Research Notes

We revised our target price for Surgutneftegaz shares to $1.41 based on a rally in crude prices, H106 operating and financial results of the oil producer and also a detailed forecast for the oil producer’s capital investments.

More than six months have passed from the time when we last upgraded our target price for Surgutneftegaz stocks and assigned a Sell recommendation. During this period the oil firm’s stocks underperformed the market: the RTS Index gained 55.8%, whereas SNGS commons and prefs added only 32.4% and 13.4%, respectively.

Rising petroleum prices and a jump in oil output still allow Surgutneftegaz to exhibit strong revenue growth, but the oil major’s cost side is growing at a faster pace than sales due to swelling tax payments (especially, export duties and MET). Rising inflation and ruble appreciation against the greenback have also exerted an adverse impact on cost dynamics. However, for the time being the company has managed to report a fairly high pace in EBIT growth. However, the oil major’s H106 net profit dropped 7.5% due to a 4.5-fold increase in non-sales expenses.

A shortage of refining facilities limits the oil producer’s ability to optimize its sales structure depending on the market environment. The lack of interest on the part of Surgutneftegaz management in boosting the company’s equity capital is followed by the accumulation of an abnormally high amount of cash on its balance sheet which previously generated low returns for the company. But in January-June 2006 these financial resources and the dollar’s decline against the ruble led to $800 mln losses from exchange rate differences.

However, Surgutneftegaz stands out among other Russian oil producers by lax corporate governance standards, opacity and a hostile policy towards minority shareholders.

Based on our DCF model, the fair value of Surgutneftegaz commons is $1.41 which implies a Sell recommendation. Meanwhile, we assign a Hold recommendation to the oil producer’s preferred stocks with a target price of $1.13.

Clients of Finam Investment Company may receive full versions of analytical research reports translated into English by sending requests to the International Trading Department.

Timur Hayrullin

* Short overviews of equity research reports and sector reports are posted on the website http://www.finamrus.com with a 1-day delay after their full versions are emailed to the company’s clients. To get overviews on the day of their release, please contact your manager at Finam to sign up for full versions of research reports.