Novatek: A Falling Knife Not Worth Catching

Summary

• Novatek showed robust operational growth in Q4.
• The stock has fallen dramatically amid the recent market panic.
• The gas market environment repels me from recommending buying the dip.

For the last few years, Novatek (OTC:NOVKY) (OTC:NSTKF) remained one of the most highly valued companies in Russia with a 12-15 EV/EBITDA multiple which was justified by outstanding (at least, on paper) growth prospects. However, at the beginning of the year, investors' patience started to melt, and the price war in the oil market will finally bring the stock down to earth.

The gas market will fully share the damage from the market panic as it has similar concerns: a huge oversupply and lack of demand. Cheaper oil will only deepen these problems as it will become a more competitive energy source. Hence, the gas market is going to be full of uncertainty. In such an environment, I can't call Novatek an attractive investment even at a much lower price.

Q4 And Full-Year Financial Results Highlights

In Q4, sales revenue amounted to 221 billion roubles, down 7% YoY (+17% QoQ). Low LNG prices affect the profitability of the business. Despite all efforts, the average selling price of Novatek's gas fell by more than 2 times, therefore there's no significant year-over-year growth in revenues.

Source: Company data, Author's spreadsheet

Net profit attributable to shareholders amounted to 44.5 billion roubles for the fourth quarter of 2019, an increase of 4% compared to the fourth quarter of 2018.

The company's net profit for 2019 was significantly affected by the sale of a 40% stake in the Arctic LNG-2 project and the reorganization of its joint venture, Arcticgas. For the fourth quarter, normalized profit attributable to shareholders amounted to 66.4 billion roubles (+0.3% YoY; 36.9% QoQ).

Source: Company data, Author's spreadsheet

Capital expenditures in Q4 amounted to 52.3 billion roubles, up 39% YoY (+43% QoQ). Novatek has three big projects the company heavily invests in: Obskiy LNG (the commissioning of the first train is scheduled on 2022), Arctic LNG-2 (2023), and Arctic LNG-1 (2025-2026).

Source: Company data, Author's spreadsheet

At the end of 2019, the company's free cash flow amounted to 144.9 billion roubles, which is 19% higher than in 2018. In Q4, free cash flow increased by 52% YoY (+57% QoQ) to 27.9 billion roubles.

Source: Company data, Author's spreadsheet

The Outlook

Gas prices will continue to be pressurized as the peak season ends and coronavirus may adjust demand in a negative way. Crude oil prices are also actively looking for a bottom somewhere in a $25-35 price range, leaving its gas counterpart without any price support. This year seems to be a real meat grinder for the oil and gas sector.

Source: TradingView

The stock plummeted from 1,300-1,350 roubles per share to just 964 roubles, reverting back to mid-2018 levels. In the medium term, I see nothing that could stop this bearish movement until we see the recovery of the global economy after the coronavirus outbreak. The all-out price war between oil exporters will also be a factor defining investor sentiment towards Russian stocks.

Novatek is currently in a situation where some of the projects have just reached their target capacity, commodities prices are approaching historic lows, and the next big projects will be introduced only in 2021-2022. With low prices and without launches of new capacities, it is likely that the company will face not just a slowdown, but a real decline in its financial performance.

Final Thoughts

Even though I appreciate the company's efficiency, I'm still quite unconvinced about LNG's long-term potential. Even though Novatek is more cost-effective than the majority of LNG companies, I expect the LNG industry to operate in a tough environment with razor-thin margins as it would need to withstand competition with pipe gas suppliers like Gazprom (OTCPK:OGZPY).

If you believe that in the next 3-5 years gas prices will recover and you're looking for potential investments among LNG producers - Novatek may become one of the best investments here. Otherwise, I'd suggest looking for other attractive options as the bear market is going to deliver some in the next few months.

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.