OMV AG Looks Attractive Again (OTCMKTS:OMVJF)

A few months ago, I downgraded OMV AG (OTCPK:OMVJF, OTCPK:OMVKY) due to a changing risk profile and a significantly higher share price compared to when I previously covered the stock. Since then, the share price has fallen sharply – at the time of writing – by more than 15 percent. At the same time, the business development was generally quite positive. The company has taken steps to make its supply more resilient and reduce dependence on Russia’s Gazprom, and the estimated cash flow was high due to a stronger than expected energy market environment.

Consequently, OMV again looks more attractive as an investment. Below, I’ll provide an update on recent developments and how they affect the investment case. Please note that all figures are per share to the common stock. There are also ADRs that represent ¼ share each.

No major Adnoc news

Currently, OMV and Abu Dhabi National Oil Company (“Adnoc”) remain involved in advanced discussions regarding the merger between Borealis – in which OMV owns 75 percent, Adnoc owns 25 percent – and Borouge, controlled by Adnoc, of which Borealis in tower holds 36 percent. I have previously written about the strategic viability of a merger, as well as the terms that would have been negotiated. For the sake of brevity, I will not go into detail at present, as there are currently no indications of major changes in this regard. Suffice it to say here that both companies would likely end up with equal stakes in a combined Borouge-Borealis. The intention is for the combined entity to be listed – although it is not yet clear on which stock exchange(s) and where the primary listing would be – with a free float likely in the range of 10% of outstanding shares. Based on the respective valuations and the various cross-holdings, OMV would probably have to make an additional investment of 1.5 and 2 billion euros to reach equal stakes of around 45 percent each.

Recently, there have been no major developments in either direction in terms of negotiations. Or at least, no developments have been made public (or become public through leaks of any kind). I doubt that an agreement will be reached before the Austrian parliamentary elections at the end of September. This presents an obvious disadvantage as it adds an element of uncertainty regarding the composition of the next Austrian government and its position on a possible deal with Adnoc. In the worst case scenario, a deal could be canceled entirely. That said, I remain cautiously optimistic. I am reaffirmed in this view by Adnoc progressing its takeover talks for Covestro AG (OTCPK:CVVTF; OTCPK:COVTY) as it underlines the Emirates’ broad strategic direction and focus on diversifying into petrochemicals.

ASSESSMENT

Assuming an Adnoc deal eventually happens, I base my long-term valuation on a sum-of-the-parts approach. Borouge-Borealis’ initial valuation would likely be somewhere around $30 billion, regardless. Obviously, this figure may diverge from whatever the stock market ultimately decides to value the business, if and when it goes public. Based on this figure and assuming a 45% stake for each partner with 10% free-float, Borouge-Borealis would represent a value of $13.5 billion (which translates to around €12.2 billion at the time of writing of this article).

My assessment of the oil and gas business (including downstream components), meanwhile, remains unchanged. I apply a fairly conservative multiple of 3 times peak cycle earnings. 2022 is a very strong year for the oil and gas sectors. Therefore, I use that year’s earnings figures as an approximation. Based on an assumption of comparable peak earnings of around €2.4 billion, the business should be worth around €7.2 billion.

Mainly as a result of the dividend payment, cash and equivalents fell to €5.4 billion, leading to a significant increase in net debt to €3.3 billion as at 30 June.^th. We should, in my opinion, also factor in the cost of raising the stakes in a potential Borouge-Borealis. To be sure, I will calculate with 2 billion euros, thus arriving at a pro forma net debt of about 5.3 billion euros.

Based on the calculations above, the share price should be around €42.75 on a non-diluted basis, representing an upside of just 10 percent. However, this does not take into account the seasonal effect of the sizeable dividend, which is paid annually, not quarterly. Net debt regularly rises significantly in the second quarter and tends to improve from there. Based on these considerations, I think a price closer to €50 per share is reasonable.

Dividends remain a key driver (and may become even more important)

One of the most important features of OMV as an investment is its dividend. Going forward, the dividend could become even more of a factor as interest rate cuts look increasingly likely in both America and the Eurozone. The expected result of lower bond yields naturally increases the relative attractiveness of equities in general. Additionally, income-focused investors may increasingly look to dividend-paying stocks, especially in this type of scenario.

In addition to its regular dividend, which the company intends to maintain or increase consistently, OMV has introduced special dividends. The goal is to distribute 20 to 30 percent of operating cash flow as dividends as long as the leverage ratio is below 30 percent. At the end of the second quarter, the leverage ratio was 12 percent, thus remaining well below this threshold. In particular, the dividend for the financial year 2023 was paid in that quarter, so a substantial payment (= cash outflow) is already taken into account. Accordingly, I believe that annual distributions of €2.95 + X are expected for the foreseeable future. At the current share price, that translates into a dividend yield of at least 7.3 percent. Including special dividends, the total return is unlikely to reach double-digit territory, even if the special dividend could fall slightly below the 2023 level of €2.1.

The thesis risk

In terms of risk factors, not that much has changed compared to the last time we covered the stock. Geopolitics remains a concern. There is the legacy relationship with Russia’s Gazprom. Despite diversification efforts, an interruption in the supply of (relatively cheap) gas could have a negative impact on OMV’s profitability. Even without the intervention of the Russian government, the current incursions of the Ukrainian armed forces into Russian territory may, in my view, pose an additional risk in this regard, due to the possibility of damage to physical infrastructure. Meanwhile, in Libya, militias under the command of Field Marshal Khalifa Haftar recently occupied the Sharara oil field in what appears to be a protest against the issuance of a Spanish arrest warrant for Lt. Gen. Saddam Haftar, the field marshal’s son, which is leading to dwindling production . OMV, in this case, appears to have been caught in the metaphorical crossfire, as Spain’s Repsol, SA (OTCQX:REPYF) is a joint venture partner in Sharara.

Another negative aspect is the relatively high percentage of government ownership. OMV is of national importance to Austria, and state holding company ÖBAG owns 31.5 percent. The interests of the Republic of Austria – or, more specifically, its elected representatives – may not always be aligned with the interests of other shareholders. In particular, political considerations can contribute to overly ambitious ESG commitments at the expense of here-and-now profitability. And of course, both the energy and petrochemical divisions are inherently cyclical businesses.

Arguably, the most important risk to my investment thesis is that of an Adnoc deal not going through for good. Absent a possible Borouge-Borealis combination, the current share price implies a Borealis share valuation of €12.8 billion (or €9.6 billion for OMV’s 75 percent stake) on a hypothetical debt-free basis. That is, of course, as far as we agree with my fairly conservative value estimate for the oil and gas business. At a multiple of nearly 60 times 2023 net profit of €216 million, that’s not exactly cheap. Accordingly, the valuation advantage would be somewhat limited without a merger.

Conclusion

OMV, in my opinion, is a great deal at a reasonable price. If a Borouge and Borealis merger comes to fruition, I see at least a 25 percent advantage. At the same time, attractive dividend policy could become even more of a factor going forward, as the prospect of lower interest rates will likely cause income-focused investors to look more toward dividend-paying stocks instead of fixed income.

All in all, OMV is again attractively priced as an investment. At these levels, I am considering adding to my position. I am therefore updating my rating to a buy.

Editor’s Note: This article discusses one or more securities that are not traded on a major US exchange. Please be aware of the risks associated with these stocks.