Gurus’ Particular Bid on Sinopec

As China enters a new phase of economic development, characterized by slower growth, analysts begin to wonder about the future of companies deeply related to state activities. Common knowledge indicates that as the economy's growth slows down, activities at the industries associated with that growth will slow too. Nonetheless, that simple take on economics can be deceiving and an analysis of Sinopec (SIN) will uncover considerable growth opportunities. The reasoning is the following. First, the Chinese economy will not stop growing. Second, the slowdown is not a product of model exhaustion, but a mere capacity readjustment. Third, the oil and gas industry will remain a key to continue growing for the Chinese economy. And the priority placed upon the oil and gas is where growth opportunities for the industry lie. Gurus are divided over this position, but their trading activities on Sinopec have not ceased.

Rumors About No Growth

For fiscal 2013, Sinopec reported that operating profit was up 9.7% year-on-year, and net profit attributable to equity shareholders was up 5.8% year-on-year. Moreover, the firm saw stable growth in oil and gas production in the upstream business, while achieving an oil reserve replacement ratio of over 100%. Additionally, improvements in the refined oil pricing mechanism returned the business to operating profit, at the same time that retail volume and sales of high value added oil products were increased. Last, the chemical segment adjusted raw material structure and lowered raw material cost.

Those results, as expressed by the same report were achieved with an economic environment where the world economy slowly recovered while economic growth for China slowed down. The offset of the environment is a direct consequence of increasing exploration and development activities in five key areas of China, optimization of product mix according to market conditions, focusing market strategy on high-octane gasoline and jet fuel sales while introducing premium products ahead of competitors, and adjusted facility utilization rate and production plan for the chemicals segment.

During 2013, Sinopec saw a drop on capital expenditure of 7% when compared to projections made at the beginning of the year. The exploration and production segment accounted for 50% of total expenditures, while refining and marketing accounted for another 25%. The remaining share was distributed mostly between acquisitions and the chemicals segment.

Looking Ahead

For the upcoming year, Sinopec expects a continuing recovery of the world economy with a Chinese economy growing steadily. And as expressed in the introduction, management expects a growing domestic demand for oil products and chemicals. Also, the firm expects a shift in the structure of consumption, a trend already being addressed by management.

Amid all the good market signs, and managerial decisions to improve Sinopec's overall performance, there are a few issues that must be addressed. Given the not totally free nature of the Chinese economy, the company is exposed to price controls by government officials. The obvious impact of these measures is reduced profits, especially in this particular industry where the state plays a major a role. Additionally, domestic areas continue to reach maturity while offshore and abroad opportunities continue to be scarce. The company is also characterized as downstream weighted, implying a second competitive disadvantage against western industry peers.

Currently trading at 9.1 times its trailing earnings, Sinopec carries a 14% discount to the industry average. Gurus have mostly divested away from this stock, with Renaissance Technologies and Sarah Ketterer (Trades, Portfolio) being the high rollers. However, their transactions are strictly short sighted as evidenced by their continuous and simultaneous purchases and sales. Hence, taking a position with long-term prospects is not recommendable given the current strict state control on profit.

Disclosure: Vanina Egea holds no position in any of the mentioned stocks.

About the author:Vanina EgeaA fundamental analyst at Lone Tree Analytics

Visit Vanina Egea's Website

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