Jan-16 Feb-16 Apr-16 May-16 Jul-16 Aug-16 Oct-16 Nov-16 Jan-17 Feb-17 Apr-17 May-17 COMPANY NOTE Limited upside to earnings June 16, 2017 Event: Ahead of the summer peak season, we look into China s aviation sector. The latest industry data from the Civil Aviation Administration of China (CAAC) and individual airline companies shows accelerating passenger traffic growth and an improving passenger load factor, which should help improve passenger yield and airline companies profitability in 2017-2018E. We selected China Southern Airlines to see how much oil price and FX changes would impact its earnings. The Company is ranked the largest airline company in China s aviation sector in terms of fleet size and passenger traffic. It has the largest market share on domestic routes. Hence, its earnings are the most sensitive to 1) rising peak season passenger traffic, and 2) movement in oil prices and FX. We found that if we assume RMB to be relatively stable this year, the implied jet fuel price based on market consensus suggests limited earnings upside for 2017. China Southern Airlines Company Limited 7.00 6.00 5.00 4.00 3.00 Turnover(HK$m, rhs) Price(HK$) 400 350 300 250 200 150 100 50 0 Passenger traffic growth exceeded market expectations in 2017E: Weak macro-economic growth slowed down passenger traffic growth for domestic airlines in 2016. But there are signs of demand growth re-acceleration in 2017. China s aviation sector reported passenger traffic growth of 14.9% YoY in 3M17 vs. growth of 15.0% YoY in 2016. With its leading position on domestic routes and the fast ramp-up of its international passenger transportation business, China Southern Airlines delivered higher passenger traffic growth in 5M17 than Air China (753 HK) or China Eastern Airlines (670 HK). China Southern Airlines reported total passenger traffic growth of 12.1% YoY in 5M17 vs. overall passenger traffic growth of 8.7% YoY in 2016. Its domestic passenger traffic grew 12.4% YoY in 5M17 compared with 7.0% for Air China and 10.6% for China Eastern Airlines. Its international passenger traffic grew 13.4% YoY in 5M17, while that of Air China and China Eastern Airlines grew 8.6% and 10.7% YoY in 5M17, respectively. Passenger yield likely to recover from 2H17 on: The overall industry supply and demand dynamics remain favourable. As shown in Fig 2, overall industry capacity growth measured in ASK (available seat/kilometre) was below industry demand growth measured in RPK (revenue per passenger kilometre) in 2010-2016. This has led to an increasing load factor. But airlines have been adding capacity to international routes, which has led to intensified price competition among airlines on international routes. In the meantime, there is competition between airlines and high-speed railways on routes below 800km. Hence, passenger yield on domestic routes has remained on a downward trend for the past four years. But passenger yield is likely to see growth recovery in 2017. The airline passenger ticket price index suggests that airline ticket prices started to move upward in 2016 (Fig 6). Strong passenger traffic growth and rising ticket prices should lead to improving passenger yield for airline companies in 2017. In addition, the coastal highspeed railways lifted ticket prices >30% in April 2017, which should reduce the price competition between airlines and high-speed railways. China Southern Airlines, with its larger exposure to domestic routes, should benefit the most from improving passenger yield. But consensus-implied jet fuel price largely factored into the latest oil price movement: Despite improving operations, we see limited upside for 2017 consensus forecast. Assuming a largely stable exchange rate, we ran a sensitivity analysis on China Southern Airlines to see the earnings impact from rising oil prices in 2017E. We calculated consensus-implied oil price assumptions based on consensus earnings estimates for the Company in 2017E. We calculated that the consensus earnings estimates are based on an average jet fuel price of US$59.0/bbl in 2017, suggesting a 10.2% YoY Market Cap: US$11,440m; Free Float: 63.0% Rmb m 2014 2015 2016 2017E 2018E Revenue (m) 108,584 111,652 114,981 124,879 136,458 Operating profit (m) 4,774 13,438 12,702 8,793 8,624 OPM (%) 4.4 12.0 11.0 7.0 6.3 Net profit (m) 1,777 3,736 5,044 5,021 5,156 NPM (%) 1.6 3.3 4.4 4.0 3.8 EPS 0.18 0.38 0.51 0.50 0.52 ROE (%) 5.0 9.5 11.6 10.3 10.0 Dividend yield (%) 0.7 1.5 1.8 1.6 1.7 PER (x) 30.3 14.4 10.7 11.0 10.5 PBR (x) 1.5 1.4 1.2 1.1 1.1 Source: Bloomberg increase in jet fuel prices in 2017. CYTD, the average jet fuel price rose 16% YoY to US$62.5/bbl. To achieve the consensus-implied jet fuel price in 2017, the jet fuel price would have to fall HoH to US$55/ bbl in 2H17. Since June, the jet fuel price has fallen below US$60/bbl. It suggests unless jet fuel price falls sharply, the current market consensus already reflected a relatively optimistic jet fuel price trend in 2H17, which caps the potential for upward earnings revision. Valuation: CYTD, the airline companies outperformed the HSI Index. China Southern Airlines share price has risen 54.2% CTYD, vs. a 3.2% rise in the HSI. The share price outperformance was due to market expectations of largely stable FX and likely falling oil prices in 2017. Based on consensus earnings estimates, the stock currently trades at 1.1x 2017E PBR, one standard deviation above its historical average forward PBR of 0.9x (Figure 10). We believe the current valuation is too rich, especially considering the limited upside risk to its 2017E earnings. We don t expect oil prices to come down significantly in 2H17. The production cut agreement among major oil producing countries should limit the downside of oil prices. In addition, the potential reduction of the FED s balance sheet may lead to RMB depreciation late this year. If there is not much earnings upside, the 1.1x PBR does not look cheap based on 10.3% 2017E ROE. We believe investors should gradually take profits in coming summer peak season. 1
COMPANY NOTE Figure 1: China aviation sector: passenger traffic growth by different routes 5 4 3 2 - -2 43.9% 25.5% 21.2% 14.6% 15.4% 11.0% 13.8% 13.8% 12.2% 15.2% 14.0% 13.6% 11.8% 10.5% 11.0% 6.4% 3.3% 10.6% 2011 2012 2013 2014 2015 2016 2017CYTD -2.3% -5.7% -11.2% Domestic International Regional Source: CAAC, CGIS Research Figure 2: China aviation sector: RPK vs. ASK growth 35.0% 3 25.0% 29.8% 28.2% 2 15.0% 11.7% 9.7% 11.1% 12.0% 11.7% 12.3% 15.0% 14.9% 14.0% 12.7% 5.0% -5.0% 0.1% -0.3% 2011 2012 2013 2014 2015 2016 2017CYTD RPK ASK Source: CAAC, CGIS Research 2
COMPANY NOTE Figure 3: Passenger traffic growth comparison for three Chinese airlines 16.0% 14.0% 12.0% 14.6% 14.5% 13.8% 11.0% 8.7% 9.6% 12.1% 10.5% 8.0% 7.0% 6.0% 4.0% 2.0% 2015 2016 5M2017 China Southern Airline China Eastern Airline Air China Source: Company data, CGIS Research Figure 4: Passenger load factor comparison for three Chinese airlines 82.5% 82.2% 82.0% 81.5% 81.0% 80.5% 8 79.5% 79.0% 81.2% 80.7% 80.4% 80.5% 80.5% 79.9% 81.3% 81.1% 78.5% 2015 2016 5M2017 China Southern Airline China Eastern Airline Air China Source: Company data, CGIS Research 3
COMPANY NOTE Figure 5: China s aviation sector passenger ticket price index 2 - -2 0.2% 0.2% -6.9% -2.5% -1.7% -9.9% -9.9% 8.1% 3.0% 0.8% -7.2% -5.2% -13.9% 6.4% 4.9% -2.9% -3-4 -5-32.3% -45.4% 2012 2013 2014 2015 2016 2017CYTD Domestic International(ex-Asia) Regional Source: WIND data, CGIS Research Figure 6: Oil price sensitivity test on China Southern Airlines 2017E earnings Jet fuel price (US$/bbl) % chg 2017E Change from base 2016 % YoY chg case Net profit (Rmb m) 5,065 5,044 69.00 17% 1,641-67.6% -67.5% 64.00 8% 3,353-33.8% -33.5% 59.00 0% 5,065 0.4% 54.00-8% 6,777 33.8% 34.3% 49.00-17% 8,488 67.6% 68.3% Source: Company data, CGIS Research 4
Jan-16 Feb-16 Apr-16 May-16 Jul-16 Aug-16 Oct-16 Nov-16 Jan-17 Feb-17 Apr-17 May-17 Jan-16 Feb-16 Apr-16 May-16 Jul-16 Aug-16 Oct-16 Nov-16 Jan-17 Feb-17 Apr-17 May-17 COMPANY NOTE Figure 7: Jet fuel price (US$/bbl) 70.0 65.0 60.0 55.0 50.0 45.0 40.0 35.0 30.0 Source: Bloomberg, CGIS Research Figure 8: RMB/US$ exchange rate 7.0 6.9 6.8 6.7 6.6 6.5 6.4 Source: Bloomberg, CGIS Research 5
Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 COMPANY NOTE Figure 9: Peer comparison Ticker Mkt cap Price PER EPS growth PEG P/Bk EV/EBITDA Dividend yield ROE US$ m (lc) 2016 2017E 2018E 2016 2017E 2018E 2017E 2016 2017E 2018E 2016 2017E 2018E 2016 2017E 2018E 2016 2017E 2018E H-share airline companies Air China 753 HK 18,814 7.53 11.8 11.4 10.3-3.6% 4.0% 10.8% 2.8 1.2 1.1 1.0 7.6 7.7 7.2 1.4% 1.2% 1.4% 10.5% 9.7% China Southern Airline 1055 HK 11,440 6.29 10.7 11.0 10.5 27.5% -2.0% 4.2% -5.6 1.2 1.1 1.1 7.4 8.7 8.2 1.4% 1.2% 1.3% 11.5% 10.3% China Eastern Airline 670 HK 12,443 4.45 11.7 10.0 9.6-5.7% 17.6% 4.6% 0.6 1.1 1.0 1.0 8.1 9.2 8.8 2.0% 1.4% 1.4% 9.7% 10.4% 10.1% Cathay Pacific 293 HK 6,234 12.36-84.7-49.8 58.9-109.6% 69.9% -184.7% -0.7 0.9 0.9 0.9 11.8 11.6 9.9 0.4% 0.2% 0.6% -1.0% -1.8% 1.5% A-share airline companies Air China 601111 CH 18,814 9.83 17.8 17.1 15.3-3.6% 3.6% 11.8% 4.7 1.9 1.7 1.5 7.5 8.1 7.7 1.2% 1.0% 1.1% 10.5% 9.8% 10.1% China Southern Airline 600029 CH 11,444 8.89 17.4 22.7 22.6 27.5% -23.3% 0.8% -1.0 2.0 1.8 1.7 7.4 8.5 8.0 1.1% 1.0% 1.1% 11.5% 8.1% 7.4% China Eastern Airline 600115 CH 12,443 6.78 20.5 20.1 20.1-5.7% 2.4% 8.3 2.0 1.9 1.7 8.0 8.8 8.5 1.5% 1.0% 0.9% 9.7% 9.2% 8.4% Spring Airline 601021 CH 3,799 32.25 27.1 23.1 18.6-29.2% 17.5% 24.0% 1.3 3.5 3.1 2.6 25.6 16.5 13.4 0.5% 0.5% 0.7% 13.0% 13.2% 14.0% Hainan Airline 600221 CH 8,066 3.25 15.5 13.5 12.6-14.6% 14.3% 7.1% 0.9 1.1 1.0 0.9 na na na 1.6% na na 6.9% 7.5% 7.4% Source: Bloomberg, CGIS Research, Note: based on closing prices on 15 June 2017 Figure 10: China Southern Airlines PBR band 2.5 2.0 1.5 1.0 0.5 0.0 PB Average +1 Stdev -1 Stdev Source: Bloomberg, Company data, CGIS Research 6
Disclaimer This research report is not directed at, or intended for distribution to or used by, any person or entity who is a citizen or resident of or located in any jurisdiction where such distribution, publication, availability or use would be contrary to applicable law or regulation or which would subject China Galaxy International Securities (Hong Kong) Co., Limited ( Galaxy International Securities ) and/or its group companies to any registration or licensing requirement within such jurisdiction. This report (including any information attached) is issued by Galaxy International Securities, one of the subsidiaries of the China Galaxy International Financial Holdings Limited, to the institutional clients from the information sources believed to be reliable, but no representation or warranty (expressly or implied) is made as to their accuracy, correctness and/or completeness. This report shall not be construed as an offer, invitation or solicitation to buy or sell any securities of the company(ies) referred to herein. Past performance should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied, is made regarding future performance. The recipient of this report should understand and comprehend the investment objectives and its related risks, and where necessary consult their own independent financial advisers prior to any investment decision. Where any part of the information, opinions or estimates contained herein reflects the personal views and opinions of the analyst who prepared this report, such views and opinions may not correspond to the published views or investment decisions of China Galaxy International Financial Holdings Limited and any of its subsidiaries ( China Galaxy International ), directors, officers, agents and employees ( the Relevant Parties ). All opinions and estimates reflect the judgment of the analyst on the date of this report and are subject to change without notice. China Galaxy International and/or the Relevant Parties hereby disclaim any of their liabilities arising from the inaccuracy, incorrectness and incompleteness of this report and its attachment/s and/or any action or omission made in reliance thereof. Accordingly, this report must be read in conjunction with this disclaimer. Disclosure of Interests China Galaxy Securities Co., Ltd. (6881.HK; 601881.CH) is the direct and/or indirect holding company of the group of companies under China Galaxy International. China Galaxy International may have financial interests in relation to the subjected company(ies) the securities in respect of which are reviewed in this report, and such interests aggregate to an amount may equal to or more than 1 % of the subjected company(ies) market capitalization. One or more directors, officers and/or employees of China Galaxy International may be a director or officer of the securities of the company(ies) mentioned in this report. China Galaxy International and the Relevant Parties may, to the extent permitted by law, from time to time participate or invest in financing transactions with the securities of the company(ies) mentioned in this report, perform services for or solicit business from such company(ies), and/or have a position or holding, or other material interest, or effect transactions, in such securities or options thereon, or other investments related thereto. China Galaxy International may have served as manager or co-manager of a public offering of securities for, or currently may make a primary market in issues of, any or all of the entities mentioned in this report or may be providing, or have provided within the last 12 months, significant advice or investment services in relation to the investment concerned or a related investment or investment banking services to the company(ies) mentioned in this report. Furthermore, China Galaxy International may have received compensation for investment banking services from the company(ies) mentioned in this report within the preceding 12 months and may currently seeking investment banking mandate from the subject company(ies). Analyst Certification The analyst who is primarily responsible for the content of this report, in whole or in part, certifies that with respect to the securities or issuer covered in this report: (1) all of the views expressed accurately reflect his or her personal views about the subject, securities or issuer; and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific views expressed by the analyst in this report. Besides, the analyst confirms that neither the analyst nor his/her associates (as defined in the code of conduct issued by The Hong Kong Securities and Futures Commission) (1) have dealt in or traded in the securities covered in this research report within 30 calendar days prior to the date of issue of this report; (2) will deal in or trade in the securities covered in this research report three business days after the date of issue of this report; (3) serve as an officer of any of the Hong Kong-listed companies covered in this report; and (4) have any financial interests in the Hong Kong-listed companies covered in this report. Explanation on Equity Ratings BUY SELL HOLD : : share price will increase by >20% within 12 months in absolute terms share price will decrease by >20% within 12 months in absolute terms : no clear catalyst, and downgraded from BUY pending clearer signal to reinstate BUY or further downgrade to outright SELL Copyright Reserved No part of this material may be reproduced or redistributed without the prior written consent of China Galaxy International Securities (Hong Kong) Co., Limited. China Galaxy International Securities (Hong Kong) Co. Limited, CE No.AXM459 Room 3501-3507, 35/F, Cosco Tower, Grand Millennium Plaza, 183 Queen s Road Central, Sheung Wan, Hong Kong. General line: 3698-6888. 7