Chinese Airlines:Favorable FX and fuel trends partially offset international yield pressure

Limited excitement despite slower RMB depreciation and fuel appreciation

    Chinese airlines’ H share prices have risen 31-53% YTD (vs. HSCEI’s 14%),despite soft international yields and a jump in fuel price vs. 2016. We attributeoutperformance to expectations for slower RMB depreciation and fuel priceappreciation from now on. Although we see potential earnings upside due tolower FX loss forecasts, we aren't overly excited, given tough competition oninternational routes. We prefer Buy-rated China Eastern-H and Spring Airlines.

    Lower FX loss to offset weaker core FY17E profitability

    The Big Three airlines have been cutting their USD debt exposure, from over 70%at the peak level to under 50% by year-end 2016. Together with the slower pacein RMB depreciation, we now see more upside potential to FY17-19E reportedearnings, on lower FX losses, and we raise our FY17-18E reported net profitforecasts for the Big Three airlines by 16% on average. However, we think thatthis should not completely mask the fact that airlines are going to report loweroperational profit this year, on soft international yield and higher fuel price.

    International routes’ yields to stay soft on capacity additions

    For the past six years, China's international flight passenger capacity (ASK) hadalmost tripled and it is still growing at the mid-teen level YoY. As internationalpassenger traffic growth has been tapering off from a high base, we will likely stillsee some pressure on ticket pricing, not to mention threats from low-cost carriers(LCCs). That said, with our expectations for a milder jet fuel price uptrend, wethink network carriers can still report core earnings improvement in FY18-19E.

    Buy airlines with better growth prospects; valuation and risks

    We raise our reported earnings forecasts for the Big Three airlines, mainly onlower FX loss and fuel price assumptions, despite revenue cuts on lower yieldestimates. We raise our FY18-19E earnings for Spring Airlines to reflect ourconstructive profit expectation. For target prices, we increase our P/BV-basedtarget multiples, given higher ROE estimates, and roll over our P/BV benchmarkperiod to the end of FY18E. We see less upside to network carriers but maintainour Buy on China Eastern Airlines-H (CEA-H) with our optimism on its Shanghaihub. We also have a Buy on Spring Airlines as a unique LCC beneficiary. Keysector upside risks are no RMB depreciation, fuel price weakness and a risein travel demand. Key downside risks are the reverse of the above. This reportchanges target prices and estimates for several companies under our coverage. Fora detailed listing of the estimate changes, see Figure 3on page 2.