1H16E net profit to jump by 70-90% YoY on inventory gains
SPC issued a positive profit alert for 1H16E results. SPC expects net income togrow by c.70-90% to a record c.RMB2.9-3.3bn (or EPS of c.RMB0.27-0.30)under the China Accounting Standard. For 2Q16E, SPC will register record highnet profits of c.RMB1.80-2.14bn (or EPS of c.RMB0.16-0.19), up 57-87% QoQand 7-28% YoY. We believe the strong set of 1H16E earnings is driven by thefollowing: 1) inventory gains from crude oil with long procurement cycles forimported crude oil, 2) margin expansion as product ASPs declined less thanfeedstock costs, 3) improved associate income from Shanghai Secco and 4)lower financial expenses. Conversely, the stronger 2Q16 was driven by thefollowing: 1) inventory gains from crude oil, refined products and chemicalsproducts; 2) a resilient gross refining margin in China and 3) strongerchemicals spreads (+USD52/ton in ethylene QoQ).
Tracking 76-85% of FY16E consensus earnings
The preliminary 1H16 results track 75-85% of consensus and DB FY16E netincome. DB FY16E adopted a more prudent approach by excluding windfallprofits in 1Q16, which were generated from refined product floor priceswithout NDRC's clarification on whether the extra profits could be keptpermanently by refiners. As per our analysis, the refined product floor priceprovided extra profits of USD4.5/bbl (c.RMB550m) to SPC in 1Q16. Excludingthe extra profits, 1H16 results will track c.61-71% of DB and consensus FY16Enet profits. The windfall profit from refined products gives 15% upsidepotential to DB FY16E net profits.
ROIC improvement, strong FCF & high dividend yields to trigger rerating ahead
SPC-H trades at 1.4x/8.3x FY16E P/B/P/E, representing 7% and 46% discountsto its Asian peers, respectively. We believe SPC deserves a premium valuationto Asian peers, with its higher FCF yield and ROIC. We estimate SPC’s FY16EFCF yield and ROIC at 11.4% and 16.6%, respectively, some 89%/126% higherthan its Asian peers' average. Our DCF based target price (assuming WACC of8.4%, with COE of 9.4%) of HKD5.0 implies 2.1x/12x FY16E P/B/P/E. Webelieve the 2.1x P/B (51% above +1SD of historical average) is justified as aresult of strong refining and petrochemical outlooks with strong free cash flow,a higher dividend yield of 3.6% and ROIC improvement ahead.