JAGUAR MEDIA DEC 2ND, 2020

JAGUAR THEMATIC IDEAS Long Idea: Eastern Airlines (CEA)

While nothing is certain in markets, I think it’s highly probable that the world will return to some semblance of normality by 2022. Judging by how the stocks of distressed travel and retail companies have remained resilient in recent months despite worsening coronavirus trends, this tells me the market is prepared to “write off” the past nine months and perhaps the next couple quarters as an anomaly. In other words, the prevailing view that the current shocks/problems are temporary rather than secular is what has prevented stocks like CCL, SABR, AAL, JWN, etc., from further crashing, as the market looks to “pull forward” the re-acceleration in physical traffic by say, late 2021 or early 2022.

As such, shorting travel stocks or distressed companies is probably not going to bring much success, and assuming no more black swans, this may continue to be the case for an extended period. Instead, going into 1H20, I think every portfolio could stand to have at least one such long “wildcard” position which will experience sudden tremendous upside on reopenings and continually positive vaccine developments. Even if many of these stocks currently don’t have charts that look technically strong, when they take off on a sudden positive headline, you’re either in them or you’re not (for example, CCL shot up more than 40% overnight on November 9th because of Pfizer vaccine news). Moreover, because the market is giving them a “free pass” for the current five to six quarters, it means your downside is arguably capped as long as the company has enough liquidity to last till late 2021.

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Within the US space, which specific “wildcard write-off” stock to be long can be left to the discretion of the reader. There are plenty of obvious candidates here, and depending on how one structures the trade (with leap OTM 2022 expiry calls or call spreads, for instance) one could end up making several times the debit if those stocks double or triple during 2021.

“Writing off” China’s pandemic woes

It’s safe to say that China has recovered faster from the pandemic than any other major country that is not a small island or an archipelago. Traffic and travel trends certainly show this.

After recovering to above 90% of 2019 levels in August, flight passenger activity at China’s major airports have continued to hover around that range through October. According to the Civil Aviation Administration of China, total air passengers reached 50.32M in October (down 10% YoY), and flights from Shanghai’s Hongqiao International Airport dropped just 2.0% through November 10th despite Golden Week being in the rear-view mirror. Meanwhile, the International Air Transport Association (IATA) reported just last week that Chinese airports made up the top five of six positions globally in its quarterly composite activity measure:

As a result, the IATA is forecasting that the domestic market in China will return to profitability by year end. And with respect to the broader APAC region, their report goes on to mention:

“Air passenger demand in Asia-Pacific in 2021 is also expected to have the second-highest increase compared with this year among the regions at 50%, just behind North America at 60.5%, supported by the recovery in China and India's large domestic markets… Asia-Pacific being a manufacturing hub also allows it to benefit from the strength of cargo revenues.”

All of this is also consistent with 3Q20 earnings commentaries from the lodging space. Impressively, Hyatt CEO Mark Hoplamazian said that occupancies in most of Greater China have now fully recovered:

“Occupancies in most areas of Greater China, excluding , Macao and Taiwan, have reached pre-COVID levels as the rebound in domestic travel has fully replaced inbound travelers. We also continue to drive very strong RevPAR index results in China, a continuation of our second quarter performance. The strength of our brands, combined with the operating excellence of our teams, has led to continued outperformance versus the competition with an over 900 basis point increase in RevPAR index across Greater China. Travel demand in China also continued to show strength beyond the end of the third quarter…

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… Leisure transient demand continues to lead the recovery in Greater China, but we are also seeing some meaningful recovery in both transient business travel and group business. As a percentage of realized demand in Greater China during the quarter, group business was at similar levels to 2019 and business transient was only off approximately 200 basis points.”

Meanwhile, Marriot CFO Leeny Oberg said that “Over 90% of our hotels in Greater China had positive gross operating profit in September with almost three quarters generating positive profit for the first nine months of the year.” CEO Arne Sorenson would later go on to add that the driver for this rebound has been travel abroad being restricted, which has resulted in a meaningful increase in domestic leisure travel. And then looking through Hilton’s latest conference call, their management pretty much confirmed as well that China is leading the recovery in their business.

Lastly, looking at the latest flight seat occupancy statistics compiled by Moodie Davitt, Asia Pacific is currently leading other continents by origin and destination. As shown below, through November 24th, seat capacity for travel within APAC is down only 11.9% YoY, and overall capacity is down only 14.7%.

The bottom is likely in for (and peers)

Arguably the second largest state-owned flight operator in China, China Eastern Airlines typically (i.e. ex- 2020) reports roughly two-thirds of its total annual RPK to be within Greater China. And the vast majority of their international flights are within Asia Pacific.

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As one would expect, the first half of 2020 was a disaster for the company, with revenue and gross profit down 57% and down 212% on a YoY basis, respectively, both hitting multi-decade lows. When the Chinese government ordered the strict lockdowns in January and February, both hotel and flight occupancies in many affected cities plunged into single-digits.

However, as highlighted in the previous section, there are now more than enough corresponding signs that point to a rebound in the domestic aviation business for us to “write off” 1H20 and believe that the improvement seen in 3Q20 can be sustained. In fact, many smaller Chinese players which only cater to local flights have already returned to profitability in Q3. For example:

• (Shanghai-based low-cost carrier), reported a net profit of CNY 259M while reporting domestic passenger count of just -1% YoY! • Juneyao Airlines (another Shanghai-based carrier) recorded a net profit of CNY 195M. • (-based regional carrier) raked in a CNY 171M net profit.

Looking ahead, with the Lunar New Year on the horizon in February, I think there will be pent-up demand for even more local flights, considering the amount of people who weren’t allowed travel for this year’s celebrations (due to enforced lockdowns across the country in January and February). Customarily, the Lunar New Year holidays are generally viewed by Chinese people as an opportunity to either return to their home cities or to travel somewhere as a family. In previous years, the latter has been a major contributor to outbound flights to APAC destinations such as Southeast Asia and Japan. For instance, the following tables show the Top 10 countries and cities by bookings from coronavirus epicenter Wuhan, back when things were “normal” in 1Q19 (i.e. last year’s Lunar New Year), courtesy of OAG:

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But barring a miracle, we should assume that travel to Thailand, Japan, Malaysia, etc. will remain restricted come February. Which means all that pent-up demand will likely once again be directed towards domestic tourism, as was the case during the recent Golden Week. But either way, I expect China Eastern Airlines will be a beneficiary.

Technically, the stock is preparing for a breakout.

Shares of China Eastern Airlines recently made a failed attempt to break through the key multi-year resistance level of ~$23.50, and they are currently making a second attempt on somewhat rising volume. The stock also has a history of making fast and furious moves during economic recoveries. As mentioned on Page 1, if and when such moves happen, there’s no catching them. The only way to profit from such moves is to buy early, when few others are paying attention.

Chronicle Yu Research Analyst, Jaguar Analytics Email: [email protected]

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