Inside Corporate Uzbekistan

In my research and investing I stress three things: people, structure, and value.  I look for companies that are controlled and managed by quality people, have corporate structures that align minority and majority shareholder interests and trade at valuations that are below fair value if not outright cheap.

This blog is about corporate Uzbekistan and the second post about that country (first one is here). In the first post I noted that Uzbekistan is one of the fastest reforming countries in the world. These are continuing despite the Covid-19 pandemic. This past fall the government announced a major privatization program to sell government assets and reform those that remain under government control.

The country’s economic reforms and opening are gaining traction. There have been so many announcements of new factories, infrastructure projects, and foreign firms entering or expanding in Uzbekistan that I’ve stopped keeping track.

Mapping the RSE. One of the first things I do when looking at a new market is to determine who owns what. People are extremely important to the running of a company. I try to determine who are the good and not-so-good controlling shareholders. I do further research on those companies controlled by the good people and avoid the rest. This helps me quickly get up to speed on a new market, identify quality companies, and form a framework of a country’s business structure.

The fund I work for did this for Uzbekistan. We spend proportionately more time researching Uzbekistan and its listed companies than other markets. This is because it’s harder to access information there as none of the super expensive financial databases, such as Bloomberg or FactSet, has yet added Uzbek corporate data. While many view this as an impediment, I think it's a huge opportunity. I like to do my own on-the-ground, bottom-up work that no one else is doing. It's a good way to find and invest in quality companies, especially those that are off the beaten track.

Below are some interesting findings from our research:

• The total value of all 144 Republican Stock Exchange (RSE) listed companies was USD5.2b as of December 11, 2020 when we locked numbers for the report
• To put this in perspective, the market value of Apple (USD2.2T) is some 420x larger than the entire value of all companies listed in Uzbekistan. The market value of all companies listed on the RSE equates to a ‘mid cap’[1] company in the United States
• The total value of the market accounts for just 8.9% of Uzbekistan’s 2019 GNP or USD58b. This may be one of the lowest in the world. This compares to the United States at 190% (see here). In India it’s over 100% (see here)  
• For our report we mapped 98 of the largest listed companies to their controlling shareholder. Together they account for 96.8% of the entire market’s value. The remainder of the bullet points below refer to these 98 companies we mapped
• The market is top-heavy with the five largest companies accounting for 64% of the total that we mapped.  Just one company, Uztransgaz, accounts for 35%. The smallest 20 companies together account for less than 0.1%
• Banks are the largest sector. They account for almost half of the total
• The investible market is much smaller. This is because Uztranzgas is 100% held by the government and it barely trades. Since 2016 there have only been two transactions in its stock, together worth less than USD100. Removing Uztransgas decreases the mapped value of the Uzbek market to USD3.2b
• Even this may be overstated as there are several restrictions on foreigners owning bank shares. The most prohibitive is that investment firms registered in countries deemed to be tax havens by the Uzbekistan government are not allowed to invest in bank shares. The list is long and includes several locations where global funds are domiciled including Delaware, the Cayman Islands, the UAE, and Guernsey
• The market value falls to just USD762m if banks and Uzransgaz are removed.  This means that for most institutions the investable value of the Uzbek market is equivalent in size to a single small-cap[2] stock in the USA
• Two government-owned agencies dominate the control of companies listed in Uzbekistan. The State Assets Management Agency (SAMA) and the Ministry of Finance (MOF) control 59 of the 98 companies we mapped. The companies they control have a combined market value of USD4.4b or 87.8% of the total market we looked at
• Just 8% of the market value is controlled by 23 companies which have a diverse shareholder base
• Five listed companies are subsidiaries of foreign entities. They account for 2.9% of the total
• Just 1.1% of total market value is controlled by Uzbek individuals. Most of this is due to Hamkor Bank which accounts for 1.0%

Most investors will be put off by the market’s small size. Others will be put off by the near ubiquitous government ownership. But as famous mathematician, Carl Jacobi, once said, “Invert, always invert”.

One reason the market is so small is the low valuation that many companies trade at. Most companies listed on the RSE trade at low valuation metrics such as price-to-earnings, price-to-sales and price-to-book ratios.  As noted in the previous blog they are also trading at valuations lower than what private investors are paying for similar assets.

For instance, despite its ~140%[3] price increase since we wrote about it in the last blog, Qizulqum Cement is trading at an EV per ton of capacity of USD30.  This is 76% below the USD125 EV/ton of capacity that two Chinese cement manufacturers are budgeting for their greenfield plants.

Government ownership also puts off a lot of investors.  Uzbekistan is undertaking a wide-ranging privatization program that will affect virtually all government-owned entities. There have been several privatization drives in the past that fizzled out. The difference now is that the country has a new leader since 2016.

Under his government’s watch, there’s been broad and on-going corporate restructuring. This includes replacing top management at Uzbekistan’s largest government owned companies with leaders that have experience in the private sector. The new executives are reforming and reshaping some of the country’s largest state-owned enterprises. Many are being positioned to raise capital through bond issues or by selling shares to the public and listing on a stock exchange.

There’s a lot of corporate activity in Uzbekistan and I’m pretty sure we’ll be very busy keeping up with all the changes.

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[1] ‘Mid-caps’ generally refers to companies listed on a United States exchange that have a market capitalization of between USD2b to USD10b (see here) 

[2] ‘Small-caps’ generally refers to companies listed on a United States exchange that have a market capitalization of between USD300m to USD2b (see here)

[3] Total return is closer to 160% including dividend yields

Uzbekistan Awakes

In my research and investing I stress three things: people, structure, and value.  I look for companies that are controlled and managed by quality people, have corporate structures that align minority and majority shareholder interests and trade at valuations that are below fair value if not outright cheap.

This post is about Uzbekistan, which is possibly the fastest reforming country in the world today.

Bold Reforms 

Samarkand

Since the passing of long-term leader Islam Karimov in 2016 Uzbekistan has undertaken far-reaching political and economic reforms. This includes never before seen levels of increased transparency and public involvement in regulations and administration, increased emphasis on civil society and human rights, and restructuring many ministries and government bodies including the state-owned enterprises.

The government’s current five-year plan details a radical change in the government’s role in the economy -  from command and control to market-based, from public-sector to private, and from isolationist to trade-oriented and outward-looking.

Perhaps the most significant reform for investors was the freeing of its currency in September 2017 with the value of the Uzbek Som virtually halved to its widely used black market rate of USDUZS 8,100 (1).  Overnight, Uzbek assets became half priced for USD investors.

The reforms are likely to stick as the leader of the process, President Mirziyoyev, has reportedly reshuffled Uzbekistan’s’ ruling elite. The January 2018 replacement of the powerful National Security Services (2) head Rustam Inoyatov, who ruled the organization for almost 23 years, was perhaps the clearest sign that reformers are in charge.

It can take time for reforms to trickle down. Foreign exchange is perhaps the best example. Despite the government freeing the Som, it took about 1.5 years for capital invested in Uzbek stocks to be freely convertible into foreign exchange and repatriated. The first such deal was done just a few months ago. According to local brokers, these deals are now commonplace.

Attractive Economy
Near and long-term economic basics and outlook are promising. Uzbekistan has low levels of debt, good infrastructure, and near 100% literacy rates.  It has ample natural resources, especially gold, natural gas, copper, and uranium. Current GDP growth of 5.1% in 2018 is expected to accelerate to the 6% level over the next few years according to the IMF. 

Uzbekistan issued its first ever Eurobonds in February 2019, and Uzbek officials have reportedly said that two of its banks and state-owned energy company, Uzbekneftegaz, may also issue international bonds. Between 2011 and 2019 it moved from 164^th place to 79^th place in the World Bank’s Doing Business Report. A July 2018 presidential decree set a goal of making it into the top-20 by 2022.

Most importantly it has solid human resources. I met many switched-on, outward-looking, and reform-oriented government and corporate leaders in Tashkent, Navoiy and Samarkand.  Not everybody’s on board, but I got the impression that with an average age of 29 years Uzbekistan’s population is open to new ideas.

There’s been a trickle of overseas Uzbeks who have returned and can help the double-landlocked country access foreign markets. There are a lot of Uzbeks holding senior positions around the world, and there’s no reason they can’t do the same or probably more in their home country.

Foreign investors are making a beeline for the country. The ERBD (3) has returned after a decade’s hiatus and invested in over 21 projects since September 2017. General Motors, Peugeot, Lukoil, Gazprom and a host of other multinationals and regional corporates have invested or announced plans to invest in Uzbekistan. Locals say that grade A and B office space in Tashkent is hard to find.

Revitalized Stockmarket

Tashkent’s main board, the Republican Stock Exchange (RSE) has been virtually dormant since the 2008 ‘global financial crisis’ and government clampdown on foreign portfolio currency repatriation. Like the rest of Uzbekistan this is changing, and its young leaders are keen to learn what foreign investors want and how they can upgrade and promote the market. 

"Securities Market" magazine
circa Nov 2001. A few years
before the market's 2004-2006
heyday. Courtesy of Igor
Butikov, the first Chairman
of the Republican Stock
Exchange. Igor is now Director
of the Center for Research of
Problems in Privatization,
Development of Competition,
and Corporate Governance

It’s still small with a total value of some USD3b. But with companies trading at low valuations its market capitalization could rapidly grow. It’s not hard to find "Triple 6s" (4) here.

There is decent sector representation on the exchange including building materials, banks and insurers, food and beverage producers, miners, oil and gas servicing companies and others.

Liquidity is a problem. Of the 104 listed companies at the end of April 2019, only 52 had one or more transactions during the month. Total trades amounted to USZ33.4b (USD4.0m).  Most of the activity was off-limits to foreigners as 88% of the trading was in banks (5).  Uzbekistan’s largest cement company - Qizilqum - was the second most liquid, accounting for 9.1% of total turnover. This leaves the 40-odd other companies that traded with just USD120k in turnover. 

While liquidity is low, it’s improving. Total turnover in 2018 was more than double that of 2017. A buy order that took several days to fill a year ago, now happens in an afternoon.

Uzbekistan also has an OTC stock market.  Known as the Elsis-Savdo, it has lower fees and liquidity requirements. All of Uzbekistan’s remaining 600+ joint-stock companies that are not on the main board are here. 

Inexpensive Stocks
Uzbekistan’s small and illiquid market appears to be inexpensive, especially compared to what direct investors are doing.

So far in 2019 two Chinese companies - Huaxin and Anhui Conch - received government approval to build new cement plants. Both are planned to have the same capacity of 1.2m tons per annum and both are expected to cost USD150m. This puts each one’s expected greenfield cost at USD125 per annual ton of cement produced. This compares to the listed Qizilqum Cement who’s 3.4m ton capacity operation is trading at an enterprise value per ton of about USD20. Simply put the listed company is trading at a valuation that is about 84% less than the investments by two of China's top ten cement companies (see here and here).

Republican Sock Exchange

Another example is in the banking industry. Foreigners can only buy stakes in Uzbek banks with prior approval of the government. This means that listed bank shares can’t be bought and sold by foreigners on the stock exchange, unless they go through a lot of paperwork. This only makes it practical for large and very long-term investors. In November last year Swiss based responsibility Investments did just this.  For a 7.7% stake in Hamkor Bank, they paid USD7.9m which values the entire bank at some USD103m. While I’m writing this in mid-May, Hamkor Bank’s market capitalization is UZS364b (USD43m), meaning that the foreign direct investors value the bank at more than double the price that Uzbek investors and traders can pay when buying the same shares through the stock exchange (see here).

Long Way To Go

While impressive, Uzbekistan's reforms also indicate how bad things were in the past - forced child labor to harvest cotton, some 10,000 political prisoners, bad relations with their neighbors. Longer term Central Asian journalists and human rights workers see progress, but caution that it’s too early to be positive and that more can be done (see here and here).

Uzbekistan’s regional importance and changes were best summed up by the former Prime Minister of neighboring Kyrgystan, arguably the most politically advanced and open country in the region.

“Uzbekistan is very important, the key country for Central Asia, because it's located just in the middle of Central Asia but is the most populous with 32-35m people. During Soviet times all infrastructure were built around Uzbekistan, the roads, energy pipelines, etc. But up to now Uzbekistan is not (cooperating regionally)...now indeed a new president is going to open the country.  He made very clear statements that cooperation with Central Asia countries is going to be his priority and he's (making) concrete steps. ...", Djoomart Otorbaev, ex-Prime Minister of Kyrgyzstan, 13 October 2017, bne Intellinews Podcast (link is here).  

Samarkand

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^[1] Since then the Uzbek Som has fluctuated between UZS7,780 to 8,470 to the US Dollar

^[2] Also known by its acronym MXX, the National Security Services is the main successor of the Soviet-era KGB in Uzbekistan

^[3] European Bank for Reconstruction and Development. They are like a European IFC.  Website is here: https://www.ebrd.com/uzbekistan.html

^[4] 6x or lower PE, 0.6x or lower PB, and 6% or higher dividend yield.  A metric attributed to Peter Cundill in his biography by Christopher Risso-Gill, “There’s Always Something to Do: the Peter Cundill Investment Approach”

^[5] Uzbekistan-based brokers are hopeful that foreigners will be able to trade bank shares in the not too distant future