OREANDA-NEWS. October 7, 2011. Renaissance Capital, the leading emerging markets investment bank, has reinitiated coverage of the Central Asian oil and gas sector, with a report covering leading regional players, Dragon Oil (DGO), Zhaikmunai (ZKM) and Kazmunaigaz E&P (KMG EP).

The report, Central Asia oil and gas: Show me the munai, notes that Central Asian exploration and production companies generate much higher cash flows and benefit from greater oil price leverage than Russian upstream players, and trade at 3-4x discounts to their African peers on reserves multiples; adding that the Central Asian space looks resilient on the downside, with a combined cash balance of USD 5.3bn.

Renaissance Capital analysts conclude that in an environment where downside protection matters just as much as upside potential, they currently favour Turkmenistan-based DGO (rated BUY at Renaissance, with a GBp 693 target price). They note that “[the company’s] USD 1.5bn cash balance and recently initiated share buyback programme make the stock resilient in the current market environment. In addition, an estimated 10-15% production CAGR over the next three years, solid cash flow generation, upside from gas monetisation and a compelling M&A angle make DGO an appealing investment case.”

ZKM, Kazakhstan’s second-largest listed upstream player is reinitiated with a BUY rating and USD 14 target price at Renaissance Capital. “ZKM implies the greatest upside potential to our valuation,” conclude Renaissance analysts, “although management’s execution will be instrumental in unlocking the company’s very large resource base.” The company’s near-term production growth potential, favourable fiscal terms, potential reserves upgrade and further upside potential from gas monetisation are all cited as positives in the report.

Renaissance Capital's HOLD rating on KMG EP is assigned on a relative valuation basis (with a USD 21 target price). Renaissance analysts believe its net cash balance of USD 4.1bn, combined with a share buyback, offers downside protection for the stock. “However, upside potential is limited,” according to the team, “as the company still faces operational challenges and progress with M&A is slow.” Renaissance Capital believes more aggressive steps on the exploration front, M&A and operational discipline would help ease disappointment in the market.

All three companies offer compelling valuations, according to the report. “DGO, with a high 11% 2012E free cash flow yield, trades at a 31% discount to our target P/CF multiple of 5.5x, conclude Renaissance analysts. “ZKM looks very cheap given its growth momentum, trading at 2012E P/E of 4.3x and 2012E EV/EBITDA of 2.3x. KMG EP trades in line with LUKOIL on 2012E P/E of 3.6x (Bloomberg consensus) and close to Tatneft on the EV/2P multiple.”