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Gazprom financial analysis: actually well positioned, but…

The data sources are Google Finance for stock prices and S&P capital IQ for the financial reporting data, both as of the 23rd February 2015.

A few weeks ago, fellow Fool Matt Koppenheffer identified Gazprom OAO (MCX:GAZP)(ETR:GAZ) as the third cheapest Russian stock. Since then, the stock has soared 16% in Rubel terms and more than 30% when priced in Euros. This rising investor confidence made me want to take a closer look at the financial situation of this Russian energy giant.

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I’m using 15 Key Performance Indicators (KPIs) to break down the balance sheet and get insights into the…

  • capital structure,
  • liquidity situation,
  • power to generate returns, and
  • operating strength

of the company.

Let’s first take a look at the revenue growth in the last five years, since this is important information to assess what the KPIs tell us.

2010 2011 2012 2013 LTM Q3 2014
Yearly revenue growth 20.3% 26.3% 2.8% 10.2% 6.2%

That works out to annualized growth of almost 13% over the last five years. Not a bad start, but let’s dig a bit deeper.

Strong equity ratio, but soaring short-term liabilities

There are the four KPIs that tell us about Gazprom’s capital structure; that is, how solid its financial base is.

2010 2011 2012 2013 LTM Q3 2014
Capital Turnover 0.41 0.45 0.41 0.41 0.39
Asset Intensity 57% 59% 64% 64% 67%
Equity Ratio 71% 71% 71% 72% 72%
Payables Ratio 8% 9% 8% 7% 21%

We can see from the relatively constant capital turnover that Gazprom has been growing its balance sheet in line with revenue. That is, except for the year ending Q3 2014, where it falls despite growing revenue, which could indicate decreasing efficiency in deploying its capital. However, we also know that energy prices had started to drop at that point – so I’d posit that this change is more a result of lower energy prices as opposed to less efficient operations.

We can see from the growing asset intensity that Gazprom has been generous about investing in assets (buildings, refineries, pipelines, etc.). This is a positive sign which may indicate that the company is expecting more growth ahead. Meanwhile, an equity ratio of more than 70% is outstanding, because it means that Gazprom has financed just a bit more than a quarter of its capital-intensive business with debt!

What does concern me is the sudden rise of payables in Q3 2014. Why hasn’t Gazprom paid its suppliers as quickly as usual? Maybe it’s a timing phenomenon and Gazprom usually reduces its liabilities at year end. I doubt that, but let’s take a closer look at the liquidity situation.

Which confirms our doubts

2010 2011 2012 2013 Q3 2014
Quick Ratio 113% 113% 110% 142% 140%
Cash Cycle -9 Days -37 Days -63 Days -61 Days 10 Days
Days Payables Outstanding 63 Days 40 Days 30 Days 30 Days 83 Days
Days Sales Outstanding 71 Days 77 Days 93 Days 90 Days 73 Days
Days Cash 127 Days 79 Days 50 Days 77 Days 78 Days

If you only look at the quick ratio, the short term financial situation looks healthy, because more than 100% of short-term liabilities can be covered with cash that’s already there or expected to come in soon.

However, taking a dynamic view into consideration helps us to better evaluate the situation. The cash cycle used to be considerably negative, which means that Gazprom used to pay its suppliers way earlier than it received money from its customers. This situation suddenly changes into the opposite in Q3 2014, where days payables outstanding suddenly soared from 30 days previously to 83 days.

That’s a pretty strong sign for potential liquidity challenges, in particular since days sales outstanding decreased by 17 days compared to year end 2013, while cash remained constant. I consider a timing effect highly unlikely and I am very curious about the Q4 numbers when they are published in April.

The income statement has been almost too good to be true

2010 2011 2012 2013  LTM Q3 2014
SG&A as % of revenue 12% 1% 1% 1% 1%
R&D as % of revenue 1% 0%
Net margin 27.7% 29.6% 26.8% 22.7% 16.0%
Operating cash flow margin 40.6% 36.1% 31.6% 34.0% 32.6%

Gazprom’s numbers seem to prove once again that oil and gas are really darn easy products to sell! Gazprom only spends 1% of its revenue on sales and admin costs. Research and development are essentially non-existent as well, which lead to a historical net margin of between 20% and 30%. And just look at that operating cashflow margin – wow, Gazprom is a real cash cow!

However, our previous concern gets clearly confirmed by the numbers for the year ending Q3 2014. Sinking oil and gas prices lead to a significant net margin decrease of nearly eight percentage points, bringing it down to 16%. Even though the company has managed to sustain operating cash flow, that still hurts. It will be interesting to see what Q4 2014 has brought.

Operational strength

2010 2011 2012 2013 LTM Q3 2014
Interest coverage 29.1 51.7 35.1 37.2 34.7
Debt coverage 1.8 1.9 2.4 2.2 2.3
Investment quota 4.7 6.3 4.3 3.7 3.2

This is a consistently positive picture. The operating profit has been almost 35 times higher than interest payments even in the year ending Q3 2014 and Gazprom would be able to pay off all its debt with just a bit more than two years worth of operating cash flow – that’s a good sign. But here’s another “but.” That’s only the case as long as Gazprom will be able to sustain that cash flow, which I think is questionable at best as long as the net margin doesn’t revert back to its historical level of above 20%.

The investment quota confirms our finding above that Gazprom is investing significantly more into its assets than it is using them. Even though the ratio has declined from 4.7 in 2010 to 3.2 for the year ending in Q3 2014 – it’s investing somewhat less into growth, but still investing more than three times the depreciation into its assets.

Gazprom is faced with challanges in the near and mid term

Gazprom’s capital structure is healthy and its power to generate returns has been exceptional. But there are signs of liquidity issues. It will be very interesting to see how these developments have continued in Q4 2014 and whether the company is able to dodge danger.

If that’s the case, Gazprom has good prospects for the future. But this will also be very dependent on the development of oil and gas prices – which I don’t dare to predict.

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Bernd does not own any of the stocks mentioned. The Motley Fool does not own any of the stocks mentioned.

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