Daily analyst comments

On December 12, 2007 Lukoil (RTS: LKOH) released M907 US GAAP financials. The weighted average price of Brent crude rose 0.2% in the reporting period, fuel oil 3% and high-octane gasoline 2.6%. Lukoil's oil production climbed 2% and oil product output rose 7.7%.

We are concerned that the company is to be unable to accomplish even its downgraded target of 2.5% incremental output. Lukoil plans to double hydrocarbon output by 2016 due to accelerated production growth. However, gas production slipped 0.4% in the period under analysis. This trend is most likely attributable to difficulties with the owner of the gas transportation system – Gazprom.

The company's earnings climbed on the back of stronger crude and product sales in international markets. However, crude and product sales shrank. These changes are attributable to a rerouting of the oil major's exports to more profitable foreign markets. The table below demonstrates that higher oil product sales, which generate nearly 70% of the company's earnings, account for the bulk of incremental revenue.

Lukoil: 9M07 US GAAP revenue, USD mn

Indicator	9M07	9M06	9M07/9M06
Exploration and production	14,175	13,907	+1.9%
International projects	13,207	12,932	+2.1%
CIS	653	665	-1.8%
Russia	315	310	+1.6%
Refining and marketing	39,201	34,632	+13.2%
International projects	32,464	28,542	+13.7%
Russia	6,737	6,090	+10.6%
Petroleum segment	1,628	1,300	+25.2%
International projects	1,126	915	+30.4%
Russia	502	385	+23.1%
Other	2,092	1,620	+29.1%
Sales proceeds	57,096	51,459	+11.0%
Participatory share	251	344	-27.0%
Total revenue	57,347	51,803	+10.7%

Source: Company data, Finam estimates

Lukoil's expenses in the reporting period outpaced revenue.

Lukoil: 9M07 US GAAP financials, USD mn

Indicator	9M07	9M06	9M07/9M06
Revenue	57,347	51,803	+10.7%
Excise and export duties	10,623	9,667	+9.9%
Net revenue	46,724	42,136	+10.9%
Opex	4,469	3,338	+33.9%
Cost of crude and products purchased	19,504	17,514	+11.4%
Transport expenses	3,251	2,613	+24.4%
SG&A	2,259	2,140	+5.6%
Depreciation and amortization	1,675	1,325	+26.4%
Taxes (other than income tax)	6,529	6,175	+5.7%
Exploration costs	176	118	+49.2%
Excise and export duties	10,623	9,667	+9.9%
(Loss) profit from asset retirement devaluation	33	50	-
Total expenses	48,519	42,940	+13.0%
Operating profit	8,828	8,863	-0.4%
EBITDA	10,370	10,178	+1.9%
Non-operating line items	291	143	+103.5%
Income tax	2,239	2,278	-1.7%
Net profit	6,298	6,442	-2.2%

Source: Company data, Finam estimates

Costs rose due to the line items below:

• Crude and products purchased ballooned due to higher volumes purchased and higher feedstock prices;
• Opex rose due to higher production costs on the back of stronger output, real ruble appreciation, higher energy expenses and payrolls;
• Export duties and taxes climbed due to higher exports, production and export duty rate;
• Transport expenses due to higher transportation tariffs, higher oil product exports and changes in export routes.

Lukoil expenses: Trendline and breakdown in 9M07

Indicator	Share in expenses, %	Chng, y-o-y, USD bn
Cost of crude and products purchased	40%	1.990
Excise and export duties	22%	956
Taxes (other than income tax)	13%	354
Opex	9%	1.131
Transportation expenses	7%	638
CG&A	5%	119

Source: Finam estimates

Operating profit margin, EBITDA margin and net margin headed south due to escalating costs.

Lukoil's margins for 9M07

Indicator	9M07	9M06	?
Operating profit margin	15.39%	17.11%	-1.72%
EBITDA margin	18.08%	19.65%	-1.56%
Net profit margin	10.98%	12.44%	-1.45%

Source: Finam estimates

Thus, Lukoil released financials in line with expectations and slightly surpassed the market consensus for revenue +0.7%, EBITDA +2.6%, and net profit +1.1%. The negative factors, which lowered the company's operations, were higher taxes (pegged to oil prices), cost overruns and changes in supply routes. Lukoil is the first oil company to have released its 9M07 US GAAP financials, and so it is too early to talk about industry trends.

Our recommendation on Lukoil shares is Hold.