Deutsche Bank Markets Research
Rating Company Date 2 December 2016 Buy Spring Airlines Initiation of Coverage Asia China Reuters Bloomberg Exchange Ticker Price at 1 Dec 2016 (CNY) 41.14 Transportation 601021.SS 601021 CH SHH 601021 Price target - 12mth (CNY) 48.20 Air 52-week range (CNY) 63.31 - 41.14
Shanghai Composite 3,274
An evident winner in China’s infant Fei Sun, CFA Vincent Ha, CFA stage LCC market? Initiating with Buy Research Analyst Research Analyst (+852 ) 2203 6130 (+852 ) 2203 6247 Thriving on China's low LCC penetration; Buy with TP of RMB48.2 [email protected] [email protected] The 9% low-cost carrier (LCC) penetration in China, compared to 56% in SE Asia, suggests there is ample room for industry leaders like Spring Airlines to grow. The airline's cost leadership over full-service carriers (FSC) mitigates its Price/price relative lower yield and offers even better profitability. We expect load factor to stay at 75 c.92%, with yield bottoming out in FY17E. Despite short-term yield pressure, 60 Spring's international expansion could help it capture increasing outbound 45 tourism demand. Spring is a scarce LCC play in China and we believe it 30 deserves a valuation premium over peers. With ROE recovering to 20% in 15 FY18E, we initiate coverage with a Buy rating and TP of RMB48.2. 0 1/15 7/15 1/16 7/16 A scarce Chinese LCC airline with significant cost leadership Spring Airlines Spring is China's largest LCC, with a 29% share of the LCC market in 2015. It Shanghai Composite (Rebased) enjoys significant cost efficiency vs. network carriers, with unit operating cost Performance (%) 1m 3m 12m 35-40% lower; this enables better profitability even on 36-42% lower yields. In 1H16, sales from charter flights contributed 27% of revenue, indicating great Absolute -5.2 -12.4 -26.3 synergy with parentco Spring Tour. The airline’s international business revenue Shanghai Composite 4.9 6.9 -5.3 contribution has increased rapidly to 37.5% in 1H16, from 1.4% in 2011. Source: Deutsche Bank
International expansion to mitigate slow domestic traffic; yield to recover We expect Spring’s international RPK to expand by 25-48% YoY in FY16-18E vs. -2-4% for domestic traffic. With passenger yield bottoming in FY16E, we forecast a 4-6% YoY rebound in FY17-18. We estimate that capex (excl. disposal gain) will remain at RMB5-6bn per annum in FY16-18E, mainly for aircraft acquisition. While ROE is forecast to drop from 26% in FY15 to 19% in FY16E, we expect it return to 20% in FY18 on recovering yield and load factors. Initiating coverage with a Buy; target price set at 4.2x FY17E P/BV; risks Our target price of RMB48.2 is based on 4.2x FY17E P/BV, c.20% below Spring’s average P/BV of 5.3x since listing. We believe this is justified, given a sustainable ROE of about 19-20% in FY17-18E. Key downside risks: excessive capacity addition; fiercer-than-expected competition from regional LCCs and Chinese airlines; and slower-than-expected demand growth.
Forecasts And Ratios Year End Dec 31 2014A 2015A 2016E 2017E 2018E Sales (CNYm) 7,312.4 8,069.6 8,294.4 9,684.5 11,564.7 EBITDA (CNYm) 1,056.4 1,591.2 1,441.0 1,748.8 2,163.0 Reported NPAT (CNYm) 884.2 1,327.9 1,336.9 1,646.5 1,972.3 DB EPS FD(CNY) 1.474 1.680 1.671 2.057 2.464 DB EPS growth (%) 20.8 14.0 -0.5 23.1 19.8 PER (x) – 32.0 24.6 20.0 16.7 EV/EBITDA (x) – 27.8 24.7 20.7 16.8 Yield (net) (%) – 0.4 0.5 0.7 0.9 DB ROE (%) 28.1 26.3 18.7 19.5 19.6 Source: Deutsche Bank estimates, company data 1 DB EPS is fully diluted and excludes non-recurring items 2 Multiples and yields calculations use average historical prices for past years and spot prices for current and future years, except P/B which uses the year end close
______Deutsche Bank AG/Hong Kong Distributed on: 02/12/2016 14:03:38 GMT Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 057/04/2016.
2 December 2016
Air Spring Airlines
Model updated:02 December 2016 Fiscal year end 31-Dec 2013 2014 2015 2016E 2017E 2018E
Running the numbers Financial Summary Asia DB EPS (CNY) 1.22 1.47 1.68 1.67 2.06 2.46 Reported EPS (CNY) 1.22 1.47 1.68 1.67 2.06 2.46 China DPS (CNY) 0.12 0.16 0.21 0.22 0.31 0.37 BVPS (CNY) 4.6 5.9 8.2 9.6 11.5 13.6 Air Weighted average shares (m) 600 600 790 800 801 801 Spring Airlines Average market cap (CNYm) na na 42,520 32,912 32,912 32,912 Enterprise value (CNYm) na na 44,244 35,647 36,157 36,411 Reuters: 601021.SS Bloomberg: 601021 CH Valuation Metrics P/E (DB) (x) na na 32.0 24.6 20.0 16.7 Buy P/E (Reported) (x) na na 32.0 24.6 20.0 16.7 Price (1 Dec 16) CNY 41.14 P/BV (x) 0.00 0.00 7.43 4.26 3.58 3.02
Target Price CNY 48.20 FCF Yield (%) na na nm nm nm 0.4 Dividend Yield (%) na na 0.4 0.5 0.7 0.9 52 Week range CNY 41.14 - 63.31 EV/Sales (x) nm nm 5.5 4.3 3.7 3.1 Market Cap (m) CNYm 32,912 EV/EBITDA (x) nm nm 27.8 24.7 20.7 16.8 EV/EBIT (x) nm nm 37.6 35.5 29.4 23.5 USDm 4,774 Income Statement (CNYm) Company Profile Sales revenue 6,550 7,312 8,070 8,294 9,684 11,565 Headquartered in Shanghai, Spring Airlines is China's Gross profit 838 1,068 1,603 1,448 1,739 2,143 largest low-cost carrier by fleet size. The airline started to EBITDA 837 1,056 1,591 1,441 1,749 2,163 operate domestic flights since 2005 and international and Depreciation 271 304 375 434 515 612 regional routes since 2010. Amortisation 31 33 41 3 3 4 EBIT 536 720 1,175 1,004 1,231 1,547 Net interest income(expense) -81 -98 -154 -179 -149 -149 Associates/affiliates 0 0 -117 0 0 0 Exceptionals/extraordinaries 0 0 0 0 0 0 Other pre-tax income/(expense) 532 595 900 958 1,114 1,232 Profit before tax 987 1,216 1,804 1,783 2,195 2,630 Price Performance Income tax expense 255 332 476 446 549 657 Minorities 0 0 0 0 0 0 75 Other post-tax income/(expense) 0 0 0 0 0 0 60 Net profit 732 884 1,328 1,337 1,646 1,972
45 DB adjustments (including dilution) 0 0 0 0 0 0 30 DB Net profit 732 884 1,328 1,337 1,646 1,972 15 Cash Flow (CNYm) 0 Jan 15 Apr 15 Jul 15 Oct 15 Jan 16 Apr 16 Jul 16 Oct 16 Cash flow from operations 1,536 1,076 1,610 1,919 2,545 2,760 Net Capex -713 -2,446 -3,188 -2,654 -2,753 -2,633 Spring Airlines Free cash flow 823 -1,369 -1,578 -735 -208 127 Shanghai Composite (Rebased) Equity raised/(bought back) 0 0 1,755 14 0 0 Margin Trends Dividends paid -216 -237 -303 -166 -172 -245 Net inc/(dec) in borrowings -544 2,369 595 2,210 -192 -175 20 Other investing/financing cash flows -178 155 277 -123 -129 -136 Net cash flow -115 918 746 1,200 -702 -428 16 Change in working capital 422 -286 -355 -206 -9 -211
12 Balance Sheet (CNYm) Cash and other liquid assets 1,475 2,400 3,095 4,295 3,593 3,164 8 Tangible fixed assets 4,349 6,884 10,146 12,355 14,582 16,588 13 14 15 16E 17E 18E Goodwill/intangible assets 51 54 63 71 79 90 EBITDA Margin EBIT Margin Associates/investments 98 110 95 95 95 95
Other assets 1,679 1,813 2,630 2,702 2,867 2,974 Growth & Profitability Total assets 7,651 11,261 16,029 19,518 21,216 22,911 Interest bearing debt 2,251 4,375 4,915 7,125 6,933 6,758 25 35 Other liabilities 2,657 3,334 4,575 4,670 5,088 5,232 20 30 Total liabilities 4,908 7,708 9,489 11,795 12,021 11,990 25 Shareholders' equity 2,743 3,553 6,540 7,723 9,195 10,921 15 20 Minorities 0 0 0 0 0 0 10 15 10 Total shareholders' equity 2,743 3,553 6,540 7,723 9,195 10,921 5 5 Net debt 777 1,975 1,820 2,830 3,340 3,594 0 0 13 14 15 16E 17E 18E Key Company Metrics Sales growth (%) 16.8 11.6 10.4 2.8 16.8 19.4 Sales growth (LHS) ROE (RHS)
DB EPS growth (%) 17.2 20.8 14.0 -0.5 23.1 19.8 Solvency EBITDA Margin (%) 12.8 14.4 19.7 17.4 18.1 18.7 EBIT Margin (%) 8.2 9.8 14.6 12.1 12.7 13.4 60 12 Payout ratio (%) 10.1 10.9 12.5 13.0 15.0 15.0 50 10 ROE (%) 30.4 28.1 26.3 18.7 19.5 19.6 40 8 Capex/sales (%) 11.1 33.6 55.5 58.9 58.1 52.5 30 6 Capex/depreciation (x) 2.4 7.3 10.8 11.2 10.9 9.9 20 4 Net debt/equity (%) 28.3 55.6 27.8 36.6 36.3 32.9 10 2 Net interest cover (x) 6.6 7.3 7.6 5.6 8.3 10.4
0 0 Source: Company data, Deutsche Bank estimates 13 14 15 16E 17E 18E
Net debt/equity (LHS) Net interest cover (RHS)
Fei Sun, CFA +852 2203 6130 [email protected]
Page 2 Deutsche Bank AG/Hong Kong
2 December 2016
Air Spring Airlines
Table Of Contents
Investment thesis ...... 4 Low LCC penetration suggests great potential ...... 4 Significant cost leadership to compensate for low yields ...... 4 Charter flight arrangement for improved aircraft utilization ...... 4 International expansion: short-term pain for long-term gain ...... 5 Route subsidy sustainable; profit contribution decreasing ...... 5 RMB4bn private placement to expand fleet size ...... 5 Valuation – scarce LCC play ...... 6 Summary ...... 6 Target price of RMB48.2 based on 4.2x FY17E P/BV ...... 6 Cross-check: valuation premium to global LCCs justified ...... 7 Tiger Airways acquired by Singapore Airlines at 5.2x P/BV ...... 8 An evident winner in China’s infant LCC market ...... 10 Summary ...... 10 China’s first and largest LCC airline ...... 10 Significant cost leadership to compensate for low yields ...... 12 Charter flight arrangement for improved aircraft utilization ...... 17 International expansion: short-term pain for long-term gain ...... 17 Route subsidy sustainable; profit contribution decreasing ...... 19 More pricing freedom to fight railway competition ...... 21 Financials ...... 23 Summary ...... 23 Higher international growth mitigates slow domestic traffic ...... 23 Major cost items well controlled ...... 25 Balance sheet and cash flow summary ...... 27 Key risks ...... 31 Sector and company-specific risks ...... 31 Sensitivity to key factors ...... 31 Company background ...... 32 The first and largest player in China’s LCC industry ...... 32 Experienced management team ...... 34
Deutsche Bank AG/Hong Kong Page 3
2 December 2016
Air Spring Airlines
Investment thesis
Low LCC penetration suggests great potential
The low penetration of air travel and LCCs in China suggests to us that there is Figure 1: LCC penetration rate (to ample room for growth in this booming tourism market for Spring Airlines. total air capacity), global comparison Chinese citizens still travel less by air compared to global standards, although 56% the number of air passengers out of total transportation passengers has been 60% 50% 40% steadily increasing, growing from 0.4% in 1995 to 2.0% in 2015. 40% 32% 30% 19% 20% 9% 11% The penetration of air travel on low cost carriers (LCCs) in China is also much 10% lower than global levels. For every 1,000 air passengers in China, only 94 of 0%
them travelled on LCCs in 2015, representing a penetration of merely 9%. In China
contrast, LCC penetration stood at 56% in ASEAN, 40% in Western Europe,
Middle East Middle
North America North
Northeast Asia Northeast Asia Southeast 32% in the US, and 11% in Northeast Asia. Europe Western Source: CAPA, Diio, Deutsche Bank Significant cost leadership to compensate for low yields Figure 2: Unit operating cost (per Spring sells cheaper air tickets than full service carriers (FSC). As a result, its ASK) comparison passenger yields are lower than FSCs’. In FY11-15, the company’s passenger (RMB) Spring Airlines Air China CEA CSA yields were on average 36-42% below China’s three largest FSCs. 0.7 0.6 To offset the weaker-than-FSC yields, lower unit operating costs are crucial for 0.5 Spring to compete with network carriers. During the same period, Spring’s unit 0.4 0.3 operating costs (measured by dividing total operating expenses by total ASK) 0.2 were on average 35-40% below its FSC peers’. 0.1 0.0 2011 2012 2013 2014 2015 Charter flight arrangement for improved aircraft utilization Source: Company data, Deutsche Bank
Spring provides charter flight services to parentco Spring Tour and its subsidiaries for their group tour products. In 1H16, sales from Spring Tour’s Figure 3: Charter flight revenue charter flight service contributed 26.7% of total revenue (FY15: 21.5%). The contribution from Spring Tour trend has been steadily increasing over recent years. 30% 26.7% 25% 21.5% While carrying a slightly lower yield than regular passenger traffic, we believe 20% 17.8% 15.9% charter flights can: 1) increase daily aircraft utilization hours and lower unit 14.3% 15% 13.3% fixed cost as chartered flights often take-off during off-peak hours; 2) help maintain a healthy load factor for new routes and cultivate a market; and 3) 10% help yield management as chartered seats are booked 3-6 months in advance. 5% 0% 2011 2012 2013 2014 2015 1H16 Source: Company data, Deutsche Bank
Page 4 Deutsche Bank AG/Hong Kong
2 December 2016 Air Spring Airlines
International expansion: short-term pain for long-term gain Figure 4: Domestic and international yield and load factor comparison In view of China’s increasing outbound tourism demand, Spring started to International load factor (%, LHS) (%) (RMB) expand to international and regional routes in 2010. Its international business Domestic load factor (%, LHS) revenue contribution increased rapidly to 37.5% in 1H16, from 1.4% in 2011. 100% International pax yield (RHS) 0.50 Domestic pax yield (RHS) 90% International flights still enjoy a higher passenger yield than domestic ones, 0.40 even though Spring has experienced sequential declines in yields for both 80% 0.30 international and domestic traffic. We expect its international passenger load 70% factor to stay at a healthy 87-88% level in FY16-18 (vs. 87-90% in FY13-1H16), 60% 0.20 with yield bottoming out in FY17E. 2013 2014 2015 2016E 2017E 2018E Source: Company data, Deutsche Bank Route subsidy sustainable; profit contribution decreasing
The route subsidy accounts for a large portion of Spring’s total subsidy Figure 5: Non-operating income as a received, i.e. 73-96% in 2011-15. As route subsidy is directly related to flight percentage of reported net profit operation, we believe it is sustainable. Authorities view subsidies as a means to promote a local economy, implying strong incentives for government to 120% 105% 100% 85% continue such subsidizing practices. 76% 77% 81% 76% 80% 68% 69% 60% While non-operating incomes accounted for over 65% of Spring’s reported net 40% profit in FY11-15, our forecast show that such reliance will maintain a slight 20% downward trend going forward as Spring continues to expand to regional 0%
markets. In addition, as these subsidies are mostly offered on flights to less
2011 2012 2013 2014 2015
2018E 2017E popular destinations, this enables Spring to: 1) continue to offer low ticket 2016E prices to attract passengers; 2) cultivate local travel markets at low costs; and Source: Company data, Deutsche Bank estimates 3) rapidly grow its share of the local market and gain a dominant position, which in turn ensures healthy pricing and yields.
RMB4bn private placement to expand fleet size
Spring announced in Aug-16 that it plans to raise RMB4bn (at no less than RMB43.71 per share for a total of 91.5m shares) in a private share placement and use the proceeds to acquire 10 A320 aircraft. Our current financial forecast has not yet reflected the share placement pending the completion of the deal as it is still conditional on regulatory approval. Assuming a successful new share issuance in mid-2017, we estimate that, with an 11% increase in the number of outstanding shares, Spring's FY17E reported EPS dilution would be about 4%, while FY17E BVPS enhancement would be about 29%, leading to a drop in ROE to c.16% vs. our current forecast of 19.5% - all else equal.
Deutsche Bank AG/Hong Kong Page 5
2 December 2016
Air Spring Airlines
Valuation – scarce LCC play
Summary
Our target price of RMB48.2 is based on a FY17E target P/BV of 4.2x, about 20% below its average P/BV of 5.3x in the past two years.
While the target FY17E P/BV is at the higher end of the global LCCs peer group, we believe this is justified considering Spring’s FY18E ROE of 20%.
We also believe that Spring’s status as a scarce listed major Chinese LCC play warrants a higher P/BV target multiple than peers.
Tiger Airways was acquired by Singapore Airlines at 5.2x P/BV. Tiger had a FY16 ROE of less than 1% vs. Spring’s 19-20% in FY17-18E. Target price of RMB48.2 based on 4.2x FY17E P/BV
Among Asian airlines, we generally find a positive correlation between P/BV and forward ROE. Asian airline stocks are trading in a valuation range of 0.8- 1.7x FY17E P/BV, with FY17E core ROEs ranging 2.0-26.9%.
Similar to other Asian airlines, we value Spring Airlines using a P/BV ratio. Over the past two years since listing, the stock has traded in a range of 1.6-8.0x one-year forward P/BV, with ROEs in the range of 26-28%. Cost of equity for Spring is estimated at 5.7% (risk-free rate for China of 3.9%, equity risk premium of 5.6%, beta of 0.8, and debt/equity ratio of 1.0). With ROEs expected to trend downwards over the next two years, we think a lower target P/BV than current levels is prudent. In comparison with the rest of Asia, Spring’s FY16-18E average ROE is near the higher end of the range, and this is further supported by a relatively low COE. We also peg its valuation higher than those of its peers in China because ROEs are superior at Spring.
Figure 6: Regional airlines – FY17E P/BV vs. FY16-18E Figure 7: Chinese airlines under DB’s coverage – FY17E average ROE P/BV vs. FY16-18E average ROE 30 20 Spring Airlines
25 18
20 16 CSA CSA-A CEA CEA-A Spring Airlines
15 14 Air ROE (%) ROE
ROE (%) ROE Air China China-A
18E Average Core Average 18E 18E Average Core Average 18E -
- 10 12 FY16 FY16 5 10 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 2017E P/B (x) 2017E P/B (x)
NOTE: Singapore Air, JAL, and ANA Holdings have March fiscal year ends Source: Company data, Bloomberg Finance LP, Deutsche Bank estimates Source: Bloomberg Finance LP, Deutsche Bank estimates
Page 6 Deutsche Bank AG/Hong Kong
2 December 2016 Air Spring Airlines
Our target price of RMB48.2 for Spring is set at a target 4.2x FY17E P/BV, about 20% below its average P/BV of 5.3x in the past two years since listing to reflect our expectation of lower FY17-18E ROEs vs. previous years. This is justified, in our view, since we expect the company to deliver 19-20% three- year average ROE in FY16-18E, vs. 26-28% in FY14-15.
Figure 8: Spring Airlines – rolling forward P/BV band Figure 9: Spring Airlines – rolling forward P/BV vs. ROE
Rolling 12-mo P/BV (X) Mean Rolling 12-mo P/BV (X) Rolling 12-mo ROE (%, RHS) Mean -SD Mean +SD 9.0 30 9.0 8.0 8.0 7.0 7.0 25 6.0 6.0 5.0 5.0 20 4.0 4.0 3.0 . 3.0 2.0 2.0 15 1.0 1.0
0.0 0.0 10
15 15 16 16
16 15 15 15 16 16
15 16
- - - -
------
- -
15 16
15 15 15 16 16 16
15 16
15 16
- -
------
- -
- -
Jul Jul
Jan Jan
Jul Jul
Sep Sep
Mar Mar
Nov Nov
May May
Jan Jan
Mar Mar
Nov Nov
Sep Sep May May Source: Company data, Bloomberg Finance LP, Deutsche Bank estimates Source: Company data, Bloomberg Finance LP, Deutsche Bank estimates
Cross-check: valuation premium to global LCCs justified
Global low-cost carrier stocks are trading at 1.1-4.4x FY17E P/BV in their respective regions. For Spring Airlines, we think that our target FY17E P/BV of 4.2x at the higher end of the global trading average, is justified considering Spring’s relatively high FY18E ROE of 20%.
We do not use P/Es for valuing airlines because earnings are too volatile. Adjusted EV/EBITDAR is our preferred earnings-based valuation model. In this respect, Spring is trading at an adjusted FY17E EV/EBITDAR of 16.5x versus FY16-18E two-year compounded EBITDAR growth of 16.5%.
Figure 10: Global LCCs – FY17E P/BV vs. FY18E ROE Figure 11: Regional airlines – EV/EBITDAR comparison
45 20.0 40 15.0 35 Spring Airlines 30 10.0 25 20 5.0
15 Spring Airlines EBITDAR18E -
ROE (%) ROE 0.0
year CAGR (%)CAGR year 18E Average Core Average 18E
10 - -
2 0.0 5.0 10.0 15.0 20.0
5 FY16 -5.0
FY16 0 0.0 2.0 4.0 6.0 8.0 -10.0 FY17E adj. EV/EBITDAR (x) 2017E P/B (x)
Remark: Excluding outlier NOTE: Singapore Air, JAL, and ANA Holdings have March fiscal year ends Source: Bloomberg Finance LP, Deutsche Bank estimates Source: Company data, Bloomberg Finance LP, Deutsche Bank estimates
Deutsche Bank AG/Hong Kong Page 7
2 December 2016
Air Spring Airlines
Tiger Airways acquired by Singapore Airlines at 5.2x P/BV
In November 2015, Singapore Airlines (SIA) proposed to buy all the remaining outstanding shares of Tiger at SGD0.41. It subsequently raised the final offer price to SGD0.45 in cash for each share, which values Tiger at 5.2x FY16 P/BV (fiscal year ends Mar-16), on our estimates.
Tiger Airways is a Singapore-based regional LCC with 23 A320 aircraft in operation as of the end of 2015. Tiger recorded FY16 net profit of SGD0.28m (vs. a net loss of SGD264.2m in FY15) and ROE of less than 1%.
All in all, we believe our target multiple of 4.2x FY17E P/BV for Spring Airlines is prudent as we expect Spring to deliver FY17-18E ROE of 19-20%, i.e. significantly above Tiger’s.
Page 8 Deutsche Bank AG/Hong Kong
2 December 2016 Air Spring Airlines
2.0 2.6 0.0 0.7 0.9 1.7 0.0 0.0 0.5 0.0 0.0 4.5 6.0 1.9 1.6 0.8 1.2 0.4 5.3 2017E Yield (%) Yield
2.0 2.3 0.0 0.5 0.7 1.5 0.0 0.0 0.5 0.0 0.0 3.7 2.4 1.9 1.5 0.6 1.0 0.3 3.0 2016E
6 26.9 11.3 13.8 18.4 19.5 24.4 21.9 23.6 34.9 24.5 16.1 21.1 17.5 11.8 21.0 12. 35.4 24.0 21.5 2017E
ROAE (%) ROAE
30.7 11.0 27.7 24.8 18.7 26.3 22.5 25.3 50.0 49.4 20.6 28.1 20.8 14.4 30.5 17.2 40.9 29.0 29.6 2016E
5.7 6.2 6.2 5.9 8.2 6.0 6.7 9.0 9.5 8.9 4.2 5.6 9.6 9.2 20.7 10.8 15.8 12.4 21.6 2017E
5.8 6.9 5.9 6.0 7.1 5.8 6.7 9.9 9.3 9.3 4.5 5.8 9.2 9.3 24.7 13.2 19.0 14.6 19.7 EV/EBITDA (x) EV/EBITDA 2016E
1.50 1.32 1.45 1.35 3.58 4.00 3.79 3.03 3.86 2.90 1.46 2.53 2.18 2.39 2.55 1.36 4.44 2.90 1.11 2017E P/BV (x)
.08 3.12 2.63 2.69 3.15 1.46 5.28 3.37 1.30 1.90 1.43 1.75 1.60 4.26 5.05 4.66 3.74 5 3.72 1.67 2016E
5.5 2.5 6.9 7.2 1.4 1.3 2.0 0.9 2.6 6.6 ------(%) 17.4 14.6 16.7 13.9 23.1 24.3 23.7 16.2 24.1
- - - 2017E
5.1 8.4 7.4 0.5 2.8 8.6 5.1 - - 38.3 22.1 47.4 12.7 49.9 7 30.0 14.8 26.5 2016) 60.9 - -
174.6 147.2 112.3 2016E EPS growth
6.0 6.2 7.7 8.0 NA 13.3 13.6 21.7 14.4 11.2 13.1 12.2 12.2 20.0 16.1 18.0 14.1 13.5 10.0 PE (x) 2017E
1December 5.0 7.0 7.5 9.5 9.4 8.2 12.6 13.9 20.2 13.0 13.5 11.3 12.4 13.5 24.6 20.0 22.3 17.2 12.2 2016E
871 350 3,912 2,503 8,130 1,676 1,254 4,774 4,699 2,693 2,749 6,577 29,236 19,331 (USDm) Mkt cap Mkt
TP NA NA 3.12 7.05 53.00 56.00 57.00 15.00 48.20 55.00 29.00 (HKD) 935.00 140.00 190.00 comparison (as of (as of comparison
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Un Asia un * Fisc ** Fisc Source: China A CH 601021 CH 603885 AAX MK AAX Un AIRA MK AIRA CEB PM TB AAV Un Asia (ex Europe LN EZJ ID RYA VA US Un HA US US JBLU USLUV US SAVE Ticker U.S US ALGT Bloomberg
Deutsche Bank AG/Hong Kong Page 9
2 December 2016
Air Spring Airlines
An evident winner in China’s infant LCC market?
Summary
Spring Airlines is China’s first and largest LCC carrier with two major base airports, at Shanghai Hongqiao and Shanghai Pudong.
With its single-type A320 aircraft, Spring can cover most cities/regions in China, Northeast Asia and Southeast Asia (ASEAN).
The company has managed to steadily grow its market share in China. Spring achieved 3.0% market share in 2015. In addition, it maintained a stable lead in China’s LCC market, with 29-34% share in 2011-15.
Spring enjoys significant cost leadership over network carriers. Its unit operating costs are 35-40% lower, which enables the company to deliver better profitability even on 36-42% lower passenger yields.
Compared to ASEAN LCC peers, Spring’s unit operating cost is on par with that for Cebu, AAV and Tiger but lags behind AirAsia. However, this is offset by Spring’s higher passenger yield and load factor.
We foresee great synergy with parentco Spring Tour. In 1H16, sales from Spring Tour’s charter flights contributed 27% of revenue (FY15: 22%). The trend has been steadily increasing over recent years.
The airline started to expand to international and regional routes in 2010. Its international business revenue contribution increased rapidly to 37.5% in 1H16, from 1.4% in 2011.
As route subsidy is directly related to flight operation, we believe it is sustainable. While government subsidies still accounted for over 60% of reported net profit in FY11-15, we note that reliance on these subsidies has declined. China’s first and largest LCC airline
Headquartered in Shanghai, Spring Airlines was China’s first low-cost carrier (LCC) and one of China’s first airlines funded by private capital. The company was established in 2004 to provide domestic air passenger services and started to expand to international and regional routes in 2010. As of 1H16, the company offers 66 domestic, 50 international and 6 regional routes (122 in total).
Spring operates at two base airports, Shanghai Hongqiao and Shanghai Pudong. It has also set up hub operations at Shijiazhuang, Shenyang, Hangzhou and, most recently, Shenzhen.
Page 10 Deutsche Bank AG/Hong Kong
2 December 2016
Air Spring Airlines
Figure 13: Spring Airlines – base and hub airports
Shenyang
Shijiazhuang
Shanghai Hongqiao/ Shanghai Pudong
Hangzhou
Shenzhen
Source: Company data, Deutsche Bank
Low air travel penetration and increasing citizen travel Chinese citizens still travel less by air than global standards, although the number of air passengers out of total transportation passengers has been steadily increasing, growing from 0.4% in 1995 to 2.0% in 2015. In 2015, we estimate that on average Chinese people traveled 0.3 times by air. This compares to 2.5 times for every person in the US, 1.3 times in Korea and 0.9 times in Japan.
Penetration of LCCs in China is also much lower than global levels. For every 1,000 air passengers in China, only 94 travelled on LCCs in 2015, representing a penetration of merely 9%. In contrast, LCC penetration reached 56% in ASEAN, 40% in Western Europe, 32% in the US, and 11% in Northeast Asia.
Figure 14: Air travel penetration*, global comparison Figure 15: LCC penetration rate (to total air travel capacity), global comparison 3.0 60% 56% 2.5 2.5 50% 40% 2.0 40% 32% 2.0 30% 1.4 19% 1.5 1.2 1.3 20% 9% 11% 0.9 1.0 10% 0% 0.5 0.3
0.0
China
U.S.
U.K.
China
Japan
Korea
Middle East Middle
France
North America North
Northeast Asia Northeast Asia Southeast Germany
Europe Western * Penetration rates = total passengers carried (domestic and international) by air / total population Source: CEIC, World Bank Source: CAPA, Diio, Deutsche Bank
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2 December 2016
Air Spring Airlines
Already the largest LCC player with potential to fly higher With its single-type Airbus A320 aircraft, Spring can cover most cities/regions in China, Northeast Asia and Southeast Asia (ASEAN). According to Airbus, the maximum cruising distance of the A320-200 is 6,150km. With a typical two- class layout (business and economy) and 150 passengers on-board, the A320- 200 aircraft can reach most regions in East Asia, Northeast Asia and Southeast Asia (ASEAN) from Shanghai.
The company has managed to steadily grow its share of China’s passenger air travel market over the last several years. In 2015, Spring Airlines achieved a 3.0% market share, measured by passenger traffic (RPK), in China. In addition, it maintained a relatively stable lead in China’s LCC market with a 29-34% share in 2011-15.
Figure 16: Spring Airlines – market share in China Figure 17: Spring Airlines – market share in LCC
3.5% 40% 3.0% 34.1% 2.9% 2.9% 32.5% 3.0% 2.8% 35% 30.9% 29.3% 28.8% 30% 2.5% 2.3% 25% 2.0% 20% 1.5% 15% 1.0% 10% 0.5% 5% 0.0% 0% 2011 2012 2013 2014 2015 2011 2012 2013 2014 2015
Source: Company data, CEIC Source: Company data, CEIC, Diio
Significant cost leadership to compensate for low yields
Spring sells cheaper air tickets than its peer full service carriers (FSC) such as Air China, China Eastern Airlines (CEA) and China Southern Airlines (CSA). As a result, Spring’s passenger yields are lower than FSCs’. In FY11-15, the company’s passenger yields were on average 36-42% below those of China’s three largest FSCs.
To offset the weaker-than-FSC yields and compete with network carriers, lower unit operating costs are crucial for Spring. During the same period, Spring’s unit operating costs (measured by dividing total operating expenses by total ASK) were on average 35-40% below its FSC peers’.
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Figure 18: Passenger yield comparison Figure 19: Unit operating cost (per ASK) comparison
(RMB) Spring Airlines Air China CEA CSA (RMB) Spring Airlines Air China CEA CSA 0.7 0.8 0.7 0.6 0.6 0.5 0.5 0.4 0.4 0.3 0.3 0.2 0.2 0.1 0.1 0.0 0.0 2011 2012 2013 2014 2015 2011 2012 2013 2014 2015
Source: Company data, Deutsche Bank Source: Company data, Deutsche Bank
As Spring expand its global footprint into ASEAN market (e.g. Thailand), it will face direct competition against regional LCCs, where cost efficiency would be even more important. Compared to Asian peers, Spring’s unit operating cost is on par with that for Cebu Pacific, AAV and Tiger Airways but still lags behind LCC leader AirAsia.
Figure 20: Global LCCs – unit operating cost (per ASK) comparison
(USD) 2011 2012 2013 2014 2015 0.10 0.09 0.08 0.07 0.06 0.05 0.04 0.03 0.02 0.01
0.00
AAV
Tiger Tiger
JetBlue
Air Asia Air
WestJet
Ryanair*
Airlines
Airways*
Air Asia X Asia Air
easyJet**
Southwest Southwest Cebu Pacific Cebu
Spring Airlines Spring * March yearend. ** September yearend. Note: Tiger Airways was delisted on 11 May 2016 after Singapore Airlines acquired more than 90% of its stake to make it private Source: Company data, Deutsche Bank
We believe a large part of the difference is from scale. To elaborate, AirAsia Malaysia has a fleet size of 80 A320 as of the end of 2015, while Spring operates a total of 52 A320, 50 A320 for AAV (Thai AirAsia) and 55 for Cebu.
Our unit cost forecasts for Spring point to a narrowing gap with AirAsia as it expands its fleet to 95 aircraft by FY18E. In addition, a higher unit operating cost is offset by Spring’s higher passenger yield and load factor than ASEAN LCCs, including AirAsia.
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2 December 2016
Air Spring Airlines
Figure 21: ASEAN LCCs – passenger yield comparison Figure 22: ASEAN LCCs – passenger load factor comparison (USD) 2011 2012 2013 2014 2015 2011 2012 2013 2014 2015 0.08 95% 0.07 90% 0.06 0.05 85% 0.04 80% 0.03 0.02 75%
0.01 70%
AAV AAV
Air Asia Air Air Asia Air
Air Asia X Asia Air
Air Asia X Asia Air
Cebu Pacific Cebu Pacific Cebu
Spring Airlines Spring Airlines Spring Tiger Airways* Tiger Airways* Tiger * March yearend. Tiger Airways was delisted on 11 May 2016 after Singapore Airlines acquired more * March yearend. Tiger Airways was delisted on 11 May 2016 after Singapore Airlines acquired more than 90% of its stake to make it private than 90% of its stake to make it private Source: Company data, Deutsche Bank Source: Company data, Deutsche Bank
Single type of aircraft Spring Airlines operates only one type of aircraft (Airbus A320), to control its operating expenses. A simple fleet structure not only provides strong bargaining power with aircraft manufacturers and leasing companies when placing purchase/lease orders, but also reduces spending on aviation materials.
In addition, efficiency can be improved through: 1) customized pilot training to ensure flexibility in aircrew resource optimization; and 2) standardized aircraft maintenance processes.
Figure 23: Spring Airlines – fleet structure and delivery schedule
2011 2012 2013 2014 2015 2016E 2017E 2018E A320 28 32 39 46 52 66 80 95 - Self ow ned 5 10 12 12 19 - Finance lease 2 2 2 4 3 - Op lease 21 20 25 30 30
Source: Company data , Deutsche Bank estimates
All economy class and high-density seating Spring adopts all-economy class seating (i.e. no business or premium economy classes) with shortened seat pitch to increase seat density and therefore maximize seat capacity.
The maximum seating of an A320 aircraft is 180-186 seats at 74cm pitch, while typical seating is 150-168 seats at 81cm. According to the company, its all-economy A320 fleet can increase seating by 15-20% compared with the typical two-class A320 layout for network carriers.
Figure 24: Comparison of A320-200 aircraft layout for LCCs vs. FSCs LCC FSC Cabin class All economy Business class and economy class Seat pitch 74cm 81cm Number of seats 180-186 1-class: 164-168; 2-class: 150-158 Number of pilots 2 2 Number of flight attendants 2-3 5-6 Source: Spring Airlines, Airbus, Deutsche Bank
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With a larger number of passengers on board each flight, the all-economy cabin setting enables the budget airline to: 1) reduce unit fuel consumption; and 2) lower unit aircraft depreciation cost and leasing expenses.
Figure 25: Unit fuel cost comparison Figure 26: Unit aircraft depreciation and leasing expenses comparison (RMB) Air China China Southern Airlines (RMB) Air China China Southern Airlines China Eastern Airlines Spring Airlines China Eastern Airlines Spring Airlines 0.25 0.10 0.09 0.20 0.08 0.15 0.07
0.10 0.06 0.05 0.05 0.04 0.00 0.03 2011 2012 2013 2014 2015 2016E 2017E 2018E 2011 2012 2013 2014 2015 2016E 2017E 2018E
Source: Company data, Deutsche Bank estimates Source: Company data, Deutsche Bank estimates
High aircraft utilization to lower unit fixed cost Longer aircraft utilization lowers unit fixed costs for Spring. Average aircraft utilization for Spring is about two hours higher than the industry average in China. To elaborate, aircraft utilization hours for Spring Airlines stayed at a level of above 11 hours per day in FY11-15 (average utilization of 11.5 hours), vs. an average of 9.4 hours for Chinese carriers.
Figure 27: Utilization hours for Chinese airlines Figure 28: Unit fixed cost comparison
(hours) China Spring Airlines Air China CEA CSA (RMB) Air China China Southern Airlines China Eastern Airlines Spring Airlines 11.6 12.0 11.4 11.4 11.5 11.5 0.30 11.0 0.25
10.0 9.5 9.5 9.5 0.20 9.3 9.2 0.15 9.0 0.10 8.0 0.05 7.0 0.00 6.0 2011 2012 2013 2014 2015 2016E 2017E 2018E 2011 2012 2013 2014 2015
Source: Company data, CEIC, Deutsche Bank Source: Company data, Deutsche Bank estimates
Deutsche Bank AG/Hong Kong Page 15
2 December 2016
Air Spring Airlines
High load factor and passenger volume for preferential airport fees In China, aeronautical fees such as landing fees and passenger service fees are Figure 29: Preferential airport charge regulated by the Civil Aviation Administration of China (CAAC). According to for domestic flights
CAAC regulation on passenger service fees, domestic flights flown by Passenger load factor Discount to domestic carriers can enjoy a preferential 20-30% discount to benchmark rates, benchmark rate if those flights satisfy the following two prerequisites: 85-90% 20% 90-95% 25% 1) they deploy aircraft that are equipped with at least 10% more seats 95% & above 30% than the average seat number of comparable fleet models; and Source: CAAC
2) they achieve a minimum passenger load factor of 85%.
Figure 30: Passenger load factor for Chinese airlines Figure 31: Unit landing cost (per ASK) for Chinese airlines China Spring Airlines Air China CEA CSA (RMB) Air China China Southern Airlines China Eastern Airlines Spring Airlines 100% 0.09 94.4% 94.1% 93.5% 93.1% 95% 92.8% 0.08
90% 0.07 0.06 85% 82.1% 81.8% 81.1% 81.4% 0.05 79.6% 80% 0.04 0.03 75% 0.02 2011 2012 2013 2014 2015 2016E 2017E 2018E 70% 2011 2012 2013 2014 2015
Source: Company data, CEIC, Deutsche Bank Source: Company data, Deutsche Bank
Figure 32: Passenger load factor for global LCC airlines
2011 2012 2013 2014 2015 100%
95%
90%
85%
80%
75%
70%
AAV
JetBlue
Air Asia Air
WestJet
Ryanair*
Air Asia X Asia Air
easyJet**
Cebu Pacific Cebu
Spring Airlines Spring Tiger Airways* Tiger
Southwest Airlines Southwest Source: Company data, Deutsche Bank
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2 December 2016
Air Spring Airlines
Charter flight arrangement for improved aircraft utilization
We see great potential synergy with parentco Spring Tour. In addition to its regular air passenger service, Spring Airlines provides charter flight services to parentco Spring Tour and its subsidiaries for their group tour products. In 1H16, sales from Spring Tour’s charter flight service contributed 26.7% of Spring Airlines’ total reported revenue (FY15: 21.5%). The trend has been steadily increasing over recent years.
Figure 33: Spring Airlines – charter flight revenue contribution from Spring Tour
30% 26.7%
25% 22.5% 21.5% 20.4% 19.1% 20% 17.8% 15.9% 16.4% 14.3% 15% 13.3%
10%
5%
0% 2011 2012 2013 2014 2015 1H14 2H14 1H15 2H15 1H16
Source: Company data
Charter flights are booked for a certain route for the whole flight season or for a certain number of seats on some route. This is an important sales channel for Spring Airlines for tourist routes such as Shanghai-Sanya, Shanghai-Guilin, and Shanghai-Zhangjiajie.
While carrying a slightly lower yield vs. regular passenger traffic, we believe charter flights can benefit Spring by:
Increasing daily aircraft utilization hours and lowering unit fixed cost, as chartered flights often take-off during off-peak hours (i.e. before 8am or after 9pm)
Maintaining a healthy load factor on new routes and cultivating a market, and by leveraging on travel agencies’ strong customer acquisition capabilities
Helping yield management and increasing ticket prices for individual sales for mature routes, as chartered seats are booked 3-6 months in advance International expansion: short-term pain for long-term gain
In view of China’s increasing outbound tourism demand, Spring started to expand to international and regional routes in 2010. Its international business revenue contribution increased rapidly to 37.5% in 1H16, from 1.4% in 2011.
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2 December 2016
Air Spring Airlines
Meanwhile, international passenger capacity (ASK) grew from 1.2% of Spring’s total ASK in 2011 to 36.2% in 1H16 and registered a 120.3% 5-year CAGR in FY11-15.
Figure 34: Spring Airlines – international flights revenue Figure 35: Spring Airlines – international capacity (ASK) contribution percentage contribution Domestic International Regional Domestic International Regional 100% 100% 1.2% 3.3% 1.4% 4.2% 8.8% 12.6% 8.9% 12.9% 80% 80% 28.1% 36.2% 29.7% 37.5% 60% 60% 92.3% 90.6% 40% 40% 84.5% 81.9% 67.6% 60.0% 20% 20%
0% 0% 2011 2012 2013 2014 2015 1H16 2011 2012 2013 2014 2015 1H16
Source: Company data; Deutsche Bank Source: Company data; Deutsche Bank
Currently, major international markets for Spring include Japan, Korea, Thailand and to a lesser extent other ASEAN markets (Malaysia, Singapore and Indonesia). In addition, the airline set up a 33%-owned Japanese JV in 2012 to operate Japan-China routes. The company’s A320 fleet can cover most of the popular tourism destinations in Northeast Asia (mainly Japan and Korea markets) and the ASEAN region.
International flights still enjoy a higher passenger yield than domestic ones, even though Spring has experienced sequential declines in yields for both international and domestic traffic, probably due to: 1) declines in fuel prices and subsequent fuel surcharge cancelation for domestic routes in FY14-15; and 2) international capacity expansion by competitors in recent years resulting in a drop in international ticket prices.
Figure 36: Spring Airlines – domestic and international yield comparison
International load factor (%, LHS) Domestic load factor (%, LHS) (%) International pax yield (RHS) Domestic pax yield (RHS) (RMB) 100% 0.60 0.56 0.57 89.5% 88.8% 88.1% 90% 87.2% 86.7% 86.7% 86.7% 0.50 85.0% 83.6% 0.44 80% 0.42 0.40 0.40 0.37 0.38 0.36 0.37 70% 0.30
60% 0.20 2011 2012 2013 2014 2015 1H16 2016E 2017E 2018E
Source: Company data, Deutsche Bank estimate
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We expect Spring’s international passenger load factor to stay at a healthy 87- 88% level in FY16-18 (vs. 87-90% in FY13-1H16), with yield bottoming out in FY17E.
Japan: We expect a negative yield impact from competition in the Japan market and for Japanese Yen appreciation to ease YoY.
Korea: The additional Jeju flights should further ramp up load factor, while supply on Seoul routes remains tight given limited available slots at Incheon Airport.
Thailand: ASK on Thailand routes expanded 64.6% YoY in 1H16, with 92.7% load factor. Among Spring’s ASEAN destinations, we expect the Thailand market to remain more profitable, considering tight flight slots at major Thai airports, while the impact from the recent “zero- dollar” group tour crackdown should only be temporary.
Figure 37: Spring Airlines – international and domestic Figure 38: Spring Airlines – international and domestic passenger load factor passenger traffic growth International pax load factor International pax traffic (RPK YoY%) Domestic pax load factor Domestic pax traffic (RPK YoY%) 100% 250% 95% 200% 90% 150% 85% 100% 80% 50% 75% 0%
70% -50%
14 15
14 15 16
14 14 15 15 16 16
15 16
15 16
15 16
15 15 16
15 16
- - - - -
------
- -
- -
- -
- - -
- -
Jul Jul Jul
Jul Jul
Jan Jan Jan
Apr Apr Apr
Oct Oct
Jan Jan
Sep Sep
Mar Mar
Nov May May Source: Company data; Deutsche Bank Source: Company data; Deutsche Bank
Route subsidy sustainable; profit contribution decreasing
Spring’s subsidy income mainly comes in two ways: 1) local governments and local airport authorities subsidizing the operation of inbound/outbound flights (route subsidy); and 2) local governments’ direct financial subsidies. The amount of route subsidy usually depends on passenger traffic volume or capacity deployment on a certain route.
Route subsidy linked to flight operation; sustainable going forward As route subsidy is directly related to flight operation, we believe it is sustainable. Route subsidies account for a large portion of Spring’s total subsidy received, at 73-96% in 2011-15. Authorities view the subsidies as a means to promote the local economy by bringing in more travelers, which implies strong incentives for governments to continue such subsidizing practices.
While total government subsidy still accounted for over 60% of Spring’s reported net profit in FY11-15, we note that Spring’s reliance on subsidies declined during the period from 100.5% to 64.0%.
These subsidies are mostly offered on flights to less popular destinations. They enable Spring to: 1) continue offering low ticket prices to attract passengers; 2)
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2 December 2016
Air Spring Airlines
cultivate local travel markets at low costs and 3) rapidly grow share in the local market and gain a dominant position, which in turn ensures healthy pricing and yields.
Figure 39: Spring Airlines – route subsidy as a Figure 40: Spring Airlines – total government subsidy as percentage of total government subsidy income a percentage of reported net profit
100% 95.5% 110% 100.5% 90% 100% 80.2% 79.3% 77.7% 90% 80% 80.8% 72.5% 80% 71.3% 70% 69.7% 70% 64.0% 60% 60%
50% 50% 2011 2012 2013 2014 2015 2011 2012 2013 2014 2015
Source: Company data, Deutsche Bank Source: Company data, Deutsche Bank
Our forecasts show that profit contribution from non-operating incomes, over 90% of which are from government subsidy, will maintain a slight downward trend going forward as Spring continues to expand to regional markets.
Figure 41: Spring Airlines – non-operating income as a percentage of reported net profit
120% 105% 100% 85% 81% 77% 80% 76% 76% 68% 69%
60%
40%
20%
0% 2011 2012 2013 2014 2015 2016E 2017E 2018E
Source: Company data, Deutsche Bank estimates
Layout of civil airport construction plan implies more regional routes Central government has laid out a national construction plan for civil airports in China’s vast lower-tier cities and inland regions, which is another reason why we believe the route subsidy arrangement between airlines and municipal government is sustainable.
According to the plan issued by the Civil Aviation Administration of China (CAAC) in 2008, the country aims to have 244 civil airports by 2020, a net
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Air Spring Airlines
increase of 38 new airports from the 206 total airports by 2015. In addition, CAAC recently announced that the government has opened up the civil airport market to private capital and encourages public-private partnership models (PPP) for airport construction and operation.
More pricing freedom to fight railway competition
Easing pressure from high-speed railway roll-out We believe the peak of China’s vast launch of high-speed railways (HSR) has passed, with the large majority of trunk lines included in the nation’s “four horizontal and four vertical HSR network” plan already in operation for a few years. The key milestone of the network, the Beijing-Shanghai HSR, has been in operation for more than five years, since Jun-11. The only remaining four sections still in construction will be completed by 2018.
Figure 42: China’s four horizontal and four vertical HSR network Four horizontal HSR lines Sections in operation Sections in construction Xuzhou-Zhengzhou-Lanzhou Xuzhou-Zhengzhou in operation Sep-16, Zhengzhou- Baoji-Lanzhou to operate by mid-17 Xi'an Feb-10, Xi'an-Baoji Dec-13 Shanghai-Hangzhou-Nanchang-Changsha-Kunming Shanghai-Hangzhou in operation Oct-10, Hangzhou- Guiyang-Kunming to operate by end-16 Changsha Dec-14, Changsha-Guiyang Jun-15 Qingdao-Shijiazhuang-Taiyuan Qingdao-Jinan in operation Jul-08, Shijiazhuang- Jinan-Shijiazhuang to operate by end-17 Taiyuan Apr-09 Shanghai-Nanjing-Wuhan-Chongqing-Chengdu Whole line in operation Jul-14 Nil
Four vertical HSR lines Sections in operation Sections in construction Beijing-Wuhan-Guangzhou-Shenzhen Beijing-Wuhan in operation Dec-12, Wuhan-Guangzhou Nil Dec-09, Guangzhou-Shenzhen Dec-11 Beijing-Shanghai (incl. Bengbu-Hefei, Nanjing- Whole line in operation Jun-11 Nil Hangzhou) Beijing-Shenyang-Harbin (Dalian) Harbin-Dalian in operation Dec-12 Beijing-Shenyang to operate by end-18 Shanghai-Hangzhou-Ningbo-Fuzhou-Shenzhen Whole line in operation Dec-13 Nil Source: Deutsche Bank
Competition from the HSR network is intense for routes with lengths of less than 800km, given the shorter commute time. However, HSR is less attractive for routes over 1,000km due to prolonged travelling time, as HSR takes longer than air travel even considering the time needed for airport security checks and possible flight delays of 1-2 hours. Figure 43 shows a travel time and ticket price comparison between air travel and HSR.
Routes below 600km: We see fierce competition between the two means of transport and the contest clearly favors HSR given its short travel time of merely c.1-3 hours. As a result, airlines terminate flight services once HSR enters operation.
Routes of 600-800km: We see fierce competition but certain airlines still offer scheduled flights on these routes on a reduced frequency and with ticket prices close to HSR. Some of the flights serve as feeders to airlines’ transit flights, in our view.
Routes of 800-1,000km: The competitiveness of air travel increases due to prolonged travel times on HSR.
Routes above 1,000km: We foresee limited traffic dilution as HSR takes longer than air travel even considering the time needed for commuting to the airport, security checks and possible flight delays.
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2 December 2016
Air Spring Airlines
Figure 43: Travel time and ticket price comparison for HSR and air travel Flight and train route Travel duration Lowest economy-class ticket (hour) price (all fees inclusive, RMB) Hangzhou-Hefei (404km) HSR 2h18m-2h43m 178 Flight N/A N/A Zhengzhou-Shijiazhuang (418km) HSR 1h21m-2h4m 189.5-208 Flight N/A N/A Hefei-Fuzhou (630km) HSR 4h19m-4h43m 357 Flight N/A N/A Hangzhou-Wuhan (656km) HSR 4h38m-5h18m 283 Flight 1h20m-1h36m 250-510 Hangzhou-Xiamen (717km) HSR 5h18m-5h44m 376 Flight 1h35m-1h45m 370-440 Fuzhou-Nanjing (747km) HSR 5h5m-5h36m 410 Flight 1h5m 300-470 Ningbo-Wuhan (754km) HSR 5h46m-6h27m 354 Flight 1h40m-1h45m 250-500 Hangzhou-Changsha (805km) HSR 4h34m-5h 405 Flight 1h45m-2h 230-510 Hangzhou-Zhengzhou (841km) HSR 4h56m-5h26m 431 Flight 1h45m-1h50m 270-530 Shanghai Hongqiao-Xiamen (878km) HSR 6h22m-6h46m 449 Flight 1h50m-2h 600-690 Wuhan-Guangzhou (873km) HSR 3h54m-4h6m 444-464 Flight 1h45m-1h55m 370-490 Shanghai Hongqiao-Shijiazhuang (1,130km) HSR 7h6m-7h31m 623.5 Flight 2h10m-2h25m 296-730 Source: Deutsche Bank, Company data
Increasing pricing freedom for domestic routes In early October, CAAC and NDRC together issued a statement that, with effect from November, the government will allow domestic carriers to adjust pricing more freely according to the market situation for: 1) routes of less than 800km; and 2) routes over 800km and in direct competition with HSR (with the cumulative upward revision not exceeding 10% per flight season for a particular route).
We estimate that about 35-40% of domestic routes are within the 800km flight distance. We expect domestic airlines to be more independent in setting airfares going forward. In addition, the price reform could enable airlines to better manage yields in peak season and lower prices to improve load factor (to at least cover fixed costs) in offseason.
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Air Spring Airlines
Financials
Summary
The composition of Spring’s air transport has changed over the years, with a meaningful increase in international business. Domestic passenger revenue contributed 87% of total revenue in FY11 vs. 59% in FY15, while international business climbed from 1% to 29%.
We expect international RPK to expand by 25.0-47.5% YoY in FY16- 18E, with a relatively stable load factor of 87-88% for the same period.
With passenger yield bottoming in FY16E, we forecast a 4.1-6.0% YoY rebound in FY17-18. We also expect load factor to remain stable on more balanced demand and supply increases.
We project a decline in operating profit margin from 14.6% in FY15 to 12.1% in FY16E and recovery to 12.7-13.4% in FY17-18E.
The airline is considering an overall fleet increase from 52 planes at the end of FY15 to about 80 by the end of FY17 and 95 by FY18.
We estimate that capex will remain at about RMB5-6bn per annum in FY16-18E, with the majority of the spending on aircraft acquisition.
While ROE is forecast to drop from 26.3% in FY15 to 18.7% in FY16E, we expect it to return to 19-20% in FY17-18 with recovering passenger yield and load factors on international routes.
The debt-to-equity ratio, if off-balance lease obligations are included, was 1.4x at the end of FY15, well down from 2.2-2.5x at the end of FY13-14. We believe it should fall to around 1x within two years. Higher international growth mitigates slow domestic traffic
Passenger air transportation is the biggest contributor to revenue and gross profits, at roughly 95% and 75-80%, respectively. There has been little change in this composition in recent years.
Figure 44: Spring – revenue and growth trend Figure 45: Spring – revenue breakdown Total gross revenue (RMBm) YoY (%, RHS) Passenger service Cargo service Others 12,500 30% 100% 26% 10,000 80% 19% 20% 7,500 17% 17% 60% 94% 95% 95% 95% 93.6% 93% 93% 93% 5,000 12% 40% 10% 10% 2,500 20% 3%
0 0% 0%
2011 2012 2013 2014 2015
2012 2011 2013 2014 2015
2016E 2017E 2018E
2017E 2018E 2016E Source: Company data, Deutsche Bank estimates Source: Company data, Deutsche Bank estimates
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2 December 2016
Air Spring Airlines
Meanwhile, the composition of Spring Airlines’ air transport business has changed rapidly over the years, with a meaningful increase in international business, particularly since 2014. The passenger business still dominates. In FY11, passenger revenue was 93.7% of total gross revenue, with domestic at 87.1% of total revenue and international at 1.4%. By the end of FY15, passenger revenue as a percentage of total gross revenue was stable at 93.6%, but with domestic falling to 59.4% and international climbing to 29.2%. Over the same period (FY11-15), air cargo remained almost flat, going from 2.2% to 1.2%. All of Spring’s cargo capacity is belly-hold.
Figure 46: Spring – passenger revenue breakdown Figure 47: Spring – passenger RPK breakdown Domestic International Regional Domestic International Regional 100% 100% 1% 1% 3% 4% 9% 14% 8% 12% 80% 31% 80% 27% 35% 38% 43% 47% 40% 45% 60% 60% 93% 93% 91% 40% 89% 84% 80% 40% 85% 83% 63% 69% 57% 53% 61% 57% 53% 20% 50% 20%
0% 0%
2011 2012 2013 2014 2015 2011 2012 2013 2014 2015
2017E 2018E 2016E 2017E 2018E 2016E Source: Company data, Deutsche Bank estimates Source: Company data, Deutsche Bank estimates
International RPK has been growing much faster than domestic traffic, partly due to a low base, and we expect this trend to continue, driven by Chinese citizens’ increasing outbound tourism demand. We expect Spring’s international RPK to expand by 25.0-47.5% YoY in FY16-18E on the back of 20.0-50.0% YoY growth in international passenger capacity (ASK), translating to a relatively stable load factor of 87-88% for the same period (FY15: 88.1%). Meanwhile, we expect domestic load factor to remain around a robust c.94% level in FY16-18E on more balanced demand and supply increases.
We forecast passenger yield will bottom in FY16E (8.4% YoY decline) and rebound by 4.1-6.0% in FY17-18E to a level close to the yield in FY15.
For domestic passenger yield, the decline in FY16E is mainly due to the removal of fuel surcharges for domestic routes amid low fuel price since FY15. With the dissipation of such negative impact amid our expectation of stable load factor outlook, we expect a 5.0-6.0% growth in domestic yield for FY17-18E.
For international yield, while we estimate a 2.0-5.0% increase in FY17- 18 given slowing capacity expansion in the North Asia and Thailand markets, yield will by no means return to FY11-15 levels as Spring expands its ASEAN operation and competes with other LCCs in the region.
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Figure 48: Spring – RPK growth breakdown Figure 49: Spring – passenger load factor and yield Domestic International Regional Passenger load factor (%, LHS) 281% 233% 175% 95% Passenger yield (RMB, RHS) 0.5 60% 57% 48% 94% 0.4
40% 34% 93% 0.3 28% 25% 92% 0.2 20% 10% 8% 1% 4% 4% 91% 0.1 0% 90% 0.0
-2%
2013 2015 2014
-20% 2012
2013 2011 2012 2014 2015
2017E 2016E 2018E
2017E 2018E 2016E Source: Company data, Deutsche Bank estimates Source: Company data, Deutsche Bank estimates
Major cost items well controlled
Fuel costs are the most volatile of the major costs. In FY15, jet fuel accounted for the largest portion (30%) of Spring’s operating expenses. Other significant expense items include depreciation and leasing expenses (18%), take-off and landing charges (18%) and staff costs (16%).
Figure 50: Spring – breakdown of major cost items for FY15
Civil Aviation Others Ancillary services Development 6% related costs Fund 1% 3%
Pilot training 2% Fuel costs 30% Maintenance, repair and overhaul costs 6%
Take-off, landing and depot Depreciation and charges operating lease 18% rentals Staff 18% 16%
Source: Company data; Deutsche Bank
Lower jet fuel prices help The fall in fuel prices, while having a direct negative effect on the top-line fuel surcharge, has a positive indirect effect through: 1) lower ticket prices fueling demand; and 2) a reduction in costs. Fuel costs tanked 25.4% YoY in FY15, on the back of a c.31% drop in jet fuel price during the year, despite 21.6% growth in ATK (total passenger and cargo capacity).
The Deutsche Bank commodities team expects a slow recovery in fuel pricing following a similar trend in crude oil. Going forward, we expect jet fuel to remain a core expense item and estimate Spring’s unit fuel cost (in terms of
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fuel costs divided by ATK) will decline 16.6% YoY in FY16 followed by 15.7- 22.0% growth in FY17-18.
Figure 51: Brent prices Figure 52: Spring – unit fuel cost per ATK (USD/bbl) Unit fuel cost (RMB/ATK, LHS) YoY (%,RHS) 140 130 2.0 40% 120 110 100 1.5 20% 90 80 70 1.0 0% 60 2015 average Brent price: USD 54.19/bbl 50 DB's 2016 assumption: USD45.0/bbl 40 0.5 -20% 30 DB's 2017 assumption: USD55.0/bbl
20 0.0 -40%
14 12 13 15 16
11
12
16 12 13 13 14 14 15 15 16
13 14 15 16
12
11
- - - - -
-
-
------
- - - -
-
-
Jul Jul Jul Jul Jul
Apr Oct Oct Oct Apr Apr Oct Apr Oct
Jan Jan Jan Jan
Feb
Aug Nov
May
2013 2011 2012 2014 2015
2016E 2018E 2017E Source: Bloomberg Finance LP, Deutsche Bank estimates Source: Company data , Deutsche Bank estimates
Other non-fuel expenses In FY15, the 14.6% YoY growth in depreciation and leasing expenses was the result of the addition of six aircraft to the company’s fleet. In the past four fiscal years, depreciation and rental expenses have on average increased by 18.3% per annum due to fleet expansion from 28 to 52 airplanes.
The marked 26.1% YoY jump in wages and staff costs in FY15 was mainly due to the increase in staff numbers and growth in total hours flown.
Another major cost item, take-off and landing charges, increased 21.3-37.7% in FY12-15 as Spring grew its fleet size and expanded international flights.
We think it is reasonable to assume that most of the major other costs will continue to gradually trend up in absolute terms.
With the current plan of fleet expansion, we expect depreciation and lease rentals to increase in the next two years and then tail off in YoY terms as the rate of fleet expansion declines.
The government’s regulated airport fee structure and the company’s strategy in international traffic expansion imply that landing fees are unlikely to flatten or fall, as airports are unable to cut fees without government price guidance.
Staff costs are unlikely to drop either given wage inflation pressure and Spring’s ongoing expansion in operation scale.
With the increase in fleet size and thus total capacity (ATK), it is also natural to assume maintenance costs will continue to climb in absolute terms.
Similarly, pilot training and civil aviation development commissions should also increase, although more slowly than sales. The net effect is a projected decrease in operating profit margin from 14.6% actual in FY15 to 12.1% in FY16E and a recovery to 12.7-13.4% in FY17-18E.
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Figure 53: Spring – operating expenses and growth Figure 54: Spring – operating profit margin trend Total operating expenses (core business) YoY 16% 14% 14.6% 10,000 30% 13.4% 26.3% 12% 12.7% 12.1% 8,000 10% 9.8% 20% 8% 8.2% 6,000 18.5% 7.7% 16.1% 6% 4,000 16.0% 4.8% 9.5% 10% 4% 2,000 5.7% 2% 3.2% 0%
0 0%
2013 2011 2012 2014 2015
2016E 2017E 2018E
2013 2011 2012 2014 2015
2017E 2018E 2016E
Source: Company data , Deutsche Bank estimates Source: Company data , Deutsche Bank estimates
Balance sheet and cash flow summary
Spring Airlines is considering an overall fleet increase from 52 planes (at an average age of 3.5 years) at the end of FY15 to about 80 by the end of FY17 and 95 by FY18. The planes ordered for the next few years are A320neo (the latest generation of the A320 series).
Figure 55: Spring Airlines – fleet structure and delivery schedule
2011 2012 2013 2014 2015 2016E 2017E 2018E A320 28 32 39 46 52 66 80 95 - Self ow ned 5 10 12 12 19 - Finance lease 2 2 2 4 3 - Op lease 21 20 25 30 30
Source: Company data , Deutsche Bank estimates
The change in lease versus owned from 75/25 to 60/40 is notable, indicating that the company prefers to own and maintain its aircraft. We expect the proportion of owned aircraft vs. leased to continue to increase, considering that the current low interest rates allow low-cost financing for aircraft acquisition.
In addition, Spring announced in Aug-16 that it plans to raise RMB4bn (at no less than RMB43.71 per share for a total of 91.5m shares) in a private share placement and use the proceeds to acquire 10 A320 aircraft. Our current financial forecast has not yet reflected the share placement pending the completion of the deal as it is still conditional on regulatory approval. Assuming a successful new share issuance in mid-2017, we estimate that, with an 11% increase in the number of outstanding shares, Spring's FY17E reported EPS dilution would be about 4%, while FY17E BVPS enhancement would be about 29%, leading to a drop in ROE to c.16% vs. our current forecast of 19.5%.
Capex increased steadily from RMB697.5m in FY11 to RMB4.5bn in FY15. We estimate that capex will remain at about RMB5-6bn per annum in FY16-18E, with the majority of the spending on aircraft acquisition.
While ROE is forecast to decline from 26.3% in FY15 to 18.7% in FY16 on our estimates, due to a likely decline in yield (amid lower fuel surcharges) affecting
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profitability, we expect ROE to return to 19-20% in FY17-18E with recovering passenger yield and load factors on international routes.
We note that the debt-to-equity ratio, if off-balance lease obligations are included, was 1.4x at the end of FY15, well down from 2.2-2.5x at the end of FY13-14. On our forecasts, it should fall to around 1x within two years, depending on whether the company undertakes finance leases. We are expecting a steady low increase in dividends to maintain the payout ratio for at least the next two years.
Figure 56: Spring Airlines – summary of income statement Year-end December (RMBm) 2013 2014 2015 2016E 2017E 2018E Net revenue 6,549.8 7,312.4 8,069.6 8,294.4 9,684.5 11,564.7 Cost of sales -5,711.9 -6,244.8 -6,466.4 -6,846.6 -7,945.4 -9,421.8 Gross (loss)/profit 837.9 1,067.6 1,603.2 1,447.9 1,739.1 2,142.9 Gross profit margin (%) 12.8% 14.6% 19.9% 17.5% 18.0% 18.5% Selling and distribution expenses -152.8 -184.5 -233.1 -248.8 -285.7 -335.4 Administrative expenses -149.4 -163.5 -194.6 -194.9 -222.7 -260.2 Operating (loss)/profit (EBIT) 535.7 719.6 1,175.5 1,004.1 1,230.6 1,547.3 Operating profit margin (%) 8.2% 9.8% 14.6% 12.1% 12.7% 13.4% Investment income -22.0 -80.7 -117.3 -123.1 -129.3 -135.8 Finance income/(costs), net -81.0 -98.4 -154.5 -179.1 -149.1 -149.3 Non-operating income 554.5 683.5 902.4 1,082.9 1,245.3 1,369.8 Non-operating expense -0.1 -8.1 -2.1 -2.2 -2.3 -2.4 (Loss)/profit before income tax 987.0 1,215.9 1,804.0 1,782.5 2,195.3 2,629.7 Income tax credit/(expense) -254.8 -331.7 -476.2 -445.6 -548.8 -657.4 (Loss)/profit for the period/year 732.2 884.2 1,327.9 1,336.9 1,646.5 1,972.3 Minority interest 0.0 0.0 0.0 0.0 0.0 0.0 Net profit 732.2 884.2 1,327.9 1,336.9 1,646.5 1,972.3 YoY% 17.2% 20.8% 50.2% 0.7% 23.2% 19.8% Source : Company data, Deutsche Bank estimates
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Figure 57: Spring Airlines – summary of balance sheet As of 31 December (RMBm) 2013 2014 2015 2016E 2017E 2018E Total current assets 1,916.4 2,921.9 4,264.4 5,507.9 4,941.1 4,587.7 Cash and cash equivalent 1,474.8 2,399.9 3,094.5 4,294.9 3,592.7 3,164.3 Bills and accounts receivables 63.1 75.1 101.8 91.5 147.4 153.8 Prepayments 169.3 194.7 261.2 274.3 288.0 302.4 Other receivables 159.4 192.8 720.5 756.6 794.4 834.1 Inventory 41.6 42.8 55.0 57.6 83.9 96.8 Other current assets 8.1 16.5 31.4 33.0 34.7 36.4
Total non-current assets 5,735.0 8,339.6 11,764.6 14,010.0 16,275.1 18,323.4 Long-term equity investment 97.5 110.3 95.3 95.3 95.3 95.3 Property, plant and equipment 3,799.5 4,371.8 5,858.4 6,781.4 7,893.0 9,230.9 Construction in progress 549.4 2,512.1 4,287.6 5,573.9 6,688.6 7,357.5 Intangible assets 51.3 54.3 63.0 70.6 79.5 89.7 Long term deferred expense 299.9 362.3 441.6 463.7 486.9 511.2 Deferred tax asset 102.4 112.8 127.7 134.1 140.8 147.9 Other non-current assets 835.0 816.1 891.0 891.0 891.0 891.0 Total assets 7,651.4 11,261.5 16,029.0 19,517.8 21,216.2 22,911.2
Total current liabilities 2,227.8 4,217.1 4,978.7 5,094.4 5,533.7 5,700.2 Short term borrowings 290.2 2,045.5 1,561.1 1,639.1 1,721.1 1,807.1 Bills and accounts payables 362.5 204.3 339.5 223.2 418.9 329.6 Advance received from customers 554.7 679.1 1,355.0 1,422.8 1,493.9 1,568.6 Payroll payable 141.1 131.0 199.6 209.6 220.0 231.1 Tax payable 339.2 255.9 317.0 332.8 349.5 366.9 Interest payable 21.2 37.8 32.8 34.5 36.2 38.0 Other payables 108.8 119.7 150.3 157.9 165.7 174.0 Non-current liabilities maturing within 410.1 743.7 1,023.4 1,074.6 1,128.3 1,184.7 one year
Total non-current liabilities 2,680.6 3,491.1 4,510.5 6,700.6 6,487.1 6,290.3 Long term borrowings 1,961.2 2,329.1 3,353.5 3,185.9 3,026.6 2,875.2 Bonds payable 0.0 0.0 0.0 2,300.0 2,185.0 2,075.8 Long-term payables 675.2 1,066.6 1,006.1 1,056.4 1,109.2 1,164.7 Deferred revenue 0.0 9.7 17.4 18.3 19.2 20.1 Other non-current liabilities 44.2 85.6 133.4 140.1 147.1 154.5 Total liabilities 4,908.4 7,708.2 9,489.2 11,795.1 12,020.8 11,990.4
Net assets 2,743.0 3,553.3 6,539.8 7,722.8 9,195.4 10,920.7 Minority interests 0.0 0.0 0.0 0.0 0.0 0.0
Share capital & Reserves 729.7 729.7 2,613.9 2,627.9 2,627.9 2,627.9 Retained earnings 2,013.3 2,823.6 3,925.9 5,094.8 6,567.5 8,292.8 Total shareholder's equity 2,743.0 3,553.3 6,539.8 7,722.8 9,195.4 10,920.7 Source: Company data, Deutsche Bank estimates
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Figure 58: Spring Airlines – summary of cash flow statement As of 31 December (RMBm) 2013 2014 2015 2016E 2017E 2018E Cash flows from operating activities Net profit after tax 732.2 884.2 1,327.9 1,336.9 1,646.5 1,972.3 Adjustments for: Depreciation and amortization 301.7 336.8 415.7 436.9 518.2 615.7 Losses (gains) on disposal of fixed assets, intangible -7.3 -9.6 -24.8 0.0 0.0 0.0 assets and other long-term assets & Losses on write-off of fixed assets Finance costs 65.3 69.9 129.2 228.8 260.1 246.4 Losses (gains) arising from investments 22.0 80.7 117.3 123.1 129.3 135.8 Change in working capital: 422.4 -285.6 -354.9 -206.4 -9.1 -210.5 Net cash flow from operating activities 1,536.4 1,076.4 1,610.3 1,919.3 2,545.0 2,759.6
Cash flows from investing activities Cash received from investments income 0.0 0.0 1.8 -98.5 -103.4 -108.6 Net cash received from disposal of fixed assets, 10.4 12.9 1,288.6 2,233.8 2,876.9 3,434.3 intangible assets and other long-term assets Net change in other investing activities -29.4 135.0 -101.8 0.0 0.0 0.0 Cash paid to acquire fixed assets, intangible assets and -723.9 -2,458.6 -4,477.0 -4,887.7 -5,630.3 -6,066.9 other long-term assets Cash paid for equity investment -89.3 -93.5 -104.2 -24.6 -25.9 -27.2 Net cash flow from investing activities -832.2 -2,404.2 -3,392.6 -2,777.1 -2,882.7 -2,768.4
Cash flows from financing activities Equity issuance 0.0 0.0 1,754.6 14.1 0.0 0.0 Net change in borrowings -543.6 2,369.1 595.0 2,210.4 -192.3 -174.5 Interest expenses and dividends -216.4 -236.8 -302.7 -166.4 -172.1 -245.2 Other financing cash flow -54.3 111.3 388.0 0.0 0.0 0.0 Net cash flow from financing activities -814.2 2,243.6 2,434.9 2,058.1 -364.4 -419.7
Net increase/(decrease) in cash and cash equivalents -115.3 918.2 746.2 1,200.4 -702.2 -428.5 Source: Company data, Deutsche Bank estimates
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Key risks
Sector and company-specific risks
Key sector downside risks: 1) depreciation of RMB; 2) an unexpected decline in yield on US and other international routes amid aggressive capacity expansion; 3) a fuel price surge beyond our expectations; 4) a sequential decline in air passenger traffic demand in 2017E; and 5) a worse-than-expected impact from high-speed rail competition.
Specific downside risks for Spring Airlines include: 1) excessive new capacity on international routes; 2) worse-than-expected competition in the ASEAN market from other regional LCC players; 3) slower-than-expected demand growth on the North Asia and ASEAN routes; 4) competition from other Chinese airlines on domestic and regional routes; and 5) a worse-than- expected impact from high-speed railway line launches in China (passenger traffic diversion from high-speed railway routes).
Sensitivity to key factors
Starting from our base scenario, we estimate that a 1% increase in RPK would add 3.5%, or RMB57m, to reported net profit, while a 1% increase in yield would boost net profit by 3.8%, or RMB62m (all else equal). A USD1/bbl decrease in fuel price results in a 1.4% net profit gain of RMB23m. Changes in the RMB/USD rates are more complex, as they affect both demand and costs, as discussed in the revenue and profit review earlier. On a 1ppt weakening of the RMB, the simple direct effect on fuel would cause a 0.5% decrease in net profit. According to Spring, the company’s US dollar liabilities are hedged by US dollar denominated assets.
Figure 59: Spring Airlines – key FY17E earnings/book value sensitivity Key variables Change in FY17E % change in % change in net profit (RMBm) FY17E net profit FY17E book value 1ppt change in passenger traffic growth 57 3.5% 0.6% 1ppt change in passenger yield growth 62 3.8% 0.7% USD1/bbl change in fuel price (un- 23 1.4% 0.2% hedged portion) 1ppt change in RMB/USD appreciation 8 0.5% 0.1% rate (unrealized FX-gain portion) Source: Deutsche Bank estimates
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Company background
The first and largest player in China’s LCC industry
Headquartered in Shanghai, Spring Airlines was China’s first low-cost carrier (LCC) and one of China’s first airlines funded by private capital. The parent company of Spring Airlines is Shanghai Spring International Travel Services Group, the largest private travel agency in China.
With the mission of making air travel affordable and available to ordinary people, Spring Airlines was established in 2004 to provide domestic air passenger services and started to expand to international and regional routes in 2010. As of 1H16, the company offers 66 domestic, 50 international and 6 regional routes (122 in total).
Spring operates at two base airports, Shanghai Hongqiao and Shanghai Pudong, and has also set up hub operations at Shijiazhuang, Shenyang, Hangzhou and, most recently, Shenzhen.
Figure 60: Spring Airlines – development milestones Year Milestones Jul-2004 Civil Aviation Administration of China granted operation certificate to Spring Airlines, indicating its establishment Jul-2005 Spring Airlines successfully completed its first flight from Shanghai to Yantai Dec-2006 Spring Airlines launched its second base, at Sanya Phoenix International Airport Mar-2009 Spring Airlines formed Safe Management System (SMS), which was approved in Feb 2010. Mar-2009 Spring Airlines purchased its own A320 for the first time and offered 1 million tickets at RMB199/299/399 Jul-2010 Spring Airlines launched a new route from Shanghai to Ibaraki, the first international route to be operated by a private airline company Sep-2010 Spring Airlines launched a new route from Shanghai to Hong Kong Apr-2011 Spring Airlines launched a new route from Shanghai to Macao Aug-2012 Spring Airlines launched a new route from Shanghai to Bangkok Aug-2014 Spring Airlines Japan commenced domestic flights Jan-2015 Spring Airlines was listed on the Shanghai Stock Exchange Source: Company data, Deutsche Bank
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The company’s founder, Mr. WANG Zhenghua, holds 25% of Spring’s public shares. Mr. WANG Zhenghua is the father of WANG Yu, President and Director, and WANG Wei, head of Spring Airlines Japan, who hold 0.8% and 0.2%, respectively. As Mr. WANG Zhenghua’s most important subordinate, Ms. ZHANG Xiuzhi assisted Mr. WANG in founding Spring Airlines in 2004. She was President of Spring Airlines before Mr. WANG Yu succeeded her in April 2016. She holds 1.3% of Spring Airlines.
Other middle and senior management, key technicians and business backbones also hold shares of Spring Airlines through Chunxiang Investment and Chunyi Investment.
Figure 61: Spring Airlines – corporate structure
Source: Company data, Deutsche Bank
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Experienced management team
Spring Airlines was founded and led by Mr. WANG Zhenghua, who brought the LCC concept to China. He is famous for his hardworking and thrifty style, which he later integrated into the company’s core values and operation.
Overall, most of Spring Airlines’ senior management team (including the executive directors and non-executive directors), on average, have more than 20 years of experience in the airline industry.
Figure 62: Spring Airlines – senior management Name Age Position Background Mr. WANG Zhenghua 71 Chairman Senior economist. Mr. Wang was Deputy Party Secretary of Changning District of Shanghai. He 王正华 established Shanghai Spring Travel Services in 1981. He has been Chairman of Spring International Travel Services Group Co., Ltd since 1987 and Spring Airlines Co., Ltd since 2004, when it was established. Apart from that, Mr. Wang is currently Chairman of Shanghai Spring Training Center and Shanghai Spring Property Development Limited. He is an Executive Director of Spring Culture and Media Company and Shanghai Spring Conference and Exhibition Services Company. Mr. Wang was awarded "Model Worker in Shanghai" in 1992-1993, 1994-1995, 1996-1997 and was awarded "Lifetime Model Worker in Shanghai" in 1998. Ms. ZHANG Xiuzhi 51 Deputy Chairman, MBA. Her past roles include Deputy General Manager of Shanghai Spring International Travel Services 张秀智 Director and Group Co., Ltd, General Manager of Spring Baoji Company, President of Spring Airlines Co., Ltd. Her President current roles include Deputy Chairman of Spring Airlines Co., Ltd, Deputy Chairman of Spring International Travel Services Group Co., Ltd, Director of Shanghai Spring Property Development Limited, Chairman of Chunxiang Investment, Executive Director of Spring Baoji, Pilot Training Company, Equipment Technology Company and Qiushi Company. She is also a Director of Hong Kong International Holdings, a Director of Spring Airlines Singapore and a Director of Spring Finance Leasing Company. Mr. WANG Yu 45 President and Mr. Wang graduated from Southern Illinois University with a master’s degree in Economics and an 王煜 Director MBA. In the past he worked at Roland Berger, Bearing Point and Hewitt. He is currently President and Director of Spring Airlines, Director of Spring International Travel Services Group Co., Ltd, Chairman of Chunyi Investment, Executive Director of Shanghai Business Travel Services, Director of Hong Kong International Holdings, Chairman of Spring Financial Leasing, Executive Director of Chunji (Shanghai) Aircraft Finance Leasing Limited, Chunliao (Shanghai) Aircraft Finance Leasing Limited, Chunzhe (Shanghai) Aircraft Finance Leasing Limited, No.3/4/7/8 Spring (Tianjin) Aircraft Finance Leasing Limited and Shanghai Spring Investment Management Limited. Mr. WANG Zhijie 46 Vice-president and Mr. Wang graduated from Beijing University of Aeronautics and Astronautics with a master’s degree in 王志杰 Director Aero-engine Engineering. He worked as an Engineer, Technical Project Manager and General Engineer at Shanghai Airlines Limited. Mr. Wang started to work with Spring Airlines Co., Ltd as the Vice President and General Engineer in 2005. He is currently a Director of Spring Airlines, Spring Finance Leasing Company and Chunxiang Investment. He is also the Chairman of Chunxu Company. Mr. CHEN Ke 39 CFO and Secretary Mr. Chen holds a bachelor’s degree from Nanjing University of Aeronautics and Astronautics and a 陈可 of the Board master’s degree from Brunel University. He was an engineer at Shanghai Airlines Limited. Since 2005, he has worked with Spring Airlines as Deputy Manager of Planning Department, Manager of Finance and Planning Department. He is currently CFO, Secretary of the Board of Spring Airlines. He is also a Director of Chunxiang Investment, General Manager of Spring Finance Leasing, Executive Director of Chunhu (Shanghai) Aircraft Leasing Limited, Chunjing (Shanghai) Aircraft Leasing, No.1/2/3/4/5/6/7/8 Spring (Tianjin) Aircraft Finance Leasing, Chunjin (Shanghai) Aircraft Leasing Limited, Chunyu (Shanghai) Aircraft Leasing and Chunyue (Shanghai) Aircraft Leasing limited. Mr. WANG Gang 42 Vice-president Mr. Wang graduated from Civil Aviation Flight University of China with a Bachelor of Aviation (Pilot). He 王刚 was a pilot at the Gansu branch of China Eastern Airlines. He was General Manager of the Flight Scheduling Department, Deputy Manager and General Manager of the Flight Department at Spring Airlines from 2005 to 2013. He was the Chief Pilot of Spring Airlines from Aug 2013 to Sep 2014. He is currently Vice-President of Spring Airlines. Mr. WU Xinyu 47 Chief Engineer Mr. Wu graduated from Civil Aviation Flight University of China with a Bachelor of Aviation Automation. 吴新宇 He was an engineer in the maintenance base of China Northwestern Airlines. Since 2005, he has worked with Spring Airlines as Supervisor of Route Maintenance Room and General Manager of the Maintenance Engineering Department. He is currently Chief Engineer of Spring Airlines. Mr. TENG Shimin 42 Chief Pilot Mr. Teng Shimin graduated from Civil Aviation Flight University of China. He was a pilot in the Gansu 滕石敏 branch of China Eastern Airlines. Since 2005, he has worked with Spring Airlines as a Manager in the Flight Scheduling Department, Flight Training Department and Flight Technology Management Department. He is currently the Chief Pilot of Spring Airlines. Source: Company data, Deutsche Bank
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Appendix 1
Important Disclosures
*Other information available upon request
Disclosure checklist Company Ticker Recent price* Disclosure Spring Airlines 601021.SS 41.14 (CNY) 1 Dec 16 NA Prices are current as of the end of the previous trading session unless otherwise indicated and are sourced from local exchanges via Reuters, Bloomberg and other vendors . Other information is sourced from Deutsche Bank, subject companies, and other sources. For disclosures pertaining to recommendations or estimates made on securities other than the primary subject of this research, please see the most recently published company report or visit our global disclosure look-up page on our website at http://gm.db.com/ger/disclosure/DisclosureDirectory.eqsr. Aside from within this report, important conflict disclosures can also be found at https://gm.db.com/equities under the "Disclosures Lookup" and "Legal" tabs. Investors are strongly encouraged to review this information before investing.
For disclosures pertaining to recommendations or estimates made on securities other than the primary subject of this research, please see the most recently published company report or visit our global disclosure look-up page on our website at http://gm.db.com/ger/disclosure/Disclosure.eqsr?ricCode=601021.SS
Analyst Certification The views expressed in this report accurately reflect the personal views of the undersigned lead analyst(s) about the subject issuer and the securities of the issuer. In addition, the undersigned lead analyst(s) has not and will not receive any compensation for providing a specific recommendation or view in this report. Fei Sun
Historical recommendations and target price: Spring Airlines (601021.SS) (as of 12/1/2016)
160.00 Previous Recommendations
Strong Buy 140.00 Buy Market Perform 120.00 Underperform Not Rated 100.00 Suspended Rating Current Recommendations 80.00 Buy Hold
Security PriceSecurity 60.00 Sell Not Rated 40.00 Suspended Rating
*New Recommendation Structure 20.00 as of September 9,2002
**Analyst is no longer at Deutsche 0.00 Bank Jan 15 Apr 15 Jul 15 Oct 15 Jan 16 Apr 16 Jul 16 Oct 16 Date
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Equity rating key Equity rating dispersion and banking relationships Buy: Based on a current 12- month view of total 500 53 % share-holder return (TSR = percentage change in 450 share price from current price to projected target price 400 350 37 % plus pro-jected dividend yield ) , we recommend that 300 investors buy the stock. 250 200 Sell: Based on a current 12-month view of total share- 150 19 % 10 % 100 18 % 25 % holder return, we recommend that investors sell the 50 stock 0 Buy Hold Sell Hold: We take a neutral view on the stock 12-months out and, based on this time horizon, do not Companies Covered Cos. w/ Banking Relationship recommend either a Buy or Sell. Asia-Pacific Universe Newly issued research recommendations and target
prices supersede previously published research.
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Additional Information
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Macroeconomic fluctuations often account for most of the risks associated with exposures to instruments that promise to pay fixed or variable interest rates. For an investor who is long fixed rate instruments (thus receiving these cash
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flows), increases in interest rates naturally lift the discount factors applied to the expected cash flows and thus cause a loss. The longer the maturity of a certain cash flow and the higher the move in the discount factor, the higher will be the loss. Upside surprises in inflation, fiscal funding needs, and FX depreciation rates are among the most common adverse macroeconomic shocks to receivers. But counterparty exposure, issuer creditworthiness, client segmentation, regulation (including changes in assets holding limits for different types of investors), changes in tax policies, currency convertibility (which may constrain currency conversion, repatriation of profits and/or the liquidation of positions), and settlement issues related to local clearing houses are also important risk factors to be considered. The sensitivity of fixed income instruments to macroeconomic shocks may be mitigated by indexing the contracted cash flows to inflation, to FX depreciation, or to specified interest rates – these are common in emerging markets. It is important to note that the index fixings may -- by construction -- lag or mis-measure the actual move in the underlying variables they are intended to track. The choice of the proper fixing (or metric) is particularly important in swaps markets, where floating coupon rates (i.e., coupons indexed to a typically short-dated interest rate reference index) are exchanged for fixed coupons. It is also important to acknowledge that funding in a currency that differs from the currency in which coupons are denominated carries FX risk. Naturally, options on swaps (swaptions) also bear the risks typical to options in addition to the risks related to rates movements.
Derivative transactions involve numerous risks including, among others, market, counterparty default and illiquidity risk. The appropriateness or otherwise of these products for use by investors is dependent on the investors' own circumstances including their tax position, their regulatory environment and the nature of their other assets and liabilities, and as such, investors should take expert legal and financial advice before entering into any transaction similar to or inspired by the contents of this publication. The risk of loss in futures trading and options, foreign or domestic, can be substantial. As a result of the high degree of leverage obtainable in futures and options trading, losses may be incurred that are greater than the amount of funds initially deposited. Trading in options involves risk and is not suitable for all investors. Prior to buying or selling an option investors must review the "Characteristics and Risks of Standardized Options”, at http://www.optionsclearing.com/about/publications/character-risks.jsp. If you are unable to access the website please contact your Deutsche Bank representative for a copy of this important document.
Participants in foreign exchange transactions may incur risks arising from several factors, including the following: ( i) exchange rates can be volatile and are subject to large fluctuations; ( ii) the value of currencies may be affected by numerous market factors, including world and national economic, political and regulatory events, events in equity and debt markets and changes in interest rates; and (iii) currencies may be subject to devaluation or government imposed exchange controls which could affect the value of the currency. Investors in securities such as ADRs, whose values are affected by the currency of an underlying security, effectively assume currency risk.
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India: Prepared by Deutsche Equities India Pvt Ltd, which is registered by the Securities and Exchange Board of India (SEBI) as a stock broker. Research Analyst SEBI Registration Number is INH000001741. DEIPL may have received administrative warnings from the SEBI for breaches of Indian regulations.
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United Arab Emirates: Deutsche Bank AG in the Dubai International Financial Centre (registered no. 00045) is regulated
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by the Dubai Financial Services Authority. Deutsche Bank AG - DIFC Branch may only undertake the financial services activities that fall within the scope of its existing DFSA license. Principal place of business in the DIFC: Dubai International Financial Centre, The Gate Village, Building 5, PO Box 504902, Dubai, U.A.E. This information has been distributed by Deutsche Bank AG. Related financial products or services are only available to Professional Clients, as defined by the Dubai Financial Services Authority.
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Australia and New Zealand: This research is intended only for "wholesale clients" within the meaning of the Australian Corporations Act and New Zealand Financial Advisors Act respectively.
Additional information relative to securities, other financial products or issuers discussed in this report is available upon request. This report may not be reproduced, distributed or published without Deutsche Bank's prior written consent. Copyright © 2016 Deutsche Bank AG
Page 40 Deutsche Bank AG/Hong Kong
David Folkerts-Landau Group Chief Economist and Global Head of Research
Raj Hindocha Michael Spencer Steve Pollard Global Chief Operating Officer Head of APAC Research Head of Americas Research Research Global Head of Economics Global Head of Equity Research
Anthony Klarman Paul Reynolds Dave Clark Pam Finelli Global Head of Head of EMEA Head of APAC Global Head of Debt Research Equity Research Equity Research Equity Derivatives Research
Andreas Neubauer Stuart Kirk Head of Research - Germany Head of Thematic Research
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