Chinese Airlines Breaking Through Turbulence

Our Hong Kong/China Transportation & Infrastructure Analyst Qianlei Fan explains why a resurgence in air travel is leading China’s emergence from deflation.

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Welcome to Thoughts on the Market. I’m Qianlei Fan, Morgan Stanley’s Hong Kong/China Transportation Analyst. Chinese airlines are at a once-in-a-decade inflection point, and today I’ll break down the elements of this turnaround story.

It’s Thursday, Feb 6th at 10am in Hong Kong.

Last week, hundreds of millions of people across Asia gathered to celebrate the lunar new year with their families. I was one of them and took a flight back to my hometown Nanjing. Airports were jam-packed for days, with air travel expected to exceed 90 million trips.

It’s all indicative of Chinese airlines making a comeback after a seven-year run of underperformance. In fact, we believe Airlines will be one of the first industries to emerge from China's deflationary pressures this year. And this has implications for the country's broader economy.

Although COVID impacted Airlines globally, other regions have since recovered. In China, the earnings recovery is just beginning. Since 2018, Chinese Airlines have experienced demand hits from the trade tension, currency depreciation, COVID-19, and post-COVID macro headwinds.

It’s been two years since Chinese borders lifted restrictions and air travelers are returning in force. Excess capacity has now been digested. Slower deliveries of aircrafts continue to limit supply, and it is more difficult for airlines to get new aircraft and increase their available seats. Passenger load factors will continue to strengthen this year, which means the airlines are running close to full capacity. This will increase Airlines' pricing power within the next 6 to 12 months, feeding through to earnings.

If we put that in a global context, China’s airlines industry handled around 700 million passengers in 2024, 8 per cent of global air passengers; but that 700 million passengers only account for half of China’s population. In the US, air passenger numbers can be three times its population.

Chinese airlines have just reached break-even in the past year, while many of their global peers have already generated robust profits. Chinese Airlines’ earnings and valuations have lagged global peers in both absolute and relative terms. But now, with a turnaround coming into view, Chinese Airlines have a longer runway for stronger earnings growth and share price performance than global peers.

What’s more, the August 2024 turnaround in US airlines offers several key takeaways for China. US Airlines’ share prices recovered last year, following a long period of underperformance post COVID. The wait before the inflection was long, but share prices moved up quickly once the turning point was reached, and valuation expanded ahead of earnings recovery. Big US airlines outperformed smaller players during the most recent rally. We think all these are relevant to the Chinese Airlines story.

If we look at earnings – Chinese Big Three airlines reached breakeven in 2024, making a small profit in 2025, and that profit will double in 2026. But that’s not yet the peak of the cycle; peak cycle earnings could again double the 2026 level, probably in 2027 to 2028. That’s the reason why we think Chinese airlines are on the path to doubling share prices.

To sum up, Chinese Airlines represent a once-in-a-decade opportunity for investors. With strengthened passenger load factors and a positive demand outlook, coupled with significant potential for earnings growth, this industry looks ready for takeoff.

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