By the time Buffett finished buying in 2003, Berkshire’s total cost for the 2.3 billion shares was $488 million. This gives the investment an average cost per share of about $21 for the ADSS (for the rest of the post, all figures will be in US$ and refer to the PTR shares traded on the NYSE). On October 18, Buffett sat down with Liz Clayman for an interview on the Fox Business Network where she asked him about his investment in PetroChina. In addition to confirming they had sold the entire stake, Buffett mentioned that at the time of purchase he read through the annual report and pegged PetroChina’s intrinsic value at around $100 billion.
PetroChina was established in 1999 as the publicly traded arm of China National Petroleum Corporation (CNPC), the largest producer of oil in China. PetroChina is vertically integrated where it explores, refines, and sells oil and natural gas. Because of the company’s duopoly in China with Sinopec, PetroChina is the most profitable company in Asia1.
Using the $100 billion estimated value at the time of purchase, Buffett valued PetroChina’s enterprise value at about 12x operating income. Assuming Buffett can’t predict oil prices or precise currency fluctuations, this seems like a fairly reasonable multiple for the largest oil company in one of the world’s fastest growing economies.
Not being an expert on the business, I used the 12x multiple for all the value calculations below. With not much changing in the actual business (not oil prices), I think this is reasonable over the 5 year period. The table below shows a comparison between the price of oil, intrinsic value and market price since the investment was made2.
| Date | Oil barrel | Intrinsic value | Price | Margin of safety |
| 2002 | $22.81 | $56 | $15.87 | 72% |
| 2003 | $27.69 | $80 | $48.53 | 39% |
| 2004 | $37.66 | $119 | $47.09 | 60% |
| 2005 | $50.04 | $160 | $75.78 | 53% |
| 2006 | $58.30 | $171 | $135.76 | 21% |
| 2007(S) | $58.05 | $173 | $165 | 5% |
| Annual | +22% | +27% | +64% |
The Sale
Given Buffett’s amended 13G filing for September 30 (where 2/3 of shares had been sold), the comments he made in the FBN interview, and other observations made by analysts—Buffett most likely sold all PetroChina shares during September and the first part of October. Average sale price was probably around $160-170 per share. Using the average purchase price of $21, annualized return for the 4¾ year period was 54% (not including any dividends).Like always, a large margin of safety played an important role in the outcome of this investment. What actually happened with the investment was one of many possible scenarios (it happened to be one of the good scenarios). Had oil prices remained flat over the years, intrinsic value may have increased by only 2-3% instead of 27%. In that outcome, if shares traded inline with value after the 4¾ year period, annualized return would still be a very respectable 27%.
In a more worst-case scenario (some unforeseen event), PetroChina’s value could have decreased up to 72% over the years, and assuming there was no price/value gap Buffett would have no permanent loss of capital. This would be an extremely rare Black-Swan-type event—and even then, there would be little to no loss. This is the value of a huge margin of safety in a world where we can’t predict the future (hence the name of this blog). Rule number one: don’t lose money. Rule number two: don’t forget rule number one.
Related articles:
Quality Without Compromise / Buffett’s investment in See’s Candy
Warren Buffett and the Washington Post
- Wikipedia: PetroChina [ ^ ]
- Notes: Price’s are end of year, except 2007 which is Buffett’s estimated sale price. Oil barrel prices are average prices over the years through the end of September in 2007. “Sale” intrinsic value is based off of June 30, 2007 numbers. [ ^ ]
I try to back engineering Buffett’s valuation of PetroChina back in 2002. In 2001, PetroChina had free cash flow of $4billion, assuming 5% growth in cash flow for the next 10 years, and no growth starting the 11th year, discount rate 9%, the DCF valuation of PetroChina looks like this:
Year—- Free Cash Flow—- Discounted Value (Billion)
2002—- 4.00—- 3.67 (4/1.09)
2003—- 4.20—- 3.54 (4/(1.09^2))
2004—- 4.41—- 3.41
2005—- 4.63—- 3.28
2006—- 4.86—- 3.16
2007—- 5.11—- 3.04
2008—- 5.36—- 2.93
2009—- 5.63—- 2.82
2010—- 5.91—- 2.72
2011—- 6.21—- 2.62
10-year total—-$31.19 billion
Year—-Free Cash Flow—- Discounted Value (Billion)
Later—-6.52—- 72.40 billion (6.52/0.09=72.40)
$31.19B plus $72.40 =$ 103.59 billion.
I’m a newbie learning the valuation right now. Please let me know if my valuation is correct
Bill,
Using the assumptions you laid out, your “10-year total” number looks correct. However, the value in perpetuity (the 11th year) must also be discounted back to the present.
In other words, the $6.52 annual cash flow is worth $72.4 in the 11th year. But that figure must be discounted back to 2002 (72.4/1.09^11) = $28.1 billion.
So, the final value, using your figures, would be: $31.2 $28.1 = $59.3 billion. With 1.76B shares outstanding at the time, this would be about $34 per share. Not as much as my value above (at 12x operating income), but still double the price it was trading for at the time.
Hi Max,
Thanks for your help on this.
My understanding is that Buffett prefers to use Free Cash Flow to value business, instead of operating income. Am I correct?
Bill,
Yes, Buffett usually prefers Free Cash Flow, depending on the type of investment. PetroChina didn’t have a lot of excess capital expenditures, so in this case there won’t be much difference between net income and FCF.
In my above “valuation”, I was using 12x EBIT only because that’s the multiple that Buffett valued PTR at when he bought (he gave the $100B value). If I used Free Cash Flow instead, the multiple would be 25x FCF ($100B / $4B). I only used operating income because it is a more “normalized” number, and I didn’t have to take into account any growth capital expenditures. The EV/EBIT multiple also helped take away the effects of debt on the valuation.
Thanks again. I learned a lot.
How would you define “a lot of excess capital expenditures’? Is there a ratio to measure it?
In the future, when I value an energy company without excessive capital expenditure, can I just use 12*EBIT?
Thanks again.
“Is there a ratio to measure it?”
> Not necessarily. There are ways to measure growth expenditures for certain types of businesses but I can’t say for energy companies. I was referring to excess expenditures as (Total CapEx - Depreciation). It was fairly high in 2002 (they could have been building more refineries, or something similar), but leveled off to approximate depreciation in the years after.
No, I wouldn’t use the 12xEBIT number for energy companies in general. Again, they aren’t in my circle of competence, so I can’t tell you exactly how to value them. It really will depend on the specific company. Remember that PetroChina is the largest and most profitable energy company in Asia (which is growing much faster than the US). So it probably deserves a higher multiple than the average oil company.
I just finished Phil Town’s book “Rule #1″. –
Using his valuation method–in 2001 PTR’s EPS was $2, assuming the yearly growth rate of 24% for the next 10 years, the EPS will be around $17 in year 2011. Using the average P/E for petroleum companies–12, the “Sticker Price” of PTR will be 17*12=204 in year 2011. –
My desired return rate is 15% per year, $204 in year 2011 dicounted back to 2001 using 15% discount rate would be $51.Require a margin of safety 50%, I would buy PTR below 25 dollars. In 2002, the price for PTR was $16.–
This is neat.Thanks
[…] in PetroChina. In October I wrote up a short case study on the investment in PTR, which you can see here. He confirms in writing that when they sold PTR back in September, he believed it was fairly […]