3 Oil & Gas Stocks From Emerging Markets

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Emerging markets provide plenty of growth opportunities, especially with their higher current and expected GDP growth rates. In this article we will look into three interesting oil and gas companies from two quickly developing economies, Brazil and China. These are Petrobras (NYSE: PBR), China Petroleum & Chemical Corp. (NYSE: SNP) and CNOOC Ltd. (NYSE: CEO), companies that provide compelling long-term growth prospects and ones which you should consider for your portfolio.

A company that boots production outside China

CNOOC is an oil and gas exploration and production company that focuses on offshore Chinese exploitation. However, it is also the only Chinese company allowed to conduct these activities outside of Chinese borders, which provides it with a big advantage over its local competitors and makes it one of the largest E&P firms in the world. Not only has the company reported strong results lately, mainly on the back of production volume growth, but also several projects in development –all outside of China- should start paying off in the upcoming 3 to 5 years. The company expects to maintain a 6%-10% production CAGR over this period. In order to achieve this goal, the firm has projects several capital deployments, which could reach $14 billion in 2013.

Furthermore, several acquisitions should boost production even further. Not long ago, CNOOC purchased Nexen, a Canadian energy producer, for over $15 billion, considerably expanding its assets and international presence, especially in Canada and the U.K., where it will operate the largest oil field in the country.

As stated by Morningstar analysts, “From a macro perspective, we believe natural gas demand will grow relative to oil and coal in China, as government authorities provide incentive for (or possibly promulgate) adoption of lower-cost and cleaner forms of energy.” CNOOC is very well positioned to benefit from this in the short term, thanks to its domestic production, and in the long term as well, due to its high amounts of capital available for exploration and acquisitions overseas.

Having offered a yearly return of 0.45% and trading at only 8 times its earnings, I would say that this stock stands as a strong buy for both long and short-term investors, and would advocate not letting this chance go.

A strong company in the E&P business (Sinopec)

The other major player in the E&P sector in China is Sinopec. Leading the little bunch operating in this industry, its refining activities represent over 50% of the country´s total capacity (Morningstar). Although the Chinese market provides plenty of growth opportunities as the economy develops, being a firm confined to just one market, it is highly exposed to rising oil prices, which heavily impact its revenues. The thing about Sinopec is that it imports over 80% of its crude oil supply, so while gasoline prices are controlled by the government, meaning that the company possesses no pricing power, crude oil prices are dictated by the international market. Nevertheless, Sinopec has focused its efforts on reducing its import expenses by obtaining better import deals and investing in methods to process lower grade, cheaper, crude.

The chemical segment of the company faces fewer headwinds related to regulations and a favorable geographic positioning. However, although prices are in fact dictated by market demand, the firm´s pricing power is still not very high, due to the limited spending power of the Chinese population.

Furthermore, Sinopec looks well positioned to benefit from the increasing growth in the demand of natural gas as it has been working on its production capacity and operational organization in this field.

Although valued a little higher than CNOOC, Sinopec is still cheap at 9.1x P/E (versus the 22.8x industry mean). However, the mixed picture portrayed and somewhat poor economics make this company a hold. Although not yet a buy, I’d advise keeping an eye on the stock.

One of the main Brazilian players of the sector 

Petrobras is the second largest Brazilian company selling on the NYSE, after Ambev. This is a pretty interesting company in many senses. However, I would advise investors to hold, as several risks raise concerns about the future viability of the company. Seeing as the Brazilian government is the largest shareholder of the company with an approximate stake of 63%, the company has turned in many cases into an important instrument of social welfare. This is a major worry for stockholders as decisions made to benefit the country’s population could be in expense of the minority owners.

In addition, the discovery of offshore resources which once portrayed an encouraging outlook now looks more problematic. Having to deal with government influence and needing substantial amounts of capital deployments to achieve exploitation due to the water depth –over 2000 meters- and geological structure of the fields, the risks are high, although the rewards are too, as the new developments could double Petrobras’ resource base and production volumes. These huge investments have led to planned investments of $236 billion until 2017, considerably increasing the company’s leverage ratio.

However, the firm is the largest publicly-traded E&P company in Latin America. As such, its market share and scale are impressive; in Brazil, it is by far the largest. As the demand increases in the region, the firm should beneficiate largely, especially as its production levels have been steadily increasing and its current investments could unlock great potential. International expansion has grown a lot over the past years and will most likely continue, constituting another important growth catalyst. Furthermore, it has become an exporter of its own deepwater drilling technology, now used in other parts of the world such as the Gulf of Mexico and West Africa. Its refining activities provide further growth opportunities, especially as the demand and prices of diesel fuels continue in an uptrend.

Although this company is not the strongest of buys, it offers interesting long term growth prospects and trades at only nine times consensus estimates. This is why I would recommend keeping a close eye on this company and watching how it evolves. The unlocking of new assets could rocket its production and revenues.

Bottom line

Although the oil industry is a risky one with high capital requirements, especially in emerging countries, the companies above offer interesting long-term prospects and trade below the industry average. CNOOC, in particular, seems poised to grow and deliver plenty of upside for investors in the years to come as the Chinese and world demand increases and the firm expands further coverseas.

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Victor Selva has no position in any stocks mentioned. The Motley Fool recommends Petroleo Brasileiro S.A. (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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