Oil and gas

A revision of Ukrnafta’s prospects incorporates sharply lower expectations, but nevertheless renders the stock underpriced.

Ukrnafta did not pay dividends in early summer 2007, contrary to expectations, and is in the midst of a shareholder conflict, upsetting investors. The stock behaved as a PFTS index dummy for most of 2008 (see right), ignoring roaring oil prices and Ukrnafta’s own profits. The 2Q08 results will remind investors once again that these are fundamentally good times for the business.

The corporate conflict at Ukrnafta led to unreasonable compression of investors’ expectations. An ignition may be close in time.

One of the best companies in terms of corporate governance, Concern Galnaftogaz may be able to deliver value to shareholders using a long and windy road of self-sustained development and expansion. However, ample opportunities for corporate maneuvers may present much speedier and certain ways of deliverance.

Oil prices rises, mixed with moderate expectations of fuel sales increases, both vindicate an upward revision of Ukrnafta’s prospects.

Ukrnafta has two business arms. The hydrocarbons extraction arm pumps oil and condensate (71% of domestic output) and extracts natural gas (16%). The retail arm sells fuel via company’s own filling stations network (its market share by volume was 24% in 2005 and 19% in 2006). Both business arms are fundamentally strong, but are held back by Ukrnafta’s strategic investors.

A lucrative purely extraction business in 2002, Ukrnafta is changing. The extraction segment is squeezed by high rent rates and low natural gas prices. The company counters by expanding the fuel retail segment. The changes intensify during 2005–2007, and our analysis shows that income from retail sales would offset rent increase losses almost fully. Ukrnafta’s margins would be boosted once the company implements another change: expansion of processing segment.