Initiation of Coverage: China Refining Sector 12 July 2018
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China Refining Sector
UBS-S Research THESIS MAP Most Favoured Least Favoured
Tongkun Group N/A
PIVOTAL QUESTIONS Q: Do private mega refiners have competitive advantages over large SOE and local refiners
Yes. We believe these advantages include greater economies of scale, a higher Nelson complexity and
petrochemical yield, better refining-petrochemical integration, and a focus on cost control. Key risks
include a lack of distribution channels, higher oil prices, PX overcapacity, construction execution and a
sluggish polyester industry. We expect private mega refineries to be considerably profitable.
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Q: Can record refining profitability be sustained despite high oil prices and overcapacity
Most likely. We believe oil prices around US$60-80/bbl could underpin a comfortable operating
environment for refiners. We expect a further extended petrochemical upcycle, which is likely to
enhance returns. Finally, we believe the Government is likely to allow product export quotas to rise,
which could prevent domestic product inventory from overbuilding.
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Q: Will tightening PFY and PTA fundamentals offset deteriorating PX profitability
Yes. We expect integrated polyester producers to remain highly profitable, although we think the key
source of profit generation will move from upstream PX to downstream PTA-PFY. Large Chinese
producers will gain competitiveness due to their advantages in scale, facilities and integration.
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WHAT'S PRICED IN Based on our research and discussions with related parties, we expect HPIP/ZPC to launch in late
2018/early 2019, respectively, unlike the bearish views of international petrochemical consultants,
which estimate the two projects will launch in 2020. Based on average 2020E PE of Asian peers, the
current share prices of Tongkun, Hengli and Rongsheng factor in respective 64%/70%/80%
utilization for mega refining projects in 2020 (we estimate 80% utlilization).
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UBS-S VIEW
We believe new refineries may be more competitive and profitable, and project execution could be faster,
than the market expects. Tongkun, Hengli and Rongsheng are trading at 6x/6x/9.5x 2020E EPS. We are
initiating coverage of Tongkun and Hengli with Buy ratings and Rongsheng with a Neutral rating.
EVIDENCE
We project Hengli Petrochemical and Zhoushan Petrochemical will have Nelson Complexity Index
ratings of 13.8 and 12.5, respectively (among the highest in Asia). Historically, China's refined product
policy has adversely impacted profit only during times of extremely high oil prices and high inflation.
China plans to launch 14.1m tons of new PX capacity in 2019-20. Our bottom-up supply-demand
forecast suggests new PFY capacity will just keep up with demand growth.
China's refining capacity