China's Big Three:
bouncing back Jul/Aug 2020

China’s major carriers have been as badly impacted by the coronavirus crisis as any other airline in the world. But they have seemingly had little difficulty in raising liquidity, show no signs of the deep retrenchment planned by major carriers in Europe and North America, and are swiftly restoring operations from the Covid-19 pandemic inspired lockdowns.

Indeed the PRC’s quarantine measures, while draconian, were effectively targeted on the infection hotspots, and the country started encouraging people back to work towards the end of February, less than a month after their imposition, in an attempt to limit the economic impact.

This may have worked. According to the latest forecasts from the IMF, China will be the only major economy to show growth this year. The estimates of a mere 1% increase in GDP fall a bit short of the 6% targeted for the final year of the country’s 13th Five Year Plan — whose aim was, by the end of 2020, to have produced a “moderately prosperous society in all respects”.

The airlines slashed capacity: in February and March the top three Chinese carriers (Air China, China Southern and China Eastern) between them generated 80% fewer ASKS than in the same period the year before.

Since then, domestic demand has gradually returned (see chart), and the three have slowly reintroduced domestic operations: load factors, which had hit 47% in February, have climbed to an almost respectable 73% in July (10 percentage points down year-on-year). For the three in July, domestic traffic was only 27% below last year’s levels.

International services suffered even further from the end of March when the PRC effectively closed its external borders. It introduced what it called a “five-one” policy (this then being the fifth phase of reactive measures to the pandemic): Chinese airlines would only be allowed to operate one international route to any specific country with a maximum of one flight a week (foreign carriers were also limited to one route and one flight a week) — although it had offered a small cash subsidy of 0.01-0.05 yuan per seat kilometre to keep some routes open. Since April, the Big Three’s international capacity has been running at 5% of the level seen in 2019, although load factors have shown recovery to around 60%.

The Chinese carriers are also required to report traffic figures for “regional” routes — those encompassing services to Hong Kong, Macau and cross-straits to Taiwan — although these account for less than 5% of total passenger numbers.

The traffic decline had already started following the civil unrest in Hong Kong in the middle of last year with traffic declines of 20% year on year through the second half. This has now been further exacerbated, not merely by the pandemic, but also by the further complications of the new security law imposed what was the SAR of Hong Kong.

Where there used to be 20 flights a day between Beijing and the territory, and 30 to Shanghai, currently there is barely two on either route: and even in July, load factors had only recovered to 23%, down nearly 60 percentage points from July 2019.

But through this crisis, the Chinese Big Three have shown little of the apocalyptic forecasting of the industry in other parts of the world. They appear to be deferring some aircraft deliveries, but do not seem to be planning to shrink operations. Only 5% of the fleets appear to be officially parked (and those are mostly grounded 737MAXs) compared with around 50% of the fleets of the major US and European carriers. They are not threatening massive layoffs, not clamouring for government bailout (although admittedly China Southern did receive an equity injection).

Still, half year financial results were dire (see table). Total revenues for the six months to June were down by around 55% year on year, although the largest carrier, China Southern saw turnover fall by only 47% to RMB40bn (US$5.85bn).

The three between them produced operating losses totalling RMB22bn ($3.3bn) reversing the prior year profits of RMB17bn.

Within that, passenger revenues fell by around 60%. In the domestic market, traffic was down by 50% and yields by 10-15%. There seem to have been quite a few innovative moves to get demand back. China Eastern claims it is “the first airline in the industry to launch ‘customized charter flights’ for companies resuming work to bring their staff from different regions back to their duties”. It also introduced what it calls in its result statement as a “Wild Your Dream” package (which probably actually translates into a more prosaic but cumbersome “fly at will at weekends”): priced at 3,300 yuan (about $470) it allows passengers unlimited numbers of flights at weekends for the rest of the year. China Eastern’s domestic yields only fell by 8% in the first half.

International traffic fell by nearly 80% but those who flew paid for it with yields up by 45% at China Eastern, 50% at Air China and doubled for China Southern.

A strange by-product of the crisis and mandated decimation of international routes was that China Southern pushed its A380s, normally mostly used domestically, on to international destinations (limited to one flight a week a big plane can carry more passengers), and at one point in the last quarter was the only airline in the world flying the type.

Cargo revenues were strongly up: although volumes were down because of the lack of overall international belly-hold capacity, yields doubled and the carriers (to quote China Southern) “comprehensively improved the capacity utilisation rates of freighters and actively organised 3,771 flight shifts by freighters converted from passenger aircraft, as a way to seize the opportunity to increase freight revenue”.

On the balance sheets (see table) all three increased liquid funds significantly from the position at the start of the year: Air China and China Eastern respectively increased cash by RMB4.5bn and RMB6bn from the end of last year, each adding over RMB27bn in short term debt, while China Southern received a RMB16bn equity injection from its state-owned holding company (for the complications of the Chinese ownership structure see Aviation Strategy, Jul/Aug 2019) and raised a further RMB20bn in debt to end the half year with RMB17.4bn in cash up from RMB1.8bn in January. In addition each has significant levels of unused credit facilities: Air China RMB128bn, China Southern RMB248bn and China Eastern RMB49bn.

Has Covid-19 changed anything?

Chinese Aviation has been the powerhouse of growth in the airline industry in the past ten years: routes within, to and from mainland China accounted for a quarter of the global industry growth in the decade just gone. Total world traffic increased by 75% since 2008 reflecting an annual average growth of 5.8%, but Chinese traffic has nearly tripled growing by 11% a year.

The domestic Chinese market has grown faster. In 2008, it accounted for 5% of world demand. Since then it has grown at an average annual rate of 13% a year to end 2019 with just about a 10% share, nearly three and a half times the size it was a decade ago.

The dynamics behind this are still in place. China’s massive economic growth over the period accelerated an urbanisation trend: 60% of the population live in cities, up from 45% ten years ago. There has been an explosive growth in the numbers in the “middle classes” — those variously defined as people with money available to spend on non-essentials. It has been estimated that over 40% of the 1.4bn population (ie around 550m people) fall into this category, up threefold since 2010, and that their numbers will double again in the next decade.

The Chinese Big Three are bouncing back from the pandemic crisis through the dynamism of their domestic market. But what will happen when they return to international markets is less certain: they could return to pre-covid type growth rates, or their activity could be stunted by geopolitics.