Investments secured. Interview with Andrey Kruglov
December 28, 2016
Published in corporate Gazprom Magazine Issue 12, interview conducted by Sergey Pravosudov
Andrey Kruglov, Deputy Chairman of the Gazprom Management Committee, answers questions from Gazprom Magazine
- Mr. Kruglov, what financial results (revenue, EBITDA, net profit) is Gazprom Group expecting at the end of 2016?
The challenging environment in the commodity markets and the continuing decline in global energy prices are putting pressure on the financial performance of oil and gas companies such as Gazprom. According to our preliminary estimates, the Group’s dollar revenue may drop by more than 10 per cent in 2016. EBITDA may fall by over 30 per cent in dollar terms and by more than 25 per cent in ruble terms against 2015.
Due to the prevalence of foreign currency debt in our credit portfolio, the Group’s net profit in 2016 will largely depend on the dynamics of currency exchange, which will be determined by the ruble exchange rate on the last business day of the year. The changes in valuation reserves and additional updates to the year-end financial statements under IFRS may also have a strong impact on the bottom-line results. Under the current conditions, we expect decent results by the end of the year, but it is too early for specific forecasts.
In 2016, Gazprom’s dollar revenue may drop by more than 10 per cent. EBITDA may fall by over 30 per cent in dollar terms and by more than 25 per cent in ruble terms against 2015
- What EBITDA profitability do you anticipate at the end of 2016?
Gazprom Group’s EBITDA is expected to be around 25 per cent in 2016, which is somewhat lower than in 2015, when it was 31 per cent. The expected slump in profitability can be primarily attributed to the downturn in the oil and gas markets, the increased tax burden, and the upsurge in low-margin trading operations thanks to the consolidation of trading businesses in Europe. It should be noted that Gazprom is reducing its expenses, which partly offsets the aforementioned factors.
- How large will the free cash flow be at the end of 2016?
Considering the financing requirements of the investment program and the deterioration in the energy markets, the free cash flow will be significantly lower in 2016 than in the previous years. Capital investments will be close to the level of cash flow from operations. We are trying to maintain the positive trend for this indicator.
- What is the current level and prospects of Gazprom Group’s debt load?
According to Gazprom Group’s financial statements under IFRS for the first six months of 2016, the most representative indicator of debt load – net debt to EBITDA ratio – was 1.1, a figure considered low by Russian and international companies alike. We expect EBITDA to decline by the end of 2016, which will prompt debt ratios to grow, but they will still be manageable.
Gazprom remains financially sound amid low energy prices thanks to the groundwork laid in the previous years through strengthening the Group’s financial stability, pursuing a conservative financial policy, prioritizing foreign currencies in the revenue structure, and maintaining the low cost of production, all of which will keep Gazprom competitive in its key markets.
In view of the sizable amount of debt obligations we plan to repay and a rather favorable environment in the debt markets, we are going to expand our borrowings program. We intend to avoid a significant increase in debt obligations and take steps to gradually reduce them. We will continue to optimize our debt portfolio and lower the average interest rates.
- What are Gazprom’s priorities in debt financing?
Our borrowings strategy is guided by the situation in the major financial markets, especially those dealing in bank loans and bond issues (in foreign currencies and rubles). Most of Gazprom’s borrowings are made in foreign currencies (EUR, USD, CHF) due to a number of factors, such as low interest rates abroad and the market capacity for foreign exchange borrowings being larger than the one for ruble-denominated instruments. Moreover, about two-thirds of the Company’s revenue is made in foreign currency, resulting in a natural foreign currency hedge for debt servicing.
That said, Gazprom is also active in the ruble market. Around 13 per cent of the Company’s debt portfolio is comprised of ruble borrowings, which dominate the debt portfolios of many of our subsidiaries. For instance, Gazprom Neft, confronted with limits on international borrowings because of sanctions, actively uses debt financing in rubles.
- Is Gazprom facing any difficulties in financing its major investment projects?
Gazprom’s investment program takes into account the priorities in the commissioning of production capacities and the market situation. Top-priority projects allow the Company to achieve its strategic goals. As of 2016, the largest of those projects include the development of the Bovanenkovskoye field in the Yamal Peninsula, the expansion of the Bovanenkovo – Ukhta and Ukhta – Torzhok gas pipeline system, and the construction of the Power of Siberia gas pipeline together with the development of the Chayandinskoye field.
Gazprom’s adjusted Investment Program for 2016 provides for investing RUB 56 billion in the pre-development of Bovanenkovskoye, RUB 131 billion and 52 billion in the expansion of Bovanenkovo – Ukhta and Ukhta – Torzhok, respectively, RUB 76 billion in the construction of Power of Siberia, and RUB 55 billion in the pre-development of Chayandinskoye.
ЧWhen it comes to financing all those projects, we rely primarily on our operating income. By using a comprehensive approach in planning, we have maintained our free cash flow positive for over 10 years now, with Gazprom Group’s cash flow from operations exceeding its capital investments. We will adhere to the principle of financing the investment program through cash flow from operations. We may, to a limited extent, use other sources in particularly difficult times of low energy prices. Besides, Gazprom is successfully attracting loans in the debt market. We have access to major international capital markets and the bank loan market. This is vividly exemplified by this November’s Eurobond issues worth EUR 1 billion and CHF 500 million, with record-low coupon rates for Russian issuers.
Of course, the challenging environment in the oil and gas market requires us to undertake extensive cost optimization and prioritize our expenditures, including with regard to the investment program. Nevertheless, Gazprom will secure financing for all of its top-priority investment projects.
- Please comment on Gazprom’s project financing plans.
Gazprom views project financing as an essential tool for implementing large-scale investment projects, especially those delivered jointly with foreign partners. Through project financing, we have successfully executed such projects as Nord Stream (EUR 6.4 billion in debt financing), Sakhalin II (USD 6.7 billion), and the development of the Yuzhno-Russkoye field (EUR 1.1 billion). Moreover, as far as project financing for Yuzhno-Russkoye is concerned, Severneftegazprom repaid in advance the remaining portion of that loan in early August of this year.
At present, the Company’s project financing-related efforts include Nord Stream 2, the Amur gas processing plant, and the development of Blocks 4A and 5A of the Achimov deposits in the Urengoyskoye field.
In 2016, the amount of tax payments from Gazprom and its gas production, transmission, processing and storage subsidiaries will near RUB 1.3 trillion
- How much will Gazprom pay in taxes in 2016?
Gazprom is one of the biggest taxpayers in our country. In 2016, the amount of tax payments from Gazprom and its gas production, transmission, processing and storage subsidiaries will near RUB 1.3 trillion. Amid the unstable macroeconomic environment in Russia accompanied by the growing budget deficit and other negative economic trends, the Russian Government once again takes measures to increase tax exemptions in the oil and gas industry.
2016 saw an increase in severance tax exemptions for gas and gas condensate produced by Gazprom, with the exemption ratio in the severance tax formula raised from 0.15 to 0.2051. The aggregate growth in severance tax burden for Gazprom Group will be around RUB 100 billion in 2016. The initial plan was to adopt an elevated exemption ratio for one year. However, this year the Russian legislation was amended yet again to increase the tax burden for Gazprom Group in relation to severance tax for gas in 2017–2019. That will pose an additional burden on Gazprom’s budget in 2017, totaling some RUB 170 billion in severance tax (or about RUB 70 billion versus the 2016 rates).
The increase in the severance tax burden anticipated within the next three years will not apply to gas condensate, as its exemption ratio is still 0.15 for all taxpayers.
- Is Gazprom planning to expand its cooperation with Asian banks and stock exchanges?
Gazprom is intensifying its cooperation with Asia-Pacific credit institutions, namely Japanese and Chinese banks, for the purposes of debt financing. In August 2015, Gazprom took out a loan of USD 1.5 billion from a consortium of Chinese banks for the first time. This March, we entered into a EUR 2 billion loan facility agreement with Bank of China. It is the largest deal in Gazprom’s history in terms of financing attracted directly from a single financial institution, as well as its first bilateral loan facility agreement with a Chinese bank.
Asian investors are actively involved in the issuance of Gazprom’s Eurobonds. Bank of China was among the bookrunners for Gazprom’s Eurobond issue this November. The Company is going to further step up its presence in China’s promising bank loan market.
In addition, we take consistent efforts to broaden our cooperation with Chinese banks in project financing. On November 7, 2016, Alexey Miller, Chairman of the Gazprom Management Committee, and Zheng Zhijie, President of China Development Bank Corporation, signed a Memorandum of Understanding as part of the meeting between the Prime Ministers of Russia and China. The document outlines the general principles of cooperation between the parties in arranging project or any other financing, including for the Amur GPP construction project.
Although today Asia-Pacific investors hold a smaller share in Gazprom’s equity capital than those from Europe and the U.S., the Company continues to increase that share in its equity structure. Every year, we participate in high-profile investment conferences across Asia-Pacific and hold individual meetings with our current and potential equity investors. In 2017, we plan to hold a key annual event – the Investor Day of Gazprom – in Hong Kong and Singapore, Asia’s major financial centers.
In June 2014, Gazprom became listed on the Singapore Exchange. We are currently seeking wider representation in the key stock markets of Asia-Pacific, which includes getting a higher listing level for our GDRs on the Singapore Exchange and obtaining a listing on the Hong Kong Stock Exchange. As for financing from the capital markets of Asia-Pacific, it should be noted that Asian markets do not have the liquidity and depth of the European and U.S. markets. A wide range of Asian currencies are characterized by significant cross-border demand among investors. At the same time, the market capacity of Asian capital markets grows each year and Asian investors constantly participate in our Eurobond offerings. Gazprom does not rule out the possibility of tapping the Eurobond market through a deal, provided that the value of such borrowing meets our expectations.
Dividends and stock prices
- What plans do you have for the dividend payout?
In 2016, Gazprom paid out RUB 7.89 per share in dividends, or a total of RUB 187 billion, which corresponds to 24 per cent of the net profit for Gazprom’s shareholders under IFRS (above 50 per cent of the adjusted net profit under RAS). The amount of dividends rose by 10 per cent versus the previous year. No other Russian public company paid as much to its shareholders as Gazprom in its dividend payout based on the results of 2015.
The Company’s management realize the importance of keeping payouts for shareholders stable and predictable. At the same time, it is imperative to maintain a responsible and well-balanced approach to dividend distribution for the purposes of preserving financial stability in view of a challenging and highly volatile external environment, a considerable amount of due payments under debt obligations, and the need to finance priority investment projects.
In order to ensure predictability, we will remain committed to maintaining dividends equal to or above last year’s amounts in absolute terms. We are also working to further streamline the Company’s dividend policy. The final decision on Gazprom’s dividends will be made at the Shareholders Meeting in accordance with the Board of Directors’ recommendation.
- The capitalization of Russian oil and gas companies is very low. What is the reason for that? Are there any prerequisites for stock price growth?
The stock prices of Russian oil and gas companies have been under strong pressure for the last two years due to negative external factors, chief among which are the decline in oil and gas prices across the world, the higher tax burden on the industry, and the sanctions against a number of Russian companies imposed by the U.S., the European Union, and other countries. Moreover, increased geopolitical risks have curbed investor interest in Russian issuers. At the same time, there is a recent trend of gradual recovery in external markets and there is hope for geopolitical tensions to subside.
What we are witnessing today is a surge of interest in Gazprom’s shares among market players
ЧAs far as Gazprom is concerned, our primary goal is to ensure sustainable financial and operating performance and consistent business development in the long term. We aim for efficiency improvement and optimization in the current strict and highly competitive regulatory environment, as well as for exploring opportunities to boost cash flow generation.
We also pay great attention to ensuring the rights of minority shareholders by improving corporate governance. In 2016, three independent directors joined our Board of Directors, and such governing bodies were formed as the Audit Committee led by an independent director, the Nomination and Remuneration Committee, where the majority of members are independent, and the Corporate Secretary unit.
We continue to actively engage Russian and international investors with a view to elucidate the key components of Gazprom’s current strategy, our priorities and achievements in the European gas market, as well as our financial results, financial policy priorities, etc.
What we are witnessing today is a surge of interest in Gazprom’s shares among market players.