China Airlines: Why Jefferies Is Bearish
Jefferies remains bearish on Chinese airline stocks despite revising up its earnings forecasts for the sector to reflect lower oil prices and potential foreign exchange gains.
The broker now forecasts the big three Chinese airlines - Air China (753.HK), China Eastern Airlines (670.HK) and China Southern Airlines (1055.HK) - to post a combined FX gain in 2017 of CNY 3.9 billion, up from the original forecast of a CNY 4.5 billion loss. This has prompted the broker to raise its 2017 earnings forecasts by up to 32% on the three airlines.
However, lower oil prices and FX gains will fail to offset higher operating costs which will see margins of the big airlines squeezed:
Excluding CX, we estimate sector margins continuing to decline next year with operating margin of only 8.7% next year from 12.5% in 2016 due to higher costs with capacity increases will likely cap ticket price increases. For example, the 3 major Chinese airlines are slated to increase number of planes by 25% by end-2019 from end-1H17, primarily passenger planes. Taking 2016 as example, number of passenger planes increased 6.4% with seat capacity increasing 10.0%. Global air cargo remains the key bright spot with 2H, especially 4Q, seasonally stronger demand and yields - CX has the highest revenue exposure to air cargo.
Based on IATA data, July and YTD global demand increased 11.4% and 10.6% y-y.
Jefferies has underperform ratings on Air China, China Eastern and China Southern. With an outperform rating, Cathay Pacific (293.HK) is its favorite pick, despite posting worse-than-expected losses of USD2.1 bill in the first half of this year. Jefferies believes losses have bottomed, while passenger yield and cargo demand should rebound in the second half of this year.
Cathay Pacific shares are up 15% this year, while Air China has soared 38%, China Eastern is up 17.5% and China Southern has gained 47%.