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Veles Capital reduced price target on Lukoil from $138.44 to $129.63, recommendation "buy" unchanged 15 September 2008 Source: www.veles-capital.ru
On August 29th LUKOIL published its 2Q 2008 report under US GAAP. During 2Q 2008 net income of the company rose +64.1% versus similar value of 2007, form 2,517 bn USD to 4,130 bn USD. Versus 1Q 2008 (3.163 bn USD), net income had also demonstrated growth of +30.5%. The quarter value of net income had also appeared below market expectations at average of 10.3%, but met out forecast, based on value of 4.128 bn USD. Net income growth was supported by several factors, among which – first of all: growth of quarter average price of oil and oil products sold by the group, which expanded at average of about 81.5% in between 2Q 2007 and 2Q 2008. Secondly – improvement of oil products sales in 2Q 2008 +6.3%. We must also note that company continued reducing export of crude oil, a plan started earlier in 1Q. This is a negative factor that slaps company’s income. Export of crude oil from Russia in 1H 2008 has been dropped -11.9% versus 1H 2007. Throughout 1H 2008 LUKOIL exported 43.4% of oil extracted in Russia (1H 2007 – 48.1%). The reduction of export is related to increase in oil refining in Russia and decrease in oil extraction over the country. We must point out though – LUKOIL attempted to compensated for the loss of extraction by extracting more of a highly profitable natural gas. During 2Q LUKOIL boosted its gas extraction up +19.3%, which is quite a decent value. The withholding factor of LUKOIL’s net income growth is a high share of company’s purchased oil products for its gas pumps in US. The purchase of oil products is made by market prices, while resale margin is at minimum. The oil products purchase costs have rose through 2Q +77% versus similar term of past year. Some negative pressure was also provided by growth of tax payments +63.6%, as well as payment of export duties, adding +52.6%. We must also note that three previously reviewed expenditure items take up a share of 80.1% of total costs, due to which the growth of operating costs has formed 57.6% in 2Q 2008 versus 2Q 2007. We see no other important factors to influence the growth of net income for LUKOIL at the moment. Now, let us get back to LUKOIL’s finances of 2Q 2008, we must note that other values of the oil company have demonstrated a significant growth. During 2Q 2008 LUKOIL’s sales increased +58.7% versus similar term of 2007 and formed 31.935 bn USD, although we have expected this value to form 35.507 bn USD, EBITDA added +59.8% to 6,403 bn USD, whereas we anticipated this value to achieve 6,388 bn USD. Let us take a closer look at company’s effectiveness in 2Q 2008. All financial income values of the company have been improved versus 2Q 2007. EBITDA margin has formed 20%, appearing +0.2 p.p. over the past year and +1 p.p. above year’s value, net income margin increased +0.4 p.p. to a total of 12.9%. Invested capital yield of LUKOIL is still rather high and formed 32.64% in annual value, including results of 2Q 2008. Considering high ROIC value and reduction of extraction in 2Q down -3.1%, company misses the chance for a much more significant expansion of additional value for the shareholders. In general – we see the issued report as quite expected. The sole thing to surprise us was low sales throughout the reported term, caused by degraded sales of crude oil to the west. The current actvities of the company, plans on reducing the tax load and strategic plans still allow LUKOIL to be seen through a prism of optimism. Company had officially started extraction and Yuzhno-Khilchuyskoye deposit on August 28th. Another important issue is company’s equity. After publishing the report, LUKOIL’s quotes have dropped over -2.5% at MICEX. This we related first of all to a technical factor, reflecting player’s reaction at real net income results failing to achieve the forecast by -10%. And with another fact that after a positive closing of oil & gas sector, oil prices during the American session have dropped (over -2.5%). In the prospect we see quite decent chances of the company to expand its capitalization, as for now LUKOIL is traded as one of the most underestimated company versus primary foreign and Russian counterparts. We must note future results of 3Q. Taking into account today’s trend of crude oil and oil products market, when starting from early July to given days oil prices have dropped -22.8% and more, under constantly highest export duties of 495.9 USD per ton, we could once more witness the effect of “Kudrin’s Scissors”. Such as in 2Q – the duty-free price per ton of oil formed 508.7 USD, now the ton worth 14.5% below (434.6 USD). And this very effect stops LUKOIL from demonstrating effectiveness similar to 1H. Now, to sum up, we must say that company seems rather strong if compared to its counterparts, and we assume that in mid-term and long-term LUKOIL’s stocks would increase, subjecting their quotes to technical corrections from time to time. Forecasts and estimates Now we correct our model of LUKOIL, adding several changes into it. For example, we have reviewed our forecast of oil and oil products sales price upwards at average of +10%, using current trends of global energy-carriers market and our forecast of world’s economic and political environment development. In our opinion, the long-term growth trend dominating world oil market, would continue. Then the drop that we are witnessing right now is a correction towards a sharp growth of latest half of year. Every since the early 2008 towards the end of June oil prices have expanded +50%. And obviously the current drop of -19.5% is a healthy technical correction, which in any case would be brought by a number of speculative factors. If we look from a fundamental technical stand point, which we reflected in our previous reviews of oil companies, our model remains mostly intact and in long-term we think that oil price would float at about 100-115 USD per barrel. Our model reflects a number of year’s final macroeconomic values of Russia (GDP, inflation, electric tariffs and pipeline transport costs) and respective forecasts for upcoming years. The forecasted values remained unchanged, aside from values of 2008 which we expanded using the expectations of Russian government on inflation and GDP growths. We have reflected decrease of crude oil export to the west, considering the results of 2Q. LUKOIL’s sales structure has been left unchanged, as since the year’s beginning it suffered no changes. The sole value to be corrected by us was increase of refining next year +7.84 mn tons through purchase of 49% of Italy’s petrochemical complex of ISAB. In addition we have corrected oil extraction rate downwards in forecasted term, due to company’s already ongoing reduction of -3.1%. And now the company would only be able to stabilize the extraction within next couple of years, afterwards the increase in extraction could be restarted. We connect this growth extraction with further development of Yuzhno-Khilchuysky deposit and development of Northern Caspian. Through a slower increase of extraction the target price of the company suffered a moderate decrease. In addition to this we have also reviewed capital investments volume, expanding it at +3.3% (average) throughout forecasted term, mostly due to a much more aggressive spending this year, through which we expected costs to grow +19% and in the end the growth could form 22.5%, as seen through results of 1H 2008. Another important top is increased investment risk for Russian companies, due to the latest events at Northern Caucasus, political risks and general crisis events throughout international financial markets. Our model was built to include all the re-appearing risks, which boosted weighted average cost of capital rate at +0.65 p.p. The resulting corrections brought a new fair price for LUKOIL’s stock, which now forms 129. 63 USD apiece versus previously forecasted 138.44 USD (-6.4%). And therefore, due to a significant growth potential (+74.71%) we confirm “BUY” recommendation on company’s stocks. |
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