Stronger yields & fuel hedging mitigate Japanese carriers’ profit decline with JAL outperforming ANA

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ANA Holdings Inc (9202:JP)

Price Target: JPY5200 | Rating: Buy

Japan Airlines company logo

Japan Airlines Co. Ltd (9201:JP)

Price Target: JPY5500 | Rating: Buy

31 July 2018, Japan – ANA Holdings and Japan Airlines’ 1QFY18/19 (April-June 2018) financial results are in line with our expectations. Overall, Japan Airlines’ financial performance was better than ANA Holdings’, helped by its stronger international passenger yield improvement and higher fuel hedging level.

JAPAN AIRLINES OUTPERFORMS ANA HOLDINGS 

JAL’s net profit margin fell 1.1ppt y/y to 5.1% versus ANA’s 1.3ppt y/y decline to 3.3% net profit margin excluding the impact of its special gain in the previous year, based on our estimates. We maintain our Buy ratings on both stocks but expect Japan Airlines’ current 5% Price/Book and 8% P/E valuation discounts to ANA Holdings to narrow.

ANA and JAL’s management are maintaining their full year FY18/19 net profit guidance of JPY102 billion (down 29.1% y/y) and JPY110 billion (down 18.8% y/y) respectively. ANA plans to release its revised 2H Business Plan in late August.

Chart: Japanese carriers 1QFY18/19 Financial Results Comparison

Japanese carriers 1QFY18/19 Financial Results Comparison

Chart: Japanese Carriers Price/Book Valuation Range (2013 to 2018)

Japanese Carriers Price/Book Valuation Range (2013 to 2018)

JAPAN AIRLINES 1QFY18/19 FINANCIAL RESULTS – OUR 5 KEY TAKEAWAYS

#1 Japan Airlines’ (JAL) net profit fell 10% y/y to JPY17.5 billion in 1QFY18/19, mainly driven by higher fuel costs (+20% y/y) and sales commissions (+17%). Considering that spot jet fuel prices in JPY terms rose 38% y/y during the quarter, JAL’s 40% fuel hedging has significantly helped to mitigate the fuel cost increase.

This beats Singapore Airlines’ 28% y/y decline in recurring net profit during the same period even though SIA has hedged 46% of its fuel consumption; mainly because JAL managed to raise passenger yields while SIA could not. JAL has hedged 40% of its fuel and forex requirements for FY18/19, 15% for FY19/20 and 5% for FY20/21.

See our previous report on Singapore Airlines’ 1QFY18/19 financial results for comparison:

Fuel hedging gain saves SIA from losing all its profits in 1QFY18/19

#2 JAL still generated positive free cash flow of JPY9.6 billion during the quarter even though its capex increased by 37% y/y but this is 66% lower than the JPY28.1 billion FCF generated a year ago.

#3 Passenger yield and unit revenue improved significantly by 7.4% and 9.0% y/y on international routes in 1QFY18/19, after excluding the change of settlement adjustment method for domestic sectors on international itineraries.

Based on our estimates (before excluding the change of settlement adjustment method for domestic sectors on international itineraries), JAL’s unit revenue on European routes improved the most by 23% y/y, followed by America (+6%) and Rest of Asia/Oceania (+5%) routes.

Chart: Japan Airlines Unit Revenue Growth (Decline) Y/Y in Each Route Region (1QFY18/19)

Japan Airlines Unit Revenue Growth (Decline) Y/Y in Each Route Region (1QFY18/19)

#4 China routes grew the most rapidly, with passenger revenue up 38% y/y in 1QFY18/19. Passenger load factor improved 15ppts y/y to 85.1%, driven by the 26% rise in passenger traffic. China routes now contribute 11% of Japan Airlines’ passenger revenue.

China plus Rest of Asia/Oceania are the largest revenue contributor, accounting for 44% of JAL’s passenger revenue in 1QFY18/19. This is followed by America at 26% (down 2ppts y/y) and Europe at 17% (up 1ppt y/y).

Chart: Japan Airlines International Passenger Revenue Contribution (1QFY18/19)

Japan Airlines International Passenger Revenue Contribution (1QFY18/19)

#5 Japan Airlines’ unit cost excluding fuel rose 3.1% y/y during 1QFY18/19 which is a concern if this continues.

 

ANA HOLDINGS 1QFY18/19 FINANCIAL RESULTS – OUR 5 KEY TAKEAWAYS

#1 ANA Holdings’ headline net profit fell 68% y/y to JPY16.1 billion in 1QFY18/19, mainly due to the special gain of JPY35.5 billion in the previous year. Excluding this, ANA’s recurring net profit fell 22% y/y based on our estimates, worse than JAL’s 4% decline during the quarter, mainly due to its lower fuel hedging level and smaller improvement in international passenger yields compared to JAL.

ANA generated positive free cash flow of JPY12.4 billion in 1QFY18/19, a marked improvement from its negative free cash flow of JPY6.5 billion a year ago as capex fell 13% Y/Y. ANA has hedged 30% of its fuel requirements for FY18/19, 20% for FY19/20, 10% for FY20/21 and 5% for FY21/22. For its foreign currency exposure, ANA is hedged 25% for FY18/19, 10% for FY19/20 and 5% for FY20/21 and FY21/22.

ANA Holdings’ overall 1QFY18/19 financial performance was slightly weaker than Japan Airlines and Singapore Airlines. Excluding the impact of its special gain in the previous year, ANA’s net profit margin fell 1.3ppts y/y to 3.3%. This is lower than JAL’s 5.1% net profit margin which fell 1.1ppt y/y during the same period. ANA Holdings’ net profit margin is also slightly lower than Star Alliance partner Singapore Airlines’ net profit margin of 3.6% in 1QFY18/19.

#2 ANA Holdings’ passenger yields on international routes improved. ANA’s passenger yield and unit revenue improved meaningfully by 4.0% and 6.3% y/y on international routes in 1QFY18/19 but these increases were smaller compared to JAL’s.

Based on our estimates, ANA’s unit revenue on China routes improved the most by 31% y/y, followed by Resort (+9%) and Europe (+8%) routes - a different trend from Japan Airlines' (see above section on JAL for the details).

Chart: ANA Unit Revenue Growth (Decline) Y/Y in Each Route Region (1QFY18/19)

ANA Unit Revenue Growth (Decline) y/y in Each Route Region (1QFY18/19)

China plus Rest of Asia/Oceania are the largest revenue contributor, accounting for 45% of ANA’s passenger revenue in 1QFY18/19, similar to JAL's 44%. This is followed by America at 31% (down 1ppt y/y) and Europe at 20% (down 0.6ppt y/y).

Chart: ANA International Passenger Revenue Contribution (1QFY18/19)

ANA International Passenger Revenue Contribution (1QFY18/19)

#3 International cargo revenue surged ANA’s international cargo revenue rose 19% y/y, mainly driven by the 15.2% growth in international cargo yields and 10.8% growth in unit revenue, ahead of our expectations. This, along with SIA Cargo’s 10% y/y yield improvement in 1QFY18/19, is a positive read-through for Cathay Pacific Cargo’s upcoming financial results on 8 August 2018.

#4 Domestic revenue rose slightly y/y in 1QFY18/19 but will be hurt by multiple domestic flight cancellations in the coming quarter (arising from mandatory inspections of the Rolls-Royce engine for its Boeing 787 aircraft). ANA is cancelling 17 domestic flights per day on average from 6th July to 31st August 2018. ANA’s domestic passenger revenue rose 1.5% y/y in 1QFY18/19. Specifically, passenger yield fell 2.4% y/y while unit revenue rose 0.5% y/y on domestic routes.

#5 Low cost carrier (LCC) segment, comprising of both Peach Aviation and Vanilla Air, performed well, with revenue rising 8.7% y/y. Passenger load factor improved 1ppt y/y to a high of 86.4% and based on our estimates, LCC passenger yield improved 3.7% y/y and unit revenue increased 5.0%, better than our expectations.

Chart: ANA Holdings Unit Revenue Improvement Across Business Segments (1QFY18/19)

ANA Holdings Unit Revenue Improvement Across Business Segments (1QFY18/19)

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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