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Morningstar | China Southern Airlines' 4Q Results Beat Our Estimates, FVE Maintained; Shares Fairly Valued

No-moat China Southern Airlines’ fourth-quarter results come in slightly ahead of our estimates, but this was primarily driven by an around 40% surge in bottom line in government grants received. Our fair value estimate for China Southern is unchanged at HKD 7.8 (CNY 6.80). While the carrier’s near-term capacity growth will be matched by strong demand for air travel, we do not see any more upside in yield over the next five years. We also believe the indefinite grounding of Boeing 737 MAX 8 planes will weigh on the group’s capacity expansion in 2019, but the exact impacts will depend on the outcome of investigations. The shares of China Southern are fairly valued in our view.

During the fourth quarter, the flagship carrier grew overall available-seat-kilometers, or ASK, by 11.8%, led by 12.9% growth in international capacity. Demand, on the other hand, trailed supply by 90 basis points. Like its peer China Eastern, China Southern expanded its capacity quite aggressively during the first two months of 2019. However, unlike China Eastern which focused its expansion on Chinese domestic flights, China Southern has been pumping ASK onto the international front. At the same time, we continue to see demand outgrowing supply since the start of the year. We believe that China Southern and its peers will continue to benefit from close ties with the government and each other, which should enable them, collectively, keeping capacity growth in line with that of demand over the long-term. Thus, we expect a stable load factor for China Southern Airlines over the next five years.

On the yield side, however, we are less optimistic. Considering our oil price forecast of a total 15% drop in Brent over the next five years, we now expect the carrier’s yields to decline by a total of 800 basis points over the next five years, in line with the carrier’s past performance. Furthermore, the ongoing liberalization of the Chinese aviation market is creating the perfect breeding ground for low-cost airlines. At the end of 2018, as many as 21 airports in tier-two Chinese cities operated international flights, up from only three airports in 2009. Coupled with the rise of domestic low-cost-carriers like Spring Airlines and loosening of the regulations in the overall aviation industry, we believe legacy carriers will find it difficult to control as many slots in the new airports, as they did in tier-one hubs. As a result, legacy carriers like China Southern will most likely expand capacity at rates below those of the market.

When it comes to the issue of the grounding of 737 MAX aircraft, we think it will take about two months for Boeing to repair the MCAS software, certify the plane, and train pilots. We estimate that 747 MAX 8 aircraft makes up a sizable portion of the group’s 2019 planned deliveries. China Southern can certainly slow their planned 45 aircraft retirements to fill some of the void left by delays in 32 MAX 8 deliveries, but it is unlikely the group can fully offset the groundings' adverse effects. Therefore, we now see China Southern expanding its passenger capacity by 8.9% in 2019, lagging the expected growth rate of the overall industry.