Chinese Airlines Finally Get a Lift After a Bitter 2018

(Bloomberg) -- After their worst annual performance in seven years, shares of Chinese airlines are surging on stable outlook for oil prices and a strengthening yuan.

The nation's top-three state carriers -- Air China Ltd., China Eastern Airlines Corp. and China Southern Airlines Co. -- had their Shanghai-listed stocks upgraded by brokerages including Credit Suisse Group AG. Analysts cited a solid outlook bolstered by optimism crude oil prices will be capped this year and that the U.S. and China will soon resolve their dispute over trade. Macquarie Group Ltd. also raised its rating on the stocks.

Shanghai-listed A-shares of Air China, China Eastern and China Southern soared 4.5-6.5 percent Friday, while their Hong Kong-listed stocks advanced 4.7-8.6 percent. Shares of China Southern have already advanced 10 percent this year in Shanghai, while Air China has risen about 6 percent and China Eastern 7 percent. Each of the three Shanghai-listed stocks has at least 18 buy rating and maximum three sell from analysts tracked by Bloomberg.

“Overall, in our view the reducing macro risks with easing U.S.-China tension should bode well for the airlines,” Credit Suisse analysts Lok Kan Chan and Kenneth Fong wrote in a research report Thursday. “We reiterate our constructive view on the China airlines sector driven by solid air demand with low penetration, ongoing supportive policy.”

Although policy makers in Beijing have given the airlines more freedom to increase fares and tightened supply of flight slots to help increase passenger yields -- a key measure of industry profitability -- the 5.3 percent slide in the yuan and crude oil gain for the most part of last year added to their costs and weighed on their earnings. The shares of the three carriers slumped about 40 percent in 2018.

While fuel costs top the expenses typically for Asian airlines, a weaker yuan compounds the woes by raising finance costs for companies that earn in the local currency but pay for imports -- such as expensive aircraft -- with dollars.

Unlike its peers elsewhere, Chinese airlines don't hedge against fuel, leaving them vulnerable to volatility in oil prices. Price of Brent oil was on a steady climb to $86 per barrel in early October before nosediving to just a tad above $50 in late December. It last traded around $61 in Asia.

A one percentage point increase in oil will drag down earnings of the three carriers by two to three percentage points in the next two years through 2020, Credit Suisse said. China Southern, it said, will feel the biggest impact given its big fleet size and higher fuel consumption.

Better ROE

Credit Suisse expects Brent at about $63 to $65 this year and next and forecasts the yuan will hover around 6.8 to the dollar, providing some stability to the carriers. Bank of America Merrill Lynch predicts the currency to rise to 6.65 per dollar in the near term on a possible deal between the U.S. and China as the two parties negotiate a settlement to their dispute.

“Investors would refocus on yield improvement that could drive better ROE (return on equity) in 2019,” the Credit Suisse analysts wrote, lifting mainland-listed shares of Air China and China Eastern to outperform and China Southern to neutral. The brokerage also boosted target prices of the Hong Kong-listed shares of the three carriers on which it already had outperform rating.

Air China's ROE stands at 8.7 percent, compared with 10.9 percent for China Southern and 6.65 percent for China Eastern, according to data compiled by Bloomberg.

China's air travel demand remains resilient despite a slowdown in the world's second-biggest economy amid the prolonged trade conflict with the U.S. The country is set to unseat the U.S. as the world's biggest air travel market by as early as 2022.

The Civil Aviation Administration of China has mandated moderate increase in flight capacity since 2018 as aggressive expansion of flights over the past few years had stretched airports beyond their capacity, causing massive delays.

The aviation regulator has kept this year's targeted growth of passenger traffic largely unchanged from actual increase in 2018, providing a favorable supply condition for airlines to increase fares and improve passenger yields.

To contact Bloomberg News staff for this story: Dong Lyu in Beijing at dlyu3@bloomberg.net;Abhishek Vishnoi in Singapore at avishnoi4@bloomberg.net

To contact the editors responsible for this story: Anand Krishnamoorthy at anandk@bloomberg.net, ;Divya Balji at dbalji1@bloomberg.net, Sam Nagarajan, Charlie Zhu

©2019 Bloomberg L.P.

With assistance from Bloomberg