Loosening of Fare Restrictions a Likely Benefit for China's Airline Sector, But Obstacles Remain

author: James Rubin   

In what is considered a significant breakthrough, the recent decision by the Civil Aviation Administration of China to allow airlines to set pricing on more than 300 domestic routes could boost profits at the industry giants that control most of the country's routes and smaller rivals.

CAAC's ruling also underscores a growing, albeit slow-moving effort to relax regulations that observers believe have hamstrung the industry. But while the industry seems primed to continue its rapid growth, significant obstacles remain that hurt the three dominant carriers' financial performance. 

It is the third time since 2013 that the CAAC, China's primary aviation oversight agency, has given carriers more autonomy over ticket prices. China sees a more relaxed regulatory environment as a key for improving operations and accelerating growth in its airline sector.

"The lifting of the lid on restrictions will allow a more market-based pricing dynamic," said John Grant, a senior analyst for OAG, a British-based aviation research group. He added that the easing on prices "would increase competition and improve performance."

Although fare increases will be capped at 10 percent for any one travel season, analysts said that the CAAC action would lead to an improved financial performance for the current quarter. 

Corrine Png, CEO of the research group Crucial Perspectives, commented that just a 1-percent rise in fare prices would lead to an increase in earnings for the industry, according to Reuters. And in a separate interview with CNN, she said she expects a 5 percent increase overall. 

And for the industry, the timing could not have been better. CAAC's ruling went into effect immediately and one month prior to the Chinese Lunar New Year on Feb. 16, which is a high-travel holiday.

In response, the country's two largest airlines by passengers carried and fleet size, China Southern Airlines Co. Ltd. (NYSE: ZNH) and China Eastern Airlines Corp. Ltd. (NYSE: CEA) saw their share prices increase over the past several days. On Monday, both companies achieved long-time highs before retrenching at mid-week as investors scooped up profits. China Southern, which topped $58 a share for the first time in 11 years, finished last week at $58.35 per share. China Eastern closed at $41.97. 

Sector Challenges

To be sure, Chinese carriers have faced headwinds in recent months as fuel prices rose and revenues for international flights were slower than hoped. China Southern profits sank 11 percent in its most recent quarter despite an 11 percent increase in revenue. Operating profits declined 11 percent at China Eastern. A flight ban to South Korea stemming from the ongoing conflict between the U.S. and North Korea also impacted international passenger traffic. 

Meanwhile, competition in the market has increased with the growth of budget carriers and more airlines vying for competition on the same routes. At least 15 airlines have launched, or are in the process of starting, including Donghai Airlines and Long Air, small carriers serving a limited number of locations. 

Continued Fast Growth

The latest move by regulators in considered particularly significant given that previous deregulatory steps related to pricing have been smaller in scope. In 2013, the CAAC removed a price floor that allowed carriers to set prices as low as they wanted, but the ruling affected only 31 routes. The aviation industry was smaller in scope with fewer than 400 million passengers and 193 airports with scheduled, commercial flights. 

Passenger volume reached 541 million in 2017, a nearly 40 percent jump over four years, according to the research firm IBIS World. Revenue for the country's carriers surpassed $75 billion and has been growing 3 percent annually. 

Some forecasts are predicting 10 to 15 percent growth in 2018 for the three largest carriers. A report by the International Air Transport Association predicts that China will supplant the U.S. as the world's largest air travel market by 2022. 

Airplane manufacturer Boeing anticipates that Chinese carriers will purchase about 7,200 aircraft representing $1 trillion in sales in the years ahead. Last year, China Southern's closed separate deals with Boeing and Airbus to buy a total of 59 airplanes at a cost of more than $11 billion. In addition, the Chinese airplane manufacturer Comac conducted its first test of its C919 model last summer. The 158-seat jet will compete with Boeing and Airbus models targeting regional routes. China Eastern will reportedly be the first airline to fly the planes when they receive final approval for commercial use. 

Building New Airports

Meanwhile, the country has been upgrading its air travel infrastructure and adding capacity. There are now 220 airports offering commercial service and the number is projected to reach 244 by 2020. 

A $13 billion airport in the Beijing suburb of Daxing is also expected to more than double runway capacity to the city. When completed, the airport would be able to handle 100 million passengers, more than Beijing Capital Airport. China Eastern plans to base its Beijing operations at the new airport, and the carrier and China Southern is expected to control 80 percent of the traffic there. The two airlines said they would base 450 planes at Daxing.

OAG's Grant said that "market forces will dictate" fare price. He said that he was "cautiously optimistic for Chinese airlines throughout 2018 and moving into 2019. There's lots of positivity and no reason to see any obstacles in the near future."