AirAsia (AIRA:MK) Fair Value: M$3.40
19 June 2017, China – Earlier in May this year, AirAsia Bhd (AIRA:MK) signed a memorandum of understanding with China Everbright Group and the Henan Government Working Group to establish AirAsia (China), a low-cost carrier (LCC) to be based in the Henan provincial capital of Zhengzhou.
AirAsia (China)’s similarities to Henan Cargo Airlines joint venture
The shareholding of the joint venture, AirAsia (China) has yet to be finalised but we believe that that it will be capped at 25%; similar to the Henan Cargo Airlines joint venture that was just granted final approval on 12th June 2017.
Henan Cargo Airlines, which until recently was referred to as Cargolux China, is a cargo airline that will operate out of Zhengzhou under a Chinese Air Operator’s Certificate (AOC). 75% of the joint venture will be owned by Henan provincial government companies: Henan Civil Aviation Development and Investment Co. (HNCA), Henan Airport Group and Xinggang Investment Group which represent the Zhengzhou economic zone. The remaining 25% will be taken owned by Cargolux.
The two joint ventures have clear similarities, both are airlines that will be based out of Zhengzhou Xinzheng International Airport and are essentially supported by the Henan provincial government. Cargolux was rumoured to be holding out for a 35% stake in Henan Cargo Airlines but had to settle for 25% under China foreign airline ownership laws.
AirAsia Bhd (AIRA:MK) has historically sought the highest stake that is allowed based on regulatory requirements in its overseas joint venture airlines and is therefore likely to want a bigger stake and might arguably be adding greater value than Cargolux to its respective China joint venture through the proposed establishment of a dedicated low cost carrier (LCC) terminal, an aviation academy and aircraft maintenance, repair & overhaul (MRO) facilities as well as possessing one of the world’s strongest airline brand. However, a crucial difference lies in the shareholding of AirAsia Bhd (AIRA:MK) and Caroglux. The Henan Civil Aviation Development and Investment Co. (HNCA) owns a 35% stake in Cargolux while AirAsia Bhd (AIRA:MK) has no significant shareholding by a Chinese state or provincial company.
Chart: Potential shareholding structure of AirAsia (China)
AIRASIA (CHINA) LCC MODEL WELL-SUITED FOR HENAN REGARDLESS OF FOREIGN AIRLINE OWNERSHIP CAP
Low cost carrier (LCC) market penetration remains low in China and the North Asia region at less than 10% market share compared to over 50% in South Asia and Southeast Asia regions.
While Henan province has a lower per capita income relative to the wealthier Chinese provinces, it has an estimated population of around 100 million. Henan province’s population is easily the 3rd largest and possibly the largest in China depending on the demographic methodology used.
Henan’s less developed economy dependent on agriculture and vulnerability to flooding has also historically led to a huge population of Henan migrant workers employed in other provinces.
Thus AirAsia (China)’s low fare, no frills and high flight frequency LCC business model is well positioned to tap into Henan’s passenger market.
Due to Zhengzhou’s strategic location in central China, AirAsia (China) will be able to cover all the cities in China using its narrowbody aircraft fleet and the average flight time from Zhengzhou to the major cities in China is less than 3 hours. We expect AirAsia (China) to operate the Airbus A320ceo or A320neo aircraft but do not rule out the possibility of the Comac C919 aircraft or its variant if it generates further political goodwill.
STRATEGIC LOCATION WITH ACCESS TO LARGE TRAVEL CATCHMENT AREA – ZHENGZHOU IS RANKED THE 15th BUSIEST PASSENGER AIRPORT IN CHINA
Zhengzhou Xinzheng International Airport’s passenger throughput grew 18% CAGR in the past 10 years, ahead of the 12% CAGR growth pace of the Chinese airports industry.
This has raised Zhengzhou Xinzheng International Airport’s ranking to the 15th busiest passenger airport in China in 2016 from 22nd position ten years ago in 2006. Zhengzhou Xinzheng International Airport handled 40.5 million passengers in 2016, implying 2.0% market share of the Chinese airports industry’s total passenger throughput.
Chart: Zhengzhou Airport passenger throughput growth (2001 to 2016)
Chart: Top 50 passenger airports in China (2016)
Given Henan’s lower average per capita income relative to the more developed cities in China, AirAsia China is well positioned to help stimulate travel demand given its low cost structure and attractive airfares. Due to Zhengzhou’s strategic location in central China, AirAsia (China) will be able to cover most cities in China with its narrowbody aircraft fleet’s flying range.
The initial target passenger market could include migrant workers, visiting friends & relatives (VFR) traffic as well as leisure travellers as AirAsia (China) improves the affordability of air travel for people in the Henan area. Once more flight frequencies are in place, AirAsia (China) could also attract passengers travelling on business, particularly those working in private and small & medium enterprises. We expect AirAsia (China) to boost international traffic between Zhengzhou and Asia.
ZHENGZHOU AIRPORT NEEDS TO BROADEN ITS DIRECT FLIGHTS NETWORK REACH
Zhengzhou Airport has many airline customers but significantly fewer destinations compared to its stronger neighbours Chengdu and Chongqing airports. AirAsia (China)’s largest growth opportunity will be China-Asia routes.
Zhengzhou Airport serves predominantly domestic flights at present (96%). International flights account for only 4% of the total capacity to/from Zhengzhou Airport. In contrast, neighbouring airports Chengdu and Chongqing have a larger international route exposure and handle larger passenger and cargo volumes than Zhengzhou Airport.
Zhengzhou Airport has 46 airline customers but is connected to only 68 domestic and 20 international destinations. In comparison, Chengdu Airport has 61 airline customers and serves 111 domestic and 54 international destinations. Chongqing Airport has 49 airline customers (only 3 airlines more than Zhengzhou Airport) and serves 105 domestic and 31 destinations (55% more destinations than Zhengzhou Airport).
International routes are likely to face less competition than domestic routes and enable AirAsia (China) to leverage on the AirAsia Group’s international branding and wide network in Asia.
Chart: Zhengzhou airport route exposure (1H17)
Chart: Airline market share at Zhengzhou Airport (1H17)
Low cost carrier market penetration remains relatively low in China and therefore offers large untapped domestic and international markets for AirAsia (AIRA:MK). However, the key challenges are the large incumbent airlines which also operate young aircraft fleets and have fairly competitive cost structures. These airlines also have deep pockets and access to cheap financing which enable them to withstand the impact of yield pressure. AirAsia (AIRA:MK) also needs to adapt to vastly different cultures and regulatory framework. In addition, AirAsia Group management resources may be spread too thinly given its large number of geographically spread-out joint venture airlines.
Another key constraint to growth is air traffic congestion. Greater access to the airspace for commercial use is needed to improve the operating efficiency and on-time performance of the Chinese passenger and cargo airline industry. In addition, start-up airlines typically take at least 2 to 3 years before they turn profitable. As such, more government incentives and/or subsidies will be required to help AirAsia (China) in its initial phase of expansion.
AirAsia (AIRA:MK) plans to invest in building a dedicated low cost carrier terminal at Zhengzhou Airport. It will also establish an aviation academy to train pilots, engineers and crew and an aircraft maintenance, repair and overhaul (MRO) facility. This will help tackle the pilot shortage issue and reduce the MRO-related costs of operating in China, enabling AirAsia (China) to be more cost competitive.
Negatively impacted listed airlines:
- China Southern Airlines (1055:HK) is the dominant carrier with 24% market share at Zhengzhou Airport and 40% share including its subsidiary and associate airlines.
- Hainan Airlines (600221:CH) has a market share of 7% at Zhengzhou Airport and 28% share including its subsidiary and associate airlines.
- China Eastern Airlines (670:HK) and its 100%-owned Shanghai Airlines have a market share of 10% at Zhengzhou.
The neighbouring airports Chengdu and Chongqing may also be negatively impacted if more international passenger and cargo flights are launched to/from Zhengzhou Airport, increasing the competition for traffic among the three airports.
- Air China (753:HK) has the largest market share at Chengdu Airport and Chongqing Airport at 27% and 19% respectively among all the carriers.
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