DURING CRUDE OIL'S BULL RUN, Sinopec played the part of ugly sister, while the two other listed Chinese oil majors, CNOOC and PetroChina, were belles of the ball. Now with crude at about $60 a barrel -- 23% below its peak -- and Beijing edging toward oil-product pricing reforms, investors should re-examine Sinopec's charms, some analysts and fund managers say.
Sinopec , or China Petroleum & Chemical (ticker: SNP), is largely a downstream operator. Only 8.7% of its 493 billion Chinese yuan ($62.4 billion) first-half operating revenues came from exploration and production. The rest mainly was from refining, marketing, distribution and petrochemical production. Beijing lets crude-oil prices move in line with international markets -- but has controls on refined-oil products to avoid civil unrest. In the past two years, this has hurt Sinopec, which is listed in Hong Kong, Shanghai, New York and London. Losing money for each barrel of oil it refines, it has remained profitable overall, thanks to its high-margin oil-production operations -- and subsidies from the government.
In this year's first half, Sinopec netted CNY21.4 billion, 8.9% above the year-earlier level. Before interest and tax, exploration and production contributed CNY33.3 billion in earnings, while refining posted a CNY16.6 billion loss. Last year, exploration and production provided 70% of Sinopec's profit, despite contributing less than 10% of revenue, says brokerage Core Pacific-Yamaichi.
Now, Sinopec's refining losses have finally stopped, Lehman Brothers said in a recent research note. Comments Gordon Kwan, an analyst with CLSA Asia-Pacific Markets: "The rest of the world's [oil majors] are suffering, but Sinopec is laughing all the way to the bank." He rates the stock Outperform and says its Hong Kong-listed shares are heading toward his target of HK$6. "At this point, Sinopec's valuation is still attractive," he adds. The stock, recently at HK$5.31, is about 13% below his target.
Observes Lehman Brothers: "Sinopec remains the cheapest sector stock in terms of price-earnings, at only 6.5 times" its estimated earnings for next year.
Rival PetroChina (PTR) is predominantly an upstream play, while CNOOC (CEO) is China's sole offshore producer. Analysts have only just begun marking down their earnings forecasts, while waiting to see if oil can meaningfully rebound. The same rationale likely explains why they've only just begun to upgrade their views on Sinopec.
CNOOC's earnings per share are expected to fall only 6.8% next year, despite oil's price plunge, according to Thomson Financial's consensus estimate, while PetroChina's are expected to stay flat.
Sinopec's profits are expected to rise 13%, according to Thomson, but that forecast could easily prove to be conservative, given the leverage within its refining operations. Lawrence Lau, an analyst with BOCI Research, thinks that earnings could jump by up to 45% next year; he has one of the highest price targets for the stock: HK$6.89; it's now some 24% below that.
The Chinese refinery sector has drawn investment from foreign firms such as ExxonMobil (XON) and Saudi Aramco. Keeping price controls in place may discourage further investment, warns Steven Yuan of Sun Hung Kai Financial Group. However, he expects "a more flexible pricing regime going forward."
Another reason to like Sinopec is the long-term potential of the Puguang natural-gas fields in Sichuan province, which might boost its gas reserves by 8.6 times. The value of the discovery this year will grow with the likely liberalization of Chinese gas prices, which are also now controlled, says DBS Vickers.
Also, Sinopec's state-owned parent, China Petroleum, which holds 71.2% of Sinopec, may inject into the listed company some of the assets it's been buying abroad, in places like Africa and the former Soviet Union. And Sinopec's big chain of gas stations in wealthy southeastern China promises to keep returning steady profits. Operating profits from the unit have grown at a 13% annual pace in the past five years, and are a play on China's rising middle class and car-ownership.
Of course, there are potential pitfalls. Oil could jump sharply again, or Beijing might forgo the expected pricing reforms and instead give motorists a break by ordering a price cut at the gasoline pump to reflect the drop in crude prices. Barring those possibilities, however, Sinopec looks undervalued.