September 10, 2007
Chinese airlines

Business travellers may still demur, but investors are rushing to jump aboard Chinese aircraft. Singapore Airlines this month finally bagged a 15.7 per cent stake in China Eastern Airlines (NYSE:CEA), sparking a doubling in the number three carrier's Hong Kong listed shares the following day. Shares in Air China, the flag carrier, are up 115 per cent so far this year.

There is plenty for investors in the sector to like. China's domestic airline market is the second biggest in the world measured by the number of passenger seats. Passenger traffic is growing at about 17 per cent a year, according to Citigroup (NYSE:C), outstripping capacity growth of 14-15 per cent. That helped Air China treble its net income for the first half of 2007, on a year-on-year basis, and swung both Guangzhou-based China Southern and China Eastern into the black. The icing on the cake for investors is the prospect of further consolidation. Those hopes were tickled last month when Air China hinted at a possible industry restructuring.

Nothing is impossible, especially when the regulator calls the shots. But Air China's swift "clarification", plus the fact that its holding in China Eastern is diluted by the Singaporean deal, means any rejigging of the big three looks more remote. Even so, bankers will not be packing away their PowerPoint presentations quite yet. China Southern, alone among the big three, lacks a strategic partner, a gap plenty of foreign carriers would be happy to fill. By far the lion's share of Chinese traffic is domestic, creating huge opportunities for building international routes. Consolidation is more likely among the smaller airlines, some of which serve tiny markets and are rapidly running out of cash. Fervour ahead of the Beijing Olympics next year suggests aviation stocks have further to fly. But investors should recall the downsides too, including a high level of fixed costs and regulated ticket prices, before rushing to embark.

(Source: FT.com)