China Aviation Oil - UOB Kay Hian 2016-06-10: Postcard From Taipei

China Aviation Oil - UOB Kay Hian 2016-06-10: Postcard From Taipei CHINA AVIATION OIL(S) CORP LTD G92.SI 

China Aviation Oil Singapore Corp (CAO SP) - Postcard From Taipei

  • CAO’s Taipei NDR enjoyed strong investor interest. The group is well placed to benefit from China’s global aviation traffic boom given its monopoly over China’s jet fuel imports. 
  • Maintain BUY with a DCF-based target of S$1.56.



WHAT’S NEW

  • We hosted the senior management of China Aviation Oil (CAO) to a non-deal roadshow in Taipei on 7 and 8 June. This report highlights the key takeaways and updates following the trip.


INVESTMENT HIGHLIGHTS


Enjoying keen interest. 

  • CAO’s Taipei NDR was well attended. Investors were re- acquainted with this well-run SOE that has a solid business model with strong cash flow. 
  • Investors were also impressed with CAO’s good corporate governance and risk management practices, which have been put in place by its strategic shareholder, BP Investments
  • BP currently has a 20.2% stake in CAO, and two board members are from BP while its COO was previously from BP.

Impressive corporate governance and risk management. 

  • Management highlighted its commitment to these two key areas through examples such as various awards for corporate governance, information transparency (various best annual report awards, investor relations award) as well as its dividend policy (since 2015) of paying 30% of net profit as dividends. 
  • In terms of risk management, it has a strict framework where the head of risk management reports to a risk committee, which comprises directors from BP, an independent director as well as from its parent company China National Aviation Fuel (CNAF) group. As an indication of its risk profile, its 2015 average daily value at risk is only US$0.6m. Comparing this to its revenue, the value at risk is one-tenth of CAO’s oil- trading peers.

Growing source of recurring income from monopoly over China jet fuel imports. 

  • Thanks to its state-owned parent, CAO is the sole supplier of imported jet fuel for China’s civil aviation industry. The fixed fee on a cost-plus model charged to supply jet fuel to China is a solid source of recurring income for CAO which will grow in tandem with the boom in China’s global aviation traffic (estimated growth at 7-8% p.a.). We estimate this would account for 18.7% of 2016 operating profit.

Another stream of recurring income comes from associate. 

  • The “crown jewel” of CAO’s investments is its 33% stake in the exclusive jet fuel refueller for Shanghai Pudong International Airport (SPIA). This second recurring income stream is also expected to grow on the back of increased passenger traffic and covers 58.1% of 2016 operating profit. 
  • Investors were also excited as a catalyst on the horizon is Shanghai Disneyland’s opening (in June) which is expected to significantly increase traffic at SPIA. Looking further ahead, a potential second catalyst pertains to China’s aim to grow its general aviation industry to Rmb1t. This is expected to boost demand for imported jet fuel and benefit CAO, albeit in the longer term.

Five-year plan to double profits through organic growth and M&A acquisitions. 

  • Management targets to double profits to US$120m by 2020 through both organic (as it establishes itself overseas in Europe and the US) and M&A growth. They intend to deploy its war chest of US$228m (S$319m) in net cash (around 37% of its market cap) to acquire more synergistic fuel-related assets. 
  • Depending on the size of the M&A, we believe CAO is likely to fund the M&A via bonds or bank borrowings given its unencumbered balance sheet.

Further cost reduction and arbitrage opportunities from critical mass. 

  • CAO’s supply and trading volume has been steadily increasing and we believe that once CAO hits the next level of critical mass, its market access and sheer scale will bring about greater benefits such as cost optimisation in key areas like transportation and freight. New arbitrage trading opportunities will also become available.


VALUATION/RECOMMENDATION


Maintain BUY with S$1.56 target price. 

  • Our target price is based on a DCF model with 9.5% WACC and 0% terminal growth) with 33% upside to current price levels, even after its recent surge. 
  • The target price implies a reasonable 2017F PE of 12.0x and P/B of 1.4x, which compares with its global peers’ average of 14x.

Share price catalysts. 

  • In our view, potential share price catalysts include: 
    1. better-than- expected 2016/17 earnings, and 
    2. accretive or strategic M&As that could propel its earnings growth trajectory to the next level.




Edison Chen UOB Kay Hian | Andrew Chow UOB Kay Hian | http://research.uobkayhian.com/ 2016-06-10
UOB Kay Hian SGX Stock Analyst Report BUY Maintain BUY 1.56 Same 1.56


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