July 25 (Bloomberg) -- OAO Transneft probably will produce what investor Ivan Mazalov calls “massive” cash this year as the pipeline operator delivers Kremlin-backed projects supplying oil to Asia and the Baltic Sea. That may return investors to one of Russia’s cheapest energy stocks.
Transneft says investment spending will decline 29 percent this year to 107.6 billion rubles ($3.4 billion) as it completes a pipe shipping oil to the Pacific port of Kozmino. The first leg opened last year with deliveries of crude to China. The state-controlled company is over the hump on at least 502 billion rubles in planned investments, including a pipeline and port on the Baltic that opened this March.
“Completion of these pipeline projects is important because the company will start to have massive free cash flow” as capital spending falls, said Mazalov, who helps manage about $4 billion at Prosperity Capital Management in Moscow and holds Transneft’s preferred shares. The Russian state owns 100 percent of the company’s common stock.
Transneft has served as President Vladimir Putin’s main instrument in implementing the Kremlin’s energy strategy of reaching new markets and diversifying export routes. The pipeline operator has linked Russian output to growing Asian demand previously dependent on the Middle East for supply.
It hasn’t been cheap. Transneft took out $10 billion in loans from China as part of a 20-year, 300,000 barrel-a-day supply deal with Asia’s largest economy. China also lent OAO Rosneft, Russia’s largest oil producer, $15 billion to help produce the crude. November’s second leg of the East Siberian Pacific Ocean pipeline adds another $10 billion to the bill, though much of it has already been invested, Transneft says.
The shares have fallen 1.9 percent to 48,654 rubles this year, less than the 2.4 percent decline in Moscow’s Micex Index. At the same time, investors have reacted to spending and low dividend yields by making the Moscow-based company’s preferred shares the cheapest in Russian energy, according to data compiled by Bloomberg. Shares trade at 1.7 times earnings, followed by 2.7 times for OAO Gazprom.
“Transneft has gone over its spending peak,” said Olga Danilenko, an oil and gas analyst at VTB Capital in Moscow. “Even if major outflows remain, it will become free cash flow positive this year or next. It is imminent.”
Dividend growth will be the catalyst for Transneft shares, Danilenko said. She has a buy recommendation on the stock.
Putin asked Russian companies to examine increasing dividend payouts to boost market value at a meeting with executives including Transneft Chief Executive Officer Nikolay Tokarev in Moscow. The July 10 request followed a June decision by state-run OAO Rosneft to boost payouts to 25 percent of income. Rosneft shares, which trade at 5.2 times earnings, have fallen 7.7 percent this year.
Transneft management has resisted any change to its policy of paying out no more than about 10 percent of net income by Russian Accounting Standards to preferred shareholders.
Minority shareholders Prosperity Capital, East Capital and Vostok Nafta sent a letter to then-Prime Minister Putin in 2010 asking him to privatize 25 percent of the company’s common stock, saying a change in dividend policy was a way to improve valuation. Transneft said in a March 16, 2011, document that paying more dividends would curtail aid to orphans and other charity work.
Transneft’s dividend policy is set by its main shareholder, the Russian state, said company spokesman Igor Dyomin. It may not be expedient to increase dividends while the company has such a high level of investment commitments and debt payments, Dyomin said, citing management. These conditions will last until 2015 at the earliest, Renaissance Capital said on May 18, citing Transneft First Vice President Maxim Grishanin.
The company’s investment case may end up mirroring that of Rosneft, which focused on reducing debt rather than raising dividends, Oleg Maximov and other analysts at Troika Dialog wrote in a May 18 note.
Rosneft ran net debt up to $26.3 billion in 2007 as it bought assets from bankrupt Yukos Oil Company. By the end of 2010 it had cut that figure to $13.7 billion, according to documents on the company website. The stock’s dividend yield failed to rise above 1.5 percent during that same period, according to Bloomberg data.
Transneft revenue rose 49.8 percent to 670.3 billion rubles last year, according to a company presentation. Net income jumped 58.6 percent to 188.1 billion rubles and Transneft had 605.3 billion rubles of current and non-current borrowings.
The company’s leverage has risen to the level where net debt in 2011 equaled 0.9 times earnings before interest, taxes, depreciation and amortization, as opposed to 0.1 times the indicator in 2001. Danilenko said. Dividends, by contrast, are down, to $24.40 per preferred share in 2011. That’s lower than in each of 2001, 2002 and 2003, she added.
The company ships about 93 percent of the oil produced in Russia, the world’s second-largest producer behind Saudi Arabia.
The main risk with Transneft is that the state may propose another large-scale project that would again stretch Transneft’s resources, Danilenko said.
Any Transneft involvement in Rosneft’s projects to explore the arctic Kara Sea with Exxon Mobil Corp., for instance, would certainly be expensive, she said. Thus far, Exxon and Rosneft haven’t involved Transneft, planning to load crude to tankers from floating storage and off-loading facilities, she said.
“Nobody doubts Transneft’s capability and the value of the assets,” she said. The preferred shares are cheap because “minorities are not sure if they are treated as shareholders or if they will ever get returns.”
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