Peggy Mak of PhillipCapital has initiated coverage of China Aviation Oil (Singapore) Corporation with a “buy” call and $1.01 target price on expectations that this company will see its earnings double over the next two years.
CAO is a counter with direct exposure to the aviation market of China. Besides its key base in Shanghai, CAO is involved in the trading of jet fuel, other oil products as well as carbon credit. It is 51.3% owned by state-owned China National Aviation Fuel Group, which holds the mandate to supply all jet fuel requirements in China.
CAO’s key business is its 33% stake in Shanghai Pudong International Airport Aviation Fuel Supply Company, the monopoly jet fuel supplier in Shanghai’s Pudong International Airport (SPIA).
In FY2022 ended December 2022, CAO’s stake in the entity contributed 62% of its earnings. CAO had generated an average ROE of 13.5% in the last two years in spite of the lull in the aviation market.
In addition, CAO holds stakes in a clutch of associates and joint ventures inside and outside China equivalent to 28.7% of its net assets. These ventures and associates give CAO exposure to other markets besides China. “These assets are the critical infrastructure that underpins CAO’s entrenched position as the largest physical jet fuel trader in Asia Pacific,” says Mak.
For example, it holds a 39% stake in Shenzhen Zhenghe Petrochemicals Co, which leases storage capacity, notably, a 79,000 cubic metre tank farm in Guangdong, and trade oil products.
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Another CAO associate within China is 49%-owned China National Aviation Fuel TSN-PEK Pipeline Transportation Corporation, whose business is in pipeline transportation.
Over in Europe, CAO holds 12.5% of an entity called Aircraft Fuel Supply, which holds the concession from Schipol Airport to manage the storage and distribution of jet fuel. CAO also holds a 26% stake in Oilhub Korea Yeosu Co, described as Korea’s largest independent storage tank terminal in Yeosu, with a capacity of 1.3 million cubic metres.
Mak believes that CAO’s potential upside will come from its China exposure. In her Oct 30 note, Mak points out that international passenger traffic in China, as of September, is up 18-fold year to date and has only reached 33% of pre-pandemic levels. “We expect international travel volume recovery to gain pace in FY2024, fuelling demand for jet fuel at international airports,” says Mak.
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She notes that China’s jet fuel consumption has risen by a CAGR of 8.4% over the last 10 years. “More airports have been added over the years to cope with the rise in air travel demand. We think CAO could potentially expand its footprint to international airports in other Chinese cities,” says Mak.
Mak observes that China has been building new airports, as a rise in affluence and mobility has fuelled demand for air travel. Over the past decade, the number of airports in China has risen at a CAGR of 3.4%. Meanwhile, jet fuel consumption has been growing at a faster pace of 8.4% CAGR over the same period.
According to Mak, without the impact of the pandemic in 2020, which caused travel to come to a near standstill, growth would have been an average of 9.7% per year.
She notes that China’s civil aviation industry is dominated by the three carriers, Air China, China Eastern Air and China Southern Airlines, all of which have plans to expand their fleet by 2.0% to 5.8% per annum in the next three years, as they seek to grow their combined market share of two-thirds now.
Mak notes that with the lifting of Covid restrictions early this year, total air transport turnover in China rebounded by 80% y-o-y in the first eight months of this year. However, this is still 41% below the level in FY2019.
The recovery seen so far has been led by domestic travel, with international travel only accounting for 24.6% of total volume, versus 42.3% in the pre-pandemic FY2019. She believes that the restoration of these routes has been slower due to geopolitical tensions and capacity constraints. “Demand and capacity have been climbing steadily, and we expect total transport volume to return to the pre-Covid level in FY2025. CAO’s supply volume of jet fuel should rise in tandem,” says Mak.
Mak likes CAO for its improving return on capital invested as supply volume picks up. She points out that CAO’s balance sheet is asset-light with no borrowings. Its key assets comprise mainly cash (34%), associates (25%) and working capital. Cash balance as of the end of 2022 was equivalent to two-thirds of CAO’s market cap.
On the other hand, SPIA accounted for 19% of net assets and 62% of net profit in FY22 and has been generating a strong return on invested capital (ROIC) of above 20% pre-Covid. “We expect ROIC to recover in the next few years as demand for jet fuel in China rises in tandem with the resumption of flights,” says Mak, whose target price of $1.01 was derived using a discounted cash flow model.
