Gazprom Bulls’ China Fixation Is Misguided to Top Moscow Broker

May 22, 2014 10:12 am ET

May 22 (Bloomberg) -- BCS Financial Group has a problem with the rally in OAO Gazprom.

While stock buyers are fixating on the revenue Gazprom will receive from the $400 billion deal signed yesterday to supply gas to China for 30 years, BCS is focusing on another figure: the $55 billion the company will dole out to develop the reserves in Siberia and build the pipelines.

Gazprom’s spending “is going to spike big time,” Luis Saenz, head of equity sales and trading in London at BCS, which is the biggest broker on the Moscow exchange, wrote in an e-mail yesterday. “Free cash flow will fall at a time when earnings are sliding.”

Gazprom has jumped 12 percent this month as speculation mounted that the country would finally get the gas-supply deal it had sought for more than a decade. BCS says the rally will fade and recommends investors shift into shares of OAO Novatek, Russia’s second-biggest natural gas producer after Gazprom. The call puts BCS in the minority: 14 of 21 analysts tracked by Bloomberg had buy ratings on the state-run company as of yesterday.

Gazprom Chief Executive Officer Alexey Miller disclosed the capital spending plan after signing the accord with Zhou Jiping, chairman of China National Petroleum Corp. The increased capital expenditure comes as Russia’s economic growth is being squelched by sanctions linked to the standoff in Ukraine.

Gazprom’s share price already reflects the income from the China deal, while its Siberia-based competitor offers investors better fundamental value, according to BCS.

Long-Term ‘Catalyst’

“We are opening up a principally new market that has a huge potential,” Gazprom spokesman Sergei Kupriyanov said by phone today. “The fact that our first contract with China is already Gazprom’s biggest contract ever speaks for itself.”

Shares of Gazprom slid 1.5 percent to 144.36 rubles as of 6:01 p.m. in Moscow after rising 0.8 percent yesterday. Novatek rose for the fifth day in London today. The Bloomberg index of the most-traded Russian stocks in the U.S. fell 0.7 percent for the first retreat in a week.

Bank of America Corp. and Sanford C. Bernstein reiterated buy recommendations on Gazprom after the company said it had reached the agreement with China.

“It’s very good that Gazprom signed the deal,” Karen Kostanian, an analyst at Bank of America, said by phone from Moscow yesterday. “The price seems to be right, while the deal itself opens up not only the Chinese market, but Asian markets to Gazprom over the longer term. The deal is going to be a catalyst for the stock longer term.”

30-Year Deal

The agreement is for 38 billion cubic meters of gas annually over 30 years, or about 20 percent of its sales to Europe, Miller said. The price was not disclosed. Gazprom sold gas in Europe at an average of $380.50 per thousand cubic meters last year. The contract price with China is more than $350, Interfax reported yesterday, citing a person it didn’t identify.

RTS stock-index futures expiring next month increased 0.4 percent to 130,410 in U.S. hours yesterday. Contracts on Gazprom’s Moscow-listed stock rose 0.6 percent.

“Gazprom remains our preferred way to play the Russian energy sector, given Europe’s high reliance on Russian gas and today’s progress in China,” Sanford C. Bernstein research analysts led by Neil Beveridge, wrote in a report yesterday. “Signing the deal is a long-run positive for Gazprom, even though exact pricing details have not been released.”

‘Unpredictability’

Gazprom’s stock in Moscow trades at 3.1 times estimated earnings for the next 12 months. That compares with a multiple of 10.8 for Novatek’s London-listed shares, which are the most- actively traded.

BCS forecasts that Novatek will increase dividends by 70 percent and accumulate $8 billion of cash over the next five years, while Gazprom’s earnings sink by 20 percent, according to a May 19 research note.

Gazprom’s capacity to increase dividends will be reduced because of the capital spending required to begin production and shipments to China, Renaissance Capital Ltd. wrote in a note to clients yesterday. The firm reiterated a hold recommendation on Gazprom and a buy on Novatek.

“We’ve got a very big factor of unpredictability as the Chinese deal is signed,” Alexei Kokin, analyst at UralSib Financial Corp. in Moscow said by phone yesterday. “We prefer Novatek over Gazprom as it looks way more predictable. We appreciate Novatek’s growth trajectory and its focus on production of liquefied natural gas.”

Novatek plans to supply liquefied natural gas to Asia and Europe from the $27 billion Yamal LNG joint venture, in which the company has a 60 percent stake while Paris-based Total SA and China National Petroleum Corp own 20 percent each.

Gazprom has rallied 24 percent from this year’s low of 117.87 rubles in Moscow on March 14.

“The China deal is the last remaining rabbit in Gazprom’s hat,” Saenz of BCS wrote yesterday in a note. “We hardly see any reasons to own Gazprom and recommend taking advantage of the recently rally to reduce your position.”

--With assistance from Ksenia Galouchko in Moscow.