Thesis: KazTransOil (KZTO) is Kazakhstan s oil pipeline monopoly that

Transcription

1 Thesis: KazTransOil (KZTO) is Kazakhstan s oil pipeline monopoly that - - Offers multi-year, double digit dividend and earnings growth prospects driven by Kazakhstan s increased oil production as the giant Kashagan oil field comes online, via exports to China and Europe as well as continued double digit tariff growth While trading at an incredibly cheap price relative to its NAV (3x P/CF, 15% dividend yield, and.5x adjusted P/B) and offering 350%+ returns with downside limited by $400 million of net cash on the balance sheet, as well adjusting for the market value of the linefill oil in the pipeline. My price target is KZT per share, and a downside price of KZT Key Statistics *The EBITDA results do not include approximately KZT 17b in unconsolidated EBITDA from the KCP pipeline for

2 Company Profile/History KazTrainsOil is the Kazakhstan oil monopoly. It s KTO arm maintains the country s internal oil (and water for oil services) infrastructure while its investments in KCT, MunaiTas and Batumi terminals allow the company to participate in the export of oil to growing markets in Europe and China. 2

3 A Brief Overview of Kazakhstan s Oil Market (via EIA) According to the Oil & Gas Journal (OGJ), Kazakhstan had proved crude oil reserves of 30 billion barrels as of January 2014 the second largest endowment in Eurasia after Russia, and the twelfth largest in the world, just behind the United States. Kazakhstan's current oil production is dominated by two giant onshore fields in the northwest of the country: Tengiz and Karachaganak, which produce about half of Kazakhstan's total petroleum liquids output. The offshore Kashagan field, in Kazakhstan's part of the Caspian Sea, will also play a major role in Kazakhstan's liquids production in the coming years. Kazakhstan is an exporter of light, sweet crude oil. In 2013, Kazakhstan exported nearly 1.4 million bbl/d of crude oil and condensate, according to the Global Trade Information Service. More than three quarters of Kazakhstan's crude exports travel around or across the Caspian Sea headed to European markets. An additional 16% of Kazakhstan's crude exports head east via a pipeline to China. Kazakhstan's exports will likely increase in the coming years, as production begins at Kashagan and expands at Tengiz and Karachaganak. Although it is the second largest liquid fuels producer among Former Soviet Union republics, Kazakhstan's future as a producer of petroleum liquids depends on the development and expansion of its three largest projects: Karachaganak, Kashagan, and Tengiz. Kazakhstan's two largest projects, Tengiz and Karachaganak, accounted for 48% of the country's production in the first nine months of 2014, according to data published by Energy Intelligence. A third large project, Kashagan, is due to start production in 2016 or 2017, with the combined output of all three projects likely to account for more than half of Kazakhstan's total production going forward. Additionally, both Tengiz and Karachaganak consortia have discussed expansion plans that could result in increased production from these two fields within the next few years. The Tengiz partners were due to make a final investment decision by the end of 2014 on the Future Growth Project, but by early January, no decision had been announced. The Karachagank Expansion Project is at a less advanced stage of planning. Both expansion projects will focus on increasing handling and reinjection of natural gas to increase production and ultimate recovery levels of petroleum liquids. However, continued negotiations with the government on terms and lower global crude oil prices could delay decisions on these projects. The Kashagan field, the largest known oil field outside the Middle East and the fifth largest in the world in terms of reserves, is located off the northern shore of the Caspian Sea near the city of Atyrau, Kazakhstan. Kashagan's recoverable reserves are estimated at 7 to 13 billion barrels of crude oil. On September 11, 2013, production from the supergiant field commenced, eight years after the original scheduled startup date. In October 2013, just a few weeks after production began, 3

4 production had to be halted because of leaks in the pipeline that transports natural gas from the field to shore. Production is not expected to resume until the second half of 2016 at the earliest. Much of the repeated delays at Kashagan were the result of the field's adverse operating environment and complexity, resulting in significant cost overruns. The Kashagan reservoir is located more than 13,000 feet below the seabed and is under very high pressure (770 pounds per square inch). The reservoir contains high levels of hydrogen sulfide. Hydrogen sulfide is both highly toxic and highly corrosive and has been blamed for the pipeline leaks. In addition, conventional drilling and production technologies such as fixed or floating platforms cannot be used because of the shallow water and cold climate. Instead, offshore facilities are installed on artificial islands (drilling and hub islands) that house drilling and processing equipment. The processing facilities separate recovered liquid from the gas, then reinject a portion of the gas, sending the liquids and the remainder of the gas to shore for further processing. Before production can restart, these pipelines connecting the field with the onshore processing facilities will have to be replaced using higher grade materials that are more resistant to corrosion. If Kashagan comes online as expected Kazakhstan s production could increase between 50 to 100% from today s levels of 1.4 mbl/d to over 2.5 mbl/d (60mm MT to 108mm MT) 4

5 Kazakhstan s Oil Transport Market Kazakhstan's pipeline system is operated by the state run KazTransOil, a subsidiary of KazMunaiGas, which runs approximately 3,400 miles of pipelines. Because of Kazakhstan's landlocked location and the continued use of Soviet era infrastructure, much of Kazakhstan's oil and gas export infrastructure is integrated with major Caspian oil and natural gas export routes that interlink the region. Since independence, Kazakhstan has successfully expanded and diversified its export capabilities. Major crude oil export pipelines currently include the Caspian Pipeline Consortium (CPC) pipeline to the Black Sea port of Novorossiysk, the Kazakhstan China pipeline, and the Uzen Atyrau Samara pipeline to Russia. Kazakhstan also exports crude oil via the Caspian Sea and via rail. Oil is loaded onto tankers or barges at Kazakhstan's port of Aktau or the smaller Atyrau port and then shipped across the Caspian Sea, where it is loaded onto the BakuTbilisiCeyhan pipeline or the Northern Route pipeline (BakuNovorossiysk) for onward transport, mainly to Europe. Additionally, Kazakhstan has an extensive rail network, which it increasingly uses to transport liquid fuels both for domestic consumption and for exports. Tengizchevroil is the largest petroleum user of the rail network. It loaded approximately 70,000 bbl/d of petroleum liquids onto rail cars for transport in Continued expansion and diversification of Kazakhstan's petroleum liquids transport capacity, particularly export capacity, is key to its future ability to increase production. 5

6 Strengths KTO is 90% owned by KazMuniaGas (KMG), the state oil company, in effect just making it a publicly traded subsidiary of the state. Besides an implicit financial sponsorship, strategic importance to the state (57% of KZ s oil is shipped through KTO s pipes), this also brings a host of opportunities including participation in lucrative growth projects including the $2 billion expansion of the CPC pipeline, and the potential sale of state assets at below market prices such as KMG s 1.75% stake in CPC and government s stake of 19%. With state ownership also comes preferential treatment on any future pipelines and pipeline expansions. As example A of why this is a benefit just consider the onerous multiyear political process of approving Keystone XL in the United States. Strong financial position, including $400 million in cash on the balance sheet and $500 - $600 million in annual operating cash flow should allow the company to continue to invest in growth projects and continue to pay out and grow dividends from today s $200+ million level. Note that the KCP investment while contributing to earnings as a JV, does not contribute to OCF and has an EBITDA of over $100 million. In the future, once the expansion phase is complete, it should start to pay out dividends to the parent company. (However, KTOs share of KCPs debt is KZT 84b/$450 million). While it may all be for show, KTO s desire to be a legitimate public company with independent directors (despite 90% owned by the state), Ernst & Young audited statements and relative transparency into its operations should benefit the company in the long term with access to capital markets and future international pipeline growth opportunities. Relatively speaking, to the US/West, KZ tariffs are still very cheap by a factor of 2 to 3 times. While its hard to compare apples to apples on a MT*km approach in KZ versus a FERC per section trunk tariff in the US, KZs transportation costs are still relatively cheap. Opportunities/Growth KTO and KCP have a host of ongoing expansion projects in taking the country s export capacity from the current 60MMTs to over 100MMT+ of oil, as the Kashgan field comes online again. The company has a goal of increasing its throughput to 50,000 MT*Km by 2022, for an approximate 2% volume CAGR (5.6% last 5 years). While the Monopoly Regulatory Agency seems to approve tariff increases in an opaque and not very consistent manner, the KTO and KCP export tariffs have had CAGR growth rates of 11.6% to 15% last few years outpacing the KZ inflation rates of 4.5% to 9%. 6

7 Current and intermediate term projects involve expanding the capacity of its current pipelines, most of which should be completed through

8 KTO is considering participating in "Eskene-Kuryk" pipeline construction project the implementation of which is to be synchronized with Kashagan production schedule. "EskeneKuryk" pipeline capacity will be increased stage-by-stage up to 56 MMT/year of design capacity depending on resource base. CAPEX is currently estimated at about KZT billion KMG owns (through KPV BV) 1,75% stake in CPC and manages 19% stake in CPC on behalf of the RoK Government. KTO intends to explore together with KMG NC the possibility of transferring the management or sale in favor of KTO of the RoK Government and KMG NC stakes in CPC. Currently, CPC implements 5-year project to expand the pipeline capacity. The pipeline throughput capacity for Kazakh crude oil will increase up to 62 MMT/year with the use of antifriction additives. Note: a lot of the additional section expansions are through KCP which is an unconsolidated subsidiary of KTO and has its own, limited, financials, though some information was provided in the 2013 and ks (see Appendix). 8

9 Threats/Competition Services for transportation of crude oil are generally controlled by the government oil company KasMunaiGas or the government itself via its direct or indirect stakes in all of the oil shippers in Kazakhstan. In that sense, threat from competition is almost non existent. (from k) 1. KazTransOil JSC The Company has an extensive network of main pipelines, providing about 57% of the total oil production volume transportation in the Republic of Kazakhstan. The Company provides transportation services of Kazakhstan oil to oil refining plants of Kazakhstan and for export in the following directions: - through Atyrau Samara oil pipeline further to the system of AK Transneft JSC in the direction of the Black Sea and Baltic Sea ports; - transfer to Atasu-Alashankou oil pipeline for further export to PRC; - transfer of oil in the Aktau Sea Port; - transfer in the system of the Caspian Pipeline Consortium (CPC); - filling railroad tanks for further export via railroad transport. 2. CPC is the international oil transportation project involving Russia and Kazakhstan, as well as the world s leading mining companies, including Chevron, Shell, ExxonMobil, ENI, British Gas, Rosneft and Lukoil. The CPC pipeline transports crude oil mainly from the Tengiz and Karachaganak fields to a marine terminal near Novorossiysk. The government of Kazakhstan owns 19% of CPC and KMG owns 1.75% of CPC. 3. MunaiTas is the owner of Kenkiyak-Atyrau main oil pipeline. KTO owns 51% of MunaiTas. 4. KCP is the owner of two main oil pipelines Atasu-Alashankou and Kenkiyak-Kumkol. KTO owns 50% of KCP. 5. Transportation of oil for export is also carried by tankers through the Aktau port and railroad transport which is likely the biggest competitive threat, though at 6% of total volumes which is expected to disappear once the AA and KK pipelines are expanded. Kazakhstan Political Situation (Opinion): Having lived in Kazakhstan for 2 years and followed the political/economic development of the country closely, I believe that the country s political risk is less than that of its close peers, Russia, and the rest of the stans. While the country certainly suffers from endemic corruption and severe government nepotism, its unofficial dictator for life, Nasurltan Nazarbaev has also put in significant steps to make sure his country is not beholden politically and economically just to Russia. He has played his oil wealth and strategic, yet unfortunately landlocked, geographical location to forge partnerships with Russia, China, and to a smaller extent, the West. From a realpolitik standpoint, Russia s aggression in Crimea and east Ukraine, opened up Kazakhstan to a higher probability of being invaded by Russia to protect its sizable Russian population if it does not tow Kremlin s economic and political line. However, a few things make Kazakhstan s political risks different from Ukraine s. While the major oil fields lie close to the Russian border/caspian, most of the native Russian population lives closer to the North, away from the South and Central location of the pipelines, thus in the event of a war Russia is likely to only invade the North and West. From a purely demographic comparison Eastern Ukraine holds 35% of Ukraine s 45 million population, while Kazakhstan s population of 17 million (of which 23% is Russian) in a country the size of Western Europe, is more spread out. Russia s history of attempting to conquer the stans in what is known to be The Great Game over the last 150 years has been spotty at best due to the low population density, the great geographical distances 9

10 involved and unfamiliarity with the terrain. The CPC pipeline goes through Russia and in the event of a war and Russia shutting down KZ s exports of oil to Europe (noting it has not done so to gas pipelines in Ukraine) KCP is likely to benefit via increased export flows to China or via KTO s Batumi seaport In the end, I would say Russia is a real and credible threat to Kazakhstan, especially when considering recent events, however, given KTOs geographical position and diversified revenue stream it is unlikely to suffer much in a low grade war. As a side note, I do believe KTOs valuation is being thrown out with the bath water as a Russian pipeline which makes today s price a good entry point. Weaknesses/Risks I would consider the weakness of KZ currency against the dollar as a threat to an investment in KTO. One February 11th, 2014 the National Bank of the Republic of Kazakhstan made a decision to cease supporting exchange rate of Tenge against US Dollar and other major currencies on the same level, reduce volume of currency interventions and reduce interventions in process of exchange rate formation. Exchange rate before and after devaluation was Tenge and Tenge per 1 US Dollar respectively. Currency risk is certainly something to be mindful, especially since KCPs debt is dollar based and the last devaluation resulted in a KZT 30 billion market value readjustment loss. Untested management. I couldn t find anything about KTOs management or its performance or compensation. As KTO is a new public company it remains to be seen how the current management reacts to current and future challenges as well as operating performance. Management seems to have very little stake in KTO, with just nominal value amounts ($1,000 to $20,000). KTO s ownership of the Batumi seaport provides diversification, especially against Russian aggression, however, its had declining results in oil shipments which have resulted in continued write offs of its assets. This is likely to continue, especially with the growth of CPC pipeline. (Batumi provides less than 5% of KTO s revenues) 10

11 Valuation/Forecasts Valuing KazTransOil is more of an art than a science, however, in looking at what the company is worth I am considering a few important attributes It has strong support of the state to win growth projects going forward; growing the tariff, especially to export markets; as well as potentially supporting it in times of trouble Free Cash Flow and Dividends are likely to keep growing at strong rates even in the face of large potential projects such as the CPC expansion or buying up stakes in other pipelines as well as KCP starting to pay dividends Any increase in Kashgan field production in the next 5 years would be a windfall to KTO and KCP While I cannot predict with any certainty results today or next year, due to unpredictability of tariffs or Kashgan coming on line, I am more comfortable looking out 5 years ahead to 2019 in valuing this investment I expect that in the next 5 years KasTransOil will pay out between KZT 700 to 800 in dividends thus covering the initial investment at today s price of KZT thus providing a significant margin of safety to the investor. Once KCP finishes out its growth phase it should start to pay out significant dividends ($100 to $150 million) to the parent Finally, whatever the price target should be, looking at the valuation today, despite being in Kazakhstan, KTO seems to be trading at a large bargain. Base Case: 2019 P/E KZT on a 10x multiple, which is on par with its historical high (albeit at a limited trading history) and its EM peers, based on the comp table below, on a 2019 KZT EPS estimate EV/EBITDA KZT on a 8.0x multiple, below its peers of 10.5x, with an additional assumed KZT 100b in cash on the balance sheet, on a 2019 EBITDA estimate of KZT 151, Dividend Yield KZT on a 10% yield on a 2019 dividend estimate of KZT Average 2019 Price Target: KZT Additionally, KZT 776 in dividends from 2015 through 2019 amount to a total of approximately KZT for a return from today s price of KZT 730 of 365% or 36% annualized return. 11

12 Side Analysis: While I put less stock into DCFs, I thought for the sake the exercise I would run a couple of models to see the results. Using a 20% discount rate and a 5.5% terminal growth rate (below KZ s inflation and prime rate of 5.5%) I got an average valuation of KZT 1250 or 71% higher from today s price. As an aside the company s audited financial statements use discount rates of 12.7% to 14.7% to value its assets for impairment with a 5%+ growth rate. Note the FCF does not include potential dividends from KCP. 12

13 Downside Case: I honestly don t know how to approach this one given how low this company is trading. From a price perspective its traded as low as KZT or so, off 15% from today s price, which would really be made up with one year s worth of dividends. Looking at it 5 years out, even if I am wrong on all the forecasts and the dividends are cut in half to say KZT that means the stock would have fall over 50% still to lose money. Its not impossible, but I would say improbable. However a global economic crisis, war with Russia, oil prices falling below $20.00/bbl are all possible so the possibility should not be discounted. From the perspective of real capital loss in this investment, its hard for me to justify the enterprise value of the company going below today s price. To dissect further: - Current market value is $1,500 million. - Of this approximately $400 million is in cash - Additionally, the oil in the line fill, called technological oil, is currently valued at KZT 69.5 billion. However, the 2,307,052 MTs or million barrels is valued at $22.55/bbl or $378 million. Today s Brent oil price is $55.00 which values the oil at $922 million. There are two ways to look at this: One is to say between the cash and the oil in the pipeline the market values current assets on the book at less than $200 million, including the 5,500+ kilometers of pipeline (on the books at more than $700 million). Or adjust the book value by an additional KZT 210 to 1390 ($922 million less $378 million, less 20% tax, times 185 KZT/$ exchange rate, divided by 384 million shares). - If you count the KPC pipeline at book value, which is $200 million, you are essentially getting KTO for free at current price. KTO, the main asset which generates $500 million plus per year. - Western pipeline replacement costs are approximately $2 to $5 million per mile (or $1.25 to $3.125 per km). If you look KTO (not even counting KCP), $200 million left over after the cash and market value of oil revaluation, you are getting the pipelines for approximately $58,000 per mile. So I don t know what the potential for real capital loss for KazTransOil is but my gut tells me its trading at levels which are below any true value of the firm, whether its as liquidation value or as a going concern. 13

14 Best Case: I would say in the best case the firm trades up to western level multiples and has double digit growth in revenues, cash flows and dividends on Kashgan restart as well dividends from the KCP JV flowing back to the parent P/E KZT on a 23.5x multiple, which is on par with its historical high (albeit at a limited trading history) and its EM peers based on the comp table below, on a 2019 KZT 337 EPS estimate EV/EBITDA KZT on a 10.5x multiple, below its peers, with an additional assumed KZT 200b in cash on the balance sheet, on a 2019 EBITDA estimate of KZT 185, Dividend Yield KZT on a 4.5% yield on a 2019 dividend estimate of KZT Average 2019 Price Target: KZT Additionally, KZT in dividends from 2015 through 2019 amount to a total of approximately KZT for a return from today s price of KZT 730 of 939% or 60% annualized local currency return. 14

15 Appendix A Summary of Financials and Forecasts 15

16 Appendix B Joint Venture Details in KCP and MunaiTas 16

17 17