PetroChina:Upgrade H to Hold after share price collapse /A:Reduce

Thesis in brief. PetroChina’s 1H15 results and presentation showed the intense focus onthe operating cost structure. While we view this as a positive, the company remainsextremely exposed to the commodity price environment, particularly crude oil prices.

    Because of this exposure, we assume the shares will move to 0.8-0.9x book, lower thanthe 1x PB during the 2008-2009 trough cycle, as ROEs in 2015 will be well below theprevious downcycle. The government has eased windfall taxes and raised gas prices, butthe next move in gas prices will likely be lower. Management plans actions to improveoperating performance and cash flow including E&P and pipeline asset sell-downs, whichcould occur in 2015.

    Net income fell 63% to RMB25.4bn/ RMB0.14, was short of a thin consensus(cRMB30bn) and represents 45% of our FY2015 forecast. After a very weak 1Q(RMB6bn) results improved in 2Q (RMB19bn), particularly in refining & chemicals andin marketing, while E&P and pipeline results were relatively stable. The dividend ofRMB0.0625 represented a consistent payout of 45%. Cost control remains a focus withSelling, General & Administrative Expenses declining slightly and staff compensationexpense falling for the first time in history according to management. The balance sheetand financing position were stable, with a closing RMB66bn of cash.

    Upgrade H-shares to Hold with no change in target price (TP HKD7.5) and maintain Asharesat Reduce with a new target of RMB6.25. We use a target PB multiple of 0.92xversus an expected 5% ROE to derive our target price for PetroChina-H. Our A-share fairvalue TP of RMB6.25 is based on the H-share TP conversion at the HSBC FX team’s 2015eHKD/RMB rate of 1.20. Key upside risks: China equity market liquidity and potentialgovernment equity market support, an early and sharp recovery in oil prices, effective costcontrol, changes in tax or other energy policies (China/Intl) , earlier-than-expected divestitureof the Eastern section of the West-East-Pipeline 1&2 and other non-performing upstream andchemical assets, other accretive M&A. Key downside risk: Crude oil price weakness, assetimpairments, China economic growth slowdown, Chinese economic policy stimulus andmonetary/rate/currency policy management risks, and other global macroeconomic andcommodity risks.