Why China's 297 Million Fliers Aren't Boosting Airline Profits

(Bloomberg) -- China’s top three airlines are poised to show this week that they’ve been hard hit by a jump in crude prices and the yuan’s depreciation.

Combined net income at Air China Ltd., China Eastern Airlines Corp. and China Southern Airlines Co. probably fell more than 50 percent to 4.95 billion yuan ($727 million) in the first half of 2018, based on the median of estimates in a Bloomberg News survey of analysts.

Chinese carriers aren’t allowed to lock in fuel costs -- the largest expense for Asian airlines -- through hedging. On top of that, with major expenses including aircraft purchases being paid for in dollars, Chinese airlines are vulnerable to a weakening yuan as they have “insignificant” currency hedging in place, according to Toliver Ma, an analyst at Guotai Junan Securities Co. in Hong Kong.

These charts show what’s in focus when the airlines report results this week. Last year’s first-half profit was boosted by a one-time gain from China Eastern’s asset sale, as well as a more favorable exchange rate and oil prices.

1. Fuel Surge

The three carriers’ fuel expenses probably accounted for about 31 percent of total costs in the first half, more than in recent years, according to Tianfeng Securities Co.

The absence of hedging for fuel increases earnings volatility, said Corrine Png, founder of Singapore-based transport-focused research firm Crucial Perspective. “The sharp spike in jet fuel prices will also eat into the Chinese airlines’ first-half profit margins.”

Why China's 297 Million Fliers Aren't Boosting Airline Profits

2. Yuan Versus Dollar

The Chinese currency declined more than 5 percent against the dollar in the second quarter amid a slowing domestic economy and escalating trade tensions with the U.S.

A weaker yuan weighs on profit as domestic routes account for about 70 percent on average of the China-based airlines’ revenue, yet they pay for major expenses in dollars. The carriers have reduced the proportion of dollar-denominated debt to lessen their exposure to the U.S. currency and debt-servicing costs.

Why China's 297 Million Fliers Aren't Boosting Airline Profits

3. Better Yields

The airlines have a silver lining in yields -- the money earned from carrying a passenger per kilometer. The number of travelers by air in China climbed 12 percent to 297 million in the first half of this year. Thanks to the robust demand and government easing of a regulation this year to allow higher ticket prices on certain domestic routes, yields will continue to rise, according to Guotai Junan’s Ma.

“Yields are definitely going up as airlines began raising ticket prices in April,” Ma said. “Airlines have reported sound growth in traffic numbers in the second quarter and this is well balanced by a slower expansion in capacity.”

Why China's 297 Million Fliers Aren't Boosting Airline Profits

To contact Bloomberg News staff for this story: Dong Lyu in Beijing at dlyu3@bloomberg.net

©2018 Bloomberg L.P.

With assistance from Editorial Board