Robust China outbound travel to exceed Chinese airlines capacity growth for next 5 years

Air China (753:HK) Fair value: HK$11.50
Air China (753:HK) Rating: Outperform

China Eastern Airlines (670:HK) Fair value: HK$7.00
China Eastern Airlines (670:HK) Rating: Outperform

China Southern Airlines (1055:HK) Fair value: HK$9.50
China Southern Airlines (1055:HK) Rating: Outperform

29 January 2018, China – Airline capacity growth on China’s domestic and international routes is conservative, rising only 11% y/y in 1Q18 and will be more than met by robust China outbound travel demand. More importantly, based on our analysis of the Chinese airlines sector’s aircraft orderbook, the sharp drop in capacity growth from 2019 will drive industry supply shortage, boosting the Chinese airlines’ ability to raise their yields and profitability, facilitated by the recent China airfare deregulation plans.

AIRLINE CAPACITY GROWTH IS MODERATE IN MOST MAJOR ROUTE REGIONS IN 1Q18

We analyze the airline capacity growth on China’s domestic and international routes in 1Q18. Overall, the airlines’ capacity expansion is pragmatic, projected to rise only 11% y/y in 1Q18.

Excessive competition on Australia/New Zealand routes

The only market where we see oversupply hurting passenger yields is the China-Australia/New Zealand route region where capacity is growing at 23% y/y.

Implications on stocks: Among the Chinese airlines, China Southern Airlines (1055:HK) has the largest exposure to China-Australia/New Zealand routes. This is also negative for Qantas (QAN:AU) and Air New Zealand (AIR:NZ).

Overcapacity eases on North American routes

On the bright side, a key positive development is that the excessive capacity expansion on China-North America routes has finally ended. Airline capacity growth is slowing to only 6% y/y in 1Q18. This is likely to ease yield pressure on Transpacific routes.

Implications on stocks: China Eastern Airlines (670:HK) has the largest exposure to China-North America routes among the Chinese airlines and will benefit from this.

Moderate capacity growth on China domestic and China-Europe routes

Meanwhile, capacity growth on China Domestic and China-Europe routes is expected to be at a moderate pace of 11% y/y which will be met or surpassed by demand growth.

Implications on stocks: China Southern Airlines (1055:HK) is the largest domestic carrier while Air China (753:HK) has the largest China-Europe route exposure among the Chinese airlines.

Rapid capacity growth on South East Asia (excluding Singapore) routes offset by limited capacity growth or capacity cuts on South Korea, Japan, Singapore, Regional routes

Airline capacity on China-Rest of Asia routes is expected to grow at 15% y/y in 1Q18. This is mainly driven by significant capacity injection on China-South East Asian routes (other than Singapore) which will put pressure on yields on these routes. Planned airline capacity growth is nearly 50% on Indonesia and Philippines routes, 33% on Thailand and Vietnam routes and 25% on Malaysia routes.

In contrast, airline capacity on China’s major international markets in Asia is generally lower – South Korea (down 18% y/y), Japan and Singapore (down 1%) in 1Q18.

Finally, airline capacity on Hong Kong, Taiwan and Macau routes has risen 1%, 4% and 17% y/y respectively in 1Q8.

Implications on stocks: China Eastern Airlines (670:HK) has the largest exposure on South East Asian routes and could face greater yield pressure in these markets. AirAsia Group (AIRA:MK) will also face greater competition on these routes. For China-South Korea routes and China-Japan routes, Asiana Airlines (020560:KS), ANA Holdings (9202:JP), China Eastern (670:HK) and Spring Airlines (601021:CH) are the most exposed.

Chart: Planned airline capacity growth on China domestic and international routes (1Q18)

Chart: Planned airline capacity growth on China domestic and international routes (1Q18)

 

AIRLINE CAPACITY GROWTH TO MODERATE FURTHER IN 2018; CAPACITY SHORTAGE LIKELY FROM 2019

Looking more long term, the Chinese airlines sector’s seat capacity growth is expected to moderate to 12% in 2018 from 15% in 2017. More significantly, the Chinese airlines’ capacity growth is expected to drop sharply to 7% per annum from 2019 to 2022 based on our analysis of the Chinese airlines sector’s current aircraft orderbook.

Chart: Chinese airline sector projected seat capacity growth (2017 to 2022)

Chart: Chinese airline sector projected seat capacity growth (2017 to 2022)

Although we do expect the Chinese airlines to continue to order more aircraft, industry oversupply risk will be low. In fact, industry supply shortage is likely as China’s air traffic growth will far exceed the projected capacity growth from 2019 to 2022, boosted by robust China outbound travel demand, helping to lift the Chinese airlines’ passenger yields and profitability from 2019, facilitated by the recent China airfare deregulation plans.

Chart: Chinese airline sector passenger demand and supply growth (2017 to 2022)

Chart: Chinese airline sector passenger demand and supply growth (2017 to 2022)

RECENT PASSENGER TRAFFIC GROWTH STRONGER THAN EXPECTED, BOOSTED BY ROBUST CHINA OUTBOUND TRAVEL DEMAND

The Chinese airline sector’s demand is turning out to be stronger than expected, boosted by robust China outbound travel demand. Passenger traffic growth surged to 18% y/y in November 2017, well above the 11% growth pace in the previous 3 months (August to October 2017). This is surprising given the high base last year when passenger traffic grew 15% y/y in November 2016.

We forecast the Chinese airline sector’s passenger traffic growth to moderate to 12% in 2018 from 14% in 2017. This will come in line with the industry’s projected capacity growth, resulting in a balanced demand and supply growth environment in 2018.

More significantly, the sharp drop in Chinese airline sector capacity growth from 2019 to 7% per annum will drive industry supply shortage. This will greatly enhance the Chinese airlines’ ability to boost their yields, facilitated by the recent China airfare deregulation plans, raising their profit margins.

Chart: Chinese airline sector passenger traffic growth (2016 to 2017)

Chart: Chinese airline sector passenger traffic growth (2016 to 2017)

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.

 

Related Reports:

Air China Initiation Research Report 2017: Top choice among the Chinese airlines

China Eastern Airlines Initiation Research Report 2017: Rapid improvement but aggressive expansion risk abounds

China Southern Airlines Initiation Research Report 2017 – Strong domestic drivers tempered by funding needs

 

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