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Short shrift for Gazprom’s portfolio investors

The world’s largest gas producer is once more likely to ignore calls to increase dividends

Investors hoping for a dividend windfall from Gazprom are likely to be shortchanged again, as Russia's gas export monopoly prepares for a spending splurge to fund new pipelines to China, Turkey and Germany.

Analysts say Gazprom is hell-bent on spending money on "value-destructive" investment projects rather than complying with a Kremlin decree to raise dividends to 50% of earnings, as defined under International Financial Reporting Standards (IFRS).

In the past two years, Gazprom has managed to wiggle out of its obligations by securing a controversial waiver. At this stage in the financial year, it's looking as if negative free cash flow leaves limited room for dividend upside and investors will again be disappointed.

"Some investors still have high hopes for Gazprom to change its stripes and increase its dividend pay-out relatively—even slightly," said Luis Saenz, head of equities at Moscow brokerage BCS Financial.

"We caution that with Brent at $70 a barrel, we see the Russian authorities having little urge to really push for more from the oil and gas companies."

In April last year, the Kremlin decreed that state-owned companies must fork out half of their earnings in dividends, in a renewed bid to squeeze companies like Gazprom.

The windfall would help to prop up the federal budget, which has been hit by recession, lower energy prices and sanctions imposed by the US and the EU.

With a higher oil price resulting in fuller federal coffers, the finance ministry appears to be under less pressure to force state-owned companies to fulfil their obligations.

The official budget deficit for 2018 was forecast to be -3.2% of GDP, but the Kremlin may now run a surplus for the first time in almost three years, if the average oil price for the year is higher than the estimated breakeven of $53 per barrel.At the time of writing Brent was trading at around $70/b.

State budget prop

Gazprom, the world's largest gas producer, is the biggest contributor of dividends to Russia's federal budget, and has previously sought and obtained two waivers to avoid paying higher dividends.

The company's chief executive Alexei Miller doesn't seem unduly concerned. He has said he expects Gazprom's current total dividend payment of R190bn ($3.26) to remain steady until 2020.

That's about 20% of profits, under IFRS, so well below the threshold required by the government decree. Gazprom's chairman, Viktor Zubkov, said in late January that the company's share of the European gas market, where it generates the majority of its revenue, increased last year to a record high of more than 35%, up from about 33% in 2016.

Gazprom's 2017 gas exports to Europe and Turkey were up 8.1% to a record 193.9bn cubic metres, despite Europe's efforts to cut its reliance on Russian energy supplies.

In December 2017, Gazprom's board of directors approved a record investment program of almost R1.4 trillion, 13.3% higher than the previous year. Russia has been seeking to boost its energy influence in Europe by building more pipelines to bypass Ukraine, such as Nord Stream 2—across the Baltic to Germany—and TurkStream.

In 2018, the investments in TurkStream will total R182.4bn, almost double the R92.8bn spent in 2017. Gazprom this year plans to invest R114.5bn in Nord Stream 2, compared to R102.4bn invested last year.

The construction of Gazprom's 3,000km Power of Siberia pipeline to China and the development of the Chayandinskoye resource base in Yakutia are ahead of schedule.

Chief executive Alexei Miller has named 20 December 2019 as the start date for deliveries. The pipeline, which is supposed to transport up to 38bn cm per year of gas to China, is expected to cost R770bn, while the investment in the gas production is R430bn.

Capex threat

Analysts believe management will use these new investment projects as an argument not to comply with the decree.

An increased dividend pay-out would put a large dent in the capex programme of Gazprom, which may also have to contend with the possibility of increased taxation. Gazprom, which is not subject to Western sanctions resulting from Russian interference in the Ukraine conflict, could try to borrow heavily on capital markets to pay the higher dividend payments.

But most investors accept Gazprom will neither pay the higher dividend, nor be prepared to rein in its ambitious capex programme.

That's reflected in the company's share price, which has suffered from the slump in energy prices, and political unrest within its sphere of operations. From a high of around $17 in 2011, its shares now trade at around $5 in London.

"A year ago, President Vladimir Putin said that Gazprom's profits are mostly on paper," said a veteran Russian portfolio manager. "So, we take it that this decree requiring the company to pay investors more dividends is purely theoretical."

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