WOOD Flash – Gazprom: 2Q18 – strong gas markets driving FCF higher

Gazprom reported 2Q18 IFRS results today (29 August), which we see as quite strong, with a quality earnings beat, as well as much better FCF (driven partially by lower capex). Gazprom is one of our top picks in the sector, despite it being the least-favoured stock in the market. We understand the market’s concerns surrounding the weak corporate governance standards and the poor alignment of interests between the controlling shareholder (the Russian government) and the minority investors. Without a clear link between earnings and shareholder returns (as management has committed to flat dividends in the medium term), on top of the peak investment cycle and various negative geopolitical headlines, it is somewhat understandable that the stock has underperformed its peers significantly. However, we believe that the market is underestimating the upside from the stronger gas market, which should allow the company to remain FCF positive this year and, assuming an unchanged 25% dividend payout ratio, should allow Gazprom to pay a c.10% dividend yield next year. Moreover, as Gazprom’s capex cycle starts coming off and new exports volumes start contributing, the company should experience a material transformation in FCF, with likely growth in dividends. Gazprom trades at our FY18E 2.6x P/E – close to the lower end of its historic valuation range (2.5-5x).