Dec. 29, 2009 (Scott Lin) -This report is available in pdf format: click here
We recommend a HOLD rating on China Southern Airlines Limited (NYSE:ZNH), as we expect recovery in passenger demand and earnings to be gradual and slow in 2010. With government financial intervention to relieve its debt-to-equity ratio, earnings is set to stabilize along with the domestic travel economy. However, the outlook is cautious and more funding is required to shore up more debt relief.
- Company overview
-Earnings increase buoyed by higher demand and government subsidy
In the first nine months (three quarters) of 2009, Chinese domestic travelers rose 20% due to government stimulus. Overall, China’s GDP rose 8.9%, causing a rise in domestic travel.
China Southern Airlines (NYSE:ZNH) earned Net Profit of $322M RMB in the first three quarters of 2009, compared to a loss of $21M RMB year-on-year. Sales rose 9.5% to $15.95B RMB due to overall expansion in the third quarter.
According to China Southern Airlines (NYSE:ZNH) sources, the large increase in profits is due to a reduction in operating costs and financial aid of $1.57B RMB subsidy payments from the Chinese government. This boosts one-off gains by $1.30B RMB. China Southern Airlines (NYSE:ZNH) is still, however, highly levered and are still in need for additional debt finance relief.
Chairman Si Xianmin says that China Southern Airlines is set to expand in overseas markets, because of intense competition in domestic travel – air and rail. Currently, China Southern Airlines’ international portfolio comprises 17% of its total travel. In the next 3-5 years, it will rise to over 20%.
China Southern Airlines (NYSE:ZNH) said that its large losses in 2008 were a combination of factors. These included weaker passenger demand, cost pressure resulting from higher oil prices and impairment of fixed assets.
- Government financial aid props up Earnings-Per-Share performance measure
The June 2009 earnings-per-share figure does not appear as rosy as the above chart depicts. Financial aid from the Chinese government has propped up overall net profit for June 2009, totaling $1.5B RMB for China Southern Airlines (NYSE:ZNH).
- Cash and cash equivalents remain relatively unchanged
Cash has changed relatively little in light of the government subsidy payment. This implies that operating costs have only decreased marginally, and the large increase in net profit is due mostly to government intervention.
- Industry Analysis
Domestic aviation industry
A high speed rail network, set to be completed in 2020, will compete directly with China’s domestic airline industry. China Southern Airlines (NYSE:ZNH) operates 160 domestic routes, of which 38 will compete directly with the new high-speed rail network. Train tickets are expected to be 40% cheaper than plane tickets when the new high-speed rail network opens in 2020.
Note, however, that 2020 is still some time away, and there are more important short-term issues to resolve. The industry pressures at the moment reside mostly in waning passenger demand and rivalry with competitors. Financing is also a major issue within the aviation industry. The issue is whether the airline has enough liquidity to pay off its long-term debt. China Southern Airlines (NYSE:ZNH) has a Long-term Debt-to-Equity ratio of 276.57. Overall, the industry’s figure is also high at 220.08.
International aviation industry
Air China will expand domestically and internationally, with four new domestic routes and two new international routes. International Air Transport Association (IATA) claimed that the lull in the airline industry has reached a bottom, however warned that a ‘recovery was still a long way off.’
According to Singapore Airline’s Q2 release, the industry outlook suggests that air travel demand had stopped declining, as evidenced by the volume of pre-bookings. Current market conditions allow for a reduction of promotional pricing, but yields are unlikely to recover to pre-crisis levels within the next six months.
Japan Airlines’ recent press release of its consolidated results shows that industry conditions remain extremely difficult, with waning air travel demand. Japan Airlines has responded by discontinuing unprofitable routes, downsized flight frequencies, reduced plane sizes and other cost cutting measures to ensure an increased load factor. Both airlines are responding to industry pressures by horizontal diversification through strategic alliances with other airlines.
The load factor increase demonstrates Japan Airlines’ response to tight industry conditions by being more efficient with its capacity to demand management.
- Competitor Analysis
Competition in the Chinese domestic travel industry is increasingly fierce; Southern China Airline (NYSE:ZNH) plans to expand in overseas markets to diversify its revenue stream. Southern China Airlines’ main competitors are Air China and China Eastern Airlines Corporation Limited. China Eastern Airlines is set to merge with Shanghai airlines by year’s end. China Eastern Airlines is also seeking to horizontally diversify through joining an alliance.
Due to fierce competition, cost efficiency and liquidity are key issues to consider. Cost efficiency includes operating costs, load factors, RPK and ASK. Liquidity includes cash and cash equivalents.
- Competitor comparable RPK, ASK and load factor analysis
China Southern Airlines (NYSE:ZNH)
Central hub: Guangzhou and Beijing
China Southern Airlines (NYSE:ZNH) is China’s largest airline. It plans to double its services to Australia due to demand growth. It has enjoyed 11% passenger growth y-o-y to 5.49M, but load factor in domestic flights fell. Domestic passenger growth of 10% made up most of the increase (5.06M), regional up 17% to 104000, international travel up 12% to 326000. Despite passenger growth, overall load factor fell 4% to 72.2%.
Air China (HKG:0753)
Central hub: Hong Kong and Macau
Air China (HKG:0753) is China’s second largest airline. China posted 11% increase in passenger traffic in October, 2009 – strong growth in domestic and regional markets. Air China’s domestic RPK was up 11% y-o-y, international RPK was up 5% y-o-y and regional RPK was up 14% y-o-y. Total passenger numbers increased: domestic was up 16% to 3.1M, international was up 4% to 484000, regional was up 25% to 116900.
Capacity also increased. Domestic ASKs were up 12%, regional ASKs were up 20%, and international ASKs were down slightly 2%. Overall ASKs were up 7%.
Overall Load factor increased 3.3% to 82%. Domestic was up 2.7% to 82%, international load factor was up 4.9% to 82%, and regional load factor was down 3.5% to 72%.
China Eastern Airlines (NYSE:CEA)
Central hub: Shanghai
China Eastern Airlines (NYSE:CEA) is China’s third most valuable airline.
Passenger traffic in September rose 16%: domestic was up 22% to 3.17M, international numbers rose 9% to 349000, and regional fell 8% to 137000.
Domestic RPK were up 20% y-o-y, regional RPK were down 13% y-o-y, and international RPK was up 11% y-o-y. Overall RPK was up 16%.
Capacity: in response to decreased regional RPK, ASKs were decreased by 6%, domestic ASKs were up 24%, and international ASKs were up 5%. Overall ASK increased by 17%.
Load factor: domestic factor fell 2.5% to 71.3%, regional load factor fell 4.9% to 60.9%, international load factor rose 3.3% to 68.2%. Overall load factor fell 0.8% to 70.1%.
- Competitor comparable revenue and earnings analysis
Air China (KHG:0753)
Air China was able to turn a profit in interim 2009 by decreasing operating expenses by 20.86% y-o-y.
China Eastern Airlines (NYSE:CEA)
The revenue and net profit chart of Air China (HKG:0753) and China Eastern Airlines (NYSE:CEA) is similar. Air China ( HKG:0753) appears to have faired better for net profit over the comparative period. Air China (HKG:07530 also did not suffer as large decrease in its revenues.
- Comparable Debt Coverage Ratio analysis
Japan Airlines’ figures are expressed in ‘000 000 yen.
Total debt service includes: current borrowings, operating leases and net finance costs. Non-current borrowings are not included and non-current operating leases are not included in calculations.
Both China Southern Airlines (NYSE:ZNH) and Japan Airlines have a negative Debt Coverage Ratio for interim 2009. This means that both airlines have negative cash flow to cover its debt. China Eastern Airlines’ Debt Coverage Ratio of 0.071 shows that there is also not enough cash flow to cover its debt. This could pose serious liquidity problems in the short to medium term.
I, Scott Lin, hereby certify that the views expressed in this research report accurately reflect my personal views about the subject securities and issuers. I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or view expressed in this research report.
Other Important Disclosures
The analyst(s) responsible for covering the securities in this report receive compensation based upon, among other factors, the overall profitability of Chinavestor.com.
Copyright, user agreement and other general information related to this report:
Copyright 2007 Chinavestor.com. All rights reserved. This research report is prepared for the use of Chinavestor.com clients and may not be redistributed, retransmitted or disclosed, in whole or in part, or in any form or manner, without the express written consent of Chinavestor.com.
This research report provides general information only. It is not intended to provide personal investment advice and it does not take into account the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. Investors should seek financial advice. Past performance is not necessarily a guide to future performance.
Fundamental equity reports are produced on a regular basis as necessary to keep the investment recommendation current.
This report © is published by Chinavestor.com. The information herein was obtained from source which Chinavestor believes reliable. However we do not guarantee its accuracy. Neither the information, not any opinion expressed, constitutes a recommendation to buy or to sell any securities or commodities.