3Q22 results in line with our forecast
　　COSCO Shipping Energy Transportation announced its 1-3Q22 results: Revenue grew 33.5% YoY to Rmb12.4bn and attributable net profit reached Rmb640mn, with EPS of Rmb0.13 (up 44.2% YoY), in line with our expectation. The firm’s 3Q22 revenue rose 54.0% YoY or 21.1% QoQ to Rmb4.89bn, and attributable net profit totaled Rmb481mn (up 259.5% QoQ) (vs. loss of Rmb100mn in 3Q21). Earnings recovered rapidly in 3Q22 thanks to significant improvement in the freight rates of very large crude carriers (VLCC) from the lows of 1H22.
　　By business, the international (foreign trade) oil shipping business turned profitable in 3Q22 thanks to high freight rates. The firm’s gross profit from the international tanker fleet was -Rmb97mn in 1-3Q22 and Rmb333mn in 3Q22, significantly improving QoQ as the firm captured opportunities in refined oil transportation markets by leveraging its advantages in domestic and international shipping. The firm’s coastal (domestic trade) oil shipping business reported gross profit of Rmb996mn in 1-3Q22 and Rmb280mn in 3Q22. Its liquefied natural gas (LNG) transportation business expanded further with 1-3Q22 net profit at Rmb575mn. The firm had 18 LNG vessels for delivery as of end-September 2022.
　　Trends to watch
　　From a long-term perspective, we see improvement on the supply side and expect capacity expansion to decelerate in the next 2 years. VLCC orders on hand are limited, representing only 4.5% of the current capacity and the lowest level since 1997. We thus see limited capacity expansion in the next 2 years. In addition, we expect the exit of existing older vessels to accelerate. As of September 2022, the average age of the VLCC fleet is 10.58 years globally, and those aged over 15 years account for 25.1% of total capacity. We expect environmental policies to accelerate the demolition of older vessels, but actual demolition may be postponed due to rising freight rates. We foresee stricter policies going forward, but caution against overestimating the impact of the policy in the early stages.
　　We view share prices of shipping companies as call options for potential optimization in fundamentals. While supply growth in the oil shipping market is highly likely to be limited in the long term, we suggest watching the match between expectations and fundamentals in the near term. We have seen stronger-than-expected rebound in freight rates since 3Q22, benefiting from rising oil imports by China and the release of oil from the Strategic Petroleum Reserve of the US. Looking forward, we suggest watching the sustainability of oil exports from the US and potential incremental demand for oil shipping (e.g., progress in negotiations in Iran nuclear deal, changes in production, and restructuring of Russian crude oil exports along with implementation of sanctions on Russia).
　　Financials and valuation
　　We raise our 2022 and 2023 earnings forecasts 40% and 32% to Rmb1.84bn and Rmb4.74bn given improving earnings amid rising freight rates. A-shares are trading at 45x and 18x 2022e-2023e P/E and 2.7x and 2.4x 2022e-2023e P/B. H-shares are trading at 14x and 5x 2022e-2023e P/E, and 0.8x and 0.7x 2022e-2023e P/B. We use P/B valuation due to improving sector valuation. We maintain OUTPERFORM for A-shares and lift our TP 22% to Rmb19.18, implying 3.0x 2022e and 2.7x 2023e P/B with 10.4% upside. We maintain OUTPERFORM for H-shares, and due to improving sector valuation, we raise our TP 11% to HK$8.93, implying 1.1x 2022e and 1.0x 2023e P/B with 43.6% upside.
　　Risks
　　Decline in demand for crude oil due to macroeconomic downturn; further reduction in crude oil output.