Gazprom Energoholding - Cash-Fired Turbines

OGK-2 and Mosenergo have announced that they will make equity injections into their new business that manufactures generating equipment (e.g. gas turbines). Because details are scant at this juncture, we have run a stress scenario for the valuation of both stocks in expectation of no cash inflow or positive synergies from the new business for the existing assets. We downgrade OGK-2 to HOLD and cut our target price by 12% to R0.65 per share. We also downgrade Mosenergo to HOLD and lower our target price by 14% to R2.48 per share.> OGK-2 and Mosenergo to provide cash to create equipment manufacturing business. OGK-2 and Mosenergo have approved substantial cash injections (R20 bln and R22.7 bln, respectively) for GEH Industrial Assets, an SPV that will manufacture power generating equipment. Another R10 bln will be provided by Gazprom Energoremont, which is a Gazprom subsidiary engaged in servicing. Mosenergo will control 43.1%, OGK-2 37.9% and Gazprom Energoremont 19%. TGK-1 was not involved in this particular transaction, though its BoD has approved a R11 bln loan to Gazprom.> No official press release... Neither OGK-2, Mosenergo nor GEH itself has provided any details on the development strategy for GEH Industrial Assets, though parent company Gazprom Energoholding (GEH) has announced plans to close a deal to purchase equipment manufacturer REP Holding from Gazprombank by the year-end. In June, REP Holding signed an agreement with Ansaldo Energia to create a JV to manufacture and service large gas turbines in St Petersburg. Media reports have indicated that GEH is considering partnering with Siemens to localize the production of large gas turbines in Russia.> ...pushes us into incorporating a "stress scenario" in our valuation. Lacking official information, we have opted to incorporate a stress scenario into our valuation. We believe that the prospects for GEH Industrial Assets remain unclear. There appear to be competing projects (such as InterRAO's JV with General Electric). We conservatively assume that GEH Industrial Assets will not provide any meaningful dividends for the foreseeable future. We await more comments from the companies and estimates with regard to potential opex/capex savings from having an equipment manufacturer under the same umbrella; at present, we do not incorporate any of these potential savings in our models.> Impact on dividends/debt. We believe that both OGK-2 and Mosenergo will continue paying dividends and continue to increase their payout ratios even after this substantial capital injection into GEH Industrial Assets. We currently model the payout stepping up to 40%, 45% and 50% of net income over the next three years. Mosenergo has enough cash on its balance sheet and will not need to take on additional debt. We calculate that OGK-2 might need to attract roughly R9 bln to increase its dividends, though Kommersant recently reported that it might sell Krasnoyarsk TPP-2 for R10 bln (although we do not incorporate this deal into our model yet) and receive the first R5 bln tranche as early as this coming January.> Impact on sentiment. A major deal that will take substantial amounts of cash from the balance sheets of two GEH subsidiaries and has not been sufficiently commented on by the major shareholder or the companies themselves looks detrimental to sentiment, in our view. GEH's recent steps, such as promising a higher payout, appeared to be positive for minority shareholders, but investors could now be prompted to reassess their view of corporate governance risks once again.> We downgrade both names to HOLD. Having updated our valuation models, we downgrade OGK-2 and Mosenergo to HOLD. We lower our target price for OGK-2 by 12% to R0.65 per share and we cut our target price for Mosenergo by 14% to R2.48 per share.