China's Sky-High Evaluations Don't Compute

By ANDREW BARY

IT'S TOUGH TO SAY WHEN THE CURRENT mania for Chinese stocks will end, but the potential for a significant decline is growing. China's benchmark index has shot up 109% this year, and major Chinese companies now are valued at steep premiums to their U.S. counterparts.

Warren Buffett urged investors last week to be "cautious" on Chinese stocks, adding that "we never buy stocks when we see prices soaring." Buffett recently sold Berkshire Hathaway's (ticker: BRK/A) 1.3% stake in PetroChina (PTR), China's largest company, based on its sharply rising share price. PetroChina is valued at about $440 billion, nearly double its midsummer capitalization.

The world's No. 2 company based on market value, it rapidly is closing in on ExxonMobil's (XOM) $508 billion valuation. PetroChina trades for more than 20 times estimated 2007 profits, or twice its historic price/earnings multiple, versus Exxon's P/E of 13 and P/Es of about 10 for other Western oil companies such as Chevron (CVX) and ConocoPhillips (COP). Some analysts and investors think the Chinese oil company deserves no premium to its Western peers, and is overvalued by 50% or more.





In a valuation gap now typical among U.S. and Chinese resources concerns, coal producer Peabody Energy fetches 30 times earnings, its Chinese rival 60.
PetroChina isn't alone. China's largest coal company, China Shenhua Energy (1088.Hong Kong), is valued at almost $200 billion, a gargantuan premium to St. Louis-based Peabody Energy (BTU), the world's largest private-sector coal producer. Baoshan Iron & Steel (600019.China), China's premier steel company, has a market value of $42 billion, more than three times that of U.S. Steel (X), though their annual production is similar. Korea's Posco (PKX), which produces just 30% more steel than U.S. Steel, sports a market value of $60 billion.

Huge valuation gaps between Chinese and U.S. companies exist outside the resource sector, as well. Take the financial sector: China Life Insurance (LFC) has a market value of $245 billion, five times that of MetLife (MET) or Prudential Financial (PRU).


East Beats West: As a result of its surging share price, PetroChina now has a market value while approaching that of ExxonMobil.
It is especially tough to argue Chinese resource companies should command huge premiums over American producers, because oil is a fungible international commodity and coal and steel are becoming global commodities.

The valuation gap between resource producers could spur the Asian companies to buy their U.S. rivals. U.S. Steel, for instance, long has been considered a buyout candidate for a big foreign steel company. But politics could prevent such deals. Congressional opposition helped thwart an attempted takeover of Unocal by China's state-owned oil company in 2005; Unocal later was sold to Chevron.

One key to elevated stock-market values in China is that ordinary Chinese face capital restrictions that make it difficult for them to invest overseas. Add to that the scarcity value created by the thin floats in many big Chinese companies. PetroChina, now 88%-owned by the Chinese government, plans to sell Chinese investors as much as $9 billion of Class A shares that will be listed on the Shanghai Stock Exchange. But the government's stake will slip only to 86%. Until now, PetroChina's shares have traded only in Hong Kong and as ADRs on the New York Stock Exchange. If all the company's shares were publicly held, it is doubtful PetroChina would command such a high valuation.

It is also doubtful PetroChina would trade at such lofty levels relative to Exxon if Chinese investors could buy non-Chinese stocks. "There presumably would be an arbitrage between PetroChina" and Western oil companies, says Kurt Wulff, president of McDep Associates, an independent provider of energy research.

Wulff values PetroChina at about $166 a share, while John S. Herold, a Connecticut-based energy-research firm, pegs fair value at just $115 a share. PetroChina has a similar reserve base to Exxon, at 20 billion barrels equivalent (BOE) of oil and gas, nearly all of it in China. This calculation converts natural-gas reserves to an equivalent amount of oil based on energy content.

Exxon has a strong edge in almost every other arena, including management, financial strength, exploration prospects, technology and daily production. Its projected 2007 annual cash flow is about double that of PetroChina. Exxon also has net cash of about $25 billion. When factoring in Exxon's cash and PetroChina's debt, the values of the two companies are about the same.


PetroChina's profits are depressed by price controls in the Chinese market for gasoline, other oil products and natural gas. The company gets about $3 per thousand cubic feet of natural gas, half of what Exxon nets. The gradual lifting of price controls in China may boost PetroChina's refining and natural-gas profits, but parity is a long way off, given Chinese citizens' lack Western incomes.

Some investors have been tempted to short PetroChina and buy Exxon and a basket of Western oil companies because of the big valuation gap. Assuming PetroChina is worth $160 to $170 per ADR, it is overvalued by about $150 billion, roughly equal to the market value of ConocoPhillips. "There's nothing PetroChina can do to create $150 billion of value," one investor tells Barron's. The company's production outlook is no better than Exxon's over the next few years.

Buffett may have made some of these calculations when he decided to sell PetroChina. Berkshire bought its stake four years ago for less than $500 million, and may have netted a profit of $4 billion on the sale.

U.S. Steel is now in its best shape in decades, due to several years of ample earnings that have liquefied its balance sheet and given it the wherewithal for acquisitions. The company's share price has doubled in the past 13 months to 105, but the company trades for a modest 10 times estimated 2007 profits of $10.43 a share. "U.S. Steel has a raw-materials advantage," says John Hill, the domestic-steel analyst at Citigroup, who has a price target of $118.

U.S. Steel is nearly self-sufficient domestically in iron ore, the key raw material for steel, thanks to its ownership of long-lived mines in the upper Midwest. In this it has a big edge over Baoshan and Posco, which import nearly all their iron ore, the price of which has risen sharply in recent years and could increase another 30% in 2008. But Baoshan and Posco are far more profitable than U.S. Steel, which sells less-lucrative products.

Citigroup's Asian-steel analyst, Thomas Wrigglesworth, recently began coverage of Baoshan with a Sell rating and a price target of 16.9 renminbi per share, compared with the current price of 18 renminbi on the Shanghai exchange. He cited rising competition and the company's exposure to surging iron-ore prices.

What could U.S. Steel fetch in a buyout? Industry mergers are occurring at nine times annual cash flow, which would translate into a price of $150 a share. Some bulls think the company could get even more in a deal.

China Shenhua, China's largest coal company, had a stunning debut in Shanghai earlier this month: Its share price doubled in value. It since has risen to 77 renminbi per share. China Shenhua, which already was listed in Hong Kong, now has a market value of about $190 billion, more than 10 times Peabody's value.

The Bottom Line:

The valuations accorded many Chinese companies suggest China's market is overheated and due for a fall. Until then, the Chinese might try to buy cheaper U.S. concerns.The Chinese company sells for more than 60 times projected 2007 earnings, versus a P/E of 30 for Peabody. Yet its annual production and reserves are less than Peabody's. But China Shenhua gets far higher prices for its coal than Peabody, and has power and railroad assets.

China may be the globe's biggest growth story, but the share prices of its major companies are out of whack with peers'. Among resource producers, some of the best values lie in America.

 

Kevin,

OP mentioned something about this very thing to me a year or two ago and I never really paid that much into it.

Personally, I invest in Canadian Companies because I live and work here. Next, I invest in some US but mostly EU companies. My advantage there is that they are generally stable, slower rising stocks (albeit 17 to 23% average returns yearly). Anything that shoots up as shown above I would run far away from and not even consider as value. Those kinds of cycles are very dangerous to be involved in and I would caution anyone thinking of riding that wave in doing so. Investments are similar to gambling you must be prepared to loose that money down.

Cheers.

 

I totally agree with you Devon

I think the whole China bubble is gonna come down hard soon..................just my thinkin


I do however remember looking at Petrochina stock a year ago and thinkin bout investin in it but I didnt..............oh well....like you said that kinna crap scares me ...and I aint scared of much

 

No kidding. Probably glad you didn't at this point because you'd be going OMG this is great today and then forget to sell at some point and have it become penny stock months later - leaving you holding the bag as it were.

Good article none the less.

 

a few years ago I was up on a very volitile stock...I was up like 87% and it took a dive..I got out real quick and salvaged a 56% gain on the year.

not bad not bad

 

If you are willing it isn't bad. If you had those gains spent on something else already - pretty foolish. Of course you'd never do that, would you?

I've done some, well, stupid things in my past before as well.

 

Whitmore's LOADED (in more ways than one)....he can afford it...

 

I can afford to come over there and whip yer *** Doc heheheheheheheee

 

 

China rations diesel after shortages

Truck drivers in southeast line up at filling stations as severe shortages and soaring demand impact businesses.
October 30 2007: 7:28 AM EDT


BEIJING (AP) -- Filling stations in China's fast-growing southeast were rationing sales of diesel fuel Tuesday due to severe shortages amid soaring demand, disrupting trucking and prompting accusations that oil companies were hoarding supplies.

In the export-driven coastal provinces of Guangdong, Zhejiang and Fujian, truck drivers lined up to buy as little as a quarter-tank at a time and some stations closed for lack of supplies, news reports and trucking companies said. They said supplies ran short about a week ago


"One-third of our trucks are grounded and we raised prices by 5 percent to offset our losses," said a manager at the Shanghai Fly Logistics Co. in Hangzhou, a city in Zhejiang, who would give only his surname, Fu. "The situation has really hurt our business."

China's major oil companies - China National Petroleum Corp. and China Petroleum & Chemical Corp., also known as Sinopec - blame the shortage on bad weather that disrupted supplies.

But also they say government controls that have frozen retail diesel and gasoline prices have inflicted huge losses on refiners that must pay soaring world prices for crude oil, discouraging them from expanding supplies.

"Domestic oil refiners already have suffered great losses, so they are greatly reducing production, even suspending it," said a statement by the CNPC branch in the southern province of Hunan, quoted by the official Xinhua News Agency.

The impact on China's key export industries and overall economy was not immediately clear.

"If it's temporary, then it will be nothing, but if it lasts for six months, then that will be a big problem," said Lehman Bros. economist Mingchun Sun in Hong Kong. "The issue is that we don't know how severe it is or how widespread."

In Shanghai, filling station operators confirmed they are reducing or halting diesel sales due to shortages.

"We have no diesel at all. I have no idea when the situation will return to normal. We're not getting any supplies from our company," said an employee at a Sinopec Qibao gas station on Shanghai's west side. She gave only her surname, Dong.

Some Shanghai filling stations limited customers to a quarter-tank, newspapers said.

The communist government has held state-set gasoline and diesel prices steady this year, even as the price of crude oil soared close to $100 a barrel. The price of light, sweet crude for December delivery on the New York Mercantile Exchange hit a record high of $93.80 on Monday but fell back on Tuesday.

Regulators have resisted appeals from oil companies to raise retail prices, citing the possible impact on China's poor majority, who already have endured a sharp rise in food costs this year.

China has become the world's second-largest oil consumer after the United States amid economic growth that has topped 10 percent for the past four years. Demand for gasoline and diesel is soaring to supply export industries and explosive growth in private car ownership.

Businesses and some Chinese commentators accused CNPC and Sinopec of creating phony shortages to force Beijing to raise prices.

"This is because CNPC and Sinopec have applied to the National Development and Reform Commission for a price increase but it has not been accepted. So this is their attempt to force the NDRC to surrender," said the newspaper Orient Today, published in the central province of Henan.

"State monopolies have a major responsibility to maintain normal order in the national economy. They should not be like private companies, trying to maximize profit. They should give first priority to social interests," the newspaper said.