China Aviation Oil

UOBKayhian on 6 Aug 2012

Valuation
· We maintain our BUY recommendation on China Aviation Oil (CAO), but with a lower target price of S$1.22. This is due to higher forecasted expenses associated with an increase in business operations globally. Larger trading volume will also incur a higher financing cost relating to issuance of Letters of Credit and interest expense on bank loans.
· We derive our target price at the average fair value suggested from our dividend discounted cashflow model and the PE valuation model pegged to its peer group average PE of 9.5x FY12F. The stock is still trading at a discount to the 3-year average PE ratio of 12.9x.
1H12 Financial Results
· CAO reported a disappointing set of results as 1H12 net profit fell 14.5% yoy to US$34.8m despite higher revenue and gross profit. Volume of jet fuel supplied and traded increased 17.8% yoy to 5.0m tonnes for 1H12 driven by stronger demand in China as well as higher optimisation activities. Jet fuel prices averaged at US$128.80 per bbl for 1H12 compared to an average price of US$124.03 per bbl for 1H11. As CAO receives a fixed dollar spread over the price for jet fuel supplied to China (75% of volume), gross profit only rose 18.9% yoy to US$23.7m as compared to the 48.6% yoy rise in revenue.
· However, increased business operations for mid and back office operations and consolidation in the expenses from CAOHK and North American Fuel Corporation eroded profitability as CAO recorded an 84.6% increase in total expenses to US$8.6m. The share of profits from associates was also lower compared to the last corresponding period at US$20.8m (-21.7% yoy) as declining jet fuel price in the quarter compressed gross profit margin.
Earnings Revision
· We lower our 2012 and 2013 net profit forecasts by 13% and 22% respectively, mainly due to higher operating expenses and financing costs from larger business operations. Key risk is volatile jet fuel prices resulting in wide swings in the contributions from associate Shanghai Pudong International Airport Aviation Fuel Supply Company Ltd (SPIA).
· CAO is also working with MF Global Singapore to retrieve the US$4.3m it had with the bankrupt broker. According to management, the provisional liquidators have already received 90% of total funds entitled to MF Global customers but CAO is unable to give guidance on when they will be able to write back most of the provision.