Sinopec Kantons Has Plenty In The Tank

Savvy investors can make good money by anticipating the future. In the case of battle-weary investors in the oil industry, it may pay them to keep a close eye on futures, crude oil futures that is.

If investors spared a moment to divert their stunned gaze away from the gut-wrenching carnage being meted out on the spot oil price and instead refocused their attention on the prices traders are willing to pay for oil in the future, they would understand that better days may be ahead given expectations that oil prices in six months will be higher than they are now. The canny way to profit from futures prices being higher than spot prices – or in ‘contango’ in trader parlance – is to buy oil now, store it, then sell it later at higher prices implied by the futures market, and hopefully make a profit once you subtract your storage costs. Well, that’s the theory.

And that’s where Sinopec Kantons ( 934.HK ) comes into play. The company, which is a listed subsidiary of China Petroleum & Chemical Corp, better known as Sinopec ( 386.HK ) / ( SNP ), is the largest oil storage and terminal company in China. Kantons operates in three businesses that support its parent’s massive refining operations: crude oil trading, jetty services, and vessel chartering services. It may not be the most exciting part of the oil industry, but owning storage facilities can be a great business when crude buyers are looking for somewhere to park their oil.

The company’s shares are down about one-third from its mid-January high around HKD9.60 a share, but that weakness may provide an attractive entry point into a company that could be well positioned to benefit from China’s development of a strategic petroleum reserve (SPR). The pummeling of the oil price may have prompted the wringing of hands in the Middle East and in the U.S. shale industry, but there are many who anticipate China will be swiftly moving to exploit their collective misery – if they haven’t already.

The amount of oil flowing through Kantons’ domestic terminals increased 8% year-on-year in the first half of the financial year. Given the hammering of the oil price it wouldn’t be surprising if the amount of black gold flowing through the company’s terminals has increased significantly as China seeks to accumulate an oil reserve.

China acknowledged last week that it had built an inventory of 91 million barrels in the first phase of stocking up between 2006 and 2009. However, Bernstein Research estimates China’s SPR contained 220 million barrels in October, 53 million barrels more than at the end of last year. They calculate that China may have an extra 100 million barrels of phase two capacity to come on line by the end of 2016, while phase three could add a further 171 million barrels to China’s SPR capacity. Sinopec Kantons could see its bottom line bolstered if it can capture a share of that increased inflow of oil.

Sinopec Kantons has clearly sharpened its focus on the logistics of energy. A fall in oil trading revenue suggests the company is more focused on its physical assets that store and move energy. The commitment to logistics is underscored by its plans to invest in a fleet of up to ten liquefied natural gas vessels that will transport the fuel from Australia and Papua New Guinea to its parent. The LNG fleet provides the company with a play on China’s fight against pollution given natural gas contains much less carbon than thermal coal. The company will also benefit from its parent transferring to it ownership of the Yulin-Jinan gas pipeline in northern China. The company also owns or is building storage terminals close to key oil trading centers in the Netherlands, the United Arab Emirates and Singapore.

A lack of similar companies in Asia makes a comparison of valuations difficult. Few companies in the region own petroleum storage assets. Kantons trades on a trailing price-earnings multiple of 24 times, which is less than the 35 times that marine fuel trader Brightoil Petroleum ( 933.HK ) fetches. China Aviation Oil ( G92.SG ), a jet-fuel trader that suffered heavy derivative losses about a decade ago, trades at about seven times, while Indian LNG importer Petronet LNG (532522.IN) is priced at 21 times. U.S.-listed World Fuel Services ( INT ) is a closer pure-play energy storage company that trades at around 16 times. While there is a wide spectrum of valuations, it is worth noting that Nomura has a HKD12 a share valuation on the stock, which is nearly double the HKD6.30 it was trading at on Tuesday.

Given Kanton’s stable and strategically important client, Asia’s largest refiner Sinopec, and its growth prospects in logistics and LNG shipping, the stock arguably deserves a premium rating. The stock should be relatively immune to the absolute price of crude oil, but watch that futures curve.