04-Nov-2011 10:53 AM

Sharp declines in profitability for EVA Air and China Airlines in 2011 but profits in 3Q

Analysis

China Airlines and EVA Air, Taiwan's largest and second largest air carriers by revenue and traffic respectively, have reported sharp declines in profitability in the nine months ended 30-Sep-2011 weighed down by the poor performance of the air cargo transportation sector. The third quarter, traditionally a stronger period for earnings for Taiwanese carriers, delivered profits for both carriers, with an operating profit of around USD34 million for China Airlines and of around USD82 million for EVA Air.

Net profits for China Airlines stood at around USD29 million in the third quarter, with a net profit result of around USD42 million for EVA Air, based on CAPA calculations. However, the weakness in the cargo transportation sector, driven by a slump in the electronics industry whose shipments rely on air cargo transportation services, has impacted the carriers. Continued pressure on the cargo segment is expected in the months ahead.

Summary

China Airlines and EVA Air, Taiwan's largest and second-largest air carriers, reported declines in profitability due to poor performance in the air cargo transportation sector.
Both carriers experienced a decline in operating profit and net profit, with China Airlines reporting a 94.1% decline in operating profit and a 97.9% decline in net profit.
The weak cargo transportation sector, driven by a slump in the electronics industry, has impacted the profitability of the carriers.
Despite the decline in profitability, both carriers expect an improved fourth quarter due to solid demand for cross-Strait and European services.
Passenger revenue has remained relatively strong for both carriers, with EVA Air reporting growth in passenger revenue for the past six months.
Cargo revenue and yields have declined for both carriers over the past six months, with EVA Air selling two MD-11 freighter aircraft due to the economic changes in the cargo market.

China Airlines' third quarter profit covered the losses from the first half of the year as it benefited from strong seasonal passenger demand, cross-Strait capacity increases, still-high albeit declining load factors and flat oil prices (fuel costs account for 40-45% of the carrier's expenses). These factors also aided in the profit result for EVA Air in the third quarter.

Looking forward, the carriers are still expecting an improved fourth quarter, amid solid demand for cross-Strait and European services, although continued cargo weakness will limit their profit making potential.

EVA Air and China Airlines financial highlights for nine months ended 30-Sep-2011

USD mill	China Airlines	y-o-y change	EVA Air	y-o-y change
Operating revenue	3309	-4.6%	2587	-1.9%
Operating costs	3069	+9.1%	2350	+11.8%
Operating expense	215.4	-12.3%	178.7	+9.8%
Operating profit	24.3	-94.1%	58.3	-84.3%
Net profit	7.2	-97.9%	53.3	-85.6%
Total assets	6730	-5.5%	4696	-5.4%
Cash and cash equivalents	251.9	-37.7%	337.6	-0.3%
Total liabilities	5091	-5.4%	3347	-5.1%

EVA Air reports USD58.3 million operating profit; China Airlines reports USD24.3 million
operating profit in nine months to Sep-2011

EVA Air, which celebrated its 20th anniversary in Jul-2011, reported an operating profit of USD58.3 million in the nine months to Sep-2011, an 84% year-on-year decline. Net profits also weakened significantly, by 85.6% to USD53.3 million. China Airlines reported a 94.1% decline in operating profit to USD24.3 million with an even larger 97.9% slump in net profitability to USD7.2 million.

Operating and net profit margins for both carriers were weak, at under 2%, with a 0.7% operating profit margin and a 0.2% net profit margin for China Airlines, with a slightly higher 2.3% operating profit margin and 2.1% net profit margin for EVA Air. In the third quarter, China Airlines' operating margin stood at 3.0% with a 2.0% net profit margin, marking the first quarter of positive margins in 2011.

China Airlines' operating and net profit margins: 1Q2009 to 3Q2011

Single-digit revenues declines and continued operating cost growth

In the nine-month period, EVA Air and China Airlines reported single-digit revenue declines and high single-digit/low double-digit increases in operating costs. EVA Air's operating revenues weakened 1.9% to USD2.6 billion and China Airlines experienced a 4.6% revenue decline to USD2.3 billion, with the strongest decline experienced in 2Q2011. Cargo comprises around 40% of China Airlines' revenues, with cross-Strait services now accounting for around 10% of total revenues. Operating costs increased at both carriers, by 11.8% to USD2.4 billion at EVA and by 9.1% to USD3.1 billion at China Airlines.

China Airlines operating revenue growth: 1Q2009 to 3Q2011

Passenger revenue growth but operating revenues brought down by cargo weakness

EVA Air reported a 7.2% year-on-year reduction in operating revenue to TWD8261 million (USD274 million) in Sep-2011, for the sixth consecutive month of reductions, following a 4.6% decline in Aug-2011 to TWD9396 million (USD312 million) and a 1.2% decline in Jul-2011 to TWD9707 million (USD322 million).

EVA Air operating revenue (TWD, bill): 2009 to 2011

EVA Air's passenger revenue has increased for the past six months, with growth of 5.3% in Sep-2011 to TWD4868 million (USD162 million), following growth of 5.5% to TWD5912 million (USD196 million) in Aug-2011 and 45.9% in Jul-2011 to USD5861 million (USD195 million).

EVA Air passenger revenue (TWD, bill): 2009 to 2011

It was however a different story for freight revenue, which has declined for the past six consecutive months and for seven of the past nine months. EVA Air's freight revenues slumped 20.5% to TWD2881 million (USD96 million) in Sep-2011 following a 17.5% decline in Aug-2011 to TWD2983 million (USD99 million) and a 11.1% decline in Jul-2011 to TWD3245 million (USD108 million).

EVA Air cargo revenue (TWD, bill): 2009 to 2011

China Airlines has similarly reported six consecutive months of operating revenue declines, with a 5% year-on-year reduction in sales revenue to TWD10,701 million (USD355 million) in Sep-2011. This follows declines of 4.7% to TWD11,788 million (USD391 million) in Aug-2011 and a 7.3% decline in Jul-2011 to TWD12,267 million (USD407 million).

China Airlines operating revenue (TWS, bill): 2009 to 2011

Like EVA Air, China Airlines' passenger revenue has held up in 2011, with growth over the past 20 months. Passenger revenues increased 9.7% to TWD6824 million (USD226 million) in Sep-2011, with growth of 7.1% to TWD7828 million (USD260 million) in Aug-2011 and 1.8% growth of TWD7826 million (USD260 million) in Jul-2011.

China Airlines passenger revenue (TWD, bill): 2009 to 2011

China Airlines has also witnessed steep reductions in cargo revenue over the past six months, with a 23.4% decline to TWD3493 million (USD116 million) in Sep-2011. Cargo revenues weakened 22.1% in Aug-2011 to TWD3563 million (USD118 million) following a 21.3% slump in Jul-2011 to TWD4018 million (USD133 million).

China Airlines cargo revenue (TWD, bill): 2009 to 2011

Cargo yields decline over past six months

EVA Air and China Airlines have reported yield declines for their respective cargo operations for the past six months. EVA Air's cargo yields have declined 10.3% in Sep-2011 to TWD7 (USD 23.23 cents), following declines of 10.2% in Aug-2011 and 8.5% in Jul-2011. China Airlines' cargo yields have fallen to a similar degree, down 8.5% to TWD8 (USD 26.55 cents) in Sep-2011, following declines of 10.4% in Aug-2011 and 8.1% in Jul-2011.

EVA Air cargo yield (TWD): 2009 to 2011

China Airlines cargo yield (TWD): 2009 to 2011

Passenger yields also falling

EVA Air's passenger yields have weakened during 3Q2011, with declines of 2.3% to TWD3 (USD 9.96 cents) in Sep-2011 and declines of 3.4% in Aug-2011 and 1.5% in Jul-2011. This follows 17 consecutive months of growth from Feb-2010 through Jun-2011.

EVA Air passenger yield (TWD): 2009 to 2011

China Airlines' passenger yields have remained stronger than its rival, with continued growth throughout 2011 for 20 consecutive months of passenger yield growth. Passenger yields at China Airlines strengthened 9.5% in Sep-2011 to TWD3, following gains of 5.2% in Aug-2011 and 1.6% in Jul-2011.

China Airlines passenger yield (TWD): 2009 to 2011

Passenger declines in 2011 at both China Airlines and EVA Air

China Airlines has reported passenger declines in all but two months of 2011 (through Sep-2011) with the smaller EVA reporting passenger growth in the past four months following declines in the first nine month of the year.

China Airlines handled 2.9 million passengers in the third quarter, with 878,108 passengers in Sep-2011 (-3.6%), and 1.0 million passengers in both Aug-2011 (-0.9%) and Jul-2011 (-2.6%). EVA Air handled 1.8 million passengers in the third quarter, including 537,285 passengers in Sep-2011 (+8.8%), 634,896 passengers in Aug-2011 (+10.7%) and 626,556 passengers in Jul-2011 (+10%).

China Airlines passenger numbers (mill): 2009 to 2011

EVA Air passenger numbers (mill): 2009 to 2011

EVA Air passenger demand remains robust and slightly ahead of forecasts.
Air cargo expected to decline further in 2012

EVA Air president Chang Kuo-wei stated in late Oct-2011 that passenger demand remains robust and slightly better than previous forecasts. Traffic on North American routes has declined in light of US economic conditions and Southeast Asian routes remains unprofitable, Mr Chang said. However, passenger traffic to European destinations has grown 85% during 2011 due to the European Union's visa-exemption granted to Taiwanese passport holders earlier this year. Routes between Taiwan and China have also seen high demand, particularly by business passengers, and remained profitable, with strong cross-Strait growth expected to continue in 2012. He added the carrier will closely monitor passenger trends.

Mr Chang also warned that the carrier expects a continued decline in air cargo shipments from Taiwan in 2012 as the air cargo business experiences its worst period in over a decade. Mr Chang said the fourth quarter is traditionally the busiest quarter for cargo due to the Christmas peak period, but as at the end of Oct-2011, there had yet to be any sizable surge in volume.

"This year has been the worst year since I entered the trade," Mr Chang said, adding: "Previously, demand from the US and Europe continued more or less until New Year's Eve, even with a slowing global economy, but I have not seen any [demand] this year." In light of the declining demand for air cargo, EVA Air has already sold two MD-11 freighter aircraft, with plans to sell another by the end of the year. "It is appropriate to get rid of cargo planes because of the economic changes, and the move conforms with actual operations in the market," he said.

China Airlines Hong Kong general manager Tong Huai Ming separately stated new freighter capacity has worsened the situation and has put freight rates under great pressure.

Taiwan feeling impact of slowdown in electronic demand from US and Europe

Taiwan's manufacturing sector is feeling the impact from a slowdown in demand from the US and Europe for high end goods such as electronics and components.

According to Taiwan's Ministry of Finance, electronic products made up 27.2% of Taiwan's exports in the first nine months of 2011. The value of direct shipments between Taiwan and China rose 12% to USD121 billion in the nine months to Sep-2011, with European shipments contributing 10.3% of the total and the US contributing 11.5% of the total. Taiwan's economy grew at its slowest pace in two years last quarter according to the Statistics Bureau, which stated GDP rose 3.37% in the Sep-2011 quarter following growth of 5.02% in 2Q2011.

Taiwan's Five Leading Export Commodities by Trade Value for Sept-2011

Cross-Strait services a life-saver for Taiwanese carriers

On the positives, Taiwan's airlines are gearing up for a continued surge in visitors from Mainland China, as cross-Strait rights grow and restrictions are eased. Taiwan's Government has urged its carriers to purchase more aircraft before the number of mainland tourists permitted to visit the island increases from 5 million to 10 million annually over the next three to four years. (See Background Information on Boeing's Taiwan forecast).

Taiwan and China in Jun-2011 agreed to increase the number of weekly cross-Taiwan Strait services by 50% from 370 to 558. Carriers on each side were allocated an additional 94 weekly services. This follows an expansion in weekly services in 2010 from 270 to 370.

China Airlines will add 18 services to five Chinese cities by the end of 2011, cementing its position as the operator of the most cross-Strait services, with around a 20% capacity (seats) share at present. China Airlines president Sun Huang-Hsiang this month reiterated expectations that revenue and traffic contribution from the carrier's cross-Strait services will double while revenue contribution would increase from 13.6% in 2010 to more than 30% after it launches direct cross-Strait services to second tier cities in mainland China over the next two to three years.

However, Air China Taiwan GM Zhang Yun in Sep-2011 reported cross-Strait passenger revenue fell 14% year-on-year during the summer travel period due to the Shanghai World Expo last year, which has resulted in a decline in premium passengers, and the request by Taiwan's Civil Aeronautics Administration for airlines to reduce cross-Strait fares.

China to Taiwan (seats per week, one way, 19-Sep-11 to 21-Apr-12)

In addition to passenger services, there are 56 weekly direct cross-Strait cargo-only services. China Airlines and EVA Air each have 14 flights as the only operators in Taiwan, while Air China Cargo and China Southern Airlines are among five mainland carriers operating a combined 28 weekly services. In Taiwan, route rights are handed out based on fleet size, giving China Airlines an edge over EVA Air and other operators in the market. China Airlines senior VP finance Roger Han stated the carrier's cross-Straits cargo flights are "doing pretty well and our passenger flights also have pretty good loading rates", adding: "We expect increases in our cross-strait cargo business next year," though he described the traffic as a "niche business."

In a global economic picture clouded with uncertainty, it is indeed fortunate China Airlines and EVA Air have a growing "niche" in China. Cargo sector weakness will pressure margins in 4Q2011 and into 2012, though rising cross-Strait services will soften in the impact.

Background Information

Taiwan's airlines will purchase 250 aircraft over 20 years - Boeing

Boeing Commercial Airplanes marketing VP Randy Tinseth, in an interview with the China Daily on 02-Nov-2011, stated Taipei is now positioned as an important hub connecting the world to major cities in mainland China including Beijing and Shanghai.

According to Mr Tinseth, Taiwan is now the world's 20th largest purchaser of aircraft and is expected to purchase 250 aircraft, worth approximately USD60 billion, over the next 20 years. According to Taiwan's Civil Aeronautics Administration, Taiwan had 195 registered aircraft at the end of Sep-2011, including 67 registered aircraft at China Airlines (increasing to 68 as at 31-Oct-2011) and 50 at EVA Air. UNI Air had a fleet of 19 aircraft, TransAsia operated a fleet of 16 aircraft, FAT had a 10-aircraft fleet, with Mandarin Airlines (eight) and Daily Air (six) had under 10 aircraft in their respective fleets.

China Airlines fleet as at 31-Oct-2011

SkyTeam membership to increase China Airlines' destinations tenfold

Meanwhile, China Airlines has stated its new membership in SkyTeam from 28-Sep-2011 will increase its network by ten times. China Airlines' chairman Chia-Juch Chang stated joining the alliance is an "integral part of our strategy for increased international growth and profitability".

The carrier has stated it hopes to reduce costs through resource sharing through the alliance and boost revenues through enhanced codeshare operations with alliance members. The carrier stated it hopes to reduce operation costs by at least 0.5% or around TWD1 billion (USD32.89 million) in the first year of membership. "The ability to make more flexible flight arrangements might bring us TWD1 billion to TWD2 billion in additional revenue during the same period," China Airlines president Sun Hung-hsiang said.

In addition, Mr Sun stated the carrier would will seek for further cooperation with countries such as Japan, Thailand and Vietnam to extend its cargo flight service in these regions to the US and European countries.

Taiwan and Japan to sign open skies agreement soon; airlines prepare to add Japan capacity

Taiwan's foreign minister Timothy Yang this week stated Taiwan expects to sign an open skies agreement with Japan this month, after Tokyo cancelled the previously scheduled signing of the bilateral pact at the last minute on 22-Sep-2011. Japan will be the third country to establish an open skies agreement with Taiwan after the United States and Singapore.

Under the new agreement, any carriers applying to operate scheduled services to Japan will be approved with the exception of services to/from Tokyo Narita, Tokyo Haneda and Taipei Songshan airports due to capacity constraints. This will enable all Taiwanese carrier to operate scheduled services to 10 Japanese destinations aside from Tokyo without any restrictions on the number of services.

EVA Air stated it is already laying out its plans to increase its Japan capacity from its current 51 weekly flights. China Airlines, the largest operator between Japan and Taiwan, plans to increase frequency across its eight Japan destinations to at least two per day while TransAsia Airways plans to launch scheduled service to three to four Japanese cities including Osaka and Sapporo Chitose later this year or early next year. Far Eastern Air Transport stated it will prepare its Japanese launch after it commences cross-Strait services at the end of Oct-2011

Japan to Taiwan (seats per week, one way, 19-Sep-11 to 21-Apr-12)