PetroChina:Uncertainty trumps optionality

We cut our Petro

China one-year price target by 24% to HK$5.50 and downgradeour recommendation to Neutral on more conservative upstream and pipeline gasassumptions. PetroChina ranks behind CNOOC and Sinopec in our large-caporder of preference. See companion sector note ‘Defensive oil optionality’.

Attractions—SOTP unlocking, FCF turnaround underway

SOTP unlocking. Our HK$8.5 sum-of-the-parts valuation for PetroChina is55% above our one-year price target. PetroChina shares trade at 0.7x PBwhile the recent farm-down of its West-East pipeline stake and sale of KunlunGas has yielded an average 1.5x PB. Apart from guiding where PetroChina’svaluation could tend towards, these transactions support reported EPS and inturnthe cash dividend due to a rigid 45% payout policy.

Strong reserve metrics. PetroChina’s proven reserve life of 15 years and 10-year organic reserve replacement ratio of 115% is in the top-quartile globally,while its finding and development cost is in the bottom-quartile.

Low FCF breakeven oil price. PetroChina has significantly ‘tightened its belt’since 2013. We calculate PetroChina needs a relatively low US$47 per barrelBrent to cover capex, dividends, and interest via internal cash flows.

The Pushback—‘it’s a black box’Petro

China is still subject to significant state intervention—what China’sNDRC does next with regards gas pricing, pipeline tariffs, the creation of anew midstream infrastructure entity etc. all make a very meaningful impact.

Gas price regulatory risk negatively skewed. While in a falling oil priceenvironment, China’s NDRC would be incentivized to further cut gas prices tohelp spur its gas-for-coal substitution agenda... it remains to be seen if theywould follow through and increase gas prices if oil were to rise to $75.

Easier upside with CNOOC, Sinopec. PetroChina trades on a 10-40%premium EV-EBITDA to Sinopec-CNOOC, despite less attractive growth anddividend metrics.

Neutral base case, but wide range of bull-bear outcomes

While our base case valuation is near the current share price... if oil rises to $90and the NDRC allows an $8/mscf wellhead price and PetroChina is able tounlock hidden value via asset sales then our bull case valuation implies c.70%upside. Unsurprisingly in a ‘lower for longer’ oil price scenario both PetroChina’soil and gas businesses would suffer and there would be no investment case.