NRA Capital Pte Ltd

Written by: NRA Team

Monday 21 Mar 2016

China Aviation Oil Limited - FY15 results

Aviation fuel supply continues to profit despite falling oil prices

China Aviation Oil’s (CAO) net profit grew 24.7% year-on-year despite a 41% slide in jet fuel prices. Sustained improvements in total volume traded and increased market penetration despite a tough 2015 for oil markets indicate that CAO is a significant outperformer among oil-related stocks.

China Aviation Oil (CAO), the largest physical jet fuel trader in Asia, registered a full year profit of US$61.3m. This comes on the back of a 47.4% reduction in revenue, which reached US$9.0b for FY15. Trading optimization allowed CAO to improve its gross margin to 0.39%, from 0.16% the previous year. An 8.5% reduction in administrative expenses and a 66% reduction in finance costs aided in improving operating profit by 171.9% to US$21.3m. While year-on-year (yoy) income from associates fell 2.1% to US$42.3m, this US$0.9m loss was more than offset by the US$13.47m increase in operating profit.

Key highlights of the briefing:

-          The main revenue driver for CAO is its core jet fuel segment, accounting for US$7b, or 78%, of total revenue, while other oil products constituted 21.9% of revenue. CAO has suspended petrochemical trading in September 2015 due to weak market conditions, though CAO intends to eventually trade the entire spectrum of oil products. Total supply and trading volume has remained stable at approximately 20.2m tonnes of oil products for FY15, compared with 20.4m tonnes in FY14.

-          Improvements in the international distribution of CAO oil products is a major component of the growth strategy, with CAO registering only 52.5% of its revenue in China for FY15, compared with FY10 where China accounted for 80% of all its revenue. CAO has reached agreements to supply fuel at 4 new airports outside mainland China, therefore increasing supply volumes 32% year on year to 1.77m tonnes at said airports.

-          Associates have had more mixed fortunes, given that lower oil prices have reduced the commission value that can be charged for oil services rendered. As such, revenue from refuelling at SPIA fell despite higher refuelling volumes, while higher transportation and leasing activity and TSN-PEKL and OKYC contributed to profits there.

-          Lower working capital requirements as a result of lower oil prices aided in improving cash flow from operating activities, which rose to US$52.1m from US$47.2m. All cash borrowings for CAO were paid for within the year, which has resulted in the zero borrowings at end FY15 and a net cash position of US$170.5m.

Takeaway

CAO looks like it has profited very well from both the slide in oil prices as well as the focus on its core jet fuel market. Trading discipline by avoiding large positions in risky calls has been crucial in allowing oil trading companies to maintain profits when oil markets are going down. We are confident that CAO can maintain this level of performance going forward, based on the continued performance of jet fuel and the demonstrated strength of the CAO trading strategy.

Beyond the strengthening of the core jet fuel trading business, it looks like the increased penetration of CAO into other oil markets is serving the company well. Increasing the breadth of CAO supply options allows the company to participate in more markets that increase arbitrage opportunities and reduce specific risks. While an increase in friction costs is typical for trading companies when expanding their geographical reach, low oil prices now mean that the costs incurred for this greater breadth of operations is low, and therefore gives CAO a lower threshold to clear before reaching profitability.

Prognosis for the future

Oil trading companies profit from volatility more than anything else, and the direction of the oil markets gives CAO significant arbitrage opportunities to work with. The expansion of CAO into other international oil markets is significant because international air travel into China would result in more synergistic opportunities for CAO to form preferential supply deals for airlines which expand their routes. Furthermore, CAO is intending to expand its scope of oil product offerings, which would expand the bargaining power the company has and give it greater flexibility when structuring supply deals and trades.

In terms of major risks for CAO, we noted that their prudent trading strategy has effectively squared off much risk of major upside or downside for CAO. A cursory analysis of the working capital of CAO indicate that they likely have about 1 to 2 months of inventory that they are trading and working with at any time, which means that CAO is not engaging in trading strategies that have elements of long term risks. As such, we think that CAO is highly protected against downside risks.

Strategically we think that CAO can maintain a positive growth momentum. Technology and regulatory trends for motor gas and marine gas would lead to potential disruptions in these markets, but the economics of aviation gas indicate greater longevity for oil based aviation fuel. Expanding into other oil sectors would increase the options and the breadth of the spectrum of oil products CAO operates in, but the secure and growing volume of aviation fuel that CAO trades will likely lead to increased and improved revenue performance going forward.

CAO trades at S$0.80 which translates to a PER of 8.8x. Dividend of 2 cents gives a dividend yield of 3.8% Compared to its peer CEFC which is trading at 44.5x PER, CAO is undervalued by 80% and is trading at a discount 22.7% to its 7-year historical PER average of 11x. While the comparison to CEFC is not particularly useful due to the abnormal trading pattern of CEFC stock, we find that the historical discount offers a clue as to the trading price that CAO should be more accurately assessed by. Investors looking at an oil and gas related stocks can consider the investment merits of CAO. 


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