change of recommendation alexander nazarov · pdf filechange of recommendation alexander...

NOVEMBER 5, 2015 RUSSIA > EQUITY RESEARCH > OIL & GAS

Research Department

Copyright © 2003-2015. Gazprombank (Joint Stock Company)

1

CHANGE OF RECOMMENDATION

Alexander Nazarov

[email protected]

Konstantin Asaturov

Konstantin [email protected]

Evgenia Dyshlyuk

Evgenia [email protected]

Andrey Klapko

Andrey [email protected]

Surgutneftegas RUSSIA > EQUIT Y RESEARCH

Assessing the true value of money OIL & GAS

Lower valuations — commons down to U/W, prefs still NEUTRAL

With this note we update our valuation and investment case for Surgutneftegas

(SurgutNG). We downgrade our target price for common shares to RUB 26.6

per share ($4.2 per ADR) and lower our recommendation to UNDERWEIGHT.

Our recommendation on prefs remains at NEUTRAL based on high 2015

dividend expectations.

We value SurgutNG’s cash pile as a separate financial entity

For the first time and for the purpose of accurate valuation of the cash pile, we

decided to divide SurgutNG into two parts: the core oil business and the cash

pile, the latter valued as a financial entity. As a result, we estimate the target

price of SurgutNG common shares at RUB 26.6, with only 55% (RUB 14.5) of

the amount coming from the company’s main oil and gas activity and the rest

(RUB 12.1) from deposits and generated finance income.

RUB/USD rate is core for dividends, operating results are not

The investment case for SurgutNG preferred shares currently hinges on just a

single number on a precise date — the CBR’s official RUB/USD rate as of

December 31, 2015, which will determine the exact amount of FX gains and the

respective amount of dividends. For 2015, the company’s operating

performance is unlikely to matter for the investment case. As the ruble may

depreciate against the dollar by end 2015 compared to end 2014 (RUB 56.26),

there is a substantial possibility of a good dividend yield on preferred shares.

Preferred shares to trade at a premium to commons

We note the main reasons for the premium: 1) no difference in real voting rights;

2) better liquidity on MOEX; and 3) a significantly larger dividend payout. There

is only one reason that argues against a premium — the vulnerable position in

case of potential acquisition. That said, unless SurgutNG is acquired, preferred

shares should trade at a premium approximately equal to the size of dividends.

SurgutNG is one of the main sufferers from proposed tax hike

SurgutNG has one of the largest shares of exports in its revenue base across

the industry. Also, due to its relatively low refining quality, it also has rather thin

downstream margins. As a result, SurgutNG is one of the most sensitive to a

potential hike in tax rates among Russian oils.

SurgutNG cash pile — too significant to be withdrawn from the Russian banking system, usage is unlikely

SurgutNG’s cash pile ($37.72 bln) mainly consists of FX deposits in Russian

banks and has historically served as a large and important source of funding for

the entire system. Suffice to say that as of July 1, 2015, it represented 13.7% of

total FX customer deposits and 10.9% of total FX liabilities of the sector. That

said, in the medium term we see no option for SurgutNG or anyone else to use

the company’s cash pile.

Source: Bloomberg, Gazprombank estimates

Source: Bloomberg



MICEX vs. SurgutNG commons and prefs

Source: Bloomberg

TICKER SNGS RX

Closing price, RUB 36.0

Target price, RUB 26.6

Upside -26%

Recommendation UNDERWEIGHT

MCap, $ mln 24,703

Net debt, $ mln -32,011

EV, $ mln -7,305

52-week high, RUB 39.0

52-week low, RUB 23.5

SELECTED STOCK DATA

TICKER SGGD LI

Closing price, $ 5.7

Target price, $ 4.2

Upside -26%

Recommendation UNDERWEIGHT

TICKER SNGSP RX

Closing price, RUB 44.3

Target price, RUB 40.5

Upside -9%

Recommendation NEUTRAL

0.8

1.3

1.8

JAN

14

MA

R 1

4

MA

Y 1

4

JUL

14

SE

P 1

4

NO

V 1

4

JAN

15

MA

R 1

5

MA

Y 1

5

JUL

15

SE

P 1

5

SURGUTNEFTEGA COMMON SHARE SURGUTNEFTEGAS PREFERRED SHARE MICEX


2

Source: company data, Gazprombank estimates

Source: company data, Gazprombank estimates

Key financials, RUB mln

2013 2014 2015E 2016E 2017E 2018E

Revenues 1,316,171 1,360,533 1,211,048 1,333,046 1,529,114 1,685,503

EBITDA 265,824 237,411 261,375 248,012 321,499 359,364

EBITDA margin 20.2% 17.4% 21.6% 18.6% 21.0% 21.3%

Net income 279,081 884,833 236,370 211,952 265,650 292,281

EV/EBITDA, x -1.8 -2.0 -1.8 -1.9 -1.5 -1.3

P/E, x 5.5 1.7 6.5 7.3 5.8 5.3

Valuation multiples

2014 2015E 2016E 2017E

P/E, x 1.8 6.6 7.4 5.9

EV/EBITDA, x -1.9 -1.8 -1.9 -1.4

EV/Revenues, x -0.3 -0.4 -0.3 -0.3

Dividend yield 1.8% 1.4% 1.3% 1.6%

FCF yield 0.8% 6.6% 4.6% 7.4%

Income statement, RUB mln

2014 2015E 2016E 2017E

Revenues 1,360,533 1,211,048 1,333,046 1,529,114

Operating costs 727,774 794,373 933,050 1,094,232

incl. SG&A 293,506 310,097 322,434 331,657

DD&A 74,611 63,029 83,831 92,664

EBITDA 237,411 261,375 248,012 321,499

Operating profit 162,800 198,347 164,181 228,835

Financial income net 69,297 97,115 100,759 103,228

Pretax profit 1,069,539 295,462 264,940 332,063

Income tax -166,515 -59,092 -52,988 -66,413

Net income 884,833 236,370 211,952 265,650

EPS 20.37 5.44 4.88 6.12

Key margins

2014 2015E 2016E 2017E

EBIT 12.0% 16.4% 12.3% 15.0%

EBITDA 17.4% 21.6% 18.6% 21.0%

Net income 65.0% 19.5% 15.9% 17.4%

Balance sheet statement, RUB mln

2014 2015E 2016E 2017E

Cash and equivalents 1,968,433 2,048,187 2,102,240 2,201,436

Accounts receivable 60,419 53,781 59,198 67,905

Inventories 65,446 72,952 80,633 97,229

Total current assets 957,500 998,245 1,038,369 1,113,271

PP&E 1,112,476 1,249,947 1,381,654 1,517,460

Total assets 3,306,093 3,524,187 3,723,044 3,983,349

Short-term debt 0 0 0 0

Accounts payable 43,121 48,067 53,127 64,062

Total current liabilities 177,853 182,799 187,859 198,794

Long-term debt 0 0 0 0

Total non-current liabilities 219,192 219,192 219,192 219,192

Total shareholders’ equity 2,908,879 3,122,018 3,315,807 3,565,168

Minority interest 169 178 185 195

Total liabilities and equity 3,306,093 3,524,187 3,723,044 3,983,349

Cash flow statement, RUB mln

2014 2015E 2016E 2017E

Operating cash flow 181,181 303,476 287,745 343,946

incl. changes of w/c 1,320 4,078 -8,038 -14,368

Investing cash flow -168,489 -200,500 -215,538 -228,470

incl. CAPEX 196,530 200,500 215,538 228,470

Financing cash flow -28,328 -23,221 -18,154 -16,279

Change in cash -5,071 79,754 54,052 99,197

Free cash flow 12,692 102,976 72,207 115,476

Key leverage data, RUB mln

2014 2015E 2016E 2017E

Total debt 0 0 0 0

Net debt -1,968,433 -2,048,187 -2,102,240 -2,201,436

Total debt/Equity, x 0.0 0.0 0.0 0.0

Net debt/EBITDA, x -8.3 -7.8 -8.5 -6.8


3

CONTENTS

Assessing the true value of money .................................................................................................................. 4

Dividends — a cornerstone for prefs valuation ......................................................................................... 6

Fundamentals do not leave much upside .................................................................................................. 10

Valuation puzzle ................................................................................................................................................. 13

Final question — who is the owner? It does not matter ...................................................................... 17


4

ASSESSING THE TRUE VALUE OF MONEY

We update SurgutNG’s valuations — commons down to U/W, prefs still at NEUTRAL

With this note we update our valuation and investment case for Surgutneftegas

(SurgutNG). We downgrade our target price on common shares to RUB 26.6 ($4.2 per

ADR) and lower our recommendation to UNDERWEIGHT. Our recommendation on the

prefs remains NEUTRAL based on high 2015 dividend expectations.

We value SurgutNG’s cash pile as a separate financial entity

In order to correctly estimate the target price of SurgutNG common shares, we suggest

a new approach to their valuation that implies separate estimation of the company’s two

segments. The first is the core oil and gas business, while the second consists solely of

the company’s deposits and generated finance income. We then applied a premium to

the common shares to calculate the preferred share target price. Our valuation

methodology is presented in greater detail below.

As a result, we estimated the target price of SurgutNG common shares at RUB 26.6,

with only 55% of this amount coming from main oil and gas activity. Thus, we have an

UNDERWEIGHT recommendation on the commons with downside potential of 26%.

We have a NEUTRAL recommendation on the preferred shares with a target price of

RUB 40.5, which shows a premium to common shares of 52.3%. Given the current

preferred share price, our recommendation implies downside of 9%.

SurgutNG cash pile — too significant to be withdrawn from the Russian banking system, usage is unlikely

SurgutNG’s cash pile ($37.72 bln) mainly consists of FX deposits in Russian banks and

has historically served as a large and important source of funding for the entire system.

Suffice to say that as of July 1, 2015, it represented 13.7% of total FX customer

deposits and 10.9% of total FX liabilities of the sector. Furthermore, the company’s cash

is equal to 32.8% of total liquid assets of the banking sector and as much as 82.2% of

total sector FX liquidity.

The stable growth in SurgutNG’s cash pile through new contributions from the company

as well as interest rate recapitalization has lifted the share of the company in key bank

funding metrics to the highest level since 2013.

Composition of common and preferred share target prices

Source: Gazprombank estimates

14.5

26.6 +12.1

+13.9 40.5

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

45.0

FAIR PRICE OF COMMON SHARE

(OIL&GAS BUSINESS)

FAIR PRICE OF COMMON SHARE

(BANKING BUSINESS)

TARGET PRICE OF COMMON SHARE

PREMIUM TARGET PRICE OF PREFERRED SHARE


5

We believe it is highly unlikely that the banking system could afford to painlessly replace

SurgutNG’s FX cash, particularly given the limited access of Russia’s largest banks to

international capital markets. Given the high systematic importance of its cash for the

Russian banking system, we assume that the company will keep the lion`s share in

Russian banks in the long run.

That said, in the medium term we see no option for SurgutNG or anyone else to use the

company’s cash pile. Using it to save any particular company would probably trigger a

need to save the entire Russian banking system.

Cash pile vs. key banking metrics (1H15): sizable by any means... …with its share at the highest level in 18 months

Source: company data, CBR sector statistics, Gazprombank estimates Source: company data, CBR sector statistics, Gazprombank estimates

82.2%

20.4%

13.7% 10.9%

FX LIQUIDITY FX TOTAL DEPOSITS FX CORPORATE DEPOSITS

FX LIABILITIES

SURGUTNG CASH PILE $37.72 BLN

10%

11%

11%

12%

12%

13%

13%

14%

14%

29

30

31

32

33

34

35

36

37

38

39

2013 1H14 2014 1H15

SURGUTNG FX DEPOSITS SHARE IN TOTAL FX DEPOSITS (RHS)

$ BLN


6

DIVIDENDS — A CORNERSTONE FOR PREFS VALUATION

RUB/USD rate is core for dividends, operating results are not

The investment case for SurgutNG preferred shares currently hinges on just a single

number on a precise date — the CBR’s official RUB/USD rate as of December 31, 2015,

which will set the exact amount of FX gains and the respective amount of dividends. For

2015, the company’s operating performance is unlikely to matter for the investment case.

As the ruble may depreciate against the dollar by end 2015 compared to end 2014 (RUB

56.26), there is a substantial possibility of a good dividend yield on preferred shares.

We estimate that under a Brent price averaging $50/bbl in 2015 and a RUB/USD rate of

63, SurgutNG may earn gross RAS net income of about RUB 500 bln with FX gains.

This implies a dividend of RUB 4.6 per preferred share, yielding about 5% at the current

market price. We also provide a simple sensitivity of preferred dividends to the ruble

exchange rate. For example, if the dollar stands at RUB 70 at year end, SurgutNG will

pay RUB 7.1 per share, while dollar depreciation toward RUB 45 would leave SurgutNG

with a net loss and preferred shareholders with zero dividends.

SurgutNG historical dividends on preferred shares SurgutNG preferred dividend sensitivity to RUB/USD rate

Source: Bloomberg, Gazprombank estimates Source: Bloomberg, Gazprombank estimates

What lies beyond 2015? We are looking for a 5% yield on prefs

As we have highlighted several times in our reports on SurgutNG, the company’s

operating activity generates quarterly net income of ~RUB 50-70 bln (RAS). This implies

dividends of RUB 1.8-2.5 per preferred share and a yield of just 4-6%, a very ordinary

level for the Russian oil and gas sector. Our current model for 2016 assumes 2016

dividends of RUB 1.79 per preferred share.

Preferred shares to trade at a premium to commons

We note the main reasons for the premium: 1) no difference in real voting rights; 2)

better liquidity on MICEX; and 3) a significantly larger dividend payout. There is only one

argument against a premium – the vulnerable position in case of potential acquisition.

Despite the latest round of speculation regarding a possible acquisition of SurgutNG,

our position remains that such a deal is highly unlikely as long as the company’s CEO,

Vladimir Bogdanov, remains in his post.

Thus, three other reasons for the premium should prevail. Moreover, based on liquidity

and the payout ratio, we have seen more movement toward the preferred shares – they

have consistently been among the top 10 most liquid shares traded on the Moscow

1.05 1.18

2.15

1.48

2.36

8.21

4.6

0

1

2

3

4

5

6

7

8

9

2009 2010 2011 2012 2013 2014 2015E0.0

1.1

2.6

4.1

4.6

5.0 5.6

7.1

8.6

0

1

2

3

4

5

6

7

8

9

10

40 45 50 55 60 65 70 75

RUB PER SHARE

USD/RUB

BASE CASE


7

Exchange, while the common shares are outside the top 10. Trading volume in the prefs

is often double that in the commons.

Moreover, in 2015, SurgutNG for a third year reduced the payout ratio for common

shares. As we have discussed in the past, this is logical, as the company’s charter does

not require that common shareholders be paid a share of non-cash profit. Flat YoY

dividends on common shares indirectly support our notion of flat profit net of FX gains.

What is the fair premium? Well, the difference in dividends seems the most logical amount,

but we should account also for the future dividends. The RUB 4.6 premium in 2015 looks

fair, but the longer term difference should be larger, we see the fair premium at RUB 13.9.

Historical discount of SurgutNG prefs to commons, % SurgutNG commons to prefs absolute spread, 2014-15, RUB

Source: Bloomberg, Gazprombank estimates Source: Bloomberg, Gazprombank estimates

-70%

-50%

-30%

-10%

10%

30%

50%

JAN

09

JUL

09

JAN

10

JUL

10

JAN

11

JUL

11

JAN

12

JUL

12

JAN

13

JUL

13

JAN

14

JUL

14

JAN

15

JUL

15

SURGUTNEFTEGAS COMMON - PREFFERED SHARE RELATIVE SPREAD, %

-14

-12

-10

-8

-6

-4

-2

0

2

4

JAN

14

FE

B 1

4

MA

R 1

4

AP

R 1

4

MA

Y 1

4

JUN

14

JUL

14

AU

G 1

4

SE

P 1

4

OC

T 1

4

NO

V 1

4

DE

C 1

4

JAN

15

FE

B 1

5

MA

R 1

5

AP

R 1

5

MA

Y 1

5

JUN

15

JUL

15

AU

G 1

5

SE

P 1

5

OC

T 1

5

SURGUTNEFTEGAS COMMON - PREFFERED SHARE SPREAD, RUBLES


8

Best ruble instrument in the market? Not really, but a hedge against ruble devaluation is rare

The turbulence on financial markets at end 2014 prevented us from suggesting

SurgutNG preferred shares as the most attractive ruble instrument in the market, but the

situation may now have changed. We note that the dividend yield on the company’s

preferred shares is comparable to the yield on ruble eurobonds or local bonds of various

issuers, including sovereign. So, on the one hand, even now SurgutNG prefs should not

be overweighted solely because of their yield, which is another argument in support of

our NEUTRAL recommendation.

On the other hand, as we mentioned above, no other ruble bond provides a natural

hedge against ruble depreciation to the extent that SurgutNG preferred shares do. This

argues against underweighting this instrument, at least until we see strong signs of oil

price recovery and substantial ruble appreciation.

SurgutNG pref dividend yield vs. yield on other instruments, as of November 3


Outlook for 2016 not so encouraging thus far, but we saw the same situation 12 months ago

Assuming that the RUB/USD rate remains in the range of 60-70, SurgutNG preferred

shares are unlikely to offer a dividend yield of more than 5% for 2016. That said, we

note that 12 months ago the consensus was saying the same thing about 2015 – the

market expected a rebound in oil prices and a corresponding rebound in the ruble.

Although our base case scenario does not anticipate further substantial ruble

depreciation, we still see SurgutNG preferred shares as the main hedge against such a

possibility. This is another reason to stay NEUTRAL on this instrument.

Is there a risk of changes to the charter? Low, in our view

One might argue that major shareholders of the company may try to amend the charter

in order to delete the minimum payout ratio on prefs. This would be challenging task, in

our view. The following is the relevant quote from the Law on Joint-Stock Companies:

The fourth point says: shareholders-owners of preferred shares participate in a general

shareholders meeting and have a voting right with regard to reorganization and

liquidation as well as issues stipulated by paragraph 3 of Article 7.2 and Article 92.1 of

the present Federal Law.

Shareholders-owners of preferred shares of a particular type — are entitled to vote at

the general shareholders meeting on amendments and additions to the company's

charter, which restrict the rights of shareholders-owners of preferred shares of this type,

including in cases of establishing or increasing dividend size and/(or) establishing or

12% 12% 12%

11%

11%

10% 10%

9%

10%

10%

11%

11%

12%

12%

13%

GPB RUBLE EUROBOND

NOVATEK RUBLE

EUROBOND

FGRID RUBLE EUROBOND

RURAIL RUBLE BOND

SURGUTNG PREF SHARE

OFZ RUSSIA RUBLE EUROBOND


9

increasing liquidation value paid on preferred shares of the preceding priority, as well as

granting the shareholders-owners of preferred shares of a different type — advantages

in the order of payment of dividends and/(or) liquidation value of shares. The decision

on the introduction of such amendments is considered adopted if supported by at least

three quarters of shareholders — owners of voting shares — participating in the general

meeting, except for the votes of shareholders — owners of preferred shares with

restricted rights, and three quarters of votes of all shareholders — owners of preferred

shares of each type with restricted rights, unless the company’s charter envisages a

greater number of shareholders’ votes needed to approve the aforementioned decision.

Shareholders-owners of preferred shares of a certain type — are entitled to vote at the

general shareholder meeting on submission of an application for permission to list or

delist the preferred shares of this type. The relevant decision is considered approved if it

was upheld by at least three quarters of shareholders owning the voting shares and

participating in the general meeting (excluding the shareholders holding preferred

shares of this type) and three quarters of all shareholders-owners of preferred shares of

this type, unless the company’s charter envisages a greater number of shareholders’

votes needed to approve the aforementioned decision.

Summarizing, under current law, SurgutNG’s charter can be amended regarding the

part on dividends to preferred shareholders, but only if this change is supported by two

thirds of preferred shareholders. We see this as hardly possible given the current level

of free float.


10

FUNDAMENTALS DO NOT LEAVE MUCH UPSIDE

SurgutNG is one of the main sufferers from the proposed tax hike

SurgutNG has one of the largest shares of exports in its revenue base across the

industry. In 2014, its export share in total revenues amounted to 65%. Thus, the

company benefited to a greater extent due to the oil price slump and tax maneuver

effect compared to peers. The share of MET and CED payments in the company’s

revenues decreased by 8.3 pps YoY in 1H15, which is the best result after Tatneft.

Moreover, its revenues less MET and CED per produced bbl were down by only 30%

YoY, while the Urals price fell by 46% YoY.

However, the flip side is that SurgutNG’s tax burden is very sensitive to changes in the

oil price, and thus in case of oil price recovery the company suffers to a greater degree

than its rivals. We forecast a small recovery in the oil price over the next three years,

which will lead to growth in the company’s tax burden.

Recently, the Finance Ministry decided to leave the export duty rate in 2016 at the same

level as in 2015. It is assumed that this step will aid in the collection of RUB 195 mln. As

a result of this measure, we estimate that SurgutNG lost RUB 26 bln, or 10% of its

2016E EBITDA.

YoY change in export duties and MET share in revenues in 1H15, pps

YoY change in (Revenue - MET - CED)/production ratio per produced bbl vs. YoY Urals price decrease in 1H15, %

Source: companies data, Gazprombank estimates Source: companies data, Gazprombank estimates

Upstream — similar to Tatneft, a flat outlook

We forecast almost flat crude oil production dynamics. In our view, production growth

stemming from the launch of new projects (Uvatskoye, Rogozhnikovskoye fields) will be

almost completely offset by decreased output from other fields. Thus, we expect crude

production to grow by only 3% to 63.3 mln t in 2024E from 61.4 mln t in 2014. At the

same time, we think that the share of Eastern Siberia in total production will decrease

from 13% to 9% in 2024E.

-14.1

-8.3

-7.1

-5.6

-4.2

-4.2

-18.0 -13.0 -8.0 -3.0 2.0

TATNEFT

SURGUTNEFTEGAS

ROSNEFT

BASHNEFT

LUKOIL

GAZPROM NEFT

-46%

-43%

-41%

-35%

-31%

-30%

-8%

-60% -50% -40% -30% -20% -10% 0%

URALS PRICE DECREASE

BASHNEFT

GAZPROM NEFT

ROSNEFT

LUKOIL

SURGUTNEFTEGAS

TATNEFT


11

Crude production, mln t Structure of crude production

Source: Gazprombank estimates Source: company, Gazprombank estimates

Downstream — no hope for a breakthrough

The situation is similar in the downstream: we expect almost flat oil product output with

insignificant gradual growth. However, with the launch of the hydrocracker and

implementation of other downstream projects, we forecast great improvement in the

sales structure.

Oil products output, mln t Structure of oil products output

Source: Gazprombank estimates Source: company, Gazprombank estimates

In our view, improvement in the sales structure will have an essential impact on oil

product revenues. Under our calculations, the sales structure effect will account for 33%

of the total increase in oil product revenues from 2014 to 2024E, while price and

quantity effects will account for 65% and 2.1%, respectively.

55

56

57

58

59

60

61

62

63

64

65

2012

2013

2014

2015

E

2016

E

2017

E

2018

E

2019

E

2020

E

2021

E

2022

E

2023

E

2024

E

CRUDE PRODUCTION, MT

87%

13%

91%

9%

WESTERN SIBERIA EASTERN SIBERIA

2014

2024E

17.0

17.5

18.0

18.5

19.0

19.5

20.0

2013

2014

2015

E

2016

E

2017

E

2018

E

2019

E

2020

E

2021

E

2022

E

2023

E

2024

E

OIL PRODUCTS, MT

12%

30%

53%

5%

15%

42%

38%

5%

GASOLINE DIESEL AND JET KERO FUEL OIL OTHER

2013

AFTER LAUNCH OF HYDROCRACKER


12

Oil product revenues dynamics in 2014-2021E, RUB bln


452.8

+107.1

+211.9 +6.7

0.0

100.0

200.0

300.0

400.0

500.0

600.0

700.0

800.0

900.0

OIL PRODUCT REVENUES IN 2014

SALES STRUCTURE EFFECT

PRICE EFFECT QUANTITY EFFECT OIL PRODUCT REVENUES IN 2021E

778.5


13

VALUATION PUZZLE

Surgutneftegas: NEUTRAL recommendation on prefs, UNDERWEIGHT on commons

In order to correctly estimate the target price of SurgutNG common shares, we suggest

a new approach to their valuation, which implies separate estimation of the company’s

two segments. The first is the core oil and gas business, while the second consists

solely of the company’s deposits and generated finance income. We then applied a

premium to the common shares to calculate the preferred share target price. Our

valuation methodology is presented in greater detail below.

As a result, we estimated the target price of SurgutNG common shares at RUB 26.6,

with only 55% of this amount coming from main oil and gas activity. Thus, we have an

UNDERWEIGHT recommendation on the commons with downside potential of 26%. We

have a NEUTRAL recommendation on the preferred shares with a target price of RUB

40.5, which represents a premium to common shares of 52.3%. Given the current

preferred share price, our recommendation implies downside of 9%.

Different valuations for different businesses

We suppose that SurgutNG can be divided into two different businesses for the

purposes of valuation. The first is the core oil and gas business and the second is the

company’s cash deposits, which generate finance income. The huge difference between

the two activities is the reason why different valuation approaches should be employed

for each business. Besides, these businesses have different risks, and therefore we

utilized different capital costs to estimate the fair price of both activities.

On the one hand, we think it is incorrect to entirely ignore finance income, which

contributes to stronger financials and even leads to greater dividends for shareholders,

as DCF methodology assumes. On the other hand, we also consider it incorrect to add

the company’s deposits to net cash in the way that classical DCF assumes, as we do

not believe that all of this enormous cash pile will ever be in the hands of shareholders.

Moreover, in case of a standard DCF approach, SurgutNG’s deposits lead to a strongly

biased target price, making the company’s oil and gas operating activity almost entirely

insignificant for estimation purposes.

Composition of common and preferred share target prices


14.5

26.6 +12.1

+13.9 40.5

0

5

10

15

20

25

30

35

40

45

FAIR PRICE OF COMMON SHARE (OIL&GAS

BUSINESS)

FAIR PRICE OF COMMON SHARE (BANKING

BUSINESS)

TARGET PRICE OF COMMON SHARE

PREMIUM TARGET PRICE OF PREFERRED SHARE


14

Oil and gas business adds only 55% to the target price

For the company’s oil and gas business, we applied a standard DCF model and

estimated the fair price of this part at RUB 14.5. We used RUB FCF and RUB WACC of

18.6%, as this business generates RUB cash flows. Our WACC estimation is based on

an equity-risk premium of 9.3%, a RUB risk-free rate of 11.2% and beta of 0.8. The

latter is equal to the unlevered beta of Russian oil and gas companies, as SurgutNG

has no debt.

WACC calculation for SurgutNG’s oil and gas business

UNIT VALUE

Share of equity % 100%

Share of debt % 0%

National risk-free rate, RUB terms % 11.2%

Equity-risk premium % 9.3%

Surgutneftegas beta for oil and gas business - 0.80

WACC, RUB terms % 18.6%

RUB cost of equity % 18.6%


It is worth mentioning that we used net debt excluding deposits, as we wanted to

estimate SurgutNG’s oil and gas business separately from its giant deposits, which

could skew the results.

DCF model for SurgutNG’s oil and gas business

UNIT 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E

EBT RUB bln 198.3 164.2 228.8 257.6 296.3 308.1 330.2 337.8 346.2 355.3

- Profit tax RUB bln 39.7 32.8 45.8 51.5 59.3 61.6 66.0 67.6 69.2 71.1

- Capex, incl. acquisitions RUB bln 200.5 215.5 228.5 239.9 249.5 259.5 269.8 277.9 286.3 294.9

- Change in working capital RUB bln 4.1 -8.0 -14.4 -10.3 -12.6 -5.5 -5.7 -4.7 -4.9 -5.1

+ DD&A RUB bln 63.0 83.8 92.7 101.8 111.0 120.3 129.7 139.1 148.4 157.6

Free cash flow RUB bln 17.1 7.7 61.6 78.2 111.2 112.9 129.7 136.1 144.0 152.1

Terminal cash flow RUB bln

1 003.1

Perpertual growth rate %

3%


Fair price estimation for SurgutNG’s oil and gas business

UNIT VALUE

NPV RUB bln 498.7

Net debt excl. deposits RUB bln -130.2

Minority interest RUB bln 0.2

Total fair value RUB bln 629

Total shares outstanding mln 43 428

Total common shares outstanding mln 35 726

Total preferred shares outstanding mln 7 702

Fair price of common share (oil and gas business) RUB 14.5



15

SurgutNG’s banking part: an estimation riddle

For SurgutNG shareholders, the company’s cash deposits can be considered as

investment in a classic deposit with a floating rate, as the amount on deposit increases

each year by the part of cash generated from the company’s core business, which

makes interest payments volatile.

If we hypothetically divide SurgutNG’s cash pile into a separate company, it would

resemble a bank that has effectively granted huge loans (generating finance

income) but has no deposit base. This is why we suppose that this part of the

company should be estimated with methods more suitable for bank valuation. We

utilized a residual income approach for assessing this business. This method, which

is a general form of the Edwards-Bell-Ohlson model, assumes that the fair price of a

share equals the balance sheet value of a share plus discounted residual income

per share in subsequent years. Residual income (RI) is net income less a charge

reflecting the required cost of capital.

In the case of SurgutNG, cost of capital is the Russian risk-free rate in USD terms,

which equals 6%, as most of the company’s deposits are USD-denominated. However,

instead of investing in a bank deposit, a potential investor in SurgutNG shares directly

takes on additional risk associated with holding equity. Thus, a standard equity-risk

premium (9.3%) multiplied by beta should be added to the risk-free rate to estimate the

appropriate required ROE. Taking into account that SurgutNG has no debt, its beta for

estimation of the banking part should equal the unlevered beta of Russian banks, which

stands at 0.5. Thus, we applied a required return of 10.5%.

Required ROE calculation for SurgutNG’s banking business

UNIT VALUE

National risk-free rate, USD terms % 5.9%

Equity-risk premium % 9.3%

Surgutneftegas beta for banking business - 0.5

Required ROE, USD terms % 10.5%


In order to calculate the ROE of the banking part, we estimated the after-tax finance

income return on deposits as a share of equity. We arrived at a figure at 4.1%, which

was used for residual income calculation. It is worth mentioning that as of October,

the rate on USD-denominated corporate deposits in Russian banks stood at 4.0%

after income tax.

We estimated RI per share as the difference between ROE and the required return

multiplied by the balance sheet value of shares. Our fair price of SurgutNG’s

banking/deposits part stands at $0.2. Based on the current exchange rate, this figure

amounts to RUB 12.1.

Residual income model for SurgutNG’s banking business

UNIT 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E

EPS (banking part) $ 0.029 0.030 0.031 0.032 0.034 0.036 0.038 0.041 0.044 0.047

BVPS (banking part) $ 0.74 0.76 0.79 0.83 0.88 0.94 1.00 1.07 1.15 1.23

ROE (banking part) % 4.1% 4.1% 4.1% 4.1% 4.1% 4.1% 4.1% 4.1% 4.1% 4.1%

Residual income (banking part) $ -0.046 -0.047 -0.049 -0.051 -0.053 -0.057 -0.060 -0.065 -0.069 -0.074

Terminal RI $

-0.70

2014 BVPS (banking part) $ 0.8

Fair price of common share (banking business) $ 0.2

Fair price of common share (banking business) RUB 12.1



16

Common share target price of RUB 26.6, implying downside of 26%

Summing two figures, we arrive at a common share target price of RUB 26.6,

implying downside of 26%. Based on the current RUB/USD rate, this implies an

ADR price of $4.2.

Common share target price estimation

UNIT VALUE

Fair price of common share (oil and gas business) RUB 14.5

Fair price of common share (banking business) RUB 12.1

Total target price of common share (SNGS RX) RUB 26.6

Total target price of ADR (SGGD LI) $ 4.2


Preferred shares valuation

For our preferred shares valuation, we applied a 52% premium to the target price of

common shares. This figure includes a premium for liquidity and dividends less a

discount for lack of voting rights. The premium for liquidity was calculated using

relative trading volumes adjusted for the percentage of shares in free float (LT trading

volume divided by free-float MCap) for both preferred and common shares. We

estimate this ratio at 44.5% and 69.2% for common and preferred shares,

respectively, which implies a premium of 55%. The dividend premium was calculated

as the difference between the dividend yields of both shares and amounted to 6.9%

(we used figures for 2013 to calculate the difference, as in 2014 the gap in dividend

yields was strongly biased by FX gains). We utilized a voting rights discount of 10%.

Thus, the total premium to common share stands at 52%, implying a preferred share

target price of RUB 40.5 and downside of 9%.

Preferred share target price estimation

UNIT VALUE

Total target price of common share (SNGS RX) RUB 26.6

Total premium % 52.3%

Voting rights discount (-) % 10.0%

Liquidity premium (+) % 55.4%

Dividend yield premium (+) % 6.9%

Total target price of preferred share (SNGSP RX) RUB 40.5



17

FINAL QUESTION — WHO IS THE OWNER? DOES NOT REALLY MATTER

Ownership scheme broadly unchanged

As we highlighted in our initiation report of December 2012 entitled “Surgutneftegas —

opening the coffer”, approximately 65% of the company’s common shares were owned

by non-commercial entities (NCEs). Nothing has really changed since that time — NCEs

are still the major owners of the company, although in 2015 we were able to trace no

more than 55% of such shares. Still, no NCE holds more than a 5% stake in order to

avoid regulatory disclosure.

We still see the company’s CEO, Vladimir Bogdanov, as the main beneficiary

As we have discussed on several occasions, this structure allows the management to

make all strategic decisions within the board, with the general meetings essentially

being a formality. We reiterate our position that full operational and financial control over

the company lies in the hands of a single person — CEO Vladimir Bogdanov. That said,

as long as he remains in his post, we anticipate no changes in the company’s

operations or shareholding structure and argue that the identity of the real owner of the

company does not really matter.

Risk remains the same — transfer of ownership may be conducted without a buyback offer

According to the Federal Law on NCE’s, an NCE may transfer its property if this transfer

agrees with the NCE’s goals in its charter. As we do not have access to such charters,

we can still assume that an NCE may transfer its stake in SurgutNG at any price.

Moreover, new shareholders may also hold less than 5% each and thus are formally not

obliged to offer a buyback to minority shareholders. So, in our view, SurgutNG common

shareholders are at greater risk compared to any other Russian oil and gas major of an

unfriendly acquisition with no compensation offered. At the same time, we should not

exclude the possibility of a proper sale of the company to a single shareholder at the

market price — in this case, preferred shareholders would be in a worse position, as

they are unlikely to be subject to an offer.

Another reason to UNDERWEIGHT the commons and be NEUTRAL on the prefs

In case of a possible acquisition, one should always keep in mind the part of

SurgutNG’s charter regarding dividends on preferred shares, which we examined in

greater detail above. This dividend protection is another strong feature of the

company’s preferred shares, in our view, and is additional reason to be NEUTRAL on

the prefs. Meanwhile, the greater risk of an unfriendly acquisition with no real

protection of common shareholder rights is another reason to be UNDERWEIGHT the

common shares.

http://www.gazprombank.ru/upload/iblock/1f0/gpb_surgutneftegas_initiation.pdf

HQ: 16/1 Nametkina St., Moscow 117420, Russia. Office: 7 Koroviy val St.

Research Department

+7 (495) 983 18 00

EQUITY SALES FIXED INCOME SALES

+7 (495) 988 23 75 +7 (495) 983 18 80

EQUITY TRADING FIXED INCOME TRADING

+7 (495) 988 24 10 +7 (499) 271 91 04

Copyright © 2003-2015. Gazprombank (Joint Stock Company). All rights reserved

This report has been prepared by the analysts of Gazprombank (Joint Stock Company) (hereinafter — Gazprombank) and is based on information obtained from public sources believed to be reliable, but is not guaranteed as necessarily being accurate. With the exception of information directly pertaining to Gazprombank, the latter shall not be liable for the accuracy or completeness of any information shown herein. All opinions and judgments herein represent solely analysts’ personal opinion regarding the events and situations described and analyzed in this report. They should not be regarded as Gazprombank’s position and are subject to change without notice, also in connection with new corporate or market events that may transpire. Gazprombank shall be under no obligation to update , amend this report or otherwise notify anyone of any such changes. The financial instruments mentioned herein may be unsuitable for certain categories of investors. This report should not be the only basis used when adopting an investment decision. Investors should make investment decisions at their own discretion, inviting independent consultants, if necessary, for their specific interests and objectives. The authors shall not be liable for any actions resulting from the use of this report. Any information contained herein or in the appendices hereto shall not to be construed as a solicitation or an offer to buy or sell any securities or advertisement, unless otherwise expressly stated herein or in the appendices hereto.

change of recommendation alexander nazarov · pdf filechange of recommendation alexander...

Documents