China Oil & Gas:2014 Considering Risk: 5 to Own, 2 to Avoid

2014 - A positive macro backdrop

Our positive outlook for regional equity markets, oil prices, China gas prices, refining and petchems margins all support our outlook for rising EPS through 2014 for the China oil and gas sector, despite continued cost inflation pressures.

Mid/large caps - Kunlun, CNOOC, Sinopec then PetroChina

We think the key value driver themes will be: CNOOC committing to double digit production growth in 2014; Sinopec gaining from better refining, petchems, gas production and its Fuling shale gas success; and continued uncertainty over PetroChina’s operational performance and executive investigation outcome. We continue to like Kunlun for its discounted gas substitution thematic exposure. We raise our Kunlun price target to HK$20 and add it to the Marquee Buy list.

Onshore oilfield services - five reasons to own

We expect the onshore OFS sector to re-rate from 13-15x one yr fwd PE back to 20x+ on the back of: 1) Robust Mar results and 2014 guidance, 2) SOE customers likely guiding to rising upstream capex, 3) Sinopec likely announcing 50-100 horizontal shale wells vs. c.10 last year, 4) the 3rd shale gas licence round reboot and, 5) more supportive gas policy with the 13th NPC meeting (early Mar). Our top picks are Petroking and Anton.

Avoid COSL (downgrade to Underperform) and Honghua

We think COSL’s 44% 2013 EPS growth will prove to be an anomaly, and forecast a slowdown to single digit levels in 2014 and 2015, leaving the current premium valuation to global peers unsupported. We continue to see rising execution and funding risks for Honghua and reiterate our Underperform rating.

Risk adjusted expected returns - 5 to own, 2 to avoid

In this report we also look at our implied expected one-year share price returns in the context of risk. Kunlun, Petro-king, CNOOC, Sinopec, and Anton have the best risk adjusted expected returns, while MIE, Honghua, and COSL the worst.