20131008-美银美林-Neutral__Refining_seemingly_fixed__coal_chemical_risk_rising_23页_1mb

Sinopec Summary

Core Content

Sinopec is an integrated oil and petrochemical company, and the largest petrochemical company in Asia by ethylene capacity. The report from BofA Merrill Lynch reinstates coverage on Sinopec with a Neutral rating and a Price Objective (PO) of HK$7.2. The analysis highlights both the benefits from China's fuel price reforms and the risks posed by coal chemical expansion and slow demand growth in the oil and chemical sectors.

Main Points

Refining Sector

• Fuel Price Reforms: The new pricing mechanism, introduced in March 2013, has made China's fuel pricing more efficient, resulting in improved refining margins for Sinopec.
• Refining Margins: Sinopec's cash refining margins improved to US$1.5-2.0/bbl in 3Q13, aligning with Asian complex refiners. The report estimates that the reform will lead to a US$1.1-1.2/bbl refining margin gain, or an 11.6-12.6% increase to 2014E earnings.
• Valuation: Refining is valued at 3x EBITDA, significantly lower than regional peers (6-7x), which contributes to the HKD0.7/share value accretion.

Chemicals and Marketing

• Coal Chemical Expansion: By 2015E, coal chemical supply will account for 18% of China's ethylene capacity, with production costs at 50-60% of Sinopec's. This is expected to negatively impact Sinopec's chemical segment.
• Demand Growth: The report estimates that China's oil and chemical demand CAGR for 2014-15E will be 3-4% and 6-7%, respectively, which is much lower than the 8% and 16.2% in the 11th FYP.
• Chemical Earnings Contribution: The Chemicals division is expected to contribute 0-1% of EBIT in 2014-15E, down from 15-25% in the past.

Investment Outlook

• Earnings Growth: The report expects earnings growth of 8% in 2014E and 4% in 2015E, which is described as solid but not exciting.
• Valuation Metrics:
  • P/E: 9.1x in 2013E and 8.4x in 2014E.
  • EV/EBITDA: 5.3x in 2013E and 4.9x in 2014E.
  • Dividend Yield: 6.00% in 2011A and 6.67% in 2015E, with the highest among China oils.
  • Free Cash Flow Yield: Negative in 2013E and 2014E, indicating potential cash flow challenges.

Price Objective

• The PO of HK$7.2 provides 16% upside potential from the current price of HK$6.17.
• The valuation is based on:
  1. E&P at a 30% discount to NAV.
  2. Refining at 3x EBITDA.
  3. Marketing at 6x EBITDA (in line with peers).
  4. Chemicals at zero value due to competitive pressures.

Key Risks and Concerns

• Coal Chemical Competition: The rapid expansion of coal chemical capacity in China, particularly in ethylene and propylene, will likely reduce the profitability of the chemical sector.
• Sluggish Demand Growth: China's oil and chemical demand growth is expected to be lower than historical rates, limiting the recovery potential for the chemical segment.
• Low Multiplier Impact: The weak link between demand growth and GDP in 2014-15E is expected to continue, affecting the overall earnings recovery.
• M&A Risks: Sinopec may be cautious with its M&A strategy due to past overpaying for overseas assets and potential impairment write-downs.

Scenario Analysis

Conclusion

Despite the benefits from the fuel price reforms, Sinopec faces significant challenges from the expansion of coal chemical capacity and slower-than-expected demand growth. The company's Chemicals segment is unlikely to provide meaningful earnings contributions in the coming years due to the low-cost coal chemical competition. The report's Neutral rating reflects the company's solid but unexciting earnings outlook for 2014-15E, with limited upside potential for the stock.