Chinese airline sector:A seasonally strong January

Conclusion.

As expected, the big three Chinese carriers reported strong sets of operatingstatistics in January 2017, distorted by the earlier Chinese New Year.

Similarly, ticket prices recorded double-digit % increases in January. We thinkthe trend will reverse in February.

The big 3 airlines have outperformed the Hang Seng Index by 8-11% YTD.

However, we believe airline fundamentals have not changed and thusmaintain our bearish view on the Chinese airlines sector. We believe pricingremains excessively aggressive and airlines face declining profits due tohigher fuel price and stronger US$.

The stocks are trading at 0.8-1.0x 17E P/BV, between -1 SD and their mean.

Our implied target P/BV for Chinese airlines is their -1SD.

Impact.

Air China continued to grow fast in the domestic segment, with domestictraffic rising 13% YoY in January 2017, after 11% YoY growth in 4Q16. Wethink the strong growth is mainly attributable to: 1) the previous year’s lowbaseeffect; and 2) a shifting focus on the domestic segment. Internationaltraffic grew 9% YoY.

China Eastern (CEA) and China Southern (CSA) had double-digit trafficgrowth in Jan. CEA’s and CSA’s overall monthly traffic increased 17% and18%, respectively, in January, mainly driven by robust growth in the domesticsegment (13% and 16% YoY, respectively). This was due to the Chinese NewYear falling in January this year rather than in February. CEA and CSA alsohad strong growth in international traffic (23% and 24% YoY, respectively),reflecting strong outbound travel demand during the CNY holiday.

Ticket prices rose in January, due to seasonality and the earlier CNY. Ourchannel checks suggest that international ticket price grew 15% YoY inJanuary, whereas domestic ticket prices were up 10% YoY. Overall ticketprices rose 11% YoY. We believe the upbeat January pricing does not reflectthe full-year outlook, as it was distorted by an earlier holiday effect.

Cargo business was weak due to industrial activities. A slowdown inindustrial activities during Chinese New Year contributed to weak results (loadfactor down 2.9-3.8ppt YoY) from cargo segment for the big 3 carriers.

Nevertheless, growing supply from passenger aircraft belly will continue tohurt the sector in medium to long term, in our view.

Outlook.

We maintain our bearish view on the Chinese airline sector. MaintainUnderperform on China Eastern Airlines (670 HK) and China SouthernAirlines (1055 HK), Neutral on Air China (753 HK).