Will China's latest economic stimulus lead to more air travel? This company (3.6X ex-cash PE) stands to benefit

This article is republished with permission from NextInsight .

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24-Sep    Share!

THE CONTEXT ● China today (24 Sept) unveiled fresh stimulus to boost its economy, sending Shanghai and HK stocks on a rally. Interest rate cuts and measures to revive the local stock markets could lead to increased consumer spending, including on travel and tourism. ● On the Singapore Exchange, China Aviation Oil (CAO) is one of the possible beneficiaries of a recovery in Chinese consumption and, specifically, aviation travel. ● The Covid pandemic dealt a blow to its business. With domestic and international travel picking up pace, but still below pandemic levels, CAO's supply of jet fuel should rise accordingly. ● CAO staged a recovery in profit in 2023 and is set to extend the trend in 2024 (see chart).  CAO stock currently trades at 3.6X PE after excluding its large cash balance. ● While CAO's profits have been recovering, its stock price has continued to languish. Chart: ReutersPhillip Securities and Lim & Tan Securities have target prices of $1.05 and $1.24, respectively. CAO's business is low in capex and high in cash generation, leading to a US$354 million cashpile (zero debt) which is about 62% of its current market cap (S$735 m). ● However, margins are thin as this is a volume game: Gross margins are merely 0.4%! CAO operates a cost-plus model whereby it earns a margin for every unit of fuel it supplies. Volatile oil prices, among other things, pose a risk. Read more what Phillip Securities says below....

 

● CAO supplies imported jet fuel to the civil aviation industry in China. CAO is 51.3%-owned by state-owned China National Aviation Fuel Group Limited, which holds the mandate to supply all jet fuel requirements in China. ● CAO also markets jet fuel to airports outside China, and engages in international trading of jet fuel and other oil products, as well as carbon credits. ● It has a 33% stake in Shanghai Pudong International Airport (SPIA). SPIA accounted for 62% of net profit in FY22.

 

Excerpts from Phillip Securities' report
Analyst: Liu Miaomiao

Spike in air traffic ● Revenue for 1H24 increased by 20% YoY to US$7.5bn, slightly below expectations and accounting for 44% of our FY24e forecast. The revenue growth is primarily attributed to a rise in oil prices and an increase in supply and trading volume (+7.5% YoY).  CHINA AVIATION OIL Share price:  $0.86 Target:  $1.05 ● Net income soared by 117.8% YoY to US$42.4mn for 1H24, in line with our forecast, forming 54% of our FY24e estimates. The jump came from SPIA's 154.9% YoY rise to US$22.38mn, driven by an uptick in international air demand that led to higher refueling volumes. Gross profit rose 127% YoY to S$24.2mn from increase contribution of end -to -end sales and contango curve.

 

● 2024e earnings supported by the recovery in international air traffic in China, which we anticipate will reach c.90% of pre-pandemic levels (currently 25% below pre-COVID levels).

We are positive on CAO as the largest physical importer in China and associate SPIA, the sole jet fuel supplier for international flights at Shanghai airport.

We maintain our FY24e earnings forecast and BUY recommendation with an unchanged DCF-TP of S$1.05.

Outlook
CAO is diversifying its geographical presence outside of China, although revenue from the PRC still accounts for 75% of its total income. 

"According to a report from the Civil Aviation Administration of China, international air passenger demand in China grew rapidly in the first half of 2024, with a remarkable rebound exceeding 80% of pre-pandemic levels for 5 consecutive months since February 2024 and further growth in the international air passenger traffic is expected in the second half of the year." --China Aviation Oil, 14 Aug 2024 media release

We expect higher contributions from other regions as several partnerships, particularly in Korea and the US (+30%YoY), are progressing well.

We believe there is an good opportunity for CAO to increase its payout ratio or announce a special dividend, given its current cash-rich position of US$353mn.

In addition State Owned Enterprises have been encouraged to raise dividends.

Liu Miaomiao, analystMaintain BUY with an unchanged TP of S$1.05 Earnings will be supported by a recovery in international air traffic in China, which we expect to reach c.90% of pre-pandemic levels (currently around 25% below pre-COVID levels). We maintain our BUY recommendation with an unchanged DCF-TP of S$1.05.

Full report here.