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. Last Updated: 07/27/2016

Secretive Giant Surgut Lagging Behind Peers

Secretive oil giant Surgutneftegaz has fallen behind competitors who have won favor by opening their books, and investors are wondering if it is serious about a promise to catch up.

Encouraged by the success of top two oil firms LUKoil and Yukos in embracing investor-friendly policies, analysts hope Surgut will now approve a corporate governance charter and adopt Western financial reporting standards by the end of 2002.

But they have lingering doubts about Surgut's ability to follow through with more generous dividends -- a sore point among investors who feel short-changed -- and convince investors the company has a dynamic long-term development strategy.

"Surgut's market capitalization could more than double if it decided to change its obsolete corporate governance policy," said Kaha Kiknavelidze from the Troika Dialog brokerage.

Surgut emerged as a top player in the oil industry in the country's controversial privatization of Soviet state assets in the early 1990s together with LUKoil and Yukos. The oil firm's management, headed by Vladimir Bogdanov since the Soviet era, has secured control of around 70 percent of the firm, while the remaining 30 percent is freely traded.

In the mid-1990s Surgut became a market favorite as one of the few actively traded stocks. It was also praised for rapid output growth, which it kept on the boil even during the financial crisis of 1998, when other firms saw their production fall.

This year Surgut's output will approach a strategic 1 million barrels per day, from 600,000 bpd five years ago. But unlike in 1998, the output of its rivals is also booming and investors have become choosier and are clamoring for the company to present a clear picture of where it is going.

"Surgut operations are strong, but it deserves a discount to its peers given its lack of an elaborated development strategy ... and the fact that it has failed to follow its peers' lead in improving corporate governance," said Paul Collison from Brunswick UBS Warburg.

Surgut has underperformed the market by 14 percent so far this year. Eight major Russian and Western brokerages say its shares are a "buy," while only three recommend them as a "hold." However, several brokerages have recently issued a "buy" on Surgut based not only on its underperformance but the prospect of a new management philosophy.

"Senior management appears intent on issuing a corporate governance charter at the end of this year or early next," Collison said, adding that he expects Surgut to elect at least one truly independent, probably Western, member to its board and release its 2001 U.S. GAAP results. Thereafter he expects it to adopt regular interim reporting to Western standards, like its peers.

"Surgut still has a long way to go, but every step will narrow the current discount," said Vladislav Metnyov from Renaissance Capital.

Other analysts are more cautious.



"The dividend policy is a crucial issue. And unfortunately we don't expect prompt changes on this front," said Kiknavelidze from Troika.

Russian legislation obliges firms to pay shareholders a minimum of 10 percent of annual net profit as a dividend on preferred shares. But the law does not clearly define just what net profit is.

And while market rivals pay dividends of hundreds of millions of dollars to minority shareholders, Surgut is refusing to budge from a policy of deducting capital expenditure and reserves from net profit before calculating dividends, saying investors make money from share price gains. "We anticipate Surgut will include a minimum dividend payout policy in its charter. It would signal a desire to stop being a [loner] and reassess relations with the international capital markets," Collison said.

Leonid Mirzoyan from Deutsche Bank said Surgut may even be forced to pay a bigger dividend if a new law defining the notion of net profit is approved -- as expected -- later this year.

Kiknavelidze was more skeptical: "The law is unlikely to change the situation because multiple ways will remain to bypass it. Investors want the management to be with them on the same page rather than being forced to change their behavior."

Both Troika and Deutsche maintain "hold" recommendations on Surgut.

While high oil prices have enabled Russian oil majors to push through ambitious overseas expansion plans from Eastern Europe to America, Surgut is firmly entrenched in its western Siberian heartland and sits on a large cash pile.

The company has an investment chest of up to $10 billion, including around $4.5 billion in cash and nearly $5.5 billion worth of its own shares. Surgut has said it sees the shares as a strategic reserve for acquisitions.

"Surgut can grow on its traditional Siberian fields for another five to 10 years. But any reasonable acquisition would be extremely welcomed by the market, giving a guidance of the firm's strategy," Mirzoyan said.

Analysts said they acknowledged that huge cash reserves and zero-exposure to foreign lenders cushioned Surgut against oil price fluctuations.

Although Surgut's managers appear to be well dug in and immune to hostile takeover, the company's cash pile made the company attractive to corporate raiders.

"In theory Surgut is a fantastic acquisition target. Under the current market capitalization you can buy this 1 million-bpd producer for just $8 billion and immediately get your hands on $5 billion in cash," said one analyst.