China Eastern ponders next move as time ticks
Just how much longer can the country's third-largest carrier hold out on a merger stalemate before it is grounded by increasingly harsh operating conditions?
When shareholders overwhelmingly voted down China Eastern Airlines' proposal to sell a 24 per cent stake to Singapore Airlines and Temasek Holdings in January, they were counting on a better offer from China National Aviation Corp (CNAC).
Little did they realise that the counteroffer would be turned down by China Eastern's management, leaving the carrier high and dry.
China Eastern has to rework its flight plan soon either to accept a merger with Air China, CNAC's unit, or lobby Beijing to let it resume talks with its Singapore suitors to survive a slowdown in domestic air traffic growth and rising jet fuel prices.
Despite strong domestic economic growth last year, the airline only managed to break even at the operating level, making a measly operating profit of 39 million yuan (HK$43.47 million), below analysts' estimates.
A bigger than expected foreign exchange gain of 2 billion yuan helped reduce the cost of its US dollar borrowings, lifting net profit to 269 million yuan or 6 fen per share. Still, that was 41 per cent below the market consensus estimate.
Analysts say that suggests an urgent need to improve management efficiency and restructure the firm.
China Eastern had hoped that by partnering with Singapore Air, it could achieve precisely that. But after shareholders rejected the foreign proposal, management did not give them a chance to consider CNAC's counteroffer, rejecting it as soon as it was presented in February.
'We still do expect some sort of restructuring to be completed this year, given the company's desperate need for capital and China's desire to establish a 'super carrier' by 2010,' said Andrew Au, a transport analyst at Cazenove.
This year, the carrier plans to add 19 aircraft, including 17 Airbus and two Boeing models. Its finance costs or net interest expenses will remain high at 1.8 billion yuan this year and 1.6 billion yuan next.
Without any capital infusion, its debt ratio will continue to deteriorate. Last year, net gearing increased to 1,475 per cent from 1,349 per cent in 2006.
What makes the situation more critical for China Eastern is the slowing domestic economy. The more than 50 per cent drop in the mainland stock market and rising consumer prices have already taken a toll on air traffic.
Rivals China Southern Airlines and Air China posted slower passenger growth in the first quarter. Air China saw a 0.9 per cent drop in passenger numbers last month and 5.7 per cent growth in the first quarter, compared with 10.6 per cent growth for the same period last year. Meanwhile, passenger numbers at China Southern rose 11.2 per cent in the first quarter, compared with 15.6 per cent last year.
At China Eastern, passenger numbers rose only 1.12 per cent year on year last month and 4.8 per cent in the first quarter, compared with 14 per cent for the same period last year.
'We expect less air travel, sky-high oil prices and rising labour costs to contribute to a challenging 2008,' said Ally Ma, a transport analyst at Citigroup.
Analysts expect oil prices to hover above US$100 per barrel this year, up an average of 15 per cent from last year. This will translate into a 7.5 per cent increase in the average fuel price for mainland airlines, according to Citigroup research. Fuel cost accounts for 43 per cent of operating costs at China Eastern.
A shortage of cockpit crew is also forcing mainland airlines to raise pilots' salaries. Last year, China Eastern's salary costs rose 22 per cent on a 12 per cent growth in headcount, longer flying hours and staff bonuses to celebrate the firm's return to the black after three years of losses. Citigroup predicts that staff costs will be about 20 per cent of expenses in the next two years.
Apparently overworked pilots at Yunnan Air, a China Eastern subsidiary, called a strike last month. Eighteen flights turned back in mid-flight, angering thousands of passengers and tarnishing the airline's image.
Citigroup expects China Eastern to book a smaller foreign exchange gain of 1.3 billion yuan this year and 1.86 billion yuan next year - not enough to prop up its bottom line.
The carrier seems to have no choice but accept a partner capable of making changes. The sooner it gets hitched the better, be it to a welcome suitor or one that is barely tolerated.