Russia’s second largest oil producer, Lukoil (LUKOY, Financial), announced its third-quarter results on November 27, and analysts were not very happy with the posted numbers. In fact, the company also agreed that the quarter was not a solid one and did face several macroeconomic headwinds which have taken a toll on the quarter’s results. However, the company management has stated that it might increase the dividend payout to investors to over 50% of the profits if crude oil prices continue to slide further in the coming year. Let’s quickly take a peek into the quarter’s major takeaways that could serve as vital information from the long-term investment perspective.
Revenue rose, but profits were not sustained
The oil company’s third-quarter revenue rose 6.2% to $39 billion from $36.7 billion a year ago. Analysts have opined that the increase in revenue was mainly attributed to the Iraqi West Qurna-2 project which is pumping around 320,000 barrels per day (bpd) while the total production for the quarter stood at around 2 million bpd.
The Iraqi project contributed 22% to EBITDA, and the rampup at West Quarna-2 where output began from this year maintained Lukoil’s position as the Russian oil producer having major overseas projects.
However, though the revenue rose due to healthy project execution overseas, net profit took a hit of around 50% standing at $1.62 billion whereas Reuters analysts had expected Lukoil to report net profit of around $2 billion. The drastic fall in the net profit was attributed to the lowered oil prices which are still on a dip and the weaker ruble compared to the dollar.
Future outlook is dim
Leonid Fedun, vice president of Lukoil, stated in a recent Financial Times interview that Russian oil production would drop from the peak of about 525m tonnes to around 490m tonnes within the coming four to five years, though he also insisted that the decline would not be a dramatic one.
Furthermore, the U.S. sanctions over Russia on the Ukraine issue is further pushing the forecast into the negative territory creating pressure on the whole extractive industry in Russia. Fedun added that Lukoil did not have any deep water projects in Russia, while shale formed a minor portion of its portfolio. Hence, the impact of the U.S. sanctions would not be too fatal for the company in the coming years.
But Lukoil would face extreme difficulty in tapping the western financing due to such sanctions. In reality, Lukoil stands completely irked by the western sanctions as such bans prevent the transfer of western technology vital for developing Russian reserves in the Artic Sea and other deep water locations.
International expansion program on the rise
Lukoil has plans of ramping up output at the Uzbek gas project which has received the attention of Chinese companies. Indeed, the Uzbek gas supply contract with China is more favourable than the one signed in May between Russia’s monopoly gas exporter OAO Gazprom (OGZPY, Financial) and the Asian nation. The company believes that the pact with China would aid in bringing Chinese technology into Russia, thus reducing the reliance on the U.S. for long-term projects and aid in reducing the impact of the sanctions.
The payoff from Iraq’s project has been remarkable during the quarter that has added around $1.25 billion to the earnings of the third-quarter, and pulled up the revenue stream for Lukoil.
The company invested $248 million in Uzbekistan during the third quarter, compared to $185 million in 2013, for implementation of gas projects. Notably, Lukoil is the largest foreign investor in Uzbekistan and since 2004 has invested around $3 billion in the Uzbek economy. Currently, Lukoil is working on implementation of three projects in Uzbeksitan - Kandym-Hauzak-Shady-Kungrad, the mining of the Southwestern Hissar, and the exploration of the Uzbek part of the Aral Sea in the international consortium. The oil giant plans to produce 18 billion cubic meters of gas annually by 2017 and improve its investment up to $5 billion within the framework of the first two projects.
Cash flow remains firm
As the West Qurna-2 Iraq project has started to generate revenue, Lukoil’s free cash flow stood solid at $730 million in the third quarter, up from $170 million reported in the second quarter of the fiscal year. Maybe that’s the reason behind the company promise to pay a really hefty dividend to its investors if oil prices continue showing a downtrend. The company’s dividend policy calls for a pay-out of no less than 15% of net profit, and historically the company has always paid much more than the bare minimum pay-out set by the top bosses. So if the company pays out around 50% of its net profit as dividend in any of the upcoming quarters, it should not be a surprising element in its dividend pay-out history.
To conclude
Lukoil is on the growth mode with heavy investments happening overseas to improve its top line further in the coming quarters. Though softness in oil prices is presently creating stress on the company financials and U.S. sanctions is a black spot in the report card, Lukoil’s management have firm strategies in place to maintain the bottom line of the company. Also investors are usually well rewarded by the Russian oil company that still holds a solid cash flow, irrespective of the external headwinds. Thus, one thing is for sure: Lukoil’s future seems bright enough to stay invested in the long term.
