Lukoil Stock Forecast: What Investors Should Consider Going Forward (OTCMKTS:LUKOY)

Article Thesis

PSJC Lukoil (OTCPK:LUKOY) is one of Russia’s largest oil producers. It was highly profitable in 2021, even before the recent upwards move in oil prices. All else equal, profitability in 2022 would be quite strong. But self-sanctioning, sanctions, and trading restrictions should be considered before investors move into this stock too quickly.

Lukoil Stock Key Metrics

PSJC Lukoil is a leading Russian oil producer. Its market capitalization was $60 billion at the end of 2021, based on a share price of $90 and a share count of 650 million (according to YCharts). Since the beginning of the Russia-Ukraine war, the stock has plunged, however. The most recent price as quoted by Seeking Alpha is $6.96 per share, which implies a market capitalization of just $4.5 billion.

The company’s most recent quarterly report can be found here. Seeking Alpha’s coverage of that earnings report is available here. Per this most recent report, Lukoil’s book value stood at 4.5 trillion Rubles at the end of the fourth quarter. Based on a Ruble-USD exchange rate of 0.013 at the end of 2021, that was equal to $59 billion. We can thus say that Lukoil was trading almost perfectly in line with its book value at the end of last year. Today, with a Ruble-USD exchange rate of 0.010, the company’s book value is around $45 billion. Per the most recent quoted price, Lukoil is thus trading at just ten cents on the dollar.

In 2021, Lukoil generated a profit of 775 million Rubles, equal to around $8 billion at current exchange rates. That would be a very solid profit for a company valued at $60 billion. Again, this indicates that Lukoil was reasonably valued or undervalued at the beginning of the current year, before factoring in geopolitical risks and uncertainties from sanctions, etc.

Since oil prices have risen considerably so far in 2022, we can assume that Lukoil would generate massively higher profits this year if sanctions, parts shortages, etc. would not have an impact on the company’s operations. Since Brent (CO1:COM) averaged around $60-$70 in 2021, whereas Brent trades at $120 today, profits would likely be massive this year if not for the impact of the war. Lukoil has produced a little more than two million barrels of oil per day last year. If that oil is sold at a premium of just $20 over the average price of 2021, that would make for an additional $15 billion in net profits. And a $20 premium over the price in 2021 is very conservative still, as the current premium is at the $50 level. Even in a $20 oil price increase scenario, Lukoil would likely still be able to generate north of $20 billion a year in net profits.

What Is Lukoil’s Outlook?

Investors should consider several important impacts from the Russia-Ukraine war and reactions by other countries, however. First, differentials between Brent and Russian crude, e.g. the Urals grade, have blown up. Per Neste, the Urals-Brent differential is around -$30 right now, whereas the differential was just a couple of dollars before the war. That means that the actual price that Russian producers receive for their crude is well below the $120 quoted for Brent (and what many non-Russian producers receive for their oil). It should be noted, however, that even a $90 price for Urals is way higher than the average price over the last year.

Sanctions and self-sanctioning also have an impact on Lukoil and other Russian producers. With financial sanctions against many Russian entities in place, trading commodities with foreign partners has become more complicated. Insurance of cargos on the sea, logistics, and so on have all become more difficult, in some cases impossible. Self-sanctioning by Western oil buyers, e.g. refineries in Europe, have led to lower demand for Russian oil. That oil will, I believe, eventually find buyers, but it is still pretty clear that sanctions will have an impact on Lukoil’s operations.

Sanctions by Europe, the US, and others will also lead to issues when it comes to maintaining or growing oil production in the future. Machinery exports to Russia, and other tech exports, have been hindered, which could lead to parts shortages and maintenance issues for the industrial companies in Russia — Lukoil could be one of the companies affected by that.

It is currently not possible to forecast how large the impacts of these factors will ultimately be. But I assume that Lukoil will be by far not as profitable this year as the current oil price environment suggests, although they could still be way more profitable than they were in 2021.

There are thus major uncertainties when it comes to Lukoil’s outlook for 2022 and beyond. To some extent, those exist with all oil equities — they all depend on oil prices, global demand, etc. But in Lukoil’s case, geopolitics, sanctions, and ultimately the ongoing war in Ukraine play a large role as well.

Many readers likely know about the Ruble’s weak performance versus the USD and other currencies in 2022. Lukoil could be relatively unaffected by that, however. Most of its sales are denominated in USD, which means that the company is somewhat hedged against a declining Ruble. Recent news indicates that Russia might demand Rubles for natural gas shipments in the future, at least from some customers. Something similar might happen for oil shipments as well, although it has not been announced so far. In that case, Lukoil would be more exposed to exchange rate changes.

How Should Investors View Lukoil Stock?

Importantly, Lukoil is not a state-owned company. Buying Lukoil is thus not equal to investing alongside the Russian government — in contrast to Saudi Arabia’s Aramco (ARMCO), where the government owns more than 90% of the company. Rosneft (OTCPK:RNFTF) and Gazprom (OTCPK:OGZPY) are Russian examples of energy companies where the state has a lot of control.

That being said, it is still pretty clear that an investment in Lukoil is both controversial as well as risky. Sanctions, war impacts, price differentials between Brent and Urals, and so on do still have a huge impact on Lukoil, despite it not being a state-owned company.

Trading in many stock exchanges has been restricted, which means that buying and selling may not be an option for some investors, depending on what brokerage you use. Trading in Russia has started again on March 24, according to TradingEconomics, following a trading halt of around one month. Somewhat surprisingly, equity prices in Russia are higher than what the most recent closing prices in Western bourses had indicated, at least in some cases. On the Moscow exchange, Lukoil has last been traded at 5200 Rubles (on March 25). This implies a price of $53 — way more than the $7 per share last quoted on Seeking Alpha (which uses the last trading price in the US, not Moscow). A $53 share price implies a market capitalization of around $34 billion, which is far from expensive in case Lukoil can maintain profitability at 2021’s level of $7 billion. If profits are above that level in the future, Lukoil would look even cheaper.

Takeaway

Lukoil was highly profitable in 2021, with oil prices at way lower levels than today. In 2022, profits could soar versus 2021 based on the steep increase in oil prices. On the other hand, sanctions, logistics issues, parts shortages, and so on could also hurt Lukoil’s profits this year.

Lukoil looked rather inexpensive at the beginning of 2022, and with current share prices meaningfully lower, LUKOY looks quite cheap in absolute terms. But considering the geopolitical risks, I believe that it might still be best for investors to stay away for now. Very enterprising, risk-hungry investors might want to establish a small position — in case the conflict is resolved and shares recover to pre-crisis levels, a position in LUKOY could experience a lot of upside potential. Liquidity issues and trading restrictions should be considered, however. I do thus believe that staying away from LUKOY until we get a clearer picture might be the best idea for now. Many other oil equities with fewer geopolitical risks are still inexpensive, so good alternatives to a Lukoil investment exist.