20131008-新鸿基金融集团-Increasing_Production_and_Solid_Fundamentals_To_Drive_Upside__Initiate_At_Buy_14页_1mb

CNOOC Research Summary

Core Content

This report outlines a research idea to initiate coverage of CNOOC with a Buy rating and a HK$19.25 12-month price target, which represents a 20% upside from current levels. The analysis is based on the company's strong fundamentals, accelerating production growth, and the successful integration of the Nexen acquisition.

Main Points

1. Accelerating Production Growth

• CNOOC is expected to increase production by +13% in 2014E and +10% in 2015E, with a 6–10% CAGR from 2011–2015.
• Management has maintained its production growth guidance, and the company's production growth is projected to outperform both its Chinese and global peers.
• The 2013E production target is between 338–348 million boe (excluding Nexen), with Nexen contributing approximately 59 million boe.

2. Strong Fundamentals

• CNOOC's free cash flow yield is the highest among its peers, significantly above the negative yields of domestic and global competitors in 2012.
• The company maintains a higher ROE compared to both its Chinese and global peers.
• CNOOC's reserve replacement ratio is 181%, the highest among its Chinese peers, and its reserves to production CAGR is +4.8%, outperforming global peers and its PRC counterparts.
• The company has a lower percentage of developed reserves (42%) compared to its peers, indicating a strong growth potential.

3. Nexen Integration On Track

• The integration of Nexen is progressing well, contributing 23% of CNOOC's total production in 1H13.
• Nexen's acquisition increased CNOOC's reserves by 22% and added a diversified asset base in regions such as the UK North Sea, Offshore West Africa, and the Gulf of Mexico.
• Despite the initial financial dilution, the company's ROIC of 17.2% in 2012 is above the global E&P peer average of 5.9%, indicating value creation.
• The company is expected to focus on sustainable growth rather than pursuing further large acquisitions.

Key Metrics

Metric	CNOOC (2013E)	Global E&P Peer (2012)	PRC Peers (2012)
Free Cash Flow Yield	5.4%	-2.7%	-3.2%
ROE	17.4%	12.7%	11.8%
Reserve Replacement Ratio	181%	-	-
Reserves to Production CAGR	4.8%	3.5% (global)	2.4% (PRC)
Operating Margin	33.4%	22.6% (global)	25.7% (PRC)

Valuation

• The base case price target is HK$19.25, based on a discounted cash flow (DCF) analysis using a WACC of 8.2%, an intermediate-term growth rate of 5.0%, and a terminal growth rate of 2.0%.
• The stock currently trades at 8.8x 2013E EPS, which is -8% below its three-year average and -17% below its five-year average.
• The upside case (HK$21.50) assumes a FCF CAGR of 11.3%, while the downside case (HK$14.75) assumes a FCF CAGR of 4.3%.
• On a P/E basis, the price target corresponds to 12.4x 2013E EPS, indicating a premium valuation compared to the current price.

Catalysts

• 3Q13 results
• Nexen earnings contribution trends
• Production volume growth
• Nexen integration progress

Risks

• Lower than expected oil and natural gas prices
• Lower than expected production growth
• Decrease in reserve discoveries
• Integration risk from the Nexen acquisition

Performance Comparison

• CNOOC's price change in 2013E is -4.4%, while the Hang Seng Index (HSI) is +2.2% and the global E&P peer group is +23.2%.
• CNOOC's sales CAGR is 7.7% for 2013E, compared to 9.1% for the global peer group.
• The company's operating margin is expected to decline to 33.4% in 2013E, compared to the global average of 22.6%.

Conclusion

CNOOC is positioned for sustainable growth with a solid financial foundation, increasing production volumes, and a successful Nexen integration. Despite recent challenges, the company's strong fundamentals and attractive valuation metrics support a Buy rating and a HK$19.25 price target. The stock is currently undervalued relative to its historical averages and offers significant upside potential if production and earnings growth meet expectations.