China Aviation Oil - RHB Invest 2021-05-05: Beneficiary Of Recovery In Aviation Traffic

CHINA AVIATION OIL(S) CORP LTD (SGX:G92)

China Aviation Oil - Beneficiary Of Recovery In Aviation Traffic

China Aviation Oil is proxy to strong rebound in domestic aviation traffic in China;
To gain from recovery in international aviation traffic into China;
~20% profit CAGR for the next two years;
Strong net cash balance sheet (36% of the market cap);
10.8x 2021F P/E is below peers and implies only 0.5x 2021F PEG;
Compelling ex-cash 6.9x 2021F P/E.

China Aviation Oil (SGX:G92) supplies jet fuel to foreign and domestic airlines flying through China’s airports. It also has a strong and growing presence at key international aviation hubs in Hong Kong SAR, Los Angeles and London. The company also trades in other oil products, such as fuel oil and gas oil. Its state-owned parent is Asia-Pacific’s largest physical jet fuel trader, and sole supplier of imported jet fuel for China’s civil aviation market.

While domestic aviation traffic in China had improved signifincatly from a trough hit during the COVID-19 outbreak last year, it did witness a m-o-m decline in February after the Chinese Government put the brakes on local travel during the Lunar New Year holiday period to curtail the rise in domestic COVID-19 cases. We believe that the normalisation of domestic aviation traffic – once travel restrictions placed for the Lunar New Year period are lifted – could be a near-term catalyst.
We remain optimistic of a sustained domestic air traffic recovery in China for the rest of 2021. The ongoing inoculation drive in China and the rest of Asia should create opportunities for the resumption of international passenger traffic as well. We are forecasting a 20% rebound in jet fuel supply and trading volume in 2021, to mirror the expected recovery in China’s domestic and international aviation traffic for the year.

SPIA, China Aviation Oil’s 33%-owned associate, remains the exclusive refueller at Shanghai Pudong International Airport (SPA). While domestic flight traffic at SPA has recovered sharply, jet fuel volume has not increased proportionately, as domestic flights require lower fuel load compared to international flights. Given SPIA’s high operating leverage, its profitability should improve materially once the recovery in international flight traffic kicks in during the latter part of 2021.

Normally, 10% of China Aviation Oil’s trading volumes are based on paper (financial market) trades. To take advantage of the contango market, the proportion of paper trading volume was increased to 20% in 2020. China Aviation Oil reiterated that despite the increase in paper trading volume, all of its trades were backed by confirmed orders.
While it remains sanguine on the trading business in 2021 – on the back of improving aviation traffic – we believe margins may remain subdued, as the oil market currently is in backwardation. Based on our estimates, China Aviation Oil has not reported a loss on its trading business since 4Q15. We expect this segment to remain profitable during the forecast period.

Latest results. In FY20, amid the COVID-19 pandemic, China Aviation Oil’s revenue decreased 48.3% y-o-y to US$10.5bn due mainly to the decrease in oil prices as well as total supply and trading volumes. Contribution from its associate business was also weak amidst a y-o-y decline in earnings contribution from SPIA. The group, however, remained profitable and reported a net profit of US$56.2m (down 43.7% y-o-y). While the change in cash was negative, China Aviation Oil still reported a healthy net cash balance of US$269m, which accounts for 36% of its market cap.
Dividend. For FY20, China Aviation Oil announced a tax-exempt dividend amount of 2.58 cents per share vs 4.70 cents per share dividend paid in FY19. This implies a dividend yield of 2.2%. Given expectations to profit recovery over the next two years, we expect dividend payments to gradually revert back to pre-pandemic levels over the forecast period.
Management. After going through a troubled phase in 2004-2005, China Aviation Oil’s parent company completely revamped the management team and brought in global oil major, BP, as a strategic investor. This management team turned around the business operations and brought back strong profit growth. However, there have been some changes in the management team – a new CEO taking over in with a clear focus on achieving profitability over registering volume growth, and growing the group’s external business.

We expect China’s domestic aviation traffic to rebound strongly, once domestic travel restrictions – in effect over the Lunar New Year holidays – are eased. Meanwhile, ongoing COVID-19 vaccination drives in Asia should translate to a gradual recovery in international aviation traffic over 2H21. This should drive the
~20% pa profit growth over next two years. China Aviation Oil is likely to also use its cash to make an earnings accretive acquisition overseas or in China, should an opportunity arise. Its current valuation, at 0.5x 2021F PEG, remains compelling.
We maintain our BUY recommendation on China Aviation Oil, with a S$1.30 target price derived from an average of forward P/E, P/BV, EV/adjusted EBITDA, and DCF of adjusted free cash flow. Our S$1.30 target price implies 12.1x 2021F P/E, which is in line with its peer valuation.
See
Key downside risks. Lack of rebound in China’s domestic aviation traffic due to the resurgence of COVID-19 infections, and delays in the recovery in international aviation traffic.
China Aviation Oil (SGX:G92) is one of the Top Singapore Small Cap Companies highlighted in RHB's 20 Jewels 2021 Edition.

Shekhar Jaiswal RHB Securities Research | https://www.rhbinvest.com.sg/ 2021-05-05

SGX Stock Analyst Report BUY MAINTAIN BUY 1.30 SAME 1.30