July 10, 2019

Although China Aviation Oil (CAO)’s share price has moved lower in line with jet fuel prices, we highlight that profitability of its China jet fuel business is driven by volumes and not so much by the oil price outlook. We remain upbeat on the long term growth of China’s aviation passenger traffic, in line with its rising per capita income and expanding aviation infrastructure. We believe our earnings estimates remain conservative and ex-cash 4.3x 2020F P/E remains compelling.

This year, China’s aviation passenger traffic registered 8.6% YoY growth, while its international aviation passenger traffic has grown 16.6% YoY. All international flights flying out of China are required to use imported jet fuel, which is supplied only by China Aviation Oil (CAO). Amidst expectation of some negative impact from the US-China trade war, we have conservatively forecasted mid single-digit jet fuel supply volume growth in 2019. This compares with an average volume growth of c.11% in the last 10 years.

Shanghai Pudong International Airport Aviation Fuel Supply Company (SPIA, which is 33%-owned by CAO) is a refueller of jet fuel at Shanghai Pudong International Airport (SPA). SPA has witnessed average passenger traffic growth of 6% over the last eight quarters. The completion of capacity expansion by end-2019 could translate into a high growth rate in traffic at SPA and enable SPIA to register higherthan-estimated jet fuel volume growth in 2020-2021.

During the last one year, CAO’s share price has moved in tandem with jet fuel prices. While an outlook of weaker jet fuel price does limit CAO’s ability to grow its trading volumes, it does not impact the profitability of its China jet fuel supply business, which has registered steady volume growth and earns a fixed USD per ton margin.

CAO has been seeking opportunities to grow its jet fuel business outside China. A zero debt balance sheet and large net cash position (c.46% of its market cap), should enable CAO to undertake an earnings-accretive acquisition.

Despite outperforming the STI by 14% YTD, CAO’s stock continues to trade at an FY20F P/E of 7.9x (ex-cash FY20F P/E of 4.3x). This compares with a conservative estimated FY20F earnings growth of 7.6%. The stock also remains cheap vs regional and global peers (Figure 5). BUY, SGD1.60 TP offers 23% upside, 3.5% yield. – RHB

China Aviation Oil closed at: S$1.30