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UFS Investment Company - Commentary on LUKOIL Q1 2012 US GAAP Results, Jun 5, 2012.

Commentary on LUKOIL Q1 2012 US GAAP Results

- LUKOIL is one of the leading international vertically integrated O&G companies;

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- In 2012 LUKOIL's CAPEX will amount to about $16 billion;

- LUKOIL is planning to increase production to 170 million tons OE by 2021;

- Significant growth of operating highlights owing to high oil prices: operating profit has increased by 145% to $4 billion; EBITDA rose by 28% to $5.3 billion, net profit has grown by 182% to $3.8 billion;

- Debt burden has fallen by 17%; net debt/EBITDA is 0.27N;

- EBITDA margin has grown (due to an increase of refinement share) from 14.6% in Q4 2011 to 15.2% in Q1 2012.

Credit Portfolio

LUKOIL's debt burden is among the lowest in oil and gas sector.

During the first three months 2012 the total debt of LUKOIL has grown by 3% to $9.4 billion compared to Q4 2011. The increase was mainly brought about by the growth of short-term debt by 12% in comparison to Q4 2011. It should be noted that short-term debt makes slightly more than 20%. Hence, the company's debt structure is at the comfortable level.

Though the total debt has risen, the net debt in Q1 2012 has decreased by 17% to $5.3 billion against $6.3 billion in Q4 2011. It was due to the fact that cash and cash equivalents of LUKOIL have grown 1.5 times to $4.1 billion.

Investment volume has declined in comparison to Q4 2011 by 9% and amounted to slightly more than $2.4 billion. The most part of investments (more than 80%) has been allocated to upstream segment (development and production).

Meanwhile, net cash flow from operating activities in Q1 2012 was $3.9 billion, which is 75% more than in the last quarter of 2011.

Hence, in Q1 2012 free cash flow of LUKOIL totaled about $1.5 billion. It means that the company doesn't have to resort to market funding.

Net debt to EBITDA cover remains among the lowest in the oil and gas sector. Net debt/EBITDA ratio has fallen to 0.27N (Q4 2011 0.33N). Debt/EBITDA ratio amounted to 0.48N (Q4 2011 0.47N). A decrease in net debt/EBITDA ratio in Q1 2012 has been caused by advancing growth of operating profit compared to debt growth.

The volume of LUKOIL's investment programme in the following 10 years is $155 billion (at the end of 2011 the figure was 1.5 times less - $100 billion). In 2012-2014 the volume of investments will total about $48 billion, out of which $16 billion are planned to be invested in 2012 (against earlier reported $13.9 billion). By means of capital investment LUKOIL is planning to boost production to 170 million tons OE by 2021. We expect that the increase of CAPEX will reduce the free cash flow, and should the expected model of falling oil prices realize it will be brought to zero.

We expect an increase in net debt/EBITDA ratio to 0.4-0.6N by the year-end.

The company is to redeem bonds to the sum of $1.81 billion by the end of 2012, including interest payments. The main part of the debt is made by bonds. Thus, in August the company is to redeem 5 issues of ruble exchange bonds in the total volume of 25 billion rubles (about $849 million) in August and ruble bonds to the sum of 10 billion rubles ($204 million) in December.

In April 2012 LUKOIL repaid credit in the volume of $700 million. However, this redemption will be reflected in Q2 2012 report.

Nevertheless, liquidity position is strong. The volume of cash and cash equivalents in Q1 2012 - more than $4 billion - more than twice exceeds the volume of redemptions.

Financial Results

In Q1 2012 LUKOIL's revenues have risen by 2% to more than $35 billion. Despite a decline in oil production in Q1 by 1% to 22,400 tons, an increase in revenues was due to high oil prices and sales structure optimization.

In addition, the use of effective tax rate for corporate tax (9.1%) as well as reduced rate for NDPI in fields with high depletion allowed to reduce expenses and caused the growth of key operating indicators.

Besides, it should be noted that during the first three months of 2012 the volume of gas production has grown by 8.4% to 5.3 million m3, while hydrocarbons production has risen by 2.1% to 200,000 BOE.

EBITDA has risen by 28% and totaled about $5.4 billion in late March. It was first of all due to an increase in refinement and reduction in crude oil sales. As a result of such modifications in sales structure net profit in Q1 2012 amounted to almost $3.8 billion against $1.3 billion in Q4 2011. The same factor had a positive impact on profitability. In Q1 2012 EBITDA margin totaled 15.2% against 14.6% in Q4 2011.

At the moment oil prices are in decline. Hence, in Q2 2012 the highlights will demonstrate a decline.

The positive on grown gas production is neutralized by expectations of fourfold NDPI increase by 2015. For independent companies it implies the average annual NDPI growth above 40%. As a result, it may negatively affect production volumes.

In late May Rosnedra was reported to have cancelled its order to grant Bashneft-Polyus (subsidiary of Bashneft) a licence for developing an area of Trebs and Titov field. LUKOIL expended 4.8 billion rubles (25.1%) for a stake in Bashneft-Polyus. According to Bashneft's site, the company is intending to negotiate with LUKOIL on possibilities of further colloboration.


LUKOIL has a wide range of bonds in the ruble debt market as well as in the Eurobond market. Thus, 7 exchange issues and 1 issue of classic bonds are circulating in the ruble market. Besides, 5 Eurobonds are in circulation.

During May the spread of LUKOIL's curve to OFZ had widened on the short segment of the curve from 100 b. p. at the beginning of the year to 175 b. p. in late May. On the long segment the spread of LUKOIL's curve to OFZ reached 183 b. p. against 75 b. p. in early 2012.

We expect exceeding volatility in stock market to persist during the coming two months, and corporate bond market won't be an exception. Financial position of LUKOIL doesn't raise concern. We recommend purchasing exchange bonds maturing in August 2012 within the buy&hold strategy. BO-1, BO-2, BO-4 have the largest liquidity with the yields of about 8% per annum. Besides, Series 4 of classic bonds is also quite actively traded in the secondary market. In our opinion, the issue has been obviously overestimated: with duration of 1.4 years its yield is at about 8.13% per annum.

At the moment the yield curve of LUKOIL's Eurobonds is at about the same levels as the yield curve of Gazprom. On the long segment the premium to Gazprom's curve is about 20 b. p. Only Lukoil-14 is traded with a 20 b. p. discount to Gazprom's curve.

The premium to the sovereign curve of most LUKOIL issues is 120-130 b. p., which is 20- 30 b. p. wider than at the beginning of the year. In our view, practically all LUKOIL issues have been fairly estimated. Bearing in mind the current market position, we don't expect quotes to rise in the coming months.

Lukoil-14 may be an exception, which might be attractive within the buy&hold strategy.


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Publication:Russian Banks and Brokers Reports
Date:Jun 5, 2012
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