The Uncertain Recovery
In China, people are flying again. But airlines face risks beyond the current pandemic
As most of the world suffers a deep recession, China’s economy managed to grow last quarter, by 3% y/y. But make no mistake: Its airlines face challenges no less daunting than those of its rivals abroad.
The Covid crisis hit early for Chinese airlines. The disease emanated from Wuhan, incidentally the country’s only airport—among its 25 busiest—to record double-digit growth in passenger traffic last year, according to China’s civil aviation regulator. Wuhan’s passenger volumes rose 11% y/y, to 27m, making it China’s 14th busiest airport. That’s now a quaint and distant memory. Starting in January, the virus spread, quickly enough and widely enough to force a near-freeze of all air travel nationwide during the Lunar New Year period in late January. That happens to be one of the busiest and most lucrative times of the year for Chinese carriers, underpinning strong first quarter profits in normal times. During this year’s first quarter though, the cumulative net losses of China’s four largest airlines, excluding special items, amounted to $3.7b.
Through May, demand (measured in revenue passenger kilometers, RPKs) is down 59% y/y for all Chinese airlines. That’s on 57% less capacity (measured in available seat kilometers, ASKs). Airport traffic, which includes foreign airlines as well domestic, recorded a similar 57% decline in passenger volumes during the first five months of 2020.
But are trends improving? Monthly traffic figures suggest the answer is yes, but only marginally. Air China, for its part, recorded a 3% y/y drop in RPKs during January. The decline was 81% in February, 74% in March, 79% in April, 69% in May, and 65% in June. During just the second quarter, its load factors have stabilized between 65% and 68%. The trend, however, looks somewhat better for just the domestic market. International flying remains largely dormant, with RPKs still down 97% as recently as last month. Domestically though, Air China’s monthly traffic declines from January to June were: 2%, 84%, 63%, 64%, 48%, and 41%. Domestic load factors were 76%, 50%, 61%, 67%, 69%, and 68%. What kind of fares and yields are Air China and its peers seeing? There’s a lot less transparency on that. But with China Eastern offering all-you-can-fly weekend passes, retail sales nationwide still down by double digits, and travel distributors like Trip.com expecting to report Q2 revenue declines of as much 77%, it’s safe to conclude that revenue weakness and financial losses remain the reality, even in China’s domestic market.
Air China did face exposure to a momentary mini-outbreak of Covid-19 in its home city Beijing last month. China Eastern’s trends look a bit better, with RPK traffic for June down not 48% but 41% (on 26% fewer ASKs). Its June domestic load factor was 67%, down from 83% last June. China Southern saw only a 33% drop in June domestic traffic (and a 69% load factor).
All three of China’s national airlines are benefitting from deeper cutting at Hainan Airlines, a carrier troubled even before the crisis. Its survival required significant government assistance, details of which are murky. But what’s unhidden is a big 54% contraction in June domestic traffic, on 44% less capacity. Load factor was 73%. Hainan might be shrinking dramatically, creating opportunities—or at least relieving pressure—for Air China, China Eastern, and China Southern. But the Big Three aren’t getting any help from the low-cost carrier Spring Airlines. It’s carrying more domestic traffic this year than last, as its 10% increase in June RPKs reveals. Counterintuitively, Spring increased its June domestic capacity 18%. But not without reason. Spring needed somewhere to redeploy narrowbody planes that were flying internationally, to markets like Japan, South Korea, and Thailand. It also had a sizeable presence in Hong Kong, Macao, and Taiwan. The only other mainland Chinese carrier reporting June traffic was Shanghai’s Juneyao Airlines. Its domestic traffic dropped 33% on 17% fewer ASKs.
It’s a lot of numbers to digest, but the larger tale they tell is one of ongoing overcapacity and still rather weak demand. As Reuters reported last week, and as Cirium FlightStats data show, July reveals further progress relative to June’s number, with domestic flight departures at about 80% of normal levels, and domestic traffic at about 70% of normal levels. July though, is a peak leisure travel month. And rising demand reflects heavy fare discounting.
As they look beyond the Covid crisis, into 2021 and thereafter, Chinese carriers will have new challenges to confront. One is a world in which China’s economic relationships with other countries could look very different. A big part of China’s four-decade rise to economic superpower involved importing raw materials and exporting manufactured goods. This model generated international air traffic to all parts of the world. But greatly rising geopolitical tensions could limit future travel demand. U.S.-China relations have rarely been worse. Relations with Canada, India, Japan, Australia, Vietnam, parts of Africa, and much of Europe are likewise tense. Controversies over Hong Kong, Taiwan, human rights, Huawei, intellectual property theft, territorial claims, and military investment have many foreign governments rethinking their economic ties with Beijing. Less at risk but not immune is tourist and student traffic, with outbound demand from China a major component of economic growth for nations like Thailand and Australia, and no less an important driver of demand for Chinese airlines.
Tensions with the U.S. have already led to trade wars damaging to airline cargo revenues. Beijing’s tightening grip on Hong Kong, meanwhile, threatens the city’s status a global financial and tourism center (Air China, remember, has a large ownership stake in crumbling Cathay Pacific). China, of course, hasn’t just imported raw materials like oil, coal, and copper over the course of its economic ascendancy. It also purchased hundreds of billions of dollars of Boeing and Airbus aircraft for its airlines. As tensions have escalated in recent years though, new orders have declined sharply. Even pre-crisis, Boeing cited a slowdown in widebody sales to China as a major setback. Western countries now worry about overdependence on China for crucial medical equipment. But China is equally vulnerable with its dependence on Western-built aircraft. It’s trying to build its own planes as substitutes. Progress on its C919 narrowbody most importantly, has been slow. And besides, the C919 relies on Western technology, like GE engines. The smaller ARJ-21 plane, for its part, recently joined the fleets of several domestic airlines, which didn’t have a choice in the matter. One day, Chinese-built aircraft might be every bit as good, if not better, than those produced in Seattle and Toulouse. But that could take a decade or more, before which Chinese carriers will be forced to fly more and more uncompetitive aircraft.
Geopolitical risk might ultimately prove less threatening to Chinese airlines than it now appears. But it at least merits a rethink of pre-crisis international expansion strategies. This time last year, China Eastern, China Southern, Hainan Airlines, Spring Airlines, Sichuan Airlines, Juneyao, and Shandong Airlines were all growing international seat capacity by double digits, according to Cirium schedule data. Juneyao, on the receiving end of B787-9s, told China Daily earlier this year that it still intends to launch service to Istanbul, Athens, Manchester, and Reykjavik when the Covid pandemic resides. China Eastern and China Southern were both building major hubs at Beijing’s newly opened Daxing airport, counting on support from foreign partners like Delta and American, respectively. These plans might in retrospect seem better fit for a world that no longer exists.
Helpfully, Chinese carriers don’t have many new widebodies on order, especially with Hainan likely abandoning B787 and A350 orders. Hainan’s contraction, as mentioned, will itself be helpful to rivals as they navigate a post-pandemic market both at home and abroad. Lower fuel costs, a managed currency, reduced need for pricey foreign pilots, tax relief, and government efforts to stimulate domestic tourism will help. So will the cost advantage Chinese carriers will continue to hold versus many of their foreign peers. Remember too that China might be the only major economy in the world that grows this year. The activity might be more domestic than international, but the domestic market is big and getting bigger. The question is, can airlines adapt?