This article is part two of a three part series in which I review three of the largest oil and gas stocks in each of the foreign, emerging, and US stock market segments. In the first article, I also discussed the correlation of oil and gas stocks as a whole to other segments of the economy.
Review of Emerging Economies Oil and Gas Stocks
China Petroleum & Chemical Corporation (SNP)
China Petroleum & Chemical Corporation a/k/a Sinopec, is one of the two large Chinese oil and gas companies and the largest Chinese refiner/producer of certain petroleum related products. As an integral part of the Chinese economy, and given China's economic policies such as price controls on gasoline, SNP should continue to be the beneficiary of aggressive governmental policies to support its profitability and long-term success. On the other hand, given China's explosive growth relative to its oil reserves, SNP has to import approximately 80% of its oil, and its domestic oil sources are becoming increasing expensive to extract. There is a well documented race to secure the world's oil, particularly the oil that is easy to obtain, and it appears that SNP is not in a good position in this race. Source: Morningstar
SNP has not been a model dividend-growth citizen, having cut its dividend on at least three occasions in the past ten years. As a result, SNP's range has varied from 1.2% to 3.7% over the past five years.
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Source: Morningstar. The most recent dividend payment gives SNP a yield of 6.3%, well above its 5 year average of 2.7%. From a simple fundamental analysis, SNP would have to trade around $120-125 for its P/E, P/B, P/S and P/CF to be closer to its 5 year average. That the yield is currently very high also supports the idea the stock is undervalued. With SNP trading around $90, it appears to be a great value right now. I do not consider SNP to be a buy and forget type of dividend growth stock because of its lack of consistency with its dividend increases and because of the problems it will have accessing cost-efficient sources of oil. Rather, SNP should be viewed as a good value stock that pays a good dividend while you wait for the stock to return to a reasonable value.
PTR is the other major Chinese integrated oil and gas company. Unlike SNP, PTR has a significant amount of oil reserves, but it is subject to the same difficulties as SNP relative to having to import much of its oil and the cost of its domestic production increasing significantly. PTR also has access to a significant amount of natural gas reserves, and has been investing heavily in its infrastructure to take advantage of that much larger and accessible resource, even though it will take some time for this investment to pay off.
As with SNP, PTR both benefits from and is a victim of the Chinese government. Price controls, taxes and other measures taken by the Chinese government, and the inconsistency of their enforcement, can create significant headwinds on PTR's ability to predictably grow, make capital improvements, and invest in new technology. On the other hand, as an integral part of China's economy, PTR will essentially have a "floor" set by China relative to its access to financing and any other governmental changes that are necessary for its long-term success.
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PTR seems like a much better long-term investment than SNP, even though it is also not a consistent dividend-grower. My discounted free cash flow and discounted dividend valuations result in a fair value around $95-100, but without much confidence because of the inconsistency of its free cash flow and the downward trajectory of its net income and operating cash flow. A fundamental analysis of PTR indicates that its fair value is closer to $130-140. PTR appears to be a better long-term option than SNP, but it is not as good of a value right now.
According to its 2012 annual report, Petrobas is 29% owned by the Brazilian government, which has just over 50% of the voting shares of Petrobas. PBR produces approximately 96% of all oil produced in Brazil, and has proven reserves of approximately 12,800 mmboe of oil and gas. PBR is subject to laws enacted in 2010 that resulted in the Brazilian government assigning to PBR the right to explore and produce oil, natural gas and related commodities in specified areas, with an initial purchase price of U.S. $42.5B. This assignment and related investment obligation has resulted in PBR not only using its operating cash flow to meet these obligations, but also having to borrow money and issue shares. In addition, PBR is required to use certain equipment, including rigs, that are manufactured in Brazil, which inhibits the reliability and increases the cost relative to such a crucial part of the process. As a result, while PBR's revenue (in U.S. Dollars) has increased from $30.8B in 2003 to $144B in 2012, its operating cash flow has only increased from $8.6B in 2003 to $28B in 2012 and its free cash flow has been negative in each of the past 4 years for which I could find information.
If PTR and SNP are good value stocks that pay a respectable dividend, then PBR is the opposite, as it is hard to find much value right now, and it is not paying a dividend. Eventually, PBR should profit significantly from its capital expenditures and from the continued growth and modernization of Brazil. Further, PBR has numerous other properties that may increase its proven reserves. Investors who purchase PBR now should eventually be rewarded with significant stock price growth and dividends, but it could take 5-10 years before the rewards are received, and there is never a guarantee that your returns will be greater than the broader market, especially on a risk-adjusted basis. If you are comfortable with buying and holding securities for the long term, not worrying about stock price fluctuations, but rather are willing to wait 10 or more years for your investments to pan out, then consider buying PBR. For most others, this stock is not worth the risk over the next few years.
As always, please do your own due diligence, or consult an advisor, before investing.