Chinavestor Downgrades China Southern Airlines to Hold

ZNH_09Q3thumb Dec. 29, 2009 (Scott Lin) -This report is available in pdf format: click here

Summary
We recommend a HOLD rating on China Southern Airlines Limited (NYSE:ZNH), as we expect recovery in passenger demand and earnings to be gradual and slow in 2010. With government financial intervention to relieve its debt-to-equity ratio, earnings is set to stabilize along with the domestic travel economy. However, the outlook is cautious and more funding is required to shore up more debt relief.

- Company overview

China Southern Airlines (NYSE:ZNH) joined Skyteam alliance in 2007. China Southern Airlines (NYSE:ZNH) is China’s largest airline with 54 international offices, 13 branches, 18 domestic ticket and sales offices in China, 5 holding subsidiaries and 2 bases. It is China’s largest domestic airline with 160 domestic routes. China Southern Airlines flies in 169 cities in 27 countries, however it flies mostly on domestic routes. On 16 July 2008, it achieved a Five-Star Flight Safety Award rating from the General Administration of Civil Aviation (CAAC) – China Southern Airlines (NYSE:ZNH) is the leader in flight safety and international leadership amongst Chinese aviation carriers. Beijing and Guangzhou are China Southern Airlines’ hubs to extend across Asia. It operates 348 aircraft – they comprise of Boeing, Airbus and McDonnell Douglas series aircraft.

-Earnings increase buoyed by higher demand and government subsidy

China Southern Airlines (NYSE:ZNH) recently posted a third quarter profit of $284M RMB, compared to a $830M RMB loss one year earlier.


Key Income Statement Data	1^st half 09	2nd half 08	1st half 08	2^nd half 07	1st half 07
In Millions of CNY or RMB
Total Operating Revenue	24268	26724	28564	24556	29845
Total Operating Expense	25034	27984	33783	24574	28382
Other income (net)	11	53	(112)	80	50
Operating Income (loss)	(755)	(1207)	(5331)	62	1513
Net non-operating income	983	4216	(2402)	386	918
Net Income Before Taxes	228	905	(5629)	448	2431
Tax / tax credit	(93)	4	(66)	(222)	(625)
Net Income	135	909	(5695)	226	1806

Key Balance Sheet Data	1^st half 09	2nd half 08	1st half 08	2^nd half 07	1st half 07
In Millions of CNY or RMB
Cash & Equivalents	4726	4649	5139	3824	N/A
Pledged bank deposits /financial asset	--	51	4	2	N/A
Total Receivables, Net	3453	2688	3169	3041	N/A
Total Inventory	1192	1229	1293	1213	N/A
Prepaid expenses	621	620	541	592	N/A
Amounts due from related companies	11	11	100	118	N/A
Total Current Assets	10003	9248	10246	8790	N/A
Property/Plant/Equipment - Net	57169	53237	56662	58441	N/A
Construction in progress	19273	17321	15698	11385	N/A
Other non-current assets	3738	3236	3394	3317	N/A
Total Assets	90183	83042	86000	81933	N/A

Total Current Liabilities	36969	41538	45632	42601	N/A
Total Long Term Liabilities	43288	32025	24747	24620	N/A
Total Liabilities	80257	73563	70379	67221	N/A
Total Equity	9926	9479	15621	14712	N/A
Total Liabilities and Equity	90183	83042	86000	81933	N/A

Market Comparisons	China Southern Airlines	Industry	Sector	S&P500
Current Ratio (MRQ)	0.24	0.94	1.76	1.09
Total Debt / Equity (MRQ)	469.06	260.59	91.20	185.50
Asset Turnover (TTM)	0.61	0.46	0.25	0.49
ROA (TTM)	-4.83	1.97	0.23	4.02
ROI (TTM)	-9.35	2.44	0.28	5.51
ROE (TTM)	-40.18	9.40	0.46	9.66
Gross Margin (TTM)	6.31	20.08	9.16	29.55
Operating Margin (TTM)	-10.95	4.20	1.41	--
Pre-tax Margin (TTM)	-7.29	2.81	0.99	8.41
Net Profit Margin (TTM)	-7.89	2.29	0.65	6.61

In the first nine months (three quarters) of 2009, Chinese domestic travelers rose 20% due to government stimulus. Overall, China’s GDP rose 8.9%, causing a rise in domestic travel.

China Southern Airlines (NYSE:ZNH) earned Net Profit of $322M RMB in the first three quarters of 2009, compared to a loss of $21M RMB year-on-year. Sales rose 9.5% to $15.95B RMB due to overall expansion in the third quarter.

According to China Southern Airlines (NYSE:ZNH) sources, the large increase in profits is due to a reduction in operating costs and financial aid of $1.57B RMB subsidy payments from the Chinese government. This boosts one-off gains by $1.30B RMB. China Southern Airlines (NYSE:ZNH) is still, however, highly levered and are still in need for additional debt finance relief.

Chairman Si Xianmin says that China Southern Airlines is set to expand in overseas markets, because of intense competition in domestic travel – air and rail. Currently, China Southern Airlines’ international portfolio comprises 17% of its total travel. In the next 3-5 years, it will rise to over 20%.

ZNH_09Q31

China Southern Airlines (NYSE:ZNH) said that its large losses in 2008 were a combination of factors. These included weaker passenger demand, cost pressure resulting from higher oil prices and impairment of fixed assets.

- Government financial aid props up Earnings-Per-Share performance measure

ZNH_09Q32

The June 2009 earnings-per-share figure does not appear as rosy as the above chart depicts. Financial aid from the Chinese government has propped up overall net profit for June 2009, totaling $1.5B RMB for China Southern Airlines (NYSE:ZNH).

- Cash and cash equivalents remain relatively unchanged

ZNH_09Q33

Cash has changed relatively little in light of the government subsidy payment. This implies that operating costs have only decreased marginally, and the large increase in net profit is due mostly to government intervention.

- Industry Analysis

Domestic aviation industry

A high speed rail network, set to be completed in 2020, will compete directly with China’s domestic airline industry. China Southern Airlines (NYSE:ZNH) operates 160 domestic routes, of which 38 will compete directly with the new high-speed rail network. Train tickets are expected to be 40% cheaper than plane tickets when the new high-speed rail network opens in 2020.

Note, however, that 2020 is still some time away, and there are more important short-term issues to resolve. The industry pressures at the moment reside mostly in waning passenger demand and rivalry with competitors. Financing is also a major issue within the aviation industry. The issue is whether the airline has enough liquidity to pay off its long-term debt. China Southern Airlines (NYSE:ZNH) has a Long-term Debt-to-Equity ratio of 276.57. Overall, the industry’s figure is also high at 220.08.

International aviation industry

Air China will expand domestically and internationally, with four new domestic routes and two new international routes. International Air Transport Association (IATA) claimed that the lull in the airline industry has reached a bottom, however warned that a ‘recovery was still a long way off.’

According to Singapore Airline’s Q2 release, the industry outlook suggests that air travel demand had stopped declining, as evidenced by the volume of pre-bookings. Current market conditions allow for a reduction of promotional pricing, but yields are unlikely to recover to pre-crisis levels within the next six months.

Japan Airlines’ recent press release of its consolidated results shows that industry conditions remain extremely difficult, with waning air travel demand. Japan Airlines has responded by discontinuing unprofitable routes, downsized flight frequencies, reduced plane sizes and other cost cutting measures to ensure an increased load factor. Both airlines are responding to industry pressures by horizontal diversification through strategic alliances with other airlines.

ZNH_09Q3JAL

Source: http://press.jal.co.jp/en/release/200911/001374.html

The load factor increase demonstrates Japan Airlines’ response to tight industry conditions by being more efficient with its capacity to demand management.

- Competitor Analysis

Competition in the Chinese domestic travel industry is increasingly fierce; Southern China Airline (NYSE:ZNH) plans to expand in overseas markets to diversify its revenue stream. Southern China Airlines’ main competitors are Air China and China Eastern Airlines Corporation Limited. China Eastern Airlines is set to merge with Shanghai airlines by year’s end. China Eastern Airlines is also seeking to horizontally diversify through joining an alliance.

Due to fierce competition, cost efficiency and liquidity are key issues to consider. Cost efficiency includes operating costs, load factors, RPK and ASK. Liquidity includes cash and cash equivalents.

- Competitor comparable RPK, ASK and load factor analysis

China Southern Airlines (NYSE:ZNH)

Central hub: Guangzhou and Beijing

China Southern Airlines (NYSE:ZNH) is China’s largest airline. It plans to double its services to Australia due to demand growth. It has enjoyed 11% passenger growth y-o-y to 5.49M, but load factor in domestic flights fell. Domestic passenger growth of 10% made up most of the increase (5.06M), regional up 17% to 104000, international travel up 12% to 326000. Despite passenger growth, overall load factor fell 4% to 72.2%.

Air China (HKG:0753)

Central hub: Hong Kong and Macau

Air China (HKG:0753) is China’s second largest airline. China posted 11% increase in passenger traffic in October, 2009 – strong growth in domestic and regional markets. Air China’s domestic RPK was up 11% y-o-y, international RPK was up 5% y-o-y and regional RPK was up 14% y-o-y. Total passenger numbers increased: domestic was up 16% to 3.1M, international was up 4% to 484000, regional was up 25% to 116900.

Capacity also increased. Domestic ASKs were up 12%, regional ASKs were up 20%, and international ASKs were down slightly 2%. Overall ASKs were up 7%.

Overall Load factor increased 3.3% to 82%. Domestic was up 2.7% to 82%, international load factor was up 4.9% to 82%, and regional load factor was down 3.5% to 72%.

China Eastern Airlines (NYSE:CEA)

Central hub: Shanghai

China Eastern Airlines (NYSE:CEA) is China’s third most valuable airline.

Passenger traffic in September rose 16%: domestic was up 22% to 3.17M, international numbers rose 9% to 349000, and regional fell 8% to 137000.

Domestic RPK were up 20% y-o-y, regional RPK were down 13% y-o-y, and international RPK was up 11% y-o-y. Overall RPK was up 16%.

Capacity: in response to decreased regional RPK, ASKs were decreased by 6%, domestic ASKs were up 24%, and international ASKs were up 5%. Overall ASK increased by 17%.

Load factor: domestic factor fell 2.5% to 71.3%, regional load factor fell 4.9% to 60.9%, international load factor rose 3.3% to 68.2%. Overall load factor fell 0.8% to 70.1%.

- Competitor comparable revenue and earnings analysis

Air China (KHG:0753)

ZNH_09Q34

Air China was able to turn a profit in interim 2009 by decreasing operating expenses by 20.86% y-o-y.

China Eastern Airlines (NYSE:CEA)

ZNH_09Q35

The revenue and net profit chart of Air China (HKG:0753) and China Eastern Airlines (NYSE:CEA) is similar. Air China ( HKG:0753) appears to have faired better for net profit over the comparative period. Air China (HKG:07530 also did not suffer as large decrease in its revenues.

- Comparable Debt Coverage Ratio analysis

ZNH_09Q36

Japan Airlines’ figures are expressed in ‘000 000 yen.

Note:

Total debt service includes: current borrowings, operating leases and net finance costs. Non-current borrowings are not included and non-current operating leases are not included in calculations.

Both China Southern Airlines (NYSE:ZNH) and Japan Airlines have a negative Debt Coverage Ratio for interim 2009. This means that both airlines have negative cash flow to cover its debt. China Eastern Airlines’ Debt Coverage Ratio of 0.071 shows that there is also not enough cash flow to cover its debt. This could pose serious liquidity problems in the short to medium term.

Annual Income Statement	China Southern Airlines
In Millions of CNY	2008	2007	2006	2005	2004
Traffic revenue	53913	53196	45087	37419	23344
Other operating revenue	1375	1205	1132	874	630
Revenues	55288	54401	46219	38293	23974
Operating expenses
Flight operations	34982	29082	25022	19394	10418
Maintenance	4890	4643	3999	4589	3459
Aircraft and traffic servicing	8476	8160	7063	5759	3503
Promotion andsales	3491	3421	2811	2780	1940
General and administrative	2041	1874	1941	2457	1323
Impairment on property, plant, equipment	1884	109	--	--	--
Depreciation and amortisation	5746	5554	4971	4440	2413
Others	257	113	100	179	9
Other (loss)/income, net	(59)	130	333	--	--
Profit from Operating Activities	(6538)	1575	645	(1305)	909
Interest Income	103	73	41	55	22
Interest expense	(1987)	(2291)	(2070)	(1616)	(691)
Share of associates’ results	(12)	57	5	(285)	10
Share of jointly controlled entities’ results	170	123	115	36	(16)
(Loss)/gain on derivatives, net	(124)	90	(19)	--	--
Exchange gain, net	2592	2832	1492	1220	(59)
Gain on sale of other investments	--	107	--	(32)	(1)
Gain on sale of jointly controlled entity	143	--	--	--	--
Gain on sale of subsidiary equity interest	37	7	--	--	--
Others, net	892	306	148	74	46
Profit before tax	(4274)	2879	357	(1846)	220
Tax	(62)	(847)	(153)	7	(65)
Net Income	(4786)	2032	204	(1846)	155

Basic net income (loss) per share	(0.74)	0.28	0.04	(0.42)	(0.01)
Diluted net income (loss) per share	N/A	N/A	0.04	(0.42)	N/A

Annual Balance Sheet	China Southern Airlines
In Millions of CNY	2008	2007	2006	2005	2004
Cash and cash equivalents	4649	3824	2264	2901	3083
Pledged bank deposits	51	--	--	--	--
Financial assets	--	2	--	--	683
Inventory	1229	1213	1315	1382	1302
Trade receivables	1317	1966	1512	1518	1203
Other receivables	1371	1075	879	956	616
Prepaid expenses and other current asset	620	592	585	380	378
Amounts due from related companies	11	118	128	84	--
Total Current Assets	9248	8790	6683	7221	7265
Property/Plant/Equipment - Net	53237	58441	56347	54266	46841
Construction in progress	17321	11385	951	674	565
Lease prepayments	531	556	441	333	346
Interest in associates	235	219	149	142	429
Interest in jointly controlled entities	1048	873	870	805	782
Other investments in equity securities	166	168	330	320	272
Lease deposits	563	659	9458	7265	5397
Available for sale equity securities	114	362	--	--	--
Deferred tax assets	167	84	95	74	316
Other assets	412	469	260	302	15
Total Assets	83042	82006	75585	71402	62228

Financial liabilities	116	5	26	--	--
Bank and other loans	22178	24948	23822	16223	11518
Short-term financing bills	2000	--	--	--	--
Obligations under finance leases	1781	2877	3091	3373	2144
Trade and bills payables	1353	1844	1909	3929	1690
Sales in advance of carriage	2244	1891	1436	1413	874
Deferred revenue	261	168	--	--	--
Taxes payable	120	500	126	28	39
Amounts due to related companies	102	194	254	116	2330
Accrued expenses	8420	7290	4942	4250	4551
Other liabilities	2963	2994	3257	3796	2974
Total Current Liabilities	41538	42711	38863	33128	26120
Long Term Bank Loans	17429	90974	10018	12740	11935
Obligations under finance leases	11157	12858	12307	12459	9599
Deferred revenue	445	422	--	--	--
Provision for major overhauls	945	683	805	301	284
Provision for early retirement benefits	179	230	306	--	--
Deferred benefits and gains	1109	1027	792	496	100
Deferred tax liabilities	761	691	372	342	287
Total Liabilities	73563	67696	63464	59466	22205

Share capital	6561	4374	4374	4374	11848
Reserves	460	7489	5814	5626	--
Minority interests	2458	2447	1933	1936	2055
Total Equity	9479	14310	12121	11936	13903
Total Liabilities& Shareholders’ Equity	83042	82006	755585	71402	62228

Annual Cash Flow Statement	China Southern Airlines
In Millions of CNY	2008	2007	2006	2005	2004
Cash generated from Operations	4256	9698	4719	5419	4555
Interest received	103	73	41	55	22
Interest paid	(2805)	(2814)	(2419)	(1616)	(754)
Income taxes paid	(399)	(88)	(46)	(23)	(227)
Net Cash from Operations	1155	6869	2295	3835	3596

Proceeds from sale of property, plant and equipment	312	288	492	238	47
Proceeds from sale of jointly controlled entity	210	--	--	--	--
Proceeds from sale of equity interest in subsidiaries	61	--	--	--	--
Proceeds from sale of other investments	--	127	--	689	--
Net cash settlement of derivative financial instruments	(11)	67	7	--	--
Increase in deferred credits	--	--	--	57	--
Dividends received from associates	--	--	33	2	12
Dividends received from jointly controlled entities	14	79	50	39	5
Dividends received from other non-current investments	14	12	7	4	13
Decrease in other non-current assets	--	--	16	4	(9)
Payment for acquisition of China Northern and Xinjiang Airline	--	--	--	(1959)	398
Payment of acquisition equity interest of minority shareholders	--	--	(12)	(118)	(72)
Payment of lease and equipment deposits	--	(86)	(5464)	(6649)	(3151)
Refund of lease and equipment deposits	54	165	2031	4619	1253
Capital expenditures	(8364)	(5502)	(2644)	(4935)	(6631)
Increase in pledged bank deposits	(51)	--	--	--	--
Payment for the investment in an associate	(29)	(10)	(31)	--	(689)
Payment for Nan Lung Freight and Air Catering	--	(58)	--	--	--
Proceeds from disposal of GZ Aviation Hotel	--	74	--	--	--
Through acquisition of CHAHC Hainan	--	--	33	--	--
Net cash used in Investing	(7790)	(4844)	(5482)	(8009)	(8824)

Proceeds from bank loans	41450	30984	24983	18238	14555
Proceeds from issue of short-term financing bills	2000	--	--	--	--
Repayment of bank loans	(33783)	(28660)	(19113)	(12193)	(7108)
Repayment of principal under finance lease obligations	(2335)	(3021)	(3313)	(2050)	(1272)
Capital contribution received from minority shareholders	--	240	--	17	71
Dividends paid to minority shareholders	(28)	(8)	(7)	(20)	(15)
Net Cash used in Financing	7460	(465)	2550	3992	6231

Net Change in Cash and Cash equivalents	825	1560	(637)	(182)	1003
Net Cash - Begin Balance	3824	2264	2901	3083	2080
Effect of foreign exchange rate changes, net	--	--	--	--	--
Net Cash and Cash equivalents - End Balance	4649	3824	2264	2901	3083

Analyst Certification

I, Scott Lin, hereby certify that the views expressed in this research report accurately reflect my personal views about the subject securities and issuers. I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or view expressed in this research report.

Other Important Disclosures

The analyst(s) responsible for covering the securities in this report receive compensation based upon, among other factors, the overall profitability of Chinavestor.com.

Copyright 2007 Chinavestor.com. All rights reserved. This research report is prepared for the use of Chinavestor.com clients and may not be redistributed, retransmitted or disclosed, in whole or in part, or in any form or manner, without the express written consent of Chinavestor.com.

This research report provides general information only. It is not intended to provide personal investment advice and it does not take into account the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. Investors should seek financial advice. Past performance is not necessarily a guide to future performance.

Fundamental equity reports are produced on a regular basis as necessary to keep the investment recommendation current.

This report © is published by Chinavestor.com. The information herein was obtained from source which Chinavestor believes reliable. However we do not guarantee its accuracy. Neither the information, not any opinion expressed, constitutes a recommendation to buy or to sell any securities or commodities.