Deutsche Bank Markets Research Rating Company Date 2 December 2016 Buy Spring Airlines Initiation of Coverage Asia China Reuters Bloomberg Exchange Ticker Price at 1 Dec 2016 (CNY) 41.14 Transportation 601021.SS 601021 CH SHH 601021 Price target - 12mth (CNY) 48.20 Air 52-week range (CNY) 63.31 - 41.14 Shanghai Composite 3,274 An evident winner in China’s infant Fei Sun, CFA Vincent Ha, CFA stage LCC market? Initiating with Buy Research Analyst Research Analyst (+852 ) 2203 6130 (+852 ) 2203 6247 Thriving on China's low LCC penetration; Buy with TP of RMB48.2 [email protected] [email protected] The 9% low-cost carrier (LCC) penetration in China, compared to 56% in SE Asia, suggests there is ample room for industry leaders like Spring Airlines to grow. The airline's cost leadership over full-service carriers (FSC) mitigates its Price/price relative lower yield and offers even better profitability. We expect load factor to stay at 75 c.92%, with yield bottoming out in FY17E. Despite short-term yield pressure, 60 Spring's international expansion could help it capture increasing outbound 45 tourism demand. Spring is a scarce LCC play in China and we believe it 30 deserves a valuation premium over peers. With ROE recovering to 20% in 15 FY18E, we initiate coverage with a Buy rating and TP of RMB48.2. 0 1/15 7/15 1/16 7/16 A scarce Chinese LCC airline with significant cost leadership Spring Airlines Spring is China's largest LCC, with a 29% share of the LCC market in 2015. It Shanghai Composite (Rebased) enjoys significant cost efficiency vs. network carriers, with unit operating cost Performance (%) 1m 3m 12m 35-40% lower; this enables better profitability even on 36-42% lower yields. In 1H16, sales from charter flights contributed 27% of revenue, indicating great Absolute -5.2 -12.4 -26.3 synergy with parentco Spring Tour. The airline’s international business revenue Shanghai Composite 4.9 6.9 -5.3 contribution has increased rapidly to 37.5% in 1H16, from 1.4% in 2011. Source: Deutsche Bank International expansion to mitigate slow domestic traffic; yield to recover We expect Spring’s international RPK to expand by 25-48% YoY in FY16-18E vs. -2-4% for domestic traffic. With passenger yield bottoming in FY16E, we forecast a 4-6% YoY rebound in FY17-18. We estimate that capex (excl. disposal gain) will remain at RMB5-6bn per annum in FY16-18E, mainly for aircraft acquisition. While ROE is forecast to drop from 26% in FY15 to 19% in FY16E, we expect it return to 20% in FY18 on recovering yield and load factors. Initiating coverage with a Buy; target price set at 4.2x FY17E P/BV; risks Our target price of RMB48.2 is based on 4.2x FY17E P/BV, c.20% below Spring’s average P/BV of 5.3x since listing. We believe this is justified, given a sustainable ROE of about 19-20% in FY17-18E. Key downside risks: excessive capacity addition; fiercer-than-expected competition from regional LCCs and Chinese airlines; and slower-than-expected demand growth. Forecasts And Ratios Year End Dec 31 2014A 2015A 2016E 2017E 2018E Sales (CNYm) 7,312.4 8,069.6 8,294.4 9,684.5 11,564.7 EBITDA (CNYm) 1,056.4 1,591.2 1,441.0 1,748.8 2,163.0 Reported NPAT (CNYm) 884.2 1,327.9 1,336.9 1,646.5 1,972.3 DB EPS FD(CNY) 1.474 1.680 1.671 2.057 2.464 DB EPS growth (%) 20.8 14.0 -0.5 23.1 19.8 PER (x) – 32.0 24.6 20.0 16.7 EV/EBITDA (x) – 27.8 24.7 20.7 16.8 Yield (net) (%) – 0.4 0.5 0.7 0.9 DB ROE (%) 28.1 26.3 18.7 19.5 19.6 Source: Deutsche Bank estimates, company data 1 DB EPS is fully diluted and excludes non-recurring items 2 Multiples and yields calculations use average historical prices for past years and spot prices for current and future years, except P/B which uses the year end close ________________________________________________________________________________________________________________ Deutsche Bank AG/Hong Kong Distributed on: 02/12/2016 14:03:38 GMT Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 057/04/2016. 2 December 2016 Air Spring Airlines Model updated:02 December 2016 Fiscal year end 31-Dec 2013 2014 2015 2016E 2017E 2018E Running the numbers Financial Summary Asia DB EPS (CNY) 1.22 1.47 1.68 1.67 2.06 2.46 Reported EPS (CNY) 1.22 1.47 1.68 1.67 2.06 2.46 China DPS (CNY) 0.12 0.16 0.21 0.22 0.31 0.37 BVPS (CNY) 4.6 5.9 8.2 9.6 11.5 13.6 Air Weighted average shares (m) 600 600 790 800 801 801 Spring Airlines Average market cap (CNYm) na na 42,520 32,912 32,912 32,912 Enterprise value (CNYm) na na 44,244 35,647 36,157 36,411 Reuters: 601021.SS Bloomberg: 601021 CH Valuation Metrics P/E (DB) (x) na na 32.0 24.6 20.0 16.7 Buy P/E (Reported) (x) na na 32.0 24.6 20.0 16.7 Price (1 Dec 16) CNY 41.14 P/BV (x) 0.00 0.00 7.43 4.26 3.58 3.02 Target Price CNY 48.20 FCF Yield (%) na na nm nm nm 0.4 Dividend Yield (%) na na 0.4 0.5 0.7 0.9 52 Week range CNY 41.14 - 63.31 EV/Sales (x) nm nm 5.5 4.3 3.7 3.1 Market Cap (m) CNYm 32,912 EV/EBITDA (x) nm nm 27.8 24.7 20.7 16.8 EV/EBIT (x) nm nm 37.6 35.5 29.4 23.5 USDm 4,774 Income Statement (CNYm) Company Profile Sales revenue 6,550 7,312 8,070 8,294 9,684 11,565 Headquartered in Shanghai, Spring Airlines is China's Gross profit 838 1,068 1,603 1,448 1,739 2,143 largest low-cost carrier by fleet size. The airline started to EBITDA 837 1,056 1,591 1,441 1,749 2,163 operate domestic flights since 2005 and international and Depreciation 271 304 375 434 515 612 regional routes since 2010. Amortisation 31 33 41 3 3 4 EBIT 536 720 1,175 1,004 1,231 1,547 Net interest income(expense) -81 -98 -154 -179 -149 -149 Associates/affiliates 0 0 -117 0 0 0 Exceptionals/extraordinaries 0 0 0 0 0 0 Other pre-tax income/(expense) 532 595 900 958 1,114 1,232 Profit before tax 987 1,216 1,804 1,783 2,195 2,630 Price Performance Income tax expense 255 332 476 446 549 657 Minorities 0 0 0 0 0 0 75 Other post-tax income/(expense) 0 0 0 0 0 0 60 Net profit 732 884 1,328 1,337 1,646 1,972 45 DB adjustments (including dilution) 0 0 0 0 0 0 30 DB Net profit 732 884 1,328 1,337 1,646 1,972 15 Cash Flow (CNYm) 0 Jan 15 Apr 15 Jul 15 Oct 15 Jan 16 Apr 16 Jul 16 Oct 16 Cash flow from operations 1,536 1,076 1,610 1,919 2,545 2,760 Net Capex -713 -2,446 -3,188 -2,654 -2,753 -2,633 Spring Airlines Free cash flow 823 -1,369 -1,578 -735 -208 127 Shanghai Composite (Rebased) Equity raised/(bought back) 0 0 1,755 14 0 0 Margin Trends Dividends paid -216 -237 -303 -166 -172 -245 Net inc/(dec) in borrowings -544 2,369 595 2,210 -192 -175 20 Other investing/financing cash flows -178 155 277 -123 -129 -136 Net cash flow -115 918 746 1,200 -702 -428 16 Change in working capital 422 -286 -355 -206 -9 -211 12 Balance Sheet (CNYm) Cash and other liquid assets 1,475 2,400 3,095 4,295 3,593 3,164 8 Tangible fixed assets 4,349 6,884 10,146 12,355 14,582 16,588 13 14 15 16E 17E 18E Goodwill/intangible assets 51 54 63 71 79 90 EBITDA Margin EBIT Margin Associates/investments 98 110 95 95 95 95 Other assets 1,679 1,813 2,630 2,702 2,867 2,974 Growth & Profitability Total assets 7,651 11,261 16,029 19,518 21,216 22,911 Interest bearing debt 2,251 4,375 4,915 7,125 6,933 6,758 25 35 Other liabilities 2,657 3,334 4,575 4,670 5,088 5,232 20 30 Total liabilities 4,908 7,708 9,489 11,795 12,021 11,990 25 Shareholders' equity 2,743 3,553 6,540 7,723 9,195 10,921 15 20 Minorities 0 0 0 0 0 0 10 15 10 Total shareholders' equity 2,743 3,553 6,540 7,723 9,195 10,921 5 5 Net debt 777 1,975 1,820 2,830 3,340 3,594 0 0 13 14 15 16E 17E 18E Key Company Metrics Sales growth (%) 16.8 11.6 10.4 2.8 16.8 19.4 Sales growth (LHS) ROE (RHS) DB EPS growth (%) 17.2 20.8 14.0 -0.5 23.1 19.8 Solvency EBITDA Margin (%) 12.8 14.4 19.7 17.4 18.1 18.7 EBIT Margin (%) 8.2 9.8 14.6 12.1 12.7 13.4 60 12 Payout ratio (%) 10.1 10.9 12.5 13.0 15.0 15.0 50 10 ROE (%) 30.4 28.1 26.3 18.7 19.5 19.6 40 8 Capex/sales (%) 11.1 33.6 55.5 58.9 58.1 52.5 30 6 Capex/depreciation (x) 2.4 7.3 10.8 11.2 10.9 9.9 20 4 Net debt/equity (%) 28.3 55.6 27.8 36.6 36.3 32.9 10 2 Net interest cover (x) 6.6 7.3 7.6 5.6 8.3 10.4 0 0 Source: Company data, Deutsche Bank estimates 13 14 15 16E 17E 18E Net debt/equity (LHS) Net interest cover (RHS) Fei Sun, CFA +852 2203 6130 [email protected] Page 2 Deutsche Bank AG/Hong Kong 2 December 2016 Air Spring Airlines Table Of Contents Investment thesis ...............................................................