Chinese airlines improve earnings, but struggle to raise efficiency

Finding less demand than expected for air travel, and facing competition from foreign carriers, China''s airlines move into a period of consolidation.

Boosted by stronger economic growth in China and the region, two of ChinaÆs three major air carriers reported improved earnings for the first half of the year, compared with the same period in 1999.StockHouse Logo

China Southern Airlines [1055], the mainlandÆs biggest carrier by fleet size, said its net profit rose 46.1% to RMB347.97 million (HK$328.27 million), against RMB238.16 million a year earlier. Earnings per share was RMB0.10 (HK$0.09), up from RMB0.07.

China Eastern Airlines [670], the countryÆs third-largest airline, posted a 1.1-fold rise in net profit to RMB203.67 million. In the first half of 1999, the company earned RMB96.97 million. Earnings per share wasáRMB0.042, up from RMB0.02 previously.

The stronger balance sheets on rising demand for air travel as economic growth in the region gathers pace, serve as a much-needed boost to ChinaÆs money-losing aviation industry, which lost RMB560 million in the first six months of the year.

"During the period (first-half), economies in Asia further stabilized," saidáYan Zhiqing,áSouthernÆs vice-chairman and president at a press conference.

"In addition, ChinaÆs economy continued to show steady improvement, leading to an increase in demand for aviation services," he said.

With 78% of its passenger revenue coming from domestic routes, China Southern is benefiting from the mainlandÆs accelerating economic growth, which has slowed since 1990.

Turnover for China Southern rose 11.6% to RMB7.06 billion, compared with the year-earlier period. Traffic revenue jumped 11% to RMB6.78 billion. The carrierÆs load factor - a measure of available seats filled - rose to 52.1% for the first half, compared with 51.1% a year ago.

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Similarly, China Eastern reported a rise in turnover to RMB5.34 billion, up 13.3%. Its traffic revenue rose 14.2% to RMB5.15 billion, of which nearly 80% came from passenger traffic. The load factor rose to 56.45% in the first six months, against the previous 50.70%.

Both airlines are expanding their air cargo services to take advantage of a boom in trade as ChinaÆs first-half exports surged 38%. China Southern said cargo volume grew 27.5%, while ChinaáEasternÆs rose 44% during the period.

A weaker Japanese yen - the currency fell nearly 3.7% against the dollar in the six months to June - also boosted the companiesÆ earnings. China Southern has debts in the Japanese currency totaling Y37 billion, while China Eastern has debt worth some Y16 billion.

Industry still struggling

china airlineStill, the companiesÆ financial statements donÆt reflect a complete turnaround in the industry.

Air travel is still a luxury, even for most urban Chinese - the group most likely to spend - who have a per capita income of about RMB5,810 (HK$5,481).áTrains offers a more economical means of domestic transportation, compared with any of the nationÆs 34 airlines.

(This compares with Hong KongÆs two carriers -áCathay Pacific Airways and sister airline, Dragonair. The average Hong Kong resident earns HK$192,660, or 35 times more than his Chinese peer.)

Chinese airlines are still struggling to reverse the past two yearsÆ losses in an industry plagued with overcrowding. Carriers, when drafting their business plans in the early 1990s in the midst of a booming economy, overestimated the demand for aircraft. Most are heavily in debt, and few of them are profitable.

Time to merge

In the latest attempt to reduce inefficiency in the state-owned sector, the Civil Aviation Administration of China (CAAC) has launched an industrial overhaul through mergers and acquisitions.

The shake-up will result in China having three major carriers - China Southern and China Eastern, and flagship Air China - each with US$6 billion in assets.

Under the plan, seven regional carriers - China Southwest Airlines, China Northwest Airlines, China Northern Airlines, ChinaáXinjiang Airlines, ChinaáYunnan Airlines, Great Wall Airlines andáZhejiang Airlines - will come under the control of the big three.

Earnings boost

For China Southern, China Eastern and Air China, the consolidation is expected to boost earnings prospects.

"Less competition will mean less tendency to discount [ticket prices]," said Lim Chin Yong, an analyst at Morgan Stanley Dean Witter in Singapore.

To counter falling ticket sales, the airlines have launched a series of price wars to stay afloat in a dwindling market.

But that was met with strong disapproval from the CAAC, which feared massive discounting would create chaos in the market. The authorities ordered a ban on the practice.

While downsizing is difficult it as cuts into the interests of various levels of the government that control the different airlines, the move is necessary as China prepares to join the World Trade Organization. WTO membership will force the country to open up more of its economy to foreign competition and loosen its grip on the 'pillar' industries including aviation, automobiles, petrochemicals and agriculture.

The hard times for Chinese airlines really began after the financial crisis hit Asia in the second-half of 1997, as Chinese companies and individuals tightened their belts, depressing demand for air travel.

To help carriers alleviate losses, the government introduced measures such as a temporary ban on new aircraft purchases, and ordering certain unprofitable domestic routes to be closed.

The airlines themselves have also resorted to ways to cut losses. China Southern and Eastern have sold and leased out surplus jetliners.

Foreign competition threat

Still, skeptics believe the effects of the reforms introduced wonÆt come too soon, even though the threat of foreign competition is expected to become more real. US carriers will increase transpacific flights, between China and the US, to 54 next year from the current 27.

For the rest of this year though, Chinese carriers remain worried that rising oil prices will eat further into profits. Prices of crude oil futures traded on LondonÆs International Petroleum Exchange have jumped 21% to date.

China Southern said fuel costs rose 29.5% in the first half of the year, compared to a year ago.

"The impact could be bigger in the second half of the year," vice-chairman Yan said.

But analysts said prospects are good for Chinese airlines in the long term, based on the fact that the mainland remains potentially the worldÆs biggest untapped consumer market.

Thomas Deng, an analyst at BNP Prime Peregrine Securities in Hong Kong said the Chinese aviation industry generally grows 70% faster than the economy as a whole.

China Southern and China Eastern didnÆt pay any dividend for the first-half.

Stocks of China Southern and China Eastern rose about 43% to HK$2.425 and HK$1.32 respectively since the beginning of the year.

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