26 June 2018, Asia Pacific – The US Dollar has strengthened 3% against most of the Asia Pacific currencies on average year-to-date. This is detrimental to the Asia Pacific airlines’ financial performance going forward as they have more USD-denominated costs than USD-denominated revenue. Moreover, their aircraft capex is also paid in USD and often financed with USD debt or USD leases. In the case of Cathay Pacific, the stronger HKD results in weaker foreign currency translated revenue and yield.
Asia Pacific currencies have weakened 3% against the US Dollar year-to-date
The US Dollar has rebounded 3% against most of the Asia Pacific currencies on average year-to-date. The Philippines Peso (down 7%), Indian Rupee (6%), Australian Dollar (down 5%), Indonesian Rupiah (down 4%) and Korean Won (down 4%) have been the weakest performing currencies so far this year.
However, to put things into perspective, half of the Asia Pacific currencies have still strengthened against the US Dollar compared to a year ago while half have weakened so the impact is less significant for some of the airlines such as the Chinese, Malaysian, Singapore and Thai carriers.
Chart: Asia Pacific currencies have weakened against the US Dollar year-to-date, except for the Japanese Yen and Malaysian Ringgit (2018)
Chart: Half of the Asia Pacific currencies have strengthened against the US Dollar while half have weakened year-on-year (2018)
Stronger US Dollar inflates fuel costs and aircraft capex payments
Further strengthening in the US Dollar would be detrimental to the Asia Pacific airlines’ financial performance going forward as they have more USD-denominated costs than USD-denominated revenue.
In addition, their aircraft capex is also paid in USD and often financed with USD debt or USD leases. In the case of Cathay Pacific, the stronger HKD results in weaker foreign currency translated revenue and yield.
Airlines also have to book foreign exchange translation losses when the USD strengthens
Moreover, as the Asia Pacific airlines tend to fund their capex with a sizeable level of USD debt, this results in unrealized foreign exchange translation losses (gains) that the airlines are required to mark to market and book in their financial statements at the end of each reporting period when their local currencies weaken (strengthen) against the US Dollar.
For highly leveraged airlines with substantial US Dollar debt levels, this forex loss (gain) can be disproportionately larger than their recurring earnings impact from the stronger (weaker) US Dollar.
Although it is a non-cash item and could potentially reverse if the local currency rebounds against the US Dollar in the future, the stock market has historically reacted negatively (positively) to Asia Pacific airline stocks when their local currencies weaken (strengthen) against the US Dollar.
Some airlines, such as the Big 3 Chinese carriers Air China, China Eastern and China Southern Airlines have significantly pared down their US Dollar debt exposure to mitigate this non-cash accounting impact.
Investors tend not to favour the Asia Pacific airlines when the US Dollar is strong
Based on our correlation analysis of their daily market price movements for the past 3 years, the share prices of Nok Air (NOK:TB), Air China (753:HK), Garuda Indonesia (GIAA:IJ), Indigo (INDIGO:IN) and AirAsia Group (AAGB:MK) are the most strongly correlated with the strength of their local currencies and will therefore suffer the greatest impact when their home currencies weaken (strengthen) against the US Dollar.
Chart: Asia Pacific airlines share price performance correlation with the strength of their local currencies (2015 to 2018)
Airlines whose share prices tend to react less to their local currency movements are the domestically listed Chinese, Taiwanese and Thai carriers
By contrast, the share prices of domestically listed Chinese carriers (including Hainan Airlines 600221:CH, Spring Airlines 601021:CH, Juneyao Airlines 603885:CH) as well as Thai Airways (THAI:TB) and the Taiwanese carriers EVA Airways (2618:TT) and China Airlines (2610:TT) do not have any meaningful correlation with their local currency movements.
Key exception – Japanese airline stocks tend not to perform well when the US Dollar is weak
Interestingly, the Japanese airlines ANA Holdings (9202:JP) and Japan Airlines’ (9201:JP)’s share price performance are negatively correlated with the Japanese Yen which seems counter-intuitive since they are also short of US Dollars. This could be due to market expectations of reduced inbound tourism traffic due to the stronger Yen. Therefore, their share prices may not necessarily perform well if the Japanese Yen continues to strengthen against the US Dollar.
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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