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Morningstar | Lowering Our FVE to HKD 6.50 on Weaker 4Q Estimates; Minimal Change in Outer Years

We are lowering our fourth-quarter profit estimate for no-moat-rated Sinopec after additional assessment of its potential mark-to-market inventory losses. We have also factored in increased losses related to its oil hedging trades. This leads to a 21% cut in our 2018 earnings estimate to CNY 67.2 billion and implies that the company’s fourth-quarter net profit will drop 86% year over year from growth of 45% for the first three quarters, leaving full-year 2018 EPS growth at 31%. Our post-2018 income expectations are minimally changed. The cut in our earnings estimates leads to a reduction in our fair value estimate to HKD 6.50 from HKD 6.80 and to USD 84 per ADR from USD 87. There is still upside to our fair value estimate from the current share price, but we believe a larger risk buffer is warranted before buying.

The expected drop in Sinopec’s fourth-quarter income is in line with the trend that peer PetroChina has forecast but amplified because of Sinopec’s hedging losses. We estimate that these may have emanated from an excess hedge position on around 9 million metric tons of oil, which has since normalized. Speculation remains about the size of the loss, which will probably only be confirmed with the company’s earnings release on March 25, but we factor in a loss of around CNY 8.4 billion. The inventory markdowns likely wiped out profit from the refining and marketing divisions in the fourth quarter.

While there is risk that capital expenditures could rise around 10%-20% from our estimate, we expect the spin-off of its pipelines and marketing activities to reduce spending requirements. We believe these spin-offs will occur within the next year or two. Our fair value estimate continues to factor in gains from these spin-offs of around HKD 0.27 per share.

Sinopec has received government approval to separately list its marketing division via an IPO. However, because its marketing unit owns some product pipelines and storage units that are meant to be carved out and injected into a new national pipeline company, there is a delay to the marketing unit spin-off until the framework for the pipeline company is formalized. We think it is the method of valuation on these asset injections that has yet to be decided. Market talk is that there may be some framework determined this year.