Russia Risk


Russia investments have a risk to keep in mind now.

There has been some good news about one of Russia’s biggest companies, Gazprom the world’s largest vertically integrated natural gas company in terms of reserves, production and transportation.

Jyske Bank says:

Gazprom is also involved in oil production and oil refining, petrochemicals and other oil-related products. Gazprom’s key activities are located in Russia, and the Russian state owns a majority stake in the company.

Recent Developments

Gazprom has released its accounts for Q2 2008. Again, the accounts were a good deal stronger than expected in the market. Sales were up by 57.8% at RUB 840.3bn (USD 28.6bn), while EBITDA was up by 113.4% at RUB 394.3bn (USD
13.4bn). The strong improvement in the accounts is due to the higher European gas prices in the first half of 2008 and to higher earnings from the CIS countries and the Russian market.

However, cash flow from operations amounted to only RUB 122.2bn (USD 4.2bn) because more capital was tied up as working capital. The quarter’s investments amounted to RUB 177.2bn (USD 6.0bn) and the free cash flow was
thus negative at RUB 54.9.5bn (USD 1.9bn).

Total debt fell from RUB 1,467.8bn (USD 50.0bn) at the end of Q1 2008 to RUB
1,116.2bn (USD 38.0bn) at the end of Q2 2008.

But the fall was principally due to the fact that Gazprombank is no longer consolidated in the accounts. Leverage in terms of net debt to LTM
EBITDA fell from 1.0x at the end of Q1 to 0.7x at the end of Q2 2008. In 2009 Gazprom expects to continue its massive investment programme, but expects to be able to finance the investment programme through cash flow from
operations.

Recommendation

Gazprom’s quarterly accounts were a good deal stronger than expected in the market. Looking ahead, focus will be on the refinancing of loans
amounting to USD 10.1bn which are due for repayment before the end of H2 2009.

In this respect, Gazprom is facing a refinancing risk, but in our view Gazprom will be able to refinance its loans through internally-generated cash flow as
loans taken up through the Russian state. In our view, the Russian government will go far to provide financing for Gazprom. We maintain our BUY recommendation for Gazprom, finding that the yield is very attractive in view of the credit
risk.

Strengths/Opportunities

• Positioned as the largest gas producer in the world with massive reserves.
• Vertically well-integrated in the Russian market.
• Holds a monopoly on the export of gas from Russia.
• Access to new gas projects in Russia.
• The Russian state is the main shareholder.
• Potential of further government subsidies.

Weaknesses/Threats

• Large capital costs on existing pipelines and major investments in the expansion of pipelines.
• The expansion strategy involving major acquisitions may increase the debt burden.
• Low gas prices in the Russian market.
• High degree of public regulation.
• Dependent on political climate in Russia.

Development in Price and Spread

S&P: BBB (stable outlook)
Moody’s: A3 (positive outlook)

There are several Gazprom issues

Currency            Bond                       Price            Yield

EUR             7.80% 2010                  99.25           8.24%

EUR             5.03% 2014                  68.50         14.02%

EUR             5.44% 2017                  60.25          13.37%

GBP             6.58% 2013                  77.00           13.33%

USD             9.625% 2013                93.25            11.71%

Those long term double digit yields really look attractive to me…except I keep remembering a dinner I had in Copenhagen with Andrei Kozyrev, the former foreign minister of the Russian Federation for Boris Yeltsin from 1990 to 1996.

After the failed Soviet coup attempt of 1991,  Kozyrev  found himself in Yeltsin’s team of young reformers, which included Yegor Gaidar and Anatoly Chubais,
and shared their Western liberal-democratic ideals. This was one of the
men who helped dismantle the Soviet Union.

Merri and I enjoyed meeting him. He was a wealth of information.

I continue to recall his one comment when  asked him about Russian economics. He said, “Gary to understand how Russia will do, simply watch the price of oil.”

I may well take advantage of these high yields myself but in moderation because of those words.

Gary

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