SK Innovation - Credit Suisse

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03 July 2012

Asia Pacific/South Korea

Equity Research

Independent Refiners

SK Innovation

(096770.KS / 096770 KS) COMMENT

Base oil business—the growth driver

■ Market missing the story. Lubricants are in downstream refining and

contribute 20% of company earnings. The market seems to have missed this

(and we will show how on page 7). One would just not expect deep

exposure to (1) a high-return, high-growth area, and (2) a dominant global

share in Group III, where we see demand growth of some 13% p.a, to trade

near trough levels, on 0.8x P/B. We think book is quite reasonable.

■ Demand. SK is the biggest beneficiary of demand growth in Group III base

oil market: Base oil demand should migrate from Group I to Group II and III,

as demand grows in the more environmental-friendly and better quality base

oil, which is Group III. On our analysis, SK should maintain a minimum 40%

global market share in the Group III, and generate more than 30% ROE.

■ Expansion ahead. The recent completion of its #3 lube base oil JV project

with JX Energy sees a net 50% rise in capacity even after considering the #1

LBO plant shutdown. The proposed JV project with Repsol by 2014 could

see 30% more capacity growth YoY. As a result, we see the bottom-line

contribution here rising from the present 20% to 30% by 2014.

■ Earnings. We modelled, lube base oil business expansion boosting the

return profile, easing earnings volatility and driving FY13E EPS growth of

23%. Here, the contribution should rise from 20% to 30% by 2014.

■ Risk and valuation. We believe SK’s global dominance and expansion

plan in the lube base oil business justify more than the present close-to-

trough valuation of 0.8x P/B. Current valuation seems to reflect risks on

macro concerns and near-term earnings vulnerability from inventory loss.

However, we believe SK’s dominant presence in the lube industry merits

upside. We maintain our target price of W210K based on 1x 2013E P/B.

Share price performance

100

120

140

160

180

100000

150000

200000

250000

300000

Jul-10 Nov-10 Mar-11 Jul-11 Nov-11 Mar-12

Price (LHS) Rebased Rel (RHS)

The price relative chart measures performance against the

KOREA SE KOSPI IDX which closed at 1851.65 on 02/07/12

On 02/07/12 the spot exchange rate was W1143.29/US$1

Performance over 1M 3M 12M Absolute (%) 4.0 -11.8 -32.3 Relative (%) 3.1 -3.6 -18.6

Financial and valuation metrics

Year 12/11A 12/12E 12/13E 12/14E Revenue (W bn) 68,366.7 68,107.0 66,715.3 65,868.3 EBITDAX (W bn) 3,370.2 3,065.7 3,675.8 3,704.5 EBIT (W bn) 2,848.8 2,544.3 3,092.8 3,062.6 Net profit (W bn) 3,181.0 1,882.5 2,306.4 2,331.1 EPS (CS adj.) (W) 34,786.78 20,329.99 24,914.65 25,181.55 Change from previous EPS (%) n.a. Consensus EPS (W) n.a. 22,249 24,189 25,719 EPS growth (%) 152.0 -41.6 22.6 1.1 P/E (x) 4.1 7.0 5.7 5.6 Dividend yield (%) 2.0 1.8 1.8 1.8 EV/EBITDAX (x) 5.2 5.9 4.6 4.3 P/B (x) 0.90 0.81 0.72 0.64 ROE (%) 27.2 12.3 13.4 12.1 Net debt/equity (%) 30.2 30.7 20.7 13.5

Source: Company data, Thomson Reuters, Credit Suisse estimates.

Rating OUTPERFORM* [V] Price (02 Jul 12, W) 141,500 Target price (W) 210,000¹ Upside/downside (%) 48.4 Mkt cap (W bn) 13,083.9 (US$ 11.4) Enterprise value (W bn) 18,142 Number of shares (mn) 92.47 Free float (%) 69.0 52-week price range 223,000.0 - 122,500.0

*Stock ratings are relative to the relevant country benchmark.

¹Target price is for 12 months.

[V] = Stock considered volatile (see Disclosure Appendix).

Research Analysts

A-Hyung Cho

822 3707 3735

[email protected]

Jihong Choi

82 2 3707 3796

[email protected]

03 July 2012

SK Innovation

(096770.KS / 096770 KS) 2

Focus charts Figure 1: Lube base oil market Group I, II and III Figure 2: Group III supply growth outlook

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

35%

1Q04 4Q04 3Q05 2Q06 1Q07 4Q07 3Q08 2Q09 1Q10 4Q10 3Q11 2Q12

0

20

40

60

80

100

120

140

160

SKI Dubai oil spot

(U$/bbl)

lagging effect

0%

5%

10%

15%

20%

25%

0

20

40

60

80

100

120

2011 2012 2013 2014 2015

Group III YoY growth

(kbd)

Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates

Figure 3: Aggregate ROIC vs. Lube ROIC Figure 4: OP contribution by business

0%

5%

10%

15%

20%

25%

30%

2009 2010 2011

Lub ROIC Agg ROIC

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2010 2011 2012 2013 2014

Lub

E&P

Petrochemical

Petroleum


Figure 5: SK Lub—capacity expansion schedule Figure 6: SK Group III m/s (SK vs. global capacity)

12,300 12,300 12,300 12,300

12,000 12,000 12,000 12,000

5,850 5,850 5,850 5,850

18,720 18,720 18,720

8,911

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

2011 2012E 2013E 2014E

#1 LBO #2 LBO Pertamina JV #3 LBO #4 LBO

(b/d)

0%

10%

20%

30%

40%

50%

0

20

40

60

80

100

120

2010 2011 2012 2013 2014

SK Group III Global Group III SKLub M/S (RHS)

(kbd)


Figure 7: Current market cap implies 0.5x P/B on SK Lubricants

Current market cap (W bn) 12,760.3

SK Innovation (book value) 2,799.4

SK Energy(book value) 7,830.8

SK Global Chem(book value) 1,681.6

Implied value of SK Lub 448.6

Implied valuation on SK Lubricants 0.5x P/B

Source: Company data, Credit Suisse estimates

03 July 2012

SK Innovation

(096770.KS / 096770 KS) 3

Base oil business—the growth driver Lube base oil is used in producing lubricants. A lubricant reduces friction between moving

surfaces, and reduces heat generation, noise and vibration. The major application and

most widely used lubricant is motor oil, which protects internal combustion engines in

motor vehicles and power equipment. Typically lubricants contain 90% base oil and less

than 10% additives.

As discussed in the appendix, growth prospects differ by product. Group III is more

expensive, more environmently-friendly and has better quality (engine-protective) than

Group II, and so is Group II base oil over Group I. Lube base oil is made up of UCO

(unconverted oil) which is a by-product of the refiners’ hydrocracker. SK is 100%

integrated into the UCO from its hydrocracker.

High return and high-growth business

The lube base oil business is a high-margin business given the relatively high entry

barriers, explained by (1) the vertical integration to the feedstock, (2) a limited number of

players globally, and (3) leadership in the business.

Figure 8: Business profitability comparison

2011 1Q12

SK Innovation ROE 17% 7%

OPM 26% 24%

ROIC 18% 6%

Equity (Wbn) 2,109.5 2,799.4

SK Energy ROE 10% 19%

OPM 2% 3%

ROIC 7% 14%

Equity (Wbn) 7,925.3 7,830.8

SK Global Chemical ROE 12% 18%

OPM 3% 2%

ROIC 6% 9%

Equity (Wbn) 1,620.4 1,681.6

SK Lubricants ROE 42% 38%

OPM 17% 12%

ROIC 28% 22%

Equity (Wbn) 911.6 831.3

Source: Company data

Group III demand and supply to grow fast

Group I demand migrating into II and III

Each type of base oil has different characteristics. The American Petroleum Institute (API)

has developed a Base Oil Classification System which categorises base oils into five

major groups, i.e., Group I to V. Each group is classified on the basis of (1) percentage of

saturates, (2) sulphur content, and (3) viscosity index. Below we explain what each

specification means to the end-user.

The higher the number of saturates, the higher molecular bond strength of the oil and

therefore the better the resistance to breakdown or loss of viscosity.

The lower the sulphur content, the better the purity: thus the product is less corrosive

and there is less potential for oxidation.

What is lube base oil used

for?

How big is the market?

03 July 2012

SK Innovation

(096770.KS / 096770 KS) 4

The Viscosity Index is an indication of the rate of change of viscosity against

temperature, and the higher the VI, the better. (Viscosity: Viscosity is an oil’s

resistance to flow and shear. It is the single most critical physical property of the oil as

it affects both the wear rate and the fuel efficiency, i.e. water is a low viscosity fluid

and syrup is a high viscosity fluid).

Figure 9: Different specifications of base oil

API category Viscosity Index Saturates (%) Sulfur (%)

Group I 80-120 <90 >0.03

Group II 80-120 >90 <0.03

Group III 120+ >90 <0.03

Group IV PAO

Group V All others

Source: American Petroleum Institute (API)

Group III becoming more price-competitive with more capacity?

Group III base oil price has been trading at a premium to its peers: the past 12 months

have been tighter than usual. While capacity addition could result in a narrower premium

over other grades, we believe demand will remain robust and more importantly, operating

profit margins should rise past 10%, as has been the case historically.

Figure 10: Base oil price trend Figure 11: Lube operating profit margin vs. oil price

0

50

100

150

200

250

300

Jan-05 Nov-05 Sep-06 Jul-07 May-08 Mar-09 Jan-10 Nov-10 Sep-11

Group I Group II Group III

($/bbl)

0

20

40

60

80

100

120

140

160

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

35%

1Q04 4Q04 3Q05 2Q06 1Q07 4Q07 3Q08 2Q09 1Q10 4Q10 3Q11 2Q12

SKI Dubai oil spot

(U$/bbl)

Source: Lube Report Source: Bloomberg, Credit Suisse estimates

As suggested above, demand is driven by auto and machinery, hence could be sensitive

to the economy; but as suggested below, we see a structural change in demand, i.e.,

migration to Group III.

As such, we estimate Group III base oil demand will grow in line with the capacity. This

rapid capacity expansion in Group III could make the market more price-competitive.

However, this seemingly aggressive demand growth looks realistic.

■ We believe all global demand growth for lubricants should be in the Group III base oil

while demand for lower grade base oil should fall. Base oil demand should migrate

from Group I to Group II and III, as demand grows in the more environmental-friendly

and better-quality base oil. Government regulations, fuel economy requirements, CO2

emission reductions and performance upgrades should continue to drive higher-quality

base oil demand.

■ These expansion plans by merchant players (non-integrated) are based on multi-year-

based supply contracts with the end-customers’ (mostly oil majors such as Exxon

Mobil, Chevron, Shell, Total, etc). Hence, unless demand fundamentals change

significantly, we think Group III base oil-makers should meet their sales targets.

03 July 2012

SK Innovation

(096770.KS / 096770 KS) 5

Figure 12: Lube base oil market Group I, II and III Figure 13: Group III supply growth outlook

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

35%

1Q04 4Q04 3Q05 2Q06 1Q07 4Q07 3Q08 2Q09 1Q10 4Q10 3Q11 2Q12

0

20

40

60

80

100

120

140

160

SKI Dubai oil spot

(U$/bbl)

lagging effect

0%

5%

10%

15%

20%

25%

0

20

40

60

80

100

120

2011 2012 2013 2014 2015

Group III YoY growth

(kbd)


SK Lubricants with largest market share in Group III

SK Lubricants is the biggest beneficiary of strong demand growth in Group III base oil.

Among the merchant players, (non-integrated through lubricant and mostly selling lube

base oil) SK Lubricants has a dominant global share in Group III, where we see robust

demand growth of around 13% p.a. Based on our analysis, SK should maintain a minimum

40% global market share in the Group III, and generate more than 30% ROE.

Capacity expansion ahead

Expansion is ahead of us. The recent completion of its #3 lube base oil JV project with JX

Energy should result in a net 50% increase in capacity, taking into account the shutdown

of the #1 LBO plant (which should be turned into Group II base oil). The expected JV

project with Repsol by 2014 should drive 30% more capacity growth.

Details of supply contracts are not disclosed by the company, but most of the global

majors including Exxon Mobil are on SK’s customer list, which is why we remain confident

on its sell-through.

Figure 14: SK Lub—capacity expansion schedule Figure 15: SK Group III m/s (SK vs. global capacity)

12,300 12,300 12,300 12,300

12,000 12,000 12,000 12,000

5,850 5,850 5,850 5,850

18,720 18,720 18,720

8,911

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

2011 2012E 2013E 2014E

#1 LBO #2 LBO Pertamina JV #3 LBO #4 LBO

(b/d)

0%

10%

20%

30%

40%

50%

0

20

40

60

80

100

120

2010 2011 2012 2013 2014

SK Group III Global Group III SKLub M/S (RHS)

(kbd)

Source: Company data Source: Company data, Credit Suisse estimates

Optimised operation maximises return

On a consolidated basis, SK Innovation is 7% integrated from E&P to refining, but almost

100% integrated from refining to petrochemical and lubricants businesses. SK Innovation

produces 63K bbl/day of oil/gas. SK Energy’s throughput volume is around 900K bbl/day.

Of the refinery output, most of its naphtha production is consumed by SK Innovation’s

100%-owned affiliate SK Global Chemical, which has 860K MT of ethylene capacity and 4

mn MT of BTX. Similarly, all its UCO from the refiner’s HOU is wholly consumed internally

at its lubricants capacity. The full integration optimises the refinery plant’s operations and

maximises returns via the lubricants business. Lubricants earnings are up 163% over the

past five years and returns have consistently outpaced those of the refining business.

03 July 2012

SK Innovation

(096770.KS / 096770 KS) 6

Figure 16: Aggregate ROIC vs. Lube ROIC Figure 17: Operating profit breakdown

0%

5%

10%

15%

20%

25%

30%

2009 2010 2011

Lub ROIC Agg ROIC

0

500

1,000

1,500

2,000

2,500

3,000

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Petroleum Petrochemical E&P Lub

(W bn)


SK—the largest producer among merchant sellers

Korean refiners have gained stature in the lube base oil industry on technical

competitiveness. Their relatively new refinery facilities also mean that hydrocracker

bottoms have been available for Group II/III base oil production.

SK Lubricants, post the expansion (mechanically completed in 2Q12, to start production in

3Q), has become the largest Group III producer among the non-integrated merchant

sellers globally (i.e,. not selling the lubricants but the base oil, which is the feed). It is

among the global Top 3, even including the integrated players such as Shell and Exxon

Mobil. The company has shown competitiveness in technology (expertise in catalyst) and

economies of scale.

Figure 18: Group II+III capacity Figure 19: SK Lub—capacity schedule detail

0

10

20

30

40

50

60

(kbd)

Plant 2011 2012E 2013E 2014E Location Share

#1 LBO 12,300 12,300 12,300 12,300 Korea, Ulsan 100%

#2 LBO 12,000 12,000 12,000 12,000 Korea, Ulsan 100%

Pertamina JV 5,850 5,850 5,850 5,850 Indonesia, DumaiJV with Pertamina

(SK:Petramina = 65:35)

#3 LBO 18,720 18,720 18,720 Korea, UlsanJV with JX Energy (SK:JX =

72:28)

#4 LBO 8,911 Spain, CartagenaJV with Repsol

(SK:Repsol=67:33)

Total 30,150 48,870 48,870 57,781

*SK capacity net of #1 LBO shutdown Source: Company data, Credit

Suisse estimates


More JVs to expand capacity

While SK’s downstream business has been fully integrated and optimised, this means that,

to expand, the company needs to increase JV projects overseas. We believe the company

should be able to make the most of its track record and widen presence through other JVs

by leveraging leading technology and market positions to continue to grow this business.

Implied value of the lubricants business is low

SK’s expansion in the lube base oil business should boost its return profile, reduce

earnings volatility and drive FY13E EPS growth of 23%, on our forecasts. We believe SK’s

global dominance and expansion plan in the lube base oil business are worth well more

than the close-to-trough valuation of 0.8x P/B the shares are on. We believe this sort of

growth is worth at least book, which is where we set our target price.

03 July 2012

SK Innovation

(096770.KS / 096770 KS) 7

We think the market is underestimating SK’s lubricants business. The share price implies

almost no value for the lubricants business. Based on our calculation, assuming book

value for all other businesses, SK Lubricant’s implied valuation is only 0.5x P/B, while it

generates 30-40% ROE.

Figure 20: Business profitability comparison

2011 1Q12

SK Innovation ROE 17% 7%

OPM 26% 24%

ROIC 18% 6%

Equity (Wbn) 2,109.5 2,799.4

SK Energy ROE 10% 19%

OPM 2% 3%

ROIC 7% 14%

Equity (Wbn) 7,925.3 7,830.8

SK Global Chemical ROE 12% 18%

OPM 3% 2%

ROIC 6% 9%

Equity (Wbn) 1,620.4 1,681.6

SK Lubricants ROE 42% 38%

OPM 17% 12%

ROIC 28% 22%

Equity (Wbn) 911.6 831.3

Source: Company data

Figure 21: Current market cap implies 0.5x P/B for SK Lubricants

Market cap (W bn) 12,760.3

SK Innovation (book value) 2,799.4

SK Energy (book value) 7,830.8

SK Global Chem (book value) 1,681.6

Implied value of SK Lub 448.6

Implied valuation on SK Lubricants 0.5x P/B


03 July 2012

SK Innovation

(096770.KS / 096770 KS) 8

Financial summary Figure 22: SK Innovation—summary financials (K-IFRS consolidated)

(W bn) 2010 2011 2012E 2013E 2014E

Income statement

Total sales 53,706 68,367 68,107 66,715 65,868

COGS 49,831 63,792 63,750 61,719 60,807

Gross profit 3,875 4,575 4,357 4,996 5,061

SG&A 1,644 1,726 1,813 1,903 1,998

Operating income 2,231 2,849 2,544 3,093 3,063

Non-operating income 2,067 1,965 340 340 340

Non-operating expense 2,762 518 342 318 254

Recurring profit 1,536 4,296 2,542 3,115 3,148

Pre-tax profit 1,536 4,296 2,542 3,115 3,148

Income taxes 273 1,115 660 808 817

Net profit 1,264 3,181 1,883 2,306 2,331

Balance sheet

Current assets 14,374 19,887 19,099 18,054 17,811

Cash & equivalents 2,283 4,380 4,289 4,274 4,220

Account receivables 4,178 6,080 5,641 5,118 5,053

Inventory 5,463 7,482 7,232 6,764 6,664

Others 2,450 1,945 1,938 1,898 1,874

Non-current assets 15,986 15,140 17,999 19,657 20,755

Investments 1,497 1,617 1,857 2,097 2,337

Tangible assets 11,847 10,171 12,791 14,208 15,066

Intangible assets 1,305 1,206 1,206 1,206 1,206

Total assets 30,360 35,027 37,099 37,710 38,565

Current liabilities 11,520 14,305 14,266 14,054 13,925

Account payables 4,175 7,189 7,162 7,016 6,927

Short-term borrowings 3,361 2,782 2,782 2,782 2,782

Current long-term debt 1,649 1,101 1,101 1,101 1,101

Others 2,336 3,233 3,221 3,155 3,115

Non-current liabilities 7,324 5,890 6,380 5,132 4,017

Bonds 3,299 4,970 5,464 4,233 3,130

Long-term debt 1,685 0 0 0 0

Others 2,340 920 916 898 888

Paid in capital 469 469 469 469 469

Capital surplus 5,873 5,886 5,886 5,886 5,886

Retained earnings 2,457 8,203 9,824 11,896 13,993

Others 2,718 275 275 275 275

Total shareholder's equity 11,516 14,832 16,453 18,525 20,622

Cash flow statement

Total operating cash flow 72 2,722 2,931 3,580 2,906

Total investing cash flow (682) 814 (1,999) (1,996) (1,497)

Capital expenditure (425) (1,192) (2,000) (2,000) (1,500)

Total financing cash flow 753 (2,085) (1,022) (1,599) (1,463)

Cash at beg. of period 2,105 2,283 4,380 4,289 4,274

Cash at end of period 2,283 4,380 4,289 4,274 4,220

Net increase in cash 177 2,097 (91) (15) (54)


03 July 2012

SK Innovation

(096770.KS / 096770 KS) 9

Appendix Technical details of lubricants

Lubricants

1. What is a lubricant?

A lubricant is a substance that reduces friction between moving surfaces. This has the

benefit of reducing friction and surface fatigue, together with reduced heat generation,

noise and vibration. The major application and most widely used form of lubricants is

motor oil, which protects internal combustion engines in motor vehicles and power

equipment. Automotive applications dominate, but others (i.e., industrial, marine, and

metal working applications) are also big consumers. Although air and other gas-based

lubricants are well-known, liquid lubricants are the most common. Typically lubricants

contain 90% base oil and less than 10% additives.

2. Applications: Automotive (takes up most of lubricants demand), Industrial, Aviation

and Marine.

Lubricants base oil

1. What is a lubricant base oil?

Base oil is the name given to lubrication grade oils initially produced from refining crude oil

(mineral base oil) or through chemical synthesis (synthetic base oil). Base oil is typically

defined as oil with a boiling point range between 550F and 1050F, consisting of

hydrocarbons with 18 to 40 carbon atoms. Base oil is the feedstock of lubricants, the final

product used by the end-customer.

2. History of lube base oil

The first catalytic dewaxing and wax hydroisomerisation technologies were

commercialised in the 1970s. Shell deployed a combination of hydroisomerisation and

solvent dewaxing to produce high V.I. feedstock. Exxon Mobil used catalytic dewaxing in

place of solvent dewaxing, but still used it with solvent extraction.

In 1984, Chevron was initiated on combining catalytic dewaxing with hydrocracking and

hydrofinishing. This was the first commercial demonstration of an all-hydroprocessing-

manufactured base oil.

In 1993, Chevron commercialised the first modern wax hydroisomerisation process. This

was an improvement over previous catalytic dewaxing since it lowered the pour point of

the base oil by isomerising (reshaping) the n-paraffins and other molocules with waxy side

chains into very desirable branched compounds with superior lubricating qualities rather

than cracking them away. This process is licensed by Chevron under the name

ISODEWAXING. More than 30% of the base oil manufactured in North America is

manufactured under the licence of this process. Another advantage of this process is the

greater range of crude oil flexibility and less reliance of a narrow range of crude oils from

which to make high-quality base oils. ExxonMobil has an all-hydroprocessed technology

called Mobil Selective Dewaxing (MSDW).

3. Differences among Group I, II, III base oils

The American Petroleum Institute (API) has developed a Base Oil Classification System

which classifies base oils into five major groups, from Group I to V. Each different group is

classified on the basis of different (1) percentage of saturates, (2) sulpher content and (3)

viscosity index. Below explains what each specification means to the end-user.

■ The higher the number of saturates, the higher molecular bond strength of the oil and

therefore the better the resistance to breakdown or loss of viscosity.

03 July 2012

SK Innovation

(096770.KS / 096770 KS) 10

■ The lower the sulphur content, the better the purity and thus the less the corrosive and

oxidation potential that exists.

■ Viscosity Index is an indication of the rate of change of viscosity against temperature,

and the higher the VI, the better. (Viscosity: Viscosity is an oil’s resistance to flow and

shear. It is the single most critical physical property of the oil as it affects both the wear

rate and the fuel efficiency, i.e. water is a low viscosity fluid; syrup is a high viscosity

fluid).

Group I

Group I base oil contains less than 90% saturates and/or greater than .03% sulphur and

has viscosity index greater than or equal to 80 and less than 120.

Group II

Group II base oil contains greater than or equal to 90% saturates and less than or equal

to .03% sulphur and has viscosity index greater than or equal to 80 and less than 120.

Group III

Group III base oil contains greater than or equal to 90% saturates and less than or equal

to .03% sulphur and has viscosity index greater than or equal to 120. From a process

standpoint, Group III oils are made by the same process as Group II oils, but the V.I. is

increased by increasing the temperature of the hydrocracker. The product V.I. can also be

increased by increasing the V.I. of the feedstock which is done by selecting the

appropriate crude. Advantages over Group I and II base oils are that it is fuel efficient, has

longer Drain intervals, is environmentally friendly and engine protective.

Figure 23: Different specifications of base oil

API category Viscosity Index Saturates (%) Sulphur (%)

Group I 80-120 <90 >0.03

Group II 80-120 >90 <0.03

Group III 120+ >90 <0.03

Group IV PAO

Group V All others

Source: American Petroleum Institute (API)

Figure 24: Base oil manufacturing process

Source: Yubase

03 July 2012

SK Innovation

(096770.KS / 096770 KS) 11

Companies Mentioned (Price as of 02 Jul 12)

Chevron Corp. (CVX, $105.86, OUTPERFORM, TP $130.00) China Petroleum & Chemical Corporation - H (0386.HK, HK$6.88, NEUTRAL, TP HK$7.05) ConocoPhillips (COP, $55.73, NEUTRAL, TP $67.00) ExxonMobil Corporation (XOM, $85.34, NEUTRAL, TP $91.00) Formosa Plastics (1301.TW, NT$80.20, NEUTRAL, TP NT$94.20) Petronas Chemicals Group BHD (PCGB.KL, RM6.42, NEUTRAL, TP RM6.80) Royal Dutch Shell plc (RDSa.L, 2160 p, NEUTRAL, TP 2,530.00 p) SK Innovation (096770.KS, W141,500, OUTPERFORM [V], TP W210,000) S-Oil Corp (010950.KS, W93,100, OUTPERFORM, TP W140,000) Total (TOT.N, $45.50, NEUTRAL, TP $57.00)

Disclosure Appendix Important Global Disclosures

A-Hyung Cho & Jihong Choi each certify, with respect to the companies or securities that he or she analyzes, that (1) the views expressed in this report accurately reflect his or her personal views about all of the subject companies and securities and (2) no part of his or her compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report.

See the Companies Mentioned section for full company names.

3-Year Price, Target Price and Rating Change History Chart for CVX

CVX Closing

Price

Target

Price

Initiation/

Date (US$) (US$) Rating Assumption

7/31/09 69.47 70

9/17/09 71.97 80 O

11/3/09 76.7 86

12/3/09 X

4/14/10 80.58 93 X

9/17/10 78.43 96

12/14/10 88.38 103

3/17/11 102.24 130

70

80

86

9396

103

130

12/3/09 4/14/10

O

61

71

81

91

101

111

121

131

Closing Price Target Price Initiation/Assumption Rating

US$

O=Outperform; N=Neutral; U=Underperform; R=Restricted; NR=Not Rated; NC=Not Covered

3-Year Price, Target Price and Rating Change History Chart for 0386.HK

0386.HK Closing

Price

Target

Price

Initiation/

Date (HK$) (HK$) Rating Assumption

16-Jul-09 6.26 6.39

20-Aug-09 6.9 7.16

25-Aug-09 7.12 7.5

4-Mar-10 6.09 6.9 O

30-Mar-10 6.35 7

19-Apr-10 6.35 7.7

22-Sep-10 6.67 7.1

14-Oct-10 7.46 8.2

14-Dec-10 7.45 8.34

18-Feb-11 8.54 R

18-Mar-11 7.47 8.5 O

29-Mar-11 7.7 8.8

4-Oct-11 7.54 8.5 N X

1-Nov-11 7.36 8.4

9-Jan-12 8.9 8.9

23-Feb-12 8.8 9.3

27-Mar-12 8.84 9

13-Apr-12 8.31 7.05 U

30-May-12 7.05 N

6

78

7 7

8

7

8 8 99

9 8

99

9

7

4-Oct-11

O

R

O N

U

N

5

6

7

8

9

10

11


HK$


03 July 2012

SK Innovation

(096770.KS / 096770 KS) 12

3-Year Price, Target Price and Rating Change History Chart for COP

COP Closing

Price

Target

Price

Initiation/


10/7/09 49.7 47

11/3/09 50.75 50

12/3/09 X

3/25/10 51.53 60

4/14/10 56.89 68 O X

9/17/10 55.27 66

10/20/10 61.27 69

12/14/10 65.65 71

1/27/11 69.39 80

3/17/11 76.72 90

3/24/11 79.7 93

9/9/11 64.23 R

5/9/12 53.47 67 N

4750

60

6866

6971

80

9093

67

12/3/09 4/14/10

O

R

N

39

49

59

69

79

89


US$


3-Year Price, Target Price and Rating Change History Chart for XOM

XOM Closing

Price

Target

Price

Initiation/


11/3/09 71.74 70

12/3/09 X

3/11/10 67.22 72

4/14/10 68.61 75 X

7/12/10 58.94 71

10/28/10 66.22 74

12/14/10 72.18 76

2/1/11 83.91 84

3/17/11 81.16 95

3/9/12 84.3 91

7072

75

71

7476

84

95

91

12/3/09 4/14/1056

61

66

71

76

81

86

91

96


US$


3-Year Price, Target Price and Rating Change History Chart for 1301.TW

1301.TW Closing

Price

Target

Price

Initiation/

Date (NT$) (NT$) Rating Assumption

28-Aug-09 60.5 44.5

30-Oct-09 63.2 54.5

30-Mar-10 70.7 62

8-Nov-10 94.5 91.1 N X

15-Feb-11 100 104.2

3-Aug-11 94.1 100.2

18-Nov-11 80.3 94.2

26-Jun-12 X

45

55

62

91

104100

94

8-Nov-10 26-Jun-12

N

44

54

64

74

84

94

104

114


NT$


03 July 2012

SK Innovation

(096770.KS / 096770 KS) 13

3-Year Price, Target Price and Rating Change History Chart for PCGB.KL

PCGB.KL Closing

Price

Target

Price

Initiation/

Date (RM) (RM) Rating Assumption

16-Feb-11 6.1 7.5 O X

5-Apr-11 7.47 8.5

29-Aug-11 6.03 6.8 N

8

9

7

16-Feb-11

O N

5

6

6

7

7

8

8

9

9

10

10


RM


3-Year Price, Target Price and Rating Change History Chart for RDSa.L

RDSa.L Closing

Price

Target

Price

Initiation/

Date (p) (p) Rating Assumption

2-Nov-09 1,812.5 1650 N

19-Feb-10 1,791.5 1790

15-Apr-10 1,992.5 1900

11-May-10 X

22-Jun-10 1,843.5 1990

6-Aug-10 1796 2045

14-Dec-10 2,089.5 2400

31-Jan-11 2,198.5 2560 O

17-Mar-11 2131 2780

15-Dec-11 2264 2750

6-Feb-12 2257 2600 N

13-Apr-12 2117 2530

1650

1790

19001990

2045

2400

2560

2780 2750

26002530

11-May-10

N

ON

1437

1637

1837

2037

2237

2437

2637


p


3-Year Price, Target Price and Rating Change History Chart for 096770.KS

096770.KS Closing

Price

Target

Price

Initiation/

Date (W) (W) Rating Assumption

29-Sep-09 131500 165000 O

22-Apr-10 125000 181000

14-Oct-10 151000 175000

21-Jan-11 182500 220000

18-Mar-11 209500 245000

2-May-11 232500 300000

20-Sep-11 166500 275000

5-Jun-12 129000 210000

165000

181000175000

220000

245000

300000

275000

210000

O

93000

143000

193000

243000

293000


W


03 July 2012

SK Innovation

(096770.KS / 096770 KS) 14

3-Year Price, Target Price and Rating Change History Chart for 010950.KS

010950.KS Closing

Price

Target

Price

Initiation/

Date (W) (W) Rating Assumption

23-Oct-09 59000 65000 N

2-Aug-10 56800 71000 O

22-Nov-10 77000 90000

5-Jan-11 87300 110000

28-Jan-11 112000 130000

2-May-11 153000 190000

27-Oct-11 121000 170000

27-Apr-12 99300 150000

5-Jun-12 88600 140000

6500071000

90000

110000

130000

190000

170000

150000

140000

N O49150

69150

89150

109150

129150

149150

169150

189150


W


3-Year Price, Target Price and Rating Change History Chart for TOT.N

TOT.N Closing

Price

Target

Price

Initiation/


9/3/09 56.48 45.176

9/17/09 60.85 53.39 N

10/6/09 59 54.888

11/3/09 60.8 55.591

1/20/10 63 55.064

4/15/10 59.41 55.761

5/11/10 X

6/22/10 48.42 58.5

10/15/10 54.88 55.25

12/14/10 53.79 61

3/17/11 57.02 68.5

4/18/11 58.09 65 U

9/21/11 43.14 N

12/15/11 47.86 61

4/13/12 47.77 58

4/27/12 48.37 57

45

5355 56 55 56

59

55

61

69

65

61

5857

5/11/10

N

U

N

41

46

51

56

61

66


US$


The analyst(s) responsible for preparing this research report received compensation that is based upon various factors including Credit Suisse's total revenues, a portion of which are generated by Credit Suisse's investment banking activities.

Analysts’ stock ratings are defined as follows: Outperform (O): The stock’s total return is expected to outperform the relevant benchmark* by at least 10-15% (or more, depending on perceived risk) over the next 12 months. Neutral (N): The stock’s total return is expected to be in line with the relevant benchmark* (range of ±10-15%) over the next 12 months. Underperform (U): The stock’s total return is expected to underperform the relevant benchmark* by 10-15% or more over the next 12 months. *Relevant benchmark by region: As of 29th May 2009, Australia, New Zealand, U.S. and Canadian ratings are based on (1) a stock’s absolute total return potential to its current share price and (2) the relative attractiveness of a stock’s total return potential within an analyst’s coverage universe**, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. Some U.S. and Canadian ratings may fall outside the absolute total return ranges defined above, depending on market conditions and industry factors. For Latin American, Japanese, and non-Japan Asia stocks, ratings are based on a stock’s total return relative to the average total return of the relevant country or regional benchmark; for European stocks, ratings are based on a stock’s total return relative to the analyst's coverage universe**. For Australian and New Zealand stocks, 12-month rolling yield is incorporated in the absolute total return calculation and a 15% and a 7.5% threshold replace the 10-15% level in the Outperform and Underperform stock rating definitions, respectively. The 15% and 7.5% thresholds replace the +10-15% and -10-15% levels in the Neutral stock rating definition, respectively. **An analyst's coverage universe consists of all companies covered by the analyst within the relevant sector. Restricted (R): In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications, including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other circumstances.

Volatility Indicator [V]: A stock is defined as volatile if the stock price has moved up or down by 20% or more in a month in at least 8 of the past 24 months or the analyst expects significant volatility going forward.

03 July 2012

SK Innovation

(096770.KS / 096770 KS) 15

Analysts’ coverage universe weightings are distinct from analysts’ stock ratings and are based on the expected performance of an analyst’s coverage universe* versus the relevant broad market benchmark**: Overweight: Industry expected to outperform the relevant broad market benchmark over the next 12 months. Market Weight: Industry expected to perform in-line with the relevant broad market benchmark over the next 12 months. Underweight: Industry expected to underperform the relevant broad market benchmark over the next 12 months. *An analyst’s coverage universe consists of all companies covered by the analyst within the relevant sector. **The broad market benchmark is based on the expected return of the local market index (e.g., the S&P 500 in the U.S.) over the next 12 months.

Credit Suisse’s distribution of stock ratings (and banking clients) is:

Global Ratings Distribution Outperform/Buy* 48% (59% banking clients) Neutral/Hold* 41% (57% banking clients) Underperform/Sell* 9% (51% banking clients) Restricted 2%

*For purposes of the NYSE and NASD ratings distribution disclosure requirements, our stock ratings of Outperform, Neutral, and Underperform most closely correspond to Buy, Hold, and Sell, respectively; however, the meanings are not the same, as our stock ratings are determined on a relative basis. (Please refer to definitions above.) An investor's decision to buy or sell a security should be based on investment objectives, current holdings, and other individual factors.

Credit Suisse’s policy is to update research reports as it deems appropriate, based on developments with the subject company, the sector or the market that may have a material impact on the research views or opinions stated herein.

Credit Suisse's policy is only to publish investment research that is impartial, independent, clear, fair and not misleading. For more detail please refer to Credit Suisse's Policies for Managing Conflicts of Interest in connection with Investment Research: http://www.csfb.com/research-and-analytics/disclaimer/managing_conflicts_disclaimer.html

Credit Suisse does not provide any tax advice. Any statement herein regarding any US federal tax is not intended or written to be used, and cannot be used, by any taxpayer for the purposes of avoiding any penalties.

See the Companies Mentioned section for full company names. Price Target: (12 months) for (CVX) Method: We determine our $130 target price for CVX based on the EVA (Economic Value Added) fair value model, using expected long-term returns on gross invested capital (ROGIC), supported by cash flow multiple comparisons. Our returns analysis is based on our long-term crude forecast of $80/bbl and long-term crack spreads of $7.00/bbl. We estimate 2011 ROGIC to be 10.7%. Our $130 target price is 5.1x 2011 EV/EBIDAX (enterprise value/earnings before interest, depreciation, amortization, and exploration expense), which is below the peer group. Risks: Risks to our $130 target price for CVX are, in the short term: geopolitical risk, as the company operates in diverse countries; natural disasters (i.e., hurricanes); and in the long term: cost pressure from rising labor and raw material costs, volatile oil & natural gas prices, refining and marketing margins, opportunities. Price Target: (12 months) for (0386.HK) Method: Our target price of HK$7.05/share for Sinopec (China Petroleum & Chemical Corp) is based on our Sum of the Parts (SoTP) valuation. We use field-by-field run-out DCFs to value Sinopec's existing upstream businesses, valuing it at HK$7.85/share at a US$97/bbl long-term oil price assumption - without any blue-sky production growth assumptions. We value Sinopec's downstream businesses using conservative comparable multiples - Refining & Marketing business is valued at 3.3x EV/EBITDA, and Chemicals business at 6x EV/EBITDA. Risks: The primary risks to our target price of HK$7.05/share for Sinopec (China Petroleum & Chemical Corp) is is that crude prices continue to move up and beyond US$120/bbl thereby incurring significant refining losses. The political uncertainty in the Middle East, concerns on Europe debt crisis and global economic recovery also poses risks to overall equity market. Price Target: (12 months) for (COP) Method: Our target price of $67 is derived by taking the current PD Plus NAV ($74/sh) and assigning a 10% discount to account for execution risk and the overspending of cashflow in the near term. Risks: Risks to our $67 target price for ConocoPhillips include: Short-term: Financial leverage, earnings volatility, commodity market volatility, Storm and other enviromental damages; Long-term: returns, oil & natural gas prices, refining margins. More specific to COP, we are relying on continued successful asset sales and the ability of the company to grow production and generate cash flow sufficient to support the significant planned capital program - weak execution and failure to close the current funding gap could have an impact on valuation. Price Target: (12 months) for (XOM) Method: Our $91 target price for XOM is based on the EVA (Economic Value Added) discounted cash flows method using expected long-term returns on gross invested capital. Our primary long-term assumptions are: $90/bbl oil price, $6.50/mcf gas price, and a $7.50/bbl Gulf Coast refining margins. Our $91 price target implies a 2012E EV/EBIDAX (enterprise value/earnings before interest, depreciation, amortization and exploration) of 7.7x, which is above the peer group. Risks: Risks to XOM's $91 target price incude: short-term: commodities volatility; emerging market political tensions; long-term: returns; oil & natural gas prices; and refining margins. As XOM is the largest private oil company in the world with diversified operations both geographically and across various segments of energy, limited growth is a risk, based on its size. Price Target: (12 months) for (1301.TW) Method: Our 12-month target price of NT$94.2 for Formosa Plastics is based on 2.2x 12E P/B, which is a middle cycle average from 2001-2010. Its historical PB high/low sits at 4.4x/1x. Our valuation is justified given its ROE of 13.4% in 2012E.

03 July 2012

SK Innovation

(096770.KS / 096770 KS) 16

Risks: Risks to our 12-month target price of NT$94.2 for Formosa Plastics are on the downside of petrochemical sector, supply shock and value decline of its long term investments, including Formosa Petrochemical (6505 TT), Formosa Chemical & Fiber (1326 TT) and Nan Ya plastics (1303 TT). Price Target: (12 months) for (PCGB.KL) Method: We set our target price at RM6.80/sh based on P/B of 2.5x, reflecting the valuation premium of Bursa Malaysia against the Stock Exchange of Thailand (SET) of 11% on EV/EBITDA. The premium reflects higher liquidity in domestic market in Malaysia, which explained the valuation premium of Bursa Malaysia against other markets in ASEAN Risks: Risks to our target price of RM6.80/sh are 1) ethan price renegotiation with Petronas Group companies 2) Avaliability of gas supply with Petronas 3) Appreciation of Malaysian Ringgit as PCG's revenue and major part of its costs are denominated in US$, 4) Flucturation in oil price and petrochemical margins, and 5) Unscheduled shutdown of plants from unforseenable events Price Target: (12 months) for (RDSa.L) Method: We value the company on a combination of 2013e P/E and EV/CF multiples (30% weighting each), a SOTP running a Net Asset Value of 2P reserves (20%) and a DCF (20%). Our TP is 2530 GBp. Risks: Risks to our TP: Short-term: commodity prices; Long-term: returns, oil & natural gas prices, refining margins. RDS is investing a lot of its capital on long-term gas projects to try to increase its reserve life. The future price of natural gas could impact the success/profitability of these projects. Price Target: (12 months) for (096770.KS) Method: Our target price of W210,000 is based on the mid-cycle valuation multiple of 1X of 2013E P/B. Risks: Risks for to our target price of W210,000 for SK Innovation are: (1) slowdown in global economy, (2) government pressure on retail oil product price. Price Target: (12 months) for (010950.KS) Method: Our target price of W140,000 is based on mid-cycle average of 2.3x forward P/B. Risks: S-Oil is a pure refiner, exposed to the regional refining industry dynamics. Risks to our target price of W140,000 are: (1) slower pick up in global demand, (2) disappointment in dividend and (3) volatile and weak KRW relative to USD given its leverage in USD-based liabilities. Price Target: (12 months) for (TOT.N) Method: We use a combination of Credit Suisse HOLT, and multiples such as EV/EBIDA, EV/EBITDA, P/CF and P/E. In addition, we use other tools such as the Credit Suisse Sum of the Parts tool Risks: Short term: earnings volatility, general market volatility, fx and country risk; Long term: returns, oil and natural gas prices, refining margins,

Please refer to the firm's disclosure website at www.credit-suisse.com/researchdisclosures for the definitions of abbreviations typically used in the target price method and risk sections.

See the Companies Mentioned section for full company names. The subject company (096770.KS, XOM, CVX, TOT.N, COP, 1301.TW, RDSa.L, 0386.HK) currently is, or was during the 12-month period preceding the date of distribution of this report, a client of Credit Suisse. Credit Suisse provided investment banking services to the subject company (096770.KS, XOM, CVX, TOT.N, COP, 1301.TW, RDSa.L, 0386.HK) within the past 12 months. Credit Suisse provided non-investment banking services, which may include Sales and Trading services, to the subject company (XOM, COP) within the past 12 months. Credit Suisse has managed or co-managed a public offering of securities for the subject company (TOT.N, COP, 0386.HK) within the past 12 months. Credit Suisse has received investment banking related compensation from the subject company (096770.KS, XOM, CVX, TOT.N, COP, 0386.HK) within the past 12 months. Credit Suisse expects to receive or intends to seek investment banking related compensation from the subject company (096770.KS, XOM, CVX, TOT.N, 010950.KS, COP, 1301.TW, RDSa.L, 0386.HK) within the next 3 months. Credit Suisse has received compensation for products and services other than investment banking services from the subject company (XOM, COP) within the past 12 months. As of the date of this report, Credit Suisse Securities (USA) LLC makes a market in the securities of the subject company (XOM, CVX, TOT.N, COP). As of the end of the preceding month, Credit Suisse beneficially owned 1% or more of a class of common equity securities of (010950.KS, 0386.HK). This holding is calculated according to U.S. regulatory requirements which are based on Section 13(d) of the Securities and Exchange Act of 1934.

Important Regional Disclosures

Singapore recipients should contact a Singapore financial adviser for any matters arising from this research report.

The analyst(s) involved in the preparation of this report have not visited the material operations of the subject company (CVX, 0386.HK, COP, XOM, 1301.TW, PCGB.KL, RDSa.L, 096770.KS, 010950.KS, TOT.N) within the past 12 months.

Restrictions on certain Canadian securities are indicated by the following abbreviations: NVS--Non-Voting shares; RVS--Restricted Voting Shares; SVS--Subordinate Voting Shares. Individuals receiving this report from a Canadian investment dealer that is not affiliated with Credit Suisse should be advised that this report may not contain regulatory disclosures the non-affiliated Canadian investment dealer would be required to make if this were its own report. For Credit Suisse Securities (Canada), Inc.'s policies and procedures regarding the dissemination of equity research, please visit http://www.csfb.com/legal_terms/canada_research_policy.shtml.

The following disclosed European company/ies have estimates that comply with IFRS: XOM, RDSa.L.

03 July 2012

SK Innovation

(096770.KS / 096770 KS) 17

As of the date of this report, Credit Suisse acts as a market maker or liquidity provider in the equities securities that are the subject of this report.

Principal is not guaranteed in the case of equities because equity prices are variable.

Commission is the commission rate or the amount agreed with a customer when setting up an account or at anytime after that. Taiwanese Disclosures: This research report is for reference only. Investors should carefully consider their own investment risk. Investment results are the responsibility of the individual investor. Reports may not be reprinted without permission of CS. Reports written by Taiwan-based analysts on non-Taiwan listed companies are not considered recommendations to buy or sell securities under Taiwan Stock Exchange Operational Regulations Governing Securities Firms Recommending Trades in Securities to Customers.

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03 July 2012

Asia Pacific/South Korea

Equity Research

OG0440-new2.doc

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