Action
We upgrade SPC-H to BUY from ACCUMULATE on likely strong 3Q13 refining earnings, a favorable longer-term pricing/margin outlook due to implementation of higher National Fuel Standards, the management incentive scheme, and restructuring upside supported by parentco Sinopec. We maintain TP at HK$3.2, and expect to see trading opportunities on SPC-A.
Reasoning
Refining earnings to swing high in 3Q13, helped by low-cost crude oil inventories. We expect domestic refining margin to expand US$5~6/bbl QoQ in 3Q13. Based on crude oil throughput of 3.9Mt a quarter, we expect >Rmb1bn refining operating profit in 3Q13, 50% above 1H13’s total of Rmb650mn.
Product prices are likely to rise on better quality. China will implement National Standard-IV for gasoline and diesel in 2014 and Standard-V in 2018. Sinopec and its subsidiaries may comply with the new standards in developed regions earlier than scheduled. We expect the Chinese government to allow a price premium for better quality auto fuel, which would improve the profitability of leading refineries, such as SPC, going forward.
Multiple benefits from refinery renovations and expansion projects. SPC has expanded its crude processing capacity to 16Mt, and cut energy consumption and processing expense to two-thirds of the industry averages. Gasoline yield increased from 18% to 26%. Given the fact that 93# gasoline is Rmb652/t more expensive than 0# diesel, the product mix improvement towards more output of 93# gasoline could increase profit by Rmb1bn on an annualized base. At present, all gasoline output from SPC meets National Standard-V, and 50% of diesel output is already National Standard-IV compliant, with the remainder National Standard-V ready.
Petrochemical margin steady; new fine chemical products to be launched: The petrochemical business bottomed out since May~June and may recover modestly in 2H13.
Earnings forecast and valuation
We raise our 2013/14e EPS forecasts by 26%/16% to Rmb0.25/0.28. SPC-A now trades at 18x/16x 2013/14e P/E, and SPC-H at 8x/7x 2013/14e P/E.
Risks
International oil price fluctuations; slowdown in demand for refined oil and petrochemical products; rising costs; slow progress in upgrading refined oil quality and incentive policies; negative impact from coal chemicals.