This morning, we have published Russian oil and gas: No rush. The front page is given below.
Russian O&G has been outperforming the wider Russian market, in line with its usual historical role as a defensive low-beta sector and now also supported by harsh RUB devaluation. Nevertheless, the stocks are currently trading at record low 2014 °F EV/EBITDA and P/E of 3.0x and 4.8x, respectively. However, the most appealing argument in the current environment of extremely low visibility is that almost all the companies deliver high DYs. This appeal might be lessened, though, by recent developments, e.g. the drop in oil prices, ‘Kudrin’s scissors’ and refinancing difficulties. Were the current oil price trend to continue, that could force O&G companies to decide between capex and dividends, in our view, and what alternative they might choose is unclear. This overall lack of certainty engenders caution that is likely to put pressure on some of the most vulnerable names in the O&G sector.
Low valuation and high dividend yield. The sector outperformed the RTS Index by 2.6% during a period of declining oil prices, which is what normally happens when low valuations combined with high dividends are naturally hedged by the structure of taxation as well as RUB correlation with oil prices. All this makes oil a relatively safe sector to play.
But can dividends withstand oil at USD 80/bbl? They might, but are highly unlikely to owing to the harsh combination of the drop in oil prices, ‘Kudrin’s scissors’ and refinancing difficulties. In this note, we calculate that with oil prices staying at USD 80/bbl, the sector would require almost USD 16.6bn of additional external funds by end-2015 to cover the overpayment of taxes (Kudrin’s scissors), maturing debt, targeted dividends and planned investments. Without additional borrowing, companies face a tough decision: to cut dividends or capex?
Recent oil price volatility hike to prey on market perception mid-term. Though we are not convinced oil companies would prefer to cut dividends in favour of capex, we cannot imagine a scenario that would decisively allay investors’ concerns in the short and medium term. This will therefore continue to pressure the sector’s valuation.
Hence turn-around in our view on the sector. From a low beta, defensive sector, it is evolving into a sector that will most likely underperform the market if oil prices remain weak (although we expect the sector to outperform if oil prices recover). Not all oil companies are equally exposed to liquidity issues. Highly leveraged Rosneft will likely be hit the hardest if the current environment prevails, followed by Novatek, Lukoil and Gazprom Neft, while Surgutneftegas, Tatneft, and Bashneft will feel quite comfortable, we believe. Surgut will likely have sufficient fire power to pay dividends in 2015, even assuming an USD 80/bbl oil price and closed external financing. In our base case, we forecast a 13.0% DY for prefs and 3.7% for ords in 2014. Surgut prefs are therefore our top pick. We have left all our recommendations unchanged and decreased our Target Prices 4–17%.