1H16 NDR takeaways in Singapore; reiterating Buy with TP of HKD7.31
Given SNP's strong balance sheet, capital allocation was the main topic ofdiscussion. SNP assured investors that: 1) purchasing high cost fields from itsparent was not an option; 2) dividend payout is likely on the rise (>50%); and 3)FY capex of RMB100.4bn will be achieved despite only tracking 13% in 1H.Shale gas is a key growth driver and has now become more profitable thanconventional gas since 2Q, post the rollout of new Fuling pipelines. Marginoutlook for refining remains on an uptrend, supported by the nationwideupgrade to GBV standards in 2017. Marketing spin-off is progressing andhigher retail mark-up will act as a hedge to lower run rates due to teapots.
Difficult to lower unit E&P costs in the face of production declines
Progress in cutting costs has been made in 1H, but there is pressure to lowercosts further if SNP was to close the gap with its Chinese peers (all-in cost ofc.USD50/bbl). SNP cut unit lifting cost by 9.5% yoy despite its 14% yoy drop indomestic oil production. However, scope to reduce unit lifting cost further islimited, particularly if domestic production faces further declines in 2017.SNP's fields have a natural decline rate of 10-15% so oil will need to reboundto c.USD55/bbl before SNP can boost capex to tackle the decline rate.
Furthermore, SNP has yet to do any impairment of higher cost fields
purchased in 2012-14, which limits its ability to lower DD&A costs.Refining margins shine with GB-V upgrades; teapots’ refining appetite slowedStripping out a net inventory loss of RMB0.7bn, SNP achieved GRM ofUSD10.8/bbl in 1H16 (incl. windfall profit). Management is confident that in themedium term GRM will exceed USD7/bbl without windfall profits/inventorygains, and that margins will be higher when GB-V upgrades are completed.Given that 2Q GRM was at USD9.7/bbl (excl. inventory gains), managementwas being conservative, in our view. Regarding the impact of teapots’ rampup,SNP’s run rate was hit by 2% in 1H but sees 2H run rate rebounding ashigher oil prices have discouraged imports from teapots of late. Oversupply inrefining has incentivized SNP to export more refined products, raising its FY16export target by 78% yoy to 16mmton.
SNP is top pick in China oil and gas; valuation and risks
SNP is leveraged to the upside in oil price and is also defensive given it pays 4-5% dividend yield. SNP is cheap, currently pricing in strip+ USD1.2/bbl(USD52.5/bbl). We derive our TP with SOTP, valuing E&P with DCF (WACC:8.4%, terminal rate: 2%) and downstream segments with P/B vs. ROE. Our TPimplies 1.1x 16E P/B (below +1SD of historical mean). We believe a highermultiple is justified as SNP’s ROIC should double by 2018 (10%). Risks:inability to pass through feedstock cost, oil & gas prices, and policy changes.