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Uralsib - Russia Equity Research - Gazprom Neft - Scale Growth Continues; Efficiency Preserved; Expansion to Eastern Siberia - Strategic Upside - Feb 24, 2010.

SCALE GROWTH CONTINUES; EFFICIENCY PRESERVED

Expansion to Eastern Siberia - Strategic Upside

Expansion continues. We have updated our DCF model to reflect indications provided by Gazprom Neft's (SIBN - Buy) management during Gazprom's investor days in Moscow and London. Gazprom Neft continues to grow through both upstream and downstream acquisitions. The growth in scale is supported by financial efficiency.

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Buy reiterated. We have added production from Slavneft's greenfields in Eastern Siberia and oil licenses transferred by Gazprom to our model, and increased our capex estimate following the company's guidance. This gives a marginal increase in our DCF target price to $6.9/share (from $6.8/share previously), implying 46% upside. We maintain our Buy recommendation. Such upside reflects the company's growth potential and its business efficiency. We also have a Buy recommendation on Slavneft (SLAV - Buy) and target price of $1.7/share.

PRODUCTION-DECLINE RISK NEGATED

Production stabilizes after decline. Gazprom Neft's organic production has stabilized, while acquisitions (Sibir Energy, Malka Oil) provide new growth opportunities.

Gazprom license transfer started. Two of Gazprom's fields will be transferred to Gazprom Neft in 2010.

Slavneft provides additional value. Three new fields owned by Slavneft (Messoyaha, Kuyumbinskoye, Tersko-Kamovskoe) will be developed jointly by Gazprom Neft and TNK-BP.

INCREASING FREE FLOAT MAY PROVIDE UPSIDE

Does not look cheap on multiples. Gazprom Neft outperformed the market in 2009, hence it does not look particularly cheap on a relative basis; 2010-11E P/E and EV/EBITDA show no upside.

Increasing free float targets upside potential. We believe that Gazprom will consider increasing Gazprom Neft's free float from the current 4%, potentially to 10-15%.

2009 GAAP PREVIEW: REVENUES TO BE UNDERMINED BY TAXES

Revenue growth in oil, but taxes likely to erode EBITDA. We expect 4Q09 results to be neutral, with our expected 6% QoQ revenue growth to $7.5 bln to be worn down by taxes, resulting in a 9% QoQ EBITDA decline. Equity income is expected to be up 11% QoQ to $0.9 bln, and should compensate net income.

Long-term efficiency sustained. We expect a three-year revenue CAGR of 12%, an average EBITDA margin of 20%, and ROACE of 25%, which would be one of the best among Russian oils.

SPREADING GRABBERS

Production stabilizes after decline. Gazprom Neft provided strong preliminary operating figures for 2009. The results show less crude being sold and more refined. Given the fiscal stimulus for processing, the company decreased crude sales by 7.3% YoY, sending more oil to its own refineries. In 2009 it boosted refining against a backdrop of stable output. Crude output was 47.9 mtpa (up 3.5% YoY), of which 2.4 mt was from Sibir Energy; refining was 34.2 mtpa (up 20% YoY), accounting for 60% of the company's total revenues, the highest percentage among its peers; oil-product sales were 32.1 mt (up 10.7% YoY). According to the company, production (Gazprom Neft plus 50% of Tomskneft and 50% of Slavneft) is to remain stable at 48 mtpa this year, while refining is to reach 37 mtpa due to consolidation of the Moscow refinery in its financials. EBITDA is expected at $5.4 bln, and capex at $3.88 bln (not including Slavneft and Tomskneft's capex), of which 54% is to be invested in upstream and 15% in refining.

Gazprom license transfers started. Gazprom Neft is to add another two licenses to its portfolio this year in the framework of the ongoing transfer of licenses from Gazprom. The Novoportovskoye and Orenburgskoye fields will increase the company's reserves by 319 mt to 1,844 mt, implying five-fold reserve growth. We have included production for these fields in our DCF model. The license transfers will be carried out in three stages: first, oil licenses owned by Gazprom subsidiary are to be sold directly to Gazprom Neft; second, Gazprom's own oil licenses are to be carved out and moved into subsidiaries, which could in turn be sold to Gazprom Neft; third, Gazprom Neft is to work as operator at the fields which have combined licenses for gas and oil, developing oil layers and receiving a fixed operator's fee from Gazprom.

Slavneft provides additional value. Three new fields (Messoyaha, Kuyumbinskoye, Tersko-Kamovskoye) are to be developed jointly by Gazprom Neft and TNK-BP. The Messoyakha block is in the northern part of Eastern Siberia (NPES) near Rosneft's Vankor field, and this may provide the block with infrastructure support. The Kuyumbinskiy and Tersko-Kamovskiy blocks are in the southern part of Eastern Siberia (SPES), with the Tersko-Kamovslky block in the south-eastern part of Rosneft's Yurubcheno- Takhomskoye oilfield (Rosneft's second-most important field in Eastern Siberia after Vankor). The Kuyumbinsky block borders the north of the Yurubcheno-Takhomskoye field. We estimate that production at these fields could reach 0.6 mtpa by 2012, 2.75 mtpa by 2015, and 8.1 mtpa by 2020. We have incorporated 50% of the fields' the production in our model, assuming a proportional consolidation method. Higher production levels in the long run mean that the updated valuation offers a new target price of $6.8/share for Gazprom Neft.

INCREASING FREE FLOAT CAN PROVIDE UPSIDE

No upside on the multiples. Gazprom Neft does not provide upside to Russian peers on 2010-11E EV/EBITDA and P/E multiples. The company's shares outperformed other Russian oil companies in 2009, providing an approximately 180% return. We believe that Gazprom Neft's share price growth potential stems from continued business expansion through M&As and a potential increase in its free-float.

Increasing free-float - provides upside potential. Gazprom controls approximately 97% of Gazprom Neft. The gas giant acquired 73% in 2005 directly from former core shareholders of Sibneft, and then an additional 3% was acquired also in 2005 by Gazprom Bank from the market, while a 20% stake was acquired from ENI in 2009, after ENI bought this stake at the auction for sale of YUKOS assets. We believe that Gazprom will not fully absorb Gazprom Neft, but will instead retain it as an independent entity, fully responsible for its oil sector interests. We believe that Gazprom Neft and Gazprom will choose a conservative approach to determine an optimal target free-float: it should be close to what Rosneft targeted at its IPO (i.e. 10-15%). We believe that increasing the free-float to 20-25%, as with LUKOIL, will increase the dependence of the stock on beta factors and will make it too volatile.

2009 GAAP PREVIEW: EFFICIENCY UNDERMINED BY TAXATION

Revenue growth on oil, but taxes erode EBITDA. On 1 March, Gazprom Neft will issue 2009 US GAAP results, which we believe will be neutral. We expect 4Q09 revenues to grow just 6% QoQ to $7.5 bln. We believe this sluggish growth is attributable to a decline in domestic gasoline prices and a drop in domestic crude production in the company's core Noyabrsk area, which offsets a 12.5% increase in the oil price. Additionally, we believe the growth in taxes in 4Q09 resulting from oil price growth is likely to erode 4Q09 EBITDA by 9% QoQ to $1.3 bln. On a YoY basis, we forecast a sharp decrease in revenues of 27.6% to $23.9 bln, in EBITDA by 34.6% to $4.9 bln and in net income by 28% to $3.3 bln - all due to the 34.4% fall in the oil price during 2009.

Acquisitions support bottom line. We expect 4Q09 EBITDA adjusted for income from equity affiliates to rise 9% QoQ to $1.7 bln. Specifically for Gazprom Neft, we use the adjusted EBITDA parameter to reflect the substantial share of equity affiliates: the company controls and accounts as equity a 50% stake in Slavneft, a 50% stake in Tomskneft and a 50% stake in Salym Petroleum Development. A substantial share of income from equity affiliates should support net income, which we expect to grow by 11% QoQ $0.9 bln in 4Q09.

Long term efficiency sustainable. We expect Gazprom Neft to sustain strong financial growth long term (within the next 5 years), with a 2010-12E revenue CAGR of 12% and EBITDA CAGR of 8%. We estimate the company's EBITDA margin at 25% over the long term, similar to those of the most efficient Russian oil peers (Rosneft and TNK-BP). We expect ROACE to grow from 15% in 2010 to 20% by 2012, reaching ROACE levels of Rosneft and TNK-BP.

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Publication:Russian Banks and Brokers Reports
Geographic Code:4EXRU
Date:Feb 24, 2010
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