China’s major airlines set for sunnier skies after lowering US dollar debt levels
China’s three major airlines are on course for improving earnings this year amid ongoing passenger traffic growth and diminished concerns over foreign exchange losses.
In anticipation of a further depreciation in the Chinese yuan, Air China, China Eastern Airlines and China Southern Airlines have been cutting their US dollar debt exposure, from above 70 per cent at the peak level to below 50 per cent by year-end 2016.
Because Chinese airlines earn most of their revenue in yuan, they are vulnerable to shifts in foreign exchange markets, even though borrowing abroad can be cheaper than the interest rates on offer domestically.
“The lower US dollar debt levels have mitigated the risks of foreign exchange loss,” said Vincent Ha, an analyst from Deutsche Bank. “For US dollar debt, Chinese airlines still seem to be aiming for more cuts. As such, we see... lower foreign exchange losses.”
In previous years, Chinese airlines have been hesitant to covert US dollar debt into yuan-denominated equivalents due to higher borrowing costs. However, thanks to ample liquidity in the Chinese banking system, options to refinance in yuan are now available at compelling rates, according to Ha.
In the past, lower interest rates on US dollar borrowings, combined with a backdrop of a strengthening Chinese yuan, led to practises where Chinese airlines would typically finance more than 70 per cent of aircraft procurement and leasing agreements in US dollars.
But this benign scenario came to an end when the Chinese yuan made an abrupt U-turn from what had been a long period of appreciation against the greenback, slipping 4.6 per cent and 6.9 per cent against the US dollar in 2015 and 2016 respectively.
That led to combined foreign exchange losses at the three major airlines of 16.1 billion yuan in 2015, and 11.6 billion yuan in 2016, according to estimates by Deutsche Bank.
Further depreciation in the yuan is expected, with Deutsche Bank forecasting the currency will ease to
7.4 per US dollar by the end of 2017 and 8.1 per US dollar by end 2018.
Meanwhile, passenger traffic growth at China’s airlines continues to rise, driven by resilient outbound tourism.
Passenger volume during the Lunar New Year holiday was up 15.1 per cent on year, totaling 9.84 million, accelerating from a 4 per cent passenger volume growth in 2016, according to the Civil Aviation Administration of China.
Air China’s February passenger load factor (PLF) rose to 83.4 per cent, up 2.2 percentage points on year, while China Southern Airlines increased to 84 per cent, reflecting a 3 percentage point rise from a year earlier.
Passenger load factor, a measure of capacity utilisation, helps show how well an airline is filling seats, and is an important indicator of revenue generation.
“A one percentage point rise in PLF would enhance the big three’s 2017 estimated net profit by 9 to 13 per cent according to our estimate,” said Yang Xin, an analyst from CICC.
Still, some analysts caution that mainland international air passenger travel growth has likely peaked and that the era ahead will entail more modest rates of growth in passengers heading abroad.
International air travel by mainlanders grew 7 per cent during the 2017 Lunar New Year, compared with 15 per cent in the same period in 2016, according to the National Tourism Administration.
“In our view, the slowdown could be led by lingering headwinds from Chinese yuan’s depreciation and ongoing political issues between China and certain Asian countries and regions,” said Edward Xu, an analyst from Morgan Stanley.
Some Chinese carriers have halted flights to South Korea because of escalating tensions between the two countries over the deployment of a US missile defence system.
Addition uncertainties facing Chinese airlines include the outlook for jet fuel prices.
“Since the Chinese airlines are mostly unhedged, they can rely only on the fuel surcharge to partially mitigate cost pressure,” said Ha.
Yang from CICC also warned that “the sharp rise in oil prices” is a major risk for Chinese airlines.