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Broker's take: RHB upgrades China Aviation Oil to 'buy' on recovery in passenger traffic growth

RHB Research upgraded China Aviation Oil (CAO) to "buy" from "neutral" with a target price of S$1.60 on Wednesday, citing signs of strong recovery in international passenger traffic growth in China.

Shares of the jet fuel trader were up four Singapore cents, or 3.15 per cent, to S$1.31 at 11.32am on Wednesday.

Analyst Shekhar Jaiswal noted that China registered 15 per cent year-on-year growth in international passenger traffic in 2018, up from 7 per cent growth in 2017. Jet fuel imports also rose in tandem with passenger traffic, registering a 9 per cent year-on-year increase in 2018 versus 6 per cent growth in 2017.

"We expect jet fuel imports to continue growing in line with growth in international passenger traffic," wrote Mr Jaiswal. "CAO will be a key beneficiary of this trend as it is the sole importer of jet fuel into China that is consumed by all of the country's outbound international flights."

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Growth in profit contribution from CAO's 33 per cent-owned associate Shanghai Pudong International Airport Aviation Fuel Supply Co (SPIA) has moderated over the last few years, but could soar once more when capacity constraints at Shanghai Pudong International Airport (SPA) are resolved in the near future.

SPIA is the sole supplier of jet fuel at SPA and accounts for 65 per cent of CAO's profit before tax. The airport's capacity issues should be resolved by early 2020, as it commissioned its fifth runway in late 2018, and operations at its new satellite terminal building, which will be the world's largest, are expected to commence in H2 2019.

"With the resolution of capacity constraints, growth in SPIA's profits could exceed our current conservative estimates," Mr Jaiswal said.

RHB expects CAO to receive 90 per cent of its share of profits from SPIA in 2019, now that SPIA has completed its capacity expansion and returned to paying out higher dividends. This will add to CAO's net cash balance, which accounts for 45 per cent of its market cap. CAO is trading at 4.6 times 2019 forecast price/earnings on an ex-cash basis, which RHB deems to be compelling.