OMV: A Vertically Integrated Energy Company Trading At A 15% Free Cash Flow Yield

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About: OMV Aktiengesellschaft (OMVJF)
by: The Investment Doctor
Summary

OMV reports strong production results and robust cash flows in the first quarter.

At $65 Brent, OMV remains on track to generate in excess of 7 EUR/share in free cash flow.

The money is being spent on expansion (into Asia) and diversification (through the purchase of a 15% stake in an Abu Dhabi refinery).

The production profile is riskier, but the 15% free cash flow yield compensates for the higher risk profile.

Introduction

When my first article on OMV AG (OTCPK:OMVJF) was published last year, I thought the company’s financial results appeared to be ‘too good to be true’. While OMV is operating in some riskier regions which justifies a discount, sometimes a company is trading just too cheap. Now OMV’s Q1 results confirm the strong cash flows and high margins and considering the company will spend $2.5B on acquiring a stake in an Abu Dhabi refinery, it’s perhaps a good moment to check up on the original investment thesis.

Source: Yahoo Finance

Although OMV has a market capitalization of 14.2B EUR, its only listing that’s sufficiently liquid is the Vienna Stock Exchange, where it’s trading with OMV as its ticker symbol. The average daily volume in Austria is just over 300,000 shares, making it the best place to trade in the company’s stock. There are also option chains available in Vienna.

OMV reports a strong start to 2019

OMV’s results in the first quarter show a very clear improvement compared to the first quarter of last year. The total revenue from its hydrocarbon production increased by 9% to 5.4B EUR, and this increase was mainly generated by a higher attributable oil production rate (up 9% to 474,000 barrels of oil-equivalent per day) and a higher realized oil price ($60 versus $58/barrel). Unfortunately the gas price decreased by approximately 3% and as OMV’s production is approximately 50/50 gas and oil, the impact of the higher oil price was countered by the lower gas price.

Source: company presentation

As its other incoming revenue streams (net income from equity accounted investments and ‘other income’) increased by a similar percentage, the total reported revenue in Q1 increased to 5.6B EUR. Unfortunately the excellent revenue performance wasn’t reflected in the operating result and net income (which both came in lower) due to higher depreciation charges (an increase of 106M EUR which singlehandedly resulted in the 35M EUR lower net income). These depreciation charges were related to the acquisitions that were completed last year.

The net income attributable to OMV’s shareholders came in at 354M EUR, resulting in an EPS of 1.08 EUR per share using a share count of 328M shares (rounded).

Source: Q1 report

OMV’s cash flows also remained strong, as it reported an operating cash flow of 866M EUR and after isolating the changes in OMV’s working capital position (caused by an increase in receivables and inventories), the adjusted operating cash flow was approximately 1.18B EUR. Please note this is based on the consolidated financial results and as not all subsidiaries were 100% owned, we will very likely see some ‘payments to non-controlling interests’ later this year. As no such payments were made in the first quarter, let’s keep in mind approximately 140M EUR of the net income that was used as starting point for the cash flow calculations was attributable to minority interests.

OMV spent 518M EUR on capex, and although the company said just 404M EUR was ‘organic capex’, I will just use the full 518M EUR to err on the cautious side.

This means that OMV generated a net free cash flow result of approximately 660M EUR in the first quarter of this year. A part will be related to the non-controlling interests, but a part of the capex could also be attributed to said minority interests so I think using 600M EUR as attributable free cash flow would be a reasonable assumption.

Source: company presentation

The company will spend in excess of 5B EUR this year

Considering OMV has been guiding for a full-year organic capex of 2.3B EUR, the capex will be predominantly spent in the next few quarters. However, if we would multiply the Q1 operating cash flow to an annualized result of 4.6B EUR, deducting the 2.3B EUR in organic capex would still result in 2.3B EUR in free cash flow, which is approximately 7 EUR per share. So yes, OMV is still very cheap as it’s trading at a free cash flow yield of approximately 15%.

Fortunately OMV has plenty of ideas what it could do with its incoming cash. In January, it closed a 540M EUR acquisition of a 50% stake in SapuraOMV allowing OMV to gain a position in the Asian energy market. Sapura is a Malaysian oil producer with an attributable production of just over 4 million barrels of oil per year (approximately 11,000 boe/day). A new project will be brought into production in 2020 with peak gas production to occur in 2023 when the total oil-equivalent production rate would increase to 60,000 barrels of oil-equivalent per day.

Additionally, OMV remains on track to close a strategic acquisition of a 15% stake in ADNOC Refining, an Abu Dhabi based refinery. This deal will cost OMV approximately $2.5B, and the acquisition should be completed in the third quarter of this year.

Source: company presentation

Should OMV not pursue any additional acquisitions this year, its total investment expenditures will come in at 5.35B EUR in 2019 (consisting of 2.3B EUR in capex, 0.54B EUR for the SapuraOMV acquisition and 2.5B EUR for the ADNOC acquisition). Based on a total operating cash inflow of 4.6B EUR, there will be a funding deficit of approximately 750M EUR.

But that’s not an issue thanks to OMV’s robust balance sheet. As of the end of 2018, OMV had 3.66B EUR in cash on the bank and 9B EUR in gross debt (including ‘other financial liabilities’ which very likely are future lease payments but excluding the 1.12B EUR pension deficit) resulting in a net debt of 5.33B EUR (6.45B EUR including the pension requirements). Considering OMV had a total EBITDA of 1.33B EUR indicating its full-year EBITDA will increase to in excess of 5B EUR, the debt ratio is quite low at just 1.1 based on the financial debt while the debt ratio would still be just 1.3 if you would include the pension requirements.

Source: company presentation (note, the image excludes the ‘other financial liabilities’, which I have included)

So borrowing an additional 750M EUR (1.3B EUR if you include the dividend of 1.75 EUR per share which also has to be funded from the incoming cash flows) this year won’t be an issue at all, as OMV’s underlying EBITDA result will increase as well (although a minority stake in ADNOC will be accounted for as an equity investment so only the dividends that will be ‘upstreamed’ will end up on the income statement). Even if there would be no corresponding reported EBITDA increase, the debt ratio (including the pension deficit) would remain below 1.5. A very comfortable situation to be in.

Investment thesis

It doesn’t happen very often to encounter a mature company trading at a free cash flow yield of approximately 15% and I strongly believe OMV is unique in that regard. The free cash flow yield (based on the market capitalization) isn’t caused by a balance sheet with too much leverage either, as the debt ratios remains very low, allowing OMV to pursue large acquisitions like the $2.5B deal for a minority stake in an Abu Dhabi based refining company without jeopardizing the strength of its balance sheet.

I currently have a small long position in OMV and I do regret not having added more stock to that position in December when the share price briefly dipped below 40 EUR per share. I am still planning to add to my position, and I have already written a put 40, expiring in July of this year and added a little bit of stock at the current share price of 43.84 EUR.

Disclosure: I am/we are long OMVJF. 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.

Additional disclosure: I have written an out of the money put option on OMV and am planning to add to my stock position

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.