Zhengzhou Airport flying high with Henan Cargo Airlines, Cargolux/Emirates partnership and AirAsia China JV

22 June 2017, Global – Zhengzhou, the capital of the land-locked and once impoverished province of Henan, has emerged as an important logistics hub in recent years. The recent establishment of Henan Cargo Airlines and the strategic operational partnership between Emirates SkyCargo and Cargolux Airlines as well as a planned joint venture between the Henan provincial government and AirAsia (AIRA:MK) mark further efforts by Zhengzhou Xinzheng International Airport to rank among China’s top aviation hubs.

EMIRATES SKYCARGO AND CARGOLUX STRATEGIC OPERATIONAL PARTNERSHIP

In 2014, as part of the Henan Civil Aviation Development and Investment Co. (HNCA)’s agreement to purchase a 35% stake in CargoLux; Cargolux agreed to a dual hub strategy at Luxembourg Findel Airport and Zhengzhou Xinzheng International Airport. By 2016, Cargolux was operating seven flights per week between Zhengzhou and Luxembourg with cargo volumes surpassing 100,000 tons on that route.     

Cargolux then went on to establish a strategic operational partnership with Emirates SkyCargo in May 2017. Emirates SkyCargo has just launched weekly freighter services between Dubai and Luxembourg. Emirates SkyCargo and Cargolux are the 2nd and 8th largest cargo airlines in the world with global market shares of 6% and 3% respectively.

This highly significant partnership will enable access to more cargo destinations and flight frequencies for each carrier through block space and interline agreements as well as the ability for Emirates to accept outsized cargo that requires nose-loading capability using the Boeing B747 freighters operated by its partner Cargolux. Emirates SkyCargo and Cargolux’s combined global air cargo traffic and capacity surpasses that of industry leader Federal Express (FDX:US) which has 7% global market share.

Among the top 10 air cargo carriers in the world, 4 are Asian carriers – Cathay Pacific (5% global market share), Korean Air (4%), Singapore Airlines (3%) and Air China (3%). These Asian carriers will face even stronger competition in the East-West long-haul air cargo market following Emirates Skycargo and Cargolux’s strategic cooperation going forward. The Asia-US and Asia-Europe air cargo trade lanes are the most important routes in the global air cargo market, accounting for 20% and 21% of global air cargo traffic.

Chart: Top 10 air cargo carriers in the world (2016) – 4 are Asian airlines

Chart: Top 10 air cargo carriers in the world (2016) – 4 are Asian airlines

Chart: Distribution of global air cargo traffic flows (2016)

Chart: Distribution of global air cargo traffic flows (2016)

HENAN CARGO AIRLINES – JOINT VENTURE BETWEEN HENAN PROVINCIAL GOVERNMENT-CONTROLLED COMPANIES AND CARGOLUX

Henan Cargo Airlines, which until recently was referred to as Cargolux China, is a cargo airline that will operate out of Zhengzhou under a Chinese Air Operator’s Certificate (AOC). 75% of the joint venture will be owned by the Henan Civil Aviation Development and Investment Co. (HNCA), Henan Airport Group and Xingggang Investment Group which represent the Zhengzhou economic zone with the remaining 25% owned by Cargolux. Note that HNCA also currently owns a 35% stake in Cargolux.

Henan Cargo Airlines targets to launch services in 4Q2018 and is expected to operate Intra-Asia and Transpacific freighter services. Henan Cargo Airlines will be based in Zhengzhou which is being developed into a key logistics hub under China’s Belt-and-Road strategic initiative and could potentially feed cargo into Cargolux and Emirates SkyCargo’ global network.

Chart: Henan Cargo Airlines shareholding structure

Chart: Henan Cargo Airlines shareholding structure

Chart: Cargolux shareholding structure

Chart: Cargolux shareholding structure

ZHENGZHOU XINZHENG INTERNATIONAL AIRPORT – RAPID AIR TRAFFIC GROWTH IN THE PAST 10 YEARS

In the past 10 years, Zhengzhou Xinzheng International Airport’s growth has outpaced China’s overall airport sector in all three metrics – passenger throughput, cargo throughout and aircraft movements, raising its ranking in the Chinese airports industry.

Zhengzhou is now the 7th busiest cargo airport in China

Zhengzhou Xinzheng International Airport’s cargo throughput grew 25% CAGR in the past 10 years, ahead of the 7% CAGR growth pace of the Chinese airports industry.

This has raised Zhengzhou Xinzheng International Airport’s ranking to the 7th busiest cargo airport in China in 2016 from 22nd position ten years ago in 2006. Zhengzhou Xinzheng International Airport handled 0.46m tons of cargo in 2016, equivalent to 3.0% of China’s total air cargo throughput.

Being part of the Zhengzhou Airport Economic Zone which has eight industrial parks, Henan Cargo Airlines and Cargolux will be able to leverage on the large source of cargo traffic feed from smartphone production facilities situated in Zhengzhou. Zhengzhou has one of the biggest Apple iPhone production facilities in the world. In addition, Zhengzhou is also a major frozen foods supplier for China. Express freight service providers including SF Express, China Post, DHL, UPS also operate in Zhengzhou.

Zhengzhou is also connected to Hamburg in Germany via a rail link which operates rail services three times a week and has a transit time of only 14 days, much faster than via container shipping.

Chart: Zhengzhou Airport cargo throughput growth (2001 to 2016)

Chart: Zhengzhou Airport cargo throughput growth (2001 to 2016)

Chart: Top 50 cargo airports in China (2016)

Chart: Top 50 cargo airports in China (2016)

ZHENGZHOU-BASED AIRASIA (CHINA) – PLANNED JOINT VENTURE AIRLINE BETWEEN AIRASIA BHD (AIRA:MK), EVERBRIGHT AND HENAN PROVINCIAL GOVERNMENT

Notably, Zhengzhou is also the hub base where low cost carrier AirAsia (China) plans to be established for passenger transport. AirAsia China’s shareholding structure has not been disclosed yet. AirAsia (AIRA:MK) has historically sought the highest stake that is allowed based on regulatory requirements in its overseas joint venture airlines. In China, the maximum foreign airline shareholding is 25% and as such, we expect AirAsia (AIRA:MK) to own a 25% stake in AirAsia China and the remaining 75% stake will be held by Henan Government Working Group and China Everbright Group.

Chart: Potential shareholding structure of AirAsia China

Chart: Potential shareholding structure of AirAsia China

AIRASIA (CHINA) LCC MODEL WELL-SUITED FOR HENAN REGARDLESS OF FOREIGN AIRLINE OWNERSHIP CAP

Low cost carrier (LCC) market penetration remains low in China and the North Asia region at less than 10% market share compared to over 50% in South Asia and Southeast Asia regions.

While Henan province has a lower per capita income relative to the wealthier Chinese provinces, it has an estimated population of around 100 million. Henan province’s population is easily the 3rd largest and possibly the largest in China depending on the demographic methodology used.

Henan’s less developed economy dependent on agriculture and vulnerability to flooding has also historically led to a huge population of Henan migrant workers employed in other provinces. 

Thus AirAsia (China)’s low fare, no frills and high flight frequency LCC business model is well positioned to tap into Henan’s passenger market.

Due to Zhengzhou’s strategic location in central China, AirAsia (China) will be able to cover all the cities in China using its narrowbody aircraft fleet and the average flight time from Zhengzhou to the major cities in China is less than 3 hours. We expect AirAsia (China) to operate the Airbus A320ceo or A320neo aircraft but do not rule out the possibility of the Comac C919 aircraft or its variant if it generates further political goodwill.

STRATEGIC LOCATION WITH ACCESS TO LARGE TRAVEL CATCHMENT AREA – ZHENGZHOU IS RANKED THE 15th BUSIEST PASSENGER AIRPORT IN CHINA

Zhengzhou Xinzheng International Airport’s passenger throughput grew 18% CAGR in the past 10 years, ahead of the 12% CAGR growth pace of the Chinese airports industry.

This has raised Zhengzhou Xinzheng International Airport’s ranking to the 15th busiest passenger airport in China in 2016 from 22nd position ten years ago in 2006. Zhengzhou Xinzheng International Airport handled 40.5 million passengers in 2016, implying 2.0% market share of the Chinese airports industry’s total passenger throughput.

Chart: Zhengzhou Airport passenger throughput growth (2001 to 2016)

Chart: Zhengzhou Airport passenger throughput growth (2001 to 2016)

Chart: Top 50 passenger airports in China (2016)

Chart: Top 50 passenger airports in China (2016)

Given Henan’s lower average per capita income relative to the more developed cities in China, AirAsia China is well positioned to help stimulate travel demand given its low cost structure and attractive airfares. Due to Zhengzhou’s strategic location in central China, AirAsia (China) will be able to cover most cities in China with its narrowbody aircraft fleet’s flying range.

The initial target passenger market could include migrant workers, visiting friends & relatives (VFR) traffic as well as leisure travellers as AirAsia (China) improves the affordability of air travel for people in the Henan area. Once more flight frequencies are in place, AirAsia (China) could also attract passengers travelling on business, particularly those working in private and small & medium enterprises. We expect AirAsia (China) to boost international traffic between Zhengzhou and Asia.

ZHENGZHOU AIRPORT NEEDS TO BROADEN ITS DIRECT FLIGHTS NETWORK REACH

Zhengzhou Airport has many airline customers but significantly fewer destinations compared to its stronger neighbours Chengdu and Chongqing airports. AirAsia (China)’s largest growth opportunity will be China-Asia routes.

Zhengzhou Airport serves predominantly domestic flights at present (96%). International flights account for only 4% of the total capacity to/from Zhengzhou Airport. In contrast, neighbouring airports Chengdu and Chongqing have a larger international route exposure and handle larger passenger and cargo volumes than Zhengzhou Airport.

Zhengzhou Airport has 46 airline customers but is connected to only 68 domestic and 20 international destinations. In comparison, Chengdu Airport has 61 airline customers and serves 111 domestic and 54 international destinations. Chongqing Airport has 49 airline customers (only 3 airlines more than Zhengzhou Airport) and serves 105 domestic and 31 destinations (55% more destinations than Zhengzhou Airport).

International routes are likely to face less competition than domestic routes and enable AirAsia (China) to leverage on the AirAsia Group’s international branding and wide network in Asia.

Chart: Zhengzhou airport route exposure (1H17)

Chart: Zhengzhou airport route exposure (1H17)

Chart: Airline market share at Zhengzhou Airport (1H17)

Chart: Airline market share at Zhengzhou Airport (1H17)

Low cost carrier market penetration remains relatively low in China and therefore offers large untapped domestic and international markets for AirAsia (AIRA:MK). However, the key challenges are the large incumbent airlines which also operate young aircraft fleets and have fairly competitive cost structures. These airlines also have deep pockets and access to cheap financing which enable them to withstand the impact of yield pressure. AirAsia (AIRA:MK) also needs to adapt to vastly different cultures and regulatory framework. In addition, AirAsia Group management resources may be spread too thinly given its large number of geographically spread-out joint venture airlines.   

Another key constraint to growth is air traffic congestion. Greater access to the airspace for commercial use is needed to improve the operating efficiency and on-time performance of the Chinese passenger and cargo airline industry. In addition, start-up airlines typically take at least 2 to 3 years before they turn profitable. As such, more government incentives and/or subsidies will be required to help AirAsia (China) in its initial phase of expansion.

AirAsia (AIRA:MK) plans to invest in building a dedicated low cost carrier terminal at Zhengzhou Airport. It will also establish an aviation academy to train pilots, engineers and crew and an aircraft maintenance, repair and overhaul (MRO) facility. This will help tackle the pilot shortage issue and reduce the MRO-related costs of operating in China, enabling AirAsia (China) to be more cost competitive.

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AirAsia Bhd (AIRA:MK)’s stake in planned China JV likely to be capped at 25%

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