An Oil Behemoth Is Worth Less Than Its Energy Reserves In the Ground
PetroChina Co. looks cheap on many levels, perhaps none more so than comparing it to the value of its reserves beneath the Earth’s surface.
By plotting its enterprise value against reserves, China’s state-run oil and gas champion is the cheapest among global energy firms tracked by Sanford C. Bernstein & Co. Its shares have sunk 14% in Hong Kong this year to trade almost at the lowest since 2005. That’s despite a 19% gain in crude prices.
“With PetroChina’s current assets and asset quality, even with modest valuation methods, the H-share price should be easily doubled from current levels,” Jefferies Group LLC analyst Laban Yu said by phone. “There is no valuation method that can validate the current share price.”
That’s a sentiment shared by most analysts. The stock has drawn 20 buy ratings and only one sell. The consensus of more than 25 forecasters sees prospects for PetroChina to surge 42% over the next year, according to data compiled by Bloomberg.
“In theory, oil companies should never trade below their proven reserves value,” Bernstein analysts including Neil Beveridge said in a May 22 report. With PetroChina trading below that metric, it raises the question of how much lower it can get, Bernstein said.
To truly unlock its potential requires a major jolt, such as a breakup of its assets or a management mindset shift to put the needs of shareholders on par with national service, analysts say. If PetroChina existed in the U.S., it would be worth about four times more than its current price of HK$4.20, according to Jefferies.
Beijing-based PetroChina was formed in 1999 after its parent China National Petroleum Corp. transferred most of its major upstream assets inherited from the former oil ministry. The company listed in Hong Kong a year later and in Shanghai in 2007, becoming the world’s first trillion-dollar company.
As oil prices tumbled, PetroChina suffered more than its international peers. Its current market value of $169 billion makes it the fourth largest oil major after Exxon Mobil Corp., Royal Dutch Shell Plc and Chevron Corp. Confidence was also hurt by a corruption scandal in 2013 that led to the imprisonment of a few board members, including former chairman Jiang Jiemin.
Oil companies typically trade at a premium to their reserve value to reflect the growth potential from those resources, according to Bernstein. PetroChina is a “noticeable outlier” among 25 global energy companies assessed, which is based on the value of proven reserves under current prices among other factors. Bernstein estimates PetroChina’s reserves are worth $208.7 billion.
Part of what ails PetroChina is endemic to the oil industry: back when oil prices were high, it piled up debt in chase of production growth. Return on capital, a popular measure of efficiency in oil companies, dropped from double-digit percentages in the 2000s to single digits in recent years.
Its return on equity of 4.3% is at the bottom 5% of global integrated oil and gas companies, while its operating margin of 5.09% is lower than 65% of the majors, data compiled by Bloomberg show.
“They pursued a strategy of volume growth at the expense of returns,” Beveridge said in a phone interview. “That’s obviously led to massive loss in shareholder value.”
PetroChina also suffers from troubles specific to it being the nation’s top supplier. It is under pressure to increase spending this year, a good chunk of it on old or high-cost fields, after President Xi Jinping called for higher domestic oil and gas production. It also consistently loses money from reselling imported natural gas locally at lower, state-regulated prices — a problem that has intensified amid booming consumption.
Reform could be around the corner. The Chinese government plans to combine the pipeline resources of PetroChina and its two other state-owned peers into a national operator. This could unlock value for PetroChina if those assets are worth more than what the company has them booked for, Beveridge said.
The pipeline spinoff will provide clarity for investors as well as a short-term share price boost, Daiwa Capital Markets Hong Kong Ltd. analysts including Dennis Ip said in a note Monday that initiates coverage of PetroChina with an outperform rating.
The government is also revamping the upstream industry to make it easier for foreign companies to invest, and forcing producers to drill or lose exploration rights, according to Yu. That may push PetroChina to sign more production-sharing agreements, form joint ventures or spin off some other assets, Yu said.
Beveridge highlighted Russia’s Gazprom PJSC as an example of how value can be unlocked when executives address shareholders’ needs. The company boosted dividends in May and followed that up by promising senior management changes. Its share price has jumped by more than 50% since.
“Fundamental reform of the company, management and incentive schemes that are more focused on return-type metrics, that’s what’s needed to turn around the company,” Beveridge said. “If you do something positive for the shareholders, then you can start to unlock the upside.”