Over the past few years, emerging market equities have delivered lackluster performance. As negative headlines come to the fore, the focus tends to be less on individual companies and their fundamentals and more on fears of a deteriorating macroeconomic environment. We believe that at precisely these times—when concerns over geopolitical events swamp considerations at the company-specific level—that potentially compelling entry points may emerge.
On March 17–18, 2014, we participated in HSBC’s CEEMEA1 Investor Forum in New York and met with a variety of Russian companies. It was a great opportunity to hear directly from Russian managers what they thought of their operating environment, as well as their geopolitical picture. In this blog post, we will highlight our meetings with Gazprom2 and Novatek3. Major focal points of those meetings include:
For Gazprom:
• Gazprom’s outlook for natural gas demand and important weather-related concerns
• Unique aspects of Gazprom’s dividend policy
• Potential risks to Gazprom from the Ukraine situation
For Novatek:
• Novatek’s share buyback program
• Unique aspects of Novatek’s ownership structure and dividend policy
• Potential risks to Novatek from the Ukraine situation
Europe and Asia Need Natural Gas, and Gazprom Is a Significant Supplier
According to Gazprom, the company currently supplies approximately 30% of Europe’s natural gas. This means Russia’s decision to annex Crimea creates a tricky political calculus for the European Union. If the EU responds with any sanctions, it could potentially cut off its own energy supplies.
Potential Deal Between China and Gazprom
Gazprom representatives believe there is potential of engaging China in a long-term resource partnership. President Vladimir Putin, as of the time of our meeting, was scheduled for a trip to China in May to discuss a potential treaty with China National Petroleum Corporation (CNPC). China has been using recent commodity price weaknesses to help secure its long-term goals of acquiring resources. China has also used the political disruption between Europe, the U.S. and Russia as an opportunity to step in and fill the void, given its own resource needs.
Weather: A factor that could impact European Political outcomes
As Europe’s demand for natural gas increases, the political appeal of Russian sanctions will likely decrease. According to Gazprom, the current political turmoil could last until the end of summer—once fall hits and temperatures start going down again, the need for natural gas will rise. Gazprom does not see any easy way for Europe to replace its gas supplies in mere months.
A Potential Catalyst for Gazprom’s Dividend Growth: Changing Accounting Standards
A potential switch to International Financial Reporting Standards (IFRS)4 from Russian Accounting Standards could critically impact Gazprom’s dividend levels. A switch to IFRS could mean almost doubling Gazprom’s dividends if and when it happens, according to stock analysts we follow5.
Gazprom has many subsidiaries in which it holds stakes ranging from less than 1% ownership to 100% ownership. At present, Gazprom reports its financials for purposes of its dividend payout using Russian Accounting Standards, which inhibit the consolidation of results from all of the different subsidiaries into the results of the parent company. Should the government approve this accounting change—and it is a government-level decision—the 25% mandated payout ratio for state-owned enterprises (such as Gazprom) could potentially be applied to the results of the entire set of businesses in which Gazprom owns a stake.
Gazprom was unable to give specific guidance on the potential impact of this new set of accounting standards on future dividends, or exactly if and when the government would approve the change.
Gazprom’s Current Dividend Picture
The latest results of Gazprom stock trading in Russia show an annual dividend of approximately 6 rubles per share, with an ex-date of May 14, 2013. With a price of 127.00 rubles per share on March 18, 2014, the approximate dividend yield equals 4.7%. If the dividend were to double as some expect with the changeover to IFRS accounting standards, at the same price that could mean an almost double-digit dividend yield.
Thinking from a risk/return perspective, this higher income level could make Gazprom more attractive to income-oriented investors as the yield may compensate for the increased headline risk levels of Russian companies.
The Ukraine Risk Is Significant for Gazprom
Gazprom supplies much of its natural gas through Ukraine, including almost half the company’s exports to Europe. This makes Gazprom vulnerable to economic sanctions against Russia for its annexation of Crimea. On a fundamental basis, the stock was already one of the most inexpensive stocks on a price-to-earnings (P/E) ratio basis before tensions between Russia and Ukraine began, trading at below three times earnings. As of our meeting, there were no forecasts for significant declines in earnings. Catalysts are always hard to see in advance, but these very depressed valuations make Gazprom an interesting opportunity for income strategies such as the WisdomTree Emerging Markets Equity Income Fund, DEM. The specific index DEM tracks caps its top holdings at 5% at each annual rebalance; as a result, Gazprom is unlikely to see its weight increase at the 2014 rebalance. That said, it could see its weight drift up between rebalances with positive performance turns compared to other holdings.