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China's Leading Oil Company is a Foreign Growth
and Value Play |
Published:
June 27,
2007
China Petroleum & Chemical (NYSE: SNP), commonly referred to as "Sinopec," is China's leading
integrated oil company. The Beijing-based firm is involved in
all facets of the oil business, from exploration and production
all the way to retail marketing.
At the end of last year, Sinopec had proven reserves of around
3.3 billion barrels of oil, which produced a steady stream of
900,000 barrels every day. And in late May, the company
announced a major new find -- an oil field in the Xinjiang
region of northwestern China with oil reserves of up to 1.5
billion barrels.
Sinopec is also the top petrochemical refiner in all of Asia,
operating more than two dozen refineries with a combined
capacity of 3.6 million barrels per day. And after it has been
refined and processed, much of the finished product is
eventually sold throughout the company's extensive chain of
30,000 retail gas stations. Last year, operating income
generated from these outlets soared +61%.
Aside from its oil & gas operations, the firm is also a major
producer of ethylene, synthetic resin and rubber, fertilizers,
and other chemicals for a wide variety of industrial uses. Last
year, it sold nearly 30 million tons of chemical products.
Combined, these business segments account for almost $135
billion in annual revenues, a figure that has more than tripled
over the past five years. Meanwhile, profits have been climbing
at roughly the same pace during that stretch, soaring from $1.9
billion in 2001 to almost $7 billion last year -- a compound
annual growth rate (CAGR) of around +30%.
While that pace is tough to sustain, Sinopec should have the
wind at its back for years. Demand for gasoline and energy is a
constant, and the company is an established leader in one the
world's most energy-hungry nations. Sinopec's home turf spreads
throughout the southern and eastern areas of the country, where
growth has been the most brisk. As the Chinese economy continues
to expand, so too will disposable incomes, meaning more and more
consumers will be buying cars -- leading to even stronger demand
for fuel.
Of course, while the upside is compelling, investing in China
also carries unique risks. For example, the government has
imposed price controls that have taken a toll on the firm's
refining business. However, Sinopec has a key advantage over its
competitors -- the firm is partially state-owned, and the
government holds three-fourths of the outstanding shares.
This cozy relationship has its perks. For instance, while China
is actively boosting domestic oil exploration to reduce its
reliance on foreign sources, the government has also worked with
oil-rich countries in Africa and the Middle East to boost
Sinopec's foreign oil reserves.
Looking forward, the continued growth of the Chinese economy is
expected to power earnings ahead at an impressive +20% annual
clip. A new 20-year partnership agreement with McDonald's (NYSE:
MCD), where drive-thru outlets will be installed at many of
Sinopec's gas stations, could also prove to be highly lucrative.
Yet, for all this, the stock trades at just eight times cash
flows and carries a rock-bottom PEG ratio of just 0.5 -- one of
the lowest we have ever come across. Even with a rather high
discount rate of 12% (well above what we would typically use for
a stable blue-chip industry leader with more than $100 billion
in revenues) we still calculate a conservative fair value of
$126.
While the shares have surged over the past five years, our fair
value estimate represents a discount of about
12%. However,
given the volatility of both the Chinese markets and the price
of crude oil, we would demand at least a 20% discount before
buying.
Good investing!
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Nathan Slaughter
Editor
Half-Priced Stocks, The ETF Authority
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