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Asia: Asia Refining Sector





Asia Refining Sector

Low expectations are an opportunity

● Divergence between equities and commodities is also evident for Asian refiners, with share prices implying margin cuts. While low levels of 2012 capacity addition can support margins through the year, seasonal strength in diesel cracks on winter demand and increasing exports can be a shorter term catalyst.
● Asian refiner valuations (P/E, EV to EBITDA) are close to their 2009 lows. We estimate the market implies 2012 EBITDA cuts of 17-46%, which translates to about US$2/bbl reduction in GRM on average. This would bring refining benchmarks back to the (low)levels seen in 2010. Benchmarks have been less than 2010 during the crisis, or prior to 2004 (when oil was about US$30/bbl).
● The recent strength in gasoline and FO cracks has helped benchmark margins reach all-time highs. Asian refiners, though, are diesel heavy. Even if gasoline/ FO cracks eased (as they have recently), strength in diesel should more than compensate.
● We would buy the Korean refiners (with S-Oil having the least expectations) for seasonal demand strength. GS is least expensive on P/B multiple, which may limit potential downside.
Please see our detailed note published Oct 27 for details.

Expectations are of declining margins

Asian refining stocks have corrected sharply despite stable and improving near-term refining margins and flat consensus earnings estimates. Headline sector P/E and EV/EBITDA multiples are consequently close to 2009 lows. We believe this is reflective of the uncertain macro and the limited confidence in oil demand and refining margin forecasts. The 2012E consensus EBITDA would have to be downgraded by 17-46% for each of the Asian refining stocks to effectively trade at its five-year average EV/EBITDA multiple (only FPCC does not imply downside). This implies a c.US$2/bbl reduction in GRM on average (highest for RIL, and lowest for TOP), which would bring margins for most companies back to the 2010 levels.

Refining margin benchmarks have been less than those in 2010 and 2009 (due to the financial crisis) and prior to 2004 (when global utilisation rates were low and declining; and oil prices were about

US$30/bbl). Outside of a significant negative surprise on oil demand (perhaps led by another crisis), headline margins should not fall below the 2010 levels, in our view. Stock implied earnings expectations should not have a downside in the near term.

While margins can remain strong near term

Benchmark refining margins (such as the Reuters Singapore Dubai crack) are at all-time highs, but the recent strength has been driven by improving gasoline and fuel oil cracks (on specific supply issues in the near term and stronger Japanese demand for FO post the earthquake). Most Asian refiners have a diesel heavy output. Diesel cracks can improve in the near term on seasonality (winter demand), increasing exports to Europe, and on declining inventories (now downto five-year averages). Even if gasoline/ FO cracks come off their recent highs, stronger diesel can compensate; company profitability
should remain robust in the near term. The 2012E net global refining capacity addition should be at low (0.7 mbopd) levels, which could support margins even in a soft demand environment.

Asian refining stocks should have upside

While stock prices imply refining margins will fall to relatively low levels, they are likely to remain robust in the near term. Strength in diesel cracks in winter could lead to an expansion in stock multiples and improvement in Asian refiner stock prices, we believe.

Each of the three major Korean refiners should have a potential upside. S-Oil implied the largest consensus downside and, with less non-refining earnings, should have the largest sensitivity to refining margin strength. GS Holdings appears the most inexpensive on a P/B metric, which might limit its downside. TOP stock price implies consensus earnings cuts as well, though not to the extent of the Korean refiners. RIL has the largest refining capacity, but with material other businesses (petchem, E&P) and low balance sheet leverage, it may not be the highest ‘Beta’ refining play. FPCC in Taiwan is expensive, and implies upgrades to 2012E consensus. We would buy the Korean refiners (with S-Oil having the largest sensitivity) for seasonal demand strength. Government intervention on retail pricing and the potential for another economic crisis are the key risks.

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