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More subdued outlook for China in short term but some mighty changes afoot

18-Apr-2012

The year of the dragon, 2012, is typically the mightiest of the Chinese signs, symbolising dominance and ambition; consequently this should be a time for making a large leap forward. However, indicators and performance in the first few months of 2012 suggest a more subdued outlook, at least on the surface with recent commentary coming out of China revealing a tone of caution and concern, a foreboding situation given the previous robustness of demand in the country. Yet below the surface, there are indeed some mighty changes afoot. Liberalisation and economic growth are laying the foundation for a rapid acceleration, for aviation overall, but more particularly for a new generation of airlines, most of which did not exist a decade ago.

China's aviation sector continues to expand, although growth levels were more subdued in 2011 with 2012 also promising modest growth. China’s air transport industry has recently entered a stage of slower growth, registering single-digit total air traffic (RTKs, including passenger and cargo traffic) of growth in 2011, according to the CAAC. CAAC director general Li Jiaxiang, last month, forecast that passenger growth would likely slow in 2012, after previously forecasting growth of 10% in passenger traffic this year to 320 million passengers, following growth of 9.2% in 2011, although recent comments could indicate that the market could witness another year of single-digit growth in 2012.

The industry experienced double-digit traffic growth from 2004 through 2010, with 2010 clearly a banner year of recovery for China, after the downturn in 2008/09. Over the past decade, departures have increased from 69,810 scheduled air services (including Macau and Hong Kong) and 5.56 million available seats in 1982 to 2.39 million air services and 366.87 million available seats in 2011, according to UBM Aviation Routes data. There has been year-on-year capacity growth in each of the 30 years between 1982 and 2011, with double-digit growth in more than two thirds of these periods. Only two years – 1984 and 1992 – saw a year-on-year reduction in the number of services. The country’s blossoming high-speed rail network has claimed some passenger traffic from airlines. Domestic airspace limitations have also constrained expansion, while international growth in 2011 and in early 2012 impacted by global economic concerns and rising oil prices.

China’s international travel market is still in its infancy, with local carriers still heavily reliant on the domestic market, indicating considerable scope for expansion in coming years. If the 89:11 split domestic-international split seen in the US market is applied to China’s traffic forecast for 2020, there would be 77 million international passengers to/from China in 2020 – or 32.3 million more than in 2010. If the US proportion is applied to China’s 2030 traffic forecast, the total international traffic would rise to 165 million, or 3.6 times the 2010 figure. In fact, CAPA expects these figures to be exceeded as China’s aviation links with its Asian neighbours expand. The ascent of Beijing and the other major Chinese airports in the global traffic rankings also highlights the rise of the country’s economic standing and the structural changes taking place in the global economy. Continued economic growth and a rising middle class in China is expected to spur rapid traffic growth at the nation’s airports in the years to come, providing a boon for airlines and the global aerospace industry – and spurring the Asia Pacific region to new heights.

China’s commercial aircraft fleet grew to 1745 aircraft, with 148 new units in 2011. In this hybrid commercial/government market, Chinese airlines took delivery of only 805 aircraft between 2008 and 2011, 149 short of forecast levels. As in 2011, when Chinese airlines were requested to delay the delivery of 60 new aircraft, CAAC deputy director general Li Jun announced late last year that “control (on the importing of planes) will continue … and not more than 150 planes would be added to the fleet in 2012.”

CAAC is, however, encouraging airlines to acquire more widebody aircraft to replace the current single-aisle aircraft on high-density domestic sectors, especially between Beijing, Shanghai and Guangzhou, where airport capacity is under pressure. Mr Li last month, as reported by Securities Daily, stated the overall competitiveness of China’s civil aviation industry is weak compared to the top global aviation players. Mr Li encouraged Chinese carriers to open new international routes, join global alliances and to associate themselves with competitive airlines around the world in order to strengthen their competitive positions. 

China, meanwhile, remains aggressive with infrastructure development plans. The “original plan of building 60 new airports during the 12th Five-Year Plan period (2011-2015) will be extended to 70 in order to encourage the development of local air transport,” according to Mr Li. China had 180 operational airports at the end of 2011, up from 175 in 2010. While new airports continue to be built, expansion activity is occurring at almost all of the nation’s largest airports and strong competition exists among the nation’s second-tier airports to increase traffic levels to join Beijing, Shanghai Pudong and Guangzhou among the nation’s Top 5 airports and on the global Top 30 airport list in the years ahead.

China Southern and China Eastern expect 50% declines in net profits in 1Q2012

Both China Southern Airlines and China Eastern Airlines on 13-Apr-2012 stated they expect weaker results in 1Q2012, slower economic growth, higher fuel prices and smaller foreign-exchange gains. The substantial increase in the price of jet fuel contributed to higher operating costs for the carriers during 1Q2012, with jet fuel prices reaching a 10-month high on 09-Mar-2012 and averaging 9.1% higher than previous year levels in the quarter. The exchange gains for the carrier were also lower than the previous corresponding period due to the fluctuation of the Chinese yuan. The Chinese currency weakened against the US dollar in the three months ended Mar-2012, the first decline since the fourth quarter of 2009.

China Southern forecasts a more than 50% year-on-year decline in net profit in 1Q2012 from the CNY1236 million (USD193 million) it reported in 1Q2011, based on Chinese Accounting standards, due to “the slowdown in the domestic economic growth and the substantial increase of jet fuel prices”. China Eastern Airlines chairman Liu Shaoyong last month stated the carrier expects a “big” drop in travel demand growth in 2012 due to the economic slowdown and the European debt crisis. Demand for international passenger and cargo services is “clearly falling”, predominately because European consumers are cutting spending, Mr Liu said, noting there will be a “big difference” in full year travel growth in 2012, with weakness particularly seen in freight and international passenger markets. “We are also seeing China’s economic growth under pressure,” Mr Liu added, noting traffic demand in 2H2012 will likely improve from 1H2012 levels. Mr Liu also noted that during the 40-day Spring Festival holiday period, capacity growth (+7.7%) exceeded traffic growth (+3.6%), which is rare over the past several years. Despite the cautious outlook for 2012, Mr Liu stated in the long term, China’s aviation markets remains a “high growth, good return” market, according to Yicai reports.

Similarly, China Eastern expects to report a more than 50% year-on-year decline in net profit in 1Q2012 from the CNY1013 million (USD158.2 million) it reported in 1Q2011 due to “the slowdown in the growth of the demand in the civil aviation market of passenger traffic and the inadequate demand in the international cargo traffic market”.

The carrier, upon the release of its FY2011 results, commented, “In 2012, the aviation industry of the PRC is expected to face significant pressures as a result of complex and changing domestic and international operating environments, significant cost increases an general downturn in the global aviation industry.... To counter these developments, the Group will seek to proactively implement its operational plans and promote the transformation of the Group to an integrated, modern aviation services provider, which it believes will improve operating results while maintain stability”.

China Southern Airlines previously noted, “As the negative influence of the European debt crisis, it is anticipated that the world economy will recover at a slow pace in 2012. Along with the sluggish economy in developed economies and the domestic macro control measures, domestic economic activities will be hampered and economic growth in the PRC is expected to slow down. Affected by the overall economic condition, the 2012 international aviation market will be relatively weak with anemic growth, and cargo transport market will also remain depressed”.

Domestic growth has also been pressured. China Eastern Airlines commented, “With the slowdown of the PRC economy, the domestic PRC aviation industry will be further affected.” Similarly, China Southern Airlines stated, “Though the domestic passenger aviation market will continue to grow due to the economic environment in China, the growth rate is expected to slow down”.

Chinese carriers reported a collective loss of CNY540 million (USD85.69 million) in Feb-2012 and CNY200 million (USD31.74 million) in Mar-2012, according to CAAC. 

China economy general in stable shape but facing challenges

The more cautious outlook coincides with the overall economic situation in the country.

The Chinese Government last month cut its growth target to its lowest rate since 2004, with Premier Wen Jiabao reducing economic growth forecasts from the previous target of 8% to 7.5%. In 2011, China’s GDP increased by 9.2%, preceded by growth of 10.4% in 2010, with growth of 8.1% reported in 1Q2012, according to China’s National Bureau of Statistic. It also marks the fifth consecutive quarter of slowing growth and is the slowest pace of growth in 11 quarters. The State Council said the nation’s economy is generally in stable shape, but is faced with many difficulties and challenges. 

In its latest forecast, the World Bank has similarly cut its forecast for China's GDP growth from 8.4% to 8.2%. While this growth rate seems enviable, it is at a 13-year low. The bank also forecasts that the Chinese economy will bounce back by 3Q2012. 

The Conference Board has similarly noted “continued but slower growth in 2012”, with growth trends remaining slower than in 1H2011. “Hence while the economy continues to expand, it is unlikely to strengthen any further in the coming months. In particular, the momentum in consumer expectations slowed this month, and new loans remain distinctly subdued compared to last year,” The Conference Board said.

Meanwhile, China’s exports grew at a slower pace than forecast in Feb-2012, contributing to the largest trade deficit in at least 22 years in the month, with Mar-2012 reports on factory output and retail sales also signalling slowing economic growth. China reported the weakest Jan/Feb-2012 factory-production gain since 2009 and retail sales are now below expectations. Meanwhile, China’s imports in Mar-2012 rose seven times less than in Feb-2012.

Other economic indicators, such as real estate construction, car sales and retail growth, also indicate slowing growth. The slowdown in China is cause for concern far from its shores, given the size and significance that China holds as a trade partner to many of the world’s largest economies. China, for example, contributes over 1% to the GDP of Russia, Korea, Indonesia and Brazil, with a 0.8% contribute to Germany’s GDP growth. 

In further developments, People’s Bank of China announced plans to widen the band the yuan is allowed to trade within from 0.5% to 1%, marking the first widening since 2007. Concerns exist for the nation's airlines that a more flexible yuan will erode foreign-exchange gains. 

Air China reports 39% reduction in 2011 net profit

Air China reported a sharper-than-expected fall in 2011 net profit as the carrier struggled with the combined effect of rising costs and an unexpectedly high impairment charge in 4Q2012 as a weak second-hand market prevented the company from completing its planned sales of 33 aircraft. Air China had decided to dispose of 49 ageing aircraft in order to improve its operating efficiency.

Air China, the largest Chinese carrier by revenue, said its net profit declined 41% year-on-year to CNY7.08 billion (USD1.123 billion), with a 42.7% year-on-year reduction in operating profit to CNY6.26 billion (USD992 million), despite a 19% year-on-year increase in revenue and amid a 29% year-on-year increase in operating costs, driven by a 44% increase in fuel costs. All of the 'Big Three' carriers reported revenue growth in the year, although this was offset by increased operating costs.

Air China, China Eastern and China Southern revenue: 2007 to 2011

Air China revenue up 19.3% – financial highlights for the 12 months ended Dec-2011:

  • Revenue: USD15,600.9 million, +19.3% year-on-year;
  • Operating costs: USD14,608.7 million, +28.8%;
    • Fuel: USD5501.5 million, +44.0%;
    • Labour: USD1945.2 million, +24.5%;
  • Operating profit: USD992.2 million, -42.7%;
  • Net profit: USD1122.8 million, -41.0%;
  • Passenger load factor: 81.5%, +1.4 ppts;
  • Passenger yield: USD 10.78 cents, +6.3%;
  • Capacity (ASKs): +14.8%;
  • Cargo load factor: 59.3%, -2.4 ppts;
  • Cargo yield: USD 28.38 cents, -3.2;
  • Capacity (AFTKs): +4.2%. 

*Based on the conversion rate at USD1 = CNY6.30795

The carrier noted the airline industry faced a "very complicated" market situation in 2011, with relatively rapid growth in the Chinese domestic market contrasting with weakness in international travel and a large drop in air cargo. Air China nonetheless pushed forward with international expansion in the year, with a focus on boosting transfer traffic through its key hubs.

China Southern Airlines net profit declined 12%

China Southern Airlines reported a 11.8% decline in net profits in 2011 to CNY5.11 billion (USD805.6 million) and a 30.7% slump in operating profit to CNY4.34 billion (USD674 million), amid high fuel prices and muted cargo growth. Operating revenue increased 18.2% to CNY90.40 billion (USD14.0 billion), outpaced by a 23.2% increase in operating costs to CNY87.06 billion (USD13.49 billion). Increased fuel costs severely pressured the carrier’s cost base in 2011, with a 39% increase in fuel costs to CNY32.58 billion (USD5.1 billion). 

China Southern Airlines operating expenses: 2011

The carrier handled 80.7 million passengers in the year, up 5.5%, with load factors improving 1.8 ppts to 81% as capacity (ASKs) growth of 7.5% was outpaced by traffic (RPKs) growth of 9.9%. Cargo traffic volume increased 1.6% to 1.135 million tonnes. Passenger yields increased in domestic (+9.7%) and regional (+3.5%) markets but were pressured internationally (-3.4%) in the quarter, at a time when the carrier is increasing focus on the ‘internationalisation’ of its network.

The carrier has said it plans to take advantage of the long-term stable economic growth of China and the “domestic consumption upgrade” that will stimulate the continuous growth of market demands. The carrier, which has increased its focus on strengthening operations through its Guangzhou hub, warned that weak global economic growth and the slowdown of the domestic economic growth rate could weaken the operating environment.

Meanwhile, China Southern has forecast an 8% increase in revenue in 2012. With its plan to take delivery of 57 new aircraft this year, China Southern's capital spending will rise by nearly half to CNY19 billion (USD2.9 billion) from around CNY13 billion (USD2 billion) in 2010, the carrier has said. The airline forecast its revenue to increase by around 8% in 2012 to around CNY100 billion (USD15.5 billion).

China Southern Airlines revenue up 18% – financial highlights for 12 months ended 31-Dec-2011:

  • Revenue: CNY90,395 million (USD14,003 million), +18.2% year-on-year;
    • Passenger: CNY81,492 million (USD12,624 million), +18.6%;
    • Domestic: CNY68,222 million (USD10,568 million), +17.3%;
    • Hong Kong, Macau and Taiwan CNY1834 million (USD284.1 million), +20.6%;
    • International: CNY11,436 million (USD1772 million), +26.7%;
    • Cargo: CNY5760 million (USD892.3 million), +6.0%;
  • Total operating costs: CNY87,063 million (USD13,487 million), +23.2%;
    • Fuel: CNY32,675 million (USD5062 million), +39.1%;
    • Labour: CNY4412 million (USD683 million), +29.0%;
  • Operating profit: CNY4353 million (USD674 million), -30.7%;
  • Net profit: CNY5110 million (USD792 million), -11.8%;
  • Total assets: CNY129,412 million (USD20,047 million), +16.2%;
  • Cash and cash equivalents: CNY9863 million (USD1528 million), -5.2%;
  • Total liabilities: CNY91,635 million (USD14,195 million), +13.1%;
  • Passenger numbers: 80.7 million, +5.5%;
    • Domestic: 72.9 million, +4.6%;
    • Hong Kong, Macau and Taiwan: 1.8 million, +12.3%;
    • International: 6.0 million, +16.1%;
  • Passenger load factor: 81.0%, +1.8 ppts;
    • Domestic: 82.7%, +2.6 ppts;
    • Hong Kong, Macau and Taiwan: 75.7%, -0.3 ppt;
    • International: 73.9%, -0.9 ppt;
  • Yield per RPK: CNY0.67 (USD 10.38 cents), +8.1%;
    • Domestic: CNY0.68 (USD 10.53 cents), +9.7%;
    • Hong Kong, Macau and Taiwan: CNY0.88 (USD 13.63 cents), +3.5%;
    • International: CNY0.67 (USD 8.67 cents), -3.4%;
  • Cargo volume: 1.1 million tonnes, +1.6%;
    • Domestic: 857,000 tonnes, -1.9%;
    • Hong Kong, Macau and Taiwan: 13,000 tonnes, +8.3%;
    • International: 265,000 tonnes, +14.7%;
  • Fleet: 444 aircraft, +5.2%;
    • Boeing: 223 aircraft: +7.2%;
    • Airbus: 208 aircraft: +8.9%;
    • McDonnell Douglas: None, -100%;
    • Others: 13, +18.2%. 

*Based on the average conversion rate at USD1 = CNY6.4554

The carrier reported it received CNY828 million (USD128 million) in government grants, an increase of 49.7%.

Meanwhile, China Southern will add 43 new routes including 40 domestic and three international routes during the 2012 summer season between 25-Mar-2012 and 27-Oct-2012. Capacity on the carrier’s international routes will account for 27.2% of the carrier’s total capacity during the season, which the carrier plans to increase to 30% by the end of 2012. During the peak travel season, China Southern stated it will operate 516 routes including 400 domestic, 92 international and 24 regional. Meanwhile, the carrier is targeting an 8.9% year-on-year growth in passenger numbers to 87.9 million and an 8.1% growth in cargo volume to 1.2 million tonnes in 2012, according to Caixin reports. The carrier expects weak growth in the international market with the downturn in freight to continue in 2012.

China Eastern Airlines net profit weakens by 10%

China Eastern Airlines net profitability also weakened in 2011, with net profits weakening 10% to CNY4.44 billion (USD688 million) and operating profit down 26.8% to CNY4.17 billion (USD646 million). Revenue increased 11.7% to CNY82.4 billion (USD12.77 billion), although this revenue growth was outpaced by a 15.3% year-on-year increase in operating costs to CNY79.29 billion (USD12.28 billion), predictably led by a 35% increase in fuel costs to CNY29.23 billion (USD4.53 billion).

Air China, China Eastern and China Southern operating margin: 2007 to 2011

The carrier handled 68.7 million passengers in 2011, a 5.8% year-on-year increase, with passenger load factor improving 0.91 ppts to 78.9%. Passenger yields were stronger across the board, with overall yield growth of 7.9% to be marginally stronger than its peers, driven by a 7.8% increase in domestic yields. International yields improved 5.0% and regional yields were up 3.9%. In the freight sector, the carrier reported a 1.5% year-on-year reduction in cargo volume to 1.4 million tones, although cargo load factors improved 1.4 ppts to 61.8%. Cargo yields were weaker by 6.2% as the 12.5% increase in domestic yields failed to offset the 11% reduction in international and 1.1% decline in regional cargo yields. The carrier reported losses in the freight segment despite its restructuring efforts that saw the reorganisation of the three cargo airlines (China Cargo Airlines Co, Shanghai Airlines Cargo International Co and and Great Wall Airlines) into a new China Cargo Airlines.

Air China, China Eastern and China Southern passenger yield: 2007 to 2011

As the smallest of China's three state-owned carriers by revenue, China Eastern Airlines has refocused its intention away from the weaker international market back to the domestic market, which remained robust during the year despite the high-speed rail impact. From its main hub of Shanghai, and Xi'an and Kunming regional hubs, the carrier is increasing its international footprint through the help of its SkyTeam membership. In 2011, the group accounted for 52.38% and 39.01% of the market share of aircraft movements at Shanghai Hongqiao and Shanghai Pudong, respectively, and 50.08% and 37.58% respectively of the passenger market share at the two airports. In Oct-2011, the carrier cancelled orders for 24 Boeing 787s, replacing them with 45 smaller 737 aircraft to focus more on short-haul routes, as approved in Mar-2012. China Eastern also began shifting capacity from international to domestic routes beginning in the fourth quarter to take advantage of a relatively robust domestic aviation market at a time of weakening global demand – a strategy that will help it to offset pressure from continued high fuel prices and slowing global growth in 2012.

China Eastern Airlines revenue up 12% – financial highlights for 12 months ended 31-Dec-2011:

  • Revenue: CNY82,403 million (USD12,765 million), +11.7% year-on-year;
    • Passenger: CNY68,434 million (USD10,601 million), +16.1%;
    • Cargo: CNY8080 million (USD1252 million), -4.1%;
    • Domestic: CNY57,576 million (USD8934 million), +13.0%;
    • Hong Kong, Macau and Taiwan: CNY3771 million (USD584.2 million), -3.3%;
    • International: CNY22,528 million (USD3490 million), +12.7%;
  • Total operating costs: CNY79,292 million (USD12,283 million), +15.3%;
    • Fuel: CNY29,229 million (USD4528 million, +35.3%;
    • Labour: CNY8665 million (USD1342 million), -3.1%;
  • Operating profit: CNY4173 million (USD646.4 million), -26.8%;
  • Net profit: CNY4441 million (USD688.0 million), -10.1%;
  • Total assets: CNY114,739 million (USD17,774 million), +11.0%;
  • Cash and cash equivalents: CNY3861 million (USD598.1 million), +25.4%;
  • Total liabilities: CNY92,934 million (USD14,396 million), +7.1%);
  • Passenger numbers: 68.7 million, +5.8%;
    • Domestic: 58.8 million, +6.0%;
    • International: 7.2 million, +9.8%;
    • Regional: 2.7 million, -5.5%;
  • Passenger load factor: 78.9%, +0.9 ppt;
    • Domestic: 80.6%, +1.1 ppt;
    • International: 75.4%, +0.6 ppt;
    • Regional: 73.4%, +0.3 ppt;
  • Cargo volume: 1.4 million tonnes, -1.5%;
    • Domestic: 699,430 tonnes, -4.1%;
    • International: 626,260 tonnes, +1.5%;
    • Regional: 117,370 tonnes, -1.2%;
  • Cargo load factor: 61.8%, +1.4 ppt;
    • Domestic: 47.0%, -1.3 ppt;
    • International: 68.8%, +2.6 ppts;
    • Regional: 47.6%, -2.0 ppts;
  • Passenger yield: CNY 68 cents (USD 10.53 cents), +7.9%;
    • Domestic: CNY 69 cents (USD10.69 cents), +7.8%;
    • International: CNY 60 cents (USD 9.76 cents), +5.0%;
    • Regional: CNY 80 cents (USD12.55 cents), +3.9%;
  • Cargo yield: CNY1.83 (USD 28.35 cents), -6.2%;
    • Domestic: CNY1.44 (USD 22.31 cents), +12.5%;
    • International: CNY1.80 (USD 28.19 cents), -10.8%;
    • Regional: CNY4.50 (USD 69.55 cents), -1.1%;
  • Aircraft utilisation: 9.8 hours per day, +0.1 hours;
  • Employees: 59,872.  

 *Based on the average conversion rate at USD1 = CNY6.4554 during the period

Call for further government support for aviation sector

Amid a more cautious outlook for 2012, China Eastern Airlines chairman Liu Shaoyong stepped up pressure on the Government to support the nation’s ‘Big Three’ carriers. Mr Liu urged the State Administration of Foreign Exchange to inject between CNY18.0 billion (USD2.8 billion) to CNY20.0 billion (USD3.1 billion) into the three carriers, Air China, China Eastern and China Southern. According to Mr Liu and as quoted by local media sources including Yicai, SoHu and Xinhua, the move could guarantee the preservation and appreciation of the country’s foreign exchange reserves, reduce domestic inflationary pressures as the airlines are able to use foreign exchange to purchase aircraft, and it will also support the airlines’ growth and international competitiveness.

In 2011, China’s Big Three carriers paid a total of CNY15.0 billion (USD2.3 billion) in taxes and fees, Mr Liu said, while also estimating that the airlines will pay an additional CNY4.0 million (USD625 million) in fuel expenditure in 2012, of which only 75% can be eliminated through fuel surcharges. Mr Liu called on the Government to abolish some taxes and fees including tax on imported aircraft and their maintenance as well as value-added tax on aviation fuel to “give Chinese carriers a better stance in international competition”. He also raised the concern of congestion and delays, stating that for every minute of delay experienced by the carrier, it costs the carrier CNY1000 (USD156.25). According to Mr Liu, more than 20% of China’s 290 million air travellers experienced flight delays in 2011.

However, despite the short-term challenges that will result in a "big" drop in travel demand in 1H2012, Mr Liu stated China's aviation market remains a “high growth, good return” market. In fact, in the long term, China’s aviation potential has no parameters. The aviation world has no reference points to indicate the growth profile for this high-potential market.


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