company report: sinopec seg (02386 hk) dec-16 …...demand growth in the asia-pacific region will...

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Company Report: Sinopec SEG (02386 HK) David Liu 刘静骁

公司报告：中石化炼化工程集团（02386 HK） +852 2509 5441

[email protected]

20 December 2017

A Leading Petrochemical EPC Contractor, Initiate with “Accumulate” 优秀的石化EPC承包商，首次覆盖并给予“收集”投资评级

Demand growth in the Asia-Pacific region will digest capacity expansions

coming online globally in the oil refining and petrochemical industries.

GDP growth in China and India from 2017-2022 is estimated to be 5.9% p.a.

and 7.8% p.a., respectively. The two countries are estimated to account for half

of global oil demand growth and a third of refinery capacity expansions. Their

import demand will be fueled by additional supply from the Middle East and U.S.

Petroleum engineering investment has entered a stage of growth recovery

from 2016. Global investment for petroleum engineering peaked around 2013,

reaching a low in 2016 as oil prices fell and large oil majors cut back on

spending. Data in 2017 show investment has begun growing, with the trend

likely to persist as oil majors’ earnings continue to improve.

Sinopec Engineering Group can leverage its favorable market position to

increase earnings. The Company has a strong track record of successful

project execution and technological innovation which has led to greater

numbers of high-value, large-scale EPC projects domestically and abroad. We

expect profitability to improve as the Company acquires more large-scale,

complex EPC projects in the future as investment recovers.

We initiate coverage with an “Accumulate” investment rating and TP of

HK$8.50. The TP is equivalent to 15.98x/13.81x/10.93x 2017E/2018E/2019E

PER and 1.23x/1.16x/1.08x 2017E/2018E/2019E PBR and represents a 25.0%

discount from our DCF valuation. Recovering industry investment provides room

for earnings growth and opens opportunity to invest.

亚太地区的需求增长将消化国际炼油和石化行业即将增加的新产量。中国和印度 2017-2022

的 GDP 增长预计分别为 5.9%和 7.8%。两个国家预计占全球石油需求增长的近一半和炼油产

量扩张的三分之一。两国进口需求将来自于中东和美国的新产量。

石油工程投资已经进入恢复性增长。全球石油工程投资从 2013年的顶峰降到 2016 年的最低，

主要由于油价暴跌导致石油公司削减开支。2017 年数据已经显示投资开始从去年复苏，我们

预计随着石油公司盈利逐渐的改善，投资增长的趋势会继续。

中国石化工程集团可以利用自己有利的市场地位来增加盈利。公司的技术创新能力和良好的

业绩记录帮助公司获得越来越多的国内外优质大型 EPC 项目，并获得国际认可。随着工业投

资回升，我们预期公司将获得更大规模和复杂的 EPC 项目，盈利将有所改善。

首次覆盖并给予“收集”投资评级，目标价为$8.50 港币。我们的目标价相当于 15.98 倍/13.81

倍/10.93 倍 2017-2019 年市盈率和 1.23 倍/1.16 倍/1.08 别 2017-2019 年市净率，对我们做

出 2017 年 DCF 估值分析有 25.0%的折让。行业投资的恢复将给公司提供盈利增长空间以及

创造投资机会。

Rating: Accumulate

Initial

评级：收集（首次覆盖）

6-18m TP 目标价: HK$8.50

Share price 股价： HK$6.280

Stock performance 股价表现

(20)

(10)

0

10

20

30

40

50

Dec-16 Feb-17 Apr-17 Jun-17 Aug-17 Oct-17 Dec-17

% of return

HSI index Sinopec Engine-H

Change in Share Price

股价变动

1 M

1 个月

3 M

3 个月

1 Y

1 年

Abs. % 绝对变动 %

8.3 4.7 (0.9)

Rel. % to HS index 相对恒指变动 %

4.1 (4.7) (23.0)

Avg. share price(HK$)

平均股价（港元） 8.9 8.7 9.2

Source: Bloomberg, Guotai Junan International.

Year End 年结

Turnover 收入

Net Profit 股东净利

EPS 每股净利

EPS 每股净利变动

PER 市盈率

BPS 每股净资产

PBR 市净率

DPS 每股股息

Yield 股息率

ROE 净资产收益率

12/31 (RMB m) (RMB m) (RMB) (△%) (x) (RMB) (x) (RMB) (%) (%)

2015A 45,498 3,318 0.750 (5.1) 8.4 5.564 1.1 0.301 5.6 13.5

2016A 39,375 1,663 0.376 (49.9) 16.7 5.691 1.1 0.255 4.4 6.6

2017F 39,009 2,057 0.464 23.7 13.5 6.015 1.0 0.134 1.8 7.7

2018F 40,193 2,379 0.537 15.7 11.7 6.380 1.0 0.173 2.3 8.4

2019F 43,395 3,007 0.679 26.4 9.2 6.851 0.9 0.208 2.8 9.9

Shares in issue (m) 总股数 (m) 4,428.0 Major shareholder 大股东 China Petrochemical Corporation 67.01%

Market cap. (HK$ m) 市值 (HK$ m) 27,807.8 Free float (%) 自由流通比率 (%) 83.0

3 month average vol. 3 个月平均成交股数 (‘000) 6,177.9 FY17 Net gearing FY17 净负债/股东资金 (%) Net cash

52 Weeks high/low (HK$) 52 周高/低 8.580/6.030 FY17 Est. NAV (HK$) FY17 每股估值（港元） 11.3

Source: the Company, Guotai Junan International.

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Sinopec SEG (02386 HK)


TABLE OF CONTENTS

OVERVIEW OF THE GLOBAL AND CHINESE ECONOMY ................................................................... 3

PETROCHEMICALS INDUSTRY ............................................................................................................ 3

OVERVIEW OF DOWNSTREAM INDUSTRIES ......................................................................................................3 OIL REFINING ..........................................................................................................................................................5 PETROCHEMICALS ................................................................................................................................................5

CHINA’S PETROCHEMICAL AND OIL REFINING INDUSTRIES .......................................................... 7

DEMAND ..................................................................................................................................................................7 CAPACITY ................................................................................................................................................................7 INVESTMENT ..........................................................................................................................................................9 OVERSEAS OPPORTUNITIES ............................................................................................................................ 10

CHINA’S COAL CHEMICALS INDUSTRY ............................................................................................ 10

ENVIRONMENTAL PROTECTION ....................................................................................................... 12

COMPETITION ...................................................................................................................................... 12

COMPANY ANALYSIS ......................................................................................................................... 14

ENGINEERING, CONSULTING AND LICENSING BUSINESS ............................................................................ 15 EPC CONTRACTING BUSINESS ........................................................................................................................ 16 CONSTRUCTION BUSINESS .............................................................................................................................. 18 EQUIPMENT MANUFACTURING BUSINESS ..................................................................................................... 19

FINANCIAL ANALYSIS ........................................................................................................................ 20

NEW CONTRACT VALUE AND REVENUE .......................................................................................................... 20 COST OF SALES .................................................................................................................................................. 21 GROSS PROFIT ................................................................................................................................................... 22 OPERATING PROFIT ........................................................................................................................................... 22 FINANCE INCOME AND EXPENSES ................................................................................................................... 23

VALUATION.......................................................................................................................................... 24

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OVERVIEW OF THE GLOBAL AND CHINESE ECONOMY

As the global economy is expected to accelerate, China’s economy enters a transitional period of decelerating growth.

The global economy has grown steadily during the past five years where developing economies in Asia averaged 6.8% real GDP

growth annually, compared with 1.7% growth in advanced economies. According to data provided by the International Monetary

Fund (the “IMF”), the global GDP in 2016 was approximately US$75,367.75 billion, which is an average annual growth rate of

3.7% from 2006 to 2016. The IMF forecasts growth of the global economy to maintain a similar pace in the medium term,

estimating GDP to grow at an average of 3.7% from 2017 to 2022. In China, GDP grew at a CAGR of 9.0% from 2006-2016, the

IMF forecasts China’s economy to decelerate and grow at a CAGR of approximately 6.3% from 2016 to 2022 as China

strategically shifts from manufacturing and export-oriented growth to more service-oriented growth. With GDP of approximately

RMB74,594.98 billion in 2016, China is the second largest economy in the world preceded by the United States, with GDP of

approximately US$16,716.15 billion (approximately RMB116,088.65 billion) in 2016. China’s economic transition will be important

to follow as its movements will have broad implications for the global economy as a whole.

Figure-1: Real GDP Outlook of China and Global Economy

14.2

9.6 9.2

10.6

9.5

7.9 7.8 7.3

6.9 6.7 6.8 6.5 6.3 6.2 6.0 5.8 5.6

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2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

Real GDP: China Real GDP Growth: China (RHS) Real GDP Growth: World (RHS)

RMB bn %

Forecast

Source: IMF World Economic Outlook Database.

PETROCHEMICALS INDUSTRY

OVERVIEW OF DOWNSTREAM INDUSTRIES

Downstream industries consist of the oil refining industry and the chemical industry. The oil refining industry mainly

involves the processing of crude oil into oil products such as gasoline, diesel, kerosene, naphtha, and fuel oil. The chemical

industry is multifaceted and complex due to its presence in all industries, but for the purposes of this report, we primarily focus on

primary “base” chemicals that form the building blocks for the rest of the industry and include olefins ethylene and propylene,

aromatics benzene, toluene, and xylenes, and finally ammonia and methanol. The hydrocarbons that serve as feedstocks for

production of the primary chemicals are naphtha, liquefied petroleum gases (“LPG” or propane), ethane, synthetic natural gas

(“SNG” or methane), and butane.

Figure-2: Chemical Industry Value Chain

Source: IHS Markit.

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The Asia-Pacific will lead global oil demand growth. In 2017 and 2018, IEA estimated in its October Oil Market Report that

global oil demand will increase by 1.58 mb/d and 1.41 mb/d p.a., respectively. Over the same time period, China is expected to

contribute approximately 0.54 mb/d and 0.32 mb/d of oil demand growth; India is expected to contribute approximately 0.09 mb/d

and 0.32 mb/d, respectively. Regionally, the two nations are expected to be the largest drivers of oil demand growth over the next

20-25 years with India’s growth in oil demand to overtake China’s as China’s economic growth decelerates. In terms of sector,

growth in freight, aviation, transportation, and chemical sectors will account for almost all of the growth in oil demand.

Figure-3: Total Petroleum Consumption by Region

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

China Africa Central & South AmericaMiddle East Non OECD Asia-Oceania (excl. China) RussiaNon-OECD others OECD-Europe OECD-North AmericaOECD-Asia and Oceania OECD-Others

kb/d

Source: EIA.

Global natural gas demand is poised to grow faster than oil demand as natural gas becomes a larger portion of power

generation. Global natural gas demand growth will likely more than double that of oil, driven by liquefied natural gas (“LNG”)

capacity. Shell estimated in its 2017 LNG outlook that global LNG demand will grow 4%-5% p.a. from 2015-2030. This is more

than twice the growth rate that BP has estimated for global natural gas demand at 1.8% p.a. and oil at 0.8% p.a. over the same

time period. China will again be the primary driver for growth in gas demand. From 2015-2035, BP estimates that China will

contribute 328.5 mtoe, approximately 28.3% of total growth in gas demand, growing 5.4% p.a. This is compared to an estimated

2.4% p.a. growth for China’s oil demand over the same period. From 2015-2035, according to BP’s 2017 Energy Outlook,

approximately 2,478 mtoe or 61.8% of global growth in total energy consumption will be for power generation, 426 mtoe or 17.2%

of which will be natural gas. Over the same period, approximately 36% of total growth in natural gas demand will be for power

generation, 406 mtoe or 34.3% will go to the industrial sector. The two sectors together constitute the largest portion of global

natural gas demand growth, as natural gas burns more cleanly than coal and is in relative abundance.

Figure-4: Global Energy Consumption by Sector, 2015-2035

Figure-5: Global Energy Consumption by Sector, 2015-2035

32.4%

23.8%

29.2%

11.2%

3.3% 28.5%

25.2%

23.5%

12.8%

10.0%

Oil Gas Coal Nuclear & Hydoelectricity Renewables

Inside-2015Outside-2035

Transport Power Industry Non-combusted Buildings

0

1000

2000

3000

4000

5000

6000

7000

8000

9000

Oil Gas Coal Nuclear/Hydroelectricity Renewables

mtoe

Source: BP Energy Outlook 2017. Source: BP Energy Outlook 2017.

A significant share of the petrochemical industry will shift towards natural gas, particularly LNG, as feedstock, with the

transportation industry remaining as the largest driver of oil demand. Within the non-combusted use sector which includes

the petrochemical industry, 195 mtoe or 64.7% of consumption growth will be accounted for by oil, 90 mtoe or 29.7% by gas, and

17 mtoe or 5.5% by coal. More than half of the growth in gas consumption will be LNG. In the transportation sector, 368 mtoe or

77.9% of growth in consumption will be accounted for by oil, 62 mtoe or 13.1% by gas, and 43 mtoe or 9.1% by renewable

sources. While the petrochemical industry will continue to rely primarily on oil as a feedstock, growth is expected in the use of

natural gas as feedstock for ethylene production, this will be led by supply expansions in the U.S. There are competitive

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economics of using natural gas as opposed to crude for chemical feedstocks as oil prices are projected to trend upward in the

medium term and environmental advantages concerning global emissions standards are expected to continuously tighten over

time.

OIL REFINING

With refinery investment having bottomed out in 2016, starting a recovery phase in 2017, new capacity additions to

secondary upgrading processes are expected to outpace growth in primary CDU capacity in the medium term. According

to IEA’s Energy Investment 2017 report, global downstream investment was US$215 bn in 2016, down 13.7% YoY from US$249

bn in 2015. The decline was due to decline in OECD countries, whose investment dropped dramatically from US$109 bn to US$65

bn; the decline overshadowed an increase in investment from non-OECD countries, which increased 11.1% YoY from US$117 bn

to US$130 bn, led by China, India, and Latin America. Investment seems to have bottomed out however, with the majority of

international oil majors having announced a rise in planned capital expenditure from the previous year in order to not only increase

oil production, but to also build new refinery capacity. According to IEA’s Oil 2017 report, approximately 7.0 mb/d and 7.2 mb/d of

primary CDU capacity and secondary processing capacity is forecast to be added globally from 2016 through 2022, respectively.

IEA estimates China and the Middle East to lead capacity growth, accounting for 31.6% and 27.1% of CDU capacity additions and

36.1% and 29.7% of secondary capacity additions, respectively. The slightly larger expected growth in secondary capacity is due

in part to the expected continued tightening of global environmental regulations which will increase demand for cleaner and better

quality oil products. In addition, refinery upgrading capacities corresponds with the expected growth in demand for more gasoline,

diesel, kerosene, and petrochemical feedstocks on the lighter end of the hydrocarbon spectrum such as LPG.

The oversupply of global CDU capacity is unlikely to subside in the medium term, with refinery capacity growth expected

to outpace the corresponding growth in global oil demand. Refiners will be pressured to look further downstream towards

higher quality products. Estimates for CDU capacity expansions from IEA’s Oil 2017 report and OPEC’s WOO 2017 report fall in a

range of 1.0 mb/d to 1.3 mb/d per year from 2016-2022, respectively; global oil demand is estimated to lag behind refinery

capacity growth to increase approximately 0.9 mb/d to 1.0 mb/d per year over the same period, respectively. The Asia-Pacific

region will account for 40-50% of new CDU capacity growth, about half of which is expected from China. Globally, there is an

oversupply of distillation capacity and the estimates from IEA and OPEC suggest that oversupply may extend to 1.0 mb/d by 2022,

which will most likely lead to the closures of older refineries in certain mature economies of OECD, Europe, and the Asia-Pacific

(Japan) that exhibit weak demand growth as well as turn existing and new refiners to adding upgrading processes to increase high

value oil product capacity.

Figure-6: Global Base Refining Capacity, as of Jan. 2017 Figure-7: Distillation Capacity Additions from Existing Projects, 2017-2022

20.3

8

4.1

17.1

7.1

8.9

13.9

18.0

9.3

3.6

1.0

6.7

2.92.5

5.5

5.7

29.6

11.6

5.1

23.8

10.0 11.4

19.4

23.7

0

5

10

15

20

25

30

35

US & Canada

Latin America

Africa Europe Russia & Caspian

Middle East China Other Asia-Pacific

Crude oil (atmospheric) Vacuum

mb/d

1.2

0.8

1.8

1.21.3

1.4

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

2

2017 2018 2019 2020 2021 2022US & Canada Latin America AfricaEurope Russia & Caspian Middle EastChina Other Asia-Pacific

mb/d

Source: BP Statistical Review of World Energy 2017. Source: OPEC WOO 2017.

PETROCHEMICALS

The Asia-Pacific will lead global petrochemicals industry growth. The IMF estimates real GDP to grow 6.4% p.a. through

2022 for the Asian-Pacific region, compared to 3.7% p.a. globally over the same time period. China and India’s GDP are expected

to grow 6.3% and 7.7% p.a. through 2022 respectively. Demand growth of petrochemicals and chemical products in the

Asia-Pacific will be led by India and China, where demand growth is expected to be approximately in-line with their projected GDP

growth due to rising consumption of finished goods derived from the chemical value chain from an expanding middle-class.

According to the American Chemistry Council (“ACC”), China’s domestic chemical production exhibited a 5-Yr CAGR of 6.0% as

of Oct. 31st 2017, whereas the entire Asia-Pacific region’s 5-Yr CAGR is 3.9% over the same period. While production growth is

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expected to continue, the rate will be lower than the corresponding growth in demand as OPEC countries in the Middle East

continues to supply a significant portion of the region’s petrochemical needs. Therefore, even as capacity expansions in the

Asia-Pacific region come online, demand growth will likely outstrip supply growth in the medium term and could potentially

increase import demand from the Middle East and the United States.

While naphtha remains as the most widely used petrochemical feedstock, and will likely remain so, the U.S. is quickly

developing towards becoming a disruptive global ethylene supplier. It takes about 3.3 mt of naphtha, 2.2 mt of LPG, or 1.25

mt of natural gas liquid feedstock (“NGL”) ethane to produce 1 mt of ethylene. The ratio between the ethane-ethylene and

naphtha-ethylene spread has averaged nearly 3 to 1 over the past five years, making ethylene significantly cheaper and more

efficient to produce with ethane. Due to the emergence of shale gas in the U.S. making ethane based petrochemicals cheap

enough to export, North America’s annual ethylene capacity is expected to reach 44.6 mmt by 2026, growing 3.3% p.a . from 32.2

mmt in 2016.

Table-1: Steam Cracker Yields of Various Petrochemical Feedstocks

(Yield by weight) Ethane LPG/Propane Butane Naphtha Gasoil

Hydrogen & Methane 13% 28% 24% 26% 18%

Ethylene 80% 45% 37% 30% 25%

Propylene 2% 15% 18% 13% 14%

Butadiene 1% 2% 2% 5% 5%

Mixed butylenes 2% 1% 6% 8% 6%

C5+ 2% 9% 13% 8% 7%

Benzene 0% 0% 0% 5% 5%

Toluene 0% 0% 0% 4% 3%

Fuel Oil 0% 0% 0% 2% 18%

Source: US Association of Energy and Economics.

U.S. petrochemical exports are growing dramatically due to the shale revolution. The ACC reported US$185 bn of

investment projects have been publically announced as at July 2017, of which, 52% are either completed or under construction

and the remaining 48% are in the planning phase. According to data from U.S. International Trade Commission, exports of

petrochemicals (NAICS Code: 325110) reached 4.61 mmt from Jan.-Oct. 2017, 44.2% higher YoY and more than all of 2015 when

the U.S. only exported 2.3 mmt of petrochemicals. 5.5 million mtpa of steam cracker capacity and approximately 3.8 mtpa of PE

capacity is expected to come online in 2017-2018, with the start up of five crackers and three PE plants. Export growth of

petrochemicals from the U.S. is inevitable in 2017-2018 as data suggests domestic demand will not be able to digest new capacity

additions in its entirety. From Jan.-Oct. 2017, U.S. crude oil and LPG exports to China reached 63.4 mb and 43.8 mb, respectively,

representing 20.1% and 14.3% of total U.S. exports of crude oil and LPG, and also indicates increases of 1,474.7% and 31.8%

YoY, respectively. The U.S. only exported 8.3 mb of crude oil to China in all of 2016. Besides the surge of crude oil exports to

China, total U.S. exports of crude oil and LPG was up 98.6% YoY and 18.2% YoY, respectively. The “American Shale Revolution”

has enabled the U.S. to expand its petrochemical trade and is likely to lead the U.S. becoming a net exporter of oil within the next

decade.

Figure-8: American Chemistry Council Production Activity Indexes and Global Capacity Utilization

Figure-9: Ethane, Naphtha, and LPG Prices, and Corresponding Ethylene Spread

79

80

81

82

83

84

90

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100

105

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115

120

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135

140

2012 2013 2014 2015 2016 2017

Global Capacity Utilization: % (RHS) Global Production

Basic Chemicals Production China Production

Asia-Pacific Production NorthAmerica Production

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Ethane - Ethylene (RHS)LPG - Ethylene (RHS)Naphtha - Ethylene (RHS)NaphthaEthanePropane

USD/mt USD/mt

Source: American Chemistry Council. Note: Base year=2007; index represents 90 day moving averages.

Source: Bloomberg, Guotai Junan International.

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CHINA’S PETROCHEMICAL AND OIL REFINING INDUSTRIES

DEMAND

Oil consumption growth is driven by the transportation industry and petrochemical industry. China’s oil and gas

consumption grew at a CAGR of 4.7% and 10.7% from 2012-2016, respectively. China’s oil demand growth is expected to reach

13.7 mb/d through 2022, representing 2.5% p.a. growth. Despite gas consumption growing faster than oil, total annual oil

consumption is still more than three times more than that of natural gas. Specifically, consumption of gasoline, kerosene, naphtha,

and LPG grew at CAGRs of 8.4%, 10.8%, 6.5%, and 19.2% from 2012-2016, respectively. Growth in gasoline and kerosene

consumption are due to rising car sales and increased air travel, growth in naphtha and LPG consumption growth are due to rising

demand in China’s petrochemical and chemical industries. The rapid growth in consumption of LPG from a number of new

propane dehydrogenation (“PDH”) plants coming online, which will extend the domestic supply of propylene, has been reducing

import dependence. Most of the growth in oil products can be attributed to an expanding Chinese middle class in terms of both

size and wealth, which has led to an increasing number of families buying their first car, having enough disposable income to

travel more, and increasing general consumption of various consumer products. Diesel and fuel oil consumption dropped 0.7%

p.a. and 5.3% p.a. over the same time period.

Figure-10: Domestic Apparent Consumption of Crude Oil and Natural Gas: YTD, YoY

Figure-11: Domestic Apparent Consumption of Petroleum Products: YoY

(5%)

0%

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600

2012 2013 2014 2015 2016 2017Natural Gas Crude Oil

Natural Gas: YoY (RHS) Crude Oil: YoY (RHS)

mtoe

(30%)

(20%)

(10%)

0%

10%

20%

30%

40%

50%

2012 2013 2014 2015 2016 2017

Naphtha LPG Fuel Oil Diesel Kerosene Gasoline

Source: CEIC, Wind Information, Guotai Junan International. Source: CEIC, Wind Information, Guotai Junan International.

Figure-12: Domestic Apparent Consumption Breakdown

of Oil Products, 2014-2016

Figure-13: Domestic Apparent Consumption of

Petrochemicals, YTD: YoY

8%

9%

43%6%

26%

8%

10%

7%

41%7%

27%

8%

12%

6%

38%

7%

28%

9%

LPG

Fuel Oil

Diesel

Kerosene

Gasoline

Naphtha

Outside = 2016Middle = 2015Inside = 2014

(5%)

0%

5%

10%

15%

20%

25%

30%

35%

2012 2013 2014 2015 2016 2017

Ethylene Benzene LPG

10,000 tons

Source: CEIC. Source: CEIC, Guotai Junan International.

CAPACITY

Domestic refinery overcapacity will likely persist in the medium term. According to CNPC’s ETRI (Economics &

Technology Research Institute), China’s oil refining capacity in 2016 reached 748 mtpa, representing 15% of global

capacity and 2nd

in the world. Teapot refinery capacity reached 262 mtpa, representing 34.9% of total domestic capacity.

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China is estimated to have 4 mb/d of unused refining capacity, a combination of oversupply and outdated capacity in China’s o il

refining industry. According to the IEA, approximately 560 kb/d of new primary refining capacity is expected to come online in

2017, compared to oil demand growth of around 300 kb/d. Cumulatively, approximately 120 mtpa of refining capacity is

expected to come online by 2020 based on current project investments; ETRI estimates China’s oil refining industry will

likely remain oversupplied by at least 110 mtpa by that time. The capacity expansion represents a 3.8% CAGR from

2017-2020 and the overcapacity assessment takes into account both domestic demand growth and expected increases of

exports of refined products. From Jan.-Oct. 2017, China produced 287.9 mmt of refined oil products, 8.7% higher YoY,

consumption of refined oil products reached 258.2 mmt, 8.8% higher YoY.

China’s burgeoning refining capacity has transformed China into a net exporter of refined petroleum products and

capacity expansion will likely shift further down the value chain towards high-value chemical feedstocks. The spread

between China’s apparent consumption and production of refined petroleum products has widened 43.7% p.a. from 2012-2016;

the spread from Jan.-Oct. averaged 1.75 mmt, up 8.9% YoY. Producers are exporting more product overseas as the pace of

domestic refining capacity growth is higher than the growth in demand, oil product exports have approximately doubled since 2012

and China became a net exporter of refined products starting 2H2015. Due to the large number of capacity additions in recent

years, imports of refined products have dropped 8.5% p.a. from 2012-2016. Exports will likely continue to exhibit stable growth as

domestic demand growth lags behind new capacity expansion for refined products. As China exports more of its refined petroleum

products, domestic demand for products made from ethylene, benzene, propylene, methanol, and butadiene is expected to

continue growth, and capacity expansion investments will likely shift further downstream towards increasing processing capacity

of petrochemical feedstocks.

Figure-14: China’s Apparent Consumption and

Production of Refined Petroleum Products, Monthly

Figure-15: China’s Imports & Exports of Refined

Petroleum Products, Monthly

0

1

2

3

4

5

6

7

8

9

10

0

5

10

15

20

25

30

2012 2013 2014 2015 2016 2017

Spread (RHS) Production Apparent Consumption

mmtmmt

(2,000)

(1,500)

(1,000)

(500)

0

500

1,000

1,500

2,000

2,500

3,000

0

1,000

2,000

3,000

4,000

5,000

6,000

2012 2013 2014 2015 2016 2017

Spread (RHS) Imports Exports

ktkt

Source: NDRC. Source: China Customs.

China is has largely achieved self-sustainability in its refining and petrochemical needs with downstream chemical

products lagging behind. In terms of oil products, China is fully self-sufficient for diesel, kerosene, and gasoline, with naphtha

and fuel oil both exhibiting self-sufficiency rates above 80%. LPG is lowest, averaging 69.2% from Jan.-Oct. Thus, from Jan.-Oct.

import dependence of LPG averaged 33.1%, up 0.9ppts YoY. Further downstream, self-sufficiency rates for PE resin and

synthetic rubber were lowest amongst the list of major raw chemical feedstocks and products. Consequentially, import

dependence for PE resin and synthetic rubber were highest, averaging 44.5% and 42.6% from Jan.-Oct., which is 4.5ppts and

5.4ppts higher YoY. Investments in building PE and synthetic rubber capacity will likely outpace capacity expansions elsewhere

along the chemical value chain. Chinese imports from the Middle East and Europe are expected to remain healthy in 2017

according to ICIS, citing new CFR and term contracts signed with overseas producers and Asian importers. However, China’s total

imported oil products decreased at a CAGR of 7.1% from 2012-2016, despite consumption of oil products having increased at a

CAGR of 2.6% over the same period. We expect China’s refined product imports to continue the trend to decrease gradually, with

downstream chemical products to contribute a majority share of future imports such as American and Middle Eastern PE, which

are cheaper than domestic production.

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Figure-16: Import Dependence of Oil Products

Figure-17: Import Dependence of Raw Chemicals and

Chemical Products

0

10

20

30

40

50

60

70

80

90

2012 2013 2014 2015 2016 2017

Fuel Oil Kerosene LPG Naphtha Crude Oil

0

10

20

30

40

50

60

2012 2013 2014 2015 2016 2017

Methanol PE Resin PP Resin

Ethylene Benzene Synthetic Rubber

%

Source: National Bureau of Statistics of China, China Customs. Source: National Bureau of Statistics of China, China Customs.

INVESTMENT

The operational performance of China’s petrochemical industry and oil refining industry are on a path of recovery 2016

led by strong demand growth despite an oversupply of capacity. China’s Petroleum and Chemical Industry Federation

(“CPCIF”) reported that the petroleum industry and chemical industry for Jan.-Oct. remained in healthy condition, recording

RMB11.9 trillion in operational revenue, up 16.5% YoY. Revenue for sales of oil refining, chemical production special equipment

from Jan.-Oct. reached RMB80.3 billion, up 13.9% YoY. Profitability for refiners and chemical producers continued improving in

2017 despite rising oil price, with October margins up 0.6ppts and 1.1ppts, respectively.

Figure-18: Sales Revenue of Oil Refining & Chemical

Production Special Equipment, YTD: YoY

Figure-19: Sales Margins of Petroleum Processing and

Chemical Manufacturers

(10)

0

10

20

30

40

50

60

70

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

100,000

2012 2013 2014 2015 2016 2017

YTD (RMB million) YTD: YoY (RHS, %)

(5.0)

(4.0)

(3.0)

(2.0)

(1.0)

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

2012 2013 2014 2015 2016 2017

Processing of Petroleum, Coking, Nucleus FuelManufacture of Chemical FibersManufacture of Chemical Raw Materials and Products

%

Source: China Petroleum and Chemical Industry Federation. Source: National Bureau of Statistics of China.

China’s FAI investment in the petrochemical industry is recovering since reductions in 2015 and 2016 resulting from low

oil prices, but growth is decelerating. In 2015 and 2016, China saw sequential average YoY declines in FAI for the processing

of petroleum, coking, and nuclear fuel of 12.5% and 1.8%. FAI for manufacturing of chemicals and chemical products on the other

hand increased 5.7% YoY in 2015 then decreased 3.8% in 2016. The reduction in FAI as a result of project delays and

cancellations the past couple years due to low oil prices will likely depress capacity expansions coming online in the near term.

Since 2H2016, FAI of processing of petroleum, coking, and nuclear fuel has reverted back to growth. For Jan.-Oct., FAI of

processing of petroleum, coking, & nuclear fuel was up 2.8% YoY and total manufacturing FAI was up 3.8% YoY. As oil prices

recover gradually over the next few years and demand growth from downstream petrochemical industries continue, China’s FAI in

the petrochemical sectors will continue to grow, albeit at a slower pace than years past as China’s overall economic growth

decelerates.

Capital expenditures of the Chinese integrated oil majors have recovered from a trough in 2016 following consecutive

years of decline. CAPEX for Sinopec and Petrochina during the period 1-3Q2017 was up 37.1% and 9.1%, respectively. After

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three consecutive years of decline, CAPEX for Sinopec and Petrochina along with the oil industry as a whole has started to

recover after bottoming out in 2016. Sinopec revised downwards its full-year CAPEX plans by 10.6% during its 3Q2017 report,

planning to spend RMB98.5 bn for 2017, up 28.8% YoY. Petrochina’s CAPEX plans for 2017 remains at RMB191.3 bn, up 11.0%

YoY. CAPEX recovery is likely to remain gradual, as oil prices are not likely to rebound back to over US$100/b levels and industry

players remain cautious. However, increased spending will benefit the petroleum engineering industry as more contracts for a

variety of midstream and downstream projects are tendered.

Figure-20: China’s FAI of Petroleum and Chemical

Manufacturing Sectors YTD, YoY, and FAI of

Manufacturing

Figure-21: Sinopec and Petrochina’s Capital Expenditure,

YoY

0

2

4

6

8

10

12

14

16

18

20

(30%)

(20%)

(10%)

0%

10%

20%

30%

2013 2014 2015 2016 2017

Manufacturing (RHS) Petroleum, Coking & Nuclear Fuel

Chemical Material & Product Chemical Fiber

Rubber & Plastic Product Manufacturing

RMB Trillion

185.1

154.6

112.4

76.5

25.034.2

318.7

291.7

202.2

172.4

114.1124.6

(16.5%)

(8.5%)

(27.3%)

(30.7%)(32.0%)

(14.8%)

37.1%

9.1%

(40%)

(30%)

(20%)

(10%)

0%

10%

20%

30%

40%

50%

0

50

100

150

200

250

300

350

2013 2014 2015 2016 1-3Q2016 1-3Q2017

Sinopec Petrochina YoY

RMB billion

Source: National Bureau of Statistics of China. Source: Company Reports, Guotai Junan International.

OVERSEAS OPPORTUNITIES

China’s Belt and Road Initiative (“BRI”) allows domestic oil and gas firms to expand overseas strategically, serving

China’s increasing oil and gas resource needs. The pace of economic cooperation in the development of oil and gas resources

has accelerated since President Xi proposed the initiative in 2013. According to China’s Ministry of Commerce, from Jan.-Oct.,

new BRI engineering projects overseas contracted by domestic firms reached USD102.1 billion, up 21.0% YoY and constituted

55.4% of all overseas projects; completed projects value was USD57.5 billion over the same time period, up 9.1% YoY.

Transnational pipelines that carry oil and gas connecting China with Russia and Central Asia reached around 11,000km;

development of oil and gas transport and storage has accelerated along the 21st Century Maritime Silk Road connecting Africa, the

Middle East, and Europe. China’s demand for crude oil and natural gas resources will continue to increase at a rapid pace, driving

the need to continue developing large-scale, sustainable, and cheap imports. We expect the BRI to support growth in overseas

expansion of domestic petroleum firms along the entire value chain, with upstream extraction resources investment, midstream oil

and gas transport projects, and downstream capacity expansion.

CHINA’S COAL CHEMICALS INDUSTRY

CTO investment and existing production performance in China has been recovering slowly in 2017 from a poor 2016

when low oil prices rendered coal-based chemical feedstocks economically uncompetitive. Low oil and gas prices through

2016 have made coal-based olefins uncompetitive when compared with cheaper feedstocks such as naphtha, LPG, and

NGL/ethane. This led to project delays of a number of MTO and coal-based monoethylene glycol (“MEG”) plants throughout the

year. In 1H2017 however, a number of previously postponed coal chemical projects were reported to have resumed work as a

response to higher oil prices with profitability of existing plants having improved YoY as well. There is approximately 1.85 mtpa of

coal-based polyethylene (“PE”) and polypropylene (“PP”) capacity to be added in 2017, which would mean an increase of 25.9%

YoY. It is possible only 950 ktpa will come online in 2017 as competition from lower naphtha prices due to slower oil price recovery

and PDH plant additions using LPG reduces demand for coal-based PE and PP. There has been approximately RMB305.75 bn in

reported coal chemicals related project investment in 2017.

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Figure 22: Coal to Intermediate Feedstock Process

Source: IHS..

Methanol consumption is growing, however, coal prices remain high. China’s apparent consumption for methanol has grown

YoY by 24.7%, 11.0%, and 14.1% from 2014-2016 to reach 51.9 mtpa. Growth of methanol consumption has been due to

increasing methanol-to-olefin (“MTO”) capacity expansion over the past few years as China commits to expanding its coal

chemical industry. However, as coking coal prices have remained above RMB1,000 per ton since 4Q2016, input costs remain

high. Oil prices have also failed to recover as quickly as many had hoped, adding downward pressure on the competitiveness of

the coal chemical industry. From Jan.-May, apparent consumption of methanol reached 40.3 mmt, up 4.8% YoY.

Competition from polyolefin imports from the US and Middle East will challenge the economic competitiveness of

China’s coal chemical plants. The Middle East accounted for 54.4% of PE and PP exports to the Northeastern Asia region

(China, Hong Kong, North & South Korea, Japan, and Taiwan) in 2016; and the U.S., which accounted for 9.3% of exports in 2016,

is expected to be the fastest growing exporter to the region, growing 17.1% YoY in 2017. Cheap naphtha and ethane based

polyolefin imports to the region will put pressure on domestic coal-based chemicals. Low cost PE imports from the U.S. could start

arriving in China 4Q2017, adding additional supply to compete with domestic coal chemical producers.

The coal chemicals industry will continue to be prevalent due to China’s strategic policy support, but significant

downside risks will keep growth subdued. Fundamentally, China is rich in coal, and short on oil and gas, and strategically the

CCP stated in the 13th

Five-Year Plan to further develop coal chemical technologies in order to meet its carbon emissions goals

set in the Paris Agreement, and to also address long-term resource security needs. Despite significant challenges of the coal

chemical industry, such as high water needs and high CO2 and wastewater emissions, the CCP is committed to the development

of the industry as it serves an important strategic objective for securing China’s resource and energy independence. In Feb. 2017,

China removed consumption taxes for products made from the coal-to-liquids (“CTL”) process for five years, reducing costs by

about 30%. Upside risks for the industry include a faster-than-expected rise in oil prices, a drop in coal prices, and technological

breakthroughs. Downside risks are more prevalent: low oil prices, high coal prices, a lack of improvement on coal chemical

industry emissions, and competition from Middle Eastern and U.S. imports.

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ENVIRONMENTAL PROTECTION

China’s commitment to the Copenhagen Accord from 2009 and The Paris Agreement in 2015 symbolizes China’s drive to

tighten reductions in CO2 emissions from coal processing. China committed to decrease carbon intensity by 40%-50% from

the 2005 level and to increase the share of non-fossil fuels in primary energy usage to 15% by 2020 as agreed in the Copenhagen

Accord. In the Paris Agreement, China pledged to reach CO2 emissions peak around 2030, decrease carbon intensity by

60%-65% from 2005 levels, and ensure that non-fossil fuels will be responsible for over 20% of primary energy consumption by

around 2030. Potential annual growth is expected to be over 20% with total investment over RMB17 trillion as outlined in the 13th

Five-Year Plan. Part of the investment will go toward the development and implementation of treatment technologies for coal

chemical wastewater as well as treatment of CO2 emissions from coal chemical industries.

Hazardous waste output in China reached 44.5 mmt in 2016 and is expected to increase at a CAGR of 10.5% from 49.9

mmt in 2017 to 74.4 mmt in 2021. Data from the Ministry of Environmental Protection and research from Frost & Sullivan suggest

that actual output of hazardous waste exceeds available output due to illegal dumping, but increased regulatory enforcement

coupled with tightening environmental protection policy is expected from the Chinese government. There is also a shortage of

overall treatment capacity in China, with treatment rate in 2016 at 83.7%. Treatment rate is estimated to increase to 91.6% by

2021, representing a 5-year CAGR of 12.8%.

COMPETITION

The petroleum engineering industry is fragmented and highly competitive on a global scale, with the top industry players

operating from various regions. The top three global publically listed firms with significant petroleum engineering business

ranked by 2016 revenue are based in the US, South Korea, and France, respectively. The US, South Korea, and China are home

to the largest petroleum engineering firms by revenue; Europe is fourth largest. Competition for petroleum engineering contracts is

fierce, there are 11 similarly sized firms with annual revenues in the USD5 billion-USD10 billion range. In addition, not all large

engineering contractors are publically listed, with firms such as Mott Macdonald, one of the largest employee-owned firms in the

world, and Bechtel, the largest construction and civil engineering company in the US (2016 revenue: USD32.9 billion), being

privately held.

In China, three players dominate an increasingly competitive industry. Sinopec SEG, China Petroleum Engineering, and

China National Chemical Engineering’s revenues during 2014-2016 collectively represented approximately 58.8%, 83.8%, and

67.9% of the total CAPEX spending of China’s three oil majors, respectively. Besides the three largest competitors in the Chinese

petroleum engineering market, a large number of smaller privately owned companies compete for the remaining market share in a

fragmented environment. Due to the declining capital investment trend from the oil majors in recent years, competition has

intensified, with total revenues in 2015 and 2016 declining 14.4% YoY and 17.7% YoY to RMB173.3 bn and RMB142.7 bn,

respectively. This has negatively impacted company performance as well, with average ROE of the three engineering firms down

4.7ppts YoY to 6.3% in 2016. Looking forward, there is upside as the investment decline trend seems to be reversing with

investment from oil majors showing growth in 2017 as oil prices rise and balance is gradually restored to the global oil industry.

Figure-23: Methanol Price and Spread vs. Naphtha, 2012-2017 Figure-24: Coking Coal Prices, 2013-2017

0

200

400

600

800

1,000

1,200

0

200

400

600

800

1,000

1,200

2012 2013 2014 2015 2016 2017

China Methanol CFR - Naphtha Spread

China Methanol CFR

Naphtha (RHS)

USD/ton USD/ton

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000

2013 2014 2015 2016 2017

Coking Coal

RMB/ton

Source: Bloomberg, Guotai Junan International Source: Bloomberg

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Figure 25: Revenue and Gross Margins (%) of Major Chinese Petroleum Engineering Competitors

Figure 26: ROE (%) of Major Chinese Petroleum Engineering Competitors

14.3 14.7

12.713.5

10.9

12.9 13.0

11.912.5

13.3

2.8

10.6

7.6

9.18.7

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

2012 2013 2014 2015 2016

Sinopec SEG

China National Chemical Engineering

China Petroleum Engineering

RMB million

(30)

(20)

(10)

0

10

20

30

40

50

2012 2013 2014 2015 2016

Sinopec SEG

China National Chemical Engineering

China Petroleum Engineering

5.7%-6.6%

8.3%-13.5%

Source: the Companies, Guotai Junan International. Source: the Companies, Guotai Junan International.

Figure 27: 2016 Revenues of Publically Listed Global Petroleum Engineering Firms

19.0 17.3

13.8

10.7 10.2 10.0

9.1 8.0 7.9 7.9 7.7

6.6 6.4 6.2 6.0 5.7 4.3 4.0

2.8

1.2 0.5 0.1

0

2

4

6

8

10

12

14

16

18

20

USD BillionU.S. - $51.9 bnKorea - $50.9 bnChina - $23.3 bnEurope - $22.3 bn

Source: the Companies, Bloomberg, Guotai Junan International.

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COMPANY ANALYSIS

Sinopec Engineering (Group) Corporation (“the Company” or “SEG”) is a leading oil refining, petrochemical and new

coal chemical engineering company in the People’s Republic of China (PRC). According to Engineering News-Record

(“ENR”), the Company ranked 1st, 23

rd, and 46

th in its 2015 Top Chinese Design Firms, 2016 Top Global Engineering-Construction

Design Firms, and 2016 Top Global Contractors lists, respectively. With over 60 years of industry experience and innovation of

specialized technologies, the Company has extensive expertise on engineering integrated technical solutions for the oil refining,

petrochemical, and coal chemical industries in the PRC. Domestically, the Company is ranked 2nd

within its operating sectors in

terms of revenue generated, behind only state-owned giant China National Chemical Engineering.

Figure-28: Sinopec SEG’s Corporate Structure

100%

100%

100%

100%

Hainan Great Wall Machinery

Engineering Co., Ltd.

Lanzhou Great Wall Touping

Machinery Engineering Co., Ltd.

50%

50%

Beijing BPEC Engineering and

Construction Supervision Co., Ltd.

Beijing Petrochemical Engineering

Consulting Co., Ltd.

Dalian Economy and Technology

Zone Jinghai Petrochemical New Technology Development Co., Ltd.

SEI (London) Co., Ltd.

Sinopec

Group

The

Company

Public H

Shares

NSSF

SAMC100%

65.67%

2.97%

30.02%

1.34%

100%

100%

SNEI

Shanghai KSD Bulk Solids


LPEC

SNEC

SGEC

SFCC

Ningbo Institute

SE&C Middle East

SE&C Nigeria

SE&C Singapore

SE&C America

China Petrochemical

Technology Co., Ltd.

TCC

FCC

SSEC

SEI

Huizhou Tianxin Petrochemical


35%

40%

36.4%

100%

100%

100%

Luoyang Gaoxinlongpu

Petrochemical Development Co., Ltd.

Luoyang Xinuo Fuel Oil Quality

Testing Center Co., Lt d.

Shanghai LPEC Energy Engineering

Technology Development Co ., Ltd

100%

100%

90%

80%

100%

Sinopec Shanghai Pharmaceutical

Industry Designing Institute Co., Ltd

Zhuhai Shibidi Pharmaceutical

Technology Development Co., Ltd.

SSEC Canada Ltd.

Shanghai Eastern Engineering

Consulting Co., Ltd.

Shanghai Sanyuan Engineering

Consulting and Supervision Co., Ltd.

20%

10%

Shanghai Sanding Environmental

Engineering Investment Co., Ltd.

Shanghai Petrochemical Machine

Manufacturing Co., Ltd.

Ningbo Tianyi Equipment

Technology Co., Ltd.

Ningbo Tianyi Petrochemical Heavy

Equipment Manufacturing Co., Ltd.

100%

100%

100%

37% 60%

Jiangsu Nanhua Engineering and

Technology Complete Development Co., Ltd.

Shanghai Pujing Industrial and

Civilian Architectural Designing Co., Ltd.

100%

100%

Tianjin Tianshi Engineering Project

Management Co., Ltd.

Lanzhou Xinyue Refining and

Petrochemical Engineering Designing Co., Ltd.

Sinopec Tenth Construction Qingdao

Co., Ltd.

Beijing Jinhaiwan Engineering and

Construction Supervision Co., Ltd.

Urumqi Chenjiqian Construction

Equipment Co., Ltd.

100%

100%

100%

100%

100%

100%

100%

100%

100%

100%

100%

100%

100%

100%

100%

100%

100%

Sinopec Energy-Saving

Technology Service Co., Ltd.

100%


The Company provides engineering, consulting and licensing, EPC contracting, construction, and equipment

manufacturing services. According to our analysis, SEG has one of the strongest technical execution capabilities in China with

respect to engineering and constructing large-scale oil refineries, petrochemical plants, and new coal chemical complexes, as at

2016. The Company’s 2014-2016 revenue was RMB49.346 bn, RMB 45.498 bn, RMB 39.375 bn, respectively. In 2016,

engineering, consulting and licensing, EPC contracting, construction, and equipment manufacturing accounted for 6.6%, 48.3%,

44.1%, and 1.0% of SEG’s total revenue, respectively.

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Table-2: SWOT Analysis of SEG

Strengths Weaknesses

SEG has technical advantages to its domestic peers and growing

competitiveness against its international competitors.

SEG’s technological abilities and innovation have been recognized

internationally by both Shell and Exxon Mobil, putting the

Company on track to compete with more established international

firms.

SEG is a publicly listed subsidiary of Sinopec Group, the largest

publicly listed oil company in the world by revenue (FY2016).

The coal chemical industry still has efficiency and environmental

challenges to resolve, which is taking significant time and funding.

While increasingly competitive on a global scale, SEG is not as

well established as some of its international peers, and face an

extremely competitive global EPC Contracting market.

Opportunities Threats

While demand for petrochemicals in China is expected to grow

over the medium term, high-value olefins demand will provide

largest room for investment. SEG has the technical expertise,

experience, and market share to benefit.

Tightening global environmental regulations in the petrochemicals

industry will drive producers to invest in upgrading projects for

refineries as well as capacity expansion for higher value oil

products.

Overseas investment on new and upgrading capacity in the Middle

East and Asia-Pacific provide potential avenues for new contract

value growth.

SEG is positioned to benefit greatly from the coal chemicals

industry if certain challenges are overcome and favourable

economic factors allow the industry to grow.

Oil prices may fail to recover to levels that spur investment growth

from oil majors.

Global and domestic industrial investment is subject to various

macro-economic shocks which could adversely affect SEG’s ability

to secure new contracts.

The global oil refining and petrochemical engineering markets are

extremely competitive and SEG will need to compete successfully

overseas to maintain growth.

Global refining capacity is already in overcapacity, planned

additional capacity expansions could adversely impact the market

if demand growth weakens.

Source: Guotai Junan International.

ENGINEERING, CONSULTING AND LICENSING BUSINESS

SEG possesses strong technical expertise and specialized process technologies which enhances SEG’s engineering

and consulting business. SEG provides services during the preparatory work phase, project definition phase and project

implementation phase, as well as project management contracting. SEG is responsible for formulating a vast majority of national

and industrial standards and codes in oil refining and petrochemical engineering, and the majority of national and industrial

standards and codes in pharmaceutical chemical engineering in the PRC. SEG licenses its solely-owned or jointly-owned process

technologies to its clients through process design packages or other deliverables. The engineering work for a project typically lasts

approximately 8-12 months; consulting and technology licensing services typically last 3-6 months; and project management

contracting service is provided throughout the life cycle of the project, which is usually 3-4 years. The Company’s revenue derived

from its Engineering, consulting and licensing business in 2014-2016 was 7.4%, 5.8%, and 6.6% of the Company’s total revenue,

respectively, but SEG’s strong technical capabilities represented in this segment forms the backbone for its other businesses.

Figure-29: SEG’s Revenue Breakdown by Industry Figure-30: SEG’s Revenue Breakdown by Business Segment

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

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20,000RMB mn

Petrochemicals Oil ref ining

New coal chemicals Other industries

0

5,000

10,000

15,000

20,000

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35,000RMB mn

Engineering, consulting and licensing EPC Contracting

Equipment manufacturing Construction Source: the Company. Source: the Company.

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Figure-31: SEG’s Project Phases and Scope of Services Provided

Scope

of

Services

Phases Preparatory work phase

Ma

ste

r pla

nn

ing

Pro

posal re

searc

h

Pro

ject e

nviro

nm

enta

l

imp

act a

sse

ssm

en

t

Fe

asib

ility s

tud

y

Pro

ject a

pplic

atio

n a

nd

rep

ortin

g

Pro

cess p

ackage d

esig

n/

Te

ch

no

log

y L

ice

nsin

g

Ma

ste

r de

sig

n

Ba

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gin

ee

ring

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Built-u

p a

cce

pta

nce

Com

mis

sio

n s

erv

ices

Constru

ctio

n

Eq

uip

me

nt a

nd

ma

teria

l

pro

cure

ment

De

taile

d e

ng

ine

erin

g d

esig

n

Project

definition phase

Project

implementation

phase

Project commission

and built-up

acceptance phase

Project management contracting, EPC Contracting


SEG’s process technology expertise ranges from the primary stages of oil refining such as crude and vacuum distillation

to downstream production of ethylene and polyolefins, as well as MTO and other new coal chemical technologies. The

Company conducts its Engineering, consulting and licensing business mainly through its subsidiaries, SEI, LPEC, SSEC, SNEC

and SNEI. Four of SEG’s subsidiaries hold Class A certification in engineering (工程设计综合甲级资质), which represents the highest

level of certification for providing engineering services in the PRC, and one subsidiary holds a Class A certification in chemical and

petroleum industrial engineering (化工石油行业工程设计甲级资质). The Company’s subsidiary, SEI, has the strongest engineering

capabilities in the PRC with respect to oil refining and petrochemical integrated engineering projects for 10 Mtpa capacity oil

refineries and 1 Mtpa capacity ethylene plants and was ranked first by revenue in ENR’s 2015 Top Chinese Design Firms list.

EPC CONTRACTING BUSINESS

SEG provides engineering, procurement, and construction (“EPC”) contracting services throughout the entire course of

engineering and construction projects. In addition to operating in the oil refining and petrochemical sectors, SEG is undertaking

an increasing number of EPC contracting projects in sectors including new coal chemical, pharmaceutical chemical, clean energy

and environmental engineering sectors. The Company’s revenue derived from its EPC Contracting business in 2014-2016 was

RMB30.1 bn, RMB27.8 bn, and RMB20.6 bn, respectively; which represents 55.8%, 56.2%, and 48.3% of the Company’s total

revenue over the same period.

Figure-32: New Contract Value, Backlog, and Revenue for SEG’s Engineering, Consulting, and Licensing Business

Figure-33: Gross Profit, Margin, and % of Total of SEG’s Engineering, Consulting, and Licensing Business

0

1,000

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7,000

8,000

9,000RMB mn

New Contract Value Backlog Revenue

49.1

44.4 45.1 46.343.8

35.3 34.635.0

29.9 33.6

31.5

25.4

15.0

21.0

0

10

20

30

40

50

60

0

500

1,000

1,500

2,000

2,500

2010 2011 2012 2013 2014 2015 2016

Gross profit Gross margin (RHS) % of total (RHS)

RMB mn %

Source: the Company. Source: the Company.

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Table-3: SEG’s Representative EPC Contracting Projects

Project Name Location Project Description

Total Contract Value (RMB bn)

Actual/ Expected

Date of Completion

NRP AL-ZOUR Project w/ KNPC

Al-Zour, Kuwait

The work scope for the greenfield refinery includes a 10 mtpa CDU unit, hydro-treating units for diesel, naphtha, kerosene, and residue totalling 11.5 mtpa, as well as heavy oil recycling units and a set of saturated gas processing unit.

10.75 Dec. 2018

Project RAPID in Malaysia w/ Petronas

Pengerang, Johor, Malaysia

The work scope for the greenfield refinery includes a 15 mtpa CDU unit, an 8.8 mtpa atmospheric residue desulphurisation unit, a hydrogen collection and distribution unit, and a fuel oil system.

8.19 Dec. 2018

Atyrau Refinery Modernisation Project

Atyrau, Kazakhsatan

The scope of work involves 13 process units, including a 2.43 mtpa Fluid Catalytic Cracker unit, and 47 utilities units. It is the largest overseas oil refinery project undertaken by the Company to date.

11.4 2017

Zhongtian Hechuang Coal Chemical Project

Inner Mongolia, China

The world’s largest Coal-to-Olefin project to date, utilizes SMTO technology developed by SEG to convert coal to various olefins including PP, LDPE, LLDPE, MTBE, butane-1, etc. With a MTO capacity of 3600 KTPA it is a landmark project for SEG to showcase its integrated technology for the coal chemical industry.

18.67 Dec. 2016

Fujian Refining and Ethylene Complex Expansion

Fujian, China

Demonstrated SEG’s ability to successfully undertake integrated oil refining and petrochemical engineering projects. The Company engineered and constructed an oil refining capacity expansion project from 4 mtpa to 12 mtpa, a 0.8 mtpa ethylene plant, and a 0.7 mtpa p-Xylene plant.

23.8* 2009

Qingdao Oil Refining Complex

Qingdao, China

This project included the first single-train oil refinery with a processing capacity of 10 mtpa, and demonstrates SEG’s leading position in the PRC in undertaking large-scale single-train projects.

12.5* 2007

Huizhou Oil Refinery Crude and Vacuum Distillation Unit

Huizhou, China

This project included the largest single-train oil refining complex in the PRC in terms of processing capacity at 12 mtpa and the largest crude and vacuum distillation unit in the PRC at the time based on single-train production capacity. The refinery would go on to win IMPA’s Project Excellence award in 2010.

21.6* 2009

Source: the Company. *Note: Represents total project investment, the Company’s project contract value may be less than stated.

The EPC model is one of the primary models adopted in the global engineering market as it contains more stringent

requirements for funding, technology and management. SEG selects and pursues EPC Contracting projects by collecting

timely and reliable market intelligence to identify projects, performing technical and commercial assessment on the project,

undergoing a qualification review, and then engaging in bidding and pricing for the project. After contracting with the client, the

Company begins implementation of the project by setting up a project management task force to oversee the quality, safety,

progress, and costs of the project. Payment terms for SEG’s EPC contracts typically consist of an advance payment of 5%-15% of

the total contract value, and progress payments which are paid upon achievements of project milestones, and typically constitutes

70%-90% of the total contract value. Approximately 5% of the total contract value will be held by the client for the duration of the

warranty period of the project (1-2 years). An EPC project generally requires 20-40 months to be completed.

Figure-34: New Contract Value, Backlog, and Revenue for SEG’s EPC Contracting Business

Figure-35: Gross Profit, Margin, and % of Total of SEG’s EPC Contracting Business

0

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90,000RMB mn


15.519.3

14.2 14.111.9

13.812.2

55.6 56.9

51.7 51.7

57.1

62.5 58.7

0.0

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2010 2011 2012 2013 2014 2015 2016

Gross profit Gross margin (RHS) % of total (RHS)

RMB mn %


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Figure-36: General Workflow of SEG’s EPC Contracting Business

Market information

collection & project

evaluation

Qualification Review

Documentation & filing

of engineering and other

project records

Project revisit

Project

implementation

(engineering,

procurement,

construction, and commissioning)

Project kick-off

Coordination and

control

Project approval,

preparation, and

assignment of task

Signing EPC

Contracting contract

Project settlement,

review, and

assessment

Appointment of project

manager and

establishment of

project task forceProject completion

Project

implementation

planning and review

Financing supportInvestment

consulting

Bidding and pricing


CONSTRUCTION BUSINESS

SEG is one of the largest providers of construction contracting and specialized construction in the oil refining and

chemical industries in China. The Company provides construction services for new construction, modification, and expansion

projects, as well as overhaul and maintenance projects in the oil refining, petrochemicals, new coal chemicals, pharmaceutical

chemicals, clean energy, environmental engineering, power generation, and storage and transportation industries in China and

overseas. SEG possesses the national Class A certification in construction contracting (施工总承包企业一级资质), the highest level

of certification granted in the PRC for providing construction contracting services, as well as other professional certifications. The

Company has led or participated in the formulation of national and industrial standards for construction techniques, and has

established complete sets of construction methods. The Company’s revenue derived from its Construction business in 2014-2016

was RMB19.2 bn, RMB18.1 bn, and RMB18.8 bn, respectively, which represents 35.5%, 36.6%, and 44.1% of the Company’s

total revenue over the same period.

SEG has expertise and competitive advantages in technologies and use of advanced equipment for its Construction

business. The Company has extensive expertise in the lifting and transportation of large equipment, installation of large rotating

equipment (such as compressor units), installation of large storage tanks, installation and commissioning of complex distributed

control systems, and welding of special materials. SEG has installed a number of 30,000 m3 cryogenic spherical tanks, 150,000

m3

crude oil tanks, and 160,000 m3 full containment above-ground LNG tanks. The Company is an industry leader in China for

welding of special materials and has also won various National Outstanding Welding Work Awards (全国优秀焊接工程奖). SEG

employs the prefabrication and modular construction model, which has improved SEG’s construction efficiency, reduced costs,

improved safety, ensures work quality, and shortens construction timelines.

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Figure-37: New Contract Value, Backlog, and Revenue for

SEG’s Construction Business

Figure-38: Gross Profit, Margin, and % of Total of SEG’s

Construction Business

0

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3.74.5

5.16.0 5.6

6.9

4.4

9.2

12.5

15.1

16.8 17.0

20.2 19.5

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400

600

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1,200

1,400

2010 2011 2012 2013 2014 2015 2016

Gross prof it Gross margin (RHS) % of total (RHS)

RMB mn %


The business process involved in SEG’s Construction business is similar to that of its EPC Contracting business. The

contract provisions are similar to the Company’s EPC contracts, with the exception of payment terms, which for construction

contracts usually require clients to make payments in installments on a monthly basis. The construction work contracted generally

takes 12-24 months to complete.

EQUIPMENT MANUFACTURING BUSINESS

SEG is one of the major manufacturers and suppliers of large static equipment used in oil refineries and chemical plants

in China. The Company manufactures various types of large static equipment which are used in its EPC Contracting and

construction projects as well as for sales to clients. SEG’s principal products include pressure vessels and related equipment such

as towers, reactors, vessels and heat exchangers, as well as components such as steel structures, spool pipes and industrial

furnace modules. In addition, the Company also provides related services including technical consultation, installation and

inspection, and equipment overhaul and maintenance. The Company’s revenue derived from its Equipment manufacturing

business in 2014-2016 was RMB0.70 bn, RMB0.68 bn, and RMB0.44 bn, respectively; which represents 1.3%, 1.4%, and 1.0% of

the Company’s total revenue over the same period.

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FINANCIAL ANALYSIS

NEW CONTRACT VALUE AND REVENUE

SEG derives the majority of its earnings from EPC contracts, a significant portion of which is related to the level of

capital expenditure from Sinopec Group, the Company’s majority shareholder. The new contract value, backlog, and

revenue from its EPC Contracting business during 2012-2016 for the Company averaged 59.3%, 77.7%, and 51.8% of their

respective totals. Average gross profit and operating profit from EPC Contracting over the same period averaged 56.3% and

70.9% of the total. The Company’s total new contract value from Sinopec Group was 34.3%, 39.9%, 39.8%, and 36.6% of the total

during 2013-2016, respectively. SEG’s new contract value is strongly correlated to Sinopec Group’s capital expenditure plans, with

a correlation coefficient of 0.975 during 2013-2016. Sinopec Group’s capital expenditure plans for 2017 is RMB110.2 bn, a 44.1%

increase YoY, which should lead to growth in SEG’s new contract value for 2017 correspondingly. We estimate new contract value

to increase 37.9%, 12.9%, 10.7% to RMB38.0 bn, RMB42.9 bn, RMB47.5 bn in 2017, 2018, and 2019, respectively.

Figure-39: SEG’s Revenue, New Contract Value, and Sinopec Group CAPEX, 2010-2019E

Figure-40: SEG’s Revenue Breakdown by Source, 2015-2016

0

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2010 2011 2012 2013 2014 2015 2016 2017E 2018E 2019E

SEG Revenue

SEG Total New Contract Value

Sinopec Group CAPEX

RMB mn

44.1%

55.9%

36.9%

63.1%

Sinopec Group Non-Sinopec Group

2016

2015

Source: the Company, Guotai Junan International. Source: the Company.

The majority of the Company’s revenue is derived from China, which despite decelerating overall economic growth,

recovery of investment in the petrochemical sector will drive modest new contract value and revenue growth. Regional

revenue contribution from China to SEG’s total revenue was 83.1%, 83.9%, 86.1%, 80.0%, and 63.2% for 2012-2016,

respectively. New contract value from China decreased 31.9% and 48.7% in 2015 and 2016, with revenue from China falling

14.4% and 31.6% over the same time period. In 2017, China’s FAI for petrochemicals has reverted to growth since declining for

two straight years in 2015 and 2016. Any acceleration in growth will likely be gradual and downsides remain prevalent as oil prices

remain low and China’s oil refining capacity remains in a state of overcapacity. However, we expect demand driven growth in the

downstream petrochemical sectors to encourage investment and increase SEG’s new contract value, which will in turn drive

revenue growth. From 2017-2019, we estimate revenue to decrease 0.9%, then increase 3.0%, and increase 8.0% as the

Company’s revenue growth lag behind new contract value growth.

The Company’s backlog provides support for revenue from excessive decline, with new contract value as the key growth

driver for revenue. SEG’s revenue is usually recognized on a percentage of completion basis, and is typically a function of its

backlog and new contract value, assuming there is no impairment of backlog in case of project cancellation or postponements.

Taking into account total write-offs of RMB22,515 bn since 2014 due to the cancellation of a RMB11,400 bn project with

Kazakhstan Petrochemical Industries in addition to other write-offs of RMB11,115 bn during low oil prices in 2015, SEG’s backlog

averaged RMB89,855 bn from 2014-2016. From 2014-2016, SEG’s backlog declined 11.0%, 3.9%, and 0.8%, and new contract

value declined 26.0%, 13.2%, and 47.7%, respectively. Revenue rose 13.3% in 2014, mostly due to a large increase in new

contracts value growth in 2013, then declined 7.8% and 13.5% in 2015 and 2016. Revenue realization rate, calculated as a

percentage of revenue over the sum of backlog (previous FY) and new contract value remained relatively stable, averaging 29.8%

from 2014-2016. The recent declines in revenue were due mostly to declines in new contract value, as fluctuations in backlog have

been relatively minor and inconsequential in determining revenue trends. New contract value, therefore, is a much stronger

indicator of revenue growth as it contributes to not only the Company’s current fiscal year’s revenue, but also the backlog, which

affects future revenue.

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New contract value growth relies on consistent acquisition of contracts for large and complex EPC projects. SEG has

signed a number of large EPC projects that contributed to substantial growth for the Company and will need to continue to pursue

and win future projects of similar contractual value to maintain new contract value growth. The Company’s three largest projects

that it undertook since going public, Project RAPID with Petronas in Malaysia, Kuwait’s Al-Zour Oil Refinery Project, and the

Zhongtian Hechuang Coal Chemical Project had contractual values of RMB8.19 bn, RMB10.75 bn, and RMB18.67 bn,

respectively, which accounted for 13.5%, 20.4%, and 22.8% of total new contract value corresponding with the fiscal year in which

the contracts were signed. The three projects’ contract values were equal to 21.2% of SEG’s total recognized revenue from

2013-2016. With over a fifth of revenue over the last 4 years from only three large contracts demonstrates the importance of

identifying and pursuing large EPC projects on a global scale. In March 2017, Sinopec Group announced that it will invest

RMB200 bn through 2020 to upgrade four refinery bases, with SEG as the favoured contractor. SEG’s share price jumped 18.9%

in the 3 following weeks. We think as SEG successfully completes more high value EPC projects, its global competitiveness will

continue to improve, leading to high value contract growth as the Company enhances its global recognition and reputation.

COST OF SALES

The majority of SEG’s cost of sales are from subcontracting and material and equipment costs, which fluctuate with the

amount of EPC Contracting and Construction business the Company undertakes. The Company’s subcontracting and

material and equipment costs averaged 75.8% of the total cost of sales from 2010-2016. Any changes in revenue has an in

proportion affect to the costs for subcontracting and procurement of materials and equipment, essentially acting as a variable cost

based on the volume EPC Contracting and Construction business. The Company’s other costs are structurally more inelastic and

typically consist of items such as staffing costs and depreciation, which accounted for an average of 24.2% of the Company’s

historical costs of sales. We estimate cost of sales to decrease 0.4% then increase 3.4% and 7.5% in 2017, 2018, and 2019,

respectively, as our expectation for new contract value growth will drive up costs.

Figure-41: SEG’s Backlog, New Contract Value, Revenue Growth and Realization Rate, 2011-2019E

Figure-42: SEG’s New Contract Value, Revenue, and Backlog Change: YoY

2.4%

25.9%

13.1% 13.3%

(7.8%)

(13.5%)

(0.9%)

3.0%

8.0%

29.1%

37.0%

29.5% 32.2% 31.3%

25.8%

33.7% 31.9%

30.3%

(20%)

(10%)

0%

10%

20%

30%

40%

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

180,000

200,000

2011 2012 2013 2014 2015 2016 2017E 2018E 2019E

RMB mn

Backlog New Contract Value

Series3 Revenue Realization Rate (RHS)

37.9%

12.9% 10.7%

(50%)

(40%)

(30%)

(20%)

(10%)

0%

10%

20%

30%

40%

50%

60%

70%

2011 2012 2013 2014 2015 2016 2017E 2018E 2019E

New Contract Value Revenue Backlog

Source: the Company, Guotai Junan International. Source: the Company, Guotai Junan International.

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GROSS PROFIT

SEG will continue to rely on its two most profitable segments, we forecast total gross profit to improve gradually, but will

likely fail to reach previous peaks. SEG’s EPC Contracting business gross profit margin and contribution to total gross profit

averaged 14.4% and RMB3.08 bn since 2010. SEG’s Engineering, consulting, and licensing business’s gross profit margin and

contribution to total gross profit averaged 42.7% and RMB1.49 bn since 2010. Together, the two segments contributed 83.4% of

total gross profit since 2010. As the Construction and Equipment manufacturing segments primarily support the Company’s EPC

Contracting business, SEG can achieve sustainable growth by leveraging its technical expertise and strong project track record to

compete for EPC projects, particularly in the overseas market. We estimate gross profit growth to accelerate from 2017-2019,

rising 4.6% YoY, 7.5% YoY, and 17.0% YoY, respectively. We believe even as SEG’s improving international competitiveness will

support growth; competition in the global EPC Contracting market for the petrochemical industry will keep growth modest.

Table-4: SEG’s Gross Profit by Segment

RMB million 2010 2011 2012 2013 2014 2015 2016 2017E 2018E 2019E

Engineering, consulting and licensing 1,587 1,516 1,858 2,017 1,597 926 903 1,086 1,191 1,421

EPC Contracting 2,523 2,889 2,857 3,312 3,590 3,848 2,520 2,526 2,721 3,179

Construction 416 633 834 1,079 1,072 1,242 838 848 881 1,008

Equipment manufacturing 13 35 (20) (2) 31 140 30 26 30 34

Total Gross Profit 4,539 5,074 5,528 6,406 6,291 6,157 4,291 4,486 4,823 5,641


Table-5: SEG’s Gross Profit Margin by Segment, (%)

% 2010 2011 2012 2013 2014 2015 2016 2017E 2018E 2019E

Engineering, consulting and licensing 49.1 44.4 45.1 46.3 43.8 35.3 34.6 34.1 32.2 34.2

EPC Contracting 15.5 19.3 14.2 14.1 11.9 13.8 12.2 12.4 13.0 14.4

Construction 3.7 4.5 5.1 6.0 5.6 6.9 4.4 4.7 5.4 6.1

Equipment manufacturing 1.7 4.5 (3.3) (0.2) 4.4 20.7 6.8 4.5 12.4 9.8

Consolidated Gross Profit Margin 15.2 16.6 14.3 14.7 12.7 13.5 10.9 11.5 12.0 13.0


OPERATING PROFIT

Operating income is estimated to be in line with the gross profit trajectory as we expect the Company to continue to

invest in R&D while practising operational prudence to rein in runaway SG&A cost growth. SEG increased its research and

development spending by 20.9% p.a. to RMB1.1 bn in 2016 since going public in 2013, and as the Company’s expertise lies in its

engineering technologies and project management, we expect continued spending as the Company strengthens its most valuable

technological assets. We expect R&D expenses to be relatively flat in 2017, rising 0.3% YoY, then growing 2.0% in 2018 and

2019. SG&A expenses grew 2.1% p.a. since SEG went public and we expect modest growth over the next few years even as SEG

takes on a higher workload volume. We estimate SG&A expenses to decrease slightly by 2.7% and 0.2% in 2017 and 2018 due to

lighter work volume, then increase 4.1% in 2019.

Figure-43: SEG’s Cost of Sales Breakdown, 2010-2016

Figure-44: SEG’s Total Gross Profit Breakdown by

Business Segment, % of Total, 2010-2019E

32% 38% 38% 39%

45% 44% 41%

44% 32% 38% 38%

37% 37%

29%

24% 30% 24% 23% 18% 19% 31%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2010 2011 2012 2013 2014 2015 2016

Subcontracting costs Material and Equipment costs Other costs

55.6 56.9

51.7 51.7

57.1

62.5

58.7 56.3 56.4 56.3

9.2 12.5

15.1 16.8 17.0

20.2

19.5

15.8 16.7 17.3

35.0

29.9

33.6 31.5

25.4

15.0

21.0

27.3 26.3 25.7

0.3 0.7 (0.4) (0.0) 0.5 2.3

0.7 0.6 0.6 0.6

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

(5)

0

5

10

15

20

25

30

35

40

45

50

55

60

65

2010 2011 2012 2013 2014 2015 2016 2017E 2018E 2019E

Total Gross Profit (RHS) EPC Contracting

Construction Engineering, consulting and licensing

Equipment manufacturing

RMB mn%

Source: the Company. Source: the Company, Guotai Junan International.

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Figure-45: SEG’s SG&A Expenses, R&D Expenses, and Total Operating Expenses, 2010-2019E

Figure-46: SEG’s Operating Income and YoY Change, 2011-2019E

3.9%

4.6%

4.1% 4.2% 4.4%

5.3%

6.0% 6.0% 5.9% 5.6%

0%

1%

2%

3%

4%

5%

6%

7%

0

250

500

750

1,000

1,250

1,500

1,750

2,000

2,250

2,500

2,750

2010 2011 2012 2013 2014 2015 2016 2017E 2018E 2019E

SG&A Expenses R&D Expenses SG&A and R&D % of Revenue (RHS)

RMB mn

11.6%

2.9%

15.2%

(8.5%)(4.8%)

(49.7%)

10.9% 14.8%

25.9%

(60%)

(50%)

(40%)

(30%)

(20%)

(10%)

0%

10%

20%

30%

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000

2011 2012 2013 2014 2015 2016 2017E 2018E 2019E

Operating Income Δ YoY (RHS)

Source: the Company, Guotai Junan International. Source: the Company, Guotai Junan International.

FINANCE INCOME AND EXPENSES

SEG has large entrustment loans to its parent Sinopec Group which act as low-risk, highly liquid investments that

provide interest income while understating the Company’s cash profile. In 2014, 2015, and 2016, the Company had

short-term loans due of RMB9.6 bn, RMB11.1 bn, and RMB14.1 bn, respectively, from its ultimate holding company, Sinopec

Group. The loans are payable within a year and had interest rates of 4.0%-4.5%, 2.7%-4.3%, and 2.5%-3.0% over the same

period, higher than the Company’s one-year time deposits. SEG had excess cash of RMB9.2 bn, RMB11.4 bn, and RMB11.9 bn

over the same time period. The Company’s financial income (interest income minus expenses) was RMB496.7 mn, RMB374.6

mn, and RMB418.6 mn over the same time period, respectively. EPC Contracting projects are inherently capital intensive, and

contractors often need to borrow on credit to meet working capital demands for their projects. SEG however, keeps enough cash

on hand to cover working capital requirements and moves the rest of its cash to its state-owned parent company to earn interest.

SEG’s loans to its parent company amounted to 0.9%, 1.4%, and 3.2% of Sinopec Group’s (386 HK) total borrowings for 2014,

2015, and 2016, respectively. At the end of 2016, Sinopec Group had excess cash of RMB98.3 bn.

SHAREHOLDERS’ PROFIT

We estimate 2017E-2019E shareholders’ profit to be RMB2,057 mn/ RMB2,379 mn/ RMB3,007 mn, representing YoY

growth of 23.7%/ 15.7%/ 26.4% and a 3-Yr CAGR of 21.8%, respectively. SEG’s earnings are expected to rebound due to

higher new contract value and project completion from past years. Due to the nature of SEG’s business model, current year

earnings are more reflective of the prior years’ business performance. Compared to Bloomberg consensus, our estimates for

2017E-2019E are lower by 2.7%, 9.6%, and 0.3% respectively.

Table-6: SEG’s Shareholders Profit and EPS, 2015-2019E

RMB millions except per share 2015A 2016A 2017E 2018E 2019E

Our estimates:

Shareholder's Profit 3,318 1,663 2,057 2,379 3,007

YoY (4.9%) (49.9%) 23.7% 15.7% 26.4%

EPS (RMB) 0.750 0.376 0.464 0.537 0.679

Bloomberg Consensus:

Shareholders’ Profit

2,207 2,763 3,037

YoY

32.7% 25.2% 9.9%

EPS (RMB)

0.477 0.594 0.681


Table-7: SEG’s Backlog, 2015-2019E

RMB million 2015A 2016A 2017E 2018E 2019E

Oil Refining 32,951 32,216 33,082 34,316 36,017

Petrochemical 22,731 17,650 16,518 16,598 17,439

New Coal Chemicals 26,231 20,227 17,363 16,381 17,718

Other Industries 18,072 18,080 19,913 21,578 22,841

Total 99,985 88,173 86,876 88,874 94,015


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Table-8: SEG’s New Contract Value 2015-2019E


Oil Refining 13,995 10,025 12,531 13,784 15,162

Petrochemical 11,112 7,444 10,422 11,464 12,610



Total 52,676 27,564 37,598 42,176 47,943


Table-9: SEG’s Revenue 2015-2019E


Oil Refining 7,683 10,760 11,779 12,550 13,462

Petrochemical 11,983 12,525 11,554 11,398 12,362



Total 45,498 39,375 39,009 40,193 43,395


The Company’s interim results and third quarter operating data showed an improving outlook as new contract value is on

track to meet the annual target. SEG’s 1-3Q2017 new contract value is up 87.0% YoY as SEG signed large numbers of

petrochemical projects domestically complemented by a large overseas EPC project with Gazprom. The Company’s 2017 annual

new contract value target is approximately RMB38.0 bn, and its 1-3Q2017 new contract value represents 72.1% of the target. We

expect the Company to meet its annual target as petroleum engineering project investment domestically in China and overseas

continue to rise through 2017 and into 2018. While we think the annual new contract value target is somewhat conservative and

the Company could overshoot the target, we maintain a conservative position on our estimates as downside risks remain prevalent

as investment growth remain in the recovery stages for the industry.

We expect 2017E shareholders’ profit to be realized through 2H2017 as SEG moves out of the early expensive stages of a

number of its overseas projects. During 1H2017, revenue and shareholders’ profit decreased 22.4% YoY and 22.6% YoY due to

high costs from large projects started in 2H2016 such as Phase I of the Kuwait Al-Zour Project (RMB2.1 bn contract value), Project

RAPID in Malaysia (RMB1.2 bn contract value), Phase I Abadan refinery upgrading project (RMB4.8 bn contract value), and the

Fadhili natural gas project with Saudi Aramco (RMB1.7 bn contract value). As these projects move out of its early stages, where

equipment manufacturing and material costs incurred can be significant, earnings should improve. Our 2017E estimates for

shareholders’ profit is RMB2,057 bn, an increase of 23.7% YoY.

Table-10: SEG’s 1H2017 Results and 1-3Q2017 Operating Data

RMB million 1H2015 1H2016 1H2017 1-3Q2017

New Contract Value 27,852 8,397 17,769 27,364

YoY Growth (69.9%) 111.6% 87.0%

Backlog 99,985 90,647 92,178 94,088

YoY Growth (9.3%) 1.7% 4.8%

Revenue 20,905 17,735 13,764

YoY Growth (15.2%) (22.4%)

Shareholders’ Profit 1,711 1,079 835

YoY Growth (36.9%) (22.6%)

Source: the Company.

VALUATION

Initiate with investment rating “Accumulate” and TP of HK$8.50, which is equal to 15.98x/13.81x/10.93x 2017E/2018E/

2019E PER and 1.23x/1.16x/1.08x 2017E/2018E/2019E PBR. The target price implies a 33.9% upside from its last closing

trading price and reflects a 25.0% discount from our DCF valuation. The Company’s 11.2x 2017F PER trades at a premium

against its HK-listed construction oriented peers’ weighted average 7.1x 2017F PER, and at a discount against its more closely

related international peers’ weighted average 26.6x 2017F PER. The Company has a strong financial structure for an EPC firm

with process technologies and project management capabilities that can challenge international competitors. We expect the share

price for SEG to be driven by improving profitability as opposed to higher revenue.

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Table-11: Investment Highlights and Risk Factors

Investment Highlights Key Risk Factors

SEG is the largest EPC contractor by revenue with the strongest

technical capabilities in China operating in the oil refining,

petrochemical, and coal chemical industries.

Demand led growth in capacity expansions for the refining and

petrochemical industries overseas and the coal chemical

industry in China is expected.

Limited competition in the domestic coal chemicals sector

The Company has strong cash flow and flexible cash

management for an EPC contracting firm.

Strong performance from SEG’s parent company, Sinopec

Group, will benefit SEG’s new contract value growth as the

Group initiates more projects.

Deceleration in China’s economic growth could cause

cancellations and delays in capacity expansion investment

plans and adversely affect the Company’s business.

Failure to acquire large EPC contracts could add pressure on

new contract value growth.

Oil prices may persistently remain low which could postpone

investment plans and lead to project cancellations.

Backlog is subject to impairment which is difficult to predict and

could hurt the Company’s business.

Unfavourable movements in foreign exchange rates could

adversely affect SEG’s business.

Figure-47: SEG’s PER Band Figure-48: SEG’s PBR Band

0

2

4

6

8

10

12

14

16

18

20

2014-01 2015-01 2016-01 2017-01

PER Band High Low Mean Current 2017F

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

2014-01 2015-01 2016-01 2017-01

PBR Band High Low Mean Current 2017F

Source: Bloomberg, Guotai Junan International. Source: Bloomberg, Guotai Junan International.

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Table-12: Peers Valuation

Company Stock Code Currency Last price

PE (fiscal year) PB (fiscal year) ROE(%) D/Y(%) EV/EBITDA

16A 17F 18F 19F 16A 17F 18F 19F 17F 17F 17F

International Peers

Worleyparsons Ltd WOR AU AUD 14.32

151.9 106.9 21.8 18.9

1.9 1.9 1.8 1.7

1.8

0.0

17.7

Snc-Lavalin Group Inc SNC CN CAD 55.80

32.8 24.0 18.2 16.5

2.2 1.8 1.8 n.a.

9.6

2.0

14.3

Maire Tecnimont Spa MT IM EUR 3.90

16.0 10.7 11.2 10.5

7.0 4.6 3.5 2.9

51.0

3.1

5.7

Tecnicas Reunidas Sa TRE SM EUR 25.54

10.7 23.5 25.0 13.1

3.3 3.2 3.2 2.9

13.3

5.4

10.6

Petrofac Ltd PFC LN GBp 455.30

2,119.5 6.2 7.9 10.3

1.7 1.8 1.7 1.5

28.5

5.7

4.3

Jgc Corp 1963 JP JPY 2,067.00

12.2 n.a. 22.0 17.9

1.2 1.4 1.3 1.2

(5.5)

1.6

26.0

Daelim Industrial Co Ltd 000210 KS KRW 83,000.00

12.1 5.0 5.4 5.5

0.6 0.6 0.6 0.5

12.7

0.4

5.7

Hyundai Engineering & Const 000720 KS KRW 34,700.00

6.8 8.8 6.5 6.3

0.6 0.6 0.5 0.5

7.0

1.5

3.5

Sk Engineer & Construct 003340 KF KRW 24,550.00

10.7 n.a. n.a. n.a.

0.6 n.a. n.a. n.a.

n.a.

n.a.

n.a.

Samsung Engineering Co Ltd 028050 KS KRW 12,500.00

83.3 73.1 16.6 11.6

2.4 2.3 2.0 1.7

3.6

0.0

19.0

Daewoo Engineering & Constr 047040 KS KRW 5,530.00

n.a. 4.3 4.5 4.6

1.1 0.9 0.8 0.7

22.9

0.0

4.4

Fluor Corp FLR US USD 50.03

24.8 32.9 21.2 17.0

2.2 2.0 1.9 1.7

6.6

1.7

10.9

Chicago Bridge & Iron Co Nv CBI US USD 18.03

n.a. n.a. 9.7 8.1

1.3 1.5 1.3 1.2

(15.4)

1.6

n.a.

Technipfmc Plc FTI US USD 28.61

27.0 19.0 21.7 18.1

1.0 1.1 1.1 1.0

5.9

1.0

5.3

Jacobs Engineering Group Inc JEC US USD 68.16

38.9 27.7 18.9 16.6

1.9 1.9 1.7 1.6

6.8

0.0

12.7

Kbr Inc KBR US USD 19.11

n.a. 12.9 14.1 13.2

3.6 3.0 2.5 2.2

24.6

1.7

7.3

Simple Average 195.9 27.3 15.0 12.5 2.0 1.9 1.7 1.5 11.6 1.7 10.5

Weighted Average 109.5 26.6 17.4 14.7 1.8 1.7 1.5 1.4 8.4 1.4 10.7

Hong Kong Listed Peers

Sinopec Engineering Group-H 2386 HK HKD 6.35

14.3 11.2 9.0 7.9

1.0 0.9 0.8 0.8

8.2

3.5

3.1

Wison Engineering Services C 2236 HK HKD 1.68

135.6 n.a. n.a. n.a.

3.0 n.a. n.a. n.a.

n.a.

n.a.

n.a.

China Energy Engineering C-H

3996 HK HKD 1.23

7.5 6.2 5.6 5.0

0.7 0.6 0.6 0.5

10.3

3.1

5.9

China Machinery Engineerin-H

1829 HK HKD 4.81

8.1 8.4 7.2 6.6

1.2 1.0 0.9 0.9

12.3

4.6

n.a.

China Communications Const-H

1800 HK HKD 8.58

6.9 6.4 5.7 5.0

0.8 0.7 0.6 0.6

11.2

3.1

9.1

China Railway Construction-H 1186 HK HKD 9.04

7.5 6.7 6.0 5.3

0.8 0.7 0.6 0.6

11.3

2.4

5.3

China Railway Group Ltd-H 390 HK HKD 5.73

9.5 7.6 6.8 6.0

0.9 0.8 0.7 0.6

10.4

2.1

7.8

China State Construction Int 3311 HK HKD 10.66

8.9 8.8 7.6 6.2

1.9 1.5 1.3 1.1

18.5

3.3

8.6

Metallurgical Corp Of Chin-H 1618 HK HKD 2.23

7.6 6.5 5.3 4.3

0.7 0.6 0.5 0.5

8.7

3.5

11.6

Beijing Urban Construction-H 1599 HK HKD 4.43

10.2 8.4 7.1 6.0

1.5 1.3 1.2 1.1

15.4

3.3

7.1

Simple Average 21.6 7.8 6.7 5.8 1.3 0.9 0.8 0.7 11.8 3.2 7.3


Mainland Listed Peers

China National Chemical-A 601117 CH CNY 6.51

18.1 14.9 12.1 10.2

1.2 1.1 1.0 1.0

7.8

1.7

4.7

Enn Ecological Holdings Co-A 600803 CH CNY 16.37

30.9 22.8 13.0 10.4

3.6 2.9 2.4 1.9

13.9

0.7

n.a.

China Petroleum Engineering 600339 CH CNY 5.44

19.5 n.a. n.a. n.a.

1.5 n.a. n.a. n.a.

n.a.

n.a.

n.a.

Shandong Sunway Petrochemi-A

002469 CH CNY 6.44

322.0 n.a. n.a. n.a.

2.7 n.a. n.a. n.a.

n.a.

n.a.

n.a.

Zhenhai Petrochemical Engi-A 603637 CH CNY 24.27

39.9 n.a. n.a. n.a.

6.3 n.a. n.a. n.a.

n.a.

n.a.

n.a.

East China Engineering Sci-A 002140 CH CNY 11.02

61.2 n.a. n.a. n.a.

2.4 n.a. n.a. n.a.

n.a.

n.a.

n.a.

Metallurgical Corp Of Chin-A 601618 CH CNY 4.94

19.8 16.7 14.3 13.0

1.7 1.5 1.4 1.3

9.0

1.2

n.a.

Huadian Heavy Industries C-A 601226 CH CNY 5.91

n.a. n.a. n.a. n.a.

2.0 n.a. n.a. n.a.

n.a.

n.a.

n.a.

Sinosteel Engineering & Te-A 000928 CH CNY 6.19

14.1 10.0 7.9 6.3

1.9 1.2 1.1 0.9

13.7

1.2

n.a.

China Zhonghua Geotechnica-A

002542 CH CNY 7.76

55.4 n.a. n.a. n.a.

4.3 n.a. n.a. n.a.

n.a.

n.a.

n.a.

China Camc Engineering Co -A

002051 CH CNY 18.56

16.1 13.5 11.6 9.6

2.9 2.4 2.1 1.8

17.8

1.8

8.1

Beijing Sanju Environmenta-A 300072 CH CNY 36.36

39.5 25.2 17.1 12.1

10.1 7.3 5.2 3.6

28.9

0.6

n.a.

Norinco Intl Cooperation -A 000065 CH CNY 20.28

21.3 17.0 13.0 9.8

3.3 2.7 2.2 1.9

16.5

0.8

n.a.

Sinoma International Engin-A 600970 CH CNY 8.58

29.6 18.0 13.1 11.4

2.2 2.0 1.8 1.7

10.7

1.8

n.a.

China Gezhouba Group Co Lt-A

600068 CH CNY 8.71

11.8 9.8 7.7 6.2

1.8 1.1 1.0 0.9

11.4

3.0

n.a.

China Nuclear Engineering -A 601611 CH CNY 10.72

32.5 30.6 27.5 25.5

3.9 3.7 3.4 3.0

11.7

0.7

n.a.

Hunan Baili Engineering Sc-A 603959 CH CNY 26.55

50.1 46.6 40.8 34.5

6.8 6.2 5.6 5.0

13.2

0.6

n.a.

Simple Average 48.9 20.5 16.2 13.6 3.4 2.9 2.5 2.1 14.0 1.3 6.4


Source: Bloomberg.

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Table-13: Financial Statements and Ratios

Income Statement 2015A 2016A 2017F 2018F 2019F Cash Flow Statement 2015A 2016A 2017F 2018F 2019F

Year End 31 December


Million RMB

Million RMB

Revenue 45,498 39,375 39,009 40,193 43,395 Profit before tax 4,240 2,369 2,723 3,128 3,930

Cost of Goods Sold (39,341) (35,085) (34,523) (35,370) (37,754)

Depreciation 469 580 556 457 450

Gross Profit 6,157 4,291 4,486 4,823 5,641

Amortization 151 143 129 134 147

G&A Expenses (1,116) (1,160) (1,131) (1,125) (1,172)

Tax Paid (922) (706) (666) (750) (923)

Sales & Marketing Expenses (101) (107) (101) (105) (108)

Income/(loss) from JV/A (20) (16) (21) (22) (23)

R&D Expenses (1,185) (1,113) (1,116) (1,139) (1,162)

Change in Working Capital 1,773 2,221 (1,504) (1,359) (362)

Other gains - net 90 24 8 7 (100)

Other Operating Cash Flows 103 (68) 163 (112) (49)

Operating Profit 3,845 1,935 2,145 2,461 3,100 Operating Cash Flow 5,793 4,522 1,381 1,477 3,170

Income from JV/A 20 16 21 22 23

Capital Expenditure (292) (398) (390) (402) (434)

Interest Income - net 375 419 557 645 807

Repayment of loans - net (1,500) (3,000) (400) 1,500 700

Profit before tax 4,240 2,369 2,723 3,128 3,930

Other Investing Cash Flows (809) 34 27 (8) (28)

Tax (922) (706) (666) (750) (923) Investing Cash Flow (2,602) (3,363) (763) 1,090 238

Minority Interest 0.3 0.2 0.2 0.2 0.3

Dividends Paid (1,333) (1,129) (593) (765) (921)

Shareholders’ Profit 3,318 1,663 2,057 2,379 3,007

EPS (RMB) 0.750 0.376 0.464 0.537 0.679

Other Financing Cash Flows (2) (2) (29) 0 0

Financing Cash Flow (1,335) (1,131) (623) (765) (920)

Balance Sheet 2015A 2016A 2017F 2018F 2019F

Exchange Differences 367 428 0 0 0


Million RMB

PPE 4,014 3,975 3,808 3,753 3,737 Cash at the Beginning of the Year 9,182 11,406 11,862 11,857 13,660

Investments in JV/A 133 142 159 177 195 Net Change in Cash 2,224 456 (5) 1,802 2,488

Intangibles 327 272 222 170 113 Cash at the End of the Year 11,406 11,862 11,857 13,660 16,148

Land use Rights 2,741 2,679 2,624 2,568 2,506

Other LT Assets 725 778 731 717 722

Non-Current Assets 7,939 7,846 7,544 7,386 7,272 Financial Ratios 2015A 2016A 2017F 2018F 2019F

Cash & Equivalent 11,406 11,862 11,857 13,660 16,148

Loans due from ultimate holding

company 11,100 14,100 14,500 13,000 12,300

Growth (%)

Inventory 1,830 1,197 1,170 1,206 1,302 Revenue (7.8%) (13.5%) (0.9%) 3.0% 8.0%

Receivables 11,871 9,990 9,897 10,197 11,009 Gross Profit (2.1%) (30.3%) 4.6% 7.5% 17.0%

Other Current Assets 14,259 13,824 15,333 15,987 17,336 Operating Profit (4.8%) (49.7%) 10.9% 14.8% 25.9%

Current Assets 50,465 50,972 52,757 54,050 58,095 Net Profit (4.9%) (49.9%) 23.7% 15.7% 26.4%

Total Assets 58,404 58,818 60,301 61,436 65,367

Gross margin of segments:

Short-Term Debt 0 0 0 0 0

Engineering, consulting and

licensing 35.3% 34.6% 34.1% 32.2% 34.2%

Payables 16,679 14,217 13,994 13,452 13,997

EPC Contracting 13.8% 12.2% 12.4% 13.0% 14.4%

Contract Work Payables 6,939 10,219 9,865 10,205 11,144

Construction 6.9% 4.4% 4.7% 5.4% 6.1%

Other Current Liabilities 7,180 6,280 6,744 6,577 6,988

Equipment manufacturing 20.7% 6.8% 4.5% 12.4% 9.8%

Current Liabilities 30,799 30,717 30,603 30,235 32,129 Total gross margin 13.5% 10.9% 11.5% 12.0% 13.0%

Other LT Liabilities 271 262 310 302 291 EBITDA margin 9.8% 6.7% 7.3% 7.6% 8.5%

Retirement and other

obligations 2,696 2,637 2,752 2,648 2,610

Net margin 7.3% 4.2% 5.3% 5.9% 6.9%

Non-Current Liabilities 2,967 2,899 3,062 2,950 2,901 ROA 5.7% 2.8% 3.4% 3.9% 4.6%

Total Liabilities 33,766 33,616 33,665 33,185 35,030 ROE 13.5% 6.6% 7.7% 8.4% 9.9%

Share capital 4,428 4,428 4,428 4,428 4,428

Reserves 20,207 20,770 22,204 23,818 25,904 Liquidity

Shareholders’ Equity 24,635 25,198 26,632 28,246 30,332

Gearing ratio Net cash Net cash Net cash Net cash Net cash

Minority Interests 4 4 4 4 5 Current ratio 1.6 1.7 1.7 1.8 1.8

Total Equity 24,639 25,202 26,636 28,250 30,337 Interest coverage (x) 42.2 25.9 21.4 21.8 28.1


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Company Rating Definition

The Benchmark: Hong Kong Hang Seng Index

Time Horizon: 6 to 18 months

Rating Definition

Buy Relative Performance >15%; or the fundamental outlook of the company or sector is favorable.

Accumulate Relative Performance is 5% to 15%; or the fundamental outlook of the company or sector is favorable.

Neutral Relative Performance is -5% to 5%; or the fundamental outlook of the company or sector is neutral.

Reduce Relative Performance is -5% to -15%; or the fundamental outlook of the company or sector is unfavorable.

Sell Relative Performance <-15%; or the fundamental outlook of the company or sector is unfavorable.

Sector Rating Definition

The Benchmark: Hong Kong Hang Seng Index

Time Horizon: 6 to 18 months

Rating Definition

Outperform Relative Performance >5%; or the fundamental outlook of the sector is favorable.

Neutral Relative Performance is -5% to 5%; or the fundamental outlook of the sector is neutral.

Underperform Relative Performance <-5%; or the fundamental outlook of the sector is unfavorable.

DISCLOSURE OF INTERESTS

(1) The Analysts and their associates do not serve as an officer of the issuer mentioned in this Research Report. (2) The Analysts and their associates do not have any financial interests in relation to the issuer mentioned in this Research Report. (3) Except for GREENLAND BROAD (01253 HK),GUOTAI JUNAN INTERNATIONAL (01788 HK),BINHAI INVESTMENT (02886 HK),GFI

MSCI A I (03156 HK),CAM SCSMALLCAP (03157 HK),LINK HOLDINGS (08237 HK),GFI MSCI A I-R (CNY) (83156 HK),Guotai Junan and its group companies do not hold equal to or more than 1% of the market capitalization of the issuer mentioned in this Research Report.

(4) Guotai Junan and its group companies have not had investment banking relationships with the issuer mentioned in this Research Report within the preceding 12 months.

(5) Guotai Junan and its group companies are not making a market in the securities in respect of the issuer mentioned in this Research Report.

(6) Guotai Junan and its group companies have not employed an individual serving as an officer of the issuer mentioned in this Research Report. There is no officer of the issuer mentioned in this Research Report associated with Guotai Junan and its group companies.

DISCLAIMER

This Research Report does not constitute an invitation or offer to acquire, purchase or subscribe for securities by Guotai Junan Securities

(Hong Kong) Limited ("Guotai Junan"). Guotai Junan and its group companies may do business that relates to companies covered in research reports, including investment banking, investment services, etc. (for example, the placing agent, lead manager, sponsor, underwriter or invest proprietarily). Any opinions expressed in this report may differ or be contrary to opinions or investment strategies expressed orally or in written form by sales persons, dealers and other professional executives of Guotai Junan group of companies. Any opinions expressed in this report may differ or be contrary to opinions or investment decisions made by the asset management and investment banking groups of Guotai Junan. Though best effort has been made to ensure the accuracy of the information and data contained in this Research Report, Guotai Junan does not guarantee the accuracy and completeness of the information and data herein. This Research Report may contain some forward-looking estimates and forecasts derived from the assumptions of the future political and economic conditions with inherently unpredictable and mutable situation, so uncertainty may contain. Investors should understand and comprehend the investment objectives and its related risks, and where necessary consult their own financial advisers prior to any investment decision. This Research Report is not directed at, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any jurisdiction where such distribution, publication, availability or use would be contrary to applicable law or regulation or which would subject Guotai Junan and its group companies to any registration or licensing requirement within such jurisdiction. © 2017 Guotai Junan Securities (Hong Kong) Limited. All Rights Reserved. 27/F., Low Block, Grand Millennium Plaza, 181 Queen’s Road Central, Hong Kong. Tel.: (852) 2509-9118 Fax: (852) 2509-7793 Website: www.gtja.com.hk

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