EUR 850.00 For Business Accounts Only

Morningstar | China Eastern Airlines' 4Q Results in Line, FVE Maintained; Shares Remain Overvalued

Our fair value estimate for no-moat China Eastern is unchanged at HKD 4.25 (CNY 3.70) following fourth-quarter results because the impact of slower capacity expansion was offset by markedly stronger yield. 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 China Eastern’s capacity expansion in 2019, but the exact impacts will depend on the outcome of investigations. The shares of China Eastern are overvalued in our view.

During the second half, the flagship carrier grew overall available-seat-kilometers, or ASK, by 7.5%, led by 8.6% growth on the domestic front. Demand, on the other hand, lead supply by 180 basis points. During the first two months of this year, China Eastern did not hold back its capacity increases, putting 16% more ASK onto the domestic market than it did a year ago. Despite aggressive ASK deployment, demand for China Eastern’s domestic routes grew by a staggering 18%. China Eastern and its peers have benefited from close ties with the government and each other, which should enable them, collectively, to keep overall capacity growth rates in line with demand over the long term. We, therefore, expect to see a stable load factor for the carrier 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 China Eastern’s yields to decline by a total of 840 basis points over the next five years, in line with the carrier’s historical 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 Chines 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 Eastern 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. According to the group’s fleet plan, 747 MAX 8 aircraft make up 11 of 60 planed deliveries in 2019. Unlike other airlines who can slow their 2019 aircraft retirement to offset somewhat some of the void left by delays in MAX 8 deliveries, China Eastern only planned one aircraft to retire this year. As a result, we think the carrier will be more affected by the grounding, leading to our 2019 capacity expansion forecast of merely 7.4%.