Distinct breed in Asia oil and gas sector; initiating with Buy
In a sustainable low crude oil price situation, SPC, a pure downstream refiningand chemical company in China’s oil & gas sector, should benefit the mostfrom robust refining GRM and the chemical up-cycle. More importantly, low oilprices relieve its employed capital, with potential to drive strong FCF ahead.We expect SPC to turn net cash by 2016. Hence, we initiate with a Buy onSPC-H, with a price target of HK$5.0, offering potential total return of +32%.
Strong FCF & ROIC improvement; higher dividend payout potential
A sustainable low oil price situation should help relieve SPC’s employedcapital. We believe SPC will earn strong FCF in 2016E-18E (the current shareprice offers a 10% FCF yield). Moreover, we forecast ROIC to improve stronglyby 3.4ppts from 14.1% in 2015 to 17.5% in 2018E. As we expect the companyto be in a net cash position by 2016, we see potential for a higher dividendpayout if there is no meaningful capex ahead.
Beneficiary of refining sweet spot & chemical up-cycle
We believe SPC’s refining and chemical business will continue to generatestrong returns in 2016-18E and beyond. In our view, China refining marginswill continue to improve with refined products’ standard upgrades. We seerefining margins remaining in a sweet spot in the next few years, assuming oilprices recover to US$70/bbl gradually. A global chemical up-cycle until 2017with tightened supply and balanced demand, alongside potential delay / cancelon China CTO/MTO projects is likely to further widen the chemical spreads.
Valuation: re-rating to continue with ROIC improvement ahead
SPC-H trades at 1.6x/9.7x 2016E P/B / P/E (at +1SD of historical), reflecting thepositive outlook. Considering the likely strong FCF ahead, we use DCF toderive our price target of HK$5.0, implying 2.0x/13x 2016E P/B/P/E. We see2.0x P/B as justifiable, reflecting its asset value at a time when profitabilityahead is clearer, post its listing. The implied PB is in line with the average PBof its peer group although SPC’s ROIC is 1.2x higher. Key risks: 1) oil pricevolatility without concurrent adjustments in refined product prices; and 2)weaker-than-expected demand in refined/chemical products that could lead tolower-than-expected margins.