China's Big Three:
Parallel airlines Sep/Oct 2019

China has been one of the main powers behind global air traffic growth in the last ten years. Over that period it has seen GDP increase by an annual average of 7.6%. Air traffic has trebled — an annual average growth of 13% domestically and 9% on international routes. GDP growth has been slowing recently, with additional concerns that the current trade war with the US will reduce total economic growth further. But this is probably all to plan, and may do nothing to stop the inexorable growth in the country’s importance to the world’s aviation industry.

The PRC is still a command economy. The current five year plan (the 13th, 2015-2020) calls for economic growth targets of 6.5% a year and a “moderately prosperous society” by 2020. It is written, it will be so.

A target for the PRC is to move the economy towards domestic consumption, away from over-reliance on export-driven growth. There are various elements that will help. The massive growth in the last decade has accelerated urbanisation: 60% of the population now live in cities up from 45% ten years ago. There has been an explosive growth in the “middle classes” — those defined variously as people with money available to spend on non-essentials. It is estimated that now 40% of the 1.4bn population (c 550m people) fall into this category, up threefold in the past decade, and that this cohort will double again in the next ten years.

Boeing in its latest Current Market Outlook points out that these are two factors that are likely to continue stimulating demand for domestic and international air traffic, and particularly for cities outside the megahubs of Shanghai, Beijing, and Guanzhou. It forecasts that the country will see continued strong air traffic growth over the next decade to overtake the US as the largest air traffic market by country with an annual average domestic growth of 8% and international growth of 7%. It notes that it has taken only 17 years for Chinese aviation to go from 100bn RPK to 1 trillion RPK, half the time for the same process in the US, but that this has been effected with current GDP per capita (on purchasing power parity basis) of $20,000, less than a third the level in the US. It expects China to broach 1.5tn RPKs (the US’s current level of activity) within the next three years.

Indeed, a large element of domestic growth in the past ten years has been created by the development of routes connecting smaller cities, and an increasing trend in the last five years has been to open new international routes from gateways away from Shanghai, Beijing, and Guangzhou. However, these “smaller” cities are enormous.

The table above attempts to compare the large metropolitan areas in China, North America and Europe with the air capacity at their respective airports. If we take the definition of a megalopolis as a metropolitan area with a population of over 10m, there are two such each in North America and Europe (New York, Los Angeles, London and Paris), but 15 in China, while the top twenty metropolises in China all have populations greater than the third largest in Europe (Madrid) and the fifth largest in North America (Houston).

The data we present do not take account of huge metropolitan areas being developed in the Pearl River Delta, combining Guangzhou, Shenzhen, Macau, Zhuhai and Hong Kong that will result in a combined area encompasing a population of over 57m — a massive $18bn bridge and tunnel network connecting Hong Kong island to Macau opened a year ago making the area development a potential reality. Or indeed the developments around Shanghai in the Yangtze delta with a combined urban population of a staggering 83m.

The population of China is huge, but the number of air trips per head is still small. But the country has now reached to a level of GDP per head where this measure of air travel activity could start to explode. It is already the largest outbound tourist travel market measured by trips and expenditure — 131m trips in 2017 expected to reach 160m by 2020 — even though only 6% of the population have passports (and half of that usable passports).

The Big Three

Air China, China Southern and China Eastern are the national flag carrier of the People’s Republic. They are three companies, but perhaps only in name. Each seems to follow the same strategy, presumably under diktat from central government. (We highlighted the tangled web of state ownership of the Chinese ownership structure in Aviation Strategy, Jul/Aug 2019.)

The three are of a similar size and have been consistently profitable as they have grown. In revenue terms China Southern is the largest with a turnover of $20.6bn in 2018, up from $8bn a decade ago, but Air China the more profitable achieving a 10.5% operating margin in 2018 on revenues of $19.6bn; and an average margin of 10% over the last ten years (see chart).

Their share of total domestic activity has fallen from nearly 90% a decade ago, but the three still account for two thirds of Chinese aviation.

The first half results for this year show mixed results (see table), partly a result of a near 7% fall in the value of the renminbi against the US $, partly a result of the introduction of IFRS16, the new standard for accounting for leases. They have each chosen not to restate prior year numbers so the year-on-year comparisons are somewhat meaningless; but they remain profitable.

China Southern was the only one in its half year results statement to say that it would look in the second half of the year to improve returns to shareholders. But the prize for forward looking statements goes to Air China for its bravery in stating that “the Group will continuously adhere to the important instructions of General Secretary Xi Jinping on civil aviation”.

Each in their financial statements emphasise their efforts on hub development: Air China a “diamond shaped hub network” based on Beijing, Chengdu, Guangzhou and Shanghai; China Southern a “dual-hub” strategy at Guangzhou and Beijing (with other major bases of operation at Shenzhen, Chongqing and Ürümqi); China Eastern at the two Shanghai airports (Pudong and the smaller Hongqiao), Beijing, Kunming and Xi’an. But it is important to emphasise that these have not been hubs in the conventional western sense. Rather these have been “bases” at what are now huge gateways.

But they are targeting transfer traffic. Air China proudly states that in the first half of 2019 its transfer traffic grew by 11% (without stating the volume involved). It introduced a new “destination luggage guarantee” to allow passengers to transfer to their final destination in China without collecting bags at the first point of entry (as long as the passenger is travelling on Air China flights and signs an agreement to allow custom inspections at the port of entry).

China Southern in its first half results release mentions that the “Guangzhou hub witnessed 2.286m person-time of transfer passengers” of which 90% were international-international. Depending on what this statement really means, this may account for around 12% of its traffic. As international flights have grown, there are increasing possibilities for long-haul to long-haul connections. A quick look at Skyscanner for flights on the traditional kangaroo route between Europe and Australasia shows China Southern as the lowest cost provider for flights between the UK and New Zealand next February.

China Eastern also states that “through the scientific matching of route capacity and optimisation of transit connection, the effect of hub network has gradually appeared”, with a 12% growth in interline transits at Shanghai Pudong, and a 26% growth in domestic-international transfers at Kunming in the first half of the year.

Along with these developments the state is gradually relaxing it strategy of “one airline, one route” that has been in place for the last ten years: Air China was recently allowed to start services between Shanghai and London in direct competition with China Eastern.

Despite this apparent emphasis on hub development all three carriers seem to be actively deploying what usually are inefficient tagged routes: China Southern this year opened Guangzhou-Ürümqi-Vienna and Guangzhou-Changsha-Nairobi while Air China launched Beijing-Shanghai-Johannesburg.

A further similarity in reporting: Air China and China Southern are developing routes to fit in with the “Belt and Road” initiative, are both “ensuring development” of the Pearl River Delta, and China Eastern the Yangtze, super-megalopolis.

Beijing Daxing

The dynamics may change a little with the recent opening of Beijing’s new airport. Built in a matter of five years with a first phase capacity of four runways and 75m passengers (long term plan 100mppa and 7 runways), it is the world’s largest single terminal building under one roof. The design is extraordinary: the terminal’s shape should make each gate (built on two storeys) no more that an eight minute walk to the central area, and it will have a 60 minute minimum connection time for both international-international and domestic-international transfers (compared with 120 minutes at Beijing Capital).

Originally China Southern and China Eastern were each to have been allocated 40% of the slots with Air China remaining at the old airport. In what looks like political interference to ensure that China Eastern continues to operate its Shanghai service from the more convenient Capital airport it is relinquishing a quarter of its allocation to Air China. China Southern says that will “construct a flight wave” at Daxing.

Multibranded portfolios

Each also has a multibrand airline portfolio. The subsidiary and associate airlines are usually majority owned with local authority and city participation, and sometimes with convoluted cross-ownership participation (see Aviation Strategy, Jul/Aug 2019).

The cleanest structure appears to be China Eastern with fully-owned Shanghai Airlines consolidating its position in the financial capital and an LCC China United, formerly based at Beijing’s Nanyuan airport and now at Daxing.

Earlier this year it went further with a typically complicated cross-shareholding structure with Shanghai based Juneyao Airlines: its own state-owned parent holding company CEA Group acquired 15% of Juneyao and the latter acquired 5% of China Eastern.

(The holding company structure can be useful: last year Air China off-loaded its 51% shareholding in Air China Cargo, its joint venture with Cathay Pacific, to its state-owned parent CNAHC.)

Alliances

There are three Chinese flag-carriers, three major international carriers in the US and Europe. There are three major global branded alliances. So it makes sense that the Chinese carriers should each align with one of the GBAs. Air China and its subsidiaries is firmly in the Lufthansa-United dominated Star Alliance (except for the fact that it has a close working relationship with oneworld carrier Cathay Pacific). China Eastern is firmly in the Sky Team Alliance led by Delta and Air France KLM — and Delta holds a nominal 2% equity holding in China Eastern to cement the relationship while China Eastern was persuaded to take an 8% stake in Air France. Until the end of 2018 China Southern was nominally with the SkyTeam alliance, but has quit to concentrate on connections with the oneworld alliance. American has a nominal 2% equity stake while Qatar, 20% shareholder in British Airways and 10% shareholder in Cathay has a 5% equity stake.

Fleet

Strikingly none of the big three have any meaningful aircraft orders. Air China has an order for one outstanding 787 and 20 A350s; China Southern 34 737MAX and 19 A350s; and China Eastern 14 A350. All three airlines have nominal orders booked for five Comac C919s (+10 options). At the end of August all three announced orders for 30 Comac ARJ21s each. But both Air China and China Eastern published their medium term fleet plans summarised in the fleet tables above.

This is not necessarily a true reflection of the actual position. None of the Chinese carriers have full power over decision to acquire aircraft — that is left to the state’s National Development and Reform Commission (NDRC).

There are existing firm orders contained within the two main manufacturers' order books that have been made subject to confidentiality agreements with a stipulation not to disclose the buyer. In Boeing’s backlog of 5,705 aircraft there are orders for 950 737s, one 767, 15 777s and 56 787s allocated to “unidentified customers”. Equally Airbus shows orders at the end of September with 633 allocated to “undisclosed” customers, including 22 A330s, 24 A350s, 573 A320 family and 14 A220s.