Oct. 11 (Bloomberg) -- Air China Ltd. may lose its title as the world's most valuable airline just as quickly as it gained the top spot. The carrier surged past Singapore Airlines Ltd. earlier this year as Chinese airlines' Hong Kong-listed shares have outpaced a 46 percent gain in the Hang Seng Index.

China's three biggest carriers may decline by as much as 75 percent as rising jet-fuel prices and growing competition crimp their profitability, which already lags behind that of foreign competitors like United Airlines and Singapore Airlines. Air China, China Southern Airlines Co. and China Eastern Airlines Corp. have gained as much as fourfold in Hong Kong this year, driven in part by speculation that a tie-up among the carriers might boost profits and shares.

``It's a bubble which has sort of been fed by potential mergers and acquisitions,'' said Damien Horth, an analyst at UBS AG in Hong Kong. ``Even if we do have consolidations, it doesn't necessarily create value for shareholders.''

Horth rates all of the three major Chinese carriers ``sell'' and estimates Air China will fall to HK$4 in the next 11 months, from today's close of HK$11.22 in Hong Kong. That would place the carrier's market value below that of Singapore Air.

`Disregarding Valuations'

Beijing-based Air China, Guangzhou-based China Southern and Shanghai-based China Eastern lost money on a combined basis last year even as air travel in the country increased. Their shares are still valued at as much as 62 times estimated earnings, according to data compiled by Bloomberg. That compares with 21 times for all Hong Kong stocks and 13 times for Singapore Air, Asia's most profitable carrier.

``Investors are disregarding valuations'' of China's airlines, said Han Gang, who helps manage 60 billion yuan ($8 billion) at Great Wall Asset Management Co. in Shenzhen. ``Even institutions have abandoned their principles and started to chase quick money,'' added Han, who doesn't own Chinese carriers and doesn't plan to buy their stock.

Rising personal incomes in China have made air travel affordable to more people, boosting traffic 15 percent last year, according to the General Administration of Civil Aviation.

Still, China Eastern lost 3.31 billion yuan in 2006. China Southern posted net income of 188 million yuan, and Air China made a 2.69 billion yuan profit.

``There is an assumption growth in revenue will automatically translate into growth in profits,'' said Horth at UBS. ``That is rarely the case in the airline industry.''

Profit Margins

China Southern had a 0.4 percent profit margin last year and Air China's was 6.5 percent, compared with 6.7 percent at Cathay Pacific Airways Ltd., the biggest Hong Kong-based carrier, and 15 percent at Singapore Air.

Li Ka-Shing's Cheung Kong (Holdings) Ltd., HSBC Holdings Plc and Morgan Stanley & Co. have cut their positions in China's airlines this year. Li, Asia's richest man, reduced his stake in China Southern's Hong Kong-listed shares to 12.54 percent in the past two weeks from 15.35 percent, according to filings to the Hong Kong Stock Exchange.

Competition among the three big carriers has kept them from raising domestic fares to make up for higher fuel costs. Their spending on jet fuel more than quadrupled in the five years to 2006, according to company filings, as the Chinese government, which controls jet-fuel sales, has been lifting its price cap.

Fuel Prices

``Higher sales isn't enough to help them gain amid surging oil prices,'' said Ma Ying, an analyst at Haitong Securities Co. in Shanghai.

Hiring costs may rise as well. China's flight schools may only be able to train 7,000 pilots by the end of 2010, short of a projected need of more than 9,000, Gao Hongfeng, vice director of the General Administration of Civil Aviation, said in a Sept. 7 online interview on the central government's Web site.

``Staff costs for the airlines may increase, as they need to pay more for experienced pilots from other airlines,'' said Edward Wong, an analyst at Quam Ltd. in Hong Kong.

Competition for passengers on international routes will also intensify. U.S. airlines are set to more than double their combined number of weekly flights to China to 112 by 2009 under an ``open skies'' agreement between the two countries.

While profitability improved at the three biggest Chinese carriers in the first six months of this year, the gains were helped by a 2.5 percent rise in the yuan against the U.S. currency, which cut the cost of servicing the carriers' dollar- denominated debt.

China Southern turned to first-half profit from a loss a year earlier, while Air China's net income rose and China Eastern's loss narrowed.

``The carriers have yet to improve profitability in their main business, instead of relying on the yuan appreciation,'' said Li Lei, an analyst at China Securities Co. in Beijing.

Surging Stock

Air China's shares rose 31 percent in less than four weeks, while China Southern's gained 50 percent and China Eastern's more than doubled, after Air China President Cai Jianjiang said on Aug. 29 the carrier would consider mergers with other airlines.

On Sept. 2, Singapore Air and parent Temasek Holdings Pte agreed to pay about $918 million for 24 percent of China Eastern. Subsequent analyst and media reports raised speculation that Air China would make a rival bid for the Shanghai-based carrier, driving stocks of Chinese airlines to a peak on Sept. 21.

The carriers' shares fell after Air China's partner Cathay Pacific said Sept. 24 that while the two airlines had considered bidding for a China Eastern stake, they wouldn't proceed.

Discouraging Consolidation

Only three Chinese carriers are listed in Hong Kong, ``so the scarcity of value is there,'' said Winson Fong, who helps oversee about $2.5 billion at SG Asset Management in the city. ``Professional investors could hold for a long-term consolidation theme.''

For now, the withdrawal may signal that China's government is discouraging domestic tie-ups.

``It's quite obvious that the central government told Cathay and Air China not to proceed with the plan,'' said Jim Wong, an analyst at Nomura International in Hong Kong.

Merrill Lynch analyst Paul Dewberry lowered his ratings on China Eastern and Air China after the withdrawal to ``sell,'' from ``buy'' and ``neutral,'' respectively, on Sept. 24.

China Eastern may fall to HK$1.90 from HK$7.67 in Hong Kong, according to a price target issued Aug. 17 by Deutsche Bank analyst Joe Liew in Hong Kong. Recent analyst price targets for China Southern range as low as HK$4.50, compared with a price of HK$10.68 at today's close.

``Airline stocks are a risky investment, as they may fall on any uncertainty in other sectors, like currency or oil prices,'' said Han of Great Wall.

Buying Chinese airlines now, said Li of China Securities, ``is like suicide.''

To contact the reporter on this story: Irene Shen in Shanghai at ishen4@bloomberg.net

Last Updated: October 11, 2007 06:03 EDT