December 25, 2017
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) for the Gazprom Group do you expect at the end of 2017?
The slump in oil prices, which had begun in 2014, led to a change in price dynamics in regional energy markets, which continues to affect our financial performance. Taking into account the need for auditing, the Gazprom Group’s IFRS financial statements for 2017 will be compiled and published in late April next year, so we can only speak of preliminary forecasts at the moment.
However, taking into account the expected rebound in the average annual oil and gas prices in the European market, the record-breaking gas sales to Europe, and the steady growth in oil output, we expect the 2017 ruble revenue to increase by about 5 per cent versus 2016. EBITDA growth in ruble terms may hover from 10 to 15 per cent.
The year-end EBITDA margin, according to our forecasts, will be near the 2016 level – at around 20 to 25 per cent. It is difficult to predict net profit right now due to the heavy influence of currency exchange differences, which hinge on the currency exchange rates at the last reporting date of the year. In 2016, the appreciation of the ruble considerably enhanced the “paper component” of the net profit, resulting in a bigger profit. This year, there are much fewer prerequisites for that.
- What amount of free cash flow is anticipated at the end of 2017?
Against all odds, thanks to consistent cost optimization efforts taken in 2016, we managed to have USD 3 billion of positive free cash flow. In the first half of 2017, we generated almost USD 2 billion, thus creating a solid reserve until the end of the year. At the same time, in view of the need to launch three strategic investment projects of Gazprom before 2020 – Power of Siberia, Nord Stream 2, and TurkStream – we anticipate an increase in the Group’s investments in the second half of 2017.
We will continue to improve our free cash flow profile. Nevertheless, in view of the aforementioned factors it would be objectively difficult to generate a positive free cash flow in 2017. The bottom line will also depend on the dynamics of the working capital across the Gazprom Group throughout the year.
- Is the debt load of the Gazprom Group going to rise in 2017?
According to the Gazprom Group’s IFRS financial statements for the first half of 2017, the most telling indicator of the debt load – the net debt to EBITDA ratio – amounted to 1.6, a comfortable level by both Russian and international standards. Adjusted for the value of bank deposit agreements that contain an acceleration clause in favor of Gazprom, this indicator goes down to 1.3.
Gazprom maintains a strong financial position thanks to its conservative financial policy, the predominance of the currency component in the revenue structure, and low production costs, which keep our corporation competitive in the key markets.
In 2017, we saw a decrease in the cost of borrowings caused by the overall situation at the global financial market and Gazprom’s well-planned strategy with respect to issuing debt instruments – in particular, the timing of Eurobond offerings.
I would also like to note that we are committed to the policy of enhancing control over the Gazprom Group’s external borrowings and debts and of managing their excess liquidity. To that end, Gazprom sets limits for debt ratios of its companies, with an increasing number of subsidiaries getting involved in the cash pooling system. The Procedure on the provision and processing of debt information for the Gazprom Group has been approved.
- Tell us about the medium-term debt financing strategy of the Gazprom Group. Is it affected by foreign sanctions?
Gazprom is pursuing a conservative borrowing policy. As a result, our overall debt, repayment profile, average debt price, and debt ratios are currently at comfortable levels.
The amount of borrowings for the next year is determined in the Company’s budget approved by the Board of Directors. Taking into account the significant amount of scheduled debt repayment and loans for the Nord Stream 2 and Amur GPP projects (consolidated in the Gazprom Group’s IFRS financial statements), as well as the favorable conditions in the debt market in general, we plan to expand the borrowing program. However, we intend to try and avoid substantial increases in debt obligations and to advance toward their gradual reduction. At the same time, we will continue optimizing the debt portfolio and reducing the average interest rates.
When shaping our borrowing strategy, we follow the situation in the key financial markets of bank loans and bond issues (in foreign currency and in rubles). Gazprom mostly takes out loans in foreign currency (euros, US dollars, Swiss francs). This is explained by a number of factors, such as low interest rates in foreign markets and the much larger size of the market for foreign currency borrowings compared to ruble instruments, fulfilling the debt financing needs of a corporation as big, even by international standards, as Gazprom. Besides, about two-thirds of the Group’s revenue is generated in foreign currency, which creates a natural currency hedge for debt servicing.
Gazprom has not forgotten about the ruble market either. Ruble borrowings constitute about 18 per cent of the Group’s debt portfolio. They prevail in the debt portfolios of many of our subsidiaries. In particular, Gazprom Neft, subjected to sanctions and unable to freely borrow in international markets, is actively raising funds in rubles.
The current sanctions restrictions, despite occasionally prompting the legal departments of our counterparties to carry out additional reviews, have no direct impact on our relationship with the international financial and business community or on Gazprom’s borrowing plans in either corporate or project financing. Investors remain keenly interested in Gazprom’s activities and key projects.
- What are your plans concerning the scale of the investment program in 2018? Does the Company face any difficulties in financing investment projects?
The expected amount of investments embedded in Gazprom’s draft Investment Program for 2018 and approved by the Company’s Board of Directors on December 20, is RUB 1.28 trillion, including RUB 798 billion under the capital construction plan, RUB 439 billion under the long-term financial investments plan, and RUB 41 billion under the non-current assets purchase plan.
Such factors as the simultaneous execution of three major strategic projects – Power of Siberia, Nord Stream 2, and TurkStream – along with the need for investments in gas production and transmission capacities and the oil business undoubtedly put a heavy strain on Gazprom’s budget.
We are taking consistent efforts to optimize our operating and capital expenditures, as well as to find new sources of income. Depending on the state of the oil and gas market, Gazprom may not be able to fully cover the costs of those projects with cash revenue from its core businesses in 2018–2019.
The amount of borrowings will have to be temporarily increased for the purposes of scheduled repayment of the current debt and dividends payouts. According to the draft budget (financial plan) of Gazprom, the external financial borrowings will total RUB 416.971 billion. As a result, the financial plan will provide for a full coverage of the Company’s liabilities in 2018 without a deficit.
- Tell us about your project financing plans.
Gazprom continues to secure project financing for the Amur GPP and Nord Stream 2 projects. It is also structuring a number of other major investment projects to enable the use of this type of instrument.
The ongoing analysis of the feasibility and advisability of project financing is carried out in close cooperation with the companies of the Gazprom Group. In particular, Gazprom Investproject is developing business models for some of the Group’s projects so as to maximize the share of external funding in the financing structure and to reduce Gazprom’s investment burden.
- How much will Gazprom pay in taxes in 2017?
Unfortunately, Gazprom’s tax burden kept growing in 2017 due to the upward revision of the Cgp coefficient in the severance tax formula for natural gas. This indicator applies exclusively to Gazprom, while a lower severance tax rate is kept for independent gas producers. Therefore, the total tax payments across the Group in 2017 will be up by some 15 per cent versus 2016, reaching about RUB 2.2 trillion.
It should be noted, however, that, in accordance with the Tax Code of the Russian Federation, the scale factor in the severance tax formula for Gazprom’s gas will be reduced in 2018 roughly to the level of 2016 and will be brought down to the level of 2015 after 2020.
- What is the Company’s strategy with respect to Gazprombank?
As the Bank of Russia imposed more stringent requirements to the capital adequacy of banks in 2017, the Gazprom Group carried out additional capitalization of Gazprombank in the amount of RUB 60 billion. As a result, the Group’s effective share in Gazprombank was upped from 37 to 48 per cent.
Gazprom did not receive any dividends from Gazprombank based on the results of 2014 and 2015 due to an unfavorable economic environment, but the 2016 results yielded around RUB 3 billion of dividends for the Group. We expect a stable dividend yield from participating in Gazprombank’s capital in future periods as well.
It is planned to broaden cooperation between Gazprombank and the companies of the Gazprom Group and their staff in the area of corporate and retail banking products and services. Moreover, Gazprombank will also be engaged in securing financing for major investment projects run by Gazprom.
- What dividend amount is the Company planning to pay out based on the results of 2017?
Gazprom’s leadership seeks to maintain a balanced approach to implementing the dividend policy in 2018–2020. The Company strives to keep the ruble dividend payouts equal to or higher than in the previous year. As it happens, we paid RUB 8.04 per share in 2017.
The amount of dividends is determined taking into account the international oil and gas and financial markets, net profit coverage with free cash flow, scheduled repayment of Gazprom’s debt obligations, and the Company’s needs for financing large-scale investment projects.
Gazprom was the 2016 leader among Russian public companies in absolute terms with regard to dividend payouts and the amount of dividends attributable to the state. Gazprom’s dividend yield on the dividends for 2016 is around 6.5 per cent, one of the highest in the oil and gas industry.
- Are you planning to step up export sales in rubles?
The Company may make such a decision only after having thoroughly analyzed all pros and cons of the existing commercial practices, currency market outlooks, and the effectiveness of the currency market instruments, after negotiations with other parties in the contractual relationships and with due consideration of the potential economic benefits for Gazprom.
At present, Belarus and South Ossetia purchase natural gas for rubles, accounting for 60 per cent of sales to the former Soviet Union. At the same time, most contracts for gas supplies to the CIS include the possibility of paying for natural gas in Russian rubles.
Asia and Middle East
- Please talk about your cooperation with Asian banks and stock exchanges.
Gazprom successfully cooperates with Asia-Pacific countries in various areas. Gas supplies to China via the Power of Siberia gas pipeline and the planned buildup of LNG production capacities in Sakhalin will allow the Company to gain a solid footing in the Asian gas market. Along with extending our geographic reach, we intensify cooperation with Asia-Pacific banking institutions, in particular, with Japanese and Chinese banks, to obtain bank loans. Last year, we entered into a EUR 2 billion loan facility agreement with Bank of China. It was the largest deal in Gazprom’s history in terms of the amount of financing attracted directly from a single financial institution. Bank of China was also among the organizers of last year’s Eurobond issue. Gazprom plans to expand its presence in the promising Chinese market of bank loans.
Cooperation is advancing with Japan’s Mizuho and Sumitomo Mitsui, the banks that organized the Eurobond issues in 2017 and contributed to securing a five-year club-deal loan worth EUR 1 billion, with the corresponding agreement signed in late November.
Besides, Gazprom is consistently expanding its relationships with Asian banks in the area of project financing. Last year, Alexey Miller, Chairman of the Gazprom Management Committee, and Zheng Zhijie, President of China Development Bank Corporation, signed a Memorandum of Understanding that outlined the principles of cooperation in project financing, including for the Amur GPP construction project. This September, Alexey Miller and Tadashi Maeda, CEO and Executive Managing Director of Japan Bank for International Cooperation, signed a Memorandum of Understanding at the Eastern Economic Forum in Vladivostok. The Memorandum is aimed at advancing cooperation in securing financing for Gazprom’s projects involving Japanese companies. The document also spells out a number of provisions of the Memorandum inked in December 2016.
We continue to increase the share of Asia-Pacific investors in the Company’s equity capital. This year, we held a key annual event – Gazprom’s Investor Day – in Asia’s largest financial centers: Singapore and Hong Kong. About 200 portfolio managers and analysts from major regional and international investment funds and banking institutions attended the event.
In addition, we participate in major investment conferences in the region every year, as well as hold individual meetings with the existing and potential shareholders of the Company.
- The Gazprom Group owns assets outside of Russia. How do you assess the political risks in Iraq, Serbia, and Libya?
The Company’s presence in the Middle East and the Balkans is still strategically important. We are exploring further development options in these regions: a number of projects are under consideration and discussion right now.
In Serbia, substantial assets belong to our subsidiary Gazprom Neft, which is quite successful there.
Since 2007, the Gazprom Group has been a party to the Exploration and Production Sharing Agreements for blocks Nos. 19 and 64 in Libya. Due to civil unrest in the country, the outbreak of hostilities, and the imposition of international sanctions against Libya in February 2011, the Group had to suspend the relevant contracts, declaring force majeure and evacuating personnel. The complicated political situation in the country and the lack of security guarantees prevent us from lifting the force majeure and resuming operations in those blocks.
Also since 2007, the Gazprom Group has been a member of a joint venture with Wintershall, developing oil concessions C96 and C97 in Libya. Wells and production facilities are operational and undergo regular maintenance. Production resumes whenever the opportunity arises to transport oil to the export terminal and ship it elsewhere.
Gazprom is not implementing any gas projects in Iraq at the moment, but our subsidiary Gazprom Neft is running several oil projects there.
- How do you explain the low stock prices of Russian oil and gas companies? Are there any prospects for an upturn?
Indeed, if we compare the stock prices of Russian companies with those of corporations from developed and developing countries, Russian shares look highly undervalued. Unfortunately, the unfavorable economic situation stemming from low commodity prices coupled with negative geopolitical news has an adverse impact on the Russian stock market as a whole.
When we talk about the valuation of oil and gas companies, we should first of all highlight the industry’s capital intensity. To generate a unit of cash flow, you need much more investment than in other industries. In addition, stability and predictability of the tax regime are of great importance to investors purchasing shares of Russian oil and gas companies.
At the same time, the oil and gas market is gradually recovering, in large part thanks to concerted efforts of OPEC, Russia, and a number of other major oil producers. Over the last year, the macroeconomic situation in Russia improved dramatically. Inflation is at a record low, the ruble is getting stronger, the unemployment level is one of the lowest in the world, the GDP growth is projected to exceed 2 per cent, and, importantly, companies’ profits are growing. The risks associated with investments in Russian businesses are slowly declining.
If we compare the financial performance of Gazprom and its competitors, Gazprom obviously stands out. We have a high dividend yield (about 7 per cent), while the average dividend yield of our foreign peers is less than 4 per cent. If we look at the key market multipliers used by financial analysts, P/E and EV/EBITDA, Gazprom demonstrates the lowest figures across the industry, which indicates that the Company’s market value is strongly underestimated relative to its profits.
At the same time, Gazprom’s capitalization is undermined by the discriminatory tax regime favoring other Russian oil and gas companies. I mean the increase in the severance tax rate.
- How do you plan to improve the efficiency of the Gazprom Group?
Gazprom is making sustained efforts to improve the efficiency of both the parent company and its subsidiaries. The purpose of the financial measures is to improve the market results by cutting costs and finding new sources of income.
The Company has a conservative approach to financial planning, using various tools to curb cost increases. Those tools include cost optimization at the stage of the budget and investment program formation and adjustment, extensive use of competitive procurement procedures, and implementation of operational efficiency and cost reduction programs.
The work begins at the stage of long-term planning and shaping the composition and schedule of key investment projects and ends at the stages of budget planning for the coming year and tight control over its implementation.
- How much does the Company plan to earn from selling its non-core assets in 2017? What are the plans for 2018?
In accordance with the Property and Asset Management Strategy approved by the Board of Directors, we constantly take measures to identify and sell non-core assets. Pursuant to the Board of Directors’ decision, the Non-Core Assets Disposal Program and the Register of Gazprom’s Non-Core Assets were approved last September with due account for the specifics of Gazprom’s activities and the existing practice of selling non-core assets.
This past August, the Board of Directors approved the new versions of the Action Plan for Non-Core Assets Disposal and the Register of Gazprom’s Non-Core Assets. Jointly with its subsidiaries, Gazprom is active in selling non-core assets. The primary way of non-core assets disposal is to sell them at auctions at a price not lower than their market value.
In 2017 and 2018, the annual income from the sales of non-core assets of the Gazprom Group is expected to amount to some RUB 2 billion.