July 18th, 2015
by Michael Grogan, First Class Analytics
This year has been a fruitful one for the airline industry, but China Eastern (CEA) has certainly been making the best of it. In the past year, the company is up by almost 170 percent, which for comparison purposes is far higher than the 20 percent return achieved by Delta Airlines (DAL) over the same period. With this in mind, has the returns of China Eastern run its course, or does the company still have significant upside?
With a current P/E ratio of 12.48, the company trades at a significantly cheaper valuation to Delta Airlines with a ratio of 19.24, with the current ratio being significantly below the high of 38 being reached by China Eastern at the end of 2014. In this context, China Eastern is indicated as trading at a discount in valuation compared to that of six months ago, and below that of various competitors. Aside from valuation, China Eastern has shown highly impressive financials, most notably:
- Net profit attributable to shareholders of listed companies has risen from a level of -205 million yuan to 1.564 billion yuan, resulting in a profit increase of 862.9%.
- Moreover, net operating cash flow is up from 1.524 billion to 2.556 billion yuan; an increase of 67.70%.
- China Eastern has also managed to significantly reduce its high debt levels from a debt/equity ratio of 1.975 in December 2014 to 1.536 as of March 2015. When compared to the D/E ratio of 1.058 for Delta, the discrepancy is not that much higher given the return outperformance, along with the fact that China Eastern has been expanding its fleet aggressively.
It is safe to say that the aviation industry in China as a whole has significantly expanded in recent years, with a 57 percent growth in international passenger numbers for Chinese airlines. However, while there is a risk of a decline in international passenger demand affecting profitability in the future, domestic air travel still has a great deal of potential with growth in traffic having risen 11 percent.
In the case of China Eastern specifically, I see the company as having the greatest financial capability to capitalise on this market compared to smaller competitors. For instance, the company has rapidly been expanding its fleet with a recent order for 50 Boeing 737 aircraft in a deal worth $4.6 billion. This indicates that China Eastern is seeking to develop its capacity for short-haul routes, and has shown a clear financial capability to do so. Additionally, it was reported on July 16 that China Eastern is set to see a "huge" 1H profit increase from a level of 3.5 billion to 3.7 billion yuan.
Based on valuation and financial performance, I see China Eastern as indeed having room "left to soar". The company's share price has largely remained stationary since May as China's stock markets undergo a correction. However, I see any potential discount in this regard as being a fabulous buying opportunity given the company's performance to date.