Opus 25: Investing Adventures in Kazakhstan

A troubling fiscal situation, a great bank, and a struggling mine

Introduction

As part of my Imperium trip to Central Asia, I spent a week in Kazakhstan to better understand the country, people, economy, and reform efforts.

For those curious to visit, I recommend staying mostly in Almaty rather than Astana. Almaty is a more authentic city with more activities, culture, historical sights, and proximity to nature. Astana was built as a planned city and is the governmental center of the country. It feels like a hybrid of Dubai, Riyadh, and Washington DC. It is full of wild architecture which is fun to look at, but there isn’t much to do after seeing the 20th big, oddly-designed building. The city hasn’t really grown into itself quite yet.

I didn’t have a chance to see Kazakhstan’s nature as much but the country has world-class skiing, unique ecosystems, and endless national parks:

Kazakhstan aims to be a neutral power in the region as it sits at the geographic and political crossroads of Western, Russian, Chinese, and Gulf interests. After the Russian invasion of Ukraine, Kazakhstan and its neighboring CIS countries came under scrutiny as their exports to Russia clearly showed that they were being used as middlemen for Russian trade. Recent comments from the country’s leader, Kassym-Jomart Tokayev, point to an effort to remain neutral and not blindly follow foreign interests or influence from either side. These “middle power” countries are fascinating to spend time and understand as they serve as valuable symbols of geopolitical conflict points. Poorer nations oftentimes need to pick a side and hitch themselves to a bigger economy, naturally leading to political alignment and allegiance. Countries like Kazakhstan know their worth and get to decide more confidently where to play nice. 

A Brief Overview

Population - 20M

GDP - $300B

GDP Growth - 4-5%

GDP per capita PPP - $39,500

Geographic Size - 1.04M sq miles, 9th largest country in the world

Inflation - 8.5%

Biggest exports - Crude oil (50+%), Gold (10%), Copper (3.8%), Uranium (3%)

Median age - 30

Kazakh Economy & Reforms

The Kazakh economy is mainly driven by oil which makes up ~75% of its export base. It is the 12th largest oil producer in the world, and most of the production is managed by the state oil company. Some private operators like Chevron and Gazprom have claims on certain oil fields. It is also the world’s largest producer of uranium with ~30% of global supply.

GDP PPP per capita in Kazakhstan nearly halved between 2013 and 2017 due to the commodities crisis which led to the government making some tough decisions. Starting in 2018, President Tokayev began reformation efforts to liberalize the Kazakh economy in a way that is similar to Uzbekistan’s ongoing programs. This included SOE privatizations, economic diversification initiatives, energy transformation, and regulatory reform to support the private sector and international investment. While the Kazakh economy grew well since then, it has slowed in recent quarters and has not diversified as many hoped it would, and it is still enormously reliant on oil (more on that below). The country’s urbanization has stagnated for the last 15 years as its main metro areas underproduced, leading to a lack of population wanting to move into the cities and obtain higher-paying jobs. This vicious cycle has now put Kazakhstan into the lower ranks of emerging economies with the percentage of the population living in metro areas. 

The president and his closest confidants saw the stagnation and laid out new economic plans earlier this year. These grand plans will test Kazakhstan’s ability to transform into a market economy. The violent 2022 protests were ignited initially due to the government ending energy subsidies (LPG prices rose from $0.14 / liter to $0.28 as a result), so the government recognizes the situation's fragility. 

It is worth highlighting Kazakhstan’s fiscal, monetary, and government structures as they are odd and are leading to some issues. From what I can tell, the National Bank of Kazakhstan (NBK) is the main governing body across monetary policy, fiscal policy, and currency management. The country has multiple sovereign wealth funds with various objectives. The NBK oversees the National Fund which is primarily funded by taxes on oil and commodity companies and acts as the primary sovereign wealth fund for the country. This has always struck me as an unusual structure given that the largest oil company is government-owned, so there is a government entity (The National Fund) taxing another government entity (the state-owned gas company, KazMunayGas). Norway’s Pension Fund (their sovereign wealth fund is also managed by the central bank) has a similar funding mechanism through its ownership of Equinor, but it also taxes private gas operators. The National Fund’s assets peaked in 2014 at ~$70B but have dwindled since then as the government used and continues to use it as a piggy bank for state-sponsored investment. Oddly, the National Fund does not maintain a webpage anywhere describing its policies, objectives, or operations. There are a handful of statistics pages on the NBK website that provide high-level figures on the Fund’s liquidity position but that is all that exists on the internet from what I could find.

Another unique Kazakh entity is Samruk Kazyna, the government holding company that owns all non-financial, state-owned enterprises such as the above-mentioned KazMunayGas, the State rail company, telecom company, uranium company, and others. There is also Baiterek Holding, a state-owned fund holding eight financial and lending entities, including a mortgage company, an agricultural lender, an export / import bank, etc. It is responsible for injecting credit into parts of the economy that the State deems to be needing capital. This is analogous to the state-owned banks in Uzbekistan that I covered previously.

The President unilaterally appoints all National Fund management without any Parliamentary approval, leading to the risk that the Fund’s board will do anything the President wishes, even if it is not a rational fiscal or monetary policy decision. The same appears to be true (directly or indirectly) for Samruk Kazyna and Baiterek leadership. Feel free to reach out to me if this is incorrect and that f there are more congressional or referendum-based appointments of these funds’ decision makers - I couldn’t find anything after reading their bylaws and other legal documents.

Fiscally, the government finds itself in a challenging situation. Kazakhstan’s GDP grew at a near-record pace of 5.1% in 2023 but the government still withdrew capital from the National Fund in order to fund the ongoing deficit. According to Halyk bank analysts, without the National Fund transfer, the government would have recorded a -9.7% government budget deficit - an all-time record for the country. This figure would also place Kazakhstan in the top 15 countries in the world by deficit as a percentage of GDP, many of the other countries being governments currently funding wars, famine, or other crises. When taking into account the National Fund transfers, the government deficit was officially reported at -0.5%, but Halyk analysts estimate that the true deficit was -3.0%. Now, the differences in these two figures imply a gross transfer of ~8 trillion tenge (~$16B), roughly equivalent to 25% of the fund’s total 2023 assets. These are not official government figures, but even if Halyk’s estimates are remotely close, it paints a scary picture. For comparison, Norway’s non-oil deficit (before Pension Fund transfers) was -2.7% and north of a 10% surplus after the fund transfer. The Norweigan government is also not allowed to withdraw more than 3% of the Fund’s assets per year which has allowed the Pension Fund to grow into the largest sovereign wealth fund in the world with $1.7 trillion in assets.

A side note here, it is encouraging to see that Halyk Bank published this analysis in the first place. In many countries around the world, a politically connected bank would never dare put out a piece criticizing the government’s actions. It shows both that Halyk is a serious, commercially run company and not a puppet of the government and a rule of law that, at least for the time being, respects the freedom of speech and expression by people and companies. I can’t imagine the Chinese state banks coming out and openly criticizing and disproving official Chinese state budget figures. 

Kazakhstan’s deficits and budgetary strains have led to the government taking advantage of this unique structure and institutional opaqueness. Recent reporting suggests that the government sold shares in the state-owned gas company in order to raise funds as part of the deficit funding. The reporters explain:

“Through this new mechanism, kicked-off in late 2023, the government can essentially order transfers from the National Fund without prior approval from parliament. And the public will only learn about these transactions with KMG after they have been carried out. [...] the ministry of finance published a draft government resolution, awarding it the right to purchase KMG shares at the expense of the National Fund for an indefinite period. The one-off measure is therefore poised to be repeated. [...] Whereas previously National Fund transfers could reach the economy only through standard budget procedures, now the government can directly withdraw money from the National Fund without authorization from parliament”

Not only was this transaction done without congressional approval (or even awareness, it appears) but it was done at a “below market price,” according to the National Fund. They reasoned that this was logical as the government would like to float more of the gas company’s shares soon, so there would be a gain from these shares. Again, these shares were transferred between two government entities - the gain is just another entity’s loss within the same government but it allowed for budget subsidization from the National Fund.

The government needs to solve the deficit problem more fundamentally. Tax revenues dropped 6% last year but this point is not addressed head-on as it is politically painful to do so. The country recorded all time high per capita income and corporate profits so tax revenue should follow suit. The country cannot afford to continue on its unsustainable path especially given the medium to long-term trends in oil demand and the ultimate impact on the National Fund’s liquidity. 

The government also took a step backward with its recent block on consumer NPL portfolio sales by banks. The government reasoned that they didn’t want to burden consumers with loan collection agencies contacting them trying to collect. While this is politically popular, it sends a negative signal to lenders seeking to expand the credit market in Kazakhstan. The Central Asian governments as a whole are highly sensitive to consumer indebtedness and many are blocking international lenders from entering the country as a result. This policy makes no sense as international lenders of large scale will be highly sensitive to borrower quality in a country with FX risk, unclear regulatory landscape, and no real loan servicing companies. This apprehension likely stems from the pain that many felt years ago when most of the CIS countries went through credit crises and Tajikistan saw 40+% NPLs:

NPLs by Country (World Bank)

Kazakhstan Stock Market(s)

The Kazakh capital market is unique in that it has two large trading venues: The Astana International Exchange (AIX) and the Kazakhstan Stock Exchange (KASE). I can’t think of many, if any, other developing markets that have two active markets that trade all types of securities. Naturally, this has led to some domestic competition in the country as the exchanges fight for listings and liquidity. 

KASE was the first exchange to be set up in Kazakhstan. It initially launched in 1993 as a currency exchange and had its first bond listing in 1995. Over time the exchange added a repo market and equities trading. 

KASE’s shareholder’s list is a bit of a party, with over 80 entities owning a stake in the exchange. The National Bank of Kazakhstan (NBK) owns the lion's share at 47% and also has special voting rights to exercise governing control of the exchange effectively. The next largest owner is the Moscow Stock Exchange (13%) which they received as part of a technology-sharing agreement. However, KASE is currently trying to buy back these shares due to the recent sanctions placed on the Moscow exchange. Many shareholders (Kaspi, Halyk Bank, etc.) are companies that trade on the exchange. This is also a unique attribute of the exchange that I haven’t seen before. I suppose it is an elegant way to make sure those companies keep their listings on the exchange but there really isn’t any economic advantage to those businesses as I doubt the exchange will provide liquidity (other than dividends) to these shareholders. 

The KASE website states that there are currently 1,652 traded instruments from 289 issuers. A vast majority of these listings are bonds issued by corporations and sovereign wealth funds outlined above. There are also some locally listed DFI bonds such as the ADB, EBRD, and IFC. 

Many companies that list their shares disclose that they are 100% owned by private shareholders, so I am not entirely sure why they’d list and go through the regulatory hassle of doing so. For example, “AsiaAgroFood” shows that another entity and one individual own 100% of their issued shares, “Astel” is 100% owned by an ‘Arna Sprint Data Communications” company but still discloses information on KASE. There are even companies wholly owned by other companies listed on KASE (ForteLeasing owned by ForteBank) but the subsidiary is still listed on KASE - very weird, if anyone has details on why this is the case I would welcome your perspective. *Edit* - a reader shared there is tax regulation that allows for no taxes on dividends of listed companies.

Up the road in Astana, The Astana International Exchange (AIX) is a newer exchange venue. Located in the Astana International Finance Center (AIFC), the AIX  is aiming to become a regional hub for all capital market activity. The AIFC is modeled after the Dubai International Finance Center. I visited the AIFC and was blown away with both its physical presence and the fact that it is an entirely different jurisdiction for companies to incorporate in. All of the governing law is based on the English code and there is a dedicated court system separate from the main Kazakh courts. They also enforce IFRS accounting standards for all companies registered at the AIFC and that trade on the AIX. The AIFC is currently home to 3,000+ companies from dozens of countries. AIFC’s goal is to create a well-understood, trustworthy business environment for both domestic and international companies to domicile and operate within.

Physically, the financial center is a wild place to walk around. There is a massive globe building (see my picture below) flanked on all sides by the offices of various companies based in the AIFC. I will say it was a bit odd walking around at 10am on a workday and not seeing a single soul anywhere. According to my photos app, the picture below was taken at 10:23am and there is not one person in the photo. Most of the buildings appeared to be empty or sparsely populated. To be fair, the AIFC is still quite young, so they haven’t filled out all of the physical space. 

AIFC Campus

The Astana International Exchange is home to ~200 listings - 185 debt and 20 equity securities. The exchange is highly concentrated with 80% of the 2023 trading volume being composed of just three companies: Polymetal (now Solidcore), KazMunayGas, and Kazatomprom. 

In my conversations with people on the ground, it seems that KASE will likely evolve into a credit and repo market while AIX will work to be the leading equity market for the Central Asian region. Of course, every country wants to have its own market (see my notes in the Uzbek piece on their capital market) but AIX is significantly ahead of others in terms of its liquidity, listings, and sophistication. It will be interesting to see how the two markets interact and evolve in parallel. As it stands today, there are many dual listed companies that trade on both domestic exchanges and some equities are more liquid on KASE. 

Overall, the Kazakh equity market story is positive. Since 2014, the KASE index has returned an average of ~16% per annum in local currency but only ~8% in US Dollar terms given the greenback’s strength over the last decade. In my recent conversations, it seems that more and more people are beginning to recognize the unique situation Kazakhstan finds itself in and the attractiveness of some of the companies. Given some recent success stories, dozens of funds and investors have reached out to learn more about the ecosystem. 

KASE Index 10 year chart

Kazakh Success Stories

Kazakhstan is no longer an exotic investment destination as many investors discovered the country years ago. It is home to a few home run businesses that have made their way into many global portfolios.  

Kaspi, the Kazakh super app, is the most well-known company in the country. The $25B business is one of the greatest consumer internet businesses in emerging markets. The business will do $5B in revenue this year, growing 35% while putting down 25% in net income margins. The country seemingly runs on Kaspi. It is the main payment processing company, the main peer-to-peer payments service, one of the most popular banking apps, a leading BNPL platform, a maps app, a messaging app, a travel booking agency, and much more. The most eye-opening experience walking around Kazakhstan was seeing homeless people not asking for money with a cup but just a piece of paper with their Kaspi QR code on it. In all my travels I had never seen this before other than maybe the Chinese super apps and their market penetration. I won’t rehash the many high-quality reports on Kaspi that you can find here, here, here, and here. The business recently IPO’ed on the NASDAQ as part of its transition from the London Stock Exchange in search of better liquidity. I will remind everyone that this incredible business trades at 10-12x LTM earnings and a 5% dividend yield.

Kaspi Annual Report Highlights

Another well-covered business is the state-owned uranium company Kazatomprom. The government elected to float 25% of the company’s equity as part of the economic reforms. The country, and therefore the company itself, produces nearly a quarter of the world’s refined uranium. The uranium market is wild and full of geopolitical and energy factors. The latest drama is that the world doesn’t have enough sulfuric acid, a key component in the uranium refinement process. I am not smart enough to have an informed view on where uranium and Kazatomprom will go from here, but if you believe in the deregulation of nuclear power as countries transition away from oil then it is the single most important company in the world to own. 

Then there is Halyk Bank, the country’s largest bank. Halyk Bank is majority-owned by the former president’s daughter and son-in-law - a common thing in Central Asia. Similar to the Georgian banks, Halyk Bank reports an eye-watering 25-30% ROE. The company reports a ~20% market share in retail loans and a 50% market share in the SME lending market. Recent revenue growth was a bit anemic while operating expenses jumped 16% in H1. Capitalization (CET1) stands strong at 17-18%. You get all of this for ~3x trailing earnings on the LSE.  

Finally, there is the infamous Freedom Holdings, the largest brokerage firm in the region. It came under fire when Hindenburg wrote a short report on the business claiming that it was evading sanctions and commingling customer funds. I will let you read the report and come to your own conclusions. 

But, these companies are not the focus of the “Investing Adventures” series. We look for the less traveled paths!

Bank Center Credit, $761M Market Cap (Trades on KASE and AIX)

Bank Center Credit (BCC) is Kazakhstan's third largest bank, ranked by assets and second largest by deposits. The bank is the market leader in mortgages and secured asset lending with more than 50% market share in both categories. 

BCC 2023 Annual Report Rankings

BCC is majority-owned by Bakhytbek Baiseitov (founder) and Vladislav Lee, who hold 60% of the total voting share capital while 32% of share capital is free-floating. Looking at BCC’s two trading venues, the shares see 5x the amount of volume on KASE as they do on AIX. 

In H1 of 2024, BCC reported a 52% increase in net interest income. The net loan book in the same period grew by only 41%, implying an increase in average yield. Gross interest income only grew 40%, cost of funding grew 36%, and loan loss provisions only grew 26%, resulting in a far better net yield and growth in net interest income. The bank’s loan book is primarily consumer mortgages (32%), followed by general consumer loans and corporate loans makeup ~15% of the loan book each.

The company’s capitalization ratio (they call it K1, I believe is the same as Basel III’s CET1) stood at 15.4% EOY 2023. This figure is quite strong and comparable to the well capitalized banks in many other markets (JP Morgan for example is 15.4% EOY 2023 CET1). Oddly, they only mention this figure once in their entire 154 page 2023 annual report compared to JP Morgan, which references Tier 1 capitalization 43 times by name and many other times indirectly in their annual filing. 

BCC saw a steep rise in wage expenses with 54% growth in H1 2024 compared to H1 2023. A bit of this can be attributed to wage increases and overall market inflation but the company clearly hired a lot of people. 

The bank supposedly controls 70% of the “gold bars” market (page 29 of their 2023 annual report) and built a 24/7 precious metals marketplace in 2023. I wonder how many households currently own gold in Kazakhstan? This is a completely different market than the commodities exchange, at least as I read it, and I assume it is a physically delivery market. A few other fun highlights from the BCC annual report include a 600% increase in brokerage accounts and insurance premiums increased 300%. These are all new businesses so there is a base rate effect to take into account but impressive growth nonetheless.

Bank CenterCredit currently trades at 2.1x run-rate earnings (earnings growing 35% YoY)  and 0.74 tangible book value (book value growing 20%). Unfortunately, the company does not pay out any dividends on ordinary shares, but it is still rare to find a business that grows its earnings per share by 35% for 2x earnings. How rare, exactly? According to Koyfin, of the 1,666 publicly traded banks globally, only 13 have the same growth rate and valuation as BCC. Most are based in Africa (Access Bank, Islamic Bank of Egypt, Zenith Bank, etc.) and have far more volatile economies and currencies to operate within. 

Kolesa

Kolesa is a digital classifieds group that owns the leading real estate and auto classifieds brands in Kazakhstan and Uzbekistan. This business is quite similar to the Baltics Classifieds Group company I wrote about in my Lithuania report. These types of businesses are all around the world and are usually some of the highest quality assets to own given their domestic monopoly power and network effects. 

From 2022 to 2023, the business grew revenue 200% but only grew earnings by 110%. Most of the operating leverage loss came from a significant drop in gross margins from 60% to 35%. Growth slowed to 42% in H1 2024. 

One observation from Kolesa’s annual report is that there are 5.3M cars in KZ and 2M transactions per year. This feels like an extraordinarily high inventory turnover of ~40% a year. For comparison, there are ~100M registered passenger vehicles in the US and ~17M annual transactions, or ~17% a year, less than half of the Kazakh turnover. I assume most of the explanation is a fast growing auto market coming from a small base of vehicle ownership penetration. Interestingly, there was a law change in 2023 that allowed for unregistered vehicles to be imported into Kazakhstan - I imagine this led to a massive increase in imports from surrounding countries like Russia, Tajikistan, etc. also leading to the increase in vehicle inventory turnover. 

Kaspi purchased 40% of the business in 2023 and the founder of Kaspi owns 48% of Kolesa so there is very little public float. It is unclear where the remaining 12% of share capital is and who owns it. The business is listed on the AIX but there is no trading data available anywhere leading me to believe that it was delisted after the Kaspi acquisition. If anyone has details here, I am intrigued by the business and would be curious to know if there are ways of acquiring shares. 

Solidcore Resource (f.k.a Polymetal), $1.5B Market cap

Solidcore Resources, formerly known as Polymetal, is the world’s 2nd largest silver miner and 11th largest gold miner. Solidcore was founded in 1998 by Alexander Nesis who fully exited the company in January 2024. 

In reaction to the Russia / Ukraine war, the company elected to relocate from Russia to Kazakhstan as they feared global sanctions and the risk of nationalization in Russia. As part of this change, they divested their Russian assets and redomiciled the holding entity from Jersey to AIFC in Kazakhstan. While this was certainly the right thing to do for the business, it created headaches for shareholders who were required to transfer shares and holdings into entirely new custodians and tax jurisdictions.

Today, Solidcore operates the second-largest gold mine in Kazakhstan (only second to Glencore’s Altyntau Kokshetau mine) in the Eastern region of the country. In Q2 2024, the business produced 135,000 ounces of gold equivalent and revenues jumped 157% YoY to $409M. This level of production has remained largely unchanged for the last 5+ years for the company’s Kazakh operations. In Q2 of 2019 the business produced 128,0000 ounces and has never produced more than 164,000 in a single quarter. This is a not a growth business like the others covered above!

More generally, mining companies are just hellish businesses to operate. First, they have the pleasure of working with governments to get mining permits - a process filled with corruption, bureaucracy, and incompetence. More often than not, these mines are located in emerging markets and places with poor infrastructure, little to no rule of law, and unstable environments rampant with war and coups. They require huge capital investment to get mines operational. They start mines based on exploration and feasibility studies, which oftentimes are hypotheses at best given the nature of understanding what is in the ground thousands of feet below the surface. Then, they have to deal with ongoing costs of operating the mine including expensive equipment, labor that works in horrific conditions (the first line of the Solidcore Resources quarterly report happily states that they had no labor deaths!), and the logistical hell of transporting heavy ore to refineries. On top of all this, they then get the honor of selling a commodity product (only difference in your product vs. your competitors might be its purity) into a market with wild price fluctuations. None of it is fun! It is a modern miracle that the human race can profitably get metals out of the ground at all. 

Kyzyl Mine Operations

The company is able to get gold out of the ground for an average all in cash cost of $873 / ounce. Given current gold prices, this is a ~50% gross margin financial profile. In the last two years, Solidcore has burned a cumulative $700M in free cash flow as cash from operations came down due to the Russian divestment and capital expenditures grew to bring new operations online in Kazakhstan. The business also suspended its dividend for the last year, leading to shareholder frustration given the company has ample cash on the balance sheet. 

In a June interview with the FT, the CEO paints a pretty dark picture of the current state of affairs. The company has $400M in debt coming due in the next 2 years, lenders want to walk away given the political risk of the business, and sanctions are an ever-present threat to the company’s operations. Interestingly, the CEO shares that while European banks will likely walk away and derisk, he suspects American banks will step in and fill the funding void - I am curious to see if this is how it actually plays out. 

The company’s shares are 70% free floated on the AIX and 29% are owned by an Omani state-owned fund specializing in mining investments. As of the time of this writing, the business trades at ~2.8x trailing earnings, which is in the bottom decile of all mining companies globally. It is clear the company has generally been left for dead by investors until they can show that things are turning a corner. Quite surreal to see a mining business trade at a richer multiple than the country’s second-largest bank covered above that is growing earnings at an impressive clip and is one of the highest quality banks in the world. 

One last thing: the company’s rebranding to Solidcore is quite funny for us Americans as many people here in the States will associate the name “Solidcore” with a hip, cool pilates workout brand.