* Rub weakness, tax reform, improving capex management
Positive tax developments in the Russian oil sector and a supportive macro
(weakening Rub/US$) provide a constructive outlook for Russian energy
names in 2014. We expect upwards earnings/FCF and DPS revisions by
consensus. In addition, we think the market has still to discount the positive
tax developments of 2013: (1) greenfields support, (2) hard-to-recover tax
breaks, and (3) the offshore tax regime. These tax changes support new upstream
projects and will drive Russian oil production growth to +3% from
2016E. Despite the weak competitive positioning of Russian oils vs. global
peers, we believe their attractive valuation and earnings momentum, along
with the improving macro and tax environment, offer an attractive entry point.
* Dividend yields improving: Buy Lukoil
Our top dividend story in the sector is Lukoil, where we expect DPS to
exceed consensus expectations. Given the group’s FCF generation outlook,
we think it can sustain 20% annual DPS growth over 2014-15, and forecast
a 2014/15 dividend yield of 7.2%/9.2%. Key catalysts for the stock include
the launch of the WQ2 field and 2013 DPS announcement.
* Rosneft up to Buy on improving cash flow, production outlook
We upgrade Rosneft to Buy from Neutral, with a new 12-month price target
of US$9.7 (up 11%). We are 13% ahead of Bloomberg consensus for 2014
EBITDA. In addition to benefiting from the weak Rub/US$, we believe cost
and capex control will improve in 2014, strengthening cash flow generation.
We also see positive news flow: (1) FID on East Siberian green-fields,
which will launch in 2016/17, and (2) the results of offshore and hard-torecover
exploration, which will likely expand Rosneft’s reserves base.
* Updating estimate & price targets; SNGS, O2C down to Neutral
We update estimates reflecting new 2014-16 FX forecasts (US$/Rub35 vs.
32), and recent sector/company-specific developments; our 2014/15 EPS for
Russian oil & gas companies rises 10%/15% on average. Our 12-month
price targets for oil & gas names (rolled forward to 2015 EV/DACF valuations)
rise an average 2%. We downgrade Surgut to Neutral, as we see no further
re-rating potential. In the OFS sector, the weak Rub/US$ rate negatively
impacts earnings; we lower our 2014/15 EPS forecasts by 18%/20% and
downgrade CAT Oil to Neutral as we see greater potential for upside
elsewhere in the sector, including closest peer EDCL (Buy-rated; 72% upside).