1H22 results in line with our expectation
COSCO Shipping Energy announced its 1H22 results: Revenue grew 22.89% YoY to Rmb7.51bn and attributable net profit reached Rmb159mn, with EPS of Rmb0.03 (down 70.8% YoY), in line with the firm’s preannouncement (Rmb110-180mn) and our forecast. The firm’s 2Q22 revenue rose 32.8% YoY or 16.0% QoQ to Rmb4.04bn, and attributable net profit totaled Rmb134mn (down 33.4% YoY but up 434.7% QoQ).
　　By business, losses from international (foreign trade) oil shipping business narrowed. The firm’s 1H22 revenue from the international tanker fleet grew 45.0% YoY to Rmb3.95bn. Gross loss from this segment narrowed Rmb102mn YoY to Rmb431mn. Despite a sluggish market for very large crude carriers (VLCC) in 1H22, the firm’s earnings from the international small and medium-sized fleet improved YoY due to the Russian-Ukraine conflict. We believe this narrowed the firm’s losses. The firm’s coastal (domestic trade) oil shipping business saw slower growth, with revenue rising 6.6% YoY to Rmb2.95bn in 1H22. Gross margin for this segment dropped 7.8ppt YoY to 24.2%, due to falling freight rates as a result of weakening demand for domestic oil shipping in 1H22.
　　Trends to watch
　　From a long-term perspective, we see improvement on the supply side and expect capacity expansion to decelerate in the next two years. On the one hand, VLCC orders on hand are limited, representing only 4.5% of the current capacity, the lowest level since 1997. Moreover, we believe that capacity expansion will slow down in the next two years (capacity to expand 3.7% in 2022 and 3.3% in 2023, according to Clarksons). On the other hand, we expect the exit of existing older vessels to accelerate. As of July 2022, the average age of the VLCC fleet is 10.48 years globally, and those aged over 15 years account for 29.2% of the total capacity. We expect the demolition of older vessels to accelerate due to environmental protection policy, further decelerating the sector’s capacity expansion in the next two years.
　　We view share prices of shipping companies as call options for potential optimization in fundamentals. We see high visibility in a cyclical recovery of the oil shipping sector in the long term, but there are only early signs of the recovery. In the short term, we suggest watching the match between expectations and fundamentals. We note that freight rates for the VLCC fleet have been rising since late June, benefiting from the recovery in global demand for crude oil, the release of oil from the Strategic Petroleum Reserve of the US, and market expectations of growing demand for oil shipments amid the US-Iran nuclear talks.
　　Looking forward, we suggest watching the sustainability of oil exports from the US and potential incremental demand for oil shipping (e.g., progress in the Iran nuclear deal negotiations, production changes and restructuring of Russian crude oil exports along with the implementation of sanctions on Russia).
　　Financials and valuation
　　We raise our 2022 and 2023 earnings forecasts 12% and 19% to Rmb1.31bn and Rmb3.59bn, given the cyclical recovery of the sector. A-shares are trading at 2.4x 2022e and 2.2x 2023e P/B. H-shares are trading at 0.8x 2022e and 0.8x 2023e P/B. Due to increased visibility in recovery and improving valuation, we maintain OUTPERFORM for A-shares and lift our TP 67% to Rmb15.67, implying 2.5x 2022e and 2.3x 2023e P/B with 3% upside, and we maintain OUTPERFORM for H-shares and raise our TP 58% to HK$8.03, implying 1.0x 2022e and 0.9x 2023e P/B with 30% upside.
　　Risks
　　Declining demand for crude oil due to macroeconomic downturn; setbacks in Iran nuclear deal negotiations; OPEC+ production cut.