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Morningstar | Air China Continues to Show Strong Cost Management, FVE Maintained at HKD 7.70

No-moat Air China reported first-half results that featured higher revenue, up 12% year on year. The carrier's operating margin remains stable, with strong cost management offsetting rising fuel price. First-half profit came in at CNY 3.9 billion, in line with our estimate. We think the latest operating data pointed to strong performance, with further pricing liberalization providing additional bottom line upside. We maintain our fair value estimate of HKD 7.70 per share and consider shares fairly valued at the current level.

On the passenger side, the carrier posted solid revenue growth for all of its major operating regions. Strong growth was primarily driven by 12% domestic capacity expansion, namely introduction of new routes and increased frequencies on existing routes. While Air China is the only one of the "Big Three" airlines that experienced a decline (54 basis points) in load factor during the first half, we tend to think the demand for added routes should soon catch up. Air China's freight operation also posted a decent 13% growth in revenue, thanks to added capacity.

Recall that Air China has a 30% stake in Cathay Pacific. We recently raised our fair value estimate to HKD 12.20 for Cathay after lifting projected passenger revenue per available seat-kilometer, in concert with its strong first-half finish. However, the resulted favorable impact to Air China's fair value estimate is largely offset by recent Chinese yuan depreciation.

Air China has done very well in keeping costs down. The group's operating costs per revenue passenger kilometers excluding fuel dropped by 4.4% year over year. While we are optimistic about the carrier's devotion to cut costs, the impact on the bottom line will be somewhat muted, as some of the cost savings will inevitably be passed onto the end consumers in the long run, given that the airline operates in an industry that is highly exposed to low switching costs and price transparency.