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The Stone of Other Mountains – The Logic of Valuation Repair of Shale Oil Companies?

The PB valuation of the five major shale oil companies has risen from less than 0.6 times PB at the lowest point to 2.9 times the average PB by the end of March 2022. The valuation repair of shale oil companies comes from two aspects – 1) rising oil prices and cost control have driven the recovery of performance and operating cash flow; 2) the ratio of dividends has increased – jointly driving the increase in dividend returns. In the face of the double increase in performance and dividend ratio, the market return is valued at a higher PB.

How do Chinese energy companies allocate cash flow? How to balance dividends vs. growth?

How a company allocates its operating cash flow reflects how the company chooses to balance growth vs. returns. Three oil and gas companies were selected for this report – PetroChina, Sinopec, CNOOC, and three coal companies – China Shenhua, China Coal Energy, Yankuang Energy, and Guanghui Energy, a comprehensive company whose businesses include natural gas and Coal, this article is placed in the coal sector analysis).

Not only dividends, but the overall cost-effectiveness, who is the best?

We use two dimensions to compare – dividend yield vs. growth, and capital expenditure effectiveness. The conclusion is that CNOOC and China Coal have the best energy indicators.

To sum up a sentence: Dividends are justice, and growth is for better dividends next year.

1. The Stone of Other Mountains – The Logic of Valuation and Restoration of Shale Oil Companies

Since 2020, the valuation of shale oil companies has continued to recover. The PB valuations of the five largest shale oil companies – Occidental, EOG, PXD, Diamondback, Marathon Oil – reached their lowest point in the first half of 2020, averaging less than 0.6 times PB. Since then, the valuation has continued to recover, and the average PB has recovered to 2.9 times by the end of March 2022. Of course, this is closely related to the recovery of oil prices, as well as the adjustment of shale oil companies’ operating strategies and capital expenditure strategies.

In 2021, the operating cash flow of shale oil companies will improve significantly, driven by higher oil prices. And the reinvestment ratio of shale oil companies has continued to decline from a historical high of more than 100% to 45% by 2021. The reinvestment ratio of the top five shale oil companies is only 38%. The top five shale oil companies will have an operating cash flow of US$32.5 billion in 2021. In addition to 38% for CAPEX, a larger proportion (32%) is used for debt repayment, followed by dividends (17%) and buybacks (5%). %).

We conclude that the valuation repair of shale oil companies comes from two aspects – 1) rising oil prices and cost control have driven the recovery of performance and operating cash flow; 2) the ratio of dividends has increased – jointly driving the increase in dividend returns. In the face of the double increase in performance and dividend ratio, the market return is valued at a higher PB.

2. Cash flow distribution: How do Chinese energy companies spend their cash?

How a company allocates its operating cash flow reflects how the company chooses to balance growth vs. returns. Three oil and gas companies were selected for this report – PetroChina, Sinopec, CNOOC, and three coal companies – China Shenhua, China Coal Energy, Yankuang Energy, and Guanghui Energy, a comprehensive company whose businesses include natural gas and Coal, this article is placed in the coal sector analysis).

2.1. Chinese coal companies tend to pay dividends and hoard cash

Coal companies’ operating cash flow, with a higher percentage of dividends (compared to oil and gas companies) . In 2021, the average operating cash flow allocation of the three coal companies: 26% for capital expenditures, 39% for dividends, 37% for increased cash and others. Among them, China Shenhua has the highest proportion of cash dividends, accounting for 53% of its operating cash flow, and uses 25% of its cash flow for capital expenditures. China Coal Energy and Yankuang Energy use a large proportion of their funds to increase cash. China Coal Energy uses 21% of its cash flow for dividends and 22% of its cash flow for capital expenditures; Yankuang Energy uses 27% of its cash flow for dividends and 29% of its cash flow. for capital expenditure. 56% of Guanghui Energy is used for capital expenditure and 43% is used for dividends.

2.2. Chinese oil and gas companies, still leaning towards capital expenditure

Oil and gas companies spend significantly more of their cash flow on capital expenditures than coal companies. Of the cash flow allocations of the three oil and gas companies in 2021, 72% will be used for capital expenditures and 17% for dividends. This is because the oil and gas industry still has some room for growth, and the state requires oil and gas companies to increase reserves and increase production.

Specifically, 56% of CNOOC’s operating cash flow is used for capital expenditures, and 40% is used for dividends, which is the company with the highest proportion of dividends, mainly because of the special dividends for the 20th anniversary of its listing. Sinopec Corp. uses 64% for capital expenditures and 25% for dividends. 78% of PetroChina is used for capital expenditure, and only 12% is used for dividends.

It is worth noting that the reinvestment ratio (capital expenditure/operating cash flow) of an individual company is not directly proportional to the growth of the company. CNOOC’s reinvestment ratio is the lowest among the three (56%), but its planned production growth in 2022 is 6%; PetroChina and Sinopec’s 2022 upstream production growth plans are 3% and 2% respectively.

3. Balance sheet: Coal companies should reduce debt, not hoard cash

The asset-liability ratio of shale oil companies has continued to decline in the past 10 years, with leading companies dropping from around 50% to around 40% in 2021 on average. Because early-stage shale oil companies have higher debt costs, it is beneficial to prioritize cash flow for debt repayment.

The gearing ratio of China’s oil and coal companies has not declined in the past decade. As of the end of 2021, the average asset-liability ratio of oil companies is 45%, which is basically stable compared with ten years ago; the average asset-liability ratio of coal companies is still 54%, which is still higher than ten years ago.

It can also be seen from the cash flow distribution in the previous section that in the cash flow distribution of Chinese oil and gas companies and coal companies, the proportion used for debt repayment is very low.

From the perspective of the cost of interest-bearing liabilities, the cost of interest-bearing liabilities of oil and gas companies is relatively low, 2.6%, 4.4%, and 5.2% of CNOOC, PetroChina, and Sinopec respectively; the cost of interest-bearing liabilities of coal companies is slightly higher, and the cost of interest-bearing liabilities of China Shenhua and China Coal is slightly higher. Energy, Yankuang Energy and Guanghui Energy accounted for 4.4%, 5.4%, 6.5% and 6.7% respectively. Therefore, we suggest that coal companies can appropriately consider increasing the debt repayment ratio.

4. Comprehensive cost performance

4.1. Dividend Yield vs. Growth

Dividends and growth are a trade-off relationship, putting the dividend yield (2021) and growth rate (2022 guidance in the 2021 annual report) of several companies on one graph. It can be seen that the comprehensive cost performance of CNOOC and China Coal Energy is the best.

4.2. Capital expenditure effectiveness

For the effectiveness of capital expenditure, we compare the capital expenditure intensity (2021) and the growth rate (2022 guidance in the 2021 annual report), where the capital expenditure intensity is expressed by CAPEX/DDA. Capital expenditure intensity and growth rate generally show a positive relationship, with lower capital expenditure intensity obtaining higher growth rate, indicating that the company’s capital expenditure effectiveness is higher. As can be seen from the figure, CNOOC and China Coal Energy are still the best performers.

risk warning:

The change of ESG investment risks will lead to the risk of a substantial increase in global oil and gas capital expenditures; the risk of further acceleration of energy transformation by national policies, resulting in the risk of shortening the life of oil, gas and coal; the risk of declining capital expenditure efficiency of energy upstream companies, resulting in a decline in ROIC; the selection of samples and statistical indicators There are certain limitations, or risk of biased conclusions.

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