Chinese airlines' path to global dominance

This was written by Bloomberg Intelligence analysts Rahul Kapoor and Chris Muckensturm. It first appeared on the Bloomberg Terminal.

Air China will surpass Delta as world’s most valuable airline

Air China will be the world’s most valuable airline by market capitalization within the next three years powered by its multi-year growth potential. Chinese carriers will benefit from double-digit earnings growth driven by strong demand, higher cost economies and capacity additions.

Secular growth to propel earnings higher

Secular demand trends and domestic yield recovery will give Chinese carriers the strongest earnings growth trajectory among global full-service carriers. China’s state-owned airlines have domestic market dominance and are the biggest beneficiaries of the Chinese government’s decision to allow more freedom to set domestic fares which boosts long-term earnings growth. Robust international passenger growth and travelers’ preference for mainland carriers will continue to drive traffic growth at Chinese airlines. The move on price liberalization is among many steps the country is taking toward more market-based pricing in its aviation sector.

Western airlines have benefited from consolidation at home. Even as they experience robust near-term demand, their earnings growth is expected to be lower given their matured markets.

Full Service Airlines Market Cap vs Sales, Income

Revenue growth driven by capacity expansion

Chinese Airlines revenue growth will outpace both regional and global peers in 2018-20 driven primarily by a significant capacity and network expansion. Expanding regional and international route networks will help increase origin and destination traffic for China’s airlines and in turn aid revenue growth. Load factors, a key driver of revenue should also continue to increase as demand from both tier-1 and tier-2 airports remains robust. Rising incomes in China will drive revenue contribution from travelers using first and business-class service.

From 2012-17, Chinese airlines’ revenue increased by a CAGR of 4.3%, outpacing Delta’s topline CAGR of 2.4%. From 2018-20, Chinese carriers’ revenue is forecasted to accelerate at double the pace, at a CAGR of 9.7%, whereas Delta top-line will grow at a CAGR of 3%.

Revenue CAGR, Chinese carriers vs global majors

Double-digit profit CAGR for Chinese airlines

Demand coupled with sustained cost control will drive Chinese carriers earnings growth over the next three years. The earnings uptrend should continue, barring a major fuel price shock. Key risks stem from rising fuel bills, as elevated fuel costs bode-ill for profitability due to their practice of not hedging. While the majority of their capacity on domestic short-haul flights provides a cushion, international long-haul capacity expansion will pressure margins. Chinese airlines’ profit grew at a CAGR of 16% in 2012-17, lagging U.S. carriers Delta (18%) and United (28%). Demand, lower costs and consolidation in the U.S. aviation market helped U.S. carriers’ profitability.

For 2018-20, Chinese carriers’ profit is forecasted to grow at a CAGR of over 20%, whereas earnings growth for U.S. carriers is expected to be muted.

Profit CAGR, Chinese carriers vs global majors

Chinese Airlines’ capacity will grow 50% by 2022

Chinese airlines capacity additions will gather significant pace in coming years as they seek to benefit from continued robust domestic demand and aim to tap growth in the expanding international segment. Bloomberg Intelligence estimates show domestic annual capacity growth through 2022 at a CAGR of 9% in our low-case scenario, 9.7% in the expected case, and 11.2% in a high-case scenario. Continued international expansion by Chinese airlines will also fuel additional aircraft demand, benefiting the two big global manufacturers Boeing and Airbus.

Chinese carriers will add significant capacity over the next three years. According to the latest annual reports, the flag carrier Air China group will add 170 aircraft to its fleet in 2018-20 with 54 in 2018, 63 in 2019 and 53 in 2020.
China Southern will also add 220 aircrafts.

Chinese Airlines capacity growth (ASKs), 2018-22

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