I assign a Neutral rating to Chinese state-owned energy company China Petroleum & Chemical Corporation or Sinopec (SNP) [386:HK] [600028:CH].
The refining business was the bright spot for Sinopec in 3Q 2020, as the segment registered an operating profit of RMB31.5 billion, as compared to operating losses of -RMB26.5 billion and -RMB7.0 billion for the segment in 1Q 2020 and 2Q 2020, respectively. Sinopec also generated RMB38.8 billion in investment income from pipeline asset sales; it is positive that the deal valuation was fair and earnings contribution from the divested assets are not substantial.
Sinopec trades at 8.5 times consensus forward FY 2021 P/E, and it offers a consensus forward FY 2021 dividend yield of 7.2%. Although Sinopec’s consensus forward FY 2021 P/E valuation and dividend yield are attractive, there is still significant near-term uncertainty relating to the containment of the coronavirus pandemic in many countries globally. If lock-down and social distancing measures continued to be tightened in an increasing number of cities around the world, Sinopec could possibly disappoint the market. Sell-side analysts see Sinopec’s normalized net profit (excluding gains from pipeline asset sales) nearly doubling from RMB17.1 billion in FY 2020 to RMB33.5 billion in FY 2021.
Established in February 2020, China Petroleum & Chemical Corporation or Sinopec is one of the three major state-owned energy companies in China, alongside China National Offshore Oil Corporation or CNOOC (NYSE:CEO) (OTCPK:CEOHF) [883:HK] and PetroChina Company Limited (PTR) (OTCPK:PCCYF) [857:HK]. Apart from the US, Sinopec’s shares are also listed in China, Hong Kong, and London.
Refining Business Was The Bright Spot In 3Q 2020
Sinopec announced the company’s 3Q 2020 financial results on October 29, 2020, and its financial performance in the third quarter of this year was better than expected thanks to the turnaround of its refining business and gains associated with the sale of pipeline assets (to be discussed later).
The company’s net profit attributable to shareholders almost quadrupled from RMB12.0 billion in 3Q 2019 to RMB46.2 billion in 3Q 2020, and this was mainly driven by the improved performance of its refining business. Sinopec’s refining business achieved an operating profit of RMB31.5 billion in 3Q 2020, as compared to operating losses of -RMB26.5 billion and -RMB7.0 billion for the segment in 1Q 2020 and 2Q 2020, respectively.
Sinopec’s refinery throughput increased by +11% QoQ from 57.21 million metric tons in 2Q 2020 to 63.51 million metric tons in 3Q 2020. With Covid-19 relatively well-contained in China, the domestic economy is showing signs of recovery and this has boosted demand for the company’s refining business. Other positive factors that drove the good performance of Sinopec’s refining business include a more favorable sales mix adjusted in line with demand, the optimization of crude oil procurement, and the commissioning of a new refinery.
On the flip side, international travel restrictions could be in place for a longer-than-expected period of time as certain countries struggle to contain Covid-19, which will prevent a full demand recovery for Sinopec’s refining business. Also, the future profitability of Sinopec’s refining business might be lower, if and when the cost of inputs rises to normalized levels prior to Covid-19.
Upstream Business Still Loss Making Notwithstanding Sequential Improvement
Sinopec’s upstream or exploration & production (E&P) business remained loss making in the most recent quarter.
The E&P business suffered from an operating loss of RMB477 million in the third quarter of the year, as compared to an operating profit of approximately RMB2.5 billion in the third quarter of 2019. On the positive side of things, Sinopec’s E&P business delivered an improved financial performance on a sequential basis. As a comparison, the upstream business’ operating loss was in excess of -RMB7 billion in 2Q 2020.
Low oil prices are the main reason for the upstream business’ continued losses. The average realized price of crude oil for the E&P business decreased from $58.82 per barrel in 9M 2019 to $38.24 per barrel in 9M 2020. Notably, oil prices dropped to a new five-month low in end-October 2020 on concerns regarding a further tightening of lock-down and social distancing measures in certain countries and cities where daily confirmed cases of Covid-19 continue to rise.
Sale Of Pipeline Assets
As highlighted above, the sale of pipeline assets has helped to boost Sinopec’s 3Q 2020 financial performance, on top of the refining business’ turnaround.
Sinopec recognized RMB38.8 billion of investment income in the third quarter of this year, which is mainly attributable to the sale of pipeline assets to China’s national pipeline company, China Oil & Gas Pipeline Network Corporation. It is positive that the total consideration of RMB122.7 billion for Sinopec’s pipeline assets was equivalent to an average P/B multiple of approximately 1.4 times which is pretty fair, and the pipeline assets only accounted for 5% of the company’s FY 2019 EBITDA implying a limited impact on earnings.
Valuation And Special Dividends
Sinopec trades at consensus forward FY 2020 and FY 2021 P/E multiples of 12.1 times and 8.5 times based on its share price of $39.33 as of October 30, 2020. In comparison, the stock’s five-year and 10-year mean consensus forward next twelve months’ P/E multiples were 12.3 times and 10.9 times, respectively.
Sinopec offers consensus forward FY 2020 and FY 2021 dividend yields of 7.9% and 7.2%, respectively. Although the company was loss-making in the first half of the year, it declared a special interim 1H 2020 dividend of RMB0.07 per share in relation to the sale of certain pipeline assets. As a comparison, Sinopec’s interim dividend for 1H 2019 was RMB0.12. Market consensus expects Sinopec’s full-year dividends per share to decrease from RMB0.31 in FY 2019 to RMB0.21 and RMB0.19 for FY 2020 and FY 2021, respectively.
Note that consensus estimates from 15 sell-side analysts primarily covering the company’s shares listed in Mainland China and Hong Kong are used for the purpose of this analysis.
The key risk factors for Sinopec include weaker-than-expected demand for oil & gas as a failure to contain Covid-19 in certain parts of the world leads to more lock-downs, and lower-than-expected dividends in the future.
Asia Value & Moat Stocks is a research service for value investors seeking value stocks with a huge gap between price and intrinsic value, leaning towards deep value balance sheet bargains (i.e. buying assets at a discount e.g. net cash stocks, net-nets, low P/B stocks, sum-of-the-parts discounts) and wide moat stocks (i.e. buying earnings power at a discount in great companies like “Magic Formula” stocks, high-quality businesses, hidden champions and wide moat compounders). Sign up here to get started today!
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.