CNOOC: Trade at a future return of 30% of free cash flow using oil at $ 65 (OTCMKTS: CEOHF)

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introduction

While CNOOC (OTCPK: CEOHF) was delisted from the New York Stock Exchange after an executive order by President Trump went into effect, that obviously doesn’t mean the company has ceased to exist. In fact, CNOOC’s main listing on the Hong Kong Stock Exchange offers a very liquid listing for investors looking to gain exposure to one of the world’s largest oil producers.

Source: Yahoo Finance

The stock symbol on the HKSE is 0883, and with an average volume of over 60 million shares per day, the dollar value is about 0.5 billion HKD, or about 60 million US dollars per day. CNOOC currently has a market capitalization of approximately GHKD 375, or approximately US $ 48 billion. The company reports its financial results in RMB and I will use that currency as the base currency throughout this article. However, where applicable, I will use the HKD for any “per share” calculation, as the share trades in Hong Kong dollars. the the current RMB / HKD exchange rate is 1.22. So 1 RMB is equivalent to 1.22 HKD.

Focus on the financial results for the first half of the year

Before I get to the third quarter results, I wanted to take a minute to discuss the first half financial results.

In the first half of the year, CNOOC produced just under 223 million barrels of oil and NGLs, while it also produced 323 billion cubic feet of natural gas for a total oil-equivalent production of 278 million barrels. That’s an oil-equivalent production rate of 1.5 million barrels per day, of which about 1.2 million barrels were actually oil. This means that CNOOC produces more than 1% of the world’s oil supply.

Source: company presentation

Oil was sold at an average price of $ 62.38 / barrel while the price of gas remained relatively high (but not unusually high) at $ 6.6 / mcf.

This resulted in a total income of 100.6 billion RMB from the sale of oil and gas. The total turnover was actually 110 billion RMB, as you can see in the image below, because CNOOC also made money through the marketing of products. The total operating expenses to produce a barrel of oil were only 12.7 billion RMB (which in effect means that the pure production cost per barrel of oil is less than $ 8 / barrel) while the Total operating expenses amounted to just under 65 billion RMB. And as you can see below, this includes 5 billion RMB in exploration activities which have been expensed rather than capitalized.

Source: half-year financial report

As CNOOC has a very healthy balance sheet with very little debt, the company generates pre-tax income of just under 45 billion RMB, which translates into a net profit of 33.3 billion RMB. Since there are 44.65 billion shares outstanding, EPS was 0.75 RMB, or about 0.915 HKD.

Source: company presentation

Unfortunately, the company’s cash flow statement does not offer much detail in the interim report. According to the abridged version, the company generated around 23.6 billion RMB in free cash flow, but does not provide a detailed breakdown of how the money was spent.

Source: half-year financial report

Fortunately, a slide from the company’s H1 presentation provides a bit more clarity. According to the picture below, the operating cash flow was 64.2 billion RMB, investments were 31.2 billion US dollars while the total amount of interest paid was 3.24 billion RMB . This would translate into a free cash flow result (excluding debt repayment) of about RMB 30 billion. Of course, that still doesn’t provide a lot of detail on, say, changes in working capital and the potential difference between taxes owed and taxes owed, but it looks like the free cash flow result is roughly consistent with net income.

Source: company presentation

Cash flow will flow now, and the company is on track to further increase production

Now that we’ve established the operating cash flow for the first half of the year, it’s easier to try and build the model for the full year 2021. We know that production will be roughly the same in the first half. half year, but the price of oil will probably be around 10-15% higher. If I budgeted for a 10% increase in the price of oil and assumed there is a direct correlation with the operating cash flow of the first half of the year, we can expect the operating cash flow of the first half. half year amounted to about 67 billion RMB for a cash flow result of about 128B RMB. This is a rather conservative approach, as we know that the average realized prices in the third quarter were $ 70.38 for oil and $ 7.08 for natural gas.

CNOOC has planned an annual investment of RMB 90-100 billion. This is a bit higher than I expected, as the total capital expenditure bill was slightly less than RMB 57 billion in the first nine months of this year. For me, halfway through this forecast, CNOOC is expected to spend around 40 billion RMB in the last quarter of 2021. Not impossible, but I would like to see confirmation of that first. And maybe the company also included its exploration spending in the total investment forecast. That wouldn’t be 100% correct (because exploration “expenses” are not “capital” expenses), but this is something I’m not entirely clear about.

In any case, even if CNOOC spent 90 billion RMB on capital expenditure, the free cash flow result would be around 38 billion RMB in the current fiscal year. That would be HKD 1.04 per share.

I would like to make two remarks here. First of all, the investment guidance is around 50% higher than the depreciation charges. This means that the capital budget contains quite a bit of growth investments. It also means that reported EPS will likely be much higher than reported free cash flow. I would expect annual EPS to exceed 2 HKD, which would mean CNOOC is trading below 4.5 times profit.

The thesis that capital spending includes a substantial amount of growth capital spending seems to be borne out by the company’s own three-year production forecast. The production rate will increase by a high single-digit percentage in 2022 and 2023.

Source: company presentation

And this is where it gets interesting. Operating cash flow, using $ 65 of oil and the official production forecast, would increase to about RMB 160 billion. If the sustaining capital expenditure then amounted to around 70 billion RMB (still higher than the current depreciation rate), the underlying free cash flow result would be 90 billion RMB. That’s HKD 2.45 per share. This means that the currently reported free cash flow clearly includes a substantial investment in production growth, as CNOOC will be a major player in helping China meet its oil and gas demands.

I also really like the company’s track record. At the end of June, CNOOC had net debt of around 55 billion RMB while it generated EBITDA of around 75 billion RMB in the first half of 2021. This means that the debt ratio will likely be lower. to 0.4 times the full year EBITDA. and probably less than 0.3 times this year’s EBITDA.

Investment thesis

It is unfortunate that CNOOC no longer has a principal listing in the United States and I understand that some people will object to investing in companies in which the Chinese government and its subsidiaries have a controlling stake.

But for investors with a broader vision and access to the Hong Kong Stock Exchange, CNOOC could still offer attractive exposure to the Asian and Chinese oil and gas markets. Using an oil price of $ 65 and the company’s own production forecast for fiscal 2023, it appears the company is currently trading below 3.5 times its free cash flow in 2023. And this is reason enough for me to recover shares despite the geopolitical risk of having the Chinese government as the main shareholder.

CNOOC is expected to pay a dividend of HKD 0.60 per share in fiscal 2021, which would translate into a dividend yield of around 7%. The withholding tax rate should be 10%. During this time, the majority of the incoming cash flow is reinvested in the growth of production.


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