doomed to quick depletion.

Ball of consumers

The reason for speedy growth of non-industrial sector is obvious. Increased real incomes of population, nourished by oil dollars or directly by manufacturers, assisted by the budget or striving stock market have provoked escalation of consumer boom. Retail and telecommunication companies were obvious leaders in 2003-2004, showing dynamic growth. The current issue of “Expert- 400" has presented a new leader in the servicing sector.

Probably, the most striking revelation of the current Rating is fantastic growth of the banking sector. Within the last decade weakness of our banking system has been regularly referred to as a non-balancing factor for our economy in general. We, too, commenting on business tendencies, many times complained about lack of broad access of most companies to banking credits. At last, banks made a breakthrough.

Accumulated revenues of the current “Expert- 400" 24 banks grew up by 52.6% (diagram 2) and amounted to 24.2 billion dollars. Leading Russian banks have shown dynamic growth, almost in line with oil business, leaving behind retailers and telecommunication corporations. Understandably, in the list of the 20 leading companies of our Rating financial structures constitute the most numerous group (table 4), consisting of 6 banks. There are several reasons to account for the success in the banking sector, increased crediting of big business is far from being the main one, it is mostly desire for credits on the side of population and small enterprises.

Altogether Russian banks increased their earnings on credits and deposits by about 40%, amount of credits to population in 2005 almost doubled. Even the previous Rating registered successful achievements of the consumption credit leaders HCF-Bank and Russian Standard. Speedy development of the banking sector in 2005 made other “Expert- 400" banks expand rapidly, too. Besides, newly introduced system of deposit insurance allowed banks to regain depositors' trust. Growth of population deposits in 2005 reached 42.2% in real terms. Thus, borrowing money from banks, people actually borrowed money from themselves.

Small business crediting took quick strides, too. According to “Expert RA", the sector has grown by 45% (diagram 3). Currently banks develop special programs to attract maximum number of small enterprises. By the end of this year we may presumably state another accelerated cycle of small business crediting.

Growing stock market was another contributing factor to foster the banking situation. Banking investments to corporate securities have been booming against the backdrop of accelerated development of the corresponding markets. Last year RTSI increased by 83%. True, profit from securities' operations in Russian banks is relatively insignificant (around 3% in 2005), but the operations played decisive role for investment banking structures. For instance, CIT-Finance skyrocketing results (earnings – 5 times, second place on the list of the most dynamic companies) may be attributed to the securities sector development – investments to securities earned for the bank 65% of its total revenues.

Large-scale industry crediting was rather slow. By estimate, credits to non-finance sector leading enterprises grew by mere 25%. The slowness can not be ascribed only to inaccessibility of loans for companies. After all, the price of credits is gradually declining. Pretty often managerial talk about deficit of long and cheap money is but attempt to conceal simple absence of business strategy.

The current issue of “Expert-400" witnessed good results in insurance sector as well. Business of 9 largest insurance companies in the Rating has increased by 43.1%. Continued concentration (300 small insurance companies left the market in 2005) in combination with growing regional branches of the leading players resulted in significant growth of collected insurance premium. Consumption factor also played its role in the process. Gradual understanding of insurance culture together with availability of funds in the middle class (at least) contributes to expansion of non-mandatory types of insurance. Still, the most powerful catalyst of insurance development in Russia is introduction of mandatory insurance for particular risks. Mandatory insurance of hazardous occupations and, probably, mandatory housing insurance may raise insurance market to a new level.

The Rating growth of financial sector has not cast a shadow on retail development. It is rather the other way around. Contribution of consumption crediting to growing retail sales due to nonfood goods exceeded 40% (less than 30% in 2004). Retail companies in 2005 showed slower development comparing with “Expert- 400" last year results (growth 52% against 61.5% in 2004), bur even consumption boom can not secure exponential growth of revenues for retailers. Telecommunication sector, for instance, after vigorous growth is currently more conservative (+27.7% to 2004). Besides, two retail networks showed much better results. Holding Martha and Euroset company increased their turnover by 3.4 and 2.2 times accordingly and reached lines 4 and 17 in the list of the most dynamic companies.

Diagram 3. Small-scale business crediting sector should become the leader in growth rate in 2006 (size of the circle shows the sector volume)

Diagram 4. Decile distribution of sales volume by 400 largest Russian companies

Speedy growth of the consumption sector is a powerful element, helping to decrease concentration levels of large-scale business. Obviously, Russia has not yet reached the level of the leading world economies. Share of the first decile (aggregated proceeds of the first 40 companies) constitutes 65.8% of total sales of the largest 400 (diagram 4). But there is some room for reserved optimism, since the figure was over 70% in the Rating of 2004.

Corporations from 41 to 80 in “Expert- 400" compete more notably with the first decile frequenters (mostly large raw-material companies). The 41-80 group is domineered by non-industry companies with dynamic business growth. The second decile corporations in 2005 increased their sales by 44.1% comparing with 35.6% of the first 40 companies in the Rating.

Another factor – to be more influential with time - adding to de-concentration of big business is active corporate construction among non-industry companies. Capacities for mergers are almost exhausted at the top of the list. As to the second and third hundreds of the leading companies, there is still enough space to integrate business. Besides, large retail, telecommunication and financial companies are actively engaged in constructing their regional networks. Stable increase of share of inter-regional companies in the Rating confirms it indirectly. Their share in 2005 increased by 3 percentage points and reached 73.6% (table 5). Gradual leveling of the largest Russian companies revenues seems to be the case for the future.

New trillion Thanks to the fast growth of business new economy corporations strengthen their positions in "Expert-400" Rating Turnover of companies unrelated to the Soviet assets grows speedily. Even a year ago new economies in our Rating expanded mostly due to natural increment of companies, but at present the growth may be explained by other reasons. The current Rating of “Expert- 400" has not shown significant increase of corporations, who started business from scratch. There are 144 such companies in our Rating comparing with 123 last year and only 56 the year before. But the new generation companies learned how to get good results by skills, not by big number of people. Proceeds of such companies in our list increased by over 1 trillion rubles within one year and amounted to 2.4 trillion rubles (see diagram). Altogether new economy sector in “Expert-400" has acquired 3 percentage points more and reached 15%. Traders are in the lead. Revenues of retail and wholesale companies constitute over 45% of the sector total sales. Financial companies are reliably the second – their share among new economy corporations amounts to 22%. Cell phone operators are less lucky this year. They were stopped in their tracks due to saturated market and tough competition. As a result their share sized down to 8%. Frankly speaking, part of “new" companies are not shown in the Rating directly but hidden in the structure of big holdings. Thus, consolidated accounts of AFC Sistema include results of MTS, ROSNO and Sitroniks. Gazprom consolidation diluted Gazprombank. The new economy segment might look more impressive, had the companies been in the Rating individually. As to industry, so far there is nothing to write home about. Status of full-scale representatives of the new economy may be claimed only by food and auto industry companies. But only foreign companies managed to set new big enterprises in these sectors.