Holding the Trajectory

Dmitry Grishankov, Dmitry Kabalinsky

Raw material resources as a model for big business development have been practically exhausted. To hold the trajectory of growth you need to immediately launch mechanisms of industrial policy. According to our Rating, even the first shaky steps in this direction bring good results.

Chart 1. Oil prices entirely determine revenues’ dynamics of the Russian largest companies

Two years ago, commenting on growing revenues (over 30%) of Expert-400 companies, we remarked: the potential of increase of raw material prices is limited. Without finding alternatives to the growth of raw materials we shall inevitably face slow-down in a year or two, followed by probable recession.

Our forecasts seem to start coming true. Revenues’ dynamics of 400 largest Russian companies went down to 26.5% in 2006, and lost almost seven percentage points comparing with the previous year Rating. On the surface, there is nothing unusual about it. It is quite normal to have certain correction after several years of speedy development. After all, the annual increase of revenues by over a quarter is quite good, which is especially so in case of a stabilized business. Even considering business-deflator, used for calculating GDP, real growth of large corporations reached 9%, which is one third higher than average level of dynamics in our economy.

Still, the recorded slowing down of the Rating should rather be considered as the first testimony of cardinal changes in traditional big business development. Till present the Expert-400 dynamics has been determined almost totally by raw material industries. Failures of external economic conjuncture were inevitably replaced by periods of increased prices for oil and metals, improving results of our Rating and the economy in general. But presently one can not expect even mechanical contribution of the raw material sector to speedy development of the big business.

Upper-stage rocket separation

Oil and gas sector has no equals in influencing the Expert-400 dynamics. At least one third of accumulated revenues of the leading Russian corporations are shaped due to Gazprom and oil companies. Extremely positive economic set up in the oil market in 2003–2005 regularly played the role of an upper-stage rocket for the domestic big business (chart 1). But every new dollar in the price of a barrel of Urals inevitably brings our oil and gas industry closer to stagnation. Capacities for price increase are highly insignificant. Even if the bravest analytic forecasts come true and the oil prices would achieve desirable mark 100 dollars, proceeds of our oil and gas companies would grow only by 60% (same as sales of the largest companies in the industry in 2005).

The first alarm bell for oil and gas people has already rung. In 2006 oil prices’ increment reduced more than twice — down to 21% against 47% in 2005. Development of Russian oil and gas companies slowed down in the same proportion. After the record increase of revenues (+57.4%), registered in the previous issue of Expert-400, in 2006 the industry had to be contented with far too modest growth — comparing with better times — of 26.4%. Further slow-down is in store for exporters of hydrocarbons. The first eight months of 2007 showed the average price of a barrel of Urals to be 62.5 dollars — just 1.5 dollars above the average 2006 figures. And one should not expect large-scale increase of hydrocarbon production to make up for price stillness. Recently oil and gas production has been growing at best several percent a year (2% in 2006). So, according to Expert-400, next year oil and gas corporations’ revenues would hardly increase by more than 10–12%, meaning rate of growth would again be twice as slow.

Gazprom, though, has some chances to develop with better dynamics. The state-selected course for gradual increase of domestic gas prices would secure the gas monopolist growing revenues at the internal market within the next couple of years. So 24.7 bln dollars gap between Gazprom — our Rating leader of many years — and its nearest pursuer, LUKoil (table 1), is only going to grow. After all, oilmen have much less chances to earn inside Russia. Volume of investments into oil refining is definitely insufficient for turning the process into the basis for growth of integrated companies. The largest oil holdings’ profits even now are three times as little as that of Gazprom (table 2).

As to other export-oriented branches of industry, they are incapable of being a good substitute for oil and gas sector due to incomparable scope of activity. In 2006 the total revenues of companies in black metallurgy, non-ferrous metals, chemistry, precious metals and stones were one and half times as little as in oil and gas. Into the bargain these other branches have no reserves for the growth of prices. Copper and nickel markets have reached their peaks, due to which Russian manufacturers of non-ferrous metals managed to pile up their proceeds by 40%. Black metallurgy companies, actively purchasing foreign assets, have some growth potential. But they can hardly reach record figures of 2004, when increased world prices for rolled metals and processes of mergers and acquisitions made metallurgists increase their earnings by over 80%.

The raw material sector has almost completely lost abilities to grow, but it stopped generating risks, related to negative changes in the world economy. Increased economic stability may block large crisis manifestation for a couple of years in case of collapsed oil prices. Anyway, without speedy use of the processing sector potential the perspective of economic growth seems very vague.

First experiments with industrial policy

Industrial enterprises keep on playing less important role in general structure of revenues of 400 largest Russian companies — we mark the tendency as stable in each issue of our Rating. Current year the share of industry went down by another 1.6 percentage points — down to 66.8% (chart 2). Altogether industrial segment turned thinner since 2004 by 6.9 of percentage points. Simple calculation of industrialists in the Rating is even more demonstrative. This year, for the first time since we have started making Expert-400, it is not possible to make a list of 200 leading industrial enterprises. We do not have enough companies — only 195 companies out of 400 big business leaders are involved in industrial production.

Still, the current Rating quantity losses are made up by promising quality changes. A year ago we expressed our concern: only oil and gas sector was active in industry, but all processing branches were in the state of stagnation. Now the situation has been changing. Comparing with the previous Rating, presently we face certain revival in the majority of industrial branches. Heavy machinery is especially successful. The situation in the industry was improved due to governmental actions — the state has been making certain attempts to conduct planned industrial policy.

The current issue of Expert-400 contains 49 machine-building companies (two more than a year ago) with total amount of sales exceeding 44 bln dollars (table 3). The revenue increase in 2006 reached 24.7%. It is the fastest rate of growth in the industry for the last five years. For instance, last year the machine-building increase was nothing more than 15.4%.

Speaking about the economy dynamics inside the industry, motor companies are in the lead. Definitely, AvtoVAZ is not one of them. The Russian auto-giant management is still incapable of determine its strategic development. The company itself has been losing its market and balances between recession and stagnation. It reached some positive results comparing with the previous Rating: its turnover in 2006 increased by 15% (previous year — only 5%), but, considering increased prices for components, the growth may be equaled to zero. But AvtoVAZ competitors laid the accent on assembly of foreign brands and demonstrate very impressive rates of development. It may be directly attributed to the state initiative of the industry strategic development.

The idea of attracting the largest international automobile corporations to building their own plants inside Russia, encouraging them with beneficial rates for import of components, but obliging to gradually localize production, started its practical implementation by the end of the 90-ies. First agreements between the Russian government and Western companies were signed in 1998. In 2002 first cars left a conveyor belt of the Russian branch of Ford in Vsevolozhsk. In 2006 the company’s sales (position 43 in our Rating) amounted to 2.7 bln dollars, exceeding the results of 2005 by 90.2%. If it retains such dynamics (and there are reasons for it, considering expected expansion of capacities and a model line), in two years AvtoVAZ would lose the status of the largest auto-manufacturer in Russia.

In April 2005 the government approved of a single order of automobiles’ industrial assembly. In keeping with the new rules, foreign companies are allowed to bring in auto-components for free, but are obliged to establish in Russia a completed cycle of auto-assembly production capacities, including welding, assembly and painting. Within four and half years since the moment of commissioning a production unit an investor has to reduce the input of free components by at least 30%. To make foreign corporations act faster decision-making period for them was limited: the government stopped taking new applications on September 15 this year. The measures proved to be very effective.

Total volume of investments to the Russian automotive industry, provided by agreements signed in two years, amounts to 3.7 bln dollars. Presently cars of foreign brands on the basis of industrial assembly are manufactured in Vsevolozhsk Ford Motors Company, SOK Group, Avtoframos from Moscow. Such a strategy secures to companies high rate of growth. For instance, in the current Rating Avtoframos was 15-th among the twenty most dynamic companies (table 4). Russian suppliers have their gains, too. Localization level in Avtoframos in 2006 reached 30%, and, according to Vsevolozhsk Ford managers, 35% of their costs are accounted for by Russian components. Even Avtotor from Kaliningrad, whose leadership in the current Rating is directly connected with increased volume of "screwdriver" assembly of Kia and BMW, under the influence of competitors expressed its readiness to use certain Russian components. But quality of local products is sometimes in the way of a serious increase of purchases from national companies. Therefore new industrial assembly projects already provide for parallel development of components’ production from scratch.

Industrial policy glimpses are visible in other branches of industry, too. State officials try to adjust automotive industry tested formulas to the needs of agricultural machine-building. Simple measures to legalize import and counter smuggling and criminality permitted to overcome ten years recession in light industry. But this is where the list, probably, ends — if we leave aside reforms in aircraft and ship-building (large-scale transformations in these branches should bring fruits, at best, in several years). At the same time several big industrial sectors are completely unattended by the government.

Thirsty near the water

Heavy industry (energy and oil-and-gas machinery) is traditionally considered to be a main trump card of the domestic processing sector. Natural monopolies are in dire needs of colossal renovation of their main assets. As soon as energy companies would stop patching up holes and find money for massive modernization, Russian equipment manufacturers would immediately get inundated by avalanche of orders. It would be a sin to give such a juicy contract out. So the state carefully protects the heavy industry enterprises from foreign encroachments. For instance, recently the state declined a second attempt of Siemens to purchase a package of Silovye Mashiny shares. But all efforts to protect strategic assets may prove to be futile. Lion’s share of the investment demand passes Russian machine-builders by.

Chart 2. Fall in industrial companies’ share is a steady tendency of "Expert-400" rating

Judging by our Rating, Russian fuel and energy complex’ companies are either abstain from investments altogether or boycott domestic manufacturers. There is no other way to explain pathetic financial results of our energy machine-builders. Silovye Mashiny revenues in 2006 have dropped by 16.6%. United machine-building plants increased their sales by mere 6.5%. Average increment of prices in industrial production last year reached 10.6% — in real terms it means a notable production drop. The most dynamic company in the sector — Energomash group — increased its revenues by 18.9%, still lagging behind the average Expert-400 indicator by almost eight percentage points.

But, clearly, today you can not accuse energy companies of being investment passive. In 2006 investments of RAO EUS of Russia grew up by almost 40% to achieve a record figure of 160 bln rubles. Investments to energy would only be going up with time. The RAO EUS investment program for 2007–2010 is in the neighborhood of 3 trln rubles. The figure is almost three times bigger than aggregated revenues of machine-building companies in the current Rating, being one quarter above annual turnover of all the Russian machine-building enterprises. So the point rather lies elsewhere.

People in the energy sector, same as in oil and gas, are ready to buy "Russian stuff". Moreover, investors are very attentive in dealing with domestic suppliers of equipment, trying to understand real abilities of potential counter-agents. And they find out: pretty often Russian manufacturers are incapable of producing equipment with set features and in demanded quantity. It is caused by 70% tear-and-wear, loss of scientific schooling, an acute lack of specialists. The only alternative under such circumstances is import. No wonder, that in 2006 foreign supplies of electro-technical equipment to Russia went up half as high again.

In case of less technological items, effect of investment demand manifests itself very brightly. Let us take an example of the cable industry. In 2006 revenues of the sector large companies have grown wildly. Rosskat, one of the Russian cable leaders, increased its sales by 1.4 times. Kolchugin plant Electrocable piled up its proceeds by 57.5%.

Saturation of consumers

Non-industry sector is still more dynamic comparing with big industrial business. Banking is definitely in the lead for two years running.

Banks. Total proceeds of 26 banks in the current Rating have grown by 44% (diagram 3) and achieved 34.9 bln dollars. Turnover of banks places them in position 3 among non-industrial Rating sections, after transportation and trade retail. The success may be attributed to several reasons.

Chart 3. Banks are development dynamics implicit leaders in this rating

First, increased demand for credit products by population remains the most powerful driving force for banking development. Expansion of individual crediting has been accelerating much faster than corporate segment development. In 2006 portfolio of credits to physical persons grew up by 75%, while credits to large and medium business — only by 39%. In absolute figures banking retail is still behind crediting companies, but the gap is gradually being bridged: at the beginning of the last year the share of individuals in banks’ credit portfolio amounted to 22%, but by the beginning of 2007 the indicator reached 26%. The structure of banking products for population has been undergoing changes, too. The banking retail business core has shifted from simple consumption credits towards mortgage and card crediting. Expansion of retail banking is stimulating for specialized banks as well as for diversified financial structures. The bank Russky Standart has been among the twenty most dynamic companies in the Rating for three years. Its revenues in 2006 went up by 2.6 times. Speedy development of KIT Finance investment bank (growth by 97.1%) may be explained by active retail operations.

Second, consolidation brings about notable growth potential. Definitely, Western banks, actively purchasing Russian bank assets, remain chief players at the market of mergers and acquisitions. But domestic banks use the mechanism to enlarge their business more and more often. Such measures are very productive. URSA Bank, set as a merger of Sibacadembank and Uralvneshtorgbank, increased its earnings in 2006 by 188.1%.

Finally, the state initiatives also contribute to the banking sector development. Assets of Rosselkhozbank — an operator of the national project in agro-industrial complex — last year went up by 2.7 times. Its revenues grew even faster (2.9 times). It is the highest figure among the banking sector in Expert-400.

Construction and transport. A real surprise in the current Rating has come from builders. Earnings of the largest construction companies in the Rating increased in 2006 by more than one third. The growth was distributed evenly between housing construction corporations and infrastructural construction companies.

Nobody ever doubted profitability and speedy development of the housing construction. But there was nothing to give it a clear confirmation — leaving aside skyrocketing prices for housing. Construction business was always lacking transparency — confused books, vague organization schemes. Quite recently the word combination "construction company accounting in keeping with IAS" looked oxymoronic. But builders have to go out of the shadow, if they want to get cheap financing. It is very difficult to attract investors by unclear balance sheets of numerous companies and oral affirmations in multibillion turnovers of your construction group. The results came quickly. This year several construction companies presented their consolidated reports for our Rating in keeping with IAS. The figures show billion dollars revenues of the construction market leaders and the ascending tendency. For instance, PIK Group in 2006 earned 1.6 bln dollars with increment of revenues being 89.8%. The successful IPO of the company proved: any investor finds such business attractive.

Previous issues of our Rating registered stagnation in the infrastructural construction and made the situation look alarming. After all, long-term economic growth is not possible without proper development of infrastructures. At last, this year the tendency has been reversed, in the pipeline construction, for sure. The state-launched projects have already been bringing good results to specialized construction companies. Stroitransgaz revenues in 2006 were practically doubled. Welding and Erection Trust, involved in laying the Baltic pipeline system and presently engaged in constructing stream pipeline Yamal-Europe, shows even more dynamic results (growth by 2.1 times).

Chart 4. Big business de-concentration process is slow but steady

Expectations to launch big railway projects are directly connected with implementation of the Strategic Russian railway development till 2030, which is to be approved by the government in November 2007. The Strategy provides for capital investments totaling 13.7 trln rubles, to be covered by federal and regional budgets by 25%. 42% are to be taken care of by the Russian Railways themselves, and another one third is planned to be paid by private investors. High level of investments makes the Russian Railways seriously accumulate revenues. But so far dynamic development of the rail monopolist is contained by cross subsidies and tariff limitations. The company revenues in 2006 amounted to mere 13.4%. It is not much comparing with automotive transport, ship and air cargo large corporations. Thus, monetization of benefits and fight with free-riders increased Mostransavto earnings by 1.5 times in 2006. Increase of sea transportation of oil and metals secured 49% of added value to Sovfrakht; UTAir aircraft company moved its business up by 43.2% in 2006.

Retail and telecommunications. Leaders of the first Expert-400 issues — retail nets and telecommunication companies — have been gradually losing momentum. Small wonder — the first phase of developing new fast-growing markets has been completed.

Gradual consumer saturation is especially urgently felt by retailers. The most lucrative zones (most of all, cities with population of 1 million) have already been divided. The increased level of competition inevitably diminishes rates of growth. Last year sales of retail companies went up by 40%. Many other branches of economy may only dream of such dynamics, but for retailers it means serious rollback. Previous Rating increment of retailers’ earnings was 52%. Higher dynamics have been demonstrated either by new players successfully occupying relatively free niches in Moscow, or regional companies. For instance, Leroi Merlaine Vostok, working as construction hypermarkets in Moscow, more than doubled its turnover in 2006. In the regions Grinn corporation — trade nets’ operator in Belgorod, Kursk, Stary Oskol and Voronezh. — was most successful.

Extensive growth has been over for telecommunication sector, too. Judging by a number of circulated SIM cards, the population mobile coverage has long ago exceeded 100%. There is an aggressive fight going on for each new client. The only way to grow under such circumstances is to increase revenues per one client. According to our Rating, Megafon proved to be in the lead among mobile operators with earnings growing by 1.5 times. To get better awards you have to enter formerly monopolized markets. Mezhregionalny Tranzittelekom managed to do exactly that. In 2006 the company entered the long-distance communication market — former domain of Rostelecom. The factor is in many ways responsible for doubled sales of the company last year.

De-concentration resources. Every new issue of our Rating observes further de-concentration of large business. Without doubts, the process is slow. Annually, the first forty companies in Expert-400 — mostly raw material giants — lose at most one or two percentage points. At the current Rating their share was 64.1% (diagram 4) — 1.7 point less than a year before. But the room for hopes to make de-concentration process faster is there.

As was already mentioned, the raw material business has already reached its peak; resources for speedy growth are quite limited. Smaller processing enterprises and non-industrial companies are in a better position. They have room for development. Besides, there are capacities for mergers and acquisitions among companies in the middle of our Rating. Corporate building may play an important role in piling up business volumes. The process has been ongoing — Expert-400 demonstrates a steady growth of share of inter-regional holdings. This year they were responsible for over 79% of total revenues of the largest companies (table 5). A year ago the similar indicator was 73.6%.

There is one thing which is even more important. The state policy and, evidently - in a larger degree - pragmatic considerations encourage business to move out of shadow. Today it is advantageous to be large. About fifty ООО, at best united by one owner, often turn into a powerful holding with clear organization structure and turnover exceeding hundreds million dollars. The above mentioned construction companies may be taken as a model. Our Rating is a very proper instrument to position a company as a representative of large-scale and successful business. And, no doubt, a number of such "novices" would be inevitably increasing.

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