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Sinopec Picks a Peck of Profits

By Stephen D. Simpson, Simpson, – Updated Nov 16, 2016 at 2:22PM

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China's giant oil and chemicals company has a good year, but government price controls take their toll.

With oil and chemical prices being what they are, it's hard not to make a lot of money these days if those are your primary lines of business. So when China's China Petroleum and Chemical Corp (known to everyone as "Sinopec") (NYSE:SNP) reported good growth for the full year of 2004, it wasn't exactly a surprise.

Revenue grew about 38% for the year, with operating profit climbing more than 62%. This marks the fourth straight year of both top- and bottom-line growth for Sinopec, and the company ended the year with an 18.7% return on assets and a 12.8% return on capital employed.

Profits were boosted by strong results in exploration/production, marketing and distribution (gas stations, mostly), and the chemicals business. The refining business was not so strong, though, and operating profits actually declined slightly as strict government price controls played havoc with the company's refining margins and ability to fully pass along costs.

Perhaps even more important for the devoted China-watcher, Sinopec management's guidance for 2005 was all in all fairly sanguine. Management believes that the global upturn in chemicals has room to go and, more importantly, that China's economy should continue to grow rapidly.

Given that the Chinese government owns about 55% of the company, one would hope that Sinopec management has a better-than-average idea of what the government is planning to do with the Chinese economy next year.

Valuation on Sinopec shares looks appealing at first blush. With a trailing P/E of only about 8 and double-digit returns on capital, Sinopec looks like a bargain compared with Exxon Mobil (NYSE:XOM) and BP (NYSE:BP), and possibly even fellow Chinese company PetroChina (NYSE:PTR).

Digging a little deeper, though, you see reasons to believe that a discount may be, at least in part, appropriate. Although Sinopec posted strong profit growth, it basically broke even on a free cash flow basis for 2004, and the oil/refining/chemicals businesses all still require considerable capital expenditures.

What's more, while the company has good refinery operations and a network of more than 30,000 gas stations, government price controls throw a monkey wrench into the works. While refining can be a great business indeed (look at Bill Mann's favorite, Valero Energy (NYSE:VLO)), operating a business where neither your prices nor your costs are within your control is tricky at best.

The basic thesis at Sinopec -- China is big, growing, and needs more (pick one: oil, chemicals, gasoline, ethylene, resins, etc.) -- is firmly intact and I believe that Sinopec management generally does a good job with the situation at hand. Whether the market is currently offering enough discount to compensate for the risks of ongoing interference from the Chinese government (to say nothing of the risks of general economic slowdown) is for each investor to decide for him or herself.

For more on chemicals, consider these other Foolish opinions:

Fool contributor Stephen Simpson owns shares of PetroChina.

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Stocks Mentioned

BP p.l.c. Stock Quote
BP p.l.c.
BP
$28.08 (-8.80%) $-2.71
Exxon Mobil Corporation Stock Quote
Exxon Mobil Corporation
XOM
$85.75 (-5.32%) $-4.82
PetroChina Company Limited Stock Quote
PetroChina Company Limited
PTR
$43.03 (-1.36%) $0.59
Valero Energy Corporation Stock Quote
Valero Energy Corporation
VLO
$100.57 (-6.53%) $-7.02
China Petroleum & Chemical Corporation Stock Quote
China Petroleum & Chemical Corporation
SNP
$43.60 (-0.91%) $0.40

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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