Sinopec Engineering (64% Profit in 9 months)

Sinopec Engineering (Group) Co., Ltd. (‘Company’) is engaged in the provision of engineering and contracting services to the oil refining and chemicals industries. It is a Chinese state-controlled entity having significant dealings with other state-controlled entities (55% of the order backlog are with related parties). 33% of its shares are listed on the Hong Kong stock exchange.

It operates in the following segments: a) Engineering, consulting, licensing (5% of revenues); b) EPC Contracting (65%) i.e. project management services; c) Construction (29%) i.e. providing infrastructure; d) Equipment manufacturing.

Practically all of its projects are based in China but 10% of revenues were generated in Saudi Arabia and Kuwait.

60% of revenues were generated from the petrochemical industry, and 23% from oil refining.

The company performed reasonably well during Covid-19 due to progress on all its major contracts. Increases in project execution costs, however, slightly reduced earnings. It won new orders, which were 18% higher than last year – and has a backlog of over $107b.

It generated $59b in revenues for the last twelve months and net income of $2.5b. Overall cash generation backs earning power.

The financial position is very strong with $17b in net cash, and $22b in net current asset value. The tangible asset value (including land-use rights, and buildings) was $30b.

The current assets include $21b of loans due from the ultimate holding company, but these are on a one-year basis (at 3.6%) and substantial repayments are reflected in cash flows. Moreover, cash of $7.9b is placed with two fellow subsidiaries in the state-controlled network – there doesn’t appear to be any reason to question their safety. Further, there are unprovided receivables of $1.7b older than a year, which doesn’t affect our conclusion (see below).

The equity was selling for $14b, a 36% discount to liquidation value, and 5.6x earnings. Management paid consistent dividends, averaging 50% of earnings, which yields over 8% on the current price.

There is significant uncertainty about international oil prices, which will affect the prospects of the refining and petrochemical industries. The company is, however, prowling for opportunities, including in countries along the ‘belt and road’, and this is backed by recent order wins.

The market appears to have overpriced the risks of this company by pricing it below liquidation value with a 17% earnings yield. The entrenched nature of this state-backed entity offers additional comfort to the safety margins indicated by its asset value and earning power.