CNOOC:Back to basics

Aggressive capex/opex cutting, solid cash dividends and a strong debutfrom the new management team supported CNOOC’s share price amid theoil rout. However, we believe the company has very limited headroom forfurther cost cutting, either capex or opex, and also the dividend payoutwill have to normalize starting in 2016. The company seems to have runout of levers for now. We downgrade to SELL from O-PF, with a newHK$7.80 target price (from HK$9.50).

Back to basics

CNOOC’s share price has been holding up OK year to date, in line with marketperformance, and bested its domestic rivals PetroChina and Sinopec, mainlycredited to aggressive cost-cutting measures and attractive cash dividends.With oil hitting a 7-year low following OPEC’s decision to keep pumping atwill, we expect investors to refocus on the basics such as oil price, and it isnot pretty with Brent just hovering around its all-in cost of US$41/boe.

Cost cutting and high dividend not sustainable

The company managed to cut its capex by over 30% in 2015, the first timefor such a meaningful cut since listing. Also, we expect it to work down itsopex (excluding DD&A and windfall tax) by 22% in 15CL. Going forward, wesee limited headroom for further cuts, and we are only forecasting a 3% cutin capex and a 4% cut in opex, respectively, for 16CL. We also expect thedividend to normalize to a 35% payout ratio starting in 2016.

Significant impairment charge unlikely though

The SEC ruling of reserve booking based on spot price is independent of theimpairment test, which still solely relies on the company’s internal oilassumptions. The company has been dragging its feet in making a meaningfulimpairment charge, as 1) its internal long-term oil price assumption is stillquite bullish; and 2) impairment remains a politically sensitive issue forChinese NOCs as it is often associated with loss of state assets.

Downgrade to SELL from O-PF; A contrarian call

We still believe CNOOC is the best-run company amongst all 3 majors, andthe closest to its western peers, but risks are skewed to the downside in thenext 12 months. We trim our 15CL earnings by 19%, with half the cut fromforex losses associated with US bonds and half from higher costs. Wedowngrade to SELL from O-PF, with a new target of HK$7.80 (from HK$9.50).