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China Southern Airlines

Chinese airline earnings to begin descent next year, analysts say

Lower yields and higher costs add up a difficult coming year for mainland airlines

PUBLISHED : Monday, 12 December, 2016, 1:28pm
UPDATED : Monday, 12 December, 2016, 10:23pm

A triple threat of lower yields, higher fuel prices and yuan depreciation are expected to see Chinese airlines’ earnings slip next year, analysts say.

“Not only are airline earnings under pressure from lower yields, costs are also becoming a problem,”

said Andrew Lee, equity analyst at Jefferies.

Lee believes that earnings for mainland carriers have peaked this year and are expected to decline through 2017.

Aviation fuel is the largest cost item for airlines, accounting for up to 22 per cent of operating costs for the first half of this year, Lee said.

But a domestic China fuel surcharge can only be applied when the jet fuel price reaches 5,000 yuan per tonne, or 29 per cent higher than the current price, while a Hong Kong passenger fuel surcharge requires government approval.

“We forecast airline earnings will decline in 2017, leading to our cautious view on the sector as competition is leading to yield pressure while high oil prices are hurting bottom lines given the lack of fuel surcharge,” Lee said.

HSBC has a similarly negative view, forecasting that the major airlines will see declines in profits next year due to foreign exchange loses and falling passenger yields.

Air China, for instance, is expected to see a 40 per cent drop in net profit in 2017 on year, while China Eastern Airways is expected to see a 17 per cent slide in net profit, and China Southern Airways will see a 55 per cent plunge.

“Our 2017 earnings forecasts for Chinese airlines are significantly lower than consensus because of our expectation of a softer yield supported by our supply and demand models,” said Jack Xu, aviation analyst at HSBC.

Xu said there could be minor oversupply next year, with ticket prices under pressure especially in

China’s smaller cities.

The over supply will negatively impact China Southern Airlines, which has the highest market share in lower tier cities, relatively weak ticket pricing and a lack of business passenger traffic.

A further challenge for the airlines is the depreciating yuan, which HSBC forecasts will drop to 7.2 yuan per US dollar by the end of next year, adding up to an enlarged burden for holders of US-dollar denominated debt.

Airlines have been working to reduce their dollar denominated debt levels. State owned carriers have made early repayments in an attempt to lower their share of US-dollar denominated debt to 40 to 50 per cent of total borrowing.

On the positive side, in October, the Civil Aviation Administration of China released a new list of routes that are eligible for ticket price adjustments.

“We believe there will be significant positive impact if the government includes domestic trunk routes in the reform,” Xu said.

HSBC said it favoured the Hong Kong-listed shares of China Eastern Airlines among state owned carriers because of its high market share of domestic trunk routes.

HSBC maintained a buy rating, although it lowered the target price to HK$4.8 from HK$5.6.

Meanwhile, HSBC downgraded the Hong Kong-listed shares of China Southern Airlines to hold from buy, and slashed the target price from HK$4.8 to HK$6.1.

HSBC noted that Air China would face headwinds from Cathay Pacific, in which it owns a 30 per cent. Cathay’s chief executive Ivan Chu Kwok-leung said in early December that next year would remain challenging as pressure on yields, excessive capacity and a decline in premium traffic continued to impact the business.

Meanwhile, Xu said the Hong Kong-listed shares of mainland airlines were relatively cheap.

“In our view, the valuations of Chinese SOE Airlines’ H-shares remain at depressed levels and at large

discounts to historical averages partly because of macro headwinds.”

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