China Southern Airlines: Lower non-fuel unit cost, higher int’l RASK, govt grants help mitigate fuel impact in 1H18


China Southern Airlines Co Ltd (1055:HK)

Price Target: HK$11.00 | Rating: Buy

28 August 2018, China - China Southern Airlines’ 1H18 financial results beat our expectations as its lower non-fuel unit cost and higher international unit revenue and government grants partially offset the negative impact of higher fuel costs. Here are our key takeaways from the results:

#1 China Southern Airlines' (CSA) 1H18 financial results beat our more conservative forecast. Net profit fell 24% y/y to Rmb2.1B in 1H18, implying a net profit margin of 3.1%, down 1ppt y/y. If not for its Rmb471m forex translation loss, CSA’s recurring pre-tax profit would have fallen by only 3% y/y to Rmb3.5 billion in 1H18, based on our estimates. Excluding government grants and forex impact, CSA’s pre-tax profit would have fallen 27% y/y to Rmb1.7 billion, based on our estimates. CSA still generated positive free cash flow of Rmb602m despite the higher fuel prices in 1H18.

#2 Notwithstanding China Southern Airlines’ aggressive capacity expansion of 14% y/y on international routes in 1H18, the carrier managed to lift its international unit revenue (in terms of RASK) by 3.3% y/y in 1H18. In contrast, regional routes unit revenue RASK for HK/Macau/Taiwan fell 6.8% y/y in 1H18 which was disappointing.

#3 However, domestic unit revenue (RASK) remained steady y/y in 1H18 which led to the overall steady RASK for CSA in 1H18 as domestic revenue still drives 75% of CSA’s revenue; it would be disappointing if CSA’s domestic RASK does not improve y/y in 3Q18 following the domestic airfare reform.

Chart: China Southern Airlines Passenger Revenue Contribution (1H18)

Chart: China Southern Airlines Passenger Revenue Contribution (1H18)

#4 China Southern Airlines' cargo yield improved 2.4% y/y but this was weaker than most of the major Asian cargo airlines’ yield performance in 1H18.

#5 Based on our estimates, China Southern Airlines' non-fuel unit cost per ATK fell 2% y/y, better than expected, helping to mitigate the negative impact of the higher fuel costs.

#6 China Southern Airlines continued to pare down its US dollar debt exposure by 2ppts y/y to 32% at the end of June 2018. Renminbi debt now accounts for 63% (+3ppts y/y) of its total debt and other foreign currency debt account for the remaining 5%.

#7 The key headwinds for China Southern Airlines and its earnings sensitivities to these negative drivers are as follows:

1) Jet fuel prices remain high – every 1% rise in jet fuel price will increase CSA’s annual fuel cost by Rmb388m,

2) Weaker Renminbi – every 1% weakening in the CNY will cut CSA’s net profit by Rmb297m and

3) Rising interest rates – every 10bps increase will cut CSA’s net profit by Rmb54m.

#8 China Southern Airlines' substantial capital commitments is also a concern. As at end June 2018, China Southern Airlines has Rmb104 billion capital commitments plus Rmb67 billion operating lease commitments. China Southern Airlines is investing Rmb10 billion in cash and assets to establish a 100%-owned subsidiary Xiongan Airlines. We remain concerned about CSA’s more aggressive capacity expansion, especially at its new Beijing airport hub.


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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