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UBS Investment Research
Asia Oil and Chemicals
Alpha Preferences
„ Add SinoTech to Most Preferred
We are adding SinoTech to our list of Most Preferred stocks following UBS
initiation of coverage with 135% potential upside to our price target. (Please see
"SinoTech Energy: Riding China's EOR wave," 14 December, 2010, by Ying Lou.)
The stock looks cheap at 2011E PE of 9.2x and EV/EBITDA of 4.4x particularly
considering that we expect a rapid roll-out of its lateral hydraulic drilling (LHD)
business in China to lead to doubling of EPS from 2011 to 2013.
„ Remove S-Oil & Thai Oil from Most Preferred
We are removing S-Oil (Buy) and Thai Oil (Buy) from our list of Most Preferred
stocks. While the recent better than expected refining margins could provide
further upside potential, we note that both stocks have recently outperformed and
are now near UBS price targets of Won95,000/sh and Bt80/sh.
„ Remove PTTCH from Least Preferred
We have removed PTT Chemical (Neutral) from our list of Least Preferred stocks.
The stock is down about 10% in the last month following very strong
outperformance year-to-date. We believe the recent sell-down of Siam Cement's
15.6% stake in the company led to the underperformance.
Most Preferred
PetroChina (0857.HK)
Buy
PetroChina is our preferred pick among oil stocks in China. The stock has been a major
underperformer in 2010 following consensus EPS downgrades. We believe the 12th five-year
plan in March, a potential upstream gas price hike by mid-2011, and major progress on
China’s unconventional gas development (CBM and shale gas) could all act as catalysts for
PetroChina in 2011.
— Valuation: We base our price target on a sum-of-the-parts methodology. We value
the E&P business on DCF (9.1% WACC and a US$85/bbl long-term Brent crude oil
price), and value the downstream business segments using EV/EBITDA multiples.
— Risk: In China, we believe government intervention in the event of a material spike
in global oil prices is a key risk. Government intervention can include policies related
to, for example, downstream refined product price caps or upstream oil windfall
profit taxes. Oil prices, refining margins and petrochemical spreads can be volatile,
highly cyclical and seasonal in nature.
Formosa Chemicals & Fibre (1326.TW)
Buy
We believe FCFC is well positioned in Asia to profit from both the rising polyester demand
and prices, which should translate to stronger demand and spreads for upstream PX/PTA.
FCFC is one of the top three producers on PTA and ABS in Asia. The increasing demand
from consumer sectors such as auto market and home appliances should continue to support
ABS demand and spreads.
— Valuation: Our price target of NT$115.00 is based on our sum-of-the-parts NAV
estimate, which translates to 14x 2011E PE (its historical average PE). We think
FCFC has the highest cash dividend yield of 7% among petrochemical stocks in the
region.
— Risk: Petrochemical spreads are affected by the industry cycle, which is driven by
the balance of industry supply and demand. Major risks are weaker-than-expected
demand from China and a slower-than-expected macro recovery in the developed
economies and unexpected operating issues that can translate to short-term support
for chemical pricing in the market.
Essar Oil (ESRO.BO)
Buy
We are positive on Essar Oil based on: 1) stock underperformance—the stock has fallen from
its peak at the beginning of November; 2) the upgrade and expansion of its refinery, which
should provide substantial earnings upside; and 3) upside potential from retail price
deregulation. Expectations are generally low as Essar has a history of project delays. The
Essar refinery upgrade (Nelson complexity to increase from 6.1 to 11.8 by mid-2011) is
critical in driving stock performance. Our recent visit to Vadinar makes us confident that the
timeline will be met as will the commercial production of coal bed methane at Raniganj (this
is small but significant in proving execution capability).
— Valuation: We base our price target on a sum-of-parts based valuation. We value
refinery + retail + upstream, core refining at Rs140/share, retail at Rs17/share, and
upstream assets at Rs18/share. We estimate retail has additional potential of Rs5-
7/share and upstream Rs7-12/share if projects come on line as scheduled.
— Risk: Oil prices, refining margins and petrochemical spreads are highly seasonal,
which can sometimes lead to volatile earnings in the sector from quarter to quarter.
For India, government regulatory changes affect the oil se
Sinotech (CTE.O)
Buy
We initiate coverage of SinoTech Energy (SinoTech), which provides enhanced oil recovery
(EOR) services in China. The company is taking advantage of the Chinese oil majors’
increasing need to improve the output from their ageing oil fields. Its two key services are: 1)
lateral hydraulic drilling (LHD); and 2) EOR solutions that utilise a molecular deposition film
(MDF) technology. We think the key potential catalysts for SinoTech’s share price are: 1)
strong earnings growth; 2) an accelerated delivery of LHD units to China; 3) additional
visibility on its letters of intent (LOI) for additional LHD units; and 4) capacity expansion by
its supplier Jet Drill Well Services (Jet Drill).
— Valuation: SinoTech is trading at 9.2x FY11E pre-ex PE and 0.9x FY11E P/BV.
This compares to our forecast of an average 18% ROE (FY11-13). Its EV/EBITDA is
2.4x FY12E. We derive our price target from a DCF-based methodology and
explicitly forecast long-term valuation drivers using UBS’s VCAM tool. We assume
a 10.6% WACC.
— Risk: We think the risks to SinoTech’s businesses are: 1) single supplier risk for
LHD; 2) execution; 3) oil prices; 4) relationship with customers, including CNPC
and Sinopec (high customer concentration); 5) any loss of exclusivity and patents—
this would create increased competition for the company; 6) if its serviced
technologies becomes obsolete; and 7) replacement by alternative energy sources.
Least Preferred
China National Offshore Oil Corporation (0883.HK)
Neutral
CNOOC. We believe the stock looks unappealing at its current record high share price. The
stock is trading at a trailing EV/boe proven reserve of US$35/boe. Our top pick among China
oil and gas stocks is PetroChina (Buy).
— Valuation: We use a DCF valuation methodology that assumes a long-term Brent
crude oil price of US$85/bbl. Our WACC is 9.1% (previous 9.7%) We lowered our
assumed beta from 1.3 to 1.2 and lowered our risk-free rate from 5% to 4.6%.
— Risk: In China, we believe government intervention in the event of a material spike
in global oil prices is a key risk. Government intervention can include policies related
to, for example, downstream refined product price caps or upstream oil windfall
profit taxes. Oil prices, refining margins and petrochemical spreads can be volatile,
highly cyclical and seasonal in nature.
Formosa Petrochemical Corporation (6505.TW)
Neutral
We believe Formosa Petrochemical’s current valuation is not attractive because of: 1) limited
earnings upside in 2011 as its refining utilisation rate is likely to remain at around 80%; and
2) it has to wait six to nine months for the delivery of new RDS components (which were
seriously damaged in the fire in July). In addition, we are less bullish on upstream olefin
spreads, not downstream petrochemicals.
— Valuation: We derive our price target of NT$86.00 from a DCF-based methodology
and explicitly forecast long-term valuation drivers with UBS’s VCAM tool. Our
price target translates to 23x 2011E PE and implies limited upside from the current
share price level.
— Risk: Petrochemical spreads are affected by the industry cycle, which is driven by
the balance of industry supply and demand. Major risks are weaker-than-expected
demand from China and a slower-than-expected macro recovery in the developed
economies and unexpected operating issues that can translate to short-term support
for chemical pricing in the market
Bharat Petroleum Corporation (BPCL.BO)
Sell
We think upside from deregulation is reflected in the share price, which has risen sharply
since the Government of India announced deregulation of gasoline in June. We think there are
no further triggers for the stock. The stock trades at a substantial premium to domestic peers
HPCL and IOC on reports of its upstream success overseas, as well as the commissioning of
its Bina refinery. We believe the market is overpricing these two events; in the case of the
latter peers HPCL and IOC also have new refineries lined up for 2011 and 2012.
— Valuation: We base our price target on 1.55x P/BV (20% premium to 2005-10
average). We think the stock is expensive relative to its peers on all parameters,
including PE, EV/EBITDA and P/BV. Deregulation is a key driver, but we believe
this is priced in and HPCL and IOC provide better exposure given their more
attractive valuation. Given recent performance, current valuation and high
expectations, we think there is downside risk to BPCL’s stock price.
— Risk: Oil prices, refining margins and petrochemical spreads are highly seasonal,
which can sometimes lead to volatile earnings in the sector from quarter to quarter.
For India, government regulatory changes affect the oil sector
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