BP divests Sinopec stake

Shares priced at an impressively slim discount to spot.

BP plc offloaded a 2.1% stake in Chinese integrated oil major Sinopec yesterday (Tuesday) raising HK$5.76 billion ($739 million) from a sale that represents 10.9% of the company's H share capital. With Morgan Stanley as lead manager, the UK-based group sold 1.829 billion shares at the tightest end of a HK$3.10 to HK$3.15 pre-marketed range.

Pricing at HK$3.15 per share equates to a 0.79% discount to Sinopec's HK$3.175 close and was aggressive in the context of the 8% average achieved by most Greater China placements so far this year. Indeed, when BP sold a 2% stake in Petrochina last month, it priced it at an 8% discount to the spot close, raising proceeds of $1.7 billion.

However, Sinopec's share price has been under some pressure ever since the Petrochina sale, with investors aware a second placement was likely to come. Both stakes were acquired in 2000 when the two Chinese oil companies completed their listings and both have been sold as part of BP's divestment programme for its non-strategic assets.

The BP overhang is one of the reasons why Sinopec is down 8.63% year-to-date and 5.9% on the day the placement priced. This sharp drop enabled the lead to secure a more aggressive headline discount, although on a VWAP basis it is still a slim 3.7% discount.

Prior to this, the stock had spiked sharply over Friday and Monday, rising 11.5% following Chinese press reports about a re-valuation of the currency against the US dollar. Given that Sinopec still imports almost 70% of its crude oil requirements, it was seen as one of the biggest beneficiaries of any adjustment.

But specialists add that most of the buying was speculative and retail-based, with institutional investors discounting the rumours and ready to take profits on Tuesday. The lead's confidence about going out with a tight discount to Tuesday's close was also based on watching fundamental investors consistently support the stock around the HK$3 level.

And because the deal had been so well flagged, building a book proved extremely straightforward, with the offering closing two times oversubscribed after a two-hour bookbuild. A total of 88 accounts participated of which about 20 already held the stock.

By geography, allocations were split 77% Asia, 15% Europe and 8% US, although many of the international accounts placed orders through their Asian offices.

Specialists say the transaction's success once again underlines the huge liquidity flowing through Asian stock markets. Trading in Sinopec stock has been up massively this year, averaging 70 million shares a day compared to about 30 million a year ago.

BP is also likely to be extremely pleased with the transaction given it has made 195% on its three-and-a-quarter year investment in Sinopec and 189% on its three-and-three-quarter year investment in Petrochina.

For investors, the key question now is how much upside is left in a stock, which has outperformed the MSCI Oil and Gas Index by 74% over the past year compared to minus 2% by the big five supermajors.

The outperformance of the Chinese players relative to the rest of the sector largely reflects a shift by global investors back into high growth stocks, in the process favouring emerging market plays such as the Chinese and Petrobras in Brazil.

Therefore, while high oil prices and a weakening dollar should have supported all global oil stocks throughout 2003, the oil and gas sector underperformed the global average. A basket of 12 integrated oil companies measured by UBS shows the sector rose just 12.1% on the year.

By contrast Sinopec has returned 129% over the past 12 months and is currently trading on a 2005E EV/DACF (enterprise value to debt adjusted cash flow) of roughly 6.3 times according to UBS estimates. This represents a 20% discount to the top 12 integrated oil companies.

One of Sinopec's main challenges is to reduce the high lifting costs of its E&P operations. The company's most recently reported figures of $6.08/boe are well above the $3.65 global average and stem from the fact that most of its wells are mature.

Its legacy SOE status also means it needs to work hard to decrease productivity costs and in particular reduce headcount.

Gearing has also historically been the highest in the oil and gas sector. In 2003, for example, net debt to equity stood at 67%, although the figure is well down on the 106% level when the company listed in September 2000 also via Morgan Stanley.

However, Sinopec has been able to significantly improve its ROCE in the interim period. Having recorded a 7.1% five-year historical average - virtually the lowest of the sector - it has boosted the ratio from 8.7% in 2002 to 11.6% in 2003. The big five averaged 13.5% in 2002 and 18% in 2003.

Sinopec has four main areas of operation: E&P, refining (its downstream operations are its biggest revenue contributor); marketing (via its petrol stations) and petrochemicals. By the time its two JV ethylene crackers become fully operational in 2005, (output of 1.5 million tonnes per year), petrochemical profits should account for 22% of the total, up from 5% in 2003.

Sinopec is the world's fourth largest refiner and has a 50% market share in China. During 2003, crude oil refining jumped 10.13% to 115.65 million tonnes and the company averaged a utilization rate of 87% up from 81% in 2002.

In turn, this led gasoline output to rise 10.81% to 21.74 million tonnes and diesel up 10.41% to 41.67 million tonnes. Analysts believe the share price may continue to be supported by a shortage of diesel oil products in China. Because the country still has an industrial/agrarian base, there is always higher demand for diesel than gasoline, although car consumption is growing fast.

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