China Eastern Airlines leads sector in yield growth & non-fuel unit cost cuts in 1H18

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China Eastern Airlines Corp Ltd (670:HK)

Price Target: HK$7.30 | Rating: Buy

31 August 2018, China - China Eastern Airlines' (670:HK) 1H18 financial results beat our conservative expectations - net profit was Rmb2.3 billion, implying a net profit margin of 4.2%. Here are our key takeaways from China Eastern Airlines’ financial results and management briefing:

#1 Strongest improvement in underlying pre-tax profit among Big 3 Chinese carriers: China Eastern Airlines’ underlying pre-tax profit surged 49% y/y to Rmb898m in 1H18 if we exclude Rmb2.8B subsidy income and Rmb546m forex loss in 1H18 notwithstanding the 26% y/y increase in fuel cost which constituted 29% of its total cost. This improved its underlying pre-tax profit margin to 1.7%, up 0.5ppts y/y but still ranks lower than China Southern Airlines’ 2.5% and Air China’s 6.0% underlying pre-tax profit margins in 1H18.

#2 Turns free cash flow positive: China Eastern Airlines’ operating cash flows increased 46% y/y in 1H18 notwithstanding the higher fuel costs and generated positive free cash flows of Rmb728m, a marked improvement from its Rmb3.6B negative FCF in 1H17.

#3 Strongest improvement in passenger yields and unit revenue among Big 3 Chinese carriers: China Eastern Airlines’ passenger yield rose 2.8% y/y in 1H18. It is the only airline among the Big 3 Chinese carriers which achieved yield improvements on both domestic and international routes, a result of its more conservative capacity expansion strategy compared to peers.

China Eastern Airlines’ domestic passenger yield rose 2.8% y/y while international passenger yield rose 2.7% y/y while regional passenger yield held steady in 1H18. Even if we exclude fuel surcharges, China Eastern Airlines’ underlying passenger yield still improved by 1.9% y/y, driven by the domestic yield improvement of 2.8% while international and regional yields held steady. CEA’s overall unit revenue RASK improved 4.1% y/y in 1H18 – domestic +3.6%, international +4.9%, regional +3.6%.

Chart: China Eastern Airlines Unit Revenue RASK Improvement (1H18)

China Eastern Airlines Unit Revenue RASK Improvement (1H18)

#4 Increased pricing power on Europe, North America and Australia routes: China Eastern Airlines achieved meaningful improvement in its revenue per seat km on Europe (+5.5% y/y), North America (+2.1%) and Australia (+3.3%) routes.

#5 Largest unit cost reduction among Big 3 Chinese carriers: China Eastern Airlines cut its non-fuel unit cost by 4.4% y/y, ahead of Air China’s 4.1% reduction and well ahead of China Southern Airlines’ 2.1% drop.

 #6 Budget carrier subsidiary China United Airlines’ performance continued to improve. 100%-owned China United Airlines reported a net profit of Rmb440m, up 23% y/y and a net profit margin of 16.4% (+1ppt y/y) in 1H18.China United Airlines’ direct sales rose to 72.2% of total sales, up 5ppts y/y in 1H18. Non-flight revenue rose 46% y/y to Rmb190m.

#7 Lowest US dollar debt exposure among Big 3 Chinese carriers: China Eastern Airlines has pared down its US dollar debt exposure further to only 24.0% at the end of June 2018, down 4ppts y/y. CEA has the lowest USD debt exposure among the Big 3 Chinese carriers – Air China’s USD debt exposure is 37.5% while China Southern Airlines’ is 32%. Chinese yuan debt constitutes 66% of its total debt while other currencies account for 10% of its total debt.

#8 Market share improved at key hubs: China Eastern Airlines’ market share improved 0.2ppt, 0.5ppt and 1ppt in its Shanghai, Beijing and Kunming hubs respectively. CEA plans to transfer all of China United Airlines’ capacity to the new Beijing airport when it starts operations in Oct 2019. CEA will have 40% market share at the new airport.

#9 Capacity growth will be moderate in 2H18, supporting further yield improvement: China Eastern Airlines plans to increase capacity growth by 8.0% y/y – domestic routes (+8.1% y/y), international (+7.9%), regional (+8.1%) in 2H18. This is a moderation from 1H18, resulting in full year overall capacity growth of 8.9% y/y for 2018 (domestic +9.2%, international +8.4%, regional +7.9%).

#10 Key headwinds and China Eastern Airlines’ earnings sensitivities to these negative drivers: 1) Jet fuel prices remain high – every 1% rise in jet fuel price will increase CEA’s annual fuel cost by Rmb114m, 2) Further weakening of the Renminbi – every 1% weakening in the CNY will cut CEA’s net profit by Rmb232m and 3) Rising interest rates – every 10bps increase will cut CEA’s net profit by Rmb29m.

 

Note: Stocks with upside of more than 10% based on our fair value are assigned an Outperform rating. Stocks with downside of more than 10% based on our fair value are assigned an Underperform rating. Stocks with upside or downside of less than 10% based on our fair value are assigned an In-line rating. These are Crucial Perspective’s proprietary rating classifications and by no means serve as investment recommendations.

Independent Research Declaration: Crucial Perspective does not own any position in the equities featured in this report nor have we received any compensation for writing this report.

 

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