Corruption Scandal Creates A Buying Opportunity For CNOOC

Mar.17.14 | About: CNOOC Limited (CEO)


CNOOC is among the emerging market oil majors that is near mulit-year lows despite high oil prices.

Corruptions scandal amongst management and China hard landing concerns have hurt stock price, but not core business.

Stock is trading at bargain P/E and oversold technically, so buying opportunity is coming shortly.

With Xi Jingping's attack on corruption, some of the biggest victims have been state-owned companies. Due to implicit protections for the government and deep political ties within these companies, state companies have needed to provide bribes to government officials to do business or have management within the company that have deep connections within the Communist party structure. The oil industry historically has been very politicized not only in China, but across emerging economies. As a result, it is not surprising the China's corruption probe has exposed CNPC's vice president Zhou Shouwei, former chairman Jiang Jiemin, and Zhou Yongkang, all of whom are facing investigation. This is not just a problem from CNPC as the management of CNOOC (NYSE:CEO) is also investigated for corruption charges.

The corruption scandal amongst its upper management and a downgrade by Credit Suisse has forced the stock price of CNOOC down over 14% since October while both oil prices and the stock prices of Western oil majors are up over 10%. The indictments and arrest of these leaders may hurt investor confidence, but they do not diminish the economic fundamentals or the financial health of the company.

CNOOC is the best investment of the major Chinese oil companies because of its regulatory competitive advantages, financial strength, growth of oil demand and exploration projects in China. The oil industry in China is an oligopoly of three state-owned companies: Petrochina, CNOOC, and Sinopec. CNOOC has a significant advantage over its competition. Chinese regulations guarantee CNOOC the right to at least 51% of any joint venture with a foreign oil company in China or waters within its offshore drilling rights. As a result, Western oil companies incur the exploratory costs and production costs while CNOOC automatically gets half of any successful project. Basically, the company gets free exploration from the best oil engineers in the world and reduced exploration costs significantly improve margins. Neither Sinopec nor Petrochina gets the same benefit, which creates a huge moat for CNOOC.

The internal corruption within the company is definitely bad for public relations, but it does not change the fact that China has become the world's largest consumer of oil with continuously rising energy demands. Even as China shifts away from the export-based economy that fueled a global commodity boom, oil demand will remain high in China as consumer goods such as plastic products, gasoline, and the Chinese power grid rely on increased domestic production and crude imports to continue. CNOOC still has exclusive negotiation terms with Western oil companies for Chinese exploration projects (and is at no risk of losing these). Therefore, recent news will not affect the company's profitability in a negative way. In fact, decreased expenditures related to political graft can actually help the bottom line assuming Chinese business and bribery practices clean up as a byproduct of Xi's corruption probe.

CNOOC's financials indicate that it is the healthiest oil company in Asia and a great value. Its long-term debt/equity ratio is 0.26, which is low for an oil company. The valuation of a trailing and forward P/E ratio of 7.3 is very cheap. CNOOC has returns on equity of and investment of 43% and 17% respectively while also paying a sizable dividend yield with a 3.1% yield at current prices. Profitability is also very high with a 47% net margins which is the highest amongst NYSE-listed integrated oil companies and oil exploration companies. Also investors are not paying too much for this growth as the PEG ratio is only at 1.24 and earnings growth exceeding 10%.

Overall, CNOOC stock is an excellent long-term buy at current prices. The technical momentum setup is bearish, which means we plan on waiting before entering around support near the $140-142 range with a $6.67 trailing stop. However 14-day RSI signals on the daily and weekly patterns are oversold, which means an intermediate bottom is near. For longer-term investors, they should use a longer-term stop at $16.00 based off weekly price data.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in CEO over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.