Air China Ltd may lose its title as the world's most valuable airline just as quickly as it gained the top spot. The carrier surged past Singapore Airlines Ltd earlier this year as the Chinese airline's Hong Kong-listed shares have outpaced a 46-percent gain in the Hang Seng Index.
China's three biggest carriers may decline by as much as 75 percent as rising jet-fuel prices and growing competition crimp their profitability, which already lags behind that of foreign competitors like United Airlines and SIA. Air China, China Southern Airlines Co and China Eastern Airlines Corp have gained as much as fourfold in Hong Kong this year, driven in part by speculation that a tie-up among the carriers might boost profits and shares.
"It's a bubble which has sort of been fed by potential mergers and acquisitions," said Damien Horth, an analyst at UBS AG in Hong Kong. "Even if we do have consolidation, it doesn't necessarily create value for shareholders."
Horth rates all three major Chinese carriers as "sell" and estimated earlier this month that Air China will fall to HK$4 (51 US cents) in the next 11 months, from Monday's close of HK$20.14 in Hong Kong. That would place the carrier's market value below that of SIA.
Beijing-based Air China, Guangzhou-based China Southern and Shanghai-based China Eastern lost money on a combined basis last year even as air travel in the country increased. Their shares are still valued at as much as 62 times estimated earnings, according to data compiled by Bloomberg News. That compares with 21 times for all Hong Kong stocks and 13 times for SIA, Asia's most profitable carrier.
"Investors are disregarding valuations" of China's airlines, said Han Gang, who helps manage 60 billion yuan (US$8 billion) at Great Wall Asset Management Co in Shenzhen. "Even institutions have abandoned their principles and started to chase quick money," added Han, who doesn't own Chinese carriers and doesn't plan to buy their stock.
Rising personal incomes in China have made air travel affordable to more people, boosting traffic 15 percent last year, according to the General Administration of Civil Aviation, the regulator.
Still, China Eastern lost 3.31 billion yuan in 2006. China Southern posted net income of 188 million yuan, and Air China made a 2.69-billion-yuan profit.
"There is an assumption growth in revenue will automatically translate into growth in profits," said Horth at UBS. "That is rarely the case in the airline industry."
China Southern had a 0.4-percent profit margin last year and Air China's was 6.5 percent, compared with 6.7 percent at Cathay Pacific Airways Ltd, the biggest Hong Kong-based carrier, and 15 percent at SIA.
Li Ka-shing's Cheung Kong (Holdings) Ltd, HSBC Holdings Plc and Morgan Stanley & Co have cut their positions in China's airlines this year. Li, Asia's richest man, reduced his stake in China Southern's Hong Kong-listed shares to 12.54 percent in the past two weeks from 15.35 percent, according to filings to the Hong Kong Stock Exchange.
Competition among the three big carriers has kept them from raising domestic fares to make up for higher fuel costs. Their spending on jet fuel more than quadrupled in the five years to 2006, according to company filings, as the Chinese government, which controls jet-fuel sales, has been lifting its price cap.
"Higher sales isn't enough to help them gain amid surging oil prices," said Ma Ying, an analyst at Haitong Securities Co in Shanghai.
Hiring costs may rise as well. China's flight schools may only be able to train 7,000 pilots by the end of 2010, short of a projected need of more than 9,000, Gao Hongfeng, vice director of the regulator, said in a September 7 online interview on the central government's Website.
"Staff costs for the airlines may increase, as they need to pay more for experienced pilots from other airlines," said Edward Wong, an analyst at Quam Ltd in Hong Kong.
Competition for passengers on international routes will also intensify. US airlines are set to more than double their combined number of weekly flights to China to 112 by 2009 under an "open skies" agreement between the two countries.
While profitability improved at the three biggest Chinese carriers in the first six months of this year, the gains were helped by a 2.5-percent rise in the yuan against the US currency, which cut the cost of servicing the carriers' dollar-denominated debt.
China Southern turned to first-half profit from a loss a year earlier, while Air China's net income rose and China Eastern's loss narrowed.
"The carriers have yet to improve profitability in their main business, instead of relying on the yuan appreciation," said Li Lei, an analyst at China Securities Co in Beijing.
Air China's shares rose 31 percent in less than four weeks, while China Southern's gained 50 percent and China Eastern's more than doubled, after Air China President Cai Jianjiang said on August 29 the carrier would consider mergers with other airlines.
On September 2, SIA and parent Temasek Holdings Pte agreed to pay about US$918 million for 24 percent of China Eastern. Subsequent analyst and media reports raised speculation that Air China would make a rival bid for the Shanghai-based carrier, driving stocks of Chinese airlines to a peak on September 21.
The carriers' shares fell after Air China's partner Cathay Pacific said on September 24 that while the two airlines had considered bidding for a China Eastern stake, they wouldn't proceed.
For now, the withdrawal may signal that China's government is discouraging domestic tie-ups.
"Airline stocks are a risky investment, as they may fall on any uncertainty in other sectors, like currency or oil prices," said Han of Great Wall.
62 times vs 21 times vs 13 times
China's big three airlines - Air China, China Southern and China Eastern - lost money on a combined basis last year. Their shares are still valued at as much as 62 times estimated earnings, according to data compiled by Bloomberg News. That compares with 21 times for all Hong Kong stocks and 13 times for Singapore Airlines, Asia's most profitable carrier.
7,000 vs 9,000
China's flight schools may only be able to train 7,000 pilots by the end of 2010, short of a projected need of more than 9,000.
(Shanghai Daily October 24, 2007)
