A Little Trouble in Big China Airlines

By Greg Sushinsky | February 26, 2009 AAA

The miracle of the Chinese economic boom, where everything from Chinese infrastructure stocks to Chinese internet stocks have reaped the rewards of unprecedented growth, has been duly celebrated by observers and investors. Yet, one Chinese industry - the Chinese airlines - has run into turbulence. China Southern (NYSE:ZNH), for one, has found the skies less than friendly recently.

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The Setup
One of the well-known reasons for China's recent boom economy is the presence of the country's not-so-silent partner, the Chinese government, in all things business. The Chinese government is a major stakeholder in large companies in important industries and, clearly, carries the loudest voice - if not the biggest stick - in setting policies. In addition, the Chinese economy is macro-engineered by aggressive stimulus packages and the backing of businesses and stocks in a way that is unlikely to be seen in the West. What the U.S., Canada and Europe regard as government involvement in business has a huge influence in the Chinese economy, its companies and stocks. A February 3, 2009 Reuters article describes "the state-owned Assets Supervision and Administration Commission [as] the ultimate owner of all Chinese state firms."

The Problem
Despite seeking an advantage through active government management and economic oversight, ultimately, global economic conditions have their say. Like the rest of the global airline industry, China Southern, China Eastern (NYSE:CEA) and Air China Limited - the big three flyers in China - have not been immune from significant declines in business due to people flying less. Indeed, the airlines previously sought emergency funds from the government, so this is not new.

In 2008, Chinese air travel declined for the first time in five years. China Southern, like its Chinese competitors, flies mostly domestically, although it services some international routes - mostly nearby in the Far East. But travel is off throughout Asia. According to China Southern's earnings, a loss of $1.55 per share is expected for the year ended 2008, with a projected loss of 39 cents per share in 2009. In addition, an expected $2.97 loss per share for the quarter ended December 31, 2008 is due to be reported in April. (Learn more about per share data in our Investment Valuation Ratio Tutorial.)

Flying Right
The numbers were better for China Southern, of course, when things were going better in the global airline industry and the Chinese economy was smoking. From 2004 to 2007, annual revenue for the company grew from over $2 billion to nearly $8 billion, with net income emerging from two losing years in 2004 and 2005 to post modest profits of $16 million in 2006 and $256 million in 2007.

Returning to the present, if you add in the dismal 2008 showing and the projections for a difficult 2009, the Chinese government has "suggested" that China Southern stop ordering new planes - good idea, indeed. Further, many believe that China Southern and the other airlines need to improve their management of these issues before running to the government for solutions. (Does this sound familiar to any of you the West?) By way of remedy for the ailing industry, Chairman of Chinese Eastern, Liu Shaoyong, has pushed for a merger of the big three Chinese airlines to stem the fierce competition and reduce the huge waste of resources. Observers, on the other hand, feel that implementation of this proposal is not on the horizon. (Fly away with more information about this sector in The Industry Handbook: The Airline Industry.)

But other remedies exist and other international carriers are proceeding in a different direction than China Southern. TAM (NYSE:TAM), Brazil's carrier, has forged an alliance as a subsidiary of United Airlines's UAL Corp. (Nasdaq:UAUA), while the large Japanese airlines, Japan Airlines (OTC:JALSY) and All Nippon (OTC:ALNPY), have increased routes to increase revenue and stay competitive. The potential exists for both China Southern Air and China Eastern to grow domestically, as the enormous population of potential travelers in China remains untapped. By way of contrast, U.S. carriers like Delta (NYSE:DAL) and Continental (NYSE:CAL) have bottomed out with growth, as the U.S. consumer appears to be momentarily traveled out. Also, Japan and China both will give aid to their airline industries. Therefore, despite the seemingly regional limitations currently on China Southern, realistic growth strategies are at hand.

Investors On Standby
Some very attractive stocks remain in a beaten down Chinese market. However, while China Southern, currently trading around $8 per share (off its year-high of $34, but up from an adjusted low of $5.50) might appear inviting, most investors should stay away for now. Traders with lightning-quick triggers might want to trade the stock, but as for fundamental values or even near-term investing, a confluence of cloudy weather hovers over the Chinese airline industry.

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