Russia's Beguiled Energy Giant

| About: PJSC Gazprom (OGZPY)


In depth business model analysis.

Balance sheet asset quality & good investment projects.


Gazprom Business Model

Gazprom (OGZPY) owns the largest pipeline system in the world with a little more than 108,000 miles of pipeline. It produces the largest amount of natural gas in the world and it has the largest amount of natural gas reserves, and has a vast asset base to service its pipeline customers primarily in Russia and Europe which includes 250+ compressor stations which pump pressure to natural gas in order for it to flow through the pipelines, has underground storage facilities, and 10+ downstream gas processing plants which separates out the natural gas impurities in it's raw state to produce pipeline natural gas. Gazprom can be cut into five main business segments:

  1. The Pipeline assets are biggest in asset size and are illustrated below:
  2. Gas/Crude Oil productions are second in size, which includes Gazprom Neft oil production assets.
  3. Refining assets are third which includes the compressor stations aforementioned as well as oil refining from Gazprom Neft and Slavneft.
  4. Gazprom also has a Power Plant segment, which includes MCX:OGKB and Mosenergo MCX:MSNG. The Power Plant segment is the second smallest segment of Gazprom.
  5. Gas storage is last in asset size.

Investment Projects & Free Cash Flow/Balance Sheet

Currently a bulk of the capital expenditures is going into building out new pipelines: Power of Siberia ($55 billion capex), TurkStream ($13 billion capex), Nord Stream 2 ($11.5 billion capex). Capital expenditures are currently extremely high, and to service the debt for these projects, the current portion of long-term debt is around $9billion USD . Although a lot of this financing is at low rates and is mainly dollar and euro denominated. Another capital expenditure in recent years has been the construction of a $2billion USD headquarters in St. Petersburg, the building is extremely expensive at a time where asset sales in 2017-2018 are likely as free cash flow alone cannot cover/service all debt obligations and pay for the dividend. Which is why management's outlook is to keep the dividend at current levels until 2019. But to management's credit their new headquarter building does look really cool. And the build out of 3 pipeline projects will do a lot to gain gas exports in Europe, as well as in China, and specifically in China which is a massive market opportunity in the future. And these pipeline contracts are long-term contracts that usually float alongside the price of crude oil, although in the next couple of years natural gas prices will become more of a straight forward commodity as LNG turn regional markets into global markets. And as supply and demand completely dictates prices of commodities, natural gas demand is growing steadily as the result of more natural gas power plants on line that are more cost effective compared to nuclear power plants, and cleaner than coal power plants. And to supply, the American Shale through LNG will compete down prices in Europe a little bit, an example being Lithuania which built a LNG terminal and signed a Letter of Intent with Cheniere Energy (LNG), and did end up getting a better price for Gazprom gas as a result, but Gazprom gas is ultimately lower cost compared to Liquefied Natural Gas. LNG’s many steps of first piping the gas to a liquefaction plant to be liquefied, shipping costs, regasification costs, and piping to power plants add up to be at a competitive disadvantage compared to Gazprom’s pricing.

Another thing that is of huge intrinsic value to Gazprom is the ownership of GazpromNeft (95%) which is a very well managed oil company, probably better managed that Gazprom itself, GazpromNeft has had robust earnings growth within the last 5 years and has a market cap of $20 billion. Gazprom also has ownership in Slavneft (50%) which is also jointly owned by oil giant Rosneft. Gazprom partially owns Novatek (9.50%) which is also jointly owned by Total, and Novatek is a growing LNG company. Gazprombank is another subsidiary that is important and did $465 million in profit in the first half of 2017. And if asset sales are needed to service current portion of long-term debt, the sale of Novatek could bring $4 billion USD cash to Gazprom. The possibility of oil fields being sold could add cash to the balance sheet as well. Another noteworthy event was the repurchase of shares in July of 2016 for a total of 850 million Gazprom common shares for a purchase price of $2.2 billion USD, which was bought for a very low price if my investment thesis turns out to be correct.

Gazprom valuation

Gazprom will continue to have geopolitical problems associated with the criminality of Putin, and the operational inefficiencies present, but without these two problems it probably would be one of the top 10 most valuable companies in the world, as it is equally as profitable as Exxon Mobil which will earn roughly $15 billion USD for full year 2017 and yet Gazprom currently has the same market cap as Carnival cruise lines. But Gazprom will always be at a discount to book value due to Putin and problems that he will persistently bring. An example of a problem that Putin brings to shareholders is when he floated the idea of recapitalizing Gazprom to help with the massive capital expenditures associated with the construction of the Power of Siberia, doing so with Russia’s currency reserves, this action would have diluted shareholders for no reason, as Gazprom’s borrowing ability was fine and could easily increase leverage. Luckily he quickly dropped this idea. And that is one reason why there will always be a discount to book value, and for good reason, but in my view the valuation should not be as drastically low as it is today with a Market Cap of $49 billion, especially as the hefty 6% dividend will continue to flow.

Disclosure: I am/we are long 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.

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Tagged: , , , Oil & Gas Drilling & Exploration, Russia
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