Gazprom Is A Dividend Aristocrat With 13%+ Yield Right Now
Aug. 25, 2021 8:55 PM ETPublic Joint Stock Company Gazprom (OGZPY)10 Comments15 Likes
Summary
- Thanks to the dividend policy approved in 2019, Gazprom will pay hefty dividends (13-16% of the current price) starting from 2022.
- Gazprom's cash flow secures dividends; it used to pay less due to the low payout ratio (about 25% against the current 50% of net profit).
- The company and the consensus set too conservative gas sales prices in Europe for 2021; revision of the expected gas price will drive the growth of Gazprom's quotes.

Логотип штаб-квартиры «Газпрома» в Сербии. «Газпром» является одной из крупнейших энергетических и энергетических компаний России, с офис�
BalkansCat/iStock Editorial via Getty Images

Investment thesis
Gazprom (OTCPK:OGZPY) is becoming a big dividend chip that will earn a lot over the next few years and will give a lot to investors. The decarbonization trend in Europe is positive for Gazprom as gas prices take in the spread to the price of coal + the cost of excess CO2 emissions, and now there is a shortage of gas supply in Europe, which gives Gazprom excess profits. With the maintenance of prices of $270-300/thousand cubic meters (the spot price is $570 currently), Gazprom will pay a dividend yield of about 16% per year.

We expect the share to be revalued to 487 rubles/share, and we consider the fair yield for Gazprom at 7%. Even in the negative scenario, with average gas prices in Europe falling to the average level of 2017-2019 ($220), Gazprom still has an upside of about 20% to the current price.

We have improved our expectations for gas sales prices in Europe
We have updated our gas price model in Europe in response to the higher spot gas prices and have forecasted oil prices in 2021, while selling prices in Q1 2021 were 2% lower than expected.

We would like to remind you that Gazprom's selling prices depend mainly on oil and gas spot prices. Now, we expect the average price in 2021 to be at least $253 per thousand cubic meters and $285 in 2022, based on forecasts for oil in the range of $65-70/bbl.

At the beginning of August, spot prices in Europe are at their maximum level for the last 3 years - above $570/thousand cubic meters. High prices are supported by expectations of hotter-than-expected summer weather and the reduced supplies from Norway. Gazprom's latest forecast of June 2021 at an average price in 2021 was $240 - we believe this is a conservative forecast considering a drop in gas prices in the second half of 2021. The company is probably trying to lower market expectations to improve them quarter after quarter.

The factor of high prices being maintained until the end of the year is that gas reserves in Europe remain at low levels, and Gazprom does not book additional transit capacities through Ukraine:

Source: agsi.gie.eu

Gas prices in Europe continue to renew their highs. On August 5, the price reached $520/thousand cubic meters. On August 6, the price approached $545/thousand cubic meters against the background of the accident at the Gazprom plant in Novy Urengoy.

The filling rate of gas storage facilities in Europe continues to remain at a low level. As of August 2, European UGS facilities were filled by 57%, which is 16 p.p. below the average for the last five years.

Earlier in Europe, the cost of CO2 emission quotas and the thermal coal prices also increased. The cost of carbon dioxide quotas in May rose above €50 per ton for the first time, more than double as compared to pre-pandemic levels in 2020.

On the other hand, LNG supplies to Europe continue to fall.

According to Kommersant's data, in July, the EU received 12% less LNG than in June, and 22% less than in July last year.

All spare LNG shipments are shipped to Asia, where demand continues to rise due to the heat and the growing demand for electricity for air conditioning.

The price of the September futures contract on the Asian spot Platts JKM index reached $544 on July 29, and the most expensive contract for the coming winter - for February 2022 - will cost $613.

Source: ru.tradingview.com

In July, Gazprom's gas pipelines were repaired. Unlike in 2019, Gazprom did not increase gas supplies through Ukraine during the repairs and set the prices higher.

By creating a gas shortage in Europe ahead of the autumn-winter season, Gazprom is pushing the Europeans to launch Nord Stream 2 more quickly.

According to the Neftegaz portal, only 27.6 bcm out of the 66 bcm selected last season were replenished in European UGS facilities. The lag from the level of reserves, as of the same date last year, is 27.9 billion cubic meters. In Germany, which has the largest storage capacity in Europe, the storage capacity was only around 50%.

On August 2, Gazprom announced that it had stopped pumping gas into underground storage facilities in Europe. From July 31 to August 2, the company reduced the volume of supplies to European UGS facilities. Gazprom also reduced gas pumping through the Yamal-Europe gas pipeline even before the accident: by the end of July, 84 million cubic meters were pumped through it, and on August 3 - 50 million cubic meters were pumped.

According to Gas Infrastructure Europe, after the accident at the plant in Novy Urengoy on August 5, Gazprom began to take gas from some UGS facilities in Europe. According to Interfax, the gas withdrawal from Russian storage facilities has also begun.

When JV-2 is launched, Gazprom will be able to increase supplies to Europe. Earlier, the director of Nord Stream 2 AG announced that the construction of the second branch is planned to be completed in August and that the testing and certification will take another 2-3 months (the company applied for certification in June).

On the horizon of the next two years, gas prices in Europe will be above average due to the low occupancy of gas storage facilities. Over the next six months, prices will be adjusted from 545 to 250-300 $/thousand cubic meters as the JV-2 is commissioned and the supply from Gazprom grows. We allow prices for Gazprom at the level of $291/thousand cubic meters until the end of the year, that is, the company's shares remain attractive given the prices which are 46% lower than current spot prices.

P.S. Judging by the consensus estimates of the financial results of Gazprom, analysts, on average, count on the selling price at the level of Gazprom's of about $240/thousand cubic meters (this is our opinion). This is our main divergence from the market, but we see high gas prices as a justifiable bet.

Gazprom makes a lot even with low gas prices
Gazprom does not sell gas at spot prices, and its pricing depends on gas prices over several periods and oil prices. Therefore, the current record-high spot gas prices are not included in the company's valuation neither by us nor by other analysts.

We count on prices for Gazprom at the level of $291/thousand cubic meters in Q3-Q4 2021 (on average, $253/thousand cubic meters for 2021), that is, the company's shares remain attractive considering prices being 37% lower than current spot prices.

On average, for 2015-2019 and before the pandemic, gas prices in Europe were $216/thousand cubic meters; in 2017-2019, they were $220/thousand cubic meters. Now, even if prices drop to $200/thousand cubic meters in Q3-Q4 2021, Gazprom retains an upside of more than 20%.

With the average gas price in Europe in 2021 at the level of $250/thousand cubic meters, shares of Gazprom give a dividend yield of 13.7% for the current price; and with the average gas price for 2021 at the level of 2017-2019 at 220 $/thousand cubic meters, dividend yield of Gazprom shares would amount to 11.4% for the current price.

We expect the profit growth for Gazprom in both bearish and bullish scenarios, which makes the investment idea resistant to price risks:

Source: Company’s data, Invest Heroes forecast

We do not expect the current high gas prices to maintain for the long term, and such prices are not currently included in Gazprom's quotes. At the same time, given the current quotes, Gazprom shares give a good upside, even in a negative scenario when gas prices fall to $200-220 per barrel.

We have raised forecasts for production growth
Gazprom's production forecasts were revised upwards. Due to the cold winter and spring, gas storage facilities in Europe have been emptied; therefore, Gazprom is increasing production volumes.

Gazprom has already increased gas production in the first 7.5 months of 2021 by 18.1% YoY; we expect pre-coronavirus levels in Q3 2021 (+4.3% YoY) amid a low base in Q2 2020 and strong demand in April and May, and further growth in production volumes in Q4 2021 (+9.2%) due to the commissioning of Nord Stream-2. At the same time, gas exports are at historic highs in the first 7 months, which suggests that production grows precisely in favor of the increasing gas supplies to Europe, which is the most marginal line of business for Gazprom.

We expect the volume of exports to Europe at the level of 190.8 billion cubic meters in 2021, the company's forecast is 183 billion cubic meters. In 2019, the volume of exports amounted to 191.3 billion cubic meters. At the SPIEF, Russian President Putin set the target level of exports to Europe at 200 billion cubic meters in 2021.

Source: our forecast, company’s guidance, Putin's speech at SPIEF

Dividends are a share growth driver
In line with Gazprom's dividend policy, the company will seek to pay dividends equal to 50% of its adjusted IFRS profit. Earlier, Gazprom announced that it would reach such a payout ratio by the end of 2021.

By the end of 2020, Gazprom's management had already decided to pay shareholders 50% of net profit under IFRS. The Gazprom Management Committee recommended that at the end of 2020, dividends be paid for 12.55 rubles per share (expected to be paid in Q3 2021), having paid a part of retained earnings of previous years to dividends.

According to our forecasts, by the end of 2021, Gazprom will pay out dividends of 33.22 rubles/share (12.0% yield to the current price).

At the end of 2020, Gazprom could cover the payment of dividends with cash flow (FCF), but in 2021, the number of dividends (627 billion rubles) will exceed FCF (544 billion rubles). According to Gazprom's management, the payment of dividends is a priority, and the debt burden at a level below 2.0x Net Debt/EBITDA corresponds to a comfortable range, according to Famil Sadygov.

With an increase in debt aimed at paying dividends, the debt burden at the end of 2021 will be at 1.4x Net Debt/EBITDA, which is an acceptable level for the management. Therefore, we expect that the dividends will be paid in full at 50% of the net income.

If Gazprom's debt burden exceeds 2.5x Net Debt/EBITDA, according to the dividend policy, the company has the right to pay a smaller share of the net profit.

The planned amount of CAPEX in 2021 for the Group was increased from 1.5 to 1.8 trillion rubles.

Thus, we have a mid-term series of positive developments ahead in the form of maintaining dividend payments at 50% of the profit, completion of the construction of Nord Stream-2, consistently increasing forecast for the gas prices, growth in export volumes, and the actual receipt of high profits.

Valuation
We raised our EBITDA forecast for 2021 from 2.3 trillion rubles to 2.9 trillion rubles, resulting in an increase in our 2021 dividend forecast from 24.8 rubles to 33.2 rubles per share (12.0% yield to the current price).

EBITDA forecast has been increased due to revision of:

Gas sales volumes in Europe in 2021 from 231 to 253 billion cubic meters (+15% YoY) and average sales prices in Europe for 2021 from $230 to $233 per thousand cubic meters.
Sales volumes in the CIS countries from 34 to 36 billion cubic meters (+14% YoY), in Russia - from 226 to 237 billion cubic meters (+5% YoY).
At the same time, we raised the forecast for CAPEX for 2021 from 1,540 to 1,832 billion rubles.

Gazprom will make very good money in the upcoming years due to the high prices and the high demand for gas, while, unlike in the previous similar periods, it will allocate 50% of its profits to dividends against the earlier 27%.

The stake on Gazprom is now a stake on trust in the management. Gazprom has planned to pay dividends in the amount of at least 50% of net profit from 2022. Moreover, by the end of 2020, the management has already decided to pay 50% of dividends.

We expect the management to maintain dividend payments at 50% of the net income for 2021. In this case, we will see a significant increase in stocks and the opportunity to earn from the current price levels of +61% per year.

We estimate Gazprom giving us a target price of 471 rubles/share based on a fair EV/EBITDA FTM of 4.0x and a fair dividend yield '21 of 7.0%.

Risks
The main risk for Gazprom is a political one. Russia has recently abolished tax breaks for several crude oil fields and introduced additional taxes on steelmakers' excess profits. This suggests that the Government is looking for additional sources of budget financing. The state will receive more from the increase in assessed taxes on Gazprom than from the increase in dividends. Thus, the change in tax conditions for Gazprom is the most significant risk for the investment case.

Authors: Aleksandr Sayganov, Natalia Shangina