Gazprom Looks Incredibly Undervalued Despite Sanctions On Russia

May.12.14 | About: PJSC Gazprom (OGZPY)


Gazprom is by far the largest natural gas producer in the world but its market cap does not reflect this.

The European Union is unlikely to go along with any sanctions against Gazprom as the company is responsible for 1/3 of the gas consumed by the continent.

Gazprom's natural gas reserves are almost ten times the size of ExxonMobil's.

Gazprom is more profitable than any American oil company despite having a lower market cap.

Gazprom currently trades at a P/E of less than 3.

OAO Gazprom (OTCPK:OGZPY) is the world's largest producer of natural gas and one of the largest producers of energy in the world. In fact, according to Forbes, only Saudi Aramco supplied the world with more energy in 2013. To put this in perspective, Gazprom produced an average of 8.1 million barrels of oil equivalent per day in 2013. The biggest western energy company, ExxonMobil (NYSE:XOM), produced an average of 5.3 million barrels of oil equivalent per day in 2013. Despite this, Gazprom trades with a substantially lower market cap than ExxonMobil or any other of its "supermajor" Western peers. This may be due to the fear that many Western investors have regarding investing in Russian companies but the truth is, there really is a lot to like here.

The company that is now called Gazprom is the successor company to the Soviet Union's Ministry of Gas Industry that transformed itself into a corporation in 1989. In fact, the name Gazprom is a contraction of Gasovaya Promyshlennost, which literally means "gas industry." Gazprom then went through a long privatization process following the collapse of the communist government in 1991. The company then became the center of a corruption scandal when former Chairman Viktor Chernomyrdin became Prime Minister of Russia. This position allowed him and then CEO Rem Viakhirev to strip the company's assets and parcel them out to their friends and relatives. That abruptly changed when Vladimir Putin came to power in 2000. He was able to use the state's shares to get rid of Chernomydin and Viakhirev and appointed Dmitry Medvedev and Alexei Miller to stop the asset stripping and regain the lost assets. This effort was largely successful and Itera, which had the largest share of the stripped assets, sold the stolen assets back to Russia.

Corruption of this scale was quite common during the years following the fall of the Soviet Union and this has likely influenced the views of many investors towards Russia. However, things have been improving there and overall the country seems to be moving ever closer to a capitalist model. With that said, Russia still does have a problem with corruption but it is nowhere near as bad as it was a decade ago and the country seems to be moving in the right direction. Therefore, there may be an opportunity here to get into the company at a low valuation while there is still much fear surrounding it.

As previously mentioned, Gazprom is the world's largest producer of natural gas. Nowhere is this more apparent than in Europe where Gazprom alone is estimated to produce 1/3 of all of the natural gas consumed by the continent. Not all countries are as equally dependent on Gazprom's gas though, as shown by this chart that shows the percentage of each nation's natural gas consumption that is produced by Gazprom:

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As the chart shows, Gazprom alone produces at least 20% of all the natural gas consumed by nearly every nation in Europe except for Belgium, the Netherlands, Switzerland, and the U.K. Notably absent from this list is Norway, which is one of the other major suppliers of natural gas to the European continent. Thus, it should be immediately apparent that the scale of Gazprom's operations is simply tremendous. In fact, as the chart above shows, Gazprom is essentially a monopoly in several European countries.

Just this simple fact should allay another concern that many investors may have about investing in Gazprom. Over the past few weeks, one of the major news stories has been the problems in the Ukraine that have resulted in high amounts of violence between pro-Western and pro-Russian factions as well as the annexation of the Crimean Peninsula by Russia. Various Western European nations and the United States have imposed sanctions on Russia and have threatened further sanctions that are "much harsher" than what have already been imposed. Thus far, these sanctions have not included any measures to curtail the sale of Russian gas to Europe. However, many investors may be worried that sanctions that do curtail the sale of this gas may eventually be imposed on Russia and these sanctions would have a significantly negative effect on Gazprom's sales and cash flow. However, as the chart above shows, most European countries would be unlikely to go along with these sanctions as they are too dependent on Russian gas to meet their own needs. Losing their monopoly or near-monopoly supplier of gas would likely cause their own economies to encounter serious difficulties. Admittedly, such sanctions would also deal a severe blow to both the Russian economy as a whole and to Gazprom in particular. However, I doubt that too many European countries would go along with any sanctions against Russia that include the suspension or significant reduction of gas imports and so Gazprom's business appears to be quite safe.

Another thing to like about Gazprom as well as to put the true scale of this company into perspective is the size of its reserves. The company's reserves are large enough to make it one of, if not the, largest companies in the world. At the end of 2010, DeGolyer and MacNaughton, one of the leading U.S. consulting and reservoir appraising companies, conducted an audit of Gazprom's reserves using the international PRMS standards. This is what the firm found:

Source: Gazprom, DeGolyer & MacNaughton

As this reserves audit was performed by an American firm using international PRMS standards, we can assume that they are just as accurate as the reserves information provided by American oil and gas companies. I apologize for using information from an audit that was conducted three years ago but it was necessary to ensure a fair comparison with other energy companies outside of Russia. To put this in perspective, here is the reserves data for the largest western oil company, ExxonMobil, pulled directly from the company's 2013 annual report:

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Source: ExxonMobil

As the chart shows, at the end of 2013, ExxonMobil's proved reserves totaled approximately 7.5 billion barrels of crude oil, approximately 1.5 billion barrels of natural gas liquids and condensate, and approximately 71.9 trillion cubic feet of natural gas.

As we will quickly see, Gazprom's reserves considerably dwarf ExxonMobil's. The above chart shows Gazprom's oil and gas reserves in cubic meters whereas ExxonMobil's are in barrels and cubic feet. One cubic meter of oil is approximately 6.2898 barrels. Therefore, Gazprom's proven reserves of 717.4 billion cubic meters of oil would be approximately 4.5 trillion barrels of oil. I must admit that I have a very hard time believing that as that figure would be several times larger than even Saudi Aramco's estimated reserves. I suspect that the chart has a typo in it and that it should actually read "millions of cubic meters of oil." This would reduce Gazprom's proven oil reserves to about 4.5 billion barrels of oil. This makes more sense because Rosneft (OTC:RNFTF) is the largest oil producer in Russia, not Gazprom. This is also less oil than what ExxonMobil has been proven to have.

It is in natural gas though that Gazprom's size truly becomes apparent. The chart above shows that Gazprom's proven gas reserves totaled 18.991 trillion cubic meters at the end of 2010. This is approximately 670.66 trillion feet or 9.3 times the amount of natural gas reserves that ExxonMobil has.

It is important to keep in mind that selling natural gas is much more lucrative in Europe than it is in North America. This is because the difficulty of transporting natural gas over the oceans has made it less fungible than oil and more subject to regional variations in pricing. For example, at the time of writing, natural gas futures traded for $4.49 per MMBtu in the United States. In the European Union, the price was much higher at $10.73. This means that selling natural gas is much more lucrative for Gazprom than what might be expected.

We can see evidence of this by looking at the company's top- and bottom-line numbers.

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Source: Gazprom

In 2013, Gazprom's sales were approximately RUB 5.2 trillion. As many of you are no doubt aware, the Rouble has plunged in value since the start of the Ukraine crisis and the imposition of sanctions by the NATO nations but this still works out to approximately $146.1 billion. Admittedly, this is much smaller than ExxonMobil's 2013 sales of approximately $420.8 billion but investors should note that Gazprom's revenues have been increasing while ExxonMobil's have been decreasing. Gazprom's 2013 revenues were nearly three times that of ConocoPhilips (NYSE:COP) even after the Rouble's recent sharp decline.

Of course, as investors, we need to be concerned about a company's bottom line as well as its top line and this is where the Russian giant truly shines. As the company's income statement above shows, Gazprom had a net income of approximately 1.17 trillion Russian Roubles. This works out to approximately $32.9 billion at today's exchange rate. This is slightly higher than ExxonMobil's 2013 net income of $32.6 billion, which effectively illustrates Gazprom's significantly higher profit margin.

Perhaps the most remarkable thing about Gazprom is its incredibly low valuation. This is a company with three times the revenue of ConocoPhilips and 9.3 times the proven gas reserves and higher profits than ExxonMobil yet it has a smaller market cap than either of them. At the time of writing, Gazprom had a market capitalization of $89.7 billion which gives the company a P/E of 2.59. This valuation is quite obviously incredibly low for a company like Gazprom.

Gazprom is most certainly not an investment without risks. For example, further sanctions could be imposed on Russia that include some sort of gas export ban on the country. Such a move would have a devastating effect on Gazprom's business, at least in the short-term. In the long-term, there is a deal pending with China that may make Gazprom much less dependent on Europe, but that is a topic that requires another article at a later date. However, I think that the imposition of such sanctions by the West is unlikely given the dependence that the European Union has on Russian gas to meet its energy needs. There are also political and legal risks involved with investing in Russia. Vladimir Putin himself admitted as much. However, this risk certainly appears to be priced into the stock at this point. I will admit, I can certainly understand the position of anyone that chooses not to invest in Gazprom but there may definitely be an opportunity here for investors that are willing to take on the risk.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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