China Eastern Airlines (670:HK) Fair value: HK$7.30
China Eastern Airlines (670:HK) Rating: Outperform
30 April 2018, China – We attended China Eastern Airlines’ (670:HK) post 1Q18 financial results management briefing. In summary, China Eastern Airlines’ financial performance beat our expectations, helped by a surprising 2% y/y improvement in passenger yields and greater fuel efficiency in 1Q18. We expect domestic passenger yields to rise further from 2H2018 given CEA’s moderate capacity growth plans and the progressive liberalization of domestic airfares in China. Based on our estimates, every 1% improvement in domestic passenger yield can boost China Eastern Airlines’ net profit by 7% on a full year basis all other things being equal. We maintain our Outperform rating and HK$7.30 fair value for the stock. Here are our 5 key takeaways from the briefing:
#1 Turns free cash flow positive in 1Q18
China Eastern Airlines (CEA) reported a net profit of Rmb1.98 billion in 1Q18, down 30% y/y, under PRC accounting standards. The results were boosted by forex gains of Rmb1.46 billion in 1Q18 due to the stronger Renminbi but offset by Rmb1.75 billion investment income from the disposal of Eastern Logistics in 1Q17 which was absent this year.
Excluding non-recurring items, China Eastern Airlines’ recurring profit was Rmb1.90 billion, 62% higher y/y in 1Q18, beating our expectations, mainly driven by stronger passenger traffic (+9% y/y) and higher passenger yields (+2% y/y) across the board on domestic, international and regional routes. Importantly, China Eastern Airlines generated substantial positive free cash flows of Rmb2.3 billion in 1Q18, a marked improvement from its negative free cash flow of Rmb255 million a year ago.
Chart: China Eastern Airlines Cash Flow Summary (1Q18 versus 1Q17)
#2 Significant upside in domestic passenger yields which will flow straight to bottom line
China Eastern Airlines’ passenger yields improved 2.2% y/y in 1Q18. We expect further yield improvement on domestic routes, helped by China Eastern Airlines’ moderate planned capacity growth this year and the domestic airfare liberalization. This will enable China Eastern Airlines to progressively raise fares on nearly 50 domestic routes which contribute around 35% of China Eastern Airlines’ domestic revenue in the coming months. Based on our estimates, every 1% improvement in domestic passenger yield can boost China Eastern Airlines’ net profit by 7% on a full year basis all other things being equal.
#3 Robust China outbound travel demand will exceed China Eastern Airlines’ moderate aircraft fleet expansion plans in the coming years
China Eastern Airlines’ planned capacity growth will be moderate this year at only around 9% y/y. This should help support its domestic as well as international passenger yield improvement. In fact, in the next three years, China Eastern Airlines Group’s gross aircraft fleet expansion plans will be moderate. It is scheduled to add 67 aircraft to its fleet and retire 15 aircraft in 2018 (for the remaining 3 quarters of this year, CEA is expected to take delivery of 56 aircraft and retire 11), 62 in 2019 (with no aircraft retirements) and 61 aircraft in 2020 and retire 10, implying a net capacity growth of only 8%, 9% and 7% in the respective years. This supports our view that China’s robust outbound travel demand will exceed the Chinese airlines’ capacity growth for the next 5 years. See our previous report below:
#4 Dependence on third-party sales agents declines further
China Eastern Airlines is still pushing hard on lifting its direct sales which is helping to reduce its dependence on third-party sales agents and commissions costs. Direct sales surged 21% y/y in 1Q18 and now contribute 54% of China Eastern Airlines’ revenue, a 6ppt improvement from a year ago.
# 5 Improving fuel efficiency helps to mitigate the negative impact of higher fuel prices
We had highlighted in our previous report (see below) that the higher fuel price is the key earnings risk in 2018 as China Eastern Airlines remains unhedged and spot jet fuel prices have risen over 30% y/y this year.
The improved on-time performance of flight schedules in China has helped China Eastern Airlines to reduce fuel burn. China Eastern Airlines’ fuel consumption rose only 6% y/y in 1Q18, below its capacity expansion of 9% in ASK terms and 12% in ATK terms. CEA also operates one of the youngest aircraft fleets globally, averaging only 5.5 years old, which is more fuel efficient. Consequently, China Eastern Airlines’ fuel cost rose only 19% y/y in 1Q18.
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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