Bim
In early 2021, I recommended buying PetroChina (OTCPK:PCCYF) for its cheap valuation, its high dividend yield and my expectations for higher oil prices. Since my article, the stock has vastly outperformed the S&P 500, as it has rallied 210% whereas the index has gained only 32%. The outperformance becomes even greater if the dividends are included. After such a blowout performance, it is only natural to wonder whether the oil and gas producer has become overvalued. However, the stock remains reasonably valued.
Business overview
Most investors think that Exxon Mobil (XOM) is the second-largest oil producer in the world, behind the gigantic company of Saudi Arabia, Saudi Aramco (ARMCO). However, PetroChina produces more oil and gas than Exxon Mobil. To be sure, in 2023, the former produced 4.86 million barrels of oil equivalent per day whereas Exxon produced 3.74 million barrels of oil equivalent per day. Just like the other oil majors, PetroChina also has a refining and chemicals segment, but the primary determinant of its earnings is its upstream segment.
In 2022, the prices of oil and gas skyrocketed due to the onset of the Ukrainian crisis. Due to the sanctions imposed by western countries on Russia for its invasion in Ukraine, the global oil and gas markets greatly tightened. Consequently, the prices of oil and gas rallied to 13-year highs, and thus all the oil majors posted record earnings per share in 2022.
In 2023, the global markets of oil and gas somewhat absorbed the impact of the Ukrainian crisis. In fact, the price of natural gas collapsed due to an abnormally warm winter in most parts of the world. As a result, all the oil majors posted earnings that were still much higher than their historical average earnings but significantly lower than those in 2022. To provide a perspective, Exxon and Chevron (CVX) saw their earnings per share decline 32% and 30%, respectively, last year.
PetroChina remarkably outperformed its peers in 2023, as it grew its earnings per share 8% last year, to a new all-time high. Despite a 17% decrease in its realized price of oil, the Chinese oil company achieved record earnings thanks to 4.4% growth of production of oil and gas, 16.5% growth of output of refined products, strong development of new energies and a material increase in the production of refining specialty products as well as high-end chemical products. Notably, PetroChina grew its production of clean forms of energy 44% over the prior year.
Thanks to all these growth drivers, PetroChina reduced its debt-to-asset ratio from 42.5% to 40.8%, a 13-year low level, and its debt-to-capital ratio from 17.4% to 15.2%, a 15-year low level. Its interest expense currently consumes only 6% of operating income, while its net debt (as per Buffett’s formula: net debt = total liabilities – cash – receivables) has decreased to $101.3 billion. As this amount is only 40% of the market capitalization of the stock and less than 5 times the annual earnings of the company, it is certainly low.
A low amount of debt is paramount in the highly cyclical oil and gas industry, which is characterized by dramatic swings. The low debt will help PetroChina endure the next downturn of its industry whenever that happens.
It is also important to note that the oil major has promising growth prospects ahead. It has reported several major upstream discoveries in recent years, such as the fields in Ordos, the Tarim Basin, Sichuan and Bohai Bay. The recent discoveries are likely to enable the company to keep growing its production meaningfully for many more years.
It is also remarkable that PetroChina has grown its production by an eye-opening 21% in the last two years, from 3.99 million barrels per day in 2021 to 4.84 million barrels per day in 2023. This is by far the highest growth rate of output among oil majors. Given its strong record of growing its production and its promising recent discoveries, PetroChina has good chances of remaining in growth mode in the upcoming years. In fact, management recently pledged to step up its efforts to boost the development of oil and gas fields and thus grow the reserves and the output of the company.
Moreover, the geopolitical tensions in the Middle East are likely to support above-average oil prices, at least for this year. According to the latest forecast of the Energy Information Administration [EIA], the global oil market is likely to remain tight in 2024, with global oil consumption exceeding global oil supply by 0.3 million barrels per day. As a result, the average price of Brent is expected to rise by 9% this year. More importantly, EIA has not taken into account the recent attack of Iran in Israel in its report. If the crisis escalates, it will almost certainly provide fuel to a further rally of the price of oil. To cut a long story short, the current geopolitical landscape is undoubtedly favorable for PetroChina. The company has good chances of enjoying a double tailwind this year, namely higher output and higher oil prices.
On the other hand, investors should always keep in mind the wild swings of oil and gas prices. While the short-term outlook is certainly favorable for oil producers, PetroChina faces a long-term secular threat, namely the unprecedented boom in renewable energy projects. Due to the energy crisis caused by the war in Ukraine in 2022, all the countries are doing their best to drastically reduce their dependence on fossil fuels. To this end, they are all running an unprecedented number of clean energy projects. Whenever all these projects come online, they will almost certainly impart a hit on the prices of oil and gas. The share of renewable energy in the global energy mix has grown from 28.1% in 2020 to 30.2% in 2023 and is expected by EIA to grow above 42% by 2028. While the magnitude of the effect on the prices of oil and gas and the time are unknown, it is prudent to be aware of this risk factor facing PetroChina.
On the bright side, the company is doing its best to adjust to the fast-changing business landscape of its industry. To be sure, it grew its production of clean energy by 44% last year. Nevertheless, just like all the other oil majors, PetroChina is still far from shielding itself from the effect of the boom in the global production of green energy on its business, as its renewable business comprises an almost negligible part of its total earnings.
Valuation
PetroChina is currently trading at a trailing price-to-earnings ratio of 7.5, which is much lower than the 10-year average of 12.3 for the stock. On the one hand, given the all-time high earnings of the company in 2023 and the highly cyclical nature of its business, the low earnings multiple is justified, particularly given the aforementioned secular threat facing PetroChina. On the other hand, the stock does not appear overvalued.
The earnings of the oil and gas producer have proved very sensitive to the prices of oil and gas. In addition, it is almost impossible to forecast future oil and gas prices, particularly given the unprecedented boom in green energy projects. Therefore, it is hard to determine a fair price-to-earnings ratio for PetroChina.
PetroChina is trading at a lower trailing price-to-earnings ratio than the median of its sector, which is 11.4. Exxon Mobil and Chevron are trading at trailing price-to-earnings ratios of 12.6 and 12.0, respectively. Nevertheless, PetroChina has almost always traded at a lower price-to-earnings ratio than its peers, probably due the perceived higher risk of its country, China, and its somewhat opaque business model, as the company provides less information than its peers in its earnings reports. Overall, taking all the above factors into account, PetroChina appears approximately fairly valued right now.
Risks
Just like almost every oil and gas stock, PetroChina bears the risk related to the dramatic cycles of the oil and gas industry. However, the stock of PetroChina has an additional risk factor, namely the liquidity risk that results from the low trading volume of its OTC (Over-The-Counter) ticker. The average daily trading volume of the stock in the last three months is approximately 147,000 shares. As a result, whenever there is a broad market sell-off or a sell-off of the energy sector, the stock price may be punished to the extreme. In addition, it will probably be hard for shareholders to sell many shares without affecting the stock price materially. Due to the lack of liquidity of the stock of PetroChina, investors should probably refrain from maintaining a large position in the stock.
Final thoughts
PetroChina has vastly outperformed the S&P 500 during the last three years. It also outperformed its peers last year, as it was the only oil and gas producer that posted all-time high earnings. Moreover, the company has promising growth prospects this year thanks to a growing output and elevated oil prices amid geopolitical tensions. Nevertheless, while the short-term outlook is bright, the company faces a long-term threat due to the boom of clean energy projects and the cyclicality of its business. Overall, the stock seems to be reasonably valued right now.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
