SINGAPORE (Mar 20): RHB has upgraded China Aviation Oil (CAO) to "buy" from "neutral" convinced of the group's return to earnings growth in 2018 after a meeting with management.
Growth would be aided by strong contribution from Shanghai Pudong International Airport Aviation Fuel Supply Company (SPIA), the supply of jet fuel into Chinese aviation traffic and a more rationalised approach on the trading business.
According to analyst Shekhar Jaiswal in a Tuesday report, volumes for supply and trading of jet fuel grew at 8% in 2017. With continuing strong growth in Chinese aviation traffic along with increased contribution from supply of jet fuel to global airports, Jaiswal says 8-9% y-o-y growth in jet fuel trading and supply volumes is sustainable during the forecast period.
Although CAO could witness some decline in gasoil trading from 2018 due to recent management changes and the revised strategy for its trading business, Jaiswal says this may be positive for CAO as his financial model suggests that gasoil trading most likely led to lower profitability for the middle distillates business in 2017.
"While we forecast a 15-20% decline in gasoil trading in 2018-2019, we have not imputed any improvement in profitability for this business segment yet," says the analyst.
Meanwhile, CAO’s stake in SPIA is almost equal to its own market capitalisation. SPIA, a 33% owned associate of CAO, offers aircraft refuelling services at Shanghai Airport.
SPIA’s contribution to CAO has increased to US$64 million in 2017 from US$10 million in 2008. With upcoming capacity expansion at the Shanghai Airport, SPIA’s earnings could grow 13-15% during 2018-2019.
Jaiswal says SPIA’s business model is similar to Bangkok Aviation Fuel Services Pcl (BAFS) which is listed on the Thai stock exchange and is currently trading at 24 times earnings.
Even at a 30% discount to BAFS’ valuation, CAO’s equity stake in SPIA could be worth US$995 million as compared to its current market cap of US$1 billion.
As for the likelihood of an M&A activity during 2H18 or early 2019, Jaiswal warns that CAO may have to raise capital soon with only US$180 million of net cash on the balance sheet.
This is because the jet fuel trading and supply business outside China is well-developed and competitive in nature, any M&A would have to be large in size and would come at premium valuations. Factoring in the M&A, the analyst is increasing 2018-2019 earnings by 2-5%.
"Our revised target price of $1.80 implies a 12.2 times FY18 earnings. We expect EPS growth of 12% in 2018, implying a 2018 PEG of 1.0x, which we believe is fair," says Jaiswal.
As at 1pm, shares in CAO are up 1 cent at $1.55.