Sinopec Engineering (SEG) 1H16 Summary
Core Content
Sinopec Engineering (SEG) reported a net profit of CNY1.08bn in 1H16, representing a 37% YoY decline, which was in line with its profit warning. Despite a 15% YoY revenue decline, the decline was slower than expected, but profit margin erosion was faster, with NP margin down to 6.1%. The company's performance was significantly impacted by a big miss in new orders, which totaled CNY8.4bn (a 70% YoY decline), far below the full-year target of CNY47bn and showing no signs of short-term recovery.
Key Highlights
- Revenue decline: 15% YoY to CNY17.7bn, with PRC revenue dropping 36% and overseas revenue increasing 120%, but the overall revenue was still lower due to the larger drop in domestic sales.
- New Orders: CNY8.4bn, <20% of full-year target, and all segments except oil refining posted material YoY declines.
- Backlog: Declined 18.4% HoH, with CNY11.1bn in coal chemical EPC contracts deducted, leading to an estimated 50% backlog decline from FY15 to FY18E.
- Overseas Expansion: Did not significantly boost profitability due to severe competition, with overseas contract profit margins at ~5% compared to PRC's 16-17%.
- Dividend Policy: Maintained a 30% payout with CNY0.072/share for 1H16, and a full-year forecast of CNY0.2/share.
Policy Impact
- China may ban new refining projects until 2019 and new coal chemical/power plants until 2018 as part of the 13th Five-Year Plan.
- The policy aims to cut coal consumption to 4.1bn tons by 2020.
- Refining demand is expected to remain relatively constant due to fuel specification upgrades.
- Coal chemical projects are likely to be significantly affected, with 34% of backlog at end-15 related to coal chemical, and an estimated CNY21bn of that backlog potentially written off.
Financial Performance
| Metrics |
2014A |
2015A |
2016E |
2017E |
2018E |
| Net Income (Adjusted - mn) |
3,490 |
3,318 |
2,131 |
2,142 |
2,036 |
| EPS |
0.788 |
0.749 |
0.481 |
0.484 |
0.460 |
| EPS Change (YoY) |
-15.7% |
-4.9% |
-35.8% |
0.5% |
-4.9% |
| Dividend / Share |
0.312 |
0.297 |
0.191 |
0.192 |
0.182 |
| Free Cash Flow / Share |
(0.038) |
1.24 |
0.074 |
0.382 |
0.554 |
Valuation Metrics
| Metrics |
2014A |
2015A |
2016E |
2017E |
2018E |
| P/E |
7.00x |
7.72x |
12.30x |
12.24x |
12.87x |
| Dividend Yield |
5.65% |
5.14% |
3.22% |
3.24% |
3.08% |
| EV / EBITDA* |
3.40x |
3.54x |
5.14x |
5.19x |
5.71x |
| Free Cash Flow Yield* |
-0.643% |
20.99% |
1.25% |
6.46% |
9.36% |
- For full definitions of iQ method measures, see page 9.
Investment Rating and Price Objective
- Investment Opinion: Changed from B-1-8 to B-3-8
- Investment Rating: Changed from BUY to UNDERPERFORM
- Price Objective: Reduced from HK$8.00 to HK$6.00
- 2017E EPS: Revised from 0.70 to 0.48
- 2018E EPS: Revised from 0.75 to 0.46
Key Assumptions for Valuation
| Metrics |
Value |
| Cost of equity |
11.2% |
| Cost of debt |
0% |
| Target gearing |
0% |
| Tax rate |
20% |
| WACC |
11.2% |
| Terminal growth |
1.5% |
Key Metrics and Financial Projections
| Metrics |
2016E |
2017E |
2018E |
| Revenue |
35,087 |
32,617 |
31,654 |
| Operating profits |
2,404 |
2,325 |
2,025 |
| Net profit |
2,131 |
2,142 |
2,036 |
| Free Cash Flow |
327 |
1,694 |
2,452 |
Key Risks and Outlook
- Policy Risk: China's ban on new coal chemical projects is expected to significantly impact SEG's backlog and profitability.
- New Orders: Continued weakness in LNG, coal chemical, and other segments due to economic conditions and low oil prices.
- Segment Performance: EPC contracting remains the largest contributor to revenue and gross profit.
- Dividend Yield: Expected to be around 3.5% for the full year.
Comparison with Peers
| Company |
P/E (FY17E) |
P/B (FY17E) |
ROE (FY17E) |
FCF Yield (FY17E) |
| Sinopec Engineering |
12.4x |
1.0x |
8.2% |
6% |
| Sinopec Kantons |
8.6x |
0.9x |
12.5% |
0% |
| Hyundai E&C |
8.5x |
0.7x |
8.6% |
14% |
| Samsung Engineering |
32.7x |
2.1x |
17.8% |
0% |
| Daewoo E&C |
8.5x |
0.7x |
8.6% |
14% |
| Fluor Corp |
16.6x |
18.4x |
13.6% |
5% |
| Foster Wheeler |
9.7x |
9.8x |
16.2% |
6% |
| Larsen & Toubro Ltd |
- |
- |
- |
- |
Investment Recommendation
- Given the policy risks and declining new orders, the report recommends underperforming SEG.
- Sinopec is preferred over SEG due to its limited refining & chemical supply benefits.
- The price objective is set at HK$6.0/share based on revised financial assumptions and DCF model.
Summary of Key Financial Data
- Revenue: CNY17.7bn in 1H16, down 15% YoY.
- Net Profit: CNY1.08bn, down 37% YoY.
- EPS: CNY0.24/share in 1H16.
- Dividend Yield: Expected to be around 3.5% for the full year.
- Backlog: Estimated to decline by 50% from FY15 to FY18E.
- New Orders: Missed target significantly, at CNY8.4bn, less than 20% of the full-year target.
- Profit Margins: Sharp decline, with OP margin down to 12.5% and NP margin to 6.1%.
- Overseas Margins: Estimated at ~5% due to severe competition.
- Free Cash Flow: Positive in 2016E and expected to improve in subsequent years.
Conclusion
The report highlights significant challenges for SEG, particularly in new orders and backlog, due to China's policy restrictions and economic pressures. Despite some revenue growth in overseas markets, the low profit margins and policy risks make the company underperform in the current market environment. The price objective is revised downward to HK$6.0/share, and Sinopec is recommended as a better investment option.
