China Southern Airlines (1055:HK) Fair value: HK$11.0
China Southern Airlines (1055:HK) Rating: Outperform
2 April 2018, China – We attended China Southern Airlines’ post 2017 financial results management briefing. Here are our key takeaways. Note that our Outperform rating on China Southern Airlines has yielded a 43% return since we initiated research coverage on the stock on 10th April last year. We rank 2nd in terms of absolute return among all analysts covering China Southern Airlines for the past 1 year based on Bloomberg’s calculations, outperforming our peers by 64% in terms of absolute return. We remain positive on China Southern Airlines’ long-term growth prospects and maintain our Outperform rating and fair value of HK$11.00 on the stock.
China Southern Airlines’ planned aircraft fleet increase is larger than Air China and China Eastern Airlines’ plans in 2018 but still not excessive at 11% considering China’s robust outbound travel demand
China Southern Airlines Group (1055:HK)’s gross aircraft fleet expansion plans are more aggressive than Air China and China Eastern Airlines’ plans in the next three years, in preparation for its move to the new Beijing airport as it plans to accelerate the development of its Guangzhou-Beijing Dual Hub.
China Southern Airlines Group is scheduled to add 115 aircraft to its fleet and retire 29 aircraft in 2018, add 105 aircraft and retire 29 aircraft in 2019 and add 89 aircraft and retire 26 aircraft in 2020, implying a net capacity growth of only 11%, 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:
However, China Southern Airlines’ domestic capacity expansion plans in 2018 look aggressive which may undermine CSA’s domestic passenger yield improvement and earnings in 2018
China Southern Airlines plans to grow its overall passenger capacity (in available seat kilometres) by nearly 15% y/y this year. We are concerned about its plans to grow capacity on domestic routes by 17% y/y in 2018. This may offset China Southern Airlines’ efforts to improve its domestic passenger yields more meaningfully this year.
A mitigating factor is that China Southern Airlines is the biggest beneficiary of the VAT reduction as it is the largest domestic airline in China and has the largest domestic revenue exposure among the Big 3 Chinese carriers, accounting for 76% of China Southern Airlines’ passenger revenue, higher than 67% for Air China (753:HK) and 66% for China Eastern Airlines (670:HK).
Moreover, China Southern Airlines has the flexibility to adjust its domestic flight capacity more quickly and dynamically compared to its international flight schedules should forward bookings look soft.
Chart: Passenger revenue contribution from domestic routes (2017)
International capacity growth is more moderate this year which should ease international passenger yield decline
In contrast, China Southern Airlines’ international capacity growth plans are more moderate at 9.7% in 2018 compared to last year’s aggressive growth of 14%. We expect China Southern Airlines’ international passenger yield decline to moderate this year after falling markedly by 7.5% y/y in 2017.
High fuel price is the key earnings risk as China Southern Airlines remains unhedged
Like other Asian airlines, fuel cost is China Southern Airlines’ largest cost component and constitutes 26% of CSA’s total cost. Higher spot jet fuel prices (+20% y/y so far this year) will be the main negative earnings driver in 2018 as China Southern Airlines remains unhedged and fuel surcharges are unlikely to completely pass on the higher fuel costs to customers in markets where competition is intense.
A mitigating factor is that CSA operates one of the youngest aircraft fleets globally, averaging only 6.7 years old, which is more fuel efficient. Every US$1/bbl increase in jet fuel price will raise CSA’s fuel cost by Rmb320m on a full year basis.
Further forex gains in 2018 but lower exposure to US dollar volatility going forward
China Southern Airlines’ US dollar debt exposure has fallen further to 34% in 2017 from 39% in 2016. We expect China Southern Airlines to book further forex gains in 2018 as the US dollar has weakened further since Dec 2017. However, CSA’s overall earnings will be less leveraged to US dollar volatility going forward. Every 1% weakening (strengthening) in the US dollar boosts (cuts) China Southern Airlines’ net profit by Rmb278m.
China Southern Airlines’ 2017 financial results beat our expectations while Air China and China Eastern Airlines’ results were in line
China Southern Airlines’ net profit rose 18% y/y to Rmb6.0 billion, ahead of our forecasts, mainly driven by stronger passenger traffic (+9% y/y), surge in cargo yields (+12%) and Rmb1.8 billion forex gains (due to the stronger Renminbi) which more than offset the weaker passenger yields (down 2%) and higher fuel costs (+34%) in 2017.
Air China ranks the most profitable among the Big 3 Chinese carriers in 2017, followed by China Southern Airlines and China Eastern Airlines
Among the Big 3 Chinese airlines, Air China, which has been our top pick in the Chinese airline sector, ranks the most profitable, followed by China Southern Airlines and China Eastern Airlines (excluding its Eastern Logistics disposal gains) in 2017.
Chart: Big 3 Chinese Airlines 2017 Results Comparison
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