December, 2013 (Chinavestor) Download the report in pdf format . Based on gas pricing reforms and higher oil prices, we expect Petrochina’s business prospects to improve over the forthcoming quarters. Given Petrochina’s share of the natural gas market, they are likely to overturn downstream losses incurred in 2012 and improve their share price significantly in 2013. The revisions in gas prices are predicted to be considerably higher for industrial users than residential users. Petrochina has traded at PER of 12.5x in 2012, reflecting a 56% premium over CNOOC (NYSE:CEO) , who utilizes more aggressive E&P tactics and realised higher EPS values. 2013 estimates place PER at 13.3x, an increased premium, however, justified given Petrochina Co. Ltd. (NYSE:PTR) is able to capitalize further from price reforms. Petrochina Co. Ltd. (NYSE:PTR) and CNOOC are both susceptible to macro risks, which we estimate to deliver upsides in oil prices in 2013.
Increasing revenues compromised by NDRC impositions
2.8% increase in Q1 2013 compared to that of a year earlier. Downstream losses in 2012 met with stable E&P production. Operating expenses concerned with O&G operations to decrease given windfall threshold increases from $50 to $70 per barrel.
E&P Operations key to PTR performance
We estimate capital expenditure concerning Exploration and Production to increase to RMB 239,600 million in 2013, representing 67% of overall segmental expenditure. The ‘Peak Growth in Oil and Gas Reserves’ program will devote extra funding to ensure oil reserves are not severely matured.
China consumption to add to Petrochina performance
The PRC and NDRC are striving for a cleaner environment, where natural gas is acting as the catalyst for this revolution in a country which is blighted by air pollution. Car production embedded with Natural Gas engines are on the rise to add to this reform, which will add to Petrochina’s value.
Commodity price risk and NDRC impositions to determine Q2 profits
Fig 1 - Petrochina; Decline in Margins due to NDRC impositions
Turnover increased by 9.6% in 2012 to RMB 2,195,296 million whilst net profits realised a 13% loss. By analysing the fiscal year 2012, the profits seemed to decline rapidly after 2012 Q1. Due to the government and NDRC imposing rules on the selling price of refined products, Oil and Gas companies, in particular downstream operators such as Sinopec, are faced numerous financial setbacks. Net margins had fallen to 4%, 5% and 5% in Q2, Q3 and Q4 respectively. Increases in the total output of products had been substantial in 2012 compared with 2011. A 3.4% increase in crude oil output and 7% increase in natural gas output, over 2011, would appear like a good proxy for healthy net income figures. As Petrochina supples over 70% of Natural gas to consumers, a hike in prices is the only way PTR can outperform its competitors.
Weak profits have brought about Petrochina to offer stakes in some core pipeline operations. However, the NDRC has acknowledged that companies
who import Gas will face harsh times and in turn have put forward their pricing reform target till 2015. Given there is a Natural Gas price hike, we should expect profits to continue to follow the trend outlined in Fig 2, where QoQ changes are on the up. Q2 profit figures for 2012 were at a significant low, primarily due these impositions. Even though production output and processing can grow for PTR, improving revenues, the effect of pricing and regulation on PTR has been made apparent on the profits.
Fig 2 - Petrochina; Net Profit Profile
Petrochina profits are which are continuously susceptible to policy risk will be sure to benefit from the reforms. Whilst China is slowing down economically after posting their first decline in growth since the ‘boom’, share price for Petrochina should improve given that the People’s Republic of China and NDRC control this fairly. International crude oil prices will be a positive for share price if they remain high, however the uncertainty surrounding the commodity will pose a risk to Petrochina.
EBIT had increased by 1 % in the most recent quarter in 2013, however YOY this had decreased by 3% to RMB 53,079 million. For 2012, EBIT increased to RMB 182,461 million; an increase of 5% in contrast to EBIT 2011 figures of RMB 174519 million. The decrease in overall profits may seem rational considering PTR had to expense out more funds on certain operations.
Fig 3 - Petrochina; Steady revenues with unpredictable profits
With crude prices averaging at $103.65 per barrel 2012, representing a decrease from 2011 averages of $104 per barrel, Petrochina’s E&P segment realized a loss of 2.1%. Given crude oil output rose by 3% and natural gas production by 7%, Petrochina is heavily weighed down by global commodity prices and policy risk. PTR’s exploration and production segment is susceptible to the same risks CNOOC (CEO) is poised to receive. However, given CNOOC’s $15 billion acquisition of Canadian Oil giant Nexen, output is expected to increase by 70 million boe. Downstream losses were expected for both Petrochina and Sinopec, Asia’s largest refiner, who posted a 6.5% overall EBIT loss attributed to downstream regulations on pricing, lack of demand for oil and petrochemicals. However, they are expected to post profits during 2013, based on the superior quality of refineries they have over Petrochina, which we predict will improve figures for Sinopec given the rise in gas prices takes effect.
We expect Petrochina to improve EBIT by 5%, given a significant rise in Natural gas prices domestically takes effect. EBIT for its E&P segment will increase, whilst the Gas & Pipeline segment will feel the impact of price hikes more. Imports are currently not encouraged by the current domestic prices, which the NDRC has acknowledged. With Petrochina monopolizing the Gas industry in China, they can adjust production in line with prices, to avoid another decline in profits. With Gas demand to grow approximately 6% annually for the foreseeable future, Petrochina will be the main recipient of the profits.
Fig 4 - Petrochina; Increase in crude oil price could offset controlled gas prices
Petrochina’s subtle changes in share price goes in parallel with what the West Texas intermediate and Brent Crude prices exhibit. Economic stagnations in countries which have contractual agreements to oil states will bring down the price of WTI and Brent, which in turn affectsPTR. The issuance of extra European Sovereign Debt negatively controlled oil price in the Middle East and North African regions. Downstream losses in 2012 can be upturned given there is a spike in WTI and Brent in 2013.
Segmental operations and expenses
- Taxes other than Income Taxes
An increase in resource tax payable was realized, amounting to RMB 28,079 million from RMB 19,784 million. With Petrochina and Sinopec calling for a rise in the oil levy threshold from $50 to $70 a barrel, they expect taxes to decrease in 2013. In 2012, a RMB 15, 044 million decrease in taxes paid was primarily due to the increase in threshold from $40 to $50 a barrel.
- Exploration Costs
Fig 5 -Petrochina; Oil and Gas upstream costs expected to improve given windfall threshold increases
- Depreciation, Depletion & Amortization
Depreciation and amortization of fixed assets combined with the depletion of oil reserves is significant when overlooking PTR’s expenses. The increases in the value of these assets and life of oil reserves will increase capital expenditures significantly, hence, increase the DD&A. In 2012, costs for Depreciation, Depletion and Amortization amounted to RMB 151,975 million, a high amount in contrast to 2011 figures of RMB 138,073 million. The most recent quarter of 2013 saw DD&A increase to RMB 39, 622 million. Capital expenditures will be on the rise in oil firms unless the life of assets can increase and exploration of new oil reserves is realized each year.
- Foreign Exchange, Interest and Taxes
The US dollar depreciated against the Chinese Renminbi (RMB) whilst the Canadian dollar appreciated against the Renminbi, allowing a gain on Petrochina’s foreign exchange policies. PTR’s business, even though it is focused on using China’s Renminbi, utilizes foreign currencies to purchase crude oil imports and materials. A net exchange gain of RMB 131 million was realized in 2012. A rise in debts attributable to financing operations and production increased the interest payable on these obligations in 2012 by RMB 7,889 million. Income tax is expensed at the PRC rate of 25% whilst operations in parts of China qualify PTR for an incentive of 15%. The income tax for 2012 decreased compared to 2011 by 5%.
Development and Capitalized Exploration to increase
In our view, Petrochina’s cash flow seems to be exhibiting changes, due to an increase in outside financing and a decrease in transactions occurring from current operations. 2011 Q1 Cash from Operations (OCF) were RMB 65,940 millions and Cash from Financing Activities (CFF) posted at RMB 54,582 million. Comparing the current cash position of Petrochina, OCF was RMB 17,093 million and CFF RMB 119768 million, displaying acute changes in how Petrochina has managed cash flows.
Fig 6 - Petrochina; Leverage on the increase whilst organic growth declines
From this trend, Petrochina’s finances are utilizing extra debt QoQ and they will need to increase their operating activities and adapt to varying taxes to avoid carrying on too much outside financing. By analysing the downward trend, the decrease in OCF is also due to the increase in taxes PTR pays. Payments of these taxes and levies increased yearly from 2010; 27% in FY11 and 25% in 2012. Whilst Petrochina has hedging policies to mitigate the effects of foreign exchange rates, protecting their funds from state government impositions is much more difficult.
PTR’s capital expenditures (CAPEX) have risen steadily over the course of the five fiscal periods. PTR’s outlook on their current oil reserves may seem underwhelming, given their exposure to areas maturing in oil production.
CFI increased 17% in 2012 from 2011, primarily due to extra CAPEX amounting to RMB 311,744 million. This was a rise of 16% from 2011’s capital expenditures of RMB 267, 975 million. Whilst acquisitions and disposals contributed to a small portion of CFI inflows and outflows, CAPEX generated the largest outflows. In 2011 however, CFI decreased 3% to RMB 283638 million even though CAPEX had increased by 3.4%. This fiscal year had less outflows in its investing activities due to a decrease in acquisitions of investments in associates and jointly controlled entities.
Fig 7 - Petrochina; Increase cash investing needed to maintain and grow
Petrochina has new natural gas and oil fields to explore in the near future including an oil well in Canada and Songliao Basin. PTR needs to maintain the output of the Daquing oil field whilst their ‘Peak Growth in Oil and Gas Reserves’ program will devote extra CAPEX to maintaining the Tarim Basin, Sichuan Basin and Bohai Bay Basin. There is no doubt that PTR, a large E&P company which assigns over 64% of funds to this segment alone, will need to invest heavily to meet the requirements for further high-impact undertakings.
The vast amount of funds is injected into Exploration and Production. In 2012, CAPEX had increased to RMB 227,211 million from RMB 162,154 million. Petrochina has also decreased the amount spent on other operations for 2012 as oppose to 2011. E&P expenditure had increased 7.4 % from 57%, whilst Refining and Chemicals expenditure was reduced by 5 %, Natural Gas & Pipeline 1.3% reduction and the Marketing distribution by 1.1 %.
Fig 8 - Petrochina; Focus continues to move to E&P operations
2013 estimates display a forward emphasis on E&P, increasing expenditure to approximately RMB 239,600 million representing a share of 67%. Overseas operations in the Middle East should aid the efforts to extract further reserves. The Guangdong, Huabei, Sichuan and Yunnan Petrochemical projects will expel further capital from PTR’s cash flow. It is expected that the Refining and Chemicals segment would amount to RMB 32,400 million, however, for PTR’s operations, these estimates are bound to increase due to unexpected operations, political and economic uncertainties which have affected PTR performance in prior fiscal years. Exposure to mature reserves will also need to be overlooked as this will pose a threat to production power and increase their asset retirement obligations.
The increase in demand for Natural gas will impact PTR, who need to import the commodity in higher amounts to satisfy PRC and NDRC requirements. The Zhongwei-Guiyang, Third West-East, Third and Fourth Qingtie pipelines will contribute vastly to how much is expelled on capital as these remain key oil and gas projects in 2013.
PER trading at high premiums and highly leveraged
Petrochina is trading at a massive 105% premium of 12.5x to Sinopec’s FY12’s PER of 6.1x and a 56% premium compared to CNOOC 8x. We expect PTR to trade at 13.3x PER in FY13, given that there is a natural gas price hike and higher oil prices ensue. Even though Petrochina faces risks similar to Sinopec and CNOOC, they have the market share of natural gas distribution which is expected to improve share price performance significantly. CNOOC which is cheaper than Petrochina offers higher EPS which does make it more attractive on this basis.
Fig 10 - Petrochina; Production of current reserves to continue at a stable rate
Given international crude oil prices remain stable and production in Daquing, Changquing and Xinjiang Oilfield proceed, we expect Petrochina to increase EBITDAX to 5.9x. Compared to CNOOC, a greater increase is expected here. Nexen’s large supply and production will improve CNOOC performance and EBITDAX.
Fig 11 - Petrochina; ROA profile comparison with Refiner Sinopec
ROA peaked at 8% in 2010 for PTR, with declines thereafter. The decline in ROA is mainly due to an increase in liabilities, particularly long term debt, and also a decrease in net profits. Net profits declined to RMB 115326 million in FY12 from RMB 132961 million in FY11. Acquisitions are predicted to be high in FY13, which is usually funded by debt for both firms. They will need to consider equity funding to improve the overall return they receive on their assets.
Fig 12 - Petrochina; Structured 5 Step DuPont
Government regulations increased purchasing costs for natural gas imports whilst employee compensation also increased. The return investors expect will be correlated to how the government measures its regulations in China. The Five Step Du Pont demonstrates Petrochina’s net margins to be credited to a decline in EBIT margin which in turn contributed to the decrease in ROE for every period of ROE decline. The rise in operating expenses PTR accumulated directly affected the EBIT margin, hence affecting ROE. If PTR is expected to make future profits, they need to address issues directly with the government and NDRC with regards to pricing and volume of imports.
PTR increased both leverage and their asset base gradually over the 5 fiscal years. Assets increased on the balance sheet 38% from FY08 to FY10 and 31% from FY10 to FY12. Debt levels also increased during these periods. This trend signals that PTR is being financed more frequently by creditors rather than internal equity, which may be detrimental to future cash flows of the company. In 2012, debt to asset was 20%, with 2011 being 15%. Exploration of natural gas reserves has needed further capital expenditure to be expensed by PTR.
Fig 13 - Petrochina; Highly leveraged stock compared to XOM, BP and SNP
In 2013, both Petrochina (NYSE:PTR) and Sinopec (NYSE:SNP) have issued further debt to fund acquisitions for the coming year. PTR in particular will need to explore further reserves to meet the demand for natural gas in China which has caused a wedge in revenues in recent years.
Evaluating two of the world’s largest Oil and Gas companies, BP (NYSE:BP) and Exxon Mobil Corporation (NYSE:XOM), can draw comparisons on the how Asian O&G firms use leverage to fund operations. Whilst BP has marginal increases in Debt-to-Assets over the fiscal period, XOM has averaged 4%, which is considerably lower than that of PTR and SNP. XOM’s low ratios indicate the company is in good financial health and that debt is outweighed by assets. Having to compare PTR to BP however will be unjust, considering the government policies in China. The government impositions have caused PTR to increase exploration for natural gas therefore having to increase debt to fund operations. PTR seems to be much more leveraged than its competitors. PTR may seem it is excessively leveraged when compared to UK’s BP and US’s XOM. However, to draw comparisons would be unreasonable. State owned PTR has a need to supply oil for its domestic requirements, whereas XOM and BP focus on domestic needs as well as exports. Petrochina (NYSE:PTR) has recently overtook Exxon Mobile Corporation (NYSE:XOM) in oil production; expelling funds on oil new oil reserves and discoveries. PTR will need to continue these operations to satisfy domestic needs, hence, having to tap into creditors to finance this.
Fig 14 - Petrochina; PTR, CEO & SNP historical share price performance
Petrochina share price performance is highly correlated to CEO and SNP, who’s ADR listed shares are subject to the similar market conditions PTR confronts. The market value for Chinese stocks has been substandard in comparison to prior years. China as an economy is slowing down for the first time in 13 years. However, tactics employed by the PRC to force a slowdown and improve credit will subside and energy giants are sure to advance their performance given government overturns the economic stagnation.
Chinese environment and PTR investors set to benefit
China averages 5.7 million barrels of net oil imports a day, closing the gap on the US who has maintained a domineering stance when it comes to their dependence on foreign oil. Foreign policy in countries which China has heavily invested in will likely see further imports in the coming years. The US is becoming less reliant on foreign imports; due to increase in domestic reserves and new found shale reserves. China imported on average 5.7 m b/d of oil in 2012 whilst the US has declined from 10 m b/d in 2007 to approximately 7 m b/d in 2012. We expect China to overtake the US in net oil imports in 2013, with Petrochina central to upstream activities concerned with China.
Fig 15 - Petrochina; China to overtake US in net oil imports
The Chinese economy is tending towards a cleaner environment, making the use of natural gas central to PRC and NDRC discussions and impositions. With Petrochina dominant with Natural gas distribution, we should expect their share price and financials to improve as China’s Natural Gas consumption rates increase.
Fig 16 - Petrochina; Natural Gas Consumption to increase implying gains for PTR
China is keen to be the supreme producer of cars worldwide, which would also increase the number of cars in China which run on natural gas. For taxi drivers in rural provinces, the switch to a natural gas engine may be a costly initial procedure, however they would recoup the money spent within 8 months. From their onwards, a significant portion of their income would be spent on refuelling their natural gas vehicles, which would not be the case if they had continued with their oil injection engines. The estimates of mass car production will inevitably affect the way PTR performs. As their consumption increases, we would expect significant improvements in their share price performance.
Growth Prospect and Outlook
Petrochina is on the verge of an immense turnaround, which could see their share price and revenues increase substantially. Where China’s economic growth contributed to the large profits noted in 2007, its China’s economic slowdown coupled with the concern that emissions are harming the population that has seen Petrochina financial health subside. Natural gas imports have been on the rise with profit damaging domestic prices eating away at income. However, given that the National Development and Reform Commission (NDRC) and the People’s Republic of China (PRC) adjust domestic prices fairly, pertaining to their goal of a fully employed supply-demand market, we expect Petrochina to capitalize from this now until 2016.
Whilst modest international oil prices came to some aid in the most recent quarter, we do expect this to be the only thing that can guarantee an upside to Petrochina and improve valuations. EPS figures will be improve whilst shareholders can expect Exploration and Production to increase given current oil reserves do not mature and pending contracts in Africa, South America and the Middle East come to fruition. There will be an upside to EPS given the gas price reform does take place.
The primary risk concerned to this stock is that a pricing reform does not take place. Petrochina’s current high PER would not be justified and investor confidence will decline. An economic response triggering lower inflation would inevitably keep domestic prices at bay, harming PTR’s outlook. Given the lack of demand for oil products, this could turn out worse than expected. The ‘cash crunch’ in China and the US undergoing an economic ‘boom’ signals Chinese stocks are losing market value. This has taken effect on Petrochina; however, we still recommend a BUY rating on this stock. The pricing reform will generate a complete market adjustable system. Petrochina, which has the share of the natural gas market, will grow largely mid-long term with effects on share price to be realised in the upcoming quarters.
I, Sandun Munasinghe, hereby certify that the views expressed in this research report accurately reflect my personal views about the subject securities and issuers. I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or view expressed in this research report.
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