Fair value: HK$5.0
30 October 2017, China – We attended China Eastern Airlines (670:HK)’s briefing where management discussed China Eastern Airlines’ 3Q17 financial results (under PRC accounting standards) and the airline’s operating outlook. Here are our key takeaways and analysis:
We have also raised our earnings forecasts for China Eastern Airlines, mainly to factor in the better than expected passenger yields and stronger Renminbi exchange rate.
PEAK SEASON 3Q17 RESULTS STRONGER THAN EXPECTED, WE RAISE OUR EARNINGS FORECASTS
China Eastern Airlines (670:HK)’s 3Q17 financial performance beat our expectations. Net profit was Rmb3.6B, 3% higher y/y under PRC accounting standards.
Chart: China Eastern Airlines 3Q17 and 9M17 results at a glance (under PRC accounting standards)
Crucial Perspective verdict: The results were boosted by foreign exchange gains of Rmb620m due to the stronger Renminbi versus Rmb410m loss in 3Q16. Excluding these, China Eastern Airlines’ recurring profit would have been Rmb2.9B, 24% lower y/y in 3Q17, which still beat our forecast of Rmb2.5B. This has raised China Eastern Airlines’ 9M17 net profit to Rmb7.9B, 18% higher y/y. We have raised our full year 2017 net profit forecast to Rmb6.7B, mainly to factor in the better than expected passenger yields and stronger Renminbi exchange rate. 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.
MORE MODERATE CAPACITY GROWTH IN 4Q17 AND IN 2018 WHICH IS POSITIVE AND IN LINE WITH WHAT WE MENTIONED IN OUR PREVIOUS REPORTS
China Eastern Airlines plans to increase its overall passenger capacity (ASK) by 9% y/y in 4Q17, slightly lower than its 10% capacity growth in 9M17. Passenger capacity is expected to grow only 7% y/y (versus 9% y/y in 9M17) on domestic routes in 4Q17. However, on international routes, passenger capacity is expected to accelerate to 13% y/y (versus 12% y/y) in 4Q17. Management’s strategy is to reduce the proportion of short-haul flights and increase long-haul flights.
China Eastern Airlines is scheduled to take delivery of 67 new aircraft and phase out 15 aircraft, increasing its total fleet by 52 aircraft on a net basis in 2018. China Eastern Airlines plans to increase its overall passenger capacity (ASK) by around 10% y/y (domestic routes +8% y/y, international routes +10% to 12% y/y) in 2018.
Crucial Perspective verdict: The capacity growth moderation is in line with our expectations. See our previous report for more details:
This should help support domestic passenger load factors and yield improvement or at least keep domestic yields stable as domestic routes do face hi-speed rail competition. We expect China Eastern Airlines’ passenger yields to remain under pressure on some international routes where China Eastern Airlines will remain aggressive in its capacity expansion, namely Australia routes where it is expected to expand capacity by 20-30% y/y and South East Asia routes where it is expected to increase capacity by over 15% y/y.
China Eastern Airlines’ more moderate capacity growth plans is a negative read-through for Shanghai International Airport (600009:CH) which supports our Underperform rating on the stock. See our previous report below for more details:
DEEPENING COOPERATION WITH AIR FRANCE-KLM & DELTA AIR LINES HAS LED TO MARKET SHARE GAINS AND MORE PREMIUM TRAFFIC FOR CHINA EASTERN AIRLINES WHICH IS NEGATIVE FOR AIR CHINA
China Eastern Airlines (670:HK)’s parentco China Eastern Air Holding Company (CEAHC)’s acquisition of a 10% stake in Air France-KLM (AF:FP), China Eastern Airlines’ marketing agreement with Air France-KLM as well as Delta Air Lines (DAL:US)’ 3.22% equity investment in China Eastern Airlines will enhance China Eastern Airlines’ cooperation with the two carriers in major international markets.
Crucial Perspective verdict: This has helped to increase China Eastern Airlines’ access and connectivity on the China-Europe and China-North America route regions. This boosts China Eastern Airlines’ passenger traffic feed, particularly in the premium class segment which is yield-accretive. China Eastern Airlines’ revenue from its cooperation with SkyTeam Alliance partners as well as other airlines reached nearly Rmb4B, +37% y/y in 1H17.
China Eastern Airlines’ market share has increased 2ppts to 12% on China-Europe routes while its market share on China-North America routes remains stable y/y at 18% in 9M17, only 1ppt shy of Air China. This is negative for Air China (753:HK) as it will face a more formidable competitor airline group on China-Europe routes where Air China currently has a huge market share lead with 25% market share.
Chart: Airlines market share on China-Europe routes (9M17)
Chart: Airlines market share on China-North America routes (9M17)
LOW COST CARRIER CHINA UNITED AIRLINES’ PROFIT CONTRIBUTION HAS INCREASED SIGNIFICANTLY AND GARNERED A 1.3% DOMESTIC MARKET SHARE
China United Airlines’ operating and financial performance continued to improve in 3Q17, contributing a net profit of Rmb330m (50+% higher y/y) to the Group.
Direct sales accounted for 73% of China United Airlines’ total sales, up 9.2ppts y/y. China Eastern Airlines’ own direct sales has risen 34% y/y to 53% of total sales which continues to drive commissions costs lower (down 16% y/y) in 3Q17.
Crucial Perspective verdict: China United Airlines’ high proportion of direct sales is impressive. China Eastern Airlines is the only carrier among the Big 3 Chinese airlines which is progressive enough to operate a low cost carrier and is well-positioned to leverage on the growing budget travel market in China. China United Airlines’ domestic seat capacity has risen 15% y/y and it has garnered a 1.3% market share on China’s domestic routes in 9M17.
UNIT COST FELL SLIGHTLY NOTWITHSTANDING THE HIGHER FUEL COSTS
China Eastern Airlines’ unit cost per ATK fell 0.3% y/y in 3Q17.
Crucial Perspective verdict: This is positive considering that China Eastern Airlines’ fuel costs rose 13% y/y in 3Q17. This is also slightly better than its 0.2% y/y decline in unit cost in 1H17. China Eastern Airlines has been keeping a tight rein on costs which will support profit margin improvement once passenger yields start to recover.
US DOLLAR DEBT EXPOSURE FELL FURTHER, REDUCING EARNINGS SENSITIVITY TO RENMINBI EXCHANGE RATE VOLATILITY
US dollar debt accounts for 31% of China Eastern Airlines’ total debt, Renminbi around 62-63% and other currencies around 6-7% in end Sep 2017. China Eastern Airlines is likely to keep its US dollar debt exposure stable.
Crucial Perspective verdict: The proportion of US dollar debt has shrunk further in 3Q17 compared to China Eastern Airlines’ 34% US dollar debt, 58% Renminbi debt and 7% other currencies’ debt in end June 2017. China Eastern Airlines’ earnings will become less sensitive to Renminbi-US dollar exchange rate volatility compared to previous years.
Chart: China Eastern Airlines Financial Summary (2015 to 2019)
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