Gazprom: A Mega-Cheap Valuation

Sep. 4.12 | About: PJSC Gazprom (OGZPY)

If I had only one stock to own, it would be a stock that:

  1. Pays a dividend equal to what I could expect to earn on a balanced portfolio
  2. Has opportunities for prolonged growth
  3. Develops and sells a product consumers consider a necessity
  4. Has the political backing of the government and government leaders
  5. Sells at a ridiculously low P/E ratio giving hope for a price double just from a multiple expansion (the easy way to make money)
  6. Is either a monopoly or so large that it is unnecessary to worry about outside competition, and
  7. Is subject to inflection points that permanently change investor perception of the company. That stock exists today, and it is Gazprom.

Gazprom (OTCPK:OGZPY) is the largest company in Russia, one of the largest companies in the world, and the world's largest gas business. It is engaged in all aspects of the gas business including prospecting, exploration, production, transmission, processing and sales. The company started in 1989 when the Soviet Ministry of Gas Industry became a corporation.In 1993 Gazprom became a joint stock company with nearly 40% of the shares owned by the government.

Gazprom is now a state and investor owned company, with significant political backing. It owns approximately 17% of the world's gas reserves and 60% of Russia's. Gazprom also has significant oil production after purchasing 75% of Sibneft in 2005. Renamed Gazprom Neft, the former Sibneft was transformed into a vertically integrated oil company.

The early years of the company was marked by corruption with included massive tax evasion and asset stripping. The corruption was reduced after Vladimir Putin became president in 2000. Putin eventually replaced Gazprom leadership with Alexei Miller and Dmitry Medvedev. Miller is the current chairman of the Gazprom Management Committee. Medvedev is the current Prime Minister of Russia, and was the former President of Russia. Vladimir Putin is once again President of Russia, and most recently served as the Prime Minister of Russia. Obviously, the leadership of Russia has a direct interest in Gazprom, particularly with so many shares owned by the state!

Standard & Poors has historically rated Gazprom higher than Russia, although the current ratings are equal at BBB (investment grade). Interestingly, Russian companies currently sell at very low P/E ratios. I find it incredulous that Russian companies are valued lower than those trading in Pakistan. For example, Gazprom's currently selling at 2.75x earnings despite years of political stability and company growth.

The future growth of Gazprom looks good. Despite the economic slowdown in Europe that forced Gazprom to make concessions, and despite the lack of a completed agreement with China for gas, and despite the Shtokman liquefied natural gas project being, the company is still growing. Growth projects include the Arctic Shelf (Shtokman and Prirazlomnoye fields), the aforementioned deal with China, the Bovanenkovo field (ready with technologically advance transport system in place), significant worldwide exploration, significant investment in power generation, etc.

As chairman Miller mentioned in his last presentation to shareholders, Gazprom is "on top of the world in terms of net profit among not only oil and gas companies, but also all other companies in the world!" Total sales or goods, works and services was $3,534,341,431 in 2011, with gas sales up 26.6%. (Note: Recently price concessions were made). The total value of reserves is over US$299 billion. Gazprom produced 77% of Russia's natural gas.

In my opinion, the current financials of this company matter little to the long term stock price, which I believe will double within three years. It really doesn't matter if the company has a total gas volume of 18,000 bcf or 20,000 bcf. I am not concerned with the declining production of current fields since new field keep coming on line. It doesn't matter if the EBITDA is up or down 5% next year. It doesn't matter if the mineral extraction tax rate doubles by 2015, and it doesn't matter much is gas sells at $2.50, $3.50 or $4.50 per million BTUs.

If cheap gas is exported to Europe, Gazprom may lose what is seen as a near monopoly, but it doesn't matter. Even if the price of oil drops by 40% it doesn't matter. None of this matters because Gazprom will continue to be a worldwide leader, and my worst case scenario shows a flat to modest increase in production. With the valuation insanely cheap at less than 2.7 times earnings, the stock will double as investors believe Russia and its top stocks should be trading at double the current P/E multiple.

Most analysts program expected numbers into a computer to determine the "fair market value" of a stock. I even attempted to model this behemoth of a company (that is what analysts usually do) but my model is irrelevant for several reasons:

  • This company is so large that it is difficult to get a grasp around every operating activity
  • Disruptions and commodity price changes will naturally occur that make accurate future earnings estimates impossible
  • Corruption is still significant in Russia. Although the financial statements seem transparent and "clean" (ZAO PricewaterhouseCoopers is the auditor) with openness from management, it is difficult to determine what haircut to give reported numbers as a safety measure
  • This stock is monster cheap at 2.7x earnings. It is so cheaply valued that nothing will change my view of it needing a permanent multiple expansion outside of a global depression or a nuclear war.

The P/E ratio of this stock will change because several inflection points were recently "hit" that I believe will permanently change Gazprom's relative valuation. The first inflection point is the dividend, which more than doubled from 3.85 Rubles to 8.91 Rubles per share. The dividend is now too high for foreign investors to ignore. The second inflection point is Jim Rogers of Rogers Holdings, who was quoted a few days ago as having interest in Russia partly because of valuation.

It is likely that other large investors are seeing Russia's more openness and less corruption as being shareholder friendly. More importantly, investors like Rogers make their bets when they see the prevailing trend or thought process as wrong. The third inflection point is Russia's actions. Vadimir Putin is currently Russia's best goodwill ambassador, and is attempting to put his country in a good light given the upcoming Sochi Winter Olympics. Russia's recent action of pulling two warships from the Syrian port of Tartus last week, and suspending arms shipments, shows that the country doesn't want an international confrontation if the Bashar al-Assad regime falls.

Mr. Putin also recently visited Israel, a US ally in the Middle East. It seems Gazprom has an interest in co-developing Israel's massive 17 trillion cubic feet (est.) Leviathan gas field. Mr. Putin obviously is looking to protect Gazprom's dominance in the European market by forming partnerships with Israel and perhaps later Cyprus. These actions by Russia will serve to reduce potential competition and lower the perceived political risk of investing in the country.

Let's see how my checklist for finding a "one stock to buy" looks:

  1. Gazprom pays a dividend equal close to what I could expect to earn on a balanced portfolio.
  2. Gazprom has significant top and bottom line opportunities for growth. New projects coming on-line, a potential deal with China, eventual European growth, and a potential future rise in energy prices will all give growth to the company.
  3. Gas and oil are necessities in the world, and Gazprom is one of the leading producers.
  4. Gazprom is closely tied to Russia and her leaders. What is good for Gazprom is also good for Russia.
  5. The P/E ratio of Gazprom is ridiculously low at 2.70 times earnings. The political risk of Russia doesn't warrant such a low valuation.
  6. Gazprom is so large it is unnecessary to worry too much about new competitors or supply issues. Even if cheaper gas is imported to Europe in 3 or 4 years, Gazprom will offset the reduced margins with increased sales (assuming Europe begins to recover by then). Russia will forge partnerships where gas is found (e.g., Israel), since these partnerships are more profitable than competing.
  7. Inflection points have been reached suggesting Gazprom has bottomed in terms of its valuation.

Gazprom sports a valuation usually reserved for companies domiciled in third world countries defined by poor financial reporting, massive corruption and political instability. Russia has political stability and is not a third world country. Gazprom has transparent financial reporting, and the corruption of previous years seems to be lessened. Gazprom's debt is investment grade, and I believe it deserves a multiple expansion that will double its share price within three years.

Disclosure: I am long OTCPK:OGZPY. 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.