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January 26, 2010

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Bumpy flight to recovery for airlines

China's airline industry is expected to continue the recovery that started last year amid rising demand for seats and cargo space, and expectations of an appreciating yuan, analysts said.

But they see headwinds on the horizon as air travel faces increasing competition from new bullet train services across China.

Domestic carriers handled a combined 230.5 million passengers in 2009, up 19.7 percent from a year earlier, the Civil Aviation Administration of China said. Cargo handling rose 9.3 percent to 4.45 million tons.

The 2009 performance was a big improvement from 2008, when passenger volume edged up only 3.3 percent and cargo growth was almost flat with a 0.3 percent gain.

"Air demand is expected to grow 13 percent to 15 percent this year, with airlines expected to add between 10 percent and 12 percent capacity," said Tao Wei, an airline analyst at China International Capital Co Ltd. "That will improve load factors and ticket prices for domestic carriers.

"In addition to that," she added, "as a recovery in exports increases the possibility of an appreciation of the yuan in March and April, the performance of airlines will be further boosted by exchange gains."

The appreciation of the yuan will cut the repatriated value of US dollar-denominated debts for the airlines. For every 1 percent rise in the value of the yuan, earnings per share increase 0.04 yuan (0.59 US cent) at China Southern Airlines, 0.3 yuan at China Eastern Airlines and 0.02 yuan at Air China, according to Tao.

China's aviation industry flew back into the black last year with aggregate net profit of 12.2 billion yuan on hefty fuel-hedging gains after the oil price more than doubled. That followed a record 28 billion yuan loss in 2008.

"The oil price isn't likely to grow significantly this year, and new mechanisms linking the jet fuel price with fuel surcharges will partly offset any climbing fuel costs for domestic carriers," Tao said.

Although the industry's prospects are looking up, it's not all blue skies ahead for the industry. One of its more serious challenges lurks on the ground below.

The government said it plans to build 42 high-speed rail lines spanning 13,000 kilometers over the next three years. As bullet trains become more numerous, it may be harder for the airlines to get bums on seats.

A high-speed railway linking Guangzhou in southern China with Wuhan in the middle of the country started running in December, paring the trip to three hours from 10-and-a-half hours previously. That compares with a 90-minute air flight, excluding the time it takes to get to the airport, check in and wait at the gate.

The one-way fare by bullet train from Wuhan to Guangzhou ranges from 490 yuan to 780 yuan. Domestic carriers on that route have been forced to reduce ticket prices by as much as 80 percent to compete.

Guangzhou-based China Southern even increased flight frequencies linking the two destinations to try to forestall a loss of air passengers.

"Big cities such as Beijing, Shanghai and Guangzhou are key hubs in the high-speed railway network as well as key markets in the aviation industry," said Zou Jianjun, a professor at Civil Aviation Management Institute of China.

"Frequent flights may help airlines hold on to passengers in the short run, but the strategy won't work in the long run due to its weak profitability, so the high-speed railways will push the airlines to restructure further in the future," he said.

China Southern also plans to begin talks with railway authorities in March about possible cooperative ventures to make connections between air and rail transit more seamless, encouraging rail passengers to consider flights for part of their trips.

Macquarie Equities Research said it expects high-speed rail to become more of a diversionary factor for Chinese airlines beginning in 2012 or 2013, once the new networks are completed.

"China Southern has the largest exposure on its routes between hub and focus cities, but we think its proactive approach in seeking to cooperate with high-speed rail provides a long-term solution for mitigating the risk of intermodal substitution," the research company said.

Mergers and acquisitions will also shape the domestic airline industry this year. Shanghai-based China Eastern is expected to complete its takeover of Shanghai Airlines next month, increasing its market share in China's commercial center to more than 50 percent.

China Southern and rival Air China are circling Shenzhen Airlines as a possible takeover target, with an eye toward increasing their presence in the south of the country, according to sources.

China Southern fueled takeover speculation last month when it signed a cooperative agreement with the Shenzhen municipal government as part of efforts to raise its share of the Shenzhen aviation market to 50 percent from 30 percent in the next five years.

Although there was no mention of a stake in Shenzhen Air, media reports said China Southern has already talked to Beijing authorities about a possible purchase. Its director refused to comment.

Air China, which already owns 25 percent of Shenzhen Air, is also a player. The Beijing-based carrier took over management of Shenzhen Air after the carrier's former boss and majority stakeholder, Li Zeyuan, was arrested in November for economic crimes.

Privately owned regional airlines in China are facing nationalization in the aftermath of the global financial crisis. Chengdu Airlines, reorganized from China's first private carrier, United Eagle Airlines, started operation this month.

United Eagle Airlines, founded in 2004, suffered a cash crunch when the economic crisis slashed travel demand. It was acquired by state-owned Commercial Aircraft Corp of China, Sichuan Airlines and Chengdu Communications Investment Group last year.


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