Flight capital

Now an aviation investment firm

Warren Buffett made a surprise swoop in November, buying stakes in four airlines in the US with a $1.3 billion investment. Famous for disdaining the sector as a “death trap”, the billionaire seems to have changed his mind, basing his bet on cheap valuations in an industry that has been consolidating around the bigger players (Buffett bought shares in Delta, United, American and Southwest Airlines).

But from China the news is that one of the leading aviation groups is planning to diversify its activities away from flying. China Eastern Air Holding (CEAH), the parent firm of China Eastern Airlines, says it wants approval from Sasac (which oversees more than a hundred of the largest SOEs) to operate as an investment firm.

Wang Haitao, a vice president in the aviation group’s strategic development unit, tells CBN that the restructuring will allow CEAH to explore new opportunities. That makes it look like a similar move to some of the activity we reported at HNA Group last month, although CEAH isn’t likely to be quite so acquisitive (see WiC346).

The move came at a time when the State Council is putting the brakes on Chinese firms’ outbound M&A deals, especially those outside a company’s core business. Operating as an “investment firm”, rather than an aviation group, would allow CEAH more flexibility to expand beyond a market where passenger numbers have been on the rise but competition is putting downward pressure on fares.

China Eastern has been positioning itself as more innovative than Air China and China Southern, after selling a stake to Delta Air Lines last year. In April it also brought in Ctrip, a leader in online travel services, as a strategic investor. The partnership is focusing on distribution and e-commerce, while the Delta deal brings cooperation on code sharing and route planning.

Both initiatives have signalled a readiness to shake up its business and China Eastern claims the same at China United Airlines, its low-cost offshoot, which was launched two years ago (see WiC247).

The introduction of the budget carrier is part of China Eastern’s multi-brand strategy, with Shanghai Airlines serving as another of its wholly-owned subsidiaries.

Now its bosses want to try their luck in other parts of the aviation world, where there are plans to embrace the ‘Internet+’ era with investment in new products, technologies and business models.

China Eastern reported profits of Rmb6.7 billion ($970 million) for the first nine months of this year, up 25% year-on-year. Performance was boosted by lower fuel prices, where Chinese airlines generally aren’t hedged. Jack Xu, an analyst in HSBC’s transport team, says that China Eastern is getting higher prices than its peers on its domestic network because it has a better share of traffic between top-tier cities.

However, the drop in the renminbi is going to put pressure on profits across the sector. Aircraft ownership and jet fuel costs are denominated in US dollars, while most of the revenues are earned in yuan. Last year’s unexpected dip in the renminbi saw a surge in forex losses for the leading carriers and declines this year are eating into their profits again. China Eastern is the most exposed to currency risks, with analysts reporting that each 5% change in the dollar translates to Rmb3.4 billion in losses or gains, compared to Rmb2.8 billion for Air China and China Southern.

That’s largely because China Eastern has the most dollar debt, although HSBC’s Xu estimates that the airline has driven down its dollar liabilities by half this year to around 40% of its total debt. This has been achieved by raising billions of yuan in share placements, domestic bonds and short-term financing, and retiring as much of the dollar debt as possible.

Nonetheless, China Eastern is exposed to higher borrowing costs if interest rates increase. With a net debt-to-equity ratio of 106% at the end of June, almost half of its interest-bearing liabilities are repayable within a year, and most of its longer-term liabilities carry floating interest rates, the South China Morning Post has reported.

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