Initiate with BUY; E&P for free. We initiate SPC with a BUY rating and target price of S$2.95. Based on our free cash flow valuations, the current share price is close to the implied value for SPC's refining business segment alone. This implies that SPC's E&P business unit can theoretically be obtained for free. Buy on SPC's attractive valuation, healthy balance sheet, and potential upsides from new oil and gas discoveries.

Refining margins to average US$3.10/bbl in FY09. The Asian economic crisis resulted in weak Asian refining margins that averaged US$1.06/bbl over a sustained period in 1998-2001. We think this situation is unlikely to repeat. Refining margins have rebounded sharply to an average of US$6.60/bbl YTD from US$1/bbl in 2H08, due to refinery outages. We are not overly concerned with overcapacity, as start-ups have been pushed back and the breakeven costs of the new refineries are high. Hence, we are comfortable with our refining assumption of US$3.10/bbl in FY09.

Strong balance sheet can take more E&P acquisitions. SPC's Dec 08 balance sheet is clean with only short-term debts of S$574m (net gearing: 0.1x), for working capital. As E&P asset valuations become inexpensive, we believe SPC is well-positioned to acquire assets around the region. According to the management, SPC's comfortable capital structure is at 1x, which implies the capability to acquire assets valued up to S$1b. We are optimistic that SPC's E&P healthy operating cashflow at an average of S$350m/year is able to support the increased debt profile, if arises.

Attractive valuation. SPC is trading at 8.3x FY09F P/E, compared to refiners' peers of 8.4x and E&P players of 13.5x. While SPC's implied refining value of US$983/bopd is merely 3% lower than the average of US$1,013/bopd, SPC's E&P's implied EV/boe of US$7.80/boe is deeply undervalued, at a discount of 52% to its peers' US$16.30/boe. Hence, we think that the current share price has priced in weakening products demand amid this downturn, but has completely ignored E&P's potential.

Downside risks include 1.Worse-than-expected refining margins, 2.No new discoveries, 3.Slower-than-expected economic recovery.