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Morningstar | China Southern Is One of the Big Three in China, and Has No Moat Despite Significant Market Share

For the past decade, China Southern Airlines has been China’s largest airline in terms of revenue and passenger volume. The company now boasts the most comprehensive route networks among the Big Three operators (China Southern, Air China, and China Eastern), and enjoys first-mover advantage in international expansion by becoming the first Chinese member of SkyTeam, a global airline alliance.Despite its market share leadership position, China Southern does not command any pricing premium over its competitors. Highly overlapping domestic routes, aggressive pricing, and intensifying competition in international routes have induced serious pressure on all three firms. Still, things are looking up on the back of strong economic growth and limited capacity expansion ahead. China Southern is forecasting 9% capacity expansion per year until 2020, and new constraints on time slots at major airports will help support pricing level on major routes. Overall, we anticipate relatively steady yield per RPK to average CNY 0.53 for the next five years, warranting a stable earnings outlook. While we do not expect any material changes in the underlying competitive dynamics of China’s airline industry in the near future, we see several positive factors that will drive strong net income growth in our explicit forecast period: 1) Jet-fuel cost, the biggest operating cost component, will remain subdued over our forecast period. The Brent oil price should rise marginally to the USD 60 per barrel range in 2019, and our energy team forecasts the midcycle price to slowly decline to USD 55 per barrel by 2022. 2) The increasing shift toward the direct sales channel will help shave off CNY 1 billion-CNY 1.5 billion of sales expense per year. 3) We expect international traffic revenue to grow at 9% annually until 2022, owing to rapidly growing domestic demand for international tourism amid a booming middle class, which should help offset the virtually flat domestic top-line growth. Additionally, we anticipate a decreased headwind from Chinese yuan depreciation, as China Southern is actively reducing its U.S.-dollar-denominated debt exposure to less than 30% in 2017 (from over 39% in 2016).