Many investors believe Russian energy giant Gazprom (OGZPY +0.00%) is a cheap stock. The Russian natural gas producer trades at an astonishingly low forward P/E of 2.5 even though the company made more in net profit than ExxonMobil last year.
Gazprom has solid fundamentals -- the company controls 65% of Russia's proven gas reserves, which happen to be the largest reserves in the world, and its net sales grew by around 10% last year. The company's operating cash flow is about 40 times debt interest payments. And with 1.3 billion people in China in need of cleaner energy, there should be plenty of growth and profits ahead.
Gazprom has also remained unscathed from the Ukrainian crisis -- the company, which supplies approximately 30% of Europe's natural gas needs, has not been subject to Western sanctions so far. Given its importance to Europe, many investors believe Gazprom won't be subject to sanctions in the future.
With all the positives, investing in Gazprom may seem like a slam dunk, but the company is not without its caveats.
No free lunch
Gazprom trades at a low multiple because many investors believe the company is run as a foreign policy tool rather than being run for shareholders. The Russian government recently, for example, used Gazprom to raise natural gas prices on Ukraine in retaliation for its government coup.
Because the company is not exactly run for shareholders, some investors fear that Gazprom may make uneconomic decisions that make its cheap valuation more expensive. Because of this, Gazprom shares trade more as a function of corporate governance rather than as a function of traditional valuation metrics.
Many investors feel that if the Russian government does not change its policy on using the company as a lever, Gazprom shares will remain cheap no matter how compelling its valuation becomes.
The bottom line
When investing in Russia's energy sector, investors have two choices: They can take the traditional path and invest in Western supermajors such as BP plc (BP 0.58%), which has significant assets in Russia, or they can invest in Russian companies.
For most investors, buying shares of BP, which owns a 19.7% stake in Russian oil company Rosneft, is the better choice. With BP's near 20% ownership of the world's largest publicly traded petroleum company, BP shareholders get significant upside exposure to Russia's resource wealth. Because the majority of BP's cash-producing assets are outside of Russia, BP's shares have limited downside in a Russian bear-case scenario. The company's 4.5% dividend, for example, will most likely be safe.
But for long-term investors with a healthy appetite for geopolitical risk and extreme patience, Gazprom could be the ideal investment. Shares of the Russian natural gas producer did trade at 10 times forward earnings as recently as 2006 versus 2.5 times today.
The company also pays a healthy 5% dividend and has recently rallied 24% from its March lows. If the market does change its mind on Gazprom's corporate governance, shares could soar. The problem, however, is that it could take a lifetime for that event to occur.
