CNOOC Ltd. is facing the following pressing issues:
In 2007, CEO kept its production increase but in a weaken momentum because of the decrease of the oil production and we don't see any basis for a big production increase in the near future. The exploration and extension costs are high and will remain high, squeezing profits.Windfall tax will still be a heavy load in 2008.
Weaker growing momentum
Form 2006 to 2007, both the revenue and net income presented a decreasing growth rate. While CEO are proud of their efficient cost control, which, however, only made their bottom line growth rate fell in a gentler manner compared with the top line.
Deep ocean extensions continue
Based on its several success oil discovers, CEO will extend its deep ocean exploring in 2008, and announced to invest 15 billion RMB or more for the further development of their deep ocean platform.
Hold conservative forecast
CEO’s production terminal will gain from the soaring world oil price, however, in a weak momentum if the inflation is still on. The government are now tried everything to compensate the refiners loss, which however, did not has much affect on CEO as on SNP and PTR. We did not see great growth potential at this point.
Summary
In 2007, both the oil production and sales of CEO actually fell, which was made up by the increase in the gas sales and the high realized oil price and finally made the company present a tiny growth. At the same time, the windfall tax and the deep ocean cost will keep at a sky-high although CEO already began to divert its weight to downstream sector，which is proven to be a money-cost activity as well. As a result, the profits will continually be squeezed. While the government’s compensation for refiners is tiny and the growth poetical is still uncertain, we do observe a higher P/E ratio of CEO compared with its industry peers and thus conclude the company is overvalued.
Weaker Growing Momentum
According to its announcement in 26th March, CEO realized an increase in both the total revenue and net income; however, the growing momentum is not so strong compared to previous years.
As we can see from the line chart below, the revenue growth kept a constant rate at around 30% between 2004 and 2006, then experienced a sudden decrease in 2007 to 2%.As for the bottom line, there was a sharp decreasing trend since 2005, and the growth rate dropped from some 55% to 1.1% in 2007.
One reason for the weaker growing trend might be the decrease in the oil sales volume, which probably related to the government’s tight fiscal policy due to the inflation. While the total sales of gas and oil realized a 7.7% growth compared to 2006, the oil sales decreased by 0.6%. However, the 12.5% higher net realized oil price offset the effect of the volume, and the company still realized a more than 7 billion RMB increase in the oil sales.
Cost control ease the Slower Growth
Refer to the above line chart, we could see that facing a much faster expense growth (especially the R&D expenses, reached a growth of 101.3% from 2006 to 2007) compared to revenue growth, CEO could still kept a positive net income increase is mainly because of its efficient cost control. Although the total expenses growth is positive, it kept a steeper downward trend than revenue did, that explains why net income kept a gentler downtrend.
More Windfall Tax Paid
The windfall tax assessed by the government on the crude oil producers is began on 26th March, 2006.As a company with most exposure to oil production industry, CEO had to pay the highest margin windfall tax 40%. This pricing reforming had been further promoted over 2007 and the total special gain charged by the government increased by 33.3% in 2007 compared to 2006, which I believe CEO contributed a lot.
While CEO’s net income increasing by 1.1% in 2007, the Windfall Tax Paid is increased by 71.7%. CEO paid out approximately 22% of its total profits for this tax. As the world oil price keep soaring, the company will be load more with this tax.
Extensions & Restructures
Deep Ocean Extension Strategies
While CEO took proud of its cost competitive advantage among global peers and kept a general constant growth rate in its major expenditure items, there was a sharp rise in R&D in 2007. (See the following line chart)
CEO extended its exploration in 2007 and made 12 oil and gas major discoveries, together with the contribution of its recovering production of an important oil field, it successfully created another high in the production of its matured fields.
According to the speaker man of CEO, in the first half of 2008, they will still focus on the oil and gas exploring project, especially the deep ocean area, which believed has greater reserve potential, however, will engender much more technical difficulties.
CEO signed their first contract last Oct in Beijing for the construction of their own deep ocean development platform. It is going to be CEO’s first deep ocean platform without rented equipments, which will be a huge cost saving. CEO also plan to invest 15 billion RMB for further development of their self-owned deep ocean platform.
Upstream sector wealth ensure downstream extension
Tightly following the model of PTR and SNP，CEO are developing a more diversifies structure and enter into midstream or downstream of oil industry like refining sector. In 2007, with the domestic oil sale rights set free by the government, CEO formally entered the refining terminal. Their speak man announced that their downstream sector increased so fast that the interim sale volume of which even beyond the upstream’s in 2007.
In Oct 2007，CEO launched its first self-owned retail oil station in Guadong Province, where it planed to extend the number to 300 in its first step onto the downstream board, with at least 6 billion RMB to purchase the small private oil retailers or others. What is more, a 20 billion RMB oil refining arm was predicted to be operated and will provide 7.3 million ton product oil for this province. The above mentioned are just epitome of CEO’s extending strategy.
The challenges exist when PTR and SNP still occupied half of the domestic retailer market and many other domestic and foreign companies are eager for a piece of cake. However, CEO seems don’t worry about this because their distinctive advantages in the upstream could ensure their competitive advantages in the cake-chase, which actually is proven to be a wealth competition.
Forecast conservative
Base group stepping to go public
When we talk about CEO listed in the NYSE, it actually means CNOOC’s (CNOOC General’s) Production Group. There are other four groups: CNOOC Project, CNOOC Oil Field Service, CNOOC Chemistry，and CNOOC Base, together with CNOOC Production they all together constitute the CNOOC General. While the first four groups already listed in China domestic or international stock market, the last part, CNOOC Base Group, which covers the majority of CNOOC’s remaining 60% staff and unpublicized 8% asset, is stepping to go public in 2008 after experiencing large profit increase for several years.
If it truly happens, all the last remaining unpublicized assets for CNOOC will only be projects under developing, which could be injected into the listed companies once matured or needed. On that way, all the assets on the general base will be activated, that will increase the competitive advantage or growth potential of the corporation as a whole.
In conclusion, we believe CEO will still keep a strong productivity of both the upstream and other streams. However, the 2008 interim might not present very positive outcome because of the deep ocean development, the large growth potential will be visible later but not in a short run.
Refiners’ struggle for price inverse not work
In June 20, the Government announced their adjustment for the retail oil price by 16% to 18% up, good news for the big refiners. However, SNP and PTR were on a downhill since then, which should be the result of the soaring world oil price. The “price reverse” problem (i.e. crude oil price > retail price) seems more severe. Facing the loss in their refiner arms, SNP and PTR has already successfully got permissions for their customs deduction and resource tax deduction applications. In addition, from 1st April to 30th June 2008, the big two got a 75% crude oil tariff refund from the government. However, these compensation is claimed not enough by the two companies.
As for a prediction for CEO, its production terminal will still gain from the soaring world oil price, however, in a weak momentum if the inflation still on. However, its increasing refining arm will get hurt because of the “price inverse” and high windfall tax. What is more, CEO did not get any tariff refund or tax deduction like the other two refiners.
Company Overvalued
While the company’s growth potential in the production terminal is not as strong as previous, we do observe refiners’ downhill despite the government’s trying to compensate. Thus we could conclude that with a P/E ratio of 18, CEO is overvalued compared with its industry peers ( 10 for SNP, approximate 11 for PTR, BP and XOM ).Based on which, our forecast is conservative.