Air China 3Q17 Briefing Analysis & Implications for Cathay Pacific & Beijing Airport (694:HK)

Air China (753:HK) Fair value: HK$8.3 (raised from HK$7.5)
Air China (753:HK) Rating: Outperform

Cathay Pacific (293:HK) Fair value: HK$14.0
Cathay Pacific (293:HK) Rating: Outperform

Beijing Capital International Airport (694:HK) Fair value: HK$11.0
Beijing Capital International Airport (694:HK) Rating: Underperform

31 October 2017, China We attended Air China (753:HK)’s briefing where management discussed Air China’s 3Q17 financial results and the airline’s operating outlook. Here are our key takeaways and views on Air China as well as the implications for Cathay Pacific (293:HK) and Beijing Capital International Airport (694:HK).

 

AIR CHINA AND CATHAY PACIFIC’S SHARE PRICES HAVE RISEN 17% AND 11% SINCE OUR COVERAGE INITIATION AND RATING UPGRADE RESPECTIVELY

Note that Air China’s share price has risen 17% since we initiated coverage with Outperform rating on 4th April 2017 while Cathay Pacific’s share price has risen by 11% since we upgraded the stock from Underperform to Outperform on 27th July 2017. See our previous reports below for more details:

Air China (753:HK) Initiation Research Report 2017: Top choice among the Chinese airlines

Cathay Pacific (293:HK) upgraded to Outperform: Takeover by Air China (753:HK) likely

 

AIR CHINA’S POSITIVE FREE CASH FLOWS NEARLY TRIPLED IN 9M17 AND WE RAISE OUR EARNINGS FORECASTS AND FAIR VALUE TO HK$8.30

Air China (753:HK)’s 3Q17 financial performance beat our expectations. Net profit grew 31% y/y to Rmb5.0B, under PRC accounting standards.

Chart: Air China 3Q17 and 9M17 results at a glance (under PRC accounting standards)

Chart: Air China 3Q17 and 9M17 results at a glance (under PRC accounting standards)

 

Crucial Perspective verdict: The results were boosted by foreign exchange gains of Rmb940m due to the stronger Renminbi versus Rmb507m loss in 3Q16. Excluding these, Air China’s recurring profit would have been Rmb4.0B, 6% lower y/y in 3Q17, which still beat our forecast of Rmb3.0B. This has raised Air China’s 9M17 net profit to Rmb8.3B, 15% higher y/y.

In 9M17, Air China’s positive free cash flows nearly tripled to Rmb12B from Rmb4B in 9M16. This will help to reduce its financial leverage further. We forecast Air China’s net debt-equity to drop to 98% at the end of 2017 from 144% in 2016.

We have raised our full year 2017 net profit forecast to Rmb8.0B, mainly to factor in the better than expected passenger yields and stronger Renminbi exchange rate. Consequently, we raise our fair value to HK$8.30 from HK$7.50. Note that 3Q is typically the peak season for the Chinese carriers and they tend to incur losses during the 4th quarter. See our revised earnings forecasts in the Financial Summary table at the end of this report.

 

POSITIVE FOR CATHAY PACIFIC (293:HK): STRONG GLOBAL AIR CARGO MARKET, PEAK TRAVEL SEASON AND RESTRUCTURING BENEFITS IMPROVED CATHAY PACIFIC’S 3Q17 FINANCIAL PERFORMANCE

Crucial Perspective verdict: This is a positive read-through on Cathay Pacific (293:HK). Cathay Pacific does not report quarterly financial results but it is 29.99%-owned by Air China and one of its major associates. Based on Air China’s investment income from associates & joint ventures of Rmb94m in 3Q17 (down 55% y/y but a marked improvement from its Rmb401m investment loss in 1H17, we can infer that Cathay Pacific likely turned profitable or was at least close to break even in 3Q17, a marked improvement from its huge loss of HK$2.1B in 1H17.

The benefits of Cathay Pacific’s 3-year Transformation Programme are starting to kick in. In addition, as the world’s 4th largest cargo airline, Cathay Pacific, as well as Air China Cargo, is benefitting from the strong cargo market. 4Q17 is likely to be even stronger as we head into the peak season for cargo. Cargo drives 24% of Cathay Pacific total revenue.

Air China’s strong results will also imply higher profit contribution to Cathay Pacific which owns a 18.13% stake in Air China.

 

AIR CHINA IS RAMPING UP ITS INTERNATIONAL PASSENGER CAPACITY GROWTH WHILE KEEPING DOMESTIC CAPACITY GROWTH MODERATE

Air China plans to increase its overall passenger capacity (ASK) by 9%-10% y/y going forward, higher than its 5% capacity growth in 9M17. This is mainly driven by Air China’s plans to accelerate its passenger capacity growth on international routes to 15% y/y from 5% in 9M17. Management’s strategy is to reduce the proportion of short-haul flights and increase the number of long-haul flights. Passenger capacity is expected to grow only 5%-6% y/y on domestic routes, similar to Air China’s capacity growth pace of 5% in 9M17.


Crucial Perspective verdict: The moderate industry capacity growth on domestic routes, helped by capacity growth cutbacks by Air China’s competitor carriers, should help support domestic passenger load factors and yield improvement or at least keep domestic yields stable as the Chinese airline sector’s domestic routes have been facing greater traffic diversion to hi-speed rail, particularly on the lucrative Beijing-Shanghai route, in recent months due to the declining on-time performance of the flights.

We expect Air China’s passenger yields to remain under pressure in the South West Pacific and North America route regions given the industry overcapacity while passenger yields on Europe, Japan and Africa flight are expected to improve further y/y.

IMPLICATIONS FOR BEIJING CAPITAL INTERNATIONAL AIRPORT (694:HK): AIR CHINA’S HIGHER CAPACITY GROWTH IN 4Q17 DOES NOT IMPLY MUCH STRONGER THROUGHPUT GROWTH FOR BCIA AS AIR CHINA’S CAPACITY GROWTH IS BEING OFFSET BY OTHER AIRLINES’ CAPACITY CUTS

Crucial Perspective verdict: Although Air China is the most dominant carrier at the airport with a 39% market share of the total aircraft movements and seat capacity out of Beijing Capital International Airport (694:HK), its plans to accelerate capacity growth in 4Q17 does not translate into a similar pace of growth for Beijing Capital International Airport, contrary to common investor perception. This is because the other major Chinese airlines are cutting capacity out of Beijing Capital International Airport. See our previous report for more details:

Research Report: Chinese Airports (694:HK, 600009:CH) may see near-term price correction

Chart: Beijing Capital International Airport – Airline seat growth (4Q17)

Chart: Beijing Capital International Airport - Airline seat growth (4Q17)

AIR CHINA GROUP FLEET GROWTH WILL MODERATE TO ONLY 7%-8% PER ANNUM IN THE NEXT TWO YEARS

As at end September 2017, Air China Group has a total fleet of 643 aircraft, of which 32% are on operating leases. In 2017, Air China Group is scheduled to take delivery of 57 new aircraft, implying an annual capacity growth of 9% on a gross basis before taking into account aircraft retirement. In 2018, Air China Group is expected to take delivery of only 49 aircraft, implying a gross capacity growth of only 7%. Aircraft deliveries will pick up again in 2019 to 61 aircraft in 2019 but still at a moderate gross capacity growth rate of 8%.

Crucial Perspective verdict: Air China’s moderate aircraft fleet growth plans in 2018 and 2019 would enable the airline to be more selective in where to deploy its incremental capacity, reducing the pressure to drop fares to fill up its aircraft.

Chart: Air China Group – Number of aircraft deliveries (2017 to 2019)

Chart: Air China Group - Number of aircraft deliveries (2017 to 2019)

 

US DOLLAR DEBT EXPOSURE FELL FURTHER BUT LARGER THAN CHINA EASTERN AIRLINES’ EXPOSURE

US dollar debt accounts for 40% of Air China’s total debt, Renminbi 58% and other currencies 2% in end Sep 2017.

Crucial Perspective verdict: The proportion of US dollar debt has shrunk further in 3Q17 compared to Air China’s 49% US dollar, 49% Renminbi and 2% other currencies’ debt in end December 2016. Air China’s earnings will become less leveraged to Renminbi-US dollar exchange rate volatility compared to previous years. However, compared to China Eastern Airlines (670:HK) whose US dollar debt accounts for only 31% of its total debt, Air China still has a higher US dollar debt exposure as at end September 2017.

Chart: Air China Financial Summary (2015 to 2019)

Chart: Air China Financial Summary (2015 to 2019)

 

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