Warren Buffett first began purchasing shares of PetroChina (PTR) sometime in 2002 (because it was on a foreign exchange, we don’t know the exact date), and filed his first 13G on April 30, 2003. The following is a short case study of Berkshire Hathaway’s investment—from when the first purchase was made five years ago to when the entire stake was sold over the past month. For disclosure, oil companies like PetroChina are not in my circle of competence, so in this study I’ll stick to the very basic themes of the investment and simplified calculations of intrinsic value.
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 Asia.
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 made ((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.)).
| 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% |
Looking at the rise in average cost of oil per year (Column 2 above), it’s obvious oil played a large part in the increase in earnings and subsequently intrinsic value. Currency fluctuations between the Yuan and US Dollar added about 2% to the annualized increase in intrinsic value. For reference, output of Oil & Gas Equivalents at PetroChina grew 5% a year from 2002 to 2006. Column 5 above shows the year-end margin of safety, and as you can see it narrows from 72% to just 5% with Buffett’s recent sale.
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
FutureBlind 
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
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Doing a perpetual DCF analysis ignores the net assets of the business as well as forces you to forecast into infinity. I would not do more than 20 years, have a definitive cut off like a 20 yr bond for instance. You will need to factor in the assets or your valuation will always be way off. You can just use Graham’s liquidation value formula (can be found on the web) and add in the liquidation value on top of the DCF value. Divide by shares outstanding and you have your rough valuation. Looking at the 2001 annual report I’ve come to roughly $55B valuation with conservative numbers. The other $45B might be reserves not reflected on the balance sheet but i’d need to research it further. Buffett does DCF but no one sees him do it b/c he does a rough estimate in his head probably using some simple formula he’s come up with. I don’t think Buffett would try to “stretch it” but instead would only invest in no-brainer ideas, thus it seems likely the reserves on the books might be the no-brainer.
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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.
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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?
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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.
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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.
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“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.
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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
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Dear Bill,
I am a new fan of Ben Graham, as a beginner and a dreamer who wishes to manages money in ben’s way, after reading “the intelligent investor”, how much do you recommend “Rule #1”?
Thanks!
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HI Bill, i wonder why u said PTR’s EPS in 2001 was $2, according to the annual report in 2003, the EPS of PTR in 2001 was 0.26RMB, which means it was around 0.03 US dollar instead?
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Hi, I was exactly looking for this, and I found your article. But, can you say why buffet should choose 12x? Well, that must be the whole trick. But, to arrive at a particular multiple need a lost of wisdom. But its also equally strange, when he mentioned that company was worth $100 B when he bought it. How can he stick so exactly to the 12x multiple!
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