CFA Institute Research Challenge Hosted in Romania The Bucharest University of Economic Studies

CFA Research Challenge | 21 Feb 2015

S.N.G.N RomGaz S.A. | BVB symbol: SNG | LSE symbol: SNGR Price (BVB Close 18 Feb 2015): 34.01 Action: HOLD End-2015 target price: 38.5 Report currency: RON Analysts: Theodora Alexe, Carmen Dobrescu, Carmen Dima, Cosmin Popa Sector: Oil and Gas/Romania Radu Lupu (Faculty Advisor), Sorin Dumitrescu, CFA (Industry Mentor) Faculty of International Business and Economics, ASE Bucharest

Key stock statistics (Thomson Reuters, BSE, LSE, company reports) 52 weeks Price Range (RON/sh) 32.1- 36.4 Market cap.(£m) 222.78 Debt/Equity 0 P/NAV 0.3% Average daily volume 255,252 Free Float 20% Gearing 0 DPS 2.57 Shares Outstanding (m) 385.4 Beta 0.85 EPS 0.88 Closing price BVB 34.01 Market cap.(RON) 13,069 NAV (RON) 9736.6 P/E ratio 7.73 Closing price LSE £8.5

Highlights Price performance chart  Romgaz is the leading natural gas supplier in 37 3000 Romania, involved in exploration and 36 2500 production of natural gas, storage and 35 technological transport. The regulated market 2000 protects its competitive position, while 34 1500 strategic partnerships with international 33 1000 players sustain its stronghold in both local 32 and external operations. 31 500  As a state-owned company, Romgaz 30 0 performance depends on positive

macroeconomic outlook and industry trends.

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In the context of declining global and regional 2-Apr-14

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11-Dec-13 25-Dec-13 20-Aug-14 17-Sep-14 12-Nov-14 26-Nov-14 10-Dec-14 24-Dec-14 28-May-14 gas reserves, Romania’s exposure to Russia 14-May-14 as its main gas supplier puts it at risk, though High-Low Volume (rhs) 10-day MA 30-day MA the risk for Romgaz is capped due to

production and sales operations being 10% Returns focused extensively on the local market. In addition, the development of the Black Sea 0% area and AGRI interconnector are an -10% opportunity for Romgaz in the mid- and long- D-13 J-14 F-14 M-14 A-14 M-14 J-14 J-14 A-14 S-14 O-14 N-14 D-14 J-15 F-15 term. Source: Bucharest Stock Exchange

Financials Valuation Investment Risk 2014 2015e  Given limited risk exposure and good  One major risk for the company is Profitability business development prospects, we represented by the limited exploitable Profit margin 36.7% 31.1% recommend HOLD on Romgaz, with a 12- reserves, which cause the gas production of Dividend yield 8.4% 8.5% 13% upside on the current stock price. Romgaz to decline with more than 1 % per Liquidity Countering production decline, developing year. The company’s profitability for the Working capital turnover 5.44 5.00 new resources and continuing to establish forthcoming years will also be influenced by a Solvency key partnerships in exploitation will affect the new taxation system that could include higher Total Debt to Total Assets 0.0% 0.0% prospects of the company further on. royalty rates. Free Cash Flow 1,448 928  Financials and valuation are indicative of a  Key strengths relate to the intent of the Valuation HOLD recommendation. We established a company to mitigate financial risks through Price to Earnings 8.7 7.3 target price of RON 38.50, a 13% growth the introduction of a risk management  The 2014 financial profitability ratios highlight from the current price of RON 34.00 and department, to the significant work interest in an impressive 42.11% y-o-y increase in expect low stock price volatility due to the the Black Sea offshore discoveries and to the earnings before interest and taxes. This high price liberalization calendar. Our valuation 25% interest in the Azerbaijan-Georgia- profit margin of 36.7% reflects the effect of approach relies on Discounted Cash-Flow Romania Interconnector regional project. the gas price liberalisation for non-household Model, Net Asset Value and Multiples model.  With a high probability of materializing, consumers. The latter is computed on the stock market operational risks represent a serious concern  The relatively high dividend yields of 8.5% in trading of peer companies. for the company. However, regulatory risks 2015e compared to Romgaz peers would  The main share price triggers are the should not be overlooked by the risk offer potential investors a significant return reshuffle of the tax system, the gas demand department as they may have a significant for their investment. and the depressed oil prices which act as a impact on the profits of Romgaz.  The capital structure of Romgaz is benchmark for import gas. underleveraged, with an atypical zero debt

level. On the upside, Romgaz can attract 48 Financial more debt in the future with no risk of default. Risks 46 18% However, this implies lower returns on equity Operational which can hamper the competitive advantage 44 Risks of the company. 42 13.40%

Regulatory

Risks  The actual free cash flows for 2014 are 40 significantly high at 1,448 million RON, Environmen

Price 38 8.30% tal Risks enabling Romgaz to halt the production Potential decline and to pursue other opportunities that 36 Probability Corruption Risks enhance shareholders’ value. 34 General 32 Country 30 Risks DCF Peers NAV Valuation method Target Price Current price Upside Impact Source: team estimation Source: team assessment 1 | P a g e

CFA Research Challenge | 21 Feb 2015

Business Description

Natural gas exploration and production are the core business of the company Company info The focus of the company is on exploitation of current reserves and discovery of new sites. Address: Piata Constantin Motas, No. 4, Romgaz currently operates 3257 gas producing wells which access 147 commercial fields, as Medias, Sibiu; Romania, 551130 well as 29 exploration wells in nine on-shore exploration blocks. As of June 2013, the company Website: www.romgaz.ro held net proved reserves of 62.1 billion m3 of gas and additional net probable reserves of 13.2 FTSE Sector: Oil &Gas Producers billion m3. The use of modern specialized software and specific surface exploration methods for Shares listed on: identification of areas with accumulations of hydrocarbon led to a maximum reserves replacement  Bucharest Stock Exchange(BVB) ratio of 298% in 2012. Going forward annual investments of approximately RON 600 million have since 12/11/2013, code: SNG been announced for projects aimed at discovering new gas reserves and enhancing production  London Stock Exchange (LSE) output through improvement of equipment performance and redevelopment of mature fields. since 12/11/2013, code: SNGR Strategic partnerships sustain Romgaz’s stronghold in local and international operations ISIN number: ROSNGNACNOR3 Romania has the largest natural gas market in Central and Eastern Europe and was the first Share denomination: RON country to use natural gas for industrial purposes, allowing Romgaz to develop early expertise and transform it into a competitive advantage. To sustain its advance in know-how, Romgaz has established strategic partnerships covering 15 petroleum concessions in Romania. The company Shareholder structure has joint-ventures with Wintershall in the exploration and development of the RG 03 Transilvania South Block, with Falcon Oil & Gas in the exploitation of the Brodina and Cuejdiu Blocks, with Natural BNY persons, Amromco Energy in the rehabilitation of 11 gas fields and with Schlumberger for the rehabilitation Mellon 2.04% of Laslău Mare gas field. Moreover, as of 2008 Romgaz has been expanding internationally DRS, becoming co-titleholder of petroleum rights and obligations in 3 blocks from Slovakia(25 % 5.37% Legal persons, interest share) and 2 blocks from Poland(30% interest share) 12.58% Romanian state holds 70% A 15% stake in Romgaz was offered through the October 2013 IPO on both Bucharest Stock Exchange through shares listed and on London Stock Exchange through Global Depository Receipts (GDRs). The IPO made Romgaz the most valuable state-owned company in Romania Romanian and was therefore a success: the offer was oversubscribed nearly seven times, the share price of State, the sale – at RON 30/unit, was close to the maximum offer price of RON32/unit, and as a result Fondul 70.01% Romgaz raised EUR 390 million. As of September 30, 2014 the shareholder structure entitled a Proprietat ea S.A., majority stake of 70,01% to the Romanian State through the Ministry of Economy, 10% to Fondul 10.00% Proprietatea S.A. which works as a Romanian investment fund, 17,69% to various legal persons and 2,30% to natural persons. A long-term strategy to counter Romgaz’s main challenges Source: Romgaz The decline in natural gas production, the costs of discovering new resources and the difficulty of establishing key partnerships for exploitation are the main challenges that Romgaz plans to Projects Companies overcome. Finding new proven reserves is crucial to maintain investors’ confidence on the long term. Romgaz’s already proven reserves of natural gas will ensure internal production for the Participation agreement following 12 to 15 years. for exploration and OMV Petrom and exploitation of the Black ExxonMobil The company has planned to partner with strategic players, in accordance with its expansion Sea area strategy. As it targets development in the Black Sea, Romgaz signed a participation agreement with OMV Petrom and ExxonMobil whereby it will hold a 10% of the exploration and exploitation SC Sutech SRL Building a natural gas of the area. The exploration of the Black Sea perimeters could start in 2019 - 2020. Medias, SC compression unit in Condmag SA and SC To further strengthen operations, Romgaz is building new assets to enhance local output. The Roman Inspet SA companies SC Sutech SRL Medias, SC Condmag SA and SC Inspet SA will build a natural gas compression unit in Roman in the near future for Romgaz, the contract being valued at 58.4 Construction of a drying SC Condmag SA and million RON (13,2 million Euro). Another significant project which will be done by SC Condmag station and a gas SC Inspet SA SA and SC Inspet SA is the construction of a drying station and a gas compressor near the gas compressor deposit in Sarmasel, Mures County. The contract is valued at 237.5 million RON (53.5 million Euro) and will be completed in 24 months.

Industry Overview and Competitive Positioning Macroeconomic Outlook

Consumer confidence Consumer confidence is improving steadily As the world financial crisis began to be perceived in Romania starting with the year 2008, the 30 consumer confidence dropped because population saved more and spent less. Therefore, the 20 gas consumption in Romania maintained the decreasing trend for the following years. On the 10 above graph we can observe a tight relationship between consumer confidence and household 0 consumption. With a correlation coefficient of 59%, we can state that consumer confidence tends -10 to follow the trend of household consumption as it is lower during an economic decline. -20 -30 Romania’s GDP projection is on uptrend through 2019, generating growth also in the gas -40 industry -50 -60 In March 2014 Fitch re-affirmed Romania’s rating at BBB- with stable outlook. The rating agency -70 believes that Romania’s public finances are under control and considers that in comparison to 2013 the GDP growth is more balanced in 2014 because of the stronger contribution of domestic

demand.

Mar-2008 Mar-2009 Mar-2010 Mar-2011 Mar-2012 Mar-2013 Mar-2014

Sep-2008 Sep-2009 Sep-2010 Sep-2011 Sep-2012 Sep-2013 Sep-2014 Sep-2007 In 2014 the GDP recorded a 2.3% increase and according to IMF and European Commission Industrial production - 12 months forecasts Romania’s GDP is estimated to grow by 2.5% in 2015 and by 2.9% in 2016. With a Consumer confidence developing economy and an increasing in GDP, the gas industry is flourishing and thus triggers the need for more energy in both the industrial and household sector. In Romania, household Source: Romgaz consumption is indeed more significant than the industrial one, since there are fewer alternatives in the market.

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CFA Research Challenge | 21 Feb 2015

However, with a growing economy and an increasing GDP projected throughout 2019, the gas industry in Romania is looking toward more demand for energy in both the industrial and household sectors.

Inflation, unemployment and the evolution of government debt are expected to prop industry growth

Government debt peaked in 2014 at around 40% of GDP; the gap is expected to be at 36.5% of GDP in 2019. Lower government debt, coupled with increasing GDP, are positive developments Historical Prices Brent Crude Oil ($/bbl) for the Romanian economy and may reflect in industry trends as well. Nonetheless, several other factors influence the stock evolution of companies in the oil and gas industry, which we shall 120 review further in this document. The consumer price index was constantly in [-1%; +1%] variation interval, except for 2011 when 100 inflation reached a record -3%. There were two causes for this record low: i) the impact of VAT increase in 2010 faded, ßand ii) there was a huge deflation on food segment, which had not been 80 anticipated. Prospects for 2015 are that inflation will increase again reaching a level of 3.4% which will also be reflected in higher energy prices. Unemployment rate had a peak in 2013 60 (7.1%), and started to decrease in 2014 (7.0%). The prospects are that it will be stable at about 7% from 2015 onwards.

40 Focus on the local market protects Romgaz to a certain degree from geopolitical events The oil price is at its lowest price since 2008, affecting the stock price of companies from the oil 20 and gas industry. The risks have increased in part due to the geopolitical events and turmoil in Middle East and Russia-Ukraine. Positioned close to the Ukraine and Russia, Romania is 0 influenced by the evolution of the current conflict. However, unlike a company with import-export

activities, Romgaz runs its main operations within country borders: gas extraction, production and

1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 1976 sales are confined to Romanian territory and consumers, and thus the company stock price is not significantly dependent on events outside the country. Source:BP statistical review Industry Analysis Black Sea gas reserves are an opportunity in the context of global and regional reserves Global natural gas reserves are being depleted at a fast rate. In the year 2000, remaining Proved Reserves Romania discovered reserves of natural gas were estimated to last 58 years, assuming constant production; in 2013, accounting for new discoveries and ongoing production, remaining reserve 0.7 duration reduced to 55 years. This highlights the increased efficiency of current discovery techniques and the intense activity in the gas industry. The global proved natural gas reserves at 0.6 the end of 2013 are concentrated in Middle East and C.I.S., with Western Europe holding the 0.5 smallest share of resources. The energy industry of the European Union is predominantly dependent on imports, thus making 0.4 the European Union the greatest energy importer worldwide. Import weights vary with the types of 0.3 natural resources, so that 88% is connected with oil imports and 66% represents the import level for natural gases. The annual consumption level of natural gas in the European Union is 3 0.2 approximately 440 billion m . With fewer supply sources of natural gas, the fulfillment of European natural gas needs will remain difficult and costly. Russia currently supplies 41% of import needs, 0.1 with Norway closely following at 32%. According to European Commission forecasts, the import

0 dependency of European Union countries will rise to 73% of consumption in 2030 mainly because

of the depletion of internal resources, the stricter environmental protection policies, the closing

1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 1980 down of nuclear power stations and the strong public opposition to shale gas exploitation. Moreover, alternative sources of supply are highly unlikely to change the future energy map since Source: Romgaz complex and costly transportation systems need to be built in countries with great political uncertainty such as Azerbaidjan, Turkmenistan, Israel, Iran or Iraq. South-East Europe and hydrocarbon accumulations in the Black Sea Countries from SEE are highly dependent on gas imports from a sole supplier – Russia – which Comsumption cyclicality and seasonality are further distributed through Ukraine’s pipelines. Since 17% of Europe’s annual gas consumption is satisfied through deliveries made from Russia through Ukraine’s pipelines, the 25.00 recent Russia-Ukraine war presented serious threats to the European energy security. The conflict makes countries vulnerable to political and price conflicts that can lead to a halt in natural gas provisions as it happened in 2006 and 2009. A stress test ran by PricewaterhouseCoopers 20.00 showed that Bulgaria and Macedonia would be highly affected if the Ukraine gas transportation system were disrupted, and that Romania, Greece, Serbia, Bosnia and Hungary would be less

15.00 influenced. In such a situation, the wholesale gas prices in Europe would rise. Moreover, if Russia

interrupted its gas exports, most European countries would suffer. Therefore, the Black Sea TWh 10.00 represents a new area of opportunity for natural gas exploitation. This area will increase proven reserves of Romania, Ukraine, Russia, Georgia, Turkey and Bulgaria. This is regarded with extreme interest, given the limited reserves of conventional natural gas in SEE and the currently 5.00 unevaluated potential of shale gas in the region. The reserves are estimated at 2 billion boe in the West side of Black Sea and at 5 billion boe in the East. 0.00 Industry cyclicality and seasonality

The prices of natural gas are determined by supply and demand factors and are intrinsically

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May-13 May-14 May-12 linked to oil prices. Due to the fact that natural gas is used primarily for heating, it has an incredibly seasonal market and prices are usually dependent upon weather patterns and Source: Romgaz ultimately upon demand levels. Romania has a seasonal pattern with consumption reaching up to 20 TWh in winter months and approximately 5 TWh in summer months. This pattern will

consequently influence prices for the newly liberalised industrial market, making Romgaz a good stock acquisition when prices are low in summer months.

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CFA Research Challenge | 21 Feb 2015 Internal production supplies 85% of Romanian gas consumption, which is expected to The evolution of natural gas production and remain stable over the next years consumption in Romania Although Romania is one of the world’s main energy producers and the only country in the region with onshore resources, it became a net importer of gas from Russia in the 1970s when 45 production started to decline. Consequently, the country’s energy security is threatened by the 40 undiversified sources of external supply. Currently, Romania exploits 450 deposits of oil and 35 natural gas, out of which 255 are exploited by OMV Petrom and 153 by Romgaz. These two 30 companies are the main producers of natural gas and together account for approximately 97% of 25 total domestic production: Romgaz (6 bcm/year) and OMV Petrom (5.2 bcm/year). Other small 20 independent producers (leased gas fields) are Depomures, Amromco Energy, Amgaz. The country has approximately 150 billion m3 proven reserves of natural gas that at a level of 11 15 billion m3 in annual production and at an 80% rate of reserve recovery could be exhausted in 12- 10 15 years. One already implemented solution to stop production decrease is the redevelopment of 5 mature fields. The exploitation of the Black Sea natural gases is a long-term strategic project that 0 requires massive investments; OMV Petrom-ExxonMobil, Petroceltic and Sterling Resources are

some companies that have already invested in research and discovery.

1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012 Though potential resources need to be properly appraised, Romania considers developing consumption production interconnectors with neighbouring countries, improving the underground storage capacities and liberalizing the gas prices for both industrial and household consumers in order to integrate with Source: Romgaz the regional and European gas market. For example, the interconnector Giurgiu-Ruse between Oil & Gas stocks price performance vs. Romania and Bulgaria is waiting to be completed, the construction of interconnector Ungheni-Iasi brent crude oil price (100 = 1 Jan 2014) between Romania and Moldova started in 2013, the Arad-Szeged interconnector between Romania and Hungary was completed in 2010 but operates only to bring import gas from 120 Hungary, and the Mokrin-Arad gas interconnection between Serbia and Romania is to be 100 approved. The possibility of engaging in exports from 2020 onwards, when the Romanian gas

80 market will also be fully liberalized, is alluring. However, the importance of these interconnectors is undermined by the fact that none of the before mentioned countries are gas producers, and the 60 source of imported gas will therefore remain the same. Demand for natural gas is mainly 40 influenced by weather conditions and by national energy-efficiency programs which introduce new technologies for renewable energy production. Natural gas demand in Romania has followed the 20 European trend of lower consumption levels during the financial crisis and slight decreases since 0 2012. The Q3 2014 results of Romanian gas companies reveal that there is an increase of approximately 7% y-o-y of gas quantities sold. The pressures coming from the gas price

liberalization in Romania are not expected to diminish consumption levels.

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01-Aug-14 01-Sep-14 01-Nov-14 01-Dec-14 01-May-14 Prices to converge to European levels Brent oil The liberalization of the Romanian gas market is expected to deliver more competitive and Romgaz therefore efficient and cheaper energy. The wholesale market for natural gas is liberalized since Frontier markets 2015, but the lack of trading has left the price at the 89.4RON/MWh. The current European spot prices of 19-21 EUR/MWh have been decreasing in 2014. The US LNG prices pushed gas prices Source: Thomson Reuters Datastream, team calculations lower, and the recent conflict between Ukraine and Russia pushed oil prices at a five-year low,

below $50 a barrel which will correspondingly account for a fall in gas prices. Import prices from Household sector-Romgaz and EU prices Russia usually range from 100 to 130 RON/MWh. Eligible, non-residential Romanian customers 60.00 will have to negotiate contracts with gas distribution companies until July, 2015 and thereafter the gas prices will be based purely on market mechanisms. Since gas distribution companies have 50.00 greater bargaining power, the maximum price level for the wholesale market is set around 92 RON/MWh. For residential customers the current regulated market requires a price of 40.00 53.3RON/MWh, which is due to change once the new price increase calendar is made public on 30.00 July, 2015. The gas market for households will be fully liberalized by mid-2021. The local taxation framework will be modified as of 2016 20.00 The current Romanian taxation system will be revised as of January 1st, 2016 and the new 10.00 system will be maintained for the coming 10 to 15 years. The government plans to increase energy royalties at a level which is closer to the one practiced by other countries in the European 0.00 Union. The current level of royalties paid for natural gas development and exploration of 2013 s1 2013s2 2014s1 2014s2 production in designated blocks ranges between 3.5% and 13% of the entire value of production, depending on the size of the reservoir. The Government has not changed the royalties from 2004, Romgaz (EUR/Mwh) EU-28 (EUR/Mwh) when it has signed an agreement with Petrom, currently owned by the Austrian group OMV, in which they set the value of the royalty for the next 10 years. The average royalty paid in 2014 by Source: Romgaz Non-household sector-Romgaz and EU Romgaz was 7% and it is predicted to remain at the same value for 2015. prices The standard corporate profit tax of 16 % is applicable for petroleum operators. Furthermore, a "construction tax" of 1.5% for power plants, platforms for productions and gas wells was 40.00 introduced in 2014. The tax is computed as a percentage from the accounting value of these 35.00 constructions from which the value of buildings is deducted. This tax will decrease to 1% in 2015. There is also a windfall tax set at 60% for gas producing companies which was introduced in 30.00 2013 and applies to the additional revenues that result from gas price liberalization. The 25.00 percentage applied for additional revenues is expected to change from 2016.

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Romgaz (EUR/Mwh) EU-28 (EUR/Mwh)

Source: European Commission

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CFA Research Challenge | 21 Feb 2015 Competitive positioning

The two main suppliers of natural gas that dominate the Romanian market with a compound Forces analysis 97% share are Romgaz and OMV Petrom. As the industry is highly regulated by ANRE, it is Threat of very hard for a new large competitor to arise in the gas market. Moreover, gas is a necessary New product for both households and industrial consumers, thus for the moment, Romgaz and Entrants 5 OMV Petrom have the power to influence the price. On the other hand, there are potential upcoming concerns for these two big companies. Even 4 though natural gas is irreplaceable in the market, renewable energy might be a threat in the Threat of 3 Bargainin future. Furthermore, when gas price will be fully liberalized in Romania, the consumers’ Substitut g Power impact on price will increase, as price will be determined by market forces of supply and e 2 of Products Suppliers demand. 1 SWOT Analysis Despite new potential threats and weaknesses the company may face in the long run, Romgaz needs to innovate and to take advantage of its strengths and of the opportunities of Bargainin Competiti the market in order to mitigate them. The proven reserves of gas onshore are not g Power on in the of Buyers Industry encouraging for Romgaz, thus the company must consider alternatives. The interest the company has in the Black Sea offshore reserves and the AGRI interconnector project developed with neighboring countries must materialize and account for future production operations. 5 = most favorable to Romgaz The company’s weaknesses will affect its profitability over the next years, when actual Source: team analysis reserves of Romgaz will reduce. Nevertheless, the alignment with EU system and prices will aid the company to maintain or even increase its revenues due to higher prices applied to both industrial and household consumers.

ROE peers comparison Position in the peer group 30.00% Romgaz ROE In terms of industry profitability for the period 2010-2014, the relative valuation of peers emphasizes the striking evolution of Romgaz ROA from a 2.85% value which was below the 25.00% lower quartile returns in 2010, ranking Romgaz among the poorest performers on a global 20.00% scale, to upper quartile returns in 2014 with a ROA of around 13%. This recent substantial increase in net profit margins y-o-y have also set the Romanian natural gas leader Romgaz 15.00% ahead of its national peer, OMV Petrom, which in 2014 had a 50% decrease in profit margin and a ROA of approximately 5%. In terms of ROE, Romgaz traditionally encompasses 10.00% insignificant debt in its capital structure and therefore its leverage ratio calculated as total assets to total equity is historically close to 1.1. This unique feature of the 70%-state-owned 5.00% gas company has accounted for lower ROE when compared with its industry peers. However, 0.00% Romgaz is still an impressive story due to the jump from the 3.24% ROE in 2010 to the 14.43% figure in 2014. Even underleveraged, it offers shareholders a higher profitability -5.00% compared to its national competitor OMV Petrom which in 2014 registered a 7.8% ROE. Globally, Romgaz breaks from the lower quartile to the upper quartile for ROE based solely -10.00% on an increased profit margin due to a sound business model. 2010 2011 2012 2013 2014e The twofold geographical segmentation of the oil and gas industry for mature companies Source: S&P Capital IQ, team calculations highlights the soundness of Romgaz in relation to its regional and Russian peers. Moreover, the prominent discrepancy between the financials of Romgaz and those of the largest global players in the oil and gas market is mainly a result of the considerable difference in proven oil

and gas reserves. Whilst the largest American oil and gas producer Exxon Mobil boasts around 71,860 bcf gas reserves due to the innovative hydraulic fracturing, Romgaz possesses approximately 4.2% of this amount. ROA peers comparison Financial Valuation

25.0% Romgaz ROA In terms of financial valuation, Romgaz has the lowest 2015e EV/EBITDA multiple compared with its regional peers, at 3.67, which implies that it is traded relatively cheap compared with the wider market. At the industry level, its Russian peers have a better earning potential of 20.0% the business than Romgaz, with the average EV/EBITDA at 3.08. The 2015e P/E ratio for Romgaz, 7.73, is again closer to the average equity multiplier for the Russian competitors, 15.0% and significantly lower than the average regional ratio. This implies that Romgaz has less room for higher earnings in the future, compared for example with the regional peers Statoil 10.0% or Repsol YPF, but also that current investor demand for a company share is low. Therefore, Romgaz has an undervalued stock with a P/E well below the production and exploration industry average of 18.78, while still providing sound operational profits. 5.0% EBITDA Growth Valuation and Income Growth Valuation Over a 3-year period, Romgaz has a compound annual growth rate for EBITDA that positively 0.0% sets it apart from the regional trend of declining earnings. The 10.66% growth is also well above the investment performance of the most expensive global oil and gas stocks, and -5.0% above the average industry rate of 4%. Combined with a below industry-average EV/EBITDA, 2010 2011 2012 2013 2014e this profitable growth of Romgaz indicates that it has an upside potential for its share price that has not yet been traded and unlocked. Source: S&P Capital IQ, team calculations The 12.6% compound annual growth rate for net income emphasizes the exceptional profitability of Romgaz over a 3-year period as opposed to the sinking gains of regional and global companies that are a result of historical low oil prices and depressed gas prices.

Romgaz is advantageously isolated from the global trend of falling prices until 2021e when the domestic gas market is set to efficiently respond to market forces of supply and demand. The discrepancy between the industry average for 3-yr net income CAGR of -9% and the

average 3-yr CAGR for EBITDA of 4% reveal the effects of taxation on oil and gas profits. Romgaz benefits from a mild taxation regime in comparison to its peers, fact which could account for its stronghold position.

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CFA Research Challenge | 21 Feb 2015

Hydrocarbon gas average reserve replacement ratio Azerbaijan-Georgia-Romania Interconnector AGRI (Interconnector Azerbaijan-Georgia-Romania-Hungary) gives the possibility for Rosneft 294 transport of Azerbaijan LNG to the Black Sea, where new regasification and liquefaction Repsol YPF 214 terminals will be built and will further supply gas for the European market. Romgaz has a Romgaz 173 ConocoPhillips 152 25% interest in the AGRI project along with the other countries national gas companies ENI 132 (Georgian Oil and Gas Corporation, MVM Hungarian Electricity and State Oil Company of the Gazprom Neft 130 Republic of Azerbaijan). A feasibility study has been conducted and concluded in December Exxon 115 2014 – its conclusions are promising for the further potential achievements which the project TatNeft 114 will reach. The main benefit for Romania and implicitly Romgaz is that it can ensure a part of LUKOil 108 its domestic consumption in the current context of gas reserves depletion. The project BP 103 represents an alternative for the import of Russian Gas. Romgaz boasts a competitive Chevron 100 reserve replacement ratio of 173% over the last three years, which sets it among the top OMV 93 performers in terms of stopping the natural reserves depletion process. Moreover, the latest Royal Dutch Shell 91 financial report on Romgaz stresses the successful approach of freezing natural gas Statoil 91 MOL 85 production decline at the 5.66 billion cm for the fourth consecutive year and confirms 3 OMV Petrom 48 previous gas discoveries while presenting the discovery of 4 new ones.

Source: S&P Capital IQ, Raiffeisen Peer Valuation Metrics (a) Financial valuation (b) EBITDA growth valuation (c) Net income growth valuation

80 60% 30% Russian 70 Global 50% peers peers 20%

60 40% Romgaz 10%

50 30%

0% 40 20% 2 22 42 62 82

Regional -10% P/E 2015 P/E

3 yr 3CAGR yr Russian 30 peers 10% Romgaz Global peers peers -20% 20 0% Income Net3CAGR yr Russian 2 4 6 8 10 peers 10 -10% -30% Romgaz Regional Global peers peers Regional -40% 0 -20% peers 2 4 6 8 10 EV/EBITDA 2015 P/E 2015 EV/EBITDA 2015 Source: S&P capital IQ, team calculations

Investment Summary Price performance chart We issue a HOLD recommendation for S.N.G.N. Romgaz S.A. with a target price of 38.5 RON through the Discounted Cash-Flow technique, a target price of 36.8 RON through peers multiple valuation and a target price of 40.10 RON through Net Asset Valuation. The average upside Domestic Gas Price Evolution potential of the three methods is 13.33%. Our recommendation is in line with the consensus upside potential of 12% that market analysts agree upon. 100 Limited upside potential from the price liberalisation process due to oil price contagion 90 At the end of 2014 the non-household domestic gas market has been fully liberalised, and the still-regulated prices for household consumers are expected to converge to the market price by 80 mid-2021, as promised to the European Union/ International Monetary Fund. The revised calendar of price increases for household consumers is to be released by the government in mid- 70 2015. The last regulated prices of 2014 stood at RON 89.4/MWh for non-households and at RON

RON/MWh 60 53.3/MWh for households. These prices were not yet aligned with the average import gas costs of RON 120/MWh for the fiscal year 2014. 50 The import price of gas for Romgaz depends on only one supplier – Russian gas – and is linked to oil prices through the standard Romanian supply contracts. The unprecedented collapse of oil 40 prices from $115 a barrel in June to below $50 is therefore set to influence Romgaz revenues.

The expected delay until oil price drops are reflected in gas prices is of 6 to 9 months. The

2012 2013 2014

2016e 2017e 2018e 2019e 2020e 2021e 2015e European spot prices for gas will not be used as the benchmark prices since we expect the lower Households Industrials import gas prices to set the price convergence trend for the newly liberalised market for industrial Average price consumers. However, we do not expect significant shortfalls in terms of profitability in the latter Source: team estimation part of 2015.

Difficult shift to a truly liberalised domestic gas market for non-households

The beginning of 2015 marked the start of the fully liberalised gas market for non-households. However, no transactions have been recorded on the centralized market until now. This risk of a

quasi-deregulation should be mitigated by the 2014 Government Ordinance which requires gas producers to sell a minimum volume of gas from own production on the centralised market and which therefore seeks to increase transparency. Consequently, in 2015e Romgaz is obliged to

sell minimum 35% of the quantities produced, minimum 30% in 2016e, minimum 25% in 2017e and minimum 20% in 2018e. These measures should successfully reduce the risk of an illiquid, opaque centralized market for non-households.

The negotiation of royalties will impact profits from 2016e 6 | P a g e

CFA Research Challenge | 21 Feb 2015 The government has set the level of royalties for the period 2004-2014 through a signed Divident yield peers comparison agreement with OMV Petrom. The level of paid royalties for natural gas development ranges from Peer Group Dividend Yield 3.5% to 13%, according to the size of the reservoirs. Romgaz pays an average royalty of 7% of 14e 15e domestic gas sales, which is predicted to remain stable in 2015e. Romgaz is also impacted by the Gazprom Neft 7.7 7.2 Tatneft 4.6 4.5 windfall profit taxes which are set as 60% of the additional revenues obtained as a result of price LUKoil 7.0 7.8 deregulation. However, a new taxation system for oil and gas companies will be enforced from Rosneft 5.0 4.7 2016e and we expect the government negotiations to lead to tax restructures. Therefore we Median integrated Russian 6.0 5.9 estimate that only a higher royalty tax will be kept at around 25% of domestic gas sales and that it MOL 3.9 4.3 will incorporate the windfall tax. OMV 5.0 5.1 Repsol YPF 10.9 5.5 An attractive dividend policy with good free cash flow is expected Statoil 4.5 4.4 Romgaz plans to attract investors through its long term commitment to return cash in the form of Omv Petrom 6.7 6.1 dividends at relatively high yields compared with the median integrated values of regional, Median integrated regional 5.0 5.1 Russian and even global peers. The dividend payout ratio is expected to remain at 75% BP 5.5 5.8 throughout the following years, which indicates an estimated dividend yield between 8% and 9%. Chevron 3.6 3.8 In 2014 the expected dividend yield of 8.4% is higher than the 6.7% the national competitor OMV ConocoPhilips 3.8 4.0 Petrom rewards investors. In terms of a global outlook, Romgaz manages to outperform its ENI 6.2 6.3 largest global peers which offer a return of approximately 5%, and its regional players which Exxon 2.9 3.2 Royal Dutch Shell 5.1 5.2 provide similar yields. The expected dividend yield of 8.5% in 2015 is still advantageous indicating Total 5.2 5.4 a strong business and a management priority to reward shareholders on the long term. This Median integrated global 5.1 5.2 undoubtedly translates in a driver for stock price appreciation on the long run. Romgaz Analysts Estimates* 8.4 8.5 [insert graph cu dividend yield peers grup din “Formatare graphs”] Source: Raiffeisen Low business risk profile Being a 70% state-owned company, the natural gas leader of the Romanian market is inevitably

rigorously controlled by the appropriate national authorities which are also entitled to alter its profits. The tariffs on the underground storage business services are regulated by ANRE (National Authority for Energy Regulation) through a revenue-cap methodology, implying that

higher margins are retained when gas is stored for longer time periods due to low consumer demand. Moreover, until the full convergence of the domestic gas price to the European gas prices is reached, the gas sale prices are bound to move within foreseeable price ranges,

eliminating surprises in price volatility. The idiosyncratic risk of Romgaz is also successfully managed by a newly appointed risk management department.

Corporate Governance and Social Responsibility Romgaz has taken steps to establish responsible governance. Former general manager of Romgaz Medias, Adrian Marcel Piteiu, resigned in 2013 on account of charges of conflict of

interest and corruption offences. He is believed to have favored the allocation of public procurement contracts. His resignation endorses the company’s commitment to not tolerate such acts in the future.

Principles Observations Separations of authorities Conflict of interest may arise x Transparency  Proportional representation in the Board  of Directors Minority shareholders protection May send negative signals to local and x foreign investors Publishing on company’s website the  annual report Mandatory reporting  

Valuation

Key assumptions DCF Discounted Cash-Flow Model Revenue Growth 4% COGS/Sales 12% Our target price is based on our two-stage DCF model for Romgaz which we believe is the most Costs/Sales 32% accurate method for capturing the hidden value of the company. Therefore, we estimate a target

NWC/Sales 20% price of RON 38.57 per share for Romgaz, suggesting a 13.4% upside from the current stock TV Growth -3% price (RON 34.01 as of 18th of February), a sign for a HOLD recommendation. Tax rate 21% When valuing Romgaz, we took into consideration the fact that it is a largely regulated company. The UGS tariffs are set by the regulatory body ANRE through the revenue-cap methodology and Bond Rating* BBB- the process of gas price liberalization has been delayed until 2021. Therefore, we estimate that YTM (Bonds) - KD 6.50% the stock price will register a lower volatility with respect to Romanian market movements, and we Tax Rate 16.00% Beta 85.00% correspondingly set the beta at 0.85 after considering the historical correlation between the Debt as % of Capital - WD 0.00% market index and Romgaz. Since the company employs virtually no debt, the unlevered beta is 10-Yr Treasury Bond Yield 4.50% equal to the levered beta. Market Risk Premium 6.00% The key risk interest rate has been recently reduced by BNR in order to adjust for current market conditions, and the corresponding T-bond yields have thus lowered. Therefore we estimate the Cost of Equity - KE 9.60% medium term nominal risk free rate to be 4.5% in our valuation. Equity as % of Capital 100.00% Our discount cash flow model is a two-stage model based on a higher expected growth period WACC 9.60% until year 2018 and a stable growth thereafter. We calculated an approximate 4% growth rate for the period 2015e-2018e. The terminal growth rate is -3% assuming a Reserve Replacement Ratio of 70% due to the foreseeable exploration opportunities in the Black Sea and the optimistic average Reserve Replacement Ratio of 173% of the previous three years. Moreover, Romgaz is

expected to boost its capital expenditures in order to enhance production via application of new technologies. The estimated CAPEX figures in thousand RON are: 2014 - 1,085.5, 2015e - 1,194.1, 2016e - 1,313.5, 2017e - 1,444.8, 2018e - 1,589.3.

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CFA Research Challenge | 21 Feb 2015 For the calculation of WACC we used a target capital structure of 100% Equity and 0% Debt as Target price based on DCF there are no expectations of changes in the financing model of the company. For the market risk Terminal Value 13,084.2 premium we chose the 6% consensus estimate of Romanian financial analysts. Therefore the PV Terminal Value 8,406.0 WACC is 9.60%. PV FCF (Yr2014 to Yr2018) 3,494.0 Enterprise Value 11,900.0 Sensitivity analysis + MV of non-operating assets 94.3 The following tables summarize the sensitivity of the DCF model to key determinants. The first - MV of net debt (2,870.1) determinants are the rate of revenue growth from 2014 to 2018 and WACC. We also performed Fair value of equity 14,864.4 the sensitivity analysis of the terminal decline rate from 2018 onwards and of the revenue growth Shares outstanding 385.4 rate. The third table represents the change in share price if the effective tax rate were to change simultaneously with WACC. Market capitalization 13,108.2 Value based on DCF model 14,864.4 Multiples Valuation

Next, we used multiples valuation method through which we calculated the value of Romgaz Curent price * 34.01 based on how its peer companies are traded in the market. We identified the main players in the Target Price 38.57 oil and gas market that have a similar mature stage of growth and distributed them into three Upside potential 13.4% categories: the Russian companies comprising Gazprom, Tatneft, LUKOil and Rosneft, the Based on closing price at 18 Feb 2015 regional companies including MOL, OMV, Repsol, Statoil, and Petrom OMV and finally the global Source: team estimates players BP, Chevron, Conoco Phillips, Eni, Exxon and Royal Dutch. However, we only considered the regional and Russian companies as relevant peers. We calculated the enterprise value for the companies and two key ratios: EV/EBIT and Equity Value/Net Earnings as of 2015e. In order to arrive at the Enterprise Value (EV) of Romgaz we calculated the ratio EV/EBIT for the Target price based on Peer Valuation Russian and regional companies and multiplied it with Romgaz expected EBIT in 2015e as computed in the DCF model and averaged the EV/NE ratio for the same companies to find EV

EBIT Romgaz 2015e (USD) 512.3 Romgaz. Afterwards we averaged the two EV values to find the fair value of Romgaz. USDRON 2015e 3.6 The result offered us a similar upside potential for Romgaz: 8.3%. EBIT Romgaz 2015e (RON) 1,839.0 based on Russian and Regional peers median EV/EBIT Net Asset Value 15,994. We value Romgaz’s 2P reserves at 6.7$/boe or at 29.84 RON/share (based on an FX rate of 3.6 EV Romgaz 6 RON/$ - estimated for 2016). Cash 2,870.0 We do not considered risky the 2P reserves due to the very high proportion of developed, proved MV of non-operating assets 94.3 reserves. This valuation, when adding net cash, implies a total target core NAV of RON Adj to PV Feb 2015 (WACC = 9.6%, - 33.91/share. In addition, we applied a very low probability of success for prospective resources cash return = 4.5%) 1,162.5 (8%) and a heavily discounted NPV. In the end we have an NPV of 2.11 RON/share for 17,796. Fair value of equity based on EV/EBIT 3 prospective resources Net earnings Romgaz 2015e (USD) 439.4 We also add a 4.08 RON/share value to account for the non-E&P assets (exploration and Net earnings Romgaz 2015e (RON) 1,577.3 production) that the company owes. Finally, we arrive at our total NAV of 40.10 RON/share Adj to PV Feb 2015 (Cost of equity = 9.6%) -847.0 (compared to actual price of 34.01 RON – upside potential 18%). Despite the above mentioned, 10,587. we would recommend HOLD as the price is highly affected by the FX rate. Lately Romanian leu Fair value of equity based on EqV/NE 9 depreciated heavily in relation to USD (0.50 RON in 5 months). Actual company price is driven by based on Russian and Regional peers median Equity more than resources (current and prospective) and cash and thus, based on previous valuations Value/EBIT (peers and discounted cash-flow), we consider potential of Romgaz to be upside, at roughly 16- Shares outstanding 385.4 17%

Current price 34.01 Target price 36.8 Sensitivity analysis Upside potential 8.3% There is an upstream potential of 6% and a downstream of 7% based on the current price of Based on closing price at 18 Feb 2015 12.97. At $12.97/boe NPV/share is RON 40.10. If one assumes the price will drop to $11.80/boe Source: team estimates than the price of a share will drop 7% to 37.42. On the other side, if one assumes the price will target $14/boe than the share will be valued at 42.48 RON (6% increase). The value of a share Target price based on NAV valuation has the same sensibility for up or down movements of the price of one boe of gas

Shares outstanding 385.4 NAV Sensitivity Analysis USDRON 2015e 3.6 Price of 1 boe of gas NPV NPV/share Overall risk for resources 92% 11.80 2,907.84 37.42 Implied EV/2P (USD/boe) 7.59 12.00 2,957.13 37.88 Current price (RON) 34.01 12.20 3,006.41 38.34 Target price 40.10 12.30 3,031.06 38.57 Upside potential 18% 12.65 3,117.31 39.38 Based on closing price at 18 Feb 2015 12.70 3,129.63 39.49 Source: team estimates 12.97 3,194.93 40.10 13.00 3,203.56 40.18 13.10 3,228.20 40.41 13.25 3,265.16 40.76 13.40 3,302.13 41.10 13.50 3,326.77 41.33 14.00 3,449.98 42.48

DCF Sensitivity Analysis WACC Revenue growth WACC 7.6% 8.6% 9.6% 10.6% 11.6% 0.0% 2.0% 4.0% 6.0% 8.0% 7.6% 8.6% 9.6% 10.6% 11.6%

0.0% 35.52 32.78 30.50 28.58 26.93 0.0% 35.42 40.19 45.38 51.03 57.16 15.0% 49.28 45.14 41.69 38.77 36.27 2.0% 40.31 37.07 34.37 32.08 30.13 -1.0% 33.47 37.88 42.68 47.89 53.55 17.0% 48.03 44.00 40.65 37.81 35.38

4.0% 45.53 41.73 38.57 35.89 33.60 -2.0% 31.86 35.97 40.45 45.30 50.57 19.0% 46.78 42.87 39.61 36.85 34.49

growth

Taxrate Terminal

growth 6.0% 51.20 46.79 43.12 40.02 37.36 -3.0% 30.50 34.37 38.57 43.12 48.06 21.0% 45.53 41.73 38.57 35.89 33.60 Revenue 8.0% 57.35 52.28 48.06 44.48 41.43 -4.0% 29.35 33.00 36.96 41.26 45.92 23.0% 44.28 40.60 37.53 34.93 32.71

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CFA Research Challenge | 21 Feb 2015 Fnancial Analysis Revenue Breakdown 2010-2013 Strong growth in 2014 revenues maintain a positive financial outlook on Romgaz 6,000,000 The company revenues are historically generated in proportion of approximately 65% from

the upstream business line - internal production and sale of natural gas, while the 4,000,000 underground storage (UGS) facilities account for approximately 8% of the total revenue stream. Although Romgaz might in the future produce sufficient gas to meet the consumer demand, the UGS regulations impose limits on the amount of gas that can be retrieved at a 2,000,000 certain period from the underground reserves, which obliges Romgaz to appeal to Russian

Thousand RON Thousand import gas. The revenue from sale of import price hoovers at 20% from total revenues and the cost of import gas that ANRE considered for the Q1 of 2015 stood at 144 RON/MWh. In 0 2014 cost of commodity sold decreased by 60.01% due to a reduction in sales of import gas. 2010 2011 2012 2013 2014 However, Romgaz ensures that the import costs are fully covered through the prices of gas Electricity sold to suppliers, never recording a loss on the trade. Overall, the total revenues of Romgaz Other revenues Sale of import gas increased by approximately 15.5% y-o-y. There was a slight decrease of 8% y-o-y in Underground storage activity revenues in 2014 Q4 mainly because of mild weather conditions that led to lower quantities of Internal gas production and sale gas supplied. Nevertheless, this did not diminish the year-round quantity of gas supplied, Source: Romgaz which marginally increased by 0.62% y-o-y. The electric energy supply through Iernut power plant is responsible for 2.4% of total electric power production in Romania and recorded Romgaz Clients 324.6 million RON in revenue. The gas sold to Iernut is accounted at cost as of Q3 2014. 2% 2% Romgaz revenues in 2014 targeted RON 4.49 billion compared to 3.9 billion in 2013. 3% 9% According to the preliminary financial reports, 2014 EBIT increased y-o-y by an impressive 4% 42.11%, mainly due to the higher prices for the gas sold to non-household consumers in the process of price convergence to European levels. The revenues from UGS facilities increased by 16.69% as compared to the amount recorded in 2013 due to higher tariffs. 4% 33.27%

These high estimates for sales are also supported by their increasing capital expenditure as 16% well as by the reserves and exploration program for 2014-2015. Romgaz currently holds 62.71% proved reserved, while only 12.15% are probable and 12.14% possible In 2014 Romgaz had 90% reserves replacement rate on account of explorations investments that increased by 1.9% as compared to the previous year (exploration investment of RON 27% 427.9).The company has a development programme in place, with 36 new wells tested (20 were successful, 12 were dry hole and 4 are in progress). As of September 2014 there were E.ON Energie GDF Suez 2 wells contingent resources, 4 wells prospective resources and 9 others in testing. They Electrocentrale Bucuresti Electrocentrale Galati Conef Aazomures expect 13 new wells for 2015, contingent resources and 6 wells for prospective resources in Transgaz Ten Gaz 2015. Others Source: Romgaz As their PPE (Property, Plant and Equipment) financial statement line is decreasing with roughly 3% annually and it will reach RON 5,610 by 2016 and in order to be able to grow and Romgaz Resources develop more the company adopted a policy for increasing CAPEX and from RON 668,930 in 2013 we are expecting a RON 1,589,300 in 2018.

12, GDF Suez and E.ON are main clients Romgaz has 8 important clients: E.ON Energie, GDF Suez, Electrocentrale Bucuresti, 14% Electrocentrale Galati, Conef, Azomures, Transgaz and Ten Gaz. Its most important client is 13, E.ON with 33% of total sales, followed by GDF Suez with 27%. 15% Liquidity Working capital estimations for Romgaz are slowly increasing and are expected to reach 62, RON 1,051,300 in 2018, from RON 826,200 in 2014. Positive working capital means strong 71% short-term liquidity for the company. Romgaz is able to repay its short term debt, and also has the ability to expand its operations, with the liquidity it holds.

Equity and 0 Debt Romgaz has no short term debt, nor long term ones. Its equity mainly comprises of share Proved Probable Possible capital, reserves and retained earnings. Total equity was roughly constant during 2011-2013. In 2014 it increased from RON 9,292,774 to RON 9,736,584. On IFRS accounting standard Source: Romgaz the company reported RON 385,422 on share capital, RON 2,142,348 on reserves and RON 7,208,814 on retained earnings. Following OMF directions the company decided to record in Dividend pay-out ratio FY 2014 the adjustment for hyperinflation on retained earnings and thus they reached 7

100% million. The above mentioned idea means that the company will have enough capital to develop and expand. In order to sustain the above mentioned idea we can observe that 95% reserves also show an increase. This means that the company is willing to retain more funds now to finance future projects 90%

85% Dividend pay-out Dividend pay-out was closely to 100% in 2012 and 2013, 94.7% and 99.5% respectively. In 80% 2014 the policy is to give about 75% annually (very close to its historical value from 2011 – 79%). Given the fact that net profit is expected to rise, a 75% dividend policy is a great risk- 75% adjusted return. 70%

65% 2011 2012 2013 2014

Dividend payout ratio

Source: Romgaz

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CFA Research Challenge | 21 Feb 2015 Investment Risks

Financial Risks Romgaz is exposed to a variety of financial risks, such as: market risk which includes currency risk and interest rate risk, credit risk, liquidity risk. Currency and interest rate risk: The company is exposed to currency risks that arise from exposure to various currencies, mainly the US dollar and euro. The currency risks arise from future commercial transactions, receivables and debts. Because Romgaz imports gas from Russia, it has foreign currency denominated debts.Due to the associated high costs, the Company has adopted a policy of not using Daily volatilities derivatives to reduce risk. 4.4821 RON / EUR and 3.6868 RON / USD at 31.12.2014 ;4.4847 RON / EUR and 3.2551 RON / USD at 31.12.2013. The company is exposed to interest rate risk 10% 4th quartile on loans provided to related parties. On 30 September 2014, Romgaz had granted loans with 9% 1st quartile variable interest amounting to 16,785 thousand RON (31 December 2013: 16,422 thousand 8% RON). 7% Romgaz 6% Credit Risk 5% The financial assets, which potentially expose the company to credit risk primarily, include cash and cash equivalents, bank deposits, trade receivables and loans granted. Romgaz policies 4% stipulate that sales are made to customers with low credit risk. 3% The credit risk focuses on the most important clients of Romgaz which are Interagro Bucuresti, 2% Electrocentrale Bucuresti, Azomures Tg. Mures, GDF Suez Energy Romania, E.ON Gaz 1% Romania and account for 90% of the company’s accounts receivable. 0% Operational Risks

Depletion of gas resources is a serious issue in Romania as natural gas production has generally

13-Jul-14

13-Apr-14 13-Oct-14

13-Jun-14 13-Jan-15

13-Jan-14 decreased since 1986, although the rate of decline in annual natural gas production has

13-Feb-14 13-Mar-14

13-Nov-13 13-Dec-13 13-Aug-14 13-Sep-14 13-Nov-14 13-Dec-14 13-May-14 stabilized during the past two years. For the moment, Romgaz can produce from their existing Source: Thomson Reuters Datastream, team estimation reserves for the following 12 years. There are a few alternatives for their reserves issue. Romgaz has a 10% working interest in offshore exploration in the Black Sea with Lukoil and 2 Vanco where there are two deep water blocks (East Rapsodia and Trident) for almost 2,000 km . The Black Sea offshore fields are potentially promising, in theory, but there are substantial

technical challenges, while the underlying risks and drilling and extraction costs are high, much more expensive than onshore operations. Thus, if a final investment decision to commercially Long term volatilities - peers comparison develop new offshore fields is reached by the end of 2014, it is not until 2020 that new natural gas 3% volumes will hit the market. Annual domestic natural gas production has averaged approximately 10-11 billion cubic meters per year, but natural gas production has generally decreased since 3% 1986, although the rate of decline in annual natural gas production has stabilized during the past two years, Romgaz keeping it below 1%. 2% Regulatory risks 2% NAMR(National Agency for Mineral Resources) provides rights to production and exploration of gas under a petroleum concession agreement which is given to an entity after a public bid award. 1% Regarding the legislation concerning the issuance of authorization and licenses for the national gas sector, ANRE is the institution responsible. The titleholder of a concession agreement is fully 1% liable for damages caused to third parties. The licence may be suspended or terminated if the 0% titleholder does not manage to complete the amount of work until the deadline as per contract,

fails to pay the royalties in due time or does not respect the validity conditions of licenses.

BP

Eni MOL

OMV Romgaz fulfilled all its obligations with respect to license terms and conditions by following a best-

Statoil

Exxon

Repsol LUKOIL

Chevron practice principle. Further regulations include restrictions of performing activities on

Conoco P Conoco

TATNEFT

ROMGAZ

ROSNEFT GAZPROM RoyalDutch

OMVPetrom archaeological, historical, cultural areas and on natural reservations. Until the present day, Romgaz has only executed operations for reservoirs after being authorized by the proper Source: Thomson Reuters Datastrea, team estimation institution.

Taxation, fiscal regime The current system of royalties for natural resources in Romania will be extended one year and from January 1, 2016 will be introduced a new way of charging. There is no clear indication regarding the exact changes, but we estimate that the new regime will increase the value of the royalties. Currently, the royalty rates range between 3.5% and 13% (averaging between 7% and 8%). Romania currently has among the smaller royalties in Europe. Also, according to Prime Minister Victor Ponta, Romania plans to differentiate royalties from oil and gas production at the country’s onshore and offshore fields to stimulate investment. Furthermore, from 2016, the government may impose, based on the press reports, a new taxation, in addition to oil and gas royalties. The new taxation will surcharge strictly the profit obtained from upstream activities, exploration and production. The Government announced that it will extend by one year, until 31 December 2015, the imposed 60% tax on the income earned as a result of price hikes introduced under the country's energy market deregulation and will decrease the special construction tax from 1.5% to 1%.

Environmental risks With respect to exploration, EPA (Environmental Protection Authority) settles if a situation is subject to an EIA (environmental impact assessment), whether it will have a considerable effect on the environment. Romgaz complies with legal requirements for environmental authorization and for environmental protection through monitoring programs performed. The company created a computer application which helps them to supervise the activities that affect the environment. Companies must manage the waste resulted from extraction according to specific regulations for disposal and recovery of waste. Every year, Romgaz recycles and disposes either by incineration or by storage, large amounts of waste.

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CFA Research Challenge | 21 Feb 2015

Appendices

Appendix 1: Cash flow

Cash Flow

12 months 12 months 12 months 12 months 12 months 12 months For the Fiscal Period Ending Dec-31-2009 Dec-31-2010 Dec-31-2011 Dec-31-2012 Dec-31-2013 Dec-31-2014 Currency RON RON RON RON RON RON

Net Income [2150] - 344.5 1,187.7 1,119.2 995.6 - Depreciation & Amort. [2171] - - 678.5 653.1 623.2 607.8 Amort. of Goodwill and Intangibles [2182] - - 20.6 21.6 42.7 35.1 Impair. of Oil, Gas & Mineral Prop. [2031] - - 260.3 209.1 111.6 131.9 Depreciation & Amort., Total [2160] - 959.4 883.7 777.5 774.7 -

Other Amortization [2014] - - 0.5 0.5 0.1 0.1 (Gain) Loss From Sale Of Assets [2026] - - (21.2) 4.9 15.7 32.5 (Gain) Loss On Sale Of Invest. [2090] - - - - 3.4 7.8 Asset Writedown & Restructuring Costs [2019] - - 6.2 6.0 45.5 80.0 Provision & Write-off of Bad debts [2111] - - 56.9 (81.4) 134.7 186.8 Other Operating Activities [2047] - - (135.2) (213.2) (290.7) (113.3) Change in Acc. Receivable [2018] - - (283.3) (318.2) 89.1 (573.2) Change In Inventories [2099] - - (26.1) 641.7 (56.6) 43.9 Change in Acc. Payable [2017] - - 301.4 659.1 (382.8) 251.6 Change in Other Net Operating Assets [2045] ------Cash from Ops. [2006] - 1,203.1 2,774.2 1,451.7 1,686.5 -

Capital Expenditure [2021] - - (367.9) (292.5) (214.4) (338.0) Cash Acquisitions [2057] ------Divestitures [2077] ------Invest. in Marketable & Equity Securt. [2027] - - (47.9) (876.2) 178.1 (37.7) Net (Inc.) Dec. in Loans Originated/Sold [2032] ------Other Investing Activities [2051] - - (389.4) (272.0) (159.8) (426.4) Cash from Investing [2005] - (805.2) (1,440.8) (196.2) (802.2) -

Short Term Debt Issued [2043] ------Long-Term Debt Issued [2034] ------Total Debt Issued [2161] ------Short Term Debt Repaid [2044] ------Long-Term Debt Repaid [2036] - - - (4.5) (6.3) (6.7) Total Debt Repaid [2166] - (4.5) (6.3) (6.7) - -

Common Dividends Paid [2074] - - (585.8) (706.7) (938.0) (1,060.1) Total Dividends Paid [2022] - (585.8) (706.7) (938.0) (1,060.1) -

Special Dividend Paid [2041] ------Other Financing Activities [2050] ------Cash from Financing [2004] - (590.4) (713.1) (944.8) (1,060.1) -

Net Change in Cash [2093] - (192.5) 620.3 310.7 (175.7) -

Supplemental Items Cash Interest Paid [3028] NA NA NA 1.7 1.2 0.7 Cash Taxes Paid [3053] NA NA 247.0 264.8 295.9 284.6 Levered Free Cash Flow [4422] NA NA 1,187.5 2,217.3 926.7 1,354.9 Unlevered Free Cash Flow [4423] NA NA 1,188.5 2,218.0 927.0 1,355.0 Change in Net Working Capital [4421] 1,075.2 (367.3) (943.5) 392.1 (38.0) (108.8) Net Debt Issued [2003] NA NA NA (4.5) (6.3) (6.7) Filing Date [2155] Jan-15-2010 Aug-22-2013 Aug-22-2013 Mar-26-2014 Mar-26-2014 Feb-19-2015 Restatement Type [2208] NV O O NC O NV Calculation Type [22646] NA REP REP REP REP NA

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CFA Research Challenge | 21 Feb 2015

Appendix 2: Income Statement

Income Statement

12 months 12 months 12 months 12 months 12 months 12 months For the Fiscal Period Ending Dec-31-2009 Dec-31-2010 Dec-31-2011 Dec-31-2012 Dec-31-2013 Dec-31-2014 Currency RON RON RON RON RON RON

Revenue [112] 3,894.3 3,320.2 3,497.5 4,195.5 3,837.9 4,493.3 Other Revenue [90] ------Total Revenue [28] 3,320.2 3,497.5 4,195.5 3,837.9 3,894.3 4,493.3

Cost Of Goods Sold [34] 462.8 606.4 761.2 1,211.0 912.1 214.1 Gross Profit [10] 2,713.8 2,736.3 2,984.4 2,925.8 3,431.5 4,279.3

Selling General & Admin Exp. [102] 480.7 459.8 477.8 478.3 503.0 522.8 Exploration/Drilling Costs [49] - - - - - 43.3 R & D Exp. [100] ------Depreciation & Amort. [41] 629.8 575.1 699.6 675.2 642.3 776.8 Impair. of Oil, Gas & Mineral Prop. [71] - 131.9 - 260.3 209.1 111.6 Other Operating Expense/(Income) [260] 781.0 962.0 932.0 529.3 459.4 934.8

Other Operating Exp., Total [380] 1,996.9 2,369.7 1,891.9 1,716.4 2,023.3 2,277.7

Operating Income [21] 716.9 366.6 1,092.5 1,209.5 1,408.1 2,001.6

Interest Expense [82] 0 - (1.9) (1.7) (1.1) (0.6) Interest and Invest. Income [65] 123.3 199.1 94.3 106.8 148.3 78.7 Net Interest Exp. [368] 197.2 92.6 105.7 147.8 123.2 78.7

Currency Exchange Gains (Loss) [38] - (6.1) - (1.2) (4.5) (15.2) Other Non-Operating Inc. (Exp.) [85] (104.3) (81.8) 49.2 159.6 114.8 (292.0) EBT Excl. Unusual Items [4] 832.2 507.3 1,353.3 1,456.9 1,421.0 1,788.3

Impairment of Goodwill [209] ------Gain (Loss) On Sale Of Invest. [62] - - - (7.8) - (1.3) Gain (Loss) On Sale Of Assets [56] - (32.5) - 21.2 (4.9) (15.7) Asset Writedown [32] - (80.0) - (6.2) (6.0) (45.5) Other Unusual Items [87] ------EBT Incl. Unusual Items [139] 830.9 522.2 1,342.5 1,395.6 1,300.6 1,788.3

Income Tax Expense [75] 305.1 258.5 177.7 154.8 276.5 353.9 Earnings from Cont. Ops. [7] 572.5 344.5 1,187.7 1,119.2 995.6 1,434.4

Earnings of Discontinued Ops. [40] ------Extraord. Item & Account. Change [42] ------Net Income to Company [41571] 572.5 344.5 1,187.7 1,119.2 995.6 1,434.4

Minority Int. in Earnings [83] ------Net Income [15] 572.5 344.5 1,187.7 1,119.2 995.6 1,434.4

Pref. Dividends and Other Adj. [97] ------

NI to Common Incl Extra Items [16] 572.5 344.5 1,187.7 1,119.2 995.6 1,434.4 NI to Common Excl. Extra Items [379] 572.5 344.5 1,187.7 1,119.2 995.6 1,434.4

Per Share Items Basic EPS [9] NA 2.58 0.9 3.1 2.92 3.72 Basic EPS Excl. Extra Items [3064] NA 2.58 0.9 3.1 2.92 3.72 Weighted Avg. Basic Shares Out. [3217] NA 385.4 383.0 383.0 383.0 385.4

Diluted EPS [8] NA 2.58 0.9 3.1 2.92 3.72 Diluted EPS Excl. Extra Items [142] NA 2.58 0.9 3.1 2.92 3.72 Weighted Avg. Diluted Shares Out. [342] NA 385.4 383.0 383.0 383.0 385.4

Normalized Basic EPS [4379] NA 2.3 0.83 2.21 2.38 2.9

12 | P a g e

CFA Research Challenge | 21 Feb 2015 Normalized Diluted EPS [4380] NA 2.3 0.83 2.21 2.38 2.9

Dividends per Share [3058] NA NA NA 1.8 2.4 2.77 Payout Ratio % [4377] NA 170.1% 59.5% 83.8% 106.5% NA

Shares per Depository Receipt [4005] 1.0 1.0 1.0 1.0 1.0 1.0

Supplemental Items EBITDA [4051] 2,182.9 1,292.0 1,326.0 1,976.3 1,987.0 2,803.2 EBITA [100689] 1,443.2 716.9 387.2 1,114.1 1,252.2 2,001.6 EBIT [400] 1,408.1 716.9 366.6 1,092.5 1,209.5 2,001.6 As Reported Total Revenue* [339] NA NA NA NA NA 3,561.9 Effective Tax Rate % [4376] 31.1% 34.0% 11.5% 19.8% 23.5% 19.8% Total Current Taxes [35383] - 416.5 - 241.0 288.9 284.8 Total Deferred Taxes [35385] - (111.4) - (63.2) (134.2) (8.3)

Normalized Net Income [4378] 888.1 520.1 317.0 845.8 910.5 1,117.7 Filing Date [349] Jan-15-2010 Aug-22-2013 Aug-22-2013 Mar-26-2014 Mar-26-2014 Feb-19-2015 Restatement Type [408] P O O NC O P Calculation Type [22645] REP REP REP REP REP REP

Supplemental Operating Expense Items R&D Exp. [3168] NA NA NA NA 0.5 0.5 Exploration/Drilling Expenses [33394] NA NA NA NA NA 43.3 Source: S&P Capital IQ

Appendix 3: Balance Sheet

Balance Sheet

Balance Sheet as of: Dec-31-2009 Dec-31-2010 Dec-31-2011 Dec-31-2012 Dec-31-2013 Dec-31-2014 Currency RON RON RON RON RON RON ASSETS Cash And Equivalents [1096] 773.8 808.3 1,428.6 1,739.3 1,563.6 1,953.8 Short Term Investments [1069] 389.0 203.7 1,090.1 928.2 970.7 916.3 Total Cash & ST Investments [1002] 1,162.7 2,870.1 1,012.0 2,518.8 2,667.6 2,534.3

Accounts Receivable [1021] 1,277.8 860.3 930.8 906.8 1,086.6 1,000.2 Other Receivables [1206] - 22.3 22.3 37.2 96.5 58.9 Total Receivables [1001] 1,300.1 1,000.2 882.7 967.9 1,003.3 1,145.5

Inventory [1043] 1,076.2 1,084.5 451.2 507.8 463.9 392.1 Prepaid Exp. [1212] - - 4.8 2.8 1.9 1.9 Other Current Assets [1055] - 66.7 125.7 34.1 85.3 101.6 Total Current Assets [1008] 3,539.0 4,364.0 3,050.6 4,066.4 4,214.7 4,231.0

Gross Property, Plant & Equipment - - [1169] 7,216.4 7,700.8 7,839.7 8,363.8 Accumulated Depreciation [1075] - - (682.0) (1,336.4) (1,959.0) (2,596.5) Net Property, Plant & Equipment 4,339.6 5,962.7 [1004] 6,534.5 6,364.5 5,880.8 5,767.3

Long-term Investments [1054] 7.5 8.2 8.0 9.3 77.8 77.6 Other Intangibles [1040] 41.8 188.7 117.4 230.5 383.9 407.4 Accounts Receivable Long-Term [1088] - - - 92.1 145.4 52.6 Loans Receivable Long-Term [1050] - - 7.3 8.3 16.5 16.4 Deferred Charges, LT [1025] - 1.1 0.6 0.1 0.2 0.0 Other Long-Term Assets [1060] - - 1,124.1 0.2 0.5 0.7 Total Assets [1007] 9,060.5 10,811.8 9,874.7 10,710.3 10,405.0 10,477.2

LIABILITIES Accounts Payable [1018] 195.0 21.8 25.1 19.3 30.9 217.0 Accrued Exp. [1016] - - 156.8 235.2 201.4 362.8 Curr. Port. of LT Debt [1297] - - - 5.9 13.2 6.8 Curr. Income Taxes Payable [1094] 35.3 55.0 79.1 68.0 201.0 92.4

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CFA Research Challenge | 21 Feb 2015 Unearned Revenue, Current [1074] - - - - - 39.9 Other Current Liabilities [1057] 214.2 280.5 627.3 285.4 167.1 358.3 Total Current Liabilities [1009] 490.3 667.7 527.4 973.5 574.1 761.8

Long-Term Debt [1049] - - - - - 12.0 Unearned Revenue, Non-Current - - - - - [1256] 4.6 Pension & Other Post-Retire. Benefits [1213] 44.6 52.8 53.6 63.8 79.2 97.3 Def. Tax Liability, Non-Curr. [1027] - 400.3 266.2 257.8 146.4 108.0 Other Non-Current Liabilities [1062] 200.5 211.6 253.4 164.5 197.0 202.3 Total Liabilities [1276] 752.0 1,075.2 1,192.0 1,546.7 1,060.2 1,184.4

Common Stock [1103] 383.0 383.0 383.0 383.0 385.4 385.4 Additional Paid In Capital [1084] ------Retained Earnings [1222] 654.1 6,792.4 7,273.3 7,454.5 7,400.1 7,208.8 Treasury Stock [1248] ------Comprehensive Inc. and Other [1028] 7,271.4 1,507.3 1,507.3 1,507.3 1,507.3 2,142.3 Total Common Equity [1006] 8,308.5 9,344.8 9,292.8 9,736.6 8,682.7 9,163.6

Total Equity [1275] 8,308.5 9,344.8 9,292.8 9,736.6 8,682.7 9,163.6

Total Liabilities And Equity [1013] 9,060.5 10,811.8 9,874.7 10,710.3 10,405.0 10,477.2

Supplemental Items Total Shares Out. on Filing Date NA [24153] 383.0 383.0 383.0 385.4 385.4 Total Shares Out. on Balance Sheet NA Date [24152] 383.0 383.0 383.0 385.4 385.4 Book Value/Share [4020] NA 22.67 23.92 24.4 24.11 25.26 Tangible Book Value [1310] 8,266.7 8,494.0 9,046.2 9,114.3 8,908.9 9,329.1 Tangible Book Value/Share [4156] NA 22.18 23.62 23.79 23.11 24.2 Total Debt [4173] 17.8 13.2 6.8 0 0 0 Net Debt [4364] (1,144.9) (998.8) (2,511.9) (2,667.6) (2,534.3) (2,870.1) Equity Method Investments [3063] NA 7.3 7.1 7.6 0.9 0.7 Inventory Method [3007] NA NA NA Spec. ID NA NA Raw Materials Inventory [3171] NA 166.2 0.0 0.0 0.0 0.0 Work in Progress Inventory [3219] NA 1.8 0.6 0.1 0.3 0.2 Finished Goods Inventory [3075] NA 889.9 919.8 277.6 360.0 310.3 Other Inventory Accounts [1042] NA 18.4 181.5 182.6 156.6 162.5 Land [3098] NA NA 84.8 89.0 91.9 99.9 Buildings [3023] NA NA 324.9 348.2 355.4 435.6 Machinery [3114] NA NA 801.1 944.8 1,000.6 1,133.1 Construction in Progress [3033] - - 252.9 197.5 171.5 271.2 Natural Resources, at Cost [24457] - - 4,455.7 4,750.7 4,716.2 4,884.4 Accum. Allowance for Doubtful Accts NA NA [3012] 565.3 631.5 767.5 393.2 Filing Date [1264] Jan-15-2010 Aug-22-2013 Aug-22-2013 Mar-26-2014 Mar-26-2014 Feb-19-2015 Restatement Type [1303] P O O NC O P Calculation Type [22647] REP REP REP REP REP REP Source: S&P Capital IQ

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CFA Research Challenge | 21 Feb 2015

Appendix 4: DCF Valuation summary

DCF Valuation summary Key assumptions RON mn 2014 2015e 2016e 2017e 2018e 2019e Steady State Revenue Growth 4% Revenues (Sales) 4,493.3 4,673.1 4,860.0 5,054.4 5,256.6 5,466.8 5,685.5 COGS/Sales 12% COGS 214.1 560.8 583.2 606.5 630.8 656.0 Costs/Sales 32% Gross Profit 4,279.3 4,112.3 4,276.8 4,447.9 4,625.8 4,810.8 Other costs and expenses 1,500.9 1,495.4 1,555.2 1,617.4 1,682.1 1,749.4 NWC/Sales 20% Depreciation 776.8 776.8 776.8 776.8 776.8 776.8 TV Growth -3% EBIT 2,001.6 1,840.1 1,944.8 2,053.6 2,166.8 2,284.6 Tax rate 21% -Taxes 353.9 386.4 408.4 431.3 455.0 479.8 NOPAT 1,647.7 1,453.7 1,536.4 1,622.4 1,711.8 1,804.8 1,877.0 Bond Rating* BBB- YTM (Bonds) - KD 6.5% 776.8 776.8 776.8 776.8 776.8 776.8 776.8

Add: Depreciation Tax Rate 16.0% Less:Capital Expenditures 1,085.5 1,194.1 1,313.5 1,444.8 1,589.3 1,748.2 961.5 Beta 85.0% Less: Increase in NWC (108.8) 108.4 37.4 38.9 40.4 42.1 43.7 Debt as % of Capital - WD 0.0% FCF 1,447.8 928.0 962.4 915.5 858.9 791.4 1,648.6 10-Yr Treasury Bond Yield 4.5% Market Risk Premium 6.0% NWC 826.2 934.6 972.0 1,010.9 1,051.3 1,093.4 1,137.1 Fixed Assets (FA) 6,447.8 6,865.0 7,401.6 8,069.6 8,882.0 9,853.4 10,038.1 Cost of Equity - KE 9.6% Change in FA 201.6 417.2 536.6 668.0 812.4 971.4 184.7 Equity as % of Capital 100.0% NOPAT/ Sales 36.7% 31.1% 31.6% 32.1% 32.6% 33.0% 33.0% WACC 9.6% Source:S&P Capital IQ, team calculations

Appendix 5: Peer Valuation Summary

Peer Valuation Summary Equity Value Debt Value Industry Stage of Growth EBIT Net Earnings EV EV / EBIT Eq. Val / NE USD mn. (Market) (Book)

Gazprom Integrated Oil & Gas Mature 25,237.9 21,355.8 60,260.0 32,403.7 92,663.7 3.67 2.82 Tatneft Oil and Gas E&P Mature 2,587.1 1,789.3 12,216.4 409.2 12,625.6 4.88 6.83 LUKOil Integrated Oil & Gas Mature 10,938.1 7,811.3 36,975.0 13,076.0 50,051.0 4.58 4.73 Russian Rosneft Integrated Oil & Gas Mature 11,709.4 6,636.8 48,114.9 41,441.6 89,556.5 7.65 7.25

MOL Integrated Oil & Gas Mature 592.4 343.0 3,473.7 3,542.7 7,016.4 11.84 10.13

OMV Integrated Oil & Gas Mature 1,703.6 638.2 8,849.8 5,966.9 14,816.7 8.70 13.87 Repsol Integrated Oil & Gas Mature 2,549.3 1,664.9 26,642.0 16,392.4 43,034.4 16.88 16.00

Regional Statoil Integrated Oil & Gas Mature 10,553.7 2,947.2 61,355.0 30,542.8 91,897.8 8.71 20.82 PETROM Integrated Oil & Gas Mature 600.0 821.1 5,664.4 414.6 6,079.0 10.13 6.90 BP Integrated Oil & Gas Mature 12,051.9 7,089.0 127,102.8 52,854.0 179,956.8 14.93 17.93

Chevron Integrated Oil & Gas Mature 14,919.9 8,425.8 208,775.8 25,709.0 234,484.8 15.72 24.78

ConocoPhillips Oil and Gas E&P Mature 2,669.7 1,087.0 83,985.2 21,187.0 105,172.2 39.39 77.26

ENI Integrated Oil & Gas Mature 8,242.7 3,065.3 66,679.6 29,483.6 96,163.2 11.67 21.75 Global Exxon Integrated Oil & Gas Mature 29,232.4 17,371.9 385,381.8 21,834.0 407,215.8 13.93 22.18 Royal Dutch Integrated Oil & Gas Mature 19,983.6 14,031.5 208,191.0 45,540.0 253,731.0 12.70 14.84 Romgaz Oil and Gas E&P Mature 512.3 439.4 3,356.8 0.0 3,356.8 6.55 7.64 Russian Average 12,618.1 9,398.3 39,391.6 21,832.6 61,224.2 5.2 5.4 Regional Average 3,199.8 1,282.9 21,197.0 11,371.9 32,568.9 11.3 13.5 Global Average 14,516.7 8,511.7 180,019.4 32,767.9 212,787.3 18.1 29.8 Russian Median 11,323.8 7,224.1 42,545.0 22,739.9 69,803.8 4.7 5.8 Regional Median 1,703.6 821.1 8,849.8 5,966.9 14,816.7 10.1 13.9 Global Median 13,485.9 7,757.4 167,646.9 27,596.3 207,220.8 14.4 22.0 Discount to Russian Median 39% 32% Discount to Regional Median -35% -45% Discount to Global Median -55% -65% Source:S&P Capital IQ, team calculations

Appendix 6: Net Asset Valuation Summary

NAV Valuation Summary

Unrisked Risked boe Equity NPV/boe NPV NPV / Prob. NPV / NPV / (m) stake (USD) (USD) Share (USD) of success NPV Share (USD) share(RON) 2P Reserves 480 100% 6.7 3,195 8.29 100% 3,195 8.29 29.84 Cash 435 1.13 100% 435 1.13 4.06 Core NAV 3,630 9.42 3,630 9.42 33.91 Prospective Resources 425 100% 6.7 2,829 7.34 8% 226 0.59 2.11 Non - E&P assets (UGS) 100% 437 1.13 100% 437 1.13 4.08 Total NAV 6,896 17.89 4,293 11.14 40.10 2P = probable reserves, boe = barrels of oil

15 | P a g e

CFA Research Challenge | 21 Feb 2015 Source: team calculations

Appendix 7: Consensus estimates

F4. Consensus estimates

12.0 40% 35% 10.0 30% 8.0 25% 6.0 20% 15% 4.0 10% 2.0 5%

0.0 0%

10-Jul-14 24-Jul-14

14-Apr-14 29-Apr-14 03-Oct-14 17-Oct-14 31-Oct-14

12-Jun-14 26-Jun-14 16-Jan-15 30-Jan-15

17-Feb-14 03-Mar-14 17-Mar-14 31-Mar-14 13-Feb-15

07-Aug-14 22-Aug-14 05-Sep-14 19-Sep-14 14-Nov-14 28-Nov-14 15-Dec-14 31-Dec-14

14-May-14 28-May-14

# of Analyst Highest Recommendations (Thomson) # of Analyst High Recommendations (Thomson) # of Analyst Neutral Recommendations (Thomson) Consensus upside potential (%)

Source: S&P Capital IQ

Appendix 8: Stock performance

F4. Stock performance

20% 3.00mm

10% 2.50mm

0% 2.00mm

-10% 1.50mm

-20% 1.00mm

-30% 0.50mm

-40% 0.00mm

08-Jul-14 22-Jul-14

14-Oct-14 28-Oct-14

14-Apr-14 29-Apr-14

10-Jun-14 24-Jun-14 09-Jan-15 23-Jan-15

17-Feb-14 03-Mar-14 17-Mar-14 31-Mar-14 06-Feb-15

05-Aug-14 19-Aug-14 02-Sep-14 16-Sep-14 30-Sep-14 11-Nov-14 25-Nov-14 09-Dec-14 23-Dec-14

13-May-14 27-May-14 Volume [LSE] Volume [BSE]

Romgaz Price Index (0=17/02/14) [BSE] Romgaz Price Index (0=17/02/14) [LSE]

Source: S&P Capital IQ

Appendix 9: Generalized AutoRegressive Conditional Heteroskedasticity (GARCH)

GAZPROM TATNEFT LUKOIL ROSNEFT MOL OMV OMV PETROM REPSOL With variance With variance With variance With variance With variance With variance With variance With variance targeting targeting targeting targeting targeting targeting targeting targeting

a0 0.141639 a0 0.089622 a0 0.107395 a0 0.096575 a0 0.197924 a0 0 a0 0.068868 a0 0.023869

b0 0.812167 b0 0.895074 b0 0.860192 b0 0.879024 b0 0 b0 0.174444 b0 0.838707 b0 0.960578

w0 3.33E-05 w0 1.16E-05 w0 1.82E-05 w0 1.45E-05 w0 0.000213 w0 0.000167 w0 1.64E-05 w0 2.49E-06

a0+b0 0.953807 a0+b0 0.984696 a0+b0 0.967587 a0+b0 0.975599 a0+b0 0.197924 a0+b0 0.174444 a0+b0 0.907576 a0+b0 0.984447

MLE 742.50 MLE 748.95 MLE 795.49 MLE 791.37 MLE 863.15 MLE 901.96 MLE 928.78 MLE 946.14

STATOIL BP CHEVRON CONOCO PHILIPS ENI EXXON ROYAL DUTCH ROMGAZ With variance With variance With variance With variance With variance With variance With variance With variance targeting targeting targeting targeting targeting targeting targeting targeting

a0 0.061613 a0 0.035462 a0 0.048874 a0 0.078981 a0 0.034696 a0 0.037607 a0 0.049843 a0 0.132887

b0 0.919933 b0 0.951224 b0 0.94001 b0 0.910287 b0 0.960111 b0 0.938157 b0 0.940415 b0 0

w0 5.18E-06 w0 2.29E-06 w0 1.53E-06 w0 2E-06 w0 1.1E-06 w0 2.7E-06 w0 1.43E-06 w0 9.6E-05

a0+b0 0.981546 a0+b0 0.986686 a0+b0 0.988883 a0+b0 0.989268 a0+b0 0.994808 a0+b0 0.975764 a0+b0 0.990258 a0+b0 0.132887

MLE 880.86 MLE 951.55 MLE 990.77 MLE 958.60 MLE 914.37 MLE 1007.11 MLE 992.77 MLE 1006.37 16 | P a g e

CFA Research Challenge | 21 Feb 2015 Source: Team Estimates

Appendix 10: Main features of Romania - forecast

Annual percentage change % 95- Curr. Prices GDP 10 2011 2012 2013 2014 2015 2016 GDP 637.6 100.0 3.0 1.1 0.6 3.4 3.0 2.7 2.9 Private Consumption 395.0 62.0 5.6 0.8 1.2 1.2 5.0 3.0 2.7 Public Consumption 90.5 14.2 0.2 0.6 0.4 -4.8 2.5 0.3 3.2 Gross fixed capital formation 151.6 23.8 5.9 2.9 0.1 -7.9 -5.4 3.5 4.1 of which: equipment 52.1 8.2 5.1 19.6 -2.7 -7.2 -5.9 4.0 4.5 Exports (goods and services) 253.4 39.7 9.3 11.9 1.0 16.2 8.4 5.7 5.8 Imports (goods and services) 257.6 40.4 12.8 10.2 -1.8 4.2 6.6 5.8 6.3 GNI (GDP deflator) 621.9 97.5 3.0 1.0 0.2 2.7 3.0 2.6 2.9 Contribution to GDP growth: Domestic demand 5.8 1.4 0.9 -2.1 2.2 2.7 3.1 Inventories -0.4 -0.2 -1.4 1.2 0.2 0.0 0.0 Net Exports -2.2 -0.1 1.1 4.3 0.6 0.0 -0.2 Employment -1.8 -0.8 -4.8 -0.6 0.2 0.3 0.4 Unemployment rate (a) 6.9 7.2 6.8 7.1 7.0 6.9 6.8 Compensation of employees/head 34.5 -4.1 9.4 2.7 4.7 3.4 4.1 Unit labour costs whole economy 28.2 -5.8 3.5 -1.3 1.8 0.9 1.5 - Real unit labour costs -1.0 10.1 -1.4 -4.5 -0.6 -1.4 -0.9 - - - - Saving rate of households (b) -2.9 -7.0 -8.0 10.4 13.3 13.4 14.2 GDP deflator 29.5 4.7 4.9 3.4 2.4 2.3 2.5 Harmonised index of consumer prices - 5.8 3.4 3.2 1.4 1.2 2.5 Terms of trade goods 2.4 1.8 -3.4 -1.1 -0.1 0.0 0.7 Trade balance (goods) ( c ) -7.9 -6.7 -5.8 -3.9 -3.6 -3.6 -3.6 Current-account balance ( c ) -6.6 -4.7 -4.7 -1.2 -0.9 -1.1 -1.1 Net lending (+) or borrowing (-) vis-à-vis ROW ( c ) -6.1 -4.2 -3.3 1.1 1.4 1.3 1.2 General government balance ( c) -3.6 -5.5 -3.0 -2.2 -1.8 -1.5 -1.5 Cyclically-adjusted budget balance ( c ) -4.0 -4.4 -1.6 -1.4 -1.4 -1.2 -1.3 Structural budget balance ( c ) - -3.3 -2.1 -1.4 -1.3 -1.2 -1.3 General government gross debt ( c ) 18.1 34.2 37.3 38.0 38.7 39.1 39.3 (a) Eurostat definition. (b) gross saving dividend by gross disposable income. ( c ) as a percentage of GDP Source: European Economic Forecast EUROPEAN ECONOMY 1| 2015 Economic and Financial Affairs Winter 2015 / European Commission Appendix 11: Consensus

Romgaz RON 2013 2014 2015 2016 2017 3,894.27 4,955.53 5,219.97 5,019.85 RECOMMENDATIONS CAPITAL IQ Revenue A 4,665.69 E E E E BVB:SNG - Recommendation: Outperform (2.29) EBITDA 2007.284 2547.36667 2682.5126 2769.08775 2402.05 1 - Buy 2 EBIT 1189.582 1751.76667 1952.8762 2059.51125 1724.1 2 - Outperform 1 Net Income (Excl. Excep) 930.729 1487.9 1661.4602 1748.46625 1472.5 3 - Hold 4 Net Debt -2534.254 -2659.06667 -2525.2404 -2518.8525 -2604 Depreciation & 4 - Underperform 0 Amortization 817.702 685.03333 604.46667 622.26667 621.63333 5 - Sell 0 Cash From Operations 1686.526 2329.4 2398.8 2649.4 2422 0 - No Opinion 0 Capital Expenditure -876.264 -1119 -1232 -1367 -1442.5

Free Cash Flow 810.262 1192.46667 1149.86667 1264.4 858.2 LSE:SNGR - Recommendation: Hold (3.00)

1 - Buy 0 Industry Specific 2013 2014 2015 2016 2017 2 - Outperform 0 Total Production - Natural Gas (MMCF) 199563.1815 199563.1815 193559.6882 185825.7762 176538.0188 3 - Hold 1 Total Production (MBOE) 36900 36900 35800 34300 32600 4 - Underperform 0 Total Average Daily Production (MBOE) 101.1 101.1 98 94.1 89.4 5 - Sell 0 Exploration Expense 61 100 200 200 200 0 - No Opinion 0

RECOMMENDATIONS FT.com

ROE % 10.028 16.3 16.86 16.475 1 - Buy 2 2 - Outperform 2 ROA % 8.9164 14 13 10.7 3 - Hold 5

4 - Underperform 0 TEV 10802.33333 10611.35 10532.4 10625.55 5 - Sell 0 0 - No Opinion 0

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CFA Research Challenge | 21 Feb 2015 Sources: Team Estimates

Appendix 12: Porter’s Five Forces

Rivalry in the industry – HIGH  Two big competitors: Romgaz and OMV Petrom with similar market share  Slow growth in the industry  Homogenous products

Bargaining Power of Buyers – LOW  Gas is essential for the Bargaining Power of Suppliers customer -HIGH  Switching to alternative  Two main suppliers : Romgaz products is unrealizable for the and OMV Petrom moment  Suppliers affect the market The consumers will have in the Porter’s Five through charging high prices future a large influence on prices  Substitutes in the market are due to price liberalization Forces unavailable.

Threat of Substitutes – LOW Threat of New Entrants – LOW  Natural Gas is irreplaceable in the marketplace  The industry is highly regulated by ANRE  Renewable energy will be a threat in the future Capital requirements are very high  No cheaper alternative for now  Ownership of resources

Sources: Team Estimates

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CFA Research Challenge | 21 Feb 2015

Appendix 13: Risk Matrix

Regulatory Environmental Corruption General country Financial Risks Risks Risks Risks Risks

Higher royalties

Natural gas production of Romgaz to decline more Depletion of gas resorces in than 1% Romania

Stricter regulation of

Moderate Long term period Changes in the environmental ANRE regarding

allignment with EU system policy authorization

PROBABILITY No involvement in the

Corruption risk of Romania Lengthen the imposal of 60% Black Sea offshore

to increase witholding tax exploration

High Low

Bad debtors

Trivial Significant Severe

Impact

Source: Team Estimates

Appendix 14: SWOT

Strengths Weaknesses · Romgaz has 10 % interest recent offshore discoveries in Black · Existing reserves are sufficient only for the following 12-13 years Sea · National infrastructure to transport the gas is very complex and · Reserves replacement ratio decreased in comparison with diversified. previous years · Some production and distribution equipment are outdated and · Recent use of new technologies to mitigate production decline obsolete. · Performances under potential (area of development) for the state · Risk management department in order to mitigate risks owned companies from gas industry -Romgaz · Personnel from the gas industry is well trained and need lower · Gas production decline costs compared to employees from other EU countries. · Romgaz is the largest gas supplier in Romania

Opportunities Threats · Romania has the largest natural gas market in Central and · Exploitable reserves are limited and new reserves were not Eastern Europe discovered yet · New funding sources from European Union as a member · The risk of not being able to export · The technologies used for natural gas are very similar to the ones · An increase in the level of royalties and the an approved new used to develop renewable energy and thus the companies can grow taxation system and move their main activity · Attractive business environment for potential investors · Lack of fiscal instruments to sustain the investment programs in (privatization of companies) energy efficiency and renewable energy · Gas liberalization in both household and industrial sector · Gas price volatility on international markets · Grow of Romania’s stock market and thus the possibility for companies to go public

Source: Team estimates

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CFA Research Challenge | 21 Feb 2015

Appendix 15: Events

37.00

36.50

Govt imposed to gas Govt postponed the 36.00 producers to sell a deadline for price minimum volume of gas liberalisation of gas supplied

35.50

35.00 Mr. Dragos Dorcioman was 34.50 GMS appointed Provision of earnings appointed as the new guidance for the year Net Profit for the interim Director Negotiations for company 2014 First Nine Months: + 34.00 selling of 50% of its 30% stake in two oil The approval for the establishment of an 33.50 underground gas storage

33.00

32.50

32.00

Source: S&P Capital IQ

Appendix 16: Share capital, Reserves and Retained Earnings

2016e

2015e

2014

2013

2012

2011

0 1000 2000 3000 4000 5000 6000 7000

Retained Earnings Reserves Share capital

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Appendix 17: Revenues/ EBITDA/ Net profit

Revenues

EBITDA

Net profit

- 1,000 2,000 3,000 4,000 5,000 6,000

2016e 2015e 2014 2013 2012

Appendix 18: Sales

732.57 654.08 497.77 349 584 448.44 345 343 551 245 404 365

4,396.67 3,854 3,925.60 3,595 3,314 3,505

2011 2012 2013 2014e 2015e 2016e Upstream Storage Others

Appendix 19: Corporate Timeline

4.00mm 8.40 3.50mm 8.20 3.00mm 8.00 2.50mm 7.80 2.00mm

7.60 1.50mm

7.40 1.00mm

7.20 500,000.00

7.00 0.00

Volume Share Pricing

Potential Transactions Corporate Structure Related

Results Announcements/Corporate Communications Customer/Product Related

Company Forecasts and Ratings Dividends/Splits 21 | P a g e Listing/Trading Related

CFA Research Challenge | 21 Feb 2015

Appendix 20: Evolution of stock price and revenues

3000000 37

2500000 36

35 2000000

34 1500000 33 RON 1000000 Thousand RON Thousand 32

500000 31

0 30

41619 41626 41633 41640 41647 41654 41661 41668 41675 41682 41689 41696 41703 41710 41717 41724 41731 41738 41745 41752 41759 41766 41773 41780 41787 41794 41801 41808 41815 41822 41829 41836 41843 41850 41857 41864 41871 41878 41885 41892 41899 41906 Other Import Gas Electricity UGS Internal Production ROMGAZ PRICE

Appendix 21: Breaking down Romgaz Revenues

3000000

2500000

2000000

1500000

RON Thousand 1000000

500000

0 2010 2011 2012 2013 Internal gas production and sale Underground storage activity Sale of import gas Other revenues Electricity

Appendix 21: Romgaz revenue evolution (thousands)

4195477

3894267 3947461

3837941

3280213

3271662 3193503

2007 2008 2009 2010 2011 2012 2013

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Appendix 22: Gas supply and consumption in Romania (bcm)

20 18 16 5.4 3.3 5 5.2 5.2 14 2.9 3.5 4.8 4.4 2.3 3.2 12 2 3.2 1.9 10 8 1.2 0.4 6 13.7 13 12.9 12.1 12.7 12.4 12.1 11.6 11.1 11.1 11.5 11 10.3 10.6 4 7.9 8 2 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 9M 2013 9M 2014 Domestic supply Import

Appendix 23: Beta Romgaz

y = 0.8321x - 0.0004 5.0% R² = 0.3524 4.0%

3.0%

2.0%

1.0%

0.0%

-1.0%

-2.0%

-3.0%

-4.0%

-5.0%

-6.0% -6.0% -4.0% -2.0% 0.0% 2.0% 4.0% Source: Bucharest Stock Exchange, team calulation

Appendix 24: Romania’s Demography

25.00

20.00

15.00

10.00

5.00

0.00 2010 2011 2012 2013 Total 20.25 20.15 20.08 19.96 Rural 9.35 9.28 9.22 9.14 Urban 10.90 10.87 10.86 10.83

Total Rural Urban

Source: INSSE

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CFA Research Challenge | 21 Feb 2015

Appendix 25: Shape of the yield curve

Shape of the yield curve

6.66 6.88 6.30 6.36 6.45

5.43

4.81 4.36 3.96 3.68 3.40 Yield (%) Yield 3.00 2.70 2.93 2.77 2.25 2.31 2.31 1.51 1.75

6M 1Y 3Y 5Y 10Y Maturity

Jan-2013 Jan-2014 Jul-2014 Jan-2015

Source: Thomson Reuters Datastream, team calculations

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Appendix: Formulas

ROA = Net Income × Sales = Net Income Sales Total Assets Total Assets ROE = Net Income × Sales × Assets Sales Assets Equity   1 Ending Value CAGR = n of years − 1 Beginning Value

Net profit margin = Net Income Net Sales Asset Turnover = Revenue Total Assets Leverage = Total Assets Shareholders Equity

Enterprise Value = Debt Value + Equity Value

Gross Profit = Revenues Cost of Goods Sold EBIT = Gross Profit − Other costs and expenses − Depreciation

NOPAT = Operating Income × (1 − Tax rate)

FCF = EBIT × (1 − Tax rate) + Depreciation − ∆Net Working Capital − Capex

t Termianl Value = FCFF WACC−Terminal Value growth

Fair Value of Equity = EV + MV of non-op. assets − MV of net debt Fair Value of equity Target Price = Shares outstanding E D WACC = V × Ke + V × Kd × (1 − Tax rate)

Ke = rf + (rm − rf ) × β

Long term variance = Conditional Variance with targeting × (1 − α0 − β0)

1

Disclosures: Ownership and material conflicts of interest: The authors or a member of their household, of this report do not hold a financial interest in the securities of this company. The authors or a member of their household, of this report do not know of the existence of any conflicts of interest that might bias the content or publication of this report.

Receipt of compensation:

Compensation of the authors of this report is not based on investment banking revenue.

Position as an officer or director:

The authors or a member of their household, does not serves as an officer, director or advisory board member of the subject company.

Market making:

The authors do not act as a market maker in the subject company’s securities.

Ratings guide:

Banks rate companies as a BUY, HOLD or SELL. A BUY rating is given when the security is expected to deliver absolute returns of 15% or greater over the next twelve month period, and recommends that investors take a position above the security’s weight in the S&P 500, or any other relevant index. A SELL rating is given when the security is expected to deliver negative returns over the next twelve months, while a HOLD rating implies flat returns over the next twelve months.

Disclaimer: The information set forth herein has been obtained or derived from sources generally available to the public and believed by the author to be reliable, but the author does not make any representation or warranty, express or implied, as to its accuracy or completeness. The information is not intended to be used as the basis of any investment decisions by any person or entity. This information does not constitute investment advice, nor is it an offer or a solicitation of an offer to buy or sell any security. This report should not be considered to be a recommendation by any Research Challenge with regard to this company’s stock.