Following a resurgence in Covid-19 cases worldwide, air traffic recovery is likely to take longer than expected. Consequently, RHB analyst Shekar Jaiswal has downgraded China Aviation Oil from “buy” to “neutral” with long-run demand for aviation fuel likely to stay low. He has indicated a lower target price of $0.95 from $1.25 with a 2% upside. 

“While China’s domestic aviation traffic continues to register MoM improvement, the resurgence of COVID-19 infections will push international traffic recovery to 2021. This would impact earnings for Shanghai Pudong International Airport Aviation Fuel Supply (SPIA), which accounted for 65% of China Aviation Oil’s 2019 PBT,” he remarks in a broker’s call today. SPIA is an associate of China Aviation Oil, which has a 33% stake in the organisation. 

The stock’s main source of earnings for the aviation fuel provider is instead likely to be driven by domestic air travel. Passenger numbers have improved m-o-m despite a y-o-y decline almost certain to take place from February 2020, when aviation passenger numbers fell from 50.6 million to 8.3 million in the space of a single month. July saw 36.9 million passengers within China as the government began to lift lockdown measures, reviving domestic air travel.   

The state of international air traffic has been less optimistic, however, with aircraft movement remaining unchanged since February at only around 7000 compared to the 17,000 monthly average in 2019. The average number of passengers per international flight at SPA in 2Q2020 was less than 10, suggesting near-term downside risks to international aircraft movements.

A silver lining, however, is the strong cash position of China Aviation Oil, which received US$59.7 million ($81.8 million) of dividend from SPIA in 1H2020 paid in arrears from earnings last year. It also saw positive FCF generation in 1H2020, allowing it to record a strong net cash position of US$406.7 million, or 70% of its market cap. With the firm’s parent state-owned enterprise China National Aviation Fuel looking to use China Aviation Oil to expand its international presence, the latter will likely use its large cash balance for accretive acquisition.

At present, China Aviation Oil is recording attractive valuations, with a price-to-earnings (P/E) ratio of 8.5 that is below the average of its peers. Better yet, this implies a P/E ratio of 0.3 in 2021. Yet the present weakness of the global aviation industry has increased downside risks for the stock, with Jaiswal hinting that investors should stay their hand. 

As at 1.43pm, China Aviation Oil is trading at $0.95 with a P/E ratio of 8.67. Dividend yield is attractive at 4.95%.