China Airlines (2610:TT) Fair Value: NT$10.70
China Airlines (2610:TT) Rating: Underperform
EVA Airways (2618:TT) Fair Value: NT$15.0
EVA Airways (2618:TT) Rating: In-Line
31 January 2018, Asia – In our earlier 11th Jan 2018 report, we flagged concerns that China-Taiwan tensions might further worsen over the cross-straits airspace dispute. Our concerns were confirmed yesterday when China Eastern Airlines and Xiamen Airlines cancelled 106 and 70 additional flights to Taiwan respectively with both Mainland Chinese airlines issuing official statements blaming the Taiwanese authorities for being stubborn and ignoring the wishes of the Taiwanese public.
We expect China-Taiwan relations to continue worsening till at least after Taiwan’s mid-term local municipal elections in late 2018. This hurts the Taiwanese airlines more than the Mainland Chinese carriers as the China-Taiwan cross-straits flights contribute a much larger proportion of their total revenue compared to the Chinese airlines. We downgrade our rating for Taiwan’s China Airlines (2610:TT) to Underperform as investors are likely to focus on the weaker cross-straits revenue outlook and look past the Taiwan airlines’ strong 4Q17 results (to be released in late March 2018).
‘XI JINPING THOUGHT’ MEETS 2018 TAIWAN’S LOCAL MUNICIPAL ELECTIONS
The 2018 Taiwan local elections will be the first major China-Taiwan test for Chinese President Xi Jinping since the enshrinement of “Xi Jinping Thought on Socialism” into the constitution of China’s Communist Party during the 19th Party Congress in Oct 2017. The enshrinement effectively elevated Xi Jinping’s status to that of previous Chinese paramount leaders, Mao Zedong and Deng Xiaoping.
The supporters or perhaps, more importantly the opponents of Chinese President Xi Jinping will be keen to see how he will now yield his new powers in dealing with Taiwanese President Tsai Ing-Wen who is perceived by Beijing as supporting Taiwan independence by refusing to endorse the 1992 Consensus on the one-China principle.
China’s preferred outcome would be for Taiwanese President Tsai Ing-Wen’s Democratic Progressive Party (DPP) to suffer major losses during the 2018 Taiwan local elections thereby affirming their rhetoric that the Taiwanese people themselves have rejected Tsai’s independence sentiments.
CHINA AIRLINES AND EVA AIRWAYS HAVE MUCH LARGER EXPOSURE TO CHINA-TAIWAN CROSS-STRAITS FLIGHTS THAN THE BIG 3 MAINLAND CHINESE CARRIERS
5.7 million Taiwanese tourists visited Mainland China in 2016 while 2.7 million Mainland Chinese visited Taiwan in 2017, the majority of which travel between China and Taiwan by air.
The market share of cross-straits passenger traffic between Mainland China and Taiwan is quite evenly split between the Chinese and Taiwanese carriers. However, China Airlines 2610:TT and EVA Airways 2618:TT have much larger exposure to these routes compared to each Chinese carrier as there are only 3 Taiwanese carriers operating flights on these Mainland China-Taiwan cross-straits routes versus 12 Chinese airlines operating services on these cross-straits routes.
China Airlines (including Mandarin Airlines and Tigerair Taiwan) has a market share of 23% while EVA Airways (including Uni Air) has a market of 22% on China-Taiwan routes.
In comparison, China Southern Airlines’ 1055:HK (including Xiamen Airlines and Hebei Airlines) market share is only 14% while China Eastern Airlines 670:HK (including Shanghai Airlines) and Air China 753:HK (including Shenzhen Airlines) have 13% market share each on the Mainland China-Taiwan cross-straits routes. Hainan Airlines (600221:CH), Spring Airlines (601021:CH) and Juneyao Airlines (603885:CH)’s market shares are only 4%, 2% and 1% respectively.
Chart: Airline market share on Mainland China-Taiwan cross-straits flights (2018)
TAIWANESE CARRIERS ARE THE BIGGEST LOSERS
This hurts the Taiwanese airlines much more than the Mainland Chinese carriers as the China-Taiwan cross-straits flights contribute a much larger proportion of their total revenue compared to the Chinese airlines.
China routes contribute 11% of EVA Airways and China Airlines’ revenue (although down from 15% when cross-straits relations were warmer) based on our estimates. In comparison, Air China, China Eastern Airlines and China Southern Airlines’ revenue exposure to these routes is only 1% each while Hainan Airlines, Spring Airlines and Juneyao’s exposure is only 0.5% each based on our estimates.
CATHAY PACIFIC COULD BENEFIT FROM SOME TRAFFIC DIVERSION FROM CHINA TO TAIWAN VIA HONG KONG
Cathay Pacific (293:HK) could be a beneficiary as more Taiwanese could opt to return to Taiwan via Hong Kong instead. Taiwan flights contribute 2% of Cathay Pacific’s passenger revenue while Mainland Chinese flights contribute 7% based on our estimates.
RISING TENSIONS COULD ALSO DERAIL THE RECENT PICK-UP IN MAINLAND CHINESE VISITOR ARRIVALS TO TAIWAN
Chinese outbound traffic to Taiwan has been weakening since 2Q16 following the election of Taiwanese President Tsai Ing-Wen and the Chinese government’s decision to cut the travel quota for tour groups to Taiwan. The number of Chinese outbound tourists to Taiwan stayed weak until July 2017 (down 38% y/y in Jan-Jul 2017) and started to pick up from August 2017 and improved 18% y/y in 4Q17. Rising tensions could derail the recent pick-up in Mainland Chinese visitor arrivals to Taiwan.
Chart: Mainland Chinese visitors to Taiwan (2014 to 2017)
MAINLAND CHINESE TOURISTS TO TAIWAN COULD BE DIVERTED TO ALTERNATIVE DESTINATIONS ESPECIALLY JAPAN AND THAILAND
This could drive the Mainland Chinese tourists to visit alternative destination countries in the region, especially Japan and Thailand, benefitting the Japanese carriers ANA Holdings (9202:JP), Japan Airlines (9201:JP), Airports of Thailand (AOT:TB), Asia Aviation (AAV:TB) and Thai Airways (THAI:TB).
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.
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