PetroChina-A:Fundamentals have emerged from trough;share price has factored in L-T oil of US$65-75

Worst likely over, but it will take time to price in higher earnings expectations.

    Crude oil supply and demand have regained balance faster than expected; as a result,oil prices have gradually risen from the trough, the focus of natural gas regulation hasshifted downstream, import costs have decreased, and the medium-term risk of losseson gas imports has eased. However, since PetroChina's share price has factored in longtermoil price expectations of above US$65, it will take time to price in higher earningsexpectations.

    Earnings likely to rise gradually as crude oil price stabilises.

    In Q1, despite support from the floor price for refined oil, the average price of crude oilstood at only US$27, leading to a net loss for PetroChina. We expect the profit of theoil industry chain to improve significantly, as the average price of crude oil has risen toUS$40-45. Moreover, in the long term, the price of crude oil may rise amidfluctuations. We therefore believe there is upside potential for the company's profit.

    Focus of regulation shifted downstream; risk of losses from gas imports eased.

    Recently, the focus of gas price regulation has shifted from upstream gas producersand importers to down/mid-stream city gas and provincial pipeline network companies,squeezing downstream profits to reduce end-market gas prices in order to drive gasdemand, while making it more likely for PetroChina to see an increase in gas prices.

    Meanwhile, globally, LNG has entered a period of oversupply, with imported gas pricesremaining at low levels. Therefore, we expect PetroChina's risk of losses on natural gasimports to diminish over the medium term.

    Valuation: Lowering PT; maintain Neutral rating.

    We lower our 2016-18E EPS from Rmb-0.13/0.06/0.52 to Rmb-0.24/0.00/0.50 toreflect the rise in upstream costs resulting from a fall in reserves. Based on SOTP, welower our PT by 7% to Rmb7.63, which implies a 20% NAV discount for the upstreamsegment (L-T oil at US$75, WACC=10%); we use EV/EBITDA for the downstream.

    Although PetroChina's fundamentals have risen from the trough, we believe it will taketime for its share price to factor in higher earnings expectations, since it has alreadyfactored in long-term oil price expectations of US$65-75. We therefore maintain ourNeutral rating.