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Morningstar | Air China's 3Q 2018 Result Muted by Currency Losses and Elevated Fuel, FVE Maintained at HKD 7.70

No-moat Air China reported third-quarter results that featured solid revenue growth, but higher fuel costs continued to weigh on profitability. Third-quarter profit was also dragged down by currency losses, coming in at CNY 3.7 billion down 38% year on year. The group’s average ticket yield also posted stable growth amid capacity expansion in the third quarter, and steady demand for air travel in China indicates likely solid top-line growth ahead. We maintain our fair value estimate for Air China at HKD 7.70.

On the revenue side, strong revenue was primarily driven by 9% capacity expansion, namely the introduction of new routes and increased frequencies on existing routes. We think Air China’s future expansion will come mostly from international routes, given major Chinese airports are all running at around full capacity. However, the carrier still has plenty of room to optimize its Chinese domestic routes by swapping in more profitable routes at most popular airports. The group's overall passenger load factor also posted a decent increase of 0.13%, demonstrating the carrier's ability to fill new seats. During the third quarter, Air China's freight operation also posted increases in both capacity and demand. We are less optimistic on the carrier’s cargo operation amid U.S.-China trade war, despite the company’s ongoing efforts to shift freight mix toward high-value products.

On the cost side, we still see cost-cutting efforts bearing fruit. Although a surging oil prices drove fuel costs up by 35%, the group's operating costs per revenue metric ton kilometers excluding fuel continued to drop year over year. While optimistic in the carrier’s devotion to cut costs, we continue to think the long-term positive impact on the bottom line will be somewhat muted, as some of the cost savings will inevitably be passed onto the end consumers, given that the airline operates in an industry that is highly exposed to low switching costs and price transparency.