Last weekend I read the first extracts from Warren Buffett’s authorised biography. By sticking to his value-based principles he has amassed a $50bn fortune. One of his recent success stories was PetroChina, where he turned $488m into $4bn over five years – a 700% profit. Buffett afterwards said that “he had sold at fair value” – $150 a share – but the stock continued to rise, hitting $260 as the Shanghai composite index soared to over 6,100.
PetroChina ADRs (NYSE:PTR), rated OUTPERFORM by Credit Suisse
Since then the shares have been in freefall, hit by both the meltdown in the Chinese stockmarket and, more recently, a softer oil price as fears over global trade escalate. However, despite the fragile sentiment, I think now is a good entry point for the long-term investor. Here are my reasons why.
PetroChina is China’s largest integrated oil and gas business, with a market capitalisation of around $200bn (it’s worth more than either BP or Shell). It owns extensive up- and down-stream hydrocarbon assets covering exploration, production, refining, chemicals, petrol stations and gas pipelines. The majority of its operations are located domestically – it produces about two-thirds of China’s oil. However, it is also branching out internationally and now owns sizeable businesses in Azerbaijan, Turkmenistan, Venezuela, Algeria, Peru, Oman, Canada, Chad, Indonesia and Ecuador. About 14% of the equity is listed on international exchanges (of which 11.5% is in US American depository receipts, or ADRs) with the remainding 86% held by the state through the China National Petroleum Corporation.
At the end of last year, the firm had estimated proved and recoverable reserves of 21.4 billion barrels of oil equivalent, with the fields having an average remaining life of about 15 years. For every barrel of oil pumped it makes around $17 in after-tax profits. Roughly speaking, that translates – over the lifespan of the reserves, using a 10% discount rate – into a valuation in today’s terms of some $170bn (equivalent to $84 per ADR). PetroChina, in contrast to many of its global rivals, has also consistently increased its oil replacement ratios over the past decade. This trend is set to continue as much of China is relatively untapped with regards to oil and gas exploration.
Secondly, although the world economy is stagnating, China is still growing rapidly, so PetroChina should keep earning healthy profits. It also enjoys substantial trade barriers and governmental protection that should deter international competition. And with its large natural-gas reserves and extensive pipeline network, it is also in an excellent position to benefit from the nation’s plans to develop gas-fired power stations.
Wall Street expects revenues and underlying earnings per share (per ADR) of $146bn and $10.9 this year, rising to $174bn and $12.8 in 2009. That puts the shares on attractive p/e multiples of only 10.1 and 8.7. It pays a 3.5% dividend yield, and has comfortable net debt levels of around $13.5bn.
What about possible banana skins? As with the rest of the sector, PetroChina faces a number of challenges, including exposure to volatile oil prices, fluctuating refining margins, rising costs, foreign currency movements and geopolitical instability. Alongside this, the government holds a controlling stake, which could impact on smaller shareholders. There are also domestic price-caps on many of its gasoline/diesel products.
All the same, if Warren Buffett believed that PetroChina’s fair value was around $150 an ADR 12 months ago – when the crude oil price was bobbing around $75 a barrel (as opposed to $100 now) – then to me the ADRs look good value.
Recommendation: BUY at $110
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments. Phone 020-7633 3634 for more information.