After a rapid ascent and then descent, many Chinese stocks are now back in bargain territory. The Hong Kong Index, for example, now trades for less than 10 times trailing earnings.
While the government-mandated transition to a consumption-based economy has led to some economic dislocation, reforms around one sector may mean that stocks are undervalued even further.
In fact, one industry leader could be valued at a sharp a discount to intrinsic value if reforms are pushed through as planned.
The Chinese Government Wants Out Of The Pipeline Business
[ad#Google Adsense 336×280-IA]As part of a broad reform of the energy sector, the Chinese government announced plans in May to spin off pipeline assets at the two largest oil & gas companies, PetroChina (NYSE: PTR) and Sinopec (NYSE: SHI).
Industry competitors argue that the two companies’ ownership of 89% of the country’s total pipeline capacity acts as a barrier to entry for others.
By operating the pipeline assets independently, other upstream explorers will have easier access to the nation’s pipeline transportation capacity.
While the government has not released a timeline for finalizing the reform, analysts are expecting spinoffs to take place in the next six months.
During the recent period of excessive fear during the market selloff, investors have likely forgotten about the potential for these transactions to unlock shareholder value. Shares of Sinopec have fallen more than 30% while those of PetroChina have plummeted more than 40% since May.
In fact, shares of PetroChina are now trading below the potential spinoff value of just the pipeline assets. And that could be a huge opportunity…
This Energy Giant Could Be Undervalued By At Least 50%
At just 0.73 times book value, shares of PetroChina trade at the lowest price-to-book of the 10 largest publicly-traded oil companies, and less than half the price-to-book multiple of Exxon Mobil (NYSE: XOM). The company dominates the market for pipeline capacity, owning 47,845 miles of the country’s 74,564 miles of oil & gas pipeline. Just this month, analysts at Sanford Bernstein estimated the pipeline assets could be worth $150 billion in a spinoff.
That price is 11% above where the company is trading today, at a market capitalization of just $134.4 billion.
In a spinoff, even a conservative price for pipeline assets could lead to a big pop in the shares. The estimated $150 billion for the pipelines would mean cash proceeds of $82 per share. That money could go to opportunistic acquisitions of upstream assets or could be returned to shareholders. Dumping the lower margin assets could also help increase sentiment around the shares and raise the price-to-book multiple investors are willing to pay.
But that’s just the start… the company’s pipeline assets only account for 20% of its total assets.
The company’s upstream segment generated $122 billion in sales last year. Even on the current cheap company-wide valuation of 0.43 times sales, the upstream segment is worth another $28.67 per share. While the downstream refining and marketing segment booked $294 billion in sales, the segment ran at a $2.8 billion operating loss.
Valuing the pipeline assets and the upstream segment together yields a fair value of $110.64 per share, nearly 50% above PTR’s current share price. This is still well below the 52-week high of $136.98 per share set in April. Watch for a spin-off (and the resulting boost to investor sentiment) to take the shares to my $115 price target.
Risks to Consider: The Chinese government could ultimately set the price of the spin-off below fair market value. It’s unlikely they would set the price too far from fair value on the negative signal it would send to investors about the government’s support of free market reform.
Action to Take: Take advantage of the selloff in shares of PetroChina to position for a spin-off that could value assets well above the current market capitalization.
— Joseph Hogue[ad#sa-generic]
Source: Street Authority