Analysts from DBS Group Research and RHB Group Research are turning neutral on China Aviation Oil (CAO) amid the uncertain outlook on the reopening of China’s international air travel.
DBS analyst Jason Sum has downgraded his recommendation on the counter to “hold” from “buy” as he sees that the delay in China’s reopening will be a drag on CAO’s earnings.
He has also lowered his target price estimate to 85 cents from $1.20 to reflect the negative earnings revisions and his less optimistic outlook.
The way he sees it, the sustained weaker demand for international air travel would negatively impact CAO’s earnings.
“CAO’s key associate, Shanghai Pudong International Airport Aviation Fuel Supply Company (SPIAAFSC), which typically accounts for more than half of its earnings, is highly dependent on international traffic. Hence, the sluggish relaxation of international border controls will likely impede SPIAAFSC’s earnings recovery,” writes Sum, who has slashed his net profit estimates for the FY2022 by 41%.
“We are slashing our FY2022 net profit estimate by 41% to account for… a 10% decline in gross profit per tonne in FY2022 as we now expect crude oil prices to stay backwardated for some time, given how tight the market is at the current juncture, especially with geopolitical tensions over in Europe,” says Sum.
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Other factors include the drag from the Covid-19 Omicron variant on domestic and international flight activity in China. “We now only expect China to ease international travel restrictions towards the end of 2022 at the earliest, given that multiple studies have shown the limited efficacy of Chinese vaccines against the problematic variant. This is negative for SPIAAFSC, as the airport is highly dependent on international flights.”
However, he notes that his forecasts for the FY2022 and FY2023 stand lower than that of the consensus as he is less bullish on the recovery trajectory for CAO and SPIAAFSC.
In addition, the protracted backwardation in the crude oil and oil product market will also put pressure on CAO’s margins.
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The higher demand for crude oil and concerns of supply disruption on the back of sanctions on Russia has driven backwardation in the crude oil market to the steepest level since 2004, says Sum.
On this, he believes that the crude oil and oil product market “will remain tight for some time, making it challenging for the group’s trading operations”.
While CAO has a substantial net cash position of US$401 million ($544 million) as at December 2021, Sum is “doubtful on the group’s ability to put that capital to work in a manner that would drive shareholder returns”.
CAO’s dividend yield of 2.4% for the FY2022 is also deemed “less attractive” compared to other quality dividend plays in the market, says Sum.
Furthermore, a sharp drop in oil prices would lead to mark-to-market losses for its key associate SPIAAFSC, which would impact its contribution to CAO, says Sum.
CAO’s net profit of US$16.1 million for the 2HFY2021 ended December as well as its FY2021 net profit of US$40.4 million stood below Sum’s expectations. Its final dividend of 1.90 cents also missed his estimates.
“We will stay on the sidelines until we see greater clarity on China’s reopening trajectory; a shift in the group’s mentality towards returning capital to shareholders (dividend payout ratio has been maintained at 30% for a long time) to drive a higher return on equity; or earnings-accretive acquisitions by the group to drive inorganic earnings growth,” says Sum.
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RHB analyst Shekhar Jaiswal has also downgraded his recommendation on CAO to “neutral” from “buy”.
Like Sum, he has also lowered his target price estimate to $1 from $1.09 as he cuts his earnings estimates on CAO for the FY2022 to FY2023 by 12% to 13%.
The lower earnings estimates, says Jaiswal, is “to account for an uncertain outlook on the reopening of China’s international air travel, and after imputing our new Brent crude oil price forecasts”.
Unlike Sum, Jaiswal has deemed CAO’s FY2021 earnings as in line with his expectations.
“Earlier this year, CAO had issued a negative profit warning for its 2021 earnings. 2021 reported profit of US$41 million came in line with our estimate, which we pared down in February,” writes the analyst.
However, China’s zero Covid-19 policy will be a drag to CAO’s earnings.
“While CAO acknowledges that China’s zero Covid-19 policy could mean a slow recovery for the country’s jet fuel consumption, especially from the uneven recovery in international air traffic, it was uncertain on when the country would see any changes in the current policy,” notes Jaiswal.
“We believe this adds to the uncertainty on CAO’s earnings recovery – especially for its associate, SPIA, which is the sole jet fuel refueller at Shanghai Pudong International Airport,” he adds.
The counter currently lacks re-rating catalysts as well.
“From a low base of 2021, we expect CAO to report a 29% y-o-y profit growth in 2022. Its FY2022 P/E is at 11x, implying an exciting 0.4x FY2022 PEG,” writes the analyst. “CAO has been holding on to a net cash position (69% of its market cap) for long, and has failed to deliver any inorganic growth.”
As at 4.28pm, shares in CAO are trading 1 cent higher or 1.1% up at 92 cents, or an FY2022 P/B of 0.6x and dividend yield of 2.1%, according to RHB’s estimates.
Photo: Bloomberg
