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Morningstar | Sinopec Posts Surprise Upstream Profit but Things May Normalize, our FVE Up Slightly. See Updated Analyst Note from 30 Apr 2019

China Petroleum & Chemical Corp, or Sinopec, posted first-quarter 2019 net profit of CNY 15.5 billion that is slightly better than we expected, driven by an unexpected rebound to profit in its upstream exploration and production, or E&P, segment. Given management guidance that sharply lower selling, general and administrative, or SGA, expenses will normalize, we are, however, not changing the bulk of our assumptions. The only change we make is to raise our average oil prices for 2019 and 2020 by around 5% leading to less than a 2% rise in our earnings while our fair value estimate increases to HKD 6.40 from HKD 6.20. Our fair value estimate for the ADRs are raised to USD 82 from USD 71. We think no-moat Sinopec is fairly valued presently but we note the potential for gains from a possible spin-off of its marketing and pipelines assets to support its share price.

The E&P segment's operating profit of CNY 2.1 billion, which is the first profit for the segment since 2014, came despite around a 4% year-over-year and quarter-on-quarter drop in its average crude oil selling price. A 13% year-over-year rise in natural gas prices coupled with lower LNG import losses were probably the key drivers to the profit. However, we still reflect a full-year operating loss of CNY 4.7 billion for now, particularly with low SGA costs expected to normalize. The higher gas price is in line with our assumption but we raised our near-term oil price assumptions marginally. Our midcycle oil & gas price forecasts are unchanged at USD 60 per barrel and USD 7.19 per thousand cubic feet, or mcf.

The slide in Sinopec's first-quarter downstream profit is well within our expectation. We had factored in less favorable inventory adjustments in line with our view for lower average prices this year and a drop in refining margin to the USD 8 per barrel level. First-quarter refining margin at USD 8.38 is in line. Full-year EPS should still grow 20% in the absence of one-off losses.

We were surprised that Sinopec's E&P segment was profitable due to the 4% year-over-year and quarter-on-quarter drop in its average crude oil selling price and attribute this mainly to lower costs. Company management indicated that there was some seasonality to the company's costs and anticipate some of the expenses to normalize. Lifting cost was stable which is also within our assumption. As such, we think the deviation is mainly in SGA. We still expect an operating loss for the full year, albeit at a lesser CNY 4.7 billion versus 2018's CNY 10.1 billion in the absence of trading losses.

Sinopec's average higher natural gas selling price of USD 7.07 per mcf, is within our assumption. It is high relative to peers PetroChina at USD 6.63/mcf and CNOOC Ltd at USD 6.88/mcf, and we suspect this was possible as we believe it may reflect a more favorable location of its gas fields.

The results briefing had a number of questions regarding Sinopec's slide in refining margin to USD 8.38 per barrel from USD 9.54 in 2018. We believe this follows the sharp drop in PetroChina's refining margin as well and the market is trying to get a sense of the direction of refining margins this year. We believe it is possible for the group to see an improvement in second-quarter refining margins given the recent uptick in oil prices. However, this does not change our view that refining margins are likely to remain stable through 2020 and decline to USD 6.50 per barrel in 2022, in line with the move we expect in oil prices.

As anticipated, capital expenditure of CNY 11.9 billion was just a sliver of the CNY 136.3 billion budgeted for the full year. We expect capital expenditure to ramp up toward year-end with the bulk of this allocated to its gas infrastructure.