Russian state oil major Rosneft will pay only 35% of net IFRS profit in dividends for 2016, as it did the previous year, in direct defiance of government orders for a 50% payout by state companies, Vedomosti daily reported on April 4, citing the company’s head Igor Sechin.

Rosneft’s policy again reflects Sechin’s direct line of influence to the Kremlin and his long-time associate President Vladimir Putin, and will hinder the finance ministry’s efforts to meet the 2017 budget, since the government is the main beneficiary of dividends from giant state-owned corporations.

“Our main shareholder took the decision,” the newspaper quoted Sechin as saying. Rosneft’s main shareholder is the indirectly state-controlled holding Rosneftegas, whose chairman of the board is no other than Sechin himself.

Fight for dividends

Previous reports claimed that the Russian Finance Ministry has already budgeted all the dividend income from Rosneftegas in 2017-2019 budget in its long battle to extract finances from the holding, which is nicknamed “Sechin’s piggybank”. Rosneftegas also controls an 11% stake in Russia’s largest gas company Gazprom and utility major RAO OES.

According to unnamed government officials, the issue of the dividends was already discussed with First Deputy Prime Minister Igor Shuvalov and the talks will continue “at the highest level”, Vedomosti wrote.

Special treatment

Rosneft and Sechin previously defied the government by not disclosing the investment programme of Rosneftegas, saying they have appealed “directly to the presidential administration”. The company’s pivotal role in such strategic projects as oil supplies to China and Arctic drilling are making it easier to get special treatment approved by the Kremlin.

“This [holding] is a black hole living by its own rules,” an unnamed federal official told the daily in October when the finance ministry first locked horns with Rosneftegas over the dividends. He added that “it is not clear why Rosneftegas is ignoring all requests by its direct owners and appeals to directly to Putin as if he was the owner”.

Moreover, Rosneftegas was allowed not to publish its 2016 financial accounts, the television network Dozhd reported on January 11.

Rosneft’s argument that it is not a state company due to its indirect ownership through the Rosneftegas holding already worked when it was allowed to participate in the privatisation of the Bashneft oil company in 2016.

Rosneft this year projects IFRS net profit of RUB373.8bn ($6.6bn), rising to RUB392.3bn and RUB432.3bn in 2018 and 2019. As dividends move through Rosneftegas, the finance ministry budgeted to receive 100% of the amount of dividends passed on by state companies through the holding. Rosneftegas, in turn, invokes the 50% dividends rule and has refused to surrender more.

Rosneftegaz is budgeted to pay RUB156.5bn, RUB164.7bn and RUB148bn in dividends in 2017, 2018 and 2019, respectively. These are the funds the holding arguably needs to cover its investment programme, which the government could also suggest is financed by borrowing.

Less attractive investment case

Free cash flow of Rosneft is estimated at RUB300bn in 2017 by analysts and officials surveyed by Vedomosti, but 50% dividends are seen as too high given a number of large-scale investment projects and high leverage.

“We do not see how minority shareholders can benefit from rapid growth of Rosneft’s asset portfolio if the company’s dividend yield remains below the sector average and its debt pile continues to rise (assuming macro conditions remain stable),” Renaissance Capital wrote on March 27 in a special report on Rosneft’s investment case, arguing that company’s dividends and interest payments are likely to require additional funding.

While “a growing share of the market was buying [Rosneft’s] idea of high Free Cash Flow and consequent deleveraging followed by increased dividends”, the analysts see the risk of this not being achieved fully as expected.

Renaissance Capital expects Rosneft to increase its net debt in the next two years to $79bn, while strong (2.8x) growth in earnings would still translate into only an estimated 4.6% dividend yield by 2018.

Stronger macro fundamentals and the gains from the acquisition of Bashneft would be upset by growing capital expenditures and reduced share in the major Vankor field, the report warns.

At the same time, the majority of the FCF “essentially represents cash flow that the company cannot use freely” as it is to be spent on the reduction of prepayment financing (to oil traders and foreign buyers, such as China).

Complicated debt

“In addition, the company’s financial statements are becoming increasingly complicated, which is often associated with a growing valuation discount,” Renaissance Capital notes, estimating that Rosneft is trading at a premium to the sector on 10x 2017E P/E without real deleveraging or a superior dividend yield.

Rosneft’s financing is indeed becoming increasingly complicated, with prepayment deals acting as debt, major acquisition deals such as Bashneft and Rosneft’s own privatisation leaving many questions unanswered, and domestic bond issues repeatedly speculated to meddle with the ruble market.

While reporting revenues and earnings were in line with market expectations in the fourth quarter, Rosneft posted a negative capex of -$2bn due to seasonal jump in capex.

But, notably, while by Rosneft’s own estimates the net debt at the end of 2016 grew only marginally to $31.2bn from $26.1bn in the reporting quarter, Renaissance Capital estimates that including prepayments on supplies the net debt stood at $78.3bn.

VTB Capital also noted in February that “the company has disclosed issued sureties to banks in the amount of $9.5bn within hydrocarbon trading contracts”, which “could theoretically be treated as debt”.

Russian oil companies to bear burden of Kremlin’s Belarus deal

Meanwhile, VTB Capital analysts warned on April 5 that Russian oil companies might bear the burden of the Belarus subsidy cut which is reportedly part of the deal reached between Putin and Belarusian President Alexander Lukashenko at talks in St Petersburg on April 3.

Apart from a undisclosed gas discount provided by Gazprom, Belarus will be reportedly allowed to keep the crude oil export duty on 6mn metric tonnes of oil. Russian oil companies currently deliver some 20mn metric tonnes of crude to Belarus without paying export duty.

It is estimated that the excise duty cutback could be worth $1.6-2bn over 2017-2019, making about 1-1.2% of the Russian sector’s total estimated Ebitda for the period. Although regarding the number itself as “not that substantial”, analysts say this development is “generally not supportive for the sector”.