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Morningstar | 601111 Updated Forecasts and Estimates from 15 Feb 2019

Air China has cemented its number-two position in terms of revenue through a series of acquisitions dating back to 2001. The 2010 acquisition of Shenzhen Airlines reinforced the company's competitiveness at its home base in Beijing, as well as in new domestic destinations, such as Kunming. Moreover, the acquisition also gives Air China enough heft to go head-to-head with China Southern, China’s largest domestic carrier in terms of sales, by penetrating the latter’s home market, the Pearl River Delta region. However, this doesn’t change the broader industry landscape. The Chinese airline market remains a triopoly, and all three airlines enjoy little pricing power, despite their dominant market share leadership positions. Highly overlapping domestic routes and aggressive pricing competition in emerging passenger travel regions have induced serious pressure, and rapid expansion of nationwide high-speed railway network cuts into the profitability of regional flights. As a result, robust passenger traffic growth, on the back of a high load factor, has not translated into incremental ticket pricing growth. While the international market has been a strong top-line growth driver, with capacity deployment expanding at 10-12% annually, the ramp-up in capacity utilization and introductory pricing will weigh on pricing in the foreseeable future.While Air China has done a decent job in terms of ticket yield management, suffering the least decline out of the Big Three, we believe these structural issues will likely persist, making meaningful margin improvement very difficult without a substantial drop in fuel cost inputs. Still, we see several areas of potential profitability improvement: The ongoing transition to the direct sales channel should generate annual savings of CNY 500 million-CNY 750 million, and narrowing exposure to U.S.-dollar-denominated debt should lower foreign exchange loss to CNY 500 million in 2017 (versus CNY 4.2 billion in 2016). In the longer term, the relocation of China Southern and China Eastern to the new Beijing airport, starting in 2019, should free up the valuable Beijing-Shanghai route and international timeslots for the company.