Will China Aviation Oil Survive The Recent Oil Crash?
April 10, 2020
China Aviation Oil (Singapore) Corp Ltd (SGX: G92) is a major supplier of imported jet fuel to China’s civil aviation sector. It is the largest physical jet fuel trader by trading volume in Asia as well.
With the recent wild swing in crude oil price, China Aviation Oil (CAO)’s business would likely be affected as well. The question is, would CAO be able to weather through the storm and sustain its business growth in the future?
In this article, we will take a closer look at CAO to better understand its earnings and performance.
The core business of CAO is the supply and trading of jet fuel which contributes 66% of total 2019 revenue. As the largest entity of its kind in China, it supplies jet fuel to 17 airports across the country. These include the gateway airports in the three largest cities in China: Beijing Capital International Airport, Shanghai Pudong and Hongqiao, and Guangzhou Baiyun International Airport.
CAO is also an international jet fuel supplier. It has a presence in over 51 airports across 20 countries in Asia, North America, Europe, and the Middle East.
Source: CAO 2018 Annual Report
CAO also engages in trading of other oil products including fuel oil, aviation gas, and crude oil to complement its main business in jet fuel trading. This segment constitutes 33% of total revenue in Financial Year (FY) 2019.
The group owns oil-related assets that are synergistic to its jet fuel and oil products trading activities. The key associate here is the Shanghai Pudong International Airport Aviation Fuel Supply Ltd, the sole supplier of jet fuel in Pudong Airport. This segment is critical as it forms 60% of CAO’s profit before tax in 2019.
China National Aviation Fuel Group, a state-owned-enterprise, owns 51.3% of CAO. It is the largest aviation logistics provider in China. Interestingly, British Petroleum is also a major shareholder of CAO with a 20.1% stake.
FY2019 Results Highlights
FY2019 was a good year for CAO. The company supplied a total of 36.9 million tonnes of fuel, 5.9% more than FY2018. This indicates a higher level of business activity across the company.
Source: CAO FY2018 Annual Report
While revenue decreased slightly due to a fall in oil price, gross profit was significantly higher at US$58.46 million. This is due to a higher volume of jet fuel and more efficient operations.
CAO’s Shanghai Pudong key associate recorded lower sales which resulted in a 9.1% drop in profit from associates. As mentioned, the Shanghai Pudong business is a key profit contributor for the group. Hence investors would need to monitor profit from this segment closely.
CAO capped off the year with a US$99.83 million record net profit.
Source: CAO 2019 full-year results press release
Balance Sheet Strength
As an oil trader, CAO takes on the risk of maintaining open trading and hedging positions. Although its balance sheet seems pristine with zero borrowings and US$378 million of cash, we need to take into account liability of its open trading positions shown under trade payables and contract liabilities.
Bearing this in mind, CAO’s gearing based on total liabilities over total assets stands at 0.55. This is not worryingly high in my opinion.
Gross Profit Trend and Profit Before Tax Trend
Another key measure of CAO’s business strength is its margin. We shall look at its trend of gross profit and profit before tax as the former shows how well CAO manages its exposure to the oil price, and the latter reflects contributions from its associates.
Source: Self-compiled from Annual Reports and FY2019 financial statements
As seen from the chart, CAO’s FY2019 margin of 0.29% and 0.52% are starkly lower than that of FY2015. This is most likely due to the crude oil price crash back in late 2015, affecting CAO’s performance. In recent years, CAO’s gross margin has improved alongside stabilising oil price.
This suggests that CAO’s performance is highly correlated to crude oil prices.
Historical Cash Flow
While CAO generated positive cash flow from operating activities of US$49.8 million last year, it is a big drop from FY2018. Historical trends reveal that CAO’s net operating cash flow has been volatile in the past five years, closely tracking the rise and fall of crude oil prices.
Source: Self-compiled from Annual Reports and FY2019 financial statements
Compared to the Oil and Gas industry, CAO appears to be cheap as its PE ratio and Price/NAV value are much lower.
A better benchmark could be the Oil Refining/Marketing sector since CAO does not have oil exploration and extraction businesses. Compared to this sector, CAO’s valuation appears to be in-line.
China is currently the second-largest civil aviation market in the world after the United States. With growing disposable income and an expanding middle class, Chinese residents are expected to travel more. According to some reports, it is poised to overtake the US in the mid-2020s. The government is preparing for the boom in air travel by building new airports ahead of demand. This represents a large growth potential for CAO.
With a balance sheet that is not saddled with debts, CAO can use its existing cash to acquire competitors or companies in synergistic industries. According to a DBS research report, CAO is looking at both asset-light investments such as air spaces and customer contracts, and asset-backed investments such as refueling stations and storage facilities.
Lastly, CAO’s 33% stake in Shanghai Pudong refueling associate will continue to bolster its growth. As the financial capital and commercial center of China, Shanghai’s air travel activities should remain robust in the future. The new satellite concourse at Shanghai Pudong International Airport would ensure the future growth is well catered to.
CAO’s biggest weakness is its high correlation to oil prices. Crude oil has been in the doldrums since the market crash in 2015. Just when it was showing signs of recovery, the recent spat between Russia and OPEC caused crude oil prices to slump 30% in a day. As of point of writing, Russia and OPEC have not reached any agreement yet. Investors would have to live with the volatility in crude oil price and future swing in CAO’s earnings.
CAO is also facing a big risk currently – the significant fall in air travel demand caused by the Covid-19 pandemic. Airlines are reducing capacity with route cancellations while airports saw a big fall in passenger numbers. The effects will linger on and cause airlines to report much worse financials in the coming quarters. We are not sure how long this crisis will last. Essentially, CAO is certain to report much lower revenue soon.
CAO enjoys a monopolistic position in China’s jet fuel market. It is owned by a reputable oil major and a state-owned company. The structural advantage reflects in its steadily increasing total supply and trading volume.
However, CAO’s major flaw is its close dependence on oil prices, which is often the subject of international politics and power tussles. This results in CAO’s non-consistent cash flow and margin.
In summary, I think CAO would be suitable for investors who look to capture the rise and fall of oil prices.
It is not for the faint-hearted, judging by its significant share price fall to $0.89 in tandem with the oil price movement. It is currently trading at a PE ratio of 5.69 and a dividend yield of 5.2%.
CS Jacky is a Remisier and Financial Adviser with Phillip Securities Pte Ltd. Graduated with a Bachelor in Business Administration (Finance), he has been investing in the stock market since 2010. He identifies companies with good prospect trading at a low valuation using a unique blend of fundamental, technical, and portfolio analysis. He also holds REITs and dividend paying shares. He holds regular seminar to share about market updates, investment insights of specific stocks in his watch list, and overall wealth management for retail investors. He is the owner-blogger of 'CS Jacky - 360 Wealth Management' and a guest writer for Value Invest Asia.