A weak Chinese currency hits the state airlines' bottom lines because much of the debt they take on to finance aircraft purchases is denominated in dollars, so their debts become costlier as the yuan declines in value against the dollar. The airlines also have dollar-denominated aircraft lease and jet-fuel purchase obligations.
Air China Ltd. said Monday that its first-half net profit is expected to fall as much as 65%, due to increased finance costs arising from foreign-exchange losses. It didn't give exact figures for its profit forecast, but said it posted a first-half net profit of 1.12 billion yuan (US$180.4 million) a year earlier.
The Chinese flag carrier's profit warning comes just days after its state rival China Southern Airlines Co., the nation's biggest carrier by fleet size, warned that it expects to post a first-half net loss of 900 million yuan to 1.1 billion yuan because of foreign-exchange losses due to the Chinese currency's weakness. It posted a first-half net profit of 302 million yuan a year earlier. The carrier uses Chinese accounting standards.
As of the end of 2013, China Southern's net debt totaled 104.3 billion yuan, of which more than 80% was dominated in dollars.
The yuan fell as much as 3.4% against the dollar in the first four months of this year, after several years of consistently strengthening as the government moved to depreciate the currency. Depreciation of the yuan against the dollar narrowed to 2.5% in the first half.
Figures released in April showed China's "Big Three" state carriers were already reporting significantly weaker first-quarter results because of the yuan's 2.7% slide against the dollar during the quarter. Air China's first-quarter net profit plummeted 63% to 92.7 million yuan, compared with 249 million yuan in the year-earlier period. China Southern and China Eastern Airlines Corp., meanwhile, posted a combined net loss of 511 million yuan during the period.
Air China said its interest-bearing debt totaled 111.6 billion yuan in 2013, with more than 70% denominated in dollars. China Eastern's total liabilities were 111.49 billion in 2013; the airline didn't break out its foreign debt position in its 2013 annual report.
Barclays Research expects Air China and China Eastern to make similar profit warnings due to foreign-exchange losses ahead of their earnings releases scheduled for late August.
The brokerage firm estimates a foreign-exchange loss of 1.6 billion yuan for China Southern in the first half, compared with a foreign-exchange gain of 1.5 billion yuan the previous year, when the Chinese currency was strengthening.
To be sure, these foreign-exchange losses are mostly noncash, and they don't pose significant medium-term impact if the yuan's decline stabilizes near current levels, say analysts.
The weak net results therefore mask the underlying strength in China Southern's first-half performance, Barclays said in a note. It added that China Southern would have been profitable on an operating level if the currency impact was excluded.
Kelvin Lau, an analyst at Daiwa Securities, said China Southern's profit warning came as no surprise to a market familiar with the weak yuan. "We expect passenger yield improvements to help drive core profitability for the big three state airlines for 2014, though their bottom line would likely be weighed by exchange losses," he said.
The nation's air travel boom has helped boost core earnings at China's biggest airlines and signaled that the nation's recent slowdown hasn't weighed on consumer sentiment as much as some may have feared.
In the first six months of this year, China Southern, for example, carried 47.39 million passengers, up 8.2% from a year earlier. Demand was particularly strong in outbound air travel, with international passenger revenue up 16% during the period, as China Southern seeks to expand its overseas reach.
Source: Wall Street Journal by Joanne Chiu
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