Economic slowdown: China's top 3 airlines brace for smaller profits on slower demand; weak yuan inflates costs

Beijing: China’s top three airlines are bracing for a further margin squeeze as softer travel demand pressures passenger yields and a weakening yuan currency inflates costs, analysts said, as many of them slashed their annual profit forecasts for the carriers. [caption id=“attachment_7270031” align=“alignleft” width=“380”]  Representative image. Reuters[/caption] The outlook revision—for which analysts also cited an economic slowdown amid a US-China trade war and fears of rising oil prices—comes after China Southern Airlines, Air China and China Eastern Airlines turned in lower net profits for the January-June period last week, erasing first-quarter gains. China Southern, the country’s largest carrier by passenger numbers, posted a 20.9 percent year-on-year drop in profit to 1.69 billion yuan ($238 million), while China Eastern posted a 14.9 percent drop to 1.94 billion yuan. Air China, the country’s flagship carrier, saw a smaller 9.5 percent drop in net profit to 3.14 billion yuan due to positive returns from its investment in Hong Kong’s Cathay Pacific Airways Ltd, which swung to its first profit for the January-June period since 2016. Passenger yields, a measure of average fare per kilometre flown, fell for all three airlines, with China Southern suffering the steepest decline of 1.65 percent from a year earlier.

“With the expectation that trade talks will continue for the rest of 2019, we expect a decline in the yield to continue, resulting in a total 2.3 percent drop for the full year,” Ivan Su, an equity analyst at Morningstar, said of China Southern.

Cargo demand is also expected to stay soft, as a protracted trade war between the world’s two biggest economies continues to disrupt global supply chains and rattle financial markets. Refinitiv data shows average full-year earnings estimates for all three carriers have been lowered over the past 30 days, ranging from a 5.3 percent drop for China Eastern to a 13.3 percent fall for China Southern. Yuan depreciation The forecast cuts come as the Chinese currency yuan has lost more than 3 percent of its value against the dollar since 1 August, when US President Donald Trump announced plans to slap more tariffs on Chinese goods. A few days later, Chinese authorities allowed the tightly managed currency to breach the key 7-per-dollar level—a level not seen in a decade—feeding fears of a currency war and adding to the bearish sentiment on the yuan.

Given Chinese airlines have bought planes with mainly US dollar-denominated loans, the currency volatility is set to hammer their profit margins in the second half, analysts said. Southwest Securities forecasts foreign exchange losses in the third quarter ending 30 September for the Chinese airlines have exceeded 1.5 billion yuan so far, underscoring the cost pressure facing the carriers as the yuan falters.

Oil prices, at around $59 a barrel, are up around 10 percent so far this year, with some analysts forecasting prices could rise further before year-end. The three airlines are also among carriers around the world that have grounded Boeing 737 MAX narrow bodies following two fatal crashes. The grounding has constrained Chinese airlines’ ability to expand capacity, with available seat kilometres, a measure of passenger carrying capacity, missing targets set at the start of the year, analysts said, although weaker demand means the capacity cut is not all negative.