Pearl River Quiver: China Southern becomes a loser among winners as challenges mount

With fuel cheap, demand still strong and seat supply constrained by airport infrastructure, government policies and consolidation, Chinese airlines—at least for the time being—are winners. But China Southern seems a loser among winners. It was indeed profitable in Q2, but its operating margin was just 5% compared to 9% for China Eastern and 14% for Air China. It was alone among China’s Big Three to see margins drop y/y. And China’s Pearl River Delta region, the airline’s most important market, is among the country’s most competitive.

Like all Chinese airlines, China Southern is unburdened by fuel hedges and benefiting from strong demand as government policies shift away from encouraging exports and investment in favor of driving household spending—on air travel, among other things. Soaring property values in China’s biggest east coast economic centers and thriving technology companies, meanwhile, are offsetting slower national GDP growth overall. In addition, China’s Big Three are to some extent insulated from competitive threats by airport capacity shortages and regulations like the “one route, one carrier” policy on international routes.

At the same time, China’s major airlines, China Southern included, are gradually bringing their commercial and operational management to international standards, forming overseas airline partnerships, developing their e-commerce, growing their direct distribution, lowering travel agency commissions, signing more corporate contracts, inducting the latest-generation aircraft, increasing ancillary revenues, adding services like inflight Wi-Fi, luring sixthfreedom traffic through their hubs and now starting to exploit their giant frequent flier programs—the largest programs, in fact, outside North America.

But for all these encouraging developments, others are more worrisome, and many affect China Southern more than others. As China’s original export powerhouse, the Pearl River Delta is now bearing an outsized portion of the pain from slowing global trade, decimating airline cargo markets in the process. China Southern’s cargo revenue shrank 5% y/y in 2015, reducing its importance to just 6% of total company revenues. Not only does the airline fly cargo in the bellies of its passenger planes. It also operates 14 dedicated freighters, all large widebodies flying primarily from Guangzhou and Shanghai.

China Southern is likewise affected by China’s weakening currency, which has lost about 7% of value since the beginning…

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