1Q22 results in line with our forecast
　　1Q22 revenue rose 13% YoY to Rmb3.48bn and net profit attributable to shareholders declined 93% YoY to Rmb25mn (Rmb0.005/sh). This is in line with our forecast. The decline YoY in earnings was mainly because tanker shipping rates still remained low and government subsidies decreased compared with last year. In 1Q22, the oil tanker shipping market remained under pressure due to oversupply, especially in the large vessels market for very large crude carriers (VLCC); VLCC TCE (time-charter equivalent) rates were low, and the 1Q22 gross margin of the firm’s oil tanker fleet declined by 6ppts YoY to 1%. According to the firm’s previous announcement, in 2021 revenue declined 22.3% YoY to Rmb12.6bn and attributable net loss was Rmb4.98bn, lower than we expected. We attribute this mainly to a shipping asset impairment provision of Rmb4.96bn.
　　Trends to watch
　　We expect the oil tanker shipping market to bottom out and suggest investing in the upcycle while sector valuations remain low given the high upside.
　　Supply side: New orders gradually digested; watch exit of old tankers. According to Clarksons, new orders for very large crude carriers (VLCC) totaled only 61 units as of April, a 30-year low. That is equivalent to 7% of the current fleet size. These new orders will largely be delivered in 2022-2023 (adding 2.9% and 1.6% to capacity growth in 2022 and 2023). So far, few orders have been placed for delivery in 2024. Old tankers with over 20 years of service account for 8% of the VLCC fleet, and new orders are not sufficient to meet replacement demand. Given rising ship-building prices, tightened slipway supply, and uncertainties in the shipbuilding technology pathway imposed by environmental protection requirements, we believe the supply side will tighten. If shipping rates remain low in the near term, it could accelerate the exit of old tankers, creating a larger upside in the following upcycle.
　　Demand side: Low inventory supports demand; watch synergies between crude oil shipping and storage demand. Crude oil output is decreasing, and destocking is underway. Crude oil prices remain high. We believe these conditions put high pressure on oil tanker shipping demand. However, crude oil inventory is currently at a historical low (both US and OECD inventories are lower than their 5-year averages). In our view, the possibility of restocking will grow over time. Based on experience in the 2014-2016 cycle, when oil prices fell from a high level, we think demand for restocking (driven by low prices) and storage (forward premiums) could create synergies, starting an uptrend that lasts a few years. In addition, the Russia-Ukraine conflict has changed the trading structure of crude oil. Shipping distances have been extended. So far, shipping rates of small- and medium-size tankers, including Suezmax and Aframax, have soared. This drove up VLCC shipping rates as well. However, as demand has not picked up, we are waiting for more data to prove our view.
　　Financials and valuation
　　As demand is constrained and earnings will likely remain under pressure in the near term, we lower our 2022 earnings forecast 23% to Rmb1.17bn and introduce a 2023 earnings forecast of Rmb3.01bn. COSCO Shipping Energy Transportation A-shares are trading at 1.3x 2022e P/B and 1.2x 2023e P/B, while H-shares are trading at 0.5x 2022e P/B and 0.5x 2023e P/B. We maintain an OUTPERFORM rating for A-shares and H-shares. We switch to P/B evaluation based on 2023e financials. As the industry is bottoming out and rising shipping prices boosting replacement value, we lift our target prices for A-shares and H-shares by 28% to Rmb8.75 (1.3x 2023e P/B, 11% upside) and HK$5.09 (0.6x 2023e P/B, 32% upside).
　　Risks
　　Restocking demand delayed by high crude oil prices or weaker crude oil consumption.