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Previously…
We wrote a comprehensive piece on CNOOC (883 HK) in Jan 2021 (see article here), as it was our preferred oil stock at that time. We had a position then (as disclosed) and subsequently exited for a 36% return in about a month.
The stock is looking interesting again, having come off by 22% from its Feb-2021 peak, and we have bought back into the stock for the following three reasons…
1) Post oil price rally, CNOOC’s valuations are now dirt cheap
2) Upcoming China listing may drive rerating of HK-listed shares
3) Announcement of dividend policy looks likely (~10% yield?)
Reason 1: With the strong oil price rally, CNOOC’s valuations have become that much more attractive
Between 2016-2020, CNOOC’s share valuations have tracked movements in Brent prices very closely (see chart below).
However, CNOOC has been lagging the rally in Brent prices in recent months, and we see potential to play catch up. CNOOC’s share price is down 22% from its Feb-2021 peak, despite Brent crude rallying 32% (from $63/bbl to $83/bbl) over the same period. There’s reasons for this (which we think are overblown), and we discuss this shortly.
We do note a few reasons to stay bullish on Brent from here, which would be supportive for CNOOC.
- On 4 November 2021, OPEC refused requests from the US to increase oil production further (from the existing plan to increase output by 400k bpd every month).
- Goldman Sachs: Expects oil demand will shortly reach pre-COVID-19 levels of around 100 million barrels per day (bpd) as consumption in Asia rebounds after the Delta COVID-19 wave. Given the current high gas prices, gas-to-oil switching may contribute at least 1 million bpd to oil demand. Goldman’s Brent forecast is $90/bbl for 4Q2021-1Q2022, with risks to the upside (source: Reuters).
- Morgan Stanley: Forecasts $95/bbl in 1Q2022
- Bank of America: Forecasts $95/bbl in 2Q2022
- J.P. Morgan: “Adjusting for inflation, consumer balance sheets, total oil expenditures, wages and prices of other assets, we think even with oil at $130 or $150, equity markets and the economy could function well.”
CNOOC is trading at historical trough valuations
CNOOC’s current EV/EBITDA is 2.4x, a level which has typically signaled the trough in previous downcycles (see chart below)…except that we are not in a downcycle now.
In addition, recall that CNOOC’s parent company (China National Offshore Oil Corporation) bought ~US$300M worth of CNOOC shares at HK$7.28 on 23 December 2020 (back when Brent was trading at $51 vs $83 today). Assuming that’s a price where we may see more insider buying, that implies a support level that’s ~11% below CNOOC’s current share price of HK$8.16.
CNOOC looks cheap relative to other oil majors
Among global oil majors, CNOOC has been the largest underperformer since the start of 2020, down 27.7% on a total return basis.
As a result of its share price underperformance, CNOOC looks most attractive among peers. The chart below shows the Price-to-Book valuations (x-axis), and profitability based on forward Return on Equity (y-axis) of global oil majors. Stocks above the red trend line would be generally more attractive.
WHY it’s trading at such low valuations
The US Blacklist: Recap
- On 3 December 2020, the U.S. Department of Defense added CNOOC to a blacklist of alleged “Chinese military companies”, potentially due to its alleged link to military activities at the South China Sea (see HK Exchange announcement).
- On 8 January 2021, the Office of Foreign Assets Control (“OFAC”) of the Department of the Treasury of the United States of America added the Company to its list of Chinese companies with alleged ties to the Chinese military (see HK Exchange announcement).
- On 14 January 2021, the the Bureau of Industry and Security (BIS) in the Department of Commerce added Chinese National Offshore Oil Corporation (CNOOC) to the Entity List. (see announcement)
The US Blacklist: Implications for CNOOC
This resulted in a few concerns which we had highlighted previously, and it’s useful to relook at them here and highlight what has changed since the start of 2021 (updates written in blue below).
- Operational impact to CNOOC Ltd expected to be manageable.
- Having been put on the US Department of Commerce’s “Entity List”, which China semiconductor company SMIC is also on, the implication is that US companies cannot export, reexport, and transfer items to CNOOC.
- US operations accounted for 5% of CNOOC’s oil and gas revenues in 2019, so the impact looks significant but manageable.
- Update: Production volumes were largely unaffected from the blacklist, with 2021 forecasted to set a new production record for the firm (see chart below).
- Restriction on US investors from investing into CNOOC. Having been put on the DoD and OFAC blacklist, US investors will have 1 year grace period to divest their holdings of blacklisted companies.
- According to J.P. Morgan, US shareholders accounted for 15% of CNOOC’s total shares as of September 2020.
- Update: On 3 June 2021, a new Executive Order was signed, extending the divestment grace period to 3 June 2022 (instead of 11 November 2021). Note that US investors are not forced to sell their CNOOC shares, just that they won’t be able to trade it after the grace period (see this article for details)
- According to a report published by CICC in June 2021, it was noted that shareholdings of US institutional investors had already declined by 90% since Nov 2020. We see this as a positive inflection point, given less implied selling pressure from US investors on a go-forward basis.
- Index compilers such as MSCI, FTSE and Hang Seng indices may reconsider removing CNOOC Ltd from certain benchmarks, adding to the selling pressure.
- Update: CNOOC has been removed from MSCI and FTSE indices since Jan 2021. It is still included on the Hang Seng Index and Hang Seng China Enterprises Index. Given its removal from two of the major Index providers earlier, we don’t envision any meaningful selling pressure due to ETF rebalancing from here.
Reason 2: Upcoming China listing may drive rerating of HK-listed shares
On 26 October 2021, CNOOC shareholders voted in favour for an onshore A-share listing (see here for exchange filing). Management mentioned that the purpose of the A-share listing would be to broaden the company’s fund raising channels (since its US ADR has been delisted) and to enhance brand value by improving its relationship with domestic Chinese investors.
The implied A-share IPO price is at a 101% premium to H-share’s current price! For the A-share listing, CNOOC aims to raise RMB 35 billion (by issuing 2.6 shares, or 2.99bn shares if greenshoe option is exercised). This implies an issue price of ~Rmb13.46/share (~HK$16.38/share), representing a 101% premium to the HK$8.16 current share price for CNOOC’s H-share (883 HK). This may serve as a potential catalyst to trigger a rerating in the H-share valuation.
While it is common for A-shares to trade at a premium to H-shares (assuming a company is dual listed across onshore China and Hong Kong), we note that the average AH premium has been ~30% historically (see chart below).
For CNOOC’s more direct peers, here’s what their current A-share premiums are relative to H-shares, after adjusting for FX.
- PetroChina: A-shares (601857 CH) trades at a 73% premium to H-shares (857 HK)
- China Petroleum & Chemical Corp (Sinopec): A-shares (600028 CH) trades at a 33% premium to H-shares (386 HK)
- China Oilfield Services Limited: A-shares (601808 CH) trades at a 161% premium to H-shares (2883 HK)
Reason 3: Announcement of dividend policy looks likely
There’s another implication to the upcoming A-share listing, in that CNOOC will likely announce an official dividend policy (which had been absent previously). This would enable the firm to be aligned with the semi-mandatory dividend policy framework that’s encouraged by the China Securities Regulatory Commission (CSRC) – read Article 5 of the guideline.
Having an official dividend policy would likely translate to a payout ratio floor, which we view as marginally positive for investors. Here’s the dividend policy of three of CNOOC’s peers for reference.
- PetroChina: minimum payout ratio of 30%, actual payout ratio has been ~45% since 2016.
- Sinopec: minimum payout ratio of 30%, actual payout ratio has been 65-80% for 2018-2020.
- China Oilfield Services Limited: minimum payout ratio of 20%, actual payout ratio has been ~30% for 2019-2020.
CNOOC has a dividend yield of 6.7% currently, and analyst consensus sees it at 10.5% on 2022 forecasted earnings (based on a 40-45% dividend payout ratio). That would certainly be very attractive for income investors, and could possibly be another catalyst for a valuation rerating.
The InvestQuest View
CNOOC’s recent share price depression presents a unique opportunity to buy into a stock with strong all-around fundamentals, in a strong performing commodities environment. The upcoming A-share listing and forward dividend yield of >10% will likely be supportive to the H-share in the near-term, and the fading of forced selling pressures (due to the US blacklist and index removals) could signal an inflection point to the stock’s underperformance that’s plagued it for much of 2021.
Appendix 1: Analyst Ratings and Target Prices
CNOOC is a 100% consensus buy among analysts, unsurprising in our view given current valuations.
Median target price is HK$12.60, implying 54% upside from the current share price of HK$8.16.
Appendix 2: Stock fundamentals for China Oil Majors
Appendix 3: CNOOC Revenue and Net Profit
During our earlier article written in Jan 2021, analysts were estimating that CNOOC’s revenues and net profits would recover back to pre-covid levels in 2023.
However, the combination of better than expected selling prices and production volumes has resulted in an acceleration of that timeline. A full earnings recovery is now in sight for 2021 instead.
Appendix 4: Total Returns by Sector for Global Stocks
Energy stocks have been star performers for 2021. However, the sector is still the worst performing when considered since the start of 2020 (chart below). We personally think there’s more room for energy stocks to run, given that the sector has been lagging the broader move in oil and gas prices.
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