13-Apr-2010 11:30 AM

China Southern Airlines returns to the black, favourable outlook

Analysis

China Southern Airlines staged a solid turnaround in profitability in 2009 on the back of a recovery in domestic demand and considerable government support. However, yields (particularly in international markets) remained under severe pressure and many non-fuel cost lines rose. The airline reported an operating profit of USD210.9 million in the 12 months to 31-Dec-2009, compared to a loss of USD827 million in the previous corresponding period, despite a 0.9% reduction in revenue, to USD8,027 million.

China Southern Airlines revenue growth and operating costs growth: 2005-2009

Back in the black, thanks mainly to fuel, government support policies

Net profit in the period reached USD48.3 million (CNY330 million), compared to a net loss of USD701 million in 2008. Operating costs fell 10.4% to USD8,108 million, as fuel costs fell by 29% to USD2,400 million.

China Southern operating costs break down in 2009

Maintenance costs fell 9.1%, while China Southern slashed its administrative costs by almost 10%.

The second biggest cost item ('Other Flight Operations', encompassing operational staffing costs), rose 8.2%, reflecting a 9.5% increase in ASK production. Aircraft/Traffic Servicing costs rose by a similar amount (+8.2%), while promotional/sales costs jumped almost 20% as domestic competition intensified. Depreciation/amortisation costs rose almost 4%.

China Southern passenger traffic (RPK) growth and passenger capacity (ASK) growth in 2009

The result was also aided by a RMB1,328 million (USD195 million) refund from Beijing from the CAAC infrastructure development fund for the period from 01-Jul-2008 to 30-June 2009, which was refunded during the year and treated as 'other net income' in the profit and loss statement.

The net result considerably below market expectations of a CNY500 million profit, but the carrier's shares closed slightly higher on the day of the results announcement (12-Apr-2010), on expectations the government will allow the local currency to appreciate, cutting the value of the carriers' considerable foreign currency denominated debts (see Outlook section below).

The airline's operating margin returned to positive territory (2.6%) in 2009, after a horror 2008.

China Southern Airlines operating profit margin and net profit margin: 2005-2009

Traffic recovers, yields don't. Cargo worries

The turnaround is attributable to a resumption of strong passenger traffic growth (+13.8%) in 2009, after a pause in 2008. Cargo volumes remained muted. Indeed, China Southern delayed its proposed cargo JV with Air France due to the global financial crisis. Chairman, Si Xianmin, stated in early Apr-2010 that the carrier is currently seeking a cooperation partner for its cargo subsidiary, including a business or investment partner. China Southern is at an increasing disadvantage to Air China in the cargo segment, following the Beijing-based carrier's signing of an agreement with Cathay Pacific to establish a Shanghai-based cargo joint venture.

China Southern Airlines passenger numbers growth and cargo volume growth: 2006-2009

Domestic passenger numbers (China Southern's core market) surged 15.2% last year, but yields slumped 10.2%. The international market remained toxic, with falling traffic (-2%) and yields (-17.9%), while Hong Kong/Macau/Taiwan volumes improved (+4.6%), but intense competition lowered yields (-10.7%).

China Southern Airlines passenger numbers growth and yield growth: 2006-2009

Expressed in terms of sector revenue per passenger, China Southern's international routes are clearly facing considerable headwinds, while pricing in the core domestic market is also challenging.

China Southern Airlines revenue per passenger growth by routes (RMB): 2009

China Southern Airlines expecting a better 2010; profits surge fivefold in 1Q2010

China Southern Airline boosted profits more than five fold in the three months ended 31-Mar-2010 (1Q2010) with the carrier benefiting from a 15% year-on-year increase in passenger levels as the aviation market rebounded, as well as the CNY1.6 billion (USD234 million) sale of its 50% stake in MTU Maintenance Zhuhai Co.

China Southern Airlines financial results: Three months ended 31-Mar-2010 (Chinese Accounting Standards)

	1Q2010	% Change
Revenue (mill)	2,472	+31%
Operating costs (mill)	2,419	+20.5%
Operating profit (mill)	217.3	^
Profit before income tax (mill)	249.2	+350%
Net profit (mill)	207.9	+539%

Net profits increased 539% to USD207.9 million in the quarter for a net profit margin of 8.4%, the highest margin in over five quarters. The carrier, meanwhile, returning to profitability at the operating level with an operating profit of USD217 million. However, without the proceeds of the stake sale, China Southern would have been loss-making in the first quarter.

China Southern Airlines net profit margin: 1Q2009 to 1Q2010

The carrier reported a 31% increase in revenue in the quarter to USD2.5 billion - the highest level in over five quarters. China Southern also retains the position as the largest revenue earner among the 'Big Three' carriers. China Southern's operating expenses were up by a lesser degree, increasing 21% to USD2.4 billion.

Chinese carriers revenue trend: 1Q2009 to 1Q2010

China Southern Airlines revenue trend: 1Q2009 - 1Q2010

Assets and owners equity increased

Total assets increased 5.9% in the period to CNY100.3 billion (USD14.7 billion) with owners equity up by 13.7% to CNY11.8 billion (USD1.7 billion). The company's Board, on 08-Mar-2010, approved the placement of not more than 1.8 billion new A shares to investors including China Southern Air Holding Company (CSAHC) and the placement of up to 312.5 million new H shares to Nan Lung Holding Limited. The placement remains subject to approval of shareholders and China Securities Regulatory Commission.

Shareholder structure: as at Mar-2010

Expecting continued passenger growth; to benefit from Yuan appreciation

Looking forward, CFO, Xu Jiebo, stated the carrier expects a CNY500 million gain in foreign exchange for each 1% the local currency strengthens against the US Dollar.

China Southern also expects sales, passenger traffic and cargo volumes to grow by more than 10% in 2010, with Mr Xu stating, "our domestic market volume has already surpassed the pre-financial crisis level". The airline will expand its fleet to 412 aircraft in 2010, up from 378 at present.

Shares in China Southern Airlines, controlled by China Southern Air Holding Co, have risen approximately 70% in Hong Kong trading so far in 2010, compared to a 55% gain for China Eastern Airlines and a 37% increase for Air China.

Outlook: Tail winds ahead

China Southern is confident that conditions will continue to improve in 2010. It stated, "given that the international financial market is becoming stable steadily, the Company expects to see a normal growth of the global economy under the recovery".

The carrier added that, "driven by the proactive fiscal policy and moderately easing monetary policy, the domestic economy will also maintain an uptrend. Besides, the PRC government has put great efforts in economic restructuring, boosting the national income and stimulating the domestic consumption, which will make favourable conditions for the rapid and health development of the domestic aviation market". China Southern concluded, "the Group is confident of ongoing improvement in its operating performance".

China Southern enjoyed considerable government support during the 2008/09 crisis - and would have been unprofitable last year without the intervention. Moves by Beijing to ease or scrap the yuan's peg to the US dollar would have a dramatic impact on Chinese airline profitability, as was the case during 2007, potentially providing the next round of (indirect) government assistance.