AVIATION: ANALYSIS
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Yuan

Chinese airlines face headwinds from weakening yuan

PUBLISHED : Tuesday, 22 November, 2016, 10:10pm
UPDATED : Tuesday, 22 November, 2016, 10:56pm

The yuan’s depreciation is most keenly felt by the country’s airlines, as the weaker currency makes aircraft and jet fuel more costly, while its weaker buying power abroad deters outbound tourism and crimp their revenue.

“A weaker yuan will typically hurt airlines the most because they have to pay for aircraft and jet fuel in US dollars but generate most of their revenue in yuan,” said Victor Au, Delta Asia Securities’ chief operating officer.

China Eastern Airlines Corp placed orders for 20 Airbus aircraft this year.

“The yuan’s depreciation also lifts interest costs for airlines which raise a lot of dollar-denominated debt,” Au said.

The yuan weakened 3.1 per cent last year, leading to an 18-fold surge in foreign exchange losses, or US$2.5 billion, for the mainland’s three biggest carriers – China Southern Airlines, Air China and China Eastern. As much as 80 per cent of their debt was denominated in dollars last year, according to Bloomberg data.

The yuan’s deterioration has gathered pace this year with a 6.2 per cent drop against the dollar.

“Accelerated yuan depreciation since October [last year] implies higher risk of foreign exchange losses for Chinese airlines,” said Edward Xu, an analyst with Morgan Stanley who has an “underweight” recommendation on Air China’s shares.

The broker cut its earning estimates for all mainland airlines from this year to 2018.

Next year’s earnings of the Big Three are expected to decline by between 9 per cent and 10 per cent for every 1 per cent that the yuan weakens against the dollar, according to a research report by Macquarie, which is recommending investors to “sell” airline shares.

Adding to the carriers’ woes, analysts are also expecting the price of jet fuel to increase, reversing the previous declining trend.

Mainland airlines have not been hedging their fuel costs since 2008, when Air China and China Eastern reported paper losses because of wrong-way bets on the price of jet kerosene. While that strategy had been beneficial with crude oil at US$40 per barrel, the same cannot be said when the price of oil is expected to double to US$80 per barrel by 2018, according to Morgan Stanley.

“In view of increasing oil prices and accelerated yuan depreciation, we expect more difficulties for Chinese airlines due to a lack of hedging positions to cover their fuel consumption or dollar debt exposures,” Xu said.

On the demand side, he said mainland outbound travel demand faced some near-term disruptions, led by political issues between Beijing and some neighbouring governments.

However, he remained positive on the long-term outlook.

“We see increasing uncertainty on the US market following the election, as potential protectionism and immigration restrictions along with further yuan weakness do not bode well for growth in Chinese passengers,” Xu said.

“Given significant price competition on the outbound travel market, exacerbated with short-term weakness on some Asian markets including South Korea, Taiwan and Japan led by political issues, there is a tendency for Chinese airlines to withdraw capacity back to domestic routes, adding near-term pressure on domestic yields.”

For domestic demand, Xu said it might continue to be constrained by limited landing slots at major hub airports such as Beijing and Shanghai, while the pricing environment would remain fragile as business travel was still depressed by macro weakness.