Investors applaud Sinopec restructuring

Mainland oil giant's move to restructure fuel marketing division and sell stake is lauded by shareholders, sending its share price soaring

PUBLISHED : Monday, 03 March, 2014, 2:59am
UPDATED : Monday, 03 March, 2014, 7:02am

China Petroleum & Chemical Corp (Sinopec) impressed the market just over a week ago with a plan to restructure its undervalued fuel marketing division and sell up to 30 per cent of the assets to private investors.

Investors cheered the move, which analysts said would "unlock hidden value" in the division that is the company's biggest profit contributor with a nationwide network of more than 30,000 fuel stations - the world's largest - selling two-thirds of the nation's motor fuel.

The division accounted for 37 per cent of Sinopec's earnings before interest and taxes during the past decade, according to a Barclays research report.

Sinopec's market valuation before the announcement, seven times its estimated profit this year compared to 12.5 times of sector leader ExxonMobil, did not adequately reflect the "hidden value" of the division, analysts said.

The poor profitability of its oil refining operation was the result of state fuel price controls designed to protect consumers, and weak oil production profits due to high costs.

Investors sent its share price up 9.4 per cent the day after the announcement, the biggest gain in almost five years. Following a small retreat, it shot up a further 9.6 per cent over two days after the mainland's China Business News last Wednesday quoted chairman Fu Chengyu as saying that further disclosures about Sinopec's restructuring would be made during the parliamentary meetings in Beijing this month.

Analysts applauded the move, with Sanford Bernstein senior analyst Neil Beveridge calling the state-backed firm's decision a "dramatic shift in strategy" that "seems more like something we would expect from a United States major".

Beveridge said in a research report it was in line with an international trend, citing nine examples since 2011 of American and European oil firms spinning off refining or fuel retailing operations, partially selling pipeline divisions or disposing of refineries.

Such deals had helped the firms outperform rivals that remained integrated in terms of share price performance, he said.

Beveridge estimated the marketing division could be worth 487 billion yuan (HK$615 billion), based on the present value of future cash flows, which could raise 146 billion yuan if a 30 per cent stake is sold.

It might take the form of an initial public offering, preceded by shares sold to private equity investors, he said.

Nomura's head of regional oil and gas research Gordon Kwan said in a note he expected insurance firms and social security funds would be potential investors, as they liked low-risk investments that provided stable cash flows.

Simon Powell, CLSA's head of Asia oil and gas research, quoted the management as saying they were hoping to find a strategic investor with deep pockets and experience in running fuel stations, such as BP and Royal Dutch Shell.

A source close to Sinopec said the firm was considering "all sorts of possibilities" regarding how the stake would be sold, with no timetable yet. But the source acknowledged that introducing partners with retail expertise would add value since Sinopec had limited experience in non-fuel retailing.

Beveridge said the non-fuel business, which contributes less than 5 per cent of Sinopec's marketing division income, was growing at over 30 per cent a year, although that was still far behind the 50 to 80 per cent growth of rivals in developed markets.

The book value of the marketing division was 179 billion yuan at the end of June last year, said rating agency Moody's Investors Service, which estimated its worth at 269 billion yuan, or 1.5 times book value.

Citi's head of regional oil and gas research Graham Cunningham estimated the division's worth at 419 billion yuan, using the same valuation method as Beveridge.

Barclays analysts came up with a similar valuation, based on the assumption that Sinopec can sell the 30 per cent stake for a price equal to the stock market valuation of overseas fuel retailing peers.

Barclays said if investors valued the remaining 70 per cent using the same multiple, it would raise Sinopec's value by 19 per cent.

Sinopec shares have gained 13.9 per cent since it announced the proposed stake sale.

Analysts believe the move is part of Sinopec's response to Beijing's call for state oil and gas firms to allow private companies to participate in the sector dominated by a duopoly, adding that proceeds from the sale would help Sinopec fund purchases of overseas oil and gas assets from parent China Petrochemical Corp in order to strengthen its upstream operations, which is currently its weakest business segment.

While allowing investment from the private sector would enhance governance and efficiency, some analysts are sceptical of the real value from the proposed restructuring.

"So far, what we have is Sinopec getting the market to behave like a voting machine by dressing up a capital-raising [exercise] as state-owned enterprise reform," wrote Jefferies analysts Laban Yu and Jack Lu in a note. "Real SOE reform … will require shareholder restructuring ... [with] changing management incentives. Real SOE reform can unlock value lost [through] inefficiency, mismanagement and corruption."

Barclays analysts said that China Petrochemical's estimated US$35 billion of overseas assets were generating lower returns than Sinopec's own oil and gas production assets, and "may not come cheap if the parent uses the process to deleverage its own stretched balance sheet".