Sinopec Is Deeply Undervalued At Its Current Stock Price

Aristofanis Papadatos profile picture
Aristofanis Papadatos
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Summary

  • Sinopec has proved one of the most resilient energy stocks to the pandemic.
  • Sinopec is currently trading at only 5.1 times its expected earnings this year and 5.2 times its expected earnings in 2022.
  • The stock has offered a 9.6% dividend this year.
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The S&P 500 has doubled off its bottom last year and thus it has climbed to new all-time highs. As a result, it has become challenging for investors to identify cheaply valued stocks. China Petroleum & Chemical Corporation (NYSE:SNP), commonly known as Sinopec, is a bright exception to this rule. The stock is currently trading at a price-to-earnings ratio of only 5.1. Even if the cyclical nature of the energy sector is taken into account, the stock is trading at only 11.3 times its decade-low earnings, which were recorded last year due to the pandemic. In this article, I will analyze why Sinopec is deeply undervalued at its current stock price.

Business overview

Sinopec is a major oil producer, with a market capitalization of $75 billion. Like the other oil majors, such as Exxon Mobil (XOM) and Chevron (CVX), Sinopec is an integrated oil company, with exploration & production, refining, marketing and chemical segments. On the other hand, it has a key difference from its peers; it relies much more on the condition of the Chinese economy, as its refining and marketing divisions are strongly tied to the growth of the Chinese economy, whereas the American oil companies are more sensitive to the status of the global energy market.

Last year, all the oil majors were severely hit by the pandemic, as the social distancing measures caused an unprecedented collapse in global oil consumption, from 100.3 to 91.8 million barrels per day. This collapse caused a plunge in the price of oil and led the refining margins to shrink to decade-low levels. Consequently, Exxon Mobil, Chevron and BP (BP) incurred material losses last year.

On the contrary, Sinopec greatly benefited from the drastic measures of the Chinese government, which managed to put the pandemic under control shortly after its onset. China was the only major country which enjoyed economic growth last year. Thanks to this tailwind, Sinopec outperformed its peers by a wide margin and posted earnings per share of $4.17 last year. While those earnings were 38% lower than in 2019, they marked an outstanding performance compared to the losses or negligible profits posted by all the other oil majors.

Even better, thanks to the massive distribution of vaccines worldwide, the energy market is recovering strongly from the pandemic this year. According to the latest report of the Energy Information Administration [EIA], global oil consumption is expected to surge from 91.8 million barrels per day in 2020 to 96.9 million barrels per day in 2021 and the pre-pandemic level of 100.5 million barrels per day in 2022.

The ongoing recovery of the global energy demand is clearly reflected in the performance of Sinopec in the first nine months of the year. The company grew its production 4.6% over last year’s period while it also enjoyed a strong tailwind from the Chinese economy, which grew 9.8% in the first nine months of the year. In addition, Sinopec greatly benefited from the tight oil supply from OPEC and Russia, which led the price of oil to rally to a 7-year high. Thanks to all these tailwinds, the Chinese oil major grew its earnings per share 150% over last year’s period. Analysts expect the company to more than double its earnings per share this year, from $4.17 to $9.22.

Unfortunately, the emergence of the omicron variant has raised some concerns that the variant may significantly reduce the efficacy of vaccines, but it is too early to draw such conclusions. The new variant seems to be somewhat resistant to two vaccine shots but it is unlikely to be resistant to three vaccine shots. Moreover, vaccine producers have stated that they can adjust their vaccines within just a few months to address the new variant. Moreover, it is almost certain that the existing vaccines are not useless; they are just likely to prove less efficient in the adverse scenario.

More importantly, thanks to a massive global vaccine rollout, 55% of global population has received at least one vaccine dose. About 1%-2% of global population is vaccinated every week. As a result, the vast majority of global population will be vaccinated in a few months and hence the risk of new mutations will decrease and the pandemic will probably be held under control. To cut a long story short, the latest mutation of the virus may delay the recovery of the global oil market from the pandemic but the massive vaccine rollout and the development of adjusted vaccines are likely to put the pandemic under control.

Dividend

Most income-oriented investors prefer to receive a predictable dividend quarter after quarter. This is the dividend policy followed by most oil majors, including Exxon Mobil, Chevron and BP. Sinopec follows a different policy; it offers a separate dividend in every semester, based on its actual earnings. Consequently, its dividend is much more volatile and unpredictable than that of its peers.

Chart
Data by YCharts

On the other hand, it is crucial to realize that Sinopec is so cheaply valued that it is likely to highly reward income-oriented investors at its current stock price. To provide a perspective, the stock has offered total dividends of $4.49 this year. These dividends correspond to an annual dividend yield of 9.6%, which is undoubtedly outstanding. Given the solid payout ratio of 58% and the resilience of Sinopec to the pandemic, the dividend has a wide margin of safety and hence investors can reasonably expect a similar dividend next year.

It is also important to note that Sinopec offered an annual dividend of $2.11 in 2016, its worst year over the last decade. Even if the company offers this decade-low dividend to its shareholders, it will offer them a 4.5% dividend yield. In other words, even in a worst-case scenario, investors will still receive an attractive dividend from Sinopec at its current stock price.

Valuation

Sinopec is currently trading at only 5.1 times its expected earnings this year and 5.2 times its expected earnings in 2022. These price-to-earnings ratios are extremely low, much lower than the historical 10-year average price-to-earnings ratio of 10.5 of the stock.

Chart
Data by YCharts

Even if the 10-year low earnings per share of $4.17 (in 2020) are taken as a base, the stock is trading at only 11.3 times its decade-low earnings. Overall, the current valuation of Sinopec is extremely cheap. Whenever the stock reverts to its average valuation level, it will approximately double merely thanks to the normalization of its valuation level.

Risk

The energy sector is infamous for its high cyclicality, which is caused by the dramatic swings of the price of oil. Therefore, it is reasonable to expect energy stocks to trade at lower price-to-earnings ratios than the broad market during boom times. This is true for Sinopec, which has traded at an average price-to-earnings ratio of 10.5 over the last decade.

On the other hand, the extremely low earnings multiple of the stock right now cannot be fully attributed to the cyclicality of the oil industry. The primary reason behind the cheap valuation of the stock is the risk of being delisted from NYSE at some point in the future due to the trading war between the U.S. and China. In March, another Chinese oil stock, CNOOC, was delisted from NYSE. However, Sinopec has never been mentioned as a candidate for delisting. More importantly, even in the unlikely adverse scenario of delisting of Sinopec, its shareholders will not lose their capital. Instead, they will retain their shares in another stock exchange and will be able to sell them at a much more reasonable valuation level at some point in the future.

Final thoughts

Sinopec has proved one of the most resilient energy stocks to the pandemic. In addition, it is offering a markedly generous dividend and is trading at an exceptionally cheap valuation level. Whenever the market shifts its focus from the trading war between the U.S. and China to the fundamentals of Sinopec, the stock will highly reward its shareholders.

This article was written by

Aristofanis Papadatos profile picture
8.07K Followers
I am a chemical engineer with a MS in Food Technology and Economics. I am also the author of 2 mathematics books ("Arithmetic calculations without a calculator" and "Word Problems") and perform almost all the calculations in my mind, without a calculator, making it easier to make immediate investing decisions among many alternatives. I invest applying fundamental and technical analysis and mainly use options as a tool for both investing and trading. I have nearly achieved my goal of early retirement, at the age of 45. In my spare time, I follow Warren Buffett's principle: "Some men read playboy. I read financial statements".
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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