Research Notes

Gazprom – Beyond Competition!

Common recommendation	Buy
Target price, $	13.40
Current price, $	11.01
Upside/downside potential:	23.8%

Reason: assigning the common share recommendation Gazprom
RTS ticker GAZP Market cap, $ bln 243.32 EV, $ bln 268.42 Number of common shares, bln 22.64 Number of preferred shares - Financial indicators, $ mln   2006F 2007F 2008F Sales 69,622 78,784 80,499 EBITDA 34,923 39,557 38,005 Operating profit 29,722 34,200 32,489 Net profit 22,134 25,809 24,529 Cash flow 17,251 21,571 21,826		Margins   2006F 2007F 2008F EBITDA margin 50.2% 50.2% 47.2% EBIT margin 42.7% 43.4% 40.4% Net margin 31.8% 32.8% 30.5% Multiples   2006F 2007F 2008F P/S 3.5 3.1 3.1 EV/EBITDA 11.2 9.6 10.1 P/E 7.1 6.2 6.5 Dividends, Rub/share   2003 2004 2005 Common shares 0,69 1.19 1.50

Gazprom demonstrates full dominance in Russia and has been bolstering its positions on the European market on the back of state support. A favorable environment on global primary markets and growth in regulated gas tariffs in Russia will enable the company to improve its financial performance. According to our estimates, the fair price of Gazprom shares is $13.40 and we assign a Buy recommendation to its shares.

The fundamental prerequisite for operations of any O&G company is its resource base and in this regard Gazprom wields an excellent competitive advantage against other entities. Gazprom has the world’s richest natural gas reserves, accounting for around 17% in proven gas reserves worldwide and over 60% domestically.

Extracting 547 bcm of gas a year Gazprom is the unrivaled leader in terms of gas output. Meanwhile, in recent years the state-controlled gas mammoth has ramped up gas recovery at a slow pace (roughly 1.5% a year), but it holds a substantial potential to boost gas production, which it is still not eager to exploit because of low gas prices on the domestic market. For example, during the January cold snap Gazprom boosted its annual gas output rate to 620 bcm a year by tapping additional resources.

An extremely auspicious climate on global primary markets enabled the company to post fairly strong 2005 results. Europe’s average gas selling prices topped $190 per 1,000 cu m. Our DCF valuation model for Gazprom is based on rather conservative assumptions about gas recovery dynamics at the gas giant and a decline in European gas selling prices after 2007. Even in this case Gazprom holds the potential to achieve improvements in its financial numbers through optimization of gas sale procedures and gas price hikes in Russia and in the FSU.

Last year Gazprom sold gas to the CIS and Baltic States at prices three times lower than in Europe, while domestic gas prices were 5 times lower than European prices. The gas holding’s obligation to deliver gas to the domestic market will be eased which is driven by rising gas prices in the country and a greater role played by independent gas producers. Gazprom’s supplies to Europe will jump by expanding its export potential once the gas transportation infrastructure is rolled out. However, Gazprom is taking measures to shift terms for gas supplies to the FSU to a market basis.

In line with our forecast, throughout the period under analysis Gazprom’s sales will be on a stable growth track and will double by 2015. Liberal taxation and faster growth in earnings compared to the cost side will result in high net margins.

Gazprom’s leadership position in the Russian gas industry allows it to set the ‘rules of the game’ for other players on the Russian gas market. All other things being equal, the state’s cavalier treatment of the company makes its plans to make a foray into Europe’s gas transportation and marketing segment fairly realistic.

According to our estimate, the fair market cap of the state-run gas holding is $328 bln, which implies a target price of $13.40 per share.

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Timur Hayrullin

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Sector: O&G
Company: Gazprom

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