C is for Trouble: New airlines, new planes and new capacity promise more yield pressure in China
From 2010 through 2012, Chinese airlines experienced their own set of C-lettered tailwinds. Their market likewise consolidated, with China Eastern buying Shanghai Airlines and Air China buying Shenzhen Airlines. Collusion on pricing and scheduling, hard to prove but widely acknowledged in a market without rigorous antitrust enforcement, helped too. Currency appreciation shielded Chinese carriers from dollar-based cost inflation, most importantly for fuel but also for maintenance, debt and aircraft leases. And while capacity growth was bullish, so too—unlike in the U.S.—was economic growth. Sure enough, in the three years 2010, 2011 and 2012, China’s four largest airlines—Air China, China Southern, China Eastern and Hainan Airlines—collectively managed close to $10b in net profits, with a 6% operating margin. Things were, to use another C-word: cheerful.
In 2013, U.S. carriers sustained their earnings momentum. But Chinese carriers did not. The big carriers managed just a 2% operating margin. China Eastern actually regressed back to operating losses, and China Southern barely broke even.
What happened? In short, a host of C-lettered headwinds: cargo losses, costly congestion, conflict with neighboring countries, cost inflation, crew shortages (especially pilots), competition from high-speed rail, cross-Strait competition, a crackdown on wasteful government worker first-class flying and a cooling economy, even as capacity again expanded by double digits. In addition, currency appreciation has given way to currency deprecation—after strengthening some in 2013, the Chinese yuan has weakened thus far in 2014.
Yield figures for Chinese carriers, particularly on domestic routes, are the clearest evidence of distress. Air China’s passenger yields last year plummeted 9% y/y, and those for its Shenzhen Airlines affiliate dropped 10%. China Eastern’s fell 8%. China Southern, even disregarding its bullish yield-depressing overseas expansion, saw even domestic yields plunge 12%.
Will the downward trend reverse? The answer to that question, of course, depends in large part on whether China’s economy is headed for further distress—as economists who point to real estate bubbles and financial system vulnerabilities contend—or a period of stabilization. But either way, established airlines should worry, because another major trend is transpiring, one that threatens further yield erosion both domestically and to the near abroad. China’s consolidated market, alas, is once again fragmenting.
One reason for this is government policy. For most of the past decade, Beijing championed consolidation and protectionism for the Big Three. In the mid-2000s, China…
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