BUY Rating
We
recommend a BUY rating on China Southern Airlines (ZNH). Due to soaring
crude oil price, jet fuel price was adjusted up significantly for the past
two years. In addition to fierce price competition and limitation on
adding bunker surcharge, airlines industry was underperforming. In 2007,
there is a strong growth in this industry and share prices of airlines
companies have been rising in spite of growing crude oil price, which have
broken $70/barrel level. ZNH has announced a likely profit for 2007
half-year performance due to the high industry demand and appreciation of
RMB. If oil price does not go far beyond $74/barrel to trigger a new fuel
price adjustment, we expect airlines companies will be highly
profitable.
1.
Strong
demand for airway transportation in China
l
In
the first half year of 2007, compared with the same period in 2006, total
freight traffic increased by 16.85%, total freight ton-kilometers
increased by 27.6, total passenger traffic rose by 17.6% and total
passenger kilometers grew by 18.2%.
2.
Operating
Performance of ZNH in 2007 has Exhibited a Significant Improvement
Compared with Year 2006
l
RPK
and RTK were consistently higher than the same period in 2006 for each of
the first seven months, gaining an accumulative increase of 17.20% and
13.50% respectively.
l
The
overall load factor up 1%, 1.6% and 0.7% in May, June and July of 2007 to
62.3%, 62.9% and 65.4% compared with the same periods in 2006.
3.
Reduced
and Stabilized Costs of Operations
l
Fuel
price was reduced by 90CNY/ton in January 2007.
l
Crude
oil price has reached a level of $76 in August 2007, close to the peak
price of $74 in 2006 when the fuel price was added 500 CNY/ton. Thus, if
oil price does not rise far away from this level, kerosene price is not
likely to be effected.
4. High Risks of High Leverage is
Controllable
l
ZNH
is highly leveraged, with debts over four times of
equity
l
However,
in 2006, ZNH obtained a loan facility up to approximately RMB59,978
million for 2007 from several PRC commercial bank, representing 91.7% of
RMB65,396 million total liabilities.
l
Appreciation
of RMB will in effect reduce USD-denominated debts.
5. Economic slow down and explosion
of oil price are risks for investments
Company
Description
China
Southern Airlines Company Limited engages in the airline operations in
mainland China, Hong Kong and Macau regions, and internationally. It
provides domestic and international passenger, cargo, and mail airline
services.
Reasons for a BUY Rating
1.
Total Volume of Transportation by Civil Aviation in China Increased
Steadily in 2007
In
2007, there is a strong market demand for airway transportation in china.
In the first half year of 2007, compared with the same period in 2006,
total freight traffic increased by 16.85% to 1826.6 thousand ton, total
freight ton-kilometers increased by 27.6 to 5148 million ton-km and total
passenger traffic rose by 17.6% to 87 million and total passenger
kilometers grew by 18.2% to 129113 million persons-km.
2.
Operating
Performance of ZNH in 2007 has Exhibited a Significant Improvement
Compared with Year 2006
The
monthly results of 2005 and 2006 showed that ZNH peaked the traffics and
the passengers and cargos carried in July and August, followed by a
cooling demand for its airway transportation In the first seven months of
2007, RPK and RTK were consistently higher than the same period in 2006
for every month, gaining an accumulative increase of 17.20% and 13.50%
respectively. RFTK generally followed a growing trend, but at a much
smaller magnitude. Although in January of 2007 RFTK experienced a slight
decrease of 1.30%, it had increased by 1.8% accumulatively by July 2007.
Besides, in July 2007, RPK and RTK rose 14.70% and 11.8%. Since August
will be another peak month, the third quarter financial result of ZNH is
expected to be further improved.
From
January to July 2007, total cargo carried rose to 473.19 thousand tons and
total passengers carried increased to 31884.04 thousand persons,
representing an accumulated increase of 7.3% and 15.66% respectively
compared with the same period of the previous year. In 2006, passenger
revenue and, cargo and mail revenue accounted for 92.2% and 7.8%
respectively of total traffic revenue which compose 97.6% of operating
revenue that year. Hence, the fast growth in the number of passengers
carried will enhance performance of ZNH.
In
the first seven months of 2007, ASK, ATK and AFTK increased respectively
by 15%, 14% and 11% compared with the same periods in 2006. This resulted
in lower overall load factor for the first four months in 2007, but strong
market demand drove the overall load factor up 1%, 1.6% and 0.7% in May,
June and July of 2007 to 62.3%, 62.9% and 65.4% compared with the same
periods in 2006. Since historically load factor peaked in July, August and
September before falling, we expected in higher load factors in August and
possibly in September as well.
3.
Reduced and Stabilized Costs of Operations
In
2006, jet fuel prices were adjusted upwards twice, increasing by 800
CNY/ton on average from July 2005. As a result, jet fuel costs of ZNH
increased by 35.7% from RMB11,929 million in 2005 to RMB16,193 in 2006 and
accounted for 65.6% of flight operation expenses in 2006. In January of
2007, jet fuel price was decreased by 90 CNY/ton as crude oil price
decreased back to around $50/barrel from over $70/barrel in 2006. In
August 2007, crude oil price reached $76/barrel, slightly higher than the
highest monthly price of $74.18/barrel in 2006. This means that if the oil
price keeps around $74/barrel, airlines companies will not face higher
fuel prices. In addition, since the bunker surcharge on travelers was
reduced by 16.67% to 20% for domestic flights in January 2007, which
extracted benefits of falling oil prices from airlines companies, a
moderate oil price increase above the current high level is not likely to
trigger an immediate fuel price upward-adjustment.
4.
High Risks of High Leverage is Controllable
ZNH
is carrying high level of debts, with total debt over four times more than
equity. Besides, its current ratios were consistently less than 1.
Although the current ratio was improved in Q1 2007 to 0.31 from 0.17 in
2006, current assets are still unable to cover current liabilities.
However, in 2006, the Group obtained a loan facility up to approximately
RMB59,978 million for 2007 from several PRC commercial bank, representing
91.7% of RMB65,396 million total liabilities. Further, since ZNH is one of
the five largest airline companies in China that account for over 90% of
total market share, ZNH will be able to obtain funding when needed.
Besides, the majority debts of ZNH are denominated in USD; hence,
appreciation of RMB will in effect reduce the debt payment.
5.
Possible Risks of Investment
Since
expectation on a better performance of ZNH is based on an assumption that
the oil price will not rise significantly above the current level to
trigger a new price adjustment and the demand for airway transportation
remains robust. If these conditions should not be satisfied, airline
companies will continue suffering from the fierce price competition and
high operating costs.
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