On the road with Sinopec in Europe in 1H of April; Buy with TP of HKD8.03
We summarize key takeaways and a detailed list of 60 Q&As given during theroad show. SNP’s downstream segments of refining and chemicals deliveredrecord earnings and margins in FY16, but those segments have yet to peak,despite a higher oil price. Sinopec has already issued its 1Q17 profit alert withearnings up 150% yoy and downstream as the key driver. Over the next fewyears, Sinopec expects oil price to stay range bound between USD50-65/bbl,which is the sweet spot for the company. Under that backdrop, investment indownstream should give SNP the highest return (8%+) and the best cash flow.Therefore, downstream will remain the focus.
Refining & Chemicals – further integration of the two businesses
Further integration of refining and chemicals businesses with the build-up offour Integrated Refining & Chemical projects by 2020 should create synergiesand lower costs further. Sinopec expects refining margins to be stable atc.USD8-9/bbl in the next few years, and further margin enhancement couldcome from: 1) product upgrades from GB-IV in 2015-16 to GB-VI in 2019 and2) lowering diesel-to-gasoline slate from 1.2 in 2016 to 1.0 by 2020. Mgmt wasconfident in higher chemical spreads after lowering its chemicals all-in costsby RMB100/t over the last few years. To lower costs further, SNP will 1) uselighter carbon refinery streams such as C2 and C4 to reduce the cost. 2)improve the resin stream to end users to maximize their efficiency. 3) optimizethe equipment and exit chemicals where performance is bad, using smallerchemical plants to test certain specialty chemicals with higher margins.
Upstream – gas is the focus, crude is the Achilles heel
Lower oil prices have forced Sinopec to do reserve impairment leaving itscrude oil reserve life at only 5.1 years by end 2016. Lower reserves will lead tohigher unit DD&A. Therefore, SNP’s upstream all-in-cost will likely remain highat USD60/bbl+ in 2017. SNP has looked at overseas M&A as an option but theasking prices were unattractively valued at USD65-70/bbl oil. Instead, SNP willcontinue to step up efforts in mainly domestic exploration and hopes to returnto 100% RRR by 2018. On the gas side, SNP was confident in achieving 15%demand growth this year, with its shale gas capacity lifted to 10bcm by end-2017 and the resumption of normal production from its Puguang gas field.
Marketing – targeting IPO by end-2017
The potential marketing IPO was the most asked question on the NDR, andrightly so, given its attractive growth prospects. According to Sinopecmanagement, over the next 3-4 years, profits from marketing should continueto grow given SNP’s established networks and a strong demand growth ofpremium gasoline. EBIT from non-fuel sales saw a 40% yoy increase in FY16and mgmt was confident in c.15-20% further growth via automobile andinsurance services. SNP is going through the audit of its 30,603 gas stations,which is a time consuming exercise, but SNP is targeting an end-2017 spin-off.In FY14, SNP sold its 29.58% stakes of the marketing company at 14.3x FY14P/E. SNP does not rule out the possibility that the planned marketing IPO couldfetch an even higher multiple of 20-25x P/E, which could lead to ~10%-20%upside potential to our TP.