Gazprom: An Investment For Generations
Mar. 14, 2021 9:56 PM ETPublic Joint Stock Company Gazprom (OGZPY)BP, BPAQF, CVX...58 Comments37 Likes

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Summary
Gazprom holds the world's largest natural gas reserves.
The Chinese gas market is the fastest growing in the world and offers great long-term potential.
Competitive gas prices, a decreasing indigenous production and its huge reserves will guarantee Gazprom a high long-term market share in Europe.
A new transparent dividend policy combined with a low valuation compared to its peers make Gazprom an attractive investment.
Investment thesis
Gazprom (OTCPK:OGZPY) holds the world's largest natural gas reserves. The Chinese gas market is the fastest growing in the world and offers great long-term potential. There is a strong need for cleaner energy and a second pipeline with a higher transport capacity is already being planned.

Extremely competitive gas prices, a decreasing indigenous production and its huge reserves will guarantee Gazprom a high long-term market share in Europe. A new, transparent dividend policy in combination with a low valuation compared to its peers make Gazprom an attractive investment.

Introduction

There are many controversial discussions about Gazprom, for example the role of the Russian government, corruption, the fact that is a Russian company, waste of resources, delay of projects, ... and many more. Let's ignore the background noise and focus on facts and valid trends.

I see absolutely no reason to talk about the numbers from last quarter/year because they are simply not important for me. Gazprom is an ultra long-term investment, it is for generations. Well, that's a bold statement in a world where technology is already outdated a day after its first release, but I am going to provide evidence for this claim. In my thesis there are a couple of key aspects to consider: China, natural resources, flying under the radar and company policy. At the end there are also risks and uncertainties we have to discuss.

China's hunger for energy
In 2019 the most important export market for Gazprom was Europe ("West" ) with roughly 95% and the remaining 5% went "East". This could significantly change in the near future, based on the projections shown in the image below.

Source: 2020 Investor Day Presentation

The Chinese natural gas market is the third largest in the world and the fastest growing. Between 2000 and 2019 China's gas consumption grew by 283% more than in any other country. It is forecasted that the consumption doubles by 2035 from 306.7bcm in 2019 to 610bcm. The indigenous gas production plans are ambitious with 300bcm in 2035. Even if this can be achieved, there is still an import demand of 310bcm. As a consequence, new import contracts for roughly 161bcm are needed. These numbers are presented by Gazprom in a report on the development of China's natural gas market and are based on information from the Chinese National Bureau of Statistics.

Gazprom has a couple of advantages in order to increase its market share in the coming years. The negotiated prices are very competitive and the Power of Siberia supply route offers short transportation distances to key areas. The image below shows regions with strong demand growth and forecasts for different sectors.

Source: China's gas market - investor roundtable presentation

It is expected that the Chinese shale gas is likely to be a local story. The share of total gas consumption might reach 8-11% by 2030 and will be consumed in Central and Eastern China. Whereas the Russian pipeline gas targets the north and northeast of the country.

There is a coal-to-gas switch program and the environmental policy combats climate change and air pollution. Both require natural gas and that's why the gas consumption will continue to grow as described above.

More and more details are available about Gazprom's next ambitious project, Power of Siberia 2. A company was registered to carry out a feasibility study regarding the construction project for a gas trunk line to supply Russian gas across Mongolia to China. The export capacity of the gas pipeline might become more than 1.3 times higher than that of Power of Siberia (annual design capacity of 38bcm). It will allow the transfer of gas from Western Siberia not only westward but also eastward.

Ramping up the gas supply through Power of Siberia, gaining shares in China's gas market, constructing Power of Siberia 2, ..., that will not happen this year or next, but will take much longer. As I said at the beginning, Gazprom is an ultra long term investment with a bright future.

Gazprom's resources
The natural resources are an aspect that cannot be overestimated. Gazprom holds the world's largest natural gas reserves with a share of 16%. We are talking about 24.396Tcm of gas under PRMS standards and in total (natural gas, gas condensate and oil) about 177.1bboe in 2019. You can see in the image below how that compares to some other major players in the business.

Source: Gazprom + annual reports 2019 major oil companies

Gazprom is exporting roughly 200bcm gas per year to Europe and was able to defend its strong market share despite some headwinds. The indigenous natural gas production is decreasing in Europe and offers new potential in the near future.

Source: 2020 Investor Day Presentation

I don't think anyone expects Gazprom to take over the entire European gas market. There is too much resistance and the energy policy is emphasizing diversification of gas imports. Nevertheless, the extremely competitive prices of the pipeline gas, a decreasing indigenous production and its huge reserves will guarantee Gazprom a high long-term market share in Europe.

Flying under the radar
I have the impression that Gazprom still flies under the radar despite its huge resources and potential (some of the possible reasons are discussed later under risks). A simple indication is the number of followers on Seeking Alpha.

Source: Seeking Alpha

SA attracts many investors from North America, so I fully understand the preference of companies like Exxon Mobil (XOM), Chevron (CVX), Royal Dutch Shell (RDS.A) (NYSE:RDS.B) or BP (BP). However, more people are following the considerably smaller Norwegian company Equinor (EQNR) on this platform and that doesn't make sense in my opinion.

Gazprom looks very attractive in terms of price / book ratio with just 0.40, compared to Exxon Mobil with 1.67, Chevron with 1.63 or Shell with 1.1 (data from Morningstar). Other key figures like price / cash flow ratio provide a similar picture, indicating an undervaluation compared to its peers.

Dividend policy
The main motivation for investments in the energy business is a steady income from dividends. Gazprom is paying dividends since many years, but it was never really consistent or transparent. In order to make the company more attractive for investors, the management announced a new dividend policy.

The new policy principles are a transparent methodology, dividends based on IFRS net profit, an adjustment for non-cash items and a payout ratio increase from at least 30% to at least 50% within a three year period. However, there is one restriction, the new payout targets only apply if net debt/EBITDA remains below 2.5x. That shouldn't be a big problem considering the currently low level of just 1.1x.

Source: 2020 Investor Day Presentation

With these changes an investment in Gazprom is much more attractive nowadays. The new dividend policy is transparent and after many years of big investments, it is time to focus on shareholder returns.

Risks and uncertainties
So far, we discussed many positive aspects of Gazprom, but investors need to consider a few downsides. There are obviously political risks involved because the Russian government controls the majority of the company. When sanctions against the country are discussed, in many cases Gazprom is part of it or at least a potential target. The Nord Stream 2 pipeline project has been severely delayed due to sanctions.

From a financial point of view, FX headwinds can have a negative impact on the business. In addition, there are uncertainties on how economical the long-term Power of Siberia deal with China really is. Some see it as just a political move. Last but not least, the switch from coal to gas makes perfectly sense to combat air pollution, but natural gas is still a fossil fuel and the resistance is growing.

Conclusion
Gazprom holds the world's largest natural gas reserves. The Chinese gas market is the fastest growing in the world and offers great long-term potential. There is a strong need for cleaner energy and the government launched a coal-to-gas switch program. The Power of Siberia pipeline started in 2019 and a second one with a 1.3 times higher transport capacity is already being planned.

The company has a strong position in Europe and the extremely competitive gas prices, a decreasing indigenous production and its huge reserves will guarantee Gazprom a high long-term market share.

In order to make Gazprom more attractive for long-term income oriented investors, the management announced a new, transparent dividend policy. Not only a potentially high dividend yield, but also a low valuation compared to its peers make an investment attractive. It is an ultra long term investment, it is for generations as described at the beginning of the article.

Before investing, there are a few risks such as FX headwinds, political risks, resistance against fossil fuels, to consider.

Disclosure: I am/we are long OGZPY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article

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