Chinese airlines’ operations cash insufficient for growth plans
An operational summary of China Eastern Airlines Company Ltd. (Part 9 of 13)
High investment in aircraft
Competition and capacity growth are the two major reasons for the lower profitability of Chinese airlines, which invest heavily in aircraft purchases. China Eastern’s capital expenditure increased at an annual growth rate of ~19% to 19,083 million renminbi from 13,594 million renminbi in FY11.
However, due to operational inefficiency and lower yields, operating cash flow growth did not keep pace to meet the high obligations related to aircraft. During the same period, operating cash flow decreased at an annual rate of 11%.
Free cash flow
In FY13, while China Eastern’s capital expenditure increased by ~42% year-over-year, operating cash flow decreased by ~14%. This resulted in a negative free cash flow of -8,277 million renminbi for China Eastern (CEA), almost ten times higher than in FY12, when it was -859 million renminbi. Even China Southern’s (ZNH) free cash flow has been negative in spite of operating cash flow increasing at a CAGR of 2% during the four-year period between FY09 and FY13.
The impact of this is even more pronounced due to the high leverage of Chinese airlines. Where free cash flow is positive, it is generally used by companies to pay off debt holders and provide returns to shareholders.
Capacity
US airlines have been growing capacity at a lower rate compared to Chinese airlines. They also have higher load factors and yield due to rapid growth in passenger traffic, enabling them to generate higher cash from operations.
Among the US airlines, Delta Air Lines (DAL), Alaska Air Group (ALK), and Southwest Airlines (LUV) had positive free cash flow during FY13. ETFs such as the iShares Transportation Average ETF (IYT) and the SPDR S&P Transportation ETF (XTN) hold 35% to 40% in airline stocks.
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