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Fasten seat belt: Chinese airlines’ corporate earnings poised for declines after peaking in 2016

The corporate earnings of China’s airlines are expected to peak this year, declining in the coming years as a weakening yuan and rising oil prices combine to erode profit margins, BNP Paribas said.

The yuan, which has weakened by almost 5 per cent against the US dollar in the past 12 months amid a slower economy, is expected to continue depreciating into next year from the current 6/67 yuan per dollar to 7.07 per dollar in 2017 and 2018, hurting airlines that owe debt denominated in dollars, the bank said.

The unfavourable exchange rate also adds to Chinese airlines’ currency losses and operating costs, including the jet fuel and aircraft leasing, the report said.

The Chinese currency strengthened 34 per cent against the US dollar between 2005 and 2013. Combined with low dollar borrowing costs, that worked in the airlines’ favour, but a turn in the renminbi compelled China’s three biggest carriers to convert their borrowings into yuan-denominated debt.

The three carriers — China Southern Airlines, Air China and China Eastern Airlines — will still have between 30 per cent and 40 per cent of their debt in US dollars next year, not enough for them to mitigate the effect completely, BNP analyst James Teo said.

Oil prices are expected to recover to $46 per barrel in the second half of this year, up 12 per cent from the first half, causing fuel costs for the top three mainland airlines to rise by up to 24 per cent in the second half of this year and 30 per cent next year, he said.

Chinese airline profits are expected to have peaked in the first half of this year before trending downwards in the second half into 2017, but it’s not all “doom and gloom,” Teo said.

“The silver lining in the clouds is that air travel demand remains strong,” he said, adding that the yuan would eventually stabilise, and airlines could raise base fares in the domestic market to mitigate higher fuel costs.

The number of outbound trips by Chinese citizens has more than tripled from 2005 to 2015, and Chinese airlines have been expanding “aggressively” on international routes, Teo said.

The top three had seen an 11 per cent to 15 per cent decline in international yields in the first half of this year, but that was likely to improve as higher oil prices offered less room for other airlines to undercut one another.

BOCOM International Holdings’ head of transportation and industrial research Geoffrey Cheng said he expected net profits among Chinese airlines to dip next year.

“It all boils down to the currency movement in the next 12 to 18 months, that continues to be a big overhang for the airlines in China,” he said. “Next year will still be a little bit difficult. Forex loss will have a very significant effect on the bottom line, no matter how good they manage their operations.”

Airlines’ earnings may still increase in the next few years if the market was able to digest the added capacity and yields continued to improve, Cheng said.

Airlines could look at putting up domestic fares and increasing capacity of airlines to mitigate the foreign exchange losses, Cheng said.

Two thirds of the losses in the first half had been caused by US dollar appreciation against the reminbi, but airlines had also been affected by the renminbi depreciating 22.63 per cent against the Japanese yen for the year to date, he said.

“The yen appreciation caught them off guard,” he said.