Turbulent times

It doesn’t happen very often: a major company announces a multibillion share sale only to report net losses a month later that exceed the fundraising in size.

Investors who took part in Air China’s Rmb15 billion ($2.15 billion) placement last month will be dealing with their disappointment, after the airline reported a record Rmb19 billion loss for the first half of 2022. But the situation is also a sign of the tough conditions afflicting the Chinese airlines, with little sign yet of better times ahead.

A dismal first half…

The reporting season for the fiscal first-half has just concluded for China’s listed firms. Aviation and tourism were the two industries with the ugliest results as the country continues to adhere to strict restrictions and quarantine controls to contain the spread of Covid-19.

The ‘Big Three’ carriers – aka Air China, China Eastern and China Southern – reported nearly Rmb50 billion in combined losses for the six months ending in June, which means the trio of state-owned firms have been running up losses at a rate of Rmb270 million a day.

That first half figure also exceeded the trio’s full-year loss in 2021, when the Chinese aviation industry was already clocking up record deficits.

Interim losses at Air China and China Eastern have both tripled from the same period last year to nearly Rmb19 billion. That of China Southern widened 1.5 times to Rmb11 billion.

The horrific numbers keep coming: Air China and China Eastern saw revenues dive more than 50% from a year earlier, while China Southern reported a 33% slide as the pandemic forced the Chinese to stay home and avoid flights.

Indeed, the four largest lossmakers among the entire universe of A-share firms were all airlines, National Business Daily reported, with Hainan Airlines joining the Big Three in a catastrophic quartet. The four carriers managed to bleed more red ink than the aggregate deficits of the next 20 lossmakers combined, the newspaper said.

Why were the results so bad?

The global travel industry has started to show signs of recovery as countries come out of Covid-19 chaos. In China there’s been less of a transition away from pandemic paralysis, of course, with the government persisting with ‘zero-Covid’ containment policy. That’s kept a strict lid on international travel: China data from flight information provider VariFlight shows around 100 international flights a day compared to more than 2,600 before 2020.

Domestic travel has also been severely constrained. Each of the nation’s four tier-one cities were subjected to some kind of lockdown for months-long periods earlier this year. Many flights from the country’s busiest airports have also been cancelled as residents have been made to stay at home or prevented from travelling to other areas.

Something similar has happened in some of China’s tourist hotspots, most notably the much-visited island of Hainan, where more than 100,000 tourists were trapped in hotels by a lockdown last month. Tens of thousands of holidaymakers were also stranded in Tibet or confined to their quarters in beach town Beihai, for similar reasons.

Unsurprisingly this has meant fewer flights on offer from the country’s carriers, with the number of passengers dropping 37% to 118 million compared to the same period in 2019, according to data from the Civil Aviation Administration of China (CAAC).

For Air China, domestic travel contributed only Rmb16 billion in revenue in the first half. Contributions from Hong Kong, Macau and Taiwan accounted for less than 3% of sales as well (and Air China also booked a Rmb423 million loss on its shareholding in Cathay Pacific, the flagship carrier of Hong Kong, which has also been largely grounded).

For the flights that are still being flown, the Chinese carriers are having to respond to volatile fuel prices triggered by the war in Ukraine. The sector is also one of the most vulnerable to a depreciating yuan, given that much of the sector’s debt, and many of its more significant expenses like fuel and aircraft leasing fees, are denominated in foreign currency.

As the Chinese currency weakened sharply against the US dollar this year, the Big Three reported a combined Rmb5.6 billion in foreign exchange losses. Assuming other variables remain unchanged, Air China warns that every 1% depreciation of the yuan against the dollar trims a further Rmb319 million from its bottom line.

Surely things can’t get worse in the second half?

After such a grim first half, aviation regulators have been trying to outline a rosier outlook for the industry. “The civil aviation sector has shown a V-shaped recovery,” an official from the CAAC claimed hopefully at a press conference in July. The regulator also noted that the number of flights had exceeded 10,000 a day in July and surpassed 12,000 on some days, which amounted to 65% of pre-epidemic levels.

Recovery momentum had also been spotted in air cargo tonnage, the CAAC said. For instance, cargo volume in April rebounded to nearly 70% of the same period in 2019 and jumped to 90% in June.

The more optimistic commentary focuses on the pent-up demand for air travel that is likely to be released when Covid restrictions are lifted. The Big Three have been also been trying to focus on the opportunities over the longer term. In early July Airbus announced a groundbreaking ‘group purchase’ in which Air China, China Southern and China Eastern have committed to buying nearly 300 passenger jets (mainly A320s), for instance. At $37 billion, it is the biggest order ever by the state-owned airlines.

Aircraft deals like these have usually been completed during high-level diplomatic visits (see WiC592). That’s been harder to arrange over the last three years because of the disruption to diplomatic travel. Yet commentators still greeted the news of the Airbus deal as a shot in the arm for a beleaguered sector because it looks beyond the current crisis to a better future.

Indeed, the unprecedented circumstances even meant that the Chinese carriers got a better deal, it was claimed. “Against the backdrop that the aviation market has not fully recovered [from the Covid-19 pandemic]… the company has obtained conditions more favourable than ever in terms of pricing and some other commercial terms,” China Eastern explained in a stock exchange circular.

The Shanghai-based carrier has undertaken to spend Rmb86 billion on deliveries of 100 A320s between 2024 to 2027 in order to meet “the growth potential of China’s domestic market”.

Can Chinese carriers cope financially in the short term?

Following the dire first half, the CAAC said the sector had been hit by more than Rmb300 billion in losses since late 2019 (when Covid-19 was first reported in Wuhan).

To put that in perspective, total profits for all the Chinese carriers in the five years to 2019 stood at about Rmb160 billion.

The airlines have also been struggling to absorb the heavy weight of soaring debts, with the CAAC acknowledging that at least 12 carriers were suffering from negative equity status by the end of June.

With more funding required, some of the biggest carriers have announced plans to recapitalise. The state-led restructuring of HNA Group has seen control of the conglomerate’s crown jewel Hainan Airlines transferred to energy firm Fangda, for instance, following a Rmb38 billion cash injection last year. In May China Eastern announced a Rmb15 billion fundraising involving 38 domestic investors. Air China also came up with its own (earlier mentioned) Rmb15 billion share sale last month.

Much of the cash infusion has been provided by state-owned enterprises, often by the various unlisted parents of the carriers concerned, although National Business Daily reckons that fund managers are starting to get more interested in the share prices of some of the carriers after the prolonged sell-offs in recent years.

Local research analysts point out too that the industry will continue to get ‘policy protection’ from an anxious government. Indeed, the Ministry of Finance announced earlier this year that it would offer subsidies to help the airlines weather the Covid-19 downturn. Cash support was provided when average numbers of flights on domestic routes fell to fewer than 4,500 a day.

Meanwhile, the State Council has made Rmb150 billion available in “emergency loans” for the sector, as well as granting a Rmb200 billion quota for carriers to raise new funding themselves by selling debt.

Tax rebates for the industry also amounted to Rmb12.5 billion during the first half of 2022, Caijing magazine reported.

Chinese leaders are travelling abroad again…

Underlying the cautious approach to containing the pandemic, senior political figures including Chinese President Xi Jinping have shunned overseas trips over the past two years.

However, in a potentially significant change in direction the foreign ministry of Kazakhstan confirmed this month that Xi will visit the central Asian country on September 14 in what will be his first foreign visit since the beginning of the Covid-19 pandemic (Xinhua has yet to confirm the news).

Li Zhanshu, one of the seven members of the Communist Party’s Politburo Standing Committee, also travelled to Vladivostok in Russia this week to attend a forum that featured Russian leader Vladimir Putin.

Chinese airline bosses will be hoping that journeys like these are a tentative signal that other passengers will start to return to domestic and international routes, especially once the all-important 20th National Congress has concluded next month.

“Chinese President Xi Jinping is one of the very few – if only – state leaders in the world to have avoided overseas travel in the past two years because of Covid-19,” the South China Morning Post noted, adding in an article this week that face-to-face diplomatic activities may indicate the “beginning of the end” of the zero-Covid policy.

---

© ChinTell Ltd. All rights reserved.

Sponsored by HSBC.

The Week in China website and the weekly magazine publications are owned and maintained by ChinTell Limited, Hong Kong. Neither HSBC nor any member of the HSBC group of companies ("HSBC") endorses the contents and/or is involved in selecting, creating or editing the contents of the Week in China website or the Week in China magazine. The views expressed in these publications are solely the views of ChinTell Limited and do not necessarily reflect the views or investment ideas of HSBC. No responsibility will therefore be assumed by HSBC for the contents of these publications or for the errors or omissions therein.