2Q20 performance exceeds our expectations

Petrochemical Oil Services announced 2Q20 results: According to Chinese corporate accounting standards, the company's 2Q20 revenue increased 11% year on year, the net profit of the mother increased sharply by 50% to 480 million yuan year on year, and the net profit after deducting non-caliber profit increased 58% year on year. It exceeded our expectations, mainly due to a 1.7 percent year-on-year improvement in gross margin in 2Q20, exceeding our expectations that remained flat over the same period.

We anticipate that the sharp improvement in the company's 2Q20 gross margin may be due to higher team utilization and lower standby costs over the previous month. As of 1H20, the average utilization rate of the domestic drilling team had reached 80%, better than 77.3% during the same period.

In 2Q20, the company's new orders fell 9% year on year to 23.9 billion yuan, but new orders signed in domestic and external markets were strong, up 45% year on year to 7 billion yuan. At the same time, the company kept its annual new contract target of 68 billion yuan unchanged. However, according to the 1H20 orders already signed and the 2H20 market outlook, Sinopec's internal order target was lowered, and the target for new orders signed in domestic and foreign markets was raised.

The company's 2Q20 operating cash flow performance was impressive. According to Chinese corporate accounting standards, it received a cash inflow of 1.5 billion yuan, driving 1H20 to the first half of the year in history to achieve positive operating cash flow, helping the company reduce its net debt to 20.6 billion yuan and the net debt-to-benefit ratio to 279%.

The profit differences reported by Chinese enterprises under the accounting standards and international accounting standards are in special reserves.

According to historical disclosures, there is usually a big difference in the semi-annual report data. We expect it is mainly the result of the need to calculate in advance under China's accounting standards; judging from the full-year data, the difference in the calculation of the company's special reserves in recent years is less than 100 million yuan.

Development trends

The gross margin of 2H20 is still uncertain, and we are concerned about the effectiveness of three-fee management. Although the company's 2Q20 performance was better than our expectations, considering that the effect of low domestic oil prices may gradually begin to affect the company's gross margin in 3Q20, we are still cautious about changes in the company's 2H20 gross margin. Furthermore, with 1H20's sales revenue increasing by only 4%, sales, management and financial costs still increased 14%, 9%, and 7%, respectively. Therefore, we also remind investors that 2H20's three-fee management falls short of expectations.

Profit forecasting and valuation

Although the company's 2Q20 performance exceeded expectations, considering that the company's 2H20 operations are still facing some uncertainty, we maintain our profit forecast and neutral ratings in the two markets. Keep the A/H target price of $2/HK$0.60 unchanged, corresponding to the 2020 net market ratio of 5.2 times/1.4 times and an upward margin of 6%/5%. The current A/H stock price is trading 4.9 times/1.3 times the 2020 net market ratio.

risks

The recovery in gross margin and cost control fell short of expectations.