Growing headwinds

By Reuters – Global Times Source:Reuters – Global Times Published: 2017/8/31 18:38:39

Chinese airlines face the storm of rising costs, falling margins amid expansion drive

A China Southern Airlines plane takes off at an airport in Guiyang, capital of Southwest China’s Guizhou Province. Photo: IC

A potent cocktail of rising costs and falling returns are behind declining first-half core profits at China's largest airlines, in a sign of the stronger headwinds they face as they compete to expand their route networks.

The State-owned airlines serve the world's fastest-growing air travel market but their margins are being dampened by their aggressive expansion of plane fleets and unhedged positions on fuel which has made them vulnerable to a 28 percent rise in price over the period.

Air China posted a 3.8 percent decline in profits attributable to shareholders. China Eastern Airlines' profit rose 34.5 percent, but this was boosted by a sale of its air freight unit.

China Southern Airlines, Asia's largest carrier by passengers, said in a statement on Tuesday that its first-half net profit fell 11.6 percent to 2.77 billion yuan ($420 million). 

The decline, however, was pared by a net exchange gain of 561 million yuan due to an appreciation of the yuan against the US dollar in the first six months, according to a filing to the Hong Kong bourse. The carrier had recorded a first-half net exchange loss of 1.52 billion yuan in the previous year.

In the first half of this year, China Southern faced a "complex external environment of great downward pressure on domestic economy, substantial increase in oil price over the same period of the previous year and rising competition from high-speed railway", Xie Bing, the company secretary, was quoted as saying in the statement.

Rising costs

Costs grew significantly, with China Southern saying that its flight operation expenses rose by 30.5 percent while China Eastern's operation expenses increased by 11.7 percent.

The cost side is facing the pressure of rising oil prices. 

In the first half of 2017, China Southern's aviation fuel costs reached 15.402 billion yuan, an increase of 50.13 percent year-on-year, and the fuel cost of China Eastern was 12.14 billion yuan, an increase of 45.15 percent.

Fuel is an airline's largest single expense. It typically makes up about one-third of an airline's total operating costs.

China Eastern said the rise in the fuel cost is caused by an increase in the oil price by 38.16 percent on average, resulting in an additional oil cost of 3.35 billion yuan, and the amount of fuel used grew by 5.06 percent, which led a spending of 423 million yuan more on fuel. 

"We forecast pre-exceptional earnings to continue to decline as Chinese airlines struggle to pass through the higher costs," Andrew Lee, an analyst from New York-based investment banking firm Jefferies, said in a note.

Shanghai-based Juneyao Airlines, one of China's largest private carriers, similarly blamed higher fuel costs for its 12 percent fall in first-half net profit.

International vs domestic routes 

Yields on international routes in particular declined over the period for the three big airlines.

Apart from capacity expansion, analysts also said cancellation of lucrative routes to South Korea played a role, as China pressured South Korea over Seoul's deployment of a US missile defense system.

China Eastern's international passenger yields, excluding the fuel surcharge, fell 1.1 percent while China Southern's yields on international routes declined 7.5 percent. Air China's yield on overseas routes dipped 3.2 percent.

Domestic routes fared better in comparison, with China Southern experiencing flat yield growth and China Eastern reporting a rise of 1.5 percent.

"We believe that competitive pressure could continue to suppress passenger yield in the second half," said BOCOM International analyst Geoffrey Cheng in a note about China Southern's performance.

However, Xie from China Southern Airlines is optimistic about the industry's performance for the second half of the year, expecting China's total passenger volume to maintain an approximate 12.4 percent growth rate and the number of outbound passengers to reach a record high of 140 million, representing a 14.8 percent increase.

While he expected the Chinese currency to strengthen against the US dollar and oil prices to stabilize, the airline would face intensified market competition abroad and at home that is brought about by China's accelerated high-speed rail development, as well as pressure from increased domestic and international airline security measures.


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