Deep-dive 2020-5: CNOOC Ltd

CNOOC Ltd (883 HK) a.k.a. "China National Offshore Oil Corporation" is one of the largest oil exploration and production companies in Asia. It remains a pure play upstream oil company with a high beta to crude oil prices. Bernstein calls CNOOC "Asia's largest and best managed E&P company... delivering exceptional production growth (with no dilution to equity holders)."

The company's track record is excellent. Production has grown at ~10% CAGR historically (excluding the acquisition of Nexen), and management is guiding for a 6% production CAGR in the years ahead. What's more is that CNOOC has achieved this while maintaining positive free cash flow, enabling the company to maintain a median dividend pay-out ratio of 40% without incurring any debt.

A key part of CNOOC's competitive advantage is that it has a monopoly on exploration under production sharing contracts in offshore China. It is then able to sell this oil domestically at prices tied to Brent, despite differences in crude quality with Bohai / South China Sea region oils having a lower API. Crude exploration in offshore China is done at shallow waters, explaining the relatively low all-in cost of just $26/boe. Oil exploration in offshore China is also a relatively new phenomenon, making it more profitable and lower risk than say in the Gulf of Mexico. Lastly, CNOOC enjoys a net cash position - giving the company significant flexibility. Low leverage enables CNOOC to grow via M&A in a period when energy stocks are trading at low valuation multiples.

The main problem with oil stocks is the impact of COVID-19 on the demand for crude oil. Gasoline demand has almost recovered. Many individuals are now driving more than last year, preferring the comfort of their vehicles to riskier public transport. Kerosene demand has however been very slow to recover as international air traffic is still weak. OPEC predicts that the demand for jet fuel might not recover until 2024, in a worst case scenario. That is certainly possible. However, given how quickly air travel has recovered within mainland China, we believe that consumers are already willing to travel. All it takes is for travel bubbles to emerge - for restrictions on air travel and quarantine requirements to finally ease.

Under a scenario of a gradual recovery in the demand for oil, we expect the Brent oil prices to recover to $60/bbl over a three-year period. Using what we consider to be realistic assumptions, we predict a target price of HK$16.6/share, implying an upside of +115% without even considering yearly dividend payouts. We expect a prospective 2023e dividend yield of 8.6%.

The largest potential downside is the potential for parent asset injections. CNOOC has historically not engaged in related party transactions with its parent. However, a proposal has emerged that the parent sell down power assets and LNG regas terminals into CNOOC Ltd. It would be a negative for the stock, without necessarily breaking the long-term investment case for the stock. A vote on such an asset injection could happen sometime in 2021. But the company's growth profile, its competitive advantage in offshore oil exploration and the very low expected 2023e PE multiple more than makes up for such risks, in our view.

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The above article and PowerPoint presentation constitute the author’s personal views only and is for entertainment purposes only. It is not to be construed as financial advice in any shape or form. Please do your own research and seek your own advice from a qualified financial advisor. The author may from time to time hold positions in the aforementioned stocks consistent with the views and opinions expressed in this article. Disclosure – we do not hold a position in CNOOC Ltd at the time of publishing this article (this is a disclosure and NOT A RECOMMENDATION).

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