DBS Group Research and RHB on Thursday (Mar 3) downgraded their calls on China Aviation Oil (CAO), as well as lowered their target prices amid a less optimistic outlook.

RHB has downgraded CAO to "neutral" from "buy" and lowered its target price to S$1 from S$1.09. The new target price implies a potential upside of 18.4 per cent from the counter's last trading price of S$0.92 as at the midday trading break on Thursday. Shares of CAO were up 1.1 per cent or S$0.01 at the time.

DBS downgraded CAO to "hold" from "buy" and lowered its target price on the stock to S$0.85 from S$1.20, implying a potential downside of 7.6 per cent. The new target price is 11 times the research team's estimates for CAO's FY2022 earnings, which is 1 standard deviation above its 5-year mean.

The downgrades come as both research teams cut their earnings estimates on CAO. Delays or uncertainties surrounding China's reopening to international travel has also led to less optimism on the stock.

Omicron will continue to drag on domestic and international flight activity in China, DBS said. It expects the variant to increase the frequency of lockdowns in China as the country maintains its zero Covid-19 policy.

RHB maintains that having this policy would mean that traffic recovery "will remain uneven and uncertain".

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DBS noted that CAO's key associate, Shanghai Pudong International Airport Aviation Fuel Supply Company (SPIAAFSC), which typically accounts for more than half of its earnings, is highly dependent on international traffic.

"Hence, the sluggish relaxation of international border controls will likely impede SPIAAFSC's earnings recovery," DBS said.

Both DBS and RHB have also cut their earnings estimates on CAO to account for recent events impacting oil prices and demand.

RHB has cut FY2022-23 estimates for CAO by 12-13 per cent to account for the uncertain outlook on China's reopening and the research team's new Brent crude oil price forecasts.

Meanwhile, DBS has slashed its FY2022 net profit estimate by 41 per cent to account for "protracted backwardation in crude oil product markets" which will weigh on trading profits.

Amid improving crude oil demand and supply disruption concerns due to sanctions on Russia, DBS believes the crude oil product market will "remain tight" for some time. This will make it challenging for the group's trading operations and erode profitability even though it has no direct impact from the sanctions on Russia as they do not have trade exposure to Russian-based companies.

That being said, RHB expects CAO to report a 29 per cent year-on-year growth in profit in 2022, from a low base in 2021. The stock is trading at 11 times the research team's FY2022 earrings estimates, which implies an "exciting" price/earnings-to-growth (PEG) ratio of 0.4.

The RHB research team has also applied an ESG (environmental, social and governance) discount of 6 per cent to its blended fair value of S$1.06 to arrive at its S$1 target price for CAO. While CAO's valuation remains compelling, RHB does not see any near-term rerating catalysts.

Both DBS and RHB have expressed concerns on CAO's ability to put its substantial net cash position (US$401 million) to work in a manner that would drive shareholder returns.

CAO has been holding on to a net cash position which is 69 per cent of its market capitalisation, but failed to deliver any inorganic growth, RHB said.