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Chinese airlines must strengthen cost controls - Fitch

22-Mar-2006

BEIJING (XFNews) - Fitch Ratings said that Chinese airlines need to strengthen their cost management in order to stabilize profits.

"Chinese carriers' cost structures, relative to leading international carriers', is a major contributor to their poor profitability," Fitch associate director of corporates Eliza Liu said in a statement.

In the statement, which followed a Fitch report on China's aviation sector, Liu said that the unit revenues of major carriers such as Air China, China Eastern Airlines Corp and China Southern Airlines Corp were broadly in line with those of leading airlines in the Asia-Pacific region.

But the unit costs of these airlines were 15-40 pct higher than those of Cathay Pacific Airways Ltd, she added.

If fuel expenses were excluded, the unit cost would be 15-30 pct higher, Liu said.

The main reason for higher unit fuel costs of Chinese airlines is lower efficiency, not higher domestic fuel prices, Fitch said.

Since 2005, domestic jet fuel prices have been very close to prevailing international prices, but the unit fuel cost of major Chinese carriers was still 15-20 pct higher than that of Cathay in the first half of 2005.

"This is probably due to their use of older, less fuel-efficient aircraft and limited operations on longer, international, routes which are inherently more fuel efficient," Liu said.

Further improvements in fuel efficiency, which can be achieved by assigning more appropriate aircraft on domestic routes and using younger aircraft, will be crucial for Chinese airlines to better control their fuel expenses, given that fuel prices are likely to remain high for a long time, Fitch said.

Chinese airlines also have higher non-fuel cost components than Cathay, including airport charges, maintenance expenses, marketing and administrative costs and inflight service expenses.

This is largely because some cost components - such as airport tariffs - are controlled by the government, while others - such as air catering services - are controlled by monopoly service providers, Fitch said.

"The higher non-fuel cost base for Chinese carriers has limited their ability to reduce costs to cope with the prevailing tough fuel cost environment," the ratings agency said.

Air China and China Eastern are better at managing their operating costs than China Southern, despite the appearance that their cost structures are very similar.

In the first half of 2005, China Southern had a 16.6 pct higher unit cost than the other two carriers, largely because of its higher unit fuel cost, unit airport charges, maintenance expenses and marketing and administrative costs, Fitch said.

China Southern's higher unit fuel cost is due to its smaller international operation, which accounted for just 15 pct of the carrier's total revenue in the first half of last year.

"This limits the carrier's ability to reduce fuel expense by purchasing lower-priced fuel (on average lower than domestic price over a longer time horizon) from overseas," Fitch said.

Other smaller domestic airlines, including privately-owned Hainan Airlines, have incurred even higher costs than the country's largest three airlines.

"This suggests that it could be very difficult for the privately-owned airlines to operate on a low cost basis in China," Liu said.

These airlines face a rigid cost structure, a lack of operational and financial flexibility as well as a lack of secondary airport facilities, which are usually used by low cost carriers in Europe and other Asian countries, Liu added.

But Fitch also noted that the introduction of more competition and deregulation of suppliers would reduce some costs of Chinese airlines.

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