Heatwave to dampen inbound tourism but Japan’s 40 million visitors target still on track

ANA Holdings (9202:JP) Rating: Buy
ANA Holdings (9202:JP) Fair Value: JPY5200

Japan Airlines (9201:JP) Rating: Buy
Japan Airlines (9201:JP) Fair Value: JPY5500

24 July 2018, Japan – Japan has been hit by severe heatwave with temperatures reaching 41.1 degrees Celsius, resulting in 77 fatalities so far. This could deter foreign tourists from visiting the country near term, dampening inbound traffic. Apart from ANA Holdings’ multiple domestic flight cancellations (arising from the need to perform Rolls-Royce engine checks for its Boeing 787 aircraft), the other domestic and foreign airlines have yet to trim capacity so far which could lead to lower load factors and profitability in 3Q18. 

However, the impact will be short-lived and we expect inbound tourism to rebound in the cooler months ahead. We remain bullish on the long-term growth prospects of Japan’s inbound tourism demand – Japan is on track to meet or even beat its ambitious 40 million foreign visitors target in 2020, in our view.

We forecast Japan to receive 33.0 million foreign visitors this year, 15% higher y/y

The number of foreign visitor arrivals to Japan grew 15% y/y in June this year and 16% y/y to 15.9 million in 1H18. We forecast Japan to receive 33.0 million foreign visitors this year versus 28.7 million visitors in 2017. This is a moderation from the 19% growth experienced in 2017 but nevertheless a robust growth rate.

Chart: Monthly Foreign Visitor Arrivals to Japan (Jan 2017 to Jun 2018)

Monthly Foreign Visitor Arrivals to Japan (Jan 2017 to Jun 2018)

Chinese and South Korean visitors are the key growth drivers

This is mainly driven by Japan’s two largest inbound tourism source markets – China and South Korea constitute 26% and 25% of Japan’s total foreign visitor arrivals and are growing at 24% and 18% y/y respectively.

Inbound tourism from the rest of Asia has also been buoyant. In fact, visitors from Asian countries constitute 86% of the total foreign visitor arrivals to Japan.

Chart: Top 20 Sources of Foreign Visitor Arrivals to Japan (2017)

Top 20 Sources of Foreign Visitor Arrivals to Japan (2017)

Japan’s ambitious 40 million foreign visitors target in 2020 is well within reach

Although the market perceives Japan’s target of hitting 40 million foreign visitors in 2020 to be an ambitious one, we believe this target is well within reach even if inbound tourism growth slows as long as foreign visitor arrivals to Japan can maintain an annual growth pace of 12% from 2018 to 2020.

There is greater upside if Japan is able to broaden its source of foreign visitor arrivals as it is still heavily dependent on Asian tourists at present. 86% of Japan’s total foreign visitor arrivals are from Asian countries.

Favourable demand-supply outlook for the Japanese airline sector in the next 3 years

We expect airline capacity growth to be low at 3% y/y on Japan’s domestic and international routes in 2H18, providing a favourable demand-supply environment for the airlines when inbound tourism picks up during the cooler months later this year.

Longer term, we forecast the Japanese airline sector to grow capacity by 6% per annum from 2018 to 2020 and expect the Japanese airline sector’s demand and supply environment to remain favourable, supported by the strong inbound tourism traffic growth which is favourable for ANA Holdings and Japan Airlines.

Maintain Buy ratings on both ANA and JAL – we expect JAL to continue to outperform ANA Holdings near term

We therefore maintain our Buy ratings on ANA Holdings and Japan Airlines and raise our price target for Japan Airlines from JPY4222 to JPY5500. We continue to expect Japan Airlines to outperform ANA Holdings near term as the latter’s Boeing 787 aircraft’s Rolls-Royce engine checks will negatively impact ANA Holdings’ operations and earnings.

Note that Japan Airlines’ share price has outperformed ANA Holdings’ by 13% since we initiated research coverage on the stocks, with a preference for Japan Airlines. See our report below for the details:

Research Report: Japan Airlines (9201:JP) offers more upside than ANA (9202:JP)

Among the foreign carriers, Korean Air, China Airlines (Taiwan), Asiana, Cathay Pacific and China Eastern Airlines have the largest seat capacity to Japan routes and will also benefit from the strong tourism traffic to Japan.

Chart: Foreign Airlines with Largest Monthly Seat Capacity to Japan (2018)

Foreign Airlines with Largest Monthly Seat Capacity to Japan (2018)

Amicable political relations with China and South Korea are paramount to support Japan’s inbound tourism growth 

Japan will need to maintain amicable political relations with China and South Korea to sustain these countries’ outbound tourism demand to Japan. Recall China has historically used tourism curbs when its tensions with Japan escalate, for example, due to the Senkaku Islands dispute.

China just launched anti-dumping investigations on stainless steel imports from Japan, South Korea, European Union and Indonesia, which could potentially strain relations and curb Chinese outbound tourism to Japan if tensions escalate.

Stronger yen is less conducive for inbound tourism

The Japanese yen has strengthened 1% against the US dollar and 5% against the Renminbi and Korean Won year-to-date. This may discourage some budget-conscious foreign leisure tourists from choosing Japan as their travel destination.

Tokyo Olympics 2020 may not necessarily boost Japan’s inbound tourism significantly

Tokyo Olympics 2020 may not necessarily boost Japan’s inbound tourism significantly, in our view. Historically, the Olympics has not always been a big air traffic booster for host countries. This is because some may decide to postpone their trip plans to/from the host country to avoid the inconvenience of going through enhanced security procedures at airports or prefer to watch the Olympics at home.

However, the Tokyo Olympics can serve to raise Japan’s profile to international tourists, particularly those outside of Asia, which will be a long-term positive driver for Japan’s tourism and airline industry. Only 14% of Japan’s foreign visitor arrivals come from outside of Asia, mostly from North America (6%) and Europe (5%). 

Chart: Asians Constitute 86% of Total Foreign Visitor Arrivals to Japan (2017)

Asians Constitute 86% of Total Foreign Visitor Arrivals to Japan (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.

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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