Description

Petrochina is a mispriced and misunderstood company, while also being an attractive play on Chinese growth and on natural gas. It also has a 5-6% dividend yield.

Petrochina (PTR) is China’s largest E&P company by reserves. PTR was set up as an entity within which most of the assets and liabilities of China National Petroleum Corporation (CNPC) were injected in 1999. The company’s A-shares are currently all held by the State, while free shares are traded in Hong Kong (H-shares) and in New York. Petrochina engages in E&P activities, refining, marketing, chemicals, and natural gas transmission. Listed competitors include Sinopec and CNOOC, both NYSE and HK-listed companies as well. All three companies maintain 20f filings and provide US GAAP-reconciliation along with standard oil-related SEC disclosures.

A brief discussion of the major segments is presented below.

E&P
Oil and gas reserves total 17.4 billion BOE, with oil representing 80% of proved developed and 2/3rds of the total reserves. Proved developed reserves represent roughly 2/3rds of total proved reserves. The company’s production totaled 902mn BOE in 2002, providing a weighted-average life of 19 years--14 years for oil and 49 years for gas. In 2002, the average realized oil price was $22.48 per barrel compared with 2001’s realized price of $23.61and an average 2002 world price of $25. The oil tends to be high-quality ‘light’ oil. The past year’s discount is fairly high compared with history because the government employs a smoothing scheme in order to forestall rapid changes in the domestic oil price. Natural gas prices are regulated and set at the national level.

29% of E&P revenues are from third parties. According to the latest figures, Petrochina accounted for 64% and 66% of China’s total oil and gas production respectively.

Marketing
Petrochina operates over 13,000 filling stations across China, over half of which are owned and all of which exclusively sell petroleum products produced by the company. The division also includes several hundred wholesale distribution outlets in high-demand areas along highways and near coastal cities.

Refining
Petrochina has 29 oil refining enterprises along China’s northeastern and northwestern regions. According to the latest figures, Petrochina accounts for 40% of China’s gasoline, diesel, kerosene and lubricant volumes, with primary processing capacity exceeding 100mn tons. With daily refining capacity of 1.6mn barrels of oil, Petrochina is second to Sinopec (discussed below).

Competition
Main listed competitors are Sinopec and CNOOC. All three companies have Hong Kong-listed H-shares and NYSE-listed ADRs. Sinopec also has a China-listed A-share, which trades for twice the price of its H-shares. All listings have equivalent rights and are, for all intents and purposes, equivalent shares with the same par value. The A-shares differ only in the inability of foreigners to purchases them.

Petrochina is by far the largest of the three by market cap and by reserves. PTR’s total reserves of over 17 billion BOE compares with Sinopec’s (SNP) 4 billion BOE, and CNOOC’s (CEO) 2 billion BOE.

There are significant differences in reserve profile between the three companies. For instance, of total reserves, oil represents 63% of PTR’s total, while the figures for SNP and CEO are 86% and 71% respectively. Also, 66% of PTR’s reserves are developed, versus 68% and 39% for SNP and CEO. By only developed reserves, PTR’s oil ratio is over 80%, on par with the others. The oil-ratio difference between total proved and developed reflects the fact the much of Petrochina’s reserve additions have been in undeveloped natural gas in recent years.

Another difference between the three is the relative importance of non-E&P assets. The value of PTR’s non-E&P assets is roughly 14% of EV, versus almost 40% for SNP. CEO is a pure E&P company, and so has no non-E&P assets to value. SNP’s major assets include 28,000 retail outlets and China’s largest refinery business, which has a daily capacity of 2.5 million BOE.

There is a sizable valuation gap between the three companies on the basis of EV/BOE, though a smaller gap on the basis of EV/EBITDA. Whereas SNP and CEO trade at roughly $6.50 per BOE, PTR trades at $3.20. On the basis of EV/EBITDA, the difference is less noticeable, but PTR still trades at less than 5x EBITDA, versus a 6x multiple for the others. The relatively lower reserve exposure to oil versus more-price-regulated gas for PTR, may explain part of the difference in valuation between the three companies along with the fact that PTR is a little top heavy and just in the beginning stages of expense curtailment.

Intrinsic Value
Petrochina’s $40 value estimate is based on four components: reserve value, per-station value of retail outlets, the value of the refinery, and value of other business such as chemicals. Reserve value is calculated based on recent global transactions ($5.50), but with a 20% adjustment to account for lower realized prices, for a per BOE value of $4.44. Retail outlets in emerging markets have sold for between $20,000 and $300,00—a huge range. A per-station value $100,000 is arbitrarily used. The refinery is valued at $2,000 per daily BOE capacity, versus a global range of between $1,000 and $4,000. Finally ‘other’ earnings are capitalized at 5x EBITDA. As a result, non-E&P businesses account for less than 14% of the EV, balancing the fact that I have less confidence in my value estimate for non-E&P assets in China.

Risks
This is a government-owned, though not controlled, entity. Also capital plans include development of the company's gas fields and infrastructure. Concurrent with these plans, the government plans to liberalize gas pricing. However, of they changed their minds and gas pricing remained under the current plans, they company may not have an adequate return.

Catalyst

The stock has been moving since before Buffett announced his interest--that was the ultimate catalyst. However, another significant catalst would be the elimination of purchase restrictions on Chinese-listed A shares and Hong Kong-listed H share classes. That would drive the H-shares higher. The Chinese shares of its competitors trade for twice the valuation.