Equity Research Report Airlines
June 2019 By: David Wu (S1700518110001) www.research.hsbc.com
China low-cost carriers China low-cost SPOTLIGHT China low-cost carriers Initiate coverage: The start of a 10-year boom
We believe low-cost carriers (LCCs) are well-positioned to enjoy a decade of vibrant growth
Demand is strong and airline capacity is set to increase as aviation regulations are eased, fleets get larger, and new airports open
Equities //Equities Airlines We initiate coverage on Spring Airlines, Juneyao Airlines and China Express Airlines with Buy ratings, we prefer Spring Airlines June 2019 June
Disclosures & Disclaimer: This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it. Equities ● Airlines June 2019
Why read this report
We explain why we think China’s low-cost carriers (LCCs) are in a sweet spot; demand is set to boom as mass tourism increases and airfares become increasingly affordable
The outlook for the supply side is improving, too; the easing of aviation regulations, airport growth, and fleet expansion will power growth in capacity
We initiate coverage on three Chinese LCCs, and we explain why we prefer Spring Airlines (Buy)
It’s not just the vast addressable market, the size of the country, the increase in disposable income, and the easing of aviation regulations that are so appealing. What we really like is the
David Wu* (S1700518110001) stage the low-cost carrier (LCC) industry has reached in China. Head of A-share transportation and logistics The US and Europe provide good pointers for how the LCC industry can develop in China. HSBC Qianhai Securities Limited These markets tell us that LCCs start to prosper when flying loses the luxury cachet associated [email protected] +86 755 8898 3436 with the wealthy and business travel. Demand booms when mass tourism increases and Sonia Luo* (S1700119030004) airfares become increasingly affordable. The two key indicators to watch are GDP per capita Associate and the price of air fares as a percentage of average disposable income. Based on these Shenzhen metrics, we believe China’s LCCs are in a sweet spot. We think they can triple their share of the country’s aviation market in the next decade. * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations The outlook for the supply side, a problem in the past, is also improving. Key factors include the easing of aviation regulations, more airport capacity, which will create new flight slots, and the mass production of a domestic aircraft.
We initiate coverage on Spring Airlines (Buy), Juneyao Airlines (Buy) and China Express Airlines (Buy). Their business models vary but they should all benefit from what we see as being a ‘golden decade’ for the LCC industry in China.
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Contents
Why read this report 1
Facts and figures 4
Related research 5
A good flight plan 6
The start of a ‘golden decade’ 17
The supply side is improving 23
Company section 29 Spring Airlines (601021 CH) 30 Juneyao Airlines (603885 CH) 45 China Express Airlines (002928 CH) 60
Disclosure appendix 78
Disclaimer 83
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The rise of China’s low-cost carrier (LCC) airlines The rise of China’s low-cost carrier (LCC) airlines We believe the growing popularity of mass travel and increasingly affordable flight tickets will drive the demand for LCCs, while easing pressure on the supply side will boost transport capacity. We initiate coverage on Spring Airlines, Juneyao Airlines and China Express Airlines
1.2%
The cost of 0.8% airfares as a % of income 5bn 0.4% has dropped air trips were made in below 1% China in 2017 0 1960 1990 2017
In 2017 By 2027 China’s LCCs flew we expect China’s LCCs to carry 62.24m 385m passengers passengers
Passenger traffic of domestic LCCs will grow at a CAGR of Spring Airlines BUY 601021 CH 20% over 2018-27 Juneyao Airlines BUY 603885 CH
China Express BUY Airlines 002928 CH 11.3% share of China’s and increase their aviation aviation market market share to 35%
Easing pressures on the supply side are positive for China’s LCCs
Revised flight slots, time allocation Mass production of the C919 Over the next five years, a number of system reform, and a quantitative expected to begin in 2021, boosting cities will build new hub airports or scoring system capacity growth expand existing facilities
Source: Bureau of Economic Analysis, HSBC Qianhai Securities
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Facts and figures 62.24 million 11.3%
LCC passenger traffic in China in LCC market share in China in 2017 2017
We believe the market share of LCCs in China will reach 35% in 2027e 20% CAGR The growth in LCC passenger traffic in China over 2018-27e
Int USD 2004-07 2010-12 18,000 The first major growth The second major growth spurt in China air travel spurt in China air travel The turning point for growth in LCC demand in China, based on per capita GDP(PPP, constant 2011)
In 2018, the average LCC fare in China 1% dropped to 1.2% of per capita disposable Average US domestic airfare, in terms income of the proportion of per capita disposable income (1960-80)
25% 2ppts
The percentage of routes on which air The expected increase in the CAGR of fares have been deregulated Spring Airlines’ flight numbers over 2019-23e after the new construction and expansion of airports
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Related research
Recommended reading
Chinese Airlines: Ready for take-off, 19 January 2019
HK and China Airlines: Boeing 737 Max grounded: we analyse the impact, 19 March 2019
European low cost airlines: Supply growth falls fast, demand falls faster, 2 April 2019
European LCCs: The times they are a changing, 27 September 2018
Indian Aviation: Traffic growth halts as rising fares hurt demand, 11 March 2019
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A good flight plan
It’s an excellent time to be a low-cost carrier (LCC) in China. We think the industry is in a sweet spot as growth in mass tourism and increasingly affordable ticket prices drive demand. The supply side, a problem in the past, is improving, too. We expect LCC passenger traffic to rise at a CAGR of 20% over 2018-27e, with the market share rising to 35%. We initiate coverage on Spring Airlines (Buy), Juneyao Airlines (Buy) and China Express Airlines (Buy), and we prefer Spring Airlines.
China’s aviation industry started late but is catching up quickly. According to the Civil Aviation Administration of China (CAAC), China’s airlines flew a total of 610m passengers in 2018, up 10.6% y-o-y, and second only to the 1.01bn passengers in the US. Low-cost carriers (LCCs) only appeared in the market in 2004. By 2017 they were carrying 62.24m passengers, accounting for 11.3% of China’s aviation market and pulling in revenues of RMB35.48bn.
However, we think LCCs can fly much higher. We expect their passenger traffic to grow at a We think LCCs can fly much higher CAGR of 20% over 2018-27e, with the market share rising to 35% and revenue hitting RMB219.4bn in 2027e. By then, we think LCCs will carry 385m passengers a year.
It’s not just the vast addressable market, the size of the country, the increase in disposable income, and the easing of aviation regulations that are so appealing. What we really like is the stage the industry has reached.
The US and Europe provide good pointers for how the low cost carrier industry can develop in China. These markets tell us that LCCs start to prosper when flying loses the luxury cachet associated with the wealthy and business travel. The two key indicators to watch are GDP per capita and the price of air fares as a percentage of average disposable income. Based on these metrics, we believe China is in a sweet spot. This reports looks at:
How industry demand is ready to surge, ushering in a ‘golden decade’ of growth
Why pressure on the supply side is easing. Key factors are the easing of aviation regulations, more airport capacity will reduce congestion, and mass production of a domestic aircraft will boost capacity.
The prospects for the three LCCs on which we initiate coverage – Spring Airlines (Buy), Juneyao Airlines (Buy) and China Express Airlines (Buy). We explain why we prefer Spring Airlines.
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Exhibit 1. Comps table Company Ticker LCY Closing ADTV Market __ PE (x) ____ _ PB (x) ______ROE (%) ___ EPS Div yield Price Cap CAGR (%) (%) (29 May) USDm USDbn 2019e 2020e 2021e 2019e 2020e 2021e 2019e 2020e 2021e 2019-21e 2019e Comparison for LCCs LCCs in China Spring Airlines* 601021 CH RMB 43.3 26.4 5.7 18.9 16.6 12.4 2.6 2.3 2.0 15 15 17 29 1 Juneyao Airlines* 603885 CH RMB 12.5 18.7 3.2 15.2 15.2 10.8 1.8 1.6 1.4 14 11 14 19 1 Average 17.1 15.9 11.6 2.2 2.0 1.7 15 13 16 24 1 American aviation companies Southwest Airlines LUV US USD 49.6 156.4 26.9 10.9 9.5 8.5 2.2 1.9 1.5 24 24 23 9 1 JetBlue Airways JBLU US USD 17.1 61.8 5.2 9.3 7.5 6.8 1.0 0.8 0.7 11 12 12 61 0 Spirit Airlines SAVE US USD 46.8 32.9 3.2 8.3 7.4 6.7 1.4 1.1 0.9 18 16 15 43 0 Allegiant Airlines ALGT US USD 143.0 20.2 2.3 10.8 10.0 9.6 2.7 2.3 1.9 28 27 23 14 2
European aviation companies Ryanair Holdings RYA LN EUR 10.4 40.2 13.1 11.4 12.4 10.0 2.4 2.1 1.8 21 18 19 16 0 EasyJet Airline EZJ LN EUR 10.1 33.5 4.5 9.9 8.8 7.7 1.0 1.0 0.9 11 11 12 8 5 Other Asian aviation companies Indigo Airlines INDIGO IN INR 1641 76.4 9.0 NA 27.0 18.8 8.9 7.5 6.2 -3 38 47 12 0 AirAsia Group Bhd AAGB MK MYR 2.6 4.3 2.1 11.4 11.1 10.1 1.2 1.2 1.2 10 8 8 -19 6 Air Arabia AIRARABI UH AED 1.0 0.8 1.3 8.7 8.1 7.9 0.9 0.8 0.8 11 11 11 NA 8 Global average 11.5 12.1 9.9 2.4 2.1 1.8 15 18 19 19 2
Comparison for regional airlines Regional airlines in China China Express Airlines* 002928 CH RMB 11.4 6.0 1.0 12.9 13.0 10.4 2.7 2.3 2.0 23 19 20 21 2
Regional airlines in the US SkyWest SKYW US USD 59.3 9.2 3.0 9.7 9.2 9.1 1.3 1.2 1.1 15 14 11 4 1 Note: Priced at close of 29 May 2019. NA – Not applicable. Source: Bloomberg, HSBC Qianhai Securities estimates (*Stocks we cover in the report)
Exhibit 2. Upside potential in terms of the Exhibit 3. China is the world’s second number of air trips per capita in China largest aviation market (in terms of passenger traffic)
3 1000 80% 2.6 2.5 2.3 60% 750 2 40% 500 1.4 1.5 20% 250 1 0% 0.5 0.4 0.5 0 -20% 1970 1977 1984 1991 1998 2005 2012 0 United States(million trip) China United United Germany Global China(million trip) States Kingdom United States YOY China YOY Source: CAAC, National Bureau of Statistics, World Bank, HSBC Qianhai Securities Source: CAAC, National Bureau of Statistics, World Bank, HSBC Qianhai Securities
A business model emphasising cost reduction and efficiency
Compared to full-service carriers, LCCs reduce their costs and improve operational efficiency by either simplifying or not offering services (e.g., baggage drop-off, in-flight meals and in-flight entertainment). The LCC business model was started in the 1970s by the American domestic carrier, Southwest Airlines (LUV US, Not Rated), now the largest of its kind. The model was soon adopted in other markets and LCCs now have a market share of between 30% and 40% in
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the US, Europe and Asia Pacific. China’s LCCs include Spring Airlines, Juneyao Airlines, China United Airlines, West Air, Capital Airlines and Chengdu Airlines.
Exhibit 4. 2017 market share of LCCs by Exhibit 5. Market share of LCCs in China continent
100% 12% 11.3%
80% 27% 32% 22% 10% 13% 8.5% 35% 60% 42% 8%
6% 40%
4% 2.9% 20% 2% 0% Asia North Europe Latin Middle Africa 0% Pacific America America East 2007 2012 2017 Full-service Carriers Lost-cost Carriers Others
Source: Airbus, HSBC Qianhai Securities Source: CAAC, Wind, HSBC Qianhai Securities
Operational differences between LCCs and full-service carriers include:
Single aircraft type: this cuts purchase costs and makes maintenance cheaper and easier.
High passenger load factor (PLF) and aircraft utilisation rate: to amortise fixed costs by increasing carrying capacity and aircraft daily flight slots.
Low ticket prices and selling expenses: high ratio of direct sales; building self-managed sales channels to reduce agency fees; attracting consumers with lower ticket prices. Due to longer average flight distances, LCCs in China have lowered fares based on the scale effect.
Point-to-point flight route: focus on major airports, different from the hub-and-spoke route network of full-service airlines.
Low staff-aircraft ratio: strict control over the number of non-frontline employees; emphasis on staff efficiency improvement and economies of scale.
High proportion of ancillary revenue: tap potential demand from consumers, expand fee- based services other than passenger and freight to improve profitability.
High profitability: by squeezing costs, enhancing efficiency and strengthening management, top-performing LCCs often achieve higher profit margins than traditional carriers.
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Exhibit 6. Aircraft utilisation rate Exhibit 7. Aircraft utilisation rate comparison of LCCs and full-service comparison of LCCs and full-service carriers in China (hours/day) carriers in the US (hours/day)
14 14 Low-cost Carriers Full-service Carriers Full-service Low-cost Carriers Carriers 12 12
10 10
8 8
6 6 Spring Juneyao Air China Southern Eastern United Jet Blue Spirit Airlines Airlines Airline Airlines Airlines Airlines Airlines 2015 2016 2017 2015 2016 2017
Source: Wind, HSBC Qianhai Securities Source: Bloomberg, HSBC Qianhai Securities
Exhibit 8. PLF comparison of low-cost and Exhibit 9. PLF comparison of low-cost and full-service carriers in China full-service carriers in the US
100% 86% Low-cost Low-cost Carriers Full-service Carriers Full-service Carriers Carriers 84% 90%
82%
80% 80%
70% 78% Spring Juneyao Air China Southern Eastern American Delta United Southwest Jet Blue Airlines Airlines Airline Airlines Airlines Airlines Airlines Airlines Airlines 2015 2016 2017 2015 2016 2017
Source: Wind, HSBC Qianhai Securities Source: Bloomberg, HSBC Qianhai Securities
Exhibit 10. Average flight length for Exhibit 11. Average flight length of low- domestic market of low-cost and full- cost and full-service carriers in US (miles) service carriers in China (km)
1800 1600 Low-cost Low-cost Carriers Full-service Carriers Full-service Carriers Carriers 1600 1400
1400 1200
1200 1000
1000 800
800 600 Spring Juneyao Air China Southern Eastern American United Southwest Jet Blue Airlines Airlines Airlines Airlines Airlines Airlines Airlines Airlines 2015 2016 2017 2015 2016 2017
Source: Wind, HSBC Qianhai Securities Source: Bloomberg, HSBC Qianhai Securities
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Exhibit 12. Yield per RPK for domestic Exhibit 13. Yield per RPM of low-cost and market of low-cost and full-service carriers full-service carriers in the US (USD cent) in China (RMB)
0.7 17 Low-cost Carriers Full-service Carriers Full-service Low-cost 0.6 Carriers Carriers 16 0.5 0.4 15
0.3 14 0.2 13 0.1 0 12 Spring Juneyao Air China Southern Eastern American Delta United Southwest Jet Blue Airlines Airlines Airlines Airlines Airlines Airlines Airlines Airlines Airlines 2015 2016 2017 2015 2016 2017
Source: Wind, HSBC Qianhai Securities Source: Bloomberg, HSBC Qianhai Securities
Exhibit 14. Ancillary revenue proportion of Exhibit 15. Ancillary revenue proportion of low-cost and full-service carriers in China low-cost and full-service carriers in the US
10% 50% Low-cost Full-service Full-service Low-cost Carriers Carriers Carriers Carriers 8% 40%
6% 30%
4% 20%
2% 10%
0% 0% Spring Air China Southern Eastern American DELTA United Allegiant Spirit Airlines Airlines Airlines Airlines Airlines Airlines Airlines Airlines 2015 2016 2017 2015 2016 2017
Source: Wind, HSBC Qianhai Securities Source: Bloomberg, IdeaWorks, HSBC Qianhai Securities
Exhibit 16. Net margins of low-cost and Exhibit 17. Net margins of low-cost and full-service carriers in China full-service carriers in the US
20% 20% Low-cost Carriers Full-service Carriers Full-service Low-cost Carriers Carriers 16% 16%
12% 12%
8% 8%
4% 4%
0% 0% Spring Juneyao Air China Southern Eastern American Delta United Southwest Jet Blue Airlines Airlines Airline Airlines Airlines Airlines Airlines Airlines Airlines 2015 2016 2017 2015 2016 2017
Source: Wind, HSBC Qianhai Securities Source: Bloomberg, HSBC Qianhai Securities
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Industry outlook
Over the last decade, airline passenger traffic in China has risen from 5.42m in 2007 to 62.24m in 2017, a CAGR of 27.6%. Inevitably, as the industry continuing to expand, the pace of growth is starting to slow down. It has eased to 14-18% since 2014, according to the CAAC estimates.
It’s a different story for LCCs. In Q4 2018 and January-February 2019, passenger traffic grew 12.3% and 16.2%, respectively, well ahead of the 8.7% and 13% for the overall aviation industry, respectively. During the same periods, the passenger load factor of Spring Airlines, the market leader, was 88% and 92%, respectively, while Juneyao Airlines’ passenger load factor was steady at 85%. The average passenger load factor for the industry was lower at 82% and 84%, respectively, during the same periods. We estimate the growth of LCC passenger traffic will be 14.4%, 17.4% and 15.7% in 2019-21e, respectively.
Another big plus is that China’s home-grown domestic aircraft, the C919, is expected to go into mass production in 2021, which will reduce the reliance on Airbus and Boeing and increase capacity, in our view.
We estimate the passenger traffic of LCCs will rise at a CAGR of 20% over 2018-27e and reach 385m in 2027e. This would represent a market share of 35%, up from 11.3% in 2017. We estimate that the revenue of China’s LCCs grew to cRMB35.48bn in 2017e. We forecast that it will increase to RMB219.4bn in 2027e. In our view, the three major industry growth drivers are:
Mass tourism: The demand for leisure travel is growing rapidly. The customer base has shifted from business travellers and high-income individuals to the general public.
Increasing affordability: Low-cost airfares now account for c1.2% of per capita disposable income. This means a large part of the population can now afford to fly. Massive low-frequency and price-sensitive travellers have fuelled the demand for LCCs.
The supply side: 1) The government is loosening aviation regulations, which benefits LCCs; 2) the construction of new airports – showcased by Daxing Airport in Beijing – and the expansion of existing facilities makes it possible for LCCs to obtain better time slots; and 4) the mass production of a domestic aircraft boosts the industry further after 2021e.
Exhibit 18. Passenger traffic and growth of Exhibit 19. Market share of passenger Chinese LCCs traffic of Chinese LCCs
500 60% 40% 35% 385 400 50% 30% 40% 300 30% 20% 12% 11% 200 11% 115 20% 10% 99 10% 74 85 10% 100 53 62 10% 8% 34 39 46 10% 6%7% 12 16 21 27 5% 5 8 3%4% - 0% 0% 1% 2007 2010 2013 2016 2019e 0% 2005 2007 2009 2011 2013 2015 2017 China's low-cost carriers passenger traffic (million trip) Low-cost carriers market share YOY(Right axis) Source: CAAC, HSBC Qianhai Securities Source: CAAC, HSBC Qianhai Securities
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Initiate coverage
Spring Airlines (601021 CH, RMB43.30, Buy, TP RMB54.96) The company is a pioneer and market leader in China’s LCC sector. Spring Airlines has good The company is a pioneer and market leader corporate governance and a well-established employee incentive system. In terms of operations, strict cost controls are in place and the airline has the highest passenger load factor, aircraft utilisation rate and net margin among China’s listed airlines. Spring Airlines has been growing rapidly. In 2013-18, its revenue passenger kilometres (RPK), revenue and net profit grew at a CAGR of 16.6%, 14.8% and 15.5%, respectively.
Since 2017 the company has stepped up efforts to balance its domestic and international route networks, which boosted its yield and profitability. We think the bottoming out of ancillary businesses in 2018 leaves ample potential for earnings growth. The opening of Beijing Daxing Airport this year will create new growth opportunities, in our view.
HSBC Global Research estimates the Brent oil price to be USD65.20/b, USD70.00/b and USD70.00/b for 2019-21e, respectively (23 April 2019). Given the above assumptions, we estimate its revenue and net profit CAGR to be 18.5% and 28.7%, respectively, in 2019-21e. We use 24x 2019e PE for the valuation, deriving a target price of RMB54.96, implying 27% upside from the current share price. Initiate coverage at Buy. The stock is trading near its historical trough. Given the long-term growth story, we think the valuation is attractive. Share price catalyst: more-than-expected flight slots at major airports.
Juneyao Airlines (603885 CH, RMB12.46, Buy, TP RMB18.04) The company has two brands, Juneyao and 9 Air, with operational hubs in Shanghai and The company has two brands: Juneyao and 9 Air Guangzhou. It has excellent cost control and operational efficiency. Juneyao is not a traditional LCC as it targets more upmarket passengers. Its fares are lower than those of China’s ‘Big Three’ airlines (Air China, China Southern Airlines and China Eastern Airlines) but higher than those of Spring Airlines. This differentiated strategy has generated higher returns. In 2018, ROE and return on invested capital were 13.6% and 8.8%, both industry-leading, respectively.
The limited supply of time slots in Shanghai, its main base, implies upside in ticket prices. The opening of Beijing Daxing Airport this year will also help the company expand its route network. The major challenge is the start of intercontinental flights this year. We believe this could cause some short-term pain but a new strategic alliance with China Eastern Airlines should help with the move into international markets.
Juneyao is one of the fastest growing airlines in China. In 2013-18, its RPK, revenue and net profit grew at a CAGR of 21.5%, 19.4% and 29.5%, respectively. We estimate its revenue and recurring net profit to grow at a CAGR of 20% and 28.8% in 2019-21e, respectively. We use 22x 2019e PE for the valuation, deriving a target price of RMB18.04, implying 45% upside from the current share price. Initiate coverage at Buy rating. The stock is trading at a PE multiple slightly below it historical average, which is attractive, in our view. Share price catalyst: intercontinental routes and time slots with high profit margins.
China Express Airlines (002928 CH, RMB11.42, Buy, TP RMB15.97) The company, which is based in western China, is the only listed regional airline. Its revenue The only listed regional airline and net profit grew at 37.5% and 20.3% over 2013-18, respectively. Thanks to its high level profitability, the company’s net margin was second only to Spring Airlines, which could offset the impact of its lacklustre passenger load factor and aircraft utilisation rate.
We believe the government capacity purchase model – which guarantees revenue levels on most flights – will ensure stable revenue and earnings. The airline also has a monopoly on most of its routes. The cutting of taxes and administrative fees this year will lower costs, increase passenger traffic and subsidies, and drive earnings growth, in our view.
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We estimate its revenue and net profit to grow at a CAGR of 19.2% and 38.6% in 2019-21e, respectively. We use 18x 2019e PE for the valuation, deriving a target price of RMB15.97, implying 40% upside from the current share price. The share price has been weak recently because the valuation was relatively high when the company listed in March 2018; it has also been affected by fluctuations in the oil price and the exchange rate. We initiate coverage with a Buy rating. The stock is trading at -2 SD to -1 SD of the historical average.
Order of preference In the order of preference, we like Spring Airlines, Juneyao Airlines and China Express Airlines. We believe China’s low-cost carrier industry is about to take off driven by increasing popularity of mass tourism and a growing number of less-frequent/price-sensitive travellers.
Spring Airlines, as the industry leader, has the largest domestic and international airline networks among LCCs, good cost control, and operational efficiency. We believe it will benefit most from the industry up-cycle. We believe the current stock price does not fully reflect these positive factors. Spring Airlines was trading at 21x 2018e PE (market consensus) in Q4 2018 and 15x 2019e PE (HSBC Qianhai estimates) in Q1 2019 on average, below the average historical forward PE of 23x (2015-19 YTD).
Juneyao Airlines has a quality airline network with great operational efficiency. However, it is launching intercontinental flights this year and we think this could weigh earnings in the short term. In addition, the grounding of the world’s 737 Max-8 fleet is a potential downside risk in terms of capacity growth. Juneyao Airlines was trading at 16x 2018e PE (market consensus) in Q4 2018 and 14x 2019e PE (HSBC Qianhai estimates) in Q1 2019, below the average historical forward PE of 21x (2015-19 YTD).
China Express Airlines is a leading regional operator that receives a lot of support from the government. The stock was trading at 18x 2018e PE (market consensus) in Q4 2018 and 15x 2019e PE (HSBC Qianhai estimates) in Q1 2019, below the average historical forward PE of 22x (2018-19 YTD).
Foreign investors are starting to show some interest in China’s LCCs, especially in Spring Airlines; however, compared with the three largest full-service carriers, the proportion of foreign investment is still relatively small.
Exhibit 20. The proportion of foreign Exhibit 21. The proportion of foreign investment in large full-service carriers in investment in Spring Airlines and Juneyao China is high Airlines is relatively low
25% 4%
20% 3%
15% 2% 10%
1% 5%
0% 0% May-18 Aug-18 Nov-18 Feb-19 May-19 May-18 Aug-18 Nov-18 Feb-19 May-19 Air Southern Eastern Spring Airlines Juneyao Airlines China Airlines Airlines Source: Wind, HSBC Qianhai Securities Source: Wind, HSBC Qianhai Securities
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Where we are different from consensus
Spring Airlines: We believe the market has underestimated the positive effects of the growing demand for LCCs on the company’s short-term ticket prices and long-term passenger volumes. However, we are cautious on the growth of government subsidies.
Juneyao Airlines: We are cautious about the outlook for the company’s new intercontinental routes. We believe low prices on these routes will affect its yield per RPK. We estimate the yield per RPK of international routes to grow -16.1%, -6.9% and -3.2% y-o-y and the PLF to grow -2ppts, -1ppts and 1ppts y-o-y over 2019-21e, respectively. We expect intercontinental routes to continue to suffer losses in 2019-20 and eventually break even in 2021. We are well below consensus in terms of 2020e and 2021 net profit.
Exhibit 22. HSBC Qianhai estimates vs Wind consensus _____ HSBC Qianhai ______Wind consensus ____ HSBC Qianhai vs market consensus Company RMBm 2019e 2020e 2021e 2019e 2020e 2021e 2019e 2020e 2021e Spring Airlines Revenue 15152 18196 21842 15827 18842 21550 -4% -3% -1% Net profit attributable to parent 2099 2385 3204 1952 2388 2816 8% 0% 14% Juneyao Airlines Revenue 16545 20749 24869 16834 19956 23854 -2% 4% 4% Net profit attributable to parent 1606 1611 2269 1646 2084 2642 -2% -23% -14% China Express Airlines Revenue 5232 6199 7211 NA NA NA NA NA NA Net profit attributable to parent 533 529 658 NA NA NA NA NA NA Source: Wind, HSBC Qianhai Securities estimates. NA – Not applicable.
Sector-related downside risks Lower-than-expected demand: Demand is positively correlated with the purchasing power of consumers. If macroeconomic conditions continue to deteriorate and growth in disposable income slows down, demand for mass tourism may decline.
Rising oil prices: HSBC Global Research estimates the Brent oil price to be USD65.20/b, USD70.00/b and USD70/b for 2019-21e, respectively. If oil prices go up significantly, earnings may suffer.
Exhibit 23. Sensitivity analysis of oil price change to EPS ____ Spring Airlines ______Juneyao Airlines ______China Express Airlines ___ Brent oil price change 2019e 2020e 2021e 2019e 2020e 2021e 2019e 2020e 2021e +1% -1% -2% -1% -2% -3% -2% -2% -2% -2% +5% -7% -8% -7% -9% -13% -11% -9% -12% -11% +10% -14% -10% -9% -19% -17% -14% -18% -24% -22% +20% -23% -15% -13% -30% -24% -21% -21% -29% -26% +30% -27% -20% -17% -34% -32% -27% -24% -34% -31% Source: Company data, HSBC Qianhai Securities estimates
RMB depreciation: HSBC Global Research estimates the Q4 2019 exchange rate of the USD to the RMB to be 6.75. If the RMB depreciates significantly, it will lead to greater foreign exchange losses and higher fuel costs and foreign currency payments.
Exhibit 24. Sensitivity analysis of exchange rate change to EPS Exchange rate ____ Spring Airlines ______Juneyao Airlines ______China Express Airlines ___ change 2019e 2020e 2021e 2019e 2020e 2021e 2019e 2020e 2021e 6.82 (-1%) -2% -2% -2% -3% -4% -3% -1% -2% -2% 6.95 (-3%) -6% -6% -5% -8% -11% -9% -2% -7% -6% 7.09 (-5%) -9% -10% -8% -14% -18% -15% -4% -12% -11% Source: Company data, HSBC Qianhai Securities estimates
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Slowdown in capacity expansion: If the grounding of the 737 Max fleet continues, civil aviation air space in China is limited and the supply of pilots does not match demand growth, capacity will likely face downside risks.
Supply constraints: The permission to access quality routes and flight slots is crucial to the industry’s development. If aviation regulation are tightened again, the allocation of flight slots will be less market-driven, thus posing a downside risk for the industry.
Environmental, social and corporate governance (ESG)
In terms of environmental protection, the CAAC attaches great importance to energy conservation and emissions reduction projects. It has set 2020 targets for per RTK energy consumption and per RTK CO2 emissions to decrease by 22% from the 2005 levels. In response, the three carriers are making efforts to improve energy conservation and emissions reduction.
For example, Juneyao Airlines has invested more than RMB200m in equipment, such as the “Sharklet” blended winglet, lightweight seating, a water cleaning system for fuselages and engines, and up-to-date flight data systems. With the introduction of the Boeing 787-9 Dreamliner and Airbus A320neo family d uring the 13th Five-Year Plan, the company’s 2017 per traveller CO2 emissions dropped to 139.3kg and they are expected to fall further.
Exhibit 25. Juneyao Airlines CO2 emissions in 2013-17
Year Total CO2 emissions CO2 emissions per aircraft CO2 emissions per capita (kg) (10,000 tonnes) (10,000 tonnes) 2013 100.2 2.9 141.2 2014 115.6 3.0 140.6 2015 141.4 2.8 141.1 2016 163.8 2.9 141.2 2017 190.3 2.8 139.3 Source: Company data, HSBC Qianhai Securities
In terms of social and corporate governance, all three airlines have created a large number of jobs with well-developed corporate governance systems in place. Spring Airlines, Juneyao Airlines and China Express Airlines created 7,605 jobs, 7,499 jobs and 3,907 jobs in 2018, respectively, with labour cost accounting for 20%, 16% and 20% of total revenue, respectively. In 2018, there were eight, nine and nine directors on the board of directors of Spring Airlines, Juneyao Airlines and China Express Airlines, respectively, over 30% of whom were independent directors, which met the requirements of regulators.
Exhibit 26. Number of employees and board structure Company No. of employee Employee salary No. of board Board member Female board /revenue (%) members independence (%) members (%) Spring Airlines 7605 20 8 38 25 Juneyao Airlines 7499 16 9 33 11 China Express 3907 20 9 33 22 Airlines Source: Company data, HSBC Qianhai Securities
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Valuation and risks
Valuation Risks
Current price: We adopt a PE-based approach for our valuation. Key downside risks: Spring Airlines RMB43.30 The company’s historical forward PE is 23.3x (1 SD: 5.7x) and its historical 3- Rising oil prices 601021 CH Target price: year CAGR of net profit attributable to the parent is 26%. We estimate the Depreciation of the RMB
RMB54.96 company’s recurring net profit attributable to the parent to grow at a CAGR of Lower-than-expected demand for air travel 28.7% over 2019-21e, slightly above the historical average. Therefore, we Loss-making risk for Spring Airlines Japan Buy Up/downside: believe it is reasonable to use 24x 2019e PE for the valuation. Based on our 27% 2019e EPS estimate of RMB2.29, we derive our target price of RMB54.96,
implying 27% upside from the current share price. Initiate coverage at Buy. David Wu * | [email protected] | +86 755 88983436 HSBC Qianhai Securities Limited
Juneyao Current price: We adopt a PE-based approach for our valuation. Key downside risks: Airlines RMB12.46 The company’s historical forward PE is 21.2x (1 SD: 7.3x) and its historical 3- Rising oil prices 603885 CH Target price: year CAGR of net profit attributable to parent is 27%. We estimate the Depreciation of the RMB company’s recurring net profit attributable to the parent to grow at a CAGR of Lower-than-expected demand for air travel RMB18.04 28.8% over 2019-21e, slightly above the historical average. Therefore, we Slowdown in capacity expansion
Buy Up/downside: believe it is reasonable to use 22x 2019e PE for the valuation. Based on our 45% 2019e EPS estimate of RMB0.82, we derive our target price of RMB18.04,
implying 45% upside from the current share price. Initiate coverage at Buy. David Wu* | [email protected] | +86 755 88983436 HSBC Qianhai Securities Limited
China Express Current price: We adopt a PE-based approach for our valuation. Key downside risks: Airlines RMB11.42 We choose SkyWest (SKYW US, Not Rated), a leading regional carrier in the Rising oil prices 002928 CH Target price: US, as a comparable company and use its fast-growing period (recurring net Depreciation of the RMB
RMB15.97 profit grew at a CAGR over 20%) over the past 15 years as a comparable Discontinuation of capacity purchase model by period, when SkyWest’s 3-year historical average recurring net profit grew at a local governments and airports
Buy Up/downside: CAGR of 22.4% and the historical forward PE was 10.8x. We estimate CEXA’s
40% recurring net profit attributable to the parent to grow at a CAGR of 38.6% over 2019-21e, higher than the estimated earnings growth of the comparable company. Therefore, we believe it is reasonable to use 18x 2019e PE for the
valuation. We base our target price of RMB15.97 on our 2019e EPS estimate of RMB0.89, implying 40% upside from the current share price. Initiate coverage at Buy. David Wu * | [email protected] | +86 755 88983436 HSBC Qianhai Securities Limited
Priced at 29 May 2019 *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations. Source: Bloomberg, HSBC Qianhai Securities
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The start of a ‘golden decade’
As in the US and Europe, demand for leisure travel from the middle class will be the key growth driver for LCCs
Mass tourism, longer flight distances and increasingly affordable tickets will accelerate industry growth
We expect passenger traffic volume to grow at a CAGR of 20% over 2018-27e, with the market share rising from 11% to 35%
Learning from the experience in the US and Europe
LCC passengers are mostly price-sensitive or infrequent travellers, and the growing popularity of mass tourism (i.e. leisure travel, visiting families and friends) is the major driving force behind the growth in the industry. We believe the US and Europe provide good pointers for how the LCC industry can develop in China. These markets tell us that LCCs start to prosper when flying loses the luxury cachet associated with the wealthy and business travel. The two key indicators to watch are GDP per capita and the price of air fares as a percentage of average disposable income.
The US story The growing popularity of mass tourism in the 1970s – mainly leisure travel, visiting families and friends – was the major growth driver. This fuelled the rapid expansion of Southwest Airlines, the trailblazer of the LCC industry.
Exhibit 27. Domestic travel demand in the US is closely related to the volume of passenger traffic of LCCs
2.5 2.29 40% 2.18 1.96 2.0 1.86 30%
1.5 1.25 1.04 20% 1.0
0.45 10% 0.5
- 0% 1970 1980 1990 2000 2010 2015 2018 US domestic tourist trips (billion) YOY of US domestic tourist trips YOY of Southwest Airlines passenger traffic
Source: U.S. Department of Commerce, Company data, HSBC Qianhai Securities
In the 1960s, GDP per capita (purchasing power parity, constant 2011 in international USD) in the US was USD15,000-20,000. As disposable income increased, the number of air trips per capita increased from 0.35 a year to 0.83 over 1950-70, a CAGR of 9.4%, before starting to
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slow down. As air travel became more mainstream, Southwest Airlines soared, with passenger traffic increasing at a CAGR of 44.8% in the 1970s and between 1980 and 2000 it beat the industry average by over 10%. It’s clear that demand in the LCC industry boomed in the US when the aviation industry approached the end of its fast-growth period and then remained strong for the next 30 years.
Exhibit 28. US GDP per capita rose from Exhibit 29. The number of air trips per USD15,000 to USD20,000 in the 1960s capita in the US rose fastest in the 1960s
60000 20% 3 30% CAGR CAGR CAGR CAGR +9.2% +4.1% +2.4% +0.6% 50000 15% 20% 40000 2 10% 30000 10% 5% 20000 1 0% 10000 0%
0 -5% 0 -10% 1960 1970 1980 1990 2000 2010 1960 1970 1980 1990 2000 2010 United States Per Capita GDP (2011 Int$, PPP) United States Per Capita trips YOY Yoy
Source: World Bank, HSBC Qianhai Securities Source: Bureau of Economic Analysis, World Bank, HSBC Qianhai Securities
The European story In the 1990s the number of air trips per capita in Europe increased at a CAGR of 10%. As in the US, Ryanair and EasyJet, the largest two LCCs in Europe, recorded robust growth in the next decade despite a slowdown in the overall aviation industry after 2000. Between 2000 and 2010, Ryanair’s volume of passenger traffic grew at a CAGR that was 21.2% higher than the aviation industry average. During the same period, GDP per capita in Europe was USD34,000-37,000.
Exhibit 30. Number of air trips per capita growth in Europe, and volume of passenger traffic growth of Ryanair and EasyJet
100%
80%
60%
40%
20%
0% 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 -20%
Yoy of per capita trips of ten countries in Europe Yoy of Ryan Air Passenger Traffic Yoy of Easyjet Passenger Traffic Source: European Statistical Office, Bloomberg, HSBC Qianhai Securities
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Exhibit 31. Number of air trips per capita CAGR in the US and Europe vs volume of passenger traffic growth of Southwest, Ryanair and EasyJet Country/region Period Number of trips per capita Volume of passenger traffic Airlines growth – industry CAGR growth of airlines growth 1960-1970 9.2% - - 1972-1980 4.7% 44.8% +40.1% US Southwest Airlines 1980-1990 3.6% 12.7% +9.1% 1990-2000 2.4% 12.4% +10.0% 1993-2000 10.0% 30.3% +20.3% Europe 2000-2010 4.1% Ryanair 25.3% +21.2% (10 countries) 2010-2017 4.1% 8.7% +4.6% Source: Bureau of Economic Analysis, World Bank, European Statistical Office, Bloomberg, HSBC Qianhai Securities
Airfare as a percentage of disposable income Flights are getting cheaper, too. As shown in the chart below, airfares in the US as a percentage of average disposable income dropped to c1% in 1980 and have kept falling.
Exhibit 32. Average flight fare as a percentage of income dropped to c1% in 1960-80s in the US
160 1.4% 140 1.2% 120 1.0% 100 0.8% 80 0.6% 60 40 0.4% 20 0.2% 0 0.0% 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014 2017 Average fare(USD) Average fare / Per capita income(right axis)
Source: Bureau of Economic Analysis, HSBC Qianhai Securities
China’s LCC industry
Mass tourism and longer travel distances are the keys Travel demand in China started to take off after 2004 and received another boost in 2010 when Travel demand in China started to take off after 2004 the RMB appreciated. What’s changed in the last few years is that the distances flown by LCCs have risen as mass tourism has become more popular. For example, the average distance for Spring Airlines increased from 1,423km in 2011 to 1,610km in 2018.
China also has the most developed high-speed rail network in the world, raising questions about how much this will affect LCCs, especially over distances of less than 1,000km. We don’t believe the competitive threat is significant as the average domestic air fare of Spring Airlines is only RMB546, which is similar to the price of a high-speed rail ticket for a journey of 1,500km. Flying saves time, so we think more people will prefer to book a flight rather than take a long train journey.
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Exhibit 33. Air vs rails: air traffic has risen Exhibit 34. Longer flights (km) since 2014
100% 1800 1600 1590 1600 80% 1400 1247 60% 1200 1000 838 760 40% 800
20% 600 423 400 0% 200 2007 2009 2011 2013 2015 2017 0 Proportion of Air Passenger Traffic 1975 1985 1995 2005 2015 2018 Proportion of High-speed Rail Passenger Traffic Average Distance of Southwest Airlines Proportion of Ordinary Railway Passenger Traffic Source: Wikipedia, Ministry of Transport of PRC, HSBC Qianhai Securities Source: Company data, HSBC Qianhai Securities
Airfares are increasingly affordable, boosting demand China is a diverse market. It not only covers a significant amount of territory, but there is also a China is a diverse market large disparity in income. In wealthy tier-one cities, such as Beijing, Shanghai, Guangzhou and Shenzhen, as well as some tier-two cities, large numbers of people can now afford to fly. This has led to a shift in demand from full-service airlines to LCCs.
Our analysis shows that when GDP per capita (PPP, constant 2011, in international USD) in the big cities was USD8,000-18,000, the number of air trips per capita rose rapidly (10% CAGR). When GDP per capita moved above the USD18,000-20,000 range, the growth in number of air trips per capita slowed down. Despite this, as in the US and Europe, demand for budget travel remained strong.
Exhibit 35. Per capita GDP, number of air Exhibit 36. Per capita GDP, number of air trips per capita and growth in Beijing trips per capita and growth in Shanghai
5 60% 5 60%
4 4 40% 40% 3 3 CAGR CAGR 20% +14.1% 20% +11.6% CAGR CAGR 2 2 +3.3% +6.4% 0% 0% 1 1
0 -20% 0 -20% 2000 2002 2004 2006 2008 2010 2012 2014 2016 1998200020022004200620082010201220142016 Per Capita Trips Per Capita Trips Per Capita GDP (2011 Int$ in ten thousand,PPP) Per Capita GDP (2011 Int$ in ten thousand,PPP) YOY of Per Capita Trips（right axis） YOY of Per Capita Trips（right axis） Source: National Bureau of Statistics, Civil Aviation Administration of China, HSBC Source: National Bureau of Statistics, Civil Aviation Administration of China, HSBC Qianhai Securities Qianhai Securities
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Exhibit 37. Per capita GDP, number of air Exhibit 38. Per capita GDP, number of air trips per capita and growth in Guangzhou trips per capita and growth in Shenzhen
5 30% 5 40% CAGR 4 +18.4% 4 30% 20% 3 3 20% CAGR 10% CAGR +5.6% 2 2 +5.2% 10% 0% 1 0% 1
- -10% 0 -10% 2004 2006 2008 2010 2012 2014 2016 2002 2004 2006 2008 2010 2012 2014 2016 Per Capita GDP (2011 Int$ in ten thousand,PPP) Per Capita Trips Per Capita Trips Per Capita GDP (2011 Int$ in ten thousand,PPP) YOY of Per Capita Trips（right axis） YOY of Per Capita Trips（right axis） Source: National Bureau of Statistics, Civil Aviation Administration of China, HSBC Source: National Bureau of Statistics, Civil Aviation Administration of China, HSBC Qianhai Securities Qianhai Securities
Exhibit 39. Per capita GDP, number of air Exhibit 40. Per capita GDP, number of air trips per capita and growth in Nanjing trips per capita and growth in Changsha
0.4 40% 0.4 50%
40% 0.3 30% 0.3 30% 0.2 20% 0.2 20% 0.1 0.1 10% 10%
- 0% - 0% 2001 2003 2005 2007 2009 2011 2013 2015 2017 2001 2003 2005 2007 2009 2011 2013 2015 2017 Per Capita Trips Per Capita Trips Per Capita GDP (2011 Int$ in ten thousand,PPP) Per Capita GDP (2011 Int$ in ten thousand,PPP) YOY of Per Capita Trips（right axis） YOY of Per Capita Trips（right axis） Source: National Bureau of Statistics, Civil Aviation Administration of China, HSBC Source: National Bureau of Statistics, Civil Aviation Administration of China, HSBC Qianhai Securities Qianhai Securities Note: Since provincial-level airports cover the demand of a whole province, the NTC Note: Since provincial-level airports cover the demand of a whole province, the NTC is calculated by dividing VPT (volume of passenger traffic) in those airports by the is calculated by dividing VPT (volume of passenger traffic) in those airports by the number of permanent residents in the province. number of permanent residents in the province.
If we look at the history of tourism in China, there have been two periods of rapid growth in the aviation industry.
2004-07: GDP per capita in tier-one cities, such as Beijing, Shanghai, Guangzhou and Shenzhen, broke through USD15,000 (PPP, constant 2011, international USD), lifting demand from high-income individuals and driving growth in the number of air trips per capita and passenger traffic.
2010-12: Average disposable income in tier-one cities rose to RMB30,000-40,000. This, combined with a stronger RMB, drove demand. However, a lot of high-speed trains went into service during this period and took considerable numbers of passengers from airlines.
Since then, GDP per capita has inevitably kept rising. In 2018, it was USD16,300 and we expect it to exceed USD18,000 in 2020e. We think the growth in trips per capita will probably slow as the aviation industry approaches the end of its fast-growth period. As in developed markets, we expect demand for low-cost flights to increase.
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The same factors apply to per capita disposable income. For urban residents it was RMB39,300 in 2018, and we expect this to rise to RMB46,000 in 2020e. The average domestic fare offered by Spring Airlines is current about RMB546, which is about 1.18% of the per capita disposable income, close to the 1% threshold we mentioned earlier. We think Chinese people’s purchasing power has made them the target customers of the LCC industry. Huge amounts of infrequent, price-sensitive travellers will bring a demand hike in the LCC industry.
The Global Market Forecast for 2018-2037 published by Airbus in July 2018 estimates that the We expect passenger traffic on China’s LCCs to grow at a volume of passenger traffic on China’s domestic routes will grow at a CAGR of 7.3% over 2017- CAGR of 20% over the next 27. Providing there are no major problems on the supply side, we expect passenger traffic on decade China’s LCCs to grow at a CAGR of 20% over the next decade – c12ppt higher than the aviation industry’s average – to 0.39bn in 2027e. This would represent 35% of the total industry volume and create a RMB219.4bn market. In our view, we are at the starting point of a ‘golden decade’.
Exhibit 41. Number of air trips per capita Exhibit 42. GDP per capita in China and growth in China exceeded USD16,000 in 2018
0.5 40% 20000 16%
0.4 First turning point: 30% 15000 12% 2004-2007 0.3 Second turning point: 20% 2010-2012 10000 8% 0.2 10%
5000 4% 0.1 0%
- -10% 0 0% 1996 1999 2002 2005 2008 2011 2014 2017 1994 1997 2000 2003 2006 2009 2012 2015 2018 China Per Capita Trips YOY China Per Capita GDP (2011 Int$, PPP) YOY
Source: National Bureau of Statistics, Civil Aviation Administration of China, HSBC Source: National Bureau of Statistics, National Tourism Administration, HSBC Qianhai Securities Qianhai Securities
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The supply side is improving
Civil aviation regulations are being relaxed in China
New airports and expansion of existing ones will increase flight slots
China’s new C919 passenger jet is set to ease fleet bottlenecks
Aviation controls are being relaxed
The civil aviation industry in China has long faced a number of challenges. For LCCs, getting access to new routes and flight slots at congested airports is often difficult. Import restrictions on certain types of aircraft also create problems. The situation now appears to be improving. For example, a number of aviation regulations were relaxed last year and mass production of China’s home-grown C919 planes is expected to start in 2021. Again, we draw comparisons with the US market to help chart the course of the industry in China.
The US industry grew rapidly after deregulation The US promulgated the Civil Aeronautics Act in 1938 and established the Civil Aeronautics Board (CAB), a move seen as a regulatory milestone. Back then, competition was limited, prices were high and service quality was low. After deregulation accelerated in the late 1970s and early 1980s, the industry entered a new phase of development, which included the launch of LCCs. From 1970, Southwest Airlines grew rapid for the next 30 years.
Exhibit 43. Aviation control relaxation in the US Phase Time Event Industry characteristics Promulgated the Civil Aviation Law and established CAB, a regulatory 1938 milestone Moderate corporate To ensure the profitability of carriers, regulations were further reinforced, competition in the Regulatory era Early including suspension of approval for new routes, allowing carriers to make industry, high prices for 1970s agreements on restricting capacity input and implementing strict price terminal services restrictions Promulgated the Air Cargo Deregulation Act, allowing cargo transport 1977 companies to have the freedom of operation and pricing on any domestic The industry gradually route entered a stage of free Promulgated Airline Deregulation Act, simplifying entry and exit procedures Era of 1978 competition. Market for routes, lifting price controls deregulation competition intensified, 1981 CAB’s route control was cancelled accelerating the fall in 1983 CAB’s price control was cancelled ticket prices 1985 CAB was abolished 1989 Lifted restrictions on market entry and exit as well as M&A of civil airlines Source: Federal Aviation Administration, HSBC Qianhai Securities
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Exhibit 44. Number of airlines surged Exhibit 45. M&A also increased following airline deregulation in the US
120 100%
100 80% 80 60% 60 40% 40
20 20%
0 0% 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 1974 1979 1984 1989 1994 1999 2004 2009 2014 Number of American Airline company CR3 CR7
Source: United States Department of Transportation, HSBC Qianhai Securities Source: United States Department of Transportation, HSBC Qianhai Securities Note: CR3 include American Airlines, Delta Air Lines and United Airlines; CR7 include American Airlines, Delta Air Lines, United Airlines, Northwest Airlines, Continental Airlines, US Airways and Southwest Airlines.
Exhibit 46. Southwest Airlines’ market Exhibit 47. Southwest Airlines’ rapid share kept growing (by ASM) growth from 1970 to 2000
14% 140 60%
12% 120 50%
10% 100 40% 80 30% 8% 60 20% 6% 40 10% 4% 20 0% 2% 0 -10% 0% 1970 1976 1982 1988 1994 2000 2006 2012 Southwest Airlines passenger traffic (million) 1979198319871991199519992003200720112015 YOY of Industry Passenger Traffic YOY of Southwest Airlines passenger traffic Source: United States Department of Transportation, Bloomberg, HSBC Qianhai Source: United States Department of Transportation, Bloomberg, HSBC Qianhai Securities Securities
Deregulation in China The process has been gradual. The first step was taken in 2013 when restrictions on the floor for ticket prices were lifted, increasing the competitiveness of LCCs. Since then, ticket prices have been further liberalised. As of 2018 there were around 1,030 commercial airline routes in China, and the government has liberalised the price of air fares on about 25% of the routes, including core routes like Beijing-Shanghai, Shenzhen-Shanghai, and Guangzhou-Shanghai. This has raised the yield for the overall industry, including LCCs.
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Exhibit 48. Number and percentage of routes where fares have been deregulated (2004- 18)
1200 306 more 30% routes added 1000 25% 498 more 800 routes added 20%
600 15%
400 101 more 10% 94 more 31 more routes added 200 routes added routes added 5%
0 0% 2004 2013 2014 2017 2018 Proportion
Source: CAAC, HSBC Qianhai Securities
The CAAC has made efforts to improve transparency in terms of route allocation by introducing new rules last year. The idea is to give smaller airlines better access to new domestic routes and flight slots, based on their ability to run punctual, safe and compliant flight services. This should benefit efficient LCCs with lower market share and non-mature route networks.
For example, new carriers – defined as those with fewer than three slots a day or 21 slots a week at an airport – are to get 20-50% of the flights slots. Another important improvement is the new rating system that rewards the best performers. All carriers are ranked based on their flight on-time rate, safety record and the compliant use of flight slots. Again, this should benefit Spring Airlines and other efficient LCCs, in our view.
Exhibit 49. Route time allocation system of the revised “Measures of Civil Aviation Flight Slots Management”
New flight time
Administrative Management: Time pool Include Unallocated allocated by the Civil Aviation (available flight time) flight time Administration according to regulations
Returned, Main and auxiliary Build recalled or airport flight time withdrawal flight time
Time warehouse Market Management: (allocated flight time) allowing exchange, transfer and joint operations
Source: CAAC, HSBC Qianhai Securities
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Exhibit 50. Spring Airlines has s higher Exhibit 51. Spring and Juneyao: more execution rate compared to its peers flights are on time
95.4% 96.8% 96% 95.0% 94.9% 97% 96.8% 96.6% 94% 97% 92.8% 96.0% 96.0% 92% 91.6% 96% 90.4% 95.5% 90% 96%
88% 95%
86% 95% Air Southern Eastern Hainan Sichuan Spring Air Southern Eastern Hainan Spring Juneyao China Airlines Airlines Airlines Airlines Airlines China Airlines Airlines Airlines Airlines Airlines
Source: CAAC, HSBC Qianhai Securities Source: CAAC, HSBC Qianhai Securities
Exhibit 52. Spring Airlines’ safety incident rate is the lowest in the industry (unit: 10,000)
0.05 0.041 0.04
0.03 0.022 0.02
0.01 0.005 0.000 0.000 0.000 0.00 Air China Southern Airlines Eastern Airlines Hainan Airlines Spring Airlines Western Airlines
Source: CAAC, HSBC Qianhai Securities
Airports: new construction and expansion will help
We estimate that over the next 3-5 years 22 major cities will build new airports or expand existing facilities. This will allow LCCs to improve their efficiency, increase their market share and enhance profitability. For example, we estimate that this will allow Spring Airlines to increase its flight numbers at a CAGR of 13.1% over 2019-23e, rather than 11.2% without the increase in capacity.
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Exhibit 53. 2018-25e new construction/expansion projects of major airports Airport Construction plan Completion time Beijing New construction of Daxing International Airport October 2019 Chengdu New construction of Tianfu International Airport 2020 Guangzhou Expansion of the 4th and 5th runways and T3 terminal building 2021 Pudong Building satellite hall 2019 Hongqiao Expansion of terminal building 2018 Shenzhen Expansion of satellite hall 2021 Expansion of one terminal building, two satellite halls and three Kunming runways NA Chongqing Expansion 2020 Xian Phase III expansion Project just approved Hangzhou Phase III expansion 2022 Urumqi Expansion 2020 Nanjing Expansion 2020 Haikou Phase II expansion October 2019 Guiyang T3 terminal building 2020 Harbin Expansion 2020 Fuzhou Expansion of terminal building 2018 Jinan Comprehensive expansion May 2023 Changchun Reconstruction and expansion 2018 Lanzhou Phase III construction 2020 Ningbo Phase III expansion 2019 Hefei Phase II expansion 2025 Lhasa New construction of T3 terminal building End of 2020 Source: CAAC, HSBC Qianhai Securities. NA – Not applicable.
Exhibit 54. We estimate Spring Airlines’ flight numbers to increase by 2ppts on new construction/expansion of major airports in 2019-23e Number of flights in airports where Scenario 2019e 2020e 2021e 2022e 2023e the company has a presence (’000) Beijing Airport 2.01 6.02 8.03 8.59 9.19 New construction y-o-y growth - 200.0% 33.3% 7.0% 7.0% Beijing Airport 0.46 0.93 0.96 0.99 1.02 No new construction y-o-y growth - 104.9% 2.8% 2.9% 3.1% Chengdu Airport 1.56 1.63 1.81 2.02 2.24 New construction y-o-y growth 4.9% 4.9% 11.3% 11.3% 11.3% Chengdu Airport 1.55 1.64 1.73 1.82 1.91 No new construction y-o-y growth 4.9% 4.9% 4.9% 4.9% 4.9% 20 other major airports 76.49 82.24 89.49 96.24 103.98 Expansion y-o-y growth 6.7% 7.5% 7.6% 8.8% 8.1% 20 other major airports 76.15 80.74 84.83 88.96 93.20 No expansion y-o-y growth 6.2% 6.0% 5.1% 4.9% 4.8% Other airports 64.31 76.09 89.30 103.79 119.69 - y-o-y growth 19.5% 18.3% 17.3% 16.2% 15.3% Total number of flights New construction or 144.36 165.98 187.62 210.63 235.11 y-o-y growth expansion 13.7% 15.0% 13.0% 12.3% 11.6% Total number of flights No new construction and 142.47 159.39 176.80 195.52 215.79 y-o-y growth expansion 12.2% 11.9% 10.9% 10.6% 10.4% Source: CAAC, HSBC Qianhai Securities estimates
Mass production of the C919 aircraft to drive capacity growth
The fleets of Chinese airlines are subject to controls imposed by the National Development and Reform Commission (NDRC) and the Civil Aviation Administration of China (CAAC). In the current policy environment, the main controls apply to narrow-body Airbus A320 and Boeing B737 aircraft, which are favoured by LCCs. This has made it more difficult to expand the size of their fleets.
This is why the development of the home-grown C919 aircraft is so important. The C919 aircraft is a 160-seat, narrow-body aircraft, which, in our view, is ideal for LCCs. According to Bloomberg (6 February 2018), mass production is expected to begin in 2021. And, according to 21jingji.com (27 February 2018), 815 are already on order from 28 customers, mainly Chinese
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aircraft leasing companies, C919 could gain more orders in the future (see China National Defence: Forward march – orders are starting to flow again, 5 June 2019). We think the leasing model will suit LCCs in China.
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Company section
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Spring Airlines (601021 CH)
The industry leader with a proven track record in cost control, operational quality and employee productivity
Yield management, ancillary businesses and increased capacity at new airports are the three key drivers
Initiate coverage at Buy with a target price of RMB54.96
Shareholding structure
The company was established in 2004 and listed on the Shanghai Stock Exchange in 2015. By the end of 2018, it operated 81 Airbus A320 aircraft on 173 routes, flying to 90 cities. The airline is a subsidiary of Shanghai Spring International Travel Service.
Wang Zhenghua, the largest shareholder of Spring International Travel Service (春秋国旅) and Spring Charter (春秋包机), holds 59.07% equity in Spring Airlines together with a number of natural persons (individuals, rather than legal entities) via these two companies. This makes him the actual controller of the listed company. He indirectly owns 21.42% of the listco based on his shareholdings in Spring International Travel Service and Spring Charter.
Wang Yu, the son of Wang Zhenghua and the largest shareholder of Chunyi Investment (春翼投 资), holds 1.73% of the listed company together with a number of natural persons via Chunyi Investment. As such, he indirectly holds a 0.614% stake in Spring Airlines based on his shareholding in Chunyi. Wang Zhenghua and Wang Yu indirectly control 60.8% equity of the company and a 22.03% interest in Spring Airlines.
Exhibit 55. Spring Airlines: shareholding structure
Wang Zhenghua
35.7% 43.8%
Spring Chunqiu Chunxiang Chunyi International Charter Investment Investment
54.97% 4.1% 3.2% 1.73%
Spring Airlines
Source: Company data, HSBC Qianhai Securities
The company has a corporate governance structure featuring “centralised control + dispersed ownership”. A number of directors, supervisors and members of the management team
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indirectly hold stakes in the listed company through Spring Charter, Chunyi Investment and Chunxiang Investment. The company launched a share incentive plan for 30 key employees in 2016 and an employee stock ownership plan with 109 participants in 2018.
Exhibit 56. Shareholdings of directors, supervisors and management members Name Title Shareholding of Shareholding of Shareholding of Shareholding of Total indirect Spring Spring Charter Chunxiang Chunyi stakeholding of International Investment Investment the listco Travel Service Zhang Xiuzhi Vice Chairman 5.7% 10.0% 28.3% - 4.46% Yang Suying Chairman 5.7% 5.0% - - 3.34% Xu Guoping Chairman of 3.4% 3.0% - - 2.01% Supervisory Board Wang Zhijie President - - 5.0% - 0.16% Shen Wei Vice President - - 2.5% - 0.08% Wang Gang Vice President - - 0.8% - 0.03% Wu Xinyu Vice President - - 2.5% - 0.08% Huang Xingwen Vice President - - - 0.00% Chen Ke CFO - - 3.3% - 0.11% Song Peng Chief Engineer - - 1.3% - 0.04% Teng Shimin Chief Pilot - - 0.6% - 0.02% Zheng Liangang Vice President of - - 3.3% - 0.11% Marketing Source: Company data, HSBC Qianhai Securities
Rapid growth of revenue and earnings The company’s 2013-18 revenue per kilometre CAGR was 16.6%. In 2018, revenue rose to RMB13.114bn, with a 2013-18 CAGR of 14.8%; net profit attributable to the parent was RMB1.503bn, a 2013-18 CAGR of 15.5%.
Exhibit 57. 2011-18 revenue and growth Exhibit 58. 2011-18 net profit attributable rate to the parent and growth rate
16000 40% 1600 1503 80% 1328 13114 1262 12000 10971 30% 1200 951 884 40% 8094 8429 7328 732 8000 6563 20% 800 625 5632 483 4463 0% 4000 10% 400
0 0% 0 -40% 2011 2012 2013 2014 2015 2016 2017 2018 2011 2012 2013 2014 2015 2016 2017 2018 Net profit attributed to shareholders (RMBm) Revenue (RMBm) YOY YOY Source: Company data, HSBC Qianhai Securities Source: Company data, HSBC Qianhai Securities
High employee productivity and good cost control
Headquartered in Shanghai, Spring Airlines also has bases in Shijiazhuang, Shenzhen, Shenyang, Ningbo, Yangzhou, and Shantou. From 2017, the company ramped up its efforts to develop its route network and, supported by an improvement in aircraft utilisation, the company has managed to reduce costs, increase its share in key markets, and drive up yield.
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Exhibit 59. Transport capacity breakdown Exhibit 60. Aircraft utilisation of Spring of Spring Airlines by major bases Airlines continues to go up (hours/day)
100% 96.9% 11.1 11.06 94.2% 7.9% 90% 86.3% 5.7% 11 0.8% 10.9 10.84 80% 16.5% 17.5% 14.4% 10.8 70% 10.7 10.7 60% 71.1% 72.0% 71.4% 10.6
50% 10.5 2016 2017 2018H1 2016 2017 2018 Shanghai+Shenzhen Shijiazhuang+Shenyang Ningbo+Yangzhou Utilization of Aircraft (hours/day)
Source: Company data, HSBC Qianhai Securities Source: Company data, HSBC Qianhai Securities
Efficiency can improve despite rising labour costs As the industry leader, Spring Airlines has good cost control and employee efficiency levels. From 2011, the company’s unit operating cost has remained stable if external costs, such as jet fuel and take-off/landing costs, are deducted. However, overall, unit operating cost has been rising since 2014, which we believe is a result of increasing labour costs. The company recruited and promoted a number of captains, which led to double-digit growth in the average employee salary in 2016-17. For other staff, Spring mainly recruits employees by using social platforms, which involves relatively higher turnover costs.
Exhibit 61. Unit operating cost remains Exhibit 62. Employee-to-aircraft ratio stable keeps falling
0.16 350 110 500 417 300 0.15 105 105 366 400 250 102 0.14 100 200 99 276 300 0.13 150 95 100 200 90 90 0.12 89 50 85 85 100 0.11 0 83 2011 2012 2013 2014 2015 2016 2017 2018 80 0 Unit operating cost (excluding fuel, take-off and landing costs, RMB/ASK) 2011 2012 2013 2014 2015 2016 2017 Average salary of employees (thousands RMB, right Number of captains (right axis) axis) Man-machine Ratio Source: Company data, HSBC Qianhai Securities Source: Company data, HSBC Qianhai Securities
The CAAC will implement a new regulation, CCAR-121-R5, in 2020. This specifies that the annual flight hours for pilots and cabin crew will be reduced from 1,000 hours and 1,200 hours to 900 hours and 1,100 hours, respectively. The company has already made plans to cushion the cost pressure by raising aircraft utilisation and labour productivity. The employee-to-aircraft ratio is around 83 vs 75-80 for Southwest Airlines (US) and West Air (China), so we believe there is room for improvement.
The company is committed to cost reduction through software and hardware upgrades. Since 2016, its self-developed fuel saving system has lowered unit fuel consumption. After 2020, the company will introduce the A321neo model, which should increase fuel efficiency by 20% and
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also expand seating capacity per aircraft from 180 passenger to 235 passengers, further bringing down unit cost. In addition, both marketing and administrative expenses are declining.
Exhibit 63. Unit fuel consumption Exhibit 64. Marketing and administrative continues to fall expenses on a downward trend
22.5 0.025
22.0 0.020 21.5 0.015 21.0 0.010 20.5 0.005 20.0 0.000 19.5 2011 2012 2013 2014 2015 2016 2017 2018 2011 2012 2013 2014 2015 2016 2017 2018 Unit Fuel Consumption (ton/million ASK) Unit marketing and management expense (RMB/ASK) Source: Company data, HSBC Qianhai Securities Source: Company data, HSBC Qianhai Securities
Balanced route network boosts profitability, ancillary businesses to recover
The company ramped up its transport capacity on international routes in 2015 and 2016 with available seat miles (ASK) on overseas routes jumping 171.6% and 39.1%, respectively. However, it had to change its strategy due to intense competition on Japan routes in 2016, sliding demand for flights to South Korea after the THAAD dispute, and the slowdown in Thailand after the country’s king passed away. The company redirected capacity to the domestic market in 2017 by cutting the number of international route’s origin in second-tier city and low-demand destinations, so as to balance capacity and maintain a stable yield level.
Exhibit 65. Spring Airlines started ramping Exhibit 66. The number of international up domestic routes from 2017 route’s origin has declined
100% 30 28 24 25 80% 25 68% 62% 66% 65% 20 18 18 60% 82% 15 40% 10 20% 32% 38% 34% 35% 5 18% 0% 0 2014 2015 2016 2017 2018 Number of Origins Number of Destinations Domestic Route Capacity for International Routes for International Routes International and Regional Routes Capacity 2016 2017 2018
Source: Company data, HSBC Qianhai Securities Source: Company data, HSBC Qianhai Securities
Although a maritime accident in Phuket, Thailand, last year resulted in a sharp decline in Chinese tourists visiting the kingdom, the company has still increased its capacity in the Thailand market, considering the long-term growth potential. The ASK of Thailand routes in H1
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2018 and H2 2018 increased by 51% and 30% y-o-y, respectively, which led to a double-digit slump in the Thailand market’s yield in 2018, creating a drag on earnings for international routes. Backed by the recovery of the tourism industries in Thailand and South Korea in 2019, we estimate the profitability of international routes will continue to rise.
Exhibit 67. Y-o-y growth in number of Exhibit 68. Thailand routes have seen outbound trips in major international continuous capacity growth routes of Spring Airlines
100% 4000 70% 3414 3547 80% 60% 60% 2737 3000 50% 40% 2259 40% 20% 2000 30% 0% 2016Q1 2016Q3 2017Q1 2017Q3 2018Q1 2018Q3 -20% 1000 20% -40% 10% -60% 0 0% -80% 2017H1 2017H2 2018H1 2018H2 Thailand Route ASK (million) Japan Korea Thailand Capacity Proportion of Thailand Route（right axis） Source: CEIC, HSBC Qianhai Securities Source: Company data, HSBC Qianhai Securities
Improvement in yield Before 2017, the focus in terms of yield management was on maximising the passenger load factor (PLF). To a large extent, this came at the expense of ticket prices. The company’s PLF is about 10% higher than that of the three largest full-service carriers in China but is 40% lower in terms of yield per RPK. In the US, LCCs, such as Southwest Airlines and JetBlue (JBLU US, Not Rated), have a PLF that is similar to full-service carriers but only c20% behind in terms of yield per RPK.
It is worth noting that, in general, Spring’s average domestic route is longer than that of the full- service airlines, which means Spring can benefit from a greater scale effect. If operating routes of the same distance, the difference in yield between the two types of airlines would be less.
Against the backdrop of a slowdown in capacity growth in the domestic aviation industry and the improvement in the supply-demand balance of first-tier and well-developed routes, the company has adjusted its yield management strategy by shifting its focus from the sale of cheap tickets to striking a balance between the ticket prices and the PLF.
The company’s PLF has slightly dropped since 2017, but the overall yield level of routes, domestic ones in particular, has seen a remarkable improvement. We believe this can not only boost earnings but also align the yield level of domestic routes with international ones, boding well for the development of a balanced route network and the allocation of capacity.
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Exhibit 69. Yield per RPK for domestic Exhibit 70. Yield per RPK for domestic market of US LCCs was c20% lower than market of Spring Airlines was c40% lower that of full-service carriers (2017) than that of full-service carriers (2017)
18.6 18.9 20 18.2 86% 0.70 0.60 95% 0.54 0.56 0.59 15.3 86% 0.60 0.53 0.54 90% 15 13.3 0.50 85% 0.36 0.40 0.34 85% 85% 10 0.30 84% 0.20 80% 0.10 5 84% 0.00 75% 83% Spring Southern Eastern Air China 0 83% Airlines Airlines Airlines JetBlue Delta American 2017 Yield Per RPK of Domestic Route (RMB) Yield Per RPM of Domestic Route (cents,Airlines left axis) 2018 Yield Per RPK of Domestic Route (RMB) Passenger Load Factor of Domestic Route 2018 Load Factor of Domestic Route (right axis) Source: Company data, HSBC Qianhai Securities Source: Company data, HSBC Qianhai Securities
Exhibit 71. Yield management effect is significant since 2017
20.0% 2.0 14.9% 10.1% 1.0 10.0% 7.2% 4.1% 0.0 0.8% -1.0 0.0% -2.0 -1.0% -2.7% -5.5% -5.2% -3.0 -10.0% -7.5% -7.1% -8.4% -8.3% -9.0% -4.0
-20.0% -17.6% -5.0 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Jul-17 Nov-17 Mar-18 Jul-18 YOY of Yield Per RPK YOY of Yield Per ASK YOY of Passenger Load Factor（right axis, ppts）
Source: Company data, HSBC Qianhai Securities *Note: Yield per RPK slumped from Q1 2015 to Q1 2016 due to the cancellation of fuel surcharges of domestic routes
Ancillary businesses to bottom out The ancillary businesses cover excess baggage, in-flight meals and product sales, express check-in and seat selection services. This was one of the key earnings drivers, contributing 7- 8% of revenue and 30-40% of overall gross profit, with a gross margin of over 80%.
However, in 2016-18, due to CAAC restrictions on the practice of bundling insurance with flight tickets, segment revenue (excluding excess baggage) declined and per capita revenue from the businesses also started to fall, creating a drag on earnings. With the negative factors factored in, we believe the ancillary businesses should bottom out, with potential for earnings upside starting from 2019e.
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Exhibit 72. We expect revenue from ancillary businesses to bottom out in 2019e
1000 60
800 50 40 600 410 457 272 30 400 424 20 287 200 227 380 338 10 186 203 218 250 128 0 31 34 57 0 2011 2012 2013 2014 2015 2016 2017 2018 Overweight Luggage Revenue (RMBm) Other Auxiliary Revenue (RMBm) Per Capita Auxiliary Revenue（RMB, right axis）
Source: Company data, HSBC Qianhai Securities
New capacity at top airports
Beijing Daxing International Airport is scheduled to open in late September 2019. It will serve as a large international aviation hub and an integrated transport hub in the Beijing-Tianjin-Hebei region. The administration expects the airport to have a passenger throughput of 45m in 2021 and 72m in 2025.
All the flights to Beijing Capital Airport operated by China Eastern Air Group (China Eastern Airlines, Shanghai Airlines and China United Airlines) other than the Beijing-Shanghai route and China Southern Air Group (China Southern Airlines, Xiamen Airlines, Hebei Airlines, Chongqing Airlines) will be transferred to Daxing Airport before the summer and autumn flight seasons of 2021. No new flights will be added to Beijing Capital Airport before the winter and spring flight seasons of 2021.
Exhibit 73. Planned passenger volume at Exhibit 74. Estimated slot allocation for Beijing’s two airports (m) airlines at Beijing’s two airports after flight transfer is completed(unit: slots/day)
100 93.1 1200 82 76.3 1000 80 72 67 800 60 45.1 600
40 28.6 400
200 20 3.5 0 0 Beijing Daxing Airport Beijing Capital Airport 2019 2020 2021 2025 Air China Group HNA Group Other Domestic Airlines Beijing Daxing International Airport Foreign Airlines Eastern Airlines Group Southern Airlines Group Beijing Capital International Airport Spring Airlines Juneyao Airlines
Source: CAAC, HSBC Qianhai Securities Source: CAAC, HSBC Qianhai Securities
According to the transfer plan, China Eastern Air Group, China Southern Air Group, Air China Group will be allocated 30%, 40% and 10% of the flight slots at Daxing Airport, their home airport, respectively, while other airlines will share the remaining 20%. We expect Spring
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Airlines to obtain 40-45 flight slots on a daily basis, which will translate into c6% of the airline’s flight volume in 2018 and c4% of its estimated flight volume in 2021e, equivalent to its volumes at its Shenzhen and Shenyang bases. After the transfer period ends in 2022e, we believe Daxing Airport will increase its flight volume significantly. By then, the company should have secured a strong foothold in Beijing, one of the most popular travel destinations in China.
We expect Daxing Airport’s yield per RPK to range between that of Pudong International Airport and Hongqiao International Airport, which should help drive up the company’s overall yield.
Exhibit 75. Estimated daily flight slots allocation at Beijing Daxing International Airport (slots/day) 1200 48 1000 4447 45 800 46 43 47 600 44 250 287 287 400 189 200 3 25 273 310 335 335 153 0 2019/10 2020/3 2020/10 2021/3 2021/10 Eastern Airlines Group Southern Airlines Group Air China Group Capital Airlines Post Airlines Hebei Airlines Reward Flight Time Foreign Airlines Other Domestic Airlines Spring Airlines Juneyao Airlines
Source: CAAC, HSBC Qianhai Securities estimates
Limited diversion from Shijiazhuang, another large airport As an integrated transport hub in the Beijing-Tianjin-Hebei region, Beijing Daxing Airport could absorb some passenger traffic from eastern Hebei province. However, major cities in Hebei, such as Langfang, Zhangjiakou, Tangshan, Chengde and Qinhuangdao either, have their own airports, or are farther away from Beijing Capital Airport and Daxing Airport by road than from Shijiazhuang Zhengding Airport. Therefore, we believe Daxing Airport will not further divert passenger traffic from these cities.
Exhibit 76. Distance by road from major cities in Hebei to neighbouring airports (km) Beijing Capital Beijing Shijiazhuang Note First choice First choice after Airport Daxing Zhengding before Daxing Daxing Airport is Airport Airport Airport is opened opened Langfang 77 52 253 Beijing Capital Daxing Airport Airport Baoding 190 143 111 Baoding Airport Baoding/Shijiazhu- Baoding/Shijiazhu ang Airport -ang/Daxing Airport Shijiazhuang 341 300 0 Shijiazhuang Shijiazhuang Airport Airport Zhangjiakou 211 239 368 Zhangjiakou Airport Zhangjiakou Airport Zhangjiakou Airport Tangshan 183 189 393 Tangshan Airport Tangshan Airport Tangshan Airport Qinhuangdao 295 302 578 Qinhuangdao Airport Qinhuangdao Qinhuangdao Airport Airport Chengde 200 248 483 Chengde Airport Chengde Airport Chengde Airport Xingtai 429 387 150 Shijiazhuang Shijiazhuang Airport Airport Handan 475 433 194 Handan Airport Handan Airport Handan Airport Source: CAAC, HSBC Qianhai Securities
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From a supply perspective, Shijiazhuang Airport received 11.33m passengers in 2018, up 18% y-o-y. As the airport is ranked as a mega airport with at least 10m annual passenger volume, it should see much slower flight slot growth, given its large base.
From the perspective of capacity launches by airlines, apart from Spring Airlines, Hebei Airlines, China United Airlines and Capital Airlines, which are also based in Shijiazhuang, will all have major operations at Daxing Airport.
According to the CAAC, Hebei Airlines will be allowed to increase flights from the winter and spring flight seasons of 2019. We expect its capacity growth at Shijiazhuang Airport to slow sharply as we believe it will launch most new capacity at Daxing Airport.
Meanwhile, China United Airlines and Capital Airlines will be allowed to add flights at Daxing Airport from 2022. Therefore, capacity launches at Shijiazhuang Airport will slow in the short to medium term after the opening of Daxing Airport, which should bode well for Spring Airlines’ yield level, in our view.
Exhibit 77. Hebei Airlines is the second Exhibit 78. Hebei Airlines’ capacity growth largest airline based at Shijiazhuang at Shijiazhuang Airport is expected to slow Airport after 2019
60 35% Spring Airlines 50 30% Hebei Airlines 12 25% 40 18% 6 Capital Airlines 20% 29% 30 5% 15% Hainan Airlines 20 38 7% 33 10% 28 10 22 China United 9% 17 5% 19% 10 11 14 Airlines 13% 0 0% Southern Airlines 2013 2014 2015 2016 2017 2018 2019 2020 Beijing Daxing Airport Others Shijiazhuang Airport YOY of Capacity in Shijiazhuang Airport
Source: CAAC, HSBC Qianhai Securities Source: CAAC, HSBC Qianhai Securities
Earnings estimates
We estimate net profit attributable to the parent will grow by 39.7%, 13.6% and 34.3% y-o-y to RMB2.099bn, RMB2.385bn and RMB3.204bn over 2019-21e, respectively. This is based on the following assumptions.
ASK: We estimate the company’s overall ASK will increase by 14%, 17% and 17% over 2019- 21e, given the faster pace of fleet expansion.
PLF: Due to the efforts to improve yield management, the PLF has been declining and fallen below 90%. We believe this will rebound moderately, driven by industry demand. We expect the PLF to be 90%, 90.5% and 90.5% over 2019-21e, up 1ppts, 0.5ppts and 0ppts y-o-y, respectively. We forecast that the PLF for domestic routes will be 92.5%, 93% and 93%, up 1ppts, 0.5ppts and 0ppts y-o-y, respectively, and for international routes it will be 85.4%, 85.9% and 85.9%, up 1ppts, 0.5ppts and 0ppts y-o-y, respectively.
Yield: In our view, the company’s yield level will rise steadily, driven by growing demand for LCCs. We expect yield per RPK to grow by 0.2%, 2.2% and 2.7% y-o-y over 2019-21e. The
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yield per RPK for domestic routes will change by -0.3%, 2.4% and 3.0% y-o-y, while that of international routes will rise by 1.3%, 1.6% and 2.1% y-o-y, respectively. After deducting fuel surcharges, we estimate that the yield per RPK for domestic routes will go up by 2%, 2.5% and 3.0% y-o-y over 2019-21e, respectively.
Fuel cost: Based on HSBC Global Research’s Brent oil price estimates of USD65.20/b, USD70.00/b and USD70.00/b in 2019-21e, we estimate that fuel cost after VAT will be RMB4,377 per tonne, RMB4,787 per tonne, and RMB4,787 per tonne, respectively, over the same period. Taking into consideration lower fuel consumption after the introduction of A320neo aircraft, we estimate that fuel cost will change by -1.3%, 26.4% and 16.5% over 2019-21e, respectively.
Labour costs: New regulations, effective in 2020, specify that the working hours of pilots and cabin crew will be reduced, indicating that more employees will be needed. After factoring in the potential improvement in labour productivity, we estimate that the company’s labour cost will rise by 15.4%, 21.8% and 15.5% y-o-y over 2019-21e, respectively.
Civil Aviation Development Fund: This charge is collected for the development of airport facilities. As contributions will be cut by half starting from H2 2019, we estimate related cost will change by -15.3%, -22.7% and 16% over 2019-21e, respectively.
Capex: According to the fleet plan disclosed by the company, we estimate capex will be RMB4.25bn, RMB4.68bn and RMB4.03bn over 2019-21e, respectively.
Margin: As we expect oil prices to decline before a rebound, we expect gross margin to be 13.9%, 13.5% and 16% over 2019-21e, respectively, with expense ratios trending down.
Exhibit 79. Spring Airlines’ ASK and RPK estimates (m) 2015 2016 2017 2018 2019e 2020e 2021e ASK (m) 23885 27004 33400 38965 44421 51972 60807 y-o-y 21.68% 13.06% 23.69% 16.66% 14.00% 17.00% 17.00% Domestic ASK 16143 16724 22181 25475 29042 33979 39755 y-o-y 0.36% 3.60% 32.63% 14.85% 14.00% 17.00% 17.00% International ASK 7742 10280 11219 13490 15379 17993 21052 y-o-y 118.40% 32.78% 9.13% 20.25% 14.00% 17.00% 17.00%
RPK (m) 22176 24759 30248 34683 39983 47040 55036 y-o-y 21.38% 11.65% 22.17% 14.66% 15.28% 17.65% 17.00% Domestic RPK 15308 15726 20562 23296 26848 31582 36951 y-o-y 1.16% 2.73% 30.76% 13.29% 15.25% 17.63% 17.00% International RPK 6868 9033 9686 11387 13135 15457 18085 y-o-y 118.87% 31.53% 7.22% 17.56% 15.35% 17.68% 17.00%
Overall PLF 92.84% 91.69% 90.56% 89.01% 90.01% 90.51% 90.51% +/- -0.23% -1.16% -1.12% -1.55% 1.00% 0.50% 0.00% Domestic PLF 94.83% 94.03% 92.70% 91.45% 92.45% 92.95% 92.95% +/- 0.75% -0.80% -1.33% -1.26% 1.00% 0.50% 0.00% International PLF 88.71% 87.87% 86.33% 84.41% 85.41% 85.91% 85.91% +/- 0.19% -0.84% -1.54% -1.93% 1.00% 0.50% 0.00% Source: Company data, HSBC Qianhai Securities estimates
Exhibit 80. Spring Airlines’ yield per RPK estimates (RMB) 2015 2016 2017 2018 2019e 2020e 2021e Yield per RPK 0.342 0.319 0.346 0.367 0.368 0.376 0.386 y-o-y -10.1% -6.7% 8.6% 6.1% 0.2% 2.2% 2.7% Domestic 0.3100 0.3000 0.3400 0.3630 0.3619 0.3708 0.3819 y-o-y -15.7% -3.2% 13.3% 6.8% -0.3% 2.4% 3.0% International 0.4121 0.3509 0.3585 0.3750 0.3799 0.3861 0.3941 y-o-y -6.3% -14.8% 2.2% 4.6% 1.3% 1.6% 2.1% Source: Company data, HSBC Qianhai Securities estimates
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Exhibit 81. Spring Airlines’ revenue estimates (RMBm) 2015 2016 2017 2018 2019e 2020e 2021e Revenue 8094 8429 10971 13114 15152 18196 21842 y-o-y 10.5% 4.1% 30.1% 19.5% 15.5% 20.1% 20.0% Revenue of main 7670 7972 10560 12842 14830 17815 21389 businesses y-o-y 8.9% 3.9% 32.5% 21.6% 15.5% 20.1% 20.1% Passenger flights 7576 7888 10464 12727 14706 17678 21238 y-o-y 9.1% 4.1% 32.7% 21.6% 15.5% 20.2% 20.1% Cargo flights 94 84 96 115 124 137 151 y-o-y -2.9% -10.0% 14.1% 19.8% 8.0% 10.0% 10.0% Others 424 457 410 272 321 382 454 y-o-y 47.8% 7.8% -10.2% -33.8% 18.1% 18.9% 18.8% Source: Company data, HSBC Qianhai Securities estimates
Exhibit 82. Spring Airlines: operating cost estimates (RMBm) 2015 2016 2017 2018 2019e 2020e 2021e Operating cost 6466 7350 9638 11844 13040 15744 18350 y-o-y 3.9% 13.7% 31.1% 22.9% 10.1% 20.7% 16.6% Fuel 1941 1880 2830 4006 3956 4998 5821 y-o-y -25.4% -3.1% 50.5% 41.6% -1.3% 26.4% 16.5% Depreciation of leased aircrafts 1146 1329 1600 1802 2033 2319 2574 and engines y-o-y 16.9% 16.0% 20.4% 12.6% 12.8% 14.1% 11.0% Take-off and landing fees 1146 1391 1664 1930 2310 2838 3321 y-o-y 32.2% 21.4% 19.6% 16.0% 19.7% 22.9% 17.0% Payroll and benefits 1038 1386 1846 2263 2611 3181 3674 y-o-y 26.1% 33.6% 33.2% 22.6% 15.4% 21.8% 15.5% Maintenance fee 401 414 483 523 653 764 1016 y-o-y 32.4% 3.1% 16.9% 8.1% 25.0% 17.0% 33.0% Pilot training and 123 152 162 209 261 313 367 compensation y-o-y -10.4% 23.4% 6.6% 28.8% 25.0% 20.0% 17.0% Civil aviation infrastructure 215 233 292 331 280 217 251 construction fund y-o-y 9.9% 8.2% 25.3% 13.4% -15.3% -22.7% 16.0% Other costs of main 374 478 645 684 821 985 1182 businesses y-o-y 45.7% 27.8% 35.0% 6.0% 20.0% 20.0% 20.0% Others 83 88 116 97 115 129 144 y-o-y 34.2% 6.0% 32.7% -16.3% 18.0% 12.0% 12.0% Source: Company data, HSBC Qianhai Securities estimates
Exhibit 83. Spring Airlines: gross profit (RMBm) and gross margin (%) estimates 2015 2016 2017 2018 2019e 2020e 2021e Gross profit 1627 1079 1332 1270 2112 2452 3492 y-o-y 47.64% -33.69% 23.48% -4.70% 66.31% 16.12% 42.42% Gross margin 20.1% 12.8% 12.1% 9.7% 13.9% 13.5% 16.0% Source: Company data, HSBC Qianhai Securities estimates
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Exhibit 84. Spring Airlines: subsidy and non-operating income estimates (RMBm) 2015 2016 2017 2018 2019e 2020e 2021e Revenue from subsidy 849 903 1,028 1,334 1,349 1,536 1,752 -Route subsidies 811 661 845 1,034 1,169 1,356 1,572 y-o-y 69% -18% 28% 22% 13% 16% 16% Other subsidies 38 241 183 300 180 180 180 Overdue ticket settlement 24 26 39 38 40 40 40 Gain on disposal of fixed assets 25 65 29 7 7 7 7 Others 4 5 8 18 6 6 6 Total subsidy and non-operating 902 999 1103 1397 1402 1589 1805 income Source: Company data, HSBC Qianhai Securities estimates
Exhibit 85. Cash flow and balance sheet estimates 2014 2015 2016 2017 2018 2019e 2020e 2021e Balance sheet Cash 2399.9 3094.5 4709.2 4279.1 4909.6 5017.3 6022.3 7226.3 Total debt 4374.6 4914.6 5068.9 5050.3 5679.5 7490.7 8663.2 22642.6 Net debt (cash) 1974.7 1820.1 359.7 771.2 769.8 2473.4 2640.9 15416.2 Total shareholder's 3553.3 6539.8 7323.5 8463.9 13324.7 15109.1 17136.5 19859.8 Equity Capex -2458.6 -4477.0 -4829.3 -2553.5 -3171.2 -4254.0 -4677.0 -4030.0
Cash Flow Operating cash flow 1076.4 1610.3 2039.7 2301.7 2895.8 3198.6 3892.3 4811.9 Investing cash flow -2404.2 -3392.6 -5091.8 -2730.1 -5513.1 -4396.1 -3539.1 -4167.6 Free cash flow -1246.8 -2700.8 -2619.0 -40.4 46.1 -721.4 -418.4 1186.1
Financial ratios Debt to asset ratio 68% 59% 63% 59% 50% 50% 49% 60% Current ratio 0.88 1.15 2.24 1.92 1.79 2.29 2.04 2.17 Quick ratio 0.87 1.13 2.21 1.90 1.77 2.26 2.01 2.13 Dividend payout ratio 0% 13% 13% 14% 12% 15% 15% 15% Source: Company data, HSBC Qianhai Securities estimates
Financial analysis Driven by fast-growing earnings, we expect operating cash flow to increase to RMB4.812bn in 2021e from RMB2.896bn in 2018, a CAGR of 18.4%. Taking into account the decline in short- term investments, we estimate investing net cash outflow will drop to RMB4.168bn in 2021e from RMB5.513bn in 2018. We also estimate free cash flow to go up to RMB1.186bn in 2021e from RMB46m in 2018. Starting from 2021, the company will adopt the new accounting standards, so the operating leases of aircraft will be recognised as assets and related debt will recognised as debt on the balance sheet, pushing up the gearing ratio to 60%, in our view.
Valuation and risks
Given the relatively low penetration and strong growth potential of LCCs in China, we adopt a PE-based approach for valuation. The company’s historical forward PE is 23.3x (1 SD is 5.7x) and its historical 3-year CAGR of forecast net profit attributable to the parent is 26%. We estimate the recurring net profit attributable to the parent will grow at a CAGR of 28.7% over 2019-21e, slightly above the historical average. Therefore, we believe it is reasonable to use 24x 2019e PE for our valuation. Based on our 2019e EPS estimate of RMB2.29, we derive our target price of RMB54.96, implying 27% upside from the current share price. Initiate coverage at Buy.
Valuation attractive Given the positive outlook for the company’s short-term earnings and the growing demand for air travel, we use a target multiple that is slightly above the historical average. Spring Airlines is
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trading at 18.9x 2019e PE, close to the bottom of the historical PE range (1 SD below the historical average). Given the upside, we believe the current valuation is attractive.
The acquisition of more new flight slots than expected at the new airports in Beijing and Chengdu would be a catalyst for the company’s stock price.
Exhibit 86. Historical forward PE and estimated earnings CAGR of Spring Airlines
50 50%
40 40%
30 30%
20 20%
10 10%
0 0% Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Jul-17 Nov-17 Mar-18 Jul-18 Nov-18 Mar-19 Forward PE Average of Historical Forward PE +1 Standard Deviation -1 Standard Deviation Compound Growth Rate of Historical Forecasted Three Years' Net profit attributed to shareholders(right axis) Source: Bloomberg, Company data, HSBC Qianhai Securities
Key downside risks Rising oil prices: HSBC Global Research estimates the Brent oil price to be USD65.20/b, USD70.00/b and USD70.00/b for 2019-21e, respectively. In our view, if the oil price goes up by 1%, 5%, 10%, 20% and 30% from the base case, the company’s EPS will change as follows:
Exhibit 87. Sensitivity analysis of oil price change to EPS of Spring Airlines ______EPS change ______Oil price change vs base case 2019e 2020e 2021e 1% -1% -2% -1% 5% -7% -8% -7% 10% -14% -10% -9% 20% -23% -15% -13% 30% -27% -20% -17% Source: Company data, HSBC Qianhai Securities
RMB depreciation: RMB depreciation could lead to greater exchange losses, higher fuel costs and foreign currency payments. By the end of 2018, the company’s foreign currency debt amounted to RMB3.13bn. Assuming that the exchange rate of the USD to the RMB is 6.75 in our base case, if the RMB depreciates by 1%, 3% and 5%, the company’s EPS will change as follows:
Exhibit 88. Sensitivity analysis of RMB depreciation to EPS of Spring Airlines ______EPS change ______RMB depreciation vs base case 2019e 2020e 2021e 6.82 (-1%) -2% -2% -2% 6.95 (-3%) -6% -6% -5% 7.09 (-5%) -9% -10% -8% Source: Company data, HSBC Qianhai Securities
Lower-than-expected demand for air travel: If macroeconomic conditions remain tepid, passenger traffic and earnings may suffer.
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Loss-making risk for Spring Airlines Japan: Spring Airlines Japan is a subsidiary that has been making losses. The book value of the long-term equity investment from Spring Airlines has been written down to zero. Further capital injections from Spring Airlines may lead to a negative investment return that drags the company’s earnings growth.
43 Equities ● Airlines June 2019
Financials & valuation: Spring Airlines Co Ltd Buy
Financial statements Valuation data Year to 12/2018a 12/2019e 12/2020e 12/2021e Year to 12/2018a 12/2019e 12/2020e 12/2021e Profit & loss summary (CNYm) EV/sales 3.1 2.8 2.3 2.5 Revenue 13,114 15,152 18,196 21,842 EV/EBITDA 25.4 17.3 14.5 13.4 EBITDA 1,590 2,442 2,923 4,113 EV/IC 3.5 2.8 2.4 1.7 Depreciation & amortisation -877 -978 -1,208 -1,457 PE* 26.4 18.9 16.6 12.4 Operating profit/EBIT 713 1,463 1,715 2,655 PB 3.0 2.6 2.3 2.0 Net interest -84 -59 -116 -182 FCF yield (%) -4.3 -6.3 -6.2 -3.0 PBT 2,002 2,799 3,180 4,272 Dividend yield (%) 0.5 0.8 0.9 1.2 HSBC Qianhai PBT 2,002 2,799 3,180 4,272 * Based on HSBC Qianhai EPS (diluted) Taxation -499 -700 -795 -1,068 Net profit 1,503 2,099 2,385 3,204 HSBC Qianhai net profit 1,503 2,099 2,385 3,204 ESG metrics Cash flow summary (CNYm) Environmental Indicators 12/2018a Governance Indicators 12/2018a Cash flow from operations 2,896 3,199 3,892 4,812 GHG emission intensity* NA No. of board members 8 Capex -3,171 -4,254 -4,677 -4,030 Energy intensity* NA Average board tenure (years) 4.5 Cash flow from investment -5,513 -4,396 -3,539 -4,168 Dividends -451 -315 -358 -481 CO2 reduction policy Yes Female board members (%) 25 Change in net debt -1 1,704 167 12,775 Social Indicators 12/2018a Board members independence (%) 37.5 FCF equity -1,722 -2,508 -2,476 -1,199 Employee costs as % of revenues 19.9 Balance sheet summary (CNYm) Employee turnover (%) NA Intangible fixed assets 67 69 72 74 Diversity policy Yes Tangible fixed assets 14,936 18,279 21,756 35,886 Source: Company data, HSBC Qianhai Securities Current assets 9,141 9,333 9,373 11,081 * GHG intensity and energy intensity are measured in kg and kWh respectively against revenue in USD ‘000s Cash & others 4,910 5,017 6,022 7,226 Total assets 26,575 30,088 33,585 49,193 Operating liabilities 7,535 7,447 7,746 6,646 Issuer information Gross debt 5,679 7,491 8,663 22,643 Share price (CNY) 43.30 Free float 100% Net debt 770 2,473 2,641 15,416 Shareholders' funds 13,325 15,109 17,136 19,860 Target price (CNY) 54.96 Sector Airlines Invested capital 11,700 15,217 17,433 33,169 RIC (Equity) 601021.SS Country China Bloomberg (Equity) 601021 CH Analyst David Wu Market cap (USDm) 5,745 Contact +86 755 8898 3436 Ratio, growth and per share analysis Year to 12/2018a 12/2019e 12/2020e 12/2021e Y-o-y % change Price relative Revenue 19.5 15.5 20.1 20.0 EBITDA 2.5 53.5 19.7 40.7 Operating profit -5.6 105.1 17.2 54.8 43.00 43.00 PBT 21.3 39.8 13.6 34.3 HSBC Qianhai EPS 4.0 39.7 13.6 34.3 38.00 38.00 Ratios (%) 33.00 33.00 Revenue/IC (x) 1.3 1.1 1.1 0.9 ROIC 5.5 8.2 7.9 7.9 28.00 28.00 ROE 13.8 14.8 14.8 17.3 ROA 6.6 7.6 7.8 8.1 23.00 23.00 EBITDA margin 12.1 16.1 16.1 18.8 2017 2018 2019 Operating profit margin 5.4 9.7 9.4 12.2 Spring Airlines Co Ltd Rel to CSI 300 Index EBITDA/net interest (x) 19.0 41.5 25.2 22.6 Net debt/equity 5.8 16.4 15.4 77.6 Source: HSBC Qianhai Securities Net debt/EBITDA (x) 0.5 1.0 0.9 3.7 Note: Priced at close of 29 May 2019 CF from operations/net debt 376.2 129.3 147.4 31.2 Per share data (CNY) EPS Rep (diluted) 1.64 2.29 2.60 3.49 HSBC Qianhai EPS (diluted) 1.64 2.29 2.60 3.49 DPS 0.20 0.34 0.39 0.52 Book value 14.53 16.48 18.69 21.66
44 Equities ● Airlines June 2019
Juneyao Airlines (603885 CH)
A high-return airline offering differentiated services; it has cross- shareholdings with China Eastern Airlines
Building high-yield route networks to boost long-term earnings; international expansion may cause short-term pain
Initiate at Buy with a target price of RMB18.04
The largest non-SOE airline in China
The company originated from Eastern Express Airlines, which was established in 2006. It was renamed Juneyao Airlines and listed in Shanghai in May 2015.
Juneyao Airlines is a subsidiary of the Juneyao Group, which was founded by three brothers, Wang Junyao, Wang Junjin and Wang Junhao. Wang Junjin directly holds 36.14% equity in Juneyao Group and indirectly holds 22.96% equity in Juneyao Investment, thereby indirectly holding 20.99% equity in Juneyao Airlines. He actually controls 71.77% and 96.12% equity in Juneyao Group and Juneyao Investment, respectively, through an equity entrustment management arrangement with Wang Han, the eldest son of Wang Junyao, who inherited most of the equity in Juneyao Group and Juneyao Investment from Wang Junyao. Therefore, Wang Junjin indirectly controls 58.82% shares in Juneyao Airlines and is the airline’s actual controller.
In January 2019, Juneyao Group and Juneyao Investment introduced China Eastern Airlines as a strategic investor by selling a combined 7% stake to Eastern Airlines Industrial Investment, a subsidiary of China Eastern Air Holding Company.
Exhibit 89. Juneyao Airlines’ shareholding structure
Wang Junjin
Control 96.12% Control 71.77%
Eastern Airlines Juneyao Investment Juneyao Group Wang Junhao Industrial Investment
7% 2.01% 56.81% 4.3%
Juneyao Airlines
Source: Company data, HSBC Qianhai Securities
Juneyao Airlines is in the process of issuing shares to Eastern Airlines Industry Investment through a private placement. Upon completion, Eastern Airlines Industry Investment will hold up
45 Equities ● Airlines June 2019
to 15% equity in Juneyao Airlines. Juneyao Group’s shareholding in Juneyao Airlines will fall to no less than 51.92%, while Juneyao Investment’s shareholding in the airline will fall to no less than 1.83%. Mr Wang Junjin will control a smaller stake, no less than 53.76%, in Juneyao Airlines, and will remain the airline’s actual controller.
Dual brands and dual hubs Juneyao Airlines owns two brands, Juneyao and 9 Air, a LCC subsidiary launched in 2015. Juneyao Airlines owns two brands: Juneyao and 9 Air Juneyao operates 70 A320 and A321 aircraft, with Shanghai and Nanjing as its primary and secondary bases, respectively. 9 Air, which is based in Guangzhou, operates 17 B737-800 aircraft. Juneyao is the largest non-SOE airline in China in terms of fleet size. Over 2013-18, its revenue passenger kilometre (RPK), revenue and net profit attributable to the parent rose at a CAGR of 21.5%, 19.4% and 29.5, respectively, making it one of the fastest growing airlines in China.
Exhibit 90. Juneyao Airlines’ revenue and Exhibit 91. Juneyao Airlines’ net profit revenue growth in 2011-18 attributable to the parent and growth rate in 2011-18
16000 14366 40% 1600 200% 1326 12412 1249 1233 150% 12000 30% 1200 1047 9928 100% 8158 8000 6647 20% 800 50% 5929 522 4036 4449 428 0% 339 4000 10% 400 230 -50%
0 0% 0 -100% 2011 2012 2013 2014 2015 2016 2017 2018 2011 2012 2013 2014 2015 2016 2017 2018 Net profit attributed to shareholders (RMBm) Revenue (RMBm) YOY YOY Source: Company data, HSBC Qianhai Securities Source: Company data, HSBC Qianhai Securities
Juneyao Airlines has a high value carrier (HVC) strategy, offering fares slightly lower than those of full-service carriers with the lowest costs possible. The aim is to provide value-for-money services for customers and high investment returns for shareholders. This means that while the airline is a LCC it is not cheap in LCC terms as its customer base is passengers with relatively high consumption power who travel frequently. Its strategic positioning is similar to that of JetBlue Airlines in the US. Since 2011, net profit margin and ROE have been at the top end of the industry range.
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Exhibit 92. Juneyao Airlines: net profit Exhibit 93. Juneyao Airlines: ROE (%) also margin(%) at the top end of the industry at the top end of the industry range range
20 45 40 15 35 30 25 10 20 15 5 10 5 0 0 2011 2012 2013 2014 2015 2016 2017 2018 2012 2013 2014 2015 2016 2017 2018 Juneyao+Nine Airlines Juneyao+Nine Airlines Spring Airlines Spring Airlines Air China Group Air China Group Southern Airlines Group Southern Airlines Group Eastern Airlines Group Eastern Airlines Group Source: Company data, HSBC Qianhai Securities Source: Company data, HSBC Qianhai Securities
Exhibit 94. Juneyao Airlines: fares are lower than those of the ‘Big Three’ airlines but higher than those of Spring Airlines
0.7 95% 0.60 0.56 0.59 0.6 0.53 0.54 0.54 0.5 0.44 0.46 90% 0.4 0.34 0.36 85% 0.3
0.2 80% 0.1 0.0 75% Juneyao+Nine Airlines Spring Airlines Southern Airlines Eastern Airlines Group Air China Group Group 2017 Yield Per RPK of Domestic Route (RMB) 2018 Yield Per RPK of Domestic Route (RMB) 2018 Passenger Load Factor of Domestic Route (right axis) Source: Company data, HSBC Qianhai Securities
Effective cost control and operational efficiency
The company manages costs effectively. In 2017, its unit cost (excluding fuel cost, take-off and landing fees, and other external costs) was c25% lower than that of the ‘Big Three’ airlines in China on average but c15% higher than that of Spring Airlines (c10% higher if meal costs are excluded).
The company’s flight distance was c12% shorter than that of Spring Airlines and seating capacity is 172 seats per aircraft, which is c5% lower than that of Spring Airlines; we believe the company’s cost control is on par with Spring.
In terms of efficiency, the employee-to-aircraft ratio (including outsourced employees) is much lower that of the Big Three’s and slightly above Spring Airlines, indicating a higher level of staff efficiency. The company’s selling and administrative expense-to-sales ratio stands between the ‘Big Three’ and Spring Airlines.
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Exhibit 95. Juneyao Airlines: unit cost – excluding fuel cost, take-off and landing fees – are c25% lower than that of the ‘Big Three’ (RMB per ASK)
0.3
0.25
0.2
0.15
0.1
0.05
0 2012 2013 2014 2015 2016 2017 2018 Juneyao+Nine Airlines Spring Airlines Air China Group Southern Airlines Group Eastern Airlines Group
Source: Company data, HSBC Qianhai Securities
Exhibit 96. Juneyao Airlines: average flight Exhibit 97. Juneyao Airlines: average distance shorter than that of Spring Airline number of seats lower than that of Spring (2018) Airline (2018)
1800 1777 182 180 1750 180
1700 178
1650 176 1590 1600 174 172 1550 172
1500 170
1450 168 Spring Airlines Juneyao+Nine Airlines Spring Airlines Juneyao+Nine Airlines Average distance (km) Average number of seats
Source: Company data, HSBC Qianhai Securities Source: Company data, HSBC Qianhai Securities
Exhibit 98. Employee-to-aircraft ratio vs Exhibit 99. Administrative and selling peers is relatively low expense-to-sales ratio lower than that of the ‘Big Three’ airlines (%)
180 164 159 15 160 140 108 10 120 98 100 86 84 80 5 60 40 20 0 2012 2013 2014 2015 2016 2017 2018 0 Spring Airlines Spring Airlines Juneyao+Nine Southern Airlines Juneyao+Nine Airlines Airlines Group Air China Group 2016 2017 Southern Airlines Group Eastern Airlines Group Source: Company data, HSBC Qianhai Securities Source: Company data, HSBC Qianhai Securities * Outsourced staff included
48 Equities ● Airlines June 2019
Building high-yield route network; expanding internationally
When it comes to routes, the airline emphasises quality rather than quantity. Shanghai, its home When it comes to routes, the airline emphasises quality base, is one China’s leading transport hubs and Juneyao has used its flight slot resources at the rather than quantity city’s two airports there and in other economically developed/hot tourist cities to build a high- yield route network.
The company has more flight slots than Spring Airlines in Shanghai, and the contribution of Shanghai’s passenger volume to Juneyao Airlines is higher than that to Spring Airlines and China Eastern Airlines, which are also based in Shanghai. The company has tried to secure quality flight slot resources at other airports and match them with scarce flight slots in Shanghai. Compared with Spring Airlines, which operates more low-yield routes to Southeast Asia from Pudong International Airport, the company’s network of Shanghai routes mainly covers high- yield domestic flights.
From the perspective of new resources, in 2018, the company launched 21% of its new domestic capacity in the top four first-tier cities – Beijing, Shanghai, Guangzhou and Shenzhen – which is higher than Spring Airline’s 13%. This mitigates the risk of the overall yield being diluted. In these cities, the company replaced small aircraft (such as the 160-seat A320) with bigger ones (such as the 190-seat A321). This means the airline has more capacity in high-yield markets as is also maximising the value of its flight slots.
Exhibit 100. Contribution of Shanghai Exhibit 101. Juneyao is maximising the passengers to Juneyao is higher than for value of its flight slots (2018) Spring Airlines and China Eastern (2018) 38% 70% 40% 61% 60% 54% 35% 31% 51% 51% 29% 30% 50% 41% 22% 40% 25% 21% 20% 40% 20% 17% 13% 30% 15% 11% 10% 20% 4% 5% 10% 0% 0% Spring June+Nine Eastern Southern Air Spring Airlines Juneyao Airlines Eastern Airlines Airlines Airlines Airlines Airlines China 2017 Contribution of Shanghai Market Passenger Traffic New Flights of First-tier Airport/Domestic New Flight 2018 Contribution of Shanghai Market Passenger Traffic New ASK of First-tier Airport/Domestic New ASK
Source: Company data, HSBC Qianhai Securities Source: CAAC, HSBC Qianhai Securities
49 Equities ● Airlines June 2019
Exhibit 102. Juneyao Airlines has more flight slots in Shanghai’s two airports than Spring Airlines in the summer and autumn flight seasons of 2019 Time slots Spring Airlines Juneyao Airlines 9 Air Shanghai Hongqiao Domestic 484 468 0 International Airport Shanghai Pudong Domestic 408 668 0 International Airport International & regional 334 267 0 Sub-total 1,226 1,403 0 Guangzhou Domestic 92 28 182 International & regional 62 0 14 Sub-total 154 28 196 Shenzhen Domestic 168 88 0 International & regional 38 0 0 Sub-total 206 88 0 Beijing Domestic 0 14 0 Total 1,586 1,519 196 Source: CAAC, HSBC Qianhai Securities
Easing the supply bottleneck in Shanghai to boost long-term yield Starting from the summer and autumn flight seasons of 2018, the regulators allowed Juneyao Airlines and 9 Air to raise the maximum economy class fares from Shanghai (11 routes) by 10% each flight season. We believe this should steadily drive up yields.
The company’s high-yield route network targets passengers with relatively high consumption power and the Shanghai market makes the biggest contribution to revenue. In our view, in the long run this means Shanghai will play a bigger role in improving the company’s overall yield than for other Shanghai-based airlines, such as Spring Airlines.
Exhibit 103. Limited upside in the flight Exhibit 104. Yield per ASK growth in supply growth of the Shanghai market Shanghai is higher than the average
20% 20%
15% 15% 10% 10% 5%
5% 0%
0% -5% 2006 2008 2010 2012 2014 2016 2018 2015 2016 2017 2018 YOY of the Number of Take-off and Landing in Spring Domestic-Shanghai Market Pudong and Hongqiao Airport Spring Domestic YOY of the Number of Nantional Take-off and Landing Eastern Airlines Domestic-Shanghai Market Eastern Airlines Domestic
Source: CAAC, HSBC Qianhai Securities Source: Company data, HSBC Qianhai Securities
International expansion may involve short-term pain Starting from 2019-20, the company will expand its fleet and upgrade its current aircraft. Its domestic strategy is to take advantage of its strength in Shanghai and new resources at the Beijing Daxing airport to expand routes to first-tier cities, especially Guangzhou. It also plans to launch intercontinental services for the first time. This is ambitious and may involve some short- term pain, given the cost involved and the tough competition on overseas routes. However, we believe the company is well prepared in terms of aircraft models, fleet planning, route selection and capital utilisation.
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Exhibit 105. Number of new aircraft could Exhibit 106. We expect Juneyao Airlines’ recover starting from 2019e capacity growth to accelerate from 2019e
25 30%
25% 20 5 6 20% 15 2 5 15%
10 7 10% 4 3 15 14 12 5 11 5% 6 6 6 0% 0 2016 2017 2018 2019E 2020E 2021E 2015 2016 2017 2018 2019e 2020e 2021e Juneyao Airlines 9 Air YOY of the capacity of Juneyao+Nine Airlines
Source: Company data, HSBC Qianhai Securities estimates Source: Company data, HSBC Qianhai Securities estimates
In terms of aircraft, the company brought in three 324-seat B787-9 aircraft last year. It plans to buy three more in 2019 and another four in 2020, taking the total to 10. This fleet of wide-body aircraft should create economies of scale as they have the lowest fuel consumption of all current wide-body aircraft.
The company’s B787-9 aircraft have 324 seats, with 25-30 more economy class seats than the same model operated by Air China, China Southern Airlines, China Eastern Airlines and Hainan Airlines, giving it a unit cost advantage. Based on the current oil prices, we expect the B787-9 to incur a unit cost of cRMB0.31 per ASK if it runs on intercontinental routes, slightly lower than the unit cost for the company’s A320 aircraft.
Exhibit 107. B787-9 has the lowest oil Exhibit 108. Juneyao Airline’s B787-9 consumption among all wide-body aircraft model has more seats than its peers
0.4 330 324 0.34 0.30 0.30 0.31 320 0.3 0.27 0.27 0.28 0.23 310 297 0.2 300 293 289 290 285 0.1 280 270 0.0 260
A380 Juneyao Southern Air Hinan Estern
B787-8 B747-8
B787-9 Airlines Airlines China Airlines Airlines
A330-300 A330-200 B777-300 B777-200 Fuel Consumption Per Ton Kilomter (kg) Numeber of Seats
Source: CAAC, HSBC Qianhai Securities Source: CAAC, HSBC Qianhai Securities
Starting from June 2019, the company will open a new route from Shanghai to Helsinki, and this may be followed by a flight to Australia. We expect the new routes will record a yield per ASK of cRMB0.28 during the preliminary operating period and believe the intercontinental routes can break even by 2021. According to the CAAC, the company is applying for a route from Beijing Daxing Airport to Paris, one of Europe’s most profitable routes.
With no experience in operating intercontinental routes, the company has the smallest share of international routes among China’s listed airlines. This means it has poor brand recognition and
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weak marketing capabilities in the international market. However, we believe its new strategic alliance with China Eastern Airlines, discussed earlier, will help in areas, such as flight negotiations, slot allocations, code sharing and joint operations of routes. In addition, the airline joined the Star Alliance Connecting Partner programme in 2017, which should help its transformation into an international airline.
Exhibit 109. Juneyao Airlines and China Eastern Airlines will hold stakes in each other after their respective non-public offerings
Juneyao Group Eastern Airlines Group 1.9% 15%
100% 51.92% 30.97%
1.34%A股 Shanghai Jidaohang Juneyao Airlines Eastern Airlines 3.16%H股
3.6%
Source: Company data, HSBC Qianhai Securities
9 Air has significant growth potential 9 Air, based in Guangzhou, was launched in 2015 to target price-sensitive passengers and the mass aviation market. It is the only LCC in Guangzhou and its business model is more akin to Spring Airlines. It has only one type of aircraft, the 189-seat B737-800. As of end-2018, it operated 17 aircraft and ran domestic routes from Guangzhou to major provincial capitals in China and international routes to Thailand and Myanmar.
Flights from Guangzhou generate a slightly lower yield than those from Beijing, Shanghai and Shenzhen. However, we see Guangzhou as an ideal choice as it is the capital of Guangdong province and has the third highest passenger volumes in China. We think 9 Air can help Juneyao Airlines differentiate the market positions of its dual brands while increasing capacity growth.
With effective cost control, 9 Air enjoys a higher passenger load factor than Spring Airlines with a similar unit cost, unit net profit and aircraft utilisation. Net profit per unit capacity is lower than Spring Airlines’ net profit per unit capacity, which we attribute to higher fare discounts due to its short history and low brand recognition, and difficulty in getting route subsidies due to its small scale.
Exhibit 110. 9 Air financial indicators Financial indicator 2015 2016 2017 Revenue (RMBm) 422.4 1029.0 1749.4 Net profit (RMBm) -83.6 56.2 164.7 Yield per ASK (RMB) 0.267 0.293 0.327 y-o-y (%) 10% 11% Unit net profit (RMB/ASK) -0.053 0.016 0.031 Unit cost (RMB/ASK) 0.319 0.272 0.286 Source: Company data, HSBC Qianhai Securities
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Exhibit 111. 9 Air unit cost is on a par with Exhibit 112. 9 Air net profit is lower than that of Spring Airlines (RMB/ASK) that of Spring Airlines (RMB/ASK)
0.33 0.08 0.32 0.06 0.32 0.06 0.31 0.04 0.04 0.04 0.03 0.30 0.29 0.02 0.29 0.29 0.02 0.28 0.27 0.27 0.27 0.00 0.27 -0.02 0.26 0.25 -0.04
0.24 -0.06 -0.05 2015 2016 2017 2015 2016 2017 Spring Airlines 9 Air Spring Airlines 9 Air
Source: Company data, HSBC Qianhai Securities Source: Company data, HSBC Qianhai Securities
Exhibit 113. 9 Air’s PLF is higher than that Exhibit 114. 9 Air’s daily aircraft utilisation of Spring Airlines is lower than that of Spring Airlines (hours/day)
94% 11.1 11.06 93% 93% 93% 11.0 92% 92% 91% 10.9 10.84 91% 91% 10.8 90% 90% 90% 10.7 10.67 89% 10.62 89% 10.6
88% 10.5
87% 10.4 2015 2016 2017 2018 Spring Airlines 9 Air Spring 9 Air 2017 2018
Source: Company data, HSBC Qianhai Securities Source: Company data, HSBC Qianhai Securities
Earnings estimates
We estimate the company’s recurring net profit attributable to the parent will grow 51.4%, 0.3% and 40.9% y-o-y to RMB1.606bn, RMB1.61bn and RMB2.27bn in 2019-21e, respectively. This is based on the following assumptions:
ASK: As the company is likely to add new aircraft at a faster pace over the next three years, we expect its overall ASK to grow 18%, 26.2% and 18.7% in 2019-21e, respectively. Given more capacity on international routes after the introduction of the B787-9 model, we expect the ASK of international and regional routes to grow 68.9%, 49% and 20.6% y-o-y in 2019-21e, respectively, and its ASK of domestic routes to rise 9.5%, 20.3% and 18.1% y-o-y, respectively.
PLF: Due to the potential decline in the PLF after the rapid capacity expansion of international routes, we expect the overall PLF to change by -0.25ppts,-0.1ppts and 0.22ppts y-o-y to 86%, 85.9% and 86.1% in 2019-21e, respectively. We expect the PLF on international routes to change -2ppts, -1ppts and 1ppts y-o-y to 81%, 80% and 81% in 2019-21e, respectively, and the
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PLF on domestic routes to rise 0.5ppts, 0.5ppts and 0ppts y-o-y to 87.3%, 87.8% and 87.8%, in 2019-21e, respectively.
RPK: As revenue from lower-yield international routes could rise sharply, short-term yield is likely to face downward pressure. We expect the yield per RPK to change by -2.1%, -0.3% and 0.8% y-o-y in 2019-21e, respectively. We expect the yield per RPK for international routes to change by -16.1%, -6.9% and -3.2% y-o-y and the yield per RPK for domestic route to increase by 0.3%, 1.4% and 2% y-o-y, in 2019-21e, respectively. Excluding the revenue from fuel surcharges, we expect the yield per RPK for domestic routes to rise by 1.5%, 1.5% and 2.0% y- o-y in 2019-21e, respectively.
Oil price: Based on HSBC Global Research’s Brent oil price estimates of USD65.20/b, USD70.00/b and USD70.00/b in 2019-21e, we estimate the fuel cost after VAT will be RMB4,438 per tonne, RMB4,854 per tonne, and RMB4,854 per tonne over the period, up 2.3%, 36.6% and 18.1% y-o-y, respectively.
Labour costs: After China Civil Aviation Regulation CCAR-121-R5 is implemented in 2020, we believe crew members’ flight and duty time may decline and headcount could rise. This, coupled with the impact of a higher labour efficiency, leads us to estimate labour cost growth at 18.7%, 37.5% and 15.5% y-o-y in 2019-21e, respectively.
Civil Aviation Development Fund: Payments will be halved in H2 2019, so we expect costs to change by -19%, -22.7% and 17.6% in 2019-21e, respectively.
Capex: Given the company’s fleet expansion plan and the disposal of its subsidiary Huarui Financing Lease, we expect capex to be RMB3.37bn, RMB3.42bn and RMB2.32bn in 2019- 21e, respectively.
Margin: As we expect oil prices to fall before rising and as intercontinental routes are still under development, we estimate gross margin to be 16.6%, 13.1% and 14.3% in 2019-21e, respectively, with expense-to-sales ratios trending down.
Exhibit 115. Juneyao Airlines’ ASK and RPK estimates (m) 2015 2016 2017 2018 2019e 2020e 2021e ASK (m) 20951 25786 31529 34812 41079 51819 61524 y-o-y 36.93% 23.08% 22.27% 10.41% 18.00% 26.15% 18.73% Domestic ASK 16761 21234 26610 29839 32679 39298 46420 y-o-y 34.15% 26.69% 25.32% 12.13% 9.52% 20.26% 18.12% International ASK 4189.8 4551.8 4918.6 4973.1 8400 12520 15104 y-o-y 49.28% 8.64% 8.06% 1.11% 68.90% 49.06% 20.64%
RPK (m) 17845 22097 27411 30021 35324 44510 52979 y-o-y 38.86% 23.83% 24.05% 9.52% 17.66% 26.00% 19.03% Domestic RPK 14673 18469 23295 25894 28522 34496 40748 y-o-y 37.30% 25.88% 26.13% 11.16% 10.15% 20.95% 18.12% International RPK 3172 3627 4116 4127 6802 10014 12232 y-o-y 46.52% 14.36% 13.48% 0.25% 64.83% 47.22% 22.15%
Overall PLF 85.17% 85.69% 86.94% 86.24% 85.99% 85.90% 86.11% +/- 1.18% 0.52% 1.25% -0.70% -0.25% -0.10% 0.22% Domestic PLF 87.54% 86.98% 87.54% 86.78% 87.28% 87.78% 87.78% +/- 2.01% -0.56% 0.56% -0.76% 0.50% 0.50% 0.00% International PLF 75.71% 79.69% 83.69% 82.98% 80.98% 79.98% 80.98% +/- -1.43% 3.98% 4.00% -0.71% -2.00% -1.00% 1.00% Source: Company data, HSBC Qianhai Securities estimates
54 Equities ● Airlines June 2019
Exhibit 116. Juneyao Airlines’ yield per RPK estimates (RMB) 2015 2016 2017 2018 2019e 2020e 2021e Yield per RPK 0.446 0.437 0.440 0.466 0.456 0.455 0.458 y-o-y -11.8% -2.1% 0.7% 5.9% -2.1% -0.3% 0.8% Domestic 0.4353 0.4298 0.4296 0.4473 0.4485 0.4549 0.4640 y-o-y -14.3% -1.3% -0.1% 4.1% 0.3% 1.4% 2.0% International 0.4960 0.4719 0.4971 0.5817 0.4880 0.4545 0.4400 y-o-y 0.5% -4.9% 5.3% 17.0% -16.1% -6.9% -3.2% Source: Company data, HSBC Qianhai Securities estimates
Exhibit 117. Juneyao Airlines’ revenue estimates (RMBm) 2015 2016 2017 2018 2019e 2020e 2021e Revenue 8158 9928 12412 14366 16545 20749 24869 y-o-y 22.7% 21.7% 25.0% 15.7% 15.2% 25.4% 19.9% Air passenger 7959.91 9650.32 12053.32 13982 16112 20242 24287 y-o-y 22.5% 21.2% 24.9% 16.0% 15.2% 25.6% 20.0% Air cargo 140 165 178 216 248 303 357 y-o-y 20.0% 18.0% 8.1% 21.0% 15.0% 22.0% 18.0% Others 58 113 180 168 185 204 224 y-o-y 73.4% 93.4% 59.1% -6.4% 10.0% 10.0% 10.0% Source: Company data, HSBC Qianhai Securities estimates
Exhibit 118. Juneyao Airline’s operating cost estimates (RMBm) 2015 2016 2017 2018 2019e 2020e 2021e Operating cost 6039 7740 9859 12208 13806 18022 21312 y-o-y 11.7% 28.2% 27.4% 23.8% 13.1% 30.5% 18.3% Jet oil cost 1841 1918 2866 3951 4044 5523 6525 y-o-y -19.2% 4.2% 49.4% 37.9% 2.3% 36.6% 18.1% Depreciation of 1136 1532 1798 2123 2542 3206 3807 leased aircrafts and engines y-o-y 55.0% 34.9% 17.3% 18.1% 19.7% 26.1% 18.7% Take-off and 873 1174 1381 1707 2014 2541 3017 landing fees y-o-y 32.0% 34.5% 17.6% 23.6% 18.0% 26.1% 18.7% Payroll and 1169 1572 1938 2314 2746 3776 4361 benefits y-o-y 28.0% 34.5% 23.3% 19.4% 18.7% 37.5% 15.5% Maintenance fee 130 445 523 555 677 812 934 y-o-y -25.1% 241.7% 17.5% 6.0% 22.0% 20.0% 15.0% Pilot training and 24 36 77 98 147 205 277 compensation y-o-y 228.5% 51.9% 114.7% 26.1% 50.0% 40.0% 35.0% Civil aviation 221 261 315 344 279 215 253 construction fund y-o-y 27.5% 18.1% 20.6% 9.2% -19.0% -22.7% 17.6% Meals & supplies 164 193 250 301 356 448 533 y-o-y 29.7% 17.5% 29.6% 20.8% 18.0% 26.0% 19.0% Navigation 122 143 199 221 261 329 391 management cost y-o-y 27.6% 17.2% 38.8% 11.3% 18.0% 26.0% 19.0% Crew cost 62 110 150 195 273 410 553 y-o-y 51.5% 78.5% 36.0% 30.0% 40.0% 50.0% 35.0% Abnormal duty 44 54 77 65 71 82 95 cost y-o-y 34.7% 22.8% 41.4% -15.6% 10.0% 16.0% 15.0% COGS 233 277 241 307 369 442 531 y-o-y 52.1% 19.1% -13.1% 27.5% 20.0% 20.0% 20.0% Other operating 20 24 45 26 29 32 35 cost y-o-y 47.1% 24.7% 84.6% -41.6% 10.0% 10.0% 10.0% Source: Company data, HSBC Qianhai Securities estimates
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Exhibit 119. Juneyao Airline’s gross profit (RMBm) and gross margin (%) estimates 2015 2016 2017 2018 2019e 2020e 2021e Gross profit 2119 2188 2553 2158 2740 2727 3557 y-o-y 70.57% 3.24% 16.67% -15.46% 26.94% -0.47% 30.45% Gross margin 26.0% 22.0% 20.6% 15.0% 16.6% 13.1% 14.3% Source: Company data, HSBC Qianhai Securities estimates
Exhibit 120. Juneyao Airline’s cash flow and balance sheet estimates Balance sheet 2014 2015 2016 2017 2018 2019e 2020e 2021e Cash 775 1287 1689 2103 1860 2186 2733 3268 Debt 3739 6232 5790 7547 6717 8741 10001 21430 Net debt (cash) 2965 4945 4101 5444 4857 6555 7268 18161 Equity 2005 3365 7628 8650 9429 13409 14859 16901 Capex -1347 -4660 -3521 -3508 -5397 -3370 -3420 -2320
Cash flow Operating cash flow 867 1976 2027 2761 1949 4129 3215 4099 Investing cash flow -1799 -4677 -3569 -3209 -4530 -7989 -3435 -2293 Free cash flow -464 -2684 -1429 -690 -3296 908 -11 2023
Financial ratio Debt-to-assets ratio 73% 74% 55% 57% 55% 51% 51% 62% Current ratio 0.73 0.57 0.78 0.82 0.73 0.69 0.80 0.99 Quick ratio 0.72 0.56 0.76 0.80 0.71 0.67 0.77 0.96 Dividend payout ratio NA NA 51% 31% 0% 10% 10% 10% Source: Company data, HSBC Qianhai Securities estimates. NA – Not applicable.
Financial analysis We expect operating cash flow to increase at a CAGR of 28% from RMB1.949bn in 2018 to RMB4.099bn in 2021e. Given the disposal of its subsidiary Huarui Financing Lease in 2018, we expect self-purchased aircrafts will account for a smaller share of the company’s fleet going forward, leading to a slight fall in investing cash flow.
However, as the strategic investment in China Eastern Airlines in 2019 will incur a significant one-off investment, we expect investing net cash outflow to fall to RMB2.29bn in 2021e from RMB4.53bn in 2018. We expect free cash flow to rise from -RMB3.3bn in 2018 to RMB2.02bn in 2021e.
Considering the gain from the disposal of Huarui Financing Lease and the company’s future earnings growth, we expect its gearing ratio to fall to 51% in 2019-20e from 55% in 2018. Starting from 2021, the company will adopt the new accounting standards, under which the operating leases of aircraft will be recognised as assets and related debt will recognised as debt on the balance sheet, pushing up the gearing ratio to 62%, in our view.
Valuation and risks
Given the relatively low penetration and strong growth potential of LCCs in China, we adopt a PE-based approach. The company’s historical forward PE is 21.2x (1 SD is 7.3x) since listing in 2015 and its historical 3-year CAGR of forecast net profit attributable to the parent is 27%. We estimate the recurring net profit attributable to the parent to grow at a CAGR of 28.8% over 2019- 21e, slightly above the historical average. Therefore, we believe it is reasonable to use 22x 2019e PE for our valuation. Based on our 2019e EPS estimate of RMB0.82, we derive our target price of RMB18.04, implying 45% upside from the current share price. Initiate coverage at Buy.
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Catalyst: In the short to medium term, we believe that if the company is granted better-than- expected flight slots for intercontinental routes its intercontinental flight operations may ramp up more quickly and contribute to earnings sooner, which would be positive for its share price.
Exhibit 121. Juneyao Airline’s forward PE and estimated net profit CAGR
50 80%
40 60%
30 40% 20
20% 10
0 0%
Forward PE Average of Historical Forward PE +1 Standard deviation -1 Standard deviation Compound Growth Rate of Historical Forecasted Three Years' Net profit attributed to shareholders(right axis)
Source: Bloomberg, Company data, HSBC Qianhai Securities
Key downside risks Rising oil prices: HSBC Global Research estimates the Brent oil price to be USD65.20/b, USD70.00/b and USD70.00/b for 2019-21e, respectively. In our view, if the oil price goes up by 1%, 5%, 10%, 20% and 30% from the base case, the company’s EPS will change as follows:
Exhibit 122. Sensitivity analysis of oil price change to the EPS of Juneyao Airline ______EPS change ______EPS change ______2019e 2020e 2021e Oil price change vs base case 1% -2% -3% -2% 5% -9% -13% -11% 10% -19% -17% -14% 20% -30% -24% -21% 30% -34% -32% -27% Source: Company data, HSBC Qianhai Securities estimates
RMB depreciation: RMB depreciation could lead to greater FX losses and higher fuel costs and foreign currency payments. By the end of 2018, the company’s foreign currency debt amounted to RMB2.78bn. Assuming that the exchange rate of the USD to the RMB is 6.75 in our base case, if the RMB depreciates by 1%, 3% and 5%, the company’s EPS will change as follows:
Exhibit 123. Sensitivity analysis of RMB depreciation to the EPS of Juneyao Airline ______EPS change ______2019e 2020e 2021e RMB depreciation vs. base case 6.82 (-1%) -3% -4% -3% 6.95 (-3%) -8% -11% -9% 7.09 (-5%) -14% -18% -15% Source: Company data, HSBC Qianhai Securities estimates
Lower-than-expected demand for air travel: A sustained macroeconomic downturn could pose downside risks for the company’s passenger traffic and yield.
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Slowdown in capacity expansion: According to the company, 9 Air plans to add five 737 MAX-8s in H2 2019 and more going forward. If the aircraft are not in an airworthy condition before delivery, the company’s capacity, revenue and earnings growth could slow. In addition, due to the limited supply of China’s civil aviation space and pilot resources, if in the future the civil aviation space and pilot supply can’t match demand growth, the company’s capacity supply could face downside risks.
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Financials & valuation: Juneyao Airlines Co Ltd Buy
Financial statements Valuation data Year to 12/2018a 12/2019e 12/2020e 12/2021e Year to 12/2018a 12/2019e 12/2020e 12/2021e Profit & loss summary (CNYm) EV/sales 1.9 1.5 1.2 1.4 Revenue 14,366 16,545 20,749 24,869 EV/EBITDA 14.4 9.7 9.7 10.4 EBITDA 1,889 2,507 2,573 3,437 EV/IC 2.0 1.7 1.5 1.2 Depreciation & amortisation -767 -926 -1,168 -1,340 PE* 21.1 15.2 15.2 10.8 Operating profit/EBIT 1,122 1,581 1,405 2,097 PB 2.4 1.8 1.6 1.4 Net interest -273 -229 -297 -298 FCF yield (%) -19.4 -1.6 -8.8 1.3 PBT 1,693 2,175 2,180 3,072 Dividend yield (%) 0.0 0.7 0.7 0.9 HSBC Qianhai PBT 1,469 2,175 2,180 3,072 * Based on HSBC Qianhai EPS (diluted) Taxation -453 -544 -545 -768 Net profit 1,233 1,606 1,611 2,269 HSBC Qianhai net profit 1,061 1,606 1,611 2,269 ESG metrics Cash flow summary (CNYm) Environmental Indicators 12/2018a Governance Indicators 12/2019e Cash flow from operations 1,949 4,129 3,215 4,099 GHG emission intensity* NA No. of board members 11 Capex -5,397 -3,370 -3,420 -2,320 Energy intensity* NA Average board tenure (years) 2.8 Cash flow from investment -4,530 -7,989 -3,435 -2,293 Dividends -782 -163 -161 -227 CO2 reduction policy Yes Female board members (%) 9.1 Change in net debt -587 1,698 714 10,893 Social Indicators 12/2018a Board members independence (%) 27.3 FCF equity -4,354 -279 -1,560 224 Employee costs as % of revenues 16.1 Balance sheet summary (CNYm) Employee turnover (%) NA Intangible fixed assets 111 124 137 150 Diversity policy Yes Tangible fixed assets 14,899 17,210 19,239 32,301 Source: Company data, HSBC Qianhai Securities Current assets 5,326 4,509 5,359 6,188 * GHG intensity and energy intensity are measured in kg and kWh respectively against revenue in USD ‘000s Cash & others 1,860 2,186 2,733 3,268 Total assets 21,455 27,712 30,837 44,849 Operating liabilities 5,123 5,352 5,744 6,248 Issuer information Gross debt 6,717 8,741 10,001 21,430 Share price (CNY) 12.46 Free float 100% Net debt 4,857 6,555 7,268 18,161 Shareholders' funds 9,429 13,409 14,859 16,901 Target price (CNY) 18.04 Sector Airlines Invested capital 13,353 14,305 16,258 29,122 RIC (Equity) 603885.SS Country China Bloomberg (Equity) 603885 CH Analyst David Wu Market cap (USDm) 3,240 Contact +86 755 8898 3436 Ratio, growth and per share analysis Year to 12/2018a 12/2019e 12/2020e 12/2021e Y-o-y % change Price relative Revenue 15.7 15.2 25.4 19.9 EBITDA -18.3 32.7 2.6 33.6 19.70 19.70 Operating profit -30.2 40.9 -11.2 49.3 17.70 17.70 PBT -7.3 28.5 0.3 40.9 HSBC Qianhai EPS -9.1 38.4 0.3 40.9 15.70 15.70 Ratios (%) Revenue/IC (x) 1.1 1.2 1.4 1.1 13.70 13.70 ROIC 6.2 8.6 6.9 6.9 11.70 11.70 ROE 11.7 14.1 11.4 14.3 ROA 6.9 7.3 6.3 6.7 9.70 9.70 EBITDA margin 13.2 15.2 12.4 13.8 2017 2018 2019 Operating profit margin 7.8 9.6 6.8 8.4 Juneyao Airlines Co Ltd Rel to CSI 300 Index EBITDA/net interest (x) 6.9 10.9 8.7 11.5 Net debt/equity 50.6 48.2 48.2 105.9 Source: HSBC Qianhai Securities Net debt/EBITDA (x) 2.6 2.6 2.8 5.3 Note: Priced at close of 29 May 2019 CF from operations/net debt 40.1 63.0 44.2 22.6 Per share data (CNY) EPS Rep (diluted) 0.69 0.82 0.82 1.15 HSBC Qianhai EPS (diluted) 0.59 0.82 0.82 1.15 DPS 0.00 0.08 0.08 0.12 Book value 5.25 6.82 7.56 8.60
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China Express Airlines (002928 CH)
The only listed regional airline in China
Its profitability and operational efficiency are better than those of its peers
Initiate at Buy with a target price of RMB15.97
The leader in the thriving regional carrier market
China Express Airlines is based at Chongqing Jiangbei International Airport in Chongqing and was listed on the A-share market in March 2018. The airline was founded in 2006 and is partially owned by Cathay Fortune. Hu Xiaojun is the actual controller of China Express Airlines (CEXA). He indirectly holds 57.2% of CEXA’s shares through Huaxia Holdings, Shenzhen Rongda Investment Guarantee and Huaxia Tongrong.
Xu Wei, Mr Hu’s wife, is the person acting in concert, who indirectly holds 11.8% of CEXA’s equity through Shenzhen Rongda Investment Guarantee, Huaxia Tongrong and Shenzhen Ruicheng. The couple together hold a total of 69% of CEXA’s equity. Huaxia Tongrong has two other employee stock ownership programmes, namely Guizhou Huatong No. 1 and Guizhou Huatong No. 2, through which senior management members of CEXA bind their interests with the company.
Exhibit 124. CEXA’s shareholding structure
Couple Huaxia Tongrong's direct shareholders also include two employee stock Hu XiaoJun Xu Wei holding platforms (Guizhou Huatong No.1 and No.2) and a platform(Guizhou Huatong No.3) controlled by Xu Wei , all of which hold 27.3% shares of Huaxia Tongrong. 100% 99% 1% 17.2% 1% 81.8% 99%
Huaxia Holdings Shenzhen Rongda Huaxia Tongrong Shenzhen Ruicheng Others
40% 15.4% 11% 7% 26.6%
China Express Airlines
Source: Company data, HSBC Qianhai Securities
CEXA was established in 2006 in Guizhou province. The company started operations as a regional airliner within the province and later set up bases in Chongqing, Dalian, Hohhot and Xi’an. The fleet has grown from 14 aircraft in 2014 to 44 aircraft in 2018 and revenue rose from
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RMB867m in 2013 to RMB4,260m in 2018, a CAGR of 37.5%. The net profit attributable to the parent has experienced drastic swings due to fluctuations in the oil price and exchange rates; growth was rapid in 2013-16 but slowed in 2017. In 2018, the oil price spike and significant RMB depreciation led to negative growth in net profit.
Exhibit 125. CEXA’s revenue and growth Exhibit 126. CEXA’s net profit attributable (2013-18) to the parent and growth (2013-18)
5000 50% 400 374 120% 4260 346 4000 40% 80% 3449 300 242 248 3000 2551 30% 40% 200 1792 2000 20% 124 0% 1287 100 887 100 1000 10% -40%
0 0% 0 -80% 2013 2014 2015 2016 2017 2018 2013 2014 2015 2016 2017 2018 Net profit attributed to shareholders (RMBm) Revenue (RMBm) YOY YOY Source: Company data, HSBC Qianhai Securities Source: Company data, HSBC Qianhai Securities
China’s thriving regional carrier market
Multiple business models in place CEXA is China’s largest and the only listed regional airliner. Other major regional carriers include Tianjin Airlines, Joy Air and Beibu Gulf Airlines (GX Airlines), while US peers include SkyWest Airlines and Republican Airways. Regional carriers around the world share the following characteristics:
Average flight distance is short and smaller aircraft are used
Low passenger traffic on regional routes leads to low passenger load factors and aircraft utilisation rates
Ticket prices and profitability vary significantly due to different business models
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Exhibit 127. CEXA’s average flight length Exhibit 128. Average flight length of US shorter than that of major Chinese carriers regional carriers shorter than that of major (km) US carriers (miles)
2500 1600 1400 2000 1200 1500 1000 800 1000 600 500 400 200 0 0 Air China Southern Eastern Spring China United Southwest Skywest Repulican Airlines Airlines Airlines Express Continental Airlines Airlines Airways Airlines 2015年 2016年 2017年 2013年 2014年 2017年 2018年
Source: Company data, HSBC Qianhai Securities Source: Company data, HSBC Qianhai Securities Note: Republic Airways was delisted in 2016 and data is updated as of 2014.
Exhibit 129. CEXA’s aircraft utilisation Exhibit 130. Aircraft utilisation rates of US rates lower than those of major Chinese regional airlines lower than those of major carriers (hours/day) US carriers (hours/day)
12 12
10 10
8 8
6 6
4 Air China Southern Spring China 4 Airlines Airlines Express United Skywest Repulican Airlines Continental Airlines Airways 2014年 2015年 2016年 2013年 2014年 2017年 2018年
Source: Company data, HSBC Qianhai Securities Source: Company data, HSBC Qianhai Securities Note: Republic Airways was delisted in 2016 and data is updated as of 2014.
Exhibit 131. CEXA’s load factors are lower Exhibit 132. Load factors of US regional than those of major Chinese carriers airlines lower than those of major US carriers
100% 88%
90% 84%
80% 80% 76% 70% 72% 60% Air China Southern Eastern Spring China 68% Airlines Airlines Airlines Express American DELTA United Southwest Skywest Repulican Airlines Airlines Airlines Continental Airlines Airlines Airways 2015年 2016年 2017年 2013年 2014年 2017年 2018年
Source: Company data, HSBC Qianhai Securities Source: Company data, HSBC Qianhai Securities Note: Republic Airways was delisted in 2016 and data is updated as of 2014.
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Exhibit 133. CEXA’s ticket prices are Exhibit 134. Fares of US regional airlines higher than those of major Chinese lower than major US carriers (USD carriers (RMB/RPK) cents/RPM)
1.2 20
1 18
0.8 16
0.6 14
0.4 12 0.2 10 0 Air China Southern Eastern Spring China 8 American DELTA United Southwest Skywest Repulican Airlines Airlines Airlines Express Airlines Airlines Continental Airlines Airlines Airways Airlines 2015年 2016年 2017年 2013年 2014年 2017年 2018年
Source: Company data, HSBC Qianhai Securities Source: Company data, HSBC Qianhai Securities Note: Republic Airways was delisted in 2016 and data updated as of 2014.
Exhibit 135. CEXA’s net margins are Exhibit 136. Net margins of American higher than those of major Chinese regional carriers are on par with those of carriers major American carriers
16% 20%
16% 12%
12% 8% 8% 4% 4%
0% 0% Air China Southern Eastern Spring China American DELTA United Southwest Skywest Repulican Airlines Airlines Airlines Express Airlines Airlines Continental Airlines Airlines Airways Airlines 2013年 2014年 2017年 2018年 2016年 2017年 2018年
Source: Company data, HSBC Qianhai Securities Source: Company data, HSBC Qianhai Securities Note: The profit margins are adjusted by excluding non-recurring gains and losses. Republic Airways was delisted in 2016 and data is updated as of 2014.
Low passenger traffic on regional routes is the primary challenge for regional carriers in terms of improving profitability. Decades of experience have led to domestic and international regional carriers devising five different business models: 1) signing capacity purchase deals with mainline carriers, local governments or airports; 2) operating as subsidiaries of mainline carriers; 3) code-sharing with mainline carriers; 4) signing service-sharing deals with mainline carriers; and 5) independent operations. Regional carriers in the US and Europe mainly use the first four models, while those in China tend to prefer No 1, the capacity purchase model.
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Exhibit 137. Business models for regional carriers at home and abroad Business model Description Examples Already Already mature in mature in the US? China? Signing capacity Mainline carriers, local governments and airports will make SkyWest/Republic/ Yes Yes purchase deals fixed payments in exchange for the capacity of a regional CEXA airline’s certain routes, and the latter is not exposed to risks related to ticket sales Operating as subsidiaries Mainline carriers establish or acquire regional carriers as PSA/Endeavor/ Yes No of mainline carriers subsidiaries in a bid to expand coverage Horizon/Piedmont Code-sharing with Mainline carriers will take care of marketing and sales, while SkyWest/Republic Yes No mainline carriers regional carriers operate regional aircraft Signing service-sharing Mainline and regional carriers negotiate and decide how to Cape Air Yes No deals with mainline share flight ticket revenue according to pre-determined rules carriers Independent operations Regional carriers operate aircraft independent of mainline Flybe/Atlantic No No carriers Airways/China Express Airlines/Tianjin Airlines
Source: Embraer S.A., HSBC Qianhai Securities
The rise of regional carriers Regional carriers in the US have developed along the same lines as low-cost carriers. The growing popularity of mass tourism supported the rise of major regional carriers, such as SkyWest. In 2002, the US government launched a civil aviation development programme for small cities and towns (小城镇民航服务发展飞行计划) to meet the needs of residents in remote areas. This led to an industry-wide rebound in demand for regional carriers. By 2017, regional carriers accounted for 18% of the total air passenger traffic in the US.
Exhibit 138. Major regional carriers Exhibit 139. Passenger traffic and growth mushroomed in the US since 1970s for regional carriers in the US (million persons)
Passenger Traffic (million) 200 15% 40
Skywest 150 10% 30 1970s to 1990s, ExpressJet 100 American regional 5% 20 airlines develop rapidly. Mes 50 0% Republic 10 0 -5% 1970198019851990199520002005201020152017 0 US Regional Air Passenger Traffic (million) 1930 1940 1950 1960 1970 1980 1990 2000 2010 Year Annual Compound Growth Rate Source: Regional Airline Association, HSBC Qianhai Securities Source: Regional Airline Association, HSBC Qianhai Securities Note: Bubble size represents market share
China had 235 airports at the end of 2018. Of these, 184 are smaller regional airports, which are proving to be increasingly popular. Passenger throughout rose from 0.96m in 2003 to 144m in 2018, a CAGR of c20%, about 6ppts above the average growth of China’s aviation industry. Regional airports accounted for 11.4% of passenger traffic in China in 2018, well below the 18% in the US, which suggests there is plenty of room for growth.
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Exhibit 140. Regional carriers in China are growing at a faster rate than the country’s overall aviation industry
40% 12%
30% 10% 8% 20% 6% 10% 4%
0% 2%
-10% 0% 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 YOY of Total Airport Throughput YOY of Regional Airport Throughput Proportion of Regional Airport Throughput (right axis) Source: CAAC, HSBC Qianhai Securities Note: 4D, 4C and 3C airports are also included in the data shown above.
Four growth drivers 1) The indigenous ARJ21 regional jetliner is tariff free. For a long time, most regional flight routes with low passenger traffic in China were flown by large carriers. This resulted in a mismatch between aircraft models, demand and low load factors, making it difficult to improve profitability. We believe this is because: 1) the import tax rate for regional aircraft (22.85%) is well above that for jets for large carriers (10.25%, up from 5.04% before 2013), and 2) the amount of government subsidies are negatively correlated to load factors. This started to change in 2015 when a domestically produced regional jetliner, the ARJ21, was introduced. As no tax has to be paid, it offers a considerable cost advantage. ARJ21 output is on the rise, so we believe the profitability of regional carriers should improve.
2) Better connections. Regional carriers can’t thrive without access to major networks. This means hub airports are key for the sustainable development of regional carriers. In the US, transfer rates are as high as 40-60% in major hub airports and regional flights account for 35- 60% of total flights. We believe China has a long way to go in this area, but transfer rates at major airports are constantly improving, which helps regional carriers.
3) On-time rate. Punctuality is fundamental to ensuring efficient connections between mainstream and regional flights. Changes to aviation regulations and better management by the CAAC have boosted the on-time rate, which is now close to that of major American carriers.
4) Subsidies. Regional carriers that operate independently report poor profitability, which makes CAAC subsidies and central government support crucial, especially in the early stages of an airline’s development. Annual subsidies for regional carriers and small airports have increased from cRMB1bn over 2009-13 to RMB2bn in 2014-18. Local governments also provide subsidies to regional carriers in a bid to boost the local economy.
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Exhibit 141. Regional aircraft account for a Exhibit 142. Global passenger aircraft fleet low proportion of all aircraft in China mix in 2013
Regional Regional Aircraft(30-120 12% 5% Aircraft(30-120 15% 19% seats) seats) Narrow Narrow Aircraft(120-180 Aircraft(120-180 seats) seats) Wide-body Wide-body 83% 66% Aircraft(230-360S Aircraft(230-360S seats) seats)
Source: VariFlight, HSBC Qianhai Securities Source: European Regions Airline Association, HSBC Qianhai Securities
Exhibit 143. Subsidy standards for regional carriers in China Load factor (RMB/passenger) Type-1 regional carriers Type-2 regional carriers Type-3 regional carriers 60-80% 20 40 60 30-60% 40 80 120 30% and below 60 120 180 Source: CAAC, HSBC Qianhai Securities Note: Type 1 regional carriers mainly operate in central and eastern regions, type 2 mainly in central and eastern, western, and northeastern regions, while type 3 regional carriers mainly operate in western and northeastern regions.
Exhibit 144. Transfer rates at China’s hub Exhibit 145. Regional flights as a airports are on the rise percentage of total flights at China’s hub airports
14% 16% 13.4% 12% 12.3% 12% 10% 9.8% 8% 8% 6% 4% 4% 2.5% 2% 0.8% 0.9% 0% 0% Beijing Capital Shanghai Pudong Guangzhou Beijing Capital Shanghai Pudong Guangzhou Baiyun Baiyun 2014 2015 2016 2017 2013 2018
Source: Company data, HSBC Qianhai Securities Source: CAAC, HSBC Qianhai Securities
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Exhibit 146. Transfer rates of the top 4 US Exhibit 147. Regional flights account for hub airports are high at 40-60% 35-60% of flights at the top 4 US hub airports
80% 80%
60% 60%
40% 40%
20% 20%
0% 0% 2000 2006 2007 2008 2009 2010 2015 2008 2009 2010 2011 2013 2014 2015 2016 2017 Chicago Dallas Denver Houston Chicago Dallas Denver Houston
Source: Company data, HSBC Qianhai Securities Source: Regional Airline Association, HSBC Qianhai Securities
Exhibit 148. On-time rates in China’s aviation industry are on the rise
95%
90%
85%
80%
75%
70%
65% Jan-15 Jan-16 Jan-17 Jan-18 Eastern Airlines Southern Airlines China Express Airlines American Airlines United Airlines Southwest Airlines Source: VariFlight, HSBC Qianhai Securities
Exhibit 149. Chinese and US airports ranked in world top 50 (July 2016)
2500 2000 1500 1000 500
0
Miami
Dallas
Detroit
Atlanta Seattle Boston
Ronald
Denver
Newark
Orlando
Phoenix
Chicago
Houston
Kennedy
Charlotte
Las Vegas Las
La Guardia La
Minneapolis
Philadelphia
Los Angeles Los
Beijing Capital Beijing
San Francisco San
Shanghai Pudong Shanghai
Guangzhou Baiyun Guangzhou Shanghai Hongqiao Shanghai Kunming Changshui Kunming Source: VariFlight, Civil Aviation Big Data Research Institute (民航大数据研究院), HSBC Qianhai Securities Note: Connectivity index is calculated based on flight data amassed by VariFlight, which reflects an airport’s capacity as a transfer hub.
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Exhibit 150. CAAC has been raising subsidies for regional carriers and airports
2.5
2 0.89 0.85 1.08 1.02 1.5 0.91
1 0.43 1.43 1.49 1.21 1.31 0.5 1.08 0.52 0 2013 2014 2015 2016 2017 2018 Small Airport Subsidy (RMBb) Regional Airlines Subsidy (RMBb)
Source: CAAC, HSBC Qianhai Securities
Government capacity purchase model and other benefits
CEXA has established five operational bases – Guiyang, Chongqing, Dalian, Hohhot, and Xi’an – and five overnight stopover bases in Tianjin, Chengdu, Xingyi, Korla and Klama. Its flight network covers China’s southwestern, northwestern, northeastern and northern regions as well as Xinjiang. Major revenue-contributing routes are the ones that connect base cities with tier-3 and tier-4 cities, where CEXA enjoys an obvious advantage in market share. At the end of 2018, CEXA operated 123 routes (120 domestic and three international).
Exhibit 151. CEXA’s flights and key host cities as a percentage of its total flights Type Host cities % of CEXA’s total flights Chongqing 13.4% Guiyang 8.9% Operational bases Hohhot 7.6% Dalian 3.1% Xi’an 3.1% Overnight base Tianjin 3.5% Baotou 2.1% Guilin 1.7% Key cities Liuzhou 1.5% Lanzhou 1.1% Total 46% Source: CAAC, Company data, HSBC Qianhai Securities
Capacity purchase model provides an earnings guarantee In the US and Europe, major airlines often buy capacity on regional carriers. However, as China’s regional carriers are still at a relatively early stage of development, the buyers of CEXA’s capacity are mainly local governments or airports.
The model works like this. The local government or airport that has acquired the capacity does not sell air tickets to passengers. The airline does. However, if revenue from ticket sales is lower than the value of capacity bought by the government institution, the institution will pay the difference to the airline. If there is a designated cap, the payment made by the institution should not exceed the cap.
As of June 2017, CEXA operated a total of 82 routes and 80 of which were in capacity purchase agreements with institutional clients. Exhibit 145 shows the four different types of revenue (A, B, C, and D). B, C and D revenue represents revenue from capacity bought by institutions. This is
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fixed revenue and represents guaranteed earnings. From 2014 to H1 2017, the total B, C and D revenue accounted for over 95% of CEXA’s revenue from passenger services.
Exhibit 152. Analysis of CEXA’s capacity sales model
Class A Revenue: directly sell to Personal customer individual customers Personal customer revenue: be sold either by company's and agency's channel, or through partner's channel Class B Revenue: after the of code sharing or sharing agreements institutional customer purchases Sales model Personal customer purchase the capacity, the airline sells to individual customer.
Institutional Class C Revenue: After the customer purchase institutional customer purchases Limited payment the capacity, institution pays the Difference: actual difference with limit regulations purchase by institutional customers Class D Revenue: After the institutional customer purchases Unlimited payment the capacity, institution pays the difference with no limit regulations
Source: Company data, HSBC Qianhai Securities
Exhibit 153. CEXA’s type A, B, C and D Exhibit 154. CEXA’s type A+B and C+D revenue as a percentage of passenger revenue as a percentage of passenger revenue from 2014 to H1 2017 transport revenue in 2014-18
100% 100%
80% 80% 60% 60% 40% 40% 20% 59.5% 63.5% 63.0% 60.0% 61.1% 20% 0% 3.5% 3.5% 5.3% 3.4% 2014 2015 2016 2017H1 0% Proportion of Class D Revenue in Passenger Revenue 2014 2015 2016 2017 2018 Proportion of Class B Revenue in Passenger Revenue Proportion of Class B Revenue in Passenger Revenue Proportion of Class C+D Revenue in Passenger Revenue Proportion of Class A Revenue in Passenger Revenue Proportion of Class A+B Revenue in Passenger Revenue
Source: Company data, HSBC Qianhai Securities Source: Company data, HSBC Qianhai Securities
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Exhibit 155. CEXA’s top 5 clients and their revenue contribution (2015 to H1 2017) ______2015 ______2016 ______H1 2017 ______Clients As a % of Clients As a % of Clients As a % of revenue revenue revenue Bijie municipal 3.2% China West Airport 2.2% Tongren municipal 3.4% government Group government China West Airport Group 2.3% Wuzhou municipal 2.1% China West Airport 3.0% government Group Wuzhou municipal 2.3% Bijie municipal 2.0% Qianxinan Xingyi 2.3% government government Civil Aviation Co. Ltd Xinganmeng 1.8% Guyuan municipal 1.7% Xinganmeng 1.9% administrative office government administrative office Hulun Buir Civil Aviation 1.5% Xinganmeng 1.7% Guyuan municipal 1.9% Airport administrative office government Total 10.9% Total 9.6% Total 12.5% Source: Company data, HSBC Qianhai Securities
Exclusive routes CEXA was an early entrant in the regional airline market. This allowed it to have a monopoly in a number of markets; the company said that 93% of its routes were exclusive in 2018 (see table).
Exhibit 156. CEXA’s top 10 revenue contributing routes and number of CEXA flights on these routes as a percentage of total flights Flight routes Revenue (RMBm) As a % of total No of CEXA flights No of CEXA’s flights on top 10 revenue on top10 routes routes/CEXA’s total flights Hohhot - Tongliao 122.2 4.8% 2912 50% Hohhot - Ulanhot 120.9 4.7% 1872 82% Guiyang - Xingyi 80.7 3.2% 4368 93% Guiyang - Chongqing 79.0 3.1% 2912 67% Chongqing - Liuzhou 51.9 2.0% 1352 100% Tianjin - Tianshui 45.4 1.8% 728 100% Guiyang - Bijie 45.1 1.8% 3640 80% Hailar - Hohhot 43.5 1.7% 3432 21% Chongqing - Changzhi 36.8 1.4% 728 100% Chongqing - Taizhou 36.0 1.4% 312 100% Source: Company data, HSBC Qianhai Securities
High yield and efficiency levels CEXA’s major competitors include Tianjin Airlines, Joy Air, and GX Airlines. CEXA ranks second after Tianjin Airlines, which has the largest regional fleet. However, Tianjin Airlines is expanding its territory to mainstream routes, so it no longer purely a regional operator.
Exhibit 157. Fleet size of CEXA vs its major competitors (April 20190) Airlines ______Regional aircraft model ______Mainline aircraft model ______Total E-190 E-195 CRJ-900 MA60 A320 A321 A330 Boeing 737 Tianjin Airlines 32 20 35 2 6 95 CEXA 38 9 47 Joy Air 24 1 25 GX Airlines 17 11 28 Source: CARNOC.com, HSBC Qianhai Securities
Yield. Driven by a lower fuel surcharge and fuel cost, CEXA’s yield per RPK in 2014-17 trended down.
Operational efficiency. Compared to Tianjin Airlines, CEXA has a more sophisticated route network and higher operational efficiency, and consequently a higher load factor and aircraft utilisation rate. Overall, CEXA is more efficient and has better cost management than its peers, so its profit margin is higher.
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Exhibit 158. CEXA’s yield per RPK and Exhibit 159. Tianjin Airlines’ yield per RPK gross margins and gross margins
1.4 35% 1.2 20% 1.21 0.98 1.2 30% 1.0 0.92 0.96 1 25% 0.77 0.78 15% 0.85 0.83 0.8 0.8 20% 0.6 10% 0.6 15% 0.4 0.4 10% 5% 0.2 5% 0.2 0 0% - 0% 2014 2015 2016 2017 2008 2009 2010 2011 Yield Per RPK (RMB) Gross Profit Margin Yield Per RPK (RMB) Gross Profit Margin
Source: Company data, HSBC Qianhai Securities Source: Company data, HSBC Qianhai Securities
Exhibit 160. CEXA’s aircraft utilisation rate Exhibit 161. Tianjin Airlines’ aircraft and load factors utilisation rates and load factors
9.05 100% 100% 8
9 80% 80% 6
8.95 60% 60% 4 8.9 40% 40%
2 8.85 20% 20%
8.8 0% 0% 0 2014 2015 2016 2017 2008 2009 2010 2011 Daily Utilization of Aircraft (hours) Passenger Load Factor Passenger Load Factor Daily Utilization of Aircraft (hours)
Source: Company data, HSBC Qianhai Securities Source: Company data, HSBC Qianhai Securities
Cutting taxes and fees by the CAAC to drive earnings growth
We believe the airline stands to benefit from three recent government initiatives.
The contribution to the Civil Aviation Development Fund will be halved from 1 July 2019. We estimate this will increase earnings by 6.6% in 2017 and 13.5% in 2018.
The CAAC and the Ministry of Finance are going to increase subsidies for regional carriers. Starting from 1 April 2019, the definition of regional aircraft models will be expanded to 13 from seven. The CRJ-900, the company’s major aircraft model, is now included. As result, we expect the company to receive cRMB20m in additional subsidies each year, which increase its earnings by about 6.8% from 2020e.
Passengers flying on some regional aircraft models will be exempted from the RMB50 domestic flight charge. This should boost volumes for China Express Airlines, which will be the biggest beneficiary of the revised policy as its CRJ-900 model qualifies for the exemption, in our view. We believe the impact on revenue will be limited as the majority of routes and flights come under the government capacity purchase model.
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Exhibit 162. China Express Airlines’ earnings change from the 50% cut in the payment to the Civil Aviation Development Fund Item 2017 2018 Original cost for the Civil Aviation Development Fund (RMBm) 58.6 79.4 The reduction in the amount collected after the Civil Aviation 29.3 39.7 Development Fund is halved (RMBm) Cost savings (RMBm) 29.3 39.7 Income tax rate 16.1% 16.2% Original net profit (RMBm) 374.2 247.5 Earnings change +6.6% +13.5% Source: Company data, HSBC Qianhai Securities estimates
Exhibit 163. Regional aircraft models specified by the CAAC (2012 and 2019 versions) 2012 version ______2019 version ______Model Type Type Cessna 208 Cessna 208 series Cessna 208 and Cessna 208B Dornier 328 Dornier 328 series Dornier 328-300 ATR-72 ATR series ATR 42-300 and ATR 42-320 CRJ-200 CRJ series CRJ-100, CRJ-700, CRJ-701, CRJ-702 and CRJ-900 (the CEX A’s major aircraft model) ERJ145 ERJ145 series ERJ145ER, ERJ145LR and ERJ145MP Modern Ark 60 Modern Ark 60 Y7-100, Y7H-500, Y7-200A, MA60 and MA600 Harbin Y-12 Harbin Y-12 series Y12II, Y12IV and Y12E ARJ21-700 ARJ21-700 DHC-8-400 series DHC-8-400, DHC-8-401 and DHC-8-402 DHC-6 series DHC-6 Series 400 PC-12 series PC-12, PC-12/45, PC-12/47 and PC-12/47E B300 series B300, B300C and 1900D Kodiak 100 Kodiak 100 Source: CAAC, HSBC Qianhai Securities estimates
Exhibit 164. Government subsidies to China Express Airlines are rising
250 36 Subsidies of local government have grown significantly. 200 35
150 91.2 34 37.8 100 4.5 33 6.4 114.1 50 2.6 98.3 100.4 32 66.4 42.1 0 31 2014 2015 2016 2017 2018 Subsidy of Civil Aviation Administration(RMBm) Subsidy of Other Government Agency(RMBm) Average Subsidy Per Pssenger(RMB, right axis)
Source: CAAC, HSBC Qianhai Securities estimates
Earnings estimates
We estimate that recurring net profit attributable to the parent will be RMB530m, RMB525m and RMB654m, +185%,-1% and +25% y-o-y, in 2019-20e, respectively. This is based on the following assumptions.
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ASK: Considering the opening of new regional airports and a faster pace of additions to the fleet, we estimate the ASK will increase by 20%, 17% and 15% y-o-y over 2019-21e, respectively.
PLF: We believe strong demand will drive growth in passenger volumes growth, but the introduction of larger A320 planes will increase supply. We expect the PLF to increase slightly to 77%, 77.5% and 77.8% over 2019-21e, respectively.
RPK: As the company uses the institutional capacity purchase model for most routes, which keeps prices stable, we expect yield per RPK to remain unchanged at RMB0.81 over 2019-21e.
Fuel costs: As HSBC Global Research estimates the Brent oil price to be USD65.20/b, USD70.00 and USD70.00 for 2019-21e, respectively, we estimate fuel cost after VAT will be RMB4,538 per tonne, RMB4,963 per tonne, and RMB4,963 per tonne, respectively. We estimate its fuel cost will grow 2%, 23.9% and 11.2% y-o-y over 2019-21e, respectively.
Labour costs: With growing economies of scale, the employee-to-aircraft ratio continues to decline, but staff remuneration is increasing. We expect 2019-21e labour costs to increase 25.4%, 20.1% and 15.8% y-o-y, respectively.
Civil Aviation Development Fund: Starting from H2 2019, payments to the Civil Aviation Development Fund will be halved. We estimate such cost to change by -10%, +0% and +30% y- o-y for 2019-21e, respectively.
Administrative costs: With growing economies of scale and improving operating efficiency, we expect the administrative expense-to-sales ratio and selling expense-to-sales ratio to decline. In 2019-21e, we forecast the administrative expense-to-sales ratio (including R&D) will be 3.2%, 3.0% and 2.9% and the selling expense-to-sales ratio will be 4.1%, 3.9% and 3.7%, respectively.
Margin: We estimate gross margin to be 18.5%, 17.3% and 18.2% for 2019-21e, respectively.
Exhibit 165. Revenue estimates of China Express Airlines (RMBm) Classification 2015 2016 2017 2018 2019e 2020e 2021e Total revenue 1791.9 2551.2 3448.5 4260.0 5232.2 6198.7 7211.0 Y-o-y 39.2% 42.4% 35.2% 23.5% 22.8% 18.5% 16.3% Passenger transport 1746.5 2457.8 3318.4 3965.6 4821.4 5665.2 6518.1 revenue Y-o-y 38.0% 40.7% 35.0% 19.5% 21.6% 17.5% 15.1% Freight revenue 2.04 4.88 5.0 6.3 8.1 10.6 13.8 Y-o-y 68.6% 139.2% 1.4% 26.5% 30% 30% 30% Other main business 40.7 85.7 121.5 286.0 400.4 520.5 676.7 revenue Y-o-y 115.8% 110.7% 41.8% 135.3% 40% 30% 30% Other businesses 2.63 2.75 3.59 2.17 2.28 2.39 2.51 Y-o-y 71.9% 4.6% 30.5% -39.6% 5% 5% 5% Source: Company data, HSBC Qianhai Securities estimates
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Exhibit 166. Operating cost estimates of China Express Airlines (RMBm) Type 2015 2016 2017 2018 2019e 2020e 2021e Total revenue 1294.7 1898.8 2706.0 3657.5 4264.6 5126.7 5897.5 Y-o-y 33.4% 48.8% 42.9% 35.2% 16.6% 20.2% 15.0% Fuel cost 348.1 421.0 697.1 1127.5 1149.7 1424.0 1583.1 Y-o-y -43.6% 20.9% 65.6% 61.7% 2.0% 23.9% 11.2% Aircraft leasing & depreciation 288.2 449.5 552.1 717.4 870.2 1017.2 1136.2 expenses Y-o-y 50.1% 56.0% 22.8% 29.9% 21.3% 16.9% 11.7% Landing charges & airport service 168.0fee 265.2 344.3 450.6 551.6 656.8 767.8 Y-o-y 59.5% 57.8% 29.8% 30.9% 22.4% 19.1% 16.9% Labour cost 278.3 404.4 542.9 707.5 887.2 1065.1 1232.8 Y-o-y 58.9% 45.3% 34.2% 30.3% 25.4% 20.1% 15.8% CAAC charges 30.1 43.6 58.6 79.4 71.5 71.5 92.9 Y-o-y 41.4% 44.7% 34.5% 35.6% -10% 0% 30% Other costs 182.0 315.2 510.9 575.1 734.5 892.2 1084.6 Y-o-y 58.8% 94.1% 65.0% 12.6% 27.7% 21.5% 21.6% Source: Company data, HSBC Qianhai Securities estimates
Exhibit 167. Gross margin estimates of China Express Airlines（%） Type 2015 2016 2017 2018 2019e 2020e 2021e Gross profit 497.2 652.4 742.5 602.5 967.6 1072.0 1313.5 Y-o-y 56.9% 31.2% 13.8% -18.9% 60.6% 10.8% 22.5% Gross margin 27.7% 25.6% 21.5% 14.1% 18.5% 17.3% 18.2% Source: Company data, HSBC Qianhai Securities estimates
Exhibit 168. Balance sheet and cash flow statement estimates of China Express Airlines (RMBm) Balance sheet 2015 2016 2017 2018 2019e 2020e 2021e Cash 294 450 622 826 527 623 724 Debt 247 349 1078 1511 1458 2423 3189 Net debt (cash) -47 -101 456 685 931 1800 2465 Shareholders' equity 449 794 1150 2124 2551 2973 3500 Capex -293 -579 -773 -1394 -1720 -1720 -1720 Cash flow statement Operating cash flow 601 758 685 521 891 1144 1430 Investment cash flow -269 -554 -784 -1441 -1715 -1714 -1715 Free cash flow 302 178 -81 -865 -819 -576 -296 Financial Ratios Debt to asset ratio 82% 78% 79% 73% 72% 72% 82% Current Ratio 1.46 1.46 1.45 1.42 1.59 1.38 1.36 Quick ratio 1.40 1.40 1.40 1.38 1.54 1.34 1.31 Cash dividend ratio 10% 5% 12% 21% 20% 20% 20% Source: Company data, HSBC Qianhai Securities estimates
Financial analysis We expect operating cash flow to increase to RMB1.430bn in 2021e from RMB521m in 2018. As stable investment in aircraft and other fixed assets supports business expansion, we estimate that the investing net cash outflow will remain steady at about RMB1.7bn in 2019-21e. We also estimate free cash flow will change to -RMB296m in 2021e from -RMB865m in 2018. Starting from 2021e, domestic listed airlines will implement a new leasing policy, under which an “aircraft” (right-of-use) asset will come on the balance sheet together with a lease liability, thus pushing up the gearing ratio to 82% in 2021e, in our view.
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Valuation and risks
As regional airlines are still growing rapidly and there is significant growth potential, we adopt a PE-based approach for our valuation. China Express Airlines was listed in March 2018, so the historical valuation is not reliable.
We select SkyWest, a leading US regional airline, as a comparable company. We use the last 15 years as a comparable period. SkyWest’s historical estimated three-year recurring net profit CAGR was 22.4% in the comparable period, with a historical forward PE average of 10.8x. We estimate CEXA’s net profit attributed to the parent CAGR to be 38.6% over 2019-21e, higher than the earnings growth of SkyWest over the comparable period. Therefore, we believe 18x 2019e PE is justified. Based on our 2019e EPS estimate of RMB0.89, we derive a target price of RMB15.97, implying 40% upside from the current share price. Initiate coverage at Buy.
Valuation Since its listing in March 2018, CEXA’s historical forward PE averages 24.1x (1 SD is 6.2x). Due to the short history of listing and high historical valuation, our target valuation multiple is -1 SD below the historical average. This reflects rapid growth expectations in the short term. The stock is trading at 12.9x 2019e PE.
Exhibit 169. SkyWest’s historical forward PE and estimated net profit CAGR (based on consensus)
30 40%
20 20%
10 0%
0 -20% May-06 May-08 May-10 May-12 May-14 May-16 May-18 Forward PE Average of Historical Forward PE +1 Standard Deviation -1 Standard Deviation Compound Growth Rate of Historical Forecasted Three Years' Net profit attributed to shareholders(right axis) Source: Wind, HSBC Qianhai Securities
Exhibit 170. China Express Airlines’ historical forward PE and estimated net profit CAGR
50 30%
40
30 20% 20
10
0 10% Mar-18 May-18 Jul-18 Sep-18 Nov-18 Jan-19 Mar-19 Forward PE Average of Historical Forward PE +1 Standard Deviation -1 Standard Deviation Compound Growth Rate of Historical Forecasted Three Years' Net profit attributed to shareholders(right axis) Source: Wind, HSBC Qianhai Securities
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Key downside risks Discontinuation of capacity purchase model: The company may suffer if the government restricts the capacity purchase model for regional airlines. Assuming costs remain unchanged, if the capacity purchase model is cancelled, the impact on gross margin is as below:
Exhibit 171. China Express Airlines’ gross margin (excluding institutions’ actual revenue contribution) RMBm 2014 2015 2016 2017 2018 Actual revenue 1287 1792 2551 3448 4260 Revenue excluding institution’s 774 1153 1641 2121 2717 actual contribution (A + B) Operating cost 970 1272 1893 2706 3658 Actual gross margin 24.6% 29.0% 25.8% 21.5% 14.1% Gross margin excluding -25.3% -10.4% -15.4% -27.6% -34.6% institutions’ actual revenue contribution Source: Company data, Bloomberg, HSBC Qianhai Securities
Rising oil prices: HSBC Global Research estimates the Brent oil price to be USD65.20/b, USD70.00/b and USD70/b for 2019-21e, respectively. In our view, if the oil price goes up by 1%, 5%, 10% and 20% and 30% from the base case, the company’s EPS will change as follows:
Exhibit 172. Sensitivity analysis of oil price change to EPS of China Express Airlines ______Change in EPS______Brent oil price change 2019e 2020e 2021e +1% -2% -2% -2% +5% -9% -12% -11% +10% -18% -24% -22% +20% -21% -29% -26% +30% -24% -34% -31% Source: Company data, HSBC Qianhai Securities estimates
RMB depreciation: RMB depreciation leads to greater foreign exchange losses and higher fuel cost and foreign currency payments. By the end of 2018, the company’s foreign currency debt amounted to USD150m. Assuming that the exchange rate of the USD to the RMB is 6.75 in our base case, if the RMB depreciates by 1%, 3% and 5%, the company’s EPS will change as follows:
Exhibit 173. Sensitivity analysis of benchmark exchange rate change to EPS of China ExchangeExpress rate Airlines ______Change in EPS______2019e 2020e 2021e 6.82 (-1%) -1% -2% -2% 6.95 (-3%) -2% -7% -6% 7.09 (-5%) -4% -12% -11% Source: Company data, HSBC Qianhai Securities estimates
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Financials & valuation: China Express Airlines Co Buy
Financial statements Valuation data Year to 12/2018a 12/2019e 12/2020e 12/2021e Year to 12/2018a 12/2019e 12/2020e 12/2021e Profit & loss summary (CNYm) EV/sales 1.8 1.5 1.4 1.3 Revenue 4,260 5,232 6,199 7,211 EV/EBITDA 11.1 7.2 7.0 6.2 EBITDA 681 1,080 1,230 1,512 EV/IC 3.4 2.9 2.2 1.9 Depreciation & amortisation -437 -507 -598 -689 PE* 24.6 12.9 13.0 10.4 Operating profit/EBIT 245 573 631 823 PB 2.2 2.7 2.3 2.0 Net interest -223 -158 -242 -299 FCF yield (%) -19.6 -18.0 -15.8 -12.7 PBT 295 635 629 784 Dividend yield (%) 1.1 1.6 1.5 1.9 HSBC Qianhai PBT 295 635 629 784 * Based on HSBC Qianhai EPS (diluted) Taxation -48 -102 -101 -125 Net profit 247 533 529 658 HSBC Qianhai net profit 247 533 529 658 ESG metrics Cash flow summary (CNYm) Environmental Indicators 12/2018a Governance Indicators 12/2018a Cash flow from operations 521 891 1,144 1,430 GHG emission intensity* NA No. of board members 9 Capex -1,394 -1,720 -1,720 -1,720 Energy intensity* NA Average board tenure (years) 2.5 Cash flow from investment -1,441 -1,715 -1,714 -1,715 Dividends -125 -107 -106 -132 CO2 reduction policy NA Female board members (%) 22.2 Change in net debt 229 247 869 665 Social Indicators 12/2018a Board members independence (%) 33.3 FCF equity -1,344 -1,234 -1,084 -874 Employee costs as % of revenues 19.9 Balance sheet summary (CNYm) Employee turnover (%) NA Intangible fixed assets 95 109 123 137 Diversity policy Yes Tangible fixed assets 4,484 5,503 6,430 14,427 Source: Company data, HSBC Qianhai Securities Current assets 2,455 2,490 2,935 3,394 * GHG intensity and energy intensity are measured in kg and kWh respectively against revenue in USD ‘000s Cash & others 826 527 623 724 Total assets 7,785 9,033 10,600 19,249 Operating liabilities 3,999 4,844 4,993 12,319 Issuer information Gross debt 1,511 1,458 2,423 3,189 Share price (CNY) 11.42 Free float 16% Net debt 685 931 1,800 2,465 Target price (CNY) 15.97 Sector Airlines Shareholders' funds 2,124 2,551 2,973 3,500 Invested capital 2,208 2,732 3,873 4,915 RIC (Equity) 002928.SZ Country China Bloomberg (Equity) 002928 CH Analyst David Wu Market cap (USDm) 993 Contact +86 755 8898 3436 Ratio, growth and per share analysis Year to 12/2018a 12/2019e 12/2020e 12/2021e Y-o-y % change Price relative Revenue 23.5 22.8 18.5 16.3 EBITDA -5.6 58.5 13.8 23.0 33.40 33.40 Operating profit -39.5 134.3 10.2 30.3 PBT -33.8 115.0 -0.9 24.5 28.40 28.40 HSBC Qianhai EPS -40.6 43.6 -0.9 24.5 23.40 23.40 Ratios (%) Revenue/IC (x) 2.5 2.1 1.9 1.6 18.40 18.40 ROIC 12.2 19.5 16.1 15.7 13.40 13.40 ROE 15.1 22.8 19.1 20.3 ROA 6.6 7.9 7.5 6.1 8.40 8.40 EBITDA margin 16.0 20.6 19.8 21.0 2017 2018 2019 Operating profit margin 5.7 10.9 10.2 11.4 China Express Airlines Co Rel to CSI 300 Index EBITDA/net interest (x) 3.1 6.8 5.1 5.1 Net debt/equity 32.2 36.5 60.5 70.4 Source: HSBC Qianhai Securities Net debt/EBITDA (x) 1.0 0.9 1.5 1.6 Note: Priced at close of 29 May 2019 CF from operations/net debt 76.2 95.7 63.6 58.0 Per share data (CNY) EPS Rep (diluted) 0.62 0.89 0.88 1.10 HSBC Qianhai EPS (diluted) 0.62 0.89 0.88 1.10 DPS 0.13 0.18 0.18 0.22 Book value 5.30 4.25 4.95 5.83
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Disclosure appendix
Analyst Certification The following analyst(s), economist(s), or strategist(s) who is(are) primarily responsible for this report, including any analyst(s) whose name(s) appear(s) as author of an individual section or sections of the report and any analyst(s) named as the covering analyst(s) of a subsidiary company in a sum-of-the-parts valuation certifies(y) that the opinion(s) on the subject security(ies) or issuer(s), any views or forecasts expressed in the section(s) of which such individual(s) is(are) named as author(s), and any other views or forecasts expressed herein, including any views expressed on the back page of the research report, accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: David Wu
Important disclosures Equities: Stock ratings and basis for financial analysis HSBC and its affiliates, including the issuer of this report (“HSBC”) believes an investor's decision to buy or sell a stock should depend on individual circumstances such as the investor's existing holdings, risk tolerance and other considerations and that investors utilise various disciplines and investment horizons when making investment decisions. Ratings should not be used or relied on in isolation as investment advice. Different securities firms use a variety of ratings terms as well as different rating systems to describe their recommendations and therefore investors should carefully read the definitions of the ratings used in each research report. Further, investors should carefully read the entire research report and not infer its contents from the rating because research reports contain more complete information concerning the analysts' views and the basis for the rating.
From 23rd March 2015 HSBC has assigned ratings on the following basis: The target price is based on the analyst’s assessment of the stock’s actual current value, although we expect it to take six to 12 months for the market price to reflect this. When the target price is more than 20% above the current share price, the stock will be classified as a Buy; when it is between 5% and 20% above the current share price, the stock may be classified as a Buy or a Hold; when it is between 5% below and 5% above the current share price, the stock will be classified as a Hold; when it is between 5% and 20% below the current share price, the stock may be classified as a Hold or a Reduce; and when it is more than 20% below the current share price, the stock will be classified as a Reduce.
Our ratings are re-calibrated against these bands at the time of any 'material change' (initiation or resumption of coverage, change in target price or estimates).
Upside/Downside is the percentage difference between the target price and the share price.
Prior to this date, HSBC’s rating structure was applied on the following basis: For each stock we set a required rate of return calculated from the cost of equity for that stock’s domestic or, as appropriate, regional market established by our strategy team. The target price for a stock represented the value the analyst expected the stock to reach over our performance horizon. The performance horizon was 12 months. For a stock to be classified as Overweight, the potential return, which equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated, had to exceed the required return by at least 5 percentage points over the succeeding 12 months (or 10 percentage points for a stock classified as Volatile*). For a stock to be classified as Underweight, the stock was expected to underperform its required return by at least 5 percentage points over the succeeding 12 months (or 10 percentage points for a stock classified as Volatile*). Stocks between these bands were classified as Neutral.
*A stock was classified as volatile if its historical volatility had exceeded 40%, if the stock had been listed for less than 12 months (unless it was in an industry or sector where volatility is low) or if the analyst expected significant volatility. However, stocks which we did not consider volatile may in fact also have behaved in such a way. Historical volatility was defined as the past month's average of the daily 365-day moving average volatilities. In order to avoid misleadingly frequent changes in rating, however, volatility had to move 2.5 percentage points past the 40% benchmark in either direction for a stock's status to change.
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Rating distribution for long-term investment opportunities As of 04 June 2019, the distribution of all independent ratings published by HSBC is as follows: Buy 52% ( 30% of these provided with Investment Banking Services ) Hold 38% ( 27% of these provided with Investment Banking Services ) Sell 10% ( 20% of these provided with Investment Banking Services )
For the purposes of the distribution above the following mapping structure is used during the transition from the previous to current rating models: under our previous model, Overweight = Buy, Neutral = Hold and Underweight = Sell; under our current model Buy = Buy, Hold = Hold and Reduce = Sell. For rating definitions under both models, please see “Stock ratings and basis for financial analysis” above.
For the distribution of non-independent ratings published by HSBC, please see the disclosure page available at http://www.hsbcnet.com/gbm/financial-regulation/investment-recommendations-disclosures.
Share price and rating changes for long-term investment opportunities Juneyao Airlines Co Ltd (603885.SS) share price Rating & target price history performance CNY Vs HSBC rating history From To Date Analyst Reduce N/A 18 May 2017 Target price Value Date Analyst 26 Price 1 15.71 08 Dec 2016 Jack Xu Price 2 N/A 18 May 2017 21 Source: HSBC
16
11
6
Jun-15 Jun-16 Jun-17 Jun-18 Jun-19 Jun-14 Source: HSBC
Spring Airlines Co Ltd (601021.SS) share price Rating & target price history performance CNY Vs HSBC rating history From To Date Analyst Buy N/A 18 May 2017 Target price Value Date Analyst 64 Price 1 64.00 13 Jun 2016 Jack Xu Price 2 56.00 31 Oct 2016 Jack Xu 54 Price 3 45.00 25 Jan 2017 Jack Xu Price 4 43.00 31 Mar 2017 Jack Xu 44 Price 5 N/A 18 May 2017 Source: HSBC 34
24
14
Jun-15 Jun-16 Jun-17 Jun-18 Jun-19 Jun-14 Source: HSBC
To view a list of all the independent fundamental ratings disseminated by HSBC during the preceding 12-month period, please use the following links to access the disclosure page:
Clients of Global Research and Global Banking and Markets: www.research.hsbc.com/A/Disclosures
Clients of HSBC Private Banking: www.research.privatebank.hsbc.com/Disclosures
79 Equities ● Airlines June 2019
HSBC & Analyst disclosures Disclosure checklist
Company Ticker Recent price Price date Disclosure SPRING AIRLINES CO LTD 601021.SS 43.94 03 Jun 2019 7 Source: HSBC
1 HSBC has managed or co-managed a public offering of securities for this company within the past 12 months. 2 HSBC expects to receive or intends to seek compensation for investment banking services from this company in the next 3 months. 3 At the time of publication of this report, HSBC Securities (USA) Inc. is a Market Maker in securities issued by this company. 4 As of 30 April 2019, HSBC beneficially owned 1% or more of a class of common equity securities of this company. 5 As of 30 April 2019, this company was a client of HSBC or had during the preceding 12 month period been a client of and/or paid compensation to HSBC in respect of investment banking services. 6 As of 30 April 2019, this company was a client of HSBC or had during the preceding 12 month period been a client of and/or paid compensation to HSBC in respect of non-investment banking securities-related services. 7 As of 30 April 2019, this company was a client of HSBC or had during the preceding 12 month period been a client of and/or paid compensation to HSBC in respect of non-securities services. 8 A covering analyst/s has received compensation from this company in the past 12 months. 9 A covering analyst/s or a member of his/her household has a financial interest in the securities of this company, as detailed below. 10 A covering analyst/s or a member of his/her household is an officer, director or supervisory board member of this company, as detailed below. 11 At the time of publication of this report, HSBC is a non-US Market Maker in securities issued by this company and/or in securities in respect of this company 12 As of 29 May 2019, HSBC beneficially held a net long position of more than 0.5% of this company’s total issued share capital, calculated according to the SSR methodology. 13 As of 29 May 2019, HSBC beneficially held a net short position of more than 0.5% of this company’s total issued share capital, calculated according to the SSR methodology. HSBC and its affiliates will from time to time sell to and buy from customers the securities/instruments, both equity and debt (including derivatives) of companies covered in HSBC Research on a principal or agency basis or act as a market maker or liquidity provider in the securities/instruments mentioned in this report.
Analysts, economists, and strategists are paid in part by reference to the profitability of HSBC which includes investment banking, sales & trading, and principal trading revenues.
Whether, or in what time frame, an update of this analysis will be published is not determined in advance.
Non-U.S. analysts may not be associated persons of HSBC Securities (USA) Inc, and therefore may not be subject to FINRA Rule 2241 or FINRA Rule 2242 restrictions on communications with the subject company, public appearances and trading securities held by the analysts.
Economic sanctions imposed by the EU and OFAC prohibit transacting or dealing in new debt or equity of Russian SSI entities. This report does not constitute advice in relation to any securities issued by Russian SSI entities on or after July 16 2014 and as such, this report should not be construed as an inducement to transact in any sanctioned securities.
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Additional disclosures 1 This report is dated as at 05 June 2019.
80 Equities ● Airlines June 2019
2 All market data included in this report are dated as at close 29 May 2019, unless a different date and/or a specific time of day is indicated in the report. 3 HSBC has procedures in place to identify and manage any potential conflicts of interest that arise in connection with its Research business. HSBC's analysts and its other staff who are involved in the preparation and dissemination of Research operate and have a management reporting line independent of HSBC's Investment Banking business. Information Barrier procedures are in place between the Investment Banking, Principal Trading, and Research businesses to ensure that any confidential and/or price sensitive information is handled in an appropriate manner. 4 You are not permitted to use, for reference, any data in this document for the purpose of (i) determining the interest payable, or other sums due, under loan agreements or under other financial contracts or instruments, (ii) determining the price at which a financial instrument may be bought or sold or traded or redeemed, or the value of a financial instrument, and/or (iii) measuring the performance of a financial instrument. 5 This report may be a translation of a report authored in another language. If so, and if there is any discrepancy between versions, the original-language version shall prevail. 6 At the time of publication of this report, HSBC Qianhai Securities Limited does not hold 1% or more of a class of common equity securities of this company. Production & distribution disclosures 1. This report was produced and signed off by the author on 04 Jun 2019 02:56 GMT.
2. In order to see when this report was first disseminated please see the disclosure page available at https://research.hsbcqh.com.cn/R/34/BNlLzPk
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82 Equities ● Airlines June 2019
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HSBC Qianhai Research Team
Head of Research, HSBC Qianhai Securities Infrastructure Associate Steven Sun +86 755 8898 3158 Analyst, Head of A-share Infrastructure Chase Ding [email protected] Research Corey Chan +86 755 8898 3404 Transportation and Logistics Deputy Head of Research, Head of [email protected] Research Product, HSBC Qianhai Analyst, Head of A-share Transportation & Securities Logistics Research John Chung Petrochemical & New Materials David Wu +86 755 8898 3436 Analyst, Head of A-share Petrochemical [email protected] China Equity Strategy and New Materials Eric Shen +86 755 8898 3403 Associate Analyst, Head of China Equity Strategy [email protected] Sonia Luo Research Steven Sun +86 755 8898 3158 Associate [email protected] Yi Ru
Associate Kate Zhang Telecoms, Media & Technology Analyst, Head of A-share Technology Consumer Hardware Research Frank He +86 755 8898 3136 Analyst, Head of A-share Food & Beverage [email protected] and Pulp & Paper Research Katharine Song +86 755 8898 3142 Analyst, Head of A-share Media & Internet [email protected] Research Yi Guo +86 755 8898 3137 Analyst, A-share Food & Beverage and [email protected] Pulp & Paper Research Darron Xue +86 755 8898 3407 Analyst, A-share Media & Internet [email protected] Jing Han +86 755 8898 3147 [email protected] Associate Joseph Zhou Analyst, Head of A-share IT Software Research Associate Sijie Ma +86 755 8898 3140 Li Quan [email protected]
Healthcare Analyst, Head of Greater China Healthcare Research Zhijie Zhao +86 755 8898 3144 [email protected]
Industrials and Environmental Services Analyst, Head of A-share Industrials and Environmental Research Bonan Li +86 755 8898 3139 [email protected]
China low-cost carriers Equities // Airlines June 2019
Shenzhen, China Shenzhen, Issuer of report: of report: Issuer research.hsbc.com Telephone: +86 755 8898 3288 +86 755 8898 Telephone: HSBC Qianhai Securities Limited Qianhai Securities HSBC S&P Global Intelligence Market Visible Alpha/ONEaccess ® ® ® ® Website: https://research.hsbcqh.com.cn Website: Block 27 A&B, Qianhai Enterprise Dream Park Dream Enterprise 27 A&B, Qianhai Block Global Research Global The EquityThe Brief , search and 63 Qianwan Yi Road, Shenzhen-Hong Kong Cooperation Zone, Cooperation Kong Road, Shenzhen-Hong Yi 63 Qianwan Google Play Red Deer Refinitiv Exchange Research ResearchPool or ® ® ® ® ® ® ® ® The MacroThe Brief App Store David joined Wu HSBC Qianhai Securities Limited as the in 2018 Head of A-share Transportation & Logistics Research. Prior to joining HSBC, he worked as an equities analyst with a top Chinese securities firm, covering airline, logistics and shipping companies. worked in has David equity research since He holds 2012. master a of commerce degree in business statistics and a master’s degree in professional accounting from the University of Sydney. to all our audio and video reports on yourpersonal phone or tablet Bluematrix Factset Markit Hub Available on iOS and Android phones and tablets and phones Android and iOS on Available Download the app from the Subscribe Special weekly podcasts include Bloomberg All our Research, including multi-asset, thematic and daily reports, is available on Subscribe by asset class, analyst, region, country, sector, and ticker, periodical ® ® ® ® ® ® ® ® ® ® ® ® ® Mobile app Mobile ® ® Podcasts ® ® Other platforms ® Website ® ® [email protected] +86 755 8898 3436 Sonia Luo* (S1700119030004) Associate David Wu* (S1700518110001) Head of A-Share Transportation & Logistics HSBC Qianhai Securities Limited Our multi-channel research * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered / qualified pursuant to FINRA regulations Main contributors