Preannouncing 67-80% YoY decline in 1H22 earnings
COSCO Shipping Energy preannounced that its 1H22 attributable net profit declined 67-80% YoY to Rmb110mn-180mn, implying 2Q22 net profit of Rmb85mn-155mn (up 240-519% QoQ and down 23-58% YoY). The preannounced results miss the market’s and our (Rmb200mn for 2Q22) expectation. Specifically, the firm estimates its 1H22 loss from foreign-trade oil tankers widened by about Rmb100mn due to Rmb420mn expansion in the loss from very large crude carriers (VLCC), though the negative impact was partly offset by the YoY growth in earnings from small and medium foreign-trade oil tankers. Sequentially, the time charter equivalent (TCE) of VLCC rose 18.5% QoQ in 2Q22 and the gross profit of foreign-trade oil tankers rose Rmb360mn QoQ to Rmb300mn, as shortage of refined oil due to the Russia-Ukraine conflict and active cross-regional trade boosted freight rates for refined oil.
　　Trends to watch
　　We think the oil tanker market is about to bottom out and turn around. We suggest seizing attractive buying opportunities to gain exposure to a potential upturn in the oil tanker market.
　　Supply: Order backlog of new vessels gradually declining; watch exit of older vessels. Following the delivery in recent years, the order backlog of new VLCC has declined to 43 as of July 2022 according to Clarksons. This represents about 5% of the existing fleet, hitting a low in about three decades. In addition, the delivery of new vessels is mainly scheduled for 2022-2023 (capacity to expand by 2.9% in 2022 and 1.6% in 2023), with almost no new vessels for delivery after 2024. Vessels aged over 20 years account for 8.5% of the existing VLCC fleet, and we do not expect new vessels to be enough to meet the replacement demand. We see potential improvement on the supply side, considering the rising prices of new vessels, tight capacity of shipyards and uncertainty in shipbuilding technologies stemming from environmental regulations. We see increased upside potential in the market, if freight rates remain weak in the near term and the exit of older vessels accelerates (Clarksons data shows that vessel demolition restarted in June).
　　Demand: Crude inventory at lows; watch for a demand boost from potential oil transportation and storage. Crude inventory is already at the lower end of its historical range. Considering the cycle in 2014-2016, we think that a decline of oil prices from highs will boost demand for both inventory replenishment (low oil prices) and oil storage (forward premium). This may drive a market upturn despite some fluctuations during the year. In addition, the Russia-Ukraine conflict has led to changes in crude trade structure, and may increase the length of haul for oil transportation. This trend is already reflected in small and medium vessels such as Suezmax and Aframax (freight rates have fallen after a sharp rise, but have still outperformed those of large vessels). We suggest waiting for more data to confirm the trend.
　　Financials and valuation
　　We maintain our earnings forecast. A-shares are trading at 1.4x 2022e and 1.3x 2023e P/B, and H-shares at 0.6x 2022e and 2022e 0.6x P/B. We maintain OUTPERFORM for A-shares and H-shares. Considering a potential market upturn and rising risk appetite, we raise our A-share TP 7% to Rmb9.36 (1.4x 2023e P/B with 5.6% upside) and maintain our H-share TP at HK$5.09 (0.6x 2023e P/B with 17% upside).
　　Risks
　　Delay in inventory replenishment due to elevated oil prices or falling consumption of crude oil.