In March this year I moved back to Russia after spending 20 years abroad. This move was a complex decision. Among other things it gave me an opportunity to run a real company and hopefully take it public one day. Additionally, being here allows me to get a better picture of the Russian stock market. Being used to GuruFocus, I feel a total lack of comfort trying to research companies trading on Micex. There is no centralized updated electronic database with financials — you have to go to dozens of different resources for bits and pieces of info. But the gold is hiding underneath the dirt. Lack of transparency and visibility for the rest of the world creates a situation of incredible underpricing for Russian securities.
Surgutneftegaz (SNGS), the company I want to focus on today, is a great example. I bet you never heard of it in your life, but it is sixth biggest public company in Russia and forth biggest oil producer in Russia with a capitalization of 1.02 trillion rubles, or $32.7 billion. It is the most secretive Russian public company, and it is the only one of such size that doesn’t publish IFRS reports. Russian accounting standards are not very different from IFRS, but there a lot of details. One such detail is asset valuation. You can bet that any asset valued under the Russian system will be valued higher under IFRS. The reason is that Russian laws allow for faster depreciation of assets on the balance sheet so that companies can pay less taxes. Therefore, nder IFRS you would typically see higher earnings and higher assets values for the same company. There is a new law that is forcing SNGS to start IFRS reporting from 2013.
With a market cap of $32.7 billion, SNGS is sitting on $50 billion of equity. This $50 billion is a combination of long- and short-term investments. You will be shocked, but the Russian accounting system doesn’t force it to disclose what exactly it consists of. Many have tried to research the matter and the consensus is that about $30 billion from it is cash deposits in few Russian banks and the rest of it is the shares of the company owned by the subsidiaries. Why do subsidiaries own shares of the company that owns them? Good question. You have to live in Russia to understand it. The ownership structure is extremely complex. Until recently,it consisted of dozens of OOOs (limited liability companies) and 23 so-called non-commercial partnerships (NPs). SNGS owns OOOs which in turn owns NPs, and NPs own the shares of the head company. The ownership structure is below. I can translate it, but it won’t give more clarity.
In preparation for IFRS, reporting of the ownership structure was transformed and now only 13 NPs remain. Such a complex structure was created for multitude of reasons including protection from unfriendly takeovers. The market has punished SNGS's lack of transparency with extremely low capitalization for such a monster in excellent financial shape.
Here are the fundamentals of the business.
|Cashflow model mil $||2009||2010||2011||2012||2013||2014||2015||2016||2017|
|(increase)/ decrease of working capital||343||-405||-726||-12||74||-55||-51||5||32|
|Free Cash Flow||1681||2949||4505||3468||3001||3343||3135||3149||2940|
WACC - 13.4% (Russian reality)
Final growth rate - 1%
Tax rate - 20%
|Discounted Cash Flow||13344|
|Adjusted terminal value||12814|
|Value of cash flows||27158|
|Valued of preferred shares||5565|
|Tangible book value||52972|
|Fair Value (end of 2012)||$1.48|
The financials are self-explanatory. If we compare SNGS to other big Russian oil producers we will see that its EV/production is about $30/bbl, while for other companies it is on average $75/bbl. SNGS however is as effective as the rest of them. EBITDA/production is about $23 to $25 which is in line with others. Another interesting fact is that Bank of New York (BK) owns 7% of shares of SNGS. SNGS also shows a cyclical pattern related to once-a-year dividend payments. It always starts to grow in August and September, reaching the peak in the winter and then dropping in March and April.
Disclaimer: I own SNGS shares.