AP OIL-KGI FRASER BUY $0.33 TP(32% UPSIDE UNLOCKING CASH)

New JV. AP Oil announced (18 Oct) that it has signed a JV agreement to subscribe to a 12.5% equity stake, at RMB25m (c.S$5.15m), in a JV company involving Shenzhen-listed Zongshen Power Machinery (70%), SGX-listed MoneyMax Financial Services (12.5%) and Free Trade Port Co. (5%). The JV co. will provide financial leasing services through hire purchase contracts with companies in Chongqing. The JV co. will be run by Zongshen, with AP Oil, MoneyMax and Free Trade Port each allowed a director seat out of a board of seven. According to AP Oil, there is a lack of hire purchase companies in Chongqing and that in order to be granted a license to conduct such a business in Chongqing, 25% foreign ownership is first required.

Zongshen and its business relationship with AP Oil. Zongshen Power Machinery is part of the Zongshen Industrial Group, a conglomerate whose businesses include (but not limited to) the production of a range of motors (including OEM for Piaggio), tire distribution for Goodyear, and lubricant distribution for AP Oil’s products. The conglomerate already has a credit department that does due diligence on micro-financing and factoring deals and is thus, no stranger to the financial leasing business in Chongqing. Zongshen is not just the lubricant distributor for AP Oil, but also an organic consumer of AP Oil’s lubricants for their manufacturing plants. AP Oil’s investment not only strengthens this business relationship but also gets exposure to dividends and capital gains (potentially) from the its stake in the JV.

Downside protection + upside participation.Two key clauses were included in the JV agreement. 1) Put Option: After 1 Jan 2018, AP Oil will have the right to sell-back its stake to Zongshen at an agreed market valuation (determined by an approved valuer) at not less than the initial capital contribution of RMB25m; this creates a sort of capital guarantee for AP Oil. 2) Tag-along rights: That ensures AP Oil is able to participate in the same kind upside as Zongshen should they decide to sell their stake in the JV to a third party. IE Singapore’s presence at the signing ceremony should also provide further comfort for shareholders of AP Oil (see figure 1).

In-line with our investment thesis of unlocking cash. This development in AP Oil moves in-line with our long-term investment thesis that AP Oil is poised to increase shareholder value by utilizing its large cash hoard for corporate actions. With this, our investment call on this severely undervalued business with a stable and cash-generative business remains unchanged. We see this as a stock catalyst and expect AP Oil to continue to invest surplus cash (S$33m net cash at 1H16; mkt cap S$41m) as we maintain our BUY rating and target price of S$0.33 (based on 1x FY16F BVPS).