Gazprom (OTCPK:OGZPY) is usually thought of as a gas company, but it also owns a 95% stake in the oil company GazpromNeft (OTCQX:GZPFY). The company originates from Roman Abramovich's Sibneft, but now manages a number of joint-ventures and the oil found by Gazprom. The company itself is extremely profitable, having hit record profits in 2011 (Year-over-Year + 70%) benefiting from record production and elevated oil prices. However, the European debt crisis, a Russian discount, a view that oil prices are unsustainable and tax speculation hitting the Russian energy sector have caused the shares to trade at 4.6x 2011 earnings with a 4.7% dividend yield.
I recently met with both Gazprom and GazpromNeft, and despite my bullish view toward Gazprom was more impressed with GazpromNeft. Its management in my eyes was extremely competent in managing the tax risks of the company. Tax has been a central issue recently for Russian energy equities, but I feel that GazpromNeft has been caught up wrongly due to its association with Gazprom. The current proposed tax increases are aimed at gas companies, while the government is simultaneously encouraging oil production through tax exemptions.
In my eyes GazpromNeft is in a unique position to benefit from the presence of Gazprom. Naturally when Gazprom develops a gas field it often finds oil, as the two hydrocarbons are usually close together. However, Gazprom as a core entity does not have the know how to manage oil - this is precisely why the Sibneft of old was bought. In 2011 Neft produced 54 million tons of oil, up 18% yoy, and this is expected to rise gradually to 80 million by 2020. This is what management has penciled in for the next 8 years, but one cannot rule out higher volumes being received from Gazprom. For instance Gazprom on the day of this writing announced two deals with Novatek to develop LNG plants in the resource-rich Yamal peninsular, where there is an estimated 230-290 million tonnes of oil.
If you believe Urals crude (similarly priced to Brent) will stay at least around the $100-$120 region, then GazpromNeft with its production growth alone will see further impressive gains in earnings. As the global recovery begins to regain strength, oil is likely to rise and confidence in energy stocks increase and thus a re-ration of P/E for Neft. Meanwhile the dividend should grow nicely along with earnings, with the board committed to paying at least a 25% payout of U.S. GAAP earnings for 2012, higher than the 22% for 2011.