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We downgraded our recommendation on China Petroleum & Chemical Corporation or Sinopec (SNP - Analyst Report) to Underperform from Neutral on Jan 10, 2014. The company currently retains a Zacks Rank #5 (Strong Sell).

Why Downgraded?

During the first nine months of 2013, the company witnessed a sharp drop in crude oil prices, which dragged down the Exploration and Production (E&P) segment’s operating profit by 15.5% year over year. However, increases in the price of international crude oil amid government caps on fuel prices prevented the company from fully passing on the spiraling costs to consumers.

Sinopec’s operating income for the Fuels Marketing segment decreased 10.5% year over year. The considerably high volumes were unable to offset lower margins. Owing to its larger downstream refining and petrochemicals operations than its rival PetroChina Co. Ltd. (PTR - Analyst Report), Sinopec remains highly exposed to government directed price controls. This is also expected to affect margins in the future.

We remain apprehensive about the volatile oil and gas fundamentals and a weak macro environment. The company’s prospects are closely linked to the successful completion of its growth projects, which in turn, might be adversely affected by operational hindrances as well as overruns and delays in completion. Further, Sinopec’s matured domestic oil fields and associated rising costs will continue to be an overhang on its operations as natural declines begin to take a toll.

The other major areas of concern include operational disruption, labor and material cost inflation that could affect project outlays, governmental regulations and severe competition from domestic and international peers. In the E&P space, Sinopec has been lagging other industry players. This is primarily due to exposure to the heavily regulated downstream sector, as well as its relatively weak and capital intensive upstream asset base. In view of these factors, we do not see any catalyst in the near term.

Other Stocks to Consider

Not all stocks indicate poor performance like Sinopec. Zacks Ranked #1 (Strong Buy) stocks – Helmerich & Payne, Inc. (HP - Analyst Report) and Seadrill Partners LLC (SDLP - Snapshot Report) – are expected to perform impressively over the short term.


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