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CNOOC: China Scandal Presents Buying Opportunity

May 24, 2014 | About:
Value Investor

Value Investor

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Corruptions and scandals in some of the big Chinese Oil and gas companies have had a downside impact on the company’s stock prices. However, this decrease in price could be a good opportunity to own an undervalued company with good growth prospects.

In this article I will discuss about the scandals, their effect on the stock prices and also why even amidst this corruption, the core business of CNOOC is not affected.

China Scandal

Senior executives of major oil companies PetroChina Co. Ltd (PTR), Sinopec Shanghai Petrochemical Co. Ltd (SHI) and CNOOC Co. Ltd. (CEO) have a strong influence in the political and military administration of China. According to the report top political and military officials along with the senior executive of these oil companies were making money by making use of Caribbean offshore haven. These companies had a tie up with the offshore oil companies without any financial record.

Yang Hua of CNOOC, one amongst the other senior executives of PetroChina and Sinopec, is also under investigation. This corruption scandal has resulted in the downgrade of the company’s stock prices by around 16% since October 2013 in spite of a 10% increase in the oil prices. Scandals and corruptions amongst upper management might hurt the investor’s sentiment, but would not have a lasting effect on the company as the core business is unaffected.

Fundamentals

Before looking into the valuations and other growth aspects of the company I would like to emphasize on the company’s financial performance over the last year. Net production for the company has increased 20.2% y-o-y to 411.7 million BOE for the FY2013 exceeding the target of 348 million BOE. Net profit of the company has decreased to $9.3 billion in FY2013 from $10.2 billion in FY2012. This decrease is primarily due to the decrease in oil prices by 5.3% and increase in the exploration and operating expenses.

However, the 26% increase in cost is attributed to the relatively high cost of Nexen assets and the exploration cost for new. It will thus have a temporary effect on the company’s business and would generate good profits once the projects start running successfully. In addition to this, the company has net proved reserves of 4.4 billion BOE and with extensive capital expenditure program of the company; the reserves are expected to increase in 2014. Overall fundamentals therefore point to positivity in the foreseeable future.

Valuations

I have evaluated the valuation of the company on the basis of three valuation techniques: forward PE, EV/EBITDA and PEG 5 year (forward).

A forward PE of 8.6 for CNOOC suggests that the investors are not paying much for this stock on a relative basis. An EV/EBITDA of 3.8, the most appropriate valuation technique for an oil and gas exploration company, is the least for CNOOC. Further, a PEG for 5 year is also attractive for CNOOC as compared to PetroChina and Sinopec.

This current undervaluation is attributed to the company’s involvement in various scandals and decreasing faith of investors in the management, which is temporary in my opinion. However with improving economic conditions and with increasing demand for energy in China and emerging Asia, the current market correction is a good opportunity for investors to consider exposure to the stock.

Parameters

CNOOC

PetroChina

Sinopec

Forward PE

8.6

10.1

NA

EV/EBITDA

3.8

5.6

NA

PEG

1.4

-6.7

6

Growth Prospects

CNOOC expects 7-10 projects to start operating in FY2014. Projest Kenli 3-2 and Qinhuandao 32-6, both located in Bohai are expected to start up in early 2014 and would have a peak daily production of 37,000 BOE and 36,000 BOE respectively.

Similarly Enping 24-2 located in Pearl River Mouth Basin and Golden Eagle project commissioned to start in late 2014 is expected to have peak daily production to 40,000 BOE and 70,000 BOE respectively.

In order to achieve the target the company has a robust exploration programme. CNOOC plans to increase the exploration wells to approximately 155 with more effort in deepwater exploration. A capital expenditure of $16.8 billion to $19 billion has been allocated for exploration and production operations of the company. This will strongly support the production and reserve growth and maintain the Reserve replacement ration above 100%.

Source: Company Presentation

Conclusion

Over the last few years China has grown to be the largest energy consumer and producer in the world. And if we look at the company’s capital expenditure break up, 54% of the company’s capital expenditure has been allocated to the exploration, development and production of energy in China.

Hence an increased production would meet the increasing demand of the country. In conclusion, this 4.3% dividend yielder, with attractive valuations is a strong buy for long-term investors.

About the author:

Value Investor
A value investor.

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