About china Essay

Overall, investors should remain positive on CEA after listening to management’s post-results briefing, held today, based on the following four key takeaways: (1) margin expansion expected, given that RASK is guided to improve further in 2019, albeit at a slower pace than last year; (2) faster ASK capacity growth of c10% planned now vs. c8% in previous guidance, which is constructive for top-line growth; (3) unit costs are guided to be at least flat, if not down y-y in 2019, providing further upside to margins; and (4) B737 MAX grounding to have a limited impact.

Strong operational metrics

CEA posted very strong unit revenue per ASK (RASK) of +5.5% y-y, including surcharge in 2018, particularly on int’l routes, at +6.0% overall, and Japan/Korea routes, at +26.8/14.7% y-y, while Europe/U.S./Australia was also positive, at +5.4/1.5/0.3%, whereas Southeast Asia was slightly down, at -1.0% y-y.

Domestic RASK was up 4.9% overall, and all positive at +4.2/8.2/6.2/4.8/3.6% y-y for CEA’s five major hubs of Shanghai-Pudong/Shanghai-Hongqiao/Beijing/Kunming/Xi’an, while regional RASKs were up 4.7% overall and +19.4/-9.6/+3.1% y-y to HK/Macau/Taiwan.

The impact of last year’s airfare deregulation on revenue was significant at Rmb800mn for the Apr-Oct’18 summer/spring season and Rmb1.4-1.5bn for 2018 as a whole.

No full-year pax yield/RASK guidance number; “steady growth” expected for 2019, but less than in 2018

The tone was cautiously positive on further RASK improvement in 2019, with Shanghai RASK expected to stay positive this year, given still-limited industry capacity increases expected.

Beijing RASK should also be positive, given that capacity should increase meaningfully only after Daxing airport opens in late 2019, while Guangzhou RASK could be more challenging due to bigger capacity increases, although CEA will be less affected.

For 1Q19, domestic RASK is guided flat, Japan/Korea routes’ RASK growth remain good, but is less positive than last year’s, while Southeast Asia RASK is stable.

Faster capacity growth of 10% planned for 2019 vs. previous guidance of 8%

Management updated its domestic/international/regional/total ASK (available-seat-km) capacity growth plans for 2019 to 10.7/9.1/13.7/10.1% y-y versus earlier guidance of c8% total ASK growth, with domestic to be faster than international ASK growth still.

To note, CEA’s initial guidance for 2018 was 9.4% total ASK growth but ended up at 8.3%. Furthermore, the updated 10.1% remains below CAAC’s pax traffic growth forecast of 11.0% for 2019. Thus, investors should remain neutral on faster growth.

B737 MAX grounding impact expected to be limited

CEA currently has 14 grounded B737 MAX aircraft (11 with Shanghai Airlines, 3 with Yunnan Airlines) and 11/24/12 more to be delivered in 2019/20/21.

But this issue is temporary and management reassured it would not drag beyond a year. It also explained that its narrowbody fleet’s daily utilization is not currently being optimized due to China’s supply-side reform, so there is room to increase utilization rates to compensate for the B737 MAX. The B737 MAX does not represent a big part of its 2019 expected aircraft deliveries, which stand at 60 in total, including 11 widebody aircraft, so there should be little impact from the non-delivery of B737 MAX aircraft.

Transition plan for Beijing second airport

Beijing-Shanghai flights to remain at Beijing Capital International Airport (BCIA) as long as possible. When asked for updates on CEA’s transition plan to the new Beijing Daxing airport, management replied that its Beijing-Shanghai flights would be kept at the old BCIA for as long as possible, possibly throughout 2019-20.

That said, CEA is committed to developing its future hub at Daxing and will also strive to obtain additional slot incentives by shifting more flights there ahead of the minimum requirement set by CAAC.

Regarding launching long-haul international flights at Daxing, flights to Australia face no traffic rights restrictions, but rights to the U.S. from the three main cities in China have been used up, although pockets of rights remain available for some European countries, like France and the U.K. The allocation of traffic rights to airlines would be based on the new policy announced by CAAC last year.

IFRS 16 lease accounting to increase FX sensitivity

Per management, CEA’s USD-denominated liabilities would increase from Rmb4.0bn currently to Rmb8.2bn after operating leases are brought onto the balance sheet with the adoption of IFRS 16 lease accounting standards in 2019. This would increase CEA’s sensitivity to FX, although the exact impact is still being determined, and management’s risk management strategy is to avoid raising USD debt where possible in the foreseeable future.

The positive impact from the opening of satellite terminals in Pudong airport; Hongqiao airport likely to receive more slot increases from CAAC

Shanghai Pudong airport’s new satellite terminals are expected to open in Sep-19, allowing significantly more aerobridge access (as opposed to remote bay access) to satisfy CEA’s requirements. Management also commented that Shanghai Hongqiao airport had been one of the best in the country in terms of flight punctuality, so it is expected to receive more slot increases from CAAC in the upcoming summer-spring season as a reward. Nevertheless, CEA plans to balance its domestic and international capacity growth going forward, as both are important to its hub strategy.

Conclusion

Overall, CEA has the highest-quality domestic route network (which gives it the best chance of successfully raising average pax yields under a deregulated domestic airfares environment), which should more than makeup for its slightly slower capacity growth plans in 2019 versus peers. CEA-H seems undervalued at a 0.9x forward P/B, especially considering it had the strongest data trend among the Big 3 by far in 2018, which should be sustainable in the medium term.

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