Energy / China 12 September 2012

China Oilfield Services Target price: HK$15.00 → HK$15.00 Up/downside: +14.7% 2883 HK | CHOLY US Share price (11 Sep): HK$13.08

Sailing in safer waters

• We see a 2013E PER of 8.7x, coupled with solid industry dynamics, as compelling; upgrade to Buy • Fundamentals for oil and gas exploration globally and offshore China look attractive

• Expansion into deepwater areas and China's new and intense focus on domestic unconventional gas represent growth areas for COSL

How do we justify our view?

We see COSL remaining the consensus, due to our higher dominant supplier of oil services for utilisation rates and day rates. offshore China; hence its growth aspects appear favourable. In our Forecast revisions (%)

view, its low-cost operating base, Year to 31 Dec 12E 13E 14E Adrian Loh unique geographic advantage (being Revenue change 0.6 0.5 (0.5) (65) 6499 6548 Net-profit change 2.8 5.9 4.6 [email protected] based in China, it is exposed to the EPS change 2.8 5.9 4.6 offshore China area which we Source: Daiwa forecasts Benjamin Lim believe is underdeveloped), and (65) 6321 3086 Share price performance [email protected] highly experienced operating team should ensure market dominance 16 (HK$) (%)130 for the foreseeable future. What's new 14 120 We believe that: 1) COSL’s share price What we recommend 12 110 underperformance since the 1H12 We upgrade our rating on COSL to 10 100 Buy (1) from Outperform (2) and 8 90 results announcement, despite Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 reiterate our PER/PBR-based six- China Oilfield Services stronger guidance, is unwarranted, (LHS) month target price of HK$15.00. We and 2) its 2013E PER of 8.7x does not reflect the volume growth coming view the stock’s 2013E PER of 8.7x 12-month range 8.80-13.88 from key client CNOOC (883 HK, as undemanding, and even the 10x Market cap (US$bn) 7.58 HK$14.34, Buy [1]). To reflect this 2013E PER implied by our target Average daily turnover (US$m) 9.12 volume growth, we are raising our price is still at a 13% discount to Shares outstanding (m) 4,495 2012-14 EPS forecasts, which assume COSL’s Asian oil services peers. Also, Major shareholder CNOOC Group (54.7%) higher utilisation and day rates with our EV/EBITDA valuation upside from deepwater exploration methodology (using global Financial summary (Rmb) offshore China. comparables) shows that COSL is Year to 31 Dec 12E 13E 14E Revenue (m) 21,136 23,232 24,737 trading at a 20% discount to its Operating profit (m) 6,050 6,784 7,170 What's the impact global peers. We prefer COSL to Net profit (m) 4,828 5,505 5,898 COSL has strong earnings CNOOC in the near term, given the latter’s share-price overhang as a Core EPS 1.074 1.225 1.312 fundamentals, in our view, reflected in EPS change (%) 19.5 14.0 7.1 result of the Nexen deal approvals. our forecasts for a net profit CAGR of Daiwa vs Cons. EPS (%) 3.3 5.9 4.6 13% over 2011-14 (10% previously) The risks we see for COSL include PER (x) 9.9 8.7 8.1 and a stable EBIT margin at about 21- lower oil and gas prices and key Dividend yield (%) 2.0 2.3 2.5 23% over the period. In addition, we customer risk in the form of CNOOC. DPS 0.215 0.245 0.263 now forecast its free cash flow yield to PBR (x) 1.2 1.1 1.0 rise to over 10% (8% before) by 2014. How we differ EV/EBITDA (x) 6.9 5.9 5.2 Our new 2013-14 EPS forecasts are ROE (%) 14.3 13.3 12.8 5-6% above those of the Bloomberg Source: Bloomberg, Daiwa forecasts

Important disclosures, including any required research certifications, are provided on the last two pages of this report. Energy / China 2883 HK | CHOLY US 12 September 2012

Table of contents

Sailing in safer waters ...... 6 Investment thesis ...... 6 Solid fundamentals ...... 6 Business growth plans ...... 9 Financial overview ...... 10 1H12 results: solid outlook ...... 10 Valuation ...... 12 Upgrading to Buy ...... 12 Risks ...... 15 Company background ...... 16 Introduction ...... 16 Drilling ...... 17 Well Services ...... 17 Marine Support and Transportation ...... 17 Geophysical ...... 18

- 2 - Energy / China 2883 HK | CHOLY US 12 September 2012

How do we justify our view?

Growth outlook Valuation Earnings revisions

Growth outlook COSL: net profit versus free cash flow

We forecast COSL’s net-profit growth to continue over (Rmb m) the 2011-14 period at a CAGR of 13%, and project a free 10,000 cash flow CAGR of nearly 42% over the same period. We 5,000 forecast the company’s operating-profit margin to remain at a steady level of around 28%. 0 (5,000)

(10,000)

(15,000)

(20,000) 2008 2009 2010 2011 2012E 2013E 2014E Net profit Free cash flow

Source: Company, Daiwa forecasts

Valuation COSL: PER bands

Since its IPO in 2002, COSL’s PER has averaged 16.5x (HK$/share) with the spike occurring in 2007-08 as oil prices jumped 35 31x significantly, and along with it, sentiment towards the 30 oil services sector. With the collapse of oil prices in 25 24x 2H08, COSL’s PER was derated to nearly a mid-single- digit level, then recovered to a mid-teens multiple in 20 1H11. 15 17x 10 10x We view COSL’s current valuations as undemanding 5 given that its 2013E PER (based on our EPS forecast) of 0 8.7x is 47% below its historical (2002-12) average PER. Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Apr-08 Apr-09 Apr-10 Apr-11 Apr-12 Oct-07 Oct-08 Oct-09 Oct-10 Oct-11 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Source: Bloomberg

Earnings revisions COSL: 12-month EPS revision momentum

The Bloomberg consensus EPS forecast revisions for (Rmb/share) COSL appear to have bottomed out in the past four 1.30 months. With the company’s 1H12 net profit beating our 1.25 and the Bloomberg consensus forecast by 5%, the 1.20 outlook for COSL in the near-to-medium term appears 1.15 good. In addition, the company’s management has 1.10 provided positive guidance for pricing and demand for its services. 1.05 1.00

Our EPS forecasts for 2013-14 are 5-6% higher than Jul-12 Apr-12 Oct-11 Jan-12 Jun-12 Feb-12 Mar-12 Sep-11 Nov-11 Dec-11 Aug-12 those of the consensus, as we have taken a more May-12 2012E 2013E aggressive stance towards COSL’s utilisation rates and day rates – this is predicated on our view that CNOOC’s Source: Bloomberg production growth should accelerate in 2013-15.

- 3 - Energy / China 2883 HK | CHOLY US 12 September 2012

Financial summary

Key assumptions Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014E Overall rig day rates (US$/day) 91,351 129,000 134,000 129,000 130,500 133,200 137,600 142,800 Rig utilization rate (%) 97.0% 92.7% 95.0% 85.4% 90.8% 93.9% 94.0% 94.2% Total operating days - drilling 5,308 5,838 8,885 9,666 10,444 11,513 11,841 12,206 Well workover (team day) 15,944 20,858 25,030 26,281 26,807 27,611 29,268 31,024 Well completion (no of wells) 487 556 751 788 804 828 878 930 Total operating days - MS&T 24,229 23,626 27,702 26,769 25,650 26,938 27,740 27,740 2D seismic data collected (km) 37,810 49,448 33,900 24,469 27,808 18,443 18,443 18,443 3D seismic data collected (sq km) 9,694 13,592 10,394 13,008 23,174 27,036 27,036 27,036

Profit and loss (Rmb m) Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014E Drilling 3,922 5,920 9,892 9,327 9,515 10,229 11,361 12,154 Well services 2,270 2,733 4,417 4,327 3,950 5,296 5,796 6,344 Others 2,855 3,539 3,665 3,996 5,074 5,610 6,075 6,238 Total revenue 9,047 12,192 17,974 17,650 18,539 21,136 23,232 24,737 Other income 0 0 0 0 0 0 0 0 COGS (2,004) (2,720) (3,610) (3,277) (3,448) (3,915) (4,246) (4,535) SG&A (2,063) (2,685) (3,661) (3,418) (4,006) (3,809) (4,130) (4,275) Other op. expenses (2,152) (3,156) (6,235) (5,755) (6,102) (7,363) (8,071) (8,756) Operating profit 2,827 3,630 4,468 5,200 4,983 6,050 6,784 7,170 Net-interest inc./(exp.) 40 (243) (766) (574) (393) (408) (335) (261) Assoc/forex/extraord./others (1) (80) 58 208 223 246 264 283 Pre-tax profit 2,867 3,307 3,760 4,834 4,813 5,888 6,714 7,192 Tax (629) (205) (624) (706) (772) (1,060) (1,208) (1,295) Min. int./pref. div./others 0 0 0 1 0 0 0 0 Net profit (reported) 2,238 3,102 3,135 4,128 4,041 4,828 5,505 5,898 Net profit (adjusted) 2,238 3,102 3,135 4,128 4,041 4,828 5,505 5,898 EPS (reported) (Rmb) 0.542 0.690 0.697 0.918 0.899 1.074 1.225 1.312 EPS (adjusted) (Rmb) 0.542 0.690 0.697 0.918 0.899 1.074 1.225 1.312 EPS (adjusted fully-diluted) (Rmb) 0.542 0.690 0.697 0.918 0.899 1.074 1.225 1.312 DPS (Rmb) 0.120 0.140 0.140 0.180 0.180 0.215 0.245 0.263 EBIT 2,827 3,630 4,468 5,200 4,983 6,050 6,784 7,170 EBITDA 3,869 5,194 7,333 8,322 8,053 9,760 10,893 11,695

Cash flow (Rmb m) Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014E Profit before tax 2,867 3,307 3,760 4,834 4,813 5,888 6,714 7,192 Depreciation and amortisation 1,042 1,564 2,865 3,122 3,070 3,710 4,109 4,524 Tax paid (324) (419) (696) (743) (540) (1,060) (1,208) (1,295) Change in working capital (596) (950) (845) (91) (1,411) (155) (362) (191) Other operational CF items (14) 536 521 733 232 162 71 (22) Cash flow from operations 2,974 4,038 5,605 7,855 6,163 8,544 9,322 10,209 Capex (3,128) (7,631) (7,399) (4,434) (4,297) (5,000) (5,500) (5,500) Net (acquisitions)/disposals (2,356) (13,305) (667) 593 (405) 0 0 0 Other investing CF items 130 311 282 267 186 192 204 217 Cash flow from investing (5,354) (20,625) (7,783) (3,574) (4,516) (4,808) (5,296) (5,283) Change in debt 644 15,211 3,051 (463) (1,010) (5,053) (3,972) (3,928) Net share issues/(repurchases) 6,740 0 0 1 7,000 0 0 0 Dividends paid (240) (539) (629) (630) (809) (809) (967) (1,103) Other financing CF items (136) (432) (1,284) (485) (752) (593) (506) (416) Cash flow from financing 7,008 14,240 1,137 (1,578) 4,429 (6,455) (5,445) (5,446) Forex effect/others 1,852 (1,701) 532 (400) 482 0 0 0 Change in cash 6,480 (4,048) (509) 2,303 6,558 (2,718) (1,418) (520) Free cash flow (155) (3,593) (1,794) 3,421 1,866 3,544 3,822 4,709

Source: Company, Daiwa forecasts

- 4 - Energy / China 2883 HK | CHOLY US 12 September 2012

Financial summary continued …

Balance sheet (Rmb m) As at 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014E Cash & short-term investment 8,766 4,564 4,015 6,247 6,528 3,873 2,520 2,068 Inventory 418 781 821 816 895 979 1,217 1,295 Accounts receivable 1,407 3,090 4,175 4,154 5,199 5,276 5,779 6,153 Other current assets 835 1,560 1,023 517 828 711 775 824 Total current assets 11,426 9,994 10,034 11,734 13,451 10,839 10,291 10,341 Fixed assets 11,118 40,345 45,087 46,371 46,285 55,195 56,695 57,759 Goodwill & intangibles 52 5,129 5,057 4,870 4,617 4,617 4,617 4,617 Other non-current assets 493 733 599 522 498 552 609 672 Total assets 23,089 56,201 60,777 63,497 64,851 71,203 72,212 73,389 Short-term debt 200 7,779 283 1,224 1,626 4,247 4,203 0 Accounts payable 2,087 3,759 4,224 4,436 4,531 4,396 4,768 5,017 Other current liabilities 1,097 777 564 981 948 971 1,042 1,103 Total current liabilities 3,384 12,315 5,071 6,642 7,105 9,614 10,013 6,120 Long-term debt 2,244 20,384 30,821 28,591 26,484 19,506 15,578 15,853 Other non-current liabilities 236 3,705 2,579 2,675 2,803 2,803 2,803 2,803 Total liabilities 5,864 36,403 38,471 37,907 36,392 31,923 28,394 24,776 Share capital 4,495 4,495 4,495 4,495 4,495 4,495 4,495 4,495 Reserves/R.E./others 12,730 15,303 17,810 21,094 23,963 34,784 39,322 44,117 Shareholders' equity 17,225 19,798 22,306 25,590 28,459 39,279 43,817 48,612 Minority interests 0 0 0 0 1 1 1 1 Total equity & liabilities 23,089 56,201 60,777 63,497 64,851 71,203 72,212 73,389

EV 41,222 71,016 74,586 71,118 69,175 67,418 64,740 61,199 Net debt/(cash) (6,322) 23,599 27,090 23,568 21,582 19,880 17,261 13,785 BVPS (Rmb) 3.832 4.404 4.962 5.692 6.331 8.738 9.747 10.814

Key ratios (%) Year to 31 Dec 2007 2008 2009 2010 2011 2012E 2013E 2014E Sales (YoY) 41.4 34.8 47.4 (1.8) 5.0 14.0 9.9 6.5 EBITDA (YoY) 68.8 34.2 41.2 13.5 (3.2) 21.2 11.6 7.4 Operating profit (YoY) 103.1 28.4 23.1 16.4 (4.2) 21.4 12.1 5.7 Net profit (YoY) 98.4 38.6 1.1 31.7 (2.1) 19.5 14.0 7.1 EPS (YoY) 92.0 27.3 1.1 31.7 (2.1) 19.5 14.0 7.1 Gross-profit margin 77.9 77.7 79.9 81.4 81.4 81.5 81.7 81.7 EBITDA margin 42.8 42.6 40.8 47.2 43.4 46.2 46.9 47.3 Operating-profit margin 31.3 29.8 24.9 29.5 26.9 28.6 29.2 29.0 ROAE 17.3 16.8 14.9 17.2 15.0 14.3 13.3 12.8 ROAA 12.4 7.8 5.4 6.6 6.3 7.1 7.7 8.1 ROCE 18.9 10.7 8.8 9.6 8.9 10.1 10.7 11.2 ROIC 23.5 12.5 8.0 9.0 8.4 9.1 9.3 9.5 Net debt to equity net cash 119.2 121.4 92.1 75.8 50.6 39.4 28.4 Effective tax rate 21.9 6.2 16.6 14.6 16.0 18.0 18.0 18.0 Accounts receivable (days) 48.3 67.3 73.8 86.1 92.1 90.5 86.8 88.0 Payables (days) 79.0 87.5 81.1 89.5 88.3 77.1 72.0 72.2 Net interest cover (x) n.a. 14.9 5.8 9.1 12.7 14.8 20.3 27.4 Net dividend payout 22.1 20.3 20.1 19.6 20.0 20.0 20.0 20.0 Source: Company, Daiwa forecasts

Company profile China Oilfield Services Limited was incorporated in December 2001. The company is the leading integrated oilfield-services provider in the offshore China market, engaged in drilling services, well services, marine support and transporation services, and geophysical services. It has the largest offshore drilling fleet in China.

- 5 - Energy / China 2883 HK | CHOLY US 12 September 2012

Solid fundamentals

Earnings momentum and visibility Earnings visibility is currently one of the stronger Sailing in safer waters elements in any investment strategy in the current market environment, in our opinion, and is especially relevant for a company the size of COSL. In the oil With the stock trading an undemanding services universe, a highly volatile macro environment 2013E PER of 8.7x, we think COSL in exploration and production (E&P) and a ‘lumpy’, project-driven earnings stream for global oil services represents a safe way to gain exposure to serve to heighten earnings uncertainty. However, we oil prices as well as exploration in suggest that COSL can offer earnings growth with a offshore China. reasonable degree of security. In this context, we believe that the company is among the leaders in the oil services group, as we believe it not only offers an Investment thesis EBITDA CAGR of 24% over 2011-14E (our forecast period), but we argue that it is relatively less affected by We are upgrading our rating for COSL to Buy (1) from the wider China macroeconomic environment as Outperform (2) and reiterate our PER/PBR-based six- opposed to most other Mainland companies. month target price of HK$15.00, implying 15% upside potential from current levels. We use a target 2013E In the following chart comparing CNOOC’s and COSL’s PBR of 1x as a floor valuation for COSL, while our EBITDA, we can see that the upward trajectory in 2013E target PER of 11.6x (a 30% discount to its 2002- COSL’s EBITDA was only briefly broken in 2011, when 12 average) takes into account the potential multiple external factors (eg, the suspension of operations in expansion that should occur if there are upward EPS Libya due to the civil war, and the production forecast revisions over the next 6-12 months, as we shutdown at Penglai 19-3 due to an oil spill) led to a 2% expect. YoY decline in its net profit for that year. For 2011-15, we forecast COSL to generate a 10.4% CAGR. Fundamentally, we like the company’s exposure to the EBITDA comparison: CNOOC vs. COSL China offshore areas that we believe remain underexplored even after the past 10 years of (Rmb m) (Rmb m) exploration activity by CNOOC. The fact that CNOOC 175,000 17,500 has continued to have good exploration success in 150,000 15,000 offshore China in 2012 to date shows that the area 125,000 12,500 remains highly prospective. 100,000 10,000 75,000 7,500 We believe that this high exploratory success should 50,000 5,000 see oil and gas production in offshore China increase 25,000 2,500 0 0 by at least 50% over the next five years based on 2004 2005 2006 2007 2008 2009 2010 2011

CNOOC’s proven undeveloped reserves. If we include 2012E 2013E 2014E 2015E the drilling successes in the past 12 months (which are CNOOC COSL (RHS) not likely to have been booked as reserves yet), then Source: Companies, Daiwa forecasts this growth should continue well into the latter part of this decade. Most of China’s prospective offshore areas are close to the coast and in shallow waters. Reservoir depths are We expect COSL to remain the dominant supplier of oil also quite shallow. These attributes mean that offshore services to this industry in offshore China; hence its exploration and development in the country will growth aspects appear favourable. Its low-cost continue even in a low oil-price environment, in our operating base in China, its unique geographic view. advantage (being based in China, it is exposed to the offshore China area, which in our view is The current inventory of offshore projects in China is underdeveloped), and its highly experienced operating extensive and these projects should not be affected by team should ensure market dominance for the movements in oil and gas prices. In our opinion, these foreseeable future, in our view.

- 6 - Energy / China 2883 HK | CHOLY US 12 September 2012

projects and the committed exploration expenditure China: offshore and onshore production growth should ensure strong revenue growth until at least 2015. ('000 boepd) Pr oduc tion growth (5-yr CAGR) 4,250 Offshore: 11.7% CNOOC’s capex vs. COSL’s revenue 4,000 Onshore: 0.5% (Rmb m) (Rmb m) 3,750 715 80,000 30,000 3,500 411 70,000 25,000 3,250 60,000 270 50,000 20,000 3,000 40,000 15,000 2,750 30,000 10,000 2,500 20,000 2001 2006 2011 5,000 10,000 Onshore Offshore 0 0 Source: Company, BP Energy Review 2012 2004 2005 2006 2007 2008 2009 2010 2011

2012E 2013E 2014E 2015E CNOOC's capex COSL's revenue (RHS) This market expansion should come about due to

Source: Companies, Daiwa forecasts China’s strong energy development as a result of its economic growth and exploration drilling success. On this score, COSL may be unique in its industry, as Daiwa’s economics team forecasts China’s GDP to rise there are few, if any, oil services companies that can at rates of 7-8% a year for 2012 and 2013, which we demonstrate this sort of sustainable growth. The believe will translate into continued strong energy company should also be a beneficiary of any future demand in the country. exploratory success in offshore China and hence has some upside potential that is not yet reflected in its China: historical oil production vs. consumption valuation metrics, in our opinion. Offshore exploration ('000 bpd) expenditure is currently at record levels, and with high 12,000 20-year CAGR (1991-2011) historical success rates, we are optimistic about further 10,000 upside to project inventory. Consumption: 7.1% 8,000 Production: 1.9%

This growth and upside potential should offset most of 6,000 the China risk factors that affect other Mainland 4,000 companies. The CNOOC group of companies has a long 2,000 history and a successful track record in the offshore oil 0 and gas business. The listed vehicle for exploration and production, CNOOC Ltd, is among the most well- 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 regarded companies in Asia, as well as globally, in the Consumption Production oil and gas business. Source: BP Energy Review 2012

China: a large and continually expanding Income growth through exposure to energy market projects in offshore China China has experienced some of the strongest growth COSL’s exposure to CNOOC and its partners in rates for oil and gas consumption in the world over the offshore China means that it is exposed to a reasonably past 20 years, and we expect this to continue into the solid production-growth profile with minimal oil-price future. This energy-demand growth, coupled with high risk, in our view. Based on CNOOC’s reserves energy prices, is causing an exploration and statements, we estimate that 55-60% of China’s development ‘boom’ that needs servicing in offshore offshore reserves at the proved level are undeveloped, China. As can be seen in the following chart, were it not totalling about 1.26-1.38bn boe. Since it was listed in for offshore China, the country’s production would 2001, CNOOC has, on average, brought onstream have been relatively flat over the past 10 years. between 3-9 new oil and gas projects each year. As a result, the number of producing fields has increased We suggest that the underexplored nature of offshore substantially, from 17 in 2001 to 77 as at the end of China and its high prospectivity for oil and gas should 2011. ensure a strong outlook for the oil services industry in offshore China. As the dominant oilfield-service CNOOC has stated that over the 2012-15 period it provider for offshore China, we believe COSL is well- expects more than 30 new oil and gas fields in offshore positioned to benefit from market expansion. China to start production. Thus, we believe its pipeline

- 7 - Energy / China 2883 HK | CHOLY US 12 September 2012

of projects for the next three years, which does not Although Daiwa has a neutral view on oil prices for the include recent appraisal and exploration success, next three years (2012-14E) – we forecast oil prices of should ensure strong medium- to long-term oil service US$112/bbl for 2012 and US$110/bbl for each of 2013 opportunities for COSL. and 2014 – we highlight that these prices should still allow oil companies to generate relatively high levels of COSL’s more predictable project schedule returns on their offshore oil and gas projects. We believe COSL’s services are relatively more Furthermore, we note that the 2015 forward Brent oil predictable than those of other oil service companies price is about US$97/bbl, which would still engender for a number of reasons: high levels of profitability for many offshore oil projects.

• All COSL’s customers are well-capitalised operators We believe that oil prices will remain higher for longer, that have had strong exploration success in offshore based on four key themes: low OPEC spare capacity, China, and thus will be bringing onstream various oil weak non-OPEC production growth, tight inventory and gas projects over the next 3-5 years. levels and resilient oil demand despite relatively high • Most of these projects have 3-5 year development prices. periods, and thus should provide COSL with a firm baseload of work over this timeframe. In general, the major companies have flat to declining oil production profiles, as all had underestimated the • The economic field threshold sizes in offshore China past few years of strong oil prices that resulted in very are reasonably low given the low water depths and strong balance sheets. In our view, the strong cash relative proximity to the market. Hence, the projects balances and the need for earnings growth will see are not dependent on high oil and gas prices. these companies increase or at least maintain their • Over 90% of COSL’s large-scale equipment is E&P capex programmes over the next five years. covered by service contracts in 2012. Thus, we OPEC spare capacity vs. Brent oil price believe the company has a dependable revenue US$/bbl mm bpd growth profile for at least the next three years as the 140 6 major projects have already been approved for 120 development. 5 100 4 80 In addition, we note that as the company’s new rigs are 3 60 delivered over the next 18 months, its average realised 2 day rates should see upward pressure. This is because 40 the new rigs have higher specifications and therefore 20 1 command higher day rates than older rigs, so this 0 0 2Q 3Q 4Q 2Q 3Q 4Q 2Q 3Q 4Q 2Q 3Q 4Q 2Q 3Q 4Q

asset-enhancement strategy should reduce the 1Q07 1Q08 1Q09 1Q10 1Q11 1Q12 downside risk to COSL’s day rates. Brent oil price OPEC spare capacity (RHS)

Source: EIA, Bloomberg COSL: historical and forecast drilling day rates (US$ '000/day) Strong operating history and backing of 250,000 CNOOC Group 200,000 COSL’s 30-year operating database, covering surface and subsurface conditions and strong logistical support, 150,000 is a key strength for the company, in our view. This 100,000 includes 30 years of providing services to foreign companies with a team of line managers that has been 50,000 together for more than two decades. (Before the 0 company was merged to form COSL, it was made of 2004 2005 2006 2007 2008 2009 2010 2011 2012E 2013E 2014E four different companies with different start-up dates.) Jack-ups Semi-subs While shallow-to-moderate water depths (20-100

Source: Company, Daiwa forecasts metres) provide a less risky operating environment, recent years have seen adverse weather and sea Oil prices: higher for longer – positive for conditions in the form of sea ice in Bohai Bay as well as the oil-services sector typhoons in the South China Sea.

The profitability of the oil-services sector is driven by E&P capex, which, in turn, is driven by oil prices. - 8 - Energy / China 2883 HK | CHOLY US 12 September 2012

In our view, COSL’s parent, CNOOC Group, has a very We believe that the integration of services, combined solid reputation in both the oil and gas business and with a significant capex programme, will result in with investors. We believe COSL’s senior management technical upgrades in Well Services that ensure the is very experienced in all facets of the oilfield services comprehensive coverage of COSL’s customers’ needs business as well as being focused on shareholder and hence enhance the ability for the company to returns. Also, CNOOC Group has a strong track record create higher operating-profit margin services. This of corporate governance that should enhance investor would also apply to the expansion of the drilling rig confidence, in our view. fleet, which would allow greater rig allocation efficiency and once again help improve margins. Integrated service platform COSL day rates vs. global average (1H12) COSL is able to offer an integrated service platform, a one-stop shop with cross-segment synergies, leading to (US$/day) 350,000 cost savings and high margins as well as allowing joint 288,000 marketing to E&P companies. We suggest that a full- 300,000 257,149 service firm that offers savings in contracting, 250,000 providing oil companies with one-stop shopping, 200,000 should generate high levels of returns. We believe that 150,000 109,000 121,255 the segments with the most significant integration 100,000 potential within COSL are Drilling and Well Services, 50,000 as both combined accounted for more than 79% of 0 operating profit for 1H12. Jack-up Semi-sub COSL Global average

Margins should remain stable Source: Company, ODS Petrodata We attribute COSL’s net income growth over the past eight years to the strong demand for its services, and its ability to increase EBIT margins in its business units. Business growth plans With high utilisation rates across the company’s four business segments for 1H12, we can see that demand in Deepwater in offshore China the oil services sector remains healthy. As a result, and With CNOOC commencing deepwater drilling in barring any material decline in the oil price, there is offshore China in earnest in 2012, COSL should be able scope for COSL to maintain its EBIT margins across to piggyback its way to more diversified earnings the various business units, in our view. streams as the volume of work in deepwater areas increases. At present, COSL’s major involvement is COSL: historical and forecast EBIT margins through the operational management of the ultra- 50% deepwater semi-submersible rig, HYSY 981 (owned by

40% parent company CNOOC). Over the near term, it should see increased demand for Well Services and 30% Marine Support.

20% Unconventional gas in China 10% The prospects for shale gas production remain murky 0% at present, given that China only recently embarked on 2004 2005 2006 2007 2008 2009 2010 2011 2012E 2013E 2014E its exploration programme. Nevertheless, the winners Drilling Well services in this business are likely to be the oilfield-service providers, such as COSL, rather than the E&P Marine Support Geophysical companies. Already, COSL has said that it so far in Source: Company, Daiwa forecasts 2012 it has won tenders for the provision of logging

services for shale gas and coal bed methane (CBM), as However, we do not expect day rates to move to parity well as for fracturing services for Sinopec. to international levels, as keeping rates lower than its global competitors should enhance the barriers to entry into offshore China as well as encourage more drilling, Enhanced oil recovery especially when this is combined with high drilling Another area that COSL has identified as a potential success rates. new business is the servicing of fields that have heavy oil in offshore China. Typically, such services have been used onshore China at both Sinopec’s and PetroChina’s - 9 - Energy / China 2883 HK | CHOLY US 12 September 2012

mature and ageing fields, and have had limited COSL: historical and forecast return metrics application in China’s offshore fields. Such services 20% would be provided by the Well Services segment and include techniques such as steam injection (which 15% earned Rmb100m for 2011), acidification and fracturing. 10%

Financial overview 5%

COSL’s financial performance was strong over the 0% 2008 2009 2010 2011 2012E 2013E 2014E 2004-11 period, with the company recording revenue, ROACE Operating ROA ROAE operating profit, and net income CAGRs of 25%, 33%, and 28%, respectively. This growth was driven by all Source: Company, Daiwa forecasts four business segments. On the margin front, the company saw its operating- For 2011-14, we forecast CAGRs in operating-profit and profit margin expand from 18% for 2004 to 27% for net income of 12% and 13%, respectively. The 2011. This was a result of better pricing power due to Geophysical segment should see the fastest-growing higher demand for its services. We forecast COSL to operating profit, with a CAGR of 25% over the period. maintain its operating-profit margin in the 26-28% However, this segment is coming off a low base for range over the next 3-4 years. 2011, due to the shutdown of the Penglai 19-3 oilfield being as well as disruption to COSL’s Libya operations. Debt funding for growth We expect the Well Services and Marine Support and Up until 2007, the company had a net cash position, transportation segments to continue to continue to see but from 2008 onwards it moved into a net debt double-digit-percentage operating profit growth rates position, as it took on leverage in order to fund its over the next three years. acquisition of Awilco Offshore in 2008 for US$2.5bn. This deal increased COSL’s number of operating rigs to COSL: operating profit by segment and annual growth rates 22 from 15 at that time. 2011-14 Rmb m 2008 2009 2010 2011 2012E 2013E 2014E CAGR Drilling 2,118 2,748 3,505 3,429 3,689 4,028 4,162 7% At its peak in 2009, COSL’s net debt-to-equity ratio Well Services 471 743 814 449 636 869 1,015 31% stood at 121%, but this has since declined and we Marine Support 491 654 542 518 619 722 861 19% forecast its net debt-to-equity ratio to reach 51% by the Geophysical 551 323 339 586 1,107 1,165 1,132 25% Total operating profit 3,630 4,468 5,200 4,982 6,050 6,784 7,170 13% end of 2012. X YoY change Well Services 42% 30% 28% -2% 8% 9% 3% 1H12 results: solid outlook Marine Support 21% 58% 10% -45% 42% 37% 17% Geophysical 20% 33% -17% -4% 20% 17% 19% Total operating profit 2% -41% 5% 73% 89% 5% -3% On 21 August, COSL announced a 1H12 net profit of Source: Company, Daiwa forecasts Rmb2.4bn (up 16% YoY) that beat our and the Bloomberg-consensus forecasts by 5%. The net profit for In terms of returns, COSL’s ROE averaged about 13% 1H12 is equivalent to 52% of our new full-year forecast. over 2004-11, while its ROA and ROIC were in the mid- to-high single digits over the period, which we note is Volume and pricing growth in the key Drilling not unusual for an oilfield services company given the segment. The main highlight of the 1H12 results was asset-heavy nature of the business. strong pricing and volume growth in the key Drilling segment, which accounted for 68% of 1H12 operating profit. This segment saw a 19% YoY increase in operating days for 1H12 as new assets were put into operation, with semi-submersibles being the key contributor as they increased their operating days by nearly 56% YoY due to two new assets entering service.

Importantly, COSL’s rig rates improved YoY, with those for semi-submersibles up 48% YoY to nearly

- 10 - Energy / China 2883 HK | CHOLY US 12 September 2012

US$288,000/day, while those for jack-ups were Solid growth outlook. We believe CNOOC’s reasonably solid, up 2% YoY. guidance for high production-growth rates from 2013 onwards will underpin COSL’s own volume and profit Only the Drilling segment saw its margin growth. Importantly, COSL continues to expand its expand. The Drilling segment was the only one to see its international business, as evidenced by the 41% YoY operating-profit margin increase, up 2pp YoY to 38% for rise in overseas revenue for 1H12. 1H12, while the other three businesses (accounting for 32% of 1H12 operating profit) saw operating-profit International markets now make up 32% of COSL’s margin declines of 2-13pp YoY, with the Geophysical total revenue. We expect incremental profit growth segment recording the steepest contraction. This may over the next few years to come from the company’s indicate that for some of the smaller, less asset-heavy deepwater rigs operating both in offshore China and businesses, the company is witnessing margin erosion, internationally, with one semi-submersible mainly from increased competition in offshore China. We commencing operation in late 2012 (COSLPromoter) also believe that rises in labour and energy costs may well and another in mid-2015 (COSLProspector). be eating into margins. COSL: forecast revisions (%) COSL: operating-profit margins by business (1H12) Year to 31 Dec 12E 13E 14E Revenue change 0.6 0.5 (0.5) 50% Net-profit change 2.8 5.9 4.6 40.3% 38.0% EPS change 2.8 5.9 4.6 40% 36.1% Source: Daiwa forecasts 31.4% 30% 27.0% We are raising our EPS forecasts for COSL, as shown in 20.5% 17.3% the preceding table. Our new forecasts incorporate the 20% 15.5% following: 10% • higher day rate increases at its Drilling segment due to asset mix improvements, 0% Drilling Well services MS & T Geophysical • a reversion to mid-teens EBIT margins for the Well 1H11 1H12 Services segment in 2013-14 as CNOOC accelerates

Source: Company the development of its fields offshore China, and • a reversion to mid-20% EBIT margins for the COSL: 1H12 vs. 1H11 results RMB m 1H11 1H12 Change Marine Support & Transportation segment in 2013- Revenue 8,202.8 10,026.2 22.2% 2014 as CNOOC accelerates the development of its Depreciation and amortisation (1,540.7) (1,663.2) 7.9% fields offshore China, and as it phases out its older Employee compensation costs (1,319.1) (1,569.0) 18.9% vessels, thus improving average day rates. Repair and maintenance costs (251.8) (286.1) 13.6% Consumptions of supplies, etc. (1,288.5) (1,633.8) 26.8% Subcontracting expenses (465.6) (1,063.4) 128.4% Operating lease expenses (210.2) (298.5) 42.0% Other operating expenses (414.9) (446.0) 7.5% Other SG&A (62.9) (89.5) 42.3% Impairment of property and equipment (41.8) (27.4) -34.4% Operating profit 2,607.2 2,949.3 13.1% Exchange gain/(loss) 29.5 (32.0) -208.4% Finance costs (254.2) (229.4) -9.8% Interest income 38.4 68.4 77.9% Share of profits 90.0 133.7 48.6% Pre-tax profit 2,511.0 2,890.0 15.1% Income tax expense (436.4) (487.6) 11.7% Net profit 2,075 2,402 15.8% Minorities (3) (5) 51.6% Net profit after minorities 2,071 2,397 15.7% X Margins Operating-profit margin 31.8% 29.4% -2.4ppt Pre-tax margin 30.6% 28.8% -1.8ppt Net profit margin (post MI) 25.3% 23.9% -1.3ppt X Tax rate 17.4% 16.9% -0.5ppt Source: Company

- 11 - Energy / China 2883 HK | CHOLY US 12 September 2012

operating base in China, its unique geographic advantage (explained earlier in this report) and its highly experienced operating team should ensure market dominance for the forseeable future, in our view.

Valuation PER valuation: HK$17.82/share We assign an unchanged target 2013E PER multiple for We like the stock for its exposure to COSL of 11.6x, representing about a 30% discount to continued exploration activity in offshore the stock’s historical (2003-11) average PER of 16.5x, which reflects our expectation of slower earnings China, while asset-mix improvements growth compared with the 2004-10 period. Our 11.6x should lead to margin expansion. target PER is in line with the Asia oil services sector’s average 2013E PER of 11.5x (based on our EPS forecasts), which we believe is fair given the quasi- Upgrading to Buy monopoly hold that COSL has in offshore China waters.

We are upgrading our rating to Buy (1) from COSL: PER bands Outperform (2). Our six-month target price, based on (HK$/share) the average of our implied 2013E PBR- and PER- 35 31x derived values, is unchanged at HK$15.00, suggesting 30 15% upside potential from the current share price level. 25 24x We like the company’s exposure to offshore China, which we believe remains underexplored even after the 20 17x past 10 years of exploration activity by CNOOC, and the 15 stock’s 2013E PER of 8.7x (based on our EPS forecast) 10 10x is undemanding. 5 0 The fact that CNOOC has continued to have good Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Apr-08 Apr-09 Apr-10 Apr-11 Apr-12 Oct-07 Oct-08 Oct-09 Oct-10 Oct-11 Jan-08 Jan-09 Jan-10 Jan-11 exploration success in offshore China over the past six Jan-12 months (as seen in the following table) shows that the Source: Bloomberg area remains highly prospective. We believe this high exploratory success should see oil and gas production PBR valuation: HK$12.26/share in offshore China increase by at least 50% over the next Given the company’s asset-heavy nature, we also use an five years, based on CNOOC’s proven undeveloped unchanged target PBR, which we peg at 1.0x. This is reserves, and if we include the drilling successes in the 11% above COSL’s historical (2003-11) low PBR past 12 months (which are unlikely to have been valuation of 0.9x, which we view as fair given that 45% booked to reserves yet), then this production growth of its rigs are more than five years old. In a worst-case should continue well into the latter part of this decade. scenario, we note that periods of recession tend to see a contraction in PBR multiples towards trough values. CNOOC: discoveries in 2012 to date However, given the level at which the stock is trading Date Field Location Type Oil/gas Pay zone Test bpd Water (metres) or depth currently, there is little downside risk on this front, in mmcfpd (metres) our view. At a PBR of 0.9x for 2013E, it would trade at 17 Apr Penglai 15-2-1 Eastern Bohai E Oil 83 1,200 25 HK$11.30, or 9% below the current share price level. 17 Apr Penglai 9-1-5 Eastern Bohai A Oil 200 700 25 20 Apr Dongfang 13-2 Yinggehai Basin, E Gas 35 42 65 WSCS At our 1x PBR valuation of HK$12.56, COSL would 24 May Luda 21-2 Liaodong Bay, Bohai E Oil 170 608 20 trade on an equivalent 2012 PER of 8.4x which is a 14 Aug Qinhuangdao Central North Bohai A Oil 218 6,600 27 29-2E-4 49% discount to its 2003-11 average PER of 16.5x. A Gas 5 20 Aug Luda 6-2-5 Liaodong Bay, Bohai E Oil 40 850 31 20 Aug Lufeng 15-1-2 Pearl River Mouth E Oil 148 800 148 Source: CNOOC Note: E = exploration well; A = appraisal well

We expect COSL to remain the dominant supplier of oil services to this industry in offshore China; hence its earnings growth aspects appear favourable. Its low-cost

- 12 - Energy / China 2883 HK | CHOLY US 12 September 2012

COSL: PBR bands obviously correlate with the global oil services industry, (HK$/share) which can also be split roughly into the same business 35 segments. We note, however, that most of COSL’s 4x 30 comparables specialise in one or two of these 25 businesses and are not integrated to the extent that 3x 20 COSL is.

15 2x COSL valuation using 2013E EV/EBITDA comps 10 EV/EBITDA COSL EBITDA Valuation 1x 5 (x) (Rmb m) (Rmb m) Drilling 10.1 6,470 65,191 0 Well Services 10.3 1,544 15,868 Marine Support 9.5 1,099 10,440 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Sep-07 Sep-08 Sep-09 Sep-10 Sep-11 May-08 May-09 May-10 May-11 May-12 Geophysical 10.3 1,570 16,201 Source: Bloomberg Equity value 107,701 less: net debt (17,601) Enterprise value 90,099 Comparison of valuations globally indicate x COSL is undervalued Value per share (HK$/share) 15.42 Using a 2012E EV/EBITDA multiple for COSL based Source: Daiwa estimates on comparable oil-services companies globally, we EV/EBITDA comparison for 2013E (x) value the company at HK$15.42/share, also indicating that the company is undervalued. In such a valuation 12 10.5 10.8 10.1 10.1 methodology, we take into account the company’s four 9.5 10 business segments: Drilling, Well Services, Marine 8 Support, and Geophysical. The Asia-Pacific region does 5.9 not have a peer group of a similar size and business mix, 6 hence we use its US and Europe peers as well to 4 provide a better comparative universe. 2

We highlight that there is a wide difference between 0 COSL’s US and Europe peers in terms of size, business COSL Marine European Oil Offshore Seismic Well Support Services Drillers Services lines, free float, etc., leading to meaningful valuation disparities, as can be seen from the table on page 14. Source: Bloomberg, Daiwa estimates Note: Priced as at 11 September 2012 We believe EV/EBITDA is a good valuation metric to use in valuing COSL, as it is provides a gauge of the company’s operational performance against its peers globally. COSL has four business segments that

- 13 - Energy / China 2883 HK | CHOLY US 12 September 2012

Oilfield services: comparable companies globally Company Bloomberg Share MTD YTD Mkt. cap PER EV/EBITDA PBR Yield code price gain gain ($USm) FY1E2 FY13E FY14E FY12E FY13E FY14E FY12E FY12E FY13E Offshore drillers DIAMOND OFFSHORE DRILLING DO.US 67.41 0.6% 26.2% $9,372 15.0x 12.5x 9.0x 7.5x 6.4x 4.8x 2.0x 5.3% 5.4% ROWAN COMPANIES PLC-A RDC.US 36.64 4.2% 20.8% $4,551 17.7x 10.3x 7.5x 9.8x 6.7x 5.2x 1.0x 0.0% 0.0% ATWOOD OCEANICS INC ATW.US 47.77 3.2% 20.1% $3,122 12.1x 9.4x 7.0x 9.9x 7.1x 5.4x 1.6x 0.0% 0.0% HELMERICH & PAYNE HP.US 46.95 2.9% -19.6% $4,962 9.3x 9.8x 9.1x 4.1x 4.1x 3.8x 1.3x 0.6% 0.6% ENSCO PLC-CL A ESV.US 56.77 -1.0% 21.0% $13,170 10.7x 8.0x 6.8x 8.6x 6.5x 5.9x 1.1x 2.7% 2.7% NOBLE CORP NE.US 36.75 -3.6% 22.9% $9,283 14.1x 8.1x 6.1x 8.3x 5.8x 4.7x 1.1x 1.6% 1.4% TRANSOCEAN LTD RIG.US 45.95 -6.3% 19.7% $16,514 15.4x 9.6x 7.4x 7.3x 5.7x 5.0x 1.0x 1.3% 2.3% SEADRILL LTD SDRL.NO 232.10 -2.6% 16.5% $18,850 12.9x 11.4x 9.1x 11.5x 9.8x 7.9x 3.0x 1.5% 1.5% FRED OLSEN ENERGY ASA FOE.NO 239.80 -2.5% 25.2% $2,768 8.7x 7.7x 6.9x 6.0x 5.6x 5.1x 1.9x 8.3% 8.3% PACIFIC DRILLING SA PACD.US 9.75 1.6% 4.8% $2,048 43.1x 19.2x 8.2x 13.1x 9.1x 5.7x 0.9x 0.0% 0.0% ABAN OFFSHORE LTD ABAN.IN 432.70 7.9% 26.2% $339 5.3x 5.1x 4.7x 6.4x 6.5x 6.0x 0.7x 0.8% 0.8% Mean 14.9x 10.1x 7.4x 8.4x 6.7x 5.4x 1.4x 2.0% 2.1% Median 12.9x 9.6x 7.4x 8.3x 6.5x 5.2x 1.1x 1.3% 1.4% X Well Services BAKER HUGHES INC BHI.US 46.65 2.3% -4.1% $20,505 12.5x 10.9x 8.6x 5.9x 5.2x 4.2x 1.2x 1.3% 1.3% HALLIBURTON CO HAL.US 34.27 4.6% -0.7% $31,794 10.7x 9.8x 7.6x 5.4x 5.0x 4.0x 2.0x 1.1% 1.1% NABORS INDUSTRIES LTD NBR.US 15.35 3.9% -11.5% $4,457 8.3x 8.3x 6.5x 4.2x 4.1x 3.7x 0.7x 0.0% 0.0% NATIONAL OILWELL VARCO INC NOV.US 81.02 2.8% 19.2% $34,549 13.6x 11.9x 10.2x 7.8x 6.8x 6.0x 1.7x 0.6% 0.6% PRECISION DRILLING CORP PD.CN 8.20 12.5% -21.9% $2,320 8.2x 8.0x 6.3x 4.2x 4.0x 3.6x 0.9x 0.0% 0.0% PATTERSON-UTI ENERGY INC PTEN.US 15.71 3.4% -21.4% $2,384 8.4x 11.5x 8.6x 2.9x 3.2x 2.8x 0.9x 1.3% 1.3% SCHLUMBERGER LTD SLB.US 72.69 0.4% 6.4% $96,462 16.9x 14.2x 11.5x 9.1x 8.0x 6.7x 2.7x 1.5% 1.6% WEATHERFORD INTL LTD WFT.US 12.65 7.6% -13.6% $9,609 11.5x 8.7x 6.1x 5.4x 4.6x 3.8x 0.9x 0.0% 0.0% KEY ENERGY SERVICES INC KEG.US 8.59 8.6% -44.5% $1,298 9.4x 8.0x 4.4x 4.5x 3.8x 2.8x 1.0x 0.0% 0.0% OCEANEERING INTL INC OII.US 54.60 2.0% 18.4% $5,892 20.6x 16.9x 14.4x 10.0x 8.7x 7.3x 3.3x 1.3% 1.3% Mean 12.0x 10.8x 8.4x 5.9x 5.3x 4.5x 1.5x 0.7% 0.7% Median 11.1x 10.3x 8.1x 5.4x 4.8x 3.9x 1.1x 0.8% 0.8% X European Oil Services SAIPEM SPA SPM.IM 37.55 -0.5% 14.3% $12,965 16.1x 13.8x 12.2x 8.8x 7.9x 7.4x 3.1x 2.0% 2.5% WOOD GROUP (JOHN) PLC WG/.LN 8.49 3.4% 32.4% $1,970 9.9x 8.7x 7.5x 10.1x 8.7x 7.9x 1.4x 2.1% 2.5% PETROFAC LTD PFC.LN 15.97 6.3% 10.8% $3,454 8.6x 7.6x 6.6x 8.8x 7.3x 6.3x 3.8x 3.9% 4.3% SBM OFFSHORE NV SBMO NA 11.98 6.6% -24.7% $1,608 5.0x 4.4x 4.1x 5.5x 4.8x 4.6x 1.2x 7.4% 8.6% SUBSEA 7 SA SUBC.NO 135.00 1.4% 27.0% $8,219 15.9x 12.3x 9.7x 7.4x 5.9x 5.0x 1.4x 0.3% 0.3% TECHNIP SA TEC.FP 86.01 2.7% 18.4% $7,599 18.6x 13.9x 11.5x 9.4x 7.3x 6.3x 2.5x 1.9% 2.4% Mean 12.4x 10.1x 8.6x 8.3x 7.0x 6.2x 2.2x 3.0% 3.4% Median 12.9x 10.4x 8.6x 8.8x 7.3x 6.3x 2.0x 2.1% 2.5% X Marine Support GULFMARK OFFSHORE INC-CL A GLF.US 34.37 -2.0% -18.2% $926 18.6x 8.7x 7.6x 8.2x 5.5x 5.0x 0.9x 0.0% 0.0% SEACOR HOLDINGS INC CKH.US 86.14 0.2% -3.2% $1,805 26.6x 12.4x 11.5x 8.7x 6.0x 5.8x 0.9x 0.0% 0.0% TIDEWATER INC TDW.US 48.84 3.0% -0.9% $2,434 14.1x 9.5x 8.4x 8.0x 6.5x 5.9x 0.9x 2.0% 2.0% HORNBECK OFFSHORE SERVICES HOS.US 38.66 -0.5% 24.6% $1,368 27.5x 14.3x 8.6x 8.4x 6.2x 4.5x 1.2x 0.0% 0.0% ASL MARINE HOLDINGS LTD ASL.SP 0.62 2.5% 21.6% $212 6.1x 6.3x 6.2x 4.2x 4.2x 4.4x 0.7x 3.5% 3.9% EZRA HOLDINGS LTD EZRA.SP 1.13 4.7% 33.9% $890 16.1x 12.1x 9.3x 13.9x 10.2x 8.3x 1.1x 0.2% 0.3% SCOMI MARINE BERHAD SMB.MK 0.31 -8.8% 31.0% $73 6.1x 5.7x 5.3x 1.7x 1.6x 1.4x 0.5x 0.0% 0.0% FARSTAD SHIPPING FAR.NO 137.00 -1.4% -9.3% $925 10.6x 7.1x 6.5x 7.5x 6.0x 5.7x 0.8x 3.8% 3.9% Mean 15.7x 9.5x 7.9x 7.6x 5.8x 5.1x 0.9x 1.2% 1.3% Median 15.1x 9.0x 8.0x 8.1x 6.0x 5.3x 0.9x 0.1% 0.1% X Seismic CIE GENERALE DE GEOPHYSIQUE GA.FP 23.90 3.6% 31.8% $2,839 21.4x 11.1x 8.7x 5.2x 4.2x 3.8x 1.1x 0.0% 0.1% TGS NOPEC GEOPHYSICAL TGS.NO 179.70 6.1% 35.6% $3,216 12.5x 11.2x 10.5x 4.1x 3.8x 3.6x 2.8x 0.6% 0.7% PETROLEUM GEO-SERVICES PGS.NO 93.80 6.5% 43.3% $3,536 19.7x 10.9x 8.8x 5.0x 4.2x 3.8x 1.8x 0.2% 0.5% ION GEOPHYSICAL CORP IO.US 7.19 10.1% 17.3% $1,121 16.0x 11.2x NA 5.5x 4.4x NA NA 0.0% 0.0% DAWSON GEOPHYSICAL CO DWSN.US 22.52 5.9% -43.0% $181 15.4x 11.9x NA 2.7x 2.4x NA NA 0.0% 0.0% GLOBAL GEOPHYSICAL SERVICES GGS.US 5.51 20.0% -18.0% $206 8.7x 6.9x NA 1.9x 2.1x NA NA 0.0% 0.0% Mean 15.6x 10.5x 9.3x 4.1x 3.5x 3.7x 1.9x 0.1% 0.2% Median 15.7x 11.2x 8.8x 4.6x 4.0x 3.8x 1.8x 0.0% 0.0% X Oil-services mean 14.1x 10.2x 8.1x 7.0x 5.7x 5.1x 1.5x 1.4% 1.5% Oil-services median 12.9x 9.8x 7.9x 7.4x 5.8x 5.0x 1.2x 0.6% 0.7% Source: Bloomberg Note: Prices, in local currencies, as at 11 September 2012

- 14 - Energy / China 2883 HK | CHOLY US 12 September 2012

In its 2012 annual report, COSL stated that should the US dollar depreciate by 5%, its net profit would Risks increase by 1% due to its US dollar-denominated debt. The company does not hedge its foreign-exchange Demand for oil services exposure currently and has no plans to do so. COSL operates in the oil and gas industry, and is therefore exposed to risks in the commodity prices of oil and gas. Such prices can have an impact on activity in offshore China and the corresponding capital spending by oil and gas companies, such as CNOOC. This could have a negative effect on the demand for COSL’s services and products, which would affect the company’s profit margin and EBITDA.

Relationship with CNOOC A large proportion of COSL’s turnover is derived from its principal customer, CNOOC. Although CNOOC is affiliated with COSL, there is no assurance that CNOOC will continue to use the company’s services and products, or use it to the extent that it has in the past.

Capex The capex plan that COSL has in place is subject to risks beyond the company’s control, including the ability to generate sufficient cash flow from operations and the availability and terms of external financing. Should acceptable financing be unavailable, COSL’s business and financial conditions would be adversely affected.

Seasonal variations Oilfield services in offshore China are affected by seasonal variations, such as winter conditions and typhoons, which are unpredictable and may have a material impact on the company operations and financial results. We note that in January 2011 and January 2012, Bohai Bay (which accounted for 47% of CNOOC’s total oil and gas production) saw the formation of material amounts of sea ice, which affected the passage of marine vessels.

Foreign-exchange movements COSL requires substantial foreign currency to buy its capital equipment. Most of the company’s turnover is denominated in Renminbi, and thus the company needs to convert this into foreign currency in order to meet these obligations. A devaluation of the Renminbi and exchange-rate fluctuations could have an adverse effect on the company’s operations and financial condition. A depreciation of the Renminbi and exchange-rate movements could also have an adverse impact on the value, translated or converted into US dollars or Hong Kong dollars, of COSL’s net assets and earnings.

- 15 - Energy / China 2883 HK | CHOLY US 12 September 2012

COSL is a well-capitalised company with strong relationships with its client companies, which include most of the oil majors. Its major client is CNOOC Ltd, from which it derives more than 65% of its revenue. In our view, the company’s major businesses have a high Company background degree of earnings visibility for at least 6-12 months, as well as positive momentum given that development COSL provides oilfield services primarily plans for many fields in offshore China are in place. in the offshore China market, which has Sources of COSL’s revenue experienced considerable growth in 100% exploration, development and production in the past five years. 80% 60%

Introduction 40% 65.5% 65.0% COSL provides oilfield services primarily in the 20% offshore China market. Such services, offered as either 0% standalone services or on an integrated basis, cover 2010 2011 each phase of exploration, development and % from CNOOC % others production in the offshore oil and natural gas industry. Source: Company China’s offshore oil industry has experienced Note: CNOOC denotes both the parent company as well as the listed company considerable growth in exploration, development and production in the past five years (2006-2011), COSL can be seen in terms of four discrete business recording a CAGR of 3.3% in oil reserves and a CAGR segments, as follows: of 11.7% in production. We believe that COSL will • Drilling continue to be a major beneficiary of this growth. • Well Services Corporate structure • Marine Support & Transportation COSL is a subsidiary of the China National Offshore Oil Corporation, which also has three other listed entities. • Geophysical Prior to its reorganisation in December 2001, COSL provided oilfield services through various antecedent COSL’s value chain entities of CNOOC. However, prior to its COSL’s IPO in Exploration Development Production 2002, the drilling, well services and geophysical •Drilling fluids •Drilling fluids Seismic •Directional drilling •Directional drilling •Well workovers •Cementing •Cementing services operations were consolidated, and a statutory •Production logging •Logging •Logging merger was undertaken with the marine support and Survey •Well completion •Well completion well services Geophysical & & Geophysical transportation subsidiary. Well workover Platform Producing team Wildcat well Appraisal Development installation platforms (3rd Structure of the CNOOC Group drilling well drilling well drilling (3rd party) party) Drilling

China National Offshore Oil Corporation •Shuttle tankers •FPSO (Parent company) •Towing and •Towing and •Standby management achoring achoring vessels •Terminal •Supply •Supply •Supply vessels management

Shipping •Support team •Support team •Crew boats •Support team China Oilfield CNOOC Offshore Oil CNOOC Ltd Source: Company, Daiwa Services Ltd Engineering China Blue Chemical (883 HK) (3983 HK) (2883 HK) (600583 CH) Float: 35.55% Float: 38.96% Float: 46.37% Float: 43.33% Market cap: US$84.6bn Market cap: US$2.6bn Market cap: US$10.1bn Market cap: US$3.5bn As shown in the preceding chart, COSL is in a unique position within its industry to offer oil companies

Exploration & Fertilizers & Oil services Marine engineering drilling in offshore China a ‘one-stop shop’ for their production chemicals drilling needs.

Source: Companies, Bloomberg

- 16 - Energy / China 2883 HK | CHOLY US 12 September 2012

COSL: 1H12 operating profit contribution by segment offshore China will remain its primary focus, since it is a market with strong, stable demand and improving Geophysical 11.4% margins. At the end of 1H12, of its 34 rigs, 21 were operating in offshore China and 13 internationally. MS & T 9.7% Well Services

Well services 11.1% Well Services involves logging, drilling fluids, directional drilling, cementing, well completion and Drilling 67.8% well workovers. The services are offered on a stand- alone or integrated basis, ie, well services can be ‘bundled’ with drilling and/or geophysical services. The Source: Company services in this segment can be quite technically demanding, and COSL has formed a number of joint ventures, allowing it to tap the technology and Drilling experience of leading oil service companies such as Baker Hughes, Schlumberger and Halliburton. Drilling is conducted via 34 drilling rigs, four modular rigs and eight land rigs. The company also has two In 1H12, Well Services contributed around 11% of accommodation rigs in service. However, arguably the COSL’s operating profit, down from the segment’s most important assets within this segment are its 27 20%-plus contribution in 2001. jack-up rigs and seven semi-submersible rigs (data as at the end of 1H12). From 1967 through to the end of Outlook 2011, we estimate that COSL has drilled nearly 1,000 Over 2011-14, we forecast a 31% CAGR in the Well exploration wells and some 1,300 development wells. Services segment’s operating profit, due mainly to a

Growth in COSL’s drilling fleet low earnings base for 2011 as a result of the Penglai 19- 3 oil spill. (No. of rigs) 40 34

30 7 Marine Support and 22 Transportation 20 3 12 27 The Marine Support and Transportation (MS&T) 10 3 19 business is carried out by the company’s fleet of 72 9 utility vessels, three oil tankers and five chemical 0 2002 2008 2012E tankers. This segment is the most domestically focused of COSL’s four businesses, as such services are low- Jack-ups Semi-submersible technology in nature and have modest barriers to entry Source: Company, Daiwa forecasts in other countries. In addition, the vessels are low in cost compared with seismic vessels or drilling rigs, In 1H12, drilling contributed around 68% of COSL’s which again presents a low barrier to entry. operating profit. Over the past eight years COSL’s jack- up utilisation rates have averaged over 93%, while for In 1H12, the MS&T business contributed slightly less semi-subs the figure has averaged 92%. This has led to than 10% of COSL’s operating profit. Nevertheless, the COSL’s EBIT margin in its Drilling segment expanding strength of this segment is its utilisation rates, which to 36% in 2011, from 22% in 2004, making Drilling the have been very steady, averaging nearly 95% from segment with the largest EBIT margin within COSL. 2004-11, while average day rates for all types of vessels increased by 16% CAGR over the same period. Outlook We forecast a 5% CAGR in the Drilling segment’s Outlook operating profit over 2011-14, driven by a combination We forecast a 13% CAGR in the MS&T business’s of slightly higher dayrates (we forecast a 3% CAGR in operating profit over 2011-14, driven mainly by rises in COSL’s average dayrates over 2011-14) and a new semi- operating days as the volume of work increases in sub due to enter service in 2H14. COSL has stated that offshore China. The company’s plans to scrap its older

- 17 - Energy / China 2883 HK | CHOLY US 12 September 2012

vessels are unknown at this stage and thus represent a COSL’s seismic vessel on the Yangon River in March 2012 risk to our earnings forecasts. Still, in 1H12, the company stated that it has retired three vessels, while twos have been upgraded and modified into geophysical vessels (and thus transferred to the Geophysical segment). On the other hand, one growth area for this segment may be in high-specification deepwater utility vessels used to service deepwater areas in offshore China, which are starting to see heightened activity this year.

MS&T segment’s average fleet age

(Age: Years) Source: Daiwa 25 22 Growth in COSL’s geophysical fleet

20 18 (no. of vessels) 15 18 15 15

10 12 7 4 9 5 3 2 6 0 8 3 6 7 2002 2008 2012E 0 Source: Company 2002 2008 2012E Seismic Vessels OBC Teams Survey Vessels

Geophysical Source: Company Note: OBC = Ocean Bottom Cable The Geophysical business involves seismic collection and surveying. Work is carried out by eight seismic ships and five integrated marine survey ships. This is probably the most internationally focused of COSL’s divisions, as its fleet has worked in the Gulf of Mexico, Brazil, Spain, West Africa, and other locations.

Two of COSL’s fleet of marine survey vessels have onboard drilling rigs, such that they can be used as geotechnical coring vessels. COSL also has a 50% survey joint venture with Thales GeoSolutions Ltd, which focuses on site surveys, cable and pipeline surveys. In 1H12, this segment contributed around 11% of COSL’s operating profit, a meaningful increase from the 5% contribution in 2001.

Outlook We forecast a 27% CAGR in the division’s operating profit over 2011-14, driven by both volume and price increases. The company had one deepwater survey vessel (HYSY 708) that started operations in April 2012, while two other vessels that entered operations in 2H11 and operated at full capacity in 1H12.

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Daiwa’s Asia Pacific Research Directory

HONG KONG SOUTH KOREA Nagahisa MIYABE (852) 2848 4971 [email protected] Chang H LEE (82) 2 787 9177 [email protected] Regional Research Head Head of Korea Research; Strategy; Banking/Finance John HETHERINGTON (852) 2773 8787 [email protected] Sung Yop CHUNG (82) 2 787 9157 [email protected] Regional Head of Product Management Pan-Asia Co-head/Regional Head of Automobiles and Components; Automobiles; Pranab Kumar SARMAH (852) 2848 4441 [email protected] Shipbuilding; Steel Regional Head of Research Promotion Anderson CHA (82) 2 787 9185 [email protected] Mingchun SUN (852) 2773 8751 [email protected] Banking/Finance Head of China Research; Chief Economist (Regional) Mike OH (82) 2 787 9179 [email protected] Dave DAI (852) 2848 4068 [email protected] Capital Goods (Construction and Machinery) Deputy Head of Hong Kong and China Research; Pan-Asia/Regional Head of Clean Sang Hee PARK (82) 2 787 9165 [email protected] Energy and Utilities; Utilities; Power Equipment; Renewables (Hong Kong, China) Consumer/Retail Kevin LAI (852) 2848 4926 [email protected] Jae H LEE (82) 2 787 9173 [email protected] Deputy Head of Regional Economics; Macro Economics (Regional) IT/Electronics (Tech Hardware and Memory Chips) Chi SUN (852) 2848 4427 [email protected] Thomas Y KWON (82) 2 787 9181 [email protected] Macro Economics (China) Pan-Asia Head of Internet & Telecommunications; Software (Korea) – Internet/On-line Game Jonas KAN (852) 2848 4439 [email protected] Shannen PARK (82) 2 787 9184 [email protected] Head of Hong Kong Research; Head of Hong Kong and China Property; Regional Custom Products Group Property Coordinator; Property Developers (Hong Kong) Jeff CHUNG (852) 2773 8783 [email protected] TAIWAN Automobiles and Components (China) Mark CHANG (886) 2 8758 6245 [email protected] Grace WU (852) 2532 4383 [email protected] Head of Research; Regional Head of Small/Medium Cap; Small/Medium Cap (Regional) Head of Greater China FIG; Banking (Hong Kong, China) Yoshihiko KAWASHIMA (886) 2 8758 6247 [email protected] Jerry YANG (852) 2773 8842 [email protected] Consumer/Retail Banking/Diversified Financials (Taiwan) Birdy LU (886) 2 8758 6248 [email protected] Joseph HO (852) 2848 4443 [email protected] IT/Technology Hardware (Handsets and Components) Head of Industrials and Machineries (Hong Kong, China); Capital Goods –Electronics Equipments and Machinery (Hong Kong, China) Christine WANG (886) 2 8758 6249 [email protected] Bing ZHOU (852) 2773 8782 [email protected] IT/Technology Hardware (PC Hardware) Consumer/Retail (Hong Kong, China) Chris LIN (886) 2 8758 6251 [email protected] Hongxia ZHU (852) 2848 4460 [email protected] IT/Technology Hardware (Panels) Consumer, Pharmaceuticals and Healthcare (China) Eric CHEN (852) 2773 8702 [email protected] INDIA Pan-Asia/Regional Head of IT/Electronics; Semiconductor/IC Design (Regional) Punit SRIVASTAVA (91) 22 6622 1013 [email protected] Felix LAM (852) 2532 4341 [email protected] Head of Research; Strategy; Banking/Finance Head of Materials (Hong Kong, China); Cement and Building Materials (China, Navin MATTA (91) 22 6622 8411 [email protected] Taiwan); Property (China) Automobiles and Components John CHOI (852) 2773 8730 [email protected] Saurabh MEHTA (91) 22 6622 1009 [email protected] Head of Multi-Industries (Hong Kong, China); Small/Mid Cap (Regional); Capital Goods; Utilities Internet (China) Mihir SHAH (91) 22 6622 1020 [email protected] Kelvin LAU (852) 2848 4467 [email protected] FMCG/Consumer Head of Transportation (Hong Kong, China); Hong Kong and China Research Deepak PODDAR (91) 22 6622 1016 [email protected] Coordinator; Transportation (Regional) Materials Jibo MA (852) 2848 4489 [email protected] Head of Custom Products Group; Custom Products Group Nirmal RAGHAVAN (91) 22 6622 1018 [email protected] Oil and Gas; Utilities Thomas HO (852) 2773 8716 [email protected] Custom Products Group SINGAPORE Tony DARWELL (65) 6321 3050 [email protected] PHILIPPINES Head of Singapore Research, Pan-Asia Head of Property Rommel RODRIGO (63) 2 813 7344 [email protected] ext 302 Srikanth VADLAMANI (65) 6499 6570 [email protected] Head of Philippines Research; Strategy; Capital Goods; Materials Banking (ASEAN) Danielo PICACHE (63) 2 813 7344 [email protected] Adrian LOH (65) 6499 6548 [email protected] ext 293 Regional Head of Oil and Gas; Oil and Gas (ASEAN and China); Capital Goods (Singapore) Property; Banking; Transportation – Port David LUM (65) 6329 2102 [email protected] Property and REITs Ramakrishna MARUVADA (65) 6499 6543 [email protected] Head of ASEAN & India Telecommunications; Telecommunications (ASEAN & India)

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Daiwa’s Offices Office / Branch / Affiliate Address Tel Fax DAIWA SECURITIES GROUP INC HEAD OFFICE Gran Tokyo North Tower, 1-9-1, Marunouchi, Chiyoda-ku, Tokyo, 100-6753 (81) 3 5555 3111 (81) 3 5555 0661 Daiwa Securities Trust Company One Evertrust Plaza, Jersey City, NJ 07302, U.S.A. (1) 201 333 7300 (1) 201 333 7726 Daiwa Securities Trust and Banking (Europe) PLC (Head Office) 5 King William Street, London EC4N 7JB, United Kingdom (44) 207 320 8000 (44) 207 410 0129 Daiwa Europe Trustees (Ireland) Ltd Level 3, Block 5, Harcourt Centre, Harcourt Road, Dublin 2, Ireland (353) 1 603 9900 (353) 1 478 3469

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DCMA Market Making For “DCMA Market Making” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action.

Research Analyst Conflicts For updates on “Research Analyst Conflicts” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. The principal research analysts who prepared this report have no financial interest in securities of the issuers covered in the report, are not (nor are any members of their household) an officer, director or advisory board member of the issuer(s) covered in the report, and are not aware of any material relevant conflict of interest involving the analyst or DCMA, and did not receive any compensation from the issuer during the past 12 months except as noted: no exceptions.

Research Analyst Certification For updates on “Research Analyst Certification” and “Rating System” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. The views about any and all of the subject securities and issuers expressed in this Research Report accurately reflect the personal views of the research analyst(s) primarily responsible for this report (or the views of the firm producing the report if no individual analysts[s] is named on the report); and no part of the compensation of such analyst(s) (or no part of the compensation of the firm if no individual analyst[s)] is named on the report) was, is, or will be directly or indirectly related to the specific recommendations or views contained in this Research Report. The following explains the rating system in the report as compared to relevant local indices, based on the beliefs of the author of the report. "1": the security could outperform the local index by more than 15% over the next six months. "2": the security is expected to outperform the local index by 5-15% over the next six months. "3": the security is expected to perform within 5% of the local index (better or worse) over the next six months. "4": the security is expected to underperform the local index by 5-15% over the next six months. "5": the security could underperform the local index by more than 15% over the next six months. Additional information may be available upon request. Japan - additional notification items pursuant to Article 37 of the Financial Instruments and Exchange Law (This Notification is only applicable where report is distributed by Daiwa Securities Co. Ltd.)

If you decide to enter into a business arrangement with us based on the information described in materials presented along with this document, we ask you to pay close attention to the following items. • In addition to the purchase price of a financial instrument, we will collect a trading commission* for each transaction as agreed beforehand with you. Since commissions may be included in the purchase price or may not be charged for certain transactions, we recommend that you confirm the commission for each transaction. • In some cases, we may also charge a maximum of ¥ 2 million (including tax) per year as a standing proxy fee for our deposit of your securities, if you are a non-resident of Japan. • For derivative and margin transactions etc., we may require collateral or margin requirements in accordance with an agreement made beforehand with you. Ordinarily in such cases, the amount of the transaction will be in excess of the required collateral or margin requirements. • There is a risk that you will incur losses on your transactions due to changes in the market price of financial instruments based on fluctuations in interest rates, exchange rates, stock prices, real estate prices, commodity prices, and others. In addition, depending on the content of the transaction, the loss could exceed the amount of the collateral or margin requirements. • There may be a difference between bid price etc. and ask price etc. of OTC derivatives handled by us. • Before engaging in any trading, please thoroughly confirm accounting and tax treatments regarding your trading in financial instruments with such experts as certified public accountants. *The amount of the trading commission cannot be stated here in advance because it will be determined between our company and you based on current market conditions and the content of each transaction etc.

When making an actual transaction, please be sure to carefully read the materials presented to you prior to the execution of agreement, and to take responsibility for your own decisions regarding the signing of the agreement with us.

Corporate Name: Daiwa Securities Co. Ltd. Financial instruments firm: chief of Kanto Local Finance Bureau (Kin-sho) No.108 Memberships: Japan Securities Dealers Association, The Financial Futures Association of Japan Japan Investment Advisers Association Type II Financial Instruments Firms Association

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