Gazprom: Upside 25%, But Market Doesn't Believe In High Dividends

| About: PJSC Gazprom (OGZPY)


According to my model fair price of Gazprom shares is $5.99 ADR.

Cost of equity is 16.9%, cost of debt - 8.2%. 1% growth rate, RUB/USD=65.

The main intrigue remains the final size of Gazprom's dividends for 2016. The board of directors will have to make a decision on May, 19-th.

The market doesn’t yet believe in the high dividends of Gazprom, so the decision should be taken with caution.

About dividends

In comments to my previous articles there were a lot of questions related to possible dividends of Gazprom (OTCPK:OGZPY). Indeed, last weeks the share price behaved very nervous, because almost every day there appeared news that Gazprom is looking for ways to pay dividends less than 50% under IFRS.

As one of the major proposed option was that Gazprom buys its own shares (2.7%) from facing serious financial problems Vnesheconombank (VEB). Now the whole package on the market is worth about 104 billion Rub ($ 1.6 billion). VEB itself bought Gazprom ADRs in late 2010 from the German E.On. The transaction's amount was not disclosed, but that time the sold share was estimated by market in the same 104 billion. rub. ($ 3.5 billion). The meaning of this operation is that the state will still give off the money to VEB, so there is no difference in principle, VEB will receive the money directly from Gazprom or transited through the state treasury.

But there is a difference for Gazprom, the state and the market in general. Payment of 50% of IFRS net income as dividends will cost the company 394 billion rubles, while the 50% of RAS net income plus the redemption of its shares from VEB will cost 280 billion rubles. The savings for Gazprom will be about 100 billion rubles, while the state will receive 88 billion rubles in the form of dividends and also approximately 104 billion rubles will get VEB.

If Gazprom nevertheless performs the government directive, the state will receive about 197 billion RUB in the form of dividends (151 billion rubles it will receive directly, and the rest will get Rosneftegas). More 10.5 billion rubles will receive VEB . Furthermore that decision would raise the capitalization of Gazprom, and VEB will be able to realize its package already by selling shares on the market.

It is obvious that the second option is more preferable for the state, so after all I hope that Gazprom will pay 50% of net profit under IFRS. The market disagrees with this: so in the September futures price Gazprom laid a dividend about 10 rubles per share. Also on Monday evening a very large volume for sale has passed on the Moscow Stock Exchange. Currently it is unclear whether someone big decided to enter the market highs or whether it was insider trading. In any case, the decision on the amount of dividends will be made by the Board of Directors on May 19th, so the wait is not long.

DCF model of Gazprom

In addition, there were a lot of issues related to my assessment of the value of Gazprom shares in the light of low gas prices in Europe, high capital costs, etc.

Below I present the data from my DCF model for Gazprom. All counting was conducted in rubles, as this is the currency which the company uses for reporting.

In 2016 Gazprom plans to increase supplies to European consumers till 162.6 billion cubic meters of gas, which is 2.3% higher than last year. Perhaps, in fact the final volume will be greater, because both Gazprom and the Norwegian producers seek to increase the volume of supplies in order to protect their market share from American LNG producers. Naturally, this adversely affects the price. However, while natural gas production will be lower than the production of liquefied and the transportation through the pipe will be cheaper than sending tankers, Gazprom will remain profitable. I don't expect that in the foreseeable future Gazprom's share in the European market will fall below 30%.

The big question is the price of gas. Due to increased competition, Gazprom begins to revise its contracts with European consumers by linking them to the quotations of prices for LNG. If before the price of gas Gazprom for virtually all consumers were calculated according to the formula based on oil prices, then now the German E.On and the French Engie will receive gas at spot prices. At the same time, due to the fact that Gazprom formula takes into account the price of oil with a lag of 1-2 quarters, spot prices are now even higher than calculated from the formula due to record low oil prices at the beginning of the year. It will find its reflection in the company results for the 1-2 Q 2016, and in general I expect 2016 to be weaker than 2015.

Now, when gas and oil prices pushed off from their lows, the market appears an expectation that in the long run they will grow from the current level in the same pace with inflation. It is on this assumption I lean when building the model.

In the baseline scenario, I assume that the capital costs of Gazprom will remain high. Gazprom's management predicts 1.6 trillion rubles and it is not going to deviate from that figure. And then the question depends on the dividend policy of the government. If, nevertheless, Gazprom directs to dividends 50% of net profit under IFRS, maybe some investment program the company will reduce, so capital investments will be lower than those laid down in the model. This will adversely affect the company's FCF, but it will be enough to maintain a high dividend payout.

I also expect a reduction of payout ratio to 25% after 2018. But here everything will depend on the state of health of the Russian economy and the government needs to plug budget holes.

According to this model as a long-term benchmark for the price of Gazprom shares I received an assessment in the amount of 195 rubles per share, which implies a target price for the ADR of $ 5.99 at the rate of 65 rubles per dollar. In the long term, in my opinion, Gazprom shares may be of interest.

What to do now?

In the short term, particularly on the eve of the announcement of amount of dividend , I see the situation as follows:

As I said above, now the market expects about 10 rubles per share, so if management after all decides to pay 16.6 rubles per share ($ 0.51 per ADR at the rate of RUR / USD = 65), it will be a serious reason for the growth. I think in this case, Gazprom will be able to grow by 10-15% during the week.

If, nevertheless, the market is right, and management approve a dividend of 7.4 rubles per share ($ 0.23 per ADR), there shouldn't be a strong wave of sales. Gazprom will react by decrease in about 2-3% compared to the RTS index.

So far, the situation remains unclear. Therefore, when deciding on further perspective of stocks in your portfolio you need to understand that now it is a game of roulette. If the position has already made a good plus, perhaps it makes sense to reduce or shut down, and to take further action after the decision on the dividend.

Disclosure: I/we 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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