China Aviation Oil - RHB Invest 2018-11-02: Moving Into Slow Earnings Growth Phase


China Aviation Oil - Moving Into Slow Earnings Growth Phase

  • We downgrade China Aviation Oil to NEUTRAL, from Buy, with SGD1.50 Target Price from SGD1.75 to imply 9% upside, following a weak 3Q18 results.
  • The expected decline in trading volumes for jet fuel and other oil products, along with a likelihood of slower growth in jet fuel supply and elevated operating cost at SPIA, should keep China Aviation Oil’s earnings growth in check during the forecast period.
  • While its FY18F 4% dividend yield and strong net cash balance sheet should limit the downside to share price, we note that its specialist M&A team has failed to deliver a large earnings-accretive acquisition in last one year.
  • We remove China Aviation Oil from Singapore’s Top BUY list.

3Q18 profits fell.

  • China Aviation Oil’s 3Q18 profit of USD18.9m was 17% below our estimate and marked a decrease of 12% y-o-y and 35% q-o-q. This decline was driven by lower volumes for middle distillates (-1% y-o-y), lower trading of other oil products (-35% y-o-y), lower jet fuel supply volume at SPIA and unfavourable forex movements.

Y-o-y higher gross profit is misleading.

  • China Aviation Oil reported 156% y-o-y increase in gross profit to USD11.1m, on a sharp rise in profits from trading of other oil products. However, this increase in trading profits also came with a higher working capital requirement and, hence, higher financing costs.
  • It is guiding for a sharp decline in trading volume for other oil products, especially crude oil, from 4Q18 as it realigns its focus away from this high-cost operation.

Shanghai Pudong International Airport Aviation Fuel Supply Company (SPIA) profit declines for second consecutive quarter.

  • SPIA, a 33%-owned associate of China Aviation Oil that offers aircraft refuelling services at Shanghai Airport, witnessed a 2.3% y-o-y decline in volume despite commencement of operations at Shanghai airport’s fifth runway. Its earnings contribution dropped 12.6% y-o-y during 3Q18.
  • This weakness was due to unfavourable forex changes and higher operating costs. SPIA is likely to experience elevated operating costs in the near term, with volume growth likely to remain below earlier expectation.

CAO could be moving past peak growth.

  • Declining volumes for crude oil and jet fuel trading, slower-than-expected growth in jet fuel supply to Chinese aviation market and cost pressures at SPIA could lead to lower earnings growth for China Aviation Oil over the forecast period.
  • We lower FY18-20 profit estimates by 3-8%.

Lowering target multiples.

  • China Aviation Oil should not see a significant expansion in valuation multiples as profit growth declines over the forecast period. We lower target P/E, P/BV and EV/EBITDA multiples to 10.0x, 1.2x and 9.0x, from 12.0x, 1.4x and 10.5x. We also pare down long-term growth used in our DCF calculation to 1% from 2%.
  • Our SGD1.50 Target Price implies 7.0x ex-cash 2019 P/E. Based on estimated growth of 5.3%, this implies 1.3x 2019 PEG.

Key risks.

  • We believe a strong balance sheet with cash accounting for 28% of its market cap and +4% dividend yield should provide downside protection to China Aviation Oil’s share price.
  • Upside surprise could come from earnings accretive acquisition, favourable FX movement and higher jet fuel volumes at SPIA.

Shekhar Jaiswal RHB Securities Research | https://www.rhbinvest.com.sg/ 2018-11-02
SGX Stock Analyst Report NEUTRAL DOWNGRADE BUY 1.50 DOWN 1.750