This morning, we have published Russian Oil and Gas - High-beta sector. Excerpts from the front page are given below.
Oil stocks have risen 22% YTD in 2015, outperforming the RTS on its way up on the back of strengthening oil prices. This supports our conviction that oil has changed from being a defensive low-beta sector into one of the most volatile, high-beta segments. We are reducing our financial estimates and downgrading Target Prices for all the oil companies under our coverage, retaining only Surgut prefs, and Bashneft ords and prefs, as Buys. Our cautious view on the oil and gas as well as OFS sectors in Russia is reiterated.
Greater sensitivity to the price of oil than before. We believe that there are several factors that make Russian oil stocks unusually sensitive to the dynamics of oil prices (and general macro). First of all, the usual hedge from oil taxation is now mitigated by the tax manoeuvre and the still uncertain implications of this tax reform. The profitability of marketing operations could also be significantly affected by recent macro developments. The situation is further aggravated by the oil sector’s role of budget supplier of last resort, which makes investors concerned about future tax amendments. On top of that, the dividend story is not in place, having been undermined by Kudrin’s scissors and financial sanctions.
Upstream is safe, refining to suffer. Fundamentally, the Russian upstream business is pretty safely hedged by oil taxation. On the other side, refining is to be severely hit by the recent macro and regulatory developments. Profitability in many ‘complementary’ sectors has also been sacrificed. Thus, despite what was always seen as a hedge against a decline in oil prices, Russian oil sector operating profitability (on the EBITDA level) is likely to drop 15-40% if oil prices are frozen at the current level.
FY14 financial results are disappointing. We think the ongoing annual reporting season is worse for O&G players than the market currently expects. This, together with the trends that justify ‘high-beta’ status for the sector, creates additional pressure on the sector’s shares. Given the uncertainty over the consequences of the current tax regime, we cannot be sure to what extent the poor 4Q14 financial results are driven by temporary factors (Kudrin’s scissors, fixed prices, etc) or whether they can be interpreted as a long-lasting trend.
No catalysts in the oil sector unless you are bullish on crude. We are reducing our financial estimates and downgrading Target Prices for the O&G and OFS sector names we cover to reflect the new oil pricing reality, and the macro and regulatory environment. This results in significant negative changes to our recommendations. Our remaining Buys are selected pref shares and Bashneft. However, these names are relatively illiquid. Overall, though, we advise investors to steer clear of the oil, gas and OFS sectors unless they have a strong belief in sizable oil prices growth. A significant appreciation in oil prices is the largest, and most direct, risk to our recommendations.
Our fundamental ratings and target prices for these stocks can be found in the Market Data section of this report.