Are Chinese Energy Producers a Good Choice for Income Investors?

The search for yield has forced investors to look in some unfamiliar places. Generous payouts, seemingly backed by a national interest, may make major Chinese oil and gas producers like China Petroleum & Chemical, PetroChina, and CNOOC intriguing considerations for those seeking greater portfolio income.

Jun 2, 2014 at 10:23AM

Stocks that provide ample dividends with meaningful capital gains potential are an income investor's dream. They don't come along often, but Chinese energy producers like China Petroleum & Chemical (NYSE:SNP), PetroChina (NYSE:PTR), and CNOOC (NYSE:CEO) may fit the bill. Does a government policy that seemingly insists on generous payouts and continued growth in Chinese energy demand make these foreign companies a good choice for income investors?

Dividends as national policy
Chinese authorities have recently decreed that state-owned companies increase the dividends they pay to the government and other shareholders. At least 10% to 25% of earnings must now be disbursed with further increases likely. A document released at China's latest Communist National Congress indicates that 30% of profits must be returned by 2020.

Government-backed Chinese oil and natural gas companies have had a history of delivering generous dividends. It appears these lucrative payouts will likely continue, given national policy. In addition, these energy producers could also offer meaningful share price appreciation. China looks to become the world's largest economy by at least the early 2020s. As the nation advances, so should the use of oil and gas and the profits of those meeting that demand.

Some Chinese oil and gas producers offering both appealing dividends and possible share price upside might include the following: 

China Petroleum & Chemical 
China Petroleum & Chemical, often referred to as Sinopec, has diversified operations in refining, oil and gas production, and chemicals. Recently, government refined product pricing intervention has suppressed profit growth even as business has boomed.

To shore up the bottom line, Sinopec has increased its focus on oil and gas production. Profits from this less regulated line of business have more than doubled since 2009, helping to offset refining declines. Though earnings fell in the recent quarter, due to lower oil prices and increased costs, production grew a favorable 8%.

The company's Fuling gas project should help keep production advancing. China's leading shale natural gas field, Fuling is reported to have estimated reserves of 74 trillion cubic feet and peak production capacity of 350 billion cubic feet per year. This find is a critical component in China's plan to develop its sizable shale reservoirs.

China Petroleum & Chemical shares might be worth investigating. Offering a roughly 4.7% dividend yield and currently priced at around 4.2 times trailing cash provided by operations, the company seems undervalued. In comparison, peer oil and gas major BP is priced at a significantly higher 7.4 times trailing cash flow while sporting a 4.6% yield.

PetroChina, China's largest energy exploration and production company, has shown relatively lackluster performance recently. In its latest quarter, crude oil output was flat year over year and profits dropped by more than 7%. Gains in natural gas were very heartening, however. Gas production grew 6%, and PetroChina's transport business saw profits spike more than 25% as Chinese demand for natural gas surged.

To ensure future growth, PetroChina has begun looking beyond its historical in-country comfort zone. Over the last 18 months, it has paid more than $2 billion for project stakes in Australia, nearly $3 billion for producing assets in Peru, and $1 billion for a third interest in an Iraqi oil venture.

The energy producer's most significant foreign deal might be the recently signed $400 billion agreement between Russia's Gazprom and PetroChina-parent China National Petroleum, however. Gazprom's intent to supply China with about 38 billion cubic meters of gas annually, roughly a quarter of the nation's current annual consumption, can only help boost demand for PetroChina's natural gas transport infrastructure.

Given its seemingly bright future, it's not surprising that PetroChina is premium priced compared to national rivals. But with a 5.8 times cash flow market worth and a 3.8% dividend yield, the shares might look compelling compared to international peers like ExxonMobil; the latter company is priced at around 9.6 times trailing cash provided by operations and offers a 2.7% yield.

CNOOC is China's dominant offshore producer. A fast grower, its oil and gas deliveries jumped more than 15% year over year in the latest quarter. A sizable acquisition and production ramp-ups in major projects abroad provided most of the gains. While CNOOC has most of its production in Chinese territory, international assets are its key growth driver.

Maintaining domestic production from new finds like the Kenli 3-2 field, offering expected peak production of more than 35,000 barrels of oil equivalent per day, CNOOC also aggressively pursues foreign reserves. Its $15.1 billion acquisition of Canadian producer Nexen is a prime example. The purchase delivered many producing properties, with the Long Lake oil sands possibly being the most exciting. With a daily 59,000 barrels of oil capacity, this Western Canadian project has significant profit potential.

Equally encouraging are CNOOC's onshore U.S. interests. After paying more than $1.5 billion for one-third stakes in Chesapeake Energy's Eagle Ford and Niobrara shale properties, the Chinese oil producer has garnered gains from our own country's unconventional drilling boom. Its Eagle Ford share saw daily deliveries of nearly 45,000 barrels of oil equivalent last year with higher production rates expected.

CNOOC shares may be worth considering. Currently priced at around 4.2 times trailing cash provided by operations and offering a 4.2% dividend yield, the company's valuation appears noticeably discounted to peer international energy producers like Chevron; the latter company trades at around 6.7 times operating cash flow with a 3.5% dividend yield.

Bottom line
Income investors have had to look far and wide for companies that deliver generous dividends and could provide noticeable capital appreciation. Chinese oil and gas producers like China Petroleum & Chemical, PetroChina, and CNOOC might offer such an opportunity. While stakes in Chinese companies do subject shareholders to some specialized risks, these companies' ample payouts and relatively appealing valuations suggest that they might be worth considering as part of an income investor's diversified portfolio.

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Bob Chandler has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.

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Jun 12, 2015 at 5:01PM

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