SNP Shanghai Petrochem-H,Downgrade to Hold/A,Reduce,Pausing after a strong run

A not-unexpected positive profit alert on 19 January 2017: The profit alert guidedto 2016 earnings of RMB5.7-6.1bn, up 78-88% yoy, above our prior forecast by 21-30%.

    Implied 4Q16 net profit is RMB1.8-2.2bn, the highest quarterly performance of the year.

    The key drivers included: 1) higher margins in refining and chemicals with wider productspreads; 2) higher investment income from associate Secco Petrochemical Co Ltd.;3) lower financial expenses. Full year results should be released around 15 March 2017.

    2017 outlook: According to the company (Jan17), core earnings are unlikely to bedown y-o-y in 2017e, but may lack further momentum. Refinery inventory gains andtighter fuel specs remain positive trends. Also, margins in chemical resins andintermediate petrochemical products are constructive. We expect SPC will maintain adividend payout ratio of at least 30% in order to conserve cash for M&A opportunitiesor capacity additions, although these growth avenues have been slow to materialize.

    Earnings revision: We increase 2016-2018e earnings by 16%/41%/23% with EPSto 0.51/0.48/0.43 to reflect: 1) higher refinery and chemical margins; 2) higherinvestment income from Secco; and 3) lower financial costs, consistent with guidance.

    We downgrade SPC-H to Hold, maintain Reduce on SPC-A with new fair valueTPs of HKD4.60/RMB4.25 (previously HKD4.70/RMB4.20), respectively. Our Holdand Reduce ratings are based on downsides of 4.8% and 36.8%, respectively,implied by current values. We are rolling our valuation reference to 2017e with thisreport. Our H-share TP is derived using a target P/B multiple of 1.9x 2017e(previously 1.9x 2016e PB), which references ROE of 20% in 2017e (previously ROEof 22% in 2016e). We have a Hold rating for the H-shares as we like the yield, andwe remain constructive on downstream profitability (eg, fuel quality upgrades,inventories, etc). Our H-share TP is 4% below consensus. Our A-share TP is derivedfrom our H-share TP and HSBC 2017e RMB/HKD FX of 1.08 (previously 1.13).

    Key upside risks: sharp rebound in oil prices, improving refining and chemicaldemand, earlier-than-expected enforcement on the China VI fuel standard, assetinjections from Sinopec, and accretive M&A. Key downside risks: narrowingchemical margins, major operational disruptions, slower demand growth/economicgrowth, more relaxed fuel specs, and higher teapot utilizations.