SHI: Sinopec Shanghai Stock Analysis

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This is part 3 of Chinese Stocks to Watch in 2007 Series.

Sinopec Shanghai Petrochemical Co. (SHI) is a Shanghai-based synthetics company that produces a vast range of petroleum products.

Sinopec Shanghai Petrochemical Company Report

Sinopec Shanghai Petrochemical Company Limited (SPC) is a petrochemical company in the People’s Republic of China. The Company produces over 60 different types of products, including a range of synthetic fibers, resins and plastics, intermediate petrochemical products, and petroleum products. The petroleum products and intermediate petrochemical products produced by the Company are used primarily in the production of its own downstream products. SPC is also engaged in activities, through its parent company China Petroleum & Chemical Corporation (Sinopec Corp), which includes exploring for, extracting and selling crude oil and natural gas; oil refining; production, sale and transport of petro-chemical, chemical fibers and other chemical products; research and development, and application of new technologies and information. The Company principally operates business in four segments: synthetic fibers, resins and plastics, intermediate petrochemicals, and petroleum products. (Source: MSN Money)

Sinopec’s management has built a strong foundation because they implemented a vertical integration business model. Sinopec operates an oil and gas exploration business through its parent company, China Petroleum & Corp, allowing Sinopec to extract the same oil it uses to produce synthetic products.

This successful model has produced above industry average 5-year net profit margins, and revenue grew 17% year over year last quarter. Sinopec has a market cap of $3.59 billion; I prefer holding SHI shares over a larger Chinese basic materials stock like PetroChina (PTR) because SHI is much smaller company. With only 72 million shares outstanding, this Shanghai mid-cap stock has room to run.

In order to make money from China’s economic growth, we need to identify the growth stocks that have the opportunity to be the next PetroChina.

Positive Stock Signals

1. 9.7 forward P/E ratio – while SHI shares currently trade at a premium, 284 times earnings, this stock is on sale for 2007.

2. 5-year growth rates outperformed their industry – China’s fuel and energy demand will continue to increase, which is why Chinese basic material stocks are positioned for strong forward growth in 2007.

  • 5-year sales growth – 16.87%, compared to -0.21% industry average
  • 5-year net income growth – 13%, compared to 12% industry average
  • Dividend 5-year growth – 10%, compared to 1.66% industry average

3. 1.24 Dividend Rate – Sinopec is committed to returning value to shareholders. The company rewards shareholders as it grows.

4. 0.29 Debt to Equity Ratio – The company has decreased long-term debt.

5. 5-year 12% Return on Equity average – 15% returns are what I look for, but considering that the industry average for the same time period stood at 7%, this stock is a consistent winner.

Negative Stock Signals

1. 8.4% gross margins, compared to 22% industry averages – gross margins have underperformed the market. I attribute this negative stock signal to Sinopec’s small size. Sinopec must compete with larger firms for deep oil wells because that’s where oil and gas integrated companies make the big bucks.

2. Poor Cash Flow – Sinopec’s cash position has decreased every quarter since 2004, primarily due to dividend payouts and debt repayments. If dividend payouts prevent SHI from establishing a strong cash position, they should scale back the dividend. I like companies with lots of cash. eBay (EBAY) and Electronic Arts (ERTS) are good examples of growth stocks with large cash positions.

3. Lack of updated information on Investor Relations site – the most recent investor presentation is from 2004. This is a terrible sign because it shows little interest from the institutional investors.

Catalysts

1. Strong energy demands from China

2. Strategic positioning in a fast growing economy

3. Key Investment opportunity for Growth Investors

If you’re searching for a basic materials company that invests in petroleum, then SHI is an option for growth investors. Another option is a Foreign ETF that maintains a large stake in SHI. You’ll reduce your risk, and still benefit from Sinopec’s future growth. Try iShares FTSE/Xinhua China 25 Index (FXI).

Sinopec has been added to my watch list.

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